<PAGE>
United States
Securities and Exchange Commission
Washington, D.C. 20549-1004
Form 10-Q
(x) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended July 1, 2000
or
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition period from _____________ to __________
Commission file number 333-24519
Pen-Tab Industries, Inc.
(Exact name of registrant as specified in its charter)
Delaware 54-1833398
(State or other jurisdiction of (I.R.S.Employer
Incorporation or organization) Identification Number)
167 Kelley Drive
Front Royal, VA 22630
Telephone: (540) 622-2000
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. As of July 1, 2000, there were
outstanding 100 shares of common stock, $0.01 par value, all of which are
privately owned and are not traded on a public market.
<PAGE>
PEN-TAB INDUSTRIES, INC.
FORM 10-Q
FOR THE QUARTER ENDED JULY 1, 2000
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
Item 1. Financial Statements (Unaudited) Page
----
<S> <C> <C>
a) Consolidated Balance Sheets as of July 1, 2000
and January 1, 2000 1
b) Consolidated Statements of Operations for the
quarters and six months ended July 1, 2000
and July 3, 1999 2
c) Consolidated Statements of Cash Flows for the
six months ended July 1, 2000 and July 3, 1999 3
d) Notes to Unaudited Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE 18
</TABLE>
<PAGE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
Pen-Tab Industries, Inc.
Consolidated Balance Sheets
(Dollars in Thousands)
<TABLE>
July 1, January 1,
2000 2000
---------------- --------------
(Unaudited)
<S> <C> <C>
Assets
Currents assets:
Cash and cash equivalents $ -- $ 175
Accounts receivable (less allowances for discounts, credits
and doubtful accounts of $2,794 and $3,794, respectively) 56,972 21,353
Inventories, net 48,342 45,015
Prepaid expenses and other current assets 1,624 810
Deferred income taxes 6,871 6,871
---------------- --------------
Total current assets 113,809 74,224
---------------- --------------
Property, plant and equipment, net 40,235 42,307
---------------- --------------
Intangibles:
Debt issuance costs, net 3,622 3,454
Goodwill, net 72,793 73,737
---------------- --------------
Total intangibles 76,415 77,191
---------------- --------------
Total assets $230,459 $193,722
================ ==============
Liabilities and stockholder's equity:
Current liabilities:
Accounts payable and bank overdraft $ 7,242 $ 6,211
Accrued expenses and other current liabilities 15,975 10,556
Accrued interest on subordinated notes 3,283 3,065
Current portion of long-term debt 184,087 21,431
Current portion of capitalized lease obligation 940 809
---------------- --------------
Total current liabilities 211,527 42,072
---------------- --------------
Long-term debt 5,943 134,456
Capitalized lease obligation 5,907 6,473
Deferred income taxes 6,871 6,871
---------------- --------------
Total long-term liabilities 18,721 147,800
---------------- --------------
Stockholder's equity:
Common Stock $.01 par value, 1,000 shares, authorized;
100 shares issued at July 1, 2000 and January 1, 2000 -- --
Additional capital 39,209 39,209
Retained deficit (38,998) (35,359)
---------------- --------------
Stockholder's equity 211 3,850
---------------- --------------
Total liabilities and stockholder's equity $230,459 $193,722
================ ==============
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
1
<PAGE>
Pen-Tab Industries, Inc.
Consolidated Statements of Operations
Unaudited
(Dollars in Thousands)
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
------------------------------------ -------------------------------------
July 1, July 3, July 1, July 3,
2000 1999 2000 1999
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net sales (Note 7) $61,598 $56,746 $86,110 $82,706
Cost of goods sold (Note 7) 45,062 35,295 65,731 54,221
---------------- ---------------- ---------------- ----------------
Gross profit 16,536 21,451 20,379 28,485
Expenses:
Selling, general and
administrative 9,144 7,192 14,959 13,087
Amortization of goodwill 473 468 944 937
Interest expense, net 5,545 4,693 9,947 8,271
---------------- ---------------- ---------------- ----------------
Total expenses 15,162 12,353 25,850 22,295
---------------- ---------------- ---------------- ----------------
Income (loss) from continuing
operations before income taxes 1,374 9,098 (5,471) 6,190
Income taxes (benefit) 678 3,603 (1,923) 2,487
---------------- ---------------- ---------------- ----------------
Income (loss) from continuing
operations 696 5,495 (3,548) 3,703
Income (loss) from operations of
discontinued segment, net of taxes 84 44 (83) (182)
---------------- ---------------- ---------------- ----------------
Net income (loss) $ 780 $ 5,539 $(3,631) $ 3,521
================ ================ ================ ================
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
2
<PAGE>
Pen-Tab Industries, Inc.
