By Jan Stoddard of Raine Consulting August 1, 2003 -- Cadmus Communications Corporation (NASDAQ/NM: CDMS) announced net sales of $114.4 million for the fourth quarter of fiscal year 2003, an increase of 5% form $109.0 million in the same quarter last year. Adjusted operating income was $8.6 million (versus $8.5 million in 2003) and net income was $3.0 million (versus $2.7 million), or $1.17 per share (versus $1.07). By segment, the Publisher Services Group reported a 3% gain to $99.2 million in sales, while the Specialty Packaging Group reported a 19% jump to $12.7 million primarily due to new business from the healthcare market. Editor's Note: Cadmus Communications today reported a strong quarter with revenue increases, as well as improvements in operating income, earning per shar,e and continuing debt reduction. The 'bottom-line' would have been even greater except Cadmus continues to invest aggressively in what CEO Bruce Thomas calls 'our differentiation strategy'. In addition, Cadmus is banking on a global strategy to chase cheap rates to stave price commoditization with production facilities (one in the Dominican Republic and two in India). Cadmus also installed two web color presses, a new Timsons 498-page zero-make ready press, Xerox 6060 Color Docutech, and a real-time information system at their warehouse facility in Hurlock, Maryland. Results for fiscal year 2003, ending June 30th, 2003, included net sales of $446.9 million, relatively flat when compared with $447.3 million in sales last year. By segment, the Publisher Services Group sales were $388.5 (down 2% from prior year) primarily due to softness in advertising and volume, as well as softness in pricing. The Specialty Packaging Segment sales were $58.4 million (up 13%). Full year operating income was $32.7 million or 7.3% of net sales (versus 7.2% for the prior year). Cash flow from operations totaling $15.4 million was used to pay down debt. Mr. Bruce V. Thomas, President and Chief Executive Officer, and Mr. Paul Suijk, Chief Financial Officer, conducted a web cast announcing Fourth Quarter and Fiscal Year 2003 results. Call Topics: * CEO Comments * Financial Summary * Outlook 2004 * Q&A CEO Comments - General Industry Update and Business Overview Bruce Thomas noted that the print industry continues to struggle while market conditions remain difficult. He cited the fact that 5700 print companies have closed in the past four years and yet the industry still has excess capacity. Advertising has had a comeback, although demand still remains soft and pricing pressures continue. Referencing these difficult conditions, Thomas noted that many of Cadmus's competitors have either reported disappointing results or reduced their guidance going forward specifically citing: Quebecor World's decline in earnings and second major restructuring since last fall, Consolidated Graphics report of both lower revenue and earnings, R.R. Donnelly's announcement of revised earnings (again) citing on-going softness of market it serves, and Courier, usually a strong performer, comments on the tight economy and 'adverse sales environment.' Particularly with this industry background, Thomas noted that they were very pleased with the past quarter's performance noting that sales and earnings were up again, showing year-over-year and sequential improvement, while debt was down again. Even though 2003 fiscal year sales were flat, Thomas labeled it as "a solid achievement in these conditions." On an annualized basis, Cadmus exceeded its business plan, met analyst expectations, and reduced total debt by $15.4 million (totaling $75 million since June 30th, 2000). Attributing this success to the Cadmus 3-year-long pursuit of an aggressive differentiation strategy Thomas stated, "With rare exception, our print competition is focused on reducing cost, improving efficiency and rationalizing capacity. The important question we have focused is on is: What happens if pricing falls faster than you can cut cost? Based on this quarter's announcements by some of those companies, we have been getting the answer…We have been unwilling to follow a strategy that further commoditizes our products and service offering. We are not willing to follow the example from the paper industry: more and more capital following falling prices and chasing demand." Thomas further describes this differentiation strategy as designed to 1) elevate the perceived value of our products to positively affect pricing, 2) gain share from competitors and, 3) to reduce our vulnerability to negative print trends. Cadmus reported top-line growth in its areas: STM and Specialty Packaging. Thomas also noted that they have continued to add capabilities, new products, offshore content processing and new technology including