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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
--------
COMMISSION FILE NUMBER 1-9335
SCHAWK, INC.
(Exact name of Registrant
as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
36-2545354
(I.R.S. Employer Identification No.)
1695 RIVER ROAD
DES PLAINES, ILLINOIS
(Address of principal executive office)
60018
(Zip Code)
847-827-9494
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by checkmark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act.)
Yes [ ] No [X]
The number of shares outstanding of each of the issuer's classes
of common stock as of April 29, 2005 is: 25,449,822 Shares of Class
A Common Stock, $.008 par value
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1
SCHAWK, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
March 31, 2005
PART I - FINANCIAL INFORMATION Page
----
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
Item 4. Controls and Procedures 15
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 16
Item 6. Exhibit 17
Signatures 19
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Schawk, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Amounts)
MARCH 31, DECEMBER 31,
2005 2004
----------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 8,228 $ 7,268
Trade accounts receivable, less allowance for doubtful accounts
of $5,973 at March 31, 2005 and $1,773 at December 31, 2004 137,732 56,332
Inventories 30,766 10,339
Prepaid expenses and other 14,778 4,702
Refundable income taxes 285 1,832
Deferred income taxes 16,404 2,353
----------- ----------
Total current assets 208,193 82,826
Property and equipment, less accumulated depreciation of
$72,017 at March 31, 2005 and $69,668 at December 31, 2004 95,517 46,431
Goodwill 209,652 71,720
Intangible assets, net 57,846 12,754
Other assets 6,581 7,032
----------- ----------
Total assets $577,789 $220,763
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 27,323 $ 8,424
Accrued expenses 89,975 26,578
Income taxes payable 11,042 --
Notes payable 7,700 --
Current portion of long-term debt and capital lease obligations 6,632 6,683
----------- ----------
Total current liabilities 142,672 41,685
Long-term debt 173,842 39,500
Capital lease obligations 270 464
Other 20,342 979
Deferred income taxes 41,494 6,695
Stockholders' equity:
Common stock, $0.008 par value, 40,000,000 shares authorized, 28,098,792 and
24,025,915 shares issued at March 31, 2005 and December 31, 2004,
respectively; 25,440,401 and 21,816,879 shares
outstanding at March 31, 2005 and December 31, 2004, respectively 223 191
Additional paid-in capital 163,614 92,350
Retained earnings 66,059 61,330
Accumulated comprehensive income 2,081 2,442
----------- ----------
231,977 156,313
Treasury stock, at cost, 2,658,391 and 2,209,036 shares of common
stock at March 31, 2005 and December 31, 2004, respectively (32,808) (24,873)
----------- ----------
Total stockholders' equity 199,169 131,440
----------- ----------
Total liabilities and stockholders' equity $ 577,789 $ 220,763
=========== ==========
See accompanying notes.
3
Schawk, Inc.
Consolidated Statements of Operations
Three Months Ended March 31, 2005 and 2004
(Unaudited)
(In Thousands, Except Per Share Amounts)
2005 2004
---------- ---------
Net sales $ 130,751 $ 52,077
Cost of sales 86,197 31,310
Selling, general, and administrative expenses 33,676 14,542
--------- --------
Operating income 10,878 6,225
Other income (expense)
Interest income 69 --
Interest expense (1,943) (465)
--------- --------
(1,874) (465)
--------- --------
Income before income taxes 9,004 5,760
Income tax provision 3,440 2,133
--------- --------
Net income $ 5,564 $ 3,627
========= ========
Earnings per share:
Basic $ 0.23 $ 0.17
Diluted $ 0.22 $ 0.16
Weighted average number of common and common
equivalent shares outstanding 25,670 22,366
Dividends per common share $ 0.0325 $ 0.0325
See accompanying notes.
4
Schawk, Inc.
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2005 and 2004
(Unaudited)
(In Thousands)
2005 2004
---------- ---------
OPERATING ACTIVITIES
Net income $ 5,564 $ 3,627
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization 6,193 2,934
Deferred income taxes 565 373
Loss realized on sale of property and equipment -- 7
Changes in operating assets and liabilities, net of effects from
acquisitions:
Trade accounts receivable (10,200) (5,120)
Inventories (423) (2,977)
Prepaid expenses and other 925 125
Trade accounts payable and accrued expenses (10,466) 59
Income taxes refundable/payable 1,567 1,286
--------- --------
Net cash provided by (used in) operating activities (6,275) 314
INVESTING ACTIVITIES
Proceeds from sales of property and equipment 651 1
Capital expenditures (3,377) (1,921)
Acquisitions, net of cash acquired (202,522) (5,126)
Contingent acquisition purchase price received from (paid to) escrow 890 (1,600)
account
Other 187 (42)
--------- --------
Net cash used in investing activities (204,171) (8,688)
FINANCING ACTIVITIES
Proceeds from debt 142,030 8,700
Principal payments on capital lease obligations (283) (9)
Payment of deferred loan fees (588) --
Common stock dividends (835) (692)
Purchase of common stock (43) --
Issuance of common stock 71,296 588
--------- --------
Net cash provided by financing activities 211,577 8,587
--------- --------
Effect of foreign currency rate changes (171) (158)
--------- --------
Net increase in cash and cash equivalents 960 55
Cash and cash equivalents beginning of period 7,268 5,227
--------- --------
Cash and cash equivalents end of period $ 8,228 $ 5,282
========= ========
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 342 $ 258
Cash paid for income taxes 1,401 474
See accompanying notes.
