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EX-32 - EXHIBIT 32 - SCHAWK INCexb32.htm
EX-31.2 - EXHIBIT 31.2 - SCHAWK INCexb31-2.htm
EX-31.1 - EXHIBIT 31.1 - SCHAWK INCexb31-1.htm



SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

þ                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR
o                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission File Number 001-09335


SCHAWK, INC.

(Exact name of Registrant as specified in its charter)

Delaware
 
66-0323724
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
     
1695 South River Road
 
60018
Des Plaines, Illinois
 
(Zip Code)
(Address of principal executive office)
   

847-827-9494
 
(Registrant’s telephone number, including area code)

 
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 þ No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
 
Accelerated filer þ
     
Non-accelerated filer o
 
Smaller reporting company o

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Act).
Yes o No þ

The number of shares of the Registrant’s Common Stock outstanding as of October 29, 2010 was 25,669,433.

 
 

 

SCHAWK, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
September 30, 2010


   
Page
 
     
 
     
 
     
 
 
     
 
 
     
 
     
     
     
     
 
     
     
     



PART I - FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements
Schawk, Inc.
(In thousands, except share amounts)

   
September 30,
2010
   
December 31,
2009
 
   
(unaudited)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 28,959     $ 12,167  
Trade accounts receivable, less allowance for doubtful accounts
of $1,187 at September 30, 2010 and $1,619 at December 31, 2009
     86,802        88,822  
Inventories
    21,324       20,536  
Prepaid expenses and other current assets
    10,314       8,192  
Income tax receivable
    212       2,565  
Deferred income taxes
    3,544       992  
Total current assets
    151,155       133,274  
                 
Property and equipment, less accumulated depreciation of $103,459 at September 30,
2010 and $96,440 at December 31, 2009
     46,215        50,247  
Goodwill
    188,641       187,664  
Other intangible assets, net
    34,534       37,605  
Deferred income taxes
    1,294       1,424  
Other assets
    6,919       6,005  
                 
Total assets
  $ 428,758     $ 416,219  
                 
Liabilities and stockholders’ equity
               
Current liabilities:
               
Trade accounts payable
  $ 15,925     $ 16,957  
Accrued expenses
    62,624       64,079  
Deferred income taxes
    5,510       205  
Income taxes payable
    4,976       14,600  
Current portion of long-term debt
    21,189       12,858  
Total current liabilities
    110,224       108,699  
                 
Long-term liabilities:
               
Long-term debt
    41,423       64,707  
Other liabilities
    15,988       15,920  
Deferred income taxes
    4,350       2,059  
Total long-term liabilities
    61,761       82,686  
 
               
 Stockholders’ equity:
               
Common stock, $0.008 par value, 40,000,000 shares authorized,
30,390,003 and 29,855,796 shares issued at September 30, 2010 and
December 31, 2009, respectively; 25,644,433  and 25,108,894
shares outstanding at September 30, 2010 and December 31, 2009,
respectively
    223       220  
Additional paid-in capital
    197,580       191,701  
Retained earnings
    108,996       85,953  
Accumulated comprehensive income, net
    10,795       7,804  
Treasury stock, at cost, 4,745,570 and 4,746,902 shares of common
stock at September 30, 2010 and December 31, 2009, respectively
    (60,821 )     (60,844 )
Total stockholders’ equity
    256,773       224,834  
                 
Total liabilities and stockholders’ equity
  $ 428,758     $ 416,219  

The Notes to Consolidated Financial Statements are an integral part of these consolidated statements.


Schawk, Inc.
(Unaudited)
(In thousands, except per share amounts)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net sales
  $ 112,562     $ 113,463     $ 342,110     $ 330,540  
Cost of sales
    68,768       67,957       209,617       209,006  
Gross profit
    43,794       45,506       132,493       121,534  
                                 
Selling, general and administrative expenses
    28,675       32,193       91,619       98,313  
Foreign exchange (gain) loss
    694       (644 )     2,244       (1,089 )
Indemnity settlement
    --       (4,986 )     --       (4,986 )
Acquisition integration and restructuring expenses
    371       1,328       1,386       3,646  
Multiemployer pension withdrawal expense
    500       --       500       --  
Impairment of long-lived assets
    --       --       680       136  
Operating income
    13,554       17,615       36,064       25,514  
                                 
Other income (expense)
                               
Interest income
    15       124       31       224  
Interest expense
    (1,642 )     (2,880 )     (5,401 )     (6,797 )
                                 
Income before income taxes
    11,927       14,859       30,694       18,941  
Income tax provision
    4,154       1,553       4,596       3,163  
                                 
Net income
  $ 7,773     $ 13,306     $ 26,098     $ 15,778  
                                 
                                 
Earnings per share:
                               
Basic
  $ 0.30     $ 0.53     $ 1.03     $ 0.63  
Diluted
  $ 0.30     $ 0.53     $ 1.01     $ 0.63  
                                 
Weighted average number of common and common
equivalent shares outstanding:
                               
Basic
    25,577       24,955       25,387       24,937  
Diluted
    25,923       25,040       25,794       24,949  
                                 
Dividends per Class A common share
  $ 0.0400     $ 0.0100     $ 0.1200     $ 0.0525  

The Notes to Consolidated Financial Statements are an integral part of these consolidated statements.


Schawk, Inc.
Nine Months Ended September 30, 2010 and 2009
(Unaudited)
(In thousands)

   
2010
   
2009
 
             
Cash flows from operating activities
           
Net income
  $ 26,098     $ 15,778  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation
    9,889       10,715  
Amortization
    3,369       3,494  
Impairment of long-lived assets
    680       136  
Insurance settlement
    (1,539 )     --  
Non-cash restructuring charge
    --       210  
Amortization of deferred financing fees
    527       626  
Share-based compensation expense
    1,414       1,290  
Loss realized on sale of property and equipment
    12       115  
Changes in operating assets and liabilities, net of acquisitions:
               
Trade accounts receivable
    2,209       2,903  
Inventories
    (1,019 )     1,195  
Prepaid expenses and other current assets
    (2,516 )     586  
Trade accounts payable, accrued expenses and other liabilities
    (2,453 )     (4,207 )
Income taxes refundable (payable)
    (1,967 )     8,980  
Net cash provided by operating activities
    34,704       41,821  
                 
Cash flows from investing activities
               
Proceeds from sales of property and equipment
    491       4,420  
Proceeds from insurance settlement
    1,539       --  
Purchases of property and equipment
    (6,724 )     (3,886 )
Acquisitions, net of cash acquired
    (895 )     (367 )
Other
    11       (18 )
Net cash provided by (used in) investing activities
    (5,578 )     149  
                 
Cash flows from financing activities
               
Proceeds from issuance of long-term debt
    82,161       65,443  
Payments of long-term debt, including current maturities
    (97,114 )     (110,549 )
Payment of deferred financing fees
    (1,017 )     (1,170 )
Cash dividends
    (3,032 )     (1,293 )
Purchase of common stock
    --       (4,277 )
Issuance of common stock
    4,468       837  
Net cash used in financing activities
    (14,534 )     (51,009 )
Effect of foreign currency rate changes
    2,200       (814 )
Net increase (decrease) in cash and cash equivalents
    16,792       (9,853 )
Cash and cash equivalents at beginning of period
    12,167       20,205  
                 
Cash and cash equivalents at end of period
  $ 28,959     $ 10,352  
                 

The Notes to Consolidated Financial Statements are an integral part of these consolidated statements.


Schawk, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
(In thousands, except per share data)

 
Note 1 – Significant Accounting Policies
 
 
The Company’s significant accounting policies are included in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Form 10-K”). There have been no material changes in the Company’s significant accounting policies since December 31, 2009, except as follows:
 
 
Derivative Financial Instruments. In May 2010, the Company executed two “variable to fixed” interest rate swaps, designated as cash flow hedges, for the total notional amount of $15,000. The Company assesses hedge effectiveness quarterly by comparing the current terms of the swaps and the debt. The effective portion of the derivative fair value gains or losses from these cash flow hedges is deferred in Accumulated comprehensive income, net. The derivatives are recorded on the Consolidated Balance Sheets at fair value. See Note 14 – Derivative Financial Instruments for further discussion.
 
 
Interim Financial Statements
 
 
The unaudited consolidated interim financial statements of Schawk, Inc. (“Schawk” or the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Certain previously reported immaterial amounts have been reclassified to conform to the current-period presentation. In the opinion of management, all adjustments necessary for a fair presentation for the periods presented have been recorded.
 
 
These financial statements should be read in conjunction with, and have been prepared in conformity with, the accounting principles reflected in the Company’s consolidated financial statements and the notes thereto for the three years ended December 31, 2009, as filed with its 2009 Form 10-K. The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2010.
 
 
Recent Accounting Pronouncements
 
 
In October 2009, the Financial Accounting Standards Board (“FASB”) amended the Accounting Standards Codification (“ASC” or “Codification”) as summarized in Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements, and ASU 2009-14, Software (Topic 985) – Certain Revenue Arrangements That Include Software Elements. As summarized in ASU 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. As summarized in ASU 2009-14, ASC Topic 985 has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are both effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2009-13 and ASU 2009-14 may have on the Company’s consolidated financial statements.
 


 
Note 2 – Inventories
 
The Company’s inventories consist primarily of raw materials and work in process inventories, as well as finished goods inventory related to the Company’s Los Angeles print operation. Raw materials are stated at the lower of cost or market.  Work-in-process consists of primarily deferred labor and overhead costs.

