1 EXHIBIT 13 NASHUA CORPORATION AND SUBSIDIARIES FIVE YEAR FINANCIAL REVIEW (In thousands, except per share data, number of employees and percentages) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------- Operations Net sales $167,831 $173,202 $199,039 $245,534 $264,431 Gross margin percentage 24.3% 23.1% 20.6% 14.3% 17.8% Selling, distribution and administrative expenses as a percentage of sales 20.3% 22.3% 21.7% 16.3% 17.9% Loss before interest expense and taxes as a percentage of sales (1) (6.9)% (5.9)% (4.5)% (12.0)% (4.2)% Loss before taxes as a percentage of sales (1) (7.1)% (5.9)% (5.8)% (14.3)% (5.2)% Loss as a percentage of sales (1) (4.3)% (3.6)% (3.7)% (10.0)% (3.2)% Effective tax rate (39.5)% (39.9)% (36.4)% (30.1)% (38.7)% Loss before income taxes(1) $(11,950) $(10,300) $(11,464) $(34,998) $(13,625) Loss after taxes(1) (7,229) (6,190) (7,290) (24,479) (8,353) Income (loss) from discontinued operations (6,687) (2,632) 460 9,748 10,500 Gain on public stock offering, disposition of stock, and disposal of discontinued operation 1,052 - 32,281 - - Extraordinary loss - - (1,257) - - Net income (loss) (12,864) (8,822) 24,194 (14,731) 2,147 Earning (loss) per common share Continuing operations(1) $ (1.15) $ (.97) $ (1.14) $ (3.84) $ (1.31) Discontinued operations (1.06) (.41) .07 1.53 1.65 Gain on public stock offering, disposition of stock, and disposal of discontinued operation .17 - 5.06 - - Extraordinary loss - - (.20) - - Net income (loss) (2.04) (1.38) 3.79 (2.31) .34 Financial Position Working capital $ 45,874 $ 18,892 $ 21,173 $ 31,787 $ 46,789 Total assets 134,095 146,762 176,689 231,372 227,825 Long-term debt 1,064 3,489 2,044 68,350 49,166 Total debt 1,575 4,000 2,855 68,850 49,816 Total capital employed 76,802 99,022 104,772 143,725 142,512 Total debt as a percentage of capital employed 2.1% 4.0% 2.7% 47.9% 35.0% Shareholders' equity $ 75,227 $ 95,022 $101,917 $ 74,875 $ 92,696 Shareholders' equity per common share 12.59 14.76 15.90 11.75 14.55 Other Selected Data Investment in plant and equipment $ 6,702 $ 4,418 $ 5,877 $ 9,044 $ 11,306 Depreciation and amortization 6,846 7,554 9,045 9,772 8,088 Dividends per common share - - - .54 .72 Return on average shareholders' equity (15.1)% (9.0)% 27.4% (17.6)% 2.3% Common stock price range: High $ 17 1/2 $ 14 3/4 $ 19 5/8 $ 21 $ 30 3/4 Low 11 9/16 9 1/2 9 1/8 12 1/4 19 3/4 Year-end closing price 13 5/16 11 5/8 12 13 5/8 20 1/2 Number of employees 725 2,041 2,398 3,447 3,054 Average common shares 6,320 6,385 6,376 6,374 6,360 See Business Changes Note to Consolidated Financial Statement for a description of certain matters relevant to this data. (1) Income (loss) is from continuing operations and includes restructuring and other unusual charges/(income) of $13.8 million for 1998 (8.2% of sales), $4.3 million for 1997 (2.5% of sales), $(1.7) million for 1996 (0.9% of sales), $16.2 million for 1995 (6.6% of sales), and $2.6 million for 1994 (1.0% of sales). 12 2 NASHUA CORPORATION AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CORPORATE MATTERS On April 9, 1998, the Company completed the sale of its Photofinishing Group. The Company received net proceeds of $49.9 million for the net assets of the Photofinishing Group and, after recording taxes of $7.9 million, recorded a gain of $1.1 million. On September 15, 1998, Cerion Technologies Inc. ("Cerion"), a publicly owned company of which the Company owns 37.1 percent of the outstanding common stock, announced its decision to cease operations in the fourth quarter of 1998 and is currently in the process of liquidation. Accordingly, the Company no longer accounts for its investment in Cerion under the equity method of accounting and has accounted for its interest in Cerion based on the expected net realizable value at an after tax basis, since the third quarter of 1998. At December 31, 1998, the Company valued its investment in Cerion at $.8 million. For the year ended December 31, 1998, the Company recognized a $4.5 million charge, net of $2.2 million in taxes, of which a portion related to Nashua's share of Cerion losses and the remainder related to the reduction in the Company's investment in Cerion to its net realizable value, net of taxes. Results of operations for Cerion and the Photofinishing Group are reported as discontinued operations for all periods presented in the accompanying consolidated financial statements. RESULTS OF CONTINUING OPERATIONS - 1998 COMPARED TO 1997 Net sales from continuing operations for 1998 were $167.8 million, a 3 percent decrease compared to 1997. The sales decline was primarily due to lower volume for toner and developer and paper products in the Imaging Supplies Division which more than offset year over year sales increases in both the Label Products and Specialty Coated Products Divisions. The Specialty Coated Products Division reported increased sales, primarily due to higher volume of thermal paper products. Increased sales in the Label Products Division were mainly due to higher volume in roll stock products partially offset by decreased prices in other product lines. The Company recorded a net loss from continuing operations of $7.2 million in 1998, compared to a net loss from continuing operations of $6.2 million in 1997. The 1998 results included restructuring and other unusual charges of $13.8 million. The 1997 results included restructuring and other unusual charges of $4.3 million. The Company's pretax operating results, before restructuring and other unusual charges, improved from a loss of $6.0 million in 1997 to a pretax income of $1.9 million in 1998 due to improved profitability in the Imaging Supplies and the Specialty Coated and Label Products segments of $1.7 million each, a $3.7 million decrease in Corporate expenses, including interest, and a decrease in Projection Systems development expenses of $.8 million. The increase in operating income resulted from higher margins related to new products in the Imaging Supplies and Specialty Coated Products Divisions and significant cost reductions in the manufacturing and procurement processes of the Label Products Division. Corporate expenses decreased in 1998 compared to 1997 primarily due to personnel reductions and increased interest income from the investment of cash generated by the sale of the Company's Photofinishing Group. The restructuring and unusual charges for 1998 included an unusual charge of $15.0 million related to damages awarded to Ricoh Corporation in a patent infringement lawsuit, as more fully detailed in both the Liquidity, Capital Resources and Financial Condition subsection of this Management Discussion and Analysis section and the Commitments and Contingencies Note to the Consolidated Financial Statements, partially offset by unusual income of $1.2 million related to an insurance settlement for environmental matters. The restructuring activities provided for in the balance at December 31, 1997 were substantially completed at December 31, 1998 and amounts incurred did not change materially from the reserve balance of $3.0 million at December 31, 1997. The balance at December 31, 1998 for severance related to workforce reductions consisted primarily of amounts payable to employees who had already left the Company. Details of the charges related to continuing operations and the activity recorded during 1998 were as follows: Balance Current Current Balance Dec. 31, Year Year Dec. 31, (In thousands) 1997 Provision Charges 1998 - --------------------------------------------------------------------------------------------------------------- 1998 Activity: Provisions for severance related to workforce reductions $1,913 $ - $1,441 $472 Provisions for assets to be sold or discarded 750 - 750 - Other 365 - 216 149 --------------------------------------- Total $3,028 $ - $2,407 $621 ======================================= 13 3 Selling and distribution expenses were relatively unchanged from the prior year. Research and development expenses decreased by 23 percent from the prior year primarily due to a reduction in Projection Systems development expenses. Administrative expenses decreased by 27 percent due to the impact of restructuring activities over the past twelve months. The effective tax rate for continuing operations was a benefit of 39.5 percent in 1998, compared to a benefit of 39.9 percent in 1997. The tax benefits in 1998 and 1997 were greater than the U.S. statutory rate primarily due to state and local income tax benefits. RESULTS OF CONTINUING OPERATIONS - 1997 COMPARED TO 1996 Net sales from continuing operations for 1997 were $173.2 million, a 13 percent decrease compared to 1996. Excluding the net sales related to the liquid toner and the organic photoconductor drum product lines, which the Company exited during 1997, sales decreased 8 percent. Sales declines in the Imaging Supplies Division and Specialty Coated Products Division were partially offset by higher sales in the Label Products Division. The sales decrease was primarily due to lower volumes and pricing in the toner and developer, laser cartridge and paper product lines of the Imaging Supplies Division and in the carbonless and facsimile paper product lines of the Specialty Coated Products Division. Higher sales in the Label Products Division resulted from increased volume of higher margin products. In 1997, the Company recorded a net loss from continuing operations of $6.2 million, compared to a net loss from continuing operations of $7.3 million in 1996. The 1997 results included restructuring and other unusual charges of $4.3 million. The 1996 results included restructuring and other unusual income of $1.7 million. The Company's pretax operating results before restructuring and other unusual charges improved from a loss of $13.2 million in 1996 to a loss of $6.0 million in 1997 due to improved profitability in the Imaging Supplies and Specialty Coated and Label Products segments of $1.8 million and $2.7 million, respectively; improved profitability in the Projection Systems business of $.3 million; and a $2.4 million decrease in Corporate expenses, including interest. The increase in operating income resulted from improved productivity and a reduction in manufacturing and operating expenses, partially offset by a reduction in sales volumes within the Imaging Supplies Division. Corporate expenses decreased in 1997 compared to 1996, primarily due to $2.3 million lower net interest expense and reduced incentive compensation expense. The restructuring and other unusual charges of $4.3 million in 1997 included charges in the fourth quarter of $.6 million related to restructuring the Corporate organization, a charge in the third quarter of $.9 million related to the sale of excess real estate in Nashua, NH, and a second quarter charge of $2.8 million for costs associated with restructuring certain distribution channels and aligning the workforce with levels of demand in the Imaging Supplies Division. Details of the charges related to continuing operations and the activity recorded during 1997 were as follows: Balance Current Current Balance Dec. 31, Year Year Dec. 31, (In thousands) 1996 Provision Charges 1997 - ------------------------------------------------------------------------------------------------------------------------------ 1997 Activity: Provisions for severance related to workforce reductions $ 475 $2,604 $1,166 $1,913 Provisions for assets to be sold or discarded 1,178 1,650 2,078 750 Other 841 - 476 365 ---------------------------------------------- Total $2,494 $4,254 $3,720 $3,028 ============================================== The 1997 provision for workforce reductions included amounts for salary and benefit continuation for 116 employees as part of the Imaging Supplies Division and Corporate reorganizations. The restructuring activities provided for in the balance at December 31, 1996 were substantially completed in 1997. Amounts incurred did not change materially from the reserve balance of $2.5 million at December 31, 1996. Administrative expenses were relatively unchanged from the prior year. Selling and distribution expenses decreased by 11 percent from 1996 as lower sales volume in the Imaging Supplies Division resulted in lower distribution costs and lower sales commissions and bonuses. Research and development expenses decreased by 13 percent from the prior year primarily due to reductions in spending in all divisions. The effective tax rate for continuing operations was a benefit of 39.9 percent in 1997 compared to a benefit of 36.4 percent in 1996. The tax benefits in 1997 and 1996 were greater than the U.S. statutory rate primarily due to state and local income tax benefits. EFFECT OF INFLATION AND CHANGING PRICES The Company believes that results of operations as reported in its historical cost financial statements reasonably match current costs, except for depreciation, with revenues generated in the period. Depreciation expense based on the current costs of plant and equipment would be significantly higher than depreciation expense reported in the historical financial statements; however, such expense would not affect cash provided by operating activities. 