ITEM 1. BUSINESS
THE COMPANY
Schawk, Inc. ("Schawk" or the "Company") has one current operating business segment, Digital Imaging Graphics Arts for consumer products packaging and advertising and promotional applications. The Company is incorporated under the laws of the State of Delaware.
BUSINESS
GENERAL
The Company is the largest independent provider of digital imaging prepress services to the consumer products packaging market in the world. The Company's facilities produce conventional, electronic and desktop color separations, creative design, art production, electronic retouching, conventional and digital platemaking and digital press proofs for the three main printing processes used in the graphic arts industry: lithography, flexography and gravure. The Company's services also include both digital and analog image database archival and management as well as digital photography and various related outsourcing services. These services require skilled, highly trained technicians applying various computerized design, manipulation and assembly techniques. The preparation of film, digital tape and press proofs for lithography, flexography and other printing processes related to packaging accounted for over 70% net sales during 1999, 1998 and 1997. The balance of the Company's business consists of the production of similar, advertising and promotional applications.
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. The Company's ability to provide high quality, customized prepress services quickly makes it a valued player in new product introduction and promotional activity.
The Company maintains both digital and analog data archives of product package layouts and designs as a value-added service which improves the Company's efficiency in accommodating clients' rapidly changing packaging design modifications and product line extensions. By continuing to provide such high-end, value-added services, the Company commands a significant share of the market for prepress services for the food and beverage industry, which uniquely positions it to benefit from positive industry trends.
The Company believes that its clients have increasingly chosen to outsource their imaging needs to the Company because of its: (i) high quality customized imaging capabilities; (ii) rapid turnaround and delivery times; (iii) up-to-date knowledge of the printing press specifications of converters and printers located throughout the United States, Canada, Mexico and Asia, (iv) digital imaging asset management; (v) art production; and (vi) ability to service its clients' global prepress requirements through the Company's North American facilities and international subsidiaries and alliance partners.
PREPRESS SERVICES INDUSTRY
"Prepress services" are the tasks involved in preparing images and text for reproduction to exact specifications for a variety of media, including packaging for consumer products, point-of-sale displays and other promotional materials. Packaging for consumer products encompasses folding cartons, boxes, trays, cans, containers, packaging labels and wrap. While prepress work represents a relatively small percentage of overall product packaging and promotion costs, the visual impact and effectiveness of product packaging and promotions are largely dependent upon the quality of prepress work.
Prepress services do not entail the actual printing or production of such packaging materials, but rather include the various preparatory steps such as art production design, digital photography, retouching, color separation and other platemaking services, for use in lithography, flexography and gravure. "Color separation" refers to preparing color images, text and layout for the printing process. Prepress services such as color separation work have traditionally been performed by skilled craftspeople almost entirely by hand, using what is known as the "conventional" method. With the development of digital technology, prepress firms such as the Company have become almost totally computerized, relying instead on digital imaging, in which digitized images and text are manipulated according to client and converter specifications. On an increasing basis, clients supply material to the Company in a digitized format on a variety of media, including tape, floppy disk, CD-ROM and via the Internet. More recently there is a trend toward an all digital work flow, from creative design through printing. The most recent innovation is the production of plates directly from a digital file, hence the term "direct to plate" (DTP) or "computer to plate" (CTP). This innovation eliminates the step of preparing photographic film and exposing the film on a plate. This CTP technology is more precise and reduces the time to produce a printing plate.
The prepress industry in North America has over 1,300 market participants, principally independent color separators, such as the Company, converters, printers and consumer products companies that perform these services in-house. The majority of prepress providers specialize in high volume, commodity-oriented publication work that includes textbooks, advertising, catalogs, newspapers and magazines. The Company's target market, however, is high-end packaging for the consumer products industry. The North American market for prepress services for packaging to the consumer products industry is estimated by the Company to range from $1.5 billion to $1.7 billion, while the worldwide market is estimated by the Company to be as high as $6.0 billion. The consumer products prepress industry is highly fragmented with hundreds of market participants, only a small number of which have annual revenues exceeding $30.0 million. The Company believes that the number of participants in the North American prepress market for the consumer products industry will diminish due to consolidation and attrition caused by competitive forces such as accelerating technological requirements for advanced systems, equipment and highly skilled personnel and the growing demands of clients for full-service global capabilities.
The rapid development of lower-cost, faster desktop publishing software systems has increased the potential for competition in the prepress industry by lowering barriers to entry relating to equipment costs. However, this development has also resulted in the proliferation of software systems, many of which have created training issues. Frequent changes in software necessitates continuous training and education and investment in faster equipment. It has also created the demand from clients for increasingly faster turnaround and delivery times. As technology advances in the imaging industry, speed has become, and continues to be a significant differentiator between the Company and its competition.
There is also a more significant barrier to entry that has always existed -- hundreds of "technician years" of expertise in working with all of major printers and convertors to make sure a package is printed according to the client's specifications. For this reason, new upstarts have difficulty competing with Schawk.
The Company focuses on three primary markets: consumer product packaging, advertising agencies, and promotion. The food and beverage segment of the consumer products industry has packaging requirements that are complex and demanding due to variations in packaging materials, shapes and sizes, custom colors, varying storage conditions and marketing enhancements. Product extensions and frequent packaging redesigns have resulted in an increasing volume of color separation and related work in the consumer products industry and in particular for the food and beverage segment. Additional industry trends include: (i) the shorter turnaround and delivery time requirements from the creative design phase to final distribution of the packaged product; (ii) an increasing number of SKUs competing for shelf space and market share; (iii) the increasing importance of package appearance and promotions due to demonstrated point-of-sale consumer purchasing behavior; and (iv) the increasing requirements for worldwide quality and consistency in packaging as companies attempt to build global brand name recognition. Increasingly, the advertising and promotion markets require coordination of these efforts, with the initiatives coming from advertising agencies. The Company's expansion into these markets strengthens and enhances the overall service offering to the unified marketing approach of our clients.
Meeting the requirements of the advertising and promotional business demands production of work under extremely short timelines, usually in under 24 hours. Creative retouching, color correction and composition in multiple file formats are produced to meet requirements of the printers. The Company is a leader in conventional, computer to plate and digital ad delivery to publications.
THE COMPANY'S GROWTH STRATEGY
The Company's primary goal is to enhance its leadership positions in the prepress imaging market serving the consumer products, advertising and promotion markets. Key aspects of the Company's business strategy to achieve this goal include the following:
- Growth through Acquisitions and Start-up Operations. The Company's profitability and ready access to capital have enabled it to make strategic acquisitions of companies that range in size from $2 million to $20 million in revenues. In its 45-year business history, the Company has integrated more than 43 prepress and imaging businesses into its operations while streamlining overhead and improving margins in the aggregate. The Company acquired 8 businesses in 1999 with combined annualized revenues of in excess of $37 million. These acquisitions are part of the Company's growth strategy to acquire market niche companies with Fortune 1000 client lists, excellent client service or proprietary products and solid management who will continue to operate the business after the acquisition. These managers of acquired businesses receive performance incentives to continue to profitably grow the business.
The Company intends to continue expanding through acquisitions of well-managed companies with solid market positions a reputation for quality work and established client lists. Schawk believes that an emphasis on complementary acquisitions of companies serving targeted markets will allow it to broaden its service offerings and provide single source prepress and imaging and image database services to its clients.
The Company believes it has greater versatility in meeting the various requirements of its clients than smaller, less integrated competitors lacking technical expertise, and that this versatility will result in greater opportunities for internal growth as well as enhancing the Company's image as an attractive purchaser for potential consolidation candidates. Schawk believes that there will continue to be a number of attractive acquisition candidates in the fragmented and consolidating industry in which it operates. The Company expects to strengthen its market position by applying its management and operational philosophies and practices, which have been successful in its graphic arts businesses, to newly acquired businesses.
