10-Q 1 l03446ae10vq.txt DAY INTERNATIONAL GROUP, INC. 10-Q/QTR END 9-30-03 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 COMMISSION FILE NOS. 33-93644 AND 333-51839 DAY INTERNATIONAL GROUP, INC. 130 West Second Street Dayton, Ohio 45402 (937) 224-4000 State of Incorporation: Delaware IRS Employer Identification No.: 31-1436349 Securities Registered Pursuant to Section 12 (b) of the Act: None Securities Registered Pursuant to Section 12 (g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] There were 23,298 Common Shares of the Company, $0.01 per share par value, outstanding as of November 1, 2003. DAY INTERNATIONAL GROUP, INC. INDEX

2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DAY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2003 AND DECEMBER 31, 2002 (IN THOUSANDS)

See notes to condensed consolidated financial statements. 3 DAY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (IN THOUSANDS)

See notes to condensed consolidated financial statements. 4 DAY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (IN THOUSANDS)

See notes to condensed consolidated financial statements. 5 DAY INTERNATIONAL GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) A. BASIS OF PRESENTATION The balance sheet as of December 31, 2002, is condensed financial information derived from the audited balance sheet. The interim financial statements are unaudited. The financial statements of Day International Group, Inc. have been prepared in accordance with accounting principles generally accepted in the United States and, in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation in accordance with accounting principles generally accepted in the United States for the periods presented. The results of operations and cash flows for the interim periods presented are not necessarily indicative of the results for the full year. B. INVENTORIES Inventories as of September 30, 2003 and December 31, 2002, consist of:

C. LONG-TERM DEBT On September 16, 2003, the Company issued $135,000 of senior secured debt under a $155,000 Senior Secured Credit Facility to refinance its existing $100,000 11-1/8% Senior Notes and repay its outstanding $24,850 term loan and $10,750 revolving credit facility. The Second Amended and Restated Senior Secured Credit Agreement consists of a $20,000 5-year Revolving Credit Facility, a Tranche A (euro)26,577 ($30,000 equivalent at issuance) 5-year Term Loan and a Tranche B $105,000 6-year Term Loan. The Revolving Credit Facility includes a $10,000 letter of credit subfacility ($455 of letters of credit were outstanding at September 30, 2003) and a $2,000 swing line loan subfacility. The Company issued a notice of redemption for the $100,000 11-1/8% Senior Notes and redeemed the Senior Notes in October at a call price of $101,236. The proceeds received from the debt issuance that were used to redeem the Senior Notes are classified as a long-term asset as of September 30, 2003. In the third quarter of 2003, the Company recorded a loss of $542 on the write-off of the remaining deferred financing fees related to the existing credit agreement and will record an additional loss of $2,241 in the fourth quarter of 2003 to write-off an additional $1,005 of deferred financing fees related to the Senior Notes when the debt is retired and to record the loss resulting from the $1,236 call premium. The Senior Secured Credit Facility requires a commitment fee of 1/2% a year on the unused portion of the Revolving Credit Facility. Interest on the Tranche A Term Loan and the Revolving Credit Facility is based on the banks' base rate plus 2.75% or the LIBOR rate plus 3.75% and is subject to change based on the debt leverage of the Company (5.88% at September 30, 2003). Interest rates on LIBOR borrowings are fixed for one, two, three or six month periods at the Company's discretion. Interest on 6 the Tranche B Term Loan is based on the banks' base rate plus 3.50% or the LIBOR rate plus 4.50% (5.62% at September 30, 2003). The Tranche A Term Loan matures in 20 consecutive quarterly installments and the Tranche B Term Loan matures in 24 consecutive quarterly installments, commencing on December 31, 2003. Principal payments on the Tranche A and the Tranche B Term Loans are to be made in the following amounts (using U.S. dollar equivalents at the issuance date for the Tranche A Term Loan denominated in euros): installments 1-4, $637 per installment; installments 5-8, $1,013 per installment; installments 9-12, $1,387 per installment; installments 13-16, $2,513 per installment; installments 17-20, $3,262 per installment; and installments 21-24, $24,938 per installment. The Senior Secured Credit Agreement includes typical covenants, including maximum total debt to EBITDA, maximum senior debt to EBITDA, minimum interest coverage, minimum fixed charge coverage and limitations on capital expenditures and distributions. The Agreement also requires 75% of excess cash flows (as defined) be used to pay down the Term Loans. D. REDEEMABLE PREFERRED STOCK The Company's 12 1/4% Senior Exchangeable Preferred Stock require that dividends must be paid in cash after March 15, 2003. The Company has not paid cash dividends after March 15, 2003, because of certain restrictions in the Company's Senior Secured Credit Agreement and Notes Indentures limiting the ability to pay cash dividends. If not paid for four consecutive quarters, the holders of the Exchangeable Preferred Stock have the right to elect two directors to the Board of Directors until the dividends in arrears have been paid. All dividends through March 15, 2003, have been in the form of additional fully-paid and non-assessable shares of Exchangeable Preferred Stock. Dividends-in-arrears are $3,979 as of September 30, 2003, which are included in the redeemable preferred stock balance. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that the Company's redeemable preferred stock be recorded in the same manner as long-term debt. The Company adopted the statement as of July 1, 2003. Beginning in the third quarter of 2003, the Company reflects the redeemable preferred stock as a liability and accrued dividends as interest expense. This statement has no effect on the cash flows of the Company, net loss available to common shareholders or the Company's compliance with its debt covenants. E. INCOME TAXES The Company's effective income tax rate is significantly different from the statutory rates in effect as a result of the adoption of SFAS No. 150 and the inclusion of the dividends on the redeemable preferred stock in income (loss) before income taxes. The non-deductible preferred stock dividends cause a significant difference between book income and taxable income subsequent to the adoption of SFAS No. 150. 7 F. BUSINESS SEGMENTS The Company produces precision-engineered products, specializing in the design and customization of consumable image-transfer products for the graphic arts (printing) industry and consumable fiber handling products for the textile industry. The Image Transfer segment designs, manufactures and markets high-quality printing blankets and sleeves, pressroom chemicals and automatic dampening systems used primarily in the offset and flexographic printing industries. The Textile Products segment manufactures and markets precision engineered rubber cots and aprons sold to textile yarn spinners and other engineered rubber products sold to diverse markets. Segment performance is evaluated based on operating profit results compared to the annual operating plan. Intersegment sales and transfers are not material. The Company manages the two segments as separate strategic business units. They are managed separately because each business unit requires different manufacturing processes, technology and marketing strategies.