5
Schawk, Inc.
Notes to Consolidated Interim Financial Statements
(Unaudited)
(In thousands of dollars, except per share data)
NOTE 1. BASIS OF PRESENTATION
The consolidated interim financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC). Certain
information and footnote disclosures normally included in annual financial
statements prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted pursuant to such rules and
regulations, although Schawk, Inc. (the Company) believes the disclosures
included are adequate to make the information presented not misleading. In
addition, certain prior year amounts have been reclassified to conform to the
current year presentation. In the opinion of management, all adjustments
necessary for a fair presentation for the periods presented have been reflected
and are of a normal recurring nature. These financial statements should be read
in conjunction with the Company's consolidated financial statements and the
notes thereto for the three years ended December 31, 2004, as filed with its
2004 annual report on Form 10-K.
NOTE 2. INTERIM RESULTS
Results of operations for the interim periods are not necessarily indicative of
the results to be expected for the full year.
NOTE 3. DESCRIPTION OF BUSINESS
The Company is a leading supplier of digitized high resolution color graphic
services to food, beverage, health & beauty, pharmaceutical, home care and
consumer products packaging, point of sale, retail and advertising markets.
NOTE 4. INVENTORIES
Inventories consist of the following:
March 31, December 31,
2005 2004
--------- ------------
Raw materials $ 4,582 $ 3,768
Work in process 27,266 7,653
-------- -----------
31,848 11,421
Less: LIFO reserve (1,082) (1,082)
-------- -----------
$ 30,766 $ 10,339
======== ===========
NOTE 5. EARNINGS PER SHARE
Basic earnings per share and diluted earnings per share are shown on the
Consolidated Statements of Operations. Basic earnings per share are computed by
dividing net income by the weighted average shares outstanding for the period.
Diluted earnings per share are computed by dividing net income by the weighted
average number of common shares and common stock equivalent shares outstanding
(stock options) for the period.
6
The following table sets forth the computation of basic and diluted earnings per
share:
Three months ended March 31,
----------------------------
2005 2004
------------- ------------
Net income $ 5,564 $ 3,627
======= =======
Weighted average shares 24,239 21,465
Effect of dilutive stock options 1,431 901
------- -------
Adjusted weighted average shares and
assumed conversions 25,670 22,366
======= =======
Basic earnings per share $ 0.23 $ 0.17
======= =======
Diluted earnings per share $ 0.22 $ 0.16
======= =======
NOTE 6. SEGMENT REPORTING
The Company operates in a single business segment, Digital Imaging Graphic Arts.
The Company operates primarily in three geographic areas, the United States,
U.K. and Europe and Canada. Summary financial information by geographic area is
as follows:
Three months ended March 31, 2005
-------------------------------------------------------
U.K. and Other
United States Canada Europe Foreign Total
------------- ------- --------- ---------- --------
Sales $ 98,259 $ 8,770 $ 19,316 $ 4,406 $130,751
Long-lived assets 318,493 19,334 24,863 6,908 369,598
Net Assets 188,677 13,026 (214) (2,320) 199,169
Three months ended March 31, 2004
-------------------------------------------------------
U.K. and Other
United States Canada Europe Foreign Total
------------- ------- --------- ---------- --------
Sales $ 41,905 $ 7,444 -- $ 2,728 $ 52,077
Long-lived assets 84,254 16,751 -- 7,586 108,591
Net Assets 101,782 10,263 -- (2,417) 109,628
NOTE 7. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the three months
ended March 31, 2005 and 2004, respectively, are as follows:
Three months ended March 31,
----------------------------
2005 2004
------------- ------------
Net income $5,564 $3,627
Foreign currency translation adjustments (361) (267)
------ ------
Comprehensive income $5,203 $3,360
====== ======
7
NOTE 8. STOCK BASED COMPENSATION
The Company has an Equity Option Plan that provides for the granting of options
to purchase up to 5,252 shares of Class A common stock to key employees. The
Company has also adopted an Outside Directors' Formula Stock Option Plan
authorizing unlimited grants of options to purchase shares of Class A common
stock to outside directors. Options granted under these plans have an exercise
price equal to the market price of the underlying stock at the date of grant and
are exercisable for a period of ten years from the date of grant and vest over a
three-year period.
The Company accounts for these plans under the recognition and measurement
principles of Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. No stock-based employee
compensation cost is reflected in the net income, as all options granted under
these plans have an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect on
net income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation", to stock-based employee compensation.
Three Months Ended March. 31,
-----------------------------
2005 2004
------------- --------------
Net income, as reported $ 5,564 $ 3,627
Less: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (130) (550)
--------- ---------
Net income, pro forma $ 5,434 $ 3,077
========= =========
Earnings per share
Basic $ 0.23 $ 0.17
Diluted $ 0.22 $ 0.16
Pro forma earnings per share
Basic $ 0.22 $ 0.14
Diluted $ 0.21 $ 0.14
In December 2004, the FASB issued SFAS 123(R) (revised December 2004), "Share-
Based Payment", which is a revision of SFAS 123, "Accounting for Stock-Based
Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees." This statement requires that the fair value at the grant date
resulting from all share-based payment transactions be recognized in the
financial statements. Further, SFAS 123(R) requires entities to apply a
fair-value based measurement method in accounting for these transactions. This
value is recorded over the vesting period. This statement is effective for the
first fiscal year beginning after June 15, 2005. The Company is currently
evaluating the provisions of SFAS 123(R), and the impact on its consolidated
financial position and results of operations.