KnowledgeWorks, MediaWorks and ArticleWorks. Citing the key industry issue as commoditization and the pricing declines that follow, Thomas remarked, "More importantly, it makes it harder for true commodity-driven buyers to make apples-to-apples comparisons and much harder for other traditional printers to compete with us." Thomas also reviewed two key objectives: growing non-print sources of revenue and leveraging a global manufacturing platform. He reviewed two recent initiatives: 1. Joint Venture in India: Located in Mumbai, India and 80% ownership by Cadmus, this dedicated production facility offers a full range of content processing, content management and related services including coding, conversion, and pagination services to the international publishing community. By January of 2004, a second facility will be fully operational and able to provide editorial account management and content management directly from India to North America and European contacts. Thomas noted that the Mumbai facility is already expanding outside core markets with new customer work from a legal publisher and a publisher of engineering-related information. 2. ArticleWorks released: This is comprehensive content and digital rights management system that allows publishers and content managers to deliver content in either printed or on-line secured formats. It facilitates incremental revenue from existing content for their customers. (Current customers include: The Kennedy School of Government, EdgarOn-line, and MarketResearch.com.). Thomas concluded with a summary of corporate governance actions. Over the past three years, Cadmus has: * Created & executed non-executive chairman position * Installed six new director's to the Board * There are now nine former CEO's on Board, seven with public company experienc * The only insider on the twelve-person board is Bruce Thomas * Developed a 3-year independent director evaluation to shareholder rights' plan (to review if plan is in best interests of shareholders). Financial Summary Chief Financial Officer, Paul Suijk reviewed financial highlights: Highlights for Fourth Quarter: Consolidated Net Sales of $114.4 million for the fourth quarter reflected an increase of 5% versus fourth quarter 2002. Overall, there were improved financials for this quarter as operating income increased to $8.6 million versus $8.5 million, earnings per share increased to $0.33, with a debt reduction of $0.6 million (despite $6.1 million for semi-annual bond interest payments, $6.1 million in capital expenditures and $3.1 million for the joint venture in India). Interest expense continues to trend lower to $3.7 million. Highlights for the Year: Net sales, at a 2% year-over-year reduction, were essentially flat at $446.9 million due to softness in advertising and volume, as well as severe pricing pressure. Operating income improved to $32.7 million (versus $32.1 million in 2002); earnings per share improvement to $1.17 per share ($1.07 FY2002); and overall debt reduction of $15.4 million. Restructuring Program Update: During the second fiscal quarter, Cadmus will close the East Stroudsburg plant and the reprint department in Easton resulting in pre-tax charge of $2 million (equivalent to $0.14 cents per share) for the fourth quarter, with full fiscal charges estimated at $12 million or $0.87 per share. The restructuring is now primarily complete except for equipment movement from East Stroudsburg that could result in up to $600,000 in additional restructuring charges. Changes to Pension Plan: The Board voted to freeze the defined employee pension plan effective 7/31/03. This will mitigate volatility of the cash flow related to the program going forward (estimated at $23.8 million after tax charge in the fourth quarter). Cadmus is planning on $8 million pension payment in Q1 2004 after which there should be substantially see less cash contribution in the coming years. Outlook 2004 Mr. Thomas closed by stating that the Cadmus differentiation strategy is continuing to make an impact on the STM market. They are pleased with both operating performance and cash flow. Given no economic downturn, Thomas said that they will sustain the year-over-year and quarter-over-quarter improvement in earnings throughout fiscal 2004, and believes the published expectations of $1.32 per share are reasonable and attainable. While continuing to focus on debt reduction initiatives, they do not expect improvement in debt position for Q1 2004 (due to above disclosed pension payment.) Thomas concluded by stating, "We are more optimistic than have been in a long time for Cadmus moving forward." Q & A: 1. When asked by analysts why earnings were not better, Thomas explained that additional costs were incurred in the category of investments. For example, the Dominican Republic facility did have start-up costs in the fourth quarter, but is now operational and has recently produced its' first live job. (He also noted that Cadmus won work from new customers for this facility.) The expansion in India (described as a "modest" investment) also impacted margins. However, Thomas noted that their current objectives are designed to improve top line and margins. He believes that Cadmus can overcome pricing pressures by adding products and services with much higher perceived value and will be successful in generating revenue from these new products and services in 2004. One caution: do not underestimate pricing pressure for commoditization. 