UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition from to
Commission File No. 027222
CFC INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
| DELAWARE | 36-3434526 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
500 State Street, Chicago Heights, Illinois 60411
Registrant’s telephone number, including area code: (708) 891-3456
Indicated by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. YES ¨ NO x
As of October 26, 2004, the Registrant had issued and outstanding 3,884,970 shares of Common Stock, par value $.01 per share, and 512,989 shares of Class B Common Stock, par value $.01 per share.
CFC INTERNATIONAL, INC.
List of Items Amended
Part I—Financial Information
Item 1.
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Notes to Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 4.
Controls and Procedures (1)
(1)
Explanatory Note: This filing solely amends the original filing on Form 10-Q with respect to treatment of Foreign Currency Translation as prescribed by Financial Accounting Standards Board Statement No. 52, when accounting for intercompany transactions and is more fully described in footnote 11 of the financial statements contained in the filing at page 14. The financial statements have been restated as well as portions of “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” revised. On the same date of the filing of this Form 10-Q/A, the registrant is filing a Form 10-Q/A for the quarters ended March 31, 2004, and June 30, 2004, to which reference is made for additional information and developments after September 30, 2004. The Company restated its financial statements to reflect the recognition of foreign currency exchange gains and losses related to intercompany transactions in the consolidated statement of operations in accordance with Financial Accounting Standards Board No. 52, “Foreign Currency Translation.” Previously the Company had improperly included such gains and losses in accumulated other comprehensive income included in its consolidated stockholders’ equity. The correction of this error effects net income, earnings per share, accumulated other comprehensive income and deferred taxes currently payable (included in accrued expenses). These changes had no effect on the balance of cash and cash equivalents in the Consolidated Statement of Cash Flows. The Company has also reclassified foreign currency exchange gains and losses previously included in selling, general and administrative expenses to foreign currency exchange (gain) loss in other income (expense) in its Consolidated Statement of Operations.
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As a result of these changes, net income and earnings per diluted share disclosed in the original Form 10-Q for the three months ended September 30, 2004 will increase from $1,300,906 and $0.29 cents per share on a fully diluted basis, to $1,431,036 and $0.32 cents per share on a fully diluted basis. Net loss and loss per diluted share disclosed in the original Form 10-Q for the three months ended September 30, 2003 decreased from ($316,427) and ($0.07) cents per share on a fully diluted basis, to ($241,240) and ($0.05) cents per share on a fully diluted basis.
As a result of these changes, net income and earnings per diluted share disclosed in the original Form 10-Q for the nine months ended September 30, 2004 will increase from $2,948,395 and $0.66 cents per share on a fully diluted basis, to $3,152,534 and $0.71 cents per share on a fully diluted basis. Net income and earnings per diluted share disclosed in the original Form 10-Q for the nine months ended September 30, 2003 increased from $40,151 and $0.01 cents per share on a fully diluted basis, to $332,553 and $0.08 cents per share on a fully diluted basis.
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INDEX TO FORM 10-Q/A
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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
The Company believes that certain statements contained in this report and in the future filings by the Company with the Securities and Exchange Commission and in the Company’s written and oral statements made by or with the approval of an authorized executive officer that are not historical facts constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and the Company intends that such forward-looking statements be subject to the safe harbors created thereby.
The words and phrases “looking ahead,” “is confident,” “should be,” “will,” “predicted,” “believe,” “plan,” “intend,” “estimates,” “likely,” “expect” and “anticipate” and similar expressions identify forward-looking statements.
These forward-looking statements reflect the Company’s current views with respect to future events and financial performance, but are subject to many uncertainties and factors relating to the Company’s operations and business environment which may affect the accuracy of forward-looking statements and cause the actual results of the Company to be materially different from any future results expressed or implied by such forward-looking statements. As a result, in some future quarter the Company’s operating results may fall below the expectations of securities analysts and investors. In such an event, the trading price of the Company’s common stock would likely be materially and adversely affected. Many of the factors that will determine results of operations are beyond the Company’s ability to control or predict.
Some of the factors that could cause or contribute to such differences include:
| • | The effect of the continuing unfavorable economic conditions on market growth trends in general and the impact on the Company’s customers, the demand for the Company’s products and services, and the Company’s ordinary sources of supply, in particular; |
| • | Risks inherent in international operations, including possible economic, political or monetary instability and its impact on the level and profitability of foreign sales; |
| • | Uncertainties relating to the Company’s ability to consummate its business strategy, including the unavailability of suitable acquisition candidates, or the Company’s inability to finance future acquisitions or successfully realize synergies and cost savings from the integration of acquired businesses; |
| • | Changes in the costs and availability of raw materials and the Company’s ability to adjust selling prices to reflect those changes; |
| • | The Company’s reliance on existing senior management and the impact of the loss of any of those persons or its inability to continue to identify, hire and retain qualified management personnel; |
| • | Uncertainties relating to the Company’s ability to develop and distribute new proprietary products to respond to market needs in a timely manner and the Company’s ability to continue to protect its proprietary product information and technology; |
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| • | The Company’s ability to continue to successfully identify and implement productivity improvements and cost reduction initiatives; |
| • | The Company’s reliance on a small number of significant customers; |
| • | Uncertainties relating to the Company’s ability to continue to compete effectively with other producers of specialty transferable coatings and producers of alternative products with greater financial and management resources; |
| • | Control of the Company by a principal stockholder; and |
| • | The effects of terrorism and armed conflicts on the Company’s operations, demands for products and sources of supply. |
The risks included here are not exhaustive. We operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for us to predict all such risk factors, nor can we assess the impacts of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. We have no obligation to revise or update these forward-looking statements to reflect events or circumstances that arise after October 25, 2004 or to reflect the occurrence of anticipated events.
