ITEM 1. BUSINESS
GENERAL
Paragon Corporate Holdings Inc. (hereinafter referred to as the "Company") is a holding company organized in September 1996 under the Delaware General Corporation law. The Company conducts all of its business through its subsidiaries.
The Company commenced operations on January 17, 1997 through the acquisition on that date of the common stock of A.B.Dick Company and its wholly owned subsidiaries (collectively "A.B.Dick"), from General Electric Company Ltd. ("GEC"). A.B.Dick is engaged in the manufacture, sale, distribution and service of offset presses, cameras and plate makers and related supplies for the graphic arts and printing industry. On December 5, 1997, the Company acquired all of the common stock of Curtis Industries, Inc. ("Curtis"), a national distributor of products to the automotive and industrial markets.
The Company's printing equipment and supplies business segment is a leading manufacturer and distributor of printing products for the global quick print and small commercial printing markets. This business has three product lines: (i) pre-press, press and other related equipment, (ii) supplies, and (iii) after-market repair service and replacement parts. The Company manufactures its own products that are sold under the A.B.Dick(R) and Itek Graphix(R) brand names, and distributes certain products manufactured by third parties. The Company's printing equipment and supplies business segment sells its products and services through a network of branches and independent distributors in the United States, its subsidiaries in Canada, the United Kingdom, the Netherlands and Belgium and independent distributors in other countries.
The Company's automotive and industrial supplies distribution business segment supplies a wide range of products including (i) automotive security products, key cutting equipment and key blanks, and non-model specific automotive parts and (ii) maintenance, repair and operating supplies, including fasteners, connectors, chemicals and tools. The Company generally markets its products under its proprietary brand names, Curtis(R) and Mechanics Choice(R). Customers of the Company's distribution business include independent auto dealerships and industrial accounts throughout the U.S., Canada and the United Kingdom.
ACQUISITIONS
The Company's acquisition strategy is to conclude acquisitions that will add complementary product lines, expand its technological capabilities, broaden its geographic reach or otherwise support its business strategy. There can be no assurance that the Company will be successful in consummating any acquisition on terms favorable to the Company, if at all. On September 29, 1999, the company entered into an agreement to acquire all the outstanding shares of Multigraphics, Inc. ("Multigraphics"), a provider of equipment, supplies and service to the graphic arts industry. The transaction was completed on January 27, 2000 and will be accounted for as a purchase. During 1998, the Company consummated two small transactions, which added complementary pre-press products and supplies and strengthened the company's foreign distribution of its printing equipment and supplies business.
CUSTOMERS
The Company's printing equipment and supplies products are marketed to commercial, franchise and independent print shops, in-plant print shops and governmental and educational institutions throughout the world. Customers for printing supplies include franchisees of national quick print chains, independent quick print shops and small commercial shops and check printers. The Company's automotive and industrial supplies distribution products are marketed to fleet operators, independent auto dealerships, selected retail outlets and industrial accounts throughout the world. The Company's printing products are sold to more than 12,000 customers and its automotive and industrial distribution products to more than 55,000 customers, with no one customer accounting
for more than 1.1% of the Company's 1999 net revenues. The Company believes this diversity in its client base minimizes its reliance on any one customer.
COMPETITION
The Company's printing equipment and supplies business competes, with respect to its manufactured products, against a number of other manufacturers of pre-press equipment and offset presses and with re-sellers of used presses, primarily on the basis of quality and price. Some of these competitors have significantly greater financial and other resources than the Company. The Company's pre-press and offset press equipment also competes, to a limited extent, with alternate technologies such as color laser printers, copiers and other duplicating equipment. In addition, in the markets for supplies, service and parts, the Company competes against a wide variety of national, regional and local distributors of graphic arts and printing supplies and related service, primarily on the basis of availability and service.
The Company's distribution business competes with OEMs and other national distributors, as well as a large number of regional and local distributors. Because of the similarity of product types, competitive advantage among national distributors is determined primarily by sales representative performance and reliability, product presentation, product quality, order fill rate, breadth of product line, speed of delivery and, to a lesser extent, price. Regional and local distributors also compete with the Company on the basis of these factors, but price and delivery are more important factors at this level.
SUPPLIERS
All materials used by the Company's printing equipment and supplies business to manufacture products are readily available in the marketplace, and the Company is not dependent upon any single supplier for any materials essential to the manufacture of any of these products. The Company has been able to obtain an adequate supply of raw materials and no shortage of raw materials is currently anticipated.
The Company's distribution business distributes products from a large and diverse supply base. In 1999, based on the Company's net revenues, no single supplier accounted for more than 8.3% of the Company's supply of products.
BACKLOG
Backlog at December 31, 1999 was $4.6 million, an increase of $1.3 million, or 40.5% from $3.3 million at December 31, 1998. The increase is primarily due to the timing of shipment of certain prepress components and presses acquired from third party manufacturers. The Company expects the majority of the backlog to ship during 2000. Since a majority of the orders in the automotive and industrial supplies distribution business are shipped within 24 hours of receipt of the order, no significant backlog exists for these products at December 31, 1999 or 1998.
EMPLOYEES
As of December 31, 1999, the Company had approximately 1,800 employees, approximately 1,350 of whom were located in the United States. The Company believes its relations with its employees are good. The Company's employees are not subject to collective bargaining agreements.
ENVIRONMENTAL AND HEALTH SAFETY MATTERS
The Company is subject to a variety of environmental standards imposed by federal, state, local and foreign environmental laws and regulations. The Company also is subject to the federal Occupational Health and Safety Act and similar foreign and state laws. The Company periodically reviews its procedures and policies for compliance with environmental and health and safety laws and regulations and believes that it is in substantial compliance with all such material laws and regulations applicable to its operations. Historically, the costs of
compliance with environmental, health and safety requirements have not been material to the results of operations or the financial position of the Company.
ITEM 2.
ITEM 2. PROPERTIES.
As of December 31, 1999 the Company conducts its operations through the following primary facilities:
APPROX. PRINCIPAL OWNED/ LOCATION SQ.FOOTAGE FUNCTION LEASED UNITED STATES: Niles, Illinois 54,000 Headquarters; Administration Leased(1) Niles, Illinois 156,000 Manufacturing; warehouse Leased(2) Des Plaines, Illinois 87,000 Warehouse Leased(3) Rochester, New York 194,000 Manufacturing Leased(4) Shelbyville, Kentucky 100,000 Warehouse; packaging Owned Atlanta, Georgia 60,000 Warehouse Leased(5) Sparks, Nevada 50,000 Warehouse Owned Mayfield Heights, Ohio 34,000 Administrative Leased(6) CANADA: Rexdale, Ontario 67,000 Administration; warehouse Owned Mississauga, Ontario 38,000 Administration; warehouse Leased(7) UNITED KINGDOM: Brentford, 26,000 Administration; warehouse Leased(8) Andover 15,000 Administration; warehouse Leased(9) BELGIUM: Brussels 11,000 Administration; warehouse Leased(10) THE NETHERLANDS: Maarssen 25,000 Administration; warehouse Leased(11) - - ----------------- (1) Expires in July, 2008. (2) Expires in July, 2003. (3) Expires in August, 2003. (4) Expires in April, 2007. (5) Expires in February, 2003. (6) Expires in November, 2006. (7) Expires in August, 2001. (8) Expires in September, 2003. (9) Expires in November, 2012. (10) Expires in December, 2004. (11) Expires in March, 2003.
The Company believes that all of its property and equipment is in a condition appropriate for its operations and that it has sufficient capacity to meet its current operational needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
On April 30, 1997, four former and current distributors of A.B.Dick filed a suit against A.B.Dick, the Predecessor Company, alleging, among other things, breach of distributorship contracts and unfair and deceptive trade practices. The plaintiffs allege that the former parent of A.B.Dick decided to exit the U.S. market for printing equipment and related supplies and services by the sale or closing of A.B.Dick and as part of such plan pursued strategies designed to eliminate or significantly weaken A.B.Dick distributors engaged under distributorship contracts during the four year period ended April 30, 1997. The Company intends to vigorously defend this case although there can be no assurance as to the eventual outcome.
GEC Incorporated has agreed to fully indemnify the Company against all costs and liabilities in connection with any litigation that is pending or may be brought against A.B.Dick and arises out of events occurring prior to the closing of the A.B.Dick acquisition, including the case mentioned in the previous paragraph, for all amounts in excess of $250,000 up to an aggregate liability of $15,000,000.