NOTE 9. ACQUISITIONS
On January 31, 2005, the Company completed its acquisition of 100% of the
outstanding stock of Seven Worldwide Holdings, Inc., formerly known as KAGT
Holdings, Inc. Seven Worldwide Holdings was the parent of Seven Worldwide, Inc,
a graphics services company with operations in North America, Europe, and the
Asia-Pacific region. The results of operations of Seven Worldwide, Inc. for the
period February 1, 2005 through March 31, 2005 are included in the Consolidated
Statement of Operations for the three month period ended March 31, 2005. The
acquisition resulted in the recognition of goodwill in the Company's financial
statements because the purchase price reflects the complimentary strategic fit
that the acquired business brings to the Company's existing operations. The
Company expects to realize significant operating synergies as a result of this
acquisition through consolidation of duplicate facilities and reduced operating
expenses. The goodwill is not expected to be deductible as an operating expense
for tax purposes.
8
The purchase price of $208,682 consisted of $135,566 paid in cash at closing,
$2,596 of acquisition-related professional fees and the issuance of 4,000 shares
of the Company's Class A common stock with a value of $70,520, based on the
average market price of the Company's common stock for the five day period
beginning two business days before the execution of the acquisition agreement.
Included in the purchase price is cash of $5,993 and 448 shares of the Company's
Class A common stock, valued at $7,892, paid to the KAGT Holdings, Inc. Rabbi
Trust, to be allocated to the subaccounts of certain stockholders and executives
under the KAGT Holdings, Inc 2005 Deferred Compensation Plan. The assets of the
Rabbi Trust are subject to the general creditors of the Company and have been
accounted for as assets of the Company on the March 31, 2005 Consolidated
Balance Sheet. The cash of $5,993 is included in Other current assets, the
shares issued are included in Treasury Stock at a value of $7,892 and a Deferred
compensation liability in the amount of $13,885 is included in Other current
liabilities. The assets of the Rabbi Trust are expected to be distributed to the
participants in the KAGT Holdings, Inc. Deferred Compensation Plan during the
second quarter of 2005.
The Company has recorded a preliminary purchase price allocation based upon a
tangible and intangible asset appraisal that is in progress and will adjust the
allocation as needed upon completion of the appraisal. A summary of the
preliminary estimated fair values assigned to the acquired assets is as follows:
Trade accounts receivable $ 71,200
Inventory 20,004
Other current assets 4,972
Fixed assets 51,602
Intangible assets, principally customer relationships 46,267
Goodwill 138,032
Other assets 1,522
Accounts payable (19,093)
Other current liabilities (61,426)
Income taxes payable (16,445)
Long term debt and capital lease obligations (50)
Deferred income taxes (14,760)
Other liabilities (19,303)
---------
Total purchase price, net of $6,160 cash received $ 202,522
The weighted-average amortization period of the intangible assets, principally
customer relationships, is 9.2 years. The intangible asset amortization expense
was $935 for the quarter ended March 31, 2005 and will be $5,610 annually for
each of the five fiscal years beginning April 1, 2005.
The Company expects significant synergies and reduced operating expenses from
the consolidation of duplicate facilities acquired in this acquisition and began
work on a consolidation plan before the acquisition was finalized. Although the
plans are still preliminary, the Company has recorded an estimated restructuring
reserve at January 31, 2005 in the amount of $11,790. The major expenses
included in the restructuring reserve are employee severance and lease
termination expenses. The Company expects that most of the facility
consolidations included in this plan will be initiated in the second and third
quarters of 2005 and will adjust the restructuring reserve as better information
becomes available. The reserve was recorded as an increase to Goodwill and
Accrued expenses. The following table summarizes the reserve recorded at January
31, 2005 and the activity through March 31, 2005:
Balance Additional Balance
Jan 31, 2005 Expense Payments Mar 31, 2005
------------ ---------- -------- ------------
Employee severance $ 7,075 ($1,729) $ 5,346
Lease termination 1,861 (62) 1,799
Other 2,854 (180) 2,674
------- ------- -------
Total $11,790 ($1,971) $ 9,819
The Company has reviewed the tax history with respect to its acquisition of KAGT
Holdings and Subsidiaries and has accrued additional tax liabilities through
purchase accounting for certain tax implications of the prior acquisition of
Seven Worldwide, Inc. (formerly known as AGT, Inc.) by the prior owner. The
Company is a party to an indemnity provision in the Stock Acquisition Agreement
which may allow for a recovery of some or all of these liabilities if and when a
final determination is made.
9
The following table presents the unaudited pro forma results of operations of
the Company for the three month periods ended March 31, 2005 and March 31, 2004.
