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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, 2006
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)
66-0323724
(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 check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Securities Act). Yes [ ] No [X]
The number of shares of the Registrant's Common Stock outstanding as of May 4,
2006, was 26,477,147.
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1
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SCHAWK, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
March 31, 2006
Page
----
PART I -- FINANCIAL INFORMATION
- -------------------------------
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Procedures 23
PART II -- OTHER INFORMATION
- ----------------------------
Item 1A. Risk Factors. 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 6. Exhibits 25
Signatures 26
2
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Schawk, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Amounts)
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2006 2005
(UNAUDITED)
------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 7,346 $ 7,519
Trade accounts receivable, less allowance for doubtful accounts
of $5,376 at March 31, 2006 and $5,940 at December 31, 2005 113,307 117,723
Inventories 28,197 24,868
Prepaid expenses and other current assets 11,800 9,701
Deferred income taxes 10,555 9,845
Assets of discontinued operations -- 29,253
------------------------------
Total current assets 171,205 198,909
Property and equipment, less accumulated depreciation of $79,653
at March 31, 2006 and $74,506 at December 31, 2005 77,209 77,291
Goodwill 240,825 233,838
Intangible assets, net 36,451 42,223
Other assets 5,314 6,557
------------------------------
Total assets $ 531,004 $ 558,818
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 24,483 $ 27,776
Accrued expenses 53,189 61,967
Income taxes payable 8,623 6,367
Current portion of long-term debt and capital lease obligations 263 454
Liabilities of discontinued operations -- 8,208
------------------------------
Total current liabilities 86,558 104,772
Long-term debt 149,259 169,528
Capital lease obligations 45 51
Other liabilities 27,283 27,383
Deferred income taxes 25,742 25,688
Stockholders' equity:
Common stock, $0.008 par value, 40,000,000 shares authorized,
28,810,595 and 28,441,689 shares issued at March 31, 2006 and
December 31, 2005, respectively; 26,438,127 and 26,070,747
shares outstanding at March 31, 2006 and December 31, 2005,
respectively 228 225
Additional paid-in capital 175,163 168,777
Retained earnings 92,354 88,424
Accumulated comprehensive income 2,376 1,933
------------------------------
270,121 259,359
Treasury stock, at cost, 2,372,468 and 2,370,942 shares of common
stock at March 31, 2006 and December 31, 2005, respectively (28,004) (27,963)
------------------------------
Total stockholders' equity 242,117 231,396
------------------------------
Total liabilities and stockholders' equity $ 531,004 $ 558,818
==============================
</Table>
See accompanying notes.
3
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Schawk, Inc.
Consolidated Statements of Operations
Three Months Ended March 31, 2006 and 2005
(Unaudited)
(In Thousands, Except Share Amounts)
<Table>
<Caption>
2006 2005
---------------------------
Net sales $ 133,754 $ 119,180
Cost of sales 88,038 77,844
Selling, general, and administrative expenses 34,316 30,333
Acquisition integration expenses 530 --
---------------------------
Operating income 10,870 11,003
Other income (expense)
Interest income 119 69
Interest expense (2,581) (1,688)
---------------------------
(2,462) (1,619)
---------------------------
Income from continuing operations before income taxes 8,408 9,384
Income tax provision 3,193 3,585
---------------------------
Income from continuing operations 5,215 5,799
Loss from discontinued operations, net of tax benefit of $266
in 2006 and $145 in 2005 (Note 12) (433) (235)
---------------------------
Net Income $ 4,782 $ 5,564
===========================
Earnings per share:
Basic:
Income from continuing operations $ 0.20 $ 0.24
Loss from discontinued operations (0.02) (0.01)
---------------------------
Net income per common share $ 0.18 $ 0.23
===========================
Diluted:
Income from continuing operations $ 0.19 $ 0.23
Loss from discontinued operations (0.02) (0.01)
---------------------------
Net income per common share $ 0.17 $ 0.22
===========================
Weighted average number of common and common
equivalent shares outstanding -- diluted 27,763 25,670
Dividends per common share $ 0.0325 $ 0.0325
</Table>
See accompanying notes
4
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Schawk, Inc.
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2006 and 2005
(Unaudited)
(In Thousands)
<Table>
<Caption>
2006 2005
---------------------------
OPERATING ACTIVITIES
Net income $ 4,782 $ 5,564
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization 6,578 6,193
Deferred income taxes (656) 565
Share-based compensation expense 423 --
Loss (gain) realized on sale of property and equipment (54) --
Changes in operating assets and liabilities, net of effects from
acquisitions and dispositions:
Trade accounts receivable 7,003 (10,200)
Inventories (3,310) (423)
Prepaid expenses and other current assets (251) 925
Trade accounts payable and accrued expenses (16,993) (10,466)
Other liabilities (5,090) --
Income taxes refundable/payable 2,181 1,567
---------------------------
Net cash used in operating activities (5,387) (6,275)
INVESTING ACTIVITIES
Proceeds from sales of property and equipment 95 651
Proceeds from sale of business 26,279 --
Capital expenditures (5,644) (3,377)
Acquisitions, net of cash acquired (669) (202,522)
Contingent acquisition purchase price received from escrow account -- 890
Other 178 187
---------------------------
Net cash provided by (used in) investing activities 20,239 (204,171)
FINANCING ACTIVITIES
Proceeds from debt -- 142,030
Net principal payments on revolving credit agreement (20,276) --
Principal payments on capital lease obligations (202) (283)
Tax benefit from stock options exercised 1,153 --
Payment of deferred loan fees -- (588)
Common stock dividends (852) (835)
Purchase of common stock (41) (43)
Issuance of common stock 4,813 71,296
---------------------------
Net cash provided by (used in) financing activities (15,405) 211,577
---------------------------
Effect of foreign currency rate changes 380 (171)
---------------------------
Net increase (decrease) in cash and cash equivalents (173) 960
Cash and cash equivalents beginning of period 7,519 7,268
---------------------------
Cash and cash equivalents end of period $ 7,346 $ 8,228
===========================
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 1,933 $ 342
Cash paid for income taxes 74 1,401
</Table>
See accompanying notes.
5
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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 unaudited 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. Certain prior year amounts on the Consolidated Balance Sheet and the
Consolidated Statement of Operations have been reclassified to reflect the
discontinued operations presented in the current year financial statements. 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, 2005, as filed with its 2005 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 independent provider of digital imaging graphic
services to the global consumer products packaging, retail, point of sale,
advertising, entertainment and promotional markets. The Company provides
clients, at their option, access to a fully integrated or modular set of
products and services on a global or local basis. The Company has been in
operation since 1953 and is incorporated under the laws of the State of
Delaware. The Company presently has operations in North America (U.S., Canada
and Mexico), Asia (Singapore, China, Japan, Thailand and Malaysia), Europe
(United Kingdom, Belgium and Spain), India and Australia.