Consolidated Statements of Cash flows
Unaudited
(Dollars in Thousands)
<TABLE>
<CAPTION>
Six Months Ended
----------------------------------------
July 1, July 3,
2000 1999
--------------- ------------------
<S> <C> <C>
Operating activities
Net income (loss) $ (3,631) $ 3,521
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 3,137 2,941
Amortization of goodwill 944 938
Amortization of debt issuance costs 630 390
Deferred income taxes -- (1,681)
Provision for losses on accounts receivable 110 580
Provision for sales allowances and credits 1,406 2,180
Changes in operating assets and liabilities:
Accounts receivable (37,135) (38,978)
Inventories (3,327) (12,784)
Prepaid expenses and other current assets (814) (2,147)
Accounts payable and bank overdraft 1,031 4,764
Accrued expenses and other current liabilities 5,419 1,985
Accrued interest on subordinated notes 4,296 (156)
--------------- ------------------
Net cash used in operating activities (27,934) (38,447)
--------------- ------------------
Investing activities
Purchase of equipment (1,065) (1,874)
Debt issuance costs (798) --
--------------- ------------------
Net cash used in investing activities (1,863) (1,874)
--------------- ------------------
Financing activities
Proceeds from revolver borrowings 60,500 79,750
Repayments of revolver borrowings (27,876) (15,750)
Principal payments on long-term debt (2,559) (2,809)
Principal payments on capitalized lease obligations (435) (395)
Payment to Newell Co. -- (20,495)
Dividends to Pen-Tab Holdings (8) --
--------------- ------------------
Net cash provided by financing activities 29,622 40,301
--------------- ------------------
(Decrease) in cash and cash equivalents (175) (20)
Cash and cash equivalents at beginning of period 175 20
--------------- ------------------
Cash and cash equivalents at end of period $ -- $ --
=============== ==================
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
3
<PAGE>
Pen-Tab Industries, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
July 1, 2000
(Dollars in thousands)
1. Basis of Presentation, Description of Business, Recent Developments and
Liquidity
The accompanying unaudited consolidated financial statements of Pen-Tab
Industries, Inc. have been prepared in accordance with generally accepted
accounting principles applicable for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the quarter ended July 1, 2000 are not necessarily indicative of the
results that may be expected for the year ended December 30, 2000. All
references to fiscal quarter refer to the 13-week periods ended July 1, 2000 and
July 3, 1999. These financial statements should be read in conjunction with the
audited financial statements of Pen-Tab Industries, Inc. as of January 1, 2000
and January 2, 1999 and for each of the three years in the period ended January
1, 2000, included in the Company's Form 10-K (#333-24519) as filed with the
Securities and Exchange Commission.
On February 4, 1997, Pen-Tab Industries, Inc., a Virginia corporation, changed
its name to Pen-Tab Holdings, Inc. ("Holdings"). On February 4, 1997 Holdings
formed a wholly owned subsidiary called Pen-Tab Industries, Inc. (the
"Company"), a Delaware corporation. On February 4, 1997, the Company issued
$75,000 10 7/8% Senior Subordinated Notes due 2007 and Holdings effected a
recapitalization pursuant to which Holdings repurchased approximately 748 shares
of Class A common stock and 122 shares of Class B common stock from management
shareholders for approximately $47,858, converted an additional 14 shares of
Class A common stock and 358 shares of Class B common stock into redeemable
preferred stock, and sold 37 shares of Class A common stock, 3 shares of Class B
common stock and 125,875 shares of redeemable preferred stock to outside
investors for proceeds of approximately $15,010. Holdings' shareholders
concurrently approved an amendment to Holdings' articles of incorporation to
increase the number of authorized shares to 8,352,500, consisting of 6,000,000
shares of Class A Common Stock, par value $.01 per share, 2,000,000 shares of
Class B Common Stock, par value $.01 per share, and 352,500 shares of redeemable
preferred stock. Following completion of the above transactions, Holdings'
shareholders approved a stock split pursuant to which each share of Holdings'
Class A Common Stock and Class B Common Stock then outstanding was converted
into 60,937.50 shares of such common stock.
On August 20, 1998, the Company acquired all of the capital stock of Stuart Hall
Company, Inc. ("Stuart Hall").
4
<PAGE>
The Company, a wholly owned subsidiary of Holdings, is a leading manufacturer of
school, home and office supply products. Its products include legal pads,
wirebound notebooks, envelopes, school supplies, and arts and crafts products.
The Company is a primary supplier of many national discount store chains, office
supply super stores, and wholesale clubs throughout the United States and
Canada. The Company, through Vinylweld L.L.C., is a leading designer and
manufacturer of vinyl packaging products. Sales are made on open account and the
Company generally does not require collateral.