Investors should also be aware that while we do, from time to time, communicate with securities analysts, it is against our policy to disclose to them any material non-public information or other confidential commercial information. Accordingly, investors should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
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CONSOLIDATED BALANCE SHEETS AT
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
| September 30, 2004 | December 31, 2003 | |||||||
| (Unaudited) Restated (Note 11) | Restated (Note 11) | |||||||
ASSETS | ||||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 9,145,438 | $ | 5,555,025 | ||||
Restricted cash | 306,072 | 117,622 | ||||||
Accounts receivable, less allowance for doubtful accounts and customer credits of $1,501,000 (2004) and $1,767,000 (2003) | 13,190,921 | 9,821,047 | ||||||
Inventories: | ||||||||
Raw materials | 3,330,662 | 4,488,351 | ||||||
Work in process | 2,525,750 | 1,858,727 | ||||||
Finished goods | 8,312,599 | 6,703,633 | ||||||
| 14,169,011 | 13,050,711 | |||||||
Prepaid expenses and other current assets | 1,032,889 | 856,153 | ||||||
Deferred income tax assets | 1,080,474 | 915,493 | ||||||
Total current assets | 38,924,805 | 30,316,051 | ||||||
Property, plant and equipment, net | 27,130,714 | 28,116,892 | ||||||
Deferred income tax assets | 3,204,130 | 3,280,891 | ||||||
Goodwill | 1,029,462 | 1,029,462 | ||||||
Intangible assets, net | 2,453,836 | 2,666,437 | ||||||
Other assets | 239,339 | 105,078 | ||||||
Total assets | $ | 72,982,286 | $ | 65,514,811 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Current portion of long-term debt | $ | 11,471,939 | $ | 9,716,066 | ||||
Accounts payable | 4,859,727 | 4,769,538 | ||||||
Accrued compensation and benefits | 2,979,388 | 1,032,115 | ||||||
Accrued expenses and other current liabilities | 6,119,086 | 4,651,313 | ||||||
Total current liabilities | 25,430,140 | 20,169,032 | ||||||
Deferred income tax liabilities | 2,605,288 | 2,680,247 | ||||||
Fair value of interest rate swap | 435 | 47,783 | ||||||
Long-term debt, net of current portion | 14,298,906 | 15,066,109 | ||||||
Total liabilities | 42,334,769 | 37,963,171 | ||||||
COMMITMENTS AND CONTINGENCIES | ||||||||
STOCKHOLDERS’ EQUITY: | ||||||||
Voting Preferred Stock, par value $.01 per share, 750 shares authorized, no shares issued and outstanding | — | — | ||||||
Common stock, $.01 par value, 10,000,000 shares authorized; shares issued and outstanding of 4,450,837 (2004) and 4,446,127 (2003) | 44,509 | 44,462 | ||||||
Class B common stock, $.01 par value, 750,000 shares authorized; 512,989 shares issued and outstanding | 5,130 | 5,130 | ||||||
Additional paid-in capital | 12,196,959 | 12,167,569 | ||||||
Retained earnings | 20,357,499 | 17,204,965 | ||||||
Accumulated other comprehensive income | 701,822 | 787,917 | ||||||
| 33,305,920 | 30,210,043 | |||||||
Less - 565,867 treasury shares of common stock, at cost | (2,658,403 | ) | (2,658,403 | ) | ||||
| 30,647,517 | 27,551,640 | |||||||
Total liabilities and stockholders’ equity | $ | 72,982,286 | $ | 65,514,811 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND NINE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003
| Three Months Ended 09/30, | Nine Months Ended 09/30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||
| Restated (Note 11) | Restated (Note 11) | Restated (Note 11) | Restated (Note 11) | |||||||||||||
Net sales | $ | 21,717,862 | $ | 15,073,709 | $ | 61,897,338 | $ | 47,473,476 | ||||||||
Cost of goods sold (excluding depreciation and amortization shown below) | 13,842,067 | 10,466,959 | 39,928,751 | 31,613,768 | ||||||||||||
Selling, general and administrative expenses | 3,724,522 | 3,179,895 | 11,180,806 | 10,043,919 | ||||||||||||
Research and development expenses | 787,097 | 539,996 | 2,184,059 | 1,623,964 | ||||||||||||
Depreciation and amortization expense | 1,238,188 | 1,093,759 | 3,593,336 | 3,256,312 | ||||||||||||
Total operating expenses | 19,591,874 | 15,280,609 | 56,886,952 | 46,537,963 | ||||||||||||
Operating income (loss) | 2,125,988 | (206,900 | ) | 5,010,386 | 935,513 | |||||||||||
Other (income) expense: | ||||||||||||||||
Interest expense, net | 307,721 | 314,174 | 894,113 | 822,568 | ||||||||||||
Interest swap valuation | 49,074 | (71,271 | ) | (47,348 | ) | 106,810 | ||||||||||
Rental income | (49,885 | ) | (5,400 | ) | (118,267 | ) | (20,040 | ) | ||||||||
Foreign currency exchange (gain) | (262,717 | ) | (110,363 | ) | (289,764 | ) | (503,213 | ) | ||||||||
Total other expense, net | 44,193 | 127,140 | 438,734 | 406,125 | ||||||||||||
Income (loss) before income taxes | 2,081,795 | (334,040 | ) | 4,571,652 | 529,388 | |||||||||||
Provision (benefit) for income taxes | 650,759 | (92,800 | ) | 1,419,118 | 196,835 | |||||||||||
Net income (loss) | $ | 1,431,036 | $ | (241,240 | ) | $ | 3,152,534 | $ | 332,553 | |||||||
Basic earnings (loss) per share | $ | 0.33 | $ | (0.05 | ) | $ | 0.72 | $ | 0.08 | |||||||
Diluted earnings (loss) per share | $ | 0.32 | $ | (0.05 | ) | $ | 0.71 | $ | 0.08 | |||||||
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Nine Months Ended September 30, | ||||||||
| 2004 | 2003 | |||||||
| (Unaudited) Restated (Note 11) | (Unaudited) Restated (Note 11) | |||||||
Cash flow from operating activities: | ||||||||
Net income | $ | 3,152,534 | $ | 332,553 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 3,628,463 | 3,440,814 | ||||||
Valuation of derivative | (47,348 | ) | 106,810 | |||||
Issuance of stock to officer | 29,437 | — | ||||||
Deferred income tax provision | (246,976 | ) | 332,662 | |||||
Changes in assets and liabilities: | ||||||||
Accounts receivable, net | (3,451,874 | ) | (1,038,863 | ) | ||||
Inventories, net | (1,187,063 | ) | (62,021 | ) | ||||
Prepaid and other current assets | (171,528 | ) | (746,026 | ) | ||||
Other assets | (134,261 | ) | 42,341 | |||||
Accounts payable | 119,654 | 844,740 | ||||||
Accrued compensation and benefits | 2,009,391 | (877,841 | ) | |||||
Accrued expenses and other current liabilities | 1,359,315 | (89,846 | ) | |||||
Net cash provided by operating activities | $ | 5,059,744 | $ | 2,285,323 | ||||
Cash flows from investing activities: | ||||||||
Additions to property, plant and equipment | (2,554,727 | ) | (2,049,272 | ) | ||||
Net cash used in investing activities | (2,554,727 | ) | (2,049,272 | ) | ||||
Cash flows from financing activities: | ||||||||
Repayment of revolver | (2,549,225 | ) | (577,500 | ) | ||||
Proceeds from revolver | 2,781,391 | 1,119,708 | ||||||
Proceeds from term loans | 3,713,317 | 122,545 | ||||||
Repayments of term loans | (4,800,593 | ) | (1,165,659 | ) | ||||
Proceeds from IRB | 2,000,000 | — | ||||||
Proceeds from issuance of stock | — | 37,073 | ||||||
Net cash provided by (used in) financing activities | 1,144,890 | (463,833 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents | 128,956 | (427,667 | ) | |||||
Increase/(decrease) in cash and cash equivalents | 3,778,863 | (655,449 | ) | |||||
Cash and cash equivalents (including restricted cash): | ||||||||
Beginning of period | 5,672,647 | 5,990,077 | ||||||
End of period | $ | 9,451,510 | $ | 5,334,628 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 AND 2003
(Unaudited)
Note 1. Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of CFC International, Inc. (the Company), and its wholly-owned subsidiaries, as of September 30, 2004 (unaudited) and December 31, 2003 (audited), the consolidated results of operations for the three months and nine months ended September 30, 2004 and 2003 (unaudited) respectively, and consolidated statements of cash flows for the nine months ended September 30, 2004 and 2003 (unaudited).
