RNS Number:4569N
Applied Graphics Technologies Inc
20 November 2001
PART 2
See Notes to Interim Consolidated Financial Statements
APPLIED GRAPHICS TECHNOLOGIES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of dollars)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of Applied Graphics Technologies, Inc. and its subsidiaries (the "Company"),
which have been prepared in accordance with the instructions to Form 10-Q and,
therefore, do not include all information and footnotes necessary for a fair
presentation of financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles, should be read in
conjunction with the notes to consolidated financial statements contained in
the Company's 2000 Form 10-K. In the opinion of the management of the
Company, all adjustments (consisting primarily of normal recurring accruals)
necessary for a fair presentation have been included in the financial
statements. The operating results of any quarter are not necessarily
indicative of results for any future period.
All references to the number of shares and per-share amounts in the
Consolidated Statement of Operations for the nine and three months ended
September 30, 2000, have been adjusted to reflect the two-for-five reverse
stock split effected on December 5, 2000. Certain prior-period amounts in the
accompanying financial statements have been reclassified to conform with the
2001 presentation.
2. DISCONTINUED OPERATIONS AND NET ASSETS HELD FOR SALE
In connection with the Company's adoption of a plan in June 2000 to sell its
publishing business, the results of operations of that business were reported
as a discontinued operation in the Company's financial statements. At such
time, the Company solicited bids and entered into negotiations with a
potential buyer. Such negotiations ceased after the Company believed it was
no longer in its best interest to pursue the proposed transaction. The
Company continued to pursue its plan to sell the publishing business, and in
2001 it retained a new investment banking firm and distributed an updated
offering memorandum. As of September 30, 2001, the Company was in discussions
with several potential buyers. As of November 2001, the Company was
proceeding toward a sale by the end of 2001, subject to the completion of due
diligence and financing arrangements of a potential buyer. Given the current
economic and political conditions, there can be no assurance that the
transaction will be consummated by that time.
Since as of June 30, 2001, one year from the measurement date, the Company had
not reached definitive terms with a potential buyer, the net assets of the
publishing business previously reported as a discontinued operation were
reclassified as "Net assets held for sale" in the Company's Consolidated
Balance Sheet at June 30, 2001, and continue to be reported as such at
September 30, 2001. Commencing July 1, 2001, the assets of the publishing
business are no longer depreciated and its results of operations are included
as part of continuing operations.
The results of operations of the publishing business for the six months ended
June 30, 2001, and the nine and three months ended September 30, 2000, and the
estimated loss on disposal and the subsequent reversal of the loss on
disposal, are presented as Discontinued Operations in the accompanying
Consolidated Statements of Operations as follows:
For the For the For the
six nine three
months months months
ended ended ended
June 30, September September
30, 30,
2001 2000 2000
Revenues $ 36,007 $ 62,183 $ 25,822
Income (loss) from operations $ 1,598 $ (620) $ 2,513
before income taxes
Provision (benefit) equivalent 868 (836) (843)
to income taxes
Income from operations 730 216 3,356
Reversal of (loss on) disposal 97,996 (98,599) (3,356)
Income (loss) from discontinued $ 98,726 $ (98,383) $ -
operations
The results of operations for the six months ended June 30, 2001, include
income from discontinued operations for the reversal of the remaining
estimated accrued loss on disposal of the publishing business originally
recognized in the second quarter of 2000. The results of operations of the
publishing business include an allocation of interest expense of $646 for the
six months ended June 30, 2001, and $3,432 and $482 for the nine and three
months ended September 30, 2000, respectively. The allocated interest expense
consisted solely of the interest expense on the Company's borrowings under its
credit facility (the "1999 Credit Agreement"), which represents the interest
expense not directly attributable to the Company's other operations. Interest
expense was allocated based on the ratio of the net assets of the discontinued
operation to the sum of the consolidated net assets of the Company and the
outstanding borrowings under the 1999 Credit Agreement.
Upon the reclassification of the publishing business to "Net assets held for
sale," the Company recognized an impairment charge of $97,766 in accordance
with the provisions of Statement of Financial Accounting Standards (SFAS) No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," which requires assets held for sale to be valued at
the lower of carrying amount or fair value less estimated costs to sell. The
fair value of the publishing business was estimated based on the current
discussions with potential buyers. The revenues, gross profit, and operating
income from the publishing business included in the Company's results of
continuing operations for the nine months and three months ended September 30,
2001, were $25,135, $13,530, and $4,826, respectively. The net assets of the
publishing business include $295 of long-term debt and obligations under
capital leases, inclusive of the current portion, at September 30, 2001.