14 4 LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION Working capital increased $27.0 million from December 31, 1997, primarily from net proceeds generated by the sale of the Company's Photofinishing Group, partially offset by an accrual of $15.0 million related to a damages award in the patent infringement lawsuit brought against the Company by Ricoh Corporation, as more fully detailed below. The Company used $10.1 million to repurchase 651,674 shares of the Company's common stock in open market transactions during 1998 pursuant to the Company's open market stock repurchase program of up to one million shares of the Company's common stock, as detailed in the Shareholders' Equity Note to the Consolidated Financial Statements. In addition, the Company expects that a portion of the proceeds will be reinvested in its continuing businesses. At December 31, 1998, the total debt as a percentage of equity decreased to 2.1 percent from 4.2 percent at December 31, 1997. The Company suspended its quarterly dividend in 1995 and intends to review this decision when the Company's financial performance would make such reconsideration appropriate. The Company relies primarily on cash provided by operating activities to fund its normal additions to plant and equipment. Investments in plant and equipment in 1998 were approximately $6.7 million. During 1997, the Company negotiated a new $18.0 million secured line of credit, of which $5.0 million is available exclusively for letters of credit. The agreement contains certain financial covenants with respect to consolidated tangible net worth, liquidity and other ratios. On August 17, 1998, the agreement was amended decreasing the amount of available funds under the secured line of credit from $18.0 million to $8.0 million and amending the consolidated tangible net worth covenant from $70.0 million to $60.0 million. Borrowings under this facility are collateralized by a security interest in the Company's receivables and inventory. Interest on amounts outstanding under the secured line of credit is payable at either 2 percent above the LIBOR rate, which was 5 percent at December 31, 1998, or at the Wall Street Journal prime rate, which was 7.75% at December 31, 1998, as elected by the Company. The maturity of this line of credit is April 30, 1999. Without prior consent of the lenders, the agreement does not allow the payment of dividends and restricts, among other things, the incurrence of additional debt, guarantees, lease arrangements or sale of certain assets. As of December 31, 1998, the Company was in compliance with the covenants of the agreement. There were no borrowings outstanding under this secured line of credit at December 31, 1998. At December 31, 1997, borrowings of $2.0 million were outstanding under this secured line of credit. On December 26, 1996, the Company entered into a note agreement under which the Company borrowed $2.6 million. The note is being paid back in sixty equal monthly payments which began in January of 1997. The note bears interest per annum equal to 2.5 percent above the LIBOR rate which was 5 percent at December 31, 1998. The note is collateralized by a security interest in certain equipment. At December 31, 1998 and 1997, borrowings of $1.6 million and $2.0 million, respectively, were outstanding under this note agreement. At December 31, 1998, the Company had $5.2 million and $.2 million of net operating loss carryforward benefits and tax credit carryforwards, respectively, which are primarily available to offset certain future domestic taxable earnings. The net operating loss carryforward benefits expire as follows: $1.0 million in 1999; $2.4 million in 2000; and $1.8 million thereafter. The tax credit carryforwards all expire after 2000. Management believes that the Company will generate sufficient future taxable income to realize deferred tax assets prior to the expiration of any net operating loss carryforwards or tax credit carryforwards and that realization of the net deferred tax assets is more likely than not. On December 11, 1998, the Internal Revenue Service ("IRS") issued the Company a Notice of Proposed Adjustment in the amount of $4.6 million principally in connection with the tax years 1992 and 1993 relating to the accounting treatment of certain items as they pertain to the restructuring effort undertaken by the Company during 1994. The Company disagreed with the position taken by the IRS and filed a formal protest of the proposed adjustment on January 12, 1999. In management's opinion, the ultimate disposition of this matter will not have a material adverse effect on the financial position or results of operations of the Company. On March 31, 1998, the New Hampshire Department of Revenue ("DOR") issued a notice of deficiency in connection with an examination of the Company's corporate income tax returns for the years 1989 through 1992 in the amount of $4.4 million, including interest. The deficiency principally relates to the tax treatment of the sale of the Company's International Office Systems business in 1990. A petition for reconsideration was filed with an appeals officer on May 26, 1998. The Company disagrees with the DOR and will continue to defend its position. In management's opinion, the ultimate disposition of this matter will not have a material adverse effect on the financial position or results of operations of the Company. In April 1994, Ricoh Company, Ltd., Ricoh Electronics, Inc., and Ricoh Corporation (collectively "Ricoh") brought a lawsuit in the United States District Court of New Hampshire ("District Court"), alleging the Company's infringement of the U.S. patents 4,611,730 and 4,878,603 relating to certain toner cartridges for Ricoh copiers. In March 1997, the District Court enjoined Nashua from manufacturing, using or selling its NT-50 and NT-6750 toner cartridges. Sales of these products in 1996 amounted to one percent of Nashua's total sales. The Company disagreed with the District Court's decision and appealed to the United States Court of Appeals for the Federal Circuit ("Court of Appeals"). On February 18, 1999, the Court of Appeals affirmed the March 1997 ruling of the District Court that the Company infringed a patent held by Ricoh. Separately, on September 30, 1998, the District Court issued an order awarding damages in the amount of $7,549,000 related to the Company's sales of NT-50 and NT-6750 toner cartridges through December 3, 1995, additional damages relating to the Company's sales of such products through March 1997, certain of Ricoh's costs relative to the suit, and interest on such 15 5 damages. The Company disagrees with the District Court's decision on the issue of damages and has appealed the decision to the Court of Appeals. The Company has adequate financial resources to pay the District Court's award of damages should its appeal on damages be unsuccessful. In connection with the damages award, the Company recorded a $15.0 million pretax charge in the third quarter of 1998 and is accruing interest on such award. In addition, in the fourth quarter of 1998, the Company posted a $16.0 million bond and placed $5.0 million in escrow to secure such bond. The $5.0 million is classified as restricted cash in the balance sheet. In August and September 1996, two individual plaintiffs initiated lawsuits in the Circuit Court of Cook County, Illinois against the Company, Cerion, certain directors and officers of Cerion, and the Company's underwriter, on behalf of classes consisting of all persons who purchased the common stock of Cerion between May 24, 1996 and July 9, 1996. These two complaints were consolidated. In March 1997, the same individual plaintiffs joined by a third plaintiff filed a Consolidated Amended Class Action Complaint (the "Consolidated Complaint"). The Consolidated Complaint alleged that, in connection with Cerion's initial public offering, the defendants issued materially false and misleading statements and omitted the disclosure of material facts regarding, in particular, certain significant customer relationships. In October 1997, the Court on motion by the defendants, dismissed the Consolidated Complaint. The plaintiffs filed a Second Amended Consolidated Complaint alleging substantially similar claims as the Consolidated Complaint seeking damages and injunctive relief. On May 6, 1998, the Court, on motion by the defendants, dismissed with prejudice the Second Amended Consolidated Complaint. The plaintiffs have filed an appeal of the Court's ruling. The Company continues to believe that this lawsuit is without merit and plans to vigorously defend itself in this matter on appeal. The Company is involved in certain environmental matters and has been designated by the Environmental Protection Agency ("EPA") as a potentially responsible party ("PRP") for certain hazardous waste sites. In addition, the Company has been notified by certain state environmental agencies that some of the Company sites not addressed by the EPA require remedial action. These sites are in various stages of investigation and remediation. Due to the unique physical characteristics of each site, the technology employed, the extended timeframes of each remediation, the interpretation of applicable laws and regulations and the financial viability of other potential participants, the ultimate cost to the Company of remediation for each site is difficult to determine. At December 31, 1998, based on the facts currently known and the Company's prior experience with these matters, the Company has concluded that there is at least a reasonable possibility that site assessment, remediation and monitoring costs will be incurred by the Company with respect to those sites which can be reasonably estimated in the aggregate range of $1.0 million to $1.5 million. This range is based, in part, on an allocation of certain sites' costs which, due to the joint and several nature of the liability, could increase if the other PRPs are unable to bear their allocated share. At December 31, 1998, the Company has accrued $1.5 million which represents, in management's view, the most likely amount within the range stated above. Based on information currently available to the Company, management believes that it is probable that the major responsible parties will fully pay the costs apportioned to them. Management believes that, based on its financial position and the estimated environmental accrual recorded, its remediation expense with respect to those sites is not likely to have a material adverse effect on its consolidated financial position or results of operations. During the fourth quarter of 1998, the Company recorded charges of $2.3 million, net of taxes