The unaudited interim consolidated financial statements included herein have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures normally accompanying the annual consolidated financial statements have been omitted. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest annual report on Form 10-K.
Results for an interim period are not necessarily indicative of results for the entire year and such results are subject to year-end adjustments and an independent audit.
Certain prior year amounts have been reclassified to conform to current year presentation. These reclassifications had no effect on the previously reported amounts of income before income taxes or net income.
Note 2. Earnings Per Share
The table below provides the reconciliation of the numerator and denominator in computing earnings per share and also gives effect to the restatement described in Note 11.
| Three Months Ended | |||||||||||||||||||
| September 30, 2004 | September 30, 2003 | ||||||||||||||||||
| Income | Shares | Per Share | Loss | Shares | Per Share | ||||||||||||||
Basic earnings (loss) per share: | |||||||||||||||||||
Income (loss) available to common stockholders, restated (Note 11) | $ | 1,431,036 | 4,395,399 | $ | 0.33 | $ | (241,240 | ) | 4,393,223 | $ | (0.05 | ) | |||||||
Effect of dilutive securities: | |||||||||||||||||||
Options exercisable | — | 45,033 | — | — | |||||||||||||||
Convertible debt | 6,950 | 47,617 | (0.01 | ) | — | — | |||||||||||||
Diluted earnings (loss) per share, restated (Note 11) | $ | 1,437,986 | 4,488,049 | $ | 0.32 | $ | (241,240 | ) | 4,393,223 | $ | (0.05 | ) | |||||||
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| Nine Months Ended | |||||||||||||||||
| September 30, 2004 | September 30, 2003 | ||||||||||||||||
| Income | Shares | Per Share | Income | Shares | Per Share | ||||||||||||
Basic earnings per share: | |||||||||||||||||
Income available to common stockholders, restated (Note 11) | $ | 3,152,35 | 4,393,966 | $ | 0.72 | $ | 332,553 | 4,390,434 | $ | 0.08 | |||||||
Effect of dilutive securities: | |||||||||||||||||
Options exercisable | — | 41,158 | — | — | |||||||||||||
Convertible debt | 27,800 | 63,490 | (0.01 | ) | 24,000 | 87,300 | |||||||||||
Diluted earnings per share, restated (Note 11) | $ | 3,180,335 | 4,498,614 | $ | 0.71 | $ | 356,553 | 4,477,734 | $ | 0.08 | |||||||
For the three and nine months ended September 30, 2003, the effect of the convertible debt would be antidilutive and as such is excluded from the calculation in the table above.
Note 3. Business Segments and International Operations
The Company and its subsidiaries operate in a single business segment, which is the formulating and manufacturing of chemically complex, multi-layered functional coatings. The Company produces five primary types of coating products. Sales for each of these products (in millions) for the three months ended September 30, 2004 and 2003, and the nine months ended September 30, 2004 and 2003 are as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||||||
| Net Sales | % | Net Sales | % | Net Sales | % | Net Sales | % | |||||||||||||
Holographic Products | $ | 5.0 | 22.9 | $ | 3.7 | 24.4 | $ | 13.6 | 21.9 | $ | 11.7 | 24.7 | ||||||||
Printed Products | 9.2 | 42.3 | 3.6 | 24.0 | 23.1 | 37.3 | 12.9 | 27.2 | ||||||||||||
Pharmaceutical Products | 3.2 | 14.9 | 2.7 | 17.8 | 9.0 | 14.5 | 8.6 | 18.1 | ||||||||||||
Security Products | 1.8 | 8.3 | 2.4 | 15.9 | 7.3 | 11.9 | 5.6 | 11.8 | ||||||||||||
Simulated Metal and Other Pigmented Products | 2.5 | 11.6 | 2.7 | 17.9 | 8.9 | 14.4 | 8.6 | 18.2 | ||||||||||||
Total | $ | 21.7 | 100.0 | $ | 15.1 | 100.0 | $ | 61.9 | 100.0 | $ | 47.4 | 100.0 | ||||||||
The following is sales by geographic area for the three months and nine months ended September 30, 2004 and 2003 and long-lived asset information as of September 30, 2004 and December 31, 2003:
Three months ended September 30, | Nine months ended September 30, | |||||||||||
Net Sales (In Thousands) | 2004 | 2003 | 2004 | 2003 | ||||||||
United States | $ | 11,757 | $ | 7,278 | $ | 32,603 | $ | 21,974 | ||||
Europe | 6,752 | 5,533 | 19,797 | 17,704 | ||||||||
Other Foreign | 3,209 | 2,263 | 9,497 | 7,795 | ||||||||
Total | $ | 21,718 | $ | 15,074 | $ | 61,897 | $ | 47,473 | ||||
Long Lived Assets (In Thousands) | September 30, 2004 | December 31, 2003 | ||||
United States | $ | 18,641 | $ | 18,543 | ||
Europe | 12,212 | 10,807 | ||||
Total | $ | 30,853 | $ | 29,350 | ||
Europe and other foreign revenue are based on the country in which the customer is domiciled.
