UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2006
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 1-13780
M & F WORLDWIDE CORP.
(Exact name of registrant as specified in its charter)
Delaware | 02-0423416 | ||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||
35 East 62nd Street New York, New York | 10021 | ||
(Address of principal executive offices) | (Zip code) | ||
(212) 572-8600
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 No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes No
As of September 30, 2006, there were 20,233,370 shares of the registrant’s Common Stock outstanding, of which 7,298,000 were held by Mafco Consolidated Group Inc., a wholly owned subsidiary of MacAndrews & Forbes Holdings Inc.
M & F WORLDWIDE CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Nine Months Ended September 30, 2006
PART I. | FINANCIAL INFORMATION | ||||||||
Item 1. | Financial Statements | ||||||||
Consolidated Balance Sheets | 1 | ||||||||
Consolidated Statements of Income | 2 | ||||||||
Consolidated Statements of Cash Flows | 3 | ||||||||
Notes to Consolidated Financial Statements | 4 | ||||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 19 | |||||||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 28 | |||||||
Item 4. | Controls and Procedures | 28 | |||||||
PART II. | OTHER INFORMATION | ||||||||
Item 1. | Legal Proceedings | 29 | |||||||
Item 1A. | Risk Factors | 29 | |||||||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 29 | |||||||
Item 3. | Defaults Upon Senior Securities | 29 | |||||||
Item 4. | Submission of Matters to a Vote of Security Holders | 29 | |||||||
Item 5. | Other Information | 29 | |||||||
Item 6. | Exhibits | 29 | |||||||
i
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
M & F Worldwide Corp. and Subsidiaries
Consolidated Balance Sheets
(in millions, except share and per share data)
(Unaudited) September 30, 2006 | December 31, 2005 | |||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 85.7 | $ | 52.4 | ||||||||
Accounts receivable (net of allowances of $0.1 and $0.1) | 38.2 | 32.5 | ||||||||||
Inventories | 71.8 | 68.1 | ||||||||||
Prepaid expenses and other current assets | 26.1 | 27.9 | ||||||||||
Total current assets | 221.8 | 180.9 | ||||||||||
Property, plant and equipment, net | 109.1 | 118.4 | ||||||||||
Goodwill | 385.9 | 388.5 | ||||||||||
Other intangible assets, net | 668.3 | 686.8 | ||||||||||
Pension asset | 17.4 | 16.5 | ||||||||||
Other assets | 62.0 | 71.0 | ||||||||||
Total assets | $ | 1,464.5 | $ | 1,462.1 | ||||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 29.4 | $ | 37.1 | ||||||||
Accrued liabilities | 60.0 | 48.8 | ||||||||||
Current maturities of long-term debt | 52.4 | 17.6 | ||||||||||
Total current liabilities | 141.8 | 103.5 | ||||||||||
Long-term debt | 647.1 | 715.6 | ||||||||||
Deferred tax liabilities | 255.3 | 264.7 | ||||||||||
Other liabilities | 17.8 | 16.9 | ||||||||||
Commitments and contingencies | — | — | ||||||||||
Stockholders' equity: | ||||||||||||
Common stock, par value $.01; 250,000,000 shares authorized; 22,775,270 shares issued at September 30, 2006 and 21,881,170 shares issued at December 31, 2005 | 0.2 | 0.2 | ||||||||||
Additional paid-in capital | 50.5 | 41.5 | ||||||||||
Treasury stock at cost; 2,541,900 shares at September 30, 2006 and December 31, 2005 | (14.8 | ) | (14.8 | ) | ||||||||
Retained earnings | 367.1 | 337.5 | ||||||||||
Accumulated other comprehensive loss | (0.5 | ) | (3.0 | ) | ||||||||
Total stockholders' equity | 402.5 | 361.4 | ||||||||||
Total liabilities and stockholders' equity | $ | 1,464.5 | $ | 1,462.1 | ||||||||
See Notes to Consolidated Financial Statements.
1
M & F Worldwide Corp. and Subsidiaries
Consolidated Statements of Income
(in millions, except per share data)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||||||||||
Net revenues | $ | 178.0 | $ | 24.6 | $ | 547.4 | $ | 74.0 | ||||||||||||||||
Cost of revenues | 109.4 | 13.0 | 331.6 | 36.9 | ||||||||||||||||||||
Gross profit | 68.6 | 11.6 | 215.8 | 37.1 | ||||||||||||||||||||
Selling, general and administrative expenses | 40.2 | 3.9 | 124.0 | 11.8 | ||||||||||||||||||||
Operating income | 28.4 | 7.7 | 91.8 | 25.3 | ||||||||||||||||||||
Interest income | 0.7 | 0.9 | 1.8 | 2.3 | ||||||||||||||||||||
Interest expense | (17.2 | ) | — | (50.6 | ) | (0.1 | ) | |||||||||||||||||
Other income (expense), net | — | — | — | 0.9 | ||||||||||||||||||||
Income before income taxes | 11.9 | 8.6 | 43.0 | 28.4 | ||||||||||||||||||||
Provision for income taxes | (0.7 | ) | (2.6 | ) | (13.4 | ) | (10.1 | ) | ||||||||||||||||
Net income | $ | 11.2 | $ | 6.0 | $ | 29.6 | $ | 18.3 | ||||||||||||||||
Earnings per common share: | ||||||||||||||||||||||||
Basic | $ | 0.56 | $ | 0.32 | $ | 1.50 | $ | 0.96 | ||||||||||||||||
Diluted | $ | 0.55 | $ | 0.31 | $ | 1.46 | $ | 0.93 | ||||||||||||||||
See Notes to Consolidated Financial Statements.
2
M & F Worldwide Corp. and Subsidiaries
Consolidated Statements of Cash Flows
(in millions)
(Unaudited)
Nine Months Ended September 30, | ||||||||||||
2006 | 2005 | |||||||||||
Operating activities | ||||||||||||
Net income | $ | 29.6 | $ | 18.3 | ||||||||
Adjustments to derive net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 43.8 | 2.2 | ||||||||||
Deferred income taxes | (11.4 | ) | 9.0 | |||||||||
Changes in operating assets and liabilities: | ||||||||||||
Accounts receivable | (5.0 | ) | (3.2 | ) | ||||||||
Inventories | (3.0 | ) | 3.5 | |||||||||
Prepaid expenses and other assets | 13.9 | (0.5 | ) | |||||||||
Pension asset | (0.9 | ) | (0.8 | ) | ||||||||
Accounts payable and accrued expenses | 13.0 | (1.1 | ) | |||||||||
Income taxes | 4.3 | 0.7 | ||||||||||
Other, net | 0.6 | 1.3 | ||||||||||
Net cash provided by operating activities | 84.9 | 29.4 | ||||||||||
Investing activities | ||||||||||||
Investment in marketable securities | — | (114.1 | ) | |||||||||
Sales of marketable securities | — | 30.0 | ||||||||||
Capital expenditures | (11.2 | ) | (1.0 | ) | ||||||||
Capitalized interest | (0.7 | ) | — | |||||||||
Net cash used in investing activities | (11.9 | ) | (85.1 | ) | ||||||||
Financing activities | ||||||||||||
Cash overdrafts | (13.2 | ) | — | |||||||||
Proceeds from stock options exercised and related tax benefits | 9.0 | 0.2 | ||||||||||
Borrowings on credit agreements | 3.3 | — | ||||||||||
Repayments of credit agreements and other borrowings | (39.0 | ) | — | |||||||||
Net cash (used in) provided by financing activities | (39.9 | ) | 0.2 | |||||||||
Effect of exchange rate changes on cash | 0.2 | (0.1 | ) | |||||||||
Net increase (decrease) in cash and cash equivalents | 33.3 | (55.6 | ) | |||||||||
Cash and cash equivalents at beginning of period | 52.4 | 103.6 | ||||||||||
Cash and cash equivalents at end of period | $ | 85.7 | $ | 48.0 | ||||||||
Supplemental disclosure of cash paid for: | ||||||||||||
Interest | $ | 44.8 | $ | 0.1 | ||||||||
Taxes paid, net of refunds | 17.0 | 1.3 | ||||||||||
See Notes to Consolidated Financial Statements.
3
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
1. | Description of the Business and Basis of Presentation |
M & F Worldwide Corp. (‘‘M & F Worldwide’’ and, together with its subsidiaries, the ‘‘Company’’) was incorporated in Delaware on June 1, 1988. M & F Worldwide is a holding company that conducts its operations through its indirect wholly owned subsidiary, Mafco Worldwide Corporation (‘‘Mafco Worldwide’’) and, since December 15, 2005, Clarke American Corp. (‘‘Clarke American’’). At September 30, 2006, MacAndrews & Forbes Holdings Inc. (‘‘Holdings’’), through its wholly owned subsidiary Mafco Consolidated Group Inc. (‘‘MCG’’), beneficially owned approximately 36% of the outstanding M & F Worldwide Common Stock.
As a result of the acquisition of Clarke American, the Company has two business lines, which are operated by Mafco Worldwide and Clarke American. Mafco Worldwide’s business is the production of licorice products for sale to the tobacco, food, pharmaceutical and confectionery industries (which is the Company’s ‘‘Licorice Products’’ segment). Clarke American’s business is providing checks, check-related products and direct marketing services. Clarke American’s business consists of two segments: the Financial Institution segment, which is focused on financial institution clients and their customers (the Company’s ‘‘Financial Institution’’ segment), and the Direct to Consumer segment, which is focused on individual customers (the Company’s ‘‘Direct to Consumer’’ segment).
