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United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2002
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 ( ).
The number of shares of the registrant's common stock outstanding on October 25,
2002 was 29,412,524.
-1-
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 . . . . . . . . . . . . . . . . 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 23
ITEM 4. CONTROLS AND PROCEDURES . . . . . . . . . . . . . . . . . . 24
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . 25
CERTIFICATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
-2-
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
------
(In thousands) September 27, December 31,
2002 2001
- ----------------------------------------------------------------------
(Unaudited)
Current Assets:
Cash and cash equivalents $ 22,510 $ 10,096
Accounts receivable - net 63,262 60,926
Inventories 18,736 19,762
Deferred income taxes 26,047 25,621
Other 14,126 11,179
---------- ----------
Total current assets 144,681 127,584
---------- ----------
Other Assets:
Investments 3,737 7,896
Goodwill - net 187,489 125,409
Intangible assets - net 13,724 9,312
Deferred income taxes 7,909 6,604
Refundable contract payments 24,494 27,563
Other 29,354 19,899
---------- ----------
Total other assets 266,707 196,683
---------- ----------
Property, plant and equipment 339,986 334,260
Less accumulated depreciation
and amortization 202,358 191,534
---------- ----------
Property, plant and equipment - net 137,628 142,726
---------- ----------
Total $ 549,016 $ 466,993
========== ==========
See Notes to Condensed Consolidated Financial Statements.
-3-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
(In thousands, except share and September 27, December 31,
per share amounts) 2002 2001
- ----------------------------------------------------------------------
(Unaudited)
Current Liabilities:
Accounts payable $ 23,756 $ 23,880
Deferred revenues 45,897 31,240
Accrued liabilities:
Salaries, wages and employee benefits 29,256 27,077
Taxes 29,781 16,729
Other 14,417 17,230
---------- ----------
Total current liabilities 143,107 116,156
---------- ----------
Long-Term Liabilities:
Long-term debt, less current maturities 138,168 124,118
Other 26,221 24,695
---------- ----------
Total long-term liabilities 164,389 148,813
---------- ----------
Total liabilities 307,496 264,969
---------- ----------
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 2,999 -
Retained earnings 399,030 372,164
Accumulated other comprehensive
income(loss) (479) 3,710
Unamortized restricted stock awards (5,606) (8,218)
---------- ----------
433,851 405,563
Less 8,526,048 and 8,977,790 shares
in treasury - at cost,
respectively 192,331 203,539
---------- ----------
Shareholders' equity 241,520 202,024
---------- ----------
Total $ 549,016 $ 466,993
========== ==========
See Notes to Condensed Consolidated Financial Statements.
-4-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 27, 2002
AND SEPTEMBER 28, 2001
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
(In thousands, except SEP 27, SEP 28, SEP 27, SEP 28,
per share amounts) 2002 2001 2002 2001
- ---------------------------------------------------------------------------
Net Sales $ 189,636 $ 179,563 $ 559,694 $ 558,121
Cost of sales 99,859 97,881 300,859 307,261
---------- ---------- ---------- ----------
Gross Profit 89,777 81,682 258,835 250,860
Selling, general and
administrative expenses 61,374 57,003 190,109 176,254
Amortization of intangibles 898 3,696 2,170 10,742
---------- ---------- ---------- ----------
Income From Operations 27,505 20,983 66,556 63,864
---------- ---------- ---------- ----------
Other Income (Expense):
Interest expense (1,412) (2,035) (4,505) (7,957)
Investment write-down - (7,848) (303) (7,848)
Other - net 51 19 40 (53)
---------- ---------- ---------- ----------
Total Other Expenses - net (1,361) (9,864) (4,768) (15,858)
---------- ---------- ---------- ----------
Income Before Income Taxes 26,144 11,119 61,788 48,006
Income Taxes 10,152 6,040 24,086 21,717
---------- ---------- ---------- ----------
Net Income 15,992 5,079 37,702 26,289
Retained Earnings at
Beginning of Period 386,560 356,966 372,164 343,998
Cash Dividends (2,206) (2,197) (6,608) (6,526)
Issuance of treasury and
deferred shares under
stock plans (1,316) (688) (4,228) (4,601)
---------- ---------- ---------- ----------
Retained Earnings at
End of Period $ 399,030 $ 359,160 $ 399,030 $ 359,160
========== ========== ========== ==========
Weighted Average Shares
Outstanding:
Basic 29,142 29,254 29,274 29,073
Diluted 29,960 30,367 30,594 30,033
Earnings Per Common Share:
Basic $ 0.55 $ 0.17 $ 1.29 $ 0.90
Diluted $ 0.53 $ 0.17 $ 1.23 $ 0.88
Cash Dividends Per
Common Share $ 0.075 $ 0.075 $ 0.225 $ 0.225
See Notes to Condensed Consolidated Financial Statements.
