ITEM 1. BUSINESS
GENERAL
Schawk, Inc. and its subsidiaries ("Schawk" or the "Company") operate in one operating business segment, Digital Imaging Graphics Arts, that serves consumer products packaging, advertising and promotional markets. The Company is incorporated under the laws of the State of Delaware.
The Company is the largest independent provider of digital imaging graphic 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 plate making 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 3D imaging for package design, large format printing, digital photography, workflow management consulting services, and various related outsourcing and graphics arts consulting 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 85% of net sales for 2002 and over 70% of net sales during 2001 and 2000. 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 graphic 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 for many of its clients. This activity brings value to those clients while improving 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 graphic 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) color expertise; (v) digital imaging asset management; (vi) workflow management; (vii) art production; and (viii) ability to service its clients' global graphic requirements through the Company's North American facilities and international subsidiaries and alliance partners.
GRAPHIC SERVICES INDUSTRY
"Graphic 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 graphic 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 graphic work.
Graphic 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 plate making services, for use in lithography, flexography and gravure. "Color separation" refers to preparing color images, text and layout for the printing process. Graphic 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, graphic firms such as the Company have become 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 workflow, 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 Company has acquired several CTP units and has the capacity to service its clients with CTP services throughout North America.
The graphic industry in North America has over 1,000 market participants, principally independent color separators, such as the Company, converters, printers and advertising agencies that perform these services in-house. The majority of graphic providers specialize in commodity-oriented publication work that includes textbooks, advertising, catalogs, newspapers and magazines. The Company's target markets, however, are high-end packaging for the consumer products industry, advertising and promotional applications. The North American market for graphic services for packaging to the consumer products industry is estimated by the Company to be approximately $2.0 billion, while the worldwide market is estimated by the Company to be as high as $6.0 billion. The consumer products graphic industry is highly fragmented with hundreds of market participants, only a small number of whom have annual revenues exceeding $30.0 million. The Company believes that the number of participants in the North American graphic 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 graphic 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 necessitate 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. Furthermore, these rapid turnaround times, regulatory requirements and demand for global brand consistency have created new, more significant barriers than had previously existed.
There is also a more significant barrier to entry that has always existed - hundreds of "technician-years" of expertise in working with all of the major printers and converters to make sure a package is printed according to the client's specifications. For this reason, new upstarts have difficulty competing with the Company.
The Company focuses on three primary markets: consumer products 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 less than 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 graphic 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:
- Organic Growth. Historically the Company has primarily grown through acquisitions. As there were fewer companies that met the Company's acquisition criteria in the marketplace in the last few years, the Company has increased its focus on organic growth, turning to its highly skilled sales force to be the primary growth driver for the Company. As a result, and in connection with this strategic planning process at the Company, the Company identified as one of its key business objectives to increase sales by increasing the amount of business the Company does with existing clients as well as increasing the number of new accounts.
The Company has increased its focus on organic growth by separating its sales force into new account development and existing account development groups. The new account development group is charged with calling on the Fortune 1000 accounts that the Company does not currently do business with. The existing account group works with their current clients to increase the number of brands that the Company handles and to increase the number of services that the Company provides to the client.
To bring focus to the organic growth objective, the Company has introduced a new sales compensation system, which rewards both sales growth and profitability growth.
- Growth through Acquisitions. 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 49-year business history, the Company has integrated more than 44 graphic and imaging businesses into its operations while streamlining overhead and improving margins in the aggregate. The Company acquired 13 businesses from March 1998 to November 1999 with combined annualized revenues in excess of $77 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. The managers of acquired businesses receive performance incentives to continue to profitably grow the business. There were no acquisitions by the Company in 2001 and there was one small acquisition in 2002.
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. The Company believes that an emphasis on complementary acquisitions of companies serving targeted markets will allow it to broaden its service offerings and provide single source design, graphic image database services and workflow management services.
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. The Company 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.
- 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 graphic 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, 2002, the Company had 41 on-site locations staffed by over 130 Schawk employees, approximately 9% of its 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 graphic 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 graphic 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
As part of the Company's ongoing strategic planning process, management of the Company introduced Vision 2020, a roadmap that the Company will follow into the future. The Chief Executive Officer, David A. Schawk, introduced an overview of the strategy to every employee of the Company and subsidiaries around the world in late 2001. In 2002, Company management organized teams from throughout the organization to work on business objectives that came out of the strategic planning process. Incentive compensation programs in alignment with the Company's strategy were developed and have been implemented for 2003. The overriding guidelines for the Company's strategy were summarized in a "Vivid Description" of what the Company believes in. The Vivid Description of the Company is as follows:
The value and breadth of our services and capabilities will be driven first and foremost by the requirements and satisfaction of our clients...We will deliver value through ensuring global brand consistency and the premiere speed-to-market solution to those clients. By becoming an integrated strategic partner to our clients, we will demonstrate value and inspire their unwavering confidence and loyalty...We will become the most profitable company in our industry and we will reach a dominant market share globally...We will continue to invest in training and development so that our employees and their tools will be the best of the best...The Schawk brand name will be recognized as the highest value answer to clients' brand image requirements.
The business objectives the Company is working on support the Vivid Description of the Company are as follows:
- Increase Global Coverage through Acquisitions Worldwide - Redefine Our Source of Revenue and Profit for the future - Invent / Reinvent Solutions for Our Clients - Increase Organic Growth - Hire and Retain the Best of the Best Employees - Measure Customer Satisfaction and Improve on our performance
To achieve the Company's business objectives, management stresses the following:
Client Service. Another key component of the Company's management philosophy has been its commitment to client service. The Company's offering continues to be increasingly focused on meeting the changing needs of its clients. This requires a commitment to working with clients to understand these needs. 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 graphic services. The Company's facilities produce conventional, electronic and desktop color separations, electronic production design, film preparation, plate making 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, 3-D imaging, art production, large format printing, and various related outsourcing and graphics arts consulting 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 graphic 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 graphic 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 graphic work.
The Company's clients typically outsource their graphic requirements and assign the Company the responsibility of interfacing with the clients and client designated suppliers in developing and printing 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) workflow management; (vi) art production; and (vii) the ability to service its clients' global graphic 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 event related 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.