The Company has also had some success in establishing start-up operations in response to client and market requirements. Schawk intends to continue this strategy as opportunities warrant. See "-- Acquisitions and Start-up Operations."
- Exploitation of Industry Trends; Outsourcing. The Company has historically attempted to strengthen its market position by identifying and exploiting industry trends. As a consequence, the Company has been uniquely positioned to benefit as consumer products companies continue to reduce both their prepress staffs and total number of suppliers. The Company's on-site strategy developed as clients outsource imaging functions in an attempt to cut costs and improve turnaround and delivery times. The Company intends to expand this effort, as clients increasingly require on-site service. As of December 31, 1999 the Company had 41 on-site locations staffed by over 130 Schawk employees, approximately 9% of our total workforce. Further, the Company believes that its commitment to client service and its broad array of premium service offerings position the Company as a cost effective, value-added supplier of digital imaging services. As clients continue to cut their staffing levels, they are expanding the number of services required of their prepress suppliers. As a result, fewer of the Company's competitors have the full complement of capabilities required in the marketplace. The Company believes outsourcing trends will continue.
Exploitation of Technology Advancements: The Company is dedicated to keeping abreast of and initiating technological process developments in its industry. To build upon its leadership position, the Company actively evaluates systems and software products of various computer and software manufacturers and also independently develops software for implementation at its operating facilities. The Company continually invests in new technology designed to support its high quality prepress services. The Company concentrates its efforts on understanding the systems and equipment available in the marketplace and creating solutions using off-the-shelf products, customized to meet a variety of specific client and internal requirements.
MANAGEMENT PHILOSOPHY
The Company believes that by adhering to its management philosophy, the Company has gained in market share and improved margin performance in its core business. The proof of the strength of its management philosophy is the fact that the company increased sales and had operating income in its digital imaging business in 18 of the last 21 years. The Company's management philosophy incorporates the following key concepts:
Total Quality Management. A cornerstone of the Company's management philosophy is its emphasis on high quality. The Company is committed to the principles of "Total Quality Management" ("TQM") and stresses to all employees, regardless of level, the importance of striving to meet or exceed client expectations. Historically, the Company has been committed to employee training and technological improvements to achieve this level of performance. Through the Company's application of TQM, employees have adopted the necessary commitment to client service that is essential to quick turnaround and consistent delivery of high quality services and products. Such increased quality results in decreased costs to clients and the Company in the long run. The Company views itself as a service provider to its clients. Understanding the needs of its clients and customizing its services and products is part of the TQM process that has helped the Company differentiate itself from the competition. Consequently, the Company makes the necessary investments to ensure that these services continue to meet the highest quality standards and needs of its clients. A number of the Company's operations are, or are soon to be, ISO 9000 and/or ISO 9002 certified.
Client Service. Another key component of the Company's management philosophy has been its commitment to client service. The Company believes that this commitment has contributed to the confidence and loyalty its clients have shown. Because of the increasingly competitive markets faced by its clients, the Company must be flexible enough to modify its operations in order to meet the specialized needs of its clients. The Company's emphasis on on-site client representatives and operations helps to address this requirement and has further solidified existing client relationships.
Employee Training and Investment in Equipment. The Company believes that its most valuable assets are its employees because its ability to provide clients with high quality services and products depends upon their dedication and expertise. The Company provides extensive and continuous training to keep its employees abreast of the latest technological developments and the particular needs of its clients. Providing its employees with the latest equipment, software and training are fundamental to the Company's philosophy.
Technical Expertise. The Company is able to provide its clients with high quality services and products and quick response time because of its efficient utilization of state-of-the-art equipment, software, digital server, storage technology and telecommunication systems. As part of its commitment to maintain its technological expertise, the Company has historically worked with software developers to create software that fully addresses the Company's and its clients' needs. The Company acts as a test site for numerous hardware and software products. In order to facilitate the exchange of information among its various facilities, in 1991, the Company established the Schawk Technical Advisory Board for the purpose of coordinating the research and evaluation of new technologies in the graphic arts industry. This group continues to be recognized for its efforts and has been invited to lecture at numerous national and international symposiums and conferences.
SERVICES
The Company offers comprehensive, high quality digital imaging prepress services. The Company's facilities produce conventional, electronic and desktop color separations, electronic production design, film preparation, platemaking and press proofs for lithography, flexography and gravure. The Company's services also include both digital and analog image database archival and management as well as creative design, art production and various related outsourcing services.
The Company interfaces between consumer products manufacturers and the creative designers and converters used by those businesses to produce packaging, such as folding cartons, boxes, trays, cans, containers, packaging labels and wrap and related point-of-sale and promotional materials. The Company's services consist principally of the electronic and digital production of art design, color separations and color proofs to client and converter specifications and imaging asset management. These services are an intermediate step between creative artwork and the actual printing of graphic materials. The production of color separations requires well-trained and highly skilled technicians applying various digital and analog image manipulation, assembly and color management techniques in order to preserve the integrity of the original image when translated into print and to ensure consistency of the printed materials.
The Company specializes in digital imaging prepress services relating to the packaging and promotional needs of clients in the consumer products industry and in the advertising and promotion markets. The Company serves Fortune 1000 companies and their advertising agencies to ensure worldwide quality and consistency in the packaging and related imagery of their products with the wide array of consumer products in the marketplace. Because there is no consistent size, shape, color or packaging material, the Company functions as a network of custom job shops taking advantage of its size for technical expertise while being able to respond quickly to the varying needs of global clients.
Image quality and consistency and ever-shortening response and delivery times are becoming increasingly important to consumer products manufacturers as packaging assumes a greater role in promotion. While prepress work represents a relatively small percentage of overall packaging costs, the visual impact and effectiveness of product packaging is largely dependent upon the quality of the prepress work.
The Company's clients typically outsource their prepress requirements and assign the Company the responsibility of interfacing with the clients' designated graphic designers, who design the packaging and the converters or printers who print and produce the packaging and related materials. The Company competes on the basis of offering its multi-national client base: (i) high quality customized imaging; (ii) rapid turnaround and delivery times; (iii) up-to-date knowledge of the printing press specifications of converters and printers located throughout the United States and Canada; (iv) digital imaging asset management; (v) art production; and (vi) the ability to service its clients' global prepress requirements through the Company's North American facilities and international subsidiaries and alliance partners.
As technology has created opportunities for quicker production turnarounds and deliveries, most of the Company's Fortune 1000 consumer products clients have capitalized on the opportunity to modify their packaging more frequently in order to customize their promotional activities on a regional, seasonal or sporting event basis. This activity has greatly increased the importance of maintaining the integrity of the digital and analog image design and text data for each package variation.
With its expansion into electronic art production design, the Company is utilizing its technical expertise to serve clients' requirements in a variety of outsourcing services including image database archiving, telecommunication and trafficking. The Company has the capacity to archive and manage past, current and future package design data and, accordingly, serves as a quick access library of accurate file data for its clients. The Company is continuously updating and improving its imaging database management system, called PaRTs(TM) (Packaging and Resource Tracking system). The Company believes that PaRTs(TM) enhances a client's ability to manage its imaging assets more efficiently and with reduced time commitments. When compared to other database management systems available in the market place, the Company believes that PaRTs(TM) contributes to the Company's ability to meet its clients' quick turnaround and delivery times and quality standards.
The Company has also developed a customized client electronic communication system called CLICk(TM) (Client Linked Information Centers) for its authorized clients, designated converters and other authorized personnel. Compatible with all major platforms and operating systems, CLICk(TM) allows clients to efficiently communicate with the Company and others on the system using telephone lines and/or the Internet.
Given the increased computerization of the prepress services industry, highly trained technicians are essential to the quality of the end product. Requirements of turnaround speed without a reduction in quality are increasing as clients strive for differentiation and customization of their products and brands. Schawk has met these requirements by continuously reinvesting in technology, training its personnel and establishing numerous satellite on-site operations to complement its main operating facilities.