-5-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 27, 2002 AND SEPTEMBER 28, 2001
(Unaudited)
(In thousands) 2002 2001
- -----------------------------------------------------------------------------
Operating Activities:
Net income $ 37,702 $ 26,289
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 42,151 45,240
Investment write-down 303 7,848
Stock-based compensation 8,173 3,739
Other 835 1,062
Change in assets and liabilities net of effects
of businesses acquired:
Deferred income taxes (838) 3,494
Accounts receivable 183 27,234
Inventories and other current assets 1,907 19,306
Deferred revenues 6,154 (15,371)
Accounts payable and accrued liabilities 7,186 (370)
Refundable contract payments (5,956) (8,916)
--------- ----------
Net cash provided by operating activities 97,800 109,555
--------- ----------
Investing Activities:
Purchases of property, plant and equipment (26,304) (34,213)
Payment for acquisition of businesses -
net of cash acquired (71,475) (1,203)
Proceeds from sale of property, plant and equipment 1,769 332
Notes receivable from Netzee, Inc. (82) 1,896
Long-term investments and other assets (249) 1,800
--------- ----------
Net cash used in investing activities (96,341) (31,388)
--------- ----------
Financing Activities:
Purchases of treasury stock (5,404) (7,217)
Issuance of treasury stock 10,474 6,386
Dividends paid (6,608) (6,526)
Long-term debt - net 13,934 (65,496)
Other - net (1,441) 34
--------- ----------
Net cash provided by (used in) financing activities 10,955 (72,819)
--------- ----------
Increase in cash and cash equivalents 12,414 5,348
Cash and cash equivalents at beginning of period 10,096 18,480
---------- ----------
Cash and cash equivalents at end of period $ 22,510 $ 23,828
========== ==========
See Notes to Condensed Consolidated Financial Statements.
-6-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 27, 2002
(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
("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. Certain reclassifications have been made in the 2001 financial
statements and notes to financial statements to conform to the 2002
classifications.
The condensed consolidated financial statements included herein should be read
in conjunction with the consolidated financial statements and notes thereto, and
the Independent Auditors' Report included in the Company's Annual Report on Form
10-K for the year ended December 31, 2001 ("2001 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 2001 Form 10-K. Other
than as described in Note 4 below, the Company has consistently followed those
policies in preparing this report.
3. Acquisitions
On September 20, 2002, Harland Financial Solutions, Inc. ("HFS"), a wholly owned
subsidiary of the Company, extended its core systems offering with the
acquisition of certain assets and related liabilities of SPARAK Financial
Systems, LLC ("SPARAK") for approximately $31.9 million, net of cash acquired.
The acquisition agreement includes a contingent purchase payment not to exceed
$2.0 million to be made in the event certain growth targets are achieved as
defined in the agreement. The contingent purchase payment is payable in 2004 and
will be recorded as an increase in goodwill, to the extent such payment is
ultimately made. SPARAK was a leading provider of integrated hardware and
software systems for community banks.
On July 24, 2002, Scantron Corporation, a wholly owned subsidiary of the
Company, acquired EdVISION Corporation ("EdVISION") for approximately $28.7
million, net of cash acquired. Related to the acquisition of EdVISION, the
Company entered into an incentive agreement with certain individuals that
includes contingent payments to be made in the event certain growth targets are
achieved as defined in the incentive agreement. These contingent payments, which
will not exceed $2.0 million, are payable during or before 2005 and will be
expensed at the time of payment. EdVISION was a leading provider of curriculum
development and assessment tools for the education industry.