The Company's services include brand strategy, creative design, tactical design
and adaptive design. The Company's services also include both digital and analog
image database archival management as well as 3D imaging for package design,
large format printing, digital photography, workflow management consulting
services, and various related outsourcing and graphics arts consulting services.
The Company's facilities produce conventional, electronic and desktop color
separations, creative design, art production, electronic retouching,
conventional and digital plate making and digital press proofs. The Company has
particular expertise in preparing color images for high volume print production
runs of consumer products packaging. The Company functions as a vital interface
between its Fortune 1000 consumer products clients, their creative designers and
their converters or printers in assuring the production of consistent, high
quality packaging materials in increasingly shorter turnaround and delivery
times.
NOTE 4. INVENTORIES
Inventories consist of the following:
March 31, December 31,
2006 2005
---- ----
Raw materials $ 4,341 $ 4,662
Work in process 24,914 21,264
-------- --------
29,255 25,926
Less: LIFO reserve (1,058) (1,058)
-------- --------
$ 28,197 $ 24,868
======== ========
6
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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.
The following table sets forth the computation of basic and diluted earnings per
share:
<Table>
<Caption>
Three months ended March 31,
-----------------------------
2006 2005
---------- ----------
Net income from continuing operations $ 5,215 $ 5,799
Loss from discontinued operations (433) (235)
---------- ----------
Net income $ 4,782 $ 5,564
========== ==========
Weighted average shares 26,183 24,239
Effect of dilutive stock options 1,580 1,431
---------- ----------
Adjusted weighted average shares and
assumed conversions 27,763 25,670
========== ==========
Earnings per share:
Basic:
Income from continuing operations $ 0.20 $ 0.24
Loss from discontinued operations (0.02) (0.01)
---------- ----------
Net income per common share $ 0.18 $ 0.23
========== ==========
Diluted:
Income from continuing operations $ 0.19 $ 0.23
Loss from discontinued operations (0.02) (0.01)
---------- ----------
Net income per common share $ 0.17 $ 0.22
========== ==========
</Table>
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,
Europe and Canada. Summary financial information by geographic area is as
follows:
Three months ended March 31, 2006
---------------------------------
Other
United States Canada Europe Foreign Total
------------- ------ ------ ------- -----
Sales $ 97,729 $ 8,787 $ 21,154 $ 6,084 $133,754
Long-lived assets 296,302 16,606 40,604 6,287 359,799
Net Assets 222,004 19,430 12,275 (11,592) 242,117
Three months ended March 31, 2005
---------------------------------
Other
United States Canada Europe Foreign Total
------------- ------ ------ ------- -----
Sales $ 86,688 $ 8,770 $ 19,316 $ 4,406 $119,180
Long-lived assets 298,450 19,334 24,863 6,908 349,555
Net Assets 188,677 13,026 (214) (2,320) 199,169
7
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NOTE 7. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the three months
ended March 31, 2006 and 2005, respectively, are as follows:
<Table>
<Caption>
Three months ended March 31,
----------------------------
2006 2005
------- -------
Net income $ 4,782 $ 5,564
Foreign currency translation adjustments 443 (361)
------- -------
Comprehensive income $ 5,225 $ 5,203
======= =======
</Table>
NOTE 8. STOCK BASED COMPENSATION
Effective January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123R ("SFAS 123R"), "Share-Based Payments,"
which requires the measurement and recognition of compensation expense for all
share-based payment awards to employees and directors based on estimated fair
values. SFAS 123R supersedes the Company's previous accounting methodology using
the intrinsic value method under Accounting Principles Board Opinion No. 25
("APB 25"), "Accounting for Stock Issued to Employees." Under the intrinsic
value method, no share-based compensation expense related to stock option awards
granted to employees had been recognized in the Company's Consolidated
Statements of Operations, as all stock option awards granted under the plans had
an exercise price equal to the market value of the Common Stock on the date of
the grant.
The Company adopted SFAS 123R using the modified prospective transition method.
Under this transition method, compensation expense recognized during the three
months ended March 31, 2006 included compensation expense for all share-based
awards granted prior to, but not yet vested, as of December 31, 2005, based on
the grant date fair value estimated in accordance with the original provisions
of SFAS 123 and using an accelerated expense attribution method. There were no
share-based awards granted during the three months ended March 31, 2006.
Compensation expense for all share-based awards to be granted subsequent to
March 31, 2006 will be based on the grant date fair value estimated in
accordance with the provisions of SFAS 123R and will be computed using the
straight-line expense attribution method. In accordance with the modified
prospective transition method, the Company's Consolidated Financial Statements
for prior periods have not been restated to reflect the impact of SFAS 123R.
OPTIONS
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 recorded $423 of compensation expense relating to outstanding
options during the quarter ended March 31, 2006. No compensation expense was
recorded related to outstanding options during the quarter ended March 31, 2005.
The Company records compensation expense for employee stock options based on the
estimated fair value of the options on the date of grant using the Black-Scholes
option-pricing model with the assumptions included in the table below. The
Company uses historical data among other factors to estimate the expected price
volatility, the expected option life and the expected forfeiture rate. The
risk-free rate is based on the U.S. Treasury yield curve in effect at the time
of grant for the estimated life of the option. There were no options granted
during the three months ended March 31, 2006. The following assumptions were
used to estimate the fair value of options granted during the three months ended
March 31, 2005, using the Black-Scholes option-pricing model:
8
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<Table>
<Caption>
Three Months ended March 31,
2006 2005
----------------------------
Expected dividend yield na 0.70%
Expected stock price volatility na 19.96%
Risk-free interest rate range na 4.0%
Weighted-average expected life of options na 7 years
</Table>
The following table summarizes the Company's activities with respect to its
stock option plans for the first three months of 2006 as follows (in thousands,
except price per share and contractual term):
<Table>
<Caption>
Weighted Average Weighted Average
Number of Exercise Price Remaining Aggregate
Shares Per Share Contractual Term Intrinsic Value
---------------------------------------------------------------------------
Outstanding January 1, 2006 3,333 $11.73
Granted --
Exercised (214) $ 9.51
Cancelled --
---------------
Outstanding March 31, 2006 3,119 $11.88 5.80 $44,063
Vested at March 31, 2006 2,740 $10.94 5.36 $41,290
Exercisable at March 31, 2006 2,740 $10.94 5.36 $41,290
</Table>
There were no options granted during the three months ended March 31, 2006. The
weighted-average grant-date fair value of options granted during the three
months ended March 31, 2005 was $5.97. The total intrinsic value for options
exercised during the three months ended March 31, 2006 and 2005 was $2,982 and
$521, respectively.
Cash received from option exercises under all plans for the three months ended
March 31, 2006 and 2005 was approximately $1,996 and $388, respectively. The
actual tax benefit realized for the tax deductions from option exercises under
all plans totaled approximately $1,153 and $111, respectively, for the three
months ended March 31, 2006 and 2005.