In addition, both A.B.Dick and Curtis are parties to routine litigation incidental to their businesses, some of which is covered by insurance. The Company does not believe that any such pending litigation will have a material adverse effect upon its results of operations or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the quarter ended December 31, 1999, NES Group, Inc., the Company's sole shareholder, by written consent, re-elected all members of the Company's Board of Directors.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company is a direct wholly-owned subsidiary of NES Group, Inc. There is no established public trading market for the Company's common stock. As of March 15, 2000, the Company had one shareholder. The Company paid no dividends in 1999, and a $10.0 million cash dividend in 1998. See Note G, "Financing Arrangements," to the Consolidated Financial Statements, Part II, Item 8, for limitations on dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents (i) consolidated financial data of the Company for the years ended December 31, 1999 and 1998 and for the period from January 17, 1997 through December 31, 1997, and (ii) consolidated financial data of A.B.Dick (Predecessor Company) for the period from April 1, 1996 through January 16, 1997 and for the year ended March 31, 1996, which have been derived from the audited consolidated financial statements of A.B.Dick. The Company believes that the financial data of A.B.Dick for the periods prior to January 17, 1997, the date on which A.B.Dick was acquired by the Company (the "Acquisition Date"), is not comparable in certain respects with the financial data of A.B.Dick subsequent to such date. Prior to the Acquisition Date, A.B.Dick maintained a defined benefit pension plan for its manufacturing employees. This plan was overfunded as of March 31, 1995 and, accordingly, pension credits of $5.1 million were recognized for the fiscal year ended March 31, 1996 and $7.0 million were recognized for the period from April 1, 1996 through January 16, 1997. In connection with the sale of A.B.Dick on January 16, 1997, GEC assumed all existing obligations under this plan. Prior to the Acquisition Date, A.B.Dick also provided post-retirement health care benefits to certain retirees. Net periodic post-retirement benefit costs of approximately $4.7 million for the fiscal year ended March 31, 1996 and approximately $3.5 million for the period April 1, 1996 through January 16, 1997 were allocated to A.B.Dick by GEC based upon actuarial valuations. In connection with the sale of A.B.Dick on January 16, 1997, GEC assumed all existing obligations under the post-retirement health care benefits plan. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements as described elsewhere herein.
(1) For 1999, represents non-recurring charges related to A.B.Dick severance and reorganization costs. For 1997 and 1998, represents non-recurring charges related to compensation agreements with certain executives in connection with the Curtis acquisition. In addition, in 1998, represents costs incurred in connection with the relocation of A.B.Dick operations as required by the A.B.Dick purchase agreement.
(2) Earnings consist of income before income taxes plus fixed charges. Fixed charges consist of interest expense, amortization of deferred financing costs and one-third of the rent expense from operating leases, which management believes is a reasonable approximation of an interest factor. Earnings were inadequate to cover fixed charges in the fiscal year ended December 31, 1999 and the period from April 1, 1996 through January 16, 1997 and the year ended March 31, 1996 by $15,391, $455, and $5,463, respectively.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The consolidated financial statements of the Company include the operations of the acquired subsidiaries from their respective dates of acquisition. A.B.Dick was acquired on January 17, 1997 and Curtis was acquired on December 5, 1997. The 1997 statement of operations for the Company represents the 49-week period from January 17, 1997 through December 31, 1997.
The following table sets forth, on a comparative basis, certain income statement data for the Company for the years ended December 31, 1999 and 1998 and the period from January 17, 1997 through December 31, 1997. The information has been derived from the audited consolidated financial statements of the Company .
YEAR ENDED DECEMBER 31, 1999, COMPARED TO YEAR ENDED DECEMBER 31, 1998.
NET REVENUE.
Net revenue decreased $19.9 million or 7.4% from $268.6 in 1998 to $248.7 million in 1999. The decrease was principally due to lower printing equipment and supplies sales which declined by $22.3 million from the prior year. Printing equipment sales were down $11.1 million or 16.1% over the prior year to $57.9 million primarily due to weaker demand in domestic and most European markets as well as an expired distribution agreement in Canada. Printing supplies sales were down $7.3 million or 9.6% to $68.5 million in 1999 due to an expired distribution agreement in Canada, a decline in the supply stream on previously discontinued domestic equipment and lower optical equipment supplies sales, partially offset by increases in digital equipment supplies sales. Service and repair parts revenues decreased $3.9 million or 9.1% primarily due to the discontinuance of A.B.Dick's line of distributed copier equipment and digital duplicators. Automotive and industrial supplies revenue increased $2.4 million or 2.9% over the prior year, to $83.5 million primarily as result of an increase in U.S. National Account sales.
GROSS PROFIT.
Gross profit decreased $14.8 million or 14.1% to $89.9 million compared to $104.7 million from the prior year. Gross profit as a percent of sales was 36.1% in 1999 compared to 39.0% in 1998 primarily due to lower printing equipment and supplies margin. A.B.Dick's gross profit decreased $15.6 million and gross profit as a percent of sales decreased by 5.3 percentage points to 25.4%. The decrease in gross profit percent resulted mainly from lower cost in 1998 due to yen denominated purchases, increased costs in 1999 on manufactured equipment due to reduced volume, and increased freight costs. Service margins were lower due to decreased installations and service contracts on previously discontinued equipment. Curtis' gross profit increased $0.9 million or 1.8% from last year due to increased sales.
COSTS AND EXPENSES.
Costs and expenses decreased by $0.9 million to $93.8 million in 1999 from $94.7 million for 1998. Sales, marketing, general and administrative expense, and management fees reductions totaling $2.1 million were offset by increases in depreciation and amortization and research and development expense totaling $2.3 million. Acquisition, relocation and severance costs were $1.6 million in 1999 and consisted of $0.8 million of severance and pension costs associated with the reorganization of A.B.Dick's Belgium subsidiary, and $0.8 million in relocation and severance costs related to A.B.Dick. A majority of these costs were paid in 1999. In 1998, acquisitions, relocation and severance expenses were $2.7 million related primarily to costs associated with relocation of the A.B.Dick facilities and severance costs with certain executives.
OPERATING INCOME.
Operating income decreased $14.0 million from $10.0 million in 1998 to a loss of $4.0 million in 1999. The 1999 amount includes operating income from Curtis of $4.4 million and an operating loss from A.B.Dick of $7.7 million. The primary factors contributing to the decline in operating income when compared to the same period a year earlier are the decreases in revenues and gross profits, partially offset by lower operating costs, for A.B.Dick.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE PERIOD FROM JANUARY 17, 1997 THROUGH DECEMBER 31, 1997.
NET REVENUE.
Net revenue increased $75.4 million or 39.0% from $193.2 in 1997 to $268.6 million in 1998. The increase was principally due to the acquisition of Curtis, which accounted for $81.1 million in sales for the year ended December 31, 1998 compared to $6.9 million in 1997. Printing equipment sales were up $4.4 million or 6.8% over the prior year to $69.0 million primarily due to increases in the domestic sales of press equipment. Supplies sales were down $2.1 million or 2.7% to $75.8 million in 1998 compared to $77.9 million in 1997. The discontinuance of certain domestic equipment lines and the introduction of a new plate product by a competitor in the pre-press market were the principal reasons for the revenue decline. Service and repair parts revenues decreased by $1.1 million primarily due to the discontinuance of the Konica copier equipment line and a trend among customers to switch from preventive service contracts to purchased service calls.
GROSS PROFIT.
Gross profit was $104.7 million compared to $63.6 million from the prior year. The increase of $41.1 million or 64.6% was principally due to the acquisition of Curtis, which had a gross margin of $47.1 million in 1998 compared to $4.1 million in 1997. Gross profit margin percentage was 39.0% during 1998 compared to 32.9% for the same period last year. The addition of the Curtis busines accounted for the significant improvement in the gross margin as a percentage of revenues. The A.B.Dick margins decreased by $1.9 million or 1.2% as a percent of revenue primarily due to the change in the mix of sales of the various products and services.
COSTS AND EXPENSES.
Costs and expenses increased by $42.1 million to $94.7 million in 1998 from $52.6 million in 1997. The acquisition of Curtis contributed $39.4 million to the increase in costs and expenses. A.B.Dick sales, marketing, general and administrative expense increases were offset by reductions in research and development and management fee. Acquisition and relocation expenses were $2.7 million during 1998 compared to $1.4 million in 1997. This increase was primarily due to the costs associated with the relocation of the A.B.Dick facilities during the year and non-recurring charges related to compensation arrangements with certain executives.