The following is a reconciliation of the segment operating profit reported above to the amount reported in the consolidated financial statements:

8 G. COMPREHENSIVE INCOME (LOSS) Total comprehensive income (loss) is comprised of net income (loss), net currency translation gains and losses and net unrealized gains and losses on cash flow hedges. Total comprehensive income (loss) for the three months ended September 30, 2003 and 2002 was $(3,288) and $1,993. Total comprehensive income for the nine months ended September 30, 2003 and 2002 was $2,783 and $7,805. The adoption of SFAS No. 150 is the primary cause of the difference between 2003 and 2002 amounts of comprehensive income (loss). H. CONTINGENCIES Claims have been made against the Company for the costs of environmental remedial measures taken or to be taken. Reserves for such liabilities have been established and no insurance recoveries have been anticipated in the determination of the reserves. In management's opinion, the aforementioned claims will be resolved without material adverse effect on the results of operations, financial position or cash flows of the Company. The Company's previous parent and its parent, PolyOne, have agreed to indemnify the Company for certain of the costs associated with these matters. I. RESTRUCTURING COSTS A pre-tax charge of $500 was recorded in the first quarter of 2001 for severance and termination costs for relocating the Textile Products operations from the Asheville, North Carolina, facility to the Greenville, South Carolina, facility. During the first quarter of 2002, the Company incurred additional relocation costs of $109, recorded a charge of $157 for write-off of fixed assets and recorded a reversal of $103 of the reserve for severance costs. As of September 30, 2002, final severance payments had been paid to 49 associates. During the fourth quarter of 2001, the Company ceased operations at its Transfer Media facility in Longwood, Florida. A pre-tax charge of $3,010 was recorded in 2001 for severance costs for 55 associates, write-off of abandoned assets and costs related to closing the facility. As of June 30, 2002, final severance payments had been paid to all associates and the remaining reserve of $45 for severance costs was reversed in the second quarter of 2002. A pre-tax charge of $988 was recorded during the fourth quarter of 2001 for severance costs for 21 associates, costs for relocating the Pressroom Chemicals' German sales office and the U.S. sales and administrative functions and loss on the sale of fixed assets. As of September 30, 2002, final severance payments had been paid to 20 associates. 9 Below is a summary of the amounts charged against the reserves for severance and facility shutdown in 2002:

As of December 31, 2002, all restructuring programs had been completed. J. STOCK-BASED COMPENSATION As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company applies the intrinsic value method of recognition and measurement under Accounting Principles Board Opinion No. 25 to its stock options and warrants. No compensation expense related to employee stock options or warrants issued to directors is reflected in net income. The following table illustrates the effect on net income if compensation cost for all outstanding and unvested stock options and warrants had been determined based on their fair values at the grant date, consistent with the method prescribed by SFAS No. 123:

10 K. NEW ACCOUNTING PRINCIPLE In July 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS Nos. 141, "Business Combinations" and 142, "Goodwill and Other Intangible Assets." These statements prohibit amortization of goodwill for periods beginning after December 15, 2001. Instead an annual review of the recoverability of the goodwill and intangible assets is required. These Statements were adopted as of January 1, 2002. As of January 1, 2002, the Company recognized pre-tax income of $1,010 for the cumulative effect of the change in accounting principle for the amount of the unamortized deferred credit related to the excess over cost arising from the TPO acquisition. L. SUPPLEMENTAL CONSOLIDATING INFORMATION The Company has outstanding $100,000, 11-1/8% Senior Notes and $115,000, 9-1/2% Senior Subordinated Notes (collectively, the "Notes"). The Company has no assets or operations other than its wholly-owned investment in Day International, Inc. ("Day International" or "Guarantor"). Day International has provided a full and unconditional guarantee of the Notes. The wholly-owned foreign subsidiaries of Day International are not guarantors with respect to the Notes and do not have any credit arrangements senior to the Notes. The only intercompany eliminations are the normal intercompany eliminations with regard to intercompany sales and the Company's investment in the wholly-owned non-guarantor subsidiaries. Intercompany notes are in place, which effectively transfers the interest expense from the Company to Day International. The following are the supplemental combining condensed balance sheets as of September 30, 2003 and December 31, 2002, and the supplemental combining condensed statements of operations and cash flows for the three and nine months ended September 30, 2003 and 2002, with the investments in the subsidiaries accounted for using the equity method. Separate complete financial statements of the Guarantor are not presented because management has determined that they are not material to the investors. 11 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED BALANCE SHEET SEPTEMBER 30, 2003

12 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL CONSOLIDATING CONDENSED BALANCE SHEET DECEMBER 31, 2002

13 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED STATEMENT OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2003

14 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED STATEMENT OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2002

15 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2003

16 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2002

17 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2003

18 DAY INTERNATIONAL GROUP, INC. SUPPLEMENTAL COMBINING CONDENSED STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2002

19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAFE HARBOR STATEMENT This Quarterly Report contains forward-looking statements within the meaning of the Securities Act of 1933. These are subject to certain risks and uncertainties, including those identified below, which could affect the Company's actual results and cause such results to differ materially from those expressed in forward-looking statements. The words "believe," "anticipate," "expect," "intend," "will likely result," "will continue," and similar expressions identify forward-looking statements. Factors that could cause actual results to differ materially from the forward-looking statements include but are not limited to (i) the effect of leverage, including the limitations imposed by the Company's various debt instruments; (ii) risks related to significant operations in foreign countries, including the translation of operating results to the U.S. dollar; (iii) the timely development and market acceptance of new products; (iv) the impact of competitive products and pricing; (v) the effect of changing general and industry specific economic conditions; (vi) the impact of environmental regulations; and (vii) the potential for technology obsolescence. While made in good faith and with a reasonable basis based on information currently available to the Company's management, there is no assurance that any such forward-looking statements will be achieved or accomplished. The Company is under no obligation to update any forward-looking statements to the extent it becomes aware that they are not achieved or likely to be achieved for any reason. BASIS OF PRESENTATION The following table sets forth selected financial information in millions of dollars and as a percentage of net sales:

COMPARISON OF RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2003, COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2002 Net sales increased $3.2 million (4.7%) to $70.1 million. Image Transfer's sales increased $4.4 million (8.1%) to $58.4 million, primarily as a result of higher sales volume in the United States of $2.7 million and in Europe of $0.5 million and positive foreign currency rate changes of $2.1 million offset by lower 20 sales volumes in the Pacific Rim of $0.8 million. The higher U.S. Image Transfer sales volume was primarily as a result of sales from an acquisition in the first quarter of 2003 of $0.8 million and from higher sales volumes across substantially all product lines. European sales volume increased primarily from market share gains in the chemical products business in the United Kingdom and Germany. Textile Products' sales decreased $1.2 million (9.5%) to $11.6 million, primarily as a result of lower sales volume in the United States of $1.6 million and in Europe of $0.5 million offset by positive foreign currency rate changes of $0.9 million. The lower U.S. Textile Products sales volume is primarily due to reduced demand in the U.S. textile industry as a result of weak consumer demand for textile and apparel products coupled with increased imports of low cost goods from Asia and South America. The ongoing restructuring of the U.S. textile manufacturing industry has resulted in further consolidation and closure of yarn spinning mills as well as weaving facilities. Weak sales have forced textile manufacturers to cut expenses and reduce inventories, which have had a direct effect on reducing Textile Products' sales. The lower European Textile Products' sales are as a result of lower sales by original equipment manufacturers ("OEMs") and lower textile mill activity in Europe. Gross profit increased $0.6 million (2.6%) to $25.0 million. As a percentage of net sales, gross profit decreased to 35.7% for the three months ended September 30, 2003, compared to 36.4% for the three months ended September 30, 2002. The decrease in the gross profit percentage was due primarily to underabsorbed fixed overhead costs of Textile Products resulting from the lower sales volumes and higher spending for research and development for Image Transfer. Selling, general and administrative expense ("SG&A") increased $0.9 million (6.0%) to $15.2 million. As a percentage of net sales, SG&A increased to 21.8% from 21.5%. Changes in foreign currency rates increased SG&A costs by $0.6 million in the third quarter of 2003 compared to the third quarter of 2002. SG&A costs also increased as a result of higher insurance costs and higher selling and distribution costs resulting from higher sales levels. Operating profit decreased $0.2 million (2.5%) to $9.3 million. As a percentage of net sales, operating profit decreased to 13.3% for the three months ended September 30, 2003, from 14.3% for the comparable period in 2002. Image Transfer's operating profit increased $0.9 million (9.7%) to $9.9 million. As a percentage of net sales, Image Transfer's operating profit increased to 17.0% for the three months ended September 30, 2003, from 16.7% in 2002. Textile Products' operating profit decreased $1.0 million (48.2%) to $1.0 million. As a percentage of net sales, Textile Products' operating profit decreased to 8.8% for the three months ended September 30, 2003, from 15.5% in 2002. Interest expense increased $5.4 million as a result of the adoption of SFAS No. 150 and the non-deductible preferred stock dividends now reflected as interest expense of $4.9 million and a loss of $0.5 million on the write-off of the remaining deferred financing fees related to the existing credit agreement. The Company will record an additional loss of $2.2 million in the fourth quarter of 2003 to write-off an additional $1.0 million of deferred financing fees related to the Senior Notes when the debt is retired and to record the loss resulting from the $1.2 million call premium. Other income was $0.2 million for the three months ended September 30, 2003, compared to other income of $0.1 million for the three months ended September 30, 2002. The other (income) expense is primarily due to foreign currency transaction (gains) losses incurred in the normal course of international subsidiaries doing business in other than their functional currency as well as a result of intercompany financing arrangements. 21 The Company recorded income tax expense on a loss before income taxes in the third quarter of 2003. The effective tax rate for 2003 is affected by the adoption of SFAS No. 150 and the non-deductible preferred stock dividends now reflected as interest expense. Adjusted for the preferred stock dividends, the effective tax rate would be 39.6% in 2003. The effective tax rate for the third quarter of 2002 was 41.4%. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that the Company's redeemable preferred stock be recorded in the same manner as long-term debt. The Company adopted the statement as of July 1, 2003. Beginning in the third quarter of 2003, the Company reflects the redeemable preferred stock as a liability and accrued dividends as interest expense. This statement has no effect on the net loss available to common shareholders, cash flows of the Company or the Company's compliance with its debt covenants. NINE MONTHS ENDED SEPTEMBER 30, 2003, COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2002 Net sales increased $16.9 million (8.8%) to $209.0 million. Image Transfer's sales increased $15.3 million (9.8%) to $171.5 million, primarily as a result of higher sales volume in Europe of $4.3 million and in the United States of $3.6 million and positive foreign currency rate changes of $8.7 million. Europe sales volume increased primarily from market share gains in the pressroom chemical business in the United Kingdom and Germany. The higher U.S. Image Transfer sales volume was primarily as a result of sales from an acquisition in the first quarter of 2003 of $1.9 million and from higher sales volumes across substantially all product lines. Textile Products' sales increased $1.6 million (4.4%) to $37.5 million, primarily as a result of positive foreign currency rate changes of $3.7 million and higher sales volumes in Europe of $0.4 million, offset by lower sales volume in the United States of $2.5 million. The lower U.S. Textile Products sales volume is primarily a result of reduced production of spun yarn in the United States as yarn production continues to shift to lower-cost areas outside the United States, coupled with the weak consumer demand for textile and apparel products. Additionally, U.S. textile manufacturers have continued to face financial difficulties resulting in bankruptcies and closure of facilities, expense reductions and inventory cuts. The European Textile Products' sales volume has increased primarily as a result of increased OEM sales over the prior year, more than offsetting weaker sales to European textile mills. Textile Products' sales to Asian markets are steady, but typically at lower unit values. Gross profit increased $4.2 million (6.0%) to $74.5 million. As a percentage of net sales, gross profit decreased to 35.6% for the nine months ended September 30, 2003, compared to 36.6% for the nine months ended September 30, 2002. The decrease in the gross profit percentage was due primarily to increased sales in non-U.S. markets where margins are typically lower combined with higher spending for research & development and higher depreciation expense resulting from capital projects completed in 2002. Selling, general and administrative expense ("SG&A") increased $4.5 million (10.9%) to $45.2 million. As a percentage of net sales, SG&A increased to 21.6% from 21.2%. Changes in foreign currency rates increased SG&A costs by $2.5 million in the first nine months of 2003 compared to the first nine 22 months of 2002. SG&A costs also increased as a result of higher insurance costs and higher selling and distribution costs from higher sales levels. A pre-tax charge of $0.5 million was recorded in the first quarter of 2001 for severance and termination costs to relocate the Textile Products operations from its Asheville, North Carolina, facility to its Greenville, South Carolina, facility. During the first quarter of 2002, the Company reversed $0.1 million of the reserve. Additionally, a pre-tax charge of $0.3 was recorded in the first quarter ended of 2002 for relocation of machinery and equipment and write-off of abandoned assets. During the fourth quarter of 2001, the Company ceased operations at its Transfer Media facility in Longwood, Florida. A pre-tax charge of $3,010 was recorded in 2001 for severance costs for 55 associates, write-off of abandoned assets and costs related to closing the facility. As of June 30, 2002, final severance payments had been paid to all associates and the remaining reserve of $45 for severance costs was reversed in the second quarter of 2002. Operating profit decreased $0.2 million (0.6%) to $27.9 million. As a percentage of net sales, operating profit decreased to 13.3% for the nine months ended September 30, 2003, from 14.6% for the comparable period in 2002. Image Transfer's operating profit increased $0.9 million (3.2%) to $28.6 million. As a percentage of net sales, Image Transfer's operating profit decreased to 16.6% for the nine months ended September 30, 2003, from 17.7% in 2002. Textile Products' operating profit decreased $0.9 million (19.0%) to $4.0 million. As a percentage of net sales, Textile Products' operating profit decreased to 10.7% for the nine months ended September 30, 2003, from 13.8% in 2002. Interest expense increased $5.4 million as a result of the adoption of SFAS No. 150 and the non-deductible preferred stock dividends now reflected as interest expense of $4.9 million and as a result of a loss of $0.5 million on the write-off of the remaining deferred financing fees related to the existing credit agreement, offset by lower interest expense resulting from lower interest rates and lower borrowing levels. The Company will record an additional loss of $2.2 million in the fourth quarter of 2003 to write-off an additional $1.0 million of deferred financing fees related to the Senior Notes when the debt is retired and to record the loss resulting from the $1.2 million call premium. Other income was $0.5 million for the nine months ended September 30, 2003, compared to other income of $0.5 million for the nine months ended September 30, 2002. The other (income) expense is primarily due to foreign currency transaction losses incurred in the normal course of international subsidiaries doing business in other than their functional currency as well as a result of intercompany financing arrangements. Other income in 2003 includes a loss of $1.1 