Reclassification of amounts. Certain amounts for 1999 have been reclassified to
reflect comparability with account classifications for 2000.
Management change. On June 29, 1999, the Company appointed Marc English as
Chief Executive Officer. Mr. English was previously President and Chief
Executive Officer of CSS Industries' Cleo unit, a consumer products company
primarily engaged in the manufacturing and sale to mass-market retailers of
seasonal gift-wrap products. In addition, Mr. English has held marketing and
sales management positions with other companies, including CPS Corp., also in
the gift-wrap industry. Mr. English replaced Mr. Hodes who resigned from the
position as Chief Executive Officer of the Company.
Company Initiatives/Reorganization. On December 30, 1999, the Company approved a
plan to rationalize its manufacturing operations. The plan includes a plant
consolidation, equipment moves, plant/product changes, and warehouse
consolidation. The rationalization is expected to result in an approximate 20%
reduction in manufacturing space. In the fourth quarter of 1999 the Company
recognized a reorganization charge of $6,100 representing the Company's
rationalization plan and included employee termination costs, including
benefits, costs to exit facilities, lease termination costs, and property taxes
after ceasing operations. The major undertakings of the rationalization plan are
expected to be completed during the fourth quarter of 2000.
On March 31, 2000, the Company decided to divest its vinyl packaging business
segment, which operates as Vinylweld L.L.C. The divestiture is anticipated to
occur by the end of the first quarter of 2001.
Covenant Violations/Amendments to Credit Facility/Note Holder Consent. As a
result of insufficient third quarter 1999 earnings, the Company was in default
of a covenant based on EBITDA (earnings before interest, taxes, depreciation,
amortization, and certain non-cash charges, as defined in the agreement) and
cash interest and principal payments (fixed charge coverage ratio) for the
twelve months ended October 2, 1999. On November 16, 1999, the Company amended
its credit facility to waive the fixed charge
5
<PAGE>
coverage ratio covenant default. This amendment also provided that the interest
rate increase by 0.625%.
As a result of insufficient fourth quarter 1999 earnings, the Company was in
default of the fixed charge coverage ratio and the minimum net worth covenants,
as defined in the agreement, at and for the twelve months ended January 1, 2000.
In addition, due to the earnings shortfall and Enterprise Resource Planning
("ERP") system implementation issues which led to higher than expected
inventories and accounts receivable collection delays, the Company was in
default of the annual revolver clean up provision. The clean up provision
requires the Company, for a period of not less than thirty days between
September 30 and November 15, to reduce the outstanding balance on the revolver
to $25,000 or less. The Company was also in default of the borrowing base
formula, as defined in the agreement, whereby the balance outstanding on the
revolver was in excess of the borrowing base formula computed amount. On March
13, 2000, the Company amended its credit facility. The amendment (i) waived the
defaults, (ii) revised the borrowing base definition to provide for an over
advance of up to $16,500 for the period of March 1, 2000 through July 15, 2000,
(iii) increased the interest rate by 0.875% plus another 0.50% during the over
advance period, (iv) revised the annual clean up provision amount to $27,000
from $25,000 and revised the clean up period to be between October 15 and
January 15 from between September 30 and November 15, (v) revised the fixed
charge coverage ratio to 1.00:1 (from 1.50:1) for the twelve month periods ended
March 31, 2000 and June 30, 2000 and to 1.50:1 (from 1.75:1) thereafter, (vi)
limits capital expenditures to $2,000 for fiscal 2000 and (vii) requires total
debt, as defined in the agreement, not to exceed $153,000 at June 30, 2000. The
Company paid fees of $798 in conjunction with the Credit Facility amendment and
will amortize such fees over the remaining life of the Credit Facility (March
2000 through August 2001).
Subsequent to January 1, 2000, a major stockholder of Holdings purchased
approximately 80% of the 10 7/8% Senior Subordinated Notes in the secondary
market.
Prior to the amendment discussed in the preceding paragraph and as a result of
the covenant violations described above, the Company was not allowed to make the
required interest payment of approximately $4,000 due on February 1, 2000 to the
holders of the Company's $75,000 10 7/8% Senior Subordinated Notes due 2007. As
a condition of the aforementioned amendment, the Company obtained consent from
substantially all of the note holders to accept the February 1, 2000 interest
payment in the form of new notes with a maturity date of January 15, 2005, in
aggregate principal amount substantially equal to such interest payment, in lieu
of a cash payment. As a result, the Company was deemed to have made the cash
interest payment and simultaneously issued new notes to existing note holders in
exchange for such cash payment.
The Company did not make the required interest payment of approximately $4,000
due on August 1, 2000 to the holders of the Company's $75,000 Senior
Subordinated Notes due 2007. The Company is currently engaged in discussions
with the note holders of the 10 7/8% Senior Subordinated Notes regarding a
restructure and conversion of such notes to non-cash interest bearing securities
or equity.