OPERATING INCOME.
Operating income decreased $1.0 million or 9.1% from $11.0 million in 1997 to $10.0 million in 1998. In 1998 the amount includes an increase in operating income from Curtis of $4.2 million. The operating income generated in 1998 by A.B.Dick decreased $2.1 million due to the relocation of its facilities and approximately $2.7 million due to the change in the mix of product sales and services compared to 1997. Corporate administrative expenses increased by $0.4 in 1998 compared to 1997.
EXTRAORDINARY ITEM.
An extraordinary expense of $1.3 million was recorded during the second quarter of 1998 related to the write-off of deferred financing costs and fees associated with the early extinguishment of certain of the Company's debt.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided (used) by operating activities was ($10.6) million, $1.5 million and $15.1 million for the years ended December 31, 1999, 1998 and the period from January 17, 1997 through December 31, 1997, respectively. The decrease in net cash from operating activities in 1999 was principally the result of net losses incurred of $15.2 million. The net loss in 1999 is primarily due to A.B.Dick operating losses and increased interest costs as a result of the issuance of $115.0 million of senior notes on April 1, 1998. The decrease in net cash from operating activities in 1998 as compared to 1997 was principally the result of decreased net income. The decline in net income is mainly due to the increased interest costs on the $115.0 million of senior notes noted above. The net cash provided from operating activities
in 1997 is primarily due to net income of $8.6 million and the reduction of inventories of $6.0 million.
Net cash provided by (used in) investing activities was $9.3 million, ($27.6) million and ($28.7) million for the years ended December 31, 1999, 1998 and the period from January 17, 1997 through December 31, 1997, respectively. Net cash provided by investing activities in 1999 includes liquidation of short-term investments of $17.9 million primarily used for debt service, a $2.0 million loan to Multigraphics, and to partially fund capital expenditures of $6.5 million. The net cash used in investing activities in 1998 includes increases in short-term investments of $17.4 million, and property, plant and equipment purchases of $10.0 million, approximately $5.8 million of which related to the relocation of the A.B.Dick facilities. The primary components of net cash used in investing activities in 1997 were $19.5 million for accounts receivable related to the A.B.Dick acquisition; $1.9 million for property, plant, and equipment purchases; $4.4 million for payment of acquisition-related liabilities, and $4.9 million related to the acquisition of Curtis.
Net cash provided by financing activities was $8.9 million, $30.6 million and $15.3 million for the years ended December 31, 1999, 1998 and the period from January 17, 1997 through December 31, 1997, respectively. Net cash provided by financing in 1999 includes an increase in the revolving lines of credit of $10.2 million incurred primarily to fund A.B.Dick operating losses, borrowings of $0.6 million under a term note, offset by a reduction of $0.4 million in long-term borrowings and a decrease of $0.9 million in amount due to GEC and affiliates. The increase in 1998 is the result of the issuance of the $115.0 million of senior notes, offset by the reduction of long-term borrowings of $41.9 million and revolving lines of credit by $26.1 million, and a payment of bond issuance costs of $5.2 million and a dividend to the sole shareholder in the amount of $10.0 million. The increase in cash provided by financing activities for 1997 was principally due to increases in borrowings on revolving credit lines.
The Company's primary capital requirements (excluding acquisitions) consist of working capital, capital expenditures and debt service. The company expects current financial resources and funds from operations to be adequate to meet current cash requirements. At December 31, 1999 the company had cash, cash equivalents and short-term investment of $19.0 million and unused credit facilities of $18.7 million available for its use. At December 31, 1999, the company was in violation of certain financial covenants under the terms of the revolving credit agreement. During March 2000, the Company received waivers of these convenants through June 29, 2000 and it also amended future covenant requirements to reflect the Company's current financial outlook and the acquisition of Multigraphics.
INTERNATIONAL OPERATIONS
The Company transacts business in a number of countries throughout the world and has facilities in the United States, Canada, the United Kingdom, The Netherlands, and Belgium. As a result, the Company is subject to business risks inherent in non-U.S. operations, including political and economic uncertainty, import and export limitations, exchange controls, and currency fluctuations. The Company believes that the risks related to its foreign operations are mitigated by the relative political and economic stability of the countries in which its largest foreign operations are located. As the U.S. dollar strengthens and weakens against foreign currencies in which the Company transacts business, its financial results will be affected. The principal foreign currencies in which the Company transacts business are the Canadian dollar, the British pound sterling, the Dutch guilder, and the Belgium franc. The fluctuation of the U.S. dollar versus other currencies resulted in increases (decreases) to stockholder's equity of approximately $0.2 million and $(0.3) million for the years ended December 31, 1999 and 1998, respectively.
IMPACT OF THE YEAR 2000
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 compliant. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company has experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expended approximately $3.4 million to upgrade its information systems which included achieving Year 2000 compliance.
The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or products and ervices of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
ENVIRONMENTAL MATTERS
The Company is subject to various laws and governmental regulations concerning environmental matters and employee safety and health in the United States and other countries. U.S. federal environmental legislation having particular impact on the Company includes the Toxic Substances Control Act, the Resource Conservation and Recovery Act, the Clean Air Act, the Clean Water Act, the Safe Drinking Water Act and the Comprehensive Environmental Response, Compensation and Liability Act (also known as Superfund). The Company also is subject to regulation by the Occupational Safety and Health Administration (OSHA) concerning employee safety and health matters. The United States Environmental Protection Agency (EPA), OSHA and other federal agencies have the authority to promulgate regulations that have an impact on the Company's operations.
In addition to these federal activities, various states have been delegated certain authority under the aforementioned federal statutes. Many state and local governments have adopted environmental and employee safety and health laws and regulations, some of which are similar to federal requirements. State and federal authorities may seek fines and penalties for violation of these laws and regulations. As part of its continuing environmental program, the Company has been able to comply with such proceedings and orders without any materially adverse effect on its business.
The Company is committed to a long-term environmental protection program that reduces emissions of hazardous materials into the environment, as well as to the remediation of identified existing environmental concerns.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which, as amended by FASB Statement 137, is required to be adopted no later than January 1, 2001. The Company does not anticipate that the adoption of this Statement will have a significant effect on its results of operations or financial position.
IMPACT OF INFLATION
Although inflation has slowed in recent years, it is still a factor in our economy and the Company continues to seek ways to mitigate its impact. To the extent permitted by competition, the Company passes increased costs on to its customers by increasing sales prices over time.
The Company uses the last in-first out (LIFO) method of accounting for its domestic inventories. Under this method, the cost of products sold reported in the financial statements approximates current costs and thus provides a closer matching of revenue and expenses in periods of increasing costs.
The Company's properties have been acquired over the past three years and have a useful life ranging from three years for equipment to forty years for buildings. Assets acquired in prior years will, of course, be replaced at higher costs but this will take place over many years. Again, these new assets will result in higher depreciation charges; but in many cases, due to technological improvements, there will be operating cost savings as well. The Company considers these matters in setting its pricing policies.
SUBSEQUENT EVENT
On January 27, 2000, the Company completed the acquisition of all of the outstanding common stock of Multigraphics, Inc. a supplier of high quality pre-press, press, and post-press equipment,
supplies, and technical services to the printing industry. Pursuant to the Merger Agreement, the Company paid $1.25 in cash per share, or $3.6 million, and assumed $7.4 million of outstanding debt of Multigraphics. In addition, the Company loaned $2.0 million to Multigraphics pursuant to a promissory note agreement executed by Multigraphics on September 29, 1999. The acquisition will be accounted for under the purchase method of accounting whereby the purchase price will be allocated to the assets acquired and liabilities assumed based upon their estimated fair values. The purchase price allocation has not been completed as of March 30, 2000. For the fiscal year ended July 31, 1999, Multigraphics had net sales of approximately $107 million and operating income of approximately $1.8 million.