The majority of the Company’s inventories are valued on the first-in, first-out (FIFO) basis. The remaining inventories are valued using the last-in, first-out (LIFO) method. The Company periodically evaluates the realizability of inventories and adjusts the carrying value as necessary.

Inventories consist of the following:

   
September 30,
   
December 31,
 
   
2010
   
2009
 
             
Raw materials
  $ 2,165     $ 2,736  
Work in process
    19,582       16,969  
Finished Goods
    517       1,771  
      22,264       21,476  
Less: LIFO reserve
    (940 )     (940 )
                 
    $  21,324     $  20,536  


Note 3 – Earnings Per Share

Basic earnings per share and diluted earnings per share are shown on the Consolidated Statements of Operations. Basic earnings per share are computed by dividing net income by the weighted average shares outstanding for the period.  Diluted earnings per share are computed by dividing net income by the weighted average number of common shares, including common stock equivalent shares (stock options) outstanding for the period. There were no reconciling items to net income to arrive at income available to common stockholders.

The following table sets forth the number of common and common stock equivalent shares used in the computation of basic and diluted earnings per share:

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2010
 
2009
 
2010
 
2009
               
Weighted average shares – Basic
25,577
 
24,955
 
25,387
 
24,937
Effect of dilutive stock options
    346
 
      85
 
    407
 
     12
Adjusted weighted average shares and assumed
conversions – Diluted
 
25,923
 
 
25,040
 
 
25,794
 
 
24,949

The following table presents the potentially dilutive outstanding stock options excluded from the computation of diluted earnings per share for each period because they would be anti-dilutive:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Anti-dilutive options
    917                                1,349                               908              2,749        
Exercise price range
  $ 12.87 - $21.08     $ 7.16 - $21.08     $ 12.87 - $21.08     $ 6.94 - $21.08  


Note 4 – Comprehensive Income

The Company reports certain changes in equity during a period in accordance with the Comprehensive Income Topic of the Codification, ASC 220. Accumulated comprehensive income, net includes cumulative translation adjustments and changes in gains and losses on hedged transactions, net of tax. The components of comprehensive income (loss) for the three and nine month periods ended September 30, 2010 and 2009 are as follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net income
  $ 7,773     $ 13,306     $ 26,098     $ 15,778  
Foreign currency translation adjustments
    4,489       1,588       3,132       5,163  
Changes in unrealized loss on hedges (net of tax)
    (50 )      --       (141 )      --  
 
Comprehensive income
  $  12,212     $  14,894     $  29,089     $  20,941  


Note 5 – Stock Based Compensation
 
The Company accounts for share-based payments in accordance with the provisions of the Stock Compensation Topic of the Codification, ASC 718, based on the grant date fair value estimated in accordance with the provisions of ASC 718 and using the straight-line expense attribution method.
 
The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model with the assumptions included in the table below. The Company uses historical data among other factors to estimate the expected price volatility, the expected term and the expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The following assumptions were used to estimate the fair value of options granted during the nine-month periods ended September 30, 2010 and September 30, 2009, using the Black-Scholes option-pricing model.

 
Nine Months Ended
 
Nine Months Ended
 
September 30, 2010
 
September 30, 2009
       
Expected dividend yield
0.88%-1.24%
 
1.34%-1.39%
Expected stock price volatility
47.75%-48.97%
 
43.75%-43.8%
Risk-free interest rate
2.87%-3.26%
 
2.79%-3.33%
Weighted-average expected life of options
6.53-7.40 years
 
6.8-7.21 years
Forfeiture rate
1.0%-3.0%
 
0.85%-1.00%

No options or shares of restricted stock were granted during the three-month period ended September 30, 2010. The total fair value of options and restricted stock granted during the nine-month period ended September 30, 2010, was $1,688. The total fair value of options and restricted stock granted during the three and nine-month periods ended September 30, 2009, was $47 and $1,742, respectively. As of September 30, 2010, there was $2,390 of total unrecognized compensation cost related to nonvested options and restricted shares outstanding. That cost is expected to be recognized over a weighted average period of approximately two years. Expense recognized under ASC 718 for the three and nine-month periods ended September 30, 2010 was $373 and $1,414, respectively. Expense recognized under ASC 718 for the three and nine-month periods ended September 30, 2009, was $411 and $1,290, respectively.

Note 6 – Impairment of Long-lived Assets and Insurance Recoveries
 
During the first quarter of 2010, certain newly purchased and installed production equipment sustained water damage and became no longer operable. The Company recorded an impairment charge in the amount of $680, the net book value of the damaged equipment, which is included in Impairment of long-lived assets in the Consolidated Statements of Operations for the nine-month period ended September 30, 2010, and filed a claim with its insurance carrier for the loss incurred. The expense was recorded in the North America operating segment. In the nine-month period ended September 30, 2009, the Company recorded asset impairment charges of $136.
 


 
The Company maintains insurance coverage for property loss, business interruption, and directors and officers liability and records insurance recoveries in the period in which the insurance carrier validates the claim and confirms the amount of reimbursement to be paid.  During the second quarter of 2010, the Company received an insurance settlement of $519 related to the damaged equipment for which impairment was recorded in the first quarter of 2010. In addition, during the second quarter of 2010, the Company received confirmation of a pending insurance settlement in the amount of $860 related to a flood loss at one of the Company’s North American operations during 2009. The Company recorded a receivable in the amount of $860 at June 30, 2010 for this pending settlement, which was received in July 2010.  During the third quarter of 2010, the Company received an additional insurance settlement related to the equipment for which impairment was recorded in the first quarter of 2010 in the amount of $279; $160 related to property damage and $119 related to business interruption coverage. During the third quarter of 2010, the Company received a directors and officers liability insurance settlement in the amount of $1,196 representing reimbursement of certain expenses related to the Company’s ongoing SEC investigation. See Note 12 – Contingencies for further information related to the SEC investigation.
 
The table below summarizes where the insurance recoveries totaling $1,475 and $2,854 for the three and nine-month periods ended September 30, 2010 are reflected in the Consolidated Statements of Operations:


   
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2010
   
September 30, 2010
 
             
Cost of sales:
           
Business interruption coverage
  $ 119     $ 119  
                 
Total cost of sales
    119       119  
                 
Selling, general and administrative expenses:
               
Property coverage
    160       1,539  
Directors and officers liability coverage
    1,196       1,196  
                 
Total selling, general and administrative expenses
    1,356       2,735  
                 
Total insurance recoveries
  $ 1,475     $ 2,854  

Note 7 – Acquisitions

Untitled London Limited

Effective September 17, 2010, the Company acquired the operating assets of Untitled London Limited, a United Kingdom-based agency that provides strategic, creative and technical services for digital marketing. The net assets and results of operations of Untitled London Limited are included in the Consolidated Financial Statements in the Europe operating segment, effective September 17, 2010. This business was acquired to expand the Company’s digital marketing capabilities in Europe.

The purchase price was approximately $860. The Company has recorded a preliminary purchase price allocation that will be adjusted upon completion of a fair value appraisal, which is in process. A summary of the preliminary fair values assigned to the acquired net assets is as follows:

Accounts receivable
  $ 79  
Inventory
    15  
Fixed assets
    80  
Goodwill
    343  
Customer relationships
    274  
Trade name
    69  
         
Total cash paid at closing
  $ 860  



Supplemental pro-forma information is not presented because the acquisition is considered immaterial to the Company’s consolidated financial statements.

Brandmark International Holding B.V.
 
Effective December 31, 2008, the Company acquired 100 percent of the outstanding stock of Brandmark International Holding B.V. (“Brandmark”), a Netherlands-based brand identity and creative design firm. Brandmark provides services to consumer products companies through its locations in Hilversum, The Netherlands and London, United Kingdom. The net assets and results of operations of Brandmark are included in the Consolidated Financial Statements in the Europe operating segment. This business was acquired to expand the Company’s creative design business in Europe, enhancing the Company’s ability to provide services for its multinational clients.
 
 
The purchase price of $10,456 consisted of $8,102 paid in cash to the seller at closing, $2,026 retained in an escrow account, less $245 received from the sellers for a Net Working Capital and Tangible Net Equity adjustment plus $573 paid for acquisition-related professional fees.
 
The Share Purchase Agreement provides that the purchase price may be increased by up to $703 if a specified target of earnings before interest and taxes was achieved for the fiscal year ended March 31, 2009. At December 31, 2009, $3 was recorded for an estimated purchase price adjustment based on the seller’s preliminary financial statements for the fiscal year ended March 31, 2009 and the additional purchase price was allocated to goodwill. During the first quarter of 2010, a final agreement was reached with the former owners to pay a total of $38 in additional purchase price. The incremental purchase price adjustment of $35 was recorded in the first quarter of 2010 and allocated to goodwill. The $38 total additional purchase price was paid to the former owners in April 2010.

Exit Reserves from Prior Acquisitions
 
The Company recorded exit reserves related to its acquisitions of Weir Holdings Limited and Seven Worldwide Holdings, Inc., which occurred in 2004 and 2005, respectively. The major expenses included in the exit reserves were employee severance and lease termination expenses. The exit reserve balances related to employee severance were paid in prior years. The exit reserves related to the facility closures are being paid over the term of the leases, with the longest lease expiring in 2015. The adjustments recorded during 2010 are principally due to a reduction in the reserve for a certain vacant facility which the Company re-occupied in September 2010. The remaining reserve balance of $970 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets as of September 30, 2010.
 