6
<PAGE>
However, no assurance can be given that such restructuring or conversion will
take place. If the Company is unable to implement such restructuring or
conversion or to cure the default under the 10 7/8% Senior Subordinated Notes,
then it would have a material adverse effect on the Company.
As a result of insufficient second quarter 2000 earnings, the Company is in
default of covenants based on EBITDA (earnings before interest, taxes,
depreciation, amortization, and certain non-cash charges, as defined in the
agreement) and cash interest and principal payments (fixed charge coverage
ratio) for the twelve months ended July 1, 2000. In addition, the Company is in
default of the total debt covenant at July 1, 2000. The Company is in discussion
with its senior lenders to obtain waivers for the above noted covenant
violations. However, no assurance can be given that the Company will be able to
obtain such waivers. If the Company is unable to obtain such waivers, it would
have a material adverse effect on the Company.
As a result of the above, the outstanding balances of the Credit Facility and
Senior Subordinated Notes are classified as current liabilities on the
consolidated balance sheet as of July 1, 2000 based on the covenant violations
and/or cross default provision. If waivers or amendments had been
obtained, $48,750 of the Credit Facility and $79,078 of the Senior Subordinated
Notes would have been classified as long term liabilities on the consolidated
balance sheet as of July 1, 2000.
2. Recently Issued Pronouncements
The Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition in Financial Statements. Companies may adopt
a change in accounting principle to comply with the SAB no later than the fourth
quarter of the fiscal year beginning after December 15, 1999. The financial
statement impact , if any, of adopting SAB 101 has yet to be determined by the
Company's management.
7
<PAGE>
3. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
July 1, January 1,
2000 2000
-------------- --------------
<S> <C> <C>
Raw materials $14,079 $17,858
Work-in-process 3,499 1,792
Finished goods 29,321 23,922
LIFO reserve 1,443 1,443
-------------- --------------
$48,342 $45,015
============== ==============
</TABLE>
An actual valuation of inventory under the LIFO method can be made only at the
end of each year based on the inventory levels and costs at that time.
Accordingly, interim LIFO calculations are necessarily based on management's
estimates of expected year-end inventory levels and costs. Because these are
subject to many forces beyond management's control, interim results are subject
to the final year-end LIFO inventory valuation.
4. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
<TABLE>
July 1, January 1,
2000 2000
---------- ----------
<S> <C> <C>
Land and buildings $16,279 $16,244
Machinery and equipment 42,710 42,601
Furniture and fixtures 4,650 3,729
Leasehold improvements 1,504 1,504
---------------- ----------------
65,143 64,078
Less: accumulated depreciation and amortization 24,908 21,771
---------------- ----------------
$40,235 42,307
================ ================
</TABLE>
5. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following:
<TABLE>
<CAPTION>
July 1, January 1,
2000 2000
------------------- -------------------
<S> <C> <C>
Accrued compensation and benefits $ 1,516 $ 632
Accrued reorganization costs 5,251 5,932
Accrued sales programs 5,452 2,538
Accrued interest 1,644 348
Other accrued expenses 2,112 1,106
------------------- -------------------
$15,975 $10,556
=================== ===================
</TABLE>
8
<PAGE>
6. Long-Term Debt
Long-term debt consist of the following:
<TABLE>
July 1, January 1,
2000 2000
---------------- ----------------
<S> <C> <C>
Credit Facility:
Revolver $ 74,124 $ 41,500
Term Loan 29,500 30,750
Senior Subordinated Notes, due 2007 75,000 75,000
Senior Subordinated Notes, due 2005 4.078 --
Industrial development revenue bonds 6,300 6,700
Equipment notes payable 1,028 1,937
Capital lease obligations 6,847 7,282
---------------- ----------------
196,877 163,169
Less: current portion 185,027 22,240
---------------- ----------------
$ 11,850 $140,929
================ ================
</TABLE>
In conjunction with the acquisition of Stuart Hall on August 20, 1998, the
Company entered into a $135,000 Credit Facility ("Credit Facility") with Bank of
America, which expires on August 20, 2001. The Credit Facility includes a
$100,000 revolver and a $35,000 term loan. The $35,000 term loan has aggregate
maturities as follows: 1998 $750; 1999 $3,500; 2000 $5,500; 2001 $25,250. The
$100,000 revolver portion of the Credit Facility provides for advances based
upon a borrowing base comprised of specified percentages of eligible accounts
receivable and inventory. During March 1, 2000 through July 15, 2000 the
borrowing base includes an overadvance of up to $16,500. The interest rate per
annum applicable to the Credit Facility is the prime rate, as announced by the
Bank plus 1.75% or at the Company's option, the Eurodollar rate plus 3.5%.