In connection with the acquisition, the Company is formulating plans for the integration of Multigraphics operations into its printing and supplies business segment. As part of this integration, the Company anticipates that it will incur restructuring costs of approximately $1.5 million comprised primarily of employee termination and relocation costs which will be expensed during 2000. Employee termination costs and other costs pertaining to Multigraphics that qualify under EITF 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, will be included in the purchase price allocation.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Forward-looking statements in this report, including without limitation, statements relating to the Company's plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) the Company's plans, strategies, objectives, expectations and intentions are subject to change at any time at the discretion of the Company; (ii) the Company's plans and results of operations will be affected by the Company's ability to manage its growth and inventory and (iii) other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK AND RISK MANAGEMENT POLICIES
The following discussion provides information concerning the Company's financial instruments that are sensitive to changes in interest rates. The Company's available for sale securities of $3.6 million at December 31, 1999 are carried at fair value and invested primarily in United States corporate debt securities. Expected maturities range from one to ten years with rates of return averaging between 4.8% to 5.7%. Interest earned on these securities, which are similar enough to aggregate for presentation purposes, is not material to the results of operations of the Company.
Substantially all of the Company's long-term debt consists of $115 million of series B Senior Notes due in April, 2008. The notes carry interest at a fixed rate of 9 5/8%, payable semi-annually. The notes are redeemable at the option of the Company, in whole or in part, any time on or after 2003, subject to certain call premiums. The carrying amount of the notes exceeded its fair value at December 31, 1999 and 1998 by $78,200 and $19,600, respectively. The fair value has been determined using the market price of the related securities at December 31, 1999 and 1998.
The Company's $32 million credit agreement is fully revolving until its maturity in 2003. The credit agreement bears variable interest at an initial rate equal to either 1) the bank's prime rate plus 75 basis points or 2) LIBOR plus 275 basis points, at the option of the Company. The weighted average interest rate for borrowings under this facility was 8.9% in 1999.
The Company's interest income and expense are most sensitive to changes in the U.S. interest rates, which impact interest earned on the Company's cash equivalents and available for sale securities as well as interest paid on borrowings under the revolving credit facility. The Company has mitigated the impact of interest rate fluctuations by issuing substantially all of its long term debt at fixed interest rates with a single maturity in 2008.
The Company's earnings are also affected by fluctuations in the value of the U.S. dollar as compared to foreign currencies, predominantly in Japan, and to a lesser extent, European countries. An additional risk relates to product shipped between the Company's European subsidiaries. In addition to the impact on the intercompany balances, changes in exchange rates also affect volume of sales or the foreign currency sales price as competitors products become more or less attractive.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The Report of Independent Auditors and the consolidated financial statements of Paragon Corporate Holdings Inc. for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997 are included herein.
PARAGON CORPORATE HOLDINGS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
To The Stockholder Paragon Corporate Holdings Inc.
We have audited the accompanying consolidated balance sheets of Paragon Corporate Holdings Inc. as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholder's equity (deficit) and cash flows for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Paragon Corporate Holdings Inc. at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997 in conformity with accounting principles generally accepted in the United States.
/s/Ernst & Young LLP
Cleveland, Ohio March 30, 2000
Paragon Corporate Holdings Inc. Consolidated Balance Sheets (Dollars in Thousands)
See notes to consolidated financial statements
Paragon Corporate Holdings Inc. Consolidated Statements of Operations (Dollars in Thousands)
See notes to consolidated financial statements.
Paragon Corporate Holdings Inc. Consolidated Statements of Stockholder's Equity (Deficit) (Dollars in Thousands)
See notes to consolidated financial statements
Paragon Corporate Holdings Inc. Consolidated Statements of Cash Flows (Dollars in Thousands)
See notes to consolidated financial statements
PARAGON CORPORATE HOLDINGS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999 (Dollars in Thousands)
A. ORGANIZATION
Paragon Corporate Holdings Inc. (hereinafter referred to as the "Company") is a Delaware holding company organized in September 1996. The Company has no independent operations or investments other than its investments in its subsidiaries, except that the Company has temporarily invested, at the holding company level, the residual proceeds from the Senior Notes issued during 1998. NES Group, Inc. is the sole stockholder of the Company.
B. ACQUISITIONS
The Company commenced operations on January 17, 1997 through the acquisition on that date of the common stock of A.B.Dick Company and its wholly owned subsidiaries (collectively "A.B.Dick"), from General Electric Company Ltd. ("GEC").
Under the terms of the stock purchase agreement, A.B.Dick transferred to GEC $19,489 of domestic accounts receivable (which were collected by A.B.Dick during 1997 and remitted to GEC) and the Niles manufacturing and headquarters facilities, which had a carrying amount of $3,500. GEC agreed to let the Company use these facilities until the Company moved to new manufacturing, headquarters and distribution facilities during 1998. GEC also agreed to fund up to $1,500 in severance costs incurred in 1997 and to reimburse the Company in 1998 for moving costs up to $2,000. These amounts have been reflected in the allocation of the purchase price.
Restructuring reserves of $6,000 were included in the purchase price allocation in accordance with the Company's business plans to substantially reorganize the A.B.Dick operations. These reserves represented accruals for severance of administrative and operating employees and occupancy costs to be incurred in 1997 and 1998 for idle manufacturing and headquarters facilities prior to the relocation of operations in 1998. As of December 31, 1998, the Company expended all of the amounts provided for in the purchase price allocation. In the first quarter of 1999, the Company completed the physical relocation of its headquarters, distribution center and manufacturing activities.
Since the fair value of the net assets acquired exceeded the purchase price by approximately $16,359, the historical book values of the acquired property, plant and equipment ($12,900) were recorded on the January 17, 1997 opening balance sheet at zero. The remaining excess ($3,459) of fair value of net assets acquired over purchase price is classified as other long-term liabilities and is being amortized into income over ten years. This transaction was accounted for under the purchase method of accounting.
On December 5, 1997, the Company acquired all the common stock of Curtis Industries, Inc. ("Curtis"), a national distributor of products in the automotive and industrial markets, for a purchase price of $22,200 composed primarily of $6,500 in cash and $15,700 in seller notes. The acquisition was accounted for under the purchase method of accounting and, accordingly, the results of operations of Curtis are included in the consolidated financial statements since the date of acquisition.
The following unaudited pro forma results of operations assume the acquisition of Curtis occurred on January 1, 1997. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the acquisition occurred on January 1, 1997:
Period from Jan. 17, 1997 through Dec. 31, 1997 --------------
Net revenues $267,419 Costs and expenses 250,295 Acquisition costs 1,400 Operating income 15,724 Net Income 8,700
During 1998, the Company acquired two businesses, which added complementary products and increased distribution for the Company's foreign printing equipment and supplies business. The cost of the acquisitions, net of cash acquired, was $1,095. The acquisitions have been accounted for as purchases with the acquired assets and liabilities recorded at estimated fair value at the date of acquisition. The acquired companies operating results have been included in the statement of operations since their respective date of acquisition. Proforma results of operations assuming the acquisitions occurred on January 1, 1997 have not been presented as the impact of these acquisitions was not material.
On January 27, 2000, the Company completed the acquisition of all of the outstanding common stock of Multigraphics, Inc. ("Multigraphics"), a supplier of high quality pre-press, press, and post-press equipment, supplies, and technical services to the printing industry. Pursuant to the Merger Agreement, the Company paid $1.25 in cash per share, or $3.6 million, and assumed $7.4 million of outstanding debt of Multigraphics. In addition, the Company loaned $2.0 million to Multigraphics pursuant to a promissory note agreement executed by Multigraphics on September 29, 1999. The acquisition will be accounted for under the purchase method of accounting whereby the purchase price will be allocated to the assets acquired and liabilities assumed based upon their estimated fair values. The purchase price allocation has not been completed as of March 30, 2000. For the fiscal year ended July 31, 1999, Multigraphics had net sales of approximately $107 million and operating income of approximately $1.8 million.
C. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Cash Equivalents and Investments
The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The Company's available-for-sale securities are comprised primarily of corporate debt securities and commercial paper and have maturities ranging from less than one year to ten years.
Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in other comprehensive income. Interest, dividends, realized gains and losses, and declines in value judged to be other than temporary, are recognized in net income (loss). The cost of securities sold is based on the specific identification method.
Accounts Receivable
Provisions for credit losses were approximately $1,546, $760 and $1,124 for the years ended December 31, 1999 and 1998, and for the period from January 17, 1997 through December 31, 1997, respectively. Accounts written off were approximately $780, $1,173 and $124 for the years ended December 31, 1999 and 1998 and the period from January 17, 1997 through December 31, 1997, respectively.
