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 June 30, 2006
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to _______________
Commission file number 1-6352
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
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 July 28,
2006 was 26,216,070.
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. . . . . . . . . . . . . . . . . 22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . 35
ITEM 4. CONTROLS AND PROCEDURES. . . . . . . . . . . . . . . . . . . 35
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . 36
ITEM 1A. RISK FACTORS. . . . . . . . . . . . . . . . . . . . . . . . 36
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. 36
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . 37
ITEM 5. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . . .37
ITEM 6. EXHIBITS. . . . . . . . . . . . . . . . . . . . . . . . . . 38
EXHIBIT LIST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
------
(In thousands) June 30, December 31,
2006 2005
- ----------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 10,125 $ 10,298
Accounts receivable - net 81,870 82,155
Inventories 19,684 20,397
Deferred income taxes 11,382 8,257
Income taxes receivable 5,779 5,163
Prepaid expenses 19,007 24,462
Other 5,088 3,843
- ----------------------------------------------------------------------
Total current assets 152,935 154,575
- ----------------------------------------------------------------------
Other Assets:
Investments 10,505 10,730
Goodwill - net 369,292 357,243
Intangible assets - net 111,151 116,477
Developed technology and content 23,396 25,317
Upfront contract payments - net 49,569 45,993
Other 4,396 4,896
- ----------------------------------------------------------------------
Total investments and other assets 568,309 560,656
- ----------------------------------------------------------------------
Property, plant and equipment 358,990 354,935
Less accumulated depreciation
and amortization 264,823 250,317
- ----------------------------------------------------------------------
Property, plant and equipment - net 94,167 104,618
- ----------------------------------------------------------------------
Total $ 815,411 $ 819,849
======================================================================
<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 June 30, December 31,
per share amounts) 2006 2005
- ----------------------------------------------------------------------
Current Liabilities:
Accounts payable $ 34,193 $ 38,822
Deferred revenues 79,285 72,245
Current maturities of long-term debt 218 5,448
Accrued liabilities:
Salaries, wages and employee benefits 32,842 44,343
Taxes 13,265 10,664
Customer incentives 12,430 12,075
Other 17,433 22,516
- ----------------------------------------------------------------------
Total current liabilities 189,666 206,113
- ----------------------------------------------------------------------
Long-Term Liabilities:
Long-term debt 270,981 250,116
Deferred income taxes 4,958 9,148
Other 37,667 35,330
- ----------------------------------------------------------------------
Total long-term liabilities 313,606 294,594
- ----------------------------------------------------------------------
Total liabilities 503,272 500,707
- ----------------------------------------------------------------------
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 9,609 2,612
Retained earnings 570,616 540,894
Accumulated other comprehensive loss 853 1,253
- ----------------------------------------------------------------------
618,985 582,666
Less 11,666,953 and 10,707,645 shares
in treasury - at cost,
respectively 306,846 263,524
- ----------------------------------------------------------------------
Total shareholders' equity 312,139 319,142
- ----------------------------------------------------------------------
Total $ 815,411 $ 819,849
======================================================================
<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 Six Month Periods Ended
(In thousands, except June 30, July 1, June 30, July 1,
per share amounts) 2006 2005 2006 2005
- ---------------------------------------------------------------------------
Sales:
Product sales $ 194,966 $ 188,763 $ 404,156 $ 363,142
Service sales 64,448 50,636 128,722 92,104
- ---------------------------------------------------------------------------
Total sales 259,414 239,399 532,878 455,246
Cost of sales:
Cost of products sold 101,036 98,429 210,090 194,639
Cost of services sold 28,949 21,522 59,109 36,659
- ---------------------------------------------------------------------------
Total cost of sales 129,985 119,951 269,199 231,298
- ---------------------------------------------------------------------------
Gross Profit 129,429 119,448 263,679 223,948
Selling, general and
administrative expenses 94,242 85,066 186,779 159,506
Amortization of intangibles 4,061 2,408 8,126 3,407
- ---------------------------------------------------------------------------
Income From Operations 31,126 31,974 68,774 61,035
- ---------------------------------------------------------------------------
Other Income (Expense):
Interest expense (4,164) (2,149) (7,893) (3,325)
Other - net 398 466 866 458
- ---------------------------------------------------------------------------
Total (3,766) (1,683) (7,027) (2,867)
- ---------------------------------------------------------------------------
Income before income taxes
and cumulative effect of
change in accounting
principle 27,360 30,291 61,747 58,168
Income taxes 10,851 11,511 24,238 22,104
- ---------------------------------------------------------------------------
Income before cumulative
effect of change in
accounting principle 16,509 18,780 37,509 36,064
Cumulative effect of change
in accounting principle,
net of taxes - - 345 -
- ---------------------------------------------------------------------------
Net Income 16,509 18,780 37,854 36,064
===========================================================================
Weighted Average Shares
Outstanding:
Basic 26,216 27,291 26,423 27,127
Diluted 27,033 28,111 27,200 27,976
===========================================================================
Earnings Per Common Share:
Income before cumulative
effect of change in
accounting principle:
Basic $ 0.63 $ 0.69 $ 1.42 $ 1.33
Diluted $ 0.61 $ 0.67 $ 1.38 $ 1.29
Net Income:
Basic $ 0.63 $ 0.69 $ 1.43 $ 1.33
Diluted $ 0.61 $ 0.67 $ 1.39 $ 1.29
===========================================================================
Cash Dividends Per
Common Share $ 0.15 $ 0.125 $ 0.30 $ 0.25
===========================================================================
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
-5-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Month Periods Ended
June 30, July 1,
(In thousands) 2006 2005
- -----------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 37,854 $ 36,064
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 17,849 17,549
Amortization of upfront contract payments 15,950 16,400
Other amortization 11,617 5,912
Cumulative effect of change in accounting
principle, net of taxes (345) -
(Gain) loss on disposal of assets - net (30) 27
Stock-based compensation 5,895 2,254
Tax benefits from stock-based compensation - 4,190
Deferred income taxes (2,294) (1,487)
Other 417 (135)
Change in assets and liabilities, net of effects of
businesses acquired:
Accounts receivable 154 (4,237)
Inventories and other current assets 2,855 93
Deferred revenues 6,786 11,763
Accounts payable and accrued liabilities (21,984) (6,327)
Upfront contract payments (19,526) (18,385)
- -----------------------------------------------------------------------------
Net cash provided by operating activities 55,198 63,681
- -----------------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (11,666) (11,334)
Proceeds from sale of property, plant and equipment 384 3,565
Payment for acquisition of businesses -
net of cash acquired (10,115) (239,606)
Long-term investments and other (181) (1,026)
- -----------------------------------------------------------------------------
Net cash (used in) investing activities (21,578) (248,401)
- -----------------------------------------------------------------------------
FINANCING ACTIVITIES:
Credit facility borrowings 236,143 366,058
Credit facility payments (220,237) (184,098)
Repurchases of stock (49,172) -
Issuance of treasury stock 7,352 11,139
Dividends paid (8,069) (6,861)
Distribution of minority interests in
Cavion operations (1,016) -
Tax benefits from stock-based compensation 1,637 -
Other - net (431) (469)
- -----------------------------------------------------------------------------
Net cash (used in) provided by financing activities (33,793) 185,769
- -----------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (173) 1,049
Cash and cash equivalents at beginning of period 10,298 9,214
- -----------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 10,125 $ 10,263
=============================================================================
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
-6-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(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 the 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, and
the Independent Registered Public Accounting Firm's Report included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2005 ("2005
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 2005 Form 10-K,
except for the adoption of Statement of Financial Accounting Standards No.
123(R), Share-Based Payment, as disclosed below.
Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes" an
interpretation of FASB Statement No. 109. FIN 48 requires the impact of a tax
position to be reflected in the Company's financial statements if it is more
likely than not that the position will be sustained on audit, based on the
technical merits of the position. The provisions of FIN 48 are effective as of
the beginning of the Company's 2007 fiscal year, with the cumulative effect of
the change in accounting principle recorded as an adjustment to opening retained
earnings. The Company is currently evaluating the impact of adopting FIN 48 on
its financial statements.
Stock-Based Compensation
Effective, January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R) ("SFAS 123(R)"), "Share-Based
Payment," which establishes accounting for stock-based awards exchanged for
employee services. Under the provisions of SFAS 123(R), share-based compensation
cost is measured at the grant date, based on the fair value of the award, and is
recognized as expense over the employee's requisite service period (generally
the vesting period of the equity grant). The Company amortizes stock-based
compensation by using the straight-line method. The Company elected to adopt the
modified prospective transition method as provided by SFAS 123(R). In accordance
with the requirements of the modified prospective transition method,
consolidated financial statements for prior year periods have not been restated
to reflect the fair value method of expensing share-based compensation.
Additionally, effective with the adoption of SFAS 123(R) excess tax benefits
realized from the exercise of stock-based awards are classified in cash flows
from financing activities.
-7-
Prior to January 1, 2006, the Company applied 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
applied 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"). In accordance with APB 25, no stock-based compensation cost was reflected
in net income for options or purchases under the Company's stock purchase plans.