During an overadvance period the interest rate is increased by 0.50%. The
Company is required to pay a commitment fee of 0.65% on the unused portion of
the $100,000 revolver. Under the terms of the Credit Facility, the Company is
required to maintain certain financial ratios relating to cash flow (fixed
charge coverage ratio, minimum EBITDA threshold and capital expenditure limit),
annually reduce the principal balance of the revolver to $27,000 for thirty
consecutive days during the period between October 15 and January 15, limit
total debt, as defined in the agreement, to $153,000 at June 30, 2000 and
restrict the amount of dividends that can be paid during the year. Except as
noted below, all assets of the company are pledged as collateral for balances
owing under the Credit Facility. See Note 1 for discussion of covenant
violations.
The 10 7/8% Senior Subordinated Notes are due in 2007. The Indenture contains
certain covenants that, among other things, limit the ability of the Company to
incur additional indebtedness. During November 1997, the Company entered into a
swap agreement, which expires February, 2002, to swap its fixed rate of payment
on $75,000 of the 10 7/8% Senior Subordinated Notes for a floating rate payment.
The floating rate is based upon a basket of the LIBORS of three countries plus a
spread, and is capped at 12.5%. The interest rate resets every six months and at
July 1, 2000, the Company's effective interest rate under the swap agreement was
10.879%. The Company can terminate the transaction on any interest reset date at
the then current fair
9
<PAGE>
market value of the swap instrument. A 1.0% change in the effective interest
rate would result in a $700 change in interest expense. See Note 1 for
discussion of covenant violations.
As a condition of the March 13, 2000 amendment to the Credit Facility, the
Company obtained consent from substantially all of the note holders of the
$75,000 10 7/8% Senior Subordinated Notes, to accept the February 1, 2000
interest payment in the form of new notes with a maturity date of January 15,
2005, in aggregate principal amount substantially equal to such interest
payment, in lieu of a cash payment. As a result, the Company was deemed to have
made the cash interest payment and simultaneously issued new notes to existing
note holders in exchange for such cash payment. See Note 1 for discussion of
covenant violations.
The industrial development revenue bonds represent 20-year tax-exempt bonds
issued through the Town of Front Royal and the County of Warren, Virginia on
April 1, 1995. Interest is paid monthly, and is calculated using a floating
rate determined every 7 days with reference to a tax-exempt bond index (4.85% as
of July 1, 2000 plus a bank letter of credit fee of 4.00%). The industrial
development revenue bonds are subject to a mandatory sinking fund redemption,
which commenced April 1, 1998, under which Pen-Tab is required to make 17 annual
installments of $400, with a final installment of $700, due in 2015. Repayment
is collateralized by a bank standby letter of credit in the amount of $6,385 and
a first security interest in Pen-Tab's land and buildings in Front Royal,
Virginia. The bonds may be redeemed at the option of Pen-Tab, in whole or in
part, on any interest payment date.
The Company has a series of equipment notes payable with CIT Group/Equipment
Financing Inc. The notes bear interest at various fixed amounts from 8.95% to
10.85% and mature at various dates through 2001. The aggregate maturities are
as follows: 2000 $986; 2001 $902.
As a result of the covenant and/or cross default violations described in detail
in Note 1, the outstanding balances of the Credit Facility and Senior
Subordinated Notes have been classified as current obligations on the
consolidated balance sheet as of July 1, 2000. If waivers or amendments had been
obtained, $48,750 of the Credit Facility and $79,078 of the Senior Subordinated
Notes would have been classified as long term liabilities on the consolidated
balance sheet as of July 1, 2000.
7. Changes in Estimates
As of January 1, 2000, management used its best estimate to establish reserves
for sales allowances incurred and liabilities for earned customer programs
totaling $6,094. During the six months ended July 1, 2000, actual sales
allowance and program credits issued relating to periods prior to January 2,
2000, exceeded the $6,094 by approximately $2,000; which is shown as a reduction
in net sales on the consolidated statement of operations for the six months
ended July 1, 2000.
In addition, management underestimated certain other liabilities relating to
inventory, as of January 1, 2000, by approximately $370, which is shown as an
increase in cost of goods sold and a decrease in gross profit on the
consolidated statement of operations for the six months ended July 1, 2000.
10
<PAGE>
8. Segment Information
The Company operates in two business segments consisting of school, home and
office products, and vinyl packaging products. The following table provides
certain financial data regarding these two segments.
