United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(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, 2005
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 1-6352
JOHN H. HARLAND COMPANY
(Exact name of registrant as specified in its charter)
GEORGIA 58-0278260
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2939 Miller Rd.
Decatur, Georgia 30035
(Address of principal executive offices) (Zip code)
(770) 981-9460 (Registrant's
telephone number, including area code)
(Not Applicable)
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( ).
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes (X) No ( ).
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes ( ) No (X).
The number of shares of the registrant's common stock outstanding on October 28,
2005 was 28,166,831.
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS. . . . . . . . . . . . . . . 3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS. 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS. . . . . . . . . . 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS . . . . . . . 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. . . . . . . . . . . . . . . . . 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . 36
ITEM 4. CONTROLS AND PROCEDURES. . . . . . . . . . . . . . . . . . . 37
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . 37
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. 38
ITEM 6. EXHIBITS. . . . . . . . . . . . . . . . . . . . . . . . . . 39
EXHIBIT LIST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
------
(In thousands) September 30, December 31,
2005 2004
- ----------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 10,216 $ 9,214
Accounts receivable - net 80,623 70,989
Inventories 21,700 16,984
Deferred income taxes 8,959 8,393
Income taxes receivable 18,077 14,608
Property held for sale - 3,438
Prepaid expenses 16,480 11,134
Other 3,063 4,693
- ----------------------------------------------------------------------
Total current assets 159,118 139,453
- ----------------------------------------------------------------------
Other Assets:
Investments 8,671 5,651
Goodwill - net 355,014 233,987
Intangible assets - net 120,535 17,168
Developed technology and content 26,821 16,462
Upfront contract payments - net 52,408 53,650
Other 4,914 5,183
- ----------------------------------------------------------------------
Total investments and other assets 568,363 332,101
- ----------------------------------------------------------------------
Property, plant and equipment 357,446 330,525
Less accumulated depreciation
and amortization 250,644 228,302
- ----------------------------------------------------------------------
Property, plant and equipment - net 106,802 102,223
- ----------------------------------------------------------------------
Total $ 834,283 $ 573,777
======================================================================
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
-3-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
(In thousands, except share and September 30, December 31,
per share amounts) 2005 2004
- ----------------------------------------------------------------------
Current Liabilities:
Accounts payable $ 34,233 $ 28,290
Deferred revenues 73,772 61,648
Current maturities of long-term debt 5,461 5,000
Accrued liabilities:
Salaries, wages and employee benefits 32,698 33,475
Taxes 11,548 15,028
Customer incentives 10,745 9,422
Other 23,476 16,706
- ----------------------------------------------------------------------
Total current liabilities 191,933 169,569
- ----------------------------------------------------------------------
Long-Term Liabilities:
Long-term debt 263,188 96,300
Deferred income taxes 7,906 4,692
Other 35,421 28,625
- ----------------------------------------------------------------------
Total long-term liabilities 306,515 129,617
- ----------------------------------------------------------------------
Total liabilities 498,448 299,186
- ----------------------------------------------------------------------
Shareholders' Equity:
Preferred stock, authorized 500,000
shares of $1.00 par value, none issued - -
Common stock, authorized 144,000,000
shares of $1.00 par value,
37,907,497 shares issued 37,907 37,907
Additional paid-in capital 20,695 11,191
Retained earnings 524,242 486,009
Accumulated other comprehensive loss 164 (184)
Unamortized restricted stock awards (22,050) (13,380)
- ----------------------------------------------------------------------
560,958 521,543
Less 9,746,200 and 10,629,800 shares
in treasury - at cost,
respectively 225,123 246,952
- ----------------------------------------------------------------------
Total shareholders' equity 335,835 274,591
- ----------------------------------------------------------------------
Total $ 834,283 $ 573,777
======================================================================
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
-4-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
(Unaudited)
Three Month Periods Ended Nine Month Periods Ended
(In thousands, except Sep 30, Sep 24, Sep 30, Sep 24,
per share amounts) 2005 2004 2005 2004
- ---------------------------------------------------------------------------
Sales:
Product sales $ 202,547 $ 157,043 $ 565,689 $ 464,074
Service sales 58,104 38,932 150,208 115,456
- ---------------------------------------------------------------------------
Total sales 260,651 195,975 715,897 579,530
Cost of sales:
Cost of products sold 105,310 83,795 299,435 257,726
Cost of services sold 26,640 13,751 62,981 42,942
- ---------------------------------------------------------------------------
Total cost of sales 131,950 97,546 362,416 300,668
- ---------------------------------------------------------------------------
Gross Profit 128,701 98,429 353,481 278,862
Selling, general and
administrative expenses 92,037 69,906 252,348 213,306
Asset impairment charges - 7,885 - 10,167
(Gain) loss on disposal of
assets - net (21) 8 6 (3,541)
Amortization of intangibles 4,126 975 7,533 2,809
- ---------------------------------------------------------------------------
Income From Operations 32,559 19,655 93,594 56,121
- ---------------------------------------------------------------------------
Other Income (Expense):
Interest expense (3,258) (951) (6,583) (3,082)
Other - net 805 77 1,263 267
- ---------------------------------------------------------------------------
Total (2,453) (874) (5,320) (2,815)
- ---------------------------------------------------------------------------
Income Before Income Taxes 30,106 18,781 88,274 53,306
Income taxes 11,555 6,688 33,659 19,297
- ---------------------------------------------------------------------------
Net Income 18,551 12,093 54,615 34,009
Retained Earnings at
Beginning of Period 509,946 461,974 486,009 448,688
Cash Dividends (4,228) (3,471) (11,089) (9,057)
Issuance of treasury shares
under stock plans and other (27) (19) (5,293) (3,063)
- ---------------------------------------------------------------------------
Retained Earnings at
End of Period $ 524,242 $ 470,577 $ 524,242 $ 470,577
===========================================================================
Weighted Average Shares
Outstanding:
Basic 27,533 27,182 27,262 27,339
Diluted 28,428 27,906 28,127 28,112
===========================================================================
Earnings Per Common Share:
Basic $ 0.67 $ 0.44 $ 2.00 $ 1.24
Diluted $ 0.65 $ 0.43 $ 1.94 $ 1.21
===========================================================================
Cash Dividends Per
Common Share $ 0.15 $ 0.125 $ 0.40 $ 0.325
===========================================================================
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
-5-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Month Periods Ended
Sep 30, Sep 24,
(In thousands) 2005 2004
- -----------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 54,615 $ 34,009
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 27,417 27,551
Amortization of upfront contract payments 24,925 18,733
Other amortization 11,749 7,284
(Gain) loss on disposal of assets - net 6 (3,541)
Stock-based compensation 4,067 2,839
Tax benefits from stock-based compensation 4,631 2,324
Asset impairment charge - 10,167
Deferred income taxes (1,930) 12,505
Other 788 1,419
Change in assets and liabilities, net of effects of
businesses acquired:
Accounts receivable (2,138) (15,550)
Income taxes receivable (216) (12,924)
Inventories and other current assets (192) 2,964
Deferred revenues 8,985 1,932
Accounts payable and accrued liabilities (17,598) 7,498
Upfront contract payments (23,683) (20,270)
- -----------------------------------------------------------------------------
Net cash provided by operating activities 91,426 76,940
- -----------------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (16,528) (20,741)
Proceeds from sale of property, plant and equipment 3,630 5,522
Payment for acquisition of businesses -
net of cash acquired (238,987) (7,118)
Long-term investments and other (2,782) (130)
- -----------------------------------------------------------------------------
Net cash (used in) investing activities (254,667) (22,467)
- -----------------------------------------------------------------------------
FINANCING ACTIVITIES:
Credit facility borrowings 458,553 197,107
Credit facility payments (292,207) (226,664)
Repayment of long-term debt (63) (89)
Repurchases of stock (4,211) (20,738)
Issuance of treasury stock 13,707 10,528
Dividends paid (11,089) (9,057)
Other - net (447) (1,721)
- -----------------------------------------------------------------------------
Net cash provided by (used in) financing activities 164,243 (50,634)
- -----------------------------------------------------------------------------
Increase in cash and cash equivalents 1,002 3,839
Cash and cash equivalents at beginning of period 9,214 8,525
- -----------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 10,216 $ 12,364
=============================================================================
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
-6-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
1. Basis of Presentation
The condensed consolidated financial statements contained in this report are
unaudited but reflect all adjustments which are, in the opinion of management,
necessary for a normal presentation of the results of operations, financial
position and cash flows of John H. Harland Company and subsidiaries (the
"Company") for the interim periods reflected. Certain information and note
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been omitted pursuant to applicable rules and regulations of the Securities
and Exchange Commission. The results of operations for the interim periods
reported herein are not necessarily indicative of results to be expected for the
full year.
The condensed consolidated financial statements included herein should be read
in conjunction with the consolidated financial statements and notes thereto,
included in the Company's Annual Report on Form 10-K, for the year ended
December 31, 2004 ("2004 Form 10-K").
2. Accounting Policies
Reference is made to the accounting policies of the Company described in the
notes to consolidated financial statements included in the 2004 Form 10-K.
Accounting Pronouncements
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations" ("FIN 47"). FIN 47 clarifies that an
entity must record a liability for a conditional asset retirement obligation if
the fair value of the obligation can be reasonably estimated. The provision is
effective for fiscal years ending after December 15, 2005. The Company does not
expect the adoption of FIN 47 will have a material effect on its consolidated
results of operations and financial position.
In December 2004, the FASB released its revised standard, FASB Statement No.
123R, "Share-Based Payment" ("SFAS 123R"). SFAS 123R supersedes APB 25,
"Accounting for Stock Issued to Employees," and its related implementation
guidance. SFAS 123R requires that a public entity measure the cost of
equity-based service awards based on the grant-date fair value of the award.
Such cost will be recognized over the period during which an employee is
required to provide service in exchange for the award. No compensation cost is
recognized for equity instruments for which employees do not render the
requisite service. A public entity will initially measure the cost of
liability-based service awards based on their current fair value; the fair value
of those awards will be remeasured subsequently at each reporting date through
the settlement date. Changes in fair value during the requisite service period
will be recognized as compensation cost over that period.
Adoption of SFAS 123R is required for the first annual reporting period
beginning after June 15, 2005. The Company is evaluating SFAS 123R to determine
whether to adopt the statement using the modified prospective application or the
modified retrospective application. The Company believes that the adoption of
this standard will have a material effect on its consolidated results of
operations and financial position with the effects on future years, dependent on
the level of awards granted.
-7-
Stock-Based Compensation
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations in accounting
for its stock-based compensation plans and applies the disclosure-only
provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), as amended by FASB Statement No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS 148").
The Company recognizes stock-based compensation expense for restricted stock
granted to employees and also for the deferred compensation plan for
non-employee directors. The Company uses the straight-line method to amortize
unearned compensation expense over the maximum vesting period for restricted
stock awards that vest at a single point in time or vest over time.