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Note 4. Debt Financing
On August 25, 2004, the Company utilized an Illinois Revenue Bond (IRB) to permanently finance the acquisition of the land and building bordering its Chicago Heights, Illinois facility. The face amount of the IRB is $2.0 million. At closing, $1,760,000 was drawn. The Company used the proceeds to repay borrowings under its revolving credit agreement. The IRB carries a weekly floating interest rate based on the remarketing agent surveying the market to determine the rate necessary to remarket bonds at par. On September 30, 2004, the rate was 1.50%. The IRB will amortize $100,000 annually over 20 years. The Company also extended the maturity date of its revolving credit agreement with its main domestic bank to April 1, 2006, and increased the maximum availability under the borrowing revolving credit agreement increased to $8.0 million from $5.5 million. This agreement bears interest at prime. The Company also extended its European revolving credit agreement to April 1, 2006, and reduced its maximum borrowings availability under this revolving loan agreement to $6.0 million from $8.4 million. This note bears interest at 1.0% over Euro overnight index average.
Note 5. Comprehensive Income
The Company’s total comprehensive income was as follows:
| Three Months Ended September 30, | ||||||||
| 2004 | 2003 | |||||||
| Restated (Note 11) | Restated (Note 11) | |||||||
Net income (loss) | $ | 1,431,036 | $ | (241,240 | ) | |||
Foreign currency translation adjustment | 57,987 | 120,319 | ||||||
Total comprehensive income (loss) | $ | 1,489,023 | $ | (120,921 | ) | |||
| Nine Months Ended September 30, | ||||||||
| 2004 | 2003 | |||||||
| Restated (Note 11) | Restated (Note 11) | |||||||
Net income | $ | 3,152,534 | $ | 332,553 | ||||
Foreign currency translation adjustment | (86,094 | ) | 500,395 | |||||
Total comprehensive income | $ | 3,066,440 | $ | 832,948 | ||||
Note 6. Contingencies and Commitments
From time to time, the Company is subject to legal proceedings and claims, which arise, in the normal course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows.
The Company has no material commitments to purchase capital assets as of September 30, 2004.
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Note 7. Derivative Instruments
On April 4, 2003, the Company executed two interest rate swap agreements to fix the interest rates on the Company’s U.S. term loans. The Company entered into these agreements to reduce the risk of adverse changes in variable interest rates. The notional amounts were $4,606,324 (with a fixed rate of 4.43%), and $2,303,840 (with a fixed rate of 4.82%) on April 4, 2003. The swap agreements terminate on January 31, 2008. These derivatives do not qualify for hedge accounting and accordingly, the Company has recorded these derivative instruments and the associated assets or liabilities at their fair values with the related gains or losses recorded as other income or expense in the consolidated statements of income.
Note 8. Supplemental Pro Forma Information
The Company currently accounts for stock based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Had the Company accounted for stock based compensation in accordance with Statement of Financial Accounting Standards No. 123 (SFAS No. 123) “Accounting for Stock-Based Compensation,” the Company would have reported the following pro forma amounts for the three and nine months ended September 30, 2004 and June 30, 2003:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| 09/30/04 | 09/30/03 | 09/30/04 | 09/30/03 | |||||||||||||
Restated (Note 11) | Restated (Note 11) | Restated (Note 11) | Restated (Note 11) | |||||||||||||
Net income (loss) as reported | $ | 1,431,036 | $ | (241,240 | ) | $ | 3,152,534 | $ | 332,553 | |||||||
Pro forma adjustment – additional compensation expense had SFAS No. 123 been adopted, net of tax | (16,296 | ) | (16,433 | ) | (48,887 | ) | (44,238 | ) | ||||||||
Pro forma net income (loss) | $ | 1,414,740 | $ | (257,673 | ) | $ | 3,103,647 | $ | 288,315 | |||||||
Diluted earnings (loss) per share as reported | $ | 0.32 | $ | (0.05 | ) | $ | 0.71 | $ | 0.01 | |||||||
Pro forma effect of compensation expense | 0.00 | (0.01 | ) | (0.01 | ) | (0.01 | ) | |||||||||
Pro forma diluted earnings (loss) per share | $ | 0.32 | $ | (0.06 | ) | $ | 0.70 | $ | 0.00 | |||||||
Note 9. Net Operating Loss Tax Asset
Our German business has generated cumulative tax net operating loss carry forwards (NOLs) totaling 7.2 million Euros through September 30, 2004. These NOLs are being carried forward to offset future taxable income in Germany. The Company has recorded cumulative deferred tax assets of $3.2 million as of September 30, 2004 relating to the benefit of these NOLs. At present time the unused NOLs have no expiration date. Although realization of the deferred tax asset is not assured, the Company has concluded that it is more likely than not that the tax asset will be realized, and accordingly no valuation allowance has been provided. This is principally based upon a prudent and feasible business strategy which shifts production to the Company’s plant in Germany and also after considering benefits realized from cost reduction measures the Company has already taken including closing the UK finishing operations and warehouse and reducing employee headcount. If the Company concludes that as a result of actions planned or taken, that the operating results in Germany can not achieve and maintain profitability, or if there are changes to the Germany tax law, the Company may need to adjust the value of the Company’s deferred tax assets resulting in a reduction to income in the period in which such determination is made.
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Note 10. Stock Issuance to Officer
On August 20, 2004, the Compensation Committee of the Board of Directors granted 4,710 shares of non-registered company voting common stock to Mr. Gregory Jehlik, President and Chief Executive Officer, in consideration for his contributions to the Company. The Company recorded a compensation charge for the fair market value of the stock of approximately $29,000 in conjunction with this grant.
Note 11. Foreign Currency Exchange Gains and Losses Restatement
The Company has restated its financial statements to correct errors discovered in determining and recording foreign currency exchange gains and losses related to intercompany transactions. The restated financial statements reflect the recognition of translation gains and losses related to intercompany transactions in the Company’s Consolidated Statements of Operations in accordance with Financial Accounting Standards Board Statement No. 52, “Foreign Currency Translation” because the functional currency of the Company’s foreign operations is not the U.S. dollar and the intercompany transactions are expected to be settled in the ordinary course of business. Previously, the Company had improperly included such gains and losses in other accumulated comprehensive income (loss) included in its consolidated stockholders’ equity. The correction of the error effected net income, earnings per share, accumulated other comprehensive income and deferred taxes currently payable. There was no effect on the balance of cash and cash equivalents in the Consolidated Statement of Cash Flows. The Company has also reclassified foreign currency exchange gains and losses previously included in selling, general and administrative expenses to foreign currency exchange (gain) loss in other income (expense) in its Consolidated Statement of Operations. The table below summarizes the effect of the correction of the error.