related to discontinued operations. The net charges included net income of $1.0 million from an insurance settlement related to environmental matters, offset by net charges of $3.3 million, which included: additional valuation reserves of $.3 million for the Company's investment in Cerion; $.1 million related to potential environmental exposures; and $2.9 million for tax exposures, including $2.3 million for the establishment of a tax valuation reserve for foreign tax credits. YEAR 2000 ISSUE The Year 2000 ("Y2K") issue is the result of computer programs being written for, or microprocessors using, two digits (rather than four) to define the applicable year. Company computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in system failures or miscalculations. The Company is currently working to mitigate the Y2K issue and has established processes for assessing the risks and associated costs. The Company categorizes its Y2K efforts as follows: hardware, software, embedded processors, vendors and customers. Progress in assessing and remediating information technology systems (hardware and software) and non-information technology systems (embedded processors) is being tracked in phases including inventory, identification of non-compliant systems, risk assessment, project plan development, remediation, testing and verification. The Company's Y2K project team has completed the risk assessment phase for all major systems, including hardware, software and embedded processors. Remediation efforts of approximately one-third of the Company's major systems have been completed. The Company expects that the internal remediation work and testing for all systems critical to run the Company's businesses will be completed by July 1999. The Company will use internal and external resources to remediate and test its systems, and to develop contingency plans to mitigate risks associated with the Y2K issue. 16 6 The Company has initiated communications with significant vendors and customers to coordinate the Y2K issue and is in the process of determining the Company's vulnerability if these companies fail to remediate their Y2K issues. The Company is reviewing responses and expects to complete its analysis early in the second quarter. There can be no guarantee that the systems of other companies will be timely remediated, or that other companies' failure to remediate Y2K issues would not have a material adverse effect on the Company. It is currently estimated that the aggregate cost of the Company's Y2K efforts will be approximately $1.1 million, of which, approximately $.4 million has been spent to date. These costs are being funded through operating cash flows and include the costs of normal system upgrades and replacements for which the timing was accelerated to address the Y2K issue. These amounts do not include any costs associated with the implementation of contingency plans, which are in the process of being developed; nor do they include internal Y2K program costs. The Company does not separately track internal Y2K program costs. These costs are principally the related payroll costs for the management information systems group. The Company has not yet developed a contingency plan for dealing with the operational problems and costs (including loss of revenues) that would be reasonably likely to result from failure by the Company and certain third parties to achieve Y2K compliance on a timely basis. The Company currently plans to complete its analysis of the problems and costs associated with the failure to achieve Y2K compliance and to establish a contingency plan in the event of such a failure by September 30, 1999. The Company presently believes that with remediation, testing and contingency planning, Y2K risks can be mitigated. However, although the Company is not currently aware of any material internal operational or financial Y2K related issues, the Company cannot provide assurances that the computer systems, products, services or other systems upon which the Company depends will be Y2K ready on schedule, that the costs of its Y2K program will not become material or that the Company's contingency plans will be adequate. The Company is currently unable to evaluate accurately the magnitude, if any, of the Y2K related issues arising from the Company's vendors and customers. If any such risks (either with respect to the Company or its vendors or customers) materialize, the Company could experience serious consequences to its business which could have material adverse effects on the Company's financial condition, results of operations and liquidity. The foregoing assessment of the impact of the Y2K problem on the Company is based on management's best estimates as of the date of this Annual Report, which are based on numerous assumptions as to future events. There can be no assurance that these estimates will prove accurate, and actual results could differ materially from those estimated if these assumptions prove inaccurate. MATTERS AFFECTING FUTURE RESULTS This Annual Report contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. When used in this Annual Report, the words "expects," "anticipates," "believes," "can," "will" or similar expressions are intended to identify such forward-looking statements. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those anticipated. Such risks and uncertainties include, but are not limited to, the Company's future capital needs, stock market conditions, price of the Company's stock, fluctuations in customer demand, intensity of competition from other vendors, timing and acceptance of new product introductions, general economic and industry conditions, delays or difficulties in programs designed to increase sales and return the Company to profitability, the possibility of a final award of material damages in the Cerion securities litigation, risks associated with the failure by the Company and certain third parties to achieve Y2K compliance on a timely basis and other risks detailed in the Company's filings with the Securities and Exchange Commission. The Company assumes no obligation to update the information contained in this Annual Report. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133 In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." The statement is effective for years beginning after June 15, 1999. FAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Management of the Company anticipates that, due to its limited use of derivative instruments, the adoption of FAS 133 will not have a significant effect on the Company's results of operations or its financial position. 17 7 NASHUA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS AND RETAINED EARNINGS Year Ended December 31, -------------------------------------- (In thousands, except per share data) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- Net sales $167,831 $173,202 $199,039 Cost of products sold 127,089 133,175 157,986 Selling, distribution and administrative expenses 34,119 38,557 43,275 Research and development expense 5,938 7,749 8,889 Restructuring and other unusual charges (income) 13,825 4,254 (1,733) Interest expense 377 129 2,604 Interest income (1,567) (362) (518) -------------------------------------- Total costs and expenses 179,781 183,502 210,503 -------------------------------------- Loss from continuing operations before income taxes (11,950) (10,300) (11,464) Income tax benefit (4,721) (4,110) (4,174) -------------------------------------- Loss from continuing operations (7,229) (6,190) (7,290) Income (loss) from discontinued operations, net of taxes (6,687) (2,632) 460 Gain on disposition of stock of discontinued operation, net of taxes - - 19,386 Gain on public stock offering of discontinued operation, net of taxes - - 4,461 Gain on disposal of discontinued operation, net of taxes 1,052 - 8,434 -------------------------------------- Income (loss) before extraordinary loss (12,864) (8,822) 25,451 Extraordinary loss on extinguishment of debt, net of taxes - - (1,257) -------------------------------------- Net income (loss) (12,864) (8,822) 24,194 Retained earnings, beginning of period 76,935 85,757 61,563 Dividends - - - -------------------------------------- Retained earnings, end of period $ 64,071 $ 76,935 $ 85,757 ====================================== Earnings per share Loss from continuing operations per common share $ (1.15) $ (.97) $ (1.14) Income (loss) from discontinued operations per common share (1.06) (.41) .07 Gain on public stock offering, disposition of stock and disposal of discontinued operation .17 - 5.06 Extraordinary loss on extinguishment of debt - - (.20) -------------------------------------- Net income (loss) per common share $ (2.04) $ (1.38) $ 3.79 ====================================== Loss from continuing operations per common share assuming dilution $ (1.15) $ (.97) $ (1.14) Income (loss) from discontinued operations per common share assuming dilution (1.06) (.41) .07 Gain on public stock offering, disposition of stock and disposal of discontinued operation .17 - 5.06 Extraordinary loss on extinguishment of debt - - (.20) -------------------------------------- Net income (loss) per common share assuming dilution $ (2.04) $ (1.38) $ 3.79 ====================================== The accompanying notes are an integral part of the consolidated financial statements. 18 8 NASHUA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET December 31, ------------------ (In thousands, except share data) 1998 1997 - --------------------------------------------------------------------------------------------------------- Assets Current assets Cash and cash equivalents $ 31,965 $ 3,736 Restricted cash 5,000 - Accounts receivable 18,232 14,915 Inventories Materials and supplies 6,326 6,196 Work in process 2,503 3,650 Finished goods 5,847 4,791 ---------------------- 14,676 14,637 Other current assets 13,474 12,362 Net current assets of discontinued operations - 120 ---------------------- 83,347 45,770 ---------------------- Plant and equipment Land 836 789 Buildings and improvements 26,388 27,371 Machinery and equipment 43,354 50,654 Construction in progress 2,479 2,206 ---------------------- 73,057 81,020 Accumulated depreciation (33,727) (40,605) ---------------------- 39,330 40,415 Other assets 10,662 11,859 Net non-current assets of discontinued operations 756 48,718 ---------------------- Total assets $134,095 $146,762 ====================== Liabilities and Shareholders' Equity Current liabilities Current maturities of long-term debt $ 511 $ 511 Accounts payable 9,028 12,595 Accrued expenses 27,934 13,772 ---------------------- 37,473 26,878 ---------------------- Long-term debt 1,064 3,489 Other long-term liabilities 20,331 21,373 Shareholders' equity Preferred stock, par value $1.00: 2,000,000 shares authorized and unissued - - Common stock, par value $1.00: authorized 40,000,000 shares; issued 6,938,397 shares in 1998 and 6,715,495 shares in 1997 6,938 6,716 Additional capital 15,057 12,129 Retained earnings 64,071 76,935 Treasury stock, at cost (10,839) (758) ---------------------- 75,227 95,022 ---------------------- Total liabilities and shareholders' equity $134,095 $146,762 ====================== The accompanying notes are an integral part of the consolidated financial statements. 