VIA FEDERAL EXPRESS, FACSIMILE AND EDGAR
- ----------------------------------------
May 6, 2005
Mr. Rufus Decker
Assistant Chief Accountant
Division of Corporate Finance
United States Securities and Exchange Commission
Mail Stop 5-10
450 Fifth Street, N.W.
Washington, DC 20549
RE: CFC International Inc.
Form 10-K for the Year Ended December 31, 2004
File No. 0-27222
Dear Mr. Decker:
This letter is in response to your April 22, 2005 letter addressed to Mr. Dennis
Lakomy, Executive Vice President and Chief Financial Officer, CFC International,
Inc. related to the Securities and Exchange Commission's review of the Company's
Form 10-K for the fiscal year ended December 31, 204. The Securities and
Exchange Commission's comments and the Company's responses are provided below.
Comment 1. (Comment applicable to overall filing)
Where a comment below requests additional disclosures or other
revisions to be made, please show us in your supplemental
response what the revisions will look like. These revisions
should be included in your future filings.
Response: Included in our responses are the expected revisions or
disclosures to be considered and incorporated in future quarterly
and annual filings.
Comment 2. (Management's Discussion and Analysis of Financial Condition and
Results of Operations - Results of Operations, page 23)
You discuss the business reasons for changes between periods in
your financial statement line items. However, in certain
circumstances where there is more than one business reason for
the change, you should quantify the incremental impact of each
individual business reason discussed on the overall change in the
line item if possible. Please quantify each business reason where
practical. Refer to Item 303 (a)(3) of Regulation S-K and
Financial Reporting Codification 501.04.
Response: We have included additional information which reflects the
quantification of each business reason where practical. Below
underlined are the added disclosures.
2004 Compared to 2003
Net sales for the year ended December 31, 2004 increased 31.5% to
$82.6 from $62.8 million for the year ended December 31, 2003.
The strength of the Euro accounted for $2.0 million of the
increase in sales in 2004. Holographic product net sales
increased 25.9% to $18.7 from $14.9 million for the year ended
December 31, 2003, primarily due to gains in the packaging
market, plus an increase in sales of security labels due to
increased penetration and new security features. Printed products
net sales for the year ended December 31, 2004 increased 73.4% to
$29.7 from $17.1 million for the year ended December 31, 2003.
This was primarily due to a major competitor exiting the market
in February 2004. Security products (mag stripe, signature
panels, tipping products for credit cards, intaglio printed
documents and gift cards) net sales increased 29.4% to $10.8 from
$8.4 million. This increase is due primarily to an increase in
the volume of gift card business. Pharmaceutical product net
sales increased 6.4% to $11.8 from $11.1 million, primarily as a
result of sales to existing European customers in the first half
of 2004. Net sales of specialty pigmented and simulated metal
products increased 1.7% to $11.5 from $11.3 million, primarily
due to the appreciation of the Euro, somewhat offset by a
decrease in domestic sales due to the Company exiting lower
margin business.
Cost of goods sold for the year ended December 31, 2004 increased
27.2% to $54.0 from $42.5 million for the year ended December 31,
2003 primarily due to the increase in sales. The cost of sales as
a percentage of net sales for the year ended December 31, 2004
was 65.4% as compared to 67.6% for the year ended December 31,
2003. The decrease in cost of goods sold as a percentage of net
sales was primarily the result of an increase in productivity
which resulted in lower direct labor costs and better utilization
of the Company's fixed manufacturing costs.
Selling, general and administrative expenses increased 11.5% to
$15.2 in 2004 from $13.6 million in 2003. The increase in
selling, general and administrative expenses is primarily due to
the increase in incentive payments of approximately $1.0 million
and to the strength of the Euro in the amount of approximately
$321,000, as well as the addition of sales and marketing
resources. Selling, general and administrative expenses for the
year ended December 31, 2004 and 2003 as a percentage of net
sales decreased to 18.4% from 21.7% as a percentage of net sales.
This decrease was a result of increased sales.
Research and development expenses for the year ended December 31,
2004 increased 36.5% to $3.0 from $2.2 million for the year ended
December 31, 2003. The increase in research and development
expense was primarily due to incentive payments of $533,000 and
cost of living adjustments. Research and development expenses for
the year ended December 31, 2004 and December 31, 2003 as a
percentage of net sales increased to 3.6 % from 3.5%,
respectively. The increase in research and development as a
percentage of net sales increased due to incentive payments and
Depreciation and amortization expense for the year ended December
31, 2004 increased 9.2% to $4.6 from $4.2 million for the year
ended December 31, 2003. This increase was primarily due to the
strength of the Euro. Depreciation and amortization expense as a
percentage of net sales for the year ended December 31, 2004
decreased to 5.5% from 6.7% for the year ended December 31, 2003.