The following table summarizes the reserve activity from December 31, 2009 through September 30, 2010 for facility closure costs:
                         
   
Beginning of
               
End of
 
   
Period
   
Adjustments
   
Payments
   
Period
 
                         
First quarter
  $ 2,431     $ (8 )   $ (263 )   $ 2,160  
Second quarter
  $ 2,160     $ (754 )   $ (238 )   $ 1,168  
Third quarter
  $ 1,168     $ 59     $ (257 )   $ 970  
 

Note 8 – Debt
 
In December 2003, the Company entered into a private placement of debt (the “2003 Private Placement”) to provide long-term financing. The terms of the Note Purchase Agreement relating to this transaction, as amended, provided for the issuance and sale by the Company of two series of notes: Tranche A, for $15,000, payable in annual installments of $2,143 from 2007 through 2013, and Tranche B, for $10,000, payable in annual installments of $1,429 from 2008 through 2014. The remaining aggregate balance of the Tranche A and Tranche B notes, $12,289, is included on the September 30, 2010 Consolidated Balance Sheets as follows: $3,072 is included in Current maturities of long-term debt
 


 
and $9,217 is included in Long-term debt.
 
 
In January 2005, the Company entered into a Note Purchase and Private Shelf Agreement (the “2005 Private Placement”) with Prudential Investment Management Inc., pursuant to which the Company sold $50,000 in a series of three Senior Notes, maturing in January 2010, January 2011, and January 2012, respectively. The remaining aggregate outstanding balance of the two remaining notes, $34,412, is included on the September 30, 2010 Consolidated Balance Sheets as follows: $17,206 is included in Current maturities of long-term debt and $17,206 is included in Long-term debt.
 
 
In December 2007, the Company’s Canadian subsidiary entered into a revolving demand credit facility with a Canadian bank to provide working capital needs up to $1,000 Canadian dollars. The credit line is guaranteed by the Company. There was no balance outstanding on this credit facility at September 30, 2010.
 
 
Effective January 12, 2010, the Company and certain subsidiary borrowers of the Company entered into an amended and restated credit agreement (the “Credit Agreement”) in order to refinance its prior revolving credit facility that was set to terminate in January 2010. The Credit Agreement provides for a two and one-half year secured, multicurrency revolving credit facility in the principal amount of $90,000, including a $10,000 swing-line loan subfacility and a $10,000 subfacility for letters of credit. The Company may, at its option and subject to certain conditions, increase the amount of the facility by up to $10,000 by obtaining one or more new commitments from new or existing lenders to fund such increase. Immediately following the closing of the facility, there was approximately $15,000 in outstanding borrowings. Loans under the facility generally bear interest at a rate of LIBOR plus a margin that varies with the Company’s cash flow leverage ratio, in addition to applicable commitment fees, with a maximum rate of LIBOR plus 350 basis points. Loans under the facility are not subject to a minimum LIBOR floor. At September 30, 2010, the applicable margin was 250 basis points, resulting in an interest rate of 2.76 percent on LIBOR-based borrowings under the revolving credit facility. In order to manage the risk of rising interest rates on the Company’s variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15,000 in May of 2010. See Note 14 – Derivative Financial Instruments for further discussion.
 
 
Borrowings under the facility will be used for general corporate purposes, such as working capital and capital expenditures. Additionally, together with anticipated cash generated from operations, the unutilized portion of the credit facility is expected to be available to provide financing flexibility and support in the funding of principal payments due in 2010 and succeeding years on the Company’s other long-term debt obligations. The total balance outstanding under the Company’s credit facility at September 30, 2010 was $15,000 and is included in Long-term debt on the September 30, 2010 Consolidated Balance Sheets.
 
 
Outstanding obligations due under the facility are secured through security interests in and liens on substantially all of the Company’s and its domestic subsidiaries’ current and future personal property and on 100 percent of the capital stock of the Company’s existing and future domestic subsidiaries and 65 percent of the capital stock of certain foreign subsidiaries.
 
 
The Credit Agreement contains certain customary affirmative and negative covenants and events of default. Under the terms of the Credit Agreement, permitted capital expenditures excluding acquisitions are restricted to not more than $18,500 per fiscal year, or $40,000 over the term of the credit facility, and dividends, stock repurchases and other restricted payments are limited to $5,000 per fiscal year. Other covenants include, among other things, restrictions on the Company’s and in certain cases its subsidiaries’ ability to incur additional indebtedness; dispose of assets; create or permit liens on assets; make loans, advances or other investments; incur certain guarantee obligations; engage in mergers, consolidations or acquisitions, other than those meeting the requirements of the Credit Agreement; engage in certain transactions with affiliates; engage in sale/leaseback transactions; and engage in certain hedging arrangements. The Credit Agreement also requires compliance with specified financial ratios and tests, including a minimum fixed charge coverage ratio, a maximum cash flow ratio and a minimum consolidated net worth requirement. The Company was in compliance with all covenants at September 30, 2010.
 
 
Concurrently with its entry into the Credit Agreement, the Company also amended the note purchase agreements underlying its outstanding senior notes in order to conform the financial and other covenants contained in the note purchase agreements to the covenants contained in the Credit Agreement described above.
 
 
In September 2010, the Company financed $911 of the business insurance premiums for the 2010 – 2011 policy term.
 


 
The premiums are due in three equal quarterly payments, ending in June 2011. The total balance of the financed insurance premiums is included in Current debt on the September 30, 2010 Consolidated Balance Sheets.
 
 
Deferred Financing Fees
 
In connection with the 2010 refinancing of the revolving credit facility, the Company capitalized $1,090 of legal fees as deferred financing fees during the nine month period ended September 30, 2010 and began amortizing them based on the term of the new credit agreement, which expires July 12, 2012. During the nine month period ended September 30, 2009, the Company capitalized $1,170 of deferred financing fees related to its June 2009 debt amendments. The total amortization during the three and nine month periods ended September 30, 2010 was $141 and $527, respectively, which is included in Interest expense on the September 30, 2010 Consolidated Statements of Operations. The total amortization during the three and nine month periods ended September 30, 2009 was $401 and $626, respectively. At September 30, 2010, the Company had $954 of unamortized deferred financing fees.

Note 9 – Goodwill and Intangible Assets
 
The Company’s intangible assets not subject to amortization consist entirely of goodwill. The Company accounts for goodwill in accordance with the Intangibles – Goodwill and Other Topic of the Codification, ASC 350. Under ASC 350, the Company’s goodwill is not amortized throughout the period, but is subject to an annual impairment test. The Company performs an impairment test annually on October 1, or more frequently if events or changes in business circumstances indicate that the carrying value may not be recoverable.  Effective September 30, 2010, the Company sold certain operating assets of its Canadian large format operation, known as Cactus. The Company determined that approximately $50 of its North America segment goodwill should be allocated to the Cactus operation and recorded a charge for this amount in the third quarter of 2010. See Note 13 – Acquisition Integration and Restructuring for further information regarding the asset sale.
 
The changes in the carrying amount of goodwill by reportable segment during the three and nine-month periods ended September 30, 2010, were as follows:
 
   
North
         
Asia
       
   
America
   
Europe
   
Pacific
   
Total
 
                         
Balance at January 1, 2010
  $ 172,484     $ 7,853     $ 7,327     $ 187,664  
Additional purchase accounting adjustments
    --       35       --       35  
Foreign currency translation
    481       (449 )     278       310  
                                 
Balance at March 31, 2010
    172,965       7,439       7,605       188,009  
Foreign currency translation
    (464 )     (356 )     (258 )     (1,078 )
                                 
Balance at June 30, 2010
  $ 172,501     $ 7,083     $ 7,347     $ 186,931  
Acquisitions
    --       343       --       343  
Goodwill allocated to operations sold
    (50 )     --       --       (50 )
Foreign currency translation
    299       580       538       1,417  
                                 
Balance at September 30, 2010
  $ 172,750     $ 8,006     $ 7,885     $ 188,641  



The Company’s other intangible assets subject to amortization are as follows:

     
September 30, 2010
 
 
Weighted Average Life
 
Cost
   
Accumulated
Amortization
   
Net
 
                     
Customer relationships
14.3 years
  $ 51,888     $ (18,228 )   $ 33,660  
Digital images
5.0 years
    450       (450 )     --  
Developed technologies
3.0 years
    712       (712 )     --  
Non-compete agreements
3.6 years
    764       (734 )     30  
Trade names
2.6 years
    811       (709 )     102  
Contract acquisition cost
3.0 years
    1,220       (478 )     742  
                           
 
13.6 years
  $ 55,845     $ (21,311 )   $ 34,534  


     
December 31, 2009
 
 
Weighted Average Life
 
Cost
   
Accumulated
Amortization
   
Net
 
                     
Customer relationships
14.3 years
  $ 51,647     $ (15,326 )   $ 36,321  
Digital images
5.0 years
    450       (420 )     30  
Developed technologies
3.0 years
    712       (712 )     --  
Non-compete agreements
3.6 years
    744       (588 )     156  
Trade names
2.7 years
    732       (681 )     51  
Contract acquisition cost
3.0 years
    1,220       (173 )     1,047  
                           
 
13.3 years
  $ 55,505     $ (17,900 )   $ 37,605  

Other intangible assets were recorded at fair market value as of the dates of the acquisitions based upon independent third party appraisals. The fair values and useful lives assigned to customer relationship assets are based on the period over which these relationships are expected to contribute directly or indirectly to the future cash flows of the Company. The acquired companies typically have had key long-term relationships with Fortune 500 companies lasting 15 years or more. Because of the custom nature of the work that the Company does, it has been the Company’s experience that clients are reluctant to change suppliers. Amortization expense related to the other intangible assets totaled $1,096 and $3,369 for the three and nine-month periods ended September 30, 2010, respectively. Amortization expense related to the other intangible assets totaled $1,236 and $3,494 for the three and nine-month periods ended September 30, 2009, respectively. Amortization expense for each of the next five twelve month periods beginning October 1, 2010, is expected to be approximately $4,349 for 2011, $4,153 for 2012, $3,804 for 2013, $3,799 for 2014, and $3,179 for 2015.
 