If the compensation cost for options granted under the Company's stock-based
compensation plans and purchases under the employee stock purchase plan had 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 as follows (in thousands):
Three Month Six Month
Period Ended Period Ended
(In thousands, except July 1, July 1,
per share amounts) 2005 2005
- -----------------------------------------------------------------------
Net income:
As reported $18,780 $36,064
Add: stock-based compensation expense
included in reported net income,
net of tax 861 1,375
Deduct: stock-based compensation expense
determined under the fair value based
method for all awards, net of tax (1,892) (3,170)
- -----------------------------------------------------------------------
Pro forma net income $17,749 $34,269
=======================================================================
Earnings per common share:
As reported
Basic $ 0.69 $ 1.33
Diluted $ 0.67 $ 1.29
Pro forma
Basic $ 0.65 $ 1.26
Diluted $ 0.63 $ 1.23
The fair value of each stock option award is estimated on the date of grant
using the Black-Scholes option valuation model. The Black-Scholes model
incorporates assumptions as to dividend yield, volatility, an appropriate
risk-free interest rate and the expected life of the option. Many of these
assumptions require management's judgment. The Company's volatility is based
upon historical volatility of the Company's stock unless management has reason
to believe that future volatility will differ from the past. The expected term
for grants under SFAS 123(R) are derived using the simplified method which is
the average of the weighted average vesting period and the contractual term. The
risk-free rate is based on the yield on the zero coupon U.S. Treasury in effect
at the time of grant based on the expected term of the option. The fair value of
restricted stock awards is based on the market value at the date of grant.
The Company uses a lattice option-pricing model to estimate the value of
cash-settled share appreciation rights ("cash-settled SARs") due to certain
features included in those awards that are not anticipated in a Black-Scholes
option-pricing model. The lattice option-pricing model incorporates assumptions
as to dividend yield, volatility, risk-free interest rate and a post-vesting
termination rate. Again, some of these assumptions require management's
judgment. The dividend yield, volatility and risk-free interest rates are
determined in the same manner as assumptions used in the Black-Scholes
option-pricing model. The expected life is derived from the output of the
binomial lattice model and represents the period of time that the cash-settled
SARs are expected to be outstanding. The post-vesting termination rate is
estimated based on the Company's past experience with its stock option awards.
Cash-settled SARs are liability-classified awards which are remeasured to fair
value at each reporting date.
-8-
Shares issued under stock compensation plans are issued from the Company's
treasury shares. In December 2005, the Company's board of directors approved a
plan to repurchase 3,000,000 shares. Shares purchased may be held in treasury,
used for acquisitions, used to fund the Company's stock-based benefit and
compensation plans or for other corporate purposes. During the six months ended
June 30, 2006, the Company repurchased 1,224,500 shares under this plan.
Although the Company currently has authority to purchase additional shares under
this plan for the purposes stated above, the timing and extent of such purchases
during the remaining periods of 2006, if any, is dependent upon a number of
factors making it difficult to estimate the number of shares that may be
purchased during this period.
Upon the adoption of SFAS 123(R) the Company recognized a benefit of $0.6
million ($0.3 million after tax) as the cumulative effect of a change in
accounting principle resulting from the requirement to estimate forfeitures of
the Company's restricted stock grants at the date of grant instead of
recognizing them as incurred. The estimated forfeiture rate was applied to the
previously recorded compensation expense of the Company's unvested restricted
stock in determining the cumulative effect of a change in accounting principle.
The cumulative benefit, net of tax, increased both basic and diluted earnings
per share by $0.01 for the six month period ended June 30, 2006.
As a result of the SFAS 123(R) requirements, stock-based compensation costs
increased $1.6 million and $2.9 million before income taxes, or $0.04 and $0.07
per diluted share, in the three and six month periods ended June 30, 2006,
respectively.
Reclassifications
Prior to 2006, the Company included substantially all stock compensation expense
and a 401(k) plan performance contribution as a corporate expense classified
within selling, general and administrative expenses. In conjunction with the
adoption of SFAS 123(R) and pursuant to SEC Staff Accounting Bulletin No. 107,
the Company elected to include stock compensation and the 401(k) plan
performance contribution expense in results of operations of the related
business segment and to classify a portion of these expenses to cost of goods
sold based on the individuals within the business segment that are participants
in these compensation programs. Prior periods have been reclassified to conform
to these changes. This reclassification to prior periods had no impact on net
income or on shareholders' equity as previously reported.
During the second quarter of 2006, the Company transferred certain business
operations related to on-site check printing systems from the Software &
Services business segment to the Printed Products business segment. Accordingly,
prior period results have been reclassified to conform to the 2006
classifications (see Note 13).
Research and Development
For the three and six month periods ended June 30, 2006, the Company incurred
research and development costs of $7.1 million and $13.2 million, respectively.
For the three and six month periods ended July 1, 2005, research and development
costs totaled $6.0 million and $11.7 million, respectively. These costs are
included in operating expenses.
3. Acquisitions
All acquisitions in 2006 and 2005 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. At
June 30, 2006, $7.0 million was being held in escrow to satisfy indemnification
claims which may be asserted by the Company under the terms of the purchase
agreements.
-9-
2006 Acquisitions
On April 28, 2006, Harland Financial Solutions, Inc. ("HFS"), a wholly owned
subsidiary of the Company, acquired the remaining 20% of equity interests in
Cavion LLC ("Cavion") from outside investors for approximately $4.2 million in
cash, including $1.0 million for the net minority interests of Cavion's
operations and acquisition costs. The transaction increased HFS's equity
ownership in Cavion to 100%. The previous 80% ownership in Cavion had been
obtained as a result of the Liberty acquisition in June 2005. The Cavion
operation includes web design, web hosting and Internet banking services and
provides financial institutions with a private secure network to conduct
business with vendors and customers. The results of Cavion's operations have
been included in the Company's operations since the Liberty acquisition. The net
minority interests portion of Cavion's operations was included in the other-net
caption on the condensed consolidated statements of income. Prior to the
acquisition of the remaining 20% equity interest in Cavion, the Company had
approximately $1.0 million of Cavion-related minority interests included in the
other long-term liabilities caption of the condensed consolidated balance sheet.
On January 31, 2006, HFS acquired Financialware, Inc. ("Financialware") for
approximately $7.0 million in a cash for equity transaction. Financialware was a
provider of enterprise content management solutions, serving domestic and
international financial institution clients. The acquisition expands and
strengthens the Company's position in electronic check processing, statement
rendering, document archival and retrieval, report management and image exchange
software. The enterprise content management system technology, through
automation, allows a consolidated view of customer accounts, transactions and
documents via an accessible browser by both the financial institution's
employees and their customers. Financialware's results of operations were
included in the Company's operations as of January 31, 2006.
The estimated fair value of assets and liabilities at the acquisition date
consisted of goodwill of $7.6 million of which $4.9 million is expected to be
deductible for tax purposes, other intangible assets of $4.0 million (estimated
weighted average useful life of nine years), which included $1.2 million in
developed technology (estimated weighted average useful life of six years), and
$2.8 million in customer lists (estimated weighted average useful life of 11
years), other assets of $0.7 million and assumed liabilities of $2.0 million.
The allocation of purchase price is preliminary and subject to refinement as the
Company finalizes the valuation of certain assets and liabilities. The pro forma
effects of these acquisitions were not material to the Company's results of
operations.
2005 Acquisitions
On June 10, 2005, the Company acquired substantially all of the assets of
Liberty Enterprises, Inc. ("Liberty") for approximately $161.7 million in cash,
including acquisition costs. Liberty was a provider of checks, marketing
services, card services, education and e-commerce solutions primarily to credit
unions. The addition of Liberty expanded the Company's presence among credit
unions, and management believes that the combined range of products and services
positions the Company to be a preferred partner for credit unions across the
country.
On April 13, 2005, HFS 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 third party
contractual issues by Mitek Systems.
-10-
On April 4, 2005, HFS acquired Intrieve, Incorporated ("Intrieve") for
approximately $77.1 million, including acquisition costs, in a cash for equity
transaction. This acquisition expanded the HFS product and service offerings to
include outsourced core processing, comprehensive item processing and electronic
banking and payments processing for thrifts and community banks. The acquisition
also included 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 following table summarizes the estimated fair values of the assets acquired
and liabilities assumed on the acquisition dates during 2005 (in thousands):
Weighted Average
Useful Life
Value in Years
- ------------------------------------------------------------------
Current assets $ 25,902
Property, plant and equipment 10,483
Goodwill 130,186
Intangibles:
Customer lists 103,300 18.7
Developed technology 12,640 5.0
Trademarks 7,600 5.4
--------
Total intangibles 123,540
Other assets 1,439
- ---------------------------------------------------------------
Total assets acquired 291,550
- ---------------------------------------------------------------
Current liabilities 37,233
Deferred income taxes 10,565
Other 4,177
- ---------------------------------------------------------------
Total liabilities assumed 51,975
- ---------------------------------------------------------------
Net assets $239,575
===============================================================
The allocation of the purchase price includes $8.4 million for actions taken for
the integration of Liberty operations.
The allocations of purchase price resulted in $130.2 million allocated to
goodwill of which $60.5 million is expected to be deductible for tax purposes.
Goodwill of $48.8 million and $81.4 million was assigned to the Company's
Printed Products and Software & Services business segments, respectively. 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
2005 (in thousands, except per share amounts):
Three Month Six Month
Period Ended Period Ended
July 1, July 1,
(Unaudited) 2005 2005
- ------------------------------------------------------------------
Net Sales $ 266,869 $ 532,266
Net Income $ 18,123 $ 29,776
Earnings per common share:
Basic $ 0.66 $ 1.10
Diluted $ 0.64 $ 1.06
-11-
The unaudited pro forma summary for the period presented includes adjustments
for changes in levels of amortization of intangible assets, interest income,
interest expense, and income taxes. The pro forma results for the three and six
month periods ended July 1, 2005 include $1.9 million and $10.8 million,
respectively, 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.