19 9 NASHUA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS Year Ended December 31, -------------------------------------- (In thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities of Continuing Operations Net income (loss) $(12,864) $ (8,822) $ 24,194 Adjustments to reconcile net income (loss) to cash provided by (used in) continuing operating activities: Depreciation and amortization 6,846 7,554 9,045 Deferred income taxes (4,721) (4,110) (4,174) Stock issued for director compensation 89 91 73 Write-down of long-lived assets to net realizable value - 990 Loss on sale of excess real estate 900 - (Income) loss from discontinued operations 6,687 2,632 (460) Gain on disposal of discontinued operation (1,052) - (8,434) Gain on disposition of stock of discontinued operation - - (19,386) Gain on public stock offering of discontinued operation - - (4,461) Extraordinary loss on extinguishment of debt - - 1,257 Change in operating assets and liabilities, net of effects from acquisition and disposal of businesses: Restricted cash (5,000) - - Accounts receivable (3,317) 1,045 1,344 Inventories (39) (370) 2,785 Other assets 4,354 (1,481) 4,528 Accounts payable (3,567) (4,624) 2,214 Accrued expenses 14,162 (4,375) (6,322) Other long-term liabilities (449) (61) 643 -------------------------------------- Cash provided by (used in) operating activities 1,129 (11,621) 3,836 Cash Flows from Investing Activities of Continuing Operations Investment in plant and equipment (6,702) (4,418) (5,877) Proceeds from sale of plant and equipment 166 825 - -------------------------------------- Cash used in investing activities (6,536) (3,593) (5,877) Cash Flows from Financing Activities of Continuing Operations Proceeds from borrowings - 2,000 3,434 Repayment of borrowings (2,425) (855) (69,429) Proceeds and tax benefits from shares issued under stock option plans 3,061 - - Extinguishment of debt - - (952) Purchase of treasury stock (10,081) (1) (6) -------------------------------------- Cash provided by (used in) financing activities (9,445) 1,144 (66,953) Proceeds from sale of discontinued operations 49,858 - 35,174 Proceeds from repayment of notes of discontinued operation - - 11,142 Proceeds from sale of stock of discontinued operation, net - - 33,080 Cash applied to activities of discontinued operations (6,781) (2,174) 817 Effect of exchange rate changes on cash 4 (38) 409 -------------------------------------- Increase (decrease) in cash and cash equivalents 28,229 (16,282) 11,628 Cash and cash equivalents at beginning of year 3,736 20,018 8,390 -------------------------------------- Cash and cash equivalents at end of year $ 31,965 $ 3,736 $ 20,018 ====================================== Interest paid $ 220 $ 92 $ 3,387 ====================================== Income tax payments net of refunds $ 4,664 $ 2,428 $ 4,476 ====================================== The accompanying notes are an integral part of the consolidated financial statements. 20 10 NASHUA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation: The accompanying consolidated financial statements include the accounts of Nashua Corporation and its wholly-owned subsidiaries ("the Company"). Revenue Recognition: Sales are recognized at the time the goods are shipped or when title passes. Sale of Stock by a Subsidiary: The Company recognizes gains and losses on its subsidiary's direct sale of shares of stock in which the selling price of the subsidiary's shares is greater than or less than the Company's carrying value. Use of Estimates: The preparation of the Company's consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. The more significant areas requiring the use of management estimates relate to allowances for obsolete inventory and uncollectible receivables, environmental obligations, postretirement and other employee benefits, valuation allowances for deferred tax assets, future cash flows associated with assets, and useful lives for depreciation and amortization. Actual results could differ from those estimates. Cash Equivalents: The Company considers all highly liquid investment instruments purchased with a remaining maturity of three months or less to be cash equivalents. At December 31, 1998, the Company held cash equivalents of $30.5 million consisting of various money market instruments carried at cost, which approximated market. The Company held no cash equivalents at December 31, 1997. Restricted Cash: Restricted cash represents $5.0 million placed in escrow to secure a bond related to the patent infringement judgement against the Company. Accounts Receivable: The consolidated balance is net of allowance for doubtful accounts of $.9 million at December 31, 1998 and $1.2 million at December 31, 1997. Inventories: Inventories are carried at the lower of cost or market. Cost is determined by the first-in, first-out ("FIFO") method for approximately 74 percent and 61 percent of the inventories at December 31, 1998 and 1997, respectively, and by the last-in, first-out ("LIFO") method for the balance. Had the FIFO method been used to cost all inventories, the inventory balances would have been approximately $2.1 million and $2.8 million higher at December 31, 1998 and 1997, respectively. Plant and Equipment: Plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to operations as incurred, while additions, renewals and betterments of plant and equipment are capitalized. Items which are fully depreciated, sold, retired or otherwise disposed of, together with the related accumulated depreciation, are removed from the accounts and, where applicable, the related gain or loss is recognized. For financial reporting purposes, depreciation is computed using the straight-line method over the following estimated useful lives of the assets: - -------------------------------------------------------------------------------- Buildings and improvements 5 - 40 years Machinery and equipment 2 - 20 years The Company reviews the value of its plant and equipment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Research and Development: Research and development costs are expensed as incurred. Stock Compensation: The Company's employee stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." The Company follows disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." 21 11 Income Taxes: Prepaid or deferred income taxes result principally from the use of different methods of depreciation and amortization for income tax and financial reporting purposes, the recognition of expenses for financial reporting purposes in years different from those in which the expenses are deductible for income tax purposes and the recognition of the tax benefit of net operating losses and other tax credits. Foreign Currency Translation: The functional currency of the Company's foreign subsidiaries is the local currency. Accordingly, assets and liabilities of these subsidiaries have been translated using exchange rates prevailing at the appropriate balance sheet date and income statement items have been translated using average monthly exchange rates. Financial Instruments: The Company enters into foreign exchange contracts as hedges against exposure to fluctuations in exchange rates associated with certain transactions denominated in foreign currencies. Market value gains or losses on these contracts are included in the results of operations and generally offset gains or losses on the related transactions. The Company may selectively enter into interest rate swap agreements to reduce the impact of interest rate changes on its floating rate debt. The notional amounts of such agreements are used to measure carrying value (interest to be paid or received) and do not represent the amount of exposure to loss. The Company does not hold or issue derivative financial instruments for trading purposes. Concentrations of Credit Risk: Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments, trade receivables and financial instruments used in hedging activities. The Company places its temporary cash investments with high credit quality financial institutions and in high quality liquid investments and, by policy, limits the amount of credit exposure with any one financial institution. Concentrations of credit risk with respect to accounts receivable are limited because a large number of geographically diverse customers make up the Company's customer base, thus spreading the trade credit risk. The Company performs ongoing credit evaluations of its customers' financial condition and maintains allowances for potential credit losses. The Company generally does not require collateral or other security to support customer receivables. The counterparties to the agreements relating to the Company's foreign exchange commitments consist of a number of high credit quality financial institutions. The Company does not believe that there is significant risk of nonperformance by these counterparties. Environmental Expenditures: Environmental expenditures relating to ongoing operations are expensed when incurred unless the expenditures extend the life, increase the capacity or improve the safety or efficiency of the property; mitigate or prevent environmental contamination that has yet to occur and improve the property compared with its original condition; or are incurred for property held for sale. Expenditures relating to site assessment, remediation and monitoring are accrued and expensed when the costs are both probable and the amount can be reasonably estimated. Estimates are based on in-house or third-party studies considering current technologies, remediation alternatives and current environmental standards. In addition, if there are other participants and the liability is joint and several, the financial stability of the other participants is considered in determining the Company's accrual. Insurance and other recoveries relating to these expenditures are recorded separately once recovery is probable. Segment and Related Information: In the fourth quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information," which changes the way the Company reports information about its operating segments. The information for 1997 and 1996 has been restated from the prior year's presentation in order to conform to the 1998 presentation. Postretirement Benefits: In 1998, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This statement standardizes the disclosure requirements for pensions and other postretirement benefits. The information for 1997 and 1996 has been restated from the prior year's presentation in order to conform to the 1998 presentation. Fair Value of Financial Instruments: The recorded amounts for cash and cash equivalents, other current assets, accounts receivable and accounts payable and other current liabilities approximate fair value due to the short-term nature of these financial instruments. The fair values of amounts outstanding under the Company's debt instruments approximates their book values in all material respects due to the variable nature of the interest rate provisions associated with such instruments. Earnings per Common and Common Equivalent Share: Earnings per common and common equivalent share are computed based on the total of the weighted average number of common shares and, when applicable, the weighted average number of common equivalent shares outstanding during the period presented. 