No stock-based compensation cost is reflected in net income for options or
purchases under the employee stock purchase plan. Had compensation cost for
options granted under the Company's stock-based compensation plans and purchases
under the employee stock purchase plan been determined based on the fair value
at the grant dates consistent with SFAS 123, the Company's net income and
earnings per share would have changed to the pro forma amounts listed below (in
thousands, except per share amounts):
Three Month Periods Ended Nine Month Periods Ended
(In thousands, except Sep 30, Sep 24, Sep 30, Sep 24,
per share amounts) 2005 2004 2005 2004
- ------------------------------------------------------------------------------
Net income:
As reported $18,551 $12,093 $54,615 $34,009
Add: stock-based
compensation expense
included in reported
net income, net of tax 1,106 738 2,481 1,732
Deduct: stock-based
compensation expense
determined under the fair
value based method for
all awards, net of tax (2,190) (1,651) (5,360) (4,618)
- ------------------------------------------------------------------------------
Pro forma net income $17,467 $11,180 $51,736 $31,123
==============================================================================
Earnings per common share:
As reported
Basic $ 0.67 $ 0.44 $ 2.00 $ 1.24
Diluted $ 0.65 $ 0.43 $ 1.94 $ 1.21
Pro forma
Basic $ 0.63 $ 0.41 $ 1.90 $ 1.14
Diluted $ 0.61 $ 0.40 $ 1.84 $ 1.11
-8-
Pro forma compensation costs associated with options granted under the employee
stock purchase plan were estimated based on the discount from market value. The
following presents the estimated weighted average fair value of options granted
and the weighted average assumptions used under the Black-Scholes option pricing
model for the nine month periods ended September 30, 2005 and September 24,
2004:
Nine Month Periods Ended
Sep 30, Sep 24,
2005 2004
- ------------------------------------------------------------------------
Fair value per option $10.82 $ 9.60
Weighted average assumptions:
Dividend yield 1.9% 1.4%
Expected volatility 31.8% 36.1%
Risk-free interest rate 4.0% 4.1%
Expected life (years) 5.0 5.0
Research and Development
For the three and nine month periods ended September 30, 2005, the Company
incurred research and development costs of $5.9 million and $17.6 million,
respectively. For the three and nine month periods ended September 24, 2004,
research and development costs totaled $5.5 million and $16.1 million,
respectively. These costs are included in operating expenses.
Reclassifications
During the nine month period ended September 30, 2005, the Company elected to
reclassify certain items in its condensed consolidated statements of income. The
reclassifications affected the categories of costs of goods sold and selling,
general and administrative expenses. The changes primarily reflected the
consistent alignment of certain functional costs throughout the Printed Products
segment. In the third quarter of 2005, certain 2004 expenses related to user
conferences held during 2004 were reclassified from selling, general and
administrative expenses to cost of goods sold to conform to the 2005
classification.
In the third quarter of 2005, the Company reassigned certain operations acquired
in the Liberty acquisition, including card services and educational services,
from its Printed Products segment to its Software & Services segment. The
Company also transferred certain business development activities related to
fraud prevention solutions to Software & Services from its Corporate operations.
These reclassifications were not significant and had no impact on net income or
shareholders' equity as previously reported. Financial data for all periods
presented have been reclassified for comparability.
3. Acquisitions
All acquisitions in 2005 and 2004 were paid for with cash provided from
operating activities and proceeds from the Company's credit facility. The
results of operations of each acquired business have been included in the
Company's operations beginning as of the date of the particular acquisition.
-9-
2005 Acquisitions
On June 10, 2005, the Company acquired substantially all of the assets of
Liberty Enterprises, Incorporated ("Liberty") for approximately $161.7 million
in cash, including acquisition costs. Liberty is a provider of checks, marketing
services, card services, education and e-commerce solutions primarily to credit
unions. The addition of Liberty expands the Company's presence among credit
unions and management believes that the combined range of products and services
should position the Company to be a preferred partner for credit unions across
the country.
On April 13, 2005, Harland Financial Solutions, Inc. ("HFS"), a wholly owned
subsidiary of the Company, amended its asset purchase agreement with Mitek
Systems, Incorporated ("Mitek Systems"), which was originally entered into in
July 2004, to purchase certain additional assets for $1.0 million. These assets
had been excluded in the original agreement pending settlement of certain
contractual issues by Mitek Systems.
On April 4, 2005, HFS acquired Cincinnati-based Intrieve, Incorporated
("Intrieve") for approximately $77.1 million, including acquisition costs, in a
cash for equity transaction. This acquisition expands HFS product and service
lineup to include outsourced core processing, comprehensive item processing and
electronic banking and payments processing for thrifts and community banks. The
acquisition also includes in-house financial management software, turnkey check
and MICR document printing systems, and a datacenter operation that provides
co-location and hot-site disaster recovery services.
The combined purchase price for assets acquired through acquisitions in the
first nine months of 2005 totaled $239.7 million, net of cash acquired. The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed on the acquisition dates (in thousands):
Weighted Average
Useful Life
Value in Years
- ---------------------------------------------------------------
Current assets $ 23,069
Property, plant and equipment 13,477
Goodwill 121,435
Intangibles:
Customer lists 103,300 18.7
Developed technology 12,640 5.0
Trademarks 7,600 5.4
--------
Total intangibles 123,540
Other assets 2,039
- ---------------------------------------------------------------
Total assets acquired 283,560
- ---------------------------------------------------------------
Current liabilities 31,060
Deferred income taxes 8,262
Other 4,511
- ---------------------------------------------------------------
Total liabilities assumed 43,833
- ---------------------------------------------------------------
Net assets $239,727
===============================================================
The allocations of purchase price to the assets and liabilities acquired in 2005
are preliminary pending detailed examinations and appraisals of the assets and
liabilities acquired and the completion of an integration plan for the Liberty
operations. The allocation of the purchase price includes $7.2 million for
actions taken or to be undertaken for the integration of Liberty operations.
Integration costs that relate to the Company's operations which existed prior to
the acquisition of Liberty will be charged to results of operations when a
liability has been incurred.
-10-
Intrieve is subject to Ohio state income taxes. Effective June 30, 2005, Ohio
revised its corporate income tax structure. The completion of the allocation of
purchase price to assets and liabilities acquired will result in a charge or
credit to income tax expense that is not expected to be material.
At September 30, 2005, the allocations of purchase price resulted in $121.4
million allocated to goodwill of which $64.0 million is expected to be
deductible for tax purposes. Goodwill of $63.3 million and $58.1 million was
preliminarily assigned to the Company's Printed Products and Software & Services
business segments, respectively. An allocation of a portion of the purchase
price to the Liberty operations assigned to the Software & Services business
unit has not yet been finalized. Upon the finalization of such allocation, a
portion of the goodwill currently assigned to Printed Products will be
transferred to Software & Services. The principal factor affecting the purchase
price, which resulted in the recognition of goodwill, was the fair value of the
going-concern element of the Liberty and Intrieve businesses, which includes the
assembled workforces and synergies that are expected to be achieved.
The following unaudited pro forma summary presents information as if the
acquisitions of the businesses acquired in 2005 occurred at the beginning of the
year of each period presented (in thousands, except per share amounts):
Three Month Nine Month
Periods Ended Periods Ended
Sep 30, Sep 24, Sep 30, Sep 24,
2005 2004 2005 2004
- ----------------------------------------------------------------------
Net sales $260,651 $243,417 $792,917 $720,964
Net income 18,551 13,635 48,327 37,388
Earnings per common share:
Basic $ 0.67 $ 0.50 $ 1.77 $ 1.37
Diluted $ 0.65 $ 0.49 $ 1.72 $ 1.33
The unaudited pro forma summary for the periods presented includes adjustments
for changes in levels of amortization of intangible assets, interest income,
interest expense, and income taxes. The nine month period ended September 30,
2005 includes $12.7 million of nonrecurring acquisition-related expenses
incurred by the acquired operations prior to the business combinations. The
Company expects to realize operating synergies with the acquired operations.
This pro forma information does not reflect any such potential synergies. The
unaudited pro forma summary does not purport to be indicative of either the
results of operations that would have occurred had the acquisitions taken place
at the beginning of the periods presented or of future results.
2004 Acquisitions
On November 12, 2004, HFS acquired London Bridge Phoenix Software Inc. ("Phoenix
System"). Phoenix System, an integrated core banking solution that operates in
both the Windows(R) NT and Unix environments, features open relational database
choices and leverages Internet and network technology to optimize delivery
channel integration. Phoenix System is delivered in both in-house and service
bureau configurations. Also included in the acquisition were the Phoenix
Internet Banking System, also known as IBANK, and the TradeWind international
trade finance management system. The acquisition provides HFS with a proven
service bureau delivery option for banks and thrifts, which is a significant
expansion to the breadth of current offerings.
-11-
On July 7, 2004, HFS acquired certain assets and operations including exclusive
distribution and licensing rights related to the CheckQuest(R) item processing
and CaptureQuest(R) electronic document management solutions from Mitek Systems.
Mitek Systems is a provider of recognition software-based fraud protection and
document processing solutions to banks and other businesses, and licenses its
recognition engine toolkits to major software and hardware providers in the
imaging and document processing industry. CheckQuest provides financial
institutions with a check imaging and item processing solution that enables them
to take advantage of the efficiencies offered by the Federal Check Clearing for
the 21st Century Act. CaptureQuest is an electronic document management system
that allows financial institutions to file, distribute, archive, retrieve and
automatically process documents and forms of all types and quantities. As part
of the agreement, HFS has also licensed from Mitek Systems the QuickStrokes(R)
family of recognition toolkits and the QuickFX(R) Pro form identification
toolkit for use with CheckQuest and a variety of other applications.
On April 30, 2004, HFS acquired certain assets and operations related to the
electronic mortgage document business of Greatland Corporation. Greatland
Corporation is a provider of forms technology, compliance expertise and software
compatible products used to meet the needs of businesses to convey regulatory
information. The GreatlandTM mortgage document set is employed by many of the
industry's leading mortgage lenders and mortgage loan origination system
technology providers. Greatland's electronic mortgage document products allow
HFS to build on its leadership position in compliance and mortgage solutions.
The combined purchase price of net assets acquired through acquisitions in 2004
totaled approximately $29.4 million, net of cash acquired. The fair value of
assets and liabilities at the acquisition dates consisted of goodwill of $21.0
million, of which $5.4 million is expected to be deductible for tax purposes,
other intangible assets of $10.2 million (estimated weighted average useful life
of eight years), which included $6.3 million in developed technology (estimated
weighted average useful life of nine years) and $3.9 million in customer lists
(estimated weighted average useful life of 13 years), other assets of $8.8
million and assumed liabilities of $9.7 million. The allocation of purchase
price for Phoenix System is subject to refinement as the Company finalizes the
valuation of certain assets and liabilities. The pro forma effects of the 2004
acquisitions were not material to the Company's results of operations.