Inventories
Domestic inventories, which represent approximately 75% and 80% of total consolidated inventory at December 31, 1999 and 1998, respectively, are determined on the last-in, first-out (LIFO) basis and foreign
inventories are determined on the first-in, first-out (FIFO) basis. Where necessary, reserves are provided to value inventory at the lower of cost or market.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, short-term investments, trade receivables and payables approximates fair value because of the short maturity of these instruments. The carrying amount of the revolving credit facility approximates fair value. The carrying amount of long-term debt exceeds its fair value at December 31, 1999 and 1998 by $78,200 and $19,600, respectively. The fair value has been determined using the market price of the related securities at December 31, 1999 and 1998.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments and trade accounts receivable.
The Company maintains cash and cash equivalents and short-term investments with financial institutions. The Company's policy is designed to limit exposure to any one investment type. The Company performs periodic evaluations of the relative credit standing of the various investments that are contained in the Company's investment portfolio.
Concentrations of credit risk with respect to trade accounts receivable are limited due to the large number of entities comprising the Company's customer base. The Company does not require collateral for trade accounts receivable.
Property, Plant and Equipment
Property, plant and equipment are stated at cost (See Note B). Depreciation is computed using the straight-line method based on the expected useful lives of the assets, which are as follows:
Building and improvements 15 to 40 years Machinery and equipment 3 to 18 years Rental equipment 3 years
Goodwill
Goodwill is being amortized on a straight-line basis over 30 years. Accumulated amortization was $2,762 and $1,585 at December 31, 1999 and 1998, respectively. The ongoing value and remaining useful life of goodwill are subject to periodic evaluation and the Company currently expects the carrying amounts to be fully recoverable.
Impairment of Long-lived Assets
Impairment of long-lived assets and related goodwill is recognized when events or changes in circumstances indicate that the carrying amount of the asset, or related groups of assets, may not be recoverable and the Company's estimate of undiscounted cash flows over the assets remaining estimated useful life are less than the assets carrying value. Measurement of the amount of impairment may be based on appraisal, market values of similar assets or estimated discounted future cash flows resulting from the use and ultimate disposition of the asset. No impairment has been recorded in the consolidated financial statements.
Income Taxes
The Company and its domestic subsidiaries, have elected Subchapter S Corporation status for United States income tax purposes. Accordingly, the Company's United States operations are not subject to income taxes as separate entities. The Company's United States income is included in the income tax returns of the stockholder. Under terms of the tax payment agreement with the stockholder, the Company makes distributions to the stockholder for payment of income taxes. No amount was accrued or paid for the years ended December 31, 1999 and 1998. At December 31, 1997, the Company accrued dividends totaling $950, for the payment of stockholder's income taxes, which was paid in 1998. On March 14, 2000, A.B.Dick elected C Corporation status for United States income tax purposes effective January 1, 2000. Pursuant to FASB 109, "Accounting For Income Taxes", A.B. Dick will recognize existing deferred income taxes of approximately $1 million in future periods. This recognition will have no impact on operating income or EBITDA of A.B. Dick Company.
The foreign subsidiaries of A.B.Dick and Curtis are subject to foreign income taxes. Accordingly, deferred taxes have been provided for the expected future tax consequences of temporary differences in the foreign subsidiaries between the carrying amount and tax basis of assets and liabilities. Where the Company has determined that it is more likely than not that deferred assets will not be realized, a valuation allowance has been established. For the years ended December 31, 1999 and 1998, and for the period January 17, 1997 through December 31, 1997, the Company paid foreign income taxes of $258, $557 and $824, respectively.
Revenue Recognition
For the majority of its operations, the Company recognizes revenues upon shipment of its equipment and products. A.B.Dick receives advance payments for service contracts and recognizes income on a straight line basis over the contract term as service is provided. Deferred revenues are recorded on the balance sheet related to these advance payments.
Product Warranty
A.B.Dick's products (pre-press, press and post-press equipment, copiers, repair parts and supplies) are subject to varying warranty periods. A reserve for estimated future warranty obligations is included in accrued expenses based on historical rates of warranty claims.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising costs for the years ended December 31, 1999 and 1998 and the period from January 17, 1997 through December 31, 1997 amounted to $2,376, $2,795 and $1,832, respectively.
Management Fee
Operations include management fees charged by Nesco, Inc., an affiliate of the stockholder of the Company, to provide management, legal, financial, strategic planning, business development and other services to the Company. Effective April 1, 1998, the Company and Nesco, Inc. entered into a new management agreement under which the Company has agreed to pay Nesco, Inc. fees for such services equal to 5% of earnings before interest, taxes, depreciation, amortization and other income and expense.
Foreign Currency Translation
The assets and liabilities of the Company's foreign subsidiaries are translated at current exchange rates, while revenue and expenses are translated at average rates prevailing during the period. The effects of exchange rate fluctuations have been reported in other comprehensive income. Gains and losses from foreign currency transactions are included in net income (loss). Foreign currency exchange gains (losses) for the years ended December 31, 1999, 1998 and the period from January 17, 1997 through December 31, 1997 were not material.
Comprehensive Income (Loss)
Accumulated other comprehensive loss at December 31, 1999 consists of $677 relating to foreign currency translation adjustments and $54 relating to unrealized losses on available-for-sale securities. Accumulated other comprehensive loss at December 31, 1998 consists of $842 relating to foreign currency translation adjustments and $46 relating to minimum pension liability adjustments.
New Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which, as amended by FASB Statement 137, is required to be adopted no later than January 1, 2001. Since it is the Company's intent not to use derivatives, management believes that the adoption of the new Statement will not have a significant effect on the results of operations or financial position of the Company.
Use of Estimates
The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of any contingent assets or 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.
Reclassifications Certain amounts from the prior year financial statements have been reclassified to conform to current year presentation.
D. INVESTMENTS
The following is a summary of available-for-sale securities:
Unrealized Unrealized Estimated DECEMBER 31, 1999 Cost Gains Losses Fair Value ------ ----- ------ ----------
U.S. corporate debt securities $2,631 $-- $ 29 $2,602 Other debt securities 1,033 -- 25 1,008 ------ --- ------ ------ $3,664 -- $ 54 $3,610 ====== === ====== ======
Unrealized Unrealized Estimated DECEMBER 31, 1998 Cost Gains Losses Fair Value ------- ------- ------ ----------
U.S. corporate securities $ 2,999 $ -- $ -- $ 2,999 Commercial paper 18,535 -- -- 18,535 ------- ------- ------- ------- $21,534 $ -- $ -- $21,534 ======= ======= ======= =======
In 1999 and 1998, the gross realized gains on sales of available-for-sale securities totaled $1 and $195, respectively, and the gross realized losses totaled $73 and $198, respectively. The net adjustment to unrealized holding losses on available-for-sale securities, included as a component of comprehensive income totaled approximately $54 in 1999.
The amortized cost and estimated fair value of debt securities at December 31, 1999, by contractual maturity, are shown below.
Estimated Cost Fair Value ------ ----------
Due after one year through five years $2,663 $2,610 Due after five years through ten years 1,001 1,000 ------ ------ $3,664 $3,610 ====== ======
E. INVENTORIES
Inventories are summarized as follows:
December 31, December 31, 1999 1998 ------------ ------------
Raw materials and work in process $ 5,527 $ 6,768 Finished goods 37,290 38,111 LIFO reserve 3,107 3,215 ------- ------- $45,924 $48,094 ======= =======
F. PROPERTY, PLANT AND EQUIPMENT
Property and equipment (See Notes B and C) is summarized as follows:
December 31, December 31, 1999 1998 ------------ ------------ Land $ 371 $ 371 Buildings and improvements 7,559 6,823 Machinery and equipment 15,144 11,018 Rental assets 7,254 4,836 ------- ------- 30,328 23,048 Less: accumulated depreciation 9,965 4,348 ------- ------- $20,363 $18,700 ======= =======
Depreciation expense for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997, was $6,101, $4,330, and $1,062, respectively.
G. FINANCING ARRANGEMENTS
Long-term debt included the following:
The aggregate maturities of the long-term debt for each of the five years subsequent to December 31, 1999 are as follows:
Year Ending December 31:
2000 $ 1,498 2001 786 2002 514 2003 406 2004 124 Thereafter 115,019
The Revolving Credit Facility is classified as a current liability on the balance sheet to comply with the accounting requirements. However, the Revolving Credit Facility amount of $10,219 expires in 2003.
