<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
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 33-31706-01
SULLIVAN COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
DELAWARE 62-1395968
<S> <C>
(State or other jurisdiction of incorporation or organization) (I.R.S. employer identification number)
</TABLE>
225 High Ridge Road
Stamford, Connecticut 06905
(203) 977-8101
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
SULLIVAN GRAPHICS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
NEW YORK 16-1003976
<S> <C>
(State or other jurisdiction of incorporation or organization) (I.R.S. employer identification number)
</TABLE>
100 Winners Circle
Brentwood, Tennessee 37027
(615) 377-0377
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Sullivan Communications, Inc. has 123,889 shares outstanding of its Common
Stock, $.01 Par Value, as of July 31, 1996 (all of which are privately owned and
not traded on a public market).
<PAGE> 2
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 1996 and March 31, 1996 3
Condensed Consolidated Statements of Operations for the
three months ended June 30, 1996 and 1995 5
Condensed Consolidated Statements of Cash Flows for the
three months ended June 30, 1996 and 1995 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
Exhibit Index 24
2
<PAGE> 3
SULLIVAN COMMUNICATIONS, INC.
Condensed Consolidated Balance Sheets
(Dollars in thousands, except par values)
<TABLE>
<CAPTION>
JUNE 30, 1996 MARCH 31, 1996
------------- --------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents -- --
Receivables:
Trade accounts, less allowance for
doubtful accounts of $5,338 and $4,830
at June 30, 1996 and March 31, 1996,
respectively $ 60,580 64,465
Other 3,386 3,588
--------- ---------
Total receivables 63,966 68,053
Inventories 14,503 13,181
Prepaid expenses and other current assets 4,678 4,285
--------- ---------
Total current assets 83,147 85,519
Property, plant and equipment 222,949 207,264
Less accumulated depreciation (56,874) (51,103)
--------- ---------
Net property, plant and equipment 166,075 156,161
Excess of cost over net assets acquired, less
accumulated amortization of $27,318 and
$25,269 at June 30, 1996 and March
31, 1996, respectively 87,275 89,324
Other assets 19,068 20,177
--------- ---------
Total assets $ 355,565 351,181
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
SULLIVAN COMMUNICATIONS, INC.
Condensed Consolidated Balance Sheets
(Dollars in thousands, except par values)
<TABLE>
<CAPTION>
JUNE 30, 1996 MARCH 31, 1996
------------- --------------
(Unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current installments of long-term debt and
capitalized leases $ 14,239 11,490
Trade accounts payable 41,041 35,931
Accrued expenses 30,282 27,271
Income taxes 881 1,215
--------- ---------
Total current liabilities 86,443 75,907
Long-term debt and capitalized leases, excluding
current installments 285,444 286,127
Deferred income taxes 7,995 7,801
Other liabilities 27,711 25,742
--------- ---------
Total liabilities 407,593 395,577
Stockholders' deficit:
Common stock, voting, $.01 par value, 5,852,223
shares authorized, 123,889 shares issued and
outstanding 1 1
Series A convertible preferred stock, $.01 par value,
4,000 shares authorized, issued and outstanding,
$40,000,000 liquidation preference -- --
Series B convertible preferred stock, $.01 par value,
1,750 shares authorized, issued and outstanding,
$17,500,000 liquidation preference -- --
Additional paid-in capital 57,499 57,499
Accumulated deficit (108,129) (100,525)
Cumulative translation adjustment (1,399) (1,371)
--------- ---------
Total stockholders' deficit (52,028) (44,396)
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' deficit $ 355,565 351,181
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
SULLIVAN COMMUNICATIONS, INC.
Condensed Consolidated Statements of Operations
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------
1996 1995
---- ----
<S> <C> <C>
Sales $ 139,704 124,490
Cost of sales 124,311 107,735
--------- ---------
Gross profit 15,393 16,755
Selling, general and administrative expenses 11,049 8,199
Amortization of goodwill 2,049 2,158
Restructuring costs 413 2,080
--------- ---------
Operating income 1,882 4,318
Other expense (income):
Interest expense 8,630 7,214
Interest income (47) (111)
Nonrecurring charge related to terminated
merger -- 1,534
Other, net (79) 144
--------- ---------
Total other expense 8,504 8,781
--------- ---------
Loss before income taxes (6,622) (4,463)
Income tax expense (982) (2,817)
--------- ---------
Net loss $ (7,604) (7,280)
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
SULLIVAN COMMUNICATIONS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
--------
1996 1995
---- ----
<S> <C> <C>
Cash flows provided (used) by operating activities:
Net loss $ (7,604) (7,280)
Adjustments to reconcile net loss to cash provided (used) by operating activities:
Depreciation 5,805 5,195
Amortization of goodwill and other assets 2,589 2,514
Amortization of deferred financing costs and bond premium 426 150
-------- --------
8,820 7,859
Decrease (increase) in working capital and other 12,706 (4,091)
-------- --------
Net cash provided (used) by operating activities 13,922 (3,512)
Cash flows provided (used) by investing activities:
Purchases of property, plant and equipment (2,277) (7,146)
Proceeds from sales of property, plant and equipment 19 1
Other (34) (18)
-------- --------
Net cash used by investing activities (2,292) (7,163)
Cash flows provided (used) by financing activities:
Repayment of long-term debt, including current maturities (2,164) (3,495)
Net (decrease) increase in revolver borrowings (9,018) 12,000
Payments under capital lease obligations (277) (69)
Payment of deferred financing costs (171) (69)
Other, net -- 55
-------- --------
Net cash (used) provided by financing activities (11,630) 8,422
Effect of exchange rates on cash and cash equivalents -- 3
-------- --------
Decrease in cash and cash equivalents -- (2,250)
Cash and cash equivalents:
Beginning of period -- 4,635
-------- --------
End of period $ -- 2,385
======== ========
Noncash investing activity:
Capital lease obligations $ 13,466 351
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
<PAGE> 7
SULLIVAN COMMUNICATIONS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
DESCRIPTION OF THE COMPANY
Sullivan Communications, Inc. ("Communications"), and, together with its wholly
owned subsidiary, Sullivan Graphics, Inc. ("Graphics"), collectively, the
("Company") was formed in April 1989 under the name GBP Holdings, Inc. to effect
the purchase of all the capital stock of GBP Industries, Inc. from its
stockholders in a leveraged buyout transaction. In October 1989, GBP Holdings,
Inc. changed its name to Sullivan Holdings, Inc. and GBP Industries, Inc.
