<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
---------------------
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 000-24411
-----------
MASTER GRAPHICS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Tennessee 62-1694322
----------------------------- -------------------
State or other jurisdiction (I.R.S. Employer
incorporation or organization Identification No.)
6075 Poplar Avenue, Suite 401, Memphis, Tennessee 38119
- ------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (901) 685-2020
----------------
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
-----------------------------
(Title of Class)
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 period 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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K ((S) 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 23, 1999 was $22,491,730 (based on the average bid
and ask price of $6.0625).
The number of shares outstanding of the registrant's common stock, $.001
par value, as of March 23, 1999 was 7,923,026.
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for the Annual Shareholders'
Meeting to be held on or about May 19, 1999, to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act
of 1934, as amended, are incorporated by reference into Part III of this report
on Form 10-K. Such Proxy Statement, except for the portions thereof which are
specifically incorporated herein by reference, shall not be deemed "filed" for
purposes of this report on Form 10-K.
EXPLANATORY NOTES
The Registrant hereby amends and restates in its entirety Item 1 of Part I
of its Annual Report on Form 10-K to correctly set forth the acquisition dates
in the table provided under the subheading "--Acquired Companies."
The Registrant hereby amends and restates in its entirety Item 6 of Part II
of its Annual Report on Form 10-K (1) to provide summarized unaudited income
statement information for the six months ended December 31, 1996, and (2) to
provide the depreciation and amortization expense for the year ended
December 31, 1998 which was inadvertently omitted from the Form 10-K.
The Registrant hereby amends and restates in its entirety Item 7 of Part II
of its Annual Report on Form 10-K (1) to provide a discussion of the
Registrant's income tax situation, and (2) to expand the discussion of the risks
to the Registrant's business and operations of Year 2000 issues.
The Registrant hereby amends and restates in its entirety the Financial
Statements of Master Graphics, Inc. and subsidiaries set forth on pages F-1 to
F-21 of its Annual Report on Form 10-K (1) to correctly state the amount of the
total minimum operating lease payments in Note 7 of such consolidated financial
statements, (2) to expand the description of the change in the valuation
allowance in note 10 to the consolidated financial statements, (3) to provide a
statement in note 13 to the consolidated financial statements that no warrants
or rights of the Registrant were exercised as of the date of the consolidated
financial statements, and (4) to include summarized unaudited income statement
information for the six months ended December 31, 1996 in note 15 to the
consolidated financial statements.
1
<PAGE>
Item 1. Business.
General
Premier Graphics, Inc. is the wholly-owned operating subsidiary of Master
Graphics, Inc. Master Graphics and Premier Graphics are the successor entities
to Master Printing and B&M Printing, respectively. Master Printing was
originally formed by John Miller (the current Chairman of the Board, Chief
Executive Officer and President of Master Graphics) in 1992 to acquire all of
the outstanding stock of B&M Printing. In 1997, in anticipation of the
implementation of an acquisition strategy, Master Printing merged with and into
Master Graphics, and B&M Printing merged with and into Premier Graphics.
Throughout this report on Form 10-K, unless the context indicates
otherwise, when we refer to "us," "we," "our" or the "Company," we are
describing Master Graphics together with Premier Graphics. References to Master
Graphics or Premier Graphics include only the named entity.
We are a leading consolidator within the general commercial printing
industry. From June 1997 through March, 1999, we have acquired 17 high quality,
general commercial printing companies which we believe are market leaders in
their respective geographic areas in terms of customer service, responsiveness
and quality. Each of the acquired companies operates as a separate division of
Premier Graphics and provides a full range of general commercial printing
services. The acquired companies have an average operating history of nearly 50
years, established customer relationships and strong reputations for customer
service, responsiveness and quality. We expect that our operating strategy will
enable each division to offer broader services to existing customers and attract
new customers.
We provide service in all areas of general commercial printing, including
prepress, printing and postpress services. Our products include annual reports,
direct mail pieces, sales literature, point of purchase materials, market
letters, newsletters, training manuals, product brochures and catalogs for
customers such as Federal Express, IBM, Provident Life, W. W. Grainger, Turner
Broadcasting and G. D. Searle. Our operating philosophy emphasizes responding
rapidly to customer requirements and producing high quality printed materials.
Responsiveness is essential because of the typically short lead time on most
general commercial printing jobs.
The General Commercial Printing Market
The printing industry is one of the largest and most fragmented industries
in the United States, with total estimated 1997 sales of $141.7 billion among an
estimated 52,000 printing companies according to the Printing Institute of
America. The printing industry includes general commercial printing, financial
printing, printing and publishing of books, newspapers and periodicals, quick
printing and production of business forms and greeting cards. We focus on
providing general commercial printing and related services. According to the
Printing Institute of America, this segment had approximately $46.8 billion in
revenue in 1997 among approximately 25,000 general commercial printing
companies.
2
<PAGE>
The general commercial printing industry involves developing a customer's
concept into printable material through the use of design and electronic
prepress services; using printing presses to imprint the printable material onto
paper; cutting, folding, and binding the finished product; and, finally, storing
and distributing the finished product at the customer's direction.
Historically, design and prepress services were performed by advertising
agencies, specialty printing services or the customer, but because of the
decreased cost of and technological advancements in computer-aided design
software and hardware, general commercial printing companies are able to offer
electronic prepress services to their customers on a more efficient and cost-
effective basis.
The primary printing process used by the general commercial printing
industry is offset lithography. Paper is fed into the printing presses utilized
in the offset lithography process either sheet by sheet (called sheet fed
presses) or on continuous rolls (called web presses). The sheet fed presses are
generally more cost-effective than web presses for jobs of fewer than 50,000
impressions. Web presses are generally used for large printing jobs such as
catalogs and magazines. Sheet fed presses vary in size and are capable of
printing up to 16 pages of letter-sized finished product on a 25 by 38-inch
sheet of paper with eight pages on each side (known as 16-page "signature") at
speeds of up to 15,000 impressions per hour. Web presses print on a continuous
roll of paper and can print on both sides of the paper at the same time, print
32-page signatures at speeds of over 40,000 impressions per hour and fold, glue
and perforate a finished product.
Large printing companies making extensive use of web presses include R. R.
Donnelley, World Color Press and Quebecor. These companies specialize in large
production runs of over 50,000 copies generally pursuant to long-term contracts.
General commercial printing companies relying heavily on sheet fed presses tend
to be smaller, locally owned and operated companies that service customers
predominately on a job-by-job basis. These companies compete by offering a high
level of customer service and rapid turnaround of projects.
Due to the fragmented nature of the general commercial printing industry,
we believe an abundance of acquisition opportunities exist. The general
commercial printing business is characterized by a significant number of locally
oriented, privately-held businesses, many of which are viable acquisition
candidates. Owners of these independent companies are often motivated to sell
their printing businesses to access the financial capital and other operating
strengths we have to offer to grow the business, increase their personal
financial liquidity or facilitate retirement. Moreover, consolidators like us
are motivated to purchase independent companies because of substantial potential
economies of scale to be achieved from a large multi-plant and geographically
diverse organization.
Operating Strategy
We have developed an integrated operating and acquisition strategy designed
to maximize internal and external growth and maintain and expand our position as
a leading provider of general commercial printing services. Our operating
strategy is to combine the service and responsiveness of a locally-oriented,
independent general commercial printing company with the resources and economies
of scale of a large company. The key elements of our operating strategy are as
follows:
. Provide Premium, High Quality Service. We target the premium segment of
the general commercial printing market. Our customers generally choose
printers primarily based on service, quality and responsiveness, and not
based solely on price.
. Stimulate Internal Growth. In order to maximize each division's internal
growth and profitability, we have developed our proprietary Master
Central equipment utilization and marketing process. Master Central is
designed to maximize utilization of our existing printing capacity and
capabilities by (1) allocating, on a real time basis, certain printing
projects to a particular division based on equipment capabilities and
availability; (2) training our sales force to market the production
capacity and capabilities of all of our divisions; and (3) expanding our
product and service offerings.
3
<PAGE>
. Achieve Economies of Scale. As a result of centralized purchasing, we
expect to receive volume discounts and rebates from manufacturers of
paper, film, printing plates and ink that would be unavailable to our
divisions on a stand-alone basis. Paper is generally the largest cost
item for general commercial printing companies, including Premier
Graphics. Our paper costs were approximately 26% of revenue for the year
ended December 31, 1998. We have pricing arrangements with five paper
suppliers which provide discounts and rebates based on volume and are
currently discussing with certain manufacturers purchase terms for film,
printing plates and ink and other printing supplies. In addition, we are
currently centralizing administrative items such as insurance and
employee benefits to further reduce costs.
. Operate on a Decentralized Basis. We intend to retain the key managers of
the businesses we acquire and allow them to maintain substantial
responsibility for the day-to-day operations, profitability and growth of
those businesses as separate divisions. We believe that the operating
autonomy provided by the decentralized structure, together with the
implementation of reporting systems and financial controls at the
corporate level, will enable us to combine the service and responsiveness
of a locally-oriented, independent general commercial printing company
with the resources and economies of scale of a large company. Moreover,
we provide incentives to our employees and align their interests with our
shareholders by using equity based compensation and earnings based
bonuses.
Acquisition Strategy
Our acquisition strategy is to become a leading provider of general
commercial printing services in the United States by acquiring independent
general commercial printing companies that are well managed and market leaders
in customer service, responsiveness and quality. We believe that our profile
within the industry and our philosophy of decentralized operations and
centralized administration enable us to identify and acquire high quality,
market leading independent general commercial printing companies. The key
elements of our acquisition strategy are as follows:
. Acquire High Quality, Well Managed Companies. We evaluate potential
acquisition candidates based on a variety of factors, including
reputation for quality, service, strength of management, competitive
market position, historical financial performance, growth potential,
customer base, equipment capabilities and available capacity. We seek to
acquire only those companies which maintain high levels of quality and
service consistent with our existing divisions. We believe this strategy
is essential to enabling each division to cross-sell the capacity and
capabilities of the other divisions without concerns about quality and
service.
. Retain Existing Management of Companies Acquired. We seek to acquire
successful companies whose key managers will become our employees and
continue to operate acquired businesses as divisions of Premier Graphics.