The unaudited pro forma financial information summarizes the results of
operations for the periods indicated as if the KAGT Holdings, Inc. acquisition
had occurred at the beginning of each period. The pro forma information contains
the actual combined operating results of Schawk Inc. and Seven Worldwide, Inc.,
with the results prior to the acquisition adjusted to include the pro forma
impact of: 1)elimination of Seven Worldwide interest expense and deferred
financing cost amortization related to bank debt retired at acquisition, offset
by pro forma interest expense on Schawk Inc. bank debt and private placement
financing used to fund the acquisition, 2)elimination of redundant Seven WW
senior management not retained post-acquisition. Pro forma adjustments for
depreciation of the fair value of fixed assets acquired and pro forma
amortization of acquired intangible assets are not needed because the pro forma
expense approximates the actual depreciation and amortization expense included
in the Seven Worldwide results of operation pre-acquisition. The Seven Worldwide
results of operations for the period ended March 31, 2004 have been restated to
eliminate discontinued operations of a division of the company divested in mid
2004.
Pro forma, unaudited, in thousands, Three months ended Three months ended
except per share amounts March 31, 2005 March 31, 2004
- ----------------------------------- ------------------ ------------------
Total revenue $154,944 $138,148
Net income 2,793 1,159
Diluted earnings per share $ 0.11 $ 0.05
In connection with its acquisition of the assets of Weir Holdings Limited
(Winnetts) on December 31, 2004, the Company established a restructuring
reserve, primarily for employee severance and lease abandonment expenses, in the
amount of $2,500. The following table summarizes the activity in the reserve for
the first three months of 2005:
Balance Additional Balance
Dec 31, 2004 Expense Payments Mar 31, 2005
------------ ---------- -------- ------------
Employee severance $1,254 $1,254
Lease termination 837 837
Other 409 409
------ ------
Total $2,500 $2,500
NOTE 10. DEBT
In connection with the Company's financing of the Seven Worldwide acquisition,
the Company entered into a credit agreement dated January 28, 2005 with JPMorgan
Chase Bank, N.A. The credit agreement provides for a five-year unsecured
revolving credit facility of $100,000, expandable to $125,000, with interest at
LIBOR plus a margin based on the Company's cash flow leverage ratio. $98,830 was
outstanding under this agreement at March 31, 2005 and is included in Long-term
debt on the Consolidated Balance Sheet.
Also on January 28, 2005, the Company entered into a Note Purchase and Private
Shelf Agreement with Prudential Investment Management Inc, pursuant to which the
Company sold $50,000 in a series of three Senior Notes. The first note, in the
amount of $10,000, will mature in 2010 and bears interest at 4.81%. The second
and third notes, each in the amount of $20,000, mature in 2011 and 2012,
respectively, and bear interest at the rate of 4.99% and 5.17%, respectively.
The total of these notes, $50,000, is included in Long-term debt on the March
31, 2005 Consolidated Balance Sheet.
The borrowings under both agreements are subject to certain restrictive
covenants. The Company is in compliance with these covenants as of March 31,
2005.
The Company executed an unsecured Line of Credit Note for $10,000 with a due
date of May 31, 2005 and interest at the prime rate. $7,700 was outstanding on
this note at March 31, 2005 and is classified as Notes payable in the current
liability section of the Consolidated Balance Sheet. $2,300 of additional credit
was available to the Company under the Line of Credit Note at March 31, 2005.
10
On April 15, 2005, the accordion feature of the credit agreement dated January
28, 2005 was utilized to increase the size of the revolving credit commitment to
$115,000 from $100,000 to provide additional flexibility to the Company. The
Company plans on refinancing the Line of Credit Note prior to its expiration
date on May 31, 2005 with borrowings under the expanded revolving credit
commitment.
NOTE 11. INTANGIBLES
As of March 31, 2005, the acquired intangible assets related to the Winnetts
acquisition on December 31, 2004 and the Seven Worldwide acquisition on January
31, 2005 have been valued based on preliminary purchase price allocations. The
amounts allocated to intangible assets may be adjusted when these purchase price
allocations are finalized. Intangible assets, resulting primarily from the
Winnetts, Seven Worldwide and previous acquisitions accounted for under the
purchase method of accounting, consist of the following:
March 31 December 31 Weighted
2005 2004 Average Life
--------- ----------- ------------
Customer relationships $ 49,375 $ 12,632 10.0 years
Non-compete agreements 681 681 3.4 years
Patents 312 311 16.5 years
Customer contracts 6,552 -- 3.8 years
Trade names 2,961 -- 9.8 years
-------- ----------
59,881 13,624 9.3 years
Accumulated amortization (2,035) (870)
-------- ----------
$ 57,846 $ 12,754
Amortization expense related to intangible assets was $1,165 for the first
quarter of 2005. Amortization expense for each of the next five fiscal years
beginning April 1, 2005 is expected to be approximately $6,900 for fiscal years
2005, 2006 and 2007, $6,500 for fiscal year 2008 and $5,200 for fiscal year
2009.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Thousands of dollars, except per share amounts)
Certain statements contained herein that relate to the Company's beliefs or
expectations as to future events are not statements of historical fact and are
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. The Company intends any such statements
to be covered by the safe harbor provisions for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1999. Although the
Company believes that the assumptions upon which such forward-looking statements
are based are reasonable within the bounds of its knowledge of its business and
operations, it can give no assurance the assumptions will prove to have been
correct and undue reliance should not be placed as such statements. Important
factors that could cause actual results to differ materially and adversely from
the Company's expectations and beliefs include, among other things, higher than
expected costs or unanticipated difficulties associated with integrating the
acquired operations of Winnetts and Seven Worldwide, higher than expected costs
associated with compliance with legal and regulatory requirements, the strength
of the United States economy in general and specifically market conditions for
the consumer products industry, the level of demand for the Company's services,
loss of key management and operational personnel, the ability of the Company to
implement its growth strategy, the stability of state, federal and foreign tax
laws, the ability of the Company to identify and exploit industry trends and to
exploit technological advances in the imaging industry, ability to implement
restructuring plans, the stability of political conditions in Asia and other
countries in which the Company has production capabilities, terrorist attacks,
wars, diseases and other geo-political events as well as other factors detailed
in the Company's filings with the Securities and Exchange Commission. The
Company assumes no obligation to update publicly any of these statements in
light of future events.