4. Goodwill and Intangible Assets
The changes in the carrying amounts of goodwill by business segment for the nine
month period ended September 30, 2005 are as follows (in thousands):
Printed Software &
Products Services Scantron Consolidated
- ------------------------------------------------------------------------
Balances as of
December 31, 2004 $ 24,709 $165,724 $ 43,554 $233,987
Goodwill acquired
in 2005 63,322 58,113 - 121,435
Purchase price
allocation adjustments - (408) - (408)
- ------------------------------------------------------------------------
Balances as of
September 30, 2005 $ 88,031 $223,429 $ 43,554 $355,014
========================================================================
-12-
Intangible assets with definitive lives were comprised of the following (in
thousands):
September 30, 2005 December 31, 2004
- ------------------------------------------------------------------------
Gross Net Gross Net
Carrying Accum. Carrying Carrying Accum. Carrying
Amount Amort. Amount Amount Amort. Amount
- ------------------------------------------------------------------------
Customer
lists $133,305 $(22,546) $110,759 $30,005 $(15,758) $14,247
Developed
technology 45,750 (20,499) 25,251 31,547 (16,828) 14,719
Trademarks 11,400 (1,624) 9,776 3,800 (879) 2,921
Content 2,300 (730) 1,570 2,300 (557) 1,743
- ------------------------------------------------------------------------
Total $192,755 $(45,399) $147,356 $67,652 $(34,022) $33,630
========================================================================
Amortization of developed technology and content is included in the cost of
sales caption on the statements of income. Aggregate amortization expense for
intangible assets totaled $11.4 million and $6.9 million for the nine month
periods ended September 30, 2005 and September 24, 2004, respectively.
The estimated future intangible amortization expense as of September 30, 2005 is
as follows (in thousands):
Year Amount
- --------------------------------------------------------------------
Remaining 2005 $ 5,720
2006 22,049
2007 20,424
2008 17,300
2009 14,165
Thereafter 67,698
- --------------------------------------------------------------------
Total $147,356
====================================================================
5. Asset Impairment Charges
In September 2004, the Company concluded that upgrading certain existing
customer care systems in its Printed Products segment would be more economical
than continued development of portions of certain new customer care systems for
the segment. The decision to terminate development efforts required a non-cash,
pre-tax impairment charge of $7.9 million which was based on previously
capitalized costs, less accumulated depreciation thereon, for the portions of
the system where development was discontinued. The Company has continued with
development and implementation of the remaining portions of the customer care
infrastructure project for the Printed Products segment.
During the second quarter of 2004, a Printed Products facility in Denver,
Colorado was closed pursuant to the plant consolidation plan (see Note 6). In
the second quarter and fourth quarter of 2004, asset impairment charges of $2.3
million and $0.1 million, respectively, were recorded to adjust the basis of the
Denver facility to its estimated fair value (see Note 7).
-13-
6. Integration and Reorganization Actions
Upon the acquisition of Liberty, an integration plan for the Liberty operations
was developed that includes the consolidation of six Liberty facilities into the
Company's existing network of regional production facilities and the elimination
of duplicate selling, general and administrative expenses. As of September 30,
2005, costs of $7.2 million were recorded for actions taken or to be undertaken
for the integration of Liberty operations. These costs were primarily for
severance benefits and lease abandonment charges and are included in other
current and noncurrent liabilities in the balance sheet.
In September 2003, the Company announced a reorganization of its Printed
Products operations including the consolidation of its domestic manufacturing
operations from 14 plants to 9 plants, which was completed during the third
quarter of 2004. Two of the facilities that were closed were leased. One of
these facilities is under lease through late 2005 and the other is under lease
through mid-2010. During the third quarter of 2004, the Company sublet the
latter facility to a third party for the remaining term of the lease.
In addition to the plant consolidation, Printed Products implemented other
staffing reductions beginning in the fourth quarter of 2003 which were completed
during the third quarter of 2004. These actions were primarily due to excess
capacity in production facilities resulting from efficiencies realized from
digital printing technology and lower volumes attributable to the losses of
certain large customers, including a direct check marketer, and general market
volume decline. The Company undertook these actions to bring its production and
support structures in line with its business levels.
The following table presents the cumulative net costs of these actions incurred
through September 30, 2005 (in thousands):
Staffing
Liberty Plant Reduction
Integration Consolidation Actions
- --------------------------------------------------------------------------
Employee severance $ 5,881 $ 2,843 $ 4,545
Revision of depreciable lives
and salvage values - 3,459 -
Asset impairment charge and
disposal (gains) and losses - (1,132) -
Relocation and other costs - 2,236 -
Contract termination costs
related to leaseholds 1,339 967 -
- --------------------------------------------------------------------------
Total $ 7,220 $ 8,373 $ 4,545
==========================================================================
The following table presents net expenses by income statement caption for plant
consolidation and other staffing reduction actions for the three and nine month
periods ended September 30, 2005 and September 24, 2004 (in thousands):
Three Month Nine Month
Periods Ended Periods Ended
Sep 30, Sep 24, Sep 30, Sep 24,
2005 2004 2005 2004
- ------------------------------------------------------------------------
Plant consolidation expenses:
Cost of products sold $ 66 $ (348) $ 208 $5,247
(Gain) loss on disposal
of assets - net - - 36 (3,612)
Asset impairment charge - - - 2,282
- ------------------------------------------------------------------------
Total $ 66 $ (348) $ 244 $ 3,917
========================================================================
Other staffing reduction actions:
Selling, general and
administrative expenses $ - $ 370 $ - $ 1,644
========================================================================
The following table reconciles the beginning and ending liability balances for
the nine month period ended September 30, 2005 related to these actions and are
included in the other accrued liabilities captions on the balance sheet (in
thousands):
-14-
Charged to Utilized
----------------- ----------------
Beginning Costs and Ending
Balance Goodwill Expenses Cash Non-Cash Balance
- -----------------------------------------------------------------------------
Liberty integration:
Employee severance $ - $ 5,855 $ 25 $(2,480) $ - $ 3,400
Contract termination
costs related to
leaseholds - 1,339 - - - 1,339
Plant consolidation:
Employee severance 211 - (2) (206) - 3
Contract termination
costs related to
leaseholds 681 - 92 (396) - 377
Other - - 118 (118) - -
Staffing reduction
actions:
Employee severance 61 - - (61) - -
- -----------------------------------------------------------------------------
Total $ 953 $ 7,194 $ 233 $(3,261) $ - $ 5,119
=============================================================================
7. Property Held for Sale
During the second quarter of 2005, the Company sold its Printed Products
facility in Denver, Colorado, which was closed during the second quarter of 2004
pursuant to the plant consolidation plan, for $3.4 million. In the second
quarter and fourth quarter of 2004, asset impairment charges of $2.3 million and
$0.1 million were recorded to adjust the basis of the Denver facility to its
estimated fair value.
During the first quarter of 2004, the Company sold its Printed Products facility
in San Diego, California, which became available pursuant to the plant
consolidation plan, and realized a pre-tax gain of $3.7 million.
8. Income Taxes
The Company's consolidated effective income tax rates were 38.1% and 36.2% the
first nine months of 2005 and 2004, respectively. The effective income tax rate
for the first nine months of 2005 was unfavorably impacted by an increase in the
effective state income tax rate for the consolidated group and a decrease in the
U.S. tax credit for the Company's operations in Puerto Rico partially offset by
the implementation of IRC Section 199, Qualified Production Activities
Deduction. The effective income tax rate for the first nine months of 2004
included favorable adjustments related to the conclusion of a review by the
Internal Revenue Service of the Company's income tax filings for 1999 and 2000,
foreign transfer pricing agreements and state retraining credits.
-15-
9. Inventories
As of September 30, 2005 and December 31, 2004, inventories consisted of the
following (in thousands):
September 30, December 31,
2005 2004
- ----------------------------------------------------------------------
Raw materials $ 17,638 $ 14,055
Work in progress 1,588 956
Finished goods 2,474 1,973
- ----------------------------------------------------------------------
Total $ 21,700 $ 16,984
======================================================================
10. Long Term Debt
In February 2004, the Company amended its credit facility (the "Credit
Facility") with a syndicate of banks increasing the amount from $325.0 million
to $425.0 million. The Credit Facility is comprised of a $100.0 million term
loan and a $325.0 million revolving loan, both of which mature in 2009. The term
loan requires annual repayments of $5.0 million and will decrease by $5.0
million per annum. As a result, the Credit Facility will decrease to $400.0
million at the 2009 maturity date. As of September 30, 2005 the Credit Facility
totaled $416.2 million. The Credit Facility may be used for general corporate
purposes, including acquisitions, and includes both direct borrowings and
letters of credit. The Credit Facility is unsecured and the Company presently
pays a commitment fee of 0.200% on the unused amount of the Credit Facility.
Borrowings under the Credit Facility bear interest, at the Company's option,
based upon one of the following indices (plus a margin as defined): the Federal
Funds Rate, the SunTrust Bank Base Rate or LIBOR (as defined therein). The
Credit Facility has certain financial covenants including, among other items,
leverage, fixed charge coverage and minimum net worth requirements. The Credit
Facility also has restrictions that limit the Company's ability to incur
additional indebtedness, grant security interests or sell its assets beyond
certain amounts.
At September 30, 2005, the Company had $267.6 million in outstanding cash
borrowings under the Credit Facility, $5.5 million in outstanding letters of
credit and $143.1 million available for borrowing under the Credit Facility. The
average interest rate in effect on outstanding cash borrowings at September 30,
2005 was 4.78%.