As of March 31, 2006, there was $541 of total unrecognized compensation cost
related to nonvested options outstanding. That cost is expected to be recognized
over a weighted average period of 1 year. A summary of the Company's nonvested
option activity for the three months ended March 31, 2006 is as follows (in
thousands, except price per share and contractual term):
<Table>
<Caption>
Weighted Average
Number of Grant Date
Shares Per Share
--------------------------------
Nonvested at January 1, 2006 570 $4.85
Granted --
Vested (191) $3.65
Forfeited --
-----------
Nonvested at March 31, 2006 379 $5.44
===========
</Table>
9
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EMPLOYEE SHARE-BASED COMPENSATION EXPENSE
The table below shows the amounts recognized in the financial statements for the
three months ended March 31, 2006 for share-based compensation related to
employees.
<Table>
<Caption>
Three Months Ended
March 31, 2006
-----------------------
Total cost of share-based compensation $ 423
Income tax (161)
-----------------------
Amount charged against income $ 262
=======================
Impact on net income per common share:
Basic $0.01
Diluted $0.01
</Table>
There were no amounts related to employee share-based compensation capitalized
as assets during the three months ended March 31, 2006.
PRO FORMA EMPLOYEE SHARE-BASED COMPENSATION EXPENSE
Prior to December 31, 2005, the Company accounted for share-based employee
compensation arrangements in accordance with the provisions and related
interpretations of APB 25. Had compensation cost for share-based awards been
determined consistent with SFAS No. 123R, the net income and earnings per share
would have been adjusted to the following pro forma amounts (in thousands,
except for per share data):
<Table>
<Caption>
Three Months Ended
March 31, 2005
-----------------------
Net income, as reported $5,564
Less: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (130)
-----------------------
Net income, pro forma $5,434
=======================
Earnings per share
Basic $ 0.23
Diluted $ 0.22
Pro forma earnings per share
Basic $ 0.22
Diluted $ 0.21
</Table>
NOTE 9. ACQUISITIONS
SEVEN WORLDWIDE HOLDINGS, INC.
On January 31, 2005, the Company acquired 100% of the outstanding stock of
Seven Worldwide Holdings, Inc., ("Seven WorldWide"), formerly known as KAGT
Holdings, Inc. Seven Worldwide Holdings, Inc. was the parent of Seven Worldwide,
Inc, a graphics services company with operations in North America, Europe, and
the Asia-Pacific region. The purchase price of $210,568 consisted of $135,566
paid in cash at closing, $4,482 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 acquisition was recorded using the purchase method of accounting.
10
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At December 31, 2005, the Company recorded a preliminary purchase price
allocation based upon a tangible and intangible asset appraisal that was in
progress. During the first quarter of 2006, the purchase price allocation was
finalized and the Company adjusted the preliminary purchase price allocation
based on the fair value appraisal performed by an independent consulting firm.
The finalization of the purchase price allocation resulted in an increase in
goodwill and intangible assets in the amount of $5,240 and $1,393, respectively.
A summary of the fair values assigned to the acquired assets is as follows:
Trade accounts receivable $ 69,885
Inventory 20,004
Other current assets 5,899
Fixed assets 39,533
Intangible assets, principally customer relationships 43,651
Goodwill 162,439
Other assets 908
Accounts payable (19,093)
Other current liabilities (73,958)
Income taxes payable (11,022)
Deferred income taxes (5,880)
Long term debt and capital lease obligations (50)
Other liabilities (27,908)
---------
Total purchase price, net of $6,160 cash received $ 204,408
=========
During the 12 months ended January 31, 2006, management of the Company completed
its assessment of the combined operations and implemented its plan to exit
certain facilities of the acquired company. During 2005, the Company closed
seven facilities in the US and the UK and downsized several others. Two
additional facilities will be closed in early 2006 in accordance with the
Company's exit plan. A total of 712 employees were terminated during 2005 or
will be terminated in early 2006. In addition, the Company's management decided
to market the Book and Publishing operations of the acquired company, since this
business is outside the core business of the Company. On March 3, 2006, the
Company entered into an Asset Purchase Agreement to sell substantially all of
the operating assets of its Book and Publishing operations. See Footnote 12 --
Discontinued Operations.
The Company recorded an estimated exit reserve at January 31, 2005 in the amount
of $11,790. The major expenses included in the exit reserve are employee
severance and lease termination expenses. As management of the Company completed
its assessment of the acquired operations, additional amounts were added to the
initial reserve estimate. The initial reserve and subsequent reserve
modifications were recorded as adjustments to goodwill and current and
non-current liabilities. The March 31, 2006 reserve balance related to employee
severance will be paid during 2006. The reserve balance related to facility
closings will be paid over the term of the leases of the closed facilities, with
the longest lease expiring in 2015.
The following table summarizes the reserve recorded at January 31, 2005 and the
activity through March 31, 2006:
<Table>
<Caption>
Balance Balance
January 31, December 31,
2005 Adjustments Payments 2005
---------------------------------------------------------------------
Employee severance $ 7,075 $5,092 ($6,721) $ 5,446
Facility closure cost 4,715 3,969 (1,114) 7,570
---------------------------------------------------------------------
Total $11,790 $9,061 ($7,835) $13,016
=====================================================================
</Table>
11
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<Table>
<Caption>
Balance Balance
December 31, March 31,
2005 Adjustments Payments 2006
---------------------------------------------------------------------
Employee severance $ 5,446 $171 ($2,946) $2,671
Facility closure cost 7,570 -- (860) 6,710
---------------------------------------------------------------------
Total $13,016 $171 ($3,806) $9,381
=====================================================================
</Table>
WEIR HOLDINGS LIMITED
On December 31, 2004, the Company acquired the operating assets and assumed
certain liabilities of Weir Holdings Limited, a company registered under the
laws of England, and its subsidiaries. Weir, which operates under the trade name
"Winnetts", is one of the leading providers of graphic services to consumer
products companies, retailers and major print groups in the United Kingdom and
European markets.
In connection with its acquisition of the assets of Weir Holdings Limited
(Winnetts), the Company established an estimated facility exit reserve at
December 31, 2004 in the amount of $2,500, primarily for employee severance and
lease abandonment expenses. During 2005, the management of the Company completed
its assessment of the acquired operations and implemented its plan to exit
certain of the facilities of the acquired company. During 2005, the Company
closed one facility in the UK and downsized several others. A total of 39
employees were terminated. The exit reserve balance related to employee
severance will be paid during 2006. The exit reserve related to the facility
closure will be paid over the term of the lease, which expires in 2014.