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
| As Reported | As Restated | As Reported | As Restated | ||||||||||||
Selling, general and administrative expenses | |||||||||||||||
2004 | $ | 3,671,693 | $ | 3,724,522 | $ | 11,220,299 | $ | 11,180,806 | |||||||
2003 | 3,190,818 | 3,179,895 | 10,012,322 | 10,043,919 | |||||||||||
Total operating expenses | |||||||||||||||
2004 | 19,539,045 | 19,591,874 | 56,926,445 | 56,886,952 | |||||||||||
2003 | 15,291,522 | 15,280,609 | 46,506,366 | 46,537,963 | |||||||||||
Operating income (loss) | |||||||||||||||
2004 | 2,178,817 | 2,125,988 | 4,970,893 | 5,010,386 | |||||||||||
2003 | (217,813 | ) | (206,900 | ) | 967,110 | 935,513 | |||||||||
Foreign currency exchange (gain) | |||||||||||||||
June 30, 2004 | — | (262,717 | ) | — | (289,764 | ) | |||||||||
December 31, 2003 | — | (110,363 | ) | — | (503,213 | ) | |||||||||
Income (loss) before income taxes | |||||||||||||||
2004 | 1,871,907 | 2,081,795 | 4,242,395 | 4,571,652 | |||||||||||
2003 | (455,316 | ) | (334,040 | ) | 57,772 | 529,388 | |||||||||
Provision (benefit) for income taxes | |||||||||||||||
2004 | 571,001 | 650,759 | 1,294,000 | 1,419,118 | |||||||||||
2003 | (138,889 | ) | (92,800 | ) | 17,621 | 196,835 | |||||||||
Net income (loss) | |||||||||||||||
2004 | 1,300,906 | 1,431,036 | 2,948,395 | 3,152,534 | |||||||||||
2003 | (316,427 | ) | (241,240 | ) | 40,151 | 332,553 | |||||||||
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| As Reported | As Restated | |||
Accrued expenses and other current liabilities | ||||
September 30, 2004 | 5,616,594 | 6,119,086 | ||
December 31, 2003 | 4,273,938 | 4,651,313 | ||
Total current liabilities | ||||
September 30, 2004 | 24,927,648 | 25,430,140 | ||
December 31, 2003 | 19,791,658 | 20,169,032 | ||
Total liabilities | ||||
September 30, 2004 | 41,832,277 | 42,334,769 | ||
December 31, 2003 | 37,585,797 | 37,963,171 | ||
Accumulated other comprehensive income | ||||
September 30, 2004 | 2,024,170 | 701,822 | ||
December 31, 2003 | 1,781,007 | 787,917 | ||
Retained earnings | ||||
September 30, 2004 | 19,537,644 | 20,357,499 | ||
December 31, 2003 | 16,589,249 | 17,204,965 | ||
Total stockholders’ equity | ||||
September 30, 2004 | 31,150,009 | 30,647,517 | ||
December 31, 2003 | 27,929,014 | 27,551,640 | ||
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
The Company formulates, manufactures and sells chemically-complex, transferable, multi-layer coatings for use in many diversified markets, such as holographic packaging and authentication seals, furniture and building products, pharmaceutical products and transaction cards (including credit cards, debit cards, ATM cards and access cards), and intaglio printing.
The Company’s cost of goods sold reflects all direct product costs and direct labor, quality control, shipping and receiving, maintenance, process engineering and plant management. Selling, general and administrative expenses are primarily composed of sales representatives’ salaries and related expenses, commissions to sales representatives, advertising costs, management compensation, and corporate audit and legal expense. Research and development expenses include salaries of technical personnel and experimental materials.
Foreign Currency Exchange Gains and Losses Restatement
The Company has restated its financial statements to correct errors discovered in determining and recording foreign currency exchange gains and losses related to intercompany transactions. The restated financial statements reflect the recognition of exchange gains and losses related to intercompany transactions in the Company’s Consolidated Statements of Operations in accordance with Financial Accounting Standards Board Statement No. 52, “Foreign Currency Translation” because the functional currency of the Company’s foreign operations is not the U.S. dollar and the intercompany transactions are expected to be settled in the ordinary course of business. Previously, the Company had improperly included such gains and losses in accumulated other comprehensive income (loss) included in its Consolidated Stockholders’ Equity. The correction of this error effected net income, earnings per share, accumulated other comprehensive income and deferred taxes currently payable. There was no effect on the balance of cash and cash equivalents in the Consolidated Statements of Cash Flows. The Company has also reclassified foreign currency exchange gains and losses previously included in selling, general and administrative expenses to foreign currency exchange (gain) loss in other (income) expense in its Consolidated Statement of Operations.
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Results of Operations
The following table sets forth, certain items from the Company’s consolidated financial statements as a percentage of net sales for the periods presented:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||
| (Unaudited) | (Unaudited) | |||||||||||
| Restated | Restated | Restated | Restated | |||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Cost of goods sold (excluding depreciation and amortization shown below) | 63.7 | 69.4 | 64.5 | 66.6 | ||||||||
Selling, general and administrative | 17.2 | 21.1 | 18.1 | 21.1 | ||||||||
Research and development | 3.6 | 3.6 | 3.5 | 3.4 | ||||||||
Depreciation and amortization | 5.7 | 7.3 | 5.8 | 6.9 | ||||||||
Operating income (loss) | 9.8 | (1.4 | ) | 8.1 | 2.0 | |||||||
Interest expense and other | 1.4 | 1.5 | 1.2 | 2.0 | ||||||||
Foreign currency exchange (gain) | (1.2 | ) | (0.7 | ) | (0.5 | ) | (1.1 | ) | ||||
Income (loss) before taxes | 9.6 | (2.2 | ) | 7.4 | 1.1 | |||||||
Provision (benefit) for income taxes | 3.0 | (0.8 | ) | 2.3 | 0.4 | |||||||
Net income (loss) | 6.6 | % | (1.6 | )% | 5.1 | % | 0.7 | % | ||||
Quarter Ended September 30, 2004 Compared to Quarter Ended September 30, 2003
Net sales for the quarter ended September 30, 2004 increased 44.1% to $21.7 million, from $15.1 million for the quarter ended September 30, 2003. The Euro appreciated in value 8% compared to the U.S. dollar, and as a result, increased sales approximately $0.4 million in the third quarter of 2004. Holographic products sales increased 35.1% to $5.0 million for the quarter ended September 30, 2004, compared to $3.7 million for the quarter ended September 30, 2003. This increase was primarily due to increased volumes for existing customers and new applications of the Company’s HoloLam Plus™, patent applied for. HoloLam Plus is a full-face holographic laminate for transaction cards that offers a new method to produce material that is a registered full face holographic image on transaction cards. Printed products sales increased 153.3% to $9.2 million, compared to $3.6 million for the same quarter in the prior year. This increase was primarily due to an increase in market share domestically as a result of a major competitor withdrawing from the market. Pharmaceutical products sales during these same periods increased 20.7% to $3.2 million, from $2.7 million, primarily due to increased demand worldwide. Security products (mag stripe, signature panels and tipping products for credit cards, intaglio-printed products and gift cards) sales for these same periods decreased 24.1% to $1.8 million from $2.4 million. This decrease was primarily the result of the slower ramp up of gift cards which should be made up in the fourth quarter. Sales of simulated metal and other pigmented products for these periods decreased 11.6% to $2.5 million, from $2.7 million, primarily due to the sluggish European economy, offset by the strength of the Euro compared to the U.S. dollar, and the strength of domestic sales.