On April 1, 1998, the Company issued $115 million of 9 5/8% Series A Senior Notes due 2008. On September 1, 1998, the Company completed an exchange of all of the 9 5/8% Series A Senior Notes for 9 5/8% Series B Senior Notes due 2008 ("Series B Notes" or "Senior Notes"). The Series B Senior Notes are registered under the Securities Act of 1933 and are redeemable at the option of the Company, in whole or in part, any time on or after 2003 subject to certain call premiums. Interest on the Senior Notes is payable semi-annually in arrears. The Senior Notes are unsecured obligations of the Company and are guaranteed by the domestic subsidiaries of the Company and contain various restrictive covenants that, among other things, place limitations on the sale of assets,
payment of dividends, incurring additional indebtedness and restrict transactions with affiliates. Debt issuance costs of $4,917 have been capitalized and are being amortized over the life of the Senior Notes. The proceeds of the Senior Notes were utilized as follows:
Gross proceeds of Senior Notes $115,000 Repayment of term loans (39,649) Repayment of revolving credit (26,084) facilities Dividend paid to stockholder (10,000) Fees and expenses (5,241) -------- Excess cash from proceeds $ 34,026 ========
The Company and Key Corporate Capital Inc. ("Key") are parties to a credit facility and security agreement dated April 1, 1998 and amended as of December 31, 1998, pursuant to which Key has provided the Company a revolving line of credit equal to $32.0 million (the "Credit Agreement"). The availability under the Credit Agreement is equal to the sum of (i) 85% of the eligible Curtis accounts receivable, plus 80% of the eligible A.B.Dick accounts receivable, plus (ii) 60% of the eligible Curtis inventory (capped at $6.4 million), plus 60% of the eligible A.B.Dick inventory (capped at $9.6 million), less (iii) reserves and outstanding letters of credit. The Credit Agreement is guaranteed by Curtis and A.B.Dick pursuant to separate credit guaranty agreements with Key. The Credit Agreement is secured by liens on accounts receivable and inventory of Curtis and A.B.Dick, pursuant to separate security agreements between Key and each of Curtis and A.B.Dick. The Credit Agreement contains certain financial and other covenants which, among other things, establish minimum EBITDA and fixed charge ratios. These financial covenants were amended in March 2000 to reflect the Company's current financial outlook and the acquisition of Multigraphics. The Credit Agreement is fully revolving until its final maturity in 2003. The Credit Agreement bears interest at a rate determined according to a sliding scale under which the rate adjusts based upon the Company's performance. The Credit Agreement bears interest at an initial rate equal to (i) Key's prime rate plus 75 basis points, or (ii) LIBOR plus 275 basis points, at the option of the Company. At December 31, 1999, $10.2 million was outstanding under the Revolving Credit Facility. A fee of 3/8% per annum is charged on the unused portion of the Revolving Credit Facility. At December 31, 1999 and 1998 there were $3.1 million and $3.7 million of letters of credit outstanding, respectively. The weighted average interest rate for this facility was 8.9% in 1999. At December 31, 1999, the Company was in violation of the minimum EBITDA and fixed charge ratio covenants for which it received waivers through June 29, 2000.
During the years ended December 31, 1999 and 1998 and the eleven-month and fifteen-day period ended December 31, 1997, the Company paid interest of $11,523 and $9,727 and $1,242, respectively.
An extraordinary expense of $1,280 was recorded during the second quarter of 1998 related to the write-off of deferred financing costs and fees associated with the early extinguishment of certain of the Company's debt.
H. LEASE COMMITMENTS
The Company leases certain facilities and equipment which generally provide that the Company pay the insurance, maintenance and property taxes related to the leases. In the normal course of business, the Company expects that, as leases expire, they will be renewed or replaced by other leases. The leases generally provide for renewal options and various escalation clauses.
As of December 31, 1999, minimum lease payments under capitalized leases and non-cancelable operating leases are as follows: Capital Operating Leases Leases ------ ------ Year Ending December 31:
2000 $1,544 $ 5,254 2001 723 4,764 2002 403 4,357 2003 246 3,196 2004 118 1,836 Thereafter 20 4,080 ------ ------- Total minimum lease payments $3,054 $23,487 ======= Imputed interest 388 Present value of minimum ------ lease payments (including current portion of $1,346) $2,666 ======
The above lease commitments have not been reduced by aggregate minimum sublease rentals of $745 due in the future under non-cancelable subleases.
The Company had $4,066, $4,682 and $2,226 of rental expense for the years ended December 31, 1999 and 1998, and for the period from January 17, 1997 through December 31, 1997, respectively.
Assets held under capitalized leases and included in machinery and equipment were $2,107 and $2,074, net of accumulated amortization of $1,093 and $248 at December 31, 1999 and 1998, respectively. Amortization of these assets is included in depreciation expense in the statement of operations. During 1999 and 1998, the Company incurred capital lease obligations of $876 and $2,240, for the acquisition of property, plant and equipment.
In connection with the relocation of its operations, A.B. Dick entered into a lease agreement during the first quarter of 1998 for new headquarters facilities with an affiliate of the Company. The lease has a term of 10 years and requires monthly rental payments of approximately $35, has one five-year renewal option and provides for rental increases of 3% per year commencing with the second lease year.
In December 1996, Curtis entered into a lease agreement with an affiliate of the Company. The lease has a ten year term, requires monthly rental payments of $37, has two five-year renewal options and provides for rental increases in year four and year eight of the lease.
I. SEGMENT INFORMATION
The Company has two reportable segments: printing equipment and supplies and automotive and industrial supplies. The Company's printing equipment and supplies business consists of operating units that sell equipment, repair parts and supplies and provide maintenance and repair service support on equipment. These products are sold directly through a network of branches and independent distributors to the global quick print and small commercial printing customers in the United States, Canada, the United Kingdom, the Netherlands and Belgium, as well as other European countries. The Company's automotive and industrial supplies business distributes automotive security products, non-model specific automotive parts and maintenance, repair and operating supplies. Customers include independent auto dealerships and industrial accounts throughout North America and the United Kingdom.
The Company evaluates performance and allocates resources based on profit or loss from operations before interest, gains and losses on the Company's investment portfolio and income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. The Company's reportable segments are business units that offer different products and services. The reportable segments are each managed separately because they manufacture and distribute distinct products in distinct markets.
The Company's principal operations are in the United States, but it also maintains operating subsidiaries in Belgium, the Netherlands, Canada and the United Kingdom.
Net revenues are attributed to countries based on the location of the subsidiary where the sale occurs. Transfers between geographic areas are accounted for at market with appropriate adjustments made to inventory carrying values in consolidation. Identifiable assets represent long-lived assets that are used in the Company's operations in each geographic area at year end.
The Company's financial data by geographic area for the years ended December 31, 1999 and 1998 and the period from January 17, 1997 through December 31, 1997 is as follows:
J. CONTINGENCIES
On April 30, 1997, four former and current distributors of A.B.Dick filed a suit against A.B.Dick, the Predecessor Company, alleging, among other things, breach of distributorship contracts and unfair and deceptive trade practices. The plaintiffs have requested that the case be given class action status with respect to all A.B.Dick distributors engaged under distributorship contracts during the four-year period ended on April 30, 1997. The Company intends to vigorously defend this case although there can be no assurance as to the eventual outcome.
GEC has agreed to fully indemnify the Company against all costs and liabilities in connection with any litigation that is pending or may be brought against A.B.Dick arising out of events occurring prior to the closing of the A.B.Dick acquisition, including the case mentioned in the previous paragraph for all amounts in excess of $250 up to an aggregate liability of $15,000. In addition, both A.B.Dick and Curtis are parties to routine litigation incidental to their businesses, some of which is covered by insurance. The Company does not believe that any such pending litigation will have a material adverse effect upon its results of operations or financial condition.
K. EMPLOYEE BENEFIT PLANS
Effective March 1, 1997, the A.B.Dick established a defined contribution plan that includes an employee 401(k)-contribution provision covering certain employees of A.B.Dick. The plan provides for employee contributions ranging from 1%-15% of employee's compensation, subject to statutory limitation, as well as a matching Company contribution equal to 25% of the employee's contribution but limited to 6% of compensation. The
Company contribution for the years ended December 31, 1999 and 1998, and for the eleven-month and fifteen-day period ended December 31, 1997, was approximately $311, $314, and $600, respectively.
Curtis has deferred compensation agreements with certain former executives, which provide for payments of a fixed level of compensation on a monthly basis from retirement until death. Curtis also maintains a Supplemental Executive Retirement Plan in which one former executive participates. Expense recognized for the executive deferred compensation and Supplemental Executive Retirement Plans for 1999, 1998 and 1997 were $73, $161 and $5, respectively.