Note 10 – Income Taxes
 
The Company’s interim period tax provision is determined as follows:

 
·
At the end of each quarter, the Company estimates the tax that will be provided for the fiscal year.

 
·
The forecasted annual effective tax rate is applied to the year-to-date ordinary income at the end of each quarter to compute the year-to-date tax applicable to ordinary income. The term ordinary income refers to income from continuing operations before income taxes, excluding significant, unusual or infrequently occurring items. The tax expense or benefit related to ordinary income in each quarter is the difference between the most recent year-to-date and the prior quarter-to-date computations.
 
 
·
The tax effects of significant or infrequently occurring items are recognized as discrete items in the interim periods in which the events occur.  The impact of changes in tax laws or rates on deferred tax amounts, the effects of changes in judgment about valuation allowances established in prior years, and changes in tax reserves resulting from the finalization of tax audits or reviews are examples of significant, unusual or infrequently occurring items which are recognized as discrete items in the interim period in which the event occurs.

 
The determination of the forecasted annual effective tax rate is based upon a number of significant estimates and judgments, including the forecasted annual pretax income of the corporation in each tax jurisdiction in which it operates and the development of tax planning strategies during the year.  In addition, the Company’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, as well as other factors that cannot be predicted with certainty.  As such, there can be significant volatility in interim tax provisions.
 
The Company’s forecasted annual effective tax rate for the third quarter of 2010 was approximately 28 percent and remained consistent with the 2010 second quarter forecasted annual effective tax rate of 28 percent.

The following table sets out the tax expense and the effective tax rates of the Company:


   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(in thousands)
 
2010
   
2009
   
2010
   
2009
 
                         
Pretax income (loss)
  $ 11,927     $ 14,859     $ 30,694     $ 18,941  
Income tax expense
  $ 4,154     $ 1,553     $ 4,596     $ 3,163  
Effective tax rate
    34.8 %     10.5 %     15.0 %     16.7 %


In the third quarter of 2010, the Company recognized tax expense of $4,154 on pretax income of $11,927, or an effective tax rate of 34.8 percent.  There were no significant discrete period items reported in the third quarter 2010. In the third quarter of 2009, the Company recognized tax expense of $1,553 on pretax income of $14,859, or an effective tax rate of 10.5 percent.  The tax rate was affected by the discrete period tax benefits related to the nontaxable indemnity settlement of $1,986 and the related benefit of amended tax return adjustments of $1,373.

For the first nine months of 2010, the Company recognized tax expense of $4,596 on pretax income of $30,694, or an effective tax rate of 15.0 percent.  Since no other significant items were reported in the third quarter of 2010, the decrease in the effective tax rate for the first nine months of 2010 is principally due to a discrete period tax benefit related to the release of uncertain tax positions, net of federal and state benefits of $6,346, of which $5,630 resulted from the receipt of approval from the Joint Committee on Taxation related to a U.S. federal audit and $716 resulted from other favorable state and international tax settlements and statute closures.  For the first nine months of 2009, the Company recognized tax expense of $3,163 on pretax income of $18,941, or an effective tax rate of 16.7 percent.  No other significant items were reported outside of the third quarter 2009.

The Company has unrecognized tax benefits, exclusive of interest and penalties of $4,329 and $16,259 at September 30, 2010 and December 31, 2009, respectively.  The reserve for uncertain tax positions decreased by $137 in the third quarter of 2010.  The reserve for uncertain tax positions decreased in the second quarter by $6,462, primarily the result of the following; $5,775 due to the Joint Committee on Taxation approval of the U.S. federal audit and other favorable state and international tax settlements, and $687 from statute of limitation closures, which was recorded as an increase in deferred tax liabilities.  The significant decrease in the reserve during the first quarter of 2010 was primarily due to the receipt of approval of a change in tax accounting method and was recorded primarily as an increase in deferred tax liabilities of $5,368.

Note 11 – Segment Reporting

The Company organizes and manages its operations primarily by geographic area and measures profit and loss of its segments based on operating income (loss). The accounting policies used to measure operating income of the segments are the same as those used to prepare the consolidated financial statements.
 
Segment Reporting Topic of the Codification, ASC 280, requires that a public business enterprise report financial information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (“CODM”) in deciding how to allocate resources and in assessing performance.

The Company’s North America reportable segment includes all of the Company’s operations located in North America,


including its Canadian and Mexican operations, its U.S. branding and design capabilities and its U.S. digital solutions business. The Company’s Europe reportable segment includes all operations located in Europe, including its European branding and design capabilities and its digital solutions business. The Company’s Asia Pacific reportable segment includes all operations in Asia and Australia, including its Asia Pacific branding and design capabilities. These reporting segments meet the quantitative thresholds for separate disclosure in accordance with the relevant provisions of ASC 280.
 
 
Corporate consists of unallocated general and administrative activities and associated expenses, including executive, legal, finance, information technology, human resources and certain facility costs. In addition, certain costs and employee benefit plans are included in corporate and not allocated to operating segments.

The Company has disclosed operating income (loss) as the primary measure of segment earnings (loss). This is the measure of profitability used by the Company’s CODM and is most consistent with the presentation of profitability reported within the consolidated financial statements.

Segment information relating to results of operations is as follows:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Sales to external clients:
                       
North America
  $ 97,360     $ 98,493     $ 297,996     $ 285,722  
Europe
    16,724       16,978       49,099       48,872  
Asia Pacific
    7,547       7,668       22,609       20,690  
Intercompany sales elimination
    (9,069 )     (9,676 )     (27,594 )     (24,744 )
                                 
Total
  $ 112,562     $ 113,463     $ 342,110     $ 330,540  
                                 
Operating segment income
(loss):
                               
North America
  $ 17,627     $ 18,164     $ 50,906     $ 38,765  
Europe
    1,490       1,022       2,853       2,180  
Asia Pacific
    982       2,192       3,637       5,287  
Corporate
    (6,545 )     (3,763 )     (21,332 )     (20,718 )
Operating income
    13,554       17,615       36,064       25,514  
Interest expense, net
    (1,627 )     (2,756 )     (5,370 )     (6,573 )
 
Income before income taxes
  $  11,927     $  14,859     $  30,694     $  18,941  


Note 12 – Contingencies

United States Securities and Exchange Commission

The United States Securities and Exchange Commission (“SEC”) has been conducting a fact-finding investigation to determine whether there have been violations of certain provisions of the federal securities laws in connection with the Company’s restatement of its financial results for the years ended December 31, 2005 and 2006 and for the first three quarters of 2007.  On March 5, 2009, the SEC notified the Company that it had issued a Formal Order of Investigation. The Company has been cooperating fully with the SEC and is committed to continue to cooperate fully until the SEC completes its investigation. The Company has incurred professional fees and other costs in responding to the SEC’s previously informal inquiry and expects to continue to incur professional fees and other costs in responding to the SEC’s ongoing formal investigation, which may be significant, until resolved.


Note 13 – Acquisition Integration and Restructuring

Actions Initiated in 2008

In 2008, the Company initiated a cost reduction and restructuring plan involving a consolidation and realignment of its


workforce and incurred costs for employee terminations, obligations for future lease payments, fixed asset impairments, and other associated costs. The costs associated with these actions are covered under the Exit or Disposal Cost Obligations Topic of the Codification, ASC 420, and the Compensation – Nonretirement Postemployment Benefits Topic, ASC 712.

The following table summarizes the accruals recorded, adjustments, and the cash payments during the nine-month period ended September 30, 2010, related to cost reduction and restructuring actions initiated during 2008. The adjustments are comprised of reversals of previously recorded expense accruals and foreign currency translation adjustments. The remaining reserve balance of $3,346 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets at September 30, 2010.

   
Employee
   
Lease
       
   
Terminations
   
Obligations
   
Total
 
                   
Liability balance at December 31, 2009
  $ 288     $ 3,924     $ 4,212  
New accruals
    1       66       67  
Adjustments
    (31 )     (7 )     (38 )
Cash payments
    (21 )     (612 )     (633 )
Liability balance at March 31, 2010
    237       3,371       3,608  
New accruals
    --       58       58  
Adjustments
    (2 )     (7 )     (9 )
Cash payments
    (1 )     (124 )     (125 )
Liability balance at June 30, 2010
    234       3,298       3,532  
New accruals
    --       51       51  
Adjustments
    (94 )     (6 )     (100 )
Cash payments
    (1 )     (136 )     (137 )
                         
Liability balance at September 30, 2010
  $ 139     $ 3,207     $ 3,346  

Actions Initiated in 2009

During 2009, the Company continued its cost reduction efforts and incurred additional costs for facility closings and employee termination expenses.

The following table summarizes the accruals recorded, adjustments, and the cash payments during the nine-month period ended September 30, 2010, related to cost reduction and restructuring actions initiated during 2009. The remaining reserve balance of $288 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets at September 30, 2010.