The following table summarizes the activity in the reserve during 2005 and the
first quarter of 2006:
<Table>
<Caption>
Balance Balance
December 31, December 31,
2004 Adjustments Payments 2005
---------------------------------------------------------------------
Employee severance $1,254 $ 65 ($902) $ 417
Facility closure cost 718 (632)
1,246 1,332
---------------------------------------------------------------------
Total $2,500 $783 ($1,534) $1,749
=====================================================================
</Table>
<Table>
<Caption>
Balance Balance
December 31, March 31,
2005 Adjustments Payments 2006
---------------------------------------------------------------------
Employee severance $ 417 -- ($98) $ 319
Facility closure cost --
1,332 (85) 1,247
---------------------------------------------------------------------
Total $1,749 -- ($183) $1,566
=====================================================================
</Table>
12
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Since the acquisitions of Seven Worldwide and Winnetts, one of the Company's
priorities has been the integration of the acquired businesses into the
Company's combined operations. This has involved planning and executing the
consolidation of duplicate facilities in locations served by separate facilities
of the pre-acquisition businesses as well as elimination of duplicate
administrative functions. During the quarter ended March 31, 2006, the Company
recorded acquisition integration expenses of $530, which are shown as a separate
line in the operating expense section of the Consolidated Statement of
Operations for the period ended March 31, 2006. The major items included in this
expense are exit costs from the shut down of our Birmingham UK operating
facility in February 2006, including retention pay for key employees whose
services were necessary during a transition period, travel expenses related to
the planning and execution of facility consolidations, and professional fees for
accounting, human resource, and integration planning advice.
OTHER ACQUISITIONS
The Company acquired certain assets and assumed certain liabilities of the
Virtualcolor division of Fort Dearborn Company, located in Elk Grove Village,
Illinois, effective as of January 1, 2004. Virtualcolor is a provider of digital
imaging graphic services and has been merged with an existing Company facility.
The purchase price of $4,929 consisted of $4,859 paid in cash to the seller at
closing and $70 in acquisition-related legal fees. In addition, $1,600 of
contingent additional purchase price was paid to an escrow account pending
settlement of the purchase price adjustments specified in the acquisition
agreement. During the period ended March 31, 2006, an agreement was reached to
release $700 of the contingent purchase price to the seller, which has been
recorded as an addition to the cost of the business acquired. The $900 remaining
in the escrow account at March 31, 2006 is included in Other Assets in the
Consolidated Balance Sheet at March 31, 2006.
In addition, during the period ended March 31, 2006 the Company paid $669 of
additional purchase price to the former owners of certain companies acquired in
2003 and 2004. The additional purchase price was paid pursuant to the
contingency provisions of the purchase agreements.
NOTE 10. DEBT
The Company borrows under 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 $115,000, expandable to $125,000, with
interest at LIBOR plus a margin based on the Company's cash flow leverage ratio.
On March 31, 2006, $74,252 was outstanding under this agreement and is included
in Long-term debt on the Consolidated Balance Sheet.
The Company also borrows under private placement financing agreements. The
Company executed a Note Purchase and Private Shelf Agreement dated January 28,
2005, 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, 2006 Consolidated Balance Sheet. The Company
also sold a series of notes under a Note Purchase Agreement dated December 23,
2003. The first note under this agreement, in the amount of $15,000, bears
interest at 4.90% and is payable in annual installments of $2,143 from 2007 to
2013. The second note under this agreement, in the amount of $10,000, bears
interest at 4.98% and is payable in annual installments of $1,429 from 2008 to
2014. The total of these notes, $25,000, is included in Long-term debt on the
March 31, 2006 Consolidated Balance Sheet. The notes issued under both these
agreements are unsecured.
The borrowings under both agreements are subject to certain restrictive
covenants. The Company is in compliance with these covenants as of March 31,
2006.
NOTE 11. INTANGIBLES
The Company accounts for its goodwill assets using SFAS No. 142, "Goodwill and
Other Intangible Assets." Under SFAS No. 142, the Company's goodwill assets are
not amortized, but are subject to an annual impairment test.
13
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The Company's intangible assets subject to amortization are as follows:
Balance at Balance at
March 31, December 31, Weighted
2006 2005 Average Life
---------- ------------ ------------
Customer relationships $ 38,891 $ 43,934 15.2 years
Digital images 882 882 5.0 years
Developed technologies 712 762 3.0 years
Non-compete agreements 681 681 3.5 years
Patents 326 326 20.0 years
Trade names 308 157 2.0 years
-------- --------
41,800 46,742 14.5 years
Accumulated amortization (5,349) (4,519)
-------- --------
$ 36,451 $ 42,223
Amortization expense related to intangible assets was $832 and $1,040 for the
three month period ended March 31, 2006 and 2005, respectively. Amortization
expense for each of the next five fiscal years beginning April 1, 2006 is
expected to be approximately $3,300 for fiscal year 2007, $3,000 for fiscal year
2008, and approximately $2,700 for fiscal years 2009, 2010 and 2011.
NOTE 12. DISCONTINUED OPERATIONS
Effective February 28, 2006, the Company sold certain operations including
substantially all of the assets of its Book and Publishing operations, most of
which were acquired as part of the Seven Worldwide acquisition in 2005. The
operations were sold because they were considered to be outside of the Company's
core business. Proceeds from the sale were $26,279, subject to an audited
working capital adjustment, which the Company estimates will result in an
increase in selling price of $1,821. No gain or loss was recorded as a result of
the sale.
In accordance with SFAS No. 144, Accounting for the Impairment of Long-Lived
Assets, the Book and Publishing operations are being accounted for as
discontinued operations and, accordingly, its assets and liabilities are
segregated from continuing operations in the accompanying consolidated balance
sheet, and its operating results are segregated and reported as discontinued
operations in the accompanying consolidated statement of operations in all
periods presented. The results of operations of the Book and Publishing
operations for the three months ended March 31, 2006 and 2005 are as follows:
<Table>
<Caption>
Three Months Three Months
ended ended
March 31, March 31,
2006 2005
------------ ------------
Revenues $ 8,612 $ 11,571
======== ========
Loss from operations before income taxes $ (699) $ (380)
======== ========
</Table>
14
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The carrying amounts of the major classes of assets and liabilities sold were as
follows:
<Table>
Current assets $16,275
Other non-current assets 2,301
Intangible assets 15,327
-------
Assets of discontinued operations $33,903
=======
Current liabilities $ 5,803
-------
Liabilities of discontinued operations $ 5,803
=======
</Table>
NOTE 13. CAPITAL STOCK
On February 3, 2006, certain stockholders of the Company sold 3,470 shares of
the Company's common stock in a public offering at $22.00 per share (before
discounts and commissions to underwriters.) All of these shares were initially
issued to such stockholders in connection with the Company's acquisition of
Seven Worldwide in January 2005. On February 17, 2006, the Company sold 142
shares of common stock at $22.00 per share (before discounts and commissions to
underwriters) pursuant to a partial exercise of an underwriters' over-allotment
option granted by the Company in connection with the offering. The Company
received net proceeds of approximately $2.9 million from the sale of the
over-allotment shares. The Company used the net proceeds to repay indebtedness
under its revolving credit facility.