changed its name to Sullivan Graphics, Inc. Effective June 1993, Sullivan
Holdings, Inc. changed its name to Sullivan Communications, Inc.
On April 8, 1993 (the "Acquisition Date"), pursuant to an Agreement and Plan of
Merger dated as of March 12, 1993, as amended (the "Merger Agreement"), between
Communications and SGI Acquisition Corp. ("Acquisition Corp."), Acquisition
Corp. was merged with and into Communications (the "Acquisition"). Acquisition
Corp. was formed by The Morgan Stanley Leveraged Equity Fund II, L.P., certain
institutional investors and certain members of management (the "Purchasers") for
the purpose of acquiring a majority interest in Communications. Acquisition
Corp. acquired a substantial and controlling majority interest in Communications
in exchange for $40 million in cash. In the Acquisition, Communications
continued as the surviving corporation and the separate corporate existence of
Acquisition Corp. was terminated.
On August 15, 1995, the Company completed a merger transaction (the "Shakopee
Merger") with Shakopee Valley Printing Inc. ("Shakopee"). Shakopee was formed to
effect the purchase of certain assets and assumption of certain liabilities of
Shakopee Valley Printing, a division of Guy Gannett Communications. On December
22, 1994, pursuant to an Agreement for the Purchase of Assets between Guy
Gannett Communications (the "Seller") and Shakopee (the "Buyer"), the Seller
agreed to sell (effective at the close of business on December 22, 1994) certain
assets and transfer certain liabilities of Shakopee Valley Printing to the Buyer
for a total purchase price of approximately $42.6 million, primarily financed
through the issuance of 35,000 shares of Common Stock and bank borrowings. The
35,000 shares were purchased by Morgan Stanley Capital Partners III, L.P.,
Morgan Stanley Capital Investors, L.P. and MSCP III 892 Investors, L.P.
(collectively, the "MSCP III Entities"), together with First Plaza Group Trust
and Leeway & Co. The general partner of each of the MSCP III Entities is a
wholly owned subsidiary of Morgan Stanley Group Inc., the parent company of the
general partner of the Company's majority stockholder. In addition, the other
stockholders of Shakopee were also stockholders of the Company.
Communications has no operations or significant assets other than its investment
in Graphics. Communications is dependent upon distributions from Graphics to
fund its obligations. Under the terms of its debt agreements at June 30, 1996,
Graphics' ability to pay dividends or lend to Communications is either
restricted or prohibited, except that Graphics may pay specified amounts to
Communications (i) to pay the repurchase price payable to any officer or
employee (or their estates) of Communications, Graphics or any of their
respective subsidiaries in respect of their stock or options to purchase stock
in Communications upon the death, disability or termination of employment of
such officers and employees (so long as no default, or event of default, as
defined, has occurred under the terms of the New Bank Credit Agreement, as
defined below, and provided the aggregate amount of all such repurchases does
not exceed $2,000,000) and (ii) to fund the payment of Communications operating
expenses incurred in the ordinary course of business, other corporate overhead
costs and expenses (so long as the aggregate amount of such payments does not
exceed $250,000 in any fiscal year) and Communications' obligations pursuant to
a tax sharing agreement with Graphics. Substantially all of Graphics' long-term
obligations have been fully and unconditionally guaranteed by Communications.
7
<PAGE> 8
SULLIVAN COMMUNICATIONS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The two business sectors of the commercial printing industry in which the
Company operates are printing and digital imaging/prepress services conducted by
its American Color division ("American Color").
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and are in accordance with instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. The operating results for the three month
period ended June 30, 1996 are not necessarily indicative of the results that
may be expected for the fiscal year ended March 31, 1997. These unaudited
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and footnotes thereto included in the
Company's Form 10-K for the fiscal year ended March 31, 1996 and the Company's
Post-Effective Amendment No. 2 to Registration Statement No. 33-97090 on Form
S-1.
Certain prior period amounts have been reclassified to conform with current
period presentation.
2. THE SHAKOPEE MERGER
On August 15, 1995, the Shakopee Merger was consummated and each outstanding
share of the Common Stock of Shakopee was converted into one share of the Common
Stock of the Company and 1/20 of one share of Series B Preferred Stock of the
Company. Also on August 15, 1995, concurrent with the Shakopee merger
transaction, the Company refinanced a significant portion of its outstanding
indebtedness, including indebtedness assumed in the Shakopee Merger (the
"Refinancing"). See note 3 for a description of the Refinancing.