To preserve local market knowledge and customer relationships, we have
entered into employment contracts and agreements not to compete with the
key managers at each acquired company and we intend to continue to do so
in the future.
4
<PAGE>
Acquired Companies
<TABLE>
<CAPTION>
Year
Acquired Company Founded Location Date Acquired
- ------------------------------ ------- ----------------------- -------------
<S> <C> <C> <C>
Blackwell Lithographers....... 1932 Jackson, Mississippi June 1997
Lithograph Printing........... 1947 Memphis, Tennessee June 1997
Sutherland Printing........... 1940 Montezuma, Iowa June 1997
Ozark, Missouri
The Argus Press............... 1922 Chicago, Illinois September 1997
Phoenix Communications........ 1960 Atlanta, Georgia December 1997
Jones Printing................ 1947 Chattanooga, Tennessee December 1997
Hederman Brothers............. 1898 Jackson, Mississippi March 1998
Phillips Litho................ 1973 Springdale, Arkansas March 1998
Harperprints.................. 1974 Henderson, North Carolina March 1998
McQuiddy Printing Company..... 1903 Nashville, Tennessee May 1998
Golden Rule Printing.......... 1978 Huntsville, Alabama August 1998
The Printing Company.......... 1983 Indianapolis, Indiana September 1998
Stephenson Printing........... 1953 Alexandria, Virginia September 1998
Technigrafiks................. 1977 Houston, Texas December 1998
Woods Lithographics........... 1978 Phoenix, Arizona March 1999
White Arts.................... 1945 Indianapolis, Indiana March 1999
Columbia Graphics............. 1977 Chicago, Illinois March 1999
</TABLE>
5
<PAGE>
Master Central
A successful printing company must have a substantial investment in
printing presses and related equipment and plant facilities. The general
commercial printing industry is characterized by unpredictable demand which
affects equipment utilization. A particular printing facility may at any given
time have either excess capacity or demands from customers which cannot be met.
Further, the size and type of printing jobs a general commercial printing
company is capable of completing is limited by type and number of printing
presses owned by that company. For example, it may not be economically feasible
for one of our divisions which operates only sheet fed presses to bid on a large
printing project which could be produced more efficiently on a web press.
We have established Master Central to utilize more efficiently printing
capacity and effectively allocate print jobs across the range of our available
equipment. Currently, three employees located at our headquarters and one
employee in each division, all under the direction of our Chief Operating
Officer, have been designated as the Master Central Team. Master Central acts as
a clearinghouse whereby a division submits a job that it cannot print either
because of capacity restraints or because the division does not have necessary
equipment. Through Master Central, this job is routed to the division with the
necessary equipment or available capacity to handle the job. Master Central is
an operating process which focuses on:
(1) effective marketing of the production capacity and capabilities of all
of our divisions;
(2) increasing equipment availability across all divisions;
(3) responsiveness to customer driven deadlines; and
(4) efficient distribution of finished products to customers.
6
<PAGE>
In connection with Master Central, we are training our sales force to
effectively promote and market the production capacity and capabilities of all
of our divisions. Master Central currently operates via facsimile, telephone and
electronic mail; however, we are currently evaluating high speed electronic data
transfer systems which will facilitate communications and data transfers between
divisions.
Operations
We provide service in all areas of general commercial printing, including:
(1) developing a customer's concept into printable material through the use
of electronic prepress services;
(2) using printing presses to imprint the printable material onto paper;
(3) cutting, folding, and binding the finished product; and
(4) storing and distributing the finished product.
Design and Prepress Services. One of the most significant technological
advancements in the general commercial printing industry in recent years has
been the computerization of the prepress area. Because of such technological
advances and a decrease in the cost of such technology, we are able to offer
design and prepress services to our customers on an efficient and cost-
effective basis. Historically, such design and prepress services were provided
by advertising agencies, specialty printing services or customers in-house.
Prepress services include the development of designs for customers and the
conversion of designs into digitized images. We offer commercial prepress
services at all of our facilities, enabling each division to service customers
from inception of the concept through delivery of the finished product.
Printing. Once a project has finished the prepress area, it is moved to the
press area where the image is reproduced on paper. We operate 91 sheet fed
presses, ranging in size from 11x17 to 28x41, which are capable of
simultaneously printing up to six colors and producing up to 15,000 impressions
per hour. We also operate 13 web presses which are capable of producing up to
40,000 impressions per hour, folding, glueing and perforating a finished
product. Our web presses are located in 6 divisions.
Finishing. The finishing operations provided by Premier Graphics include
cutting, folding, binding and other operations to finish the printed product.
Historically, general commercial printing companies outsourced those finishing
operations which required substantial capital investments. Because some of the
acquired companies own such equipment, we are able to offer finishing operations
and provide a completely integrated service from design to fulfillment.
Fulfillment. The fulfillment area provides a wide range of labor intensive
services that combine, package, store and ship our finished products. The
fulfillment area also provides electronic tracing services for customer
inventory and accumulates data for marketing departments that indicate the
effectiveness of print-related marketing campaigns. Large corporations utilize a
variety of our fulfillment services including: custom assembly of binders;
gathering information from promotional mailings; returning premium or incentive
items to respondents; and combining magnetic media with printed media prior to
shipment.
Customers
Most of our top customers are large companies such as Federal Express, IBM,
Provident Life, W. W. Grainger, Turner Broadcasting and G. D. Searle. Consistent
with the general commercial printing industry as a whole, we generally have no
significant long-term contracts with its customers. Due to the project-oriented
nature of customers'
7
<PAGE>
printing requirements, sales to particular customers may vary significantly from
year to year. Our top ten customers in 1998 accounted for less than 19% of
sales; no customer accounted for more than 3%.
Sales and Marketing
On March 23, 1999, Premier Graphics employed 177 salespeople across all of
its divisions, a majority of which are paid on a commission basis. We market our
services based primarily on quality and responsiveness and, to a lesser degree,
on price. Through our salespeople and other management professionals, we
maintain strict control of the printing process from the time a prospective
customer is identified through the scheduling, prepress, printing and postpress
operations. Our business is principally service-oriented, and our operating
philosophy emphasizes responding rapidly to customer requirements and producing
high quality products. Responsiveness is essential because of the typically
short lead time on most general commercial printing jobs. Premier Graphics, like
other general commercial printing companies, is designed to maintain maximum
flexibility to meet customer needs both on a scheduled and an emergency basis.
We believe that a well trained, experienced sales force is a vital
component of our internal growth strategy. In addition to the training provided
with respect to Master Central, we have implemented a training program designed
to enhance the effectiveness and knowledge of our sales force. The general
commercial printing business requires a substantial amount of interaction with
customers, including personal sales calls, art work and computer disk reviews,
reviews of color and other proofs and "press checks" (customer approval of the
printed piece while it is being printed).
Each of our divisions employs salespeople who are knowledgeable about the
industry and the printing capabilities of the division they serve. As a result
of the implementation of Master Central, each salesperson will also be trained
in the printing capabilities at each of the other divisions. Our sales
philosophy stresses frequent sales calls on existing customers and constant
marketing to prospective new customers. Each division emphasizes to its
customers the breadth and sophistication of the particular division's printing
capacity and the printing capacity of Premier Graphics as a whole, the speed and
quality of its service and the personal attention offered by its salespeople. In
addition to soliciting business from existing and prospective customers, the
salespeople act as liaisons between customers and production personnel and
provide technical advice and assistance to customers throughout the printing
process.
The general commercial printing industry is characterized by strong
relationships between the purchasers of printing services and the salespeople
who service their accounts. We believe that it is important to retain its
existing sales force and attract new salespeople. We believe that our existing
compensation structure is competitive with other companies in the general
commercial printing industry. Moreover, because we generally can offer greater
capacity and a broader array of capabilities than smaller, locally-owned general
commercial printing companies, Premier Graphics believes it can successfully
compete with these other printing companies to hire additional qualified
salespeople.
Purchasing and Raw Materials
As a result of centralized purchasing, we believe we will be able to take
advantage of volume discounts and rebates from manufacturers and suppliers of
paper, film, printing plates and ink that would be unavailable to the divisions
on a stand-alone basis. We purchase various materials, including paper, prepress
supplies, printing plates, ink, film, chemicals, solvents, glue and wire, from a
number of national and local suppliers. Paper is generally the largest cost item
for general commercial printing companies, including Premier Graphics. Our paper
costs were approximately 26.0% of revenue for the year ended December 31, 1998.
We do not maintain a significant inventory of paper and are generally able to
pass the cost of the paper through to our customers. We have in place pricing
arrangements with five paper suppliers which provide for discounts and rebates
based on volume.
We are currently in the process of negotiating national purchasing
arrangements with other major suppliers and manufacturers. We anticipate that
each division will order the goods and services as needed either in accordance
with the terms set forth in the national purchasing arrangements, if applicable,
or on a local basis. We will receive input from
8
<PAGE>
each division on market conditions, local supplier service and product
developments which will enable us to continually maximize the benefits of these
master purchasing arrangements.
We have not experienced any significant difficulty in obtaining raw
materials necessary for our operations.
Competition
We compete with a substantial number of other general commercial printing
companies. Because of the nature of our business, most of our competition is
confined to local printing markets. The major competitive factors in our
business are the quality of customer service, the quality of finished products
and price. Our ability to compete effectively in providing customer service and
quality finished products is primarily dependent on production and distribution
capabilities, the availability of equipment and the ability to perform the
services with speed and accuracy. We believe we compete effectively in all of
these areas.
Although the general commercial printing industry in the United States
remains highly fragmented, recent technological developments and over-capacity
in the industry have increased industry consolidation and competitive pressures.
Moreover, we compete for potential acquisition candidates with other printing
industry consolidators, some of which have greater financial resources than we
do.
Employees
On March 23, 1999, we had approximately 1,900 employees. Less than five
percent of our employees are members of the Graphic Communications Union. These
employees work under a collective bargaining agreement which expires on March
31, 2000. We believe our relationship with our employees, including those
covered by a collective bargaining agreement, is good.