On May 28, 2002, HFS completed the acquisition of Easy Systems, Inc. for
approximately $10.8 million, net of cash acquired. Easy Systems was a software
solutions company that provided turnkey branch automation solutions for the
community bank market.
The combined purchase price for assets acquired through acquisitions in 2002
totaled $71.5 million, net of cash acquired. Acquired intangible assets totaled
$19.1 million with an average weighted life of approximately 7 years. The
intangible assets that make up that amount include $10.2 million for developed
technology with an average weighted life of 6 years, $4.0 million for customer
lists with an average weighted life of 9 years, $2.6 million for trademarks with
an average weighted life of 10 years and $2.3 million for content with an
average weighted life of 10 years.
The preliminary allocations of the purchase price to the assets and liabilities
acquired in 2002 resulted in $61.9 million allocated to goodwill, of which $26.1
million is expected to be deductible for tax purposes. The allocations are
subject to refinement as the Company finalizes the valuation of certain assets
and liabilities.
-7-
The following unaudited pro forma summary presents information as if the 2002
business acquisitions occurred at the beginning of the respective year in which
the assets were acquired as well as the beginning of the immediately preceding
year (in thousands, except per share amounts):
Nine months ended
Sep 27, 2002 Sep 28, 2001
- -------------------------------------------------------------------
Net sales $ 576,840 $ 582,896
Net income $ 35,218 $ 23,524
Earnings per common share:
Basic $ 1.20 $ 0.81
Diluted $ 1.15 $ 0.79
The unaudited pro forma summary includes adjustments for increased amortization
of intangible assets and increased interest expense. 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.
In March 2001, the Company's Scantron subsidiary acquired ImTran, Inc.
("ImTran"). ImTran was a data collection and document capture solutions firm
specializing in automated data collection and document imaging. In October 2001,
the Company's Printed Products segment acquired the assets of DocuPrint,
Incorporated ("DocuPrint"). DocuPrint produced forms for major financial
institutions. Also in October 2001, the Company's Scantron subsidiary acquired
substantially all the assets of the Scanning Systems division of Associated
Business Products, Inc., a subsidiary of Global DocuGraphix, Inc. for
approximately $6.0 million in cash.
Assets acquired through acquisitions in 2001 totaled $7.5 million. Of the total
2001 acquisition costs, $5.8 million was allocated to goodwill.
All acquisitions were paid for with cash provided from operating activities and
proceeds from the Company's credit facility. The results of operations of the
acquired businesses have been included in the Company's operations since the
particular acquisition. The pro forma effects on results of operations for the
2001 business acquisitions are not material.
4. Goodwill and Intangible Assets
In June 2001, the Financial Accounting Standards Board issued Statement No. 142,
"Goodwill and Other Intangibles" ("SFAS 142"). Under SFAS 142, goodwill and
intangible assets with indefinite lives are no longer amortized but are tested
at least annually for impairment. Separable intangible assets with definitive
lives will continue to be amortized over their useful lives. Effective January
1, 2002, the Company adopted SFAS 142. The Company engaged an independent
valuation firm to perform a goodwill impairment test. Based upon the analysis,
there was no impairment of goodwill upon adoption of SFAS 142.