11
EXECUTIVE-LEVEL OVERVIEW
The Company grew substantially in the first quarter of 2005 as a result of two
important acquisitions. The Company's annual revenue is expected to reach
$625,000 - $635,000 in 2005 as compared to $238,000 in 2004 with most of the
growth attributable to the two acquisitions, Weir Holdings, Inc. (trade name
"Winnetts") on December 31, 2004 and Seven Worldwide, Inc. (Seven Worldwide) on
January 31, 2005.
A majority of the Company's revenues are driven by marketing and advertising
spending by consumer products companies and retailers. The markets served are
consumer products manufacturers and pharmaceutical, entertainment, retail and
publishing companies. All of the company's business involves producing graphic
images for various applications. Generally, a graphic image is created by the
Company or a third party and then the Company manipulates that image to enhance
the color of the image and to prepare it for print. The applications vary from
consumer product packaging, including food and beverage packaging images, to
retail advertisements in newspapers, including free standing inserts (FSI's),
magazine ads, publications, catalogs and textbooks.
The graphics process is generally the same regardless of the application. The
following steps in the graphics process must take place to produce a final
image:
- Planning and Messaging
- Strategic Design
- Content Creation
- File Building
- Retouching
- Art Production
- Pre-Media
The Company's involvement in a client project may involve many of the above
steps or just one of the steps, depending on the clients needs.
The Company has 61 operating locations globally that produce graphic images for
clients. While providing a variety of services from location to location, the
Company's operations are similar to one another in that regardless of the client
assignment, graphic artists produce the work in an office environment by
applying specialized techniques and using standard graphics software and
computers. Many locations produce graphic images for more than one market.
Each client assignment, or "job", is a custom job in that the image being
produced is unique, even if it only involves a small change from an existing
image, such as adding a "low fat" banner on a food package. Essentially, change
equals revenue. The Company is paid for its graphic imaging work based on time
and materials, not based on the success or failure of the food product, the
promotion or the ad campaign.
For the quarter ended March 31, 2005, the Company increased sales by 151.1% over
the first quarter of 2004. The revenue growth was attributable to the Company's
sales of graphic and design services to its consumer packaged goods clients.
12.3 points of the sales increase was internally generated and 138.8 points of
the increase was due to the acquisition of Winnetts and Seven Worldwide. The
Company's historical business benefited from the recent trend in the food
industry for recipe and ingredient changes based on awareness of the need for a
healthy diet. The Company's gross profit and operating income increased in the
first quarter of 2005 as a result of the acquisitions and strong results from
the historical business. Gross margin and operating margin decreased in the
first quarter of 2005 relative to the first quarter of 2004 as a result of lower
margin business from the acquired companies. Net income increased to $5,564 from
$3,627 quarter over quarter. First quarter earnings per share were 22 cents,
fully diluted, compared to the prior year first quarter earnings per share of 16
cents.
As previously disclosed, on January 31, 2005, the Company completed the
acquisition of Seven Worldwide, a $370 million in revenue graphic services
company with operations in 40 locations in the United States, Europe, Asia and
Australia. The purchase price of $208,682 consisted of $135,566 paid in cash at
closing, $2,596 of acquisition-related professional fees and the issuance of
4,000 shares of the Company's Class A common stock with a value of $70,520.
The Company expects significant synergies and reduced operating expenses from
the consolidation of duplicate facilities acquired in this acquisition and began
work on a consolidation plan before the acquisition was finalized. Although the
plans are still preliminary, the Company has recorded an estimated restructuring
reserve at January 31, 2005 in the amount of $11,790. The major expenses
included in the restructuring reserve are employee severance and lease
termination expenses. The Company expects that most of the facility
consolidations included in this plan will be initiated
12
in the second and third quarters of 2005 and will adjust the restructuring
reserve as better information becomes available.
In connection with the Company's financing of the Seven Worldwide acquisition,
the Company entered into a credit agreement dated January 28, 2005 with JPMorgan
Chase Bank, N.A. The credit agreement provides for a five-year unsecured
revolving credit facility of $100,000, which was expanded to $115,000 on April
15, 2005. Also on January 28, 2005, the Company entered into a Note Purchase and
Private Shelf Agreement with Prudential Investment Management Inc, pursuant to
which the Company sold $50,000 in a series of three Senior Notes. As of March
31, 2005 there was $188,174 of debt outstanding of which $173,842 was considered
long-term.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
Schawk, Inc.