Government and Environmental Regulation
Our manufacturing operations are subject to numerous federal, state and
local laws and regulations relating to human health and safety and the
environment. These laws and regulations address and regulate, among other
matters, wastewater discharge, air quality and the generation, handling,
storage, treatment, disposal and transportation of solid and hazardous wastes
and releases of hazardous substances into the environment. In addition, third
parties and governmental agencies in some cases have the power under such laws
and regulations to require remediation of environmental conditions and, in the
case of governmental agencies, to impose fines and penalties. We make capital
expenditures from time to time to stay in compliance with applicable laws and
regulations.
We have obtained all permits and approvals and filed all registrations
required for the conduct of our business, except where the failure to obtain any
permit or approval or file any registration would not have a material adverse
effect on our business, financial condition or results of operations. We are in
compliance in all material respects with the numerous federal, state and local
laws and regulations and permits, approvals and registrations relating to human
health and safety and the environment except where noncompliance would not have
a material adverse effect on our business, financial condition or results of
operations.
In connection with our acquisitions, each of our properties has been
subjected to a Phase I environmental site assessment (which does not involve
invasive procedures, such as soil sampling or ground water analysis) by
independent environment consultants. The purpose of a Phase I environmental site
assessment is to identify potential sources of contamination for which we may be
responsible and to assess the status of environmental regulatory compliance. We
conduct further environmental testing when we believe it prudent and advisable.
The Phase I environmental site assessment obtained for the property used by
the Stephenson Printing Division revealed that there are two underground storage
tanks listed with the Virginia Department of Environmental Quality as "currently
in use" on the property. The owner of the property has informed Premier Graphics
that the underground
9
<PAGE>
storage tanks were removed in the mid-1980's, although there is no documentation
of the removal of the tanks. The storage tanks were previously used for the
storage of alcohol and solvent. There is a potential for soil or groundwater
contamination on the property if there were any releases from the underground
storage tanks.
The Phase I environmental site assessment obtained for the property used by
our Columbia Graphics Division disclosed that asbestos-containing materials may
be present in building materials. We intend to conduct an asbestos survey and
remove and/or abate any friable asbestos that we find. The Phase I study also
pointed out possible deficiencies in the filing and record-keeping practices of
the division. Therefore, we also intend to further study these practices, as
well as the waste disposal practices of the division.
No other environmental testing has revealed any environmental condition,
liability or compliance concern that we believe would have a material adverse
effect on our business, assets or results of operations, nor are we aware of any
such condition, liability or concern by any other means. However, it is possible
that the environmental testing relating to any one of the properties did not
reveal all environmental conditions, liabilities or compliance concerns. It is
also possible that there are material environmental conditions, liabilities or
compliance concerns that arose at a property after the related review was
completed. If environmental contamination exists or existed at a property, we
may be liable for the costs of removal or remediation of the contamination and
may be liable for personal injury or similar claims by private plaintiffs.
Moreover, if there is an environmental compliance issue, we may be liable for
the costs of and penalties associated with any action necessary to correct this
deficiency. The existence of environmental liabilities with regard to a property
could adversely affect our ability to sell or borrow against that property.
No assurances can be given that all potential environmental liabilities
have been identified or properly quantified or that any prior owner, operator,
or tenant has not created an environmental condition unknown to Premier
Graphics. Moreover, no assurances can be given that
. future laws, ordinances or regulations will not impose any material
environmental liability or
. the current environmental condition of the properties will not be
affected by the condition of land or operations in the vicinity of the
properties (such as the presence of underground storage tanks), or by
third parties.
Federal, state and local environmental regulatory requirements change
often. It is possible that compliance with a new regulatory requirement could
impose significant compliance costs on us. Such costs could have a material
adverse effect on our business, financial condition and results of operations.
10
<PAGE>
Item 6. Selected Financial Data.
The following table sets forth selected financial and operating information
on an historical basis for Master Graphics and its predecessor. The following
information should be read in conjunction with the historical financial
statements of Master Graphics, including the related notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Annual Report on Form 10-K.
<TABLE>
<CAPTION>
Six Months
Ended
Year ended June 30, (1) December 31, Year ended
--------------------------------------------- ---------------- December 31,
1994 1995 1996 1997 1996 1997 1998
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C>
Income Statement Data:
Revenue............................. $10,804 $11,426 $13,244 $13,433 $6,357 $32,394 $163,277
Gross profit........................ 2,706 2,498 3,288 2,121 977 5,866 41,937
Depreciation and amortization....... 867 747 605 623 329 1,413 6,660
Operating income (loss)............. 119 (72) 597 (900) (274) (222) 14,054
Net income (loss) before
extraordinary loss (2)............. (92) (209) 172 (1,273) (415) (3,819) 3,973
Net income.......................... (92) (209) 172 (1,273) (415) (3,819) 1,875
Earnings (loss) per share before
extraordinary item:
Basic............................. $ (0.02) $ (0.05) $ 0.04 $(0.32) - $(0.95) $0.62
Diluted........................... $ (0.02) $ (0.05) $ 0.04 $(0.32) - $(0.95) $0.60
Balance Sheet Data (as end of
period):
Total Assets........................ $ 6,330 $ 6,102 $ 6,426 $37,215 $86,384 $207,876
Working capital..................... 866 765 1,286 3,056 6,691 47,925
Long-term obligations............... 3,566 3,382 32,794 30,612 69,317 145,147
Redeemable common stock
warrants........................... - - - 638 3,376 -
Redeemable preferred stock.......... - - - - - 1,437
Shareholders' equity (deficit)...... 1,880 1,671 1,843 780 (1,596)
</TABLE>
- ------------
(1) Effective January 1, 1998, Master Graphics changed its annual accounting
period to a calendar year.
(2) The Company incurred an after-tax extraordinary loss in June 1998 of
approximately $2.1 million ($0.34 per share basic and $.033 per share
diluted) related to the write-off of deferred financing costs and
unamortized debt discounts resulting from the repayment of certain
indebtedness in connection with Master Graphics' initial public offering of
common stock.
11
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion should be read in conjunction with the historical
consolidated financial statements and related notes of Master Graphics and
Selected Financial Data included elsewhere in this report on Form 10-K.
Introduction
From June 1997 through December 31, 1998, Master Graphics had acquired 14
general commercial printing companies which Master Graphics believes are market
leaders in their respective geographic areas in terms of customer service,
responsiveness and quality. Master Graphics acquired three commercial printing
companies in March, 1999. Master Graphics financed the cash portion of the
purchase price for the acquired companies primarily with debt. See Business--
Acquired Companies for information regarding the consideration paid for the
acquired companies. Each acquisition was accounted for as a purchase, and any
purchase price in excess of the fair value of the assets acquired was allocated
to goodwill which is amortized over 40 years. A substantial portion of this non-
cash expense will likely be non-deductible for tax purposes. Master Graphics'
results of operations are also impacted by the effects of purchase accounting
applied to in-process inventory acquired. Such inventory is recorded at its fair
value, which may include manufacturing profit not otherwise recognizable until
the goods are sold. The resulting cost of sales when such goods are sold,
usually in the period immediately following the acquisition date, may be
substantially higher than in a period when acquisitions are not being made.
The acquired companies were all closely-held businesses and several were S
corporations. In many cases, the tax structure influenced the historical level
of owners' compensation. Many of the owners have agreed to certain
reductions in their compensation and benefits following the acquisition by
Master Graphics.
Results of Operations
The following table sets forth certain financial data for the periods
indicated (dollars in millions) and such results as a percentage of revenue.
<TABLE>
<CAPTION>
Six months ended
Year ended June 30, December 31, Year Ended
------------------------------- -------------------------------- December 31,
1996(1) 1997(1) 1996 1997(2) 1998
------------- ------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue..................... $13.2 100.0% $13.4 100.0% $ 6.4 100.0% $32.4 100.0% $163.3 100.0%
Gross profit................ 3.3 25.0 2.1 15.7 1.0 15.7 5.9 18.2 41.9 25.7
Selling, general and
administrative expenses.... 2.7 20.5 3.0 22.4 1.3 20.3 6.0 18.5 26.9 16.5
Operating income (loss)..... 0.6 4.5 (0.9) (6.7) (0.3) (4.7) (0.2) (0.6) 14.1 8.6
Interest expense............ (0.4) (3.0) (0.4) (3.0) (0.2) (3.1) (2.2) (6.8) (10.3) (6.3)
Income tax expense
(benefit).................. 0.2 1.5 -- -- -- -- -- -- 0.6 0.9
Net earnings (loss) before
extraordinary loss......... 0.2 1.5 (1.3) (9.7) (0.4) (6.3) (3.8) (11.7) 4.0 2.4
Extraordinary loss (2)...... -- -- -- -- -- -- -- -- (2.1) (1.3)
Net earnings (loss)......... $ 0.2 1.5% $(1.3) (9.7)% $(0.4) (6.3)% $(3.8) (11.7%) $ 1.9 1.2%
</TABLE>
(1) The results of operations for all periods through June 30, 1997 effectively
reflect only the operations of B&M Printing.
(2) Effective January 1, 1998, Master Graphics changed its annual accounting
period to a calendar year.
(3) The Company incurred an extraordinary loss in June 1998 of approximately
$2.1 million (net of tax benefit of $1.5 million) related to the write-off
of deferred financing costs and unamortized debt discounts resulting from
the repayment of certain indebtedness in connection with Master Graphics'
initial public offering of common stock.
12
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Master Graphics, Inc. and subsidiaries:
Reports of Independent Public Accountants................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998............. F-3
Consolidated Statements of Operations for the years ended June 30, 1996
and 1997, the six months ended December 31, 1997 and the year ended
December 31, 1998....................................................... F-4
Consolidated Statements of Shareholders' Equity for the years ended June
30, 1996 and 1997, the six months ended December 31, 1997, and the year
ended December 31, 1998................................................. F-5
Consolidated Statements of Cash Flows for the years ended June 30, 1996
and 1997, the six months ended December 31, 1997, and the year ended
December 31, 1998....................................................... F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Master Graphics, Inc.:
We have audited the consolidated balance sheets of Master Graphics, Inc. and
subsidiaries as of December 31, 1997 and 1998, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
years in the two-year period ended June 30, 1997, the six-month period ended
December 31, 1997, and the year ended December 31, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Master
Graphics, Inc. and subsidiaries as of December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the years in the
two-year period ended June 30, 1997, the six-month period ended December 31,
1997, and the year ended December 31, 1998 in conformity with generally
accepted accounting principles.