Application of the provisions of SFAS 142 is expected to result in an increase
in net income of approximately $10.4 million for the 2002 year as compared to
2001. The following presents a reconciliation of net income and earnings per
share information for the three and nine months ended September 27, 2002 and
September 28, 2001 with the 2001 period
-8-
adjusted for the provisions of SFAS 142 (in thousands, except per share
amounts):
Three Months Ended Nine Months Ended
Sep 27, Sep 28, Sep 27, Sep 28,
2002 2001 2002 2001
--------- -------- --------- --------
Net income:
Reported $15,992 $ 5,079 $37,702 $26,289
Add: Goodwill
amortization,
net of tax effect - 2,768 - 7,959
------- ------- ------ -------
Adjusted $15,992 7,847 37,702 34,248
Reduced interest expense
on assumed conversions
of convertible
subordinated debentures - 34 - 169
------- ------- ------- -------
Net income for diluted
earnings per share
calculation $15,992 $ 7,881 $37,702 $34,417
======= ======= ======= =======
Basic earnings
per share:
Reported $ 0.55 $ 0.17 $ 1.29 $ 0.90
Add: Goodwill
amortization,
net of tax effect - 0.10 - 0.28
------- ------- ------- -------
Adjusted $ 0.55 $ 0.27 $ 1.29 $ 1.18
======= ======= ======= =======
Diluted earnings
per share:
Reported $ 0.53 $ 0.17 $ 1.23 $ 0.88
Add: Goodwill
amortization,
net of tax effect - 0.09 - 0.27
------- ------- ------- -------
Adjusted $ 0.53 $ 0.26 $ 1.23 $ 1.15
======= ======= ======= =======
The changes in the carrying amounts of goodwill by business segment for the nine
months ended September 27, 2002 are as follows (in thousands):
Printed Software &
Products Services Scantron Consolidated
----------------------------------------------------
Balances as of
December 31, 2001 $ 24,572 $ 82,128 $ 18,709 $125,409
Purchase price
allocation/adjustment 138 34,931 27,011 62,080
-------- -------- -------- --------
Balances at
September 27, 2002 $ 24,710 $117,059 $ 45,720 $187,489
======== ======== ======== ========
The Company is completing the review and determination of the fair values of
assets acquired and liabilities assumed with regard to acquisitions that
occurred in 2002 and late 2001. Accordingly, carrying amounts of goodwill and
intangible assets related to those acquisitions may have further adjustments,
although such adjustments are not expected to be material.
-9-
Intangible assets with definitive lives consist of developed technology,
customer lists, trademarks and content. Intangibles were comprised of the
following (in thousands):
September 27, 2002 December 31, 2001
----------------------------- ----------------------------
Gross Net Gross Net
Carrying Accum. Carrying Carrying Accum. Carrying
Amount Amort. Amount Amount Amort. Amount
--------------------------------- -------------------------------
Developed
technology $26,534 $ (8,482) $18,052 $16,319 $ (5,024) $11,295
Customer
lists 27,476 (16,332) 11,144 23,510 (14,198) 9,311
Trademarks 2,616 (36) 2,580 - - -
Content 2,300 (39) 2,261 - - -
------- --------- ------- ------- --------- -------
Total $58,926 $(24,889) $34,037 $39,829 $(19,222) $20,606
======= ========= ======= ======= ========= =======
Customer lists amortization expense for the nine months ended September 27, 2002
and September 28, 2001 was $2.1 million for each period. Developed technology
amortization expense for the same periods was $3.5 million and $2.7 million,
respectively. Carrying amounts of developed technology and content are included
in the other assets caption on the balance sheets and the related amortization
expense is included in the cost of goods sold caption on the statements of
income.
The estimated intangible amortization expense for each of the next five years
beginning January 1, 2002 is as follows (in thousands):
For the year ended December 31,
2002 $ 7,313
2003 $ 6,931
2004 $ 5,973
2005 $ 3,717
2006 $ 3,417
5. Income Taxes
The effective income tax rate for the nine-month period ended September 27, 2002
was 38.8% compared to 54.3% for the nine-month period ended September 28, 2001.
This decrease was primarily due to the nondeductible portion of goodwill
amortization in 2001 that is not in the 2002 period because of the
implementation of SFAS 142. Also affecting the decrease was a $1.3 million
valuation allowance in 2001 for a portion of the tax benefit related to an
investment write-down. The expected effective tax rate for 2002 is 39.5%,
excluding the effects of state tax credits and prior year adjustments arising
from an Internal Revenue Service ("IRS") examination for the years 1996 through
1998 that were recorded during the nine months ended September 27, 2002.