   
Employee
   
Lease
       
   
Terminations
   
Obligations
   
Total
 
                   
Liability balance at December 31, 2009
  $ 925     $ 108     $ 1,033  
New accruals
    3       2       5  
Adjustments
    (79 )     (27 )     (106 )
Cash payments
    (493 )     --       (493 )
Liability balance at March 31, 2010
    356       83       439  
New accruals
    --       28       28  
Adjustments
    (2 )     (28 )     (30 )
Cash payments
    (100 )     --       (100 )
Liability balance at June 30, 2010
    254       83       337  
New accruals
    8       1       9  
Adjustments
    (4 )     (24 )     (28 )
Cash payments
    (19 )     (11 )     (30 )
                         
Liability balance at September 30, 2010
  $ 239     $ 49     $ 288  



Actions Initiated in 2010
 
The following table summarizes the accruals recorded, adjustments, and the cash payments during the nine-month period ended September 30, 2010, related to cost reduction and restructuring actions initiated during 2010. The remaining reserve balance of $72 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets at September 30, 2010.
 
   
Employee
   
Lease
       
   
Terminations
   
Obligations
   
Total
 
                   
Liability balance at December 31, 2009
  $ --     $ --     $ --  
New accruals
    294       --       294  
Adjustments
    (3 )     --       (3 )
Cash payments
    (67 )     --       (67 )
Liability balance at March 31, 2010
    224       --       224  
New accruals
    456       --       456  
Adjustments
    (1 )     --       (1 )
Cash payments
    (426 )     --       (426 )
Liability balance at June 30, 2010
    253       --       253  
New accruals
    104       --       104  
Adjustments
    (13 )     --       (13 )
Cash payments
    (272 )     --       (272 )
                         
Liability balance at September 30, 2010
  $ 72     $ --     $ 72  

The combined expenses for the cost reduction and restructuring actions initiated in 2008, 2009, and 2010, shown above, were $22 and $743 for the three and nine months ended September 30, 2010, respectively. In addition, the Company recorded $349 and $643 for consulting and legal fees related to the Company’s restructuring during the three and nine months ended September 30, 2010, respectively. The total expenses for the three and nine months ended September 30, 2010 were $371 and $1,386, respectively, and are presented as Acquisition integration and restructuring expense in the Consolidated Statements of Operations.

The expenses for the nine month periods ended September 30, 2010 and September 30, 2009 and the cumulative expense since the cost reduction program’s inception were recorded in the following segments:

   
North
         
Asia
             
   
America
   
Europe
   
Pacific
   
Corporate
   
Total
 
                               
Nine months ended September 30, 2010
  $ 661     $ 91     $ (23 )   $ 657     $ 1,386  
Nine months ended September 30, 2009
  $ 1,568     $ 1,221     $ 652     $ 205     $ 3,646  
Cumulative since program inception
  $ 9,976     $ 5,043     $ 1,217     $ 1,999     $ 18,235  

Sale of Cactus assets

Effective September 30, 2010, the Company sold certain operating assets of its Canadian large format operation, known as Cactus. The assets were sold because the Company is focusing on strategy, creative design and premedia services in the Canadian region. The selling price was approximately $462 and resulted in a pretax gain of approximately $22, which included a write-off for goodwill allocated to the Cactus business. The Company determined that approximately $50 of its North America segment goodwill should be allocated to the Cactus operation and recorded a charge for this amount in the third quarter of 2010. The following table is a summary of the asset sale:

Net cash received from buyer
  $ 462  
Book value of assets sold
    (362 )
Expenses of sale
    (28 )
Goodwill write-off
    (50 )
         
Pretax gain on sale of assets
  $ 22  


The pretax gain on sale of assets is recorded in Selling, general and administrative expenses in the Consolidated Statement of Operations for the three and nine-month periods ended September 30, 2010. The operating results of the Cactus operation are not reported as discontinued operations because the impact on the Company’s consolidated financial statements is immaterial.

Note 14 – Derivative Financial Instruments
 
Interest Rate Swaps

In order to manage the risk of rising interest rates on a portion of the Company’s variable rate revolving debt, the Company entered into two “variable to fixed” interest rate swaps with financial institution counterparties for the total notional amount of $15,000 in May of 2010. The swaps, which expire in June 2012, have been designated as cash flow hedges. Under the Derivatives and Hedging Topic of the FASB Codification, ASC 815, the effective portion of the derivative fair value gains or losses from these cash flow hedges is deferred in Accumulated comprehensive income, net. The company assesses hedge effectiveness quarterly by comparing the critical terms of the swaps and the debt. Since the Company assessed the hedge to be fully effective, the derivative fair value gains or losses have been deferred in Accumulated comprehensive income, net on the Consolidated Balance Sheets at September 30, 2010.
 
The interest rate swaps are measured at fair value on a recurring basis. Monthly LIBOR rates, observable at commonly quoted intervals for the full term of the swaps and classified as Level 2 input (see Note 15 – Fair Value Measurements), provide basis for valuation of these swaps. An income approach, using the present value of projected future cash payments based on monthly LIBOR rates, is the valuation technique used in assessing the swaps’ fair value.

As of September 30, 2010, the fair value of the derivative instruments was:

   
Derivative Assets
 
Derivative Liabilities
 
Instrument
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
                   
Interest rate swaps
 
Other assets
  $ --  
Other long-term liabilities
  $ 234  

The effect of derivative instruments on the Consolidated Statements of Operations for the three months ended September 30, 2010, was:
 
 
 
 
Instrument
 
Amount of gain/(loss) recognized on derivatives in Accumulated comprehensive income, net
   
Amount of gain/(loss) reclassified from Accumulated comprehensive income, net into earnings*
 
             
Interest rate swaps
  $ (50 )   $ --  

 
The effect of derivative instruments on the Consolidated Statements of Operations for the nine months ended September 30, 2010, was:
 
 
 
 
Instrument
 
Amount of gain/(loss) recognized on derivatives in Accumulated comprehensive income, net
   
Amount of gain/(loss) reclassified from Accumulated comprehensive income, net into earnings*
 
             
Interest rate swaps
  $ (141 )   $ --  

 
* ASC 815 does not require that the amount in Accumulated comprehensive income, net be amortized to earnings unless the swaps are terminated. At the maturity of the swaps, their fair value will be zero – just as it was at inception – and each of the swap market value changes over its term will have been recorded as adjustments to both the swap asset or liability and Accumulated comprehensive income, net.


Note 15 – Fair Value Measurements

Fair value is defined under the Fair Value Measurements and Disclosures Topic of the Codification, ASC 820, as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard established a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable.

 
·
Level 1 – Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes for transactions in active exchange markets involving identical assets.

 
·
Level 2 – Inputs, other than quoted prices included within Level 1, which are observable for the asset or liability, either directly or indirectly. These are typically obtained from readily-available pricing sources for comparable instruments.

 
·
Level 3 – Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting entity’s own assumptions of the data that market participants would use in pricing the asset or liability, based on the best information available in the circumstances.

For purposes of financial reporting, the Company has determined that the fair value of such financial instruments as cash and cash equivalents, accounts receivable, accounts payable and long-term debt approximates carrying value at September 30, 2010. Interest rate swaps are measured at fair value on a recurring basis and the following table summarizes the derivative financial instruments measured at fair value as of September 30, 2010:
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Other long-term liabilities:
                       
Interest rate swaps
  $ --     $ 234     $ --     $ 234  


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking Information

Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report that relate to the Company’s beliefs or expectations as to future events are not statements of historical fact and are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. The Company intends any such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Although the Company believes that the assumptions upon which such forward-looking statements are based are reasonable within the bounds of its knowledge of its industry, business and operations, it can give no assurance the assumptions will prove to have been correct and undue reliance should not be placed on such statements.  Important factors that could cause actual results to differ materially and adversely from the Company’s expectations and beliefs include, among other things, the strength of the United States economy in general and specifically market conditions for the consumer products industry; the level of demand for the Company’s services; unfavorable foreign exchange fluctuations; changes in or weak consumer confidence and consumer spending; loss of key management and operational personnel; the ability of the Company to implement its business strategy and plans; the ability of the Company to comply with the financial covenants contained in its debt agreements and obtain waivers or amendments in the event of non-compliance; the ability of the Company to maintain an effective system of disclosure and internal controls and the discovery of any future control deficiencies or weaknesses, which may require substantial costs and resources to rectify; the stability of state, federal and foreign tax laws; the ability of the Company to identify and capitalize on industry trends and technological advances in the imaging industry; higher than expected costs associated with compliance with legal and regulatory requirements; higher than expected costs or unanticipated difficulties associated with integrating acquired operations; the stability of political conditions in foreign countries in which the Company has production capabilities; terrorist attacks and the U.S. response to such attacks; as well as other factors detailed in the Company’s filings with the Securities and Exchange Commission. The Company assumes no obligation to update publicly any of these statements in light of future events.
 


Business Overview
 

Schawk, Inc., and its subsidiaries (“Schawk” or the “Company”) provide strategic, creative and executional graphic services and solutions to clients in the consumer products packaging, retail, pharmaceutical and advertising markets.  The Company, headquartered in Des Plaines, Illinois, has been in operation since 1953 and is incorporated under the laws of the State of Delaware.

The Company is one of the world’s largest independent business service providers in the graphics industry. The Company currently delivers these services through more than 150 locations in 14 countries across North America, Europe, Asia and Australia. By leveraging its global comprehensive portfolio of strategic, creative and executional capabilities, the Company believes it helps companies of all sizes create compelling and consistent brand experiences that strengthen consumers’ affinity for these brands. The Company does this by helping its clients “activate” their brands worldwide.
 