KPMG LLP
Memphis, Tennessee
March 18, 1999
F-2
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
December 31,
-----------------
1997 1998
------- --------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................. $ 1,174 $ 13,525
Trade accounts receivable, net............................. 14,989 38,529
Inventories:
Raw materials and supplies................................ 1,927 2,909
Work-in-process........................................... 2,909 5,186
------- --------
Total inventories........................................ 4,836 8,095
Deferred income taxes...................................... 161 1,057
Prepaid expenses and other current assets.................. 1,320 4,012
------- --------
Total current assets...................................... 22,480 65,218
------- --------
Property, plant and equipment, net.......................... 29,550 75,251
Goodwill, net............................................... 28,853 64,469
Deferred loan costs, net.................................... 1,396 1,352
Due from shareholder........................................ 3,895 64
Other....................................................... 210 1,522
------- --------
Total assets.............................................. $86,384 $207,876
======= ========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Current installments of long-term debt..................... $ 3,834 $ 924
Accounts payable........................................... 5,466 10,829
Accrued expenses........................................... 6,489 5,540
------- --------
Total current liabilities................................. 15,789 17,293
------- --------
Long-term debt, net of current installments................. 65,484 144,223
Deferred income taxes....................................... 2,266 7,554
Other liabilities........................................... 1,065 1,177
Redeemable common stock warrants............................ 3,376 0
Redeemable preferred stock.................................. 0 1,437
Commitments and contingencies
Shareholders' equity:
Common stock ($0.001 par value; 100,000,000 shares
authorized; 4,000,000 shares issued and outstanding at
December 31, 1997; 7,879,997 shares issued and outstanding
at December 31, 1998)..................................... 4 8
Additional paid-in capital................................. 3,850 39,843
Retained earnings (deficit)................................ (5,450) (3,659)
------- --------
Total shareholders' equity (deficit)...................... (1,596) 36,192
------- --------
$86,384 $207,876
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Years ended June 30, Six months ended Year ended
---------------------- December 31, December 31,
1996 1997 1997 1998
---------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Net revenue............. $ 13,244 $ 13,433 $ 32,394 $163,277
Cost of revenue......... 9,955 11,312 26,528 121,340
---------- ---------- -------- --------
Gross profit.......... 3,289 2,121 5,866 41,937
Selling, general and
administrative
expenses............... 2,691 3,021 5,990 26,876
Amortization of
goodwill............... 0 0 98 1,007
---------- ---------- -------- --------
Operating income
(loss)............... 598 (900) (222) 14,054
Other income (expense):
Redeemable warrant
valuation
adjustment........... 0 0 (1,635) 0
Interest income....... 68 68 48 250
Interest expense...... (376) (439) (2,181) (10,271)
Other, net............ 44 23 191 568
---------- ---------- -------- --------
Other income
(expense), net..... (264) (348) (3,577) (9,453)
---------- ---------- -------- --------
Income (loss) before
income taxes and
extraordinary loss... 334 (1,248) (3,799) 4,601
Income tax expense...... 162 25 20 628
---------- ---------- -------- --------
Net earnings (loss)
before extraordinary
loss................. 172 (1,273) (3,819) 3,973
Extraordinary loss on
extinguishment of
debt, net of income
tax benefit of
$1,458............... 0 0 0 (2,098)
---------- ---------- -------- --------
Net earnings (loss)... $ 172 $ (1,273) $ (3,819) $ 1,875
========== ========== ======== ========
Basic earnings per
share:
Net earnings (loss)
before extraordinary
loss................. $ 0.04 $ (0.32) $ (0.95) $ 0.62
Extraordinary loss,
net.................. 0.00 0.00 0.00 (0.34)
---------- ---------- -------- --------
Net earnings (loss)... $ 0.04 $ (0.32) $ (0.95) $ 0.28
========== ========== ======== ========
Diluted earnings per
share:
Net earnings (loss)
before extraordinary
loss................. $ 0.04 $ (0.32) $ (0.95) $ 0.60
Extraordinary loss,
net.................. 0.00 0.00 0.00 (0.33)
---------- ---------- -------- --------
Net earnings (loss)... $ 0.04 $ (0.32) $ (0.95) $ 0.27
========== ========== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
Common stock
Additional Retained Total
paid-in earnings shareholder's
Shares Amount capital (deficit) equity (deficit)
--------- ------ ---------- --------- ----------------
<S> <C> <C> <C> <C> <C>
Balance at June 30,
1995................... 4,000,000 $100 $ 2,100 $ (530) $ 1,670
Net earnings for year
ended June 30, 1996.. -- 0 0 172 172
--------- ---- ------- ------- -------
Balances at June 30,
1996................... 4,000,000 $100 $ 2,100 $ (358) $ 1,842
Effects of re-
incorporation........ 0 (96) 96 0 0
Issuance of seller
warrants............. 0 0 210 0 210
Net (loss) for year
ended June 30, 1997.. 0 0 0 (1,273) (1,273)
--------- ---- ------- ------- -------
Balances at June 30,
1997................... 4,000,000 $ 4 $ 2,406 $(1,631) $ 779
Issuance of seller
warrants............. 0 0 1,444 0 1,444
Net (loss) for six
months ended December
31, 1997............. 0 0 0 (3,819) (3,819)
--------- ---- ------- ------- -------
Balances at December 31,
1997................... 4,000,000 $ 4 $ 3,850 $(5,450) $(1,596)
Initial public
offering............. 3,400,000 4 29,818 0 29,822
Acquisition of
businesses........... 213,333 0 1,282 0 1,282
Exercise of lender
warrants............. 266,664 0 2,025 0 2,025
Issuance of seller
warrants............. 0 0 755 0 755
Issuance of lender
warrants............. 0 0 2,200 0 2,200
Preferred stock
accretion............ 0 0 (87) 0 (87)
Preferred stock
dividend............. 0 0 0 (84) (84)
Net earnings for year
ended
December 31, 1998.... 0 0 0 1,875 1,875
--------- ---- ------- ------- -------
Balances at December 31,
1998................... 7,879,997 $ 8 $39,843 $(3,659) $36,192
========= ==== ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Years ended June 30, Six months ended Year ended
--------------------- December 31, December 31,
1996 1997 1997 1998
--------------------- ---------------- ------------
<S> <C> <C> <C> <C>
Cash flows from operating
activities:
Net earnings (loss)...... $ 172 $ (1,273) $ (3,819) $ 1,875
Adjustments to reconcile
net income to net cash
from operating
activities:
Depreciation........... 275 293 1,087 4,998
Amortization of intan-
gibles................ 330 330 326 1,662
Deferred compensation
provision............. 0 0 765 47
Redeemable warrants ad-
justment.............. 0 0 1,635 0
Deferred income taxes.. 63 163 0 437
(Gain) loss on disposal
of equipment.......... (10) 0 0 0
Extraordinary loss, net
of tax benefit........ 0 0 0 2,098
Changes in operating
assets and
liabilities, net of
effect of business
acquisitions:
Trade accounts re-
ceivable............ (128) (1,124) 459 (7,411)
Inventories.......... 81 (300) 651 3,937
Other assets......... (622) 197 (499) 1,285
Accounts payable..... 261 797 (15) (2,322)
Accrued expenses..... 206 837 1,903 (2,850)
-------- ----------- -------- ---------
Net cash provided by
(used in) operating
activities......... 628 (80) 2,493 3,756
-------- ----------- -------- ---------
Cash flows from investing
activities:
Business acquisitions,
net of cash acquired.... 0 (13,392) (28,511) (90,212)
Purchases of equipment... (374) (4,151) (328) (2,177)
Proceeds from sale of
equipment............... 10 0 0 0
Repayment of shareholder
note receivable......... 0 0 0 3,895
-------- ----------- -------- ---------
Net cash used in invest-
ing activities.......... (364) (17,543) (28,839) (88,494)
-------- ----------- -------- ---------
Cash flows from financing
activities:
Net proceeds from initial
public offering of
common stock............ 0 0 0 29,822
Net borrowings (repay-
ments) on lines of cred-
it...................... (272) (113) 570 (748)
Net proceeds from issu-
ance of long-term debt.. 0 20,821 27,940 72,606
Principal payments of
long-term debt.......... (291) (1,381) (778) (129,846)
Net proceeds from issu-
ance of senior notes.... 0 0 0 126,100
Loan costs incurred...... 0 (777) (709) (845)
-------- ----------- -------- ---------
Net cash provided by
(used in) financing
activities......... (563) 18,550 27,023 97,089
-------- ----------- -------- ---------
Net increase (decrease) in
cash...................... (299) 927 677 12,351
Cash (overdraft) at begin-
ning of period............ (131) (430) 497 1,174
-------- ----------- -------- ---------
Cash (overdraft) at end of
period.................... $ (430) $ 497 $ 1,174 $ 13,525
Supplemental Disclosure of
Cash Flow Information:
Cash paid for:
Interest................. $ 445 $ 312 $ 1,780 $ 8,980
Income Taxes............. $ 32 $ 156 $ 25 $ 0
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
Master Graphics, Inc. (Master Graphics) and its wholly-owned operating
subsidiaries, Premier Graphics, Inc. (Premier) and Harperprints, Inc.
(Harperprints), (collectively the "Company") are engaged in the business of
commercial printing, with 18 facilities in 12 states at December 31, 1998.
Prior to June 1997, the Company was comprised of a holding company, Master
Printing, Inc. and its wholly-owned operating subsidiary, B&M Printing, Inc. In
June 1997, the sole shareholder of Master Printing, Inc. formed a new corporate
holding company, Master Graphics, and merged Master Printing, Inc. into Master
Graphics. Contemporaneously, Master Graphics formed a new wholly-owned
subsidiary, Premier Graphics, Inc., and merged B&M Printing, Inc. into Premier.
Harperprints was acquired in March 1998. References in these consolidated
financial statements to the Company for periods prior to the June 1997
transactions described above are to Master Printing, Inc. and B&M Printing,
Inc. consolidated. The transactions discussed above were among entities totally
controlled by the sole shareholder, and, as such, gave rise to no changes in
accounting or reporting, other than an adjustment to the Company's
shareholder's equity as a result of changing the par value of common stock from
no par value to $0.001 per share.