Licorice Products
Mafco Worldwide produces a variety of licorice products from licorice root, intermediary licorice extracts produced by others and certain other ingredients at its facilities in Camden, New Jersey; Richmond, Virginia; Gardanne, France and at the facilities of its joint ventures in Zhangjiagang, Jiangsu and Weihai, Shandong, People’s Republic of China. Approximately 73% of Mafco Worldwide’s licorice product sales are to the worldwide tobacco industry for use as tobacco flavor enhancing and moistening agents in the manufacture of American blend cigarettes, moist snuff, chewing tobacco and pipe tobacco. While licorice represents a small percentage of the total cost of manufacturing American blend cigarettes and other tobacco products, the particular formulation and quantity used by each brand is an important element in the brand’s quality. In addition, Mafco Worldwide manufactures and sells cocoa and carob products for use in the tobacco industry. Mafco Worldwide also sells licorice worldwide to confectioners, food processors, cosmetic companies and pharmaceutical manufacturers for use as flavoring and masking agents, including its Magnasweet brand flavor enhancer, which is used in various brands of chewing gum, lip balm, energy bars, non-carbonated beverages, chewable vitamins, aspirin and other products. Mafco Worldwide also sells licorice root residue as garden mulch under the name Right Dress.
Checks, Related Products, and Direct Marketing Services
Clarke American is one of the three largest providers of checks and check-related products and services in the United States based on revenues, and it is a leading provider of direct marketing services to financial institutions. Clarke American serves financial institutions through its Clarke American and Alcott Routon brands and consumers and businesses directly through its Checks In The Mail and B2Direct brands.
Clarke American’s two main business segments are the Financial Institution segment, generating 84% of its revenues for the nine months ended September 30, 2006, and the Direct to Consumer segment, generating 16% of its revenues for the nine months ended September 30, 2006. The Financial Institution segment’s products primarily consist of checks and check-related products, such as deposit tickets, checkbook covers, and related delivery services, and it also offers specialized direct marketing services to its financial institution clients. The Direct to Consumer segment’s products primarily consist of checks and check related products, customized business kits, and treasury management supplies.
4
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the full fiscal year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. All terms used but not defined elsewhere herein have the meaning ascribed to them in the Company’s 2005 Annual Report on Form 10-K.
The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries after elimination of all material intercompany accounts and transactions.
Certain amounts in previously issued financial statements have been reclassified to conform to the 2006 presentation.
2. | Significant Accounting Policies |
Reference is made to the significant accounting policies of the Company described in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Derivatives
The Company began using derivative financial instruments in 2006 to manage interest rate risk related to a portion of its long-term debt. The Company recognizes all derivatives at fair value as either assets or liabilities in the consolidated balance sheets and changes in the fair values of such instruments are recognized currently in earnings unless specific hedge accounting criteria are met. If specific cash flow hedge accounting criteria are met, the Company recognizes the changes in fair value of these instruments in other comprehensive income until the cash flow hedge is settled.
As of September 30, 2006, the Company recorded an asset of $0.1 related to its cash flow hedges (see Notes 7 and 10). During the three months ended September 30, 2006, the Company recorded a reduction in values of the cash flow hedges in other comprehensive income of $1.4 (net of a reduction in taxes of $0.9). During the nine months ended September 30, 2006, the net change in the values of the cash flow hedges was nominal. The Company was not a party to any derivative instruments during 2005.
Stock-Based Compensation
The Company adopted the provisions of SFAS No. 123(R), ‘���Share-Based Payment,’’ (‘‘SFAS No. 123(R)’’), which replaces SFAS No. 123, and supersedes APB Opinion No. 25 on January 1, 2006. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The Company utilized the modified prospective method of adoption. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123(R). Adoption of SFAS No. 123(R) did not impact the Company’s statements of operations since all outstanding options were fully vested as of January 1, 2006. SFAS No. 123(R) also requires that excess tax benefits related to share-based
5
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
payments be presented in the statements of cash flows as financing cash inflow, with corresponding operating cash outflow. There were no stock options granted by the Company during the nine months ended September 30, 2006 and 2005.
In addition, during 2005, had the Company applied the fair value recognition provisions of SFAS No. 123, ‘‘Accounting for Stock-Based Compensation,’’ to stock-based employee compensation it would not have had a material effect on net income and earnings per share for the three and nine months ended September 30, 2005.
Inventories
The Company adopted the provisions of SFAS No. 151, ‘‘Inventory Costs, an amendment of ARB No. 43, Chapter 4’’ on January 1, 2006. Among other things, SFAS No. 151 clarifies that certain operating costs should be recognized as current period charges and requires the allocation of fixed production overheads to inventory. Adoption of SFAS No. 151 did not have a material impact on the Company’s financial statements.
New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (‘‘FASB’’) issued FASB Interpretation No. 48, ‘‘Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109’’ (‘‘FIN 48’’). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with FASB Statement No. 109, ‘‘Accounting for Income Taxes.’’ FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company is required to adopt the provisions of FIN 48 during the first fiscal year beginning after December 15, 2006. The Company is currently evaluating the anticipated impact of FIN 48 on its consolidated results of operations and financial position.
In September 2006, the FASB issued SFAS No. 157, ‘‘Fair Value Measurement’’ (‘‘SFAS No. 157’’). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, but does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the anticipated impact of SFAS No. 157 on its consolidated results of operations and financial position.
In September 2006, the FASB issued SFAS No. 158, ‘‘Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)’’ (‘‘SFAS No. 158’’). SFAS No. 158 requires an entity to recognize in its statement of financial position an asset for a defined benefit postretirement plan’s overfunded status or a liability for a plan’s underfunded status; measure a defined benefit postretirement plan’s assets and obligations that determine its funded status as of the end of the employer’s fiscal year, and recognize changes in the funded status of a defined benefit postretirement plan in comprehensive income in the year in which the changes occur. The requirement to recognize the funded status of a defined benefit postretirement plan and the disclosure requirements are effective for fiscal years ending after December 15, 2006, for public entities. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Earlier application of the recognition or measurement date provisions is encouraged; however, early application must be for all of an employer’s benefit plans. The Company is currently evaluating the anticipated impact of SFAS No. 158 on its consolidated results of operations and financial position.
6
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
In June 2006, the FASB ratified EITF Issue No. 06-3, ‘‘How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)’’ (‘‘EITF 06-3’’). EITF 06-3 is applicable for any tax assessed by a governmental authority that is both imposed on and concurrent with a specific revenue-producing transaction between a seller and a customer, and may include, but is not limited to, sales, use, value added, and some excise taxes. EITF 06-3 requires companies to disclose whether they present such taxes on a gross basis (included in revenues and costs) or a net basis. In addition, for any such taxes that are reported on a gross basis, companies are required to disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented if those amounts are significant. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The Company will include the required disclosures in its interim and annual financial statements beginning with the first quarter of 2007.
3. | Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from such estimates.
4. | Inventories |
Inventories consist of the following:
September 30, 2006 | December 31, 2005 | |||||||||||
Raw Materials | $ | 43.8 | $ | 41.8 | ||||||||
Finished Goods | 22.5 | 19.5 | ||||||||||
Work-in-progress | 5.5 | 6.8 | ||||||||||
$ | 71.8 | $ | 68.1 | |||||||||
5. | Goodwill and Other Intangible Assets |
The change in carrying amount of goodwill for the nine months ended September 30, 2006 is as follows:
Balance as of December 31, 2005 | $ | 388.5 | ||||
Adjustments to Clarke American goodwill | (3.5 | ) | ||||
Effect of exchange rate changes | 0.9 | |||||
Balance as of September 30, 2006 | $ | 385.9 | ||||
The decrease in Clarke American goodwill resulted from adjustments to the intangible asset valuation and deferred tax liabilities.
7
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Useful lives, gross carrying amounts and accumulated amortization for other intangible assets are as follows:
Gross Carrying Amount | Accumulated Amortization | ||||||||||||||||||||||||||
Useful Life (in years) | September 30, 2006 | December 31, 2005 | September 30, 2006 | December 31, 2005 | |||||||||||||||||||||||
Amortized intangible assets: | |||||||||||||||||||||||||||
Customer relationships | 10-30 | $ | 483.4 | $ | 480.6 | $ | 21.2 | $ | 1.2 | ||||||||||||||||||
Trademarks and tradenames | 15 | 11.5 | 11.5 | 0.5 | — | ||||||||||||||||||||||
Covenants not to compete | 1 | 0.4 | 0.4 | 0.3 | — | ||||||||||||||||||||||
Software and other | 2-3 | 2.0 | 2.0 | 0.7 | 0.1 | ||||||||||||||||||||||
497.3 | 494.5 | 22.7 | 1.3 | ||||||||||||||||||||||||
Indefinite lived intangible assets: | |||||||||||||||||||||||||||
Product formulations | 109.6 | 109.5 | — | — | |||||||||||||||||||||||
Trademarks and tradenames | 84.1 | 84.1 | — | — | |||||||||||||||||||||||
Total other intangible assets | $ | 691.0 | $ | 688.1 | $ | 22.7 | $ | 1.3 | |||||||||||||||||||
The customer relationships and amortizable trademarks and tradenames are being amortized using the cash flow method over their estimated useful lives. All other amortized intangible assets are being amortized ratably over their estimated useful lives. The weighted average amortization period for the amortized intangible assets is 25 years as of September 30, 2006. Except for the product formulations, all other intangible assets were recorded in connection with the Company’s acquisition of Clarke American. The purchase price allocation for Clarke American will be finalized in the fourth quarter of 2006.
Amortization expense was $7.2 and $21.4 for the three and nine months ended September 30, 2006, respectively. There was no amortization expense for intangible assets for the three and nine months ended September 30, 2005.