4. Goodwill and Intangible Assets
The changes in the carrying amounts of goodwill by business segment for the six
month period ended June 30, 2006 are as follows (in thousands):
Printed Software &
Products Services Scantron Consolidated
- ------------------------------------------------------------------------
Balances as of
December 31, 2005 $ 72,128 $241,724 $ 43,391 $357,243
Goodwill acquired
in 2006 - 7,593 - 7,593
Purchase price
allocation adjustments 1,389 3,067 - 4,456
- ------------------------------------------------------------------------
Balances as of
June 30, 2006 $ 73,517 $252,384 $ 43,391 $369,292
========================================================================
Intangible assets with definitive lives were comprised of the following (in
thousands):
June 30, 2006 December 31, 2005
- ------------------------------------------------------------------------
Gross Net Gross Net
Carrying Accum. Carrying Carrying Accum. Carrying
Amount Amort. Amount Amount Amort. Amount
- ------------------------------------------------------------------------
Developed
technology $ 47,182 $(25,184) $ 21,998 $ 45,834 $(22,030) $ 23,804
Customer
Lists 136,105 (33,350) 102,755 133,305 (26,143) 107,162
Trademarks 11,400 (3,004) 8,396 11,400 (2,085) 9,315
Content 2,300 (902) 1,398 2,300 (787) 1,513
- ------------------------------------------------------------------------
Total $196,987 $(62,440) $134,547 $192,839 $(51,045) $141,794
========================================================================
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 $5.7 million for the six month
periods ended June 30, 2006 and July 1, 2005, respectively.
-12-
The estimated future intangible amortization expense as of June 30, 2006 is as
follows (in thousands):
Year Amount
- --------------------------------------------------------------------
Remaining 2006 $ 11,110
2007 21,125
2008 17,998
2009 14,818
2010 13,038
Thereafter 56,458
- --------------------------------------------------------------------
Total $134,547
====================================================================
5. Integration and Reorganization Actions
Upon the acquisition of Liberty, an integration plan for the Liberty operations
was developed that included 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 June 30, 2006,
costs of $8.4 million were recorded for actions taken related to 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.
The following table presents the cumulative net costs of these actions incurred
through June 30, 2006 (in thousands):
Liberty
Integration
- ----------------------------------------------------------------
Employee severance $ 5,937
Contract termination costs
related to leaseholds 1,289
Other 1,176
- ----------------------------------------------------------------
Total $ 8,402
================================================================
The following table reconciles the beginning and ending liability balances for
the six month period ended June 30, 2006 related to the integration plan and are
included in the other accrued liabilities captions on the balance sheet (in
thousands):
Charged to Utilized
----------------- ----------------
Beginning Costs and Ending
Balance Goodwill Expenses Cash Non-Cash Balance
- -------------------------------------------------------------------------------
Liberty integration:
Employee severance $ 2,942 $ 6 $ 29 $(1,918) $ - $ 1,059
Contract termination
costs related to
leaseholds 1,339 (50) - (204) - 1,085
Other - 1,176 - (1,094) - 82
- -------------------------------------------------------------------------------
Total $ 4,281 $ 1,132 $ 29 $(3,216) $ - $ 2,226
===============================================================================
-13-
6. Inventories
As of June 30, 2006 and December 31, 2005, inventories consisted of the
following (in thousands):
June 30, December 31,
2006 2005
- ----------------------------------------------------------------------
Raw materials $ 16,594 $ 17,739
Work in progress 582 596
Finished goods 2,508 2,062
- ----------------------------------------------------------------------
Total $ 19,684 $ 20,397
======================================================================
7. Long Term Debt
In July 2006, the Company entered into a new credit facility (the "Credit
Facility") with a syndicate of banks increasing the amount available from $412.5
million under the previous credit facility to $450.0 million. The Credit
Facility is comprised of an $87.5 million term loan and a $362.5 million
revolving loan both of which mature in 2011. The term loan does not have any
annual repayment requirements. In order to conform to the terms of the Credit
Facility, the Company reclassified $5.0 million of its outstanding debt at June
30, 2006 from short-term to long-term. 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 0.10% 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 Wachovia Bank Base Rate or LIBOR (as
defined therein). The Credit Facility has certain financial covenants including,
among other items, leverage and fixed charge coverage. 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 June 30, 2006, the Company had $270.5 million in outstanding cash borrowings
under the previous Credit Facility, $5.1 million in outstanding letters of
credit and $136.9 million available for borrowing under the previous Credit
Facility. The average interest rate in effect on outstanding cash borrowings at
June 30, 2006 was 6.26%.
8. Income Taxes
The Company's consolidated effective income tax rates were 39.3% and 38.0% for
the first six months of 2006 and the first six months of 2005, respectively. The
increase in the effective income tax rate for the first six months of 2006 was
primarily due to the expiration of the IRC Section 936 U.S. tax credit for the
Company's operations in Puerto Rico and a higher state income tax rate
reflecting the impact of recent acquisitions.
9. Stock Compensation Plans
Employee Stock Purchase Plan
Under the Company's Employee Stock Purchase Plan ("ESPP"), the Company is
authorized to issue up to 5,100,000 shares of common stock to its employees,
most of whom are eligible to participate. Under the ESPP, eligible employees may
exercise an option to purchase common stock through payroll deductions. The
option price is 85% of the lower of the beginning- or end-of-quarter market
price. During the three months ended June 30, 2006, employees exercised 41,894
options to purchase stock at a price of $33.57. At June 30, 2006, there were
94,636 shares of common stock reserved for issuance under the ESPP. The Company
recognized ESPP related compensation expense of $0.3 million and $0.7 million
for the three and six months ended June 30, 2006, respectively.
-14-
Stock Incentive Plans
Under the Company's 1999 Stock Option Plan, the Company may grant stock options
to key employees to purchase common stock at no less than the fair market value
on the date of the grant or issue restricted stock to such employees. The
Company is authorized to issue up to 2,000,000 shares under the plan. Stock
options have a maximum life of ten years and generally vest ratably over a
five-year period beginning on the first anniversary date of the grant. Upon
adoption of the 1999 plan, the Company terminated a previous plan except for
options outstanding thereunder.
In 2000, the Company adopted the 2000 Stock Option Plan which authorizes the
issuance of up to 3,000,000 shares through stock options and grants of
restricted stock. The 2000 Plan is substantially similar to the 1999 Plan,
except that the Company's executive officers are ineligible to receive grants
thereunder.
In 2002, the Company adopted the 2002 Stock Option Plan which authorizes the
issuance of up to 1,000,000 shares through stock options and grants of
restricted stock. The 2002 plan is substantially similar to the 1999 plan.
In 2005, the Company adopted the 2005 New Employee Stock Option Plan which
authorizes the issuance of up to 100,000 shares. The 2005 plan is similar to the
1999 Plan except that existing employees are not eligible to receive stock
options and it is limited to grants of stock options only. Stock options may
only be granted to newly-hired employees or persons rehired following a bona
fide interruption of employment. Pursuant to an exception from the New York
Stock Exchange rules for employment inducement awards, the 2005 Plan was adopted
without shareholder approval.
In April 2006, the Company's shareholders approved the 2006 Incentive Stock Plan
which authorizes the issuance of up to 3,000,000 shares. Under the 2006 Plan,
the Company may award stock options, restricted stock, SARs and performance
share units under the Plan to any employee of the Company. Under this plan, the
Company has granted stock options and cash-settled SARs, both of which vest 25%
per year on the grant date anniversary and expire after seven years, if
unexercised. The cash-settled SARs are subject to a cap represented by the
target price ("Target Price") and require automatic settlement of vested
portions of the awards in the event the closing stock price meets or exceeds the
Target Price for 10 consecutive business days. The cash-settled SARs entitle
employees to receive a payment from the Company for the excess of the fair
market value of a share as of the date of settlement over the grant price per
share, but subject to the Target Price limit.
As of June 30, 2006, there were 5,693,567 shares of common stock reserved for
issuance under these stock option plans.
Restricted stock grants prior to April 2004 generally vest over a period of five
years, subject to earlier vesting if the Company's common stock outperforms the
S&P 500 in two of three consecutive years. The certificates covering the
restricted stock are not issued until the restrictions lapse. The shares have
all the rights of holders of common stock, including the right to receive cash
dividends, but are not transferable. The restricted stock is generally forfeited
if the employee terminates for any reason prior to the lapse in restrictions,
other than death or disability. Commencing in April 2004, restricted stock
grants do not contain the accelerated performance-related vesting described
above and generally vest ratably over five years or, in the case of certain
officers, vest on the third, fourth and fifth anniversary dates at the rate of
one third on each such date.
On December 31, 2005, the conditions for early vesting were met on 145,195
shares after the common stock outperformed the S&P 500 in 2005 and 2004. On
December 31, 2004, the conditions for early vesting were met on 136,500 shares
after the common stock outperformed the S&P 500 in 2004 and 2002.
-15-
In February 2006, the Chief Executive Officer ("CEO") was granted 15,700
restricted shares with performance-based vesting. The basis for vesting is the
cumulative fully-diluted earnings per share of the Company for the years 2006 to
2008. The award is subject to threshold and maximum performance limitations. If
the threshold is met, 3,530 shares would vest. If actual performance exceeds the
threshold (but is less than maximum performance), the number of shares vesting
will be determined on a directly proportional basis using straight-line
interpolation. If the threshold is not achieved, the entire award will be
forfeited and cancelled. However, the award will vest 100% upon (a) the
occurrence of a change in control of the Company, (b) the Company's termination
of the CEO's employment without cause, (c) termination of employment for good
reason or (d) termination of employment by reason of death or disability on or
before December 31, 2009. Dividends are accrued for these shares based on an
estimate of the number of shares that will vest; however, no dividends will be
paid on these shares until the number of shares that vest is determined.