15
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 on 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 other countries in
which the Company has production service 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.
EXECUTIVE-LEVEL OVERVIEW
Effective February 28, 2006, the Company sold certain operations including
substantially all of the assets of its Book and Publishing operations, most of
which were acquired as part of the Seven Worldwide acquisition in 2005. The
operations were sold because they were not strategic to the Company's future.
Proceeds from the sale were $26,279, subject to an audited working capital
adjustment, which the Company estimates will result in an increase in selling
price of $1,821. No gain or loss was recorded as a result of the sale. These
operations are treated as discontinued operations in the comparative
consolidated statement of operations and therefore the revenues and expenses are
removed from the categories on the statement and netted on the line "Loss from
discontinued operations" above the Net income line on the statement. Similarly,
amounts from the prior year first quarter ended March 31, 2005 have been
restated as Loss from discontinued operations in that period. Therefore, all
comparisons in this management's discussion and analysis of results of
operations refer to amounts on the comparative consolidated statement of
operations from continuing operations only.
A majority of our revenues are driven by marketing and advertising spending by
consumer products companies and retailers. The markets served are primarily
consumer products, pharmaceutical, entertainment and retail. Our business
involves producing graphic images for various applications. Generally, a graphic
image is created by us or a third party and then we manipulate 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) and magazine ads 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:
o Planning and Messaging
o Strategic Design
o Content Creation
o File Building
o Retouching
o Art Production
o Pre-Media
Our involvement in a client project may involve many of the above steps or just
one of the steps, depending on the client's needs. Each client assignment, or
"job", is a custom job in that the image being produced is unique, even if it
16
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only involves a small change from an existing image, such as adding a "low fat"
banner on a food package. Essentially, change equals revenue. We are paid for
our graphic imaging work regardless of the success or failure of the food
product, the promotion or the ad campaign.
Historically, a substantial majority of our revenues have been derived from
providing graphic services for consumer product packaging applications.
Packaging changes occur with such frequency and lack of notice, and customer
turn-around requirements are so tight, that there is little backlog. There are
regular promotions throughout the year that create revenue opportunities for us,
for example: Valentine's Day, Easter, Fourth of July, Back-to-School, Halloween,
Thanksgiving and Christmas. In addition, there are event driven promotions that
occur regularly, such as the Super Bowl, Grammy Awards, World Series,
Indianapolis 500 and the Olympics. Lastly, there are a number of health related
"banners" that are added to food and beverage packaging, such as "heart
healthy," "low in carbohydrates," "enriched with essential vitamins," "low in
saturated fat" and "caffeine free." All of these items require new product
packaging designs or changes in existing designs, in each case creating
additional opportunities for revenue. Graphic services for the consumer products
packaging industry generally involve higher margins due to the substantial
expertise necessary to meet consumer products companies' precise specifications
and to quickly, consistently and efficiently bring their products to market, as
well as due to the complexity and variety of packaging materials, shapes and
sizes, custom colors and storage conditions.
As a result of our recent acquisitions described below, we have increased the
percentage of our revenue derived from providing graphics services to our
advertising and retail clients and added to our service offering graphic
services to the entertainment market. These clients typically require high
volume, commodity-oriented prepress graphic services. Graphic services for these
clients typically yield relatively lower margins due to the lower degree of
complexity in providing such services, and the number and size of companies in
the industry capable of providing such services. As discussed more fully below
under "Acquisitions" and "Results of operations", the altered mix of services
following our acquisitions of Winnetts and Seven Worldwide impacted our results
of operations in 2005 and for the three months ended March 31, 2006 and will
continue to impact our results of operations in the future. Since our
acquisition of Seven Worldwide in the first quarter of 2005 we have been
evaluating all of the operations acquired to determine if some of the operations
should be sold. In the first quarter of 2006, we sold certain operations
including the former Seven Worldwide publishing, catalog and textbook operations
that were not strategic to our future. These operations had approximately $62
million of revenues on an annual basis.
In the first quarter of 2006 as compared to the first quarter of 2005
approximately 7% and 10%, respectively, of our total revenues came from our
largest single client in the respective period. Our single largest client for
the first quarter of 2006 reduced its business with us by $1.9 million as
compared to the first quarter of 2005, as we anticipated. On a proforma basis
(including the month of January 2005 when we did not own Seven Worldwide) the
sales decrease was $4.8 million. We currently expect this trend to continue as a
result of the client's decision to substantially reduce its overall advertising
budget. On a full year basis we expect revenues with this client to decrease to
$30 million in 2006 from $50 million in 2005. While we seek to build long-term
client relationships, revenues from any particular client can fluctuate from
period to period due to such client's purchasing patterns. Any termination of or
significant reduction in our business relationship with any of our principal
clients could have a material adverse effect on our business, financial
condition and results of operations.
ACQUISITIONS
We have grown our business through a combination of internal growth and
acquisitions. We have completed approximately 50 acquisitions since our business
was founded in 1953. Our two recent acquisitions have significantly expanded our
service offerings and our geographic presence, making us the only independent
prepress firm with operations in North America, Europe and Asia. As a result of
these acquisitions, we are able to offer a broader range of services to our
clients. Our expanded geographic presence also allows us to better serve our
multinational clients' demands for global brand consistency.
Winnetts. On December 31, 2004, we acquired certain assets and the business of
Weir Holdings, Ltd., known as "Winnetts ", a UK based graphic services company
with operations in 6 locations in the UK, Belgium and Spain. The acquisition
price was $23.0 million.
Seven Worldwide. On January 31, 2005, we acquired Seven Worldwide (formerly
Applied Graphics Technologies, Inc.), a graphic services company with operations
in 40 locations in the United States, Europe, Asia and Australia. The purchase
price was $210.6 million. Seven Worldwide's results of operations have been
included in our results since January 31, 2005. In 2004 Seven Worldwide had
revenues of $369.9 million with gross margin and operating income
17
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percentages lower than those of our company for that period.