6. Inventories
As of September 27, 2002 and December 31, 2001, inventories consisted of the
following (in thousands):
2002 2001
- ------------------------------------------------------------------------
Raw materials and semi-finished goods $ 16,380 $ 17,309
Finished goods 1,898 1,688
Hardware component parts 458 765
-------- --------
Total $ 18,736 $ 19,762
======== ========
-10-
7. Long Term Debt
The Company has a revolving credit facility (the "Credit Facility") with a
syndicate of banks in an amount of $325.0 million. The Credit Facility matures
in 2004 and 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 an annual commitment fee of 0.175%
on the unused amount of the Credit Facility. Borrowings under the Credit
Facility bear interest on the following indices at the Company's option (plus a
margin as defined): the Federal Funds Rate, the SunTrust Bank Base Rate or
LIBOR. The Credit Facility has certain financial covenants including leverage,
fixed charge and minimum net worth tests. The Credit Facility also has
restrictions that limit the Company's ability to incur additional indebtedness,
grant security interests or sell its assets beyond certain amounts.
At September 27, 2002, the Company had $138.0 million in outstanding cash
borrowings, $5.3 million in outstanding letters of credit and $181.7 million
available for borrowing under the Credit Facility. In addition to the
outstanding letters of credit, the Company has outstanding a surety bond in the
amount of $1.1 million issued by an insurance company that covers certain
insurance obligations. The average interest rate in effect on outstanding cash
borrowings at September 27, 2002, including the effect of the Company's interest
rate hedging program, was 4.19%.
The Company recognizes all derivatives at fair value as either assets or
liabilities in the statements of financial position. The Company uses derivative
financial instruments to manage interest rate risk. On the date the interest
rate derivative contract is entered into, the Company designates the derivative
as either a fair value hedge or a cash flow hedge. The Company formally
documents the relationships between hedging instruments and the hedged items, as
well as its risk-management objectives and strategy for undertaking various
hedge transactions. The Company formally assesses, both at the hedge's inception
and on an ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in cash flows of the
hedged items.
The Company enters into interest rate swap agreements to manage its exposure to
interest rate movements by effectively exchanging floating rate payments for
fixed rate payments without the exchange of the underlying principal. Both the
interest rate swaps and the Credit Facility mature in 2004. The interest rate
swaps are structured to amortize on a quarterly basis so that on a percentage
basis, they approximate the Company's forecasted cash flows. The differential
between fixed and variable rates to be paid or received is accrued as interest
rates change in accordance with the agreements and recognized over the life of
the agreements as an adjustment to interest expense. At September 27, 2002, the
notional principal amount of interest rate swaps outstanding was $122 million
and the average fixed rate in effect on the Company's interest rate swap
agreements, including the Company's credit margin, was 4.53%. The net change in
fair value of the swaps at September 27, 2002 is reported in other comprehensive
income (See Note 8). The swaps are considered to be highly effective. No amounts
for hedge ineffectiveness were reported in net income during the nine month
periods ended September 27, 2002 and September 28, 2001.
-11-
8. Comprehensive Income
Other comprehensive income for the Company includes foreign currency translation
adjustments, unrealized gains (losses) on investments and changes in fair value
of cash flow hedging instruments. Total comprehensive income for the three and
nine month periods ended September 27, 2002 and September 28, 2001 was as
follows (in thousands):
Three Months Ended Nine Months Ended
Sep 27, Sep 28, Sep 27, Sep 28,
2002 2001 2002 2001
- ------------------------------------------------------------------------
Net income: $15,992 $ 5,079 $37,702 $26,289
Other comprehensive
income, net of tax:
Foreign exchange
translation adjustments 168 41 (550) 631
Unrealized losses
on investments, net
of $17, ($14), $262 and
$260 in tax benefits
(provisions) (318) (2,063) (3,867) (11,499)
Changes in fair value of
cash flow hedging
instruments, net of $125,
$885, $49 and $985 in
tax benefits (195) (1,385) (76) (1,541)
Reclassification for
investment write-down
included in net income - 7,848 303 7,848
------- ------- ------- -------
Comprehensive income $15,647 $ 9,520 $33,512 $21,728
======= ======= ======= =======
-12-
9. Earnings per Common Share