3. RESTRUCTURING
In June 2001, the Company initiated and completed a plan (the "2001 Second
Quarter Plan") to consolidate certain of its content management facilities in
Chicago and to relocate one of its content management facilities in New York.
As part of the 2001 Second Quarter Plan, the Company terminated certain
employees and consolidated the work previously performed at three facilities
in Chicago into a single facility. The results of operations for the nine
months ended September 30, 2001, include a charge of $1,167 for the 2001
Second Quarter Plan, which consisted of $614 for facility closure costs and
$553 for employee termination costs for 50 employees. In addition, the
Company completed various restructuring plans in prior periods (the "1998
Second Quarter Plan," the "1998 Fourth Quarter Plan," the "1999 Third Quarter
Plan," the "1999 Fourth Quarter Plan," and the "2000 Second Quarter Plan,"
respectively). The amounts included in "Other current liabilities" in the
accompanying Consolidated Balance Sheets as of September 30, 2001, for the
future costs of the various restructuring plans, primarily future rental
obligations for abandoned property and equipment, and the amounts charged
against the respective restructuring liabilities during the nine months ended
September 30, 2001, were as follows:
1998 1998 1999 1999 2000 2001
Second Fourth Third Fourth Second Second
Quarter Quarter Quarter Quarter Quarter Quarter
Plan Plan Plan Plan Plan Plan
Balance at January $ 120 $ 249 $ 7 $ 407 $ 336
1, 2001
Restructuring $ 1,167
charge
Facility closure (30) (140) (427)
costs
Employee (358)
termination costs
Abandoned assets (90) (7) (141)
Balance at $ 30 $ 219 $ - $ 266 $ 196 $ 382
September 30, 2001
The charge against the 2001 Second Quarter Plan's liability for
employee termination costs included 50 employees. The employees terminated
under the 2001 Second Quarter Plan are principally production workers,
salespeople, and administrative support staff.
For the nine and three months ended September 30, 2001, the Company incurred
nonrestructuring-related severance charges of $1,622 and $856, respectively,
and incurred losses on the disposal of property and equipment of $2,242 and
$266, respectively. The losses on disposal of property and equipment for the
nine months ended September 30, 2001, primarily consisted of equipment
disposed of in connection with the 2001 Second Quarter Plan and other
integration efforts at the Company's Midwest operations.
The Company continues to perform an overall review of its operations
in an effort to identify additional operating efficiencies and synergies and,
as a result, may incur additional restructuring charges. The Company does not
anticipate any material adverse effect on its future results of operations
from its various restructuring plans.
4. INVENTORY
The components of inventory were as follows:
September 30, December 31,
2001 2000
Work-in-process $ 18,807 $ 19,089
Raw materials 2,629 2,753
Total $ 21,436 $ 21,842
5. LONG-TERM DEBT
In July 2001, the Company entered into an amendment to the 1999 Credit
Agreement (the "Fifth Amendment") that modified all of the financial covenant
requirements to be less restrictive than previously required for the quarterly
fiscal periods through December 31, 2002, removed the minimum net worth
covenant requirement, and established a minimum cumulative EBITDA covenant.
If the Company does not satisfy such minimum cumulative EBITDA covenant for
any non-quarter month end, the Company's short-term borrowing availability
would be limited until such time as the Company is in compliance with the
covenant, but such failure would not constitute an event of default. The
terms of the Fifth Amendment also accelerated the maturity of the 1999 Credit
Agreement to January 2003, deferred scheduled principal payments until July
2002, and increased interest rates on borrowings by 50 basis points. In
addition, with respect to the last $30,000 of availability under the revolving
line of credit (the "Revolver"), the Company will be limited to borrowing an
amount equal to a percentage of certain trade receivables. The first $51,000
of availability under the Revolver is not subject to such potential
limitation. At September 30, 2001, there was no limitation on the amounts the
Company could borrow under the Revolver. Furthermore, the Company agreed to
attempt to raise $50,000 to be used to repay borrowings under the 1999 Credit
Agreement. The Fifth Amendment contains a number of deadlines by which the
Company must satisfy certain milestones in connection with raising such
amount, the earliest of which has been satisfied. The next such deadline is
December 31, 2001. For each deadline missed, the Company will be required to
either pay additional fees or issue warrants to its lenders to purchase shares
representing a maximum of 10% of the then outstanding common stock or, until
such time as the Company satisfies each requirement, incur an increase in
interest rates on borrowings of a maximum of 200 basis points. The Company
incurred bank fees and expenses of approximately $2,500 in connection with the
Fifth Amendment.