<TABLE>
<CAPTION>
School, Home Vinyl
And Office Packaging
Products Products Total
------------- -------------- ------------
<S> <C> <C> <C>
Six months ended July 1, 2000
Net sales (external customers) $ 86,110 $4,373 $ 90,483
Operating earnings (loss) 4,476 (390) 4,086
Interest income (expense), net 9,947 (3) 9,944
Identifiable assets 227,309 3,150 230,459
Depreciation and amortization 4,559 152 4,711
Capital expenditures 969 96 1,065
Six months ended July 3, 1999
Net sales (external customers) $ 82,706 $4,201 $ 86,907
Operating earnings (loss) 14,461 (183) 14,278
Interest income (expense), net 8,271 (2) 8,269
Identifiable assets 228,208 3,814 232,022
Depreciation and amortization 4,148 121 4,269
Capital expenditures 1,596 278 1,874
</TABLE>
For the purposes of the segment information provided above, operating earnings
are defined as net sales less related cost of goods sold, selling, general and
administration expenses and amortization of goodwill. Inter-segment sales are
immaterial.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Net sales for the quarter ended July 1, 2000 increased by $4.9 million or 8.6%
to $61.6 million from $56.7 million for the quarter ended July 3, 1999. Net
sales for the six months ended July 1, 2000 increased by $3.4 million or 4.1% to
$86.1 million from $82.7 million for the six months ended July 3, 1999. The
increase in net sales for the quarter and six months ended July 1, 2000 was due
to price increases in paper based products partially offset by price decreases
in non-paper related products and by additional sales allowances and program
credits totaling approximately $2.0 million that related to the fiscal 2000
sales that negatively impacted the quarter and six months ended July 1, 2000.
Gross profit for the quarter ended July 1, 2000 decreased $5.0 million or 22.9%
to $16.5 million from $21.5 million for the quarter ended July 3, 1999. Gross
profit for the six months ended July 1, 2000 decreased $8.1 million or 28.5% to
$20.4 million from $28.5 million for the six months ended July 3, 1999. The
decrease in the gross profit percentage for the quarter and six months ended
July 1, 2000 is principally attributable to: (i) the Company experienced gross
profit percentage erosion in "Back to School" basic commodity paper products and
"Back to School" nylon/softside value added products. Direct foreign import
sourcing by major retailers of both basic commodity paper products and
nylon/softside value added products and foreign competition in general were
major factors impacting the gross profit percentage erosion of these product
categories. In addition, nylon/softside products selling prices continue to be
driven down by the major retailers' direct import activities and their efforts
to keep retail price points low, as well as the maturation of the product
category. (ii) An unfavorable shift in product mix. For the six months ended
July 1, 2000, differentiated higher margin product sales represented
approximately 52% of sales as compared to approximately 54% for the six months
ended July 3, 1999. (iii) Lower recovery, by approximately $1.0 million, on
close out sales during the first six months of 2000 versus the first six months
of 1999. (iv) Additional sales allowances and program credits totaling
approximately $2.0 million that related to fiscal 1999 sales that negatively
impacted the quarter and six months ended July 1, 2000, (see Note 7). (v)
Certain costs related to inventory of approximately $370, which pertained to the
year ended January 1, 2000, increased cost of goods sold and decreased gross
profit for the six months ended July 1, 2000, (see Note 7).
SG&A expenses for the quarter ended July 1, 2000 increased $1.9 million to $9.1
million or 14.8% of net sales from $7.2 million or 12.7% of net sales for the
quarter ended July 3, 1999. SG&A expenses for the six months ended July 1, 2000
increased $1.9 million to $15.0 million or 17.4% of net sales from $13.1 million
or 15.8% of net sales for the six months ended July 3, 1999. The increase is
due, in part, to an increased level of spending within the sales, marketing and
distribution areas, necessary to support current and future product and customer
demands. In addition, personnel and other related spending increased in the
information technology areas, which is necessary in order to keep pace with the
demands of information technology related to the customers and markets in which
the Company competes.
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Amortization of goodwill for the quarter and six months ended July 1, 2000
remained flat at $0.5 and $0.9 million, respectively from the quarter and six
months ended July 3, 1999.
Interest expense for the quarter ended July 1, 2000 increased by $0.8 million to
$5.5 million from $4.7 million for the quarter ended July 3, 1999. Interest
expense for the six months ended July 1, 2000 increased by $1.6 million to $9.9
million from $8.3 million for the six months ended July 3, 1999. The increase is
primarily due to the increase in interest rates on the revolver and term loan
associated with the March 13, 2000 amendment to the Credit Facility, and
increases to LIBOR and the prime rate.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities for the six months ended July 1, 2000 is
$27.9 million as compared to $38.4 million for the six months ended July 3,
1999. The decrease in cash used is related primarily to inventory reduction
activities implemented during 2000.
