Critical Accounting Policies and Estimates: The Company's consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. On an ongoing basis, management evaluates its estimates and judgments, including those related to collectibility of accounts receivable, recovery of inventories, impairment of goodwill and other intangibles, and prepublication costs. Management bases its estimates and judgments on historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results may differ from these estimates. The significant accounting policies which management believes are most critical to aid in fully understanding and evaluating the Company's reported financial results include the following: Accounts Receivable. Management performs ongoing credit evaluations of the Company's customers and adjusts credit limits based upon payment history and the customer's current creditworthiness. Collections and payments from customers are continuously monitored. A provision for estimated credit losses is determined based upon historical experience and any specific customer collection risks that have been identified. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Inventories. Management records reductions in the cost basis of inventory for excess and obsolete inventory based primarily upon historical and forecasted product demand. If actual market conditions are less favorable than those projected by management, additional inventory charges may be required. Goodwill and Other Intangibles. Other intangibles include customer lists and technology, which are amortized on a straight-line basis over periods ranging from three to fifteen years, and an indefinite-lived trade name. The Company evaluates possible impairment of goodwill and other intangibles at the reporting unit level, which is the operating segment or one level below the operating segment, on an annual basis or whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The Company completed its annual impairment test at September 28, 2013 , which resulted in no change to the nature or carrying amounts of its intangible assets. Changes in market conditions or poor operating results could result in a decline in value of the Company's goodwill and other intangible assets thereby potentially requiring an additional impairment charge in the future. Prepublication Costs. The Company capitalizes prepublication costs, which include the costs of acquiring rights to publish a work and costs associated with bringing a manuscript to publication such as artwork and editorial efforts. Prepublication costs are amortized on a straight-line basis over periods ranging from two to four years. Management regularly evaluates the sales and profitability of the products based upon historical and forecasted demand. If actual market conditions are less favorable than those projected by management, additional amortization expense may be required. 13 -------------------------------------------------------------------------------- Overview: Courier Corporation , founded in 1824, is among America's leading book manufacturers and a leader in content management and customization in new and traditional media. The Company also publishes books under three brands offering award-winning content and thousands of titles. The Company has two operating segments: book manufacturing and publishing. The book manufacturing segment streamlines the process of bringing books from the point of creation to the point of use. Based on sales, Courier is the third largest book manufacturer in the United States , offering services from prepress and production through storage and distribution, as well as innovative content management, customization and state-of-the-art digital print capabilities. The publishing segment consists of Dover Publications, Inc. ("Dover"), Research & Education Association, Inc. ("REA"), and Federal Marketing Corporation , d/b/a Creative Homeowner ("Creative Homeowner"). Dover publishes over 10,000 titles in more than 30 specialty categories including children's books, literature, art, music, crafts, mathematics, science, religion and architecture. REA publishes test preparation and study-guide books and software for high school, college and graduate students, and professionals. Creative Homeowner publishes books on home design, decorating, landscaping, and gardening, and also sells home plans. Results of Operations: FINANCIAL HIGHLIGHTS (dollars in thousands except per share amounts) Three Months Ended December 28, December 29, % 2013 2012 Change Net sales $ 72,796 $ 64,756 12 % Cost of sales 54,904 48,756 13 % Gross profit 17,892 16,000 12 % As a percentage of sales 24.6 % 24.7 % Selling and administrative expenses 13,448 11,968 12 % Operating income 4,444 4,032 10 % Interest expense, net 175 190 -8 % Pretax income 4,269 3,842 11 % Provision for income taxes 1,622 1,422 14 % Net income $ 2,647 $ 2,420 9 % Net income per diluted share $ 0.23 $ 0.21 10 % Revenues in the first quarter of fiscal 2014 were $72.8 million , up 12% from the same period last year. Book manufacturing segment sales increased 14% to $65.6 million with growth in all three of its principal markets and in both digital and offset operations. In the publishing segment, revenues of $9.1 million were comparable to last year's first quarter. Net income for the quarter was $2.6 million , up 9% from the first three months of fiscal 2013. Results in the book manufacturing segment were down slightly from the first quarter of last year while the loss in the publishing segment was reduced by 47% compared to the first three months of fiscal 2013. 