-16-
11. Comprehensive Income
Other comprehensive income for the Company includes foreign currency translation
adjustments, unrealized gains (losses) on investments and changes in fair value
of cash flow hedging instruments. Total comprehensive income for the three and
nine month periods ended September 30, 2005 and September 24, 2004 was as
follows (in thousands):
Three Month Nine Month
Periods Ended Periods Ended
Sep 30, Sep 24, Sep 30, Sep 24,
2005 2004 2005 2004
- ------------------------------------------------------------------------
Net income: $18,551 $12,093 $54,615 $34,009
Other comprehensive
Income (loss):
Foreign exchange
translation adjustments 264 173 136 (1)
Unrealized gains (losses)
on investments, net
of $(60), $(1), ($141),
and $15 in tax benefits
(provisions) 90 2 212 (24)
Changes in fair value of
cash flow hedging
instruments, net of $0,
($30), $0 and ($175)
in tax benefits - 46 - 273
- ------------------------------------------------------------------------
Comprehensive income $18,905 $12,314 $54,963 $34,257
========================================================================
12. Earnings per Common Share
The computation of basic and diluted earnings per share for the three and nine
month periods ended September 30, 2005 and September 24, 2004 is as follows (in
thousands, except per share amounts):
Three Month Nine Month
Periods Ended Periods Ended
Sep 30, Sep 24, Sep 30, Sep 24,
2005 2004 2005 2004
- ------------------------------------------------------------------------
Computation of basic earnings per common share:
Numerator
Net Income $18,551 $12,093 $54,615 $34,009
- ------------------------------------------------------------------------
Denominator
Weighted average shares
outstanding 27,361 27,038 27,098 27,203
Weighted average deferred
shares outstanding under
non-employee directors
compensation plan 172 144 164 136
- ------------------------------------------------------------------------
Weighted average shares
Outstanding - basic 27,533 27,182 27,262 27,339
- ------------------------------------------------------------------------
Earnings per share-basic $ 0.67 $ 0.44 $ 2.00 $ 1.24
========================================================================
-17-
Three Month Nine Month
Periods Ended Periods Ended
Sep 30, Sep 24, Sep 30, Sep 24,
2005 2004 2005 2004
- ------------------------------------------------------------------------
Computation of diluted earnings per common share:
Numerator
Net Income $18,551 $12,093 $54,615 $34,009
- ------------------------------------------------------------------------
Denominator
Weighted average shares
outstanding - basic 27,533 27,182 27,262 27,339
Dilutive effect of stock
options and restricted
stock 895 724 865 773
- ------------------------------------------------------------------------
Weighted average shares
outstanding - diluted 28,428 27,906 28,127 28,112
- ------------------------------------------------------------------------
Earnings per share-diluted $ 0.65 $ 0.43 $ 1.94 $ 1.21
========================================================================
13. Postretirement Benefits
The Company sponsors unfunded defined postretirement benefit plans that cover
certain salaried and nonsalaried employees. The plans provide health care
benefits and life insurance benefits. The medical plan is contributory and
contributions are adjusted annually based on actual claims experience. During
the three and nine month periods ended September 30, 2005, the Company
contributed $0.4 million and $1.0 million, respectively, to the plans.
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003
introduced a prescription drug benefit under Medicare and, in certain
circumstances, a federal subsidy to sponsors of retiree health care benefit
plans. The Company's postretirement health care plan offers prescription drug
benefits. In the second quarter of 2005, the Company completed its valuation of
its postretirement benefit plans as of January 1, 2005 including the impact of
the subsidy for maintaining retiree healthcare benefits. Due to the impact of
the subsidy, the accumulated postretirement benefit obligation ("APBO")
decreased by $2.1 million and the annual net periodic postretirement benefit
costs decreased by $0.2 million. Net amortization and interest on the APBO each
decreased by $0.1 million resulting in the $0.2 million decrease in annual net
periodic postretirement benefit costs.
Net periodic postretirement costs for the three and nine month periods ended
September 30, 2005 and September 24, 2004 are summarized as follows (in
thousands):
Three Month Nine Month
Periods Ended Periods Ended
Sep 30, Sep 24, Sep 30, Sep 24,
2005 2004 2005 2004
- ------------------------------------------------------------------------
Interest on APBO $ 321 $ 198 $ 927 $ 906
Net amortization 65 (7) 195 165
- ------------------------------------------------------------------------
Total $ 386 $ 191 $1,122 $1,071
========================================================================
-18-
14. Business Segments
The Company operates its business in three segments. The Company has organized
its business segments based on products, services and markets served. Within
each business segment are division presidents who report to the Company's Chief
Executive Officer, the chief operating decision maker. The Printed Products
segment ("Printed Products") includes checks, direct marketing activities and
analytical services marketed primarily to financial institutions. The Software
and Services segment ("Software & Services") is focused on the financial
institution market and includes core processing applications and services for
credit unions, thrifts and community banks, education and e-commerce solutions
primarily to credit unions, lending and mortgage origination applications,
mortgage servicing applications, branch automation applications, customer
relationship management applications and fraud prevention solutions. The
Scantron segment represents products and services sold by the Company's Scantron
subsidiary including scanning equipment and software, scannable forms, survey
solutions, curriculum planning software, testing and assessment tools, training
and field maintenance services. Scantron sells these products and services to
the education, commercial and financial institution markets. See Note 1
regarding certain transfers of operations between business segments that
occurred in the third quarter of 2005.
The Company's operations are primarily in the United States and Puerto Rico.
During the nine month periods ended September 30, 2005 and September 24, 2004,
there were no significant intersegment sales. The Company does not have sales to
any individual customer greater than 10% of total Company sales. Equity
investments, as well as foreign assets and revenues, are not significant to the
consolidated results of the Company. The Company's accounting policies for
segments are the same as those described in Note 2.
Management evaluates segment performance based on segment income or loss before
income taxes. Segment income or loss excludes interest income, interest expense
and certain other non-operating gains and losses, all of which are considered
Corporate items. The Company also considers stock-based compensation costs to be
a Corporate item except for a grant made in 2004 to replace an incentive
agreement. Corporate assets consist primarily of cash and cash equivalents,
deferred income taxes, investments and other assets not employed in production.
Selected summarized financial information for the three and nine month periods
ended September 30, 2005 and September 24, 2004 was as follows (in thousands):
Business Segment
-------------------------------
Printed Software & Corporate & Consoli-
Products Services Scantron Eliminations dated
- ------------------------------------------------------------------------------
As of and for the three month periods ended:
September 30, 2005
Sales $ 159,849 $ 69,978 $ 30,928 $ (104) $ 260,651
Income (loss) 24,186 8,806 9,500 (12,386) 30,106
Identifiable
assets 358,918 353,690 77,583 44,092 834,283
September 24, 2004
Sales $ 117,908 $ 47,264 $ 31,628 $ (825) $ 195,975
Income (loss) 9,683 7,369 9,786 (8,057) 18,781
As of and for the nine month periods ended:
Sales $ 448,537 $ 181,447 $ 86,469 $ (556) $ 715,897
Income (loss) 76,461 21,319 21,717 (31,223) 88,274
Identifiable
assets 358,918 353,690 77,583 44,092 834,283
September 24, 2004
Sales $ 356,497 $ 139,743 $ 85,338 $ (2,048) $ 579,530
Income (loss) 38,194 15,002 23,585 (23,475) 53,306
-19-
15. Contingencies
In the ordinary course of business, the Company is subject to various legal
proceedings and claims. The Company believes that the ultimate outcome of these
matters will not have a material effect on its financial statements.
-20-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company operates its business in three segments. The Printed Products
segment ("Printed Products") includes checks, direct marketing activities and
analytical services marketed primarily to financial institutions.
The Software and Services segment ("Software & Services") is focused on the
financial institution market and includes core processing applications and
services for credit unions, thrifts and community banks, education and
e-commerce solutions primarily to credit unions, lending and mortgage
origination applications, mortgage servicing applications, branch automation
applications, customer relationship management applications and fraud payment
prevention solutions.
The Scantron segment ("Scantron") includes scanning equipment and software,
scannable forms, survey solutions, curriculum planning software, testing and
assessment tools, training and field maintenance services. Scantron sells these
products and services to the education, commercial and financial institution
markets.
Critical Accounting Policies
In the Company's Annual Report on Form 10-K, for the fiscal year ended December
31, 2004 (the "2004 Form 10-K"), the Company's most critical accounting policies
and estimates upon which its financial status depends were identified as those
relating to revenue recognition, impairment of long-lived assets, goodwill and
other intangible assets, software and other developmental costs, income taxes
and stock-based compensation. The Company believes there were no significant
changes in the status of its accounting policies during the nine month period
ended September 30, 2005 to warrant further disclosure. See the 2004 Form 10-K
for additional disclosure with respect to the Company's critical accounting
policies.
Reclassifications
In 2005, the Company elected to reclassify certain items in its condensed
consolidated statements of income. The reclassifications affected the categories
of costs of goods sold and selling, general and administrative expenses. The
changes primarily reflected the consistent alignment of certain functional costs
throughout the Printed Products segment. In the third quarter of 2005, certain
2004 expenses related to user conferences held during 2004 were reclassified
from selling, general and administrative expenses to cost of goods sold to
conform to the 2005 classification.
In the third quarter of 2005, the Company reassigned card services and
educational services operations, which were acquired in the Liberty acquisition
(see Significant Events on following page), from its Printed Products segment to
its Software & Services segment. The Company also transferred certain business
development activities related to fraud prevention solutions to Software &
Services from its Corporate operations.
These reclassifications were not significant and had no impact on net income or
shareholders' equity as previously reported. Financial data for all periods
presented have been reclassified for comparability.
-21-
Significant Events
In April 2005, the Company acquired Intrieve, Incorporated ("Intrieve") for
approximately $77.1 million, including acquisitions costs, in a cash for equity
transaction. In June 2005, the Company acquired substantially all of the assets
of Liberty Enterprises, Inc. ("Liberty") for approximately $161.7 million in
cash including acquisition costs. See Note 3 to the Condensed Consolidated
Financial Statements for further information regarding these acquisitions.
In March 2005, the Company was notified that a major customer in its Printed
Products segment will not renew its current contract that expires in March 2006.
The current annual sales under this contract are approximately $32 million with
current annual pre-tax operating income of approximately $10 million. The
Company believes it will be able to eliminate all variable costs associated with
this customer and will adjust its infrastructure wherever possible to minimize
the impact of fixed costs. The impact of this customer loss is not anticipated
to begin until April 1, 2006.
In September 2003, the Company announced a reorganization of its Printed
Products operations including the consolidation of its domestic manufacturing
operations from 14 plants to 9 plants, which was completed during the third
quarter of 2004. Two of the facilities that were closed were leased. One of
these facilities is under lease through late 2005 and the other is under lease
through mid-2010. During the third quarter of 2004, the Company sublet the
latter facility to a third party for the remaining term of the lease.
In addition to the plant consolidation, Printed Products implemented other
staffing reductions beginning in the fourth quarter of 2003 which were completed
during the third quarter of 2004. These actions were primarily due to excess
capacity in production facilities resulting from efficiencies realized from
digital printing technology and lower volumes attributable to the losses of
certain large customers, including a direct check marketer, and general market
volume decline. The Company believes these actions brought its production and
support structures in line with its business levels.
For the three month period ended September 24, 2004, plant consolidation
expenses were favorably impacted by a net decrease in expense of $0.3 million
due to the subleasing of a closed facility. For the nine month period ended
September 24, 2004, plant consolidation expenses included $5.2 million in cost
of goods sold, a $2.3 million asset impairment charge to reduce the carrying
value of a closed facility to its estimated fair value and a net gain of $3.6
million related to asset disposals. The net pre-tax expenses associated with
other staffing reduction actions totaled $0.4 million and $1.6 million for the
three and nine months ended September 24, 2004 and were included in selling,
general and administrative expenses. Ongoing costs related to closed facilities
were incurred for the three and nine month periods ended September 30, 2005 but
were not significant.