To capitalize on market trends, management believes that the Company must continue to be able to provide clients the ability to make numerous changes and enhancements with shorter turnaround times than ever before. Accordingly, the Company has focused its efforts on improving its response times and continues to invest in rapidly emerging technology and the continuing education of its employees. The Company also educates clients on the opportunities and complexities of state-of-the-art equipment and software. The Company believes that its ability to provide quick turnaround and delivery times, dependability and value-added training and education programs will continue to give it a competitive advantage in serving clients who require high volume, high quality product imagery.
The Company's services are distinguished by its ability to complete prepress services for packaging designs in increasingly compressed time frames and with high standards of quality. In order to satisfy client requirements, the Company is frequently required to provide services in as little as 24 hours. The following core competencies of the Company are described in more detail below:
- Technical Expertise. The Company places an emphasis on investment in state-of-the-art systems and equipment and the need for continual training and development of its employees through programs offered at the Company-owned training center and operating facilities and on-site at client locations. The Company has had success in elevating its employees' competency and its clients' standards to levels requiring the superior technical expertise and capabilities that distinguish the Company's services.
- On-Site Personnel. The Company has placed over 130 employees on-site at or near 41 client locations in an effort to further integrate its prepress services directly with the client operations. This facilitates faster turnaround and delivery times and fosters stronger client relationships.
- Strong Relationships with Converters and Printers. As each client selects its own converter(s) and/or printer(s) the Company coordinates extensively with the converter to ensure uniformity in color and appearance of the printed product packages. Each client generally selects its printing services on a bid basis. By using the Company as its imaging specialist, the print/read imagery information is not captive at any one printer or converter. This affords each client consistent image replication at any printing site because the Company can supply any printer or converter with film customized for its printing press. Additionally, this allows the client to reproduce its image consistently across many printing sources and it also provides the client with information as to location and cost of its press runs.
Over the course of its 46-year business history, the Company has developed strong relationships with many of the major converters and printers in the United States and Canada.. As a result, the Company has extensive knowledge of their equipment, thereby enabling the Company to increase the overall efficiency of the printing process. Internal operating procedures and conditions may vary from printer to printer, affecting the quality of the color image. In order to minimize the effects of these variations, the Company makes necessary adjustments to its color separation work to account for irregularities or idiosyncrasies in the printing presses of each of its clients' converters. The Company strives to afford its clients total control over their imaging processes with customized and coordinated services designed to fit each individual client's particular needs, all aimed at ensuring that the color quality, accuracy and consistency of a client's printed matter are maintained.
- Imaging Asset Management. The Company maintains and manages a database for its clients' images and package designs. Once an image is in the Company's database, the client can make frequent regional, seasonal or event-related adjustments to the file image prior to printing. The Company's ability to quickly manipulate digital images enables its clients to deliver their products to the market faster. The Company's capabilities also allow it to send an image for output and printing virtually anywhere in the world. As more and more multi-national consumer products companies strengthen their international packaging quality control to enhance their global brand image, they are requiring a more consistent worldwide image. In response to this trend, the Company is playing an increasing role in ensuring that its clients' images are satisfactory and consistent both domestically and internationally. The acquisition of 65% of the Laserscan Group in September, 1999 with operations in China, Malaysia and Singapore is indicative of Schawk's commitment to its clients on a world-wide basis.
ACQUISITIONS AND START-UP OPERATIONS
The Company has acquired and integrated more than 43 prepress and imaging businesses into its operations since the business was founded in 1953. Throughout its history, the Company has successfully identified acquisition candidates that represent market niche companies with Fortune 1000 client lists, excellent client service or proprietary products and solid management. The Company favors businesses with management teams that will continue to operate the businesses as autonomous units. The Company has also commenced a number of start-up operations over the years when client servicing requirements or market conditions warranted.
During 1999 the Company made eight acquisitions: Cactus Imaging Centres in Toronto, Canada; Color One in Cincinnati, OH; Deluxe Engraving in Cincinnati, OH; Designer's Atelier in New York, NY; Inter-Process Service in Stamford, CT; The Mackinder Group in New York, NY; Plewes-Bertouche in Toronto, Canada and Laserscan, with operations in China, Malaysia, and Singapore.
The Company also established a start-up operation in Kobe, Japan.
The Company intends to continue expanding through acquisitions of well-managed companies with solid market positions and established client lists. The Company believes that emphasis on complementary acquisitions of businesses serving targeted markets will allow it to broaden its product offerings and provide its clients with a single source for imaging and image database services. The Company will also continue to analyze and investigate start-up operations on an ongoing basis.
RESEARCH AND DEVELOPMENT
The Company is dedicated to keeping abreast of and, in a number of cases, initiating technological process developments in its industry that have applications for packaging. To build upon its leadership position, the Company is actively involved in system and software technical evaluations of various computer systems and software manufacturers and also independently pursues software development for implementation at its operating facilities. The Company continually invests in new technology designed to support its high quality prepress services. The Company concentrates its efforts in understanding systems and equipment available in the marketplace and creating solutions using off-the-shelf products, customized to meet a variety of specific client and internal requirements. PaRTS(TM) and CLICk(TM) are examples of the Company's commitment to systems development.
As an integral part of its commitment to research and development, the Company has established the Schawk Technical Advisory Board for the purpose of researching and evaluating new technologies in the graphic arts and telecommunications industries. The Advisory Board meets formally, at least quarterly, to review new equipment and programs, then disseminates the information to the entire Company and to clients as appropriate.
MARKETING AND DISTRIBUTION
The Company markets its services nationally and internationally through seminars, newsletters and training sessions targeted at existing and potential clients. The Company sells its services through a group of approximately 150 direct salespersons and 200 client service technicians who call on consumer products manufacturers, including those in the food and beverage, home products, pharmaceutical and cosmetics industries and mass merchant retailers. The Company has adopted a team approach to marketing, reflective of its TQM philosophy. Both the Company's salespersons and the Company's client service technicians share responsibility for marketing the Company's offerings to existing and potential clients, thereby fostering long-term institutional relationships with its clients.
In addition to its numerous operations in the United States and Canada, the Company has operations in Queretaro, Mexico, Kobe, Japan, Malaysia, China and Singapore through the acquisition of Laserscan, and a network of global affiliations in Australia, Europe and Asia.
CLIENTS
The Company's clients consist of direct purchasers of color separations, including end-use consumer product manufacturers and mass merchant retailers, converters and advertising agencies. Many of the Company's clients, a large percentage of which are Fortune 1000 companies, are multi-national in scope and often use numerous converters both domestically and internationally. Because these clients desire uniformity of color and image quality across a variety of media, the Company plays a very important role in coordinating their printing activities by maintaining current equipment specifications regarding its clients and converters. Management believes that this role has enabled the Company to establish closer and more stable relationships with these clients. Converters also have a great deal of confidence in the quality of the Company's services and have worked closely with the Company to reduce the converters' required lead-time, thereby lowering their costs. End-use clients often select and utilize the Company to ensure better control of their packaging or other needs and depend upon the Company to act as their agent to ensure quality management of data along with consistency among numerous converters and packaging media. The Company has established 41 on-site locations at or near clients that require high volume, specialized service. As its art production services continue to expand, the Company anticipates that it will further develop its on-site services to its client base.
Many of the Company's clients place orders on a daily and weekly basis and work closely with the Company year-round as they frequently redesign product packaging or introduce new products. While certain promotional activities are seasonal, such as those relating to summer, back-to-school time and holidays, shorter technology-driven prepress cycle time has enabled consumer products manufacturers to tie their promotional activities to regional and/or current events (such as sporting events or motion picture releases). This prompts such manufacturers to redesign their packages more frequently, resulting in a correspondingly higher number of packaging redesign assignments. This technology-driven trend toward more frequent packaging changes has offset previous seasonal fluctuations in the volume of the Company's business (also see "Seasonality and Cyclicality"). In addition, consumer product manufacturers have a tendency to single-source their prepress work with respect to a particular product line, so that continuity can be assured in changes to the product image. As a result, the Company has developed a base of steady clients in the food and beverage industry. During 1999 no single client accounted for more than 5% of the Company's net sales, and the 10 largest clients in the aggregate accounted for approximately 28% of net sales.