14 -------------------------------------------------------------------------------- Book Manufacturing Segment SEGMENT HIGHLIGHTS (dollars in thousands) Three Months Ended December 28, December 29, % 2013 2012 Change Net sales $ 65,576 $ 57,481 14 % Cost of sales 51,216 44,430 15 % Gross profit 14,360 13,051 10 % As a percentage of sales 21.9 % 22.7 % Selling and administrative expenses 9,050 7,552 20 % Operating income $ 5,310 $ 5,499 -3 % Within the book manufacturing segment, the Company focuses on three key publishing markets: education, religious and specialty trade. In the first quarter of fiscal 2014, sales to the education market were $28 million , up 14% from the same period last year, primarily due to increased sales of college textbooks. Sales to the elementary and high school level also improved in the quarter, reflecting schools returning to higher funding levels. Sales to the religious market grew 14% to $19 million , with sales to the Company's largest religious customer up 8%. Sales to the specialty trade market were up 12% to $17 million , reflecting higher demand for digital and four-color books. In July 2013 , the Company announced plans to install a second HP digital inkjet press and expanded binding capabilities for the Kendallville, Indiana location. Installation was completed in the first quarter of fiscal 2014. In October 2013 , the Company announced plans to invest in the education market in Brazil , the largest such market in Latin America , through two separate agreements. Under the first agreement, completed in January 2014 , the Company has licensed its proprietary custom textbook platform to Santillana, the largest Spanish/Portuguese educational publisher in the world. With the second agreement, the Company will acquire a 40% ownership interest in Digital Page GrÁfica E Editora ("Digital Page"), a Sao Paulo -based digital printing firm, which has a long-term print agreement with Santillana. This transaction is expected to close by the end of the Company's second quarter. In the first quarter of fiscal 2014, cost of sales in the book manufacturing segment increased 15% to $51.2 million compared to the same period last year reflecting the growth in sales as well as higher depreciation expense related to the expansion of the Kendallville digital facility. Gross profit for the first quarter increased $1.3 million to $14.4 million compared with the corresponding period in fiscal 2013 and, as a percentage of sales, decreased to 21.9% from 22.7%, reflecting a continued highly competitive pricing environment and increased depreciation expense. Selling and administrative expenses for the segment increased $1.5 million in the first quarter of fiscal 2014 compared to the first three months of last year, reflecting growth in the Company's digital print operations, costs associated with the investment in Brazil , and approximately $0.9 million of expenses related to the acquisition of FastPencil in the third quarter of last year, including amortization expense and the change in fair value of contingent consideration. First quarter operating income in the book manufacturing segment declined 3% to $5.3 million compared with the first quarter of fiscal 2013, reflecting a highly competitive pricing environment, increased depreciation expense, and costs associated with the acquisition of FastPencil and the investment in Brazil . 15 -------------------------------------------------------------------------------- Publishing Segment SEGMENT HIGHLIGHTS (dollars in thousands) Three Months Ended December 28, December 29, % 2013 2012 Change Net sales $ 9,121 $ 9,134 - Cost of sales 5,682 6,195 -8 % Gross profit 3,439 2,939 17 % As a percentage of sales 37.7 % 32.2 % Selling and administrative expenses 4,039 4,075 -1 % Operating loss $ (600 ) $ (1,136 ) The Company's publishing segment reported revenues of $9.1 million , comparable to last year's first quarter. Sales at REA decreased 11% in the quarter to $0.8 million and Creative Homeowner's sales were down 23% to $0.5 million compared to the first three months of fiscal 2013. These declines reflect in part a shrinking base of brick and mortar retail channels and for Creative Homeowner, less new title development. During the quarter, the Company also took steps at REA to narrow the focus of its new product development to key test preparation markets, such as AP, CLEP and GED. Sales at Dover in the first quarter of fiscal 2014 increased 3% to $7.8 million compared to the first three months last year, reflecting growth in both ebook sales and print sales through online retailers. During the quarter, the segment continued to increase its range of titles offered online in both printed and ebook form, including approximately 4,500 titles now available as ebooks through Amazon, Apple, Barnes & Noble and Google as well as its own websites. Cost of sales in this segment declined 8% to $5.7 million in the first three months of fiscal 2014 compared to the prior year quarter, reflecting a more favorable sales mix. Gross profit increased 17% to $3.4 million compared to last year's first quarter and, as a percentage of sales, increased to 37.7% from 32.2%, reflecting the favorable sales mix, including the impact of growth in ebook sales, and an improved cost structure in the segment. Selling and administrative expenses for the segment in the first three months of fiscal 2014 were $4.0 million , comparable to the prior year period. Such expenses included approximately $100,000 related to steps taken in the first quarter of fiscal 2014 to reduce overhead at REA and refocus new product development. The publishing segment's operating loss was $0.6 million in the first three months of fiscal 2014 compared to $1.1 million in the corresponding period last year, largely due to the improvement in sales at Dover. Total Consolidated Company Interest expense, net of interest income, was $175,000 in the first quarter of fiscal 2014 compared to $190,000 of net interest expense in the first three months of last year. Average debt under the revolving credit facility in the first quarter of fiscal 2014 was approximately $24.1 million at an average annual interest rate of 1.4%, generating interest expense of approximately $88,000 . Average debt under the revolving credit facility in the first quarter of last year was approximately $9.9 million at an average annual interest rate of 1.5%, generating interest expense of approximately $36,000 . In the first quarter of fiscal 2014, the Company entered into a capital lease arrangement for certain assets in its Kendallville, Indiana digital print facility. At December 28, 2013 , $10.2 million of debt was outstanding under this arrangement at an implicit interest rate of 1.8%, generating interest expense of approximately $25,000 in the first quarter. In addition, approximately $30,000 and $34,000 of interest expense was amortized in the first three months of fiscal years 2014 and 2013, respectively, associated with the restructuring costs incurred in fiscal 2011. Interest expense also includes commitment fees and other costs associated with maintaining the Company's $100 million revolving credit facility. In the first quarter of fiscal 2014, the Company recorded interest income of approximately $50,000 from a loan relating to the investment in Brazil . 