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Cost of goods sold for the quarter ended September 30, 2004 increased 32.2% to $13.8 million, from $10.5 million for the quarter ended September 30, 2003. This increase was primarily due to the impact of higher sales as discussed above. The cost of goods sold as a percentage of net sales for the quarter ended September 30, 2004 decreased to 63.8% from 69.4% for the quarter ended September 30, 2003 primarily due to the reasons noted above and leveraging fixed production costs over a larger sales base.
Selling, general and administrative expenses for the quarter ended September 30, 2004 increased 17.1% to $3.7 million, from $3.2 million for the quarter ended September 30, 2003, due to the Company adding sales and marketing resources and the strength of the Euro compared to the U.S. dollar. Selling, general and administrative expenses for the quarter ended September 30, 2004 decreased as a percentage of net sales to 17.2% from 21.1% for the quarter ended September 30, 2003. This decrease in percentage was primarily due to the impact of higher sales.
Research and development expenses for the quarter ended September 30, 2004 increased 45.8% to $787,000 from $540,000 for the quarter ended September 30, 2003. This increase was primarily due to an increase in wages and related performance incentives. Research and development expense for the quarter ended September 30, 2004 and for the quarter ended September 30, 2003 remained the same at 3.6%.
Depreciation and amortization expenses for the quarter ended September 30, 2004 increased 13.2% to $1,238,000 from $1,094,000 for the quarter ended September 30, 2003. This increase was primarily due to an increase in depreciation associated with additional capital spending. Depreciation and amortization expense as a percentage of net sales for the quarter ended September 30, 2004 decreased to 5.7% from 7.3% for the quarter ended September 30, 2003, primarily due to higher sales in 2004.
Operating income for the quarter ended September 30, 2004, increased to income of $2.1 million, from a loss of ($207,000) for the quarter ended September 30, 2003. The increase in operating income is primarily a result of the above reasons described above in the paragraphs relating to sales, costs and expenses. Operating income for the quarter ended September 30, 2004, increased as a percentage of net sales to 9.8% from a loss of (1.4%) for the quarter ended September 30, 2003. This increase is a result of the above.
Interest expense, net for the quarter ended September 30, 2004 decreased 2.1% to $308,000, from $314,000 for the quarter ended September 30, 2003. This decrease in interest expense is primarily due to increased borrowings to finance the purchase of the land and building bordering the Company’s Chicago Heights facility, offset by lower interest rates.
Rental (income), net for the quarter ended September 30, 2004, increased to $50,000, from $5,000 for the quarter ended September 30, 2003. This increase in rental income is primarily due to the rent being paid on the newly acquired land and building bordering the Company’s Chicago Heights facility, by the former owner as they phase out of the property.
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Interest rate swap valuation provision for the quarter ended September 30, 2004, increased to a provision of $49,000, from a $71,000 benefit in the quarter ended September 30, 2003. This increase represents the change in value of a swap agreement entered into by the Company in April 2003. It is the Company’s intention to utilize this swap until its maturity. Interest rate swap valuation provision for the quarter ended September 30, 2004 increased as a percentage of sales to 0.2% from (0.5%) for the quarter ended September 30, 2003. This increase is a result of the reasons noted above.
Gain on foreign currency exchange for the quarter ended September 30, 2004 increased 138.0% to $263,000 from $110,000 for the quarter ended September 30, 2003. This was a result of the strength of the Euro against the U.S. dollar.
Provision (benefit) for income taxes for the quarter ended September 30, 2004, decreased 801.2% to a provision of $651,000, from a benefit of ($93,000) for the quarter ended September 30, 2003. The effective tax rate for the quarters ended September 30, 2004 and 2003 were both 30.5%.
Net income increased 693.2% to $1.4 million for the quarter ended September 30, 2004, from a loss of ($241,000) for the quarter ended September 30, 2003. This increase is net income is primarily due to the reasons noted above.
Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003
Net sales for the nine months ended September 30, 2004 increased 30.4% to $61.9 million, from $47.4 million for the nine months ended September 30, 2003. The Euro appreciated in value 10.1% compared to the U.S. dollar, and as a result, increased sales approximately $1.6 million for the nine months ended September 30, 2004. Holographic product sales increased 15.8% to $13.6 million for the nine months ended September 30, 2004, compared to from $11.7 for the nine months ended September 30, 2003, primarily due to an increase in demand due to new applications for holographic products. Printed product sales increased 78.5% to $23.1 million, from $12.9 million, primarily due to an increase in market share domestically as a result of a major competitor withdrawing from the market. Pharmaceutical product sales for this period increased 4.6% to $9.0 million, from $8.6 million, primarily due to increased sales in Europe, offset by softer domestic demand. Security product (magnetic stripe, signature panels and tipping products for transaction cards, intaglio-printed products and gift cards) sales for these periods increased 30.6% to $7.3 million, from $5.6 million. This increase comes primarily from increased sales of gift cards. Sales of simulated metal and other pigmented products for these periods increased 3.7% to $8.9 million, from $8.6 million in the first nine months of 2003. This increase is primarily due to the strength of the Euro compared to the U.S. dollar for European sales and the increase in domestic sales.
Cost of goods sold for the nine months ended September 30, 2004 increased 26.3% to $39.9 million, from $31.6 million for the nine months ended September 30, 2003. This increase was primarily due to higher sales in 2004. Cost of goods sold for the nine months ended September 30, 2004 decreased as a percentage of net sales to 64.5% from 66.6% for the nine months ended September 30, 2003. This decrease was primarily due to better utilization of the Company’s fixed manufacturing costs and higher productivity offset by higher material costs.
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Selling, general and administrative expenses for the nine months ended September 30, 2004 increased 11.3% to $11.2 million, from $10.0 million for the nine months ended September 30, 2003. This increase in expenses was primarily due to hiring and relocation of personnel, plus the strength of the Euro against the U.S. dollar. Selling, general and administrative expenses for the nine months ended September 30, 2004 decreased as a percentage of net sales to 18.1% from 21.1% for the nine months ended September 30, 2003, primarily due to the reasons noted above.