The Shakopee Merger has been accounted for as a combination of entities under
common control (similar to a pooling-of-interests), and accordingly, the
unaudited condensed consolidated financial statements give retroactive effect to
the Shakopee Merger and include the combined operations of Communications and
Shakopee subsequent to December 22, 1994.
8
<PAGE> 9
SULLIVAN COMMUNICATIONS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3. THE REFINANCING
On August 15, 1995, the Company sold $185 million of 12 3/4% Senior Subordinated
Notes Due 2005 (the "New Notes"). In connection with the sale of the New Notes,
the Company entered into a series of transactions (the Refinancing and
together with the Shakopee Merger, the "Transactions"), including the following:
(i) the Company entered into a Credit Agreement with BT Commercial Corporation
("BTCC") and other financial institutions (the "New Bank Credit Agreement"),
providing Graphics with a $75 million revolving credit facility maturing in 2000
(the "New Revolving Credit Facility") and a $60 million amortizing term loan
with a final maturity in 2000 (the "New Term Loan"); (ii) the repayment of all
$126.5 million of indebtedness outstanding under Graphics' old bank credit
agreement (plus $2.3 million of accrued interest to the date of repayment);
(iii) the redemption of all outstanding 15% Senior Subordinated Notes Due 2000
of Graphics at an aggregate redemption price of $105.6 million (plus $1.8
million of accrued interest to the redemption date); (iv) the repayment of all
$24.6 million of indebtedness assumed in the Shakopee Merger (plus $0.1 million
of accrued interest to the date of repayment) and (v) the incurrence of
approximately $11.8 million of fees and expenses related to the Transactions. As
a result of the Transactions, the Company recorded an extraordinary loss related
to early extinguishment of debt of $4.5 million, net of $0 taxes. This
extraordinary loss primarily consisted of the early redemption premium on the
15% Senior Subordinated Notes and the write-off of deferred financing costs
related to refinanced indebtedness partially offset by the write-off of a bond
premium associated with the 15% Senior Subordinated Notes.
Borrowings under the New Revolving Credit Facility are subject to a borrowing
base which consists of (i) 85% of Eligible Accounts Receivable plus (ii) the
lesser of (x) $15.0 million or (y) 60% of Eligible Inventory plus (iii)
Equipment Acquisition Loans in an amount not to exceed $7.5 million outstanding
at any time, each of which must be repaid within six months from the date of
borrowing minus (iv) the aggregate amount of reserves against Eligible Accounts
Receivable and Eligible Inventory established by BTCC.
At June 30, 1996, the remaining New Term Loan amortizes in the following annual
amounts: (i) $6.8 million through the remainder of Fiscal Year 1997, (ii) $10.6
million in Fiscal Year 1998, (iii) $13.3 million in Fiscal Year 1999, (iv) $15.2
million in Fiscal Year 2000 and (v) $8.0 million in Fiscal Year 2001.
Communications has guaranteed Graphics' indebtedness under the New Bank Credit
Agreement, as amended (the "Bank Credit Agreement"), which guarantee is secured
by a pledge of all Graphics' and its subsidiaries' stock. In addition,
borrowings under the Bank Credit Agreement are secured by substantially all of
the assets of Graphics. Communications is restricted under its guarantee of the
Bank Credit Agreement from, among other things, entering into mergers,
acquisitions, incurring additional debt and paying dividends.
Interest under the Bank Credit Agreement is floating based on prevailing market
rates and is computed using various rate options over periods of 30, 60, 90 or
180 days as selected by the Company.
9
<PAGE> 10
SULLIVAN COMMUNICATIONS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The amortization for total long-term debt and capitalized leases at June 30,
1996 is shown below (in thousands):
<TABLE>
<CAPTION>
LONG-TERM CAPITALIZED
FISCAL YEAR DEBT LEASES
- ---------------------------------------------------- ----------- -----------
<S> <C> <C>
1997 (remaining nine months) $ 8,226 $ 3,694
1998 13,013 4,747
1999 15,208 3,629
2000 15,793 3,082
2001 39,126 2,843
Thereafter 187,265 11,289
--------- -------
Total $ 278,631 29,284
=========
Imputed Interest (8,232)
-------
Present value of minimum lease payments $21,052
=======
</TABLE>
4. THE GOWE ACQUISITION
On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a Medina, Ohio
based regional printer of newspapers, T.V. books and retail advertising inserts
and catalogs ("Gowe"), for approximately $6.7 million in cash and assumption of
certain liabilities of Gowe, Inc., pursuant to an Asset Purchase Agreement,
among Graphics, Gowe, Inc. and ComCorp, Inc., the parent company of Gowe, Inc.
(the "Gowe Acquisition"). The Gowe Acquisition was accounted for under the
purchase method of accounting applying the provisions of Accounting Principles
Board Opinion No. 16 ("APB 16"). Pursuant to the requirements of APB 16, the
purchase price was allocated to the tangible assets and identifiable intangible
assets and liabilities assumed based upon their respective fair values. The
allocation of the purchase price is preliminary and may change during the
allocation period. Gowe's results of operations for the three month period ended
June 30, 1996 are included in the Company's consolidated financial statements.