16 -------------------------------------------------------------------------------- The Company's effective tax rate for the first quarter of fiscal 2014 was 38%, compared to the 37% rate for the same period last year, reflecting nondeductible costs associated with the FastPencil acquisition in the third quarter of last year which were offset in part by an increased benefit from the federal manufacturer's deduction. For purposes of computing net income per diluted share, weighted average shares outstanding for the first quarter of fiscal 2014 increased by approximately 91,000 shares compared with the same period last year, primarily due to an increase in potentially dilutive shares. Restructuring Costs In fiscal 2011, the Company recorded restructuring costs of $7.7 million associated with closing and consolidating its Stoughton, Massachusetts manufacturing facility due to the impact of technology and competitive pressures affecting the one-color paperback books in which the plant specialized. Restructuring costs included $2.3 million for employee severance and benefit costs, $2.1 million for an early withdrawal liability from a multi-employer pension plan, and $3.3 million for lease termination and other facility closure costs. Remaining payments of approximately $3.1 million will be made over periods ranging from 2 years for the building lease obligation to 18 years for the liability related to the multi-employer pension plan. At December 28, 2013 , approximately $0.8 million of the restructuring payments were included in "Other current liabilities" and $2.5 million were included in "Other liabilities" in the accompanying consolidated balance sheet. The following table depicts the remaining accrual balances for these restructuring costs. (000's omitted) Accrual at Charges Costs Accrual at September 28, or Paid or December 28, 2013 Reversals Settled 2013 Employee severance, post-retirement and other benefit costs $ 308 $ (136 ) $ 172 Early withdrawal from multi-employer pension plan 2,001 (19 ) 1,982 Lease termination, facility closure and other costs 1,241 (87 ) 1,154 Total $ 3,550 - $ (242 ) $ 3,308 Liquidity and Capital Resources: During the first three months of fiscal 2014, operations provided $9.5 million of cash, compared to $9.9 million in the first quarter of last year. Net income was $2.6 million and depreciation and amortization were $6.4 million . Investment activities in the first quarter of fiscal 2014 used $10.8 million of cash. Capital expenditures were $6.1 million . For the entire fiscal year, capital expenditures are expected to be approximately $14 to $16 million , with approximately $10 million related to expanding digital capabilities. Prepublication costs were $0.7 million in the first three months of fiscal 2014, comparable to the first quarter of last year. For the full fiscal year, prepublication costs are projected to be approximately $3 million . In October 2013 , the Company announced plans to invest in the education market in Brazil , the largest such market in Latin America through two separate agreements. Under the first agreement, completed in January 2014 , the Company has licensed its proprietary custom textbook platform to Santillana, the largest Spanish/Portuguese educational publisher in the world. In addition, on October 24, 2013 , the Company entered into a definitive agreement with Digital Page GrÁfica E Editora ("Digital Page"), a Sao Paulo -based digital printing firm, which has a long-term print agreement with Santillana. Under this agreement, the Company will invest a total of 20 million Brazilian reals , approximately $9 million , for a 40% equity interest. The founder of Digital Page, who will continue to own 60% of the business and actively manage the operations, is entitled to receive up to approximately $3 million of the proceeds over a twelve-month period. The Digital Page agreement includes customary representations, warranties and covenants for agreements of this type, including indemnification from the founder. One of the ancillary documents is a stockholders agreement containing restrictions on the transfer of equity interests, put and call rights and governance provisions, including restrictive covenants requiring the Company's consent for any significant action by Digital Page. During the first quarter of fiscal 2014, the Company funded two loans to Digital Page totaling approximately $4.5 million which are secured by a pledge of a 40% interest in Digital Page's equity and bears interest at 1% per month. The transaction is expected to close by the 17 -------------------------------------------------------------------------------- end of the Company's second quarter and the principal amount of the loans will be credited towards the purchase price of the Company's ownership interest. The Company will include its equity percentage of Digital Page's earnings in its consolidated financial statements from the date of the closing. In November 2013 , the Company announced the approval by its Board of Directors for the repurchase of up to $10 million of the Company's outstanding common stock from time to time on the open market or in privately negotiated transactions, including pursuant to a Rule 10b5-1 nondiscretionary trading plan. Through December 28, 2013 , the Company had not repurchased any shares of common stock under