22 12 Reclassification: Certain amounts from the prior year have been reclassified to conform to the present year presentation. BUSINESS CHANGES Discontinued Operations: During the second quarter of 1996, the Company and Cerion Technologies Inc. ("Cerion"), completed the initial public offering of common stock of Cerion at a price of $13.00 per share. A total of 4,416,000 shares were sold, of which 1,615,000 were sold by Cerion and 2,801,000 were sold by the Company. The Company received net proceeds of $33.1 million and recorded a $32.0 million pretax gain on its sale of Cerion shares and a $7.3 million pretax gain from the Company's interest in the shares sold by Cerion. As a result of the sale, the Company's ownership of Cerion was reduced to 37.1 percent, and accordingly, the Company adopted the equity method of accounting for its investment in Cerion common stock. On September 15, 1998, Cerion announced its decision to cease operations in the fourth quarter of 1998 and is currently in the process of liquidation. Accordingly, the Company no longer accounts for its investment in Cerion under the equity method of accounting and has accounted for its interest in Cerion based on the expected net realizable value at an after tax basis, since the third quarter of 1998. At December 31, 1998, the Company valued its investment in Cerion at $.8 million. For the year ended December 31, 1998, the Company recognized a $4.5 million charge, net of $2.2 million in taxes, of which a portion related to Nashua's share of Cerion losses and the remainder related to the reduction in the Company's investment in Cerion to its net realizable value, net of taxes. During the second quarter of 1996, the Company recorded a $7.0 million charge in the mainland European photofinishing business to write-down the value of its goodwill. During the fourth quarter of 1996, the Company completed the sale of its mainland European photofinishing business. The Company received proceeds of approximately $7.0 million and recorded a net pretax loss of $1.7 million. On April 9, 1998, the Company completed the sale of the remainder of its Photofinishing Group. The Company received net proceeds of $49.9 million for the net assets of the businesses and after recording taxes of $7.9 million, recorded a gain of $1.1 million. During the fourth quarter of 1998, the Company recorded charges of $2.3 million, net of taxes related to discontinued operations. The net charges included net income of $1.0 million from an insurance settlement related to environmental matters, offset by net charges of $3.3 million, which included: additional valuation reserves of $.3 million for the Company's investment in Cerion; $.1 million related to potential environmental exposures; and $2.9 million for tax exposures, including $2.3 million for the establishment of a tax valuation reserve for foreign tax credits. During the second quarter of 1996, the Company sold its Tape Products Division for approximately $28.0 million and, as a result, recorded an after-tax gain of $8.4 million. Results of operations for Cerion, the Photofinishing Group and the Tape Products Division are reported as discontinued operations for all periods presented. The Photofinishing Group and Cerion's results for 1998, 1997 and 1996, as well as the Tape Products Division results for 1996 are summarized as follows: (In millions) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- Net sales $21.6 $143.5 $214.3 Income (loss) before income taxes (6.5) (2.8) 1.7 Income taxes (benefit) .2 (.2) 1.2 -------------------------------------- Income (loss) from discontinued operations $(6.7) $ (2.6) $ .5 ====================================== The net assets of the discontinued operations in the December 31, 1998 and December 31, 1997 consolidated balance sheets include: (In thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------- Accounts receivable $ - $ 2,874 Inventories - 2,846 Accounts payable - (6,028) Accrued payroll and other expenses - (5,449) Other, net - 5,877 ------------------------ Net current assets of discontinued operations $ - $ 120 ======================== Plant and equipment $ - $13,420 Long-term liabilities - (863) Investment in unconsolidated affiliate 756 7,524 Other, net - 28,637 ------------------------ Net non-current assets of discontinued operations $756 $48,718 ======================== 23 13 Restructuring and Other Unusual Charges: The restructuring and other unusual charges for 1998 included an unusual charge of $15.0 million related to damages awarded to Ricoh Corporation in a patent infringement lawsuit, partially offset by unusual income of $1.2 million related to an insurance settlement for environmental matters. The restructuring activities provided for in the balance at December 31, 1997 were substantially completed at December 31, 1998 and amounts incurred did not change materially from the reserve balance of $3.0 million at December 31, 1997. The balance at December 31, 1998 for severance related to workforce reductions consisted primarily of amounts payable to employees who had already left the Company. Details of the charges related to continuing operations and the activity recorded during 1998 were as follows: Balance Current Current Balance Dec. 31, Year Year Dec. 31, (In thousands) 1997 Provision Charges 1998 - --------------------------------------------------------------------------------------------------------------------- 1998 Activity: Provisions for severance related to workforce reductions $1,913 $ - $1,441 $472 Provisions for assets to be sold or discarded 750 - 750 - Other 365 - 216 149 ------------------------------------------------ Total $3,028 $ - $2,407 $621 ================================================ The restructuring and other unusual charges from continuing operations of $4.3 million in 1997 included charges in the fourth quarter of $.6 million related to restructuring corporate activities, a charge in the third quarter of $.9 million related to the sale of excess real estate in Nashua, NH and a second quarter charge of $2.8 million for costs associated with restructuring certain distribution channels and aligning the workforce with levels of demand in the Imaging Supplies Division. Details of the charges related to continuing operations and the activity recorded during 1997 were as follows: Balance Balance Dec. 31, 1997 1997 Dec. 31, (In thousands) 1996 Provision Charges 1997 - ------------------------------------------------------------------------------------------------------------------------- 1997 Activity: Provisions for severance related to workforce reductions $ 475 $2,604 $1,166 $1,913 Provisions for assets to be sold or discarded 1,178 1,650 2,078 750 Other 841 - 476 365 ---------------------------------------------------- Total $2,494 $4,254 $3,720 $3,028 ==================================================== The 1997 provision for workforce reductions included amounts for salary and benefit continuation for 116 employees as part of the Imaging Supplies Division and Corporate reorganizations. The restructuring activities provided for in the balance at December 31, 1996 were substantially completed in 1997. Amounts incurred did not change materially from the reserve balance of $2.5 million at December 31, 1996. Net restructuring and other unusual income of $1.7 million in 1996 included charges of $1.1 million for the cost of divesting the organic photoconductor drum product line, $1.4 million for functional realignments in Corporate, offset by income of $4.2 million associated with reassessment in 1996 of certain charges recorded in 1995 for product and channel rationalizations in the Imaging Supplies Division. INDEBTEDNESS During 1997, the Company negotiated a new $18.0 million secured line of credit, of which $5.0 million is available exclusively for letters of credit. The agreement contains certain financial covenants with respect to consolidated tangible net worth, liquidity and other ratios. On August 17, 1998, the agreement was amended decreasing the amount of available funds under the secured line of credit from $18.0 million to $8.0 million and amending the consolidated tangible net worth covenant from $70.0 million to $60.0 million. Borrowings under this facility are collateralized by a security interest in the Company's receivables and inventory. Interest on amounts outstanding under the secured line of credit is payable at either 2 percent above the LIBOR rate, which was 5 percent at December 31, 1998, or at the Wall Street Journal prime rate, which was 7.75% at December 31, 1998, as elected by the Company. The maturity of this line of credit is April 30, 1999. Without prior consent of the lenders, the agreement does not allow the payment of dividends and restricts, among other things, the incurrence of additional debt, guarantees, lease arrangements or sale of certain assets. As of December 31, 1998, the Company was in compliance with the covenants of the agreement. There were no borrowings outstanding under this secured line of credit at December 31, 1998. At December 31, 1997, borrowings of $2.0 million were outstanding under this secured line of credit. 24 14 On December 26, 1996, the Company entered into a note agreement under which the Company borrowed $2.6 million. The note is being paid back in sixty equal monthly payments which began in January of 1997. The note bears interest per annum equal to 2.5 percent above the LIBOR rate which was 5 percent at December 31, 1998. The note is collateralized by a security interest in certain equipment. At December 31, 1998 and 1997, borrowings of $1.6 million and $2.0 million, respectively, were outstanding under this note agreement. INCOME TAXES The domestic and foreign components of loss from continuing operations before income taxes are as follows: (In thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Domestic $(11,873) $ (8,665) $(10,675) Foreign (77) (1,635) (789) ------------------------------------ Consolidated $(11,950) $(10,300) $(11,464) ==================================== Income tax benefit charged to continuing operations consists of the following: (In thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Current: United States $ - $ - $ - State and local - - - ------------------------------------ Total current - - - Deferred: United States (3,824) (2,919) (3,080) Foreign (18) (502) (260) State and local (879) (689) (834) ------------------------------------ Total deferred (4,721) (4,110) (4,174) ------------------------------------ Income tax benefit $(4,721) $(4,110) $(4,174) ==================================== Deferred tax liabilities (assets) from continuing operations are comprised of the following: (In thousands) 1998 1997 - --------------------------------------------------------------------------------------------------------- Depreciation $ 2,680 $ 3,033 Other 2,461 2,238 ---------------------- Gross deferred tax liabilities 5,141 5,271 ---------------------- Restructuring - (4,418) Legal reserve (6,473) - Pension and postretirement benefits (8,320) (8,718) Loss and credit carryforwards (5,203) (8,100) Workers compensation accrual (507) (474) Inventory reserve (1,828) (2,247) Bad debt reserve (505) (338) Other (4,827) (3,085) ---------------------- Gross deferred tax asset (27,663) (27,380) Deferred tax assets valuation allowance 300 300 ---------------------- $(22,222) $(21,809) ====================== 25 15 Reconciliations between income taxes from continuing operations computed using the United States statutory income tax rate and the Company's effective tax rate are as follows: 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- United States statutory rate (benefit) (35.0)% (35.0)% (35.0)% State and local income taxes, net of federal tax benefit (4.8) (4.3) (4.7) Tax asset valuation - 1.5 2.1 Rate difference - foreign subsidiaries - .7 .1 Other, net .3 (2.8) 1.1 ----------------------------------- Effective tax rate (benefit) (39.5)% (39.9)% (36.4)% =================================== At December 31, 1998, $12.7 million and $10.0 million of net tax assets were included in "Other Current Assets" and "Other Assets," respectively. At December 31, 1997, $11.6 million and $11.9 million of net tax assets were included in "Other Current Assets" and "Other Assets," respectively. At December 31, 1998, the Company had $5.2 million and $.2 million of net operating loss carryforward benefits and tax credit carryforwards, respectively, which are primarily available to offset certain future domestic taxable earnings. The net operating loss carryforward benefits expire as follows: $1.0 million in 1999; $2.4 million in 2000; and $1.8 million thereafter. The tax credit carryforwards all expire after 2000. Management believes that the Company will generate sufficient future taxable income to realize deferred tax assets prior to the expiration of any net operating loss carryforwards or tax credit carryforwards and that realization of the net deferred tax assets is more likely than not. During 1997, the Company settled the dispute in connection with interest assessed as part of the 1990 and 1991 tax settlement. In