COMPETITION
The Company's competition comes primarily from other independent color separators and converters and printers that have prepress service capabilities. Independent color separators are companies whose business is performing prepress services for one or more of the principal printing processes. The Company believes that only two firms, Applied Graphics Technologies, Inc., through it's Wace Group subsidiary, and Southern Graphics, a subsidiary of Reynolds Metals, compete with Schawk on a national basis. The remaining independent color separators are regional or local firms that compete in specific markets. To remain
competitive, each firm must maintain client relationships and recognize, develop and exploit state-of-the-art technology and contend with the increasing demands for speed.
Some converters with prepress service capabilities compete with the Company by performing such services in connection with printing work. Independent color separators such as the Company, however, may offer greater technical capabilities, image quality control and speed of delivery. In addition, converters often utilize the services of the Company because of the rigorous demands being placed on them by clients who are requiring faster turnaround times. Increasingly, converters are being required to invest in technology to improve speed in the printing process and have avoided spending on prepress technology.
As requirements of speed continue to be critical, along with the recognition of the importance of focusing on their core competencies, clients have increasingly recognized that the Company provides services at a rate and cost that makes outsourcing more cost effective and efficient.
PURCHASING AND RAW MATERIALS
The Company purchases photographic film and chemicals, storage media, ink, plate materials and various other supplies and chemicals on consignment for use in its business. These items are purchased from a variety of sources and are available from a number of producers, both foreign and domestic. Materials and supplies account for only a small portion of the Company's cost of production, and no shortages are anticipated. Furthermore, as a growing proportion of the workflow is digital, the already low percentage of materials in cost of sales will continue to be reduced. Historically, the Company has negotiated and enjoys significant volume discounts on materials and supplies from most of its major suppliers.
INTELLECTUAL PROPERTY
The Company owns no significant patents. The trademarks "Schawk," "Clockface and Creole," "CLICk" and "PaRTS" and the trade names "Amber Design," "Color Data East," "Schawkgraphics," "Schawk Client Services Group," "Schawk Prep," "Interchange," "Interchange Digital," "Interchange Digital Management Services," "Lincoln Graphics," "Litho Colorplate," "LSI/Atlanta," "LSI/Kala," "Process Color Plate," "Total Reproductions," "Weston Engraving," "The Palm Group," "Stebbins Photography," "Blue Barrel," "StanMont," "PrinterNet," "CyberImages," "Batten Graphics," "Fishbowl," "Deluxe Engraving," "Interprocess," "Mackinder Group," "Schawk Asia," "Schawk Japan," "Laserscan," "Laserscan Toyo Flexographic," "Rave Design," and "Xzact" are the most significant trademarks and trade names used by the Company.
EMPLOYEES
As of December 31, 1999, the Company had approximately 1,600 full-time employees. Of this number, approximately 30% are production employees represented by local units of the Graphic Arts International Union and by local units of the Toronto Typographical Union. The Company's union employees are vital to its operations. Collective bargaining agreements covering the Company's union employees in four facilities are subject to renegotiations. Three are subject to renegotiations during 1999-2000. The Company considers its relationships with its employees and unions to be good.
BACKLOG
The Company does not have or keep backlog figures as projects or orders are generally in and out of the facilities within five to seven days. Generally, the Company does not have contracts with its clients, but maintains client relationships by delivering timely prepress services, providing technology enhancements to make the process more efficient and bringing extensive experience with and knowledge of printers and converters.
SEASONALITY AND CYCLICALITY
The Company's digital imaging prepress business for the consumer product packaging prepress market is not currently seasonal because of the number of design changes that are able to be processed as a result of speed-to-market concepts and all-digital workflows. On the other hand, there is a two to three year cycle for major design changes that the Company has experienced in the last six years resulting in greater volumes in certain years followed by more modest volumes as only small changes are made before the next major redesign cycle. With respect to the advertising and promotional markets, some seasonality exists in that the months of December and January are typically the slowest months of the year in this market because advertising agencies and their clients typically finish their work by mid December and don't start up again until mid January. Advertising and promotion is generally cyclical as the consumer economy is cyclical. When consumer spending and GDP decreases, ad pages decline. When ad pages decline the Company's advertising and promotion business declines.
ITEM 2.
ITEM 2. PROPERTIES
FACILITIES
The Company owns or leases the following office and operating facilities:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
LEGAL PROCEEDINGS
From time to time, the Company has been a party to routine pending or threatened legal proceedings and arbitrations. The Company insures some, but not all, of its exposure with respect to such proceedings. Based upon information presently available, and in light of legal and other defenses available to the Company, management does not consider the liability from any threatened or pending litigation to be material to the Company. The Company has not experienced any significant environmental problems.
As a part of the final settlement of certain stockholders' litigation against the Company and its directors relating to the merger with Filtertek, Inc. on December 30, 1994, Clarence W. Schawk and David A. Schawk transferred 159,521 shares of Class A Common Stock to a settlement fund for the benefit of settlement class members. The shares are subject to a put agreement whereby the class members may require the Company to purchase the shares at a price ranging from $7.00 to $9.50 per share. The actual price depends upon the time of exercise over the exercise period which begins on the final settlement date and ends on the later of the second anniversary of the final court approval of the settlement agreement (which occurred on May 21, 1997) or 180 days after the shares are distributed to class members. Shares were distributed to class members in March, 1999.
The settlement involves no expenditure or payment by Schawk other than the $80,000 for expenses and possible contingent expenditures by Schawk in respect to any stock buybacks. There also is no issuance of capital stock by Schawk, however, current accounting rules and SEC regulations require Schawk to take a nonoperating charge in connection with this settlement in the amount of approximately $1.4 million. This amount was included in the discontinued operations charge taken by Schawk during 1996, in connection with the sale by Schawk of its Plastics Group.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted to a vote of security holders for the three months ended December 31, 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
SCHAWK, INC. SUPPLEMENTAL STOCKHOLDER INFORMATION QUARTERLY FINANCIAL DATA
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(a) Included in earnings per share for the quarter ended March 31, 1998 is $0.27 for the discount on redemption of preferred stock.
DIVIDENDS DECLARED
STOCK PRICES
The Registrant's stock is listed on the NYSE. The Registrant has approximately 997 stockholders of record as of March 15, 2000.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
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(a) On February 7, 1997, the Company sold the Plastics business segment for $93,485 plus working capital adjustments. The consolidated income statement information for 1996 and prior has been restated to exclude discontinued operations.
(b) 1998 earnings per share includes $0.27 for the discount on redemption of preferred stock.
(c) Includes data from discontinued Plastics Group in 1996 and 1995.
(d) Income taxes in 1995 includes a credit of $1,632 for net operating loss carry forwards previously recorded.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Statements contained herein that relate to the Company's beliefs or expectations as to future events relating to, among other things, the anticipated revenues from recent acquisitions, the success of the Company's growth strategy, the ability of the Company to exploit industry trends, such as outsourcing, the Company's exploitation of technological advancements in the imaging industry, 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 and are subject to the "Safe Harbor" created thereby. 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 that the assumptions will prove to have been correct. Important factors that could cause actual results to differ materially and adversely from the Company's expectations and beliefs include the level of business activity at the Company's clients and the ability of the Company to implement its growth strategy, to identify and exploit industry trends and to exploit technological advances in the imaging industry.
The following table sets forth, for the periods indicated, the percentage relationship to net sales of selected items in the Company's consolidated income statement:
1999 COMPARED TO 1998
Net sales. Net sales for 1999 increased 27.1% to $184.8 million from $145.4 million in 1998. The increase in revenues was all attributable to revenues from acquisitions in 1999. The market for digital imaging for high end consumer product packaging was soft throughout 1999. As a result, lower than anticipated volumes were experienced throughout the year at both the Company's historical operations and at its acquired businesses.