The Company operated on a fiscal year ending June 30, through its year ended
June 30, 1997. In conjunction with the corporate reorganization described above
and the acquisitions and related financings described in Notes 3 and 5 below,
the Company changed its fiscal year-end to December 31.
On May 14, 1998, the Board of Directors of the Company approved a 40,000 to 1
stock split. All references to share and per share amounts in these
consolidated financial statements have been retroactively restated to reflect
the stock split.
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of Master
Graphics, Inc. and its wholly- owned subsidiaries after the elimination of
intercompany transactions.
(b) Use of Estimates
Management uses estimates and assumptions in preparing financial
statements in accordance with generally accepted accounting principles.
Those estimates and assumptions affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities, and the
reported revenues and expenses. Actual results could differ from those
estimates.
(c) Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid debt instruments
purchased with a maturity of three months or less at the date of
acquisition.
(d) Inventories
Inventories are stated at the lower of cost (first-in, first-out method)
or market.
(e) Property, Plant and Equipment
Property, plant, and equipment is stated at cost. Depreciation is
computed using the straight-line method over the estimated useful lives of
the assets, which range from 5 to 39 years. Leasehold improvements are
amortized on a straight-line basis over the estimated useful lives of the
related property,
F-7
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
generally fifteen to forty years. Amortization of assets held under capital
leases of approximately $225,000 is included with depreciation expense.
Expenditures that materially increase values or extend the useful lives
of assets are capitalized while replacements, maintenance and repairs that
do not improve or extend the lives of the respective assets, are charged
against income as incurred. Depreciation expense for fiscal years 1996 and
1997, the six months ended December 31, 1997 and the year ended December
31, 1998 was approximately $275,000, $293,000, $1,087,000, and $4,998,000,
respectively.
(f) Intangibles
Goodwill represents costs in excess of the fair value of the net assets
of businesses acquired. Goodwill is being amortized over forty years, using
the straight-line method; accumulated amortization of goodwill was
approximately $98,000 and $1,198,000 at December 31, 1997 and 1998. In
accordance with Statement of Financial Accounting Standards No. 121, long-
lived assets, including goodwill, are reviewed for impairment whenever
events and circumstances indicate that their carrying value may not be
recoverable. Such reviews are performed using estimated undiscounted cash
flows over the remaining lives of the assets. No impairment write-downs
have been required to date.
Costs incurred in obtaining long-term financing are deferred and
subsequently amortized, using the interest method over the life of the
respective financing, as a component of interest expense. Accumulated
amortization at December 31, 1997 and 1998 was approximately $90,000 and
$356,000, respectively.
(g) Income Taxes
The Company follows the asset and liability method for deferred income
taxes as required by the provisions of Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes. Under the asset and
liability method, deferred income taxes are recognized for the tax
consequences of "temporary differences" by applying enacted statutory tax
rates applicable to future years to differences between the financial
statement carrying amounts and the tax basis of existing assets and
liabilities.
(h) Financial Instruments
The Company's financial instruments recorded on the consolidated balance
sheet include cash and cash equivalents, accounts and notes receivable,
accounts payable and debt. Because of their short maturity, the carrying
amount of cash and cash equivalents, accounts and notes receivable,
accounts payable and short-term bank debt approximates fair value. The fair
value of long-term debt, which approximates its carrying value, is based on
rates available to the Company for debt with similar terms and maturities.
(i) Revenue Recognition
Substantially all revenue is recognized when products are shipped to
customers.
(j) Earnings Per Share
Basic earnings per share for each period presented has been computed by
dividing net earnings (loss) by the weighted-average number of common
shares outstanding. Diluted earnings per share are calculated by dividing
net earnings (loss) by the sum of (1) the weighted-average number of shares
outstanding and (2) the number of additional common shares that would have
been outstanding if the dilutive potential common shares had been issued. A
reconciliation of calculation of basic and diluted earnings per share is
presented in Note 14.
F-8
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(k) Reclassifications
Certain prior year amounts have been reclassified to conform with current
year presentation.
(l) Segment Reporting
The Company considers its entire business to be in the single reporting
segment of general commercial printing.
(3) Acquisitions
In June 1997, the Company acquired all of the outstanding common stock of
Blackwell Lithographers, Inc. and of Lithograph Printing Company of Memphis,
and the assets of Sutherland Printing Company. All of these businesses are
engaged in commercial printing. The acquisitions were paid for with a
combination of cash ($10.4 million), notes given to the sellers ($5.1 million)
(see Note 5), and warrants to acquire common stock (valued at $210,000) (see
Note 13). In addition, the Company incurred other acquisition costs totaling
approximately $470,000. These acquisitions have been accounted for by the
purchase method and, accordingly, the results of operations of Blackwell,
Lithograph and Sutherland have been included in the Company's consolidated
financial statements from June 19, 1997. The excess of the purchase prices over
the fair value of the net identifiable assets acquired of $6.4 million has been
recorded as goodwill and is being amortized on a straight line basis over 40
years.
During the six months ended December 31, 1997, the Company acquired all of
the outstanding common stock of the following companies: The Argus Press, Inc.
(September 1997); Phoenix Communications, Inc. (December 1997); and Jones
Printing Company, Inc (December 1997). All of these businesses are engaged in
commercial printing. The acquisitions were paid for with a combination of cash
($17.8 million), notes given to the sellers ($6.2 million) (see Note 5), and
warrants to acquire common stock (valued at $1.4 million) (see Note 13). In
addition, the Company incurred other acquisition costs totaling approximately
$2.3 million. These acquisitions have been accounted for by the purchase method
and, accordingly, their results of operations have been included in the
Company's consolidated financial statements from their respective acquisition
dates. The excess of the purchase prices over the fair value of the net
identifiable assets acquired of $24.9 million has been recorded as goodwill and
is being amortized on a straight line basis over 40 years.
During 1998, the Company acquired eight businesses, primarily by stock
purchases, which are engaged in general commercial printing. The businesses
acquired were Harperprints, Inc., Hederman Brothers, Inc., and Phillips Litho
Company, Inc. (March 1998); McQuiddy Printing Company, Inc. (May 1998); Golden
Rule Printing (August 1998); The Printing Company and Stephenson Incorporated
(September 1998); and Technigrafiks, Inc. (December 1998). These acquisitions
were paid for with a combination of cash ($45.6 million), sellers' notes ($3.7
million), common stock (valued at $1.3 million) and warrants to acquire common
stock (valued at $0.8 million). In addition, the Company incurred other
acquisition costs totaling approximately $.9 million. All of these acquisitions
have been accounted for by the purchase method, and accordingly, the results of
their operations have been included in the company's consolidated financial
statements from their respective acquisition dates. The aggregate excess of the
purchase prices over the fair value of the net assets acquired of approximately
$34.4 million has been recorded as goodwill and is being amortized on the
straight-line method over forty years.
As a part of their respective acquisition agreements, the Company has agreed
to pay the former owners of eight of the acquired businesses additional cash
purchase price consideration, based on their surpassing certain cash flow based
targets which generally exceed the pre-acquisition performances of those
businesses. The measurement periods range from one to four years of post-
acquisition operations. Management believes that the aggregate maximum payout
will not exceed $27 million and that the actual amount is likely to be
considerably less. Payments will primarily be due in 1999-2001. Such payments
would be recorded as additional goodwill to be amortized over its remaining
life.
F-9
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following unaudited pro forma financial information presents the combined
results of operations of Master Graphics and the acquired businesses as if the
acquisitions and financings, including the issuances of common stock and Senior
Notes, had occurred as of January 1, 1997, and January 1, 1998, after giving
effect to certain adjustments, including amortization of goodwill, adjusted
depreciation expense and increased interest expense on debt related to the
acquisitions. The pro forma financial information does not necessarily reflect
the results of operations that would have occurred had Master Graphics and the
acquired businesses constituted a single entity during such periods (in
thousands, except per share amounts).
<TABLE>
<CAPTION>
Years ended December 31,
------------------------
1997 1998
--------- ----------
<S> <C> <C>
Net revenue..................................... $ 215,077 $ 221,955
Operating income................................ 13,768 19,175
Interest expense................................ 18,431 18,431
Net earnings (loss)............................. (4,196) 1,023
Net earnings (loss) per share
Basic......................................... $ (1.05) $ 0.10
Diluted....................................... $ (1.05) $ 0.10
</TABLE>
(4) Initial Public Offering
In June 1998, the Company completed an initial public offering of 3,400,000
shares ($.001 par value; 100,000,000 shares authorized) of common stock at
$10.00 per share. Proceeds of the initial public offering were used to repay
$4.3 million of indebtedness owed to Sirrom Capital, to repay $25.0 million of
the indebtedness owed to its senior lender and to pay $1.5 million of
acquisition advisory fees deferred until the completion of the offering. The
write-off of related deferred loan costs ($.6 million) and unamortized debt
discounts ($3.0 million) has been recorded as a $2.1 million extraordinary
loss, net of tax of $1.5 million.
(5) Long-Term Debt
Long-term debt consisted of (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998
------- --------
<S> <C> <C>
Senior Notes................................................ $ 0 $130,000
Credit Facilities:
Term Debt.................................................. 47,805 262
Working Capital Debt....................................... 570 0
Sellers' notes.............................................. 15,870 16,599
Sirrom Capital Corporation note............................. 4,300 0
Capital leases.............................................. 2,343 2,297
Other....................................................... 176 622
------- --------
71,064 149,780
Less unamortized debt discount.............................. 1,746 4,633
------- --------
69,318 145,147
Less current maturities..................................... 3,834 924
------- --------
$65,484 $144,223
======= ========
</TABLE>
In December 1998, the Company's primary operating subsidiary, Premier
Graphics, issued $130 million senior notes (Senior Notes). The approximate
$125.6 million of net proceeds from issuance were used to (1) repay the
outstanding borrowings under Premier Graphics acquisition credit facility
($88.6 million); (2) repay $4.8 million of sellers' notes; (3) repay
outstanding borrowings under Premier Graphics' working capital line of credit
($6.5 million); and (4) acquire Technigrafiks, Inc., a general commercial
printing
F-10
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
company, for $12.0 million; the remaining $13.7 million was available for
general corporate purposes, and in March, 1999 was effectively used to
partially finance acquisitions (see Note 17). The Senior Notes are guaranteed
by Master Graphics and by Harperprints, Inc., the Company's other operating
subsidiary. The Senior Notes mature in December 2005 and bear interest at 11
1/2 percent payable semi-annually. The Senior Notes are redeemable, in whole or
in part, beginning in December 2002 at a premium of 5.75%, declining to 2.875%
in December 2003 and to the face amount in December 2004. Additionally, during
the first three years after issuance, the Company may redeem up to 35% of the
aggregate principal amount of the Senior Notes with the net proceeds of equity
offerings; the redemption price would include an 11.5% premium.