In keeping with this need for greater control and organization, the Company has expanded its services into a number of new areas that assist the client with the overall management of their art processes. The Company has added production art services that quickly execute and expand upon new graphics ideas, and assist the client in speeding their brands to market with fewer errors and higher efficiency. Additional services are provided through InterchangeDigital, a wholly owned Schawk subsidiary. With InterchangeDigital's PaRTS product (Production and Resource Tracking System), clients are able to maintain a central archive of approved digital graphics and design templates that can be used to normalize the production of packaging and collateral graphics on a global basis. PaRTS also tracks vendor performance, time lines, and other process critical data. InterchangeDigital delivers a broader range of integrated services through its products than competing systems and in-turn is able to drive a better value proposition for its customers. Schawk 3D is another group that the Company has leveraged to provide 3D modeling capabilities to its customers allowing them to review and deploy new graphics concepts in a shorter time frame, and to proof concepts and collateral before actual manufacturing begins. All of the Company's related services are leveraging new technologies and solution services that focus on workflow and knowledge collaboration during the product and concept development cycles. We believe that this focus is a visible differentiator with would-be competitors and will help to maintain the Company's status as a preferred supplier.
Given the increased computerization of the graphic 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. The Company 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 graphic 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 graphic 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 49-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.
- Image 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 (and the subsequent purchase of the remaining 35% minority interest in 2002) with operations in China and Malaysia is indicative of the Company's commitment to its clients on a worldwide basis.
ACQUISITIONS AND START-UP OPERATIONS
The Company has acquired and integrated more than 44 graphic 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.
In 2002 the Company purchased the remaining 35% of the Laserscan Group. Also in 2002, the Company's Canadian subsidiary acquired certain assets and assumed certain liabilities of Imaginex, a Toronto area graphic company. There were no acquisitions in 2000 or 2001. During 1999 the Company completed 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 Thailand. During 1998 the Company completed five acquisitions: S&M Rotogravure in New Berlin, Wisconsin; Chromart, Inc. in New York, NY; Horan Imaging Solutions in New York, NY; Design Partners in Toronto, Canada; and Herzig Somerville, Ltd. In Toronto, Canada.
There were no start-ups established in 2002. In 2001, the Company established an art production operation in Chicago, Illinois. In 2000, the Company established start-up operations in Stamford, Connecticut and Singapore. In 1999, the Company established start-up operations in Kobe, Japan; Ardsley, New York; and Charlotte, North Carolina. In 1998, the Company established a start-up operation in Queretaro, Mexico. Due to unfavorable market conditions the start-up in Ardsley, New York was shut down in 2001, and the start-ups in Charlotte, North Carolina and Toronto, Ontario were shut down in 2000.
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 consumer products 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 graphic 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 Schawk 3D are examples of the Company's commitment to research and development. Total research and development spending is not material.
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, Singapore, Malaysia and China 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 graphic 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 graphic 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 2002 no single client accounted for more than 7.4% of the Company's net sales, and the 10 largest clients in the aggregate accounted for approximately 40% of net sales.
COMPETITION
The Company's competition comes primarily from other independent color separators and converters and printers that have graphic service capabilities. Independent color separators are companies whose business is performing graphic services for one or more of the principal printing processes. The Company believes that only two firms, Applied Graphics Technologies, Inc., through its Wace Group subsidiary, and Southern Graphics, a subsidiary of Alcoa, compete with the Company 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 graphic 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 graphic 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," and "PaRTS" and the trade names "Anthem New Jersey," "Anthem Los Angeles," "Anthem Toronto," "Anthem Chicago," "Anthem Singapore", "Schawk Asia," "Schawk Atlanta," "Schawk Cactus," "Schawk Canada," "Schawk Cherry Hill," "Schawk Chicago," "Schawk Chromart," "Schawk Cincinnati 446," "Schawk Cincinnati 447," "Schawk Designer's Atelier," "Schawk Japan," "Schawk Kalamazoo," "Schawk Kuala Lumpur," "Schawk Mexico," "Schawk Milwaukee," "Schawk Minneapolis," "Schawk New York," "Schawk Penang," "Schawk St. Paul," "Schawk Toronto" "Schawk Shanghai," "Schawk Singapore", "Schawk Stamford," "Interchange," "Interchange Digital," "Interchange Digital Management Services", "The Palm Group," "Laserscan," are the most significant trademarks and trade names used by the Company or its subsidiaries.
EMPLOYEES
As of December 31, 2002 the Company had approximately 1,400 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 Communications, Energy & Paperworkers Union of Canada. 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. 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 graphic 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 graphic business for the consumer product packaging graphic 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 three to four year cycle for major design changes that the Company has experienced in the last eight 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, the amount of ad pages declines. Generally, when ad pages decline the Company's advertising and promotion business declines.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns or leases the following office and operating facilities:
ITEM 3.
ITEM 3. 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.
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, 2002.
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 (UNAUDITED)
Prior-year amounts have been reclassified to conform to current-year presentation.
DIVIDENDS DECLARED PER CLASS A COMMON SHARE - -------------------------------------------------------------
Quarter Ended: 2002 2001 - -------------------------------------------------------------
March 31 $0.0325 $0.0325 June 30 0.0325 0.0325 September 30 0.0325 0.0325 December 31 0.0325 0.0325 ------- -------
Total $0.1300 $0.1300 ======= =======
STOCK PRICES
The Company's Class A common stock is listed on the NYSE under the symbol "SGK". The Company has approximately 901 stockholders of record as of February 24, 2003.
Set forth below are the high and low sales prices for the Company's Class A common stock for each quarterly period within the two most recent fiscal years.
- ------------------------------------------------------------- Quarter Ended: 2002 High/Low 2001 High/Low - -------------------------------------------------------------
March 31 $11.45 - 9.08 $ 9.31 - 8.60 June 30 10.70 - 9.40 11.50 - 8.80 September 30 10.60 - 9.68 11.20 - 9.61 December 31 10.17 - 9.45 11.23 - 9.27
The following table summarizes information as of December 31, 2002, relating to equity compensation plans of the Company pursuant to which Common Stock is authorized for issuance.