Operating income. Operating income decreased 16.4% to $23.7 million in 1999 from $28.3 million in 1998. Excluding restructuring and other charges, operating income decreased 5.4% to $26.0 million in 1999 from $28.3 million in 1998. The lower operating income was due to lower volumes at most of the Company's divisions in 1999. The Company has acquired 13 businesses over the last two years. As part of the Company's continuing process of integrating these businesses and improving the profitability of all of its 25 divisions, it is moving aggressively toward consolidating certain operations. The Company has identified certain operations that will be combined and/or moved and the costs related to the combinations and relocations resulted in a $2.2 million dollar pretax charge in the fourth quarter. A restructuring plan has been adopted to accomplish these changes. In addition, the Company has identified certain assets that will be written down to reflect the impairment of these assets, caused by among other things, replacement with newly acquired technically advanced hardware and software that provided more efficient throughput, rendering existing equipment obsolete. This charge is $0.9 million on a pretax basis.
Cost of sales for 1999 increased as a percent of sales to 58.5% from 54.4% for 1998 because of reduced efficiencies from the reduced volumes. Selling, general and administrative expenses increased as a percentage
of sales to 25.9% in 1999 from 25.3% for 1998 as a result of a full year of higher commission costs in the businesses acquired in 1998 that serve the advertising and promotional markets.
Restructuring. The Company acquired thirteen businesses in the last 22 months. As a result, the Company has multiple businesses operating in certain geographic areas. After a review of all of the Company's operations in the fourth quarter of 1999, management of the Company decided to consolidate certain operations.
In addition, due to the soft market experienced by the industry in 1999, the Company reviewed all of its new and existing operations and developed a restructuring plan that resulted in a reduction in staffing levels at certain operations.
Restructuring of existing operations. In the fourth quarter of 1999, the Company approved a restructuring plan ("the Plan") and recorded a charge of $2.2 million, consisting of $1.7 million of lease termination costs and $0.5 million of severance costs. This charge relates to the planned consolidation of four facilities in the following states: Illinois, Ohio (two facilities consolidating into one) and New York. The consolidations were started in December 1999, and are scheduled to be completed by September 30, 2000. With regard to workforce reductions, a total of 50 employees were laid off at four existing facilities either as part of an early retirement program or as normal terminations. In addition, the Plan included eleven layoffs at an operation in Wisconsin due to lower sales volumes. All of the above is described in more detail in the following paragraphs.
The Illinois facility will be relocated to a facility that will provide a more efficient layout for the operations as well as improved access to the Company's distribution channels. The existing lease, which expires in June 30, 2002, is with a related party who is in the process of selling the building. Based on a review of the current market demand for the area, it has been estimated that the building will be sold by December 31, 2000. Therefore, although there is no assurance the building will be sold by December 31, 2000, $245,000 representing rent charges to December 31, 2000 has been recorded as part of restructuring and other expense in the Statement of Operations.
Certain of the operations of the aforementioned facility are being consolidated with another Illinois facility. In anticipation of the Illinois consolidation, a headcount reduction program was carried out that was completed in the fourth quarter of 1999. There were 24 affected employees (approximately 12% of the combined Illinois workforce). This program had two components: normal terminations and early retirements. The normal terminations required a charge of $46,000. The early retirements required a charge of $365,000. Both of these amounts are included in the restructuring charge.
In New York, the Company had leased a facility in 1999 to enter a new market related to the large format imaging needs of its food and beverage clients in the East Coast market. The market had not developed as fast as Company Management had anticipated and monthly losses were being incurred at the facility. In addition, several months after opening the new facility, the Company acquired a business in Stamford, Connecticut in September 1999. In December 1999, in connection with the Plan, the Company decided to close the new large format facility and move the operation in with the Stamford operation to reduce costs. The New York facility will be vacated by April 30, 2000. The existing lease at the facility to be closed expires December 31, 2003. Therefore, a charge for lease abandonment cost of $1.0 million has been included in the restructuring charge which assumes the Company will be able to sublease at the existing lease rate for half of the remaining lease term after we vacate the facility. Severance cost at the business being relocated was $10,000 at December 31, 1999.
The Ohio facility is being vacated and combined with another operation at a site that the Company is leasing in connection with an acquisition of a business in Cincinnati in September 1999. The consolidation of operations is taking place because the Company operates three businesses in the Cincinnati area and the Plan calls for locating all three businesses at one site that has excess capacity thereby reducing costs and better coordinating our efforts in the Mid-East regional marketplace. There are only nine months left on the current lease, which is with an unrelated third party. The charge to vacate the current site is approximately $100,000, which represents rent after vacating the facility, net of
estimated recoveries from sublease income. Leasehold improvements of $75,000 were written off in the restructuring charge in connection with the relocation as well.
As part of the Plan, the Company carried out a workforce reduction at an operation in Wisconsin in the fourth quarter resulting in a charge of $105,000. Eleven employees were terminated (approximately 17% of the workforce). The operation was experiencing a decline in volume due to a continued weakness in sales with current customers and weak new business development results. The workforce reduction creates an ongoing cost structure that allows the operation to be profitable at the sales volume level that is expected for the next twelve months.
Restructuring at Acquired Companies. There are two operations that were acquired in the months of September 1999 and November 1999 that are part of the Plan. The September acquisition in Stamford, Connecticut is being restructured (as planned for at the acquisition date), because certain client accounts that the Stamford operation shared with our New Jersey operation when the two operations were competitors, are now consolidating at the Company's New Jersey operation at the request of a significant client. The client wants all of its work done at one Schawk facility. Conversely, one customer that was splitting its work between the two operations has requested that all of their work be handled out of Stamford going forward. The net impact of both of these volume shifts, however, is a reduction in sales volume at the Stamford operation. As a result, as contemplated at the acquisition date, the Company initiated a workforce reduction in the fourth quarter and eleven employees (approximately 15% of the workforce) were terminated in November 1999 at a cost of $35,000. The workforce reduction resulted in an adjustment of purchase price allocation increasing severance liability and increasing excess cost over net assets acquired (goodwill) and did not result in a charge to earnings.
In addition, the Company's second Cincinnati acquisition in 1999, which was consummated in November 1999, is being restructured. As contemplated at the acquisition date, the Company is combining all three of its Cincinnati operations at one location. This consolidation includes the Company's historical operation moving from the "Ohio facility" described above in "Restructuring of Existing Operations". The cost of closing the duplicate facility from the November acquisition will be an adjustment of the purchase price allocation and not result in a charge to earnings. The estimated cost of closing the duplicate facility is less than $50,000.
Impairment of machinery and equipment. In connection with the Plan, the Company performed a comprehensive review of all its fixed assets to identify any obsolete and impaired assets. As a result of this review, equipment with a net book value of $0.9 million was deemed to be impaired and a charge for that amount was recorded in the fourth quarter of 1999. The single largest dollar item included in the charge related to a short run digital press that was purchased four years ago in response to the Company's customers needs. However, the demand for short run products was not as great as management expected. As a result, the press is idle and a write down of $357,000 was taken in the impairment charge. The remaining net book value is at a level that we believe the Company can sell the press for in the used equipment market.
In addition, two high-end workstations with a net book value of $81,000 were determined to no longer be in use and are being written off. The technology that the workstations used is no longer state of the art and is not as efficient or versatile as more advanced equipment that the Company uses currently. Therefore, the salvage value was determined to be negligible.
The balance of the impairment charge relates to over one hundred individual pieces of equipment or software that for the most part are obsolete due to the fast pace of change in technology in the graphics arts industry. These items have been replaced by more modern equipment and as a result, were determined to have a negligible salvage value and were therefore written off completely.