The decrease in percentage was primarily due to the increase in
sales.
Operating income for the year ended December 31, 2004 increased
1,614.6% to $5.8 from $0.3 million for the year ended December
31, 2003. Operating income for the year ended December 31, 2004,
increased as a percentage of net sales to 7.0% from 0.5% for the
year ended December 31, 2003 due to the reasons noted above with
respect to changes in revenues and expenses.
Interest expense for the year ended December 31, 2004 remained
constant at $1.1 million when compared to the year ended December
31, 2003.
Interest income for the year ended December 31, 2004 increased to
$35,000 from $10,000 for the year ended December 31, 2003. This
increase was primarily the result of the Company accumulating
cash during the year and earnings on the cash.
Other income for the year ended December 31, 2004 increased to
$108,000 from $25,000 for the year ended December 31, 2003. This
increase represented rental income from the previous owner, now
tenant, in the adjacent building west of the Company's Chicago
Heights, Illinois facility purchased in February, 2004.
Gain on foreign currency exchange for the year ended December 31,
2004 decreased 7.4% to $939,000 from $1.0 million for the year
ended December 31, 2003. This was a result of the strength of the
Euro against the U.S. dollar.
The change in provision (benefit) for income taxes is principally
related to the change in income (loss) before income taxes.
Because of the amount of the loss generated in 2003, permanent
tax items had a more significant effect on the taxable income and
the tax provision recorded during the year.
Net income for the year ended December 31, 2004 increased to $4.0
million from $261,000 for the year ended December 31, 2003. The
net income for the year was due to reasons discussed previously
with respect to changes in revenues and expenses.
2003 Compared to 2002
Net sales for the year ended December 31, 2003 increased 1.5% to
$62.8 from $61.9 million for the year ended December 31, 2002.
The strength of the Euro accounted for $3.7 million of the
increase in sales in 2003. Holographic product net sales
increased 25.8% to $14.9 from $11.8 million for the year ended
December 31, 2002, primarily due to gains in the packaging market
plus an increase in sales of security labels due to increased
penetration and new security features. Printed products net sales
for the year ended December 31, 2003 decreased 3.0% to $17.1
million from $17.7 million for the year ended December 31, 2002.
This was primarily due to a decrease in volume due to competition
from low priced Asian imports. Security products (mag stripe,
signature panels, tipping products for credit cards, intaglio
printed documents and gift cards) net sales decreased 25.8% to
$8.4 from $11.3 million. This decrease is due primarily to a
decrease in volume of gift card business associated with a
customer that was working off excess inventory it purchased in
2002. Pharmaceutical product net sales increased 4.0% to $11.1
from $10.6 million, primarily as a result of sales to existing
European customers in the first half of 2003. Net sales of
specialty pigmented and simulated metal products increased 8.4%
to $11.3 from $10.5 million, primarily due to the appreciation of
the Euro, somewhat offset by a decrease in domestic sales due to
the Company exiting lower margin business.
Cost of goods sold for the year ended December 31, 2003 increased
10.3% to $42.5 from $38.5 million for the year ended December 31,
2002. Higher scrap domestically of $300,000, coupled with the
strength of the Euro in converting European manufacturing costs
into U.S. dollars of $2 million and a decrease in the gift card
business sales volume described above, which has a lower percent
cost (as the material is provided by the customer), resulted in
the increased costs. In addition, the Company incurred costs
necessary to retain trained production people in anticipation of
an increase in its printed woodgrain patterned products because
of a major competitor exiting the market. The Company also
incurred costs in hiring and training new printed woodgrain
patterns production personnel in the mid-fourth quarter 2003 of
$230,000. Lastly, in 2002, the Company benefited from additional
volume purchase discounts of $250,000 when compared to 2003. The
cost of sales as a percentage of net sales for the year ended
December 31, 2003 was 67.6% as compared to 62.2% for the year
ended December 31, 2002. The increase in cost of goods sold as a
percentage of net sales was due to the reasons noted above.