Research and development expenses for the nine months ended September 30, 2004 increased 34.5% to $2.2 million, from $1.6 million for the nine months ended September 30, 2003. This increase in expenses was primarily due to an increase in wages and related performance incentives. Research and development expenses for the nine months ended September 30, 2004 increased as a percentage of net sales to 3.5%, from 3.4% for the nine months ended September 30, 2003, primarily due to higher personnel costs offset by a higher sales volume.
Depreciation and amortization expenses for the nine months ended September 30, 2004 increased 10.3% to $3.6 million, from $3.3 million for the quarter ended September 30, 2003. This increase was primarily due to an increase in depreciation associated with additional capital spending. Depreciation and amortization expense as a percentage of net sales for the nine months ended September 30, 2004 decreased to 5.8% from 6.9% for the nine months ended September 30, 2003, primarily due to higher sales in 2004.
Operating income for the nine months ended September 30, 2004 increased 435.6% to $5.0 million, from $0.9 million for the nine months ended September 30, 2003. The increase in operating income is primarily due to the reasons described above in the paragraphs relating to sales, costs and expenses. Operating income for the nine months ended September 30, 2004 as a percentage of net sales increased to 8.1% from 2.0% for the nine months ended September 30, 2003. This increase is primarily due to the reasons described above reasons described above.
Interest expense, net for the nine months ended September 30, 2004 increased 8.7% to $0.9 million, from $0.8 million for the nine months ended September 30, 2003. This increase was primarily due to increased borrowings to finance the purchase of the land and building bordering the Company’s Chicago Heights facility offset by lower interest rates.
Rental (income), net for the nine months ended September 30, 2004, increased to $118,000, from $20,000 for the nine months ended September 30, 2003. This increase in rental income is primarily due to the rent being paid on the newly acquired land and building bordering the Company’s Chicago Heights facility, by the former owner as they phase out of the property.
Interest rate swap valuation provision for the nine months ended September 30, 2004, decreased to a $47,000 benefit, from a $107,000 provision in the nine months ended September 30, 2003. This decrease represents the change in value of a swap agreement entered into by the Company in April 2003. It is the Company’s intention to utilize this swap until its maturity. Interest rate swap valuation provision for the nine months ended September 30, 2004 decreased as a percentage of sales to 0.1% from 0.2% for the nine months ended September 30, 2003. This decrease is a result of the reasons noted above.
20
Gain on foreign currency exchange for the nine months ended September 30, 2004 decreased 42.4% to $290,000 from $503,000 for the nine months ended September 30, 2003. This was a result of the strength of the U.S. dollar against the Euro.
Income taxes for the nine months ended September 30, 2004, increased to $1.4 million, from $197,000 for the nine months ended September 30, 2003. The increase in the effective tax rate for the nine months ended September 30, 2004 decreased to 31.0% from 37.2% for the nine months ended September 30, 2003. The increase in income taxes was primarily due to the increase in income discussed above.
Net income for the nine months ended September 30, 2004, increased to $3.2 million, up from $333,000 for the nine months ended September 30, 2003. This increase in net income is primarily due to the reasons described above reasons described above in the paragraphs relating to sales, costs and expenses.
Liquidity and Capital Resources
The Company’s working capital increased by $2.7 million during the first nine months of 2004. The primary reasons are increases of $3.4 million in customer receivables, $1.1 million in inventories, $3.8 million in cash and $0.2 million in prepaid and other current assets and deferred assets of $0.1 million, offset by an increase in current portion of long-term debt of $1.8 million (primarily resulting from converting some long-term debt into short-term debt), and $3.5 million in accounts payable, accrued compensation and benefits, accrued expenses and other accrued liabilities.
At September 30, 2004, the Company had available $6.8 million under the revolving credit agreement maintained with the Company’s primary bank. This agreement, which expires April 1, 2006, is collateralized by the Company’s trade accounts receivables and inventories. The Company believes that the net cash provided by operating activities and amounts available under the revolving credit agreement are sufficient to finance the Company’s growth and future capital requirements. The Company has no material commitments to purchase capital assets as of September 30, 2004.
The Company’s cash provided by operations increased $2.8 million during the first nine months of 2004. The primary reasons were an increase of $2.8 million in net income, plus an increase of $2.9 million in accrued compensation and benefits, a decrease of $0.6 million in prepaid and other assets, an increase of $0.2 million in depreciation, an increase of $1.5 million in accrued expenses an other liabilities, offset by an increase in accounts receivable of $2.4 million, an increase of $1.1 million in inventories, an increase of $0.2 million in other assets, an increase of $0.6 million in deferred income taxes, a decrease of $0.7 million in accounts payable and a $0.2 million decrease in valuation of derivative.
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Debt Financing
On August 25, 2004, the Company utilized an Illinois Revenue Bond (IRB) to permanently finance the acquisition of the land and building bordering its Chicago Heights, Illinois facility. The face amount of the IRB is $2.0 million. At closing, $1,760,000 was drawn. The Company used the proceeds to repay borrowings under its revolving credit agreement. The IRB carries a weekly floating interest rate based on the remarketing agent surveying the market to determine the rate necessary to remarket bonds at par. On September 30, 2004, the rate was 1.50%. The IRB will amortize $100,000 annually over 20 years. The Company also extended the maturity date of its revolving credit agreement with its main domestic bank to April 1, 2006, and increased the maximum availability under borrowing. The revolving credit agreement increased to $8.0 million from $5.5 million. This agreement bears interest at prime. The Company also extended its European revolving credit agreement to April 1, 2006, and reduced its revolving loan agreement to $6.0 million from $8.4 million. This note bears interest at 1.0% over Euro overnight index average.
Euro Conversion
Member countries of the European Union have established fixed conversion rates between their existing currencies (“legacy currencies”) and one common currency, the Euro. Since January 1, 2002, the new Euro-denominated notes and coins are in circulation and legacy currencies have been withdrawn from circulation. The Company has a manufacturing facility located in a member country (Germany), and the conversion to the Euro has eliminated currency exchange rate risk for transactions among the member countries, which for the Company primarily consists of payments to suppliers. In addition, because the Company uses foreign-denominated debt to meet its financial requirements and to reduce its foreign currency risks, certain of these financial instruments are denominated in Euro to finance European activities. The Company addressed all issues involved with converting to the new currency, and the conversion did not have a significant impact on its financial position, results of operations or cash flows. At September 30, 2004, the Company had total assets of $29.0 million and net assets of $15.6 million invested in Europe.