EQUITY COMPENSATION PLAN INFORMATION
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(a) 1998 earnings per share include $0.27 for the discount on redemption of preferred stock. (b) Prior years include goodwill amortization of $2,161, $2,155, $1,944 and $1,143 for the years ended December 31, 2001, December 31, 2000, December 31, 1999 and December 31, 1998 respectively.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of dollars, except per share amounts)
Certain statements contained herein that relate to the Company's beliefs or expectations as to future events are not statements of historical fact and are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. The Company intends any such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1999. Although the Company believes that the assumptions upon which such forward-looking statements are based are reasonable within the bounds of its knowledge of its business and operations, it can give no assurance the assumptions will prove to have been correct and undue reliance should not be placed as such statements. Important factors that could cause actual results to differ materially and adversely from the Company's expectations and beliefs include, among other things, the strength of the United States economy in general and specifically market conditions for the consumer products industry, the level of demand for the Company's services, loss of key management and operational personnel, the ability of the Company to implement its growth strategy, the stability of state, federal and foreign tax laws, the ability of the Company to identify and exploit industry trends and to exploit technological advances in the imaging industry, the stability of political conditions in Asia and other foreign countries in which the Company has production capabilities, terrorist attacks and the U.S. response to such attacks, as well as other factors detailed in the Company's filings with the Securities and Exchange Commission. The Company assumes no obligation to update publicly any of these statements in light of future events.
New goodwill accounting rules. On January 1, 2002, the Company adopted SFAS 142, the new accounting pronouncement on goodwill accounting. Previously, the Company recorded monthly amortization of goodwill, generally over a 40-year period. The new rules that became effective January 1, 2002 prohibit the amortization of goodwill. Rather, goodwill is to be reviewed on a periodic basis, and if a write-down is required, the write-down must be taken at that time, similar to an impairment charge on other long-lived assets. The goodwill amortization was $545 and $2,161 for the quarter and year ended December 31, 2001, respectively. The Company's results with the pro-forma effect of the new accounting rules on the quarter and year ended December 31, 2001 are as follows:
Proforma results excluding goodwill amortization Quarter and year ended December 31, 2001 (In thousands, Except Per Share Amounts)
RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2002 AND 2001
Schawk, Inc. Comparative Consolidated Statements of Operations Years Ended December 31, 2002 and 2001 (in thousands)
(1) nm - Percentage not meaningful
Net sales for 2002 decreased 1.8% versus 2001. On the consumer products packaging side of the business, which represents approximately 85% of the Company's overall business, revenues with the Company's consumer products packaging accounts increased 7.8% in the current year versus the prior year. However, lower sales in the graphic for advertising agency business more than offset the gains from the consumer products packaging business. The lower sales level in the advertising agency business is due to the continuing weakness in the advertising market.
Gross margin as a percentage of net sales for 2002 increased to 39.7% from 39.6% for the prior year. Given the fact that net sales were lower than the prior period, an increase in gross margin as a percentage of sales is a positive result. The increase in gross margin as a percentage of sales indicates that the cost cutting moves the Company initiated through its restructurings is having a positive effect.
Operating income in 2002 was 26.3% higher than the previous year despite $2.6 million of asset impairment and severance charges classified as Restructuring and Other Charges on the Consolidated Statement of Operations as compared to $1.1 million of restructuring charges in 2001. The increase in operating income was attributable to cost reduction efforts and restructuring efforts completed in prior years and the nonamortization of goodwill due to the change in accounting method.
Restructuring and other charges of $2.6 million in 2002 resulted from $2.2 million of charges for asset impairment recorded in accordance with the new accounting standard for asset impairments, Statement of Financial Accounting Standard No. 144 and $0.4 million from severance costs in the second half of 2002. The new accounting standard requires a review of all long-lived assets including property, plant and equipment as well as any other long-term assets when indicators of impairment exist. The Company performed a review as of June 30, 2002 and determined that $2.1 million of assets, primarily software and software development assets, had little or no value based on obsolescence or limited use. The Company also recorded asset impairment charges of $0.1 million in the fourth quarter of 2002. In addition, in 2001 restructuring charges of $1.1 million were recorded related to severance costs and the cost to terminate a lease. . The Company continues to evaluate its operations for possible changes including consolidation of certain locations and changing the staffing levels of other operations to reflect the volume of business being serviced by such locations.
Other income (expense) - net decreased in 2002 compared with 2001. The lower net expense was primarily as a result of lower interest expense. The decrease in interest expense was from a combination of lower interest rates and lower borrowing levels in 2002 as compared to the prior year. The lower borrowing levels were due to strong cash flows from operations that were utilized, in part, to pay down debt. Interest expense also benefited from lower rates in 2002 versus 2001.
Income tax provision as a percentage of pretax income was lower than the previous year as a result of offsetting the regular tax provision with tax benefits from state tax refunds received in the second quarter of 2002 and tax benefits from the reduction in tax liabilities in connection with the settlement of an outstanding liability for lower amount than the amount that had been accrued. As a result, the effective tax rate for year ended December 31, 2002 was 31.5% as compared to 40.5% in the comparable period of the prior year.
Net income for the year ended December 31, 2002 increased significantly versus 2001 for the reasons previously discussed.
Basic and diluted earnings per share were $0.63 and $0.62, respectively, for the year ended December 31, 2002 compared with $0.37 and $0.37 for 2001.
RESULTS OF OPERATION S YEARS ENDED DECEMBER 31, 2001 AND 2000
Schawk, Inc. Comparative Consolidated Statements of Operations Years Ended December 31, 2001 and 2000 (in thousands)
2001 COMPARED TO 2000
Net sales. Net sales for 2001 decreased 10.0% from the prior year. The decrease in revenues was primarily attributable to soft market conditions and mergers among many of the Company's largest clients. Soft market conditions that began impacting the Company's results in mid-2000 continued throughout all of 2001. However, prepress for the packaging part of the business started to pick up in the fourth quarter. Conversely, the prepress for advertising and promotion part of the business remained soft throughout the fourth quarter reflecting the lowest level of advertising spending in 20 years. Nine of the Company's top 20 accounts were involved in mergers in 2000 and 2001. With respect to the impact of the mergers of many of our top accounts, branding and marketing decisions were put on hold while corporate branding strategies were being reviewed and changed. Management of the Company believes that most of the slowdown in business related to mergers at the Company's clients is over. Finally, two percentage points of the drop in sales in 2001 was from a strategic withdrawal from printing in connection with consolidation of facilities in the Toronto marketplace, which historically were at low margins and not part of the Company's plans for the future.