Income before income taxes. Income before income taxes for 1999 decreased 32.6% to $20.0 million from $29.7 in 1998. The pretax income margin for 1999 was 12.8% compared with 19.5% in 1998. The reduction in pretax income margin was primarily due to reduced sales volume, and the restructuring and other charges previously described. Additionally, interest and dividend income decreased to $0.6 million in 1999
from $2.6 million in 1998 as the Company liquidated its investment portfolio to provide funds for acquisitions. The Company had gains on the sale of investments in 1999 of $0.2 million compared with $2.4 million in 1998. Interest expense increased to $4.4 million in 1999 from $3.6 million in 1998 as the Company's outstanding debt increased.
Net income. Net income decreased 33.3% to $11.8 million for 1999 from $17.7 for 1998 for the reasons previously discussed.
Earnings per share. Both basic and diluted earnings per share decreased to $0.55 for 1999 from $1.07 and $1.06 respectively in 1998. A discount on the redemption of preferred stock increased earnings per share by $0.27 in 1998.
1998 COMPARED TO 1997
Net sales. Net sales from continuing operations for 1998 increased 25.3% to $145.4 million from $116.1 million in 1997. The increase in sales is attributable to internal revenue growth of approximately 11.3% and revenue growth from acquisitions of approximately 14.0%. The internal growth was due to increased demands related to promotional activities by clients, the continuing trend by our clients toward consolidating suppliers which has resulted in additional business for the Company, and new customers won through ongoing sales and marketing programs.
Operating income. Operating income increased 42.5% to $28.3 million in 1998 from $19.9 million in 1997 due to increased sales volume and increased operating efficiency. Cost of sales for 1998 decreased as a percent of sales to 54.4% from 56.2% for 1997 as the increased sales volume resulted in increased operating efficiency. Selling, general and administrative expenses increased $7.0 million or 22.7% but decreased as a percent of net sales from 26.7% to 26.1% as the Company was able to leverage the increased sales volume against the administrative cost structure.
Income before income taxes. Income before income taxes for 1998 increased 45.5% to $29.7 million from $20.5 in 1997. The pretax income margin for 1998 was 19.5% compared with 17.1% in 1997. The improvement in pretax income margin was primarily due to increased sales volume, the resulting increased operating efficiencies, and the gain on the sale of investments during the year. The Company had gains on the sale of investments in 1998 of $2.5 million compared with $1.3 million in 1997. Interest expense, net of interest income increased by $.3 million from 1997 to 1998 as the Company's investment portfolio was sold to provide cash for acquisitions.
Net income. Income from continuing operations and net income increased 45.7% to $17.7 million for 1998 from $12.1 for 1997 for the reasons previously discussed.
Earnings per share. Basic and diluted earnings per share increased to $1.07 and $1.06, respectively for 1998 from $.56 and $.55 respectively in 1997. A discount on the redemption of preferred stock increased earnings per share by $0.27 in 1998. Preferred dividends reduced earnings per share by $0.0 in 1998 and $0.06 in 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company presently finances its business from available cash and from cash generated from operations. Cash generated from operations in 1999 totaled $24.7 million. The Company maintains a $65 million unsecured credit facility, expiring May 2004, of which approximately $31.5 million was available for borrowings at December 31, 1999. The Company also maintains a $15 million unsecured demand line of credit to provide financing and working capital flexibility. At December 31, 1999, approximately $6.6 million was available for borrowings under the demand line of credit.
Long-term debt and capital lease obligations increased to $67.5 million at December 31, 1999 from $39.6 million at December 31, 1998 as the Company borrowed for acquisitions and other corporate needs.
The Company held invested balances of $3.6 million in bond mutual funds and U.S. Treasury and U.S. Government notes at December 31, 1999. These funds are available for sale to provide for acquisitions and corporate requirements.
At December 31, 1999, outstanding debt of the Company consisted of: (i) unsecured notes issued pursuant to a Note Purchase Agreement dated August 18, 1995, for $35.0 million with terms ranging from 2000 through 2005 (averaging seven years) at an average interest rate of 6.92%; and (ii) $33.4 million of borrowings under the Company's unsecured credit facility; and (iii) $8.4 million of borrowings under its demand credit line.
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, through cash generated from future operations or through short-term financing.
The Company had capital expenditures in 1999 of $17.9 million, in 1998 of $9.5 million, and in 1997 of $7.1 million. Capital expenditures made in 1999, 1998, and 1997 were principally for machinery, equipment and computer hardware and software to expand production facilities and improve productivity, and for the land and for building renovations.
The Company had depreciation of $10.4 million in 1999, $6.6 million in 1998, and $5.8 million in 1997. Amortization of goodwill totaled $1.9 million in 1999, $1.1 in 1998, and $1.2 million in 1997.
Cash paid for acquisitions totaled $41.6 million in 1999, $28.6 million in 1998, and negligible in 1997.
The Company repurchased $8.2 million of Class A Common Stock during 1999, $8.1 million during 1998 and $1.8 million during 1997 under a share repurchase program approved by the Board of Directors.
STOCK OFFERING
In February 1998, the company issued 1,950,000 shares of Class A Common Stock in an underwritten public offering at a price of $9.00 per share. The proceeds from the sale of the stock, net of underwriting discounts, commissions and estimated expenses, were approximately $16.3 million. Proceeds from the sale of the stock were used to repurchase 15,400 shares of Series A Preferred Stock of the Company and 5,207 shares of Series B Preferred Stock of the Company.
IMPACT OF INFLATION
The Company believes that over the past three years inflation has not had a significant impact on the Company's results of operations.
YEAR 2000 ISSUE
The Company made a concerted effort to prepare for the Year 2000 issue and there was no impact on the Company's hardware or software or other systems in January 2000 as a result of the date change. Given the above, management of the Company believe that there will not be any noticeable impact with respect with the year 2000 issue.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable to the Registrant for the reporting period.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS COVERED BY REPORTS OF INDEPENDENT AUDITORS
MANAGEMENT'S RESPONSIBILITIES FOR FINANCIAL REPORTING
The management of Schawk, Inc. is responsible for the preparation and integrity of all financial statements and other information contained in the Schawk, Inc. Form 10-K Annual Report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and necessarily include amounts based on judgments and estimates by management giving due consideration to materiality. The Company maintains internal control systems designed to provide reasonable assurance that the Company's financial records reflect the transactions of the Company and that its assets are protected from loss or unauthorized use.
The Company's financial statements have been audited by Ernst & Young LLP, independent auditors, whose report thereon follows. As part of their audit of the Company's financial statements, Ernst & Young LLP considered the Company's system of internal control to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. Management has made available to Ernst & Young LLP the Company's financial records and related data.
The Audit Committee of the Board of Directors is responsible for reviewing and evaluating the overall performance of the Company's financial reporting and accounting practices. The Committee meets periodically and independently with management and the independent auditors to discuss the Company's internal accounting controls, auditing and financial reporting matters. The independent auditors have unrestricted access to the Audit Committee.
/s/ DAVID A. SCHAWK ------------------------------------ David A. Schawk President and Chief Executive Officer Principal Executive Officer
/s/ JAMES J. PATTERSON ------------------------------------ James J. Patterson Senior Vice President and Chief Financial Officer Principal Financial Officer
/s/ DENNIS D. WILSON ------------------------------------ Dennis D. Wilson Director of Financial Reporting and Chief Accounting Officer Principal Accounting Officer
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders Schawk, Inc.
We have audited the accompanying consolidated balance sheets of Schawk, Inc. as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the index at item 8. These financial statements and schedule are the responsibility of Schawk, Inc. management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Schawk, Inc. at December 31, 1999 and 1998, and the consolidated results of its' operations and its' cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Chicago, Illinois February 15, 2000
SCHAWK, INC.
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
See accompanying notes.
SCHAWK, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes.
SCHAWK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes.
SCHAWK, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997 1998, AND 1999 (IN THOUSANDS)
See accompanying notes.