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Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following methods and assumptions were used to estimate the fair value of each class of financial instruments held by the Company for which it is practicable to estimate that value. The carrying amount of cash equivalents approximates their fair value because of the short maturity of those instruments. The estimated fair value of accounts receivable approximated its carrying value at September 30, 2004 and December 31, 2003 based upon analysis of their collectability and net realizable value. The estimated fair value of the Company’s long-term debt approximated its carrying value at September 30, 2004 and December 31, 2003, based upon market prices for the same or similar type of financial instrument. The Company minimizes its exposure to the impact of fluctuation in foreign exchange rates in situations for certain sales for products sold in Europe but manufactured in the U.S. through the movement of production of those products to Europe. There are no other activities of the Company where management believes exchange rates have a material impact with respect to the underlying transactions. In January 2003, the Company renewed its main loan agreements. The two main domestic loans, Term Loan A and Term Loan B were renewed at a floating prime rate of interest with a one-time option to lock the interest rate at LIBOR plus 1.5%. The Company executed two interest rate swap agreements to the fixed interest rate on Term Loan A at 4.82% on the principal balance of $2,303,840, and Term Loan B at 4.43% on the principal balance of $4,606,324 on April 4, 2003. The swap agreements terminate on January 31, 2008. These derivatives do not qualify for hedge accounting and accordingly, the Company will record these derivative instruments and the associated assets or liabilities at their fair values with the related gains or losses recorded as other income or expense in the consolidated statements of income. The Company does not use derivative financial instruments to address currency or commodity pricing risks.
Item 4.CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to provide reasonable assurances that information required to be disclosed in reports filed with the Securities and Exchange Commission (the “Commission”) pursuant to the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Commission and that such information is accumulated and communicated to the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosures. Under the supervision and with the participation of the Company’s management, including the CEO and CFO, the Company conducted an evaluation of the overall effectiveness of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report.
23
The evaluation of the Company’s disclosure controls and procedures by the CEO and the CFO included a review of the controls’ objectives and design, the operation of the controls, and the effect of the controls on the information presented in this Quarterly Report. The Company’s management, including the CEO and CFO, does not expect that disclosure controls and procedures can or will prevent or detect all errors and all fraud, if any, because there are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. As a result, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Also, projections of any evaluation of the disclosure controls and procedures to future periods are subject to the risk that the disclosure controls and procedures may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A significant deficiency is defined as a control deficiency, or combination of deficiencies, that adversely affects the Company’s ability to initiate, authorize, record, process or report external financial data reliably in accordance with generally accepted accounting principles, such that there is more than a remote likelihood that a misstatement of the Company’s financial statements that is more than inconsequential will not be prevented or detected. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.
Based on their evaluation, subject to the inherent limitations as described above and taking into consideration the matter described below, the CEO and CFO have concluded that the Company’s disclosure controls and procedures were not effective at September 30, 2004 as a result of the material weakness described below.
In connection with the year-end review of the Company’s consolidated financial statements as of and for the year ended December 31, 2004 and the audit of those statements by the Company’s Independent Registered Public Accounting Firm, the Company’s management and Audit Committee were informed that the Company had improperly included foreign currency exchange gains and losses related to intercompany transactions in accumulated other comprehensive income in its Consolidated Stockholders’ Equity instead of recognizing the gains and losses in its Consolidated Statements of Operations. As a result, the Company has restated its 2003 and 2002 financial statements and its quarterly filings for 2004, which includes the 2003 amounts. See Note 11 to the Consolidated Financial Statements for further discussion.
The Company was informed by its Independent Registered Public Accounting Firm that as a result of the errors identified in the recording of foreign currency exchange gains and losses, a material weakness in the Company’s design and operation of its internal controls regarding the application of generally accepted accounting principles existed at September 30, 2004. The Company has also concluded that a material weakness existed at September 30, 2004.
The Company’s management has discussed the material weakness described above with the Audit Committee and has worked with the Audit Committee and has identified and implemented corrective actions to improve the effectiveness of the Company’s internal controls, including enhancements of systems and procedures, the implementation of additional reconciliations and reviews of information by senior level management. The Company has implemented the controls necessary to make certain that foreign currency exchange gains and losses related to intercompany transactions are properly recorded. As a result of these actions, management believes that the financial statements included in this Form 10-Q/A fairly present in all material respects the Company’s financial condition, results of operations and cash flows for the periods presented.
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Item 6 - Exhibits and Reports on Form 8-K
| a. | Exhibits |
| 10.1(a) | Bond Purchase Agreement dated August 25, 2004 between the Company and LaSalle Capital Markets, a division of ABN AMRO Financial Services, Inc. * | |
| 10.1(b) | Letter of Credit Agreement dated July 1, 2004 between the Company and LaSalle National Bank Association. * | |
| 10.1(c) | Loan Agreement dated July 1, 2004 between the Company and the Illinois Finance Authority. * | |
| 31.1 | Certification of CEO required by Rule 13a-14(a) or Rule 15d-14(a) of the Security and Exchange Act of 1934. | |
| 31.2 | Certification of CFO required by Rule 13a-14(a) or Rule 15d-14(a) of the Security and Exchange Act of 1934. | |
| 32.1 | Certification of CEO required by Rule 13a-14(a) or Rule 15d-14(a) of the Security and Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of CFO required by Rule 13a-14(a) or Rule 15d-14(a) of the Security and Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002. | |
| b. | Reports on Form 8-K * |
In addition to those reports previously disclosed by the Company, during the fiscal third quarter of 2004, and through the date of this filing, the Company filed:
| • | A Report on Form 8-K dated October 1, 2004, reporting on Item 5.02 (Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers) and Item 9.01(Financial Statements and Exhibits) in connection with the appointment of Gregory Jehlik as Chief Executive Officer of the Company; and |
| • | A Report on Form 8-K dated October 25, 2004, reporting on Item 2.02 (Results of Operations and Financial Condition) and Item 9.01(Financial Statements and Exhibits) in connection with the release of the Company’s earnings for the third quarter. In accordance with General Instruction B of Form 8-K, this Report on Form 8-K is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the “Exchange Act”), and is not subject to the liabilities of that section. We are not incorporating, and will not incorporate by reference, such Report into the Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, or any other filing under the Securities Act of 1933 or the Exchange Act. |
| * - | These exhibits were previously filed with the original Form 10-Q filing. |
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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, on October 26, 2004.
| CFC INTERNATIONAL, INC. |
/s/ Dennis W. Lakomy |
| Dennis W. Lakomy |
| Executive Vice President, |
| Chief Financial Officer, |
| Secretary, and Treasurer |
| (Principal Financial Officer) |
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