Selling, general and administrative expenses increased 4.4% in
2003 to $13.6 from $12.9 million in 2002. The increase in
selling, general and administrative expenses is primarily due to
the strength of the Euro, in the amount of approximately
$800,000, and a $300,000 benefit related to a settlement of past
sales tax liabilities with the State of Illinois in 2002 that did
not repeat in 2003, offset by the time between terminations and
investment in new hires in 2003 of $126,000, and a gain on the
sale of land and building in Germany of $196,000. As a result,
selling, general and administrative expenses for the year ended
December 31, 2003 increased to 21.7% from 20.8% for the year
ended December 31, 2002 as a percentage of net sales.
Research and development expenses for the year ended December 31,
2003 increased 6.1% to $2.2 from $2.0 million for the year ended
December 31, 2002. The increase in research and development
expense was primarily due to cost of living adjustments. Research
and development expenses for the year ended December 31, 2003 and
December 31, 2002 as a percentage of net sales were 3.5% and
3.3%, respectively.
Depreciation and amortization expense for the year ended December
31, 2003 increased 6.0% to $4.2 from $4.0 million for the year
ended December 31, 2002. This increase was primarily due to the
strength of the Euro. Depreciation and amortization expense as a
percentage of net sales for the year ended December 31, 2003
increased to 6.6% from 6.4% for the year ended December 31, 2002.
Operating income for the year ended December 31, 2003 decreased
92.2% to $339,000 from $4.3 million for the year ended December
31, 2002. Operating income for the year ended December 31, 2003,
decreased as a percentage of net sales to 0.5% from 7.0% for the
year ended December 31, 2002 due to the reasons noted above with
respect to changes in revenues and expenses.
Interest expense for the year ended December 31, 2003 decreased
10.6% to $1.1 from $1.2 million for the year ended December 31,
2002. The decrease in interest expense was a result of a decrease
in the interest rate paid on outstanding debt.
Interest income for the year ended December 31, 2003 decreased to
$0 from $29,000 for the year ended December 31, 2002. This
decrease was primarily the result of the Company receiving
interest on income tax refunds in the second and fourth quarters
of 2002 that was not repeated in 2003.
Other income for the year ended December 31, 2003 decreased to
$26,000 from $28,000 for the year ended December 31, 2002.
Gain on foreign currency exchange for the year ended December 31,
2003 increased 47.5% to $1.0 million from $688,000 for the year
ended December 31, 2002. This was primarily the result of the
strength of the U.S. dollar and the variation in account balances
due to transactions during the period.
The change in (benefit) provision for income taxes is principally
related to the change in (loss) income before income taxes.
Because of the amount of the loss generated in 2003, permanent
tax items had a more significant effect on the taxable income and
the tax provision recorded during the year.
Net income for the year ended December 31, 2003 decreased to
$261,000 from $2,741,000 for the year ended December 31, 2002.
The net loss for the year was due to reasons discussed previously
with respect to changes in revenues and expenses.
Comment 3. (Significant Accounting Policies, Intangible Assets, page 29)
Please expand your discussion of intangible assets to include the
significant judgements involved with the evaluation of your
assets for impairment. Please include a discussion of how your
assets are evaluated for potential impairment, how impairment
indicators are evaluated, and how the fair value of your
long-lived assets is determined.
Response: The Company has and will continue to perform an annual
impairment test, as required by SFAS 142, for goodwill. For
its impairment test, the Company determines the fair value of
the reporting unit based upon discounted future cash flows
associated with the acquired business. Management reviews
expected future cash flows and in so forecasting considers
historical results. Judgements include estimates of future
sales volume and pricing as well as the associated expenses.
The Company also considers changes in known business trends,
including product and customer activity.
With respect to finite lived intangibles, the Company reviews and
assesses the holographic revenues generated from the asset
purchases. To date revenues and related margins associated with
these intangible purchases have grown each year. The Company
considers new product development and known sales trends in
assessing whether or not any matters requiring an impairment
review exist. This would also include a review of revenues by
product, and general business trends.
Accordingly, the disclosure in MDA will be revised in future
filings as follows:
Intangible Assets. Intangible assets include the excess of cost
over the fair value of net assets of businesses acquired
(goodwill) and holographic base coat and worldwide holographic
rights. The holographic intangible assets are being amortized on
a straight-line basis over periods of 10 to 15 years and assume
no residual value. Beginning January 1, 2002, the Company no
longer amortizes goodwill (see footnote 2 to the financial
statements), but reviews it for impairment on an annual basis.
The Company uses a discounted future cash flow analysis, prepared
as of December 31 of each year to assess whether or not goodwill
is impaired, unless events occur that require such a review.