Compensation cost related to this award is based on an estimate of the number of
shares expected to vest.
In August 2005, the CEO was granted 16,900 restricted shares with performance-
based vesting with terms similar to the February 2006 performance-based award.
The basis for vesting is the cumulative fully-diluted earnings per share of the
Company for the years 2005 to 2007. The award is subject to threshold and
maximum performance limitations. If the threshold is met, 3,800 shares would
vest. Compensation cost related to this award is based on an estimate of the
number of shares expected to vest.
In April 2005, the CEO was granted stock options to purchase 500,000 shares of
stock at a price of $37.59. These stock options have a ten-year life and vest
ratably over five years beginning on December 1, 2005.
A summary of stock option transactions for the six months ended June 30, 2006
follows:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic
Exercise Contractual Value
Shares Price Term (000)
- -----------------------------------------------------------------------------
Outstanding - December 31, 2005 2,709,090 $ 25.14
Granted 663,150 41.51
Exercised (200,885) 21.06
Forfeited (74,370) 23.32
- -----------------------------------------------------------------------------
Outstanding - June 30, 2006 3,096,985 $ 28.95 6.1 $ 45,050
=============================================================================
Exercisable - June 30, 2006 1,698,600 $ 23.21 5.0 $ 33,005
=============================================================================
During the six month periods ended June 30, 2006 and July 1, 2005, the total
intrinsic value of options exercised was $3.6 million and $10.7 million,
respectively, and the total amount of cash received from the exercise of these
options was $4.2 million and $9.1 million, respectively. During the six month
periods ended June 30, 2006 and July 1, 2005, the Company recognized an excess
tax benefit of $1.4 million and $4.2 million, respectively from stock option
exercises.
-16-
A summary of cash-settled SAR transactions for the six months ended June 30,
2006 follows:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic
Exercise Contractual Value
Shares Price Term (000)
- -----------------------------------------------------------------------------
Outstanding - December 31, 2005 - $ -
Granted 366,400 41.47
Forfeited (4,500) 41.45
- -----------------------------------------------------------------------------
Outstanding - June 30, 2006 361,900 $ 41.47 6.8 $ 735
=============================================================================
Exercisable - June 30, 2006 - $ - - $ -
=============================================================================
A summary of restricted stock transactions for the six months ended June 30,
2006, follows:
Weighted
Average
Grant Date
Fair
Shares Value
- ----------------------------------------------------------------------
Outstanding - December 31, 2005 673,760 $ 35.41
Granted 33,875 37.85
Restricted stock vested (103,630) 34.92
Forfeited (32,160) 33.63
- ----------------------------------------------------------------------
Outstanding - June 30, 2006 571,845 $ 35.74
======================================================================
The total fair value of restricted stock grants that vested during the six month
periods ended June 30, 2006 and July 1, 2005 was $4.3 million and $2.2 million.
During the six month period ended June 30, 2006, the Company recognized an
excess tax benefit of $0.3 million from vested restricted stock.
Directors Deferred Stock Compensation Plans
The Company has deferred compensation plans for its non-employee directors
covering a maximum of 400,000 shares. At June 30, 2006 and July 1, 2005 there
were 369,716 and 372,097 shares, respectively, reserved for issuance of which
198,457 and 171,974 shares, respectively, were allocated but unissued. The
remaining 171,259 and 200,123 shares, respectively, were reserved and
unallocated under those plans.
-17-
Stock Compensation Costs
The following table presents the classification of stock-based compensation
included in the Company's condensed consolidated statements of income for the
three and six month periods ended June 30, 2006 and July 1, 2005
(in thousands):
Three Month Six Month
Periods Ended Periods Ended
June 30, July 1, June 30, July 1,
2006 2005 2006 2005
- ---------------------------------------------------------------------------
Cost of sales $ 333 $ 73 $ 630 $ 134
Selling, general and
administrative 2,846 1,339 5,265 2,120
- ---------------------------------------------------------------------------
Stock-based compensation 3,179 1,412 5,895 2,254
Less income tax benefits (1,255) (559) (2,314) (879)
- ---------------------------------------------------------------------------
Stock-based compensation,
net of income tax
benefits $ 1,924 $ 853 $ 3,581 $ 1,375
===========================================================================
At June 30, 2006, unrecognized stock-based compensation costs related to
nonvested awards was $31.3 million, which is expected to be recognized over a
weighted average period of 3.1 years.
Estimation of Fair Value
The following presents the estimated weighted average fair values of stock
options granted and the weighted average assumptions used under the
Black-Scholes option pricing model during the indicated periods:
Six Month Periods Ended
June 30, 2006 July 1, 2005
- -----------------------------------------------------------------
Weighted-average fair value $ 11.47 $ 10.82
Expected life in years 4.8 5.0
Risk-free interest rate 5.0% 4.0%
Expected volatility 26.9% 31.8%
Expected dividend yield 1.5% 1.9%
The following presents the estimated weighted average fair values of
cash-settled SAR granted and the weighted average assumptions used under the
binomial option pricing model as of June 30, 2006:
As of
June 30, 2006
- ------------------------------------------------
Weighted-average fair value $ 5.66
Risk-free interest rate 5.1%
Expected volatility 31.7%
Expected dividend yield 1.5%
-18-
10. Comprehensive Income
Other comprehensive income for the Company includes foreign currency translation
adjustments and unrealized gains (losses) on investments. Total comprehensive
income for the three and six month periods ended June 30, 2006 and July 1, 2005
was as follows (in thousands):
Three Month Six Month
Periods Ended Periods Ended
June 30, July 1, June 30, July 1,
2006 2005 2006 2005
- ---------------------------------------------------------------------
Net income: $ 16,509 $ 18,780 $ 37,854 $ 36,064
Other comprehensive
Income (loss):
Foreign exchange
translation adjustments 162 26 230 (128)
Unrealized gains (losses)
on investments, net
of $489, $12, $421,and
$(81) in tax benefits
(provisions) (733) (19) (630) 122
- ----------------------------------------------------------------------
Comprehensive income $ 15,938 $ 18,787 $ 37,454 $ 36,058
======================================================================
11. Earnings per Common Share
The computation of basic and diluted earnings per share for the three and six
month periods ended June 30, 2006 and July 1, 2005 is as follows (in thousands,
except per share amounts):
Three Month Six Month
Periods Ended Periods Ended
June 30, July 1, June 30, July 1,
2006 2005 2006 2005
- ------------------------------------------------------------------------
Computation of basic earnings per common share:
Numerator
Net Income $ 16,509 $ 18,780 $ 37,854 $ 36,064
- ------------------------------------------------------------------------
Denominator
Weighted average shares
outstanding 26,024 27,128 26,235 26,967
Weighted average deferred
shares outstanding under
non-employee directors
compensation plan 192 163 188 160
- ------------------------------------------------------------------------
Weighted average shares
Outstanding - basic 26,216 27,291 26,423 27,127
- ------------------------------------------------------------------------
Earnings per share-basic $ 0.63 $ 0.69 $ 1.43 $ 1.33
========================================================================
Computation of diluted earnings per common share:
Numerator
Net Income $ 16,509 $ 18,780 $ 37,854 $ 36,064
- ------------------------------------------------------------------------
Denominator
Weighted average shares
outstanding - basic 26,216 27,291 26,423 27,127
Dilutive effect of stock
options and restricted
stock 817 820 777 849
- ------------------------------------------------------------------------
Weighted average shares
outstanding - diluted 27,033 28,111 27,200 27,976
- ------------------------------------------------------------------------
Earnings per share-diluted $ 0.61 $ 0.67 $ 1.39 $ 1.29
========================================================================
-19-
The potentially dilutive common shares relate to options and restricted stock
granted under stock compensation plans. Potentially dilutive common shares that
were not included in the calculation of diluted earnings per share because they
were anti-dilutive were 85,856 and 644 shares for the three month periods ended
June 30, 2006 and July 1, 2005, respectively, and were 77,604 and 322 shares for
the six month periods ended June 30, 2006 and July 1, 2005, respectively.
12. Postretirement Benefits
The Company sponsors two unfunded defined postretirement benefit plans that
cover certain salaried and nonsalaried employees. One plan provides health care
benefits and the other provides life insurance benefits. The medical plan is
contributory and contributions are adjusted annually based on actual claims
experience. During the three and six month periods ended June 30, 2006, the
Company contributed $0.2 million and $0.4 million, respectively to the plans.
Net periodic postretirement costs for the three and six month periods ended June
30, 2006 and July 1, 2005 are summarized as follows (in thousands):
Three Month Six Month
Periods Ended Periods Ended
June 30, July 1, June 30, July 1,
2006 2005 2006 2005
- ------------------------------------------------------------------------
Interest on APBO $ 305 $ 304 $ 610 $ 606
Net amortization 70 75 140 130
- ------------------------------------------------------------------------
Total $ 375 $ 379 $ 750 $ 736
========================================================================
13. Business Segments
The Company operates its business in three segments. The Company has organized
its business segments based on products, services and markets served. Each
business segment has a division president who reports 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
payment 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.