The principal payments on long-term debt, reflecting the modified principal
payment schedule of the Fifth Amendment, are due as follows:
2001 $ 491
2002 13,992
2003 215,131
2004 900
Total 230,514
Less current portion 6,981
Total long-term debt $ 223,533
As a result of the substantial modifications to the principal payment schedule
resulting from the Fifth Amendment, the Company's financial statements reflect
an extinguishment of old debt (the "Debt Extinguishment") and the incurrence
of new debt. Accordingly, the Company recognized a loss on extinguishment of
$3,410, net of taxes of $2,451, as an extraordinary item.
Based upon the modified financial covenants contained in the Fifth Amendment,
the Company was in compliance with all covenants at September 30, 2001. Had
the Company not entered into the Fifth Amendment, the Company would not have
been in compliance with the financial covenants. There can be no assurance
that the Company will be able to maintain compliance with the amended covenant
requirements in future periods.
6. DERIVATIVES
In accordance with the original terms of the 1999 Credit Agreement, the
Company originally entered into four interest rate swap agreements with an
aggregate notional amount of $90,000, one of which expired in August 2001, one
of which expires in December 2001 (together, the "2001 Swaps"), and two of
which expire in August 2003 (the "2003 Swaps") (collectively, the "Swaps").
The remaining outstanding Swaps at September 30, 2001, have an aggregate
notional amount of $65,000. Under the Swaps, the Company pays a fixed rate on
a quarterly basis and is paid a floating rate based on the three-month LIBOR
in effect at the beginning of each quarterly payment period. Through December
31, 2000, the Company accounted for the Swaps as hedges against the variable
interest rate component of the 1999 Credit Agreement.
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities (an amendment of FASB Statement No.
133)." SFAS No. 133, as amended, establishes accounting and reporting
standards for derivative instruments and for hedging activities, and requires
that entities measure derivative instruments at fair value and recognize those
instruments as either assets or liabilities in the statement of financial
position. The accounting for the change in fair value of a derivative
instrument depends on the intended use of the instrument. In accordance with
the provisions of SFAS No. 133, the Company designated the Swaps as cash flow
hedging instruments of the variable interest rate component of the 1999 Credit
Agreement. Upon the adoption of SFAS No. 133, the fair value of the Swaps, a
net loss of $26, was recognized in "Other noncurrent liabilities" and
reflected, net of tax, as a cumulative effect of a change in accounting
principle in "Other comprehensive income (loss)."
All previous hedging relationships terminated as a result of the Debt
Extinguishment. Accordingly, the loss in "Accumulated other comprehensive
income (loss)" of $1,052 pertaining to the Swaps on the effective date of the
Fifth Amendment is being reclassified into earnings over the shorter of the
remaining term of the individual Swaps or the remaining term of the 1999
Credit Agreement. Subsequent to the Debt Extinguishment, the 2003 Swaps did
not qualify for future hedging accounting, and the Company did not redesignate
the 2001 Swaps as hedges. Therefore, all changes in fair value of the Swaps
subsequent to the termination of the hedging relationships have been and will
be included as a component of interest expense. The Company expects $645 of
the loss in "Accumulated other comprehensive income (loss)" to be reclassified
into earnings in the next twelve months.
At September 30, 2001, the fair value of the Swaps was a net loss of $2,705,
resulting in a loss of $2,679 and $1,395 for the nine and three months ended
September 30, 2001, respectively. For the nine and three months ended
September 30, 2001, the Company recognized a non-cash charge of $1,458 and
$1,472, respectively, as a component of interest expense in the Consolidated
Statements of Operations, which consisted of the following:
Nine Three months
months
ended ended
September September
30, 30,
2001 2001
Ineffectiveness of Swaps through termination of $ 79 $ 62
hedging relationships
Reclassification of loss in "Accumulated other
comprehensive income 611 611
(loss)" pertaining to termination of hedging
relationships
Change in fair market value of Swaps subsequent to 801 801
termination of hedging relationships
Reclassification of cumulative effect recorded (33) (2)
upon adoption of SFAS No. 133
Total $ 1,458 $ 1,472
7. RELATED PARTY TRANSACTIONS
Sales to, purchases from, and administrative charges incurred with
related parties during the nine and three months ended September 30, 2001 and
2000, were as follows:
Nine months ended September Three months ended September
30, 30,
2001 2000 2001 2000
Affiliate $ 7,697 $ 7,686 $ 2,613 $ 2,193
sales
Affiliate $ 50 $ 298 $ 2 $ 20
purchases
Administrative $ 1,602 $ 1,080 $ 541 $ 346
charges
Administrative charges include charges for certain legal, administrative, and
computer services provided by affiliates and for rent incurred for leases with
affiliates.
8. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Payments of interest and income taxes for the nine months ended
September 30, 2001 and 2000, were as follows:
2001 2000
Interest paid $ 18,160 $ 23,102
Income taxes paid $ 2,718 $ 1,839
Noncash investing and financing activities for the nine months ended
September 30, 2001 and 2000, were as follows:
2001 2000
Issuance of common stock as additional consideration $ 720 $ 2,000
in connection with prior period acquisitions
Reduction of goodwill from amortization of excess tax $ 92 $ 99
deductible goodwill
Fair value of stock options issued to non-employees $ 58
Exchange of Preference Shares for subordinated notes $ 68
9. SEGMENT INFORMATION
Segment information relating to results of continuing operations for the nine
and three months ended September 30, 2001 and 2000, was as follows:
Nine months ended Three months
ended
September 30, September 30,
2001 2000 2001 2000
Revenue:
Content Management Services $ 322,885 $ 391,612 $ 103,182 $ 128,147
Publishing 25,135 25,135
Other operating segments 21,638 39,773 6,512 11,896
Total $ 369,658 $ 431,385 $ 134,829 $ 140,043
Operating Income (Loss):
Content Management Services $ 24,895 $ 45,673 $ 8,751 $ 17,240
Publishing 4,826 4,826
Other operating segments (1,540) 5,996 (772) 2,394
Total 28,181 51,669 12,805 19,634
Other business activities (22,322) (24,885) (7,742) (8,306)
Amortization of intangibles (10,113) (10,005) (3,335) (3,261)
Restructuring charges (1,167) (487) 124
Gain (loss) on disposal of fixed (2,242) 2,406 (266) 2,359
assets
Impairment charges (97,766) (1,241)
Interest expense (19,156) (20,181) (7,499) (7,238)
Interest income 513 633 176 200
Other income (expense) - net 2,213 369 43 523
Consolidated income (loss) from $ (121,859) $ (1,722) $ (5,818) $ 4,035
continuing operations before
provision for income
taxes and minority interest
Segment information relating to the Company's assets as of September 30, 2001,
was as follows:
Total Assets:
Content Management Services $ 593,122
Other operating segments 27,054
Other business activities 21,171
Net assets held for sale 40,875
Total $ 682,222
The net assets held for sale at September 30, 2001, relate entirely to the
Company's publishing business that was previously reported as a discontinued
operation (see Note 2 to the Interim Consolidated Financial Statements).
10. RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets," was issued in June 2001, and is effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 establishes accounting
and reporting standards for acquired goodwill and other intangible assets, and
supercedes Accounting Principles Board (APB) Opinion No. 17, "Intangible
Assets." Under SFAS No. 142, acquired goodwill and other intangible assets
with indefinite useful lives will no longer be amortized over an estimated
useful life, but instead will be subject to an annual impairment test. SFAS
No. 142 provides specific guidance for such impairment tests. Intangible
assets with finite useful lives will continue to be amortized over their
useful lives. Any impairment charge resulting from the initial adoption of
SFAS No. 142 will be accounted for as a cumulative effect of a change in
accounting principle in accordance with APB Opinion No. 20, "Accounting
Changes." Impairment charges subsequent to the initial adoption of SFAS No.
142 will be reflected as a component of income from continuing operations.
The calculation of the impairment charge will be based on valuations at
January 1, 2002, and will be impacted by many factors, including the overall
state of the economy. Based on preliminary analyses at September 30, 2001,
the Company estimates that it will incur an impairment charge in the range of
$300,000 to $350,000 upon the initial adoption of SFAS No. 142, which would
exceed the book value of the Company's stockholders' equity. The actual
impairment incurred could differ from this range due to a change in one or
more of the factors that impact the valuations or from additional guidance
that is currently under discussion by the Financial Accounting Standards
Board.