-22-
RESULTS OF OPERATIONS - THIRD QUARTER OF 2005 VERSUS THIRD QUARTER OF 2004
Sales
Consolidated sales and sales by segment for the three month periods ended
September 30, 2005 and September 24, 2004 were as follows (in thousands):
Three Month Periods Ended
September 30, 2005 September 24, 2004
- ----------------------------------------------------------------------
% of % of
Amount Total Amount Total
- ----------------------------------------------------------------------
Printed Products $159,849 61.3% $117,908 60.2%
Software & Services 69,978 26.8% 47,264 24.1%
Scantron 30,928 11.9% 31,628 16.1%
Eliminations (104) (0.0%) (825) (0.4%)
- ----------------------------------------------------------------------
Total $260,651 100.0% $195,975 100.0%
======================================================================
Consolidated sales increased $64.7 million, or 33.0%, to $260.7 million in the
third quarter of 2005 from $196.0 million in the third quarter of 2004. Sales of
products, which consist of all Printed Products sales (except analytical
services), software licensing sales, scanning equipment and scannable forms and
other products, increased $45.5 million, or 29.0%, to $202.5 million in the
third quarter of 2005 from $157.0 million in the third quarter of 2004. Sales of
services, which consist of software maintenance services, field maintenance
services, core processing services, analytical and consulting services and other
services, increased $19.2 million, or 49.2%, to $58.1 million in the third
quarter of 2005 from $38.9 million in the third quarter of 2004.
Printed Products sales increased $41.9 million, or 35.6%, to $159.8 million in
the third quarter of 2005 from $117.9 million in the third quarter of 2004. The
portions of the acquired Liberty operations preliminarily aligned under Printed
Products contributed $28.1 million of the increase. Domestic imprint check
printing operations, which exclude Liberty operations, were favorably impacted
by a volume increase of 22.6% partially offset by an average price per unit
decrease of 5.7%. The volume increase was primarily attributable to the addition
of a new customer in late 2004. The volume increase for the Company was
partially offset by general market volume decline related to alternative
payments systems. The decrease in average price per unit was primarily due to
incentives and price reductions resulting from contract renewals and lower than
average pricing for a major new customer added in late 2004. Sales of computer
checks and related products increased 1.8% in the third quarter of 2005 compared
to the third quarter of 2004 due primarily to higher sales from financial
institution channels partially offset by lower sales in the software and retail
channels due in part to lower average pricing. Sales of direct marketing
activities increased 1.1% in the third quarter of 2005 compared to the third
quarter of 2004 primarily due to higher volumes partially offset by decreased
analytical services sales.
-23-
Software & Services sales increased $22.7 million, or 48.1%, to $70.0 million in
the third quarter of 2005 from $47.3 million in the third quarter of 2004. The
increase in sales was due primarily to the acquisitions of Intrieve Corporation
in April 2005, the portion of Liberty operations that were aligned under
Software & Services and Phoenix System in November 2004 (see Note 3 to the
Condensed Consolidated Financial Statements included in this report). Excluding
the impact of the acquisitions, Software & Services sales increased
approximately $0.8 million, or 1.8%, primarily due to an annual user conference
held during the third quarter of 2005 that was held during the second quarter of
2004 and increases in core systems sales partially offset by a decrease in
retail and lending sales. Core systems organic sales increased 6.1% or $1.0
million primarily due to higher sales in banking systems and credit union
systems. Retail and lending solutions sales decreased 6.3% or $1.9 million in
the third quarter of 2005 compared to the third quarter of 2004 primarily due to
decreased sales of mortgage and branch automation solutions partially offset by
an increase in other compliance solutions sales. The decrease in mortgage
solutions sales was primarily due to the impact of initial recognition of
revenue related to the release of a new product during 2004. Although sales for
other compliance solutions increased, they were affected by an increase in
usage-based contracts compared with perpetual agreements. The usage-based
contracts defer revenue recognition into future periods.
Software & Services backlog, which consists of contracted products and services
prior to delivery, was $245.8 million at the end of the third quarter of 2005,
an increase of 155.0% compared to $96.4 million at the end of the third quarter
of 2004, and increased $1.1 million, or 0.4%, from $244.7 million at the end of
the second quarter of 2005. The increase from the third quarter of 2004 was due
primarily to businesses acquired in late 2004 and 2005. The increase from the
second quarter of 2005 was due to increases in compliance bookings.
Approximately $90.3 million, or 36.7%, of the backlog at September 30, 2005 is
expected to be delivered over the next twelve months and $155.5 million, or
63.3%, is expected to be delivered beyond the next twelve months due to the
long-term nature of certain service contracts.
Scantron sales decreased $0.7 million, or 2.2%, to $30.9 million in the third
quarter of 2005 from $31.6 million in the third quarter of 2004 primarily due to
decreases in sales of imaging and survey solutions products and services as well
as sales of field services partially offset by increases in sales of testing and
custom data collection forms. Increased sales of newer technology products in
the education market were offset by lower sales of legacy technology products in
that market during the third quarter of 2005. Revenue for the newer technology
products is recognized over the contract term, which results in deferrals of
revenue into future periods, whereas revenue for the legacy products is
generally recognized when the product is shipped. Scantron backlog at the end of
the third quarter of 2005 was $19.7 million, a decrease of 10.5% compared to
$22.0 million at the end of the third quarter of 2004, and decreased $0.7
million, or 3.4%, from $20.4 million at the end of the second quarter of 2005.
Approximately $18.6 million of the backlog at September 30, 2005 is expected to
be delivered within twelve months or less.
-24-
Gross Profit
Consolidated gross profit and gross profit by segment for the three month
periods ended September 30, 2005 and September 24, 2004 were as follows (in
thousands):
Three Month Periods Ended
September 30, 2005 September 24, 2004
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $ 69,206 43.3% $ 48,444 41.1%
Software & Services 41,358 59.1% 31,794 67.3%
Scantron 18,137 58.6% 18,191 57.5%
- ----------------------------------------------------------------------
Total $128,701 49.4% $ 98,429 50.2%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Printed Products gross profit in the third quarter of 2005 increased $20.8
million, or 42.9%, from $48.4 million in the third quarter of 2004 to $69.2
million in the third quarter of 2005 and increased as a percentage of sales from
41.1% in the third quarter of 2004 to 43.3% in the third quarter of 2005. The
portions of the acquired Liberty operations preliminarily aligned under Printed
Products accounted for 73.5% of the gross profit increase in the third quarter
of 2005 compared to the third quarter of 2004. Gross profit increased in
domestic imprint check printing operations and in computer checks and related
products operations due to increases in sales, efficiencies realized from plant
consolidations. Lower average pricing in domestic imprint check printing
operations partially offset these favorable factors. Gross profit in computer
checks and related products operations also was favorably impacted by
efficiencies realized from the implementation of digital printing technology
during 2004.
Software & Services gross profit in the third quarter of 2005 increased $9.6
million, or 30.1%, to $41.4 million from $31.8 million in the third quarter of
2004. The gross profit increase was due to businesses acquired in late 2004 and
in 2005 and lower costs in its other businesses and was partially offset by the
timing of an annual user conference. The annual user conference was held during
the third quarter of 2005 and the second quarter of 2004. As a percentage of
sales, Software & Services gross profit decreased to 59.1% in the third quarter
of 2005 from 67.3% in the third quarter of 2004, due primarily to the lower
margin nature of the acquired operations and the timing of the annual user
conference.
Scantron gross profit in the third quarter of 2005 decreased 0.3% from $18.2
million in the third quarter of 2004 to $18.1 million in the third quarter of
2005. The gross profit decrease was due to lower sales substantially offset by
the impact of a favorable change in sales mix. As a percentage of sales,
Scantron gross profit increased slightly to 58.6% in the third quarter of 2005
from 57.5% in the third quarter of 2004.
-25-
Selling, General & Administrative Expenses (SG&A)
Consolidated SG&A and SG&A by segment for the three month periods ended
September 30, 2005 and September 24, 2004 were as follows (in thousands):
Three Month Periods Ended
September 30, 2005 September 24, 2004
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $ 43,283 27.1% $ 30,915 26.2%
Software & Services 30,273 43.3% 23,522 49.8%
Scantron 8,576 27.7% 8,318 26.3%
Corporate 9,905 7,151
- ----------------------------------------------------------------------
Total $ 92,037 35.3% $ 69,906 35.7%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Printed Products SG&A increased $12.4 million, or 40.0%, to $43.3 million in the
third quarter of 2005 from $30.9 million in the third quarter of 2004. The
increase was primarily due to Liberty SG&A, higher marketing and call center
support expenses related to the addition of a new customer in late 2004 and a
ramp-up related to a new customer currently being implemented and higher
incentive compensation partially offset by lower information technology and
client support expenses primarily due to staffing reduction actions in 2004.
Software and Services SG&A increased $6.8 million, or 28.7%, to $30.3 million in
the third quarter of 2005 from $23.5 million in the third quarter of 2004. The
increase was primarily due to increased expenses related to operations acquired
in 2005 and late 2004 and expenses related to the development of fraud
prevention solutions partially offset by lower severance expense, headcount and
sales commissions in the third quarter of 2005.
Scantron SG&A increased $0.3 million, or 3.1%, to $8.6 million in the third
quarter of 2005 from $8.3 million in the third quarter of 2004. The increase was
primarily due to product development activities for a new imaging scanner and
selling and product launch expenses related to a new imaging software
application release.
Corporate SG&A increased $2.7 million, or 38.5%, to $9.9 million in the third
quarter of 2005 from $7.2 million in the third quarter of 2004. The increase was
primarily due to increased incentive compensation costs resulting from the
Company's financial performance, increased amortization expense related to
restricted stock grants in 2005, increased audit and tax fees and a contract
renewal for the Company's Chief Executive Officer.
Asset Impairment Charges
In September 2004, the Company concluded that upgrading certain existing
customer care systems in its Printed Products segment would be more economical
than continued development of portions of certain new customer care systems for
the segment. The decision to terminate development efforts required a non-cash,
pre-tax impairment charge of $7.9 million which was based on previously
capitalized costs, less accumulated depreciation thereon, for the portions of
the system where development was discontinued. The Company has continued with
development and implementation of the remaining portions of the customer care
infrastructure project for the Printed Products segment.
-26-
Amortization of Intangibles
Consolidated amortization of intangibles expense increased $3.1 million to $4.1
million in the third quarter of 2005 from $1.0 million in the third quarter of
2004. The increase was primarily due to the Intrieve and Liberty acquisitions
which occurred during the second quarter of 2005 and a 2004 acquisition.
Consolidated Income from Operations
Consolidated income from operations increased $12.9 million, or 65.7%, to $32.6
million in the third quarter of 2005 from $19.7 million in the third quarter of
2004. The increase in consolidated income from operations was primarily due to
higher gross profit in 2005 and asset impairment charges in 2004 which were
partially offset by increases in SG&A and amortization of intangibles in the
third quarter of 2005.