The principal objective in acquiring Winnetts and Seven Worldwide was to expand
our geographic presence and our service offering. This expansion enables us to
provide a more comprehensive level of customer service, to build a broader
platform from which to grow our business and continue to pursue greater
operating efficiencies. We expect significant synergies and reduced operating
expenses from the consolidation of duplicate facilities acquired in the Seven
Worldwide acquisition and began work on a consolidation plan before the
acquisition was finalized. We have recorded estimated exit reserves based on the
consolidation plan. The major expenses included in the exit reserves are
severance pay for employees of acquired facilities that will be merged with
existing operations and lease termination expenses. In addition, we recorded
acquisition integration expenses, which are shown as a separate line in the
operating expense section of the Consolidated Statement of Operations, of $0.5
million for the three month period ended March 31, 2006. The major items
included in this expense are exit costs from the shut down of our Birmingham UK
operating facility in February 2006 including retention pay for key employees
whose services were necessary during a transition period, travel expenses
related to the planning and execution of facility consolidations, and
professional fees for accounting, human resource, and integration planning
advice. In connection with the sale of the book and publishing operations we
received $26.3 million at closing on March 6, 2006 which we used to reduce the
amount outstanding on our revolving credit facility. As of March 31, 2006 there
was $149.6 million of debt outstanding of which $149.3 million was considered
long-term.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amount of assets and
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities at the date of our financial statements. Actual results may
differ from these estimates under different assumptions or conditions. Critical
accounting policies are defined as those that are reflective of significant
judgments and uncertainties, and potentially result in materially different
results under different assumptions and conditions. We believe that our critical
accounting policies are limited to those described below.
Accounts Receivable. Our clients are primarily consumer product manufacturers,
converters mass merchant retailers and advertising agencies; none of which
individually represents more than 7% of total revenue. Accounts receivable
consist primarily of amounts due to us from our normal business activities. We
maintain an allowance for doubtful accounts to reflect the expected losses of
accounts receivable based on past collection history and specific risks
identified in the portfolio.
Impairment of Long-Lived Assets. We record impairment losses on long-lived
assets used in operations when events and circumstances indicate that the assets
might be impaired and the undiscounted cash flows estimated to be generated by
those assets are less than the carrying amount of those items. Our cash flow
estimates are based on historical results adjusted to reflect our best estimate
of future market and operating conditions. The net carrying value of assets not
recoverable is reduced to fair value. Our estimates of fair value represent our
best estimate based on industry trends and reference to market rates and
transactions.
Goodwill and Other Acquired Intangible Assets. We have made acquisitions in the
past that included a significant amount of goodwill and other intangible assets.
Effective in 2002, goodwill is no longer amortized but is subject to an annual
(or under certain circumstances more frequent) impairment test based on its
estimated fair value. Other intangible assets that meet certain criteria
continue to be amortized over their useful lives and are also subject to an
impairment test based on estimated undiscounted cash flows. There are many
assumptions and estimates underlying the determination of an impairment loss.
Another estimate using different, but still reasonable, assumptions could
produce a significantly different result. Therefore, impairment losses could be
recorded in the future. We performed the required impairment test of goodwill
and indefinite-lived intangible assets in 2005. It was determined appropriate to
consider the company to be one reporting unit for purposes of this test.
Customer Rebates. We have rebate agreements with certain customers. The
agreements offer discount pricing based on volume over a multi-year period. We
accrue the estimated rebates over the term of the agreement, reducing revenue
and crediting a current liability account. At the end of the rebate accounting
period, typically annually, the rebate is settled in cash and the accrued
liability account is charged. We account for changes in the estimated rebate
amounts as soon as it has determined that the estimated sales for the rebate
period have changed.
18
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Income Taxes. Deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax basis of assets and
liabilities using tax rates in effect for the year in which the differences are
expected to reverse. A valuation allowance is provided when it is more likely
than not that some portion of the deferred tax assets arising from temporary
differences and net operating losses will not be realized. We, like other
multi-national companies, are regularly audited by federal, state and foreign
tax authorities, and tax assessments may arise several years after tax returns
have been filed. Accordingly, tax reserves have been recorded when, in
management's judgment, it is not probable that our tax position will ultimately
be sustained. While predicting the outcome of the audits involves uncertainty
and requires estimates and informed judgments, we believe that the recorded tax
liabilities are adequate and appropriate. The judgments and estimates made at a
point in time may change based on the outcome of tax audits, as well as changes
to or further interpretation of regulations. Income tax expense is adjusted in
the period in which these events occur or when the statute of limitations for a
specific exposure item has expired.
Exit Reserves. We record reserves for the operational restructuring of acquired
Companies and the resulting exit costs. The plans are approved by company
management prior to, or shortly after, the acquisition date and may be modified
during the twelve month period following the acquisition, as conditions change.
The plans provide for severance pay, lease abandonment costs and other exit
activities expenses.
Stock Option Expense. Effective January 1, 2006, the Company adopted the
provisions of SFAS 123(R), using the modified prospective method and therefore
has not restated results for the prior periods. Under this transition method,
stock-based compensation expense for all awards granted prior to, but not yet
vested as of January 1, 2006, are based on the grant date fair value estimated
in accordance with the original provisions of SFAS 123, "Accounting for
Stock-based Compensation" ("SFAS 123"). Stock-based compensation expense for any
grants after December 31, 2005 is based on the grant-date fair value estimated
in accordance with the provisions of SFAS 123(R). The Company recognizes stock
based compensation expense on a straight-line basis over the requisite service
period of the award, which is generally the option vesting term of three years.
Prior to the adoption of SFAS 123(R), the Company did not recognize stock-based
compensation expense in the Statement of Operations, rather the Company followed
APB Opinion No. 25 Accounting for Stock Issued to Employees and related
interpretations and indicated in the notes to the financial statements what the
expense would have been had we chosen to record stock-based compensation expense
during those periods. Since all options issued in prior periods were granted at
an exercise price equal to the market value of the underlying common stock on
the date of grant, no expense was required to be recorded in the Statement of
Operations. The impact on consolidated financial position and results of
operations is an expense of $0.4 million and an increase in additional paid in
capital for the same amount for the first quarter ended March 31, 2006. The
Company adopted the modified prospective method in accordance with the
pronouncement and therefore, the prior periods are not restated. As a result
there is no expense in the prior year first quarter ended March 31, 2005.
Determining the appropriate fair value model and calculating the fair value of
share-based payment awards require the input of highly subjective assumptions
including the expected life of the share-based payment awards and stock price
volatility. The assumptions used in calculating the fair value of share-based
payment awards represent management's best estimates, but these estimates
involve inherent uncertainties and the application of management judgment. As a
result, if factors change and we use different assumptions, our stock-based
compensation expense could be materially different in the future. In addition,
we are required to estimate the expected pre-vesting forfeiture rate and only
recognize expense for those shares expected to vest. If our actual pre-vesting
forfeiture rate is materially different from our estimate, the stock-based
compensation expense could be significantly different from our estimates. See
Note 8 to the Consolidated Financial Statements (Unaudited) for a further
discussion of stock-based compensation.
19
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship to net sales of selected items in our consolidated income statement
for continuing operations:
SCHAWK, INC.