Estimated annual aggregate amortization expense through December 31, 2010 is as follows:
Three months ending December 31, 2006 | $ | 7.2 | ||||
Year ending December 31, 2007 | 28.8 | |||||
Year ending December 31, 2008 | 27.9 | |||||
Year ending December 31, 2009 | 26.6 | |||||
Year ending December 31, 2010 | 25.6 | |||||
6. | Business Segment Information |
The Company has three reportable segments. Management measures and evaluates the reportable segments based on operating income. The segments and their principal activities consist of the following:
• | Licorice Products segment – Produces licorice products used primarily by the tobacco and food industries. This segment operates in Camden, New Jersey; Richmond, Virginia and Gardanne, France, as well through its joint ventures in Zhangjiagang, Jiangsu and Weihai, Shandong, People’s Republic of China. |
• | Financial Institution segment – Provides checks, check-related products and services, and direct marketing services to financial institutions and to the account holders of such financial institutions. Clarke American serves this segment through its Clarke American and Alcott Routon brands. This segment operates in the United States. |
8
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
• | Direct to Consumer segment – Provides checks, check-related products and services, customized business kits, and treasury management supplies directly to consumers and businesses through its Checks in The Mail and B2Direct brands. This segment operates in the United States. |
Selected summarized financial information for the three month periods ended September 30, 2006 and 2005 was as follows:
Licorice Products | Financial Institution | Direct to Consumer | Corporate | Total | ||||||||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||||||||||
Three months ended September 30, 2006 | $ | 22.7 | $ | 130.6 | $ | 24.7 | $ | — | $ | 178.0 | ||||||||||||||||||||
Three months ended September 30, 2005 | 24.6 | — | — | — | 24.6 | |||||||||||||||||||||||||
Intersegment revenues: | ||||||||||||||||||||||||||||||
Three months ended September 30, 2006 | $ | — | $ | 1.7 | $ | — | $ | — | $ | 1.7 | ||||||||||||||||||||
Three months ended September 30, 2005 | — | — | — | — | — | |||||||||||||||||||||||||
Operating income: | ||||||||||||||||||||||||||||||
Three months ended September 30, 2006 | $ | 7.3 | $ | 20.0 | $ | 2.5 | $ | (1.4 | ) | $ | 28.4 | |||||||||||||||||||
Three months ended September 30, 2005 | 8.6 | — | — | (0.9 | ) | 7.7 | ||||||||||||||||||||||||
Depreciation and amortization: | ||||||||||||||||||||||||||||||
Three months ended September 30, 2006 | $ | 0.7 | $ | 11.4 | $ | 2.1 | $ | — | $ | 14.2 | ||||||||||||||||||||
Three months ended September 30, 2005 | 0.7 | — | — | — | 0.7 | |||||||||||||||||||||||||
Capital expenditures (excluding capital leases): | ||||||||||||||||||||||||||||||
Three months ended September 30, 2006 | $ | 0.2 | $ | 3.2 | $ | 0.3 | $ | — | $ | 3.7 | ||||||||||||||||||||
Three months ended September 30, 2005 | 0.3 | — | — | — | 0.3 | |||||||||||||||||||||||||
Selected summarized financial information for the nine month periods ended September 30, 2006 and 2005 was as follows:
Licorice Products | Financial Institution | Direct to Consumer | Corporate | Total | ||||||||||||||||||||||||||
Net revenues: | ||||||||||||||||||||||||||||||
Nine months ended September 30, 2006 | $ | 73.0 | $ | 399.1 | $ | 75.3 | $ | — | $ | 547.4 | ||||||||||||||||||||
Nine months ended September 30, 2005 | 74.0 | — | — | — | 74.0 | |||||||||||||||||||||||||
Intersegment revenues: | ||||||||||||||||||||||||||||||
Nine months ended September 30, 2006 | $ | — | $ | 5.0 | $ | — | $ | — | $ | 5.0 | ||||||||||||||||||||
Nine months ended September 30, 2005 | — | — | — | — | — | |||||||||||||||||||||||||
Operating income: | ||||||||||||||||||||||||||||||
Nine months ended September 30, 2006 | $ | 26.7 | $ | 61.0 | $ | 7.6 | $ | (3.5 | ) | $ | 91.8 | |||||||||||||||||||
Nine months ended September 30, 2005 | 28.0 | — | — | (2.7 | ) | 25.3 | ||||||||||||||||||||||||
Depreciation and amortization: | ||||||||||||||||||||||||||||||
Nine months ended September 30, 2006 | $ | 3.1 | $ | 34.5 | $ | 6.2 | — | $ | 43.8 | |||||||||||||||||||||
Nine months ended September 30, 2005 | 2.2 | — | — | — | 2.2 | |||||||||||||||||||||||||
Capital expenditures (excluding capital leases): | ||||||||||||||||||||||||||||||
Nine months ended September 30, 2006 | $ | 0.7 | $ | 9.6 | $ | 0.9 | $ | — | $ | 11.2 | ||||||||||||||||||||
Nine months ended September 30, 2005 | 1.0 | — | — | — | 1.0 | |||||||||||||||||||||||||
9
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Segments’ total assets were as follows:
Licorice Products | Financial Institution | Direct to Consumer | Corporate | Total | ||||||||||||||||||||||||||
At September 30, 2006 | $ | 276.9 | $ | 1,012.6 | $ | 120.4 | $ | 54.6 | $ | 1,464.5 | ||||||||||||||||||||
At December 31, 2005 | 271.9 | 1,032.7 | 117.2 | 40.3 | 1,462.1 | |||||||||||||||||||||||||
7. | Comprehensive Income |
Other comprehensive income for the Company includes foreign currency translation adjustments and changes in the fair value of cash flow hedging instruments. Total comprehensive income for the three and nine month periods ended September 30, 2006 and 2005 was as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||||||||||
Net income | $ | 11.2 | $ | 6.0 | $ | 29.6 | $ | 18.3 | ||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||
Foreign exchange translation adjustments | 0.5 | (0.2 | ) | 2.4 | (4.3 | ) | ||||||||||||||||||
Changes in fair value of cash flow hedging instruments, net of taxes of $0.9, $0.0, $0.0 and $0.0 | (1.4 | ) | — | 0.1 | — | |||||||||||||||||||
Comprehensive income | $ | 10.3 | $ | 5.8 | $ | 32.1 | $ | 14.0 | ||||||||||||||||
8. | Net Income Per Share |
The basic and diluted per share data is based on the weighted average number of common shares outstanding during the following periods (in millions):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||||||||||
Basic weighted average common shares outstanding | 20.1 | 19.1 | 19.7 | 19.1 | ||||||||||||||||||||
Diluted weighted average common shares outstanding | 20.6 | 19.8 | 20.3 | 19.8 | ||||||||||||||||||||
Common equivalent shares consisting of outstanding stock options are included in the 2006 and 2005 diluted income per share calculations.
9. | Pension Plans |
Certain current and former employees of the Company are covered under various defined benefit retirement plans. Plans covering salaried employees generally provide pension benefits based on years of service and compensation. Plans covering hourly employees and union members generally provide stated benefits for each year of credited service. The Company’s funding policy is to contribute annually the statutory required minimum amount as actuarially determined.
10
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Net periodic pension income for the Company’s funded plans is due to the overfunded status of the plans and consisted of the following components:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||||||||||
Service cost – benefits earned during the period | $ | 0.1 | $ | 0.1 | $ | 0.3 | $ | 0.2 | ||||||||||||||||
Interest cost on projected benefit obligations | 0.2 | 0.1 | 0.6 | 0.3 | ||||||||||||||||||||
Expected return on plan assets | (0.4 | ) | (0.4 | ) | (1.4 | ) | (1.2 | ) | ||||||||||||||||
Amortization of prior service cost and net loss | — | — | 0.2 | 0.1 | ||||||||||||||||||||
Net pension income | $ | (0.1 | ) | $ | (0.2 | ) | $ | (0.3 | ) | $ | (0.6 | ) | ||||||||||||
The Company’s contributions to its pension plans, which are based on current legal requirements, were $0.4 and $0.5 for the three and nine months ended September 30, 2006. The Company’s contributions to its pension plans, which are based on current legal requirements, were minimal for the three and nine months ended September 30, 2005.
10. Long-Term Debt
September 30, 2006 | December 31, 2005 | |||||||||||
Clarke American $480.0 Senior Secured Credit Facilities, net of unamortized discount | $ | 426.9 | $ | 445.1 | ||||||||
Mafco Worldwide $125.0 Senior Secured Credit Facilities | 91.7 | 107.0 | ||||||||||
Clarke American 11¾% Senior Notes | 175.0 | 175.0 | ||||||||||
Capital lease obligations and other long-term debt | 5.9 | 6.1 | ||||||||||
699.5 | 733.2 | |||||||||||
Less: current maturities | (52.4 | ) | (17.6 | ) | ||||||||
Long-term debt, net of current maturities | $ | 647.1 | $ | 715.6 | ||||||||
Clarke American $480.0 Senior Secured Credit Facility
Concurrent with the completion of the acquisition of Clarke American by the Company on December 15, 2005 (the ‘‘Acquisition’’), Clarke American, as borrower, entered into senior secured credit facilities which provided for a revolving credit facility in an amount of $40.0 maturing on December 15, 2010 and a $440.0 term loan maturing on December 15, 2011. Portions of the revolving credit facility are available for the issuance of letters of credit and swing line loans. The senior secured credit facility has a commitment fee for the unused portion of the revolving credit facility and for issued letters of credit of 0.50% and 3.25%, respectively. The weighted average interest rate on the term loan was 8.65% at September 30, 2006. All obligations under Clarke American’s credit facilities are guaranteed by Clarke American’s direct parent and also by each of Clarke American’s direct and indirect present domestic subsidiaries and future wholly owned domestic subsidiaries. Clarke American’s credit facilities are secured by a perfected first priority security interest in substantially all of Clarke American’s and the guarantors’ assets, other than any future voting stock in excess of 65.0% of the outstanding voting stock of each direct foreign subsidiary and certain other excluded property. Clarke American currently does not have any foreign subsidiaries.
Clarke American’s term loan facility has an aggregate principal amount at maturity of $440.0. Clarke American received $437.8 of proceeds from its issuance, net of original discount of 0.5%. The
11
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
original discount is being amortized as non-cash interest expense over the life of the term loan facility using the effective interest method. Clarke American’s term loan facility is required to be repaid in quarterly installments that commenced on March 31, 2006 in annual amounts of: $15.0 in 2006, $20.0 in 2007, $30.0 in 2008, $35.0 in 2009, $40.0 in 2010 and $300.0 in 2011. Clarke American’s term loan facility requires that a portion of Clarke American’s excess cash flow be applied to prepay amounts borrowed thereunder, beginning in 2007 with respect to 2006. The amount of the estimated excess cash flow payment, with respect to 2006, included in current maturities was approximately $30.4 at September 30, 2006. The balance of the term loan facility is due in 2011.