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
Schawk, Inc. (the Company) is a leading provider of digital imaging prepress services for the consumer products industry in North America and Asia. The Company focuses on providing these services to multi-national clients in three primary markets: consumer products packaging, advertising agencies and promotion.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
The Company recognizes revenue at the later of delivery of the goods and/or services to the customer or the acceptance of the goods and/or services by the customer.
CASH EQUIVALENTS
Cash equivalents include highly liquid debt instruments and time deposits with an original maturity of three months or less. Cash equivalents are stated at cost, which approximates market.
INVENTORIES
Inventories are stated at the lower of cost or market. Certain inventories, which approximate 31% of total inventories in 1999 and 47% in 1997 are determined on the last in, first out (LIFO) cost basis. The remaining inventories are determined on the first in, first out (FIFO) cost basis.
INVESTMENTS
Generally Accepted Accounting Principles require that investments in debt securities and marketable equity securities be designated as trading, held-to-maturity or available-for-sale. Management determines the appropriate classification of its securities at the time of purchase and reevaluates such designation as of each balance sheet date. All of the Company's investments were designated as available-for-sale at December 31, 1999. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of income taxes, reported in a separate component of stockholders' equity. Realized gains and losses and declines in value judged to be other than temporary are included in investment income. The cost of securities sold is determined by the specific identification method. Interest and dividends on available-for-sale securities are included in investment income.
PROPERTY AND EQUIPMENT
Property and equipment, including capitalized leases, is stated at cost, less accumulated depreciation and amortization and are being depreciated and amortized using the straight-line method over the estimated useful lives of the assets or the term of the leases, ranging from 3 to 40 years.
EXCESS OF COST OVER NET ASSETS ACQUIRED
Excess of cost over net assets acquired (goodwill) is being amortized using the straight-line method over periods with a life of 40 years. The Company continually evaluates the existence of goodwill impairment on the basis of whether the goodwill is fully recoverable from projected, undiscounted net cash flows of the related business unit.
FOREIGN CURRENCY TRANSLATION
The Company's foreign subsidiaries use the local currency as their functional currency. Accordingly, foreign currency assets and liabilities are translated at the rate of exchange existing at year-end and income
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and expense amounts are translated at the average of the monthly exchange rates. Adjustments resulting from the translation of foreign currency financial statements are included in accumulated comprehensive income (loss) as a component of stockholders' equity.
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 enacted 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.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the years ended December 31, 1999 and 1998 and 1997 are as follows:
The components of accumulated comprehensive income (loss), net of related tax, at December 31, 1999 and 1998 are as follows:
NOTE 3. RESTRUCTURING
The Company acquired thirteen businesses in the last 22 months. As a result, in certain markets the Company operates multiple businesses in the same geographic area. After a review of all of the Company's operations, management of the Company determined that consolidation opportunities existed in certain of these geographic markets. In addition, due the soft market experienced by the industry in 1999, the Company reviewed all of its new and existing operations and developed a restructuring plan that included reduction of staffing levels at certain operations.
RESTRUCTURING OF EXISTING OPERATIONS
In the fourth quarter of 1999, the Company approved a restructuring plan ("the Plan") and incurred charges of $2.2 million, consisting of $1.7 million of lease termination costs and $0.5 million of severance
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
costs. These charges are included in "Restructuring and other charges" on the Consolidated Statement of Operations. This restructuring includes the planned shutdown and consolidation of four facilities in the following states: Illinois, Ohio (two facilities consolidating into one) and New York. The shutdowns and consolidations were started in December 1999, and are scheduled to be completed by September 30, 2000. With regard to workforce reductions, a total of 50 employees were laid off at four existing facilities either as part of an early retirement program or as normal terminations. In addition, the Plan included the layoff of eleven employees at an operation in Wisconsin due to lower sales volumes.
RESTRUCTURING AT ACQUIRED COMPANIES
There are two operations that were acquired in the months of September 1999 and November 1999 that are part of the Plan. The September acquisition in Stamford, Connecticut is being restructured (as planned for at the acquisition date) and had a workforce reduction in the fourth quarter and eleven employees (approximately 15% of the workforce) were terminated in November 1999 at a cost of $35,000. The workforce reduction resulted in an adjustment of purchase price allocation increasing severance liability and increasing excess cost over net assets acquired (goodwill).
The second acquisition involved in a restructuring is the Cincinnati acquisition in November 1999. As contemplated at the acquisition date, the Company is combining all three of its Cincinnati operations at one location. The cost of closing the duplicate facility from the November acquisition has been accounted for as an adjustment of the purchase price allocation. The estimate of the cost of closing the duplicate facility is approximately $50,000.
NOTE 4. IMPAIRMENT OF MACHINERY AND EQUIPMENT
In connection with the Restructuring, all of the Company's fixed assets were reviewed to determine whether there were any asset impairments either in the operations being consolidated or in any other of the Company's operations. As a result of this review, assets with a net book value of $869,000 were deemed to be impaired and a charge for that amount was recorded in the fourth quarter of 1999. All of the assets written down were either equipment or software. The charge is included as part of "Restructuring and other charges" on the Statement of Operations. The largest part of the charge related to a short- run digital press that was purchased in response to the Company's customers need for short run sales samples and other collateral items. The demand for short run products was not as great as the Company thought it would be. As a result, the press is idle and is held for disposal. The press was written down to net realizable value of $200,000 that resulted in a write down of $357,000. The estimated net realizable value was determined to be the amount management believes the asset can be sold for in the used equipment market. The remaining items consist of equipment which has become obsolete due to technological changes.
NOTE 5. ACQUISITIONS
The following acquisitions made during 1998 and 1999 have been accounted for using the purchase method of accounting (no acquisitions were made during 1997). Accordingly, the purchase price has been allocated to the respective net assets acquired based on the fair value of such assets, including certain noncompete agreements and liabilities as of the date of the acquisitions, and the results of operations have been included in the accompanying consolidated statements of operations from the effective date of the
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
respective acquisitions. Pro-forma financial information has not been presented because the effects of the operations of the acquired companies prior to the date of acquisition were not significant.
NOTE 6. RELATED PARTY TRANSACTIONS
Included in prepaid expenses and other at December 31, 1999 and 1998, was approximately $2 and $369, respectively, of advances to Geneva Waterfront, Inc., which is owned by a stockholder of the Company. Interest is charged on these balances at the prime rate.
The Company also leases land and a building from a related party, see Note 12.
NOTE 7. INVENTORIES
Inventories consist of the following:
NOTE 8. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
Accumulated depreciation and amortization includes $3,576 and $3,161 for building and improvements under capital leases at December 31, 1999 and 1998, respectively.
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9. INVESTMENTS
At December 31, 1999 and 1998 all of the Company's securities were classified as available for sale. Unrealized appreciation on these securities totaled $107 ($64 net of tax effect) at December 31, 1998, and is included in accumulated comprehensive income (loss) in stockholders' equity. For the year ended December 31, 1999, the value of a bond mutual fund with a cost of $3,972 was determined to be permanently impaired and was written down to fair market value at December 31, 1999, and a loss of $368 was recorded in other income (expense) in the accompanying consolidated statement of operations. The investment was disposed of subsequent to December 31, 1999.
The following table summarizes available-for-sale securities at December 31, 1999 and 1998:
During the years ended December 31, 1999 and 1998, marketable equity securities were sold or determined permanently impaired, which resulted in gross realized gains of $84 and $2,504 respectively, which are included in other income in the accompanying consolidated statement of operations.
The following table is a summary of available-for-sale securities at December 31, 1999 and 1998 by maturity date:
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. ACCRUED EXPENSES
Accrued expenses consist of the following:
NOTE 11. LONG-TERM DEBT
Long-term debt consists of the following:
The Series A note bears interest at 6.58% and are payable in annual installments of $5 million. The Series B note bears interest at 6.98% and are payable in annual installments of $6 million from 2001 to 2005. The notes may be prepaid in whole or in part at any time.