Comparative Consolidated Statements of Operations
Three Months Ended March 31, 2005 and 2004
(in thousands)
$ %
2005 2004 CHANGE CHANGE
---------- ---------- ----------- ----------
Net sales $ 130,751 $ 52,077 $ 78,674 $ 151.1%
Cost of sales 86,197 31,310 54,887 175.3%
--------- -------- ---------
Gross profit 44,554 20,767 23,787 114.5%
Gross margin percentage 34.1% 39.9%
Selling, general and administrative expenses 33,676 14,542 19,134 131.6%
--------- -------- ---------
Operating income 10,878 6,225 4,653 74.7%
Operating margin percentage 8.3% 12.0%
Other income (expense)
Interest income 69 -- 69 nm
Interest expense (1,943) (465) (1,478) 317.8%
--------- -------- ---------
(1,874) (465) (1,409) 303.0%
--------- -------- ---------
Income before income taxes 9,004 5,760 3,244 56.3%
Income tax provision 3,440 2,133 1,307 61.3%
--------- -------- ---------
Effective income tax rate 38.2% 37.0%
Net income $ 5,564 3,627 $ 1,937 53.4%
========= ======== =========
nm - Percentage not meaningful
Net sales increased $78.7 million or 151.1% as compared to the prior year first
quarter. The increase is primarily due to the acquisitions of Winnetts and Seven
Worldwide. The acquisitions accounted for 138.8 points of the net revenue
increase. In the first quarter of 2005, Seven Worldwide generated sales of $62.4
million from February 1 to quarter-end and Winnetts generated sales of $9.9
million. The remaining increase of 12.3% was due to internally generated sales
increases from existing core businesses.
Gross margin for the first quarter of 2005 decreased to 34.1% from 39.9% for the
first quarter of 2004, primarily due to lower margin business from the Seven
Worldwide and Winnetts acquisitions.
Operating income for the first quarter of 2005 increased 74.7% to $10.9 million
compared to $6.2 million in the first quarter of 2004. The increase is primarily
due to continued strength in sales to consumer products packaging clients as
well as operating income from the acquired companies. The operating margin
percentage decreased to 8.3% in the first quarter of 2005 compared to 12.0% in
the first quarter of 2004 primarily due to lower margin business from the Seven
Worldwide and Winnetts acquisitions.
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Interest expense of $1.9 million for the first quarter of 2005 increased $1.5
million compared to the same period in 2004. The increase is due to $142 million
of additional indebtedness incurred in connection with the Winnetts and Seven
Worldwide acquisitions.
Income tax expense for the first quarter of 2005 was at an effective tax rate of
38.2% compared to a rate of 37.0% in the first quarter of 2004. The higher
effective tax rate in 2005 was attributable to increased profits in higher tax
jurisdictions as compared to the prior year. It is anticipated that the
effective tax rate for 2005 will be in the range of 37.0% to 38.0%.
Net income and earnings per share were higher in the first quarter of 2005 as
compared to the first quarter of 2004 for the reasons previously described.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2005, the Company had $8,228 in consolidated cash and cash
equivalents, compared to $7,268 at December 31, 2004.
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Cash used in operations was $6,275 in the first quarter of 2005 compared to cash
provided by operations of $314 in the first quarter of 2004. The increase in
cash used in operations was primarily a result of an increase in accounts
receivable and a decrease in accrued liabilities. The increase in accounts
receivable was due in part to an increase in trade receivables at Seven
Worldwide during the period from acquisition closing to quarter-end. The Company
considers this increase to be a timing issue and anticipates improved cash flow
from operations as the jobs invoiced in the first quarter are collected. The
decrease in accrued liabilities is due in part to the timing of payroll-related
expenses at each quarter-end.
Depreciation and amortization expense in the first quarter of 2005 was $6,193 as
compared to $2,934 in the first quarter of the prior year. The increase in
depreciation and amortization expense is attributable to the additional
property, plant and equipment and intangible assets acquired in the Seven
Worldwide and Winnetts acquisitions.
CASH USED IN INVESTING ACTIVITIES
Cash used in investing activities was $204,171 in the first quarter of 2005
compared to $8,688 in the first quarter of 2004. The increase in cash used in
the first quarter of 2005 reflects the acquisition of Seven Worldwide for
$202,522. In the first quarter of 2004, $6,494 was used for the acquisition of
Virtualcolor, including $1,600 of contingent purchase price paid to an escrow
account.
Capital expenditures were $3,377 in the first quarter of 2005 compared to $1,921
in the first quarter of 2004. The increase in capital expenditures in 2005 is
primarily due to the completion of the build-out of the new Toronto facility as
well as capital expenditures at the newly acquired companies. Capital
expenditures are anticipated to be in a range of $20,000 to $22,000 for all of
2005.
CASH PROVIDED BY FINANCING ACTIVITIES
Cash provided by financing activities was $211,577 for the first quarter of 2005
compared to $8,587 in the first quarter of 2004. The cash provided by financing
activities in the first quarter of 2005 includes $142,030 of proceeds from new
debt and $70,520 of common stock issued to finance the Seven Worldwide
acquisition.
Dividend payments on common stock were $835 for the first quarter of 2005
compared to $692 in the first quarter of 2004. It is anticipated that the
Company will continue to pay dividends at the current level for the remainder of
2005.