Loans under Clarke American’s credit facilities bear, at Clarke American’s option, interest at:
• | a rate per annum equal to the higher of (a) the prime rate announced from time to time by The Bank of New York and (b) the Federal Funds rate plus 0.50%, in each case plus an applicable margin of 2.00% per annum for revolving loans, or 2.25% per annum for term loans; or |
• | a rate per annum equal to a reserve-adjusted Eurodollar rate, plus an applicable margin of 3.00% per annum for revolving loans, or 3.25% per annum for term loans. |
Clarke American’s credit facilities contain representations and warranties customary for senior secured credit facilities. They also contain affirmative and negative covenants customary for senior secured credit facilities, including, among other things, restrictions on indebtedness, liens, mergers and consolidations, sales of assets, loans, acquisitions, restricted payments, transactions with affiliates, dividends and other payment restrictions affecting subsidiaries and sale leaseback transactions. Clarke American’s credit facilities also require Clarke American to maintain certain financial covenants, including maximum consolidated secured leverage, maximum total consolidated leverage and minimum consolidated fixed charge coverage ratios.
As of September 30, 2006, $428.8 principal amount at maturity was outstanding under Clarke American’s term loan facility, and $1.9 of the original discount remained unamortized. As of September 30, 2006, no amounts were drawn under Clarke American’s $40.0 revolving credit facility, and Clarke American had $34.6 available for borrowing (giving effect to the issuance of $5.4 of letters of credit).
During February 2006, Clarke American entered into an interest rate hedge transaction, in the form of a three-year interest rate swap with a notional amount of $150.0, which became effective on July 1, 2006 and is being accounted for as a cash flow hedge. The purpose of this hedge transaction is to limit the Company’s risk on a portion of Clarke American’s variable rate senior secured credit facilities.
Mafco Worldwide $125.0 Senior Secured Credit Facility
On December 8, 2005, Mafco Worldwide entered into a credit agreement governing its $125.0 senior secured credit facility with Bear Stearns Corporate Lending Inc., as syndication agent, JPMorgan Chase Bank, N.A., as administrative agent, and Natexis Banques Populaires and National City Bank, as co-documentation agents. The Mafco Worldwide credit facility replaced Mafco Worldwide’s previously existing senior secured credit facility. The Mafco Worldwide credit facility consists of a $110.0 term loan which was drawn on December 8, 2005 and matures in six years and a five year $15.0 revolving credit facility. The indebtedness under the Mafco Worldwide credit facility is guaranteed by Mafco Worldwide's domestic subsidiaries and its direct parent corporation, Flavors Holdings Inc. (collectively, the ‘‘Mafco Worldwide Guarantors’’). Mafco Worldwide's obligations under the Mafco Worldwide credit facility and the guarantees of the Mafco Worldwide Guarantors are secured by a first-priority security interest in substantially all of Mafco Worldwide's and the Mafco
12
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Worldwide Guarantors' assets. Borrowings under the Mafco Worldwide credit facility bear interest, at Mafco Worldwide's option, at either an adjusted Eurodollar rate plus an applicable margin of 2.00% in the case of revolving loans or 2.25% in the case of term loans, or an alternative base rate, plus an applicable margin of 1.00% in the case of revolving loans or 1.25% in the case of term loans. The weighted average interest rate on borrowings outstanding under the Mafco Worldwide credit facility was 7.39% at September 30, 2006.
The Mafco Worldwide credit facility contains affirmative and negative covenants customary for such financings. The Mafco Worldwide credit facility also requires Mafco Worldwide to maintain a minimum ratio of total consolidated EBITDA, as defined in the Mafco Worldwide credit agreement, less capital expenditures to consolidated interest expense and a maximum ratio of consolidated total debt outstanding to consolidated EBITDA as of the last day of each fiscal quarter commencing with the fiscal quarter ended March 31, 2006. The Mafco Worldwide credit facility contains events of default customary for such financings, including but not limited to nonpayment of principal, interest, fees or other amounts when due; violation of covenants; failure of any representation or warranty to be true in all material respects when made or deemed made; cross default and cross acceleration to certain indebtedness; certain ERISA events; change of control; dissolution, insolvency and bankruptcy events; material judgments; actual or asserted invalidity of the guarantees or security documents; and violation of limitations on the activities of Flavors Holdings Inc. and Mafco Shanghai Corporation, a subsidiary of Mafco Worldwide. Some of these events of default allow for grace periods and materiality concepts.
The Mafco Worldwide term loan is repayable in quarterly installments of approximately $0.3 that commenced on March 31, 2006. In addition, a mandatory repayment is required in each year based upon prior year excess cash flow (as defined in the Mafco Worldwide credit agreement). The amount of the estimated excess cash flow payment, with respect to 2006, included in current maturities was approximately $0.8 at September 30, 2006. As of September 30, 2006, there were no borrowings under the Mafco Worldwide $15.0 revolving credit facility, and there was $13.3 available for borrowing (giving effect to the issuance of $1.7 of letters of credit). Mafco Worldwide made repayments totaling $15.3 on its term loan during the nine months ended September 30, 2006, which included mandatory repayments of $0.8.
During February 2006, Mafco Worldwide entered into an interest rate derivative transaction in the form of a two-year non-cancelable interest rate zero-cost collar with a notional amount of $50.0 that caps three months LIBOR at 5.25% and sets a floor at 4.79%. This derivative is being accounted for as a cash flow hedge. The purpose of this hedge transaction is to limit the Company’s risk on a portion of Mafco Worldwide’s variable rate senior secured credit facility.
Clarke American 11¾% Senior Notes
Concurrent with the completion of the Acquisition, Clarke American issued $175 principal amount of 11¾% Senior Notes (the ‘‘Senior Notes’’). The Senior Notes will mature on December 15, 2013 and bear interest at a rate per annum of 11.75%, payable on June 15 and December 15 of each year commencing on June 15, 2006. The indenture governing the Senior Notes contains customary restrictive covenants, including, among other things, restrictions on Clarke American’s ability to incur additional debt, pay dividends and make distributions, make certain investments, repurchase stock, incur liens, enter into transactions with affiliates, enter into sale and leaseback transactions, merge or consolidate and transfer or sell assets. The Senior Notes are unsecured and are effectively subordinated to all of Clarke American’s existing and future secured indebtedness. Clarke American must offer to repurchase all of the outstanding Senior Notes upon the occurrence of a ‘‘change of control,’’ as defined in the indenture, at a purchase price equal to 101% of their aggregate principal amount, plus accrued and unpaid interest. Clarke American must also offer to repurchase the Senior
13
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Notes with the proceeds from certain sales of assets, if Clarke American does not apply those proceeds within a specified time period after the sale, at a purchase price equal to 100% of their aggregate principal amount, plus accrued and unpaid interest.
In accordance with the registration rights agreement that Clarke American executed in connection with the issuance of the Senior Notes, Clarke American filed a registration statement on April 12, 2006 with respect to an exchange offer for publicly registered notes with equivalent terms, which was declared effective by the Securities and Exchange Commission (the ‘‘SEC’’) on May 1, 2006. Clarke American launched an exchange offer on May 2, 2006 and closed the offer on May 31, 2006 with all $175.0 of the principal amount of Senior Notes being exchanged.
Other Indebtedness
Clarke American had $4.9 outstanding under an information technology capital lease obligation at September 30, 2006. The obligation has an imputed interest rate of 6.0% and has required payments including interest of $0.4 for the three months ending December 31, 2006, $1.6 in 2007, $1.6 in 2008, $1.6 in 2009 and $0.3 in 2010. Clarke American had $1.0 outstanding under an information technology financing obligation at September 30, 2006. Related to this obligation, Clarke American recorded $0.6 of non-cash capital expenditures for the nine months ended September 30, 2006. No expenditures were recorded for the three months ended September 30, 2006.
Other
Mafco Worldwide’s French subsidiary has credit agreements renewable annually with two banks whereby it may borrow up to 2.9 million Euros (approximately $3.7 at September 30, 2006) for working capital purposes. The subsidiary had no borrowings at September 30, 2006.
11. | Transactions with Affiliates |
Amended and Restated Management Services Agreement
On May 24, 2006, the Company and MacAndrews & Forbes Inc., a wholly owned subsidiary of Holdings, entered into an amended and restated management services agreement (the ‘‘Management Services Agreement’’) to reflect the increased scope of the management services provided by MacAndrews & Forbes Inc. to the Company and the increased size of the Company. Under the Management Services Agreement, MacAndrews & Forbes Inc. will provide the services of the Company's Chief Executive Officer, Chief Financial Officer and General Counsel, as well as additional advisory, transactional, legal, risk management, tax and accounting services, and the Company will pay to MacAndrews & Forbes Inc. a quarterly fee of $1.25, beginning with the third quarter of 2006. On June 30, 2006, the Company paid to MacAndrews & Forbes Inc. $0.75 payable under the prior management services agreement with respect to the six months ended June 30, 2006. On September 30, 2006, the Company paid to MacAndrews & Forbes Inc. $1.25 payable under the Management Services Agreement with respect to the three months ended September 30, 2006.
The Management Services Agreement will terminate on December 31, 2008, subject to automatic one-year renewal periods unless either party gives the other party written notice at least 90 days prior to the end of the initial term or a subsequent renewal period. The Management Services Agreement will also terminate in the event that MacAndrews & Forbes Inc. or its affiliates no longer in the aggregate retain beneficial ownership of 10% or more of the outstanding common stock of the Company. The Management Services Agreement also contains customary indemnities covering MacAndrews & Forbes Inc. and its affiliates and personnel.
14
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Joint Venture Transactions
Mafco Worldwide has a 50% ownership in a joint venture to manufacture licorice derivatives in Zhangjiagang, Jiangsu, People’s Republic of China. The joint venture purchases licorice materials from Mafco Worldwide, as well as from third party suppliers. Net revenues on the accompanying consolidated statements of income include sales to the joint venture of $1.7 and $0.4 during the nine months ended September 30, 2006 and 2005, respectively.