million from the sale of the South African business, a gain of $0.9 million from the sale of excess land in Mauldin, South Carolina and a loss of $0.5 million on the sale and disposal of equipment from the Longwood, Florida, facility. The effective tax rate for the first nine months of 2003 was 101.0% compared to 40.0% for 2002. The effective tax rate for 2003 is affected by the adoption of SFAS No. 150 and the non-deductible preferred stock dividends now reflected as interest expense. Adjusted for the preferred stock dividends, the effective tax rate would be 39.0%. As of January 1, 2002, the Company adopted SFAS Nos. 141, "Business Combinations" and 142, "Goodwill and Other Intangible Assets" and recognized pre-tax income of $1.0 million for the 23 cumulative effect of the change in accounting principle for the amount of the unamortized deferred credit related to the excess over cost arising from the TPO acquisition. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that the Company's redeemable preferred stock be recorded in the same manner as long-term debt. The Company adopted the statement as of July 1, 2003. Beginning in the third quarter of 2003, the Company reflects the redeemable preferred stock as a liability and accrued dividends as interest expense. This statement has no effect on the cash flows of the Company, net loss available to common shareholders or the Company's compliance with its debt covenants. LIQUIDITY AND CAPITAL RESOURCES The Company has historically generated sufficient funds from its operations to fund its working capital and capital expenditure requirements. The Company is able to maintain relatively low levels of working capital as its converters and distributors typically carry a greater portion of inventory and finance receivables of the Company's end users. Capital expenditures were $5.5 million and $5.6 million for the nine months ended September 30, 2003 and 2002, respectively. On September 16, 2003, the Company issued $135.0 million of senior secured debt under a $155.0 million Senior Secured Credit Facility to refinance its existing $100.0 million 11-1/8% Senior Notes and repay its outstanding $24.9 million term loan and $10.7 million revolving credit facility. The Second Amended and Restated Senior Secured Credit Agreement consists of a $20.0 million 5-year Revolving Credit Facility, a Tranche A (euro)26.6 million ($30.0 million equivalent at issuance) 5-year Term Loan and a Tranche B $105.0 million 6-year Term Loan. The Revolving Credit Facility includes a $10.0 million letter of credit subfacility ($0.5 million of letters of credit were outstanding at September 30, 2003) and a $2.0 million swing line loan subfacility. The Company issued a notice for redemption of the $100.0 million 11-1/8% Senior Notes and redeemed the Senior Notes in October at the call price of $101.2 million. The proceeds received from the debt issuance that were used to redeem the Senior Notes are classified as a long-term asset as of September 30, 2003. The Senior Secured Credit Facility requires a commitment fee of 1/2% a year on the unused portion of the revolving line of credit. Interest on the Tranche A Term Loan and the Revolving Credit Facility is based on the banks' base rate plus 2.75% or the LIBOR rate plus 3.75% and is subject to change based on the debt leverage of the Company. Interest rates on LIBOR borrowings are fixed for one, two, three or six month periods at the Company's discretion. Interest on the Tranche B Term Loan is based on the banks' base rate plus 3.5% or the LIBOR rate plus 4.5%. The Tranche A Term Loan matures in 20 consecutive quarterly installments and the Tranche B Term Loan matures in 24 consecutive quarterly installments, commencing on December 31, 2003. Principal payments are to be made in the following amounts (using U.S. dollar equivalents at the issuance date for the Tranche A Term Loan denominated in euros): installments 1-4, $0.6 million per installment; installments 5-8, $1.0 million per installment; installments 9-12, $1.4 million per installment; 24 installments 13-16, $2.5 million per installment; installments 17-20, $3.3 million per installment; and installments 21-24, $24.9 million per installment. The Senior Secured Credit Agreement includes typical covenants, including maximum total debt to EBITDA, maximum senior debt to EBITDA, minimum interest coverage, minimum fixed charge coverage and limitations on capital expenditures and distributions. The Agreement also requires 75% of excess cash flows (as defined) be used to pay down the Term Loans. As of September 30, 2003, there were no outstanding borrowings under the Revolving Credit Facility and the Company had $19.5 million available under the Revolving Credit Facility. The Company's aggregate indebtedness at September 30, 2003, is $351.1 million, including the $100.0 million Senior Notes redeemed in October. At September 30, 2003, the Company held $98.0 million of cash for retirement of the Senior Notes. The aggregate liquidation preference of the Exchangeable Preferred Stock is $68.3 million and the Convertible Preferred Stock is $74.2 million. The Company is highly leveraged. The Company's ability to operate its business, service its debt requirements and reduce its total debt will depend upon its future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond its control, as well as the availability of revolving credit borrowings. See the Company's Annual Report on Form 10-K for a more extensive discussion of liquidity and capital resources. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS The Company conducts a significant amount of business and has operating and sales facilities in countries outside the United States. As a result, the Company is subject to business risks inherent in non-U.S. activities, including political uncertainty, import and export limitations, exchange controls and currency fluctuations. The Company believes risks related to its foreign operations are mitigated due to the political and economic stability of the countries in which its largest foreign operations are located, the stand-alone nature of the operations, the Company's limited net asset exposure, forward foreign exchange contract practices and pricing flexibility. Thus, while changes in foreign currency values do affect earnings, the longer-term economic effect of these changes should not have a material adverse effect on the Company's financial condition, results of operations or liquidity. Certain of the Company's international subsidiaries make purchases in foreign currencies, mainly intercompany transactions. As a result, they are subject to transaction exposures that arise from foreign exchange movements between the date that the foreign currency transaction is recorded and the date it is consummated. The Company has entered into forward foreign exchange contracts to protect it against such foreign exchange movements. The contract value of these foreign exchange contracts was approximately $13.3 million at September 30, 2003 and $10.1 million at December 31, 2002. These contracts generally expire within three to twelve months. Foreign currency transaction (gains) losses, included in other (income) expense, were $0.3 million and $0.3 million for the three months ended September 30, 2003 and 2002 and $(1.2) million and zero for the nine months ended September 30, 2003 and 2002. 25 INTEREST RATE RISKS The Company is subject to market risk from exposure to changes in the interest rates based on its financing activities. The Company utilizes a mix of debt maturities along with both fixed- and variable-rate debt to manage its exposure to changes in interest rates and to minimize interest expense. The Company does not expect interest rate changes to have a material effect on income or cash flows in 2003, although there can be no assurance that interest rates will not materially change. COMMODITY RISKS Rubber polymers and fabrics are key components in most of the Image Transfer and Textile products. The Company is exposed to changes in the costs of these components. In addition, Image Transfer's pressroom chemical products are exposed to changes in the cost of certain petroleum-based components. The largest raw material component in the pressroom chemical products is petroleum distillates, such as aliphatics and aromatics. When commodity prices increase, the Company has historically passed on increases to its customers to maintain its profit margins. Conversely, when commodity prices decline, the Company generally lowers its sales prices to meet competitive pressures. The Company is evaluating the impact of the recent increase in petroleum prices on its raw material costs and in some markets already has instituted price increases to offset the impact of these increases. Because the Company has historically been able to raise sales prices to offset higher costs, management believes that a 10% change in the cost of its components could have a short-term impact until sales price increases take effect, but overall would not have a material effect on income or cash flows for a fiscal year. ITEM 4. CONTROLS AND PROCEDURES The Company maintains a system of internal accounting controls designed to provide reasonable assurance that transactions are properly recorded and summarized so that reliable financial records and reports can be prepared and assets safeguarded. In addition, a system of disclosure controls is maintained to ensure that information required to be disclosed is recorded, processed, summarized and reported in a timely manner to management responsible for the preparation and reporting of the Company's financial information. Management assesses the internal control and disclosure control systems as being effective as they encompass material matters for the three months ended September 30, 2003. To the best of management's knowledge, there were no changes in the internal control and disclosure control systems during the quarter ended September 30, 2003, that would materially affect the control systems. 26 PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits (31) RULE 13a-14(a)/15d-14(a) CERTIFICATIONS 31.1 Chief Executive Officer Certification 31.2 Chief Financial Officer Certification (32) SECTION 1350 CERTIFICATIONS 32.1 Chief Executive Officer Certification 32.2 Chief Financial Officer Certification b. Reports on Form 8-K On September 22, 2003, the Company filed a Form 8-K reporting under Item 5 that it had refinanced a portion of its outstanding long-term debt. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Day International Group, Inc. ----------------------------- (Registrant) Date: November 4, 2003 /s/ Thomas J. Koenig ----------------------------- Thomas J. Koenig Vice President and Chief Financial Officer (Principal Financial Officer) 27

DAY INTERNATIONAL GROUP INC 10-Q