Additionally, Curtis has a deferred compensation plan for the benefit of sales representatives attaining specified sales goals. Curtis credits eligible participant's accounts with a percentage of their annual earnings. The annual amount credited to participant accounts vests at the rate of 5% per annum. Eligible participants over the age of 55 vest at an accelerated rate. Expense under this plan was $161 in 1999, $222 in 1998 and $17 in 1997.
Curtis also maintains a 401(k) retirement savings plan covering substantially all employees. Contributions to the 401(k) plan are based upon a percentage of each participant's compensation. The plan provides for employee contributions ranging from 1% - 15% of employee's compensation, subject to statutory limitation as well as a matching company contribution which is based on a formula defined in the plan document. The expense for the plan in 1999, 1998 and 1997 were $270, $250 and $22 respectively.
Liabilities recorded for the outstanding contributions to these Plans at December 31, 1999 were $2,239 and $2,150 at December 31, 1998.
Curtis maintains a defined benefit pension plan and a postretirement benefit plan for certain former UAW manufacturing employees. The following table sets forth the plans' funded status and amounts recognized in the Company's balance sheet as of December 31, 1999 and 1998:
Assumptions used in the accounting for the employee benefit plans are shown in the following table as weighted-averages:
1999 1998 ---- ---- Pension benefits: Discount rate 7.25% 6.0% Expected return on plan assets 7.0 % 7.0% Postretirement benefits: Discount rate 7.5 % 7.5%
For measurement purposes, a 9% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2000. The rate was assumed to decrease to 5.5% by 2007.
Assumed health care cost trend rates have a significant effect on the amounts reported. A one-percentage-point change in assumed health care cost trend rates would change the accumulated postretirement benefit obligation as of December 31, 1999 by approximately $100. The effect on this change on the interest expense component of the net postretirement benefit expense for 1999 would be an increase or decrease of approximately $5.
L. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION
The Company's domestic subsidiaries, all of which are directly or indirectly wholly owned, are the only guarantors of the Senior Notes. The guarantees are full, unconditional and joint and several. Separate financial statements of these guarantor subsidiaries are not presented as management has determined that they would not be material to investors.
The Company's foreign subsidiaries are not guarantors of the Senior Notes. Summarized condensed, consolidating financial statements for the Company, the guarantor subsidiaries and the non-guarantor, foreign subsidiaries are as follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the directors and executive officers of the Company.
Name Age Position with the Company - - ---- --- ------------------------- Frank D. Zaffino 59 President and Chief Executive Officer and Director A. Keith Drewett 53 Vice President Gregory T. Knipp 44 Acting Chief Financial Officer John H. Fountain 36 Chairman of the Board Donald F. Hastings 71 Director John J. Kahl, Jr. 58 Director John R. Tomsich 33 Director Robert J. Tomsich 69 Director James W. Wert 53 Director
Set forth below is a brief description of the business experience of each director and executive officer of the Company.
MR. ZAFFINO has served as President and Chief Executive Officer of the Company since December 1999. Mr. Zaffino previously served as General Manager, Global Equipment Manufacturing, and Vice President of the Eastman Kodak Company based in Rochester, New York, from 1985 to 1999. Mr. Zaffino served in various capacities within Kodak including Manager of Manufacturing and Materials Management; Superintendent of Parts Manufacturing and Department Head of Instant Camera Assembly.
MR. DREWETT has served as Vice President of the Company since March 1998. Mr. Drewett has served as President and Chief Executive Officer of Curtis since July 1998. Mr. Drewett previously served as President-Automotive and Industrial Division of Curtis from May 1992 and Senior Vice President of Curtis from May 1997 to July 1998.
MR. KNIPP has served as the Acting Chief Financial Officer of the Company and Chief Financial Officer of A.B. Dick Company since February 2000. Mr. Knipp served as the Chief Financial Officer of Multigraphics, Inc from May 1997 to February 2000. Mr. Knipp previously served Multigraphics, Inc. as Treasurer from 1995 to 1997 and Assistant Treasurer from 1994 to 1995. From 1981 to 1987, Mr. Knipp was the Cash Manager of Woodland Services Co., a spin-off company of Masonite Corporation. Prior to 1981, Mr. Knipp was an auditor with Peat Marwick Mitchell & Co.
MR. FOUNTAIN has served as Chairman of the Board of Directors of the Company since March 1998 and a member of the Board's Executive Committee since May 1998. Mr. Fountain served as Secretary and Treasurer of the Company since its inception in September 1996 through March 1998, as Vice President from November 1996 to present, and as director since January 1997. Mr. Fountain has been a Vice President of Nesco, Inc. since 1993. Mr. Fountain is the son-in-law of Mr. Robert Tomsich.
MR. HASTINGS has served as a Director of the Company since March 1998. Mr. Hastings served as Chairman of Lincoln Electric Company, a welding products manufacturer, from 1992 through 1997, and Chief Executive Officer of Lincoln Electric Company from 1992 through 1996. Mr. Hastings also serves as a director of Continental Global Group, Inc.
MR. KAHL, JR. has served as a Director of the Company since March 1998. Mr. Kahl is Chairman and Chief Executive Officer of Manco, Inc., a manufacturer of pressure sensitive tapes for household and automotive repairs, mailing and shipping supplies, weatherstripping and related home energy products and labels. Mr. Kahl also serves as a director of Applied Industrial Technologies Inc. and Royal Appliance Mfg. Co.
MR. JOHN TOMSICH has served as a Director of the Company since January 1997 and served as a Vice President of the Company since its inception through March 1998. In addition, Mr. John Tomsich has served as Vice President of Nesco, Inc. since 1995 and in various other management positions with Nesco, Inc. since 1990. Mr. John Tomsich also serves as director of Continental Global Group, Inc. Mr. John Tomsich is the son of Mr. Robert Tomsich.
MR. ROBERT TOMSICH has served as a Director of the Company since its inception and served as President of the Company from its inception to March 1998. In addition, Mr. Robert Tomsich has served as President and a Director of Nesco, Inc. (including predecessors of Nesco, Inc.) since 1956. Mr. Robert Tomsich also serves as director of Continental Global Group, Inc. Mr. Robert Tomsich is the father of Mr. John Tomsich and the father-in-law of Mr. John Fountain.
MR. WERT has served as a Director of the Company from January to April 1997 and since March 1998 and as Chair of the Board's Executive Committee since May 1998. Prior to his service with the Company, Mr. Wert held a variety of executive management positions with KeyCorp, a financial services company based in Cleveland, Ohio, and KeyCorp's predecessor, Society Corporation. Mr. Wert served as Senior Executive Vice President and Chief Investment Officer of KeyCorp from 1995 to 1996. Prior to that time, he served as Senior Executive Vice President and Chief Financial Officer of KeyCorp. for two years and Vice Chairman, Director and Chief Financial Officer of Society Corporation for four years. Mr. Wert also serves as a director of Continental Global Group, Inc. and as Chairman of the Executive and Compensation Committees of the Board of Directors, of Park-Ohio Industries, Inc.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation of the Company's Chief Executive Officer and the other most highly compensated officers of the Company having total annual salary and bonus in excess of $100,000.
(1) Amounts shown for the year and period ended December 31, 1999 reflect contributions made by A.B.Dick or Curtis on behalf of the named executives under the applicable 401(k) plan, life insurance premiums paid, car payments and miscellaneous payments made on behalf of the named executives, as follows:
(2) Mr. McConnell resigned his position effective April 7, 1999. (3) Reflects 49-week period from January 17, 1997 to December 31, 1997 at annual salary of $275,000. (4) Mr. Suchma resigned his positions with A.B.Dick effective February 11, 2000.
DIRECTOR COMPENSATION
Each director of the Company not employed by the Company or any entity affiliated with the Company is entitled to receive $25,000 per year for serving as a director of the Company. The director of the Executive Committee receives an additional $25,000 per year for his services. In addition, the Company will reimburse such directors for their travel and other expenses incurred in connection with attending meetings of the Board of Directors.
EMPLOYMENT, SEVERANCE AND BONUS AGREEMENTS
On November 10, 1995, A.B.Dick entered into a letter agreement with Gerald J. McConnell providing for Mr. McConnell's employment as President and Chief Executive Officer of A.B.Dick. Mr. McConnell resigned his position with A.B.Dick effective April 7, 1999 and, in accordance with the agreement, he will receive continued salary payments (at a rate of $302,500 per year) for the period of April 7, 1999 through April 7, 2000, and continued participation in all employee benefit plans until April 7, 2000 (having an estimated value of $26,000), or until he receives equivalent coverage and benefits from a subsequent employer, if earlier. Thus, the maximum aggregate benefits payable to Mr. McConnell under the agreement are approximately $328,500. Under the agreement, Mr. McConnell is not permitted to compete against A.B.Dick or any of its subsidiaries for a period of twelve months following the termination or expiration of the agreement.