December 1998, the Internal Revenue Service ("IRS") completed an examination of the Company's corporate income tax returns for the years 1992 through 1994. As a result of the IRS' findings, the Company agreed to and paid additional taxes of $.3 million in January 1999 in connection with adjustments mainly related to the tax treatment of research and experimentation costs. On December 11, 1998, the Internal Revenue Service ("IRS") issued the Company a Notice of Proposed Adjustment in the amount of $4.6 million principally in connection with the tax years 1992 and 1993 relating to the accounting treatment of certain items as they pertain to the restructuring effort undertaken by the Company during 1994. The Company disagreed with the position taken by the IRS and filed a formal protest of the proposed adjustment on January 12, 1999. In management's opinion, the ultimate disposition of this matter will not have a material adverse effect on the financial position or results of operations of the Company. On March 31, 1998, the New Hampshire Department of Revenue ("DOR") issued a notice of deficiency in connection with an examination of the Company's corporate income tax returns for the years 1989 through 1992 in the amount of $4.4 million, including interest. The deficiency principally relates to the tax treatment of the sale of the Company's International Office Systems business in 1990. A petition for reconsideration was filed with an appeals officer on May 26, 1998. The Company disagrees with the DOR and will continue to defend its position. In management's opinion, the ultimate disposition of this matter will not have a material adverse effect on the financial position or results of operations of the Company. Shareholders' Equity On July 19, 1996, the Company's Board of Directors adopted a Shareholder Rights Plan ("the Plan"), in which preferred stock purchase rights ("Rights") were distributed on September 2, 1996 to holders of record on August 15, 1996 ("Record Date") as a dividend at the rate of one Right for each share of the Company's common stock outstanding as of the close of business on the Record Date. These Rights replaced the rights outstanding under the Company's August 22, 1986 Rights Agreement, which expired on September 2, 1996. Rights will also attach to shares of common stock issued after the Record Date. On June 24, 1998, the Company's Board of Directors amended the plan increasing from 10 to 20 percent the beneficial ownership and tender offer threshold at which the Rights would detach from the Company's common stock and become exercisable as described below. Each Right will entitle the holders of common stock of the Company to purchase one one-hundredth of a share of Series B Junior Participating Preferred Stock of the Company ("Series B Stock") at an exercise price of $75.00 (subject to adjustment). Each share of Series B Stock would entitle its holder to a quarterly dividend of $1.00 per share, an aggregate dividend of 100 times any dividend declared on common stock and, in the event of liquidation of the Company, each such share would entitle its holder to a payment of $1.00 plus 100 times the payment made per share of common stock. Initially, the Rights will be attached to all certificates representing outstanding shares of common stock. The Rights will detach and become exercisable only after a person or group acquires beneficial ownership of 20 percent or more of the common stock of the Company or announces a tender or exchange offer that would result in such person or group owning 20 percent or more of the common stock of the Company. 26 16 After a person becomes the beneficial owner of 20 percent or more of the shares of common stock of the Company, except pursuant to a tender or exchange offer for all shares at a fair price as determined by the outside Board members, each Right not owned by the 20 percent or more shareholder will enable its holder to purchase that number of shares of the Company's common stock which equals the exercise price of the Right divided by one-half of the current market price of such common stock at the date of the occurrence of the event ("Triggering Event"). After the occurrence of a Triggering Event, the Company's Board of Directors may, at their option, exchange one share of common stock or one one-hundredth of a share of Series B Stock for each Right (other than Rights held by the 20 percent or more shareholder). In addition, if the Company is involved in a merger or other business combination transaction with another person or group in which it is not the surviving corporation or in connection with which its common stock is changed or converted, or it sells or transfers 50 percent or more of its assets or earning power to another person, each Right that has not previously been exercised will entitle its holder (other than the 20 percent or more shareholder) to purchase that number of shares of common stock of such other person which equals the exercise price of the Right divided by one-half of the current market price of such common stock at the date of the occurrence of the event. The Company will generally be entitled to redeem the Rights at $.01 per Right at any time until the 10th day following public announcement that a 20 percent stock position has been acquired and in certain other circumstances. The Rights will expire on September 2, 2006, unless earlier redeemed or exchanged. In 1989, the Board of Directors authorized the Company to repurchase up to 1,000,000 shares of its common stock (the "1989 Repurchase Program"). As of December 31, 1998, the Company had purchased 435,679 shares under this authorization. In 1998, the Board of Directors authorized the Company to repurchase up to 1,000,000 shares of its common stock and terminated the 1989 Repurchase Program. As of December 31, 1998, the Company had purchased 651,654 shares under this authorization. The following summarizes the changes in selected shareholders' equity accounts for each of the three years in the period ended December 31, 1998: Common Stock Cumulative Treasury Stock --------------------- Additional Translation -------------------- (In thousands, except share data) Shares Par Value Capital Adjustment Shares Cost - ---------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 6,502,570 $6,503 $12,178 $(4,618) (23,620) $ (751) Stock issued for Director compensation 4,685 4 69 -- -- -- Translation adjustments and gains and losses from certain inter-company balances -- -- -- 2,781 -- -- Restricted stock issuances 145,000 145 1,873 -- -- -- Deferred compensation -- -- (1,951) -- -- -- Restricted stock forfeiture (5,000) (5) (62) -- -- -- Purchase of treasury shares -- -- -- -- (410) (6) ------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1996 6,647,255 $6,647 $12,107 $(1,837) (24,030) $ (757) Stock issued for Director compensation 7,740 8 82 -- -- -- Translation adjustments and gains and losses from certain inter-company balances -- -- -- (1,445) -- -- Restricted stock issuances 85,500 86 1,077 -- -- -- Deferred compensation -- -- (1,162) -- -- -- Restricted stock forfeiture (25,000) (25) (275) -- -- -- Deferred compensation forfeiture -- -- 300 -- -- -- Purchase of treasury shares -- -- -- -- (34) (1) Discontinuance of photofinishing segment -- -- -- 3,282 -- -- ------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1997 6,715,495 $6,716 $12,129 $ -- (24,064) $ (758) Stock issued for Director compensation 5,802 5 84 -- -- -- Stock options exercised and related tax benefit 236,600 237 2,828 -- -- -- Restricted stock issuances 105,000 105 1,568 -- -- -- Deferred compensation -- -- (1,673) -- -- -- Restricted stock forfeiture and conversion (124,500) (125) (1,518) -- -- -- Deferred compensation forfeiture -- -- 1,639 -- -- -- Purchase of treasury shares -- -- -- -- (651,674) (10,081) ------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1998 6,938,397 $6,938 $15,057 $ -- (675,738) $(10,839) 27 17 STOCK OPTION AND STOCK AWARD PLANS The Company has three stock compensation plans at December 31, 1998: the 1987 Stock Option Plan ("1987 Plan"), the 1993 Stock Incentive Plan ("1993 Plan"), and the 1996 Stock Incentive Plan ("1996 Plan"). Awards may no longer be granted under the 1987 Plan and the 1993 Plan. Awards under the 1996 Plan are made at the discretion of the Leadership and Compensation Committee of the Board of Directors (the "Committee"). Under the 1987 Plan, nonqualified stock options and incentive stock options have been awarded and become exercisable either (a) 50 percent on the first anniversary of grant and the remainder on the second anniversary of grant, (b) 100 percent at six months from the date of grant, (c) 100 percent at one year from the date of grant, or (d) otherwise as determined by the Committee. Certain options may become exercisable immediately in the event of a change of control as defined under this plan. Nonqualified stock options expire 10 years and one day from the date of grant, and incentive stock options expire 10 years from the date of grant. Nonstatutory stock options, incentive stock options and shares of performance based restricted stock have been awarded under the 1993 Plan and may be awarded under the 1996 Plan. At December 31, 1998, an additional 44,623 shares may be awarded under the 1996 Plan. Stock options under both plans generally become exercisable either (a) 50 percent on the first anniversary of grant and the remainder on the second anniversary of grant, (b) 100 percent at one year from the date of grant, or (c) otherwise as determined by the Committee. Certain options may become exercisable immediately in the event of a change in control as defined under these plans. Nonstatutory stock options under both plans expire 10 years and one day from the date of grant, and incentive stock options expire 10 years from the date of grant. Performance based restricted stock awards under both plans have been granted to certain key executives and are earned only if the closing price of the Company's common stock meets specific target prices for certain defined periods of time or if significant performance based events are achieved. During 1998, the Company granted 105,000 shares of performance based restricted stock under the 1996 Plan. Restrictions on such shares lapse either (i) in equal amounts when the average closing price of the Company's common stock reaches $18 and $20 for a consecutive 10 trading day period; (ii) in equal amounts when the average closing price of the Company's common stock reaches $19 and $21 for a consecutive 10 trading day period; (iii) in equal amounts when the average closing price of the Company's common stock reaches $21 and $23 for a consecutive 10 trading day period; or (iv) 100% upon the occurrence of certain significant performance based events. Shares issued under the plans are initially recorded at their fair market value on the date of grant with a corresponding charge to additional capital representing the unearned portion of the award. Shares of performance based restricted stock are forfeited if the specified average closing prices of the Company's common stock are not met within five years of grant, the executive leaves the Company or if the said significant performance based events do not take place within the specified time period. In the event of a change in control, as defined in the 1987 Plan, certain option holders may, with respect to stock option agreements which so provide, have a limited right with respect to options under the plans to elect to surrender the options and receive cash or shares equal in value to the difference between the option price and the larger of either the highest reported price per share on the New York Stock Exchange during the sixty-day period before the change in control or, if the change in control is the result of certain defined transactions, the highest price per share paid in such defined transactions. A summary