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," was issued in August 2001,
and is effective for fiscal years beginning after December 15, 2001. SFAS No.
144 establishes a single accounting model for long-lived assets to be disposed
of, including segments, and supercedes Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," and Accounting Principles Board
Opinion (APB) No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." Under SFAS No. 144, goodwill
will no longer be allocated to long-lived assets, and therefore will no longer
be subject to testing for impairment as part of those assets, but will be
tested separately under SFAS No. 142. Additionally, SFAS No. 144 broadens the
presentation of discontinued operations to include components of an entity
rather than being limited to a segment of a business. The Company does not
expect the implementation of SFAS No. 144 to have a material effect on its
financial condition or results of operations.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Certain statements made in this Quarterly Report on Form 10-Q are "
forward-looking" statements (within the meaning of the Private Securities
Litigation Reform Act of 1995). Such statements involve known and unknown
risks, uncertainties, and other factors that may cause actual results,
performance, or achievements of the Company to be materially different from
any future results, performance, or achievements expressed or implied by such
forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are based upon
reasonable assumptions, the Company's actual results could differ materially
from those set forth in the forward-looking statements. Certain factors that
might cause such a difference include the following: the ability of the
Company to remain in compliance with the financial covenant requirements under
the 1999 Credit Agreement (as defined herein); the advertising market
continuing to soften; the effects of the events of September 11, 2001; the
timing of completion and the success of the Company's integration efforts; the
ability to consummate the sale of certain properties and non-core businesses,
including the publishing business; the ability to raise funds to repay
borrowings under the 1999 Credit Agreement by certain stated deadlines; the
rate and level of capital expenditures; and the adequacy of the Company's
credit facilities and cash flows to fund cash needs.
The results of operations of the Company's publishing business were reported
as a discontinued operation for all periods through June 30, 2001. Commencing
July 1, 2001, the results of operations of the publishing business are
included as part of the Company's continuing operations. The following
discussion and analysis (in thousands of dollars) should be read in
conjunction with the Company's Interim Consolidated Financial Statements and
notes thereto.
Results of Operations
Nine months ended September 30, 2001, compared with 2000
Revenues in the first nine months of 2001 were $61,727 lower than in the
comparable period in 2000. Revenues in the 2001 period decreased by $68,727
from content management services, $13,689 from digital services, and $4,446
from broadcast media distribution services. These decreases were partially
offset by $25,135 of revenues in the third quarter of 2001 from the publishing
business. The results of operations of the publishing business were reported
as a discontinued operation for the entire 2000 period and for the first six
months of 2001. Decreased revenues from content management services primarily
resulted from the softening advertising market, which adversely impacted the
Company's East Coast prepress operations and its Midwest prepress and creative
services operations, as well as from the loss of a low-margin customer at the
Company's West Coast operations. The Company also experienced an anticipated
reduction in revenues associated with both the sale of its photographic
laboratory business and the closing of one of its Atlanta prepress facilities,
the results of which are included for a portion of the 2000 period. Decreased
revenues from digital services primarily resulted from the sale of the
Company's digital portrait systems business in December 2000 and a decrease in
revenues resulting from the continued contraction of Internet-related
business. Decreased revenues from broadcast media distribution services
primarily resulted from the softening advertising market and from price
reductions made under a long-term contract with a significant customer.
Gross profit decreased $27,327 in the first nine months of 2001 as a result of
the decrease in revenues for the period as discussed above. The gross profit
percentage in the first nine months of 2001 was 32.1% as compared to 33.8% in
the 2000 period. Continuing operations in the third quarter of 2001 included
the results of operations of the publishing business, which has higher margins
than the Company's other businesses. Exclusive of the publishing business,
the gross profit percentage was 30.5% in the first nine months of 2001. This
decrease in the gross profit percentage primarily resulted from the decrease
in revenues from content management services and digital services discussed
above, which resulted in lower absorption of fixed manufacturing costs, as
well as from reduced margins from broadcast media distribution services as a
result of the price reductions given to a significant customer. Additionally,
the gross profit percentage was adversely impacted by the sale of the digital
portrait systems business in December 2000, which had higher margins than the
Company's other digital operations. Such decreases were partially offset by
an increase in margins resulting from the sale of the photographic laboratory
business in April 2000, which had lower margins than the Company's other
content management operations.