On July 2, 1998, Curtis entered into a letter agreement with A. Keith Drewett providing for Mr. Drewett's employment as President and Chief Executive Officer of Curtis. The agreement provides for an initial base salary at the rate of $200,000 per year. Mr. Drewett is eligible to participate in the bonus compensation plan available to executive officers of Curtis, under which bonuses are determined in the discretion of the Curtis Board of Directors. If Mr. Drewett's employment is terminated for any reason other than for cause, or if Mr. Drewett ceases to be employed by Curtis on account of death or permanent disability, or if Mr. Drewett voluntarily ceases his employment with Curtis for any reason on or after December 6, 1998, then Curtis will be required to pay Mr. Drewett severance payments calculated upon his base salary for twenty-four months, to pay bonuses earned prior to such termination or cessation of employment, and to continue his participation in all employee benefit plans for such twenty-four month period or until he receives substantially comparable coverage and benefits from a subsequent employer, if earlier. The agreement precludes Mr. Drewett from competing with Curtis, the Company or its subsidiaries, or from soliciting or employing any employee, officer or agent of Curtis, the Company or its subsidiaries, for twelve months following cessation of employment with Curtis. If Mr. Drewett were to separate from Curtis under the circumstances described above, at his current
annual salary of $225,000, the maximum aggregate benefits payable to him under the agreement (including assumed continuation of employee benefit plan participation for twenty-four months at an estimated value of $26,500) would be approximately $476,500, plus bonuses earned, if any, prior to his cessation of employment.
In connection with the Curtis Acquisition, Mr. Drewett and Curtis also entered into a Bonus Award Agreement on December 6, 1997. The agreement requires Curtis to pay Mr. Drewett quarterly payments of $5,915 through September 3, 1999, followed by a payment of $343,915 on December 3, 1999. The Company guaranteed the payment of all amounts payable to Mr. Drewett under the Bonus Award Agreement. In March 1998, Curtis paid all amounts due or that would become due in the future under the Bonus Award Agreement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of the outstanding equity securities of the Company as of March 15, 2000:
NUMBER OF SHARES TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER
1,000 Class A, Common NES Group, Inc. (1) Stock, no par value 6140 Parkland Blvd. Mayfield Hts., OH 44124
19,000 Class B, Common NES Group, Inc. (1) Stock, no par value 6140 Parkland Blvd. Mayfield Hts., OH 44124
(1) All of the Company's issued and outstanding capital stock is owned by NES Group, Inc. which is 100% owned by Mr. Robert J. Tomsich. Mr. Tomsich may be deemed to be the beneficial owner of the Company's capital stock.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
COMMON OWNERSHIP
The Company is a Delaware corporation formed in September, 1996. All of the outstanding capital stock of the Company is beneficially owned by NES Group, Inc., which is beneficially owned by Robert J. Tomsich. Mr. Tomsich also beneficially owns all the outstanding capital stock of Nesco, Inc., which has entered into a management agreement with the Company as described below.
In 1998, the Company used a portion of the proceeds of the Series A Notes Offering to fund a dividend. As the Company's sole stockholder, NES Group, Inc. was the recipient of such dividend.
TAX PAYMENT AGREEMENT
The Company and the Subsidiary Guarantors have entered into a tax payment agreement with NES Group, Inc. providing for monthly payments by each entity to NES Group, Inc. in an amount equal to the greater of (i) the total federal, state, local and, under certain circumstances, foreign income tax liability attributable to such entity's operations for the monthly period, determined on an annualized basis, and (ii) one-twelfth the total federal, state, local and foreign income tax rates imposed by Section 1 of the Internal Revenue Code of 1986, as amended, and by the equivalent provisions of state, local and foreign income tax laws. These tax payments will not recognize any future carry-forward or carry-back tax benefits to the Company and the Subsidiary
Guarantors. Future direct and indirect Subsidiaries of the Company also will become parties to the tax payment agreement.
MANAGEMENT AGREEMENT
The Company and Nesco, Inc. have entered into a management agreement (the "Management Agreement"), the material terms of which are summarized below. Under the Management Agreement, Nesco, Inc. has agreed to provide general management oversight services on a regular basis for the benefit of the Company, in regard to business activities involving financial results, legal issues and long-term planning relative to current operations and acquisitions. Business development services will include assistance in identifying and acquiring potential acquisition candidates, including negotiations and contractual preparations in connection therewith. Financial planning will include assistance in developing banking relationships and monitoring cash investments through professional money management accounts. Under the terms of the Management Agreement, the Company has agreed to pay Nesco, Inc. a management fee for such services equal to 5% of the Company's earnings before interest and estimated taxes, depreciation, amortization and other expense (income). Prior to entering into the Management Agreement, the management fee was 1.0% of net revenue. The management fee will be payable in monthly installments. The Management Agreement will remain in effect until terminated by either party upon not less than 60 days' written notice prior to an anniversary date of the Management Agreement. The Company believes there are efficiency benefits from having these management services provided by Nesco, Inc. and believes that the terms of the management agreement are reasonable. Due to the specialized nature of these services and the efficiencies associated with provision of such services by Nesco, Inc., the Company has not undertaken to determine whether more favorable terms could be obtained from an unrelated third party.
The Company will also separately employ, as required, independent auditors, outside legal counsel and other consulting services. Such services will be paid directly by the Company.
CURTIS OFFICE LEASE
Lander Enterprises Co. L.P., an affiliate of the Company ("Lander"), and Curtis have entered into a lease agreement (the "Lease") for Curtis' headquarters in Mayfield Heights, Ohio. The initial term of the Lease expires on November 22, 2006, and Curtis has the option to renew for two additional five-year terms. Curtis is obligated to pay Lander monthly rent of $37,333 during the first three years of the Lease term, $44,800 during the years four through seven and $53,200 during years eight through ten. Rent for any renewal term shall be equal to 95% of fair market rent at the time of renewal. Curtis has a right of first refusal on any additional space that becomes available for lease in the building during the Lease terms and has an option to lease additional space in the building commencing in the sixth year of the Lease. At the end of the fifth year of the Lease, Curtis will receive a credit of $5.00 per square foot to complete any refurbishing Curtis deems necessary or desirable. Lander has furnished Curtis with a cash allowance of $0.5 million to fund build-out costs, repayable in 120 equal monthly installments of $6,552. The Company believes this transaction is on terms that are no less favorable than those that would have been obtained in a comparable transaction with an unrelated person. The remaining balance of the promissory note evidencing the cash allowance was discharged with the proceeds of the Series A Notes Offering.
A.B.DICK OFFICE LEASE
Par Realty Ltd., L.P., an affiliate of the Company ("Par"), and A.B.Dick have entered into a lease agreement (the "A.B.Dick Lease") for A.B.Dick's new headquarters in Niles, Illinois. The initial term of the A.B.Dick Lease extends for ten years from the date A.B.Dick takes possession of the premises, which took place on July 1, 1998. A.B.Dick has the option to extend the term for one additional five-year period at the expiration of the initial term. The monthly rent payable by A.B.Dick to Par under the A.B.Dick Lease is approximately $35,000, which will increase 3% per year commencing with the second lease year. The Company believes this transaction is on terms that are no less favorable than those that would have been obtained in a comparable transaction with an unrelated person.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) Documents filed as part of this report:
1. Consolidated Financial Statements (included in Item 8).
Report of Independent Auditors dated March 30, 2000
Consolidated Balance Sheets at December 31, 1999 and 1998
Consolidated Statements of Operations for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997
Consolidated Statements of Stockholder's Equity (Deficit) for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997.
Consolidated Statements of Cash Flows for the years ended December 31, 1999 and 1998 and for the eleven-month and fifteen-day period ended December 31, 1997.
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Financial statement schedules have been omitted because they are either not applicable or the required information has been disclosed in the consolidated financial statements or the related footnotes.
3. Exhibits Required to be filed by Item 601 of Regulation S-K.
The information required by this paragraph is contained in the Index of Exhibits to this report which is incorporated herein by reference.
(B) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of the period covered by this report.
ITEM 15.