Cost of sales. Cost of sales for 2001 as a percent of sales was consistent with the prior year despite the decrease in sales previously described. Approximately 70% of the Company's costs are labor costs. The Company was able to reduce costs as a result of previous and current year restructuring efforts through attrition and layoffs.
Operating income. Operating income in 2001 decreased 24.4% from the prior year. Operating income was negatively impacted by lower gross profit due to lower volumes at most of the Company's divisions in 2001. Selling, general and administrative ("SG&A") expenses increased as a percentage of sales to 28.8% in 2001 from 26.1% for 2000 as a result of spending on the Company's own branding changes, including logo changes, new identities for the operating units using the Schawk name to replace the historical names of acquired companies and increased advertising. Other increases in SG&A are due to increased depreciation and amortization in SG&A related to new computer equipment and software purchased in 2000 to upgrade the Company's information systems to make them consistent throughout the organization and increased staffing in information systems to carry out the new systems initiatives.
Restructuring and other charges. The Company continued its restructuring program in 2001, reducing staffing levels by 140 positions and further consolidating certain operations. Total restructuring charges for 2001 were $1.1 million compared to $3.1 million in the previous year. The restructuring charges in 2001 consisted of severance costs of $0.8 million and lease termination and other costs of $0.3 million.
Other income (expense). The other expense decrease in 2001 is primarily due to $1.6 million less interest expense as compared to 2000. The decreased interest expense resulted from repaying debt from cash flow and from lower interest rates. Conversely, other expense in 2001 was $0.06 million as compared to $0.9 million of other income in 2000. Other income in 2000 consisted primarily of gains from the sale of printing presses in Canada in the third quarter totaling $0.9 million.
Income before income taxes. Income before income taxes for 2001 decreased 27.5% compared to the prior year. The reduction in pretax income margin was primarily due to lower sales in 2001 as compared to 2000 as described previously.
Income taxes. Income taxes were at an effective rate of 40.5% and 41.8% for 2001 and 2000, respectively. The decrease in the effective rate was primarily due to lower taxes in high tax rate states due to lower profits attributable to those states in 2001 as compared to 2000.
Net income. Net income decreased 24.6% to $8.0 million for 2001 from $10.6 million for 2000 for the reasons previously discussed.
Earnings per share. Both basic and diluted earnings per share decreased to $0.37 for 2001 from $0.50 in 2000 as a result of the decrease in net income.
LIQUIDITY AND CAPITAL RESOURCES
The Company presently finances its business from available cash and from cash generated from operations. Cash generated from operations in 2002 totaled $27.9 million. The Company maintains a $65 million unsecured credit facility, expiring May 2004, of which approximately $40.0 million was available for borrowings at December 31, 2002. The Company also maintains a $15 million unsecured demand line of credit to provide financing and working capital flexibility. At December 31, 2002, approximately $12.6 million was available for borrowings under the demand line of credit. The Company also maintains working capital demand lines of credit in Canada (US $3.2 million), China (US $1.5 million), and Malaysia (US $1.3 million).
Long-term debt and capital lease obligations decreased to $37.2 million at December 31, 2002 from $52.1 million at December 31, 2001. The Company reduced long-term debt by payment of $9.0 million on its unsecured credit facility and $6.0 million on its Note Purchase Agreement dated August 18, 1995. The outstanding amount on the demand lines of credit, included in current liabilities, increased by $0.3 million.
At December 31, 2002, outstanding debt of the Company consisted of: (i) unsecured notes issued pursuant to a Note Purchase Agreement dated August 18, 1995, for $18.0 million with terms ranging from 2001 through 2005 at an interest rate of 6.98%; (ii) $25.0 million of borrowings under the Company's unsecured credit facility; (iii) $2.4 million of borrowings under its unsecured demand credit line; and (iv) $0.2 million under a Malaysian term loan; (v) $0.3 million under its Canadian line of credit; (vi) $0.4 million under its Chinese credit facility; and (vii) $0.2 million under its Malaysian credit facility.
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 of $7.6 million, $14.4 million, and $15.5 million in 2002, 2001, and 2000 respectively.
The Company had depreciation of $12.0 million in 2002 and 2001, and $12.1 million in 2000.
In 2002, the Company paid $2.1 million for acquisitions. In 2001 and 2000, contingent payments representing additional purchase price on certain prior acquisitions totaled $0.1 million and $1.1 million, respectively.
The Company purchased $1.0 million and $1.5 million in Class A Common Stock in 2002 and 2001, respectively, under a share repurchase program approved by the Board of Directors. No Class A Common Stock was purchased in 2000.
LABOR FORCE
The Company has a concentration of its labor force, representing approximately 30% of its total employees, working under collective bargaining agreements. These agreements expire ranging from 2003 to 2005.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that effect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies, see Note 2 in the notes to the Consolidated Financial Statements.
Accounts Receivable. The Company's clients are primarily consumer product manufacturers, converters and advertising agencies; none of which individually represent more than 7% of total revenue. Accounts receivable consist primarily of amounts due to us from our normal business activities. We maintain an allowance for doubtful accounts to reflect the expected losses of accounts receivable based on past collection history and specific risks identified in the portfolio.
Impairment of Long-Lived Assets. We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. Our cash flow estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. The net carrying value of assets not recoverable is reduced to fair value. Our estimates of fair value represent our best estimate based on industry trends and reference to market rates and transactions.
Goodwill and Other Acquired Intangible Assets. The Company had made acquisitions in the past that included a significant amount of goodwill and other intangible assets. Under generally accepted accounting principles in effect through December 31, 2001, these assets were amortized over their estimated useful lives, and were tested periodically to determine if they were recoverable from operating earnings on an undiscounted basis over their useful lives.