Management also considers changes in business trends and customer
sales activity when evaluating whether any impairment exists. The
reporting unit goodwill relates to has historically been very
profitable. With respect to its Holographic intangible assets,
the Company periodically reviews sales by product type and margin
trends, customer sales activity and changes in business trends to
assess whether or not a triggering event requires an impairment
review. The Company would assess fair value based upon
discounting future cash flows when determining whether or not an
impairment exists.
Comment 4. (Revenue Recognition, page 29)
You indicate that for certain transactions revenue is recognized
upon completion of manufacturing or upon use by the customer.
Please explain the types of transactions in which revenue is
recognized upon completion of manufacturing or upon use by the
customer. Please also provide accounting literature to support
your recognition of revenue upon completion of manufacturing.
Response: For services provided which relate to some of its gift card
business (less than 3% of total revenue) the Company is paid a
fee for the actual services provided. The Company receives a
"blank" gift card from certain gift card customers and provides
some or all of the following services: prints a value, serial
number and/or PIN number on the card, applies a scratch-off
tape; edits the information electronically and packs the cards,
all of which are performed as part of the same customer order.
The Company never takes title to these cards. Revenues for
these services are recorded upon completion of the last
processing step, at which time, the Company bills the customer
for the total service as agreed to, based upon the customer's
purchase order. For example, terms of the customer purchase order
are based upon a pricing matrix which takes into account the
volume of the cards processed. In limited circumstances,
the Company is also paid a fee to deliver gift cards on behalf
of the customer. These revenues are recognized when this service
is performed.
The Company also maintains inventory at a few of its customer
locations. The Company retains title to this inventory until such
time it is used by the customer. The Company receives and reviews
monthly usage activity from these customers. Based upon the
monthly usage, revenue is recorded in the month it was used by
the customer. To validate this information, Company
representatives physically inspected the on hand inventory
quantities on a quarterly basis.
Comment 5. (Liquidity and Capital Resources - Contractual Cash
Obligations, page 32)
Please revise your table of contractual cash obligations to
include estimated payments under your interest rate swap
agreements. Because the table is aimed at increasing transparency
of cash flow, we believe these payments should be included in the
table. Please also disclose any assumptions you made to derive
these amounts.
Response: The table will be revised to incorporate interest payments
associated with the Company's interest swap agreements. The
Company believes interest rates will rise over the next couple
of years and therefore these interest swap agreements have put
a cap on the Company's exposure
The Company will revise its table in future filings to
incorporate the following:
Due Due Due 2010
< 1 Yr. 2-3 Yrs. 4-5 Yrs. After
------- -------- -------- -----
Interest payment under swap contract.... 243,384 357,668 9,841 0
Interest on Remaining Debt.............. 711,314 897,424 313,766 66,222
------- --------- ------- ------
Total Interest................. 954,698 1,255,092 323,607 66,222
======= ========= ======= ======
The Company anticipates that interest rates under its swap contract will be less
than the prevailing interest rates.
Comment 6. (Contractual Obligations, page 23)
You indicated that your total operating lease obligations was
$1,276,352 as of December 31, 2004. However, your total operating
lease obligations was $4,164,375 as of December 31, 2003. Please
tell us the reason for the significant change in your operating
lease obligations for the prior year to the current year.
Response: The main decrease in our operating lease obligations between
2003 to 2004 is the closing of our U.K. facility and subleasing
of that facility which reduced total future lease obligations by
$1.8 million. The Company also no longer leases another
building it used for storage due to the purchase of adjacent
Chicago Heights property in 2004. The landlord was able to find
another tenant and permitted the Company to exit the lease
without any cost. The Company's purchase of the Chicago Heights
property bordering its existing Chicago Heights facility,
therefore reduced operating lease expenses by $300,000 annually.
In addition, the Company revised its automobile leases which
resulted in a $600,000 decrease. The remaining variance
was due to three machine leases that were bought out during 2004,
reducing total future lease commitments by $131,000.
The Company will revise the last paragraph of Note 7 to reflect
the gross payments and expected sublease income associated with
the U.K. facility.
Comment 7. (Financial Statements, Note 3 - Significant Accounting Policies,
Warranty Costs, Page 45)
Please disclose the information required by paragraph 14 of FIN
45 regarding your product warranty costs.
Response: Based upon the nature of the products sold, the Company is
promptly notified by its customers of products that do not meet
agreed to specifications. The Company is normally notified
within 30 days of shipment. The Company provides for credit
memos to be issued for such warranty and product returns.