The computation of basic and diluted earnings per share for the three and nine
month periods ended September 27, 2002 and September 28, 2001 is as follows (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
Sep 27, Sep 28, Sep 27, Sep 28,
2002 2001 2002 2001
- ------------------------------------------------------------------------
Computation of basic earnings per common share:
Numerator
Net Income $ 15,992 $ 5,079 $ 37,702 $ 26,289
-------- -------- -------- --------
Denominator
Weighted average shares
outstanding 29,046 29,178 29,181 29,003
Weighted average deferred
shares outstanding under
non-employee directors
compensation plan 96 76 93 70
-------- -------- -------- --------
Shares outstanding for
basic earnings per share
calculation 29,142 29,254 29,274 29,073
-------- -------- -------- --------
Basic earnings per share $ 0.55 $ 0.17 $ 1.29 $ 0.90
======== ======== ======== ========
Computation of diluted earnings per common share:
Numerator
Net Income $ 15,992 $ 5,079 $ 37,702 $ 26,289
Reduced interest expense
on assumed conversions of
convertible subordinated
debentures - 34 - 169
-------- -------- -------- --------
Net income for diluted
earnings per share
calculation 15,992 5,113 37,702 26,458
-------- -------- -------- --------
Denominator
Basic weighted average
shares outstanding 29,142 29,254 29,274 29,073
Dilutive effect of stock
options and restricted
stock grants 818 974 1,320 740
Assumed conversions
of convertible subordinated
debentures - 139 - 220
-------- -------- -------- --------
Shares outstanding for
diluted earnings per share
calculation 29,960 30,367 30,594 30,033
-------- -------- -------- --------
Diluted earnings per share $ 0.53 $ 0.17 $ 1.23 $ 0.88
======== ======== ======== ========
-13-
10. Business Segments
The Company operates its business in three segments. The Printed Products
segment ("Printed Products") includes checks and direct marketing activities
marketed primarily to financial institutions. The Software and Services
("Software & Services") segment is focused on the financial institution market
and includes lending and mortgage origination and closing applications, database
marketing software, core systems applications and business intelligence
solutions. The Scantron segment ("Scantron") represents products and services
sold by the Company's Scantron subsidiary including scanning equipment and
software, scannable forms, survey solutions, curriculum development and
assessment tools 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.
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, are not significant to the consolidated
results of the Company. The Company's accounting policies for segments are the
same as those described in Note 2. Management evaluates segment performance
based on segment income or loss before income taxes. Segment income or loss
excludes interest income, interest expense, certain other non-operating gains
and losses and incentive compensation for segment management, all of which are
considered corporate items. 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 2002 and 2001 periods were as
follows (in thousands):
Business Segment
-------------------------------
Printed Software & Corporate & Consoli-
Products Services Scantron Eliminations dated
- -----------------------------------------------------------------------------------
Three months ended September 27, 2002:
Net sales $ 128,322 $ 31,600 $ 30,158 $ (444) $ 189,636
Income (loss) 21,637 3,965 9,377 (8,835) 26,144
Identifiable assets 222,214 175,504 82,738 68,560 549,016
Three months ended September 28, 2001:
Net sales $ 126,392 $ 28,360 $ 25,129 $ (318) $ 179,563
Income (loss) 19,977 425 7,800 (17,083) 11,119
Nine months ended September 27, 2002:
Net sales $ 387,589 $ 93,833 $ 79,649 $ (1,377) $ 559,694
Income (loss) 62,996 10,365 22,750 (34,323) 61,788
Nine months ended September 28, 2001:
Net sales $ 397,949 $ 89,524 $ 71,538 $ (890) $ 558,121
Income (loss) 68,470 (3,249) 18,571 (35,786) 48,006
11. 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.
12. Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board issued Statement No. 145
("SFAS 145"), "Rescission of FASB Statements 4, 44 and 64, Amendment to FASB
Statement 13, and Technical Corrections". One of the major changes of this
statement is to change the accounting for the classification of gains and losses
from the extinguishment of debt. Upon adoption, the Company will follow APB 30,
Reporting the Results of Operations--Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions in determining whether such extinguishment of debt may
be classified as extraordinary. The provisions of this statement related to the
rescission of FASB Statement 4 are effective for fiscal years beginning after
May 15, 2002. The Company does not believe the adoption of SFAS 145 will have a
material effect on the Company's financial position or results of operations.