The joint venture manufactures licorice derivatives which are sold to third party customers and to Mafco Worldwide. Mafco Worldwide uses these derivatives to manufacture certain finished goods. Mafco Worldwide purchased $6.4 and $0.4 of licorice derivatives from the joint venture during the nine months ended September 30, 2006 and 2005, respectively.
The Company accounts for this investment under the equity method and its share of earnings were $0.3 and $0.2 for the nine months ended September 30, 2006 and 2005, respectively. The investment in the joint venture was approximately $6.3 and $6.1 at September 30, 2006 and December 31, 2005, respectively, and is included in other assets in the accompanying consolidated balance sheets. The accompanying consolidated financial statements do not include any profit in inventory for goods purchased from the joint venture or profit related to sales of licorice materials to the joint venture.
12. | Commitments and Contingencies |
Non-Operating Contingent Liability, Indemnification and Insurance Matters
The Company is indemnified by third parties with respect to certain of its contingent liabilities, such as certain environmental and asbestos matters, as well as certain tax and other matters. In 1995, a subsidiary of Mafco Consolidated Group Inc. (‘‘MCG’’), M & F Worldwide and two subsidiaries of M & F Worldwide entered into a transfer agreement (the ‘‘Transfer Agreement’’). Under the Transfer Agreement, Pneumo Abex Corporation (together with its successor in interest Pneumo Abex LLC, ‘‘Pneumo Abex’’), then a subsidiary of M & F Worldwide, retained the assets and liabilities relating to the Company’s former Abex NWL Aerospace Division (‘‘Aerospace’’), as well as certain contingent liabilities and the related assets, including its historical insurance and indemnification arrangements. Pneumo Abex transferred substantially all of its other assets and liabilities to a subsidiary of MCG. The Transfer Agreement provides for appropriate transfer, indemnification and tax sharing arrangements, in a manner consistent with applicable law and existing contractual arrangements.
The Transfer Agreement requires such subsidiary of MCG to undertake certain administrative and funding obligations with respect to certain categories of asbestos-related claims and other liabilities, including environmental claims, retained by Pneumo Abex. The Company will be obligated to make reimbursement for the amounts so funded only when amounts are received by the Company under related indemnification and insurance agreements. Such administrative and funding obligations would be terminated as to these categories of asbestos-related claims in the case of a bankruptcy of Pneumo Abex or M & F Worldwide or of certain other events affecting the availability of coverage for such claims from third party indemnitors and insurers. In the event of certain kinds of disputes with Pneumo Abex’s indemnitors regarding their indemnities, the Transfer Agreement permits the Company to require such subsidiary to fund 50% of the costs of resolving the disputes.
Prior to 1988, a former subsidiary of the Company manufactured certain asbestos-containing friction products. Pneumo Abex has been named, typically along with 10 to as many as 100 or more other companies, as a defendant in various personal injury lawsuits claiming damages relating to exposure to asbestos. Pursuant to indemnification agreements, PepsiAmericas, Inc., formerly known as
15
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Whitman Corporation (the ‘‘Original Indemnitor’’), has ultimate responsibility for all the remaining asbestos-related claims asserted against Pneumo Abex through August 1998 and for certain asbestos-related claims asserted thereafter. In connection with the sale by Abex in December 1994 of its Friction Products Division, a subsidiary (the ‘‘Second Indemnitor’’) of Cooper Industries, Inc. (the ‘‘Indemnity Guarantor’’) assumed responsibility for substantially all asbestos-related claims asserted against Pneumo Abex after August 1998 and not indemnified by the Original Indemnitor. Federal-Mogul Corporation purchased the Second Indemnitor in October 1998. In October 2001, the Second Indemnitor filed a petition under Chapter 11 of the U.S. Bankruptcy Code and stopped performing its indemnity obligations to the Company. Performance of the Second Indemnitor's indemnity obligation is guaranteed by the Indemnity Guarantor. Since the bankruptcy filing of the Second Indemnitor, the Indemnity Guarantor has been fulfilling the Second Indemnitor’s indemnity obligations to the extent that they are no longer being performed by the Second Indemnitor.
In July 2006, the Company entered into a non-binding term sheet with the Second Indemnitor, the Indemnity Guarantor and others that outlined a settlement of claims against the Second Indemnitor relating to its indemnity as part of the bankruptcy reorganization of the Second Indemnitor. If the transactions outlined in the term sheet were to be reflected in binding agreements and then consummated, then either (a) (i) the Company would transfer its interest in Pneumo Abex to a trust to be created in connection with the Second Indemnitor’s bankruptcy reorganization plan, (ii) the Company would pay $10.0 to the trust, and the Indemnity Guarantor would pay $246.0 to the trust and issue a 25-year note to the trust for the payment of $500.0, (iii) the trust would assume all financial responsibility for the payment of asbestos-related claims subject to the Second Indemnitor’s indemnity, and (iv) a court-ordered injunction would bar the assertion of any claim arising out of the asbestos-related claims subject to the Second Indemnitor’s indemnity from being asserted against the Company, the Second Indemnitor or the Indemnity Guarantor (items (a)(i) through (a)(iv) collectively, the ‘‘Plan A Settlement’’) or (b) under certain conditions set forth in the term sheet relating to possible difficulties in implementing the Plan A Settlement, (i) Pneumo Abex would continue to be owned by the Company but would receive $2.0 from the Second Indemnitor’s bankruptcy estate, (ii) the Second Indemnitor would be relieved of its indemnification obligation, and (iii) the Indemnity Guarantor would continue to honor its guaranty obligation and receive $138.0 from the Second Indemnitor’s bankruptcy estate (items (b)(i) through (b)(iii) collectively, the ‘‘Plan B Settlement’’). In furtherance of the proposed settlement, the Company executed an agreement in September 2006 with the Second Indemnitor, the Indemnity Guarantor and others implementing the Plan B Settlement. The Plan B Settlement agreement is contingent upon bankruptcy court approval, which the Second Indemnitor has requested. The parties to the term sheet continue to negotiate binding agreements to implement the Plan A Settlement, although no assurance can be given regarding the outcome of those negotiations or whether the Plan A Settlement can or will be consummated.
Pneumo Abex’s former subsidiary maintained product liability insurance covering substantially all of the period during which asbestos-containing products were manufactured. The subsidiary commenced litigation in 1982 against a portion of these insurers in order to confirm the availability of this coverage. As a result of settlements in that litigation, other coverage agreements with other carriers and payments by the Original Indemnitor, the Second Indemnitor and the Indemnity Guarantor pursuant to their indemnities, Pneumo Abex is receiving reimbursement each month for substantially all of its monthly expenditures for asbestos-related claims. As of September 30, 2006, the Company incurred or expected to incur approximately $1.0 of unindemnified costs, as to which it either has received or expects to receive approximately $0.7 in insurance reimbursements. Management does not expect its unindemnified matters to have a material adverse effect on the Company’s financial position or results of operations, but Pneumo Abex is unable to forecast either
16
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
the number of future asbestos-related claimants or the amount of future defense and settlement costs associated with present or future asbestos-related claims.
The Transfer Agreement further provides that MCG will indemnify Pneumo Abex with respect to all environmental matters associated with Pneumo Abex’s and its predecessor’s operations to the extent not paid by third-party indemnitors or insurers, other than the operations relating to Pneumo Abex’s Aerospace business, which Pneumo Abex sold to Parker Hannifin Corporation in April 1996. Accordingly, environmental liabilities arising after the 1988 transaction with the Original Indemnitor that relate to the Company’s former Aerospace facilities will be the responsibility of Pneumo Abex. The Original Indemnitor is obligated to indemnify Pneumo Abex for costs, expenses and liabilities relating to environmental and natural resource matters to the extent attributable to the pre-1988 operation of the businesses acquired from the Original Indemnitor, subject to certain conditions and limitations principally relating to compliance with notice, cooperation and other procedural requirements. The Original Indemnitor is generally discharging its environmental indemnification liabilities in the ordinary course.
It is generally not possible to predict the ultimate total costs relating to any remediation that may be demanded at any of the sites subject to the indemnity from the Original Indemnitor due to, among other factors, uncertainty regarding the extent of prior pollution, the complexity of applicable environmental laws and regulations and their interpretations, uncertainty regarding future changes to such laws and regulations or their enforcement, the varying costs and effectiveness of alternative cleanup technologies and methods, and the questionable and varying degrees of responsibility and/or involvement by Pneumo Abex. However, the aggregate cost of cleanup and related expenses with respect to matters for which Pneumo Abex, together with numerous other third parties, have been named potentially responsible parties should be substantially less than $100.0.
The Company has not recognized a liability in its financial statements for matters covered by indemnification agreements. The Company considers these obligations to be those of third-party indemnitors and monitors their financial positions to determine the level of uncertainty associated with their ability to satisfy their obligations. Based upon the indemnitors’ active management of indemnifiable matters, discharging of the related liabilities when required, and financial positions based upon publicly filed financial statements, as well as the history of insurance recovery set forth above, the Company believes that the likelihood of failing to obtain reimbursement of amounts covered by insurance and indemnification is remote.
The former Aerospace business of the Company formerly sold certain of its aerospace products to the U.S. Government or to private contractors for the U.S. Government. The Company retained in the Aerospace sale certain claims for allegedly defective pricing made by the government with respect to certain of these products. In the sole remaining matter, the Company contests the Government’s allegations and has been attempting to resolve this matter without litigation.
Honeywell Indemnification
Certain of the intermediate holding companies of the predecessor of Clarke American had issued guarantees on behalf of operating companies formerly owned by these intermediate holding companies, which operating companies are not part of the Clarke American business. Honeywell International Inc. (‘‘Honeywell’’), from which the Company acquired Clarke American, has undertaken, in the Stock Purchase Agreement executed in connection with the Acquisition, to use its commercially reasonable efforts to assume, replace or terminate such guarantees and indemnify M& F Worldwide and its affiliates, including Clarke American and its subsidiaries, with respect to all liabilities arising under such guarantees. To the extent such guarantees were not so assumed, replaced or terminated at the closing, at December 15, 2005, Honeywell had posted a letter of credit for the
17
M & F Worldwide Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
benefit of M & F Worldwide in an amount of $60.0 expiring on December 15, 2007 to secure its indemnification obligations covering the guarantees. The face amount of the letter of credit is subject to adjustment based on the agreement of the parties, and was reduced to $27.0 by September 30, 2006. Since the Company believes it is remote that it will have to pay any amounts under such guarantees it has not recorded any liability in its financial statements.