Selling, general, and administrative expenses in the first nine months of 2001
were $6,203 lower than in the 2000 period, but as a percent of revenue
increased to 30.5% in the 2001 period from 27.6% in the 2000 period. Selling,
general, and administrative expenses in 2001 include charges of $1,622 for
nonrestructuring-related employee termination costs and $2,186 for consultants
retained to assist the Company with its restructuring and integration efforts.
The 2001 period also includes the results of operations of the publishing
business for the third quarter of 2001, which business incurs selling,
general, and administrative costs at a higher rate than the Company's other
businesses. Selling, general, and administrative expenses in 2000 include a
charge of $1,734 for nonrestructuring-related employee termination costs.
Exclusive of the publishing business, and adjusting for these other charges,
selling, general, and administrative expenses as a percent of revenue were
29.1% and 27.2% in the 2001 period and the 2000 period, respectively.
The results of operations for the nine months ended September 30,
2001, include a restructuring charge of $1,167 related to the closing of
certain of the Company's content management facilities in Chicago and the
consolidation of those operations into a single facility as well as the
relocation of one of its content management facilities in New York (the "2001
Second Quarter Plan"). The charge for the 2001 Second Quarter Plan consisted
of $614 for facility closure costs and $553 for employee termination costs for
50 employees.
The loss on disposal of property and equipment was $2,242 for the nine
months ended September 30, 2001, primarily resulting from equipment disposed
of in connection with the 2001 Second Quarter Plan and other integration
efforts at the Company's Midwest content management facilities.
At June 30, 2001, the Company reclassified the net assets of its
publishing business that were previously reported as a discontinued operation
to "Net assets held for sale" in its Consolidated Balance Sheet. In
connection with this reclassification, for the nine months ended September 30,
2001, the Company reversed the estimated loss on disposal of the publishing
business, resulting in after-tax income from discontinued operations of
$98,726, and incurred an impairment charge of $97,766 relating to the write
down of the net assets of the publishing business to their fair value less
estimated costs to sell.
Interest expense in the first nine months of 2001 was $1,224 lower
than in the 2000 period due primarily to the reduced borrowings outstanding
under the Company's credit facility (the "1999 Credit Agreement") as well as
an overall reduction in interest rates throughout the 2001 period. This
decrease was partially offset by a non-cash charge of $1,458 related to four
interest rate swap agreements entered into by the Company that are accounted
for in accordance with Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivatives and Hedging Activities," which was adopted by
the Company on January 1, 2001 (see Note 6 to the Interim Consolidated
Financial Statements). In addition, $3,432 of interest expense was allocated
to discontinued operations in the 2000 period as compared to only $646 in the
2001 period (see Note 2 to the Interim Consolidated Financial Statements).
The Company recorded an income tax benefit of $3,097 for the first nine months
of 2001. The benefit recognized was at a lower rate than the statutory rate
due primarily to additional Federal taxes on foreign earnings and the
projected annual permanent items related to nondeductible goodwill and the
nondeductible portion of meals and entertainment expenses.
Revenues from business transacted with affiliates for the nine months ended
September 30, 2001 and 2000, totaled $7,697 and $7,686, respectively,
representing 2.1% and 1.8%, respectively, of the Company's revenues.
Three months ended September 30, 2001, compared with 2000
Revenues in the third quarter of 2001 were $5,214 lower than in the comparable
period in 2000. Revenues in the 2001 period decreased by $24,965 from content
management services, $3,847 from digital services, and $1,537 from broadcast
media distribution services. These decreases were partially offset by $25,135
of revenues from the publishing business in the 2001 period. The results of
operations of the publishing business were reported as a discontinued
operation in the 2000 period. Decreased revenues from content management
services primarily resulted from the softening advertising market, which
adversely impacted the Company's East Coast prepress operations and its
Midwest prepress and creative services operations, as well as from the loss of
a low-margin customer at the Company's West Coast operations. Decreased
revenues from digital services primarily resulted from the sale of the
Company's digital portrait systems business in December 2000 and a decrease in
revenues resulting from the continued contraction of Internet-related
business. Decreased revenues from broadcast media distribution services
primarily resulted from the softening advertising market and from price
reductions made under a long-term contract with a significant customer.
Gross profit decreased $746 in the third quarter of 2001. The decrease in
gross profit as a result of the decrease in revenues for the period as
discussed above was almost entirely offset by the inclusion of the results of
operations of the publishing business in continuing operations in the third
quarter of 2001. The gross profit percentage in the third quarter of 2001 was
35.5% as compared to 34.7% in the 2000 period. Exclusive of the publishing
business, the gross profit percentage was 31.3% in the third quarter of 2001.