The Company's operations are primarily in the United States and Puerto Rico.
During the six month periods ended June 30, 2006 and July 1, 2005 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.
-20-
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. Certain 2005 stock compensation expenses and a 401(k) plan
performance contribution were reclassified from Corporate to the related
business segments to conform to the 2006 classifications. 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 six month periods
ended June 30, 2006 and July 1, 2005 was as follows (in thousands):
Business Segment
-------------------------------
Printed Software & Corporate & Consoli-
Products Services Scantron Eliminations dated
- --------------------------------------------------------------------------------
For the three month periods ended:
June 30, 2006
Sales $ 158,956 $ 73,596 $ 27,111 $ (249) $ 259,414
Income (loss) 26,492 7,592 6,334 (13,058) 27,360
July 1, 2005
Sales $ 150,116 $ 61,973 $ 27,327 $ (17) $ 239,399
Income (loss) 27,099 6,700 5,357 (8,865) 30,291
For the six month periods ended:
June 30, 2006
Sales $ 333,751 $ 142,903 $ 56,823 $ (599) $ 532,878
Income (loss) 59,565 12,559 14,339 (24,716) 61,747
July 1, 2005
Sales $ 290,564 $ 109,593 $ 55,541 $ (452) $ 455,246
Income (loss) 51,476 10,892 11,813 (16,013) 58,168
14. 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.
-21-
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, 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, 2005 (the "2005 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 was no material changes
in its critical accounting policies during the six-month period ended June 30,
2006, other than the change in accounting principle described below. See the
2005 Form 10-K for additional disclosure with respect to the Company's critical
accounting policies.
Change in Accounting Principle
Effective, January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R) ("SFAS 123(R)"), "Share-Based
Payment," which establishes accounting for stock-based awards exchanged for
employee services. Under the provisions of SFAS 123(R), share-based compensation
cost is measured at the grant date, based on the fair value of the award, and is
recognized as expense over the employee's requisite service period (generally
the vesting period of the equity grant). The Company amortizes stock-based
compensation by using the straight-line method. The Company elected to adopt the
modified prospective transition method as provided by SFAS 123(R). In accordance
with the requirements of the modified prospective method, consolidated financial
statements for prior year periods have not been restated to reflect the fair
value method of expensing share-based compensation.
Prior to January 1, 2006, the Company applied 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
applied 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"). In accordance with APB 25, no stock-based compensation cost was reflected
in net income for options or purchases under the Company's employee stock
purchase plan.
-22-
Upon the adoption of SFAS 123(R) the Company recognized a benefit of $0.6
million ($0.3 million after tax) as the cumulative effect of a change in
accounting principle resulting from the requirement to estimate forfeitures of
the Company's restricted stock grants at the date of grant instead of
recognizing them as incurred. The estimated forfeiture rate was applied to the
previously recorded compensation expense of the Company's unvested restricted
stock in determining the cumulative effect of a change in accounting principle.
The cumulative benefit, net of tax, increased both basic and diluted earnings
per share by $0.01.
As a result of the SFAS 123(R) requirement to expense stock options, stock-based
compensation costs increased $1.6 million and $2.9 million before income taxes,
or $0.04 and $0.07 per diluted share, in the three and six month periods ended
June 30, 2006, respectively. The Company believes the adoption of SFAS 123(R)
will continue to have a material effect on its future period results of
operations and financial position dependent upon the level of awards granted. At
June 30, 2006, unrecognized stock-based compensation costs related to nonvested
awards was $31.3 million, which is expected to be recognized over a weighted
average period of 3.1 years. See Notes 2 and 9 to the Condensed Consolidated
Financial Statements regarding the Company's accounting policies and other
information pertaining to stock compensation plans.
Reclassifications
Prior to 2006, the Company included substantially all stock compensation expense
and a 401(k) plan performance contribution as a corporate expense classified
within selling, general and administrative expenses. In conjunction with the
adoption of SFAS 123(R) and pursuant to SEC Staff Accounting Bulletin No. 107,
the Company elected to include stock compensation and the 401(k) plan
performance contribution expense in results of operations of the related
business segment and to classify a portion of these expenses to cost of goods
sold. Prior periods have been reclassified to conform to these changes. This
reclassification to prior periods had no impact on net income or on
shareholders' equity as previously reported.
The following table presents stock-based compensation included in the Company's
condensed consolidated statements of income by classification and by business
segment for the three and six month periods ended June 30, 2006 and July 1, 2005
(in thousands):
Three Month Six Month
Periods Ended Periods Ended
June 30, July 1, June 30, July 1,
2006 2005 2006 2005
- ------------------------------------------------------------------------
Stock-based compensation
included in:
Cost of sales $ 333 $ 73 $ 630 $ 134
Selling, general and
administrative 2,846 1,339 5,265 2,120
- ------------------------------------------------------------------------
Total stock-based compensation $3,179 $1,412 $5,895 $2,254
========================================================================
Stock-based compensation
included in:
Printed Products $ 791 $ 265 $1,492 $ 530
Software & Services 1,000 277 1,812 532
Scantron 351 226 646 433
Corporate 1,037 644 1,945 759
-----------------------------------------------------------------------
Total stock-based compensation $3,179 $1,412 $5,895 $2,254
========================================================================
-23-
Significant Events
In July 2006, the Company entered into a new credit facility with a syndicate of
banks increasing the amount from $412.5 million under the previous credit
facility to $450.0 million. The new credit facility is comprised of a $362.5
million revolving loan and an $87.5 million term loan both of which mature in
2011.
On April 28, 2006, Harland Financial Solutions, Inc. ("HFS"), a wholly owned
subsidiary of the Company, acquired the remaining 20% of equity interests in
Cavion LLC ("Cavion") held by outside investors for approximately $4.2 million
in cash. The transaction increased HFS's equity ownership in Cavion to 100%.
On January 31, 2006, HFS acquired Financialware, Inc. ("Financialware") for
approximately $7.0 million 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. In April 2005, the Company acquired Intrieve, Incorporated ("Intrieve")
for approximately $77.1 million, including acquisition costs, in a cash for
equity transaction. See Note 3 to the 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 would not renew its contract that expired in March 2006. The
annual sales under this contract were approximately $32 million with 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. This customer loss was effective during March 2006.
RESULTS OF OPERATIONS - SECOND QUARTER OF 2006 VERSUS SECOND QUARTER OF 2005
Sales
Consolidated sales and sales by segment for the three month periods ended June
30, 2006 and July 1, 2005 were as follows (in thousands):
Three Month Periods Ended
June 30, 2006 July 1, 2005
- ----------------------------------------------------------------------
% of % of
Amount Total Amount Total
- ----------------------------------------------------------------------
Printed Products $158,956 61.3% $150,116 62.7%
Software & Services 73,596 28.4% 61,973 25.9%
Scantron 27,111 10.5% 27,327 11.4%
Eliminations (249) (0.2%) (17) (0.0%)
- ----------------------------------------------------------------------
Total $259,414 100.0% $239,399 100.0%
======================================================================
Consolidated sales increased $20.0 million, or 8.4%, in the second quarter of
2006 from the second quarter of 2005. 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 $6.2
million, or 3.3%, to $195.0 million in the second quarter of 2006 from $188.8
million in the second quarter of 2005. Sales of services, which consist of
software maintenance services, field maintenance services, core processing
services, analytical and consulting services and other services, increased $13.8
million, or 27.3%, to $64.4 million in the second quarter of 2006 from $50.6
million in the second quarter of 2005.
-24-
Printed Products sales increased $8.8 million, or 5.9%, in the second quarter of
2006 from the second quarter of 2005. The portions of the acquired Liberty
operations aligned under Printed Products contributed $19.6 million towards the
increase. Legacy imprint check printing operations (which exclude Liberty
operations) were unfavorably impacted by a volume decrease of 9.7% and an
average price per unit decrease of 1.5%. The volume decrease was primarily
attributable to a major customer loss in March 2006 and to general market volume
decline related to alternative payments systems. The decrease in average price
per unit was primarily due to a decline in contract termination payments from
$6.0 million received in the second quarter of 2005 to $0.8 million received in
the second quarter of 2006 substantially offset by a price increase implemented
during the first quarter of 2006. Sales of computer checks and related products
increased 3.4% in the second quarter of 2006 compared to the second quarter of
2005 due primarily to increased volume through the financial institution channel
and the promotion of premium delivery options. Sales of direct marketing
activities increased 6.2% in the second quarter of 2006 compared to the second
quarter of 2005 primarily due to operations acquired in the Liberty acquisition
that have been aligned under direct marketing partially offset by lower volumes
in legacy direct marketing activities.
Software & Services sales increased $11.6 million, or 18.8%, in the second
quarter of 2006 from the second quarter of 2005. The increase in sales was due
primarily to acquisitions and organic sales increases in core systems and
lending solutions. See Note 3 to the Condensed Consolidated Financial Statements
regarding business acquisitions in 2006 and 2005. Excluding the impact of the
acquisitions, Software & Services sales increased approximately $4.1 million, or
6.5%, primarily due to increases in core systems and retail and lending
solutions sales. Core systems organic sales increased 7.3% or $2.2 million
primarily due to higher sales in banking and credit union systems and service
bureau operations. Retail and lending solutions organic sales increased 8.0% or
$2.4 million in the second quarter of 2006 compared to the second quarter of
2005 primarily due to increased sales of lending solutions partially offset by a
decrease in mortgage and retail solution sales. Payments and electronic commerce
organic sales decreased 19.4%, or $0.5 million, in the second quarter of 2006
compared to the second quarter of 2005 primarily due to lower volumes in the
electronic funds transfer business largely attributable to customer losses.