Other
In addition, various other legal proceedings, claims and investigations are pending against the Company, including those relating to commercial transactions, product liability, environmental, safety and health matters and other matters. Most of these matters are covered by insurance, subject to deductibles and maximum limits, and by third-party indemnities. In the opinion of management, based upon the information available at this time, the outcome of the matters referred to above will not have a material adverse effect on the Company’s financial position or results of operations.
18
M & F Worldwide Corp. and Subsidiaries
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion regarding our financial condition and results of operations for the three and nine months ended September 30, 2006 and September 30, 2005 should be read in connection with the more detailed financial information contained in our consolidated financial statements and their notes included elsewhere in this quarterly report.
Overview of the Business
The Company has two business lines, which are operated by Mafco Worldwide and Clarke American. Mafco Worldwide’s business is the production of licorice products for sale to the tobacco, food, pharmaceutical and confectionery industries (which is the Company’s ‘‘Licorice Products’’ segment). Clarke American’s business is providing checks, check-related products and services, and direct marketing services. Clarke American’s business consists of two segments: the Financial Institution segment, which is focused on financial institution clients and their customers (the Company’s ‘‘Financial Institution’’ segment), and the Direct to Consumer segment, which is focused on individual customers (the Company’s ‘‘Direct to Consumer’’ segment).
Licorice Products
Mafco Worldwide is the world’s largest producer of licorice products. Mafco Worldwide produces a variety of licorice products from licorice root, intermediary licorice extracts produced by others and certain other ingredients at its facilities in the United States, France and the People’s Republic of China.
Approximately 73% of the Mafco Worldwide’s licorice sales are to the worldwide tobacco industry for use as tobacco flavor enhancing and moistening agents in the manufacture of American blend cigarettes, moist snuff, chewing tobacco and pipe tobacco. While licorice represents a small percentage of the total cost of manufacturing American blend cigarettes and other tobacco products, the particular formulation and quality used by each brand is an important element in the brand’s quality. Mafco Worldwide also manufactures and sells cocoa and carob products for use in the tobacco industry.
Over the last several years, the rate of consumption of tobacco products has declined in the United States and in several other developed international markets for American blend cigarettes. Mafco Worldwide has experienced unit sales declines to both the domestic and international tobacco industry during this time.
Mafco Worldwide also sells licorice worldwide to confectioners, food processors, cosmetic companies and pharmaceutical manufacturers for use as flavoring and masking agents, including its Magnasweet brand flavor enhancer, which is used in various brands of chewing gum, lip balm, energy bars, non-carbonated beverages, chewable vitamins, aspirin and other products. Although Mafco Worldwide’s licorice sales to its confectionary customers have experienced some decline in recent years, licorice sales to food, cosmetic and pharmaceutical customers, who use Magnasweet as a flavoring or masking agent, have experienced growth and added to Mafco Worldwide’s overall sales stability for its licorice products. One important facet of Mafco Worldwide’s business strategy is to focus on growing its business through sales of licorice-derived products for use in non-tobacco related applications. Mafco Worldwide is devoting a substantial portion of its research and development efforts to Magnasweet and its potential food and beverage applications as well as to finding additional uses for components of licorice extract in cosmetic and pharmaceutical products.
Mafco Worldwide also sells licorice root residue as garden mulch under the name Right Dress.
The Clarke American Acquisition
On October 31, 2005, M & F Worldwide and Honeywell entered into a stock purchase agreement in which M & F Worldwide agreed to purchase 100% of the capital stock of Novar USA Inc.
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M & F Worldwide Corp. and Subsidiaries
(‘‘Novar’’), a wholly owned subsidiary of Honeywell and the indirect parent of the business of Clarke American, for a cash purchase price of $800.0 million. In connection with this acquisition, referred to as the ‘‘Acquisition,’’ M & F Worldwide formed CA Investment Corp., an indirect wholly owned subsidiary of M & F Worldwide.
Prior to the Acquisition, the business of Clarke American was owned by Novar, which indirectly wholly owned the operating subsidiaries of the Clarke American business. In connection with the Acquisition, Novar and its subsidiaries completed a series of merger transactions to eliminate certain intermediate holding companies. Concurrent with the Acquisition, Novar and CA Investment Corp. completed a series of merger transactions, with CA Investment Corp. as the surviving entity. On December 15, 2005, CA Investment Corp. purchased 100% of the capital stock of Novar and was renamed ‘‘Clarke American Corp.’’
In order to fund the Acquisition as well as approximately $22.5 million of expenses for the Acquisition and the related financings, the following transactions occurred:
• | Mafco Worldwide borrowed $110.0 million under a new senior secured term loan; |
• | M & F Worldwide used $95.3 million of cash and cash equivalents and proceeds from the sale of marketable securities; |
• | Clarke American entered into a term loan facility with an aggregate principal amount at maturity of $440.0 million for proceeds of $437.8 million; |
• | Clarke American borrowed $4.2 million under its revolving credit facility; and |
• | Clarke American issued $175.0 million of 11.75% Senior Notes due 2013. |
As a result of the higher leverage, the Company’s interest expense is significantly higher in periods after the completion of the Acquisition than in prior periods.
The Acquisition has been accounted for as a purchase, in accordance with the provisions of Statement of Financial Accounting Standards (‘‘SFAS’’) No. 141, which resulted in valuations for Clarke American’s consolidated assets and liabilities based on fair values as of the date of the Acquisition. These valuations are still preliminary and will be finalized during the fourth quarter of 2006. The allocation of the purchase price in the Acquisition results in higher depreciation and amortization expense in the periods following the Acquisition compared to prior periods.
In connection with the Acquisition, Honeywell agreed to indemnify the Company for losses caused by breaches of Honeywell’s representations, warranties and covenants, pre-closing taxes and other specified matters described in the stock purchase agreement. Claims for breaches of representations and warranties must be brought by the Company by December 15, 2006 and are generally subject to a deductible basket of $8.0 million and a cap of $160.0 million, except that claims related to certain environmental matters, taxes and the capitalization of Novar and its subsidiaries survive for longer periods of time and are not subject to any deductible basket or cap. Certain representations regarding corporate authorization of the transactions, capitalization, the sophistication of the parties and the nonreliance of the parties on the matters beyond those set forth in the stock purchase agreement survive indefinitely. Covenant breaches and other indemnification events in the stock purchase agreement are not subject to a deductible basket or a cap.
Clarke American is one of the three largest providers of checks and check-related products and services in the United States based on revenues, and Clarke American is a leading provider of direct marketing services to financial institutions. Clarke American serves financial institutions through the Clarke American and Alcott Routon brands and consumers and businesses directly through the Checks In The Mail and B2Direct brands. Clarke American has a solid reputation for quality and has won several third party and customer awards.
Clarke American’s two business segments are the Financial Institution segment (84% of its revenues for the nine months ended September 30, 2006) and the Direct to Consumer segment (16%
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M & F Worldwide Corp. and Subsidiaries
of its revenues for the nine months ended September 30, 2006). Customers ordering through the Financial Institution segment order checks from Clarke American’s financial institution clients, and Clarke American manages that check order process on their behalf. The Direct to Consumer segment serves customers who prefer to order checks directly from a check provider.
This section should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and the Critical Accounting Policies as disclosed under Item 7 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Critical Accounting Policies and Estimates
A description of the Company’s critical accounting policies was provided in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. There were no changes to these accounting policies during the nine months ended September 30, 2006, except as listed below.
Derivatives
The Company began using derivative financial instruments in 2006 to manage interest rate risk related to a portion of its long-term debt. The Company recognizes all derivatives at fair value as either assets or liabilities in the consolidated balance sheets and changes in the fair values of such instruments are recognized in earnings unless specific hedge accounting criteria are met. If specific cash flow hedge accounting criteria are met, the Company recognizes the changes in fair value of these instruments in other comprehensive income until the cash flow hedge is settled.
On the date the interest rate derivative contract is entered into, the Company designates the derivative as either a fair value hedge or a cash flow hedge. The Company formally documents the relationship between hedging instruments and the hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. The Company links all hedges that are designated as fair value hedges to specific assets or liabilities on the balance sheet or to specific firm commitments. The Company links all hedges that are designated as cash flow hedges to forecasted transactions or to liabilities on the balance sheet. The Company also assesses, both at the inception of the hedge and on an on-going basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. If an existing derivative were to become not highly effective as a hedge, the Company would discontinue hedge accounting prospectively. The Company assesses the effectiveness of the hedge based on total changes in the hedge’s cash flows at each payment date as compared to the change in the expected future cash flows on the long-term debt.
Consolidated Operating Results
Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005
Net Revenues
$in millions | Three Months Ended September 30, 2006 | Three Months Ended September 30, 2005 | ||||||||||
Consolidated Net Revenues: | ||||||||||||
Licorice Products Segment | $ | 22.7 | $ | 24.6 | ||||||||
Financial Institution Segment | 130.6 | — | ||||||||||
Direct to Consumer Segment | 24.7 | — | ||||||||||
Total | $ | 178.0 | $ | 24.6 | ||||||||
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M & F Worldwide Corp. and Subsidiaries
Net revenues increased by $153.4 million in the 2006 period as compared to the 2005 period, primarily as a result of the Acquisition, which occurred in December 2005 and accounted for an increase of $155.3 million.
Net revenues from the Licorice Products segment decreased by $1.9 million, or 7.7%, to $22.7 million in the 2006 period from $24.6 million in the 2005 period. This was primarily due to a decrease in revenues from the worldwide tobacco markets for both licorice and non-licorice products of $2.6 million as a result of lower shipment volumes due to timing of orders, a decrease in cigarette consumption in certain markets (in particular Western Europe), and a changing mix of products sold to the worldwide tobacco industry. Magnasweet and licorice derivative sales increased $0.3 million on higher shipment volumes. Sales of licorice products to confectionary customers declined $0.3 million on lower shipment volumes in the 2006 period versus the 2005 period. Sales of raw materials to Mafco Worldwide’s joint venture in China increased by $0.7 million in the 2006 versus the 2005 period.