The borrowings under the bank credit agreement are unsecured and are at a floating rate of interest over the Federal Funds or Eurocurrency rates based upon certain financial ratios. The effective interest rate on these borrowings was 7.12% at December 31, 1999 (6.14% on approximately $1,870 borrowed through a Canadian subsidiary). The credit agreement is for $65,000 and expires on May 6, 2004. The Company had approximately $31,630 available to borrow under this line at December 31, 1999.
Borrowings under the above agreements are subject to certain restrictive covenants. In addition, the agreements require the Company to maintain certain net worth and other financial ratio requirements. The fair value of these obligations approximates carrying value at December 31, 1999 and 1998.
Annual maturities of long-term debt at December 31, 1999 are as follows:
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has an unsecured $15 million demand line of credit with a bank in the United States to provide financing and working capital flexibility. At December 31, 1999, the Company had $8,400 outstanding under this facility.
NOTE 12. STOCKHOLDERS' EQUITY
Stockholders' equity includes the following:
The Company also has 1,000,000 shares of Series A and Series B Preferred stock authorized, of which none were issued and outstanding at December 31, 1999 and 1998.
NOTE 13. INCOME TAXES
The provision (credit) for income taxes for continuing operations is comprised of the following:
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Components of deferred income tax assets and liabilities are as follows:
A reconciliation between the provision for income taxes for continuing operations computed by applying the federal statutory tax rate to income before incomes taxes and the actual provision is as follows:
Other liabilities accrued in prior years but no longer required have been reduced during the current year which have lowered the effective tax rate by approximately 2.2% in 1999.
The undistributed earnings of foreign subsidiaries were approximately $3,314 and $1,043 at December 31, 1999 and 1998, respectively. No income taxes are provided on the undistributed earnings because they are considered permanently reinvested. The foreign component of income before income taxes was $3,808 for 1999, 1,810 for 1998 and $556 for 1997.
NOTE 14. LEASES AND COMMITMENTS
The Company leases land and a building from an unrelated party. This lease requires monthly installments of approximately $57 through January 2010. A related party has an option to purchase the land and building in January 2000.
The Company also leases land and a building from a related party, with monthly installments of approximately $32 through June 2002. The agreement contains an option to purchase the land and building at the end of the lease for 90% of fair market value at the end of the lease. The Company is required to pay utilities, real estate taxes, and insurance on the property on both leases. Both of these land and building leases are recorded as capital leases.
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also leases various plant facilities and equipment under noncancellable operating leases that expire at various dates through February 2010. Total rent expense incurred under all operating leases was approximately $2,490, $1,389 and $971 for the years ended December 31, 1999, 1998 and 1997, respectively.
Future minimum payments under leases with terms of one year or more are as follows at December 31, 1999:
NOTE 15. EMPLOYEE BENEFIT PLANS
The Company has various defined-contribution plans for the benefit of its employees. The plans provide a 100% match of employee contributions based on a discretionary percentage determined by management. The matching percentage of wages (as defined) was 5.5% in 1999, 5% in 1998 and 4% in 1997. Contributions to the plans were $1,780, $1,357 and $987 in 1999, 1998 and 1997, respectively.
The Company is required to contribute to certain defined benefit union pension plans under various labor contracts covering union employees. Pension expense related to the union plans, which is determined based upon payroll data, was approximately $1,145, $1,036 and $777 in 1999, 1998 and 1997, respectively.
NOTE 16. STOCK/EQUITY OPTION PLANS
The Company has an Equity Option Plan that provides for the granting of options to purchase up to 2,252 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.
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of options outstanding at each of the three years ended December 31, 1999, 1998 and 1997, and other data for the three years then ended under all option plans is as follows:
The following table summarizes information concerning outstanding and exercisable options at December 31, 1999:
Options available for grant under the plans were 1,183, 1,563 and 1,717 at December 31, 1999, 1998 and 1997, respectively. Options exercisable under the plans were 487 in 1998 and 460 in 1997.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation (Statement 123)," requires the use of option-valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the number of shares is fixed and the exercise price of the Company's employee stock options approximates the market price of the underlying stock on the date of grant, no compensation is recognized.
Pro forma information regarding net income and earnings per share is required by Statement 123 as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994, under the fair value method of that Statement. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period.
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's pro forma information follows:
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option valuation model with the following assumptions:
Option valuation models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate in management's opinion, the existing method does not necessarily provide a reliable single measure of the fair value of its employee stock options.
NOTE 17. EARNINGS PER SHARE
Basic earnings per share and diluted earnings per share are shown on the face of the statement of operations. Basic earnings per share is computed by dividing net income less preferred dividends by the weighted average shares outstanding for the year. Diluted earnings per share is computed by dividing net income less preferred dividends by the weighted average number of common shares and common stock equivalent shares outstanding (stock options) for the year.
The following table sets forth the computation of basic and diluted earnings per share:
SCHAWK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options to purchase 746 shares of Class A common stock at exercise prices ranging from $8.62-$15 per share were outstanding at December 31, 1999 but were not included in the computation of diluted earnings per share because the options were anti-dilutive. The options expire at various dates through December 31, 2009.
Options to purchase 232 shares of Class A common stock at exercise prices ranging from $9.75-$15 per share were outstanding at December 31, 1997 but were not included in the computation of diluted earnings per share because the options were anti-dilutive. The options expire at various dates through December 16, 2007.
NOTE 19. GEOGRAPHIC REPORTING
The Company operates a single business segment, Imaging and Information Technologies. The Company operates primarily in two geographic areas, the United States and Canada. Summary financial information for continuing operations by geographic area for 1999, 1998 and 1997 is as follows:
Identifiable assets are those assets that are identified with the operations in each geographic area and include cash and marketable securities held at those locations.
NOTE 20. YEAR 2000 ISSUE
The Company made a concerted effort to prepare for the Year 2000 issue and as a result there was no impact on the Company's hardware or software or other systems in January 2000 as a result of the date change. Given the above, management of the Company believe that there will not be any noticeable impact with respect with the year 2000 issue.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company has no items to report under item 9 of this Annual Report on Form 10-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and persons nominated to become directors and information regarding executive officers of the Registrant is included in the Proxy Statement for the Annual Meeting of Stockholders to be held Wednesday, May 24, 2000, and is to be filed with the Securities and Exchange Commission on or before April 30, 1999 ("the Proxy Statement"), and such information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item is included in the Proxy Statement under the heading "Executive Compensation" and "Proposal 1; Election of Directors" and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item is included in the Proxy Statement under the heading of "Security Ownership of Certain Beneficial Owners and Management" and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN TRANSACTIONS
Information with respect to this item is included in the Proxy Statement under the heading of "Certain Transactions" and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following financial statements are included in Item 8:
1. All financial statements
Reports of independent auditors and independent public accountants
FINANCIAL STATEMENTS:
Consolidated Balance Sheets -- Years Ended December 31, 1999 and 1998
Consolidated Statements of Operations -- Years Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows -- Years Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity -- Years Ended December 31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
2. The following financial schedules for the years 1999, 1998 and 1997 are submitted herewith:
SCHEDULE II -- Valuation Reserves
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant for the fourth quarter of 1999 through the filing date of this document:
(c) Exhibits
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* Represents management contract or compensation plan or arrangement required to be filed pursuant to Item 14(c) of Regulation S-K.
** Document attached hereto.
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized, in Cook County, State of Illinois, on the 28th day of March, 2000.
Schawk, Inc.
By: /s/ CLARENCE W. SCHAWK ---------------------------------- Clarence W. Schawk Chairman of the Board
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 26th day of March, 1999.
SCHAWK, INC.
SCHEDULE II -- VALUATION RESERVES ALLOWANCE FOR DOUBTFUL ACCOUNTS
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(1) Uncollectible accounts written off, net of recoveries.