Other Income (Expense)
Other Income (Expense) increased $1.6 million to an expense of $2.5 million in
the third quarter of 2005 from an expense of $0.9 million in the third quarter
of 2004. The increase was primarily due to an increase in interest expense which
was caused by higher amounts of debt outstanding and higher average interest
rates in the third quarter of 2005 compared to the third quarter of 2004
partially offset by interest income in the third quarter of 2005 related to
federal income tax refunds due to the Company. The increase in the amounts of
debt outstanding resulted from the Intrieve and Liberty acquisitions.
Consolidated Income Before Income Taxes
Consolidated income before income taxes increased $11.3 million, or 60.3%, to
$30.1 million in the third quarter of 2005 from $18.8 million in the third
quarter of 2004 due to increased income from operations partially offset by
higher interest expense.
Income Taxes
Consolidated effective income tax rates were 38.4% and 35.6% for the third
quarters of 2005 and 2004, respectively. The effective tax rate for the third
quarter of 2005 was unfavorably impacted by an increase in the effective state
income tax rate for the consolidated group and a decrease in the U.S. tax credit
for the Company's operations in Puerto Rico partially offset by the
implementation of IRC Section 199, Qualified Production Activities Deduction.
The lower effective income tax rate for the third quarter of 2004 resulted
primarily from favorable adjustments related to foreign transfer pricing
agreements and state retraining credits.
Net Income and Earnings Per Share
Net income in the third quarter of 2005 was $18.6 million compared to $12.1
million in the third quarter of 2004. Basic and diluted earnings per share were
$0.67 and $0.65, respectively, for the third quarter of 2005 compared to basic
and diluted earnings per share of $0.44 and $0.43, respectively, for the same
period in 2004.
-27-
RESULTS OF OPERATIONS - YEAR TO DATE 2005 VERSUS YEAR TO DATE 2004
Sales
Consolidated sales and sales by segment for the nine month periods ended
September 30, 2005 and September 24, 2004 were as follows (in thousands):
Nine Month Periods Ended
September 30, 2005 September 24, 2004
- ----------------------------------------------------------------------
% of % of
Amount Total Amount Total
- ----------------------------------------------------------------------
Printed Products $448,537 62.7% $356,497 61.5%
Software & Services 181,447 25.3% 139,743 24.1%
Scantron 86,469 12.1% 85,338 14.7%
Eliminations (556) (0.1%) (2,048) (0.4%)
- ----------------------------------------------------------------------
Total $715,897 100.0% $579,530 100.0%
======================================================================
Consolidated sales increased $136.4 million, or 23.5%, to $715.9 million for the
nine month period ended September 30, 2005 from $579.5 million for the nine
month period ended September 24, 2004. Sales increases occurred in all three
segments. Sales of products, which consist of all Printed Products sales (except
analytical services), software licensing sales, scanning equipment and scannable
forms and other products increased $101.6 million, or 21.9%, to $565.7 million
for the first nine months of 2005 from $464.1 million in the first nine months
of 2004. Sales of services, which consist of software maintenance services,
field maintenance services, core processing services, analytical and consulting
services and other services increased $34.7 million, or 30.1%, to $150.2 million
for the first nine months of 2005 from $115.5 million for the first nine months
of 2004.
Printed Products sales increased $92.0 million, or 25.8%, to $448.5 million in
the first nine months of 2005 from $356.5 million in the first nine months of
2004. Domestic imprint check printing operations, which exclude Liberty
operations, accounted for a majority of the sales increase primarily due to a
volume increase of 28.3% partially offset by a decrease in the average price per
unit of 6.3%. The volume increase was primarily attributable to the addition of
a major new customer in late 2004 and was partially offset by general market
volume decline related to alternative payment systems. The decrease in the
average price per unit was due primarily to incentives and price reductions
resulting from contract renewals and lower than average pricing for the new
customer added in late 2004, partially offset by the loss of lower priced
business and a $6.3 million increase in contract termination payments in 2005.
The portions of the acquired Liberty operations aligned under Printed Products
contributed $34.8 million of the increase in sales. Sales of computer checks and
related products increased 6.3% for the first nine months of 2005 compared to
the first nine months of 2004 due primarily to the higher sales through the
financial institution and software customer channels and the addition of a new
retail customer in 2004 partially offset by lower average pricing. Sales of
direct marketing activities increased 11.8% for the first nine months of 2005
compared to the first nine months of 2004 due primarily to higher volumes
partially offset by lower analytical services sales.
-28-
Software & Services sales increased $41.7 million, or 29.8%, to $181.4 million
in the first nine months of 2005 from $139.7 million in the first nine months of
2004. The increase in sales was due primarily to acquisitions in late 2004 and
2005 (see Note 3 to the Condensed Consolidated Financial Statements included in
this report). Excluding the impact of the acquisitions, Software & Services
sales decreased approximately $2.4 million, or 1.7%, due primarily to decreased
organic sales in retail and lending solutions sales as well as core systems.
Retail and lending solutions organic sales decreased 2.3%, or $2.0 million in
the first nine months of 2005 compared to the first nine months of 2004
primarily due to decreased sales in mortgage and retail solutions that offset an
increase in sales in other compliance solutions. Core systems organic sales
decreased 1.8% or $0.9 million primarily due to decreases in credit union
systems and banking systems sales.
Scantron sales increased $1.1 million, or 1.3%, to $86.5 million in the first
nine months of 2005 from $85.3 million in the first nine months of 2004.
Increases in sales of testing and custom data collection forms and field
services were partially offset by decreases in imaging solutions and survey
solutions sales. In addition to higher sales volume, Scantron sales of testing
and custom data collection forms had two additional production days and field
services had five additional production days for the first nine months of 2005
compared to the first nine months of 2004.
Gross Profit
Consolidated gross profit and gross profit by segment for the nine month periods
ended September 30, 2005 and September 24, 2004 were as follows (in thousands):
Nine Month Periods Ended
September 30, 2005 September 24, 2004
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $191,736 42.7% $139,432 39.1%
Software & Services 112,694 62.1% 91,324 65.4%
Scantron 49,051 56.7% 48,106 56.4%
- ----------------------------------------------------------------------
Total $353,481 49.4% $278,862 48.1%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Consolidated gross profit increased $74.6 million, or 26.8%, from $278.9 million
in the first nine months of 2004 to $353.5 million in the first nine months of
2005, and increased as a percentage of sales from 48.1% in the first nine months
of 2004 to 49.4% in the first nine months of 2005.
Printed Products gross profit for the nine month period ended September 30, 2005
increased $52.3 million, or 37.5%, from $139.4 million in the nine month period
ended September 24, 2004 to $191.7 million in the nine month period ended
September 30, 2005 and as a percentage of sales was 42.7% in the first nine
months of 2005 compared to 39.1% in the first nine months of 2004. Printed
Products gross profit was favorably impacted by sales increases in domestic
imprint check printing, direct marketing operations and computer checks and
related products and by efficiencies gained from plant consolidations and plant
consolidation costs of $5.2 million incurred during the first nine months of
2004. The acquisition of Liberty also contributed to the increase in gross
profit. Lower average pricing in domestic imprint check printing operations
partially offset these favorable factors. Gross profit in computer checks and
related products operations also was favorably impacted by efficiencies realized
from the implementation of digital printing technology during 2004.
-29-
Software & Services gross profit in the first nine months of 2005 increased
$21.4 million, or 23.4%, from $91.3 million in the first nine months of 2004 to
$112.7 million in the first nine months of 2005 primarily due to acquisitions
and higher sales in other compliance solutions and banking systems partially
offset by a decrease in retail and mortgage solutions and credit union systems
sales. As a percentage of sales, Software & Services gross profit decreased to
62.1% in the first nine months of 2005 from 65.4% in the first nine months of
2004, due primarily to the lower margin nature of the acquired operations.
Scantron gross profit increased $1.0 million, or 2.0%, from $48.1 million in the
first nine months of 2004 to $49.1 million in the first nine months of 2005. The
increase was primarily due to higher sales of testing forms. As a percentage of
sales, Scantron gross profit increased to 56.7% in the first nine months of 2005
from 56.4% in the first nine months of 2004.
Selling, General & Administrative Expenses
Consolidated SG&A and SG&A by segment for the nine month periods ended September
30, 2005 and September 24, 2004 were as follows (in thousands):
Nine Month Periods Ended
September 30, 2005 September 24, 2004
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $113,083 25.2% $ 94,561 26.5%
Software & Services 86,337 47.6% 73,723 52.8%
Scantron 27,166 31.4% 24,295 28.5%
Corporate 25,762 20,727
- ----------------------------------------------------------------------
Total $252,348 35.2% $213,306 36.8%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Printed Products SG&A increased $18.5 million, or 19.6%, to $113.1 million in
the first nine months of 2005 compared to $94.6 million in the first nine months
of 2004. The increase was primarily due to the additional Liberty SG&A, higher
marketing and call center support expenses related to the addition of new
customers in late 2004 as well as a ramp-up related to a new customer currently
being implemented, and higher incentive compensation expense. The increase in
Printed Products SG&A was partially offset by lower information technology,
selling and client support expenses primarily due to staffing reduction actions
in 2004. The first nine months of 2004 included $1.6 million of costs related to
staffing reduction actions associated with the Printed Products reorganization.
Software and Services SG&A increased $12.6 million, or 17.1%, to $86.3 million
in the first nine months of 2005 compared to $73.7 million in the first nine
months of 2004. The increase was due primarily to expenses related to acquired
operations and increased expenses for previously existing core systems
operations in the first nine months of 2005 partially offset by lower severance
expense, decreased product development expenses primarily attributable to a new
mortgage loan product that was released in 2004 and lower sales commissions in
2005.
Scantron SG&A increased $2.9 million, or 11.8%, to $27.2 million in the first
nine months of 2005 compared to $24.3 million in the first nine months of 2004.
The increase was due primarily to higher development costs related to a new
imaging scanner and selling and marketing expenses resulting from the product
launch of a new imaging software application release partially offset by lower
sales commissions.
-30-
Corporate SG&A increased $5.0 million, or 24.3%, to $25.8 million in the first
nine months of 2005 compared to $20.7 million in the first nine months of 2004.
The increase was due primarily to increased legal, audit and tax fees, increases
in incentive compensation costs due to the Company's financial performance,
increased amortization expense for restricted stock grants and a contract
renewal for the Company's Chief Executive Officer.
Asset Impairment Charges / (Gain) Loss on Disposal of Assets
In September 2004, the Company concluded that upgrading certain existing
customer care systems in its Printed Products segment would be more economical
than continued development of portions of certain new customer care systems for
the segment. The decision to terminate development efforts required a non-cash,
pre-tax impairment charge of $7.9 million which was based on previously
capitalized costs, less accumulated depreciation thereon, for the portions of
the system where development was discontinued. The Company has continued with
development and implementation of the remaining portions of the customer care
infrastructure project for the Printed Products segment.