The Company's pro forma unaudited results of operations for the three months
ended June 30, 1995, assuming that the Gowe Acquisition occurred as of April 1,
1995, were $131.6 million in sales and a $7.2 million net loss.
5. DISPOSAL OF 51% INTEREST IN NATIONAL INSERTING SYSTEMS, INC.
On March 11, 1996, the Company sold its 51% interest in National Inserting
Systems, Inc. ("NIS") for approximately $2.5 million in cash and a note for
approximately $0.2 million under the terms of a Stock Redemption Agreement
between NIS and Graphics. This transaction resulted in a net gain on disposal of
approximately $1.3 million, which was classified as other, net in the
consolidated statement of operations for the fiscal year ended March 31, 1996.
The proceeds of the sale were used to repay indebtedness under Graphics' Bank
Credit Agreement (as defined herein).
10
<PAGE> 11
SULLIVAN COMMUNICATIONS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. INVENTORIES
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1996 MARCH 31, 1996
------------- --------------
<S> <C> <C>
Paper $12,217 11,937
Ink 273 272
Equipment held for sale 641 349
Supplies and other 1,372 623
------- -------
Total Inventories $14,503 13,181
======= =======
</TABLE>
In the third quarter of the fiscal year ended March 31, 1996, the Company
changed to the first-in, first-out ("FIFO") method of accounting from the
last-in, first-out ("LIFO") method of accounting as the principal method of
accounting for inventories. The change results in a balance sheet (1) which
reflects inventories at a value that more closely represents current costs which
the Company believes are the primary concern of its constituents (bank lenders,
financial markets, customers, trade creditors, etc.) and (2) that enhances the
comparability of the Company's financial statements by changing to the
predominant method used by key competitors in the printing industry. The effect
(approximately $0.8 million) of the change for the six months ended September
30, 1995 resulted in the retroactive restatement of the first and second
quarters of the fiscal year ended March 31, 1996 of approximately $0.5 million
and $0.3 million, respectively, as a decrease of cost of goods sold and a
decrease to net loss.
7. NONRECURRING CHARGES RELATED TO TERMINATED MERGER
The Company recognized $1.5 million of expenses related to a terminated merger
in the three month period ended June 30, 1995.
11
<PAGE> 12
SULLIVAN COMMUNICATIONS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
8. RESTRUCTURING COSTS
In April 1995, the Company approved a plan for its American Color division which
is designed to improve productivity, increase customer service and
responsiveness, and provide increased growth in this business. The cost of this
plan is being accounted for in accordance with the guidance set forth in
Emerging Issues Task Force Issue 94-3 "Liability Recognition for Certain
Employee Termination Benefits and other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)". The estimated pretax costs
associated with this plan of $4.8 million represent employee termination,
goodwill write-down and other related costs that will be incurred as a direct
result of the plan. In the quarter ended June 30, 1995, the Company recognized
$2.1 million of such charges, primarily for severance and other personnel
related costs. In the quarter ended September 30, 1995, the Company recognized
$0.6 million of restructuring costs primarily related to hiring and relocating
certain management personnel. In the quarter ended December 31, 1995, the
Company recognized an additional $0.1 million of restructuring costs. In the
quarter ended March 31, 1996, the Company recognized $1.3 million of
restructuring costs, which included $0.9 million of goodwill write-down and $0.4
million primarily related to certain relocation costs associated with the
restructuring. The goodwill written down related to certain facilities that were
either shut down or relocated as part of the American Color restructuring. In
addition, approximately $0.4 million of restructuring costs were recognized in
the quarter ended June 30, 1996, primarily related to relocation costs. The
remaining costs of approximately $0.3 million, principally related to additional
relocation and other transition expenses, will be recorded as incurred.
9. COMMITMENTS AND CONTINGENCIES
The Company has employment agreements with two of its principal officers and
four other employees. Such agreements provide for minimum salary levels as well
as for incentive bonuses which are payable if specified management goals are
attained. The aggregate commitment for future salaries at June 30, 1996,
excluding bonuses, was approximately $3.1 million.
Graphics, together with over 300 other persons, has been designated by the U.S.
Environmental Protection Agency as a potentially responsible party (a "PRP")
under the Comprehensive Environmental Response Compensation and Liability Act
("CERCLA," also known as "Superfund") at one Superfund site. Although liability
under CERCLA may be imposed on a joint and several basis and the Company's
ultimate liability is not precisely determinable, the PRPs have agreed that
Graphics' share of removal costs is 0.46% and therefore Graphics believes that
its share of the anticipated remediation costs at such site will not be material
to its business or financial condition. Based upon an analysis of Graphics'
volumetric share of waste contributed to the site and the agreement among the
PRPs, the Company has recorded a reserve of approximately $0.1 million in
connection with this liability on its consolidated balance sheet at June 30,
1996. The Company believes this amount is adequate to cover such liability.
On December 21, 1989, Graphics sold its ink manufacturing operations and
facilities ("CPS"). Graphics remains contingently liable under $4.7 million of
industrial revenue bonds assumed by the purchaser ("CPS Buyer") in this
transaction. The CPS Buyer which assumed these liabilities has agreed to
indemnify Graphics for any resulting obligation and has also provided an
irrevocable letter of credit in favor of the holders of such bonds. Accordingly,
management believes that any obligation of Graphics under this contingency is
unlikely.