2. Thomas commented that while the 19% gain in packaging may not be sustainable, Cadmus is doing all the right things for solid growth performance going forward from a strategic perspective. (The Dominican Republic project is just one example.) Thomas observes a systematic and positive shift towards specialty packaging resulting in a lot of business success as Cadmus successfully implements differentiation into a highly attractive market. 3. While 2003 had a $3.5 million pension plan expense; it is expected to be under $2 million in 2004. From a cash viewpoint, $8 million was spent get to the '90% test' which will help in significantly reducing cash payment in the next couple of years. The cash payment should be significantly below $4.5 million in 2005 and going forward. 4. When asked if specialty packaging was based on one-time events, Thomas remarked that one reason they have focused on health care market is because it is high-frequency work. As long as a pharmaceutical company is producing a drug, it will need packaging to support it. Focus on the healthcare vertical allows Cadmus to have more consistent volume and build in efficiencies (improved profitability) as the same product is produced over-and-over again. 5. There is a total availability of $75 million in the revolver. Cadmus also anticipates 2004 capital expenditures in the $14-17 million range. 6. Thomas noted that while there is seasonality in certain quarters, it was more significant than typical due to start-up costs in the third quarter and a mix change from the third to fourth quarters. 7. There have been some positive trends in specialty magazines. Thomas offered three items that could positively impact in 2004: 1) They are seeing an increase in ad pages and have started to see some entirely new magazines (recently produced "Vegas") for the first time in a long time, 2) There has been improved productivity in two remaining plants that have incorporated the transferred work from East Stroudsburg, and 3) Differentiation allows Cadmus to compete on a different level than just ink on paper. However, Thomas notes that it still remains a choppy marketplace. 8. It will take 60 days to reach profitability in the Dominican Republic, but anticipate both volume and profitability throughout the first quarter 2004. 9. When asked about an aggregate number for non-recurring expenses in 2004, Thomas explained that they are investing heavily in the differentiation strategy that has had modest impact on growth margins. On the whole, Cadmus continues to invest aggressively, citing the whole suite of offerings (KnowledgeWorks, MediaWorks, and bringing ArticleWorks to market) as a continued investment in growth of the company. 10. Regarding segment projections for 2004, Thomas noted that there has been solid growth in STM services over the past year and he expects this to continue. He anticipates top line company-wide growth of approximately 3% for 2004. However, they are not modeling a positive year in the magazine business due to pricing pressures, as there is a lot of capacity chasing modest demand. 11. Cadmus started the offshore initiative to expand capacity to meet page growth in the most responsive fashion. Mumbai has been positioned to meet needs of the North American market, while the second upcoming facility will be focused on European opportunities and other markets outside STM markets such as the just-awarded a content management work for a specialty magazine. 12. Cadmus is a special services company, not just a publisher. Throughout this year, they are going to reposition Cadmus in this context. 13. Thomas does not see the pricing environment for traditional print services getting better in the foreseeable future. To combat this, Thomas stated, "You have to make what you sell (market services) not about print." In terms of pricing vulnerability on renewal contracts, Thomas noted that a very high percentage of the revenue (in excess of 70%) are in 2-3 year contracts. As part of the renewal process, the Sales group works on changing what is being bought making it less and less about print.