In the first quarter of 2004, the Company sold a Printed Products facility due
to a plant consolidation and realized a $3.7 million gain. During the second
quarter of 2004, a Printed Products facility was closed pursuant to the plant
consolidation plan and a $2.3 million asset impairment charge was recorded to
adjust the basis of the facility to its estimated fair value. The facility was
sold during the second quarter of 2005.
Amortization of Intangibles
Consolidated amortization of intangibles expense increased $4.7 million, or
168.2%, to $7.5 million in the first nine months of 2005 from $2.8 million in
the first nine months of 2004. The increase was primarily due to the Intrieve
and Liberty acquisitions which occurred during the second quarter of 2005.
Consolidated Income from Operations
Consolidated income from operations increased $37.5 million, or 66.8%, to $93.6
million in the first nine months of 2005 from $56.1 million in the first nine
months of 2004, primarily due to higher gross profit as well as asset impairment
charges incurred in 2004. Partially offsetting those favorable factors were
increases in SG&A and amortization of intangibles in the first nine months of
2005 and a net gain on disposal of assets in the first nine months of 2004.
Other Income (Expense)
Other Income (Expense) increased $2.5 million to an expense of $5.3 million in
the first nine months of 2005 from an expense of $2.8 million in the first nine
months of 2004. The increase was primarily due to an increase in interest
expense resulting from higher amounts of debt outstanding and higher average
interest rates during the first nine months of 2005 compared to the first nine
months of 2004 partially offset by higher interest income in the first nine
months of 2005 related to federal income tax refunds due to the Company. The
increase in the amounts of debt outstanding resulted from the Intrieve and
Liberty acquisitions.
Consolidated Income Before Income Taxes
Consolidated income before income taxes increased $35.0 million, or 65.6%, to
$88.3 million in the first nine months of 2005 from $53.3 million in the first
nine months of 2004 due to increased income from operations partially offset by
higher interest expense.
-31-
Income Taxes
Consolidated effective income tax rates were 38.1% and 36.2% for the first nine
months of 2005 and 2004, respectively. The effective tax rate for the first nine
months of 2005 was unfavorably impacted by an increase in the effective state
income tax rate for the consolidated group and a decrease in the U.S. tax credit
for the Company's operations in Puerto Rico partially offset by the
implementation of IRC Section 199, Qualified Production Activities Deduction.
The lower effective income tax rate for the first nine months of 2004 resulted
primarily from favorable adjustments related to the conclusion of a review by
the Internal Revenue Service of the Company's income tax filings for 1999 and
2000, foreign transfer pricing agreements and state retraining credits.
Net Income and Earnings Per Share
Net income in the first nine months of 2005 was $54.6 million compared to $34.0
million in the first nine months of 2004. Basic and diluted earnings per share
were $2.00 and $1.94, respectively, for the first nine months of 2005 compared
to basic and diluted earnings per share of $1.24 and $1.21, respectively, for
the same period in 2004.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Sources and Uses of Cash
- -----------------------------------------------------------------------------
Nine Month Periods Ended
(In thousands) Sep 30, 2005 Sep 24, 2004
- -----------------------------------------------------------------------------
Net cash provided by
operating activities $ 91,426 $ 76,940
Net cash (used for)
investing activities (254,667) (22,467)
Net cash provided by (used for)
financing activities 164,243 (50,634)
=============================================================================
Cash flow provided from operations in the first nine months of 2005 increased
$14.5 million, or 18.8%, to $91.4 million from $76.9 million for the first nine
months of 2004. Cash provided by net income adjusted for depreciation and
amortization, asset impairment charges and gain (loss) on disposal of assets
accounted for an increase of $24.5 million in cash provided by operations
primarily due to the increase in sales and efficiencies realized from plant
consolidations which occurred during 2004. Higher working capital and increased
cash utilized for upfront contract payments of $3.4 million during the first
nine months of 2005 compared to the first nine months of 2004 partially offset
the impact of factors that increased cash provided by operations. The principal
uses of cash in the first nine months of 2005 were for acquisitions ($239.0
million, see Note 3 to the Condensed Consolidated Financial Statements), upfront
contract payments ($23.7 million), capital expenditures ($16.5 million),
dividend payments to shareholders ($11.1 million) and repurchases of stock ($4.2
million). During the first nine months of 2005, cash flow provided by the
issuance of treasury stock totaled $13.7 million as a result of the exercise of
stock options ($10.2 million) and the employee stock purchase plan ($3.5
million).
Purchases of property, plant and equipment totaled $16.5 million in the first
nine months of 2005, a decrease of $4.2 million, compared to $20.7 million in
the first nine months of 2004 and were primarily for customer care
infrastructure initiatives. The Company's customer care infrastructure
initiatives for the Printed Products segment focused on improving systems that
support sales, marketing and customer service to ensure exceptional service and
added functionality for the Company's call centers.
-32-
During the first nine months of 2005, the Company repurchased 100,000 shares of
its common stock for a total of $4.2 million or an average cost of $42.11 per
share. See Part II, Item 2. "Unregistered Sales of Equity Securities and Use of
Proceeds" in this report on Form 10-Q, related to the Company's repurchases of
its common stock during the three month period ended September 30, 2005. These
purchases were made pursuant to an authorization approved by the Company's Board
of Directors in January 2003.
On February 22, 2005, the Company entered into an agreement with Mitek Systems,
Inc. to purchase up to 2,142,856 shares of Mitek common stock for up to an
aggregate of $1,500,000 (or $0.70 per share) and 321,428 warrants to purchase
Mitek Systems common stock at an exercise price of $0.70 per share. Such
warrants will expire in February 2012. The Company purchased one half of the
shares and warrants upon entering into the agreement and purchased the remainder
of the shares and warrants on May 5, 2005.
In February 2004, the Company amended its credit facility (the "Credit
Facility") with a syndicate of banks increasing the amount from $325.0 million
to $425.0 million. The Credit Facility is comprised of a $100.0 million term
loan and a $325.0 million revolving loan, both of which mature in 2009. The term
loan requires annual repayments of $5.0 million and will decrease by $5.0
million per annum. As a result, the Credit Facility will decrease to $400.0
million at the 2009 maturity date. As of September 30, 2005, the total size of
the Credit Facility was $416.2 million. The Credit Facility may be used for
general corporate purposes, including acquisitions, and includes both direct
borrowings and letters of credit. The Credit Facility is unsecured and the
Company presently pays a commitment fee of 0.20% on the unused amount of the
Credit Facility. Borrowings under the Credit Facility bear interest, at the
Company's option, based upon one of the following indices (plus a margin
specified in the agreement): the Federal Funds Rate, the SunTrust Bank Base Rate
or LIBOR. The Credit Facility has certain financial covenants including, among
other items, leverage, fixed charge and minimum net worth requirements. The
Credit Facility also has restrictions that limit the Company's ability to incur
additional indebtedness, grant security interests or sell its assets beyond
certain amounts.
At September 30, 2005, the Company had $267.6 million in outstanding cash
borrowings under the Credit Facility, $5.5 million in outstanding letters of
credit and $143.1 million available for borrowing under the Credit Facility. The
average interest rate in effect on outstanding cash borrowings at September 30,
2005 was 4.78%.
At September 30, 2005, the Company had $10.2 million in cash and cash
equivalents. The Company believes that its current cash position, funds from
operations and the availability of funds under its Credit Facility will be
sufficient to meet anticipated requirements for acquisitions, working capital,
dividends, capital expenditures and other corporate needs. Management is not
aware of any condition that would materially alter this trend.
The Company also believes that it possesses sufficient unused debt capacity and
access to equity capital markets to pursue additional acquisition opportunities
if funding beyond that available under the Credit Facility were required.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company enters into agreements with certain customers, under which the
Company is obligated to make future payments. As of September 30, 2005, the
remaining payment obligations under the existing customer contracts are
scheduled to be paid as follows: $0.9 million for the three months ending
December 31, 2005; $36.8 million for the two year period ending December 31,
2007 and $19.9 million for the two year period ending December 31, 2009. These
payments are amortized as a reduction of sales over the life of the related
contract and are generally refundable from the customer on a pro-rata basis if
the contract is terminated.
-33-
Other contractual obligations and commitments have increased since December 31,
2004 primarily due to acquired businesses and to a renewal of a lease for an
existing facility. At September 30, 2005, capital and operating lease
obligations acquired or renewed since December 31, 2004 totaled approximately
$25.4 million with payment terms extending through 2019. Other additional
contractual obligations associated with acquisitions consist of deferred
severance payment obligations of $0.7 million and a $0.3 million
uncollateralized promissory note payable July 2006. Borrowings under the
Company's line of credit increased $166.3 million since December 31, 2004 from
$101.3 million to $267.6 million primarily due to the 2005 acquisitions. See the
2004 Form 10-K with respect to the Company's other contractual obligations and
commitments.
ACQUISITIONS
All acquisitions in 2005 and 2004 were paid for with cash provided from
operating activities and proceeds from the Credit Facility. The acquisitions
were accounted for using the purchase method of accounting and accordingly, the
results of operations of the acquired businesses have been included in the
Company's operations since the respective closing dates (see Note 3 to the
Condensed Consolidated Financial Statements).
OUTLOOK
Net income for 2005 is expected to be higher than net income for 2004 with all
three segments expected to show growth in sales and income before income taxes
in 2005 except Scantron, which is expected to show a decline in income before
income taxes in 2005.
Segment income for Printed Products is expected to improve for the year as a
result of a full year of benefits from cost reductions related to its
reorganization that was completed in the third quarter of 2004. In addition,
unit volume is expected to be higher in 2005 as a result of the implementation
of new business in late 2004 as well as the 2005 acquisition of Liberty.
Software & Services segment income is expected to improve as a result of the
full-year impact of three acquisitions in 2004 and the Intrieve and Liberty
acquisitions in 2005 as well as the impact of integrating them with existing
products and services. Cost reduction initiatives implemented during 2004 are
also expected to impact segment income favorably.
The Scantron segment is expected to continue its growth of sales in traditional
products and services. Increased sales of existing technology products and the
introduction of new products are also expected to provide growth in 2005.
Product development costs and marketing costs related to the new products are
expected to more than offset expected sales growth in 2005 resulting in a
decrease in segment income before income taxes in 2005.
The Company believes cash flow provided by operations will remain strong in all
business units in 2005. The Company currently estimates that capital
expenditures will be in the range of $25 million to $28 million. The Company
believes upfront contract payments in 2005 will be similar to the 2004 level of
approximately $27 million. The Company currently expects depreciation and
amortization will be in a range of $88 million to $90 million in 2005, based on
preliminary estimates of intangible assets and the resulting amortization
related to Liberty. The Company expects its net interest expense will be
approximately $9.5 million in 2005.
ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Condensed Consolidated Financial Statements regarding the
impact of recent accounting pronouncements on the Company's financial condition
and results of operations.