The Company has been named as a defendant in several other legal actions arising
from its normal business activities. In the opinion of management, any liability
that may arise from such actions will not have a material adverse effect on the
consolidated financial statements of the Company.
12
<PAGE> 13
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
RESULTS OF OPERATIONS
GENERAL
On August 15, 1995, Shakopee Valley Printing, Inc. ("Shakopee") was merged with
and into Sullivan Graphics, Inc. ("Graphics") (the "Shakopee Merger"). The
merger has been accounted for as a combination of entities under common control
(similar to a pooling-of-interests), and accordingly, the condensed consolidated
financial statements give retroactive effect to the Shakopee Merger and include
the combined operations of Sullivan Communications, Inc. ("Communications") and
Shakopee subsequent to December 22, 1994 (the date on which Shakopee became
under common control with Graphics and Communications (the "Company")).
On March 11, 1996, Graphics sold its 51% interest in National Inserting Systems
("NIS") for approximately $2.5 million in cash and a note for approximately $0.2
million under the terms of a Stock Redemption Agreement between NIS and
Graphics. The proceeds from the sale were used to repay indebtedness under the
Bank Credit Agreement (as defined herein).
On March 12, 1996, Graphics acquired the assets of Gowe, Inc., a Medina, Ohio
based regional printer of newspapers, T.V. books and retail advertising inserts
and catalogs ("Gowe"), for approximately $6.7 million in cash and assumption of
certain liabilities of Gowe, Inc., pursuant to an Asset Purchase Agreement (the
"Gowe Acquisition"). The Gowe Acquisition was accounted for under the purchase
method of accounting applying the provisions of Accounting Principles Board
Opinion No. 16 ("APB 16"). Pursuant to the requirements of APB 16, the purchase
price was allocated to the tangible assets and identifiable intangible assets
and liabilities assumed based upon their respective fair values. The allocation
of the purchase price is preliminary and may change during the allocation
period. Gowe's results of operations for the three month period ended June 30,
1996 (the "1996 Three Month Period") are included in the Company's consolidated
financial statements.
During March 1996, the Company completed the construction and start-up of a new
plant in Hanover, Pennsylvania ("Flexi-Tech"). Flexi-Tech will be dedicated to
the production of commercial flexi books (a form of advertising inserts) serving
various segments of the retail advertising market and the production of T.V.
listing guides serving the newspaper market.
In the 1996 Three Month Period, the Company began to present certain fixed costs
of its American Color production facilities within cost of sales rather than as
selling, general and administrative expenses. This new presentation is
consistent with the Company's presentation of the printing sector's financial
information, and the Company believes that this is a more accurate measure of
the gross margin of the business. The financial information in the three months
ended June 30, 1995 (the "1995 Three Month Period") for the American Color
sector has been reclassified to conform with this presentation.
13
<PAGE> 14
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following table summarizes the Company's results of operations for the 1996
Three Month Period, and the 1995 Three Month Period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
----------------------------------
1996 1995
---- ----
(dollars in thousands)
<S> <C> <C>
SALES:
Printing $ 120,342 $ 105,378
American Color 17,759 17,953
Other (b) 1,603 1,159
--------- ---------
Total $ 139,704 $ 124,490
GROSS PROFIT:
Printing $ 11,312 $ 13,173
American Color 3,380 3,260
Other (b) 701 322
--------- ---------
Total $ 15,393 $ 16,755
GROSS MARGIN:
Printing 9.4% 12.5%
American Color 19.0% 18.2%
Total 11.0% 13.5%
OPERATING INCOME
(LOSS):
Printing $ 6,025 $ 8,981
American Color (944)(a) (1,194)(a)
Other (b) (c) (3,199) (3,469)
--------- ---------
Total $ 1,882 $ 4,318
</TABLE>
(a) Includes the impact of restructuring costs of $0.4 million in the 1996 Three
Month Period and $2.1 million in the 1995 Three Month Period.
(b) Other operations consist primarily of revenues and expenses associated with
the Company's 51% owned subsidiary, NIS (sold on March 11, 1996), and its
wholly-owned subsidiary, Sullivan Media Corporation ("SMC").
(c) Also reflects corporate selling, general and administrative expenses, and
amortization expense.
14
<PAGE> 15
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
PRINTING
SALES. Printing sales increased $14.9 million to $120.3 million in the 1996
Three Month Period from $105.4 million in the 1995 Three Month Period. This
increase includes $11.9 million of sales by Gowe and Flexi-Tech, and the impact
of increased paper prices. These increases were partially offset by the impact
of continued competitive pricing pressures which in part resulted from the weak
retail environment in the last calendar quarter of 1995. Overall production
volume (excluding Gowe and Flexi-Tech) remained relatively consistent between
the periods.
GROSS PROFIT. Printing gross profit decreased $1.9 million to $11.3 million in
the 1996 Three Month Period from $13.2 million in the 1995 Three Month Period.
Printing gross margin decreased to 9.4% in the 1996 Three Month Period from
12.5% in the 1995 Three Month Period. The decrease in gross profit includes the
impact of continued competitive pricing pressure, a reduction in the price of
paper by-products, and incremental costs related to the start-up of Flexi-Tech.