Cost of Revenues
$in millions | Three Months Ended September 30, 2006 | Three Months Ended September 30, 2005 | ||||||||||
Consolidated Cost of Revenues: | ||||||||||||
Licorice Products Segment | $ | 12.7 | $ | 13.0 | ||||||||
Financial Institution Segment | 81.2 | — | ||||||||||
Direct to Consumer Segment | 15.5 | — | ||||||||||
Total | $ | 109.4 | $ | 13.0 | ||||||||
Cost of revenues increased by $96.4 million in the 2006 period as compared to the 2005 period, primarily as a result of the Acquisition, which occurred in December 2005 and accounted for an increase of $96.7 million.
Cost of revenues for the Licorice Products segment was $12.7 million in the 2006 period and $13.0 million in the 2005 period, a decrease of $0.3 million. The decrease in cost of revenues for the Licorice Products segment was due to the decrease in sales, offset in part by substantially higher energy, raw materials and other manufacturing costs. Cost of revenues as a percentage of revenues for the Licorice Products segment was 55.9% in the 2006 period as compared to 52.8% in the 2005 period primarily as a result of the cost increases described above.
Cost of revenues in the 2006 period for the Financial Institution and Direct to Consumer segments were $81.2 million and $15.5 million, respectively. Cost of revenues as a percentage of revenues for the Financial Institution and Direct to Consumer segments were 62.2% and 62.8%, respectively.
Selling, General and Administrative Expenses
$in millions | Three Months Ended September 30, 2006 | Three Months Ended September 30, 2005 | ||||||||||
Consolidated Selling, General and Administrative Expenses: | ||||||||||||
Licorice Products Segment | $ | 2.7 | $ | 3.1 | ||||||||
Financial Institution Segment | 29.4 | — | ||||||||||
Direct to Consumer Segment | 6.7 | — | ||||||||||
Corporate | 1.4 | 0.8 | ||||||||||
Total | $ | 40.2 | $ | 3.9 | ||||||||
Selling, general and administrative expenses increased by $36.3 million in the 2006 period as compared to the 2005 period, primarily as a result of the Acquisition, which occurred in December 2005 and accounted for $36.1 million of the increase.
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M & F Worldwide Corp. and Subsidiaries
Selling, general and administrative expenses for the Licorice Products segment were $2.7 million for the 2006 period and $3.1 million for the 2005 period. The decrease in selling, general and administrative expenses was due to lower professional fees in the 2006 period. Selling, general and administrative expenses for the Financial Institution and Direct to Consumer segments included in the 2006 period were $29.4 million and $6.7 million, respectively. Corporate selling, general and administrative expenses increased by $0.6 million in the 2006 period as compared to the 2005 period, mainly as results of increase in management fees that the Company paid to MacAndrews & Forbes Inc. pursuant to the terms of the amended and restated Management Services Agreement and increased administrative costs subsequent to the Acquisition.
Interest Income
Interest income was $0.7 million in the 2006 period as compared to $0.9 million in the 2005 period. The decrease in interest income reflects lower average cash and cash equivalents balances in the 2006 period, offset in part by higher interest rates in the 2006 period as compared to the 2005 period. The lower average cash balances in the 2006 period were primarily the result of cash and cash equivalents used for the Acquisition in December 2005.
Interest Expense
Interest expense was $17.2 million in the 2006 period as compared to no interest expense in the 2005 period. The increase was due to interest on the long-term debt incurred in connection with the Acquisition in December 2005. The Company did not have any debt outstanding during the three months ended September 30, 2005.
Provision for Income Taxes
The provision for income taxes was $0.7 million in the 2006 period as compared to $2.6 million in the 2005 period. The decrease of $1.9 million in the 2006 period was primarily due to a benefit of $2.9 million from the effect of a decrease in state tax rates on Clarke American’s deferred tax balances, and reversal of reserves of $1.0 million for certain prior year issues due to the resolution of certain tax matters, offset in part by an increase in income before taxes as a result of the Acquisition. In the 2005 period the Company recorded a reversal of reserves of $0.8 million for certain prior year issues due to the resolution of certain tax matters. The provision for income taxes as a percentage of income was 5.9% in the 2006 period and 30.2% in the 2005 period.
Consolidated Operating Results
Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
Net Revenues
$in millions | Nine Months Ended September 30, 2006 | Nine Months Ended September 30, 2005 | ||||||||||
Consolidated Net Revenues: | ||||||||||||
Licorice Products Segment | $ | 73.0 | $ | 74.0 | ||||||||
Financial Institution Segment | 399.1 | — | ||||||||||
Direct to Consumer Segment | 75.3 | — | ||||||||||
Total | $ | 547.4 | $ | 74.0 | ||||||||
Net revenues increased by $473.4 million in the 2006 period as compared to the 2005 period, primarily as a result of the Acquisition, which occurred in December 2005 and accounted for an increase of $474.4 million.
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M & F Worldwide Corp. and Subsidiaries
Net revenues from the Licorice Products segment decreased by $1.0 million, or 1.4%, to $73.0 million in the 2006 period from $74.0 million in the 2005 period. This was due to a decrease in revenues from the worldwide tobacco markets for both licorice and non-licorice products of $1.7 million as a result of lower shipment volumes due to timing of orders, a decrease in cigarette consumption in certain markets (in particular Western Europe), and a changing mix of products sold to the worldwide tobacco industry. Magnasweet and licorice derivatives sales increased $1.1 million on higher shipment volumes. Sales of licorice products to confectionary and other customers decreased $1.8 million on lower shipment volumes in the 2006 period versus the 2005 period. Sales of raw materials to Mafco Worldwide’s joint venture in China increased by $1.4 million in the 2006 versus the 2005 period.
Cost of Revenues
$in millions | Nine Months Ended September 30, 2006 | Nine Months Ended September 30, 2005 | ||||||||||
Consolidated Cost of Revenues: | ||||||||||||
Licorice Products Segment | $ | 37.5 | $ | 36.9 | ||||||||
Financial Institution Segment | 247.9 | — | ||||||||||
Direct to Consumer Segment | 46.2 | — | ||||||||||
Total | $ | 331.6 | $ | 36.9 | ||||||||
Cost of revenues increased by $294.7 million in the 2006 period as compared to the 2005 period, primarily as a result of the Acquisition, which occurred in December 2005 and accounted for $294.1 million of the increase.
Cost of revenues for the Licorice Products segment was $37.5 million in the 2006 period and $36.9 million in the 2005 period, an increase of $0.6 million. The increase in cost of revenues for the Licorice Products segment was due to substantially higher energy, raw materials and other manufacturing costs. These increased costs were offset in part by lower sales volume. Cost of revenues as a percentage of revenues for the Licorice Products segment was 51.4% in the 2006 period as compared to 49.9% in the 2005 period primarily as a result of the cost increases described above.
Cost of revenues in the 2006 period for the Financial Institution and Direct to Consumer segments were $247.9 million and $46.2 million, respectively. Cost of revenues as a percentage of revenues for the Financial Institution and Direct to Consumer segments were 62.1% and 61.4%, respectively. Cost of revenues for these segments in the 2006 period includes $1.3 million for a fair value adjustment to inventory recorded in the purchase accounting for the Acquisition which will not reoccur.
Selling, General and Administrative Expenses
$in millions | Nine Months Ended September 30, 2006 | Nine Months Ended September 30, 2005 | ||||||||||
Consolidated Selling, General and Administrative Expenses: | ||||||||||||
Licorice Products Segment | $ | 8.8 | $ | 9.1 | ||||||||
Financial Institution Segment | 90.2 | — | ||||||||||
Direct to Consumer Segment | 21.5 | — | ||||||||||
Corporate | 3.5 | 2.7 | ||||||||||
Total | $ | 124.0 | $ | 11.8 | ||||||||
Selling, general and administrative expenses increased by $112.2 million in the 2006 period as compared to the 2005 period, primarily as a result of the Acquisition, which occurred in December 2005 and accounted for $111.7 million of the increase.
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M & F Worldwide Corp. and Subsidiaries
Selling, general and administrative expenses for the Licorice Products segment were $8.8 million in the 2006 period and $9.1 million in the 2005 period. The decrease in selling, general and administrative expenses was due to lower professional fees in the 2006 period versus the 2005 period. Selling, general and administrative expenses for the Financial Institution and Direct to Consumer segments included in the 2006 period were $90.2 million and $21.5 million, respectively. Corporate selling, general and administrative expenses increased by $0.8 million in the 2006 period as compared to the 2005 period. The 2006 corporate expenses reflect increased management fees payable to MacAndrews & Forbes Inc. pursuant to the terms of the amended and restated Management Services Agreement and increased administrative costs subsequent to the Acquisition.
Interest Income
Interest income was $1.8 million in the 2006 period as compared to $2.3 million in the 2005 period. The decrease in interest income reflects lower average cash and cash equivalents balances in the 2006 period, offset in part by higher interest rates in the 2006 period as compared to the 2005 period. The lower average cash balances in the 2006 period were primarily the result of cash and cash equivalents used for the Acquisition in December 2005.
Interest Expense
Interest expense was $50.6 million in the 2006 period, as compared to $0.1 million in the 2005 period. The increase was due to interest on the long-term debt incurred in connection with the Acquisition in December 2005. The Company did not have any debt outstanding at September 30, 2005.
Other Income (Expense), net
Other income (expense), net was $0.9 million in the 2005 period, which resulted from the resolution of a claim against a former shareholder of the Company.
Provision for Income Taxes
The provision for income taxes was $13.4 million in the 2006 period as compared to $10.1 million in the 2005 period. The increase of $3.3 million in the 2006 period was primarily due to the increase in income before taxes as a result of the Acquisition, offset in part by a benefit of $2.9 million from the effect of a decrease in state tax rates on Clarke American’s deferred tax balances, and net reversals of reserves of $0.1 million. In addition, in the 2005 period the Company recorded a reversal of reserves of $0.8 million for certain prior year issues due to the resolution of certain tax matters. The provision for income taxes as a percentage of income was 31.2% in the 2006 period and 35.6% in the 2005 period.