of the status of the Company's fixed stock option plans as of December 31, 1998, 1997 and 1996 and changes during the years ended on those dates is presented below: 1998 1997 1996 -------------------- ------------------- --------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price - ---------------------------------------------------------------------------------------------------------------------------- Outstanding beginning of year 853,920 $14.75 469,714 $18.12 505,909 $22.88 Granted 64,500 15.60 465,500 12.33 150,000 11.86 Exercised (233,100) 12.37 - - - - Forfeited - non-vested (34,500) 11.63 (33,950) 13.65 (35,775) 17.39 Forfeited - exercisable (103,450) 17.83 (42,060) 24.86 (147,520) 28.22 Expired - - (5,284) 28.75 (2,900) 19.38 ----------------------------------------------------------------------- Outstanding end of year 547,370 $15.47 853,920 $14.75 469,714 $18.12 Options exercisable at end of year 446,120 $15.83 402,420 $17.66 251,214 $22.04 Weighted average fair value of options granted during the year (exercise price equals market price) $ 6.60 $ 5.11 $ 4.88 28 18 The following table summarizes information about stock options outstanding at December 31, 1998: Options Outstanding Options Exercisable ---------------------------------------------- ----------------------------- Weighted Range of Number Average Weighted Number Weighted Exercise Outstanding Remaining Average Exercisable Average Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price - ------------------------------------------------------------------------------------------------------- $9.63 - $12.75 313,650 9.1 years $11.98 272,400 $12.11 13.38 - 19.75 172,650 5.1 years 17.15 112,650 17.85 22.63 - 27.00 33,870 6.0 years 25.74 33,870 25.74 28.13 - 34.63 27,200 2.6 years 32.35 27,200 32.35 - ------------------------------------------------------------------------------------------------------- $9.63 - $34.63 547,370 7.6 years $15.47 446,120 $15.83 The number and weighted average fair value per share of restricted stock granted during 1998, 1997 and 1996 are as follows: 1998 1997 1996 - ---------------------------------------------------------------------------------------------------- Restricted Stock: Number of shares 105,000 85,500 145,000 Weighted average fair value per restricted share $ 9.66 $ 5.56 $ 2.06 Weighted average share price at grant date $ 15.93 $13.59 $ 13.91 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for Stock-Based Compensation." The Company continues to measure compensation cost using the intrinsic value based method of accounting prescribed by APB Opinion 25. If the Company had elected to recognize compensation cost based on the fair value of the options and restricted stock granted at grant date as prescribed by SFAS No. 123, net income and earnings per share would have been reduced to the pro forma amounts indicated below: (In thousands, except per share amounts) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------- Net income (loss) - as reported $(12,864) $ (8,822) $24,194 Net income (loss) - pro forma $(14,266) $(10,674) $23,433 Earnings (loss) per common share - as reported $ (2.04) $ (1.38) $ 3.79 Earnings (loss) per common share assuming dilution - as reported $ (2.04) $ (1.38) $ 3.79 Earnings (loss) per share - pro forma $ (2.26) $ (1.67) $ 3.68 Earnings (loss) per share - pro forma assuming dilution $ (2.26) $ (1.67) $ 3.68 29 19 The assumptions and methods used in estimating the fair value at the grant date of options and restricted shares granted are listed below: Grant Year -------------------------------------- 1998 1997 1996 - ---------------------------------------------------------------------------------------------------- Volatility of share price: Options 37.0% 33.0% 31.0% Restricted stock 12.0% 11.0% 6.0% Dividend yield: Options - - - Restricted stock - - - Interest rate: Options 4.8% 6.3% 6.2% Restricted stock 4.8% 5.9% 5.6% Expected life of options 5.5 years 5.3 years 5.6 years Valuation methodology: Options Black-Scholes Option Pricing Model Restricted stock Binomial Pricing Model Because the determination of the fair value of all options granted includes vesting periods over several years and additional option grants are expected to be made each year, the above pro forma disclosures are not representative of pro forma effects of reported net income for future periods. EARNINGS PER SHARE Since the effect of stock options of 57,103 shares in 1998, 49,542 shares in 1997, and 25,811 shares in 1996 would be antidilutive to loss per share computations, Basic EPS and Diluted EPS are identical for the years ended December 31, 1998, 1997 and 1996. The computations of EPS for 1998, 1997 and 1996 include shares (denominator) of 6,319,775, 6,384,566 and 6,376,277, respectively. Performance based restricted stock of 286,000, 305,500 and 245,000 shares for the years ended December 31, 1998, 1997 and 1996, respectively, were not included in the above computations. Such shares may be issued in the future subject to the occurrence of certain events as described in the "Stock Option and Stock Award Plans" note. COMMITMENTS AND CONTINGENCIES Rent expense for office equipment, facilities and vehicles was $1.0 million, $.8 million and $1.0 million for 1998, 1997 and 1996, respectively. The Company also received rental income on subleased facilities of $.2 million for the years ended December 31, 1998 and 1997, and $0 for the year ended December 31, 1996. At December 31, 1998, the Company was committed, under non-cancelable operating leases, to minimum annual rentals as follows: 1999 - $.6 million; 2000 - $.4 million; 2001 - $.3 million; 2002 - $.3 million; 2003 - $.2 million; thereafter - - $.3 million. Minimum annual rentals have not been reduced for future minimum rentals under non-cancelable subleases aggregating $.8 million. At December 31, 1998, the Company had no obligations under standby letters of credit. In April 1994, Ricoh Company, Ltd., Ricoh Electronics, Inc., and Ricoh Corporation (collectively "Ricoh") brought a lawsuit in the United States District Court of New Hampshire ("District Court"), alleging the Company's infringement of the U.S. patents 4,611,730 and 4,878,603 relating to certain toner cartridges for Ricoh copiers. In March 1997, the District Court enjoined Nashua from manufacturing, using or selling its NT-50 and NT-6750 toner cartridges. Sales of these products in 1996 amounted to one percent of Nashua's total sales. The Company disagreed with the District Court's decision and appealed to the United States Court of Appeals for the Federal Circuit ("Court of Appeals"). On February 18, 1999, the Court of Appeals affirmed the March 1997 ruling of the District Court that the Company infringed a patent held by Ricoh. Separately, on September 30, 1998, the District Court issued an order awarding damages in the amount of $7,549,000 related to the Company's sales of NT-50 and NT-6750 toner cartridges through December 3, 1995, additional damages relating to the Company's sales of such products through March 1997, certain of Ricoh's costs relative to the suit, and interest on such damages. The Company disagrees with the District Court's decision on the issue of damages and has appealed the decision to the Court of Appeals. The Company has adequate financial resources to pay the District Court's award of damages should its appeal on damages be unsuccessful. In connection with the damages award, the Company recorded a $15.0 million pretax charge in the third quarter of 1998 and is accruing interest on such award. In addition, in the fourth quarter of 1998, the Company posted a $16.0 million bond and placed $5.0 million in escrow to secure such bond. The $5.0 million is classified as restricted cash in the balance sheet. 30 20 In August and September 1996, two individual plaintiffs initiated lawsuits in the Circuit Court of Cook County, Illinois against the Company, Cerion, certain directors and officers of Cerion, and the Company's underwriter, on behalf of classes consisting of all persons who purchased the common stock of Cerion between May 24, 1996 and July 9, 1996. These two complaints were consolidated. In March 1997, the same individual plaintiffs joined by a third plaintiff filed a Consolidated Amended Class Action Complaint (the "Consolidated Complaint"). The Consolidated Complaint alleged that, in connection with Cerion's initial public offering, the defendants issued materially false and misleading statements and omitted the disclosure of material facts regarding, in particular, certain significant customer relationships. In October 1997, the Court, on motion by the defendants, dismissed the Consolidated Complaint. The plaintiffs filed a Second Amended Consolidated Complaint alleging substantially similar claims as the Consolidated Complaint seeking damages and injunctive relief. On May 6, 1998, the Court, on motion by the defendants, dismissed with prejudice the Second Amended Consolidated Complaint. The plaintiffs have filed an appeal of the Court's ruling. The Company continues to believe that this lawsuit is without merit and plans to vigorously defend itself in this matter on appeal. The Company is involved in certain environmental matters and has been designated by the Environmental Protection Agency ("EPA") as a potentially responsible party ("PRP") for certain hazardous waste sites. In addition, the Company has been notified by certain state environmental agencies that some of the Company sites not addressed by the EPA require remedial action. These sites are in various stages of investigation and remediation. Due to the unique physical characteristics of each site, the technology employed, the extended timeframes of each remediation, the interpretation of applicable laws and regulations and the financial viability of other potential participants, the ultimate cost to the Company of remediation for each site is difficult to determine. At December 31, 1998, based on the facts currently known and the Company's prior experience with these matters, the Company has concluded that there is at least a reasonable possibility that site assessment, remediation and monitoring costs will be incurred by the Company with respect to those sites which can be reasonably estimated in the aggregate range of $1.0 million to $1.5 million. This range is based, in part, on an allocation of certain sites' costs which, due to the joint and several nature of the liability, could increase if the other PRPs are unable to bear their allocated share. At December 31, 1998, the Company has accrued $1.5 million which represents, in management's view, the most likely amount within the range stated above. Based on information currently available to the Company, management believes that it is probable that the major responsible parties will fully pay the costs apportioned to them. Management believes that, based on its financial position and the estimated environmental accrual recorded, its remediation expense with respect to those sites is not likely to have a material adverse effect on its consolidated financial position or results of operations. POSTRETIREMENT BENEFITS In 1998, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This statement standardizes the disclosure requirements for pensions and other postretirement benefits. Prior years' information has been restated to conform with the requirements of this statement. Pension Plans: The Company and its subsidiaries have several pension plans which cover substantially all of its regular full-time employees. Benefits under these plans are generally based on years of service and the levels of compensation during those years. The Company's policy is to fund amounts deductible for income tax purposes. Assets of the plans are invested in common stocks, fixed-income securities and interest-bearing cash equivalent instruments. Retiree Health Care and Other Benefits: The Company also provides certain health care and other benefits to eligible retired employees and their spouses. Salaried participants generally become eligible for retiree health care benefits after reaching age 60 with ten years of service. Benefits, eligibility and cost-sharing provisions for hourly employees vary by location or bargaining unit. Generally, the medical plans are fully insured managed care plans. In 1993, the postretirement benefit plan was changed to share the cost of benefits with all retirees, resulting in an unrecognized benefit which is being amortized over the future service period of the active employees. 