This decrease in the gross profit percentage primarily resulted from the
decrease in revenues from content management services and digital services
discussed above, which resulted in lower absorption of fixed manufacturing
costs, as well as from reduced margins from broadcast media distribution
services as a result of the price reductions given to a significant customer.
Additionally, the gross profit percentage was adversely impacted by the sale
of the digital portrait systems business in December 2000, which had higher
margins than the Company's other digital operations. Such decreases were
partially offset by an increase in margins at the Company's Midwest creative
services operations resulting from improved efficiencies realized from the
2001 Second Quarter Plan and from improved customer pricing.
Selling, general, and administrative expenses in the third quarter of 2001
were $5,559 higher than in the 2000 period, and as a percent of revenue
increased to 31.7% in the 2001 period from 26.5% in the 2000 period. Selling,
general, and administrative expenses in the third quarter of 2001 include
charges of $856 for nonrestructuring-related employee termination costs and
$1,012 for consultants retained to assist the Company with its restructuring
and integration efforts. The 2001 period also includes the results of
operations of the publishing business for the third quarter of 2001, which
business incurs selling, general, and administrative costs at a higher rate
than the Company's other businesses. Exclusive of the publishing business,
and adjusting for these other charges, selling, general, and administration
expenses represented 29.3% of revenues in the 2001 period.
Interest expense in the third quarter of 2001 was $221 higher than in
the 2000 period. Lower interest expense resulting from reduced borrowings
under the 1999 Credit Agreement and an overall reduction in interest rates in
2001 was more than offset by a non-cash charge of $1,472 related to four
interest rate swap agreements that are accounted for in accordance with SFAS
No. 133 (see Note 6 to the Interim Consolidated Financial Statements). In
addition, $482 of interest expense was allocated to discontinued operations in
the 2000 period with no corresponding allocation in the 2001 period (see Note
2 to the Interim Consolidated Financial Statements).
The Company recorded an income tax benefit of $617 in the third quarter of
2001. The benefit recognized was at a lower rate than the statutory rate due
primarily to additional Federal taxes on foreign earnings and the projected
annual permanent items related to nondeductible goodwill and the nondeductible
portion of meals and entertainment expenses.
Revenues from business transacted with affiliates for the three months
ended September 30, 2001 and 2000, totaled $2,613 and $2,193, respectively,
representing 1.9% and 1.6%, respectively, of the Company's revenues.
Financial Condition
In July 2001, the Company entered into an amendment to the 1999 Credit
Agreement (the "Fifth Amendment") that modified all of the financial covenant
requirements to be less restrictive than previously required for the quarterly
fiscal periods through December 31, 2002, removed the minimum net worth
covenant requirement, and established a minimum cumulative EBITDA covenant.
If the Company does not satisfy such minimum cumulative EBITDA covenant for
any non-quarter month end, the Company's short-term borrowing availability
would be limited until such time as the Company is in compliance with the
covenant, but such failure would not constitute an event of default. The
terms of the Fifth Amendment also accelerated the maturity of the 1999 Credit
Agreement to January 2003, deferred scheduled principal payments until July
2002, and increased interest rates on borrowings by 50 basis points. In
addition, with respect to the last $30,000 of availability under the revolving
line of credit (the "Revolver"), the Company will be limited to borrowing an
amount equal to a percentage of certain trade receivables. The first $51,000
of availability under the Revolver is not subject to such potential
limitation. At September 30, 2001, there was no limitation on the amounts the
Company could borrow under the Revolver. Furthermore, the Company agreed to
attempt to raise $50,000 to be used to repay borrowings under the 1999 Credit
Agreement. The Fifth Amendment contains a number of deadlines by which the
Company must satisfy certain milestones in connection with raising such
amount, the earliest of which has been satisfied. The next such deadline is
December 31, 2001. For each deadline missed, the Company will be required to
either pay additional fees or issue warrants to its lenders to purchase shares
representing a maximum of 10% of the then outstanding common stock or, until
such time as the Company satisfies each requirement, incur an increase in
interest rates on borrowings of a maximum of 200 basis points. The Company
incurred bank fees and expenses of approximately $2,500 in connection with the
Fifth Amendment.