 The Company believes that it is positioned to deliver its offering in a category that is unique to its competition. This category, brand point management, reflects Schawk’s ability to provide integrated strategic, creative and executional services globally across the four primary points in which its clients’ brands touch consumers: at home, on the go, at the store and on the shelf.  “At Home” includes brand touchpoints such as direct mail, catalogs, advertising, circulars, and the internet. “On the Go” includes brand touchpoints such as outdoor advertising, mobile/cellular and the internet. “In the Store” includes brand touchpoints such as point-of-sale displays, in-store merchandising and interactive displays. “On the Shelf” focuses on packaging as a key brand touchpoint.
 
 
The Company’s strategic services are delivered primarily through its branding and design capabilities, performed under its Anthem Worldwide (“Anthem”) brand. These services include brand analysis and articulation, design strategy and design. These services help clients revitalize existing brands and bring new products to market that respond to changing consumer desires and trends. Anthem’s services also help retailers optimize their brand portfolios, helping them create fewer, smarter and potentially more profitable brands. The impact of changes to design and brand strategy can potentially exert a significant impact on a company’s brand, category, market share, equity and sales. Strategic services also represent some of Schawk’s highest value, highest margin services.
 
 
The Company’s creative services are delivered through Anthem and through various sub-specialty capabilities whose services include digital photography, 3D imaging, creative retouching, CGI (Computer Generated Images), packaging mock-ups/sales samples, brand compliance, retail marketing (catalogs, circulars, point-of-sale displays), interactive media, and large-format printing. These services support the creation, adaptation and maintenance of brand imagery used across brand touchpoints – including packaging, advertising, marketing and sales promotion materials – offline in printed materials and online in visual media such as the internet, mobile/cellular, interactive displays and television. The Company believes that creative services, since they often represent the creation of client’s original intellectual property, present a high-margin growth opportunity for Schawk.
 
 
The Company’s executional services are delivered primarily through its legacy premedia business, which at this time continues to account for the most significant portion of its revenues.  Premedia products such as color proofs, production artwork, digital files and flexographic, lithographic and gravure image carriers are supported by color management and print management services that the Company believes provides a vital interface between the creative design and production processes. The Company believes this ensures the production of consistent, high quality brand/graphic images on a global scale at the speed required by clients to remain competitive in today’s markets on global, regional and local scales. Increasingly, the Company has been offering executional services in the growing digital space, in order to meet growing client demand to market their brands on the internet and via mobile and interactive technologies. Additionally, the Company’s graphic lifecycle content management software and services facilitates the organization, management, application and re-use of proprietary brand assets. The Company believes that products such as BLUE™ confer the benefits of brand consistency, accuracy and speed to market for its clients.
 
 
As a global supplier of integrated strategic, creative and executional graphics capabilities, Schawk helps clients meet their growing need for consistency across brand touchpoints from a single coordinated contact. A high level of consistency can impact clients’ businesses in potentially significant ways such as the retention and growth of the equity in their brands and improved consumer recognition, familiarity and affinity. The latter has the potential to help clients improve sales and market share of their brands. Additionally, through its global systems, the Company provides processes that reduce opportunities for third parties to counterfeit its clients’ brands, which is an issue in both mature and
 


 
developing regions. The Company also believes that its integrated and comprehensive capabilities provide clients with the potential for long-term cost-reductions across their graphic workflows.
 
Organization

Effective July 1, 2009, the Company restructured its operations to report its operations on a geographic basis, in three reportable segments: North America, Europe and Asia Pacific. This organization reflects the current management reporting structure. The Company’s North America segment includes all of the Company’s operations located in North America, including its Canadian and Mexican operations, its U.S. branding and design capabilities and its U.S. digital solutions business. The Company’s Europe segment includes all operations located in Europe, including its European branding and design capabilities and its digital solutions business in London. The Company’s Asia Pacific segment includes all operations in Asia and Australia, including its Asia Pacific branding and design capabilities.

Financial Overview
 
Net sales decreased $0.9 million or 0.8 percent in the third quarter of 2010 to $112.6 million from $113.5 million in the third quarter of 2009. The quarter-over-quarter sales decline reflects a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client. For the third quarter of 2010, net income was $7.8 million or $0.30 per fully diluted share, as compared to net income of $13.3 million or $0.53 per fully diluted share for the third quarter of 2009. In the third quarter of 2010 compared to the third quarter of 2009, sales decreased in the North America operating segment by 1.2 percent, in the Europe operating segment by 1.5 percent and in the Asia Pacific operating segment by 1.6 percent.
 
 
Gross profit decreased by $1.7 million or 3.8 percent in the third quarter of 2010 to $43.8 million from $45.5 million in the third quarter of 2009. The gross profit decreased in the North America and Asia Pacific operating segments, partially offset by an increase in gross profit in the Europe operating segment. The gross profit in the North America operating segment decreased by $1.5 million or 4.1 percent. The gross profit in the Asia Pacific operating segment decreased by $0.5 million or 11.4 percent. The gross profit in the Europe operating segment increased by $0.2 million or 3.9 percent.
 
Operating income decreased by $4.1 million or 23.1% in the third quarter of 2010 to $13.6 million from $17.6 million in the third quarter of 2009.  The decline in operating income, quarter-over-quarter, is principally due to a $5.0 million indemnity settlement related to the Company’s 2005 acquisition of Seven Worldwide Holdings, Inc. recorded as income in the third quarter of 2009, which did not recur in the third quarter of 2010. Other factors which affected the operating profit, quarter-over-quarter, are as follows: Selling, general and administrative expenses decreased $3.5 million, or 10.9 percent, in the third quarter of 2010 to $28.7 million from $32.2 million in the third quarter of 2009. During the third quarter of 2010, the Company recorded two insurance recoveries, totaling $1.5 million, of which $1.4 million was recorded as a reduction of selling, general and administrative expense and $0.1 million was recorded as a reduction of cost of sales.  The first recovery, in the amount of $0.3 million, related to production equipment damaged during the first quarter of 2010 at one of the Company’s North American facilities, for which a $0.7 million asset impairment charge was recorded in the first quarter of 2010.  The second recovery, in the amount of $1.2 million, resulted from a directors’ and officers’ liability insurance settlement for certain expenses related to the Company’s ongoing SEC investigation. The Company also had reduced restructuring expenses associated with the Company’s cost reduction activities of $0.4 million in the third quarter of 2010 compared to $1.3 million in the third quarter of 2009. The Company recorded a net loss on foreign exchange exposures of $0.7 million in the third quarter of 2010 as compared to a net gain of $0.6 million in the third quarter of 2009.  The net loss on foreign exchange exposures in the third quarter of 2010 included unrealized losses of $0.3 million compared to unrealized gains on foreign exchange exposures of $0.7 million in the third quarter of 2009. The unrealized foreign exchange gains and losses related primarily to unhedged currency exposure from intercompany debt obligations of the Company’s foreign subsidiaries. In addition, the Company recorded a $0.5 million expense in the third quarter of 2010 to adjust the estimated liability related to its 2008 decision to terminate participation in a certain union pension plan, which the Company expects to settle in the fourth quarter of 2010.
 
Cost Reduction and Capacity Utilization Actions
 
Beginning in 2008, continuing in 2009 and in the first nine months of 2010, the Company incurred restructuring costs for employee terminations, obligations for future lease payments, fixed asset impairments, and other associated costs as part of its previously announced plan to reduce costs through a consolidation and realignment of its work force and facilities. The total expense recorded for the three and nine-month periods of 2010 was $0.4 million and $1.4 million, respectively,


and is presented as Acquisition integration and restructuring expense in the Consolidated Statements of Operations. See Note 13 – Acquisition Integration and Restructuring in Part I, Item 1 for additional information.
 
The expense for each of the years 2008 and 2009 and for the first nine months of 2010, and the cumulative expense since the cost reduction program’s inception, was recorded in the following operating segments:
 
   
North
         
Asia
             
(in millions)
 
America
   
Europe
   
Pacific
   
Corporate
   
Total
 
                               
Nine months ended September 30, 2010
  $ 0.7     $ 0.1     $ --     $ 0.6     $ 1.4  
Year ended December 31, 2009
    3.6       1.4       1.0       0.5       6.5  
Year ended December 31, 2008
    5.7       3.6       0.2       0.9       10.4  
                                         
Cumulative since program inception
  $ 10.0     $ 5.1     $ 1.2     $ 2.0     $ 18.3  
 
It is estimated that cost savings resulting from cost reduction actions initiated in the first nine months of 2010 will be approximately $4.5 million for 2010 and recurring pre-tax savings are expected to increase over the subsequent two-year period to approximately $8 million annually. It is estimated that cost savings resulting from the 2009 cost reduction actions was approximately $8.9 million for 2009 and recurring pre-tax savings are expected to increase over the subsequent two-year period to approximately $16 million annually.  Cost savings resulting from the 2008 cost reduction actions is estimated to have been approximately $7.4 million during 2008 and recurring pre-tax savings are estimated to have increased over the subsequent two-year period to approximately $22 million annually.
 