31 21 Pension Benefits Postretirement Benefits ----------------------- ------------------------ (In thousands) 1998 1997 1998 1997 - ---------------------------------------------------------------------------------------------------------------- Change in benefit obligation Benefit obligation at beginning of year $116,671 $108,805 $ 8,527 $ 8,219 Service cost 1,470 1,669 54 59 Interest cost 8,289 8,219 532 606 Amendments 188 - - - Actuarial (gain)/loss 8,204 6,171 (764) 358 Benefits paid (9,466) (8,193) (651) (715) ------------------------------------------------- Benefit obligation at end of year $125,356 $116,671 $ 7,698 $ 8,527 ================================================= Change in plan assets Fair value of plan assets at beginning of year $125,011 $115,619 $ - $ - Actual return on plan assets 13,924 15,621 - - Employer contribution - 1,705 - - Benefits paid (9,209) (7,934) - - ------------------------------------------------- Fair value of plan assets at end of year $129,726 $125,011 $ - $ - ================================================= Funded status $ 4,370 $ 8,340 $ (7,698) $ (8,527) Unrecognized net actuarial (gain)/loss (17,717) (22,945) (2,869) (2,285) Unrecognized prior service cost 3,749 4,478 (656) (758) Unrecognized net transition asset 221 528 - - ------------------------------------------------- Net amount recognized $ (9,377) $ (9,599) $(11,223) $(11,570) ================================================= The amount recognized in the consolidated balance sheet consists of the following: Accrued benefit liability $ (9,377) $ (9,599) $(11,223) $(11,570) Additional minimum liability (382) (335) - - Intangible asset 382 335 - - ------------------------------------------------- Net amount recognized $ (9,377) $ (9,599) $(11,223) $(11,570) ================================================= Pension Benefits Postretirement Benefits -------------------------- ----------------------- 1998 1997 1996 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Weighted-average assumptions as of December 31 Discount rate 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected return on plan assets 9.70% 9.70% 9.70% 9.70% 9.70% 9.70% Average rate of compensation increase 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% For measurement purposes, a 5.0% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1999 and thereafter. 32 22 Net periodic pension and postretirement benefit costs from continuing operations for the plans, exclusive of enhanced early retirement and curtailment costs, includes the following components: Pension Benefits Postretirement Benefits ------------------------------- ------------------------- (In thousands) 1998 1997 1996 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- Components of net periodic benefit cost Service cost $ 1,470 $1,669 $2,360 $ 54 $ 59 $ 81 Interest cost 8,288 8,219 7,997 532 606 620 Expected return on plan assets (10,712) (9,834) (9,150) - - - Amortization of prior service cost 605 633 610 (56) (59) (269) Recognized net actuarial (gain) (53) (145) - (136) (118) (101) Amortization of transition obligation 161 189 199 - - - -------------------------------------------------------------- Net periodic benefit cost $ (241) $ 731 $2,016 $394 $488 $331 ============================================================== The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $3.1 million, $3.0 million, and $0, respectively, as of December 31, 1998 and $2.9 million, $2.8 million, and $0, respectively, as of December 31, 1997. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage 1-Percentage (In thousands) Point Increase Point Decrease - ---------------------------------------------------------------------------------------------------------------------- Effect on total of service and interest cost components $ 14 $ (12) Effect on accumulated postretirement benefit obligation $107 $(100) The Company recognized curtailment expenses of $.3 million relating to the sale of the photofinishing businesses in 1998, and $.3 million relating to the Tape Products Division sale in 1996. Approximately $9.8 million and $9.9 million of the accrued pension cost and $10.6 million and $10.8 million of the accrued postretirement benefits for 1998 and 1997, respectively, are included in "Other long-term liabilities" in the accompanying consolidated balance sheet. Intangible pension assets of $.4 million and of $.3 million for 1998 and 1997, respectively, are included in "Other assets" in the accompanying consolidated balance sheet. Additionally, approximately $.6 million and $.8 million of the accrued postretirement benefits for 1998 and 1997, respectively, are included in "Accrued expenses" in the accompanying consolidated balance sheet. The Company is in the process of liquidating a pension plan related primarily to the UK photofinishing business sold in 1998. At December 31, 1998, the projected benefit obligation and accumulated benefit obligation under the plan were $9.3 million and the fair value of plan assets was $11.4 million. INFORMATION ABOUT OPERATIONS During the fourth quarter of 1998, the Company adopted FAS 131. Prior year segment information has been restated to present the Company's two reportable segments - (1) Imaging Supplies and (2) Specialty Coated and Label Products. The Imaging Supplies segment produces and sells copier and laser printer supplies (primarily toner, developer, remanufactured cartridges, and the distribution of paper) to distributors, original equipment manufacturers, and end users. The Specialty Coated and Label Products segment manufactures specialty coated paper and label products. These include various converted paper products sold primarily to domestic converters and re-sellers, end users and private label distributors. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies Note to the Consolidated Financial Statements. Segment data does not include restructuring and other unusual items, and does not allocate all corporate costs and assets to the divisions. The Company evaluates the performance of its segments and allocates resources to them based on pretax income before restructuring and other unusual items. Sales between business segments are insignificant. Intrasegment sales between geographic areas are generally priced at the lowest price offered to unaffiliated customers. The Company's reportable segments are strategic business units grouped by product class. They are managed separately because each business requires different technology and marketing strategies. Due to similarities between the Label Products and Specialty Coated Product Divisions, they have been aggregated and reported as one reportable segment (Specialty Coated and Label Products). 33 23 The table below presents information about reported segments for the years ending December 31: Net Sales From Pretax Income (Loss) From Continuing Operations Continuing Operations Identifiable Assets -------------------------- ------------------------- ------------------------ (In millions) 1998 1997 1996 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ By Reportable Segment Imaging Supplies $ 57.5 $ 66.5 $ 88.3 $ (2.0) $ (3.6) $ (5.4) $ 21.2 $ 22.9 $ 23.8 Specialty Coated and Label Products 110.2 106.6 110.6 9.3 7.6 4.9 47.0 43.7 43.0 Reconciling items: Other (1) .1 .1 .1 (.6) (1.5) (1.8) 1.0 .6 .6 Corporate expenses and assets - - - (4.9) (8.5) (10.9) 64.1 30.8 26.4 Restructuring and other unusual items - - - (13.8) (4.3) 1.7 - - - Discontinued operations - - - - - - .8 48.8 82.9 ----------------------------------------------------------------------------------------- Consolidated $167.8 $173.2 $199.0 $(12.0) $(10.3) $(11.5) $134.1 $146.8 $176.7 ========================================================================================= (1) Includes activity from operations which falls below the quantitative thresholds for a reportable segment. Capital expenditures and depreciation and amortization by reportable segment are set forth below for the years ended December 31: Capital Expenditures Depreciation & Amortization ------------------------ --------------------------- (In millions) 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Imaging Supplies $1.1 $ .8 $4.1 $2.1 $2.3 $3.1 Specialty Coated and Label Products 5.4 3.2 1.1 3.7 3.7 3.8 Reconciling Items: Other (1) - - .1 .2 .2 .2 Corporate .2 .4 .6 .8 1.4 1.9 -------------------------------------------------------- Consolidated $6.7 $4.4 $5.9 $6.8 $7.6 $9.0 ======================================================== (1) Includes activity from operations which falls below the quantitative thresholds for a reportable segment. The following is information by geographic area as of and for the years ended December 31: Net Sales From Continuing Operations Long-Lived Assets -------------------------- ------------------------ (In millions) 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ By Geographic Area United States $167.5 $172.4 $198.5 $39.6 $39.9 $46.1 Europe .3 .8 .5 .4 .5 .5 Reconciling Items: Discontinued operations - - - .8 48.7 49.2 --------------------------------------------------------- Consolidated $167.8 $173.2 $199.0 $40.8 $89.1 $95.8 ========================================================= COMMON STOCK INFORMATION (UNAUDITED) The Company's stock is traded on the New York Stock Exchange. At December 31, 1998, there were 1,275 record holders of the Company's common stock. 34 24 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF NASHUA CORPORATION: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations and retained earnings and of cash flows present fairly, in all material respects, the financial position of Nashua Corporation and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP - ------------------------------ PricewaterhouseCoopers LLP Boston, Massachusetts February 5, 1999 35 25 OFFICERS Gerald G. Garbacz Bruce T. Wright Joseph I. Gonzalez-Rivas Chairman, President and Vice President Vice President/President, Chief Executive Officer Human Resources Imaging Supplies Division Peter C. Anastos Joseph R. Matson John J. Ireland Vice President, General Vice President, Vice President/President, Counsel and Secretary Corporate Controller Specialty Coated Products Division John L. Patenaude Suzanne L. Ansara Gene P. Pache Vice President-Finance, Assistant Secretary Vice President/President, Chief Financial Officer Label Products Division and Treasurer DIRECTORS Sheldon A. Buckler John M. Kucharski James F. Orr III Chairman Chairman Chairman, President and Commonwealth Energy System EG&G, Inc. Chief Executive Officer (Technical and Scientific UNUM Corporation Gerald G. Garbacz Products and Services) (Insurance) Chairman, President and Chief Executive Officer David C. Miller, Jr. Peter J. Murphy Nashua Corporation President and Chief President and Chief Executive Officer Executive Officer Charles S. Hoppin ParEx Inc. Parlex Corporation Senior Counsel (Investment Company) (Electrical Components) Davis Polk & Wardwell (Law Firm) COMMITTEES AUDIT/FINANCE AND LEADERSHIP AND INVESTMENT COMMITTEE COMPENSATION COMMITTEE GOVERNANCE COMMITTEE John M. Kucharski, Chairman James F. Orr III, Chairman Sheldon A. Buckler, Chairman Sheldon A. Buckler John M. Kucharski Charles S. Hoppin Charles S. Hoppin David C. Miller, Jr. David C. Miller, Jr. Peter J. Murphy Peter J. Murphy James F. Orr III 36