As a result of the substantial modifications to the principal payment schedule
resulting from the Fifth Amendment, the Company's financial statements reflect
an extinguishment of old debt and the incurrence of new debt. Accordingly,
the Company recognized a loss on extinguishment in the third quarter of 2001
of approximately $3,410, net of taxes of approximately of $2,451, as an
extraordinary item.
Based upon the modified financial covenants contained in the Fifth Amendment,
the Company was in compliance with all covenants at September 30, 2001. Had
the Company not entered into the Fifth Amendment, the Company would not have
been in compliance with the financial covenants. There can be no assurance
that the Company will be able to maintain compliance with the amended covenant
requirements in future periods.
During the first nine months of 2001, the Company repaid $1,035 of
notes and capital lease obligations, made contingent payments related to
acquisitions of $2,967, and invested $11,636 in facility construction, new
equipment, and software-related projects. Such amounts were primarily
generated from borrowings under the 1999 Credit Agreement and cash from
operating activities. Cash flows from operating activities of continuing
operations during the first nine months of 2001 decreased by $26,404 as
compared to the comparable period in 2000 due primarily to a decrease in cash
from operating income and the timing of vendor payments.
The Company expects to spend approximately $15,000 over the course of the next
twelve months for capital improvements and management information systems,
essentially all of which is for modernization. The Company intends to finance
a substantial portion of these expenditures with working capital or
borrowings under the 1999 Credit Agreement.
The Company believes that the cash flow from operations, including potential
improvements in operations as a result of its various integration and
restructuring efforts, sales of certain properties and noncore businesses, and
available borrowing capacity, subject to the Company's ability to remain in
compliance with the revised financial covenants under the 1999 Credit
Agreement, will provide sufficient cash flows to fund its cash needs through
2002.
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets," was issued in June 2001, and is effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 establishes accounting
and reporting standards for acquired goodwill and other intangible assets, and
supercedes Accounting Principles Board (APB) Opinion No. 17, "Intangible
Assets." Under SFAS No. 142, acquired goodwill and other intangible assets
with indefinite useful lives will no longer be amortized over an estimated
useful life, but instead will be subject to an annual impairment test. SFAS
No. 142 provides specific guidance for such impairment tests. Intangible
assets with finite useful lives will continue to be amortized over their
useful lives. Any impairment charge resulting from the initial adoption of
SFAS No. 142 will be accounted for as a cumulative effect of a change in
accounting principle in accordance with APB Opinion No. 20, "Accounting
Changes." Impairment charges subsequent to the initial adoption of SFAS No.
142 will be reflected as a component of income from continuing operations.
The calculation of the impairment charge will be based on valuations at
January 1, 2002, and will be impacted by many factors, including the overall
state of the economy. Based on preliminary analyses at September 30, 2001,
the Company estimates that it will incur an impairment charge in the range of
$300,000 to $350,000 upon the initial adoption of SFAS No. 142, which would
exceed the book value of the Company's stockholders' equity. The actual
impairment incurred could differ from this range due to a change in one or
more of the factors that impact the valuations or from additional guidance
that is currently under discussion by the Financial Accounting Standards
Board.
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," was issued in August 2001,
and is effective for fiscal years beginning after December 15, 2001. SFAS No.
144 establishes a single accounting model for long-lived assets to be disposed
of, including segments, and supercedes Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," and Accounting Principles Board
Opinion (APB) No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." Under SFAS No. 144, goodwill
will no longer be allocated to long-lived assets, and therefore will no longer
be subject to testing for impairment as part of those assets, but will be
tested separately under SFAS No. 142. Additionally, SFAS No. 144 broadens the
presentation of discontinued operations to include components of an entity
rather than being limited to a segment of a business. The Company does not
expect the implementation of SFAS No. 144 to have a material effect on its
financial condition or results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company's primary exposure to market risk is interest rate risk. The
Company had $228,985 outstanding under its credit facilities at September 30,
2001. Interest rates on funds borrowed under the Company's credit facilities
vary based on changes to the prime rate or LIBOR. The Company partially
manages its interest rate risk through three interest rate swap agreements
under which the Company pays a fixed rate and is paid a floating rate based on
the three-month LIBOR rate. The notional amounts of the three interest rate
swaps totaled $65,000 at September 30, 2001. A change in interest rates of
1.0% would result in an annual change in income before taxes of $1,640 based
on the outstanding balance under the Company's credit facilities and the
notional amounts of the interest rate swap agreements at September 30, 2001.
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