Results of Operations

Consolidated

The following table sets forth certain amounts, ratios and relationships calculated from the Consolidated Statements of Operations for the three months ended:

   
Three Months Ended
September 30,
 
2010 vs. 2009
Increase (Decrease)
(in thousands)
 
2010
 
2009
 
$
   
%
 
                 
Net sales
$
112,562
$
113,463
$
$(901)
 
(0.8)%
Cost of sales
 
68,768
 
67,957
 
811
 
1.2%
Gross profit
 
43,794
 
45,506
 
(1,712)
 
(3.8)%
                 
Selling, general and administrative expenses
 
28,675
 
32,193
 
(3,518)
 
(10.9)%
Foreign exchange (gain) loss
 
694
 
(644)
 
1,338
 
nm
Indemnity settlement
 
--
 
(4,986)
 
4,986
 
nm
Acquisition integration and restructuring expenses
 
371
 
1,328
 
(957)
 
(72.1)%
Multiemployer pension withdrawal expense
 
500
 
--
 
500
 
nm
Operating income
 
13,554
 
17,615
 
(4,061)
 
(23.1)%
                 
Other income (expense):
               
 Interest income
 
15
 
124
 
(109)
 
(87.9)%
 Interest expense
 
(1,642)
 
(2,880)
 
1,238
 
(43.0)%
                 
Income before income taxes
 
11,927
 
14,859
 
(2,932)
 
(19.7)%
Income tax provision (benefit)
 
4,154
 
1,553
 
2,601
 
nm
                 
Net income
$
7,773
$
13,306
$
(5,533)
 
(41.6)%
                 
Effective income tax rate
 
34.8%
 
10.5 %
       
 

Expressed as a percentage of Net Sales:

Gross margin
38.9%
 
40.1%
(120) bpts
Selling, general and administrative expense
25.5%
 
28.4%
(290) bpts
Foreign exchange (gain) loss
0.6%
 
(0.6)%
120 bpts
Indemnity settlement
--
 
(4.4)%
440 bpts
Acquisition integration and restructuring expenses
0.3%
 
1.2%
(90) bpts
Multiemployer pension withdrawal expense
0.4%
 
--
40 bpts
Operating margin
12.0%
 
15.5%
(350) bpts

bpts = basis points
nm = not meaningful

Net sales in the third quarter of 2010 were $112.6 million compared to $113.5 million in the same period of the prior year, a decrease of $0.9 million, or 0.8 percent.  The quarter-over-quarter sales decline reflects a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client. Net sales decreased, quarter-over-quarter, in the North America segment by $1.1 million, or 1.2 percent, in the Asia Pacific segment by $0.1 million, or 1.6 percent, and in the Europe segment by 0.3 million or 1.5 percent. While sales for the third quarter of 2010, as compared to the third quarter of 2009, were impacted by changes in foreign currency translation rates on a country-by-country basis, the overall impact on sales for the third quarter was minimal.

Consumer products packaging accounts sales in the third quarter of 2010 were $82.1 million, or 72.9 percent of total sales, as compared to $80.2 million, or 70.7 percent, in the same period of last year, representing an increase of 2.3 percent.  Advertising and retail accounts sales of $20.1 million in the third quarter of 2010, or 17.9 percent of total sales, decreased 8.8 percent from $22.1 million in the third quarter of 2009. Entertainment account sales of $7.1 million in the third quarter of 2010, or 6.3 percent of total sales, decreased 15.6 percent from $8.5 million in the third quarter of 2009. During the third quarter, the Company continued to see measured progress year-over-year with its largest client segment, consumer packaged goods accounts, with their continued product and brand innovation activity in the areas of strategy and design. However, new product introductions and packaging changes were slower than anticipated for the quarter as consumer packaged goods clients have become more cautious based on economic uncertainties that continue to exist. The quarter-over-quarter increase in sales for consumer products packaged goods accounts was offset by a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client, as previously discussed.

Gross profit was $43.8 million, or 38.9 percent, of sales in the third quarter of 2010, a decrease of $1.7 million, or 3.8 percent, from $45.5 million, or 40.1 percent of sales, in the third quarter of 2009. The decrease in gross profit is  attributable to the decrease in revenue quarter-over-quarter as well as restoration of compensation and benefit reductions implemented during 2009 as part of the Company’s cost reduction initiatives.

Operating income decreased by $4.1 million, to $13.6 million in the third quarter of 2010 from $17.6 million in the third quarter of 2009. The decline in operating income, quarter-over-quarter, is principally due to a $5.0 million indemnity settlement related to the Company’s 2005 acquisition of Seven Worldwide Holdings, Inc. recorded as income in the third quarter of 2009, which did not recur in the third quarter of 2010. The operating income percentage was 12.0 percent for the third quarter of 2010, compared to 15.5 percent in the third quarter of 2009. Other factors which affected the operating profit, quarter-over-quarter, are discussed below.

Selling, general and administrative expenses decreased by $3.5 million over the prior period, reflecting a $0.7 million decrease in professional and consulting fees related to the Company’s internal control remediation and related matters and lower operating expenses resulting from the Company’s cost reduction initiatives, partially offset by restoration of certain temporary cost reduction actions that the Company implemented for 2009.  In addition, as previously discussed, during the third quarter of 2010, the Company recorded several insurance recoveries, totaling $1.5 million, principally as a reduction of selling, general and administrative expense.  In the third quarter of 2010, the Company recorded $0.4 million of acquisition integration and restructuring expenses compared to $1.3 million in the third quarter of 2009. These expenses were recorded in connection with previously announced plans to consolidate, reduce and re-align the Company’s work force and operations and represent costs for employee terminations, obligations for future lease payments, and other associated costs. The Company recorded a $0.7 million loss on foreign exchange exposures in the third quarter of 2010, of which $0.3 million related to unrealized currency remeasurements, compared to a gain on


foreign exchange exposures of $0.6 million in the comparable 2009 period. The Company’s foreign exchange gains or losses relate primarily to unhedged currency exposure from intercompany debt obligations of the Company’s foreign subsidiaries. In addition, the Company recorded a $0.5 million expense in the third quarter of 2010 to adjust the estimated liability related to its 2008 decision to terminate participation in a certain union pension plan, which the Company expects to settle in the fourth quarter of 2010.

Interest expense in the third quarter of 2010 was $1.6 million compared to $2.9 million in the third quarter of 2009, a decrease of $1.2 million, or 43.0 percent. The reduction in interest expense is primarily due to the decrease in average debt outstanding period-over-period. As previously discussed, in order to manage the risk of rising interest rates on a portion of its variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15.0 million in May of 2010.

The Company recorded income tax expense of $4.2 million for the third quarter of 2010 compared to income tax expense of $1.6 million in the third quarter of 2009.  The income tax expense effective tax rate was 34.8 percent and 10.5 percent for the third quarters of 2010 and 2009 respectively.  The increase in the effective rate for 2010 compared to 2009 is primarily due to discrete period tax adjustments related to the nontaxable indemnity settlement and amended tax return adjustments in 2009.

In the third quarter of 2010, the Company recorded net income of $7.8 million, as compared to $13.3 million for the same period of 2009.

Other Information

Depreciation and amortization expense was $4.4 million for the third quarter of 2010 as compared to $4.7 million in the third quarter of 2009.

Capital expenditures in the third quarter of 2010 were $1.8 million compared to $1.5 million in the same period of 2009.

The following table sets forth certain amounts, ratios and relationships calculated from the Consolidated Statements of Operations for the nine months ended:
 
   
Nine Months Ended
September 30,
 
2010 vs. 2009
Increase (Decrease)
(in thousands)
 
2010
 
2009
 
$
   
%
 
                 
Net sales
$
342,110
$
330,540
$
11,570
 
3.5%
Cost of sales
 
209,617
 
209,006
 
611
 
0.3%
Gross profit
 
132,493
 
121,534
 
10,959
 
9.0%
                 
Selling, general and administrative expenses
 
91,619
 
98,313
 
(6,694)
 
(6.8)%
Foreign exchange (gain) loss
 
2,244
 
(1,089)
 
3,333
 
nm
Indemnity settlement
 
--
 
(4,986)
 
4,986
 
nm
Acquisition integration and restructuring expenses
 
1,386
 
3,646
 
(2,260)
 
(62.0)%
Multiemployer pension withdrawal expense
 
500
 
--
 
500
 
nm
Impairment of long-lived assets
 
680
 
136
 
544
 
nm
Operating income
 
36,064
 
25,514
 
10,550
 
41.3%
                 
Other income (expense):
               
 Interest income
 
31
 
224
 
(193)
 
(86.2)%
 Interest expense
 
(5,401)
 
(6,797)
 
1,396
 
(20.5)%
                 
Income before income taxes
 
30,694
 
18,941
 
11,753
 
62.1%
Income tax provision (benefit)
 
4,596
 
3,163
 
1,433
 
45.3%
                 
Net income
$
26,098
$
15,778
$
10,320
 
65.4%
                 
Effective income tax rate
 
15.0%
 
16.7%
       
 
24

 
Expressed as a percentage of Net Sales:

Gross margin
38.7%
 
36.8%
190 bpts
Selling, general and administrative expense
26.8%
 
29.7%
(290)bpts
Foreign exchange (gain) loss
0.7%
 
(0.3)%
100 bpts
Indemnity settlement
--
 
(1.5)%
150 bpts
Acquisition integration and restructuring expenses
0.4%
 
1.1%
(70) bpts
Multiemployer pension withdrawal expense
0.1%
 
--
10 bpts
Impairment of long-lived assets
0.2%
 
--
20 bpts
Operating margin
10.5%
 
7.7%
280 bpts

bpts = basis points
nm = not meaningful

Net sales in the first nine months of 2010 were $342.1 million compared to $330.5 million in the same period of the prior year, an increase of $11.6 million, or 3.5 percent.  Net sales increased, period-over-period, in all operating segments: the North America segment increased by $12.3 million, or 4.3 percent; the Europe segment increased by $0.2 million, or 0.5 percent; and the Asia Pacific segment increased by $1.9 million, or 9.3 percent. Approximately $4.4 million of the sales increase, period-over-period, was the result of changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to certain of the local currencies of the Company’s foreign subsidiaries. The period-over-period increase in sales primarily reflects an overall improvement in the global economy, which started in the latter half of 2009 and continued into 2010, although the Company’s entertainment account sales declined period-over-period. Many of the Company’s clients have increased brand innovation and introduction activities, including the frequency of packaging redesigns and sales promotion projects, resulting in higher revenue for the Company.