Net cash used in investing activities for the six months ended July 1, 2000 and
July 3, 1999 is $1.9 million.
Net cash provided by financing activities for the six months ended July 1, 2000
is $29.6 million compared to $40.3 million for the six months ended July 3,
1999. The decrease in cash provided is primarily due to lower borrowings on the
revolver for the six months ended July 1, 2000.
Company Initiatives/Reorganization. Under the leadership of Marc English, the
Company performed a review of all operations with the goals of increasing market
share, streamlining operations, reducing debt and increasing profitability.
On December 30, 1999, the Company approved a plan to rationalize its
manufacturing operations. The plan includes a plant consolidation, equipment
moves, plant/product changes, and warehouse consolidation. The rationalization
is expected to result in an approximate 20% reduction in manufacturing space. In
the fourth qurter of 1999 the Company recognized a reorganization charge of
$6,100 representing the Company's rationalization plan and included employee
termination costs, including benefits, costs to exit facilities, lease
termination costs, and property taxes after ceasing operations. The major
undertakings of the rationalization plan are expected to be completed during the
fourth quarter of 2000. Upon full implementation, the plan is expected to have a
significant positive effect on the Company's financial performance, resulting in
an estimated annualized cost savings of approximately $3,000.
As a result of insufficient third quarter 1999 earnings, the Company was in
default of a covenant based on EBITDA (earnings before interest, taxes,
depreciation, amortization, and certain non-cash charges, as defined in the
agreement) and cash interest and principal payments (fixed charge coverage
ratio) for the twelve months ended October 2, 1999. On November 16, 1999, the
Company amended its credit facility to waive the fixed charge coverage ratio
covenant default. This amendment also provided that the interest rate increase
by 0.625%.
As a result of insufficient fourth quarter 1999 earnings, the Company was in
default of the fixed charge coverage ratio covenant and the minimum net worth
covenant, as defined in the agreement, at and for the twelve months ended
January 1, 2000. In addition, due to the earnings shortfall and Enterprise
Resource Planning ("ERP") system implementation issues which led to higher than
expected inventories and accounts receivable collection delays, the Company was
in default of the annual revolver clean up provision. The clean up provision
requires the Company, for a period of not less than thirty days between
September 30 and November 15, to reduce the outstanding balance on the revolver
to $25 million or less. The Company was also in default of the borrowing base
formula, as defined in the agreement, whereby the balance outstanding on the
revolver was in excess of the
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borrowing base formula computed amount. On March 13, 2000, the Company amended
its credit facility. The amendment (i) waived the defaults, (ii) revised the
borrowing base definition to provide for an over advance of up to $16.5 million
for the period of March 1, 2000 through July 15, 2000, (iii) increased the
interest rate by 0.875% plus another 0.50% during the over advance period, (iv)
revised the annual clean up provision amount to $27 million from $25 million and
revised the clean up period to be between October 15 and January 15 from between
September 30 and November 15, (v) revised the fixed charge coverage ratio to
1.00:1 (from 1.50:1) for the twelve month periods ended March 31, 2000 and June
30, 2000 and to 1.50:1 (from 1.75:1) thereafter, (vi) limits capital
expenditures to $2 million for fiscal 2000 and (vii) requires total debt, as
defined in the agreement, not to exceed $153 million at June 30, 2000. The
Company paid fees of $0.8 million in conjunction with the Credit Facility
amendment and will amortize such fees over the remaining life of the Credit
Facility (March 2000 through August 2001).
Subsequent to January 1, 2000, a major stockholder of Holdings purchased
approximately 80% of the 10.875% Senior Subordinated Notes in the secondary
market.
Prior to the amendment discussed in the preceding paragraph and as a result of
the covenant violations described above, the Company was not allowed to make the
required interest payment of approximately $4 million due on February 1, 2000 to
the holders of the Company's $75 million 10.875% Senior Subordinated Notes due
2007. As a condition of the aforementioned amendment, the Company obtained
consent from substantially all of the note holders to accept the February 1,
2000 interest payment in the form of new notes with a maturity date of January
15, 2005, in aggregate principal amount substantially equal to such interest
payment, in lieu of a cash payment. As a result, the Company was deemed to have
made the cash interest payment and simultaneously issued new notes to existing
note holders in exchange for such cash payment.
The Company did not make the required interest payment of approximately $4
million due on August 1, 2000 to the holders of the Company's $75 million Senior
Subordinated Notes due 2007. The Company is currently engaged in discussions
with the note holders of the 10.875% Senior Subordinated Notes regarding a
restructure and conversion of such notes to non-cash interest bearing securities
or equity. However, no assurance can be given that such restructuring or
conversion will take place. If the Company is unable to implement such
restructuring or conversion or to cure the default under the 10.875% Senior
Subordinated Notes, then it would have a material adverse effect on the Company.