COMPARATIVE CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
UNAUDITED
(IN THOUSANDS)
$ %
2006 2005 CHANGE CHANGE
--------- --------- --------- --------
Net sales $ 133,754 $ 119,180 $ 14,574 12.2%
Cost of sales 88,038 77,844 10,194 13.1%
--------- --------- ---------
Gross profit 45,716 41,336 4,380 10.6%
Gross margin percentage 34.2% 34.7% (0.5%)
Selling, general and administrative expenses 34,316 30,333 3,983 13.1%
Acquisition integration expenses 530 -- 530 nm
--------- --------- ---------
Operating income 10,870 11,003 (133) (1.2%)
Operating margin percentage 8.1% 9.2% (1.1%)
Other income (expense)
Interest income 119 69 50 72.5%
Interest expense (2,581) (1,688) (893) 52.9%
--------- --------- ---------
(2,462) (1,619) (843) 52.1%
--------- --------- ---------
Income before income taxes 8,408 9,384 (976) (10.4%)
Income tax provision 3,193 3,585 (392) (10.9%)
Effective income tax rate 38.0% 38.2% --
--------- --------- ---------
Income from continuing operations 5,215 5,799 (584) (10.0%)
Loss on discontinued operations, net of tax benefit
of $266 in 2006 and $145 in 2005 (note 12) (433) (235) (198) (84.3%)
--------- --------- ---------
Net income $ 4,782 $ 5,564 $ (782) (14.1%)
========= ========= ========= ======
</Table>
nm = not meaningful
THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005
Net sales increased $14.6 million or 12.2% in the first three months of 2006 as
compared to the first three months of the prior year. The increase is primarily
due to the month of January 2006 sales from the Seven Worldwide acquisition of
approximately $19.8 million as the acquisition occurred on January 31 of 2005.
Excluding the month of January sales in 2006 from the former Seven Worldwide,
sales decreased approximately $5.2 million or 4.4%. The lower sales were from
various operations including $1.9 million decrease from the company's largest
account as anticipated, Sales at our acquired East Coast operation decreased
$0.8 million. The Company expects continued weakness from the acquired East
Coast operation in the near-term consistent with the lower revenues experienced
in the first quarter. In addition, there was a combined drop in sales of $1.0
million from our former Omaha, Nebraska and Foster City, California operations
20
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that were shut down in 2005. The Omaha and Foster City shut-downs were part of
our planned exit activities in 2005.
Gross margin for the first quarter decreased to 34.2 percent in 2006 from 34.7
percent in 2005, primarily due to a gross profit loss in the Company's East
Coast operation compared to the prior year gross profit.
Operating income for the first quarter of 2006 decreased 1.2% to $10.9 million
compared to $11.0 million in the first quarter of 2005 (before acquisition
integration expenses operating income increased $0.4 million or 3.6%). Operating
income was negatively impacted by lower than anticipated sales and higher
expenses, such as an additional month of selling, general and administrative
expenses from the Seven operations, acquisition integration expenses of $0.5
million, and stock option expense of $0.4 million as compared to the prior year.
The most significant items impacting operating income were an operating loss on
the European business primarily due to lower sales and higher costs than
anticipated and a loss from our acquired East Coast operation. The loss from the
acquired East Coast operation was as a result of lower sales of approximately
$0.8 million compared to the prior period. The Company's overall operating
margin percentage decreased to 8.1% in the first quarter of 2006 (8.5% before
acquisition integration expenses) compared to 9.2% in the first quarter of 2005
primarily due to lower sales and other factors as described above.
Interest expense of $2.6 million for the first quarter of 2006 increased $0.9
million compared to the same period in 2005. Approximately $0.5 million is due
to having the acquisition debt for three months in the first quarter of 2006 as
compared to only two months in the first quarter of 2005. In addition, interest
rates were approximately 200 basis points higher on the company's revolving
credit borrowings in the first quarter of 2006 as compared to the prior year
first quarter resulting in $0.4 million of higher interest expense.
Income tax expense for the first quarter of 2006 was at an effective tax rate of
38.0% compared to an effective tax rate in the first quarter of 2005 of 38.2%.
Income from continuing operations, net income and earnings per share were lower
in the first quarter of 2006 as compared to the first quarter of 2005 for the
reasons previously described.
Loss from discontinued operations was $0.4 million and $0.2 million for the
quarters ended March 31, 2006 and March 31, 2005, respectively. There was no
loss on disposal of the discontinued operations as the $26.3 million proceeds
from the sale of the net assets sold were the same amount as the net assets
transferred to the buyer. The operations sold included the book and publishing
operations of the former Seven Worldwide business that was acquired by the
Company on January 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2006, we had $7.3 million in consolidated cash and cash
equivalents, compared to $7.5 million at December 31, 2005.
Cash used in operating activities. We presently finance our business from
available cash, a revolving credit facility and from cash generated from
operations. The first quarter of the year in 2006 used $5.4 million of cash in
operations resulting from payments of accrued expenses and payments relating to
closed or exited facilities and a build-up in inventory as compared to the year
end December 31, 2005. Cash used in operating activities in the prior year
period was $6.3 million. Depreciation and amortization expense from continuing
operations in the first quarter of 2006 was $6.4 million as compared to $6.0
million in the first quarter of the prior year (on the Consolidated Statements
of Cash Flows the amounts are $6.6 million and $6.2 million, respectively,
includes $0.2 million in each period of depreciation and amortization from
discontinued operations). The increase in depreciation and amortization expense
is attributable to an additional month of depreciation and amortization of
property, plant and equipment and intangible assets acquired in the Seven
Worldwide acquisition as compared to the first quarter of 2005 offset by lower
depreciation and amortization costs based on finalization of asset valuations of
the Seven Worldwide assets acquired.
Cash provided by (used in) investing activities. Cash provided by investing
activities was $20.2 million in the first quarter of 2006 compared to $204.2
million of cash used in the first quarter of 2005. The cash provided by
investing activities in the first quarter of 2006 was primarily due to the sale
of the book and publishing business effective February 28, 2006 for which
proceeds of $26.3 million were received. The increase in cash used in investing
activities in the first quarter of 2005 reflects the acquisition of Seven
Worldwide, net of cash acquired, of $202.5 million. Capital expenditures were
$5.6 million in the first quarter of 2006 compared to $3.4 million in the first
quarter of 2005. The increase in capital expenditures in 2006 is primarily due
to the inclusion of capital expenditures of Seven Worldwide for an additional
month as compared to the prior year first quarter. Capital expenditures are
anticipated to be in a range of
21
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$22.0 million to $24.0 million for all of 2006.
Cash provided by (used in) financing activities. Cash used in financing
activities in the first quarter of 2006 was $15.4 million. Debt was reduced by
$20.5 million primarily as a result of applying the proceeds from the sale of
the discontinued operations to the outstanding debt under the revolving credit
facility. Cash provided by financing activities in the first quarter of 2005 was
$211.6 million primarily as a result of $142.0 million of proceeds from new debt
and $70.5 million of common stock issued to finance the Seven Worldwide
acquisition.