-34-
RISK FACTORS AND CAUTIONARY STATEMENTS
When used in this report and in subsequent filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and in
written or oral statements made by authorized representatives of the Company,
the words or phrases "believe," "should result," "are expected to," "will
continue," "is anticipated," "estimate," "project" or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements are
necessarily subject to certain risks and uncertainties, including, but not
limited to, those discussed below that could cause actual results to differ
materially from the Company's historical experience and its present expectations
or projections. Caution should be taken not to place undue reliance on any such
forward-looking statements, which speak only as of the date such statements are
made and which may or may not be based on historical experiences and/or trends
which may or may not continue in the future. The Company does not undertake and
specifically declines any obligation to update any forward-looking statements to
reflect events or circumstances occurring after the date of such statements or
to reflect the occurrence of unanticipated events.
Various factors may affect the Company's financial performance, including, but
not limited to, those factors discussed below which could cause the Company's
actual results for future periods to differ from any opinions, statements or
projections expressed with respect thereto. Such differences could be material
and adverse.
The Company is subject to federal regulations implementing the information
security requirements of the Gramm-Leach-Bliley Act and other federal
regulations and state laws regarding the privacy and confidentiality of consumer
information. These laws and regulations require the Company to develop,
implement and maintain a comprehensive information security program designed to
protect the security and confidentiality of consumers' nonpublic personal
information and to define requirements for notification in the event of improper
disclosure. The Company cannot be certain that advances in criminal
capabilities, new discoveries in the field of cryptography or other developments
will not compromise or breach the technology protecting the networks that
utilize consumers' nonpublic personal information.
Many variables will impact the ability to achieve sales levels, improve service
quality, achieve production efficiencies and reduce expenses in Printed
Products. These include, but are not limited to, the successful integration of
Liberty, the successful implementation of major new accounts and the continuing
upgrade of the Company's customer care infrastructure and systems used in the
Company's manufacturing, sales, marketing, customer service and call center
operations.
Several factors outside the Company's control could negatively impact check
revenues. These include the continuing expansion of alternative payment systems
such as credit cards, debit cards and other forms of electronic commerce or
on-line payment systems. Check revenues may continue to be adversely affected by
continued consolidation of financial institutions, competitive check pricing
including significant up-front contract incentive payments, and the impact of
governmental laws and regulations. There can be no assurances that the Company
will not lose significant customers or that any such losses could be offset by
the addition of new customers.
-35-
While the Company believes growth opportunities exist in the Software & Services
segment, there can be no assurances that the Company will achieve its revenue or
earnings growth targets. The Company believes there are many risk factors
inherent in its Software & Services business, including but not limited to the
retention of employee talent and customers. Revenues may continue to be
adversely affected by continued consolidation of financial institutions. Also,
variables exist in the development of new Software & Services products,
including the timing and costs of the development effort, product performance,
functionality, product acceptance, competition, the Company's ability to
integrate acquired companies, and general changes in economic conditions or U.S.
financial markets.
Several factors outside of the Company's control could affect results in the
Scantron segment. These include the rate of adoption of new electronic data
collection solutions and testing and assessment methods, which could negatively
impact forms, scanner sales, software and related service revenue. The Company
continues to develop products and services that it believes offer
state-of-the-art electronic data collection and testing and assessment
solutions. However, variables exist in the development of new testing methods
and technologies, including the timing and costs of the development effort,
product performance, functionality, market acceptance, adoption rates,
competition and the funding of education at the federal, state and local levels,
all of which could have an impact on the Company's business.
As a matter of due course, the Company and its subsidiaries are subject to
various federal and state tax examinations. The Company believes that it is in
compliance with the various federal and state tax regulations imposed and such
returns and reports filed with respect to such tax regulations are materially
correct. The results of these various federal and state tax examinations could
produce both favorable and unfavorable adjustments to the Company's total tax
expense either currently or on a deferred basis. At such time when a favorable
or unfavorable adjustment is known, the effect on the Company's consolidated
financial statements is recorded.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All financial instruments held by the Company are held for purposes other than
trading with the exception of $6.7 million of assets related to a nonqualified
deferred compensation plan held in a trust. The Company is exposed primarily to
market risks related to interest rates and equity prices.
Interest Rate Risk
The Company is exposed to interest rate risk on its variable rate debt. In order
to manage its exposure to fluctuations in interest rates, the Company from time
to time has entered into interest rate swap agreements, which allow it to raise
funds at floating rates and effectively swap them into fixed rates. As of
September 30, 2005, there were no interest rate swap agreements in effect. These
derivative financial instruments are viewed as risk management tools and, when
used, are entered into for hedging purposes only. The Company does not use
derivative financial instruments for trading or speculative purposes. At
September 30, 2005, the Company had outstanding variable rate debt of $267.6
million. The impact on quarterly results of operations of a hypothetical
one-point interest rate change on the outstanding debt as of September 30, 2005
would be approximately $0.4 million.
Equity Price Risk
The fair value of the Company's trading securities investments, which are
related to a nonqualified deferred compensation plan for eligible employees, is
included in investments with an offsetting obligation included in other
noncurrent liabilities. Realized and unrealized holding gains and losses related
to those investments are recorded in other income with an offsetting adjustment
to compensation expense which is included in selling, general and administrative
expenses.
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The fair value of the Company's available-for-sale investments is primarily
affected by fluctuations in the market price for the common stock of Mitek
Systems, Inc. The change in market value has been accounted for as a component
of other comprehensive income. The following presents the Company's investment
in Mitek reflecting the high and low closing market prices during the period
subsequent to the date of the investment (February 22, 2005) to September 30,
2005:
Carrying
(In thousands) Value (a) High (b) Low (b)
- -----------------------------------------------------------------------------
Investment in Mitek $1,757 $2,164 $1,179
<FN>
(a) Based on market value as of September 30, 2005
(b) Based on quoted market prices
</FN>
ITEM 4. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of management, including the
principal executive officer and principal financial officer, the Company
conducted an evaluation of its disclosure controls and procedures, as such term
is defined under Rule 13a-15(e) promulgated under the Exchange Act. Based on
this evaluation, such officers concluded that the Company's disclosure controls
and procedures were effective as of September 30, 2005.
Changes in Internal Control over Financial Reporting
In April 2005, a subsidiary of the Company acquired Intrieve, Incorporated and
in June 2005, the Company acquired the assets of Liberty Enterprises, Inc. For
more details on these acquisitions, see Note 3 to the Condensed Consolidated
Financial Statements. The Company has not evaluated any changes in internal
control over financial reporting associated with these acquisitions, and,
therefore, any material changes that might result are not included in this
report. The Company will disclose any material changes resulting from these
acquisitions within the annual assessment reports of internal control over
financial reporting that are required to include them. The total assets of the
two acquisitions constitute approximately 33.3% of consolidated assets as of
September 30, 2005.
Subject to the foregoing, there have been no changes in the Company's internal
control over financial reporting during the period covered by this report that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of business, the Company is subject to various legal
proceedings and claims. The Company believes that the ultimate outcome of these
matters will not have a material effect on its financial statements.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the third quarter ended September 30, 2005, the Company made the
following purchases of common stock:
Total
Number of Maximum
Shares Number of
Total Average Purchased Shares
Number Price as Part of Remaining
of Paid Publicly Under
Shares Per Announced Authorized
Period Purchased Share Program(1) Program
- ------------------------------------------------------------------------------
July 2 - July 31 - $ - - 1,178,722
August 1 - August 31 50,000 41.38 50,000 1,128,722
September 1 - September 30 50,000 42.84 50,000 1,078,722
- ------------------------------------------------------------------------------
Total 100,000 $42.11 100,000 1,078,722
==============================================================================
<FN>
(1) On January 28, 2003, the Company's Board of Directors authorized the
purchase of up to 3,000,000 shares of the Company's outstanding common stock.
Shares purchased under this program may be held in treasury, used for
acquisitions, used to fund the Company's stock benefit and compensation plans or
for other corporate purposes. Unless terminated earlier by resolution of the
Company's Board of Directors, the 2003 stock repurchase program will expire when
the Company has repurchased all shares authorized for repurchase under the
program. As of September 30, 2005, a total of 1,921,278 shares had been
purchased under the 2003 stock repurchase program at an average cost of $31.78
per share.
</FN>
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ITEM 6. EXHIBITS
Exhibit Description
3.1 * Amended and Restated Articles of Incorporation (Exhibit 3.1 to the
Registrant's Quarterly Report on Form 10-Q for the three months ended
March 26, 2004).
3.2 * Amended and Restated Bylaws, as amended through December 19, 2002
(Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2002).
4.1 * Rights Agreement, dated as of December 17, 1998, between the Registrant
and First Chicago Trust Company of New York (Exhibit 4.1 to the
Registrant's Registration Statement on Form 8-A dated July 1, 1999).
4.2 See Articles IV, V and VII of the Registrant's Amended and Restated
Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V and
VIII of the Registrant's Bylaws, filed as Exhibit 3.2.
10.1 * 2005 New Employee Stock Option Plan (Exhibit 10.1 to the Registrant's
Current Report on Form 8-K, filed with the Commission on August 5,
2005).
11.1 Computation of Per Share Earnings.(1)
31.1 Certification Pursuant to Rule 13a-14(a), as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Rule 13a-14(a), as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Asterisk (*) indicates exhibit previously filed with the Securities and Exchange
Commission as indicated in parentheses and incorporated herein by reference.
(1)Data required by SFAS No. 128, "Earnings Per Share," is provided in Note 12
to the Condensed Consolidated Financial Statements included in this report.
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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.
JOHN H. HARLAND COMPANY
Date: November 8, 2005 By: /s/ J. Michael Riley
-----------------------------
J. Michael Riley
Vice President and Controller
(Duly Authorized Officer and
Chief Accounting Officer)
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EXHIBIT LIST
Exhibit Description
3.1 * Amended and Restated Articles of Incorporation (Exhibit 3.1 to the
Registrant's Quarterly Report on Form 10-Q for the three months ended
March 26, 2004).
3.2 * Amended and Restated Bylaws, as amended through December 19, 2002
(Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2002).
4.1 * Rights Agreement, dated as of December 17, 1998, between the Registrant
and First Chicago Trust Company of New York (Exhibit 4.1 to the
Registrant's Registration Statement on Form 8-A dated July 1, 1999).
4.2 See Articles IV, V and VII of the Registrant's Amended and Restated
Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V and
VIII of the Registrant's Bylaws, filed as Exhibit 3.2.
10.1 * 2005 New Employee Stock Option Plan (Exhibit 10.1 to the Registrant's
Current Report on Form 8-K, filed with the Commission on August 5,
2005).
11.1 Computation of Per Share Earnings.(1)
31.1 Certification Pursuant to Rule 13a-14(a), as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Rule 13a-14(a), as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Asterisk (*) indicates exhibit previously filed with the Securities and Exchange
Commission as indicated in parentheses and incorporated herein by reference.
reference.
(1)Data required by SFAS No. 128, "Earnings Per Share," is provided in Note 12
to the Condensed Consolidated Financial Statements included in this report.
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