Effective in 2002, goodwill is no longer amortized but is subject to an annual (or under certain circumstances more frequent) impairment test based on its estimated fair value. Other intangible assets that meet certain criteria continue to be amortized over their useful lives and are also subject to an impairment test based on estimated undiscounted cash flows. There are many assumptions and estimates underlying the determination of an impairment loss. Another estimate using different, but still reasonable, assumptions could produce a significantly different result. Therefore, impairment losses could be recorded in the future.
The Company adopted the new rules on Accounting for Goodwill and Other Intangible Assets effective January 1, 2002. Application of the nonamortization provision resulted in an increase in net income of approximately $1.4 million ($0.07 per share).
During 2002, the Company performed the first required impairment test of goodwill and indefinite lived intangible assets. It was determined appropriate to consider the Company to be one reporting unit for purposes of this test and that no impairment charge was required since the fair value of the Company exceeds the Company's carrying value, including goodwill.
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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE EXPOSURE
Based on the Company's variable rate debt outstanding at December 31, 2002, a 1% change in interest rates would impact interest expense by approximately $0.3 million. Assuming similar interest rates volatility in the future, a near-term (12 months) change in interest rates would not materially affect the Company's consolidated financial position, results of operation or cash flows.
FOREIGN EXCHANGE EXPOSURE
The Company has foreign operations that expose it to translation risk when the local currency financial statements are translated to U.S. dollars. Since changes in translation risk are reported as adjustments to stockholders' equity, a 10% change in the foreign exchange rate would not have material effect on the Company's financial position, results of operations or cash flows.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements Covered by Reports of Independent Auditors
Page ----
Management's Responsibilities for Financial Reporting 25 Report of Independent Auditors 26
FINANCIAL STATEMENTS
Consolidated Balance Sheets-- December 31, 2002 and 2001 27
Consolidated Statements of Operations --Years Ended December 31, 2002, 2001 and 2000 28
Consolidated Statements of Cash Flows --Years Ended December 31, 2002, 2001 and 2000 29
Consolidated Statements of Stockholders' Equity --Years Ended December 31, 2002, 2001 and 2000 30
Notes to Consolidated Financial Statements 31
FINANCIAL STATEMENT SCHEDULE
SCHEDULE II-- Valuation Reserves 49
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 /s/ James J. Patterson - ------------------------------------- ----------------------------------- David A. Schawk James J. Patterson President and Chief Executive Officer Senior Vice President and Principal Executive Officer Chief Financial Officer Principal Financial and 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, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also include the financial statement schedule listed in the index at item 15(a). 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, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, 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.
As discussed in Note 2 to the Consolidated Financial Statements, in 2002 the Company adopted FASB Statement No. 142, "Goodwill and Other Intangible Assets".
Chicago, Illinois February 14, 2003 Ernst & Young LLP
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, 2000, 2001 and 2002 (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. including its subsidiaries (the Company) is a leading provider of digital imaging graphic 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
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of all wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
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.
ACCOUNTS RECEIVABLE AND CONCENTRATION OF CREDIT RISK
The Company sells its products to a wide range of customers in the consumer products industry. The Company performs ongoing credit evaluations of its customers and does not require collateral. An allowance for doubtful accounts is maintained at a level management believes is sufficient to cover potential losses.
INVENTORIES
Inventories are stated at the lower of cost or market. Certain inventories, which approximate 19% of total inventories in 2002 and 26% in 2001 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.
PROPERTY AND EQUIPMENT
Property and equipment, including capitalized leases is stated at cost, less accumulated depreciation and amortization, and is 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.
GOODWILL
Effective January 1, 2002, the Company adopted Statements of Financial Accounting Standards No. (SFAS) 141 Business Combinations and No. 142 Goodwill and Other Intangible Assets. SFAS No. 142 does not permit goodwill and indefinite-lived intangibles to be amortized, but requires that these assets be reviewed at least annually for possible impairment. See Note 9 for further information regarding goodwill and intangible assets.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
LONG-LIVED ASSETS
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. In accordance with SFAS 144, the Company continues to review all of its long-lived assets on an on-going basis. See Note 4 for further information regarding impairment of long-lived assets.
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 accounting principles generally accepted in the United States 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.
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 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
For purposes of financial reporting, the Company has determined that the fair value of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and long-term debt approximates book value based on terms available to the Company in financial markets at December 31, 2002 and 2001.
COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the years ended December 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000 -------------------------------- Net income $13,531 $8,018 $10,641 Foreign currency translation adjustments (311) (832) (152) -------------------------------- Comprehensive income $13,220 $7,186 $10,489 ================================
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
STOCK BASED COMPENSATION
At December 31, 2002, the Company has two stock-based employee compensation plans, which are described more fully in Note 16. The Company accounts for these plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. No stock-based employee compensation cost is reflected in the net income, as all options granted under these plans have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation.
YEAR ENDED DECEMBER 31 --------------------------------- 2002 2001 2000 --------------------------------- Net income, as reported $ 13,531 $ 8,018 $ 10,641 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 865 661 679 ---------- --------- ---------- Net income, pro forma $ 12,666 $ 7,357 $ 9,962 ========== ========= ==========
Earnings per share Basic $ 0.63 $ 0.37 $ 0.50 Diluted $ 0.62 $ 0.37 $ 0.50 Pro forma earnings per share Basic $ 0.59 $ 0.34 $ 0.47 Diluted $ 0.58 $ 0.34 $ 0.47
RECLASSIFICATIONS
Certain amounts in the 2001 and 2000 financial statements have been reclassified to conform to the 2002 presentations.
NOTE 3. RESTRUCTURING AND OTHER CHARGES
The Company acquired 13 businesses from March 1998 through November 1999. At the end of 1999, Company management determined that, since the Company had multiple operations in certain markets, there were opportunities to consolidate operations. The three markets that were to be consolidated were: New York, Cincinnati and Chicago. In addition, staffing reductions were carried out in certain other locations due to lower volumes of business. The Company carried out a 1999 United States Restructuring ("1999 Restructuring") to accomplish these objectives and in the fourth quarter of 1999, the Company incurred charges of $2.2 million, consisting of $1.7 million of lease termination costs and $0.5 million of severance costs included in "Restructuring and other charges" on the Consolidated Statement of Operations. This restructuring included 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 were completed by November 15, 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 1999 Restructuring included the layoff of eleven employees at an operation in Wisconsin due to lower sales volumes.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
During 2000 there were revisions to estimates based on changes in facts that were not anticipated when the 1999 Restructuring charges were recorded in the fourth quarter of 1999. Additional charges recorded in 2000 related to refining estimates for severance costs amounting to $0.2 million. In addition, the Company was unable to sublease a vacated facility as planned and as a result an additional accrual of $0.3 million was recorded in the fourth quarter of 2000 to increase the accrual to the estimated liability as of December 31, 2000.