As a result of insufficient second quarter 2000 earnings, the Company is in
default of covenants based on EBITDA (earnings before interest, taxes,
depreciation, amortization, and certain non-cash charges, as defined in the
agreement) and cash interest
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and principal payments (fixed charge coverage ratio) for the twelve months ended
July 1, 2000. In addition, the Company is in default of the total debt covenant
at July 1, 2000. The Company is in discussions with its senior lenders to obtain
waivers for the above noted covenant violations. However, no assurance can be
given that the Company will be able to obtain such waivers. If the Company is
unable to obtain such waivers, it would have a material adverse effect on the
Company.
As a result of the covenant and/or cross default violations described in detail
in Note 1, the outstanding balances of the Credit Facility and Senior
Subordinated Notes have been classified as current obligations on the
consolidated balance sheet as of July 1, 2000. If waivers or amendments had been
obtained, $48,750 of the Credit Facility and $79,078 of the Senior Subordinated
Notes would have been classified as long term liabilities on the consolidated
balance sheet as of July 1, 2000.
The Company's ability to fund near term anticipated capital expenditures and
working capital requirements is contingent upon obtaining the waivers for the
above noted covenant violations. HOwever, no assurance can be given that the
Company will be able to obtain such waivers. If the Company was unable to obtain
such waivers, it would have a material adverse effect on the Company. The
Company's ability to meet its long-term debt obligations will be dependant on
the Company executing its business plan, which will be subject to general
economic conditions and other factors, some of which may be beyond the Company's
control. The majority of the debt of the Company bears interest at floating
rates; therefore, its financial condition is and will continue to be affected by
changes in prevailing interest rates.
SEASONALITY AND KNOWN TRENDS
The Company experiences seasonality in its business operations. During the
Company's second and third quarters, net sales are higher that the first and
fourth quarters due to sales of back-to-school products.
FORWARD-LOOKING STATEMENTS
Written reports and oral statements made from time to time by the Company
contain "forward-looking statements." Forward looking statements can be
identified by the fact that they do not relate strictly to historical or current
facts and by their use of words such as "goals", "expects", "plans", "believes",
"estimates", "forecasts", "projects", "intends", and other words of similar
meaning. Such statements are likely to address the Company's earnings, return on
capital, capital expenditures, project implementation, production growth, sales
growth and expense reductions. They are based on management's then-current
information, assumptions, plans, expectations, estimates and projections about
their industry. However, such statements are not guarantees of future
performance, and actual results and outcomes may differ materially from what is
expressed depending on a variety of factors, many of which are outside of the
Company's control.
Among the factors that could cause actual outcomes or results to differ
materially from what is expressed in these forward-looking statements are
changes in the demand for, supply of, and market price of paper, changes in
economic conditions, changes in the availability and/or price of paper,
significant changes in rates of interest, inflation, or taxes, changes in Pen-
Tab's relationship with its employees and the potential adverse effects if labor
disputes or grievances were to occur and changes in accounting principles.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk is impacted by changes in interest rates, certain
commodity prices, namely paper and global competition. The Company attempts to
mitigate these risks by distinguishing itself from offshore competition by
providing innovative, value-added products, customer specific programs and
licensed product lines. The Company does not currently hold or issue derivative
instruments for trading or hedging purposes related to commodity price
fluctuations.
The Company has market risk related to interest rate exposure on its Credit
Facility and swap agreement. Interest rate swaps may be used to adjust interest
rate exposure when appropriate.
Based on the Company's overall commodity price and interest rate exposure at
July 1, 2000, management believes that a short-term change in any of the
exposures will not have a material effect on the consolidated financial
statements of the Company.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities
Not applicable
Item 3. Defaults upon Senior Securities
The Company is in default under its Credit Facility and its 10 7/8%
Senior Subordinated Notes. See Note 1 to the unaudited financial
statements included herein.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
a.) Exhibits
Financial Data Schedule (filed only electronically with the SEC)
b.) Reports on Form 8-K
Form 8-K filed on January 28, 2000, announcing the Company's
inability to make the interest payment due on February 1, 2000 on
the 10 7/8% Senior Subordinated Notes.
Form 8-K filed on March 13, 2000, announcing the intent of the
Company to obtain consent from the note holders to make the
February 1, 2000 interest payment in the form of new notes.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q for the quarter ended July
1, 2000 to be signed on its behalf by the undersigned thereunto duly authorized.
Pen-Tab Industries, Inc.
(Registrant)
Date By: /s/ William Leary
---- ---------------------
August 23, 2000 William Leary
Vice President, Chief Financial
and Administrative Officer
(principal financial officer and
accounting officer)
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