At June 30, 2006, Software & Services backlog, which consists of contracted
products and services prior to delivery, was $258.5 million, an increase of
$13.8 million, or 5.6% compared to $244.7 million at the end of the second
quarter of 2005, and increased $2.1 million, or 0.8%, from $256.4 million at the
end of the first quarter of 2006. The increase from the second quarter of 2005
was primarily in lending solutions and retail solutions partially offset by
decreases in service bureau services and mortgage solutions. The increase from
the first quarter of 2006 was primarily in lending solutions and retail
solutions. Approximately $97.3 million, or 37.6%, of the backlog at June 30,
2006 is expected to be delivered over the next twelve months and $161.2 million,
or 62.4%, is expected to be delivered beyond the next twelve months due to the
long-term nature of certain service contracts.
Scantron sales decreased $0.2 million, or 0.8%, in the second quarter of 2006
from the second quarter of 2005 primarily due to decreases in sales of testing
and custom data collection forms and imaging solutions partially offset by
increases in survey services and testing and assessment software. Scantron
backlog at the end of the second quarter of 2006 was $17.2 million, a decrease
of 15.7% compared to $20.4 million at the end of the second quarter of 2005, and
increased $0.3 million, or 1.8%, from $16.9 million at the end of the first
quarter of 2006. Approximately $15.2 million of the backlog at June 30, 2006 is
expected to be delivered within twelve months or less.
-25-
Gross Profit
Consolidated gross profit and gross profit by segment for the three month
periods ended June 30, 2006 and July 1, 2005 were as follows (in thousands):
Three Month Periods Ended
June 30, 2006 July 1, 2005
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $ 70,350 44.3% $ 65,374 43.5%
Software & Services 44,880 61.0% 38,958 62.9%
Scantron 14,199 52.4% 15,116 55.3%
- ----------------------------------------------------------------------
Total $129,429 49.9% $119,448 49.9%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Printed Products gross profit increased $5.0 million, or 7.6%, in the second
quarter of 2006 compared to the second quarter of 2005 and increased as a
percentage of sales from 43.5% in the second quarter of 2005 to 44.3% in the
second quarter of 2006. The portions of the acquired Liberty operations aligned
under Printed Products, sales increases in computer checks and related products
and direct marketing activities, and efficiencies gained due to plant
consolidations accounted for the gross profit increase in the second quarter of
2006. During the second quarter of 2006, six Liberty check printing facilities
were closed and the business was transferred into the legacy imprint check
printing operations. Printed Product's gross profit was unfavorably impacted by
sales decreases related to the previously discussed customer loss and general
volume erosion.
Software & Services gross profit increased $5.9 million, or 15.2%, in the second
quarter of 2006 compared to the second quarter of 2005. The gross profit
increase was due in part to businesses acquired in 2005 and 2006, sales mix and
lower costs in its other businesses. As a percentage of sales, Software &
Services gross profit decreased to 61.0% in the second quarter of 2006 from
62.9% in the second quarter of 2005 due primarily to the lower margin nature of
the acquired operations. Excluding the impact of acquisitions, Software &
Services gross profit increased approximately 8% in the second quarter of 2006
compared to the second quarter of 2005 due primarily to organic sales growth.
Scantron gross profit decreased $0.9 million, or 6.1%, in the second quarter of
2006 compared to the first quarter of 2005. The gross profit decrease was due
primarily to the decrease in sales and to sales mix. As a percentage of sales,
Scantron gross profit decreased from 55.3% for the second quarter of 2005 to
52.4% for the second quarter of 2006 primarily due to the impact of lower forms
volumes.
-26-
Selling, General & Administrative Expenses (SG&A)
Consolidated SG&A and SG&A by segment for the three month periods ended June 30,
2006 and July 1, 2005 were as follows (in thousands):
Three Month Periods Ended
June 30, 2006 July 1, 2005
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $ 42,377 26.7% $ 37,844 25.2%
Software & Services 35,166 47.8% 30,429 49.1%
Scantron 7,809 28.8% 9,693 35.5%
Corporate 8,890 7,100
- ----------------------------------------------------------------------
Total $ 94,242 36.3% $ 85,066 35.5%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Printed Products SG&A increased $4.5 million, or 12.0%, in the second quarter of
2006 from the second quarter of 2005. The increase was primarily due to the
portions of the acquired Liberty operations aligned under Printed Products which
accounted for the majority of the increase and the impact of implementing SFAS
123(R), the new accounting pronouncement for stock-based compensation, partially
offset by lower incentive compensation costs, lower call center costs and lower
marketing expenditures.
Software and Services SG&A increased $4.7 million, or 15.6%, in the second
quarter of 2006 from the second quarter of 2005. The increase was primarily due
to increased expenses related to operations acquired in 2005 and 2006, business
development expenses in the payments and electronic commerce business unit and
the impact of implementing SFAS 123(R) partially offset by lower incentive
compensation costs.
Scantron SG&A decreased $1.9 million, or 19.4%, in the second quarter of 2006
from the second quarter of 2005. The decrease was primarily due to lower product
development costs and lower selling and marketing expenses attributable largely
to cost reductions implemented in late 2005 and lower incentive compensation
costs.
Corporate SG&A increased $1.8 million, or 25.2%, in the second quarter of 2006
from the second quarter of 2005. The increase was primarily due to the impact of
implementing SFAS 123(R), increases in fees for legal and audit services and an
increase in headcount primarily for business development activities and
information security services. These increases were partially offset by a
decrease in incentive compensation costs based on the Company's financial
performance and a reduction in compensation costs related to a decrease in the
fair value of assets of a nonqualified deferred compensation plan.
Amortization of Intangibles
Amortization of intangible assets increased $1.7 million, or 68.6%, to $4.1
million in the second quarter of 2006 from $2.4 million in the second quarter of
2005. The increase was primarily due to the Liberty operations acquired in 2005
and Financialware operations acquired in 2006.
Income from Operations
Income from operations decreased $0.9 million, or 2.7%, from $32.0 million in
the second quarter of 2005 to $31.1 million in the second quarter of 2006,
primarily due to higher SG&A expenses and amortization of intangible assets in
2006, which were partially offset by higher gross profit.
-27-
Other Income (Expense)
Other Income (Expense) increased $2.1 million to an expense of $3.8 million in
the second quarter of 2006 from an expense of $1.7 million in the second quarter
of 2005. The increase was primarily due to an increase in interest expense which
resulted from higher amounts of debt outstanding and higher average interest
rates in the second quarter of 2006 compared to the second quarter of 2005.
Income Before Income Taxes and Cumulative Effect of Change in Accounting
Principle
Income before income taxes decreased $2.9 million, or 9.7%, to $27.4 million in
the second quarter of 2006 from $30.3 million in the second quarter of 2005 due
to decreased income from operations and increased interest expense.
Income Taxes
Effective income tax rates were 39.7% and 38.0% for the second quarter of 2006
and the second quarter of 2005, respectively. The increase in the effective tax
rate for the second quarter of 2006 was primarily due to the expiration of the
IRC Section 936 U.S. tax credit for the Company's operations in Puerto Rico, a
higher state income tax rate reflecting the impact of recent acquisitions and an
adjustment to reflect the year-to-date impact of an increase in the estimated
effective tax rate for 2006 from 39.0% to 39.25%.
Net Income and Earnings Per Share
Net income in the second quarter of 2006 was $16.5 million compared to $18.8
million in the second quarter of 2005. Basic and diluted earnings per share were
$0.63 and $0.61, respectively, for the second quarter of 2006 compared to basic
and diluted earnings per share of $0.69 and $0.67, respectively, for the second
quarter of 2005.
RESULTS OF OPERATIONS - YEAR TO DATE 2006 VERSUS YEAR TO DATE 2005
Sales
Consolidated sales and sales by segment for the six month periods ended June 30,
2006 and July 1, 2005 were as follows (in thousands):
Six Month Periods Ended
June 30, 2006 July 1, 2005
- ----------------------------------------------------------------------
% of % of
Amount Total Amount Total
- ----------------------------------------------------------------------
Printed Products $333,751 62.6% $290,564 63.8%
Software & Services 142,903 26.8% 109,593 24.1%
Scantron 56,823 10.7% 55,541 12.2%
Eliminations (599) (0.1%) (452) (0.1%)
- ----------------------------------------------------------------------
Total $532,878 100.0% $455,246 100.0%
======================================================================
-28-
Consolidated sales increased $77.6 million, or 17.1%, for the six month period
ended June 30, 2006 from the six month period ended July 1, 2005. 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 $41.1
million, or 11.3%, to $404.2 million for the first six months of 2006 from
$363.1 million the first six months of 2005. Sales of services, which consist of
software maintenance services, field maintenance services, core processing
services, analytical and consulting services and other services increased $36.6
million, or 39.7%, to $128.7 million for the first six months of 2006 from $92.1
for the first six months of 2005.