On February 3, 2006, certain stockholders of the Company sold 3,470,183 shares
of the Company's common stock in a public offering at $22.00 per share (before
discounts and commissions to underwriters), all of which shares were initially
issued to such stockholders in connection with the Company's acquisition of
Seven Worldwide in January 2005. On February 17, 2006, the Company sold 141,527
shares of common stock at $22.00 per share (before discounts and commissions to
underwriters) pursuant to a partial exercise of an underwriters' over-allotment
option granted by the Company in connection with the offering. The Company
received net proceeds of approximately $2.9 million from the sale of the
over-allotment shares. The Company used the net proceeds to repay indebtedness
under its revolving credit facility.
Dividends and share repurchases. Dividend payments on common stock were $0.9
million for the first quarter of 2006 compared to $0.8 million in the first
quarter of 2005. The increase in the dividends paid was due to a greater number
of shares outstanding in 2006 as compared to 2005. It is anticipated that we
will continue to pay dividends at the current level for the remainder of 2006.
Revolving credit agreement and other indebtedness. 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 $100.0 million,
expandable to $125.0 million, with interest at LIBOR plus a margin based on our
cash flow leverage ratio. This credit agreement replaced a $30.0 million
unsecured credit agreement previously in place. On April 15, 2005, the accordion
feature of the credit agreement was utilized to increase the size of the
revolving credit commitment to $115.0 million from $100.0 million to provide
additional operating flexibility to us. $74.3 million was outstanding under the
agreement at March 31, 2006 and is included in Long-term debt on the March 31,
2006 Consolidated Balance Sheet. Also, in January 2005, we entered into a Note
Purchase and Private Shelf Agreement with Prudential Investment Management Inc,
pursuant to which we sold $50.0 million in a series of three Senior Notes. The
first note, in the amount of $10.0 million, will mature in 2010 and bears
interest at 4.81%. The second and third notes, each in the amount of $20.0
million, mature in 2011 and 2012, respectively, and bear interest at the rate of
4.99% and 5.17%, respectively. The total of these notes, $50.0 million, is
included in Long-term debt on the March 31, 2006 Consolidated Balance Sheet.
In December of 2003, we entered into a private placement of debt to provide
long-term financing for acquisitions. The terms of the Note Purchase Agreement
relating to this transaction provided for our issuance and sale, 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 $15.0 million and
bearing interest at 4.90%, which closed in December 2003; and, 2) Tranche B, due
April 30, 2014, for $10.0 million and bearing interest at 4.98%, which closed in
April 2004. The total debt of $25.0 million issued under the private placement
agreement is shown as Long Term Debt on the March 31, 2006 Consolidated Balance
Sheet. Long-term debt decreased to $149.3 million at March 31, 2006 from $169.6
million at December 31, 2005 primarily as a result of reducing the debt from the
proceeds of the sale of the discontinued operations. Management believes that
the level of working capital is adequate for our liquidity needs related to
normal operations both currently and in the foreseeable future, and that we have
sufficient resources to support our growth, either through currently available
cash and cash generated from future operations, or pursuant to our 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.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
We do not have any material off-balance sheet arrangements that have, or are
reasonably likely to have, a current or future effect on our financial
condition, changes in financial condition, revenue or expenses, results of
operations, liquidity, capital expenditures or capital resources.
IMPACT OF INFLATION
We believe that over the past three years inflation has not had a significant
impact on our results of operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A discussion regarding market risk is disclosed in the Company's December 31,
2005 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, 2005.
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.
CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As disclosed in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2005, in January 2006, the Company implemented a new global
Enterprise Resource Planning ("ERP") system, PeopleSoft. This new PeopleSoft ERP
system, which replaced multiple legacy financial systems with a single,
standardized, integrated financial system, became the Company's primary
financial system beginning in January 2006. As a result of the implementation of
this new ERP system, several of the Company's internal controls over financial
reporting and related processes were modified and / or redesigned to conform
with and support the new ERP system. The Company also has plans to undertake
additional projects that will replace other Company financial systems around the
globe, and in particular in the Company's operations in the United Kingdom,
throughout the remainder of fiscal 2006 and extending into fiscal 2007.
Although management believes that the new PeopleSoft ERP system has maintained
or enhanced the Company's internal controls over financial reporting, management
has yet to complete documenting and testing the effectiveness of the new ERP
system's impact on the internal control environment for fiscal 2006. As such,
there is the risk that the new ERP system and / or new internal controls have
yet unidentified deficiencies that could constitute significant deficiencies,
material weaknesses or aggregate to material weaknesses in the Company's
internal control over financial reporting. Management anticipates testing the
new system and the new internal controls during fiscal 2006 as part of its
ongoing testing of the Company's internal controls.
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PART II - OTHER INFORMATION
ITEMS 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
ITEM 1A. RISK FACTORS
The Company has included in Part I, Item 1A of its Annual Report on Form 10-K
for the year ended December 31, 2005, a description of certain risks and
uncertainties that could affect the Company's business, future performance or
financial condition (the "Risk Factors".) The Risk Factors are hereby
incorporated in Part II, Item 1A of this Form 10-Q. Investors should consider
the Risk Factors prior to making an investment decision with respect to the
Company's stock.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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 2006. However, during the first quarter
of 2006, 1,781 shares of common stock with a market value of $41 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.
The following table summarizes the shares recorded by the Company as repurchases
in connection with stock option exercises during the first quarter of 2006:
<Table>
<Caption>
Total No. Avg. Price No. Shares Purchased
Shares Paid Per as Part of Publicly
Period Purchased Share Announced Program
--------------------------------------------------------------------------
January -- -- --
February -- -- --
March 1,781 $23.15 --
---------------------------------------------------------
Total 1,781 $23.15 --
=========================================================
</Table>
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ITEM 6. EXHIBITS
A. EXHIBITS
<Table>
<Caption>
EXHIBIT # DESCRIPTION
--------- -----------
3.1 Certificate of Incorporation of Schawk, Inc., as amended.
Incorporated herein by reference to Exhibit 4.2 to Registration
Statement No. 333-39113.
3.3 By-Laws of Schawk, Inc., as amended. Incorporated herein by
reference to Exhibit 4.3 to Registration Statement No. 333-39113.
4.1 Specimen Class A Common Stock Certificate. Incorporated herein by
reference to Exhibit 4.1 to Registration Statement No. 33-85152.
10.1 Asset Purchase Agreement, dated as of March 3, 2006, by and
between CAPS Group Acquisition, LLC and Schawk, Inc.*
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
</Table>
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on the 10th day of May 2006.
SCHAWK, INC.
- ------------
(Registrant)
/s/ David A. Schawk
- ------------------------------------
President, Chief Executive Officer and Director
/s/ James J. Patterson
- ------------------------------------
Senior Vice President and Chief Financial Officer
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