In addition, the Company did not vacate certain premises as early in 2000 as was anticipated at December 31, 1999. As a result, in the third quarter of 2000, $0.4 million of vacant premises leases accruals were revised and are included as a reduction of the Restructuring and other charges line on the Statement of Operations.
In the third quarter of 2000, the Company decided to consolidate its two graphic operations in Toronto into one facility and reduce staffing accordingly. This consolidation was the 2000 Canadian Restructuring ("Canadian Restructuring").
In the fourth quarter of 2000, the Company determined that due to softness in the market for graphic services for consumer products packaging, additional staffing reductions were required. In addition a start up facility was shut down. This restructuring was the 2000 United States Restructuring ("2000 Restructuring").
CANADIAN RESTRUCTURING
In July 2000, Company management in Toronto announced that the Herzig Somerville operation was moving into Batten Graphics location in Toronto. Severance costs for 49 employees of $0.8 million and lease termination costs of $0.5 million were charged to the "Restructuring and other charges" line on the Statement of Operations. In addition, three printing presses at Herzig Somerville were sold. The Company recognized a gain on sale of $0.9 million. The gain is reflected on the other income line in the Statement of Operations.
In the fourth quarter of 2000, there were additional lease termination costs related to the vacated facility totaling $0.2 million. These costs were included on the Restructuring and other charges line on the Statement of Operations.
Effective June 1, 2000, the Company sold its Montreal operations for total proceeds of $2.3 million, which consisted of $1.4 million cash, $0.2 million in common stock of the acquirer, and a note receivable of $0.7 million. The Company recognized a net loss of $0.5 million on the sale, which is included in other on the Statement of Operations. During 2001, the acquirer encountered financial difficulties. As a result, a reserve of $0.3 million against the note receivable was recorded and included in other on the Statement of Operations.
2000 RESTRUCTURING
In the fourth quarter of 2000 the Company carried out the 2000 Restructuring a plan that involved staff reductions and the closing of one small facility in North Carolina. The staff reductions totaled 20 employees, or 1.4% of the workforce, and the Company recorded a charge of $0.1 million for severance costs. The North Carolina plant was closed at a cost of $0.6 million consisting of: $0.1 million estimate of the cost of canceling the lease for the premises and $0.5 million of written off leasehold improvements and other costs. The total of the above items, $0.7 million, is included in the Restructuring and other charges line on the Statement of Operations.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
2001 RESTRUCTURING
In 2001 the company continued the restructuring program that began in 1999. Severance costs of $0.8 million were recorded as a result of eliminating 140 positions at several facilities. Also, additional expenses were incurred relating to the closing of an east coast facility as part of the prior year's restructuring. This resulted in expenses of $0.2 million and $0.1 million for additional lease termination expenses and asset write-offs, respectively. The total of the above items, $1.1 million, is included in the restructuring and other charges line on the statement of operations.
2002 ACTIONS
During the third quarter of 2002, a total of 16 positions were eliminated at an east coast facility due to decline in the advertising business. A provision for severance pay and other employee benefits in the amount of $421 was recorded. Although this staff reduction was not part of a formal restructuring plan, the charge for severance and other employee benefits was included in "Restructuring and other charges" on the Consolidated Statement of Operations. As of December 31, 2002, $298 of the severance pay provision has been paid; $123 remains unpaid and is included in accrued expenses on the Consolidated Balance Sheet.
SUMMARY
2002 2001 2000 --------------------------- RESTRUCTURING AND OTHER CHARGES
Severance and other employee termination costs $ 421 $ 792 $ 1,122 Lease termination costs -- 230 1,095 Reversal of lease termination costs -- -- (440) Write off of leasehold improvements and other -- 98 561 --------------------------- $ 421 1,120 2,338 IMPAIRMENT CHARGES (SEE NOTE 4) Computer equipment and software 1,851 -- 733 Other 359 -- 66 --------------------------- 2,210 -- 799 ---------------------------
RESTRUCTURING AND OTHER CHARGES $ 2,631 $ 1,120 $ 3,137 ===========================
Below is an analysis of the activity related to the Company's restructuring programs and their status at December 31, 2002:
December 31, December 31, 2001 Payments 2002 ------------------------------------------ Severance and employee benefits 310 $(123) $187 Other 20 -- 20 ------------------------------------------ $330 $(123) $207 ==========================================
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 4. IMPAIRMENT OF LONG-LIVED ASSETS
In connection with the 2000 Restructuring, Company management reviewed all of the Company's assets for impairment and assets totaling $799 were written down to net realizable value. The assets involved were primarily computer equipment and software.
No asset impairment charges were deemed necessary in 2001.
In accordance with Statement of Financial Standards No. 144 (see note 2, Summary of Significant Accounting Policies), the Company continues to review all of its long-lived assets on an ongoing basis. As a result of the reviews performed during 2002, certain assets were taken out of service or their future cash flows were not sufficient to support the book value and an asset impairment charge of $2,210 was recorded and included in "Restructuring and Other Charges" on the Consolidated Statement of Operations. The assets involved in the 2002 impairment charge were primarily computer equipment and software.
NOTE 5. ACQUISITIONS
The Company acquired certain assets of a Canadian company in 2002 for $756. The purchase price has been allocated to the respective net assets acquired based on the fair value of such assets, including non-compete agreements, and the results of operations have been included in the accompanying Consolidated Statement of Operations from the effective date of the acquisition.
The Company also acquired the remaining minority interest of its Asian subsidiary during 2002 for $1,204. The amount paid in excess of the fair value of the tangible assets acquired was recorded as goodwill.