-14-
In June 2002, the Financial Accounting Standards Board issued Statement No. 146
("SFAS 146"), Accounting for Costs Associated with Exit or Disposal Activities.
This Statement requires recording costs associated with exit or disposal
activities at their fair values when a liability has been incurred. Under
previous guidance, certain exit costs were accrued upon management's commitment
to an exit plan, which is generally before an actual liability has been
incurred. Adoption of this Statement is required with the beginning of fiscal
year 2003. The Company has not yet completed its evaluation of the impact of
adopting this Statement.
13. Subsequent Events
On October 15, 2002, HFS acquired INTERLINQ Software Corporation ("INTERLINQ")
for $6.25 per share. The purchase price, including fees and expenses, was
approximately $34 million less INTERLINQ's cash balance of approximately $7
million and short-term investments of approximately $3 million. The Company
expects the purchase price allocation will include in-process research and
development costs in the range of $3.0 - $4.0 million which will be expensed at
acquisition. INTERLINQ is the industry leader in mortgage loan production and
servicing systems, with relationships with more than 1,400 mortgage lenders.
-15-
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 and direct marketing activities
marketed primarily to financial institutions.
The Software and Services segment ("Software & Services") is focused on the
financial institution market and includes lending and mortgage origination and
closing applications, database marketing software, core systems applications and
business intelligence solutions.
The Scantron segment ("Scantron") includes scanning equipment and software,
scannable forms, survey solutions, curriculum development and assessment tools
and field maintenance services. Scantron sells these products and services to
the education, commercial and financial institution markets.
RESULTS OF OPERATIONS THIRD QUARTER 2002 VERSUS 2001
Consolidated net sales were $189.6 million for the quarter ended September 27,
2002 compared to $179.6 million for the quarter ended September 28, 2001, an
increase of 5.6%.
Printed Products sales totaled $128.3 million and $126.4 million for the third
quarters of 2002 and 2001, respectively, a year over year increase of 1.5%.
Sales for the traditional check printing operations increased over 2001 but the
related check volume was down 6.0%. The volume decline was primarily
attributable to the loss of certain large customers during 2001, an acquisition
conversion for a customer in 2001 that provided non-recurring volume and a
decline in orders received from a direct check marketer. The impact of the
volume decline was moderated by an improvement of 7.8% in average price per unit
attributable to price increases implemented in July 2002 and August 2001 as well
as to a lower volume of less favorably priced business. Computer check sales and
related products also increased in 2002 compared to 2001 due to a fulfillment
program for a software customer initiated in late 2001 and to increases in the
commercial referral business from financial institutions. Sales decreased in
direct marketing activities due primarily to fewer openings of brokerage
accounts, a general decline in large mass mail jobs and a continued slowdown in
direct mail campaigns for credit card companies.
Software & Services sales increased 11.3% from $28.4 million in the third
quarter of 2001 to $31.6 million in the third quarter of 2002. The increase in
sales was due in part to the acquisition of Easy Systems, Inc. in May 2002 (see
Note 3 to Condensed Consolidated Financial Statements included in this report).
Sales also increased in the core systems product line, lending products,
customer relationship management software and analytical services. Sales in core
systems increased due to higher initial license sales and maintenance revenues.
Sales of lending products and services increased due to higher license sales of
Laser Pro(R) and financial.center(TM) products. The sales increase was due to a
higher proportion of book and ship sales during the quarter compared with a
higher proportion of term license agreements in 2001. Revenue recognition for
term agreements is deferred from the current period into future periods. This
sales increase is a change in the trend experienced in 2001 and the first half
of 2002. The sales increase was partially offset by a decrease in mortgage
lending and business intelligence solutions due to the decision by a major
customer to bring software development in-house in late 2001 and due to the
sunsetting of certain database marketing products in 2001.
Scantron's sales for the third quarter increased 20.3% from $25.1 million in