this program. Financing activities for the first three months of fiscal 2014 provided approximately $1.4 million of cash. Cash dividends of $2.4 million were paid and net borrowings decreased by $6.3 million during the first quarter of fiscal 2014. Also, in the first quarter of fiscal 2014, the Company entered into a capital lease arrangement for printing and binding equipment in its Kendallville, Indiana digital print facility. At December 28, 2013 , $10.2 million of debt was outstanding under this arrangement and the implicit interest rate was 1.8%. Borrowings under a term loan used to finance the purchase of digital print equipment in 2010 were $0.7 million at December 28, 2013 , with $0.3 million at a fixed annual interest rate of 3.9% and $0.4 million at a fixed annual interest rate of 3.6%. The Company also has a $100 million long-term revolving credit facility in place under which the Company can borrow at a rate not to exceed LIBOR plus 2.25%. At December 28, 2013 , the Company had $18.7 million in borrowings under this facility at an interest rate of 1.4%. The revolving credit facility, which matures in March 2016 , contains restrictive covenants including provisions relating to the incurrence of additional indebtedness and a quarterly test of EBITDA to debt service. The Company was in compliance with all debt covenants at December 28, 2013 . The facility also provides for a commitment fee not to exceed 3/8% per annum on the unused portion. The revolving credit facility is used by the Company for both its long-term and short-term financing needs. The Company believes that its cash on hand, cash from operations and the available credit facility will be sufficient to meet its cash requirements for at least the next twelve months. The following table summarizes the Company's contractual obligations and commitments at December 28, 2013 to make future payments as well as its existing commercial commitments. (000's omitted) Payments due by period Less than 1 to 3 3 to 5 More than Contractual Payments: Total 1 Year Years Years 5 Years Debt, including capital lease obligation (1) $ 29,521 $ 3,187 $ 24,033 $ 2,301 - Interest due on debt (2) 370 167 184 19 - Operating leases (3) 6,019 1,114 1,729 1,669 1,507 Purchase obligations (4) 659 659 - - - Contingent consideration (5) 5,125 - 5,050 75 - Other liabilities (6) 6,821 934 2,170 637 3,080 Total $ 48,515 $ 6,061 $ 33,166 $ 4,701 $ 4,587 -------------------------------------------------------------------------------- (1) Includes $18.7 million under the Company's long-term revolving credit facility, which has a maturity date of March 2016 . (2) Represents scheduled interest payments on the Company's term loan and capital lease. Future interest on the Company's revolving credit facility is not included because the interest rate and principal balance fluctuate on a daily basis and an estimate could differ significantly from actual interest expense. (3) Represents amounts at September 28, 2013 , except for the Stoughton, Massachusetts building lease obligation which was included in the restructuring accrual in "Other liabilities." (4) Represents capital commitments. (5) Related to the acquisition of FastPencil in April 2013 . (6) Includes approximately $2.5 million of restructuring costs related to closing the Stoughton, Massachusetts facility, in addition to a current liability of $0.8 million . Operating leases exclude the Stoughton building lease obligation which is included above in other liabilities. 18 -------------------------------------------------------------------------------- Forward-Looking Information: This Quarterly Report on Form 10-Q includes forward-looking statements. Statements that describe future expectations, plans or strategies are considered "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995 and releases issued by the Securities and Exchange Commission . The words "believe," "expect," "anticipate," "intend," "estimate" and other expressions which are predictions of or indicate future events and trends and which do not relate to historical matters identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those currently anticipated. Some of the factors that could affect actual results are discussed in Item 1A of this Form 10-Q and include, among others, pricing actions by competitors and other competitive pressures in the markets in which the Company competes, consolidation among customers and competitors, changes in customers' demand for the Company's products, including seasonal changes in customer orders and shifting orders to lower cost regions, success in the execution of acquisitions and the performance and integration of acquired businesses including carrying value of intangible assets and contingent consideration, performance of investments in unconsolidated subsidiaries and exposure to risks of operating internationally, restructuring and impairment charges required under generally accepted accounting principles, insolvency of key customers or vendors, changes in technology including migration from paper-based books to digital, changes in market growth rates, changes in obligations of multiemployer pension plans and general changes in economic conditions, including currency fluctuations, changes in interest rates, changes in consumer confidence, changes in the housing market, and tightness in the credit markets, changes in raw material costs and availability, changes in the Company's labor relations, changes in operating expenses including medical and energy costs, difficulties in the start up of new equipment or information technology systems, changes in copyright laws, changes in consumer product safety regulations, changes in environmental regulations, changes in tax regulations and changes in the Company's effective income tax rate. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements will prove to be accurate. The forward-looking statements included herein are made as of the date hereof, and the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances.
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