Printed Products sales increased $43.2 million, or 14.9%, in the first six
months of 2006 from the first six months of 2005. The increase was primarily due
to the Liberty acquisition (see Note 3 to the Condensed Consolidated Financial
Statements included in this report) and to increased sales in direct marketing
activities and computer checks and related products. The increase in sales was
partially offset by a 4.1% decrease in sales in legacy imprint check printing
operations, which exclude Liberty operations, in the first six months of 2006
compared to the first six months of 2005 due to a volume decrease of 5.8%
related primarily to the loss of a large customer and general market volume
decline. The volume decrease was partially offset by an average price per unit
increase of 1.8%. The increase in average price per unit was primarily due to a
price increase implemented during the first quarter of 2006 substantially offset
by a decline in contract termination payments from $6.6 million received in the
first six months of 2005 to $1.4 million received in the first six months of
2006. Sales of computer checks and related products increased 4.1% for the first
six months of 2006 compared to the first six months of 2005 due primarily to
higher sales from the financial institution channel partially offset by lower
sales from the software customer channel. Sales of direct marketing activities
increased 13.3% for the first six months of 2006 compared to the first six
months of 2005 due to acquired Liberty operations that have been aligned under
direct marketing, new business with a national credit card company, expansion in
statement printing sales and increased volumes in on-going direct marketing
programs.
Software & Services sales increased $33.3 million, or 30.4%, in the first six
months of 2006 from the first six months of 2005. The increase in sales was due
primarily to the Intrieve acquisition, the portions of the operations from the
Liberty acquisition that were aligned under Software & Services and organic
sales increases in core systems and retail and lending solutions. Excluding the
impact of the acquisitions, Software & Services sales increased approximately
$7.0 million, or 6.3%, due primarily to increases in credit union and banking
core systems sales and lending sales. Core systems organic sales increased 8.8%
or $4.4 million primarily due to higher sales in credit union and banking
systems and service bureau operations. Retail and lending solutions organic
sales increased 5.4% or $3.1 million in the first six months of 2006 compared to
the first six months of 2005 primarily due to increased sales of lending
solutions partially offset by a decrease in mortgage and retail solutions sales.
Scantron sales increased $1.3 million, or 2.3%, in the first six months of 2006
from the first six months of 2005. The increase was due primarily to increases
in sales of field maintenance services, survey solution products and services,
testing and assessment and data collection software products, partially offset
by decreases in optical mark reading equipment, custom data collection forms and
imaging solutions. Sales of hardware were lower for commercial market
applications and non-testing applications in the education market due to a
continuing trend in data collection methods moving away from optical mark
reading to imaging and direct input technologies.
-29-
Gross Profit
Consolidated gross profit and gross profit by segment for the six month periods
ended June 30, 2006 and July 1, 2005 were as follows (in thousands):
Six Month Periods Ended
June 30, 2006 July 1, 2005
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $146,767 44.0% $122,704 42.2%
Software & Services 86,179 60.3% 70,447 64.3%
Scantron 30,733 54.1% 30,797 55.4%
- ----------------------------------------------------------------------
Total $263,679 49.5% $223,948 49.2%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
Printed Products gross profit increased $24.1 million, or 19.6%, in the first
six months of 2006 from the first six months of 2005 and as a percentage of
sales was 44.0% in the first six months of 2006 compared to 42.2% in the first
six months of 2005. The Printed Products gross profit increase was primarily due
to the Liberty acquisition and sales increases in direct marketing operations
and computer checks and related products partially offset by a sales decrease in
legacy imprint check printing operations (which exclude Liberty operations).
Software & Services gross profit increased $15.7 million, or 22.3%, in the first
six months of 2006 from the first six months of 2005 primarily due to
acquisitions and an increase in organic sales. As a percentage of sales,
Software & Services gross profit decreased to 60.3% in the first six months of
2006 from 64.3% in the first six months of 2005, due primarily to the lower
margin nature of the acquired operations.
Scantron gross profit decreased $0.1 million, or 0.2%, in the first six months
of 2006 from the first six months of 2005 primarily due to a change in sales
mix. As a percentage of sales, Scantron gross profit decreased from 55.4% in the
first six months of 2005 to 54.1% in the first six months of 2006.
Selling, General & Administrative Expenses
Consolidated SG&A and SG&A by segment for the six month periods ended June 30,
2006 and July 1, 2005 were as follows (in thousands):
Six Month Periods Ended
June 30, 2006 July 1, 2005
- ----------------------------------------------------------------------
% of % of
Amount Sales(a) Amount Sales(a)
- ----------------------------------------------------------------------
Printed Products $ 84,055 25.2% $ 70,858 24.4%
Software & Services 69,347 48.5% 56,795 51.8%
Scantron 16,269 28.6% 18,820 33.9%
Corporate 17,108 13,033
- ----------------------------------------------------------------------
Total $186,779 35.1% $159,506 35.0%
======================================================================
<FN>
(a) Percentage of sales for each segment is calculated using sales for that
segment.
</FN>
-30-
Printed Products SG&A increased $13.2 million, or 18.6%, in the first six months
of 2006 from the first six months of 2005. The increase was primarily due to the
portions of the acquired Liberty operations aligned under Printed Products,
which accounted for the majority of the increase, and the impact of implementing
SFAS 123(R) partially offset by decreases in marketing, information technology
and call center expenses.
Software and Services SG&A increased $12.6 million, or 22.1%, in the first six
months of 2006 from the first six months of 2005. The increase was due primarily
to expenses related to acquired operations, increased expenses for core systems
and the impact of implementing SFAS 123(R).
Scantron SG&A decreased $2.6 million, or 13.6%, in the first six months of 2006
from the first six months of 2005. The decrease was due primarily to lower
development costs and lower selling and marketing expenses attributable largely
to cost reductions implemented in late 2005 partially offset by the impact of
implementing SFAS 123(R).
Corporate SG&A increased $4.1 million, or 31.3% in the first six months of 2006
compared to the first six months of 2005. The increase was due primarily to the
impact of implementing SFAS 123(R), increased headcount, increased expenses
related to employee incentive compensation and retirement plans and increased
amortization expense for restricted stock grants.
Amortization of Intangibles
Amortization of intangible assets increased $4.7 million, or 138.5%, to $8.1
million in the first six months of 2006 from $3.4 million in the first six
months of 2005. The increase was primarily due to the Intrieve and Liberty
acquisitions which occurred during the second quarter of 2005.
Income from Operations
Income from operations increased $7.8 million, or 12.7%, to $68.8 million in the
first six months of 2006 from $61.0 million in the first six months of 2005,
primarily due to higher gross profit which was partially offset by increases in
SG&A and amortization of intangibles in the first six months of 2006.
Other Income (Expense)
Other Income (Expense) increased $4.1 million to an expense of $7.0 million in
the first six months of 2006 from an expense of $2.9 million in the first six
months of 2005. 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 six months of 2006 compared to the first six
months of 2005. The increase in the amounts of debt outstanding resulted from
the Intrieve and Liberty acquisitions and expenditures to repurchase the
Company's common stock.
Income before Income Taxes and Cumulative Effect of Change in Accounting
Principle
Income before income taxes increased $3.5 million, or 6.2%, to $61.7 million in
the first six months of 2006 from $58.2 million in the first six months of 2005
due to increased income from operations partially offset by increased interest
expense.
-31-
Income Taxes
Effective income tax rates were 39.3% and 38.0% for the first six months of 2006
and the first six months of 2005, respectively. The increase in the effective
tax rate for the first six months of 2006 was primarily due to the expiration of
the IRC Section 936 U.S. tax credit for the Company's operations in Puerto Rico
and a higher state income tax rate reflecting the impact of recent acquisitions.
Cumulative Effect of Change in Accounting Principle
Upon the adoption of SFAS 123(R) the Company recognized a benefit of $0.6
million ($0.3 million after tax) as a cumulative effect of a change in
accounting principle resulting from the requirement to estimate forfeitures of
the Company's restricted stock grants at the date of grant instead of
recognizing them as incurred. The estimated forfeiture rate was applied to the
previously recorded compensation expense of the Company's unvested restricted
stock in determining the cumulative effect of a change in accounting principle.
Net Income and Earnings Per Share
Net income in the first six months of 2006 was $37.9 million compared to $36.1
million in the first six months of 2005. Basic and diluted earnings per share
were $1.43 and $1.39, respectively, for the first six months of 2006 compared to
basic and diluted earnings per share of $1.33 and $1.29, respectively, for the
first six months of 2005. The cumulative effect of a change in accounting
principle, net of tax, increased both basic and diluted earnings per share by
$0.01 in the first six months of 2006.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Sources and Uses of Cash
- ------------------------------------------------------------------------
Six Month Periods Ended
(In thousands) June 30, 2006 July 1, 2005
- ------------------------------------------------------------------------
Net cash provided by
operating activities $ 55,198 $ 63,681
Net cash (used for)
investing activities (21,578) (248,401)
Net cash (used for) provided by
financing activities (33,793) 185,769
========================================================================
Cash flow provided from operations decreased $8.5 million, or 13.3%, in the
first six months of 2006 compared to the first six months of 2005. The decrease
was primarily due to an increase in working capital, the impact of adopting SFAS
123(R) (see note 2 to the Condensed Consolidated Statements), whereby tax
benefits from stock compensation which were previously included in cash flows
from operations are now included in cash flows from financing, and an increase
in upfront contract payments. The decrease was partially offset by cash provided
by net income adjusted for depreciation, amortization and the cumulative effect
of change in accounting principle (net of taxes) which increased $7.0 million in
the first six months of 2006 compared to the first six months of 2005. An
increase in stock-based compensation also had a favorable impact on cash flow
provided by operations in the first six months of 2006 compared with the first
six months of 2005. The principal uses of cash in the first six months of 2006
were for repurchases of stock ($49.2 million), upfront payment contracts ($19.5
million), capital expenditures ($11.7 million), business acquisitions ($10.1
million) and dividend payments to shareholders ($8.1 million). Cash from the
Company's credit facility provided a net inflow of $15.9 million in the first
six months of 2006. During the first six months of 2006, cash flow provided by
the issuance of treasury stock totaled $7.4 million as a result of the exercise
of stock options and the employee stock purchase plan.