In January 2005, the Company entered into a credit agreement with JPMorgan Chase
Bank, N.A. The agreement provides for a five year unsecured revolving credit
facility of $100,000, expandable to $125,000, with interest at LIBOR plus a
margin based on the Company's cash flow leverage ratio. This credit agreement
replaced a $30,000 unsecured credit agreement previously in place. $98,830 was
outstanding under the new agreement at March 31, 2005 and is included in
Long-term debt on the March 31, 2005 Consolidated Balance Sheet. On April 15,
2005, the accordion feature of the credit agreement was utilized to increase the
size of the revolving credit commitment to $115 million from $100 million to
provide additional flexibility to the Company.
Also in January 2005, the Company entered into a Note Purchase and Private Shelf
Agreement with Prudential Investment Management Inc, pursuant to which the
Company sold $50,000 in a series of three Senior Notes. The first
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note, in the amount of $10,000, will mature in 2010 and bears interest at 4.81%.
The second and third notes, each in the amount of $20,000, mature in 2011 and
2012, respectively, and bear interest at the rate of 4.99% and 5.17%,
respectively. The total of these notes, $50,000, is included in Long-term debt
on the March 31, 2005 Consolidated Balance Sheet.
The Company executed an unsecured Line of Credit Note with JPMorgan Chase Bank,
N.A. on February 1, 2005 for $10,000 with a due date of May 31, 2005 and
interest at the prime rate. $7,700 was outstanding on this note at March 31,
2005 and is classified as Notes payable in the current liability section of the
Consolidated Balance Sheet. $2,300 of additional credit was available to the
Company under the Line of Credit Note at March 31, 2005. The Company plans on
refinancing the Line of Credit Note prior to its expiration date on May 31, 2005
with borrowings under the expanded revolving credit commitment.
In December of 2003, the Company entered into a private placement of debt to
provide long-term financing. The terms of the Note Purchase Agreement relating
to this transaction provided for the issuance and sale by the Company, pursuant
to an exception from the registration requirements of the Securities Act of
1933, of two series of notes: 1) Tranche A, due December 31, 2013, for $15,000,
which closed in December 2003; and, 2) Tranche B, due April 30, 2014, for
$10,000, which closed in April 2004. The total debt of $25,000 issued under the
private placement agreement is shown as Long Term Debt on the March 31, 2005
Consolidated Balance Sheet.
Management believes that the level of working capital is adequate for the
Company's liquidity needs related to normal operations both currently and in the
foreseeable future, and that the Company has sufficient resources to support its
growth, either through currently available cash and cash generated from future
operations, or pursuant to its revolving credit facility.
SEASONALITY
With the acquisitions of Winnetts and Seven Worldwide, the seasonal fluctuations
in business on a combined basis generally result in lower revenues in the first
quarter as compared to the rest of the year ended December 31.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A discussion regarding market risk is disclosed in the Company's December 31,
2004 Form 10-K. There have been no material changes in information regarding
market risk relating to the Company's business on a consolidated basis since
December 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
it is able to collect the information it is required to disclose in the reports
it files with the Securities and Exchange Commission (SEC), and to process,
summarize and disclose this information within the time periods specified in the
rules of the SEC. Based on an evaluation of the Company's disclosure controls
and procedures as of the end of the period covered by this report conducted by
the Company's management, with the participation of the Chief Executive and
Chief Financial Officers, the Chief Executive and Chief Financial Officers
believe that these controls and procedures are effective to ensure that the
Company is able to collect, process and disclose the information it is required
to disclose in the reports it files with the SEC within the required time
periods.
In order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of
2002 ("Section 404"), beginning with the Company's Annual Report on Form 10-K
for the fiscal year ending December 31, 2005, the Company will be required to
furnish a report of management as to the effectiveness of the Company's internal
control over financial reporting and a report by the Company's independent
auditors addressing management's assessment. The Company is in the process of
documenting and evaluating the design and operating effectiveness of its
internal control procedures. These assessments, which have been underway for
more than a year and are not yet complete, have been impacted by the Company's
recent growth related to the Winnetts and Seven Worldwide acquisitions. Since
December 31, 2004, the Company has grown from approximately 30 operating
locations to approximately 61 combined operating locations worldwide, with
varied policies, procedures, systems, personnel and internal control procedures
which are still in the process of being integrated.
15
In connection with its assessment, management has identified and communicated to
the Company's Audit Committee and independent auditors the following
deficiencies in the documentation, design and effectiveness of its internal
control over financial reporting that the Company is in the process of
remediating:
Inadequate general computer controls primarily relating to a lack of
segregation of duties surrounding (i) financial systems and
information technology infrastructure change controls; and (ii) user
access rights to certain financial systems at multiple global
locations; and
Primarily as a result of the recently completed Winnetts and Seven
Worldwide acquisitions, lack of (i) documented, comprehensive,
standardized policies and procedures for the combined global
company; and (ii) sufficient documentation over the financial
statement closing process, combined with key employee turnover and
redundant staffing levels.
Although management believes it has made significant progress in these areas,
there is a significant risk that remediation and testing of these deficiencies
may not be completed on a timely basis. It is also possible that the Company
could experience further delays in its Section 404 compliance efforts or
identify deficiencies in addition to those discussed above. If the Company is
unable to complete Section 404 compliance efforts and/or its remediation and
testing process in a timely manner, management may be required to conclude that
its internal control over financial reporting is not effective as of December
31, 2005.