Because there is no extended notification timeframe, the Company
can specifically identify and quantify such items in connection
with the preparation of its financial statements in a timely
manner. The Company has historically had very few known
warranty issues for specific products more than six months after
shipment. If known, they are considered in establishing the
amount of a warranty reserve. Accordingly, the Company has no
warranty accrual at December 31, 2004 and 2003. It has provided
for customer credit memos relating to such matters and these are
included in the customer credits reserve.
As disclosed in the footnotes, warranty expenses have
historically not been significant and no accrual has been
recorded as of December 31, 2004 and 2003. Thus the Company does
not believe that any additional disclosure under FIN 45 need be
provided. If warranty expenses or the accrual are material at a
future time, the Company will include the required disclosure
under FIN 45.
Comment 8. (Financial Statements, SFAS 123, page 45)
Please disclose your comparisons of as reported earnings amounts
to the pro Forma net (loss) income amounts as if you had fully
adopted SFAS 123. Please be sure include each of the line items
required by paragraphs 45.c(1) to (4) of SFAS 123, as amended by
SFAS 148.
Response: The Company has included the required disclosures of SFAS 123
paragraph 45 in its significant accounting polices footnote.
Because such information did not fit on page 45 and has been
provided at the top of page 46. Please see the original filing.
Comment 9. (Financial Statements, Note 5 - Long-Term Debt and Other
Liabilities, page 48)
You indicate that you are in compliance with or have obtained
waivers for the covenants of various credit agreements. Please
disclose how frequently your compliance with your debt covenants
is required to be assessed under your debt agreements and the
results of those assessments subsequent to December 31, 2004.
Please disclose whether you violated one or more debt covenants
as of March 31, 2005 and whether additional waivers were
required. Please disclose the date you obtained each waiver and
the terms and duration of each waiver. Supplementally tell us
whether it was probable that you would not be able to comply with
each of the violated covenants at subsequent measurement dates
within the twelve months following December 31, 2004 and within
the twelve months following March 31, 2005. Please tell us how
you have classified each credit agreement as of each balance
sheet date. While SFAS 78 directs that the probability of future
compliance with a covenant be considered, the probability of
future waiver or covenant amendment is not relevant to debt
classification.
Response: The Company's Credit Agreements with its bank requires that an
annual physical inventory of its fixed assets be taken. In late
summer 2004, the Company received a verbal waiver from its bank
as it did not expect to complete such a physical inspection
during 2004. During the year end audit, the Company requested
and received from the bank a written waiver of the annual fixed
asset inventory requirement for fiscal 2004. The waiver letter
was dated February 9, 2005. The waiver did not include any other
requirements or terms. No other covenant violations existed at
December 31, 2004. The Company reviews compliance with its credit
agreements on a monthly, quarterly and on an annual basis. The
Credit Agreements contain very few financial covenants, the most
significant of which are the requirements of $12 million of
tangible net worth at year end and $1,000 of annual net income.
Through April 30, 2005, the Company was in compliance with all
covenants required as of that date intends to either complete a
physical inventory of its fixed assets during 2005 or modify its
existing Credit Agreements during 2005 to eliminate such a
requirement.
The Credit Agreements include revolving and term loan borrowings.
Borrowings under revolving credit arrangements are all classified
as current liabilities in the consolidated balance sheet.
Principal payments of the Company's term loans and other debt are
classified based upon the scheduled payment dates.
Comment 10. (Exhibits 31.2 and 31.2)
Please confirm that the inclusion of your CEO and CFO's title was
not intended to limit the capacity in which such individuals
provided the certifications. Please remove the reference to the
CEO and CFO's titles in the introductory paragraph of the
certifications to conform to the format provided in Item
601(b)(31) of Regulation S-K.
Response: This will confirm that the inclusion of our CEO and CFO's
titles in the introductory paragraph of the certifications was
not intended to limit the capacity in which such individuals
provided the certifications. We will remove the reference to
the CEO and CFO's titles in the introductory paragraph of the
certifications provided in future filings.
We will comply with your request. The titles were included so we would comply
with how we were advised to draft this document.
Per your direction the Company acknowledges the following:
o The company is responsible for the adequacy and accuracy of the
disclosure in their filings;
o Staff comments or changes to disclosure in response to staff comments
do not foreclose the Commission from taking any action with respect to
the filing; and
o The company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the federal
securities laws of the United States.
Sincerely,
Dennis W. Lakomy
Executive Vice President,
Chief Financial Officer