The Company also made contingent payments of $109 and $124 in 2002 and 2001, respectively that were related to a 1999 acquisition, and were recorded as additional goodwill.
A summary of the acquisitions is as follows:
2002 2001 -------- -------- Fair value of assets acquired, primarily fixed assets and non-compete agreements $ 756 $ -- Goodwill 412 124 Minority interest in consolidated subsidiary 901 -- -------- -------- $ 2,069 $ 124 ======== ========
NOTE 6. RELATED PARTY TRANSACTIONS
Included in other assets at December 31, 2002 was a receivable of approximately $117 from Geneva Waterfront, Inc., which is owned by a stockholder of the Company. At December 31, 2001 the Company had a payable, included in other liabilities, of approximately $247 to Geneva Waterfront, Inc.
During the second quarter of 2002, the Company sold a building used for storage to the Chairman of the Board, the majority stockholder of the Company. The building was sold for $750, which resulted in a gain of $145, included in "Other Income" on the Consolidated Statements of Operations. An independent appraisal was obtained and the building was sold for more than the appraised value. The independent members of the Board of Directors approved this transaction.
The Company also leases land and a building from a related party. See Note 13.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 7. INVENTORIES
Inventories consist of the following:
DECEMBER 31, ------------------------ 2002 2001 ------------------------
Raw materials $ 2,230 $ 2,315 Work in process 7,424 6,652 ------------------------ 9,654 8,967 Less: LIFO reserve (1,114) (1,042) ------------------------ $ 8,540 $ 7,925 ========================
NOTE 8. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31, ------------------------ 2002 2001 ------------------------
Land and improvements $ 793 $ 1,505 Buildings and improvements 14,736 15,457 Machinery and equipment 70,291 85,641 Leasehold improvements 8,823 8,671 Computer software 9,466 10,068 ------------------------ 104,109 121,342 Accumulated depreciation and amortization (63,457) (73,736) ------------------------ $ 40,652 $ 47,606 ========================
NOTE 9. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets. SFAS 142 requires that goodwill and intangible assets with indefinite lives no longer be amortized, but instead, be tested for impairment at least annually.
During 2002, the Company performed the first required impairment test of goodwill and indefinite-lived intangible assets. It was determined appropriate to consider the Company to be one reporting unit for purposes of this test. No impairment charge was required to be recorded in 2002.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
Below is a comparison of the results of operations for the year ended December 31, 2002 with the proforma results of operations for the year ended December 31, 2001 and 2000, adjusted to exclude goodwill amortization.
NOTE 10. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31, --------------------------- 2002 2001 ---------------------------
Accrued compensation and payroll taxes $ 7,035 $ 7,384 Accrued customer rebates 2,004 2,008 Accrued interest 581 691 Accrued property taxes 481 498 Non-compete agreements 273 -- Restructuring reserve 152 192 Other 3,261 2,334 --------------------------- $13,787 $13,107 ===========================
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 11. DEBT
Long-term debt consists of the following:
DECEMBER 31, --------------------- 2002 2001 ---------------------
Series B senior note payable $18,000 $24,000 U.S. bank credit agreement 25,000 34,000 Malaysian term loan (U.S. $) 219 -- --------------------- 43,219 58,000 Less amounts due in one year or less (6,033) (6,000) --------------------- $37,186 $52,000 =====================
The Series B note bears interest at 6.98% and is payable in annual installments of $6,000 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 2.59% at December 31, 2002. The credit agreement is for $65,000 and expires on May 6, 2004. The Company had approximately $40,000 available to borrow under this line at December 31, 2002.
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, 2002 and 2001.
Annual maturities of long-term debt at December 31, 2002 are as follows:
2004 $ 31,036 2005 6,039 2006 41 2007 45 2008 25 --------- $37,186 =========
The Company also has a $15,000 and a $3,200 line of credit with a U.S. bank and a Canadian bank, respectively, to provide financing and working capital flexibility. Interest is at a floating rate over LIBOR and Canadian prime for the U.S. line and the Canadian line, respectively. At December 31, 2002, the Company had $2,375 and $299 outstanding on the U.S. line and the Canadian line respectively. The effective interest rate on these borrowings at December 31, 2002 was 1.88% for the U.S. line and 4.5% for the Canadian line.
The Company also maintains working capital demand lines of credit in China (U.S. $1,500) and Malaysia (U.S. $1,250). At December 31, 2002, $369 and $238 was outstanding on the China and Malaysian lines, respectively.
These lines of credit are disclosed as notes payable to banks in the Consolidated Balance Sheet.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 12. STOCKHOLDERS' EQUITY
Stockholders' equity includes the following:
NOTE 13. INCOME TAXES
The provision (credit) for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31, ---------------------------------------------- 2002 2001 2000 ----------------------------------------------
Current: Federal $ 4,283 $ 2,038 $ 6,209 State 450 552 754 Foreign 973 712 1,275 ---------------------------------------------- 5,706 3,302 8,238
Deferred: Federal 858 1,797 (614) State 95 222 (76) Foreign (456) (1) 19 ---------------------------------------------- 497 2,018 (671) ---------------------------------------------- Total $6,203 $5,320 $7,567 ==============================================
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
Components of deferred income tax assets and liabilities are as follows:
DECEMBER 31, ---------------------- 2002 2001 ----------------------
Current deferred income taxes: Inventory $ 77 $ 88 Accruals and reserves not currently deductible 1,296 1,142 Foreign deferred taxes 340 11 ---------------------- Net current asset $ 1,713 $ 1,241 ======================
Noncurrent deferred income taxes: Depreciation $(1,045) $ (812) Property and equipment basis differences (491) (1,732) Goodwill on asset acquisitions (691) (370) Other (2,191) (1,529) ---------------------- Net noncurrent liability $(4,418) $(4,443) ======================
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:
The undistributed earnings of foreign subsidiaries were approximately $6,393 and $5,257 at December 31, 2002 and 2001, 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 $1,424 for 2002, $928 for 2001 and $1,431 for 2000.
NOTE 14. LEASES AND COMMITMENTS
The Company leased land and a building in Des Plaines, Illinois from an unrelated party. This lease was recorded as a capital lease. A related party had an option to purchase the land and building in January 2000. During 2000, the purchase option was exercised, the lease with the unrelated party was terminated, and the Company executed an operating lease at the same monthly rental amounts as previously with a related party. The Company recorded a gain of $524 on the termination of the capital lease.