The Company, through its primary operating subsidiary, Premier Graphics, has
borrowed term debt under various loan and security agreements (Term Debt) from
its senior secured lender. Proceeds from the loan agreement have been primarily
used for acquisitions described in Note 3. At December 31, 1997, the loan
balance under its Term Debt was $47.8 million. After four acquisitions in 1998,
the Term Debt balance reached approximately $85 million. Proceeds from the
Company's initial public offering were in part used to pay the Term Debt down
to approximately $60 million. Subsequent to its initial public offering and
after an additional three acquisitions in 1998, the Company's Term Debt reached
approximately $90 million. Proceeds from its Senior Notes offering were used to
substantially repay the outstanding balance under its Term Debt. At December
31, 1998, the loan balance under its Term Debt was $.3 million. In conjunction
with the acquisitions and financings thereof, the Company incurred fees of
approximately $2.3 million. The Company also issued to the senior lender common
stock warrants that are described in Note 12.
The Company, through its operating subsidiary, Premier Graphics, has borrowed
working capital funds (Working Capital Debt) from a commercial bank and finance
company. At December 31, 1997, the loan balance under its Working Capital Debt
was $.6 million. At December 31, 1998, there was no loan balance under its
Working Capital Debt.
As a part of the Senior Notes Offering, the Company received a non-binding
term sheet from a finance company for a new $80 million senior secured credit
facility to replace the previous Term Debt facilities and Working Capital Debt.
The new senior credit facility is more fully described in Note 17.
The Company has financed a portion of the purchase price paid for certain of
the acquired businesses by issuing unsecured subordinated notes (Seller Notes)
to the former owners of those companies. The Company also issued $5.3 million
of unsecured subordinated noted to the former owners of Hederman and Phoenix
that replaced notes between such companies and their owners. In general, the
Seller Notes (i) bore interest at 12% per annum payable quarterly, (ii) were
subject to prepayment at the option of Master Graphics upon payment of a
penalty which equaled or exceeded 20% of the amount prepaid; and (iii) matured
seven years from the date of issuance. In connection with closing of the Senior
Notes offering, the holders of approximately $12 million of Seller Notes agreed
to exchange their existing notes for new unsecured subordinated notes with the
following features: (i) balloon maturity date of June 30, 2006; (ii) monthly
interest payments at 12% per annum if paid when due, or if not paid when due
interest will accrue at 16% per annum until all accrued interest has been paid;
(iii) no restrictive covenants; and (iv) no rights or remedies against the
Company until maturity. As noted above, $4.8 million of Seller Notes were
repaid with a portion of the net proceeds of the Senior Notes offering.
In June 1997 the Company borrowed $4.3 million from Sirrom Capital
Corporation ("Sirrom") to partially finance its June 1997 business acquisitions
described on Note 3. The loan bore interest at 13.25%, payable monthly and was
subject to a security agreement, with collateral consisting of all equipment,
inventory, accounts receivable, and intangible assets. In conjunction with the
obtaining of the loan, the Company paid a processing fee of $107,500 and issued
to Sirrom a common stock warrant more fully described in Note 13. As discussed
in Note 4 above, the Sirrom note was repaid with a portion of the net proceeds
of the June 1998 initial public offering.
F-11
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Senior Notes Indenture includes restrictive covenants which limit
Premier's ability to pay dividends or make distributions to Master Graphics,
make investments, incur additional debt, issue preferred stock, incur liens,
enter into sale-leaseback, consolidation, merger, conveyance, lease or transfer
transactions, enter into transactions with affiliates, and engage in unrelated
businesses; the covenants also may require the repurchase of Senior Notes with
the proceeds of the sale of significant amounts of assets.
Under its acquisition line of credit and its working capital line of credit,
Premier is required to maintain certain financial ratios, including tests
related to net worth, EBITDA, interest coverage, fixed charge coverage and
leverage ratios. Premier is also subject to affirmative and negative covenants
which, among other things, limit capital expenditures and the payment of
dividends, and require certain debt repayments based on 50% of annual excess
cash flows, as defined.
The aggregate maturities of long-term debt, including capital lease
obligations, for each of the five years subsequent to December 31, 1998 are as
follows: 1999, $.9 million; 2000, $.6 million; 2001, $.4 million; 2002, $.4
million; 2003, $.9 million; thereafter, $146.6 million. In March, 1999, the
Company incurred additional acquisition debt of $18.5 million and assumed $4.3
million of debt of an acquiree. In addition, the Company agreed to certain
modifications to the amortization of term loans under the credit facility.
These subsequent events are not reflected in the maturities shown above.
(6) Property, Plant and Equipment
Property, plant and equipment (in thousands) was comprised of the following:
<TABLE>
<CAPTION>
December 31,
---------------
1997 1998
------- -------
<S> <C> <C>
Land......................................................... $ 176 $ 486
Buildings.................................................... 1,386 3,830
Leasehold improvements....................................... 991 1,115
Machinery and equipment...................................... 29,508 75,602
Furniture and fixtures....................................... 2,275 3,331
Vehicles..................................................... 703 1,374
------- -------
35,039 85,738
Less accumulated depreciation................................ 5,489 10,487
------- -------
$29,550 $75,251
------- -------
</TABLE>
(7) Leases
The Company is obligated under various capital leases for certain machinery
and equipment that expire at various dates during the next 5 years. At December
31, 1998, the gross amount of machinery and equipment and related accumulated
amortization recorded under capital leases were approximately $2,721,000 and
$254,000, respectively. The recorded liability for capital leases is classified
as long-term debt.
F-12
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company also has various non-cancelable operating leases, primarily for
facilities and printing equipment that expire over the next seven years. Rental
expense for operating leases during fiscal years 1996 and 1997, the six months
ended December 31, 1997, and the year ended December 31, 1998 totaled
approximately $410,000, $1,050,000, $398,000, and $2,267,000 respectively.
Future minimum lease payments under non-cancelable operating leases (with
initial or remaining lease terms in excess of one year) and future minimum
capital lease payments as of December 31, 1998 are:
<TABLE>
<CAPTION>
Capital Leases Operating Leases
-------------- ----------------
<S> <C> <C>
Year ending December 31,
1999.......................................... $ 670 $ 3,564
2000.......................................... 589 3,440
2001.......................................... 471 3,246
2002.......................................... 430 3,267
2003.......................................... 412 2,605
Later years, through 2005..................... 296 6,418
------ -------
Total minimum lease payments................. 2,868 $22,540
=======
Less amount representing interest (at rates
ranging from 5.0% to 11.5%).................. 571
------
Present value of net minimum capital lease
payments..................................... 2,297
Less current installments of obligations under
capital leases............................... 472
------
Obligations under capital leases, excluding
current installments......................... $1,825
======
</TABLE>
(8) Retirement Plans
The Company has retained the acquired companies' existing employee benefit
plans, primarily 401(k)-type arrangements with the Company matching amounts.
The Company's benefit plan expense for the plans was approximately $37,000,
$40,000, $24,000, and $348,000 for the years ended June 30, 1996 and 1997, the
six months ended December 31, 1997, and the year ended December 31, 1998.
Of those retirement plans, there is one defined benefit plan covering
employees of the Hederman Division, which represents approximately 100 of the
Company's 1,600 total employees. As of December 31, 1998, the plan had a
pension benefit obligation of $1.9 million, plan assets of $2.2 million and
prepaid pension cost of $.8 million recorded in other non-current assets.
Related net pension cost (credit) for the period was $(58,000).
(9) Related Party Transactions
As of December 31, 1997, the Company sold to its majority shareholder certain
of B&M Printing's printing equipment that was considered to be redundant as a
result of the various 1997 acquisitions. The equipment was sold at its net book
value ($2.8 million), which the Company believes approximated its fair market
value. The Company received a promissory note for the sale amount, which was
classified as an other asset at December 31, 1997. The note was repaid in 1998.
The Company's majority shareholder also had a $950,000 note payable to the
Company at December 31, 1997; the note was repaid in 1998.
The Company has leasing arrangements with its president and with certain of
the former owners of the acquired companies (each of whom is a current employee
of the Company) for certain plant facilities. The Company's aggregate annual
obligation under these operating lease agreements is approximately $2.1
million, and the agreements generally expire from 2000 through 2007.
F-13
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(10) Income Taxes
Income tax expense (benefit) consists of (in thousands):
<TABLE>
<CAPTION>
Years Ended June 30, Six Months Ended Year Ended
-------------------- December 31, December 31,
1996 1997 1997 1998
---------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Income tax (benefit) from:
Net earnings (loss)
before extraordinary
item................... $ 161 $ 25 $20 $ 628
Extraordinary loss...... 0 0 0 (1,458)
---------- --------- --- -------
$ 161 $ 25 $20 $ (830)
========== ========= === =======
</TABLE>
<TABLE>
<CAPTION>
Current Deferred Total
------- -------- -----
<S> <C> <C> <C>
Year ended June 30, 1996:
U.S. Federal........................................ $ 148 $ 19 $ 167
State and local..................................... 13 (19) (6)
----- ----- -----
$ 161 $ 0 $ 161
===== ===== =====
Year ended June 30, 1997:
U.S. Federal........................................ 0 0 0
State and local..................................... 0 25 25
----- ----- -----
$ 0 $ 25 $ 25
===== ===== =====
Six months ended December 31, 1997:
U.S. Federal........................................ 0 0 0
State and local..................................... 20 0 20
----- ----- -----
$ 20 $ 0 $ 20
===== ===== =====
Year ended December 31, 1998:
U.S. Federal........................................ (199) (578) (777)
State and local..................................... (53) 0 (53)
----- ----- -----
$(252) $(578) $(830)
===== ===== =====
</TABLE>
Income tax expense differed from the amounts computed by applying the U.S.
federal income tax rate of 34 percent to pretax income as a result of the
following:
<TABLE>
<CAPTION>
Years ended Six months ended Year ended
June 30, December 31, December 31,
------------ ---------------- ------------
1996 1997 1997 1998
----- ------ ---------------- ------------
<S> <C> <C> <C> <C>
Computed "expected" tax expense.... $ 113 $ (424) $(1,292) $ 355
Increase (reduction) in income
taxes resulting from:
Change in the beginning-of-the-
year balance of the valuation
allowance for deferred tax assets
allocated to income tax expense.. 0 527 1,272 (951)
State and local income taxes, net
of federal income tax benefit.... 13 (49) (150) (35)
Effect of S-Corporation termina-
tion............................. 0 0 (318) 0
Warrants valuation adjustment..... 0 0 556 0
Other, net........................ 35 (29) (48) (199)
----- ------ ------- -----
$ 161 $ 25 $ 20 $(830)
===== ====== ======= =====
</TABLE>
F-14
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31, 1997 and 1998 are presented below.