Liquidity and Capital Resources
The Company’s net cash provided by operating activities during the first nine months of 2006 was $84.9 million compared to $29.4 million in the first nine months of 2005. The increase in net cash provided by operating activities of $55.5 million was primarily related to increased net income and recording of higher depreciation and amortization expense as a result of the Acquisition, which did not affect cash flows, as well as favorable changes in working capital.
The Company’s net cash used in investing activities was $11.9 million during the first nine months of 2006 compared to $85.1 million for the first nine months of 2005. Primary investing activities in the 2006 period were capital expenditures, which increased as compared to the 2005 period due to Clarke American’s capital expenditures. The cash used in the 2005 period was primarily related to net sales of marketable securities in anticipation of the closing of the Acquisition in the fourth quarter of 2005.
The Company’s net cash used in financing activities was $39.9 million during the first nine months of 2006, while $0.2 million was provided by financing activities during the first nine months of 2005.
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M & F Worldwide Corp. and Subsidiaries
The 2006 activity relates to scheduled debt repayments, optional debt prepayments, change in cash overdraft balances at Clarke American, offset in part by borrowings on Clarke American’s revolving credit facility and stock option exercises and related excess tax benefits. The 2005 activity consisted of proceeds from stock options exercised.
There have been no material changes to the Company’s cash obligations and other commercial commitments which were presented in the Form 10-K for the year ended December 31, 2005.
M & F Worldwide is a holding company whose only material assets are its ownership interest in its subsidiaries and approximately $48.4 million in cash and cash equivalents as of September 30, 2006. The Company is considering various alternatives for the application of its cash and cash equivalents on hand. M & F Worldwide's principal business operations are conducted by its subsidiaries, and M & F Worldwide has no operations of its own. Accordingly, M & F Worldwide's only source of cash to pay its obligations, other than cash and cash equivalents on hand, is expected to be distributions with respect to its ownership interest in its subsidiaries. There can be no assurance that M & F Worldwide's subsidiaries will generate sufficient cash flow to pay dividends or distribute funds to M & F Worldwide or that applicable state law and contractual restrictions, including negative covenants contained in the debt instruments of such subsidiaries, will permit such dividends or distributions.
Although there can be no assurance, the Company believes that its existing working capital, together with the borrowings under its credit agreements and anticipated cash flow from operating activities, will be sufficient to meet the Company’s expected operating, capital spending and debt service requirements for the foreseeable future.
Forward-Looking Statements
This quarterly report on Form 10-Q for the nine months ended September 30, 2006, as well as certain of the Company’s other public documents and statements and oral statements, contains forward-looking statements that reflect management’s current assumptions and estimates of future performance and economic conditions. When used in this quarterly report, the words ‘‘believes,’’ ‘‘anticipates,’’ ‘‘plans,’’ ‘‘expects,’’ ‘‘intends,’’ ‘‘estimates’’ or similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. All forward-looking statements speak only as of the date of this quarterly report. Although the Company believes that its plans, intentions and expectations reflected in or suggested by the forward-looking statements are reasonable, such plans, intentions or expectations may not be achieved. Such forward-looking statements are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company cautions investors that any forward-looking statements are subject to risks and uncertainties that may cause actual results and future trends to differ materially from those projected, stated or implied by the forward-looking statements. In addition, the Company encourages investors to read the summary of the Company’s critical accounting policies in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 under the heading ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates.’’
In addition to factors described in the Company’s SEC filings and others, the following factors could cause the Company’s actual results to differ materially from those expressed in any forward-looking statements made by the Company:
• | Clarke American’s and Mafco Worldwide’s substantial indebtedness; |
• | covenant restrictions under Clarke American’s and Mafco Worldwide’s indebtedness that may limit the Company’s and their ability to operate their respective businesses and react to market changes; |
• | lack of access to cash flow or other assets of the Company’s subsidiaries, including Clarke American and Mafco Worldwide; |
• | increases in interest rates; |
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M & F Worldwide Corp. and Subsidiaries
• | the maturity of the principal industry in which Clarke American operates and trends in the paper check industry, including a faster than anticipated decline in check usage due to increasing use of alternative payment methods and other factors; |
• | consolidation among financial institutions and other adverse changes among the large clients on which Clarke American depends, resulting in decreased revenues; |
• | intense competition in all areas of the Company’s businesses; |
• | interruptions or adverse changes in the Company’s supplier relationships; |
• | increased production and delivery costs applicable to the Company; |
• | fluctuations in the costs of the Company’s raw materials; |
• | the Company’s ability to attract, hire and retain qualified personnel; |
• | technological improvements that may reduce the Company’s competitive advantage over some of its competitors; |
• | Clarke American’s ability to protect customer data from security breaches; |
• | changes in legislation relating to consumer privacy protection which could harm Clarke American’s business; |
• | contracts with Clarke American clients relating to consumer privacy protection which could restrict its business; |
• | the Company’s ability to protect its intellectual property rights; |
• | the Company’s reliance on third-party providers for certain significant information technology needs; |
• | software defects that could harm Clarke American’s businesses and reputation; |
• | the Company’s ability to successfully manage future acquisitions; |
• | sales and other taxes which could have adverse effects on the Company’s businesses; |
• | environmental risks; |
• | economic, climatic or political conditions in countries in which Mafco Worldwide sources licorice root; |
• | economic, climatic or political conditions that have an impact on the worldwide tobacco industry or on the consumption of tobacco products in which licorice products are used; |
• | additional government regulation of tobacco products, tobacco industry litigation or enactment of new or increased taxes on cigarettes or other tobacco products, to the extent any of the foregoing curtail growth in or actually reduce consumption of tobacco products in which licorice products are used; |
• | additional government regulation relating to non-tobacco uses of Mafco Worldwide’s products; |
• | the failure of third parties to make full and timely payment to the Company for environmental, asbestos, tax, Acquisition-related and other matters for which the Company is entitled to indemnification; |
• | any inability to obtain indemnification for any significant group of asbestos-related claims pending against the Company; |
• | lower than expected cash flow from operations; |
• | unfavorable foreign currency fluctuations; |
27
M & F Worldwide Corp. and Subsidiaries
• | the loss of one of the Company’s significant customers; |
• | work stoppages and other labor disturbances; and |
• | unanticipated internal control deficiencies or weaknesses. |
The Company encourages investors to read carefully the factors described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 in the section entitled ‘‘Risk Factors’’ for a description of certain risks that could, among other things, cause actual results to differ from these forward-looking statements. The Company assumes no responsibility to update the forward-looking statements contained in this quarterly report on Form 10-Q.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
The Company has exposure to market risk from changes in foreign currency exchange rates and interest rates, which could affect its business, results of operations and financial condition. The Company manages its exposure to this market risk through its regular operating and financing activities. In order to manage its exposure to fluctuations in interest rates, the Company entered into interest rate derivative transactions in 2006 in the form of a swap for Clarke American and a collar for Mafco Worldwide, as further described in the notes to the financial statements included elsewhere in this quarterly report.
At September 30, 2006, Mafco Worldwide had $91.7 million of term loans outstanding under the Mafco Worldwide credit agreement and $1.7 million outstanding under the Mafco Worldwide revolving credit facility, consisting of letters of credit. At September 30, 2006, Clarke American had $428.8 million of term loans outstanding under the Clarke American credit agreement and $5.4 million outstanding under the Clarke American revolving credit facility consisting of letters of credit. All of these outstanding loans bear interest at variable rates. Accordingly, the Company is subject to risk due to changes in interest rates. The Company believes that a hypothetical 10% increase or decrease in interest rates applicable to its floating rate debt outstanding as of September 30, 2006 would have resulted in an increase or decrease in its interest expense for the nine months ended September 30, 2006 of approximately $2.2 million.
Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 presents additional quantitative and qualitative disclosures about exposure to risk in foreign currency exchange rates. There have been no material changes to the disclosures regarding foreign currency exchange rates as of September 30, 2006.
Item 4. | Controls and Procedures |
(a) Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’)) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective.
(b) Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
28
PART II. OTHER INFORMATION
Item 1. | Legal Proceedings |
There was no material development in legal proceedings during the three months ended September 30, 2006.
Item 1 A. Risk Factors
There was no material change to the Company’s risk factors as disclosed in the Annual Report for the year ended December 31, 2005.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
Item 3. | Defaults Upon Senior Securities |
There was no event of default upon senior securities during the three months ended September 30, 2006.
Item 4. | Submission of Matters to a Vote of Security Holders |
There were no matters submitted to a vote of security holders during the three months ended September 30, 2006.
Item 5. | Other Information |
No additional information need be presented.
Item 6. | Exhibits |
4.1 | Supplemental Indenture, dated as of October 5, 2006, among Clarke American Corp., B2Direct, Inc., Checks in the Mail, Inc., Clarke American Checks, Inc. and The Bank of New York (incorporated by reference to Exhibit 4.1 to Clarke American Corp.’s quarterly report on Form 10-Q for the quarter ended September 30, 2006, filed with the Securities and Exchange Commission on November 7, 2006). |
31.1 | Certification of Howard Gittis, Chief Executive Officer, dated November 7, 2006. |
31.2 | Certification of Paul G. Savas, Chief Financial Officer, dated November 7, 2006. |
32.1 | Certification of Howard Gittis, Chief Executive Officer, dated November 7, 2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | Certification of Paul G. Savas, Chief Financial Officer, dated November 7, 2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
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.
M & F WORLDWIDE CORP. | ||||||
Date: November 7, 2006 | By: | /s/ Paul G. Savas | ||||
Paul G. Savas Executive Vice President, Chief Financial Officer and Principal Financial Officer | ||||||
Date: November 7, 2006 | By: | /s/ Alison M. Horowitz | ||||
Alison M. Horowitz Principal Accounting Officer | ||||||
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