Consumer products packaging accounts sales in the first nine months of 2010 were $245.4 million, or 71.7 percent of total, as compared to $233.2 million, or 70.6 percent, in the same period of last year, representing an increase of 5.2 percent. As market and economic conditions improved, many of the Company’s consumer products packaging clients increased their frequency of package redesigns, sales promotions and new product introductions, as compared to the prior year period.  Advertising and retail accounts sales of $64.4 million in the first nine months of 2010, or 18.8 percent of total sales, increased 0.1 percent from $64.3 million in the first nine months of 2009. Entertainment account sales of $21.6 million in the first nine months of 2010, or 6.3 percent of total sales, declined 11.7 percent from $24.5 million in the first nine months of 2009.

Gross profit was $132.5 million, or 38.7 percent, of sales in the first nine months of 2010, an increase of $11.0 million, or 9.0 percent, from $121.5 million, or 36.8 percent of sales, in the first nine months of 2009. The increase in gross profit is largely attributable to the increase in revenue period-over-period and cost savings related to the Company’s restructuring initiatives.

Operating income increased by $10.6 million, to $36.1 million in the first nine months of 2010 from $25.5 million in the first nine months of 2009. The operating income percentage for the first nine months of 2010 was 10.5 percent, compared to an operating income percentage of 7.7 percent in the first nine months of 2009. The increase in operating income in the first nine months of 2010 compared to the first nine months of 2009 is principally due to the increase in revenue period-over-period, lower operating expenses resulting from the Company’s cost reduction initiatives, and the net effect of the items discussed below.

The decrease in selling, general and administrative expenses over the prior period reflects a $4.0 million decrease in professional and consulting fees related to the Company’s internal control remediation and related matters, partially offset by restoration of certain temporary cost reduction actions that the Company implemented for 2009. In addition, as previously discussed, during the first nine months of 2010, the Company recorded several insurance recoveries, totaling $2.9 million, principally as a reduction of selling, general and administrative expense. In the first nine months of 2010, the Company recorded $1.4 million of acquisition integration and restructuring expenses compared to $3.6 million in the first nine months of 2009. These expenses were recorded in connection with previously announced plans to consolidate, reduce and re-align the Company’s work force and operations and represent costs for employee terminations, obligations for future lease payments, and other associated costs. The Company recorded a $2.2 million loss on foreign exchange exposures in the first nine months of 2010, of which $1.5 million related to unrealized currency remeasurements,


compared to a gain on foreign exchange exposures of $1.1 million in the comparable 2009 period. The unrealized currency losses in the first nine months of 2010 were principally due to the deterioration of the value of the Euro during the period. The Company’s foreign exchange gains or losses relate primarily to unhedged currency exposure from intercompany debt obligations of the Company’s foreign subsidiaries. During the first nine months of 2009, the Company recorded $5.0 million of income for an indemnity settlement related to the 2005 acquisition of Seven Worldwide Holdings, Inc.  In addition, the Company recorded a $0.7 million asset impairment charge in the first nine months of 2010 for equipment damaged at one of its North American facilities, compared to a $0.1 million asset impairment charge recorded in the first nine months of 2009. Additionally, the Company recorded a $0.5 million expense in the first nine months of 2010 to adjust the estimated liability related to its 2008 decision to terminate participation in a certain union pension plan, which the Company expects to settle in the fourth quarter of 2010.
 
Interest expense in the first nine months of 2010 was $5.4 million compared to $6.8 million in the first nine months of 2009, a decrease of $1.4 million, or 20.5 percent. The reduction in interest expense is primarily due to the decrease in average debt outstanding period-over-period. As previously discussed, in order to manage the risk of rising interest rates on a portion of its variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15.0 million in May of 2010.
 
The Company recorded income tax expense of $4.6 million for the first nine months of 2010, compared to income tax expense of $3.2 million in the first nine months of 2009.  The income tax expense effective tax rate was 15.0 percent and 16.7 percent for the first nine months of 2010 and 2009 respectively.  The decrease in the effective tax rate for the 2010 period compared to the prior year is primarily due to an increase in the amount of discrete period tax benefits from the release of uncertain tax positions during the first nine months of 2010 of $7.1 million compared to the nontaxable indemnity settlement and amended tax return adjustments of $3.4 million reflected in 2009.

In the first nine months of 2010, the Company recorded net income of $26.1 million, as compared to a net income of $15.8 million for the same period of 2009.

Other Information

Depreciation and amortization expense was $13.3 million for the first nine months of 2010 as compared to $14.2 million in the first nine months of 2009.

Capital expenditures in the first nine months of 2010 were $6.7 million compared to $3.9 million in the same period of 2009.


Segment Information

North America
   
 
Three months ended September 30,
 
2010 vs. 2009
Increase (Decrease)
(in thousands)
 
2010
 
2009
 
$
   
%
 
                 
Net sales
$
97,360
$
98,493
$
(1,133)
 
(1.2)%
Acquisition integration and
restructuring expenses
 
$
 
117
 
$
 
566
 
$
 
(449)
 
(79.3)%
Foreign exchange (gain) loss
$
(23)
$
38
$
(61)
 
nm
Depreciation and amortization
$
2,734
$
2,807
$
(73)
 
(2.6)%
Operating income
$
17,627
$
18,164
$
(537)
 
(3.0)%
Operating margin
 
18.1%
 
18.4%
     
(30)bpts
Capital expenditures
$
1,063
$
1,215
$
(152)
 
(12.5)%
Total assets
$
343,816
$
319,722
$
24,094
 
7.5%

nm = not meaningful
bpts = basis points

Net sales in the third quarter of 2010 for the North America segment were $97.4 million compared to $98.5 million in the same period of the prior year, a decrease of $1.1 million or 1.2 percent. Sales for the third quarter of 2010, as compared to the third quarter of 2009, benefited from an increase of $0.7 million resulting from changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to certain of the local currencies of the Company’s foreign subsidiaries.  While sales for the nine-month period ended September 30, 2010 increased relative to sales for the nine-month period ended September 30, 2009, sales for the third quarter of 2010 were lower compared to sales for the third quarter of 2009, reflecting a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client.

Operating income was $17.6 million or 18.1 percent of sales, in the third quarter of 2010 compared to $18.2 million, or 18.4 percent of sales, in the second quarter of 2009, a decrease of $0.5 million. The decrease in operating income is principally due to the decrease in revenue quarter-over-quarter.
 

   
 
Nine months ended September 30,
 
2010 vs. 2009
Increase (Decrease)
(in thousands)
 
2010
 
2009
 
$
   
%
 
                 
Net sales
$
297,996
$
285,722
$
12,274
 
4.3%
Acquisition integration and
restructuring expenses
 
$
 
661
 
$
 
1,568
 
$
 
(907)
 
(57.9)%
Foreign exchange (gain) loss
$
(58)
$
71
$
(129)
 
nm
Impairment of long-lived assets
$
680
$
61
$
619
 
nm
Depreciation and amortization
$
8,273
$
8,833
$
(560)
 
(6.3)%
Operating income
$
50,906
$
38,765
$
12,141
 
31.3%
Operating margin
 
17.1%
 
13.6%
     
350bpts
Capital expenditures
$
4,619
$
2,976
$
1,643
 
55.2%
Total assets
$
343,816
$
319,722
$
24,094
 
7.5%

nm = not meaningful
bpts = basis points

Net sales in the first nine months of 2010 for the North America segment were $298.0 million compared to $285.7 million in the same period of the prior year, an increase of $12.3 million or 4.3 percent. Approximately $3.6 million of the period-over-period sales increase was the result of changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to the local currencies of certain of the Company’s foreign subsidiaries. The period-over


period increase in sales reflects an improvement in the North American economy, which started in the latter half of 2009 and continued into 2010. In response to improving economic conditions, many of the Company’s consumer products clients have increased their levels of marketing and new product introductions and have increased the frequency of packaging redesigns and sales promotion projects, resulting in higher revenue for the Company. As previously mentioned, sales in the third quarter of 2010 declined slightly in comparison to the third quarter of 2009, reflecting a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client.

Operating income was $50.9 million or 17.1 percent of sales, in the first nine months of 2010 compared to $38.8 million, or 13.6 percent of sales, in the first nine months of 2009, an increase of $12.1 million. The increase in operating income is principally due to the increase in revenue period-over-period and the Company’s cost reduction initiatives, which began in the second half of 2008 and continued into the third quarter of 2010.

Europe

   
 
Three months ended September 30,
 
2010 vs. 2009
Increase (Decrease)
(in thousands)
 
2010
 
2009
 
$
   
%
 
                 
Net sales
$
16,724
$
16,978
$
(254)
 
(1.5)%
Acquisition integration and
restructuring expenses
 
$
 
(81)
 
$
 
214
 
$
 
(295)
 
nm
Foreign exchange (gain) loss
$
(186)
$
(287)
$
101