These decreases were partially offset by reduced variable production and certain
other manufacturing costs due to continued cost containment programs at the
printing plants and incremental gross margin from Gowe. The decrease in gross
margin as a percentage of sales includes the above mentioned factors and the
impact of increased paper prices.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Printing selling, general and
administrative expenses increased to $5.3 million or 4.4% of printing sales in
the 1996 Three Month Period from $4.2 million or 4.0% of printing sales in the
1995 Three Month Period. This increase includes selling, general and
administrative expenses of Gowe and Flexi-Tech, and increased sales and
marketing expenses offset in part by decreases in certain employee related
expenses.
OPERATING INCOME. As a result of these factors, operating income from the
printing business decreased to $6.0 million in the 1996 Three Month Period from
$9.0 million in the 1995 Three Month Period.
AMERICAN COLOR
SALES. American Color's sales decreased $0.2 million to $17.8 million in the
1996 Three Month Period from $18.0 million in the 1995 Three Month Period. This
decrease is primarily the result of lower prepress production volume partially
offset by increases in digital visual effects work.
GROSS PROFIT. American Color's gross profit increased $0.1 million to $3.4
million in the 1996 Three Month Period from $3.3 million in the 1995 Three Month
Period. American Color's gross margin increased to 19.0% in the 1996 Three Month
Period from 18.2% in the 1995 Three Month Period. These increases are primarily
the result of cost savings in material and other production costs offset in part
by facilities management start-up costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. American Color's selling, general
and administrative expenses increased to $3.9 million or 22.0% of American
Color's sales in the 1996 Three Month Period from $2.4 million or 13.2% of
American Color's sales in the 1995 Three Month Period. These increases are a
result of increased sales and marketing expenses and the addition of operations
and administrative personnel and related expenses.
15
<PAGE> 16
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
OPERATING INCOME (LOSS). As a result of these factors and the incurrence of
restructuring costs related primarily to employee termination and other expenses
associated with the American Color restructuring plan of $0.4 million and $2.1
million in the 1996 and 1995 Three Month Periods, respectively, operating losses
at American Color decreased to a loss of $0.9 million in the 1996 Three Month
Period from a loss of $1.2 million in the 1995 Three Month Period.
See discussion below for information regarding the American Color restructuring
plan.
OTHER OPERATIONS
Other operations consist primarily of revenues and expenses associated with the
Company's 51% owned subsidiary, NIS (sold March 11, 1996), and its wholly-owned
subsidiary, SMC. In addition, other operations include corporate selling,
general and administrative and other expenses and amortization expense.
Amortization expense related to other operations, including goodwill
amortization (see below), were $2.3 million and $2.4 million, in the 1996 Three
Month Period and the 1995 Three Month Period, respectively.
Operating losses from other operations decreased $0.3 million to a loss of $3.2
million in the 1996 Three Month Period from a loss of $3.5 million in the 1995
Three Month Period. This includes reduced amortization expenses and a reduction
in certain other employee related costs.
GOODWILL AMORTIZATION
Amortization expense associated with goodwill was $2.0 million and $2.2 million
for the 1996 and 1995 Three Month Periods, respectively.
16
<PAGE> 17
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
RESTRUCTURING COSTS
In April 1995, the Company approved a plan for its American Color division which
is designed to improve productivity, increase customer service and
responsiveness, and provide increased growth in this business. The cost of this
plan is being accounted for in accordance with the guidance set forth in
Emerging Issues Task Force Issue 94-3 "Liability Recognition for Certain
Employee Termination Benefits and other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)". The estimated pretax costs
associated with this plan of $4.8 million represent employee termination,
goodwill write-down and other related costs that will be incurred as a direct
result of the plan. In the quarter ended June 30, 1995, the Company recognized
$2.1 million of such charges, primarily for severance and other personnel
related costs. In the quarter ended September 30, 1995, the Company recognized
$0.6 million of restructuring costs, related primarily to hiring and relocating
certain management personnel. In the quarter ended December 31, 1995, the
Company recognized an additional $0.1 million of restructuring costs. In the
quarter ended March 31, 1996, the Company recognized $1.3 million of
restructuring costs, which included $0.9 million of goodwill write-down and $0.4
million primarily related to certain relocation costs associated with the
restructuring. The goodwill written down related to certain facilities that were
either shut down or relocated as part of the American Color restructuring. In
addition, approximately $0.4 million of restructuring costs were recognized in
the quarter ended June 30, 1996, primarily related to relocation costs. The
remaining costs of approximately $0.3 million, principally related to additional
relocation and other transition expenses, will be recorded as incurred.
INTEREST EXPENSE
Interest expense increased 19.6% to $8.6 million in the 1996 Three Month Period
from $7.2 million in the 1995 Three Month Period. This increase primarily
includes the impact of increased indebtedness levels including indebtedness
related to the Transactions (see note 3 to the Unaudited Condensed Consolidated
Financial Statements).
NONRECURRING CHARGES RELATED TO TERMINATED MERGER
The Company recognized $1.5 million of expenses related to a terminated merger
in the 1995 Three Month Period.
OTHER EXPENSE, NET
Other expense, net increased to income of $0.1 million in the 1996 Three Month
Period from expense of $0.1 million in the 1995 Three Month Period.