The Company also leased land and a building in Chicago, Illinois from a related party. This lease was also recorded as a capital lease. During 2000, this lease was terminated and the Company relocated its operation to another site. The Company recorded a loss of $152 on the termination of the capital lease.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 14. LEASES AND COMMITMENTS (CONTINUED)
The Company also leases various plant facilities and equipment under operating leases that cannot be cancelled and expire at various dates through December 2010. Total rent expense incurred under all operating leases was approximately $4,049, $3,548, and $2,990, for the years ended December 31, 2002, 2001 and 2000, respectively.
Future minimum payments under leases with terms of one year or more are as follows at December 31, 2002
CAPITAL OPERATING LEASES LEASES ------------------------------------ 2003 $ 227 $ 3,397 2004 46 2,641 2005 -- 1,188 2006 -- 870 2007 -- 884 Thereafter -- 2,509 ------------------------------------ $ 273 $11,489 ==================
Less: Current portion 227 ------------------- $ 46 ===================
The Company has a deferred compensation agreement with the Chairman of the Board dated June 1, 1983 which was ratified and included in a restated employment agreement dated October 1, 1994. The agreement provides for deferred compensation for 10 years equal to 50% of final salary and was modified on March 9, 1998 to determine a fixed salary level for purposes of this calculation. The Company has a deferred compensation liability equal to $815 at both December 31, 2002 and December 31, 2001. The liability was calculated using the net present value of ten annual payments at a 6% discount rate assuming, for calculation purposes only, that payments begin one year from the balance sheet date.
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 4.0% in 2002 and 5.0% in 2001 and 2000. Contributions to the plans were $1,403, $1,825 and $1,834 in 2002, 2001 and 2000, 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 $1,015, $1,125 and $1,306 in 2002, 2001 and 2000, respectively.
The Company established an employee stock purchase plan on January 1, 1999 that permits employees to purchase common shares of the Company through payroll deductions. The Company issues new shares at a discount of 15%, based upon the lower of the beginning-of-quarter or end-of-quarter closing market price of the Company stock. The discount is recorded as compensation expense. The number of shares issued for this plan was 51 in 2002, 59 in 2001 and 78 in 2000. The discount recorded as compensation expense was $76 in 2002, $83 in 2001 and $97 in 2000.
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 16. STOCK/EQUITY OPTION PLANS
The Company has an Equity Option Plan that provides for the granting of options to purchase up to 3,252 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.
A summary of options outstanding at each of the three years ended December 31, 2002, 2001 and 2000, 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, 2002:
Schawk, Inc. Notes to Consolidated Financial Statements (In Thousands, Except Per Share Amounts)
NOTE 16. STOCK/EQUITY OPTION PLANS (CONTINUED)
Options available for grant under the plans were 725, 1,304 and 681 at December 31, 2002, 2001 and 2000, respectively. Options exercisable under the plans were 1,991, 1,555, and 1,254 in 2002, 2001 and 2000 respectively. The weighted-average fair values of options granted during 2002, 2001, and 2000 were $2.37 per share, $3.03 per share, and $2.98 per share, respectively.
The Company accounts for its plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. No stock-based employee compensation cost is reflected in the net income, as all options granted under this plan have an exercise price equal to the market value of the underlying common stock on the date of grant. The table in Note 2 illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting For Stock-based Compensation", to stock-based employee compensation.
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 by the weighted average shares outstanding for the year. Diluted earnings per share is computed by dividing net income 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 (In Thousands, Except Per Share Amounts)
NOTE 17. EARNINGS PER SHARE (CONTINUED)
Options to purchase 358 shares of Class A common stock at exercise prices ranging from $10-$15 per share were outstanding at December 31, 2002 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, 2012.
Options to purchase 338 shares of Class A common stock at exercise prices ranging from $11-$15 per share were outstanding at December 31, 2001 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, 2011.
NOTE 18. GEOGRAPHIC REPORTING
The Company operates a single business segment, Digital Imaging Graphic Arts. The Company operates primarily in two geographic areas, the United States and Canada. Summary financial information for continuing operations by geographic area for 2002, 2001 and 2000 is as follows:
Long-lived assets are non-current assets that are identified with the operations in each geographic area.
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 Company is included in the Proxy Statement for the Annual Meeting of Stockholders to be held Wednesday, May 21, 2003, and is to be filed with the Securities and Exchange Commission on or before April 30, 2003 (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.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES Within the 90-day period prior to the filing date of this report, Schawk Inc.'s management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, Schawk Inc.'s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the disclosure controls and procedures are effective. There have been no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of this evaluation.
PART IV
ITEM 15.
ITEM 15. 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, 2002 and 2001 Consolidated Statements of Operations--Years Ended December 31, 2002 and 2001, and 2000 Consolidated Statements of Cash Flows--Years Ended December 31, 2002 and 2001, and 2000 Consolidated Statements of Stockholders' Equity--Years Ended December 31, 2002 and 2001, and 2000 Notes to Consolidated Financial Statements
2. The following financial schedules for the years 2002, 2001 and 2000 are submitted herewith: SCHEDULE II--Valuation and qualifying accounts.
(b) Reports on Form 8-K
The Registrant filed no reports on Form 8-K for the fourth quarter of 2002 through the filing date of this document.
(c) Exhibits
* Represents management contract or compensation plan or arrangement required to be filed pursuant to Item 14 (c). ** Document attached hereto.
Schawk, Inc.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
(1) Uncollectible accounts written off, net of recoveries.
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 14th day of March 2003.
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 14th day of March 2003.
CERTIFICATIONS
I, David A. Schawk, certify that:
1. I have reviewed this annual report on Form 10-K of Schawk, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 14, 2003 -----------------
/s/ David A. Schawk ------------------- David A. Schawk President and CEO
CERTIFICATIONS
I, James J. Patterson, certify that:
1. I have reviewed this annual report on Form 10-K of Schawk, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 14, 2003 ----------------
/s/ James J. Patterson -------------------------- James J. Patterson Sr. Vice President and CFO