Because the Company has not completed its evaluation of the deficiencies
described above, it has not been able to determine whether the deficiencies
described above or any as yet unidentified deficiencies constitute significant
deficiencies, material weaknesses or aggregate to material weaknesses in the
Company's internal control over financial reporting.
CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no other changes to our internal control over financial reporting
during the quarter ended March 31, 2005 that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II - OTHER INFORMATION
ITEMS 1, 3, 4, AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
UNREGISTERED SALES OF EQUITY SECURITIES BY THE COMPANY
As described above, on January 31, 2005, in connection with the consummation of
the Seven Worldwide acquisition, the Company issued 4,000,000 shares of its
common stock, $0.008 par value, to certain stockholders of Seven Worldwide
Holdings in a transaction not involving a public offering pursuant to the
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended.
PURCHASES OF EQUITY SECURITIES BY THE COMPANY
As previously disclosed, the Company occasionally repurchases its common shares,
pursuant to a general authorization from the Board of Directors, which is
renewed annually. There were no repurchases of common stock by the Company under
this program during the first quarter of 2005. However, during the first quarter
of 2005, 2,056 shares of common stock with a market value of $43,125 were
tendered to the Company by certain employee stockholders in payment of stock
options exercised. The Company has recorded the receipt of common stock in
payment for stock options exercised as a purchase of treasury stock.
16
The following table summarizes the shares recorded by the Company as repurchases
in connection with stock option exercises during the first quarter of 2005:
Total No. Avg. Price No. Shares Purchased
Shares Paid Per as Part of Publicly
Period Purchased Share Announced Program
- ------------------ --------- ---------- --------------------
January -- -- --
February -- -- --
March 2,056 $20.98 --
----- ------ ------
1st Qtr 2005 Total 2,056 $20.98 --
===== ====== ======
ITEM 6. EXHIBITS
A. Exhibits
EXHIBIT # DESCRIPTION
- --------- -----------
2.1 Stock Purchase Agreement by and among Schawk, Inc., Seven Worldwide,
Inc., KAGT Holdings, Inc. and the Stockholders of KAGT Holdings, Inc.
dated as of December 17, 2004. Incorporated herein by reference to
Exhibit 2.1 to Registrant's Form 8-K dated December 17, 2004 and
filed December 20, 2004 (File No. 1-09335).
3.1 Certificate of Incorporation of Schawk, Inc., as amended.
Incorporated herein by reference to Registration Statement No.
33-85152.
3.3 By-Laws of Schawk, Inc., as amended. Incorporated herein by reference
to Registration Statement No. 333-39113.
4.1 Specimen Class A Common Stock Certificate. Incorporated herein by
reference to Registration Statement No. 33-85152
10.1 Amended and Restated Registration Rights Agreement, dated as of
January 31, 2005, among Schawk, Inc. and certain principal
stockholders of Schawk, Inc. Incorporated herein by reference to
Exhibit 10.1 to Registrant's Form 8-K dated January 27, 2005 and
filed February 2, 2005 (File No. 1-09335).
10.2 Registration Rights Agreement, dated as of January 31, 2005, among
Schawk, Inc., certain principal stockholders of Schawk, Inc. and
certain stockholders of KAGT Holdings, Inc. Incorporated herein by
reference to Exhibit 10.2 to Registrant's Form 8-K dated January 27,
2005 and filed February 2, 2005 (File No. 1-09335).
10.3 Governance Rights Agreement, dated as of January 31, 2005, among
Schawk, Inc., certain principal stockholders of Schawk, Inc. and
certain stockholders of KAGT Holdings, Inc. Incorporated herein by
reference to Exhibit 10.3 to Registrant's Form 8-K dated January 27,
2005 and filed February 2, 2005 (File No. 1-09335).
10.4 Credit Agreement, dated as of January 28, 2005, among Schawk, Inc.,
certain subsidiaries of Schawk, Inc. from time to time party thereto,
certain financial institutions from time to time party thereto as
lenders, and JPMorgan Chase Bank, N.A., as agent. Incorporated herein
by reference to Exhibit 10.4 to Registrant's Form 8-K dated January
27, 2005 and filed February 2, 2005 (File No. 1-09335).
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10.5 Note Purchase and Private Shelf Agreement, dated as of January 28,
2005, among Schawk, Inc., Prudential Investment Management, Inc., The
Prudential Insurance Company of America, and RGA Reinsurance Company.
Incorporated herein by reference to Exhibit 10.5 to Registrant's Form
8-K dated January 27, 2005 and filed February 2, 2005 (File No.
1-09335).
10.6 First Amendment to Note Purchase Agreement, dated as of January 28,
2005, among Schawk, Inc. and the institutional purchasers party
thereto. Incorporated herein by reference to Exhibit 10.6 to
Registrant's Form 8-K dated January 27, 2005 and filed February 2,
2005 (File No. 1-09335).
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
*
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
*
32 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 *
* Filed herewith
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on the 12th day of May 2005.
SCHAWK, INC.
- ------------
(Registrant)
/s/ David A. Schawk
- ---------------------------------
President, Chief Executive Officer and Director
/s/ James J. Patterson
- ---------------------------------
Senior Vice President and Chief Financial Officer
19