<TABLE>
<CAPTION>
December 31,
---------------
1997 1998
------- ------
<S> <C> <C>
Deferred tax assets:
Accounts receivable principally due to allowance for doubtful
accounts.................................................... $ 136 $ 417
Income tax loss carryforwards and tax credit carryforwards... 1,467 1,482
Vacation accrual............................................. 0 264
Alternative minimum tax credit carryforwards................. 80 80
Deferred compensation........................................ 253 357
Other........................................................ 218 376
------- ------
Total gross deferred tax assets............................. 2,154 2,976
Less valuation allowance...................................... (1,800) (849)
------- ------
Net deferred tax assets....................................... 354 2,127
Deferred tax liabilities:
Plant and equipment, principally due to differences in
depreciation and capitalized interest....................... 381 6,620
Purchase accounting adjustments.............................. 2,028 1,878
Other........................................................ 50 126
------- ------
Total gross deferred liabilities.............................. 2,459 8,624
------- ------
Net deferred tax liability.................................... $ 2,105 $6,497
======= ======
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1997 and
1998 was $1,800,000 and $849,000, respectively. The net change in the total
valuation allowance for the year ended December 31, 1998 was a decrease of
$951,000. This valuation allowance decrease relates to net operating loss
carryforwards and alternative minimum tax carryforwards. These tax assets were
previously fully reserved, as realization of these assets did not meet the
"more likely than not" standard for recognition of deferred tax assets. Based
on recent operating results, management now believes that it is "more likely
than not" that these assets will be realized; therefore, the valuation
allowance has been reduced. The remaining valuation allowance relates to
acquired tax attributes of certain of the acquired businesses. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based upon the level of historical
taxable income and projections for future taxable income over the periods which
the deferred tax assets are deductible, management believes it is more likely
than not the Company will realize the benefits of these deductible differences,
net of the existing valuation allowances at December 31, 1998.
At December 31, 1998, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $4 million which are available to
offset future federal taxable income, if any, through 2010. In addition, the
Company has alternative minimum tax credit carryforwards of approximately
$80,000 which are available to reduce future federal regular income taxes, if
any, over an indefinite period.
(11) Other Liabilities
As of December 31, 1997, the Company entered into deferred compensation
agreement with its executive officers. In the aggregate, these agreements
obligate the Company to pay a total of $1,000,000 to those officers on December
31, 2002. The agreements allow the officers to receive 100,000 shares of common
stock in lieu of cash. Such calls, for settlement in stock, may be exercised at
any time. The net present values of the ultimate obligation of $1.0 million was
accrued as compensation as of December 31, 1997, with the discount being
amortized as additional compensation over the five year life of the agreement;
the net present value at December 31, 1997 and 1998 was approximately $766,000
and $813,000, respectively. An early exercise of the calls by the officers
would result in an acceleration of the discount amortization.
F-15
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(12) Redeemable Preferred Stock
The company and its senior lender effectively entered into an exchange in
March 1998, whereby the Company issued 177,776 shares of its newly created
Series A Cumulative Convertible Preferred Stock, par value $0.001 ("Series A
Preferred Stock") in exchange for the senior lender's warrant to purchase a 4%
interest in the Company's outstanding common stock. The Series A Preferred
Stock carries an annual dividend rate of 5% of its liquidation value ($12.8125
per share); dividends are payable quarterly. The Series A Preferred Stock is
convertible into common stock at the holder's option at a ratio of 1 share of
common stock per each share of Series A Preferred Stock. The Series A Preferred
Stock is redeemable by the holder at the end of seven years at a price
effectively equal to the greater of its liquidation value or the fair value of
the underlying common stock on an as-if converted basis. The Series A Preferred
Stock has been classified out of stockholders' equity because of certain holder
put features that are out of the control of the Company. The preferred stock
was initially recorded at its fair value at the date of issuance (approximately
$1.35 million) and is being accreted to its mandatory redemption value.
(13) Shareholders' Equity
The Company has reserved 2,976,918 shares of common stock for their issuance
upon the conversion of its Series A Preferred Stock, the exercise of its seller
and lender warrants, and the exercise of its stock options.
Sellers' Warrants and Rights
As part of the consideration given in certain of the acquisitions, the
Company issued common stock warrants to the sellers. The terms of warrants were
generally the same, stating that the seller would have the ability to exercise
his warrant at any time during the ten years subsequent to an initial public
offering of common stock (June 1998). The exercise price is the initial public
offering price ($10 per share), and the shares obtainable are generally the
face amount of the sellers' notes divided by the initial public offering price
(231,000 shares). The estimated fair value of the warrants at the dates of
issuance, which totaled $1.6 million and $2.4 million at December 31, 1997 and
1998, respectively, has been recorded in shareholders' equity as additional
paid-in capital.
In connection with the acquisition of B&M Printing and relating financing,
the Company gave rights to acquire common stock to the former owners of B&M
Printing. As of December 31, 1998 rights to acquire 43,000 shares of common
stock at $10 per share were outstanding; the rights will expire in June, 2001.
No sellers' warrants or rights have been exercised to date.
Lenders' Warrants
In connection with the obtaining of a loan to partially fund its June 1997
acquisitions, the Company issued a common stock warrant to Sirrom. The warrant
granted Sirrom the right to acquire shares of common stock equivalent to six
percent of the Company's outstanding shares on a diluted basis on the date of
exercise, at exercise price of $0.01. In March 1998, Sirrom exercised the
warrant and was issued 266,664 shares of common stock.
In connection with the obtaining of acquisition financing under its loan and
security agreement, the Company issued to its senior lender a warrant to
acquire a fully-diluted four percent interest in its outstanding common stock
for a total purchase price of $100. The Senior Lender was granted a right to
put the warrant back to the Company under certain conditions. The redemption
price of the warrant was its current market value (as defined) on the date of
redemption. In March 1998, this warrant was exchanged for redeemable,
convertible preferred stock (see Note 12).
Because both of the lenders' warrants described above gave the holders the
right to put the warrants back to the Company for cash, these instruments were
recorded, at their respective fair values at the dates of issuance, as
redeemable common stock warrants in the accompanying consolidated balance
sheet, and therefore were initially excluded from shareholders' equity. The
initial fair market value of the lenders' warrants was netted against the
related debt and will be amortized as a component of interest expense over the
life of the
F-16
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
debt. The carrying value of the redeemable common stock warrants was adjusted
to fair value, with a corresponding charge to other expense in the statement of
operations in accordance with EITF Issue No. 96-13 until their respective
exercise and exchange as described above. Additionally, upon their exercise and
exchange, the carrying values of those warrants was reclassified to additional
paid-in capital and redeemable preferred stock, respectively.
In connection with the obtaining of certain acquisition financing in March
1998, the Company issued to its senior lender a warrant to acquire 220,000
shares of common stock. The warrant expires, if unexercised, on September 26,
2007. The senior lender was granted demand and piggyback registration rights.
The Company has the option to call the warrant under certain conditions,
including the passage of five years, at a price equal to the warrant's current
market value at that date. This instrument was recorded at its fair value at
the date of issuance as additional paid-in capital. The initial fair market
value of this warrant was netted against the related debt, and the resulting
discount was being amortized as a component of interest expense over the life
of the debt. As discussed above in Note 4, the remaining unamortized discount
was written off upon the extinguishment of the related debt in June 1998.
Stock Options
During 1998, the Company adopted the 1998 Equity Compensation Plan, which
provides for grants of stock options, stock appreciation rights, and restricted
stock to selected employees, officers, directors, consultants, and advisers to
the Company. The plan authorizes the issuance of up to 750,000 shares of the
Company's common stock. As of December 31, 1998, options to purchase 722,363
shares had been granted to employees of the Company. The exercise price for all
shares under option is the fair market value on the grant date ($10 per share).
The options vest over three years, and will expire, if unexercised, from five
to ten years from the grant date. The weighted average remaining contractual
life of the options is 5.9 years.
During 1998, the Company also adopted the 1998 Non-Employee Director Stock
Option Plan, which authorizes the issuance of up to 50,000 shares of common
stock. Under this plan, non-employee directors have been granted options
covering 2,000 shares of common stock; the options vest over 3 years and may be
exercised over the five-year period following the grant. The exercise price is
the fair market value of the common stock at the date of grant ($10 per share).
Changes in outstanding options under the Plans during the year ended December
31, 1998 and options exercisable at December 31, 1998 are as follows:
<TABLE>
<S> <C>
Outstanding at December 31, 1997........................................ 0
Granted .............................................................. 724,363
Exercised............................................................. 0
Canceled or expired................................................... 10,934
-------
Outstanding at December 31, 1998........................................ 713,429
=======
Exercisable at December 31, 1998 at $10.00.............................. 0
=======
</TABLE>
The Company accounts for its stock based employee compensation plans in
accordance with Accounting Principals Board Opinion No. 25, "Accounting for
Stock Issued to Employees." Accordingly, no compensation cost has been
recognized for fixed stock-option plans. In accordance with Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," a valuation using the fair-value-based accounting method has
been made for stock options issued in 1998. That valuation was performed using
the Black-Scholes option-pricing model.