-32-
Purchases of property, plant and equipment totaled $11.7 million in the first
six months of 2006, an increase of $0.4 million, compared to $11.3 million in
the first six months of 2005 and were primarily in Printed Products for systems
development and equipment costs related to acquisition integration activities.
In July 2006, the Company entered into a new credit facility (the "Credit
Facility") with a syndicate of banks increasing the amount available from $412.5
million under the previous credit facility to $450.0 million. The Credit
Facility is comprised of a $362.5 million revolving loan and an $87.5 million
term loan both of which mature in 2011. The term loan does not have any annual
repayment requirements. In order to conform to the terms of the Credit Facility,
the Company reclassified $5.0 million of its outstanding debt at June 30, 2006
from short-term to long-term. 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 0.10% 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 Wachovia Bank Base Rate or LIBOR (as defined therein).
The Credit Facility has certain financial covenants including, among other
items, leverage and fixed charge coverage. 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 June 30, 2006, the total size of the Credit Facility was $412.5 million
consisting of $270.5 million in outstanding cash borrowings, $5.1 million in
outstanding letters of credit and $136.9 million available for borrowing. The
average interest rate in effect on outstanding cash borrowings at June 30, 2006
was 6.26%.
In December 2005, the Board of Directors authorized the purchase of 3,000,000
shares of its 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. During the first
six months of 2006, the Company purchased 1,224,500 shares of its common stock
for a total cost of $49.2 million or an average cost of $40.16 per share. As of
June 30, 2006, 1,775,500 shares remained under the current authorization.
At June 30, 2006, the Company had $10.1 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 has contracts with certain customers that provide for future
payments to the customers. 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. As of June 30, 2006,
the remaining payment obligations under the existing customer contracts are
scheduled to be paid as follows: $1.7 million for the six months ending December
31, 2006; $34.4 million for the two year period ending December 31, 2008 and
$14.8 million for the year ending December 31, 2009.
-33-
Borrowings under the Company's line of credit increased $15.9 million since
December 31, 2005 from $254.6 million to $270.5 million primarily due to the
repurchases of its common stock, the acquisition of Financialware, Inc and the
acquisition of the minority interests of Cavion LLC. Other contractual
obligations and commitments have not increased materially since December 31,
2005. See the 2005 Form 10-K with respect to the Company's other contractual
obligations and commitments.
ACQUISITIONS
All acquisitions in 2006 and 2005 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 2006 is expected to be higher than 2005 with all three segments
expected to show growth in sales and income before income taxes. The impact of
implementing FASB Statement No. 123R, "Share-Based Payment" effective January 1,
2006, combined with expected higher interest expense and a higher effective
income tax rate, are expected to partially offset the favorable impact of growth
in sales and income before income taxes for the three operating segments.
The Company believes cash flow will remain strong in all business units in 2006.
The Company currently estimates that capital expenditures will range from $26
million to $29 million. The Company believes upfront contract payments in 2006
will be slightly lower than 2005 based on commitments in place at the beginning
of the year. The Company currently expects depreciation and amortization in 2006
will approximate 2005 and that interest expense will be approximately $15
million. The Company also expects weighted average diluted shares outstanding
will be approximately 27.0 million which reflects the impact of repurchases of
common stock during the second quarter of 2006 and the effective income tax rate
will be approximately 39.25%.
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.
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 in Item 1A of the 2005 Form 10-K and are
incorporated into this Item 2 of this report as if fully stated herein, 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.
-34-
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 $7.9 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. 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. As of June
30, 2006, there were no interest rate swap agreements in effect. At June 30,
2006, the Company had outstanding variable rate debt of $270.5 million. The
impact on quarterly results of operations of a hypothetical one-point interest
rate change on the outstanding debt as of June 30, 2006 would be approximately
$410,000.
Equity Price Risk
The fair value of the Company's trading securities investments, which is 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.
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 June 30, 2006:
Carrying
(In thousands) Value (a) High (b) Low (b)
- -----------------------------------------------------------------------------
Investment in Mitek $2,316 $3,921 $1,179
<FN>
(a) Based on market value as of June 30, 2006 (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 June 30, 2006.
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Changes in Internal Control over Financial Reporting
On January 31, 2006, HFS acquired Financialware, Inc. ("Financialware") for
approximately $7.0 million in a cash for equity transaction. For more details on
this acquisition, see Note 3 to the Condensed Consolidated Financial Statements.
The Company has not evaluated any changes in internal control over financial
reporting associated with this acquisition, and, therefore, any material changes
that might result are not included in this report. The Company will disclose any
material changes resulting from this acquisition within the annual assessment
reports of internal control over financial reporting that are required to
include them. The total assets of the acquisition constitute approximately 1.0%
of consolidated assets as of June 30, 2006.
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.
ITEM 1A. RISK FACTORS
In the Company's 2005 Form 10-K, the risk factors relating to the Company's
business and operations were set forth. Reference should be made to the 2005
Form 10-K for the risks that could materially adversely affect the result of
operations and financial condition of the Company.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the second quarter ended June 30, 2006, 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
- ------------------------------------------------------------------------
April 1 - April 30 - $ - - 2,492,900
May 1 - May 31 336,400 42.00 336,400 2,156,500
June 1 - June 30 381,000 42.81 381,000 1,775,500
- ------------------------------------------------------------------------
Total 717,400 $42.43 717,400 1,775,500
========================================================================
<FN>
(1) In December 2005, the Board of Directors authorized the purchase of
3,000,000 shares of its 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.
During the second quarter of 2006, the Company purchased 717,400 shares of its
common stock for a total cost of $30.4 million or an average cost of $42.43 per
share. As of June 30, 2006, 1,775,500 shares remained under the current
authorization.
</FN>
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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders of the Company was held on April 27,
2006.
(b) At the Annual Meeting William S. Antle III, Robert J. Clanin, John D. Johns
and Eileen M. Rudden were elected for three-year terms expiring in 2009. The
Directors whose terms continued after the Annual Meeting are Richard K.
Lochridge, John J. McMahon, Jr., G. Harold Northrop, Larry L. Prince, Jesse J.
Spikes and Timothy C. Tuff.
(c) A brief description of each matter voted upon and the results of the voting
are as follows:
(1) Election of Directors for Three-Year Term:
William S. Antle III
Voting for 22,205,580
Withheld 1,750,636
Robert J. Clanin
Voting for 23,885,356
Withheld 70,860
John D. Johns
Voting for 14,663,452
Withheld 9,292,764
Eileen M. Rudden
Voting for 23,885,506
Withheld 70,710
(2) Ratification of the appointment of Deloitte & Touche LLP as
Auditors:
For 23,621,380
Against 332,679
Abstentions and
Broker Non-Votes 2,157
(3) Approval of the 2006 Stock Incentive Plan:
For 14,085,963
Against 8,230,175
Abstentions and
Broker Non-Votes 116,609
ITEM 5. OTHER INFORMATION
Effective on April 27, 2006, upon approval by the shareholders of the Company at
its 2006 Annual Meeting of Shareholders (the "Annual Meeting"), the Company
adopted the John H. Harland Company 2006 Stock Incentive Plan (the "Incentive
Plan"). The text of the Incentive Plan is set forth in Exhibit A to the
Company's Definitive Proxy Statement for the Annual Meeting, as filed with the
Securities and Exchange Commission (the "Commission") on March 27, 2006 (the
"Proxy Statement"), which text is hereby incorporated into this Item 5 by
reference, and a copy of the Incentive Plan is filed as Exhibit 10.1 to this
Quarterly Report on Form 10-Q.
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ITEM 6. EXHIBITS
Exhibit Description
3.1 * Amended and Restated Articles of Incorporation (Exhibit 3.1 to
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 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 registrant
and First Chicago Trust Company of New York (Exhibit 4.1 to
registrant's Registration Statement on Form 8-A dated July 1, 1999).
4.2 See Articles IV, V and VII of registrant's Amended and Restated
Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V and
VIII of registrant's Bylaws, filed as Exhibit 3.2.
10.1 * John H. Harland Company 2006 Stock Incentive Plan (Exhibit A to
registrant's Definitive Proxy Statement, filed March 27, 2006).
10.2 * Amended and Restated Credit Agreement dated as of July 3, 2006 among
Registrant and the Lenders named therein (Exhibit 10.1 to Registrant's
Current Report on Form 8-K filed July 10, 2006).
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 11
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: August 8, 2006 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
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 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 registrant
and First Chicago Trust Company of New York (Exhibit 4.1 to
registrant's Registration Statement on Form 8-A dated July 1, 1999).
4.2 See Articles IV, V and VII of registrant's Amended and Restated
Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V and
VIII of registrant's Bylaws, filed as Exhibit 3.2.
10.1 * John H. Harland Company 2006 Stock Incentive Plan (Exhibit A to
registrant's Definitive Proxy Statement, filed March 27, 2006).
10.2 * Credit Agreement dated as of July 3, 2006 among Registrant, the
lenders named therein, and Wachovia Bank, National Association, as
Administrative Agent. (Exhibit 10.1 to Registrant's Current Report
on Form 8-K filed July 10, 2006).
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 11
to the Condensed Consolidated Financial Statements included in this report.
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