17
<PAGE> 18
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
INCOME TAX EXPENSE
Income tax expense decreased to $1.0 million in the 1996 Three Month Period from
$2.8 million in the 1995 Three Month Period. This decrease is primarily due to
the Shakopee Merger, smaller amounts of taxable income in foreign jurisdictions,
and a decrease in deferred tax expense. During the 1996 Three Month Period the
Company increased its valuation allowance by $1.9 million to $23.1 million. The
valuation allowance reflects the excess of deferred tax assets (the tax effect
of future deductible temporary differences) over deferred tax liabilities (the
tax effect of future taxable temporary differences). The increase in the
valuation allowance during the 1996 Three Month Period results primarily from
the related period tax loss for which tax benefit will not be recorded.
NET LOSS
As a result of the factors discussed above, the Company's net loss increased to
$7.6 million in the 1996 Three Month Period from $7.3 million in the 1995 Three
Month Period.
LIQUIDITY AND CAPITAL RESOURCES
In August 1995, the Company refinanced substantially all of its existing
indebtedness (the "Refinancing") (see note 3 to the Unaudited Condensed
Consolidated Financial Statements). The primary objectives of the Refinancing
were to gain greater financial and operating flexibility, to facilitate the
merger with Shakopee, to refinance near-term debt service requirements and to
provide further opportunity for internal growth and growth through acquisitions.
As part of the Refinancing, the Company received gross proceeds of $185 million
from the sale of 12 3/4% Senior Subordinated Notes Due 2005 (the "New Notes").
The gross proceeds of the offering of the New Notes, together with $85.6 million
in borrowings under the amended credit agreement with BT Commercial Corporation
and other financial institutions (the "Bank Credit Agreement"), and existing
cash balances were used (i) to redeem all $100 million principal amount of the
15% Senior Subordinated Notes at a redemption price of $105.6 million (plus $1.8
million of accrued interest to September 15, 1995, the redemption date), (ii) to
repay all $126.5 million of indebtedness outstanding under Graphics' old bank
credit agreement (plus $2.3 million of accrued interest at the repayment date),
(iii) to repay all $24.6 million of indebtedness assumed in the Shakopee Merger
(plus $0.1 million of accrued interest at the repayment date) and (iv) to fund
approximately $11.8 million of fees and expenses incurred in connection with the
Transactions.
18
<PAGE> 19
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The Bank Credit Agreement includes a revolving credit facility which matures on
September 30, 2000 (the "New Revolving Credit Facility") providing for a maximum
of $75 million of borrowing availability, subject to a borrowing base
requirement (see Note 3 to the Unaudited Condensed Consolidated Financial
Statements). As of July 31, 1996, the Company had borrowings of $24.8 million
outstanding under the New Revolving Credit Facility and $28.0 million of
additional borrowing availability. After giving effect to the semi-annual
interest payment on the New Notes on August 1, 1996 of $11.8 million, the
borrowing availability was approximately $16.2 million. The Company expects that
it will from time to time during the fiscal year ending March 31, 1997 ("Fiscal
Year 1997") use a substantial portion of its availability in the normal course
of its operations.
The Bank Credit Agreement also provides for a $60 million amortizing term loan
with a final maturity on September 30, 2000 (the "New Term Loan"). Remaining
Fiscal Year 1997 scheduled payments due under the New Term Loan are $6.8
million.
Cash from operations and net borrowings under the New Revolving Credit Facility
(see the Unaudited Condensed Consolidated Statements of Cash Flows) were used to
repay $2.2 million in scheduled principal payments on indebtedness during the
1996 Three Month Period. Additionally, these cash sources were used to fund the
Company's cash capital expenditures for the 1996 Three Month Period of $2.3
million and the repayment of capital lease obligations of $0.3 million. The
Company plans to continue its program of upgrading its printing and prepress
equipment and expanding production capacity and currently anticipates that full
year Fiscal Year 1997 cash capital expenditures will approximate $11.4 million
and repayment of capital lease obligations will approximate $3.5 million. In
addition, the Company plans to acquire equipment under capital leases of
approximately $25.3 million during full year Fiscal Year 1997. The
Company had zero cash and cash equivalents on hand at June 30, 1996 due to a
requirement under the Bank Credit Agreement that substantially all of the
Company's daily available funds be used to reduce borrowings under the New
Revolving Credit Facility. The Company expects that its ongoing liquidity
requirements during Fiscal Year 1997 will be met from cash from operations and
amounts available under the Bank Credit Agreement. The Company is currently in
compliance with all financial covenants set forth in the Bank Credit Agreement.
At June 30, 1996, the Company had total debt outstanding of $299.7 million,
including capital lease obligations. Of the total debt outstanding at June 30,
1996, $84.4 million was outstanding under the Bank Credit Agreement at a
weighted average interest rate of 8.19%. A significant portion of the Company's
indebtedness (other than the New Notes) bears interest at floating rates,
causing the Company to be sensitive to prevailing interest rates. At June 30,
1996, the Company had indebtedness other than obligations under the Bank Credit
Agreement of $215.3 million (including $185 million of New Notes).
19
<PAGE> 20
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
EBITDA
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
-------------------------
1996 1995
---- ----
(dollars in thousands)
EBITDA:
<S> <C> <C>
Printing $ 10,811 $ 13,036
American Color 347(a) (7)(a)
Other (b) (c) (882) (1,005)
-------- --------
Total $ 10,276 $ 12,024
EBITDA MARGIN:
Printing 9.0% 12.4%
American Color 2.0% 0.0%
Total 7.4% 9.7%
</TABLE>
(a) Includes the impact of restructuring costs of $0.4 million in the 1996 Three
Month Period and $2.1 million in the 1995 Three Month Period.
(b) Other operations consist primarily of revenues and expenses associated with
the Company's 51% owned subsidiary, NIS (sold on March 11, 1996), and its
wholly owned subsidiary SMC.
(c) Also reflects corporate selling, general and administrative expenses.
EBITDA is presented and discussed because management believes that investors
regard EBITDA as a key measure of a leveraged company's performance and ability
to meet its future debt service requirements. "EBITDA" is defined as earnings
before net interest expense, income tax (expense) benefit, depreciation,
amortization, other special charges related to asset write-offs and write-downs,
other income (expense), discontinued operations and extraordinary items. "EBITDA
Margin" is defined as EBITDA as a percentage of net sales. EBITDA is not a
measure of financial performance under generally accepted accounting principles
and should not be considered an alternative to net income (or any other measure
of performance under generally accepted accounting principles) as a measure of
performance or to cash flows from operating, investing or financing activities
as an indicator of cash flows or as a measure of liquidity. Certain covenants in
the New Notes and the Bank Credit Agreement are based on EBITDA, subject to
certain adjustments.
20
<PAGE> 21
SULLIVAN COMMUNICATIONS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Printing. As a result of the reasons previously described under "--Printing,"
Printing EBITDA decreased 17.1% to $10.8 million in the 1996 Three Month Period
from $13.0 million in the 1995 Three Month Period, representing a decrease of
$2.2 million, and the Printing EBITDA Margin decreased to 9.0% in the 1996 Three
Month Period from 12.4% in the 1995 Three Month Period.
American Color. As a result of the reasons previously described under
"--American Color," American Color's EBITDA increased to $0.3 million in the
1996 Three Month Period from $0 million in the 1995 Three Month Period,
representing an increase of $0.3 million, and the American Color EBITDA Margin
increased to 2.0% in the 1996 Three Month Period from zero in the 1995 Three
Month Period. These EBITDA increases included Restructuring costs of $0.4
million in the 1996 Three Month Period as compared with $2.1 million in the 1995
Three Month Period.
Other. As a result of the reasons previously described under "--Other
Operations" (excluding changes in amortization expense), other operations
improved to negative EBITDA of $0.9 million in the 1996 Three Month Period from
negative EBITDA of $1.0 million in the 1995 Three Month Period.
CHANGE IN INVENTORY VALUATION METHOD
During the third quarter of the fiscal year ending March 31, 1996, the Company
changed to the first-in, first-out ("FIFO") method of accounting from the
last-in, first-out ("LIFO") method of accounting as the principal method of
accounting for inventories. The change results in a balance sheet (1) which
reflects inventories at a value that more closely represents the current costs
which the Company believes is the primary concern of its constituents (bank
lenders, financial markets, customers, trade creditors, etc.) and (2) that
enhances the comparability of the Company's financial statements by changing to
the predominant method used by key competitors in the printing industry. The
effect (approximately $0.8 million) of the change for the six months ended
September 30, 1995 resulted in the retroactive restatement of the first and
second quarters of the fiscal year ending March 31, 1996 of approximately $0.5
million and $0.3 million, respectively, as a decrease of cost of goods sold and
a decrease to net loss.
21
<PAGE> 22
SULLIVAN COMMUNICATIONS, INC.
Part II Other Information
ITEM 1. (A) LEGAL PROCEEDINGS
Reference is made to Item 3 (Legal Proceedings) disclosure in the
Company's Form 10-K filed for the fiscal year ended March 31,
1996.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
----------- -----------
27.0 Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K/A filed with Securities and Exchange Commission on May 3,
1996 under Item 7 to provide financial statements and pro forma
financial information of Gowe Printing, Inc.
22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Communications and Graphics have duly caused this report to be signed on their
behalf by the undersigned thereunto duly authorized.
Sullivan Communications, Inc.
Sullivan Graphics, Inc.
Date August 13, 1996 By /s/ Joseph M. Milano
------------------------- -------------------------------
Joseph M. Milano
Senior Vice President and
Chief Financial Officer
(Authorized Officer and
Principal Financial Officer)
Date August 13, 1996 By /s/ Patrick W. Kellick
------------------------- -------------------------------
Patrick W. Kellick
Vice President - Corporate Controller
(Chief Accounting Officer)
23
<PAGE> 24
EXHIBIT INDEX
Exhibit No. Description Page
- ----------- ----------- ----
27.0 Financial Data Schedule 25
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SULLIVAN
COMMUNICATIONS, INC.'S UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR
THE THREE MONTH PERIOD ENDED JUNE 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-START> APR-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 69,304
<ALLOWANCES> 5,338
<INVENTORY> 14,503
<CURRENT-ASSETS> 83,147
<PP&E> 222,949
<DEPRECIATION> 56,874
<TOTAL-ASSETS> 355,565
<CURRENT-LIABILITIES> 86,443
<BONDS> 185,000
0
0
<COMMON> 1
<OTHER-SE> (52,029)
<TOTAL-LIABILITY-AND-EQUITY> 355,565
<SALES> 139,704
<TOTAL-REVENUES> 139,704
<CGS> 124,311
<TOTAL-COSTS> 124,311
<OTHER-EXPENSES> (126)
<LOSS-PROVISION> 813
<INTEREST-EXPENSE> 8,630
<INCOME-PRETAX> (6,622)
<INCOME-TAX> 982
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,604)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