The Company's options were valued assuming a risk-free interest rate of 4.87%
as of their issuance date in 1998, a dividend yield of 0%, an average expected-
option life of 5.6 years, and volatility of 78.5%. The
F-17
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
valuation determined a per share weighted-average fair value for the options
granted during 1998 of $2.66. Had those options been accounted for using the
fair-value method, they would have resulted in additional compensation cost in
1998 of $0.3 million; net earnings would have been $1.7 million ($0.25 per
share basic and $0.24 per share diluted).
(14) Earnings Per Share
Basic earnings per share are calculated by dividing net earnings less
preferred stock dividend and discount accretion by the weighted average number
of common shares outstanding. For the years ended June 30, 1996 and 1997, and
the six months ended December 31, 1997, there were 4,000,000 basic weighted
average shares outstanding; for the year ended December 31, 1998, there were
6,130,117 basic weighted average shares outstanding. There were no potentially
dilutive equity instruments outstanding in the years ended June 30, 1996 and
1997. Exercise of potential equity securities, including warrants, has not been
reflected in the computation of diluted EPS for the six months ended December
31, 1997 because their impact would have been antidilutive. Conversion of the
preferred stock is not assumed in the 1998 diluted earnings per share
calculations, as the effect is anti-dilutive on an incremental basis. Exercise
of employee stock options and certain other warrants are not assumed because
their 1998 effect would be anti-dilutive using the treasury stock method. For
the six months ended December 31, 1997 and the year ended December 31, 1998,
the diluted weighted average shares outstanding were 4,000,000 and 6,367,340,
respectively. Following is a reconciliation of the numerator and denominator of
the earnings (loss) per share (EPS) computations (in thousands except shares
and per share amounts):
<TABLE>
<CAPTION>
Years ended June 30, Six months ended Year ended
--------------------- December 31, December 31,
1996 1997 1997 1998
---------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Net earnings (loss) before
extraordinary loss....... $ 172 $ (1,273) $ (3,819) $ 3,973
Less preferred stock divi-
dends.................... 0 0 0 (84)
Less accretion of pre-
ferred stock discount.... 0 0 0 (87)
---------- ---------- ---------- ----------
Net earnings (loss) before
extraordinary loss
applicable to common
shares................... 172 (1,273) (3,819) 3,802
Extraordinary loss........ 0 0 0 (2,098)
---------- ---------- ---------- ----------
Net earnings (loss) appli-
cable to common shares... $ 172 $ (1,273) $ (3,819) $ 1,704
========== ========== ========== ==========
Basic:
Weighted average common
shares outstanding...... 4,000,000 4,000,000 4,000,000 6,130,117
========== ========== ========== ==========
Basic earnings (loss) per
share before extraordi-
nary loss............... $ 0.04 $ (0.32) $ (0.95) $ 0.62
========== ========== ========== ==========
Basic loss per share--ex-
traordinary loss........ 0.00 0.00 0.00 (0.34)
========== ========== ========== ==========
Basic earnings (loss) per
share................... $ 0.04 $ (0.32) $ (0.95) $ 0.28
========== ========== ========== ==========
Diluted:
Weighted average common
shares outstanding...... 4,000,000 4,000,000 4,000,000 6,130,117
Assumed exercise of war-
rants................... 0 0 0 237,223
---------- ---------- ---------- ----------
4,000,000 4,000,000 4,000,000 6,367,340
========== ========== ========== ==========
Diluted earnings (loss)
per share before ex-
traordinary loss........ $ 0.04 $ (0.32) $ (0.95) $ 0.60
========== ========== ========== ==========
Diluted loss per share--
extraordinary loss...... 0.00 0.00 0.00 (0.33)
========== ========== ========== ==========
Diluted earnings (loss)
per share............... $ 0.04 $ (0.32) $ (0.95) $ 0.27
========== ========== ========== ==========
</TABLE>
F-18
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(15) Other Financial Information
Accrued expenses (in thousands) consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------
1997 1998
<S> <C> <C>
Accrued compensation........................................... $1,841 $2,666
Accrued interest............................................... 438 1,181
Accrued acquisitions costs..................................... 1,852 183
Other accrued expenses......................................... 2,358 1,510
------ ------
$6,489 $5,540
====== ======
</TABLE>
The allowance for doubtful accounts was $662,000 and $1,182,000, at December
31, 1997 and 1998, respectively.
Following is summarized unaudited financial information for the six months
ended December 31, 1996: Revenue, $6,357,000; Gross profit, $977,000; Net
income, $(415,000); Earnings per share (basic and diluted), $0.00.
(16) Wholly-owned Operating Subsidiaries
Master Graphics is a holding company with no operating assets or operations.
Premier Graphics, its primary operating subsidiary, is the primary obligor for
the Senior Notes. The Senior Notes are fully and unconditionally guaranteed on
a joint and several basis by Master Graphics and Harperprints, Master Graphics'
only other subsidiary which was merged into Premier Graphics in March 1999.
Premier was formed in late June, 1997, and Harperprints was acquired in late
March, 1998. Following is summarized combined financial information of Premier
and Harperprints, as of December 31, 1997 and 1998 and for the six-month period
and year then ended (in thousands).
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1998
----------------- -----------------
<S> <C> <C>
Balance sheet data:
Current assets........................... $ 24,657 $ 62,956
Property, plant and equipment............ 29,351 74,943
Goodwill, net............................ 27,653 63,771
Due from Shareholder .................... 24,084 46,025
Other non-current assets................. 2,908 1,523
-------- --------
Total assets........................... $108,653 $249,218
======== ========
Current liabilities, including current
installments of long-term debt of $3,721
and 924 in
1997 and 1998........................... $ 15,044 $ 16,327
Long-term debt, net...................... 46,793 127,624
Other liabilities........................ 2,049 3,551
-------- --------
Total liabilities...................... 63,886 147,502
Stockholders' equity..................... 44,767 101,716
-------- --------
Total liabilities and stockholders'
equity................................ $108,653 $249,218
======== ========
</TABLE>
F-19
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
Six months ended Year ended
December 31, 1997 December 31, 1998
----------------- -----------------
<S> <C> <C>
Statement of operations data:
Net revenue............................... $32,394 $163,277
Gross profit.............................. 5,926 41,937
Operating income.......................... 1,248 14,864
Interest expense.......................... 2,181 9,677
Income tax expense (credit)............... 20 628
Extraordinay (loss)....................... 0 (2,098)
Net earnings (loss)....................... (2,471) 1,181
</TABLE>
The following unaudited pro forma financial information presents the combined
results of operations of Premier and Harperprints and the businesses acquired
in 1997 and 1998 as if the acquisitions and related financings, including the
initial public offering of Master Graphics common stock and the Senior Notes
offering had occurred as of January 1, 1997 and January 1, 1998, after giving
effect to certain adjustments, including amortization of goodwill, adjusted
depreciation expense and increased interest expense on debt related to the
acquisitions. The pro forma financial information does not necessarily reflect
the results of operations that would have occurred had Premier Graphics and the
acquired businesses constituted a single entity during such periods (in
thousands).
<TABLE>
<CAPTION>
Years ended December 31, 1997 1998
- ------------------------ -------- --------
<S> <C> <C>
Net revenue................................................. $215,077 $221,955
Operating income............................................ 13,768 19,985
Depreciation and amortization............................... 9,271 9,455
Net earnings (loss) ........................................ (2,226) 3,734
</TABLE>
Management believes that there are specific items included in the acquirees'
results of operations which are non-recurring and which, if removed from the
pro forma results noted above, would increase earnings by $1.2 million and $1.3
million for the years ended December 31, 1997 and 1998, respectively.
(17) Subsequent Events
In March 1999, the Company acquired all of the outstanding common stock of
Woods Lithographics, Inc. and Columbia Graphics Corporation. In addition, in
March, 1999, the Company acquired substantially all of the assets of White
Arts, Inc. All of these businesses are engaged in general commercial printing.
The three acquisitions were paid for with a combination of cash ($30.7
million), assumption of debt ($4.3 million) and issuance of 43,029 shares
common stock (valued at $.25 million). These acquisitions will be accounted for
by the purchase method and, accordingly, the results of operations will be
included in the Company's 1999 consolidated financial statements from their
respective acquisition dates in 1999. The estimated excess of the purchase
prices over fair value of the net identifiable assets acquired is estimated to
be approximately $9.1 million, which will be recorded as goodwill and amortized
on a straight line basis over 40 years.
Approximately $13 million of the cash portion of the acquisitions was funded
by the remaining cash from the Company's Senior Notes offering. The balance of
approximately $18.5 million was funded from the Company's senior credit
facility.
In March 1999, the Company completed an amendment to its senior secured
credit facility. Pursuant to the agreement, the facility consists of two term
loans ("Term Loan A" and "Term Loan B") each of $30 million and a revolving
credit facility ("Revolver") of $20 million. Term Loan A bears interest,
payable monthly, at a
F-20
<PAGE>
MASTER GRAPHICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
floating rate equal to LIBOR plus 2.5% (7.5% at December 31, 1998), and Term
Loan B bears interest, payable monthly, at a floating rate equal to LIBOR plus
3.0% (8.0% at December 31, 1998). Term Loan A matures in March 2004, and
principal is payable based on a five year amortization. Term Loan B matures in
March 2005 with quarterly principal payments based on amount of principal
outstanding with a final balloon payment at maturity. The annual amortization
of the $18.5 million borrowed in March 1999 will approximate $2.6 million for
each of the next five years. The Revolver, which contains certain borrowing
base limitations, bears interest at LIBOR plus 2.5% and is repayable in full in
March 2004.
The security for the facility includes a lien on all of the assets of Premier
and Harperprints, as well as a pledge by Master Graphics on all of the issued
and outstanding stock of Premier and Harperprints. The facility includes a
prepayment penalty of 3% of the amount prepaid during the first year of the
loan, 2% during the second year, 1% during the third year, and no prepayment
penalty after March 2002.
Under the facility, the Company is required to maintain certain financial
tests and ratios including, but not limited to a covenant requiring a minimum
level of prepayment to Term Loan A and Term Loan B based on 50% of annual
excess cash flows, as defined.
In March, 1999, Harperprints was merged into Premier Graphics; as a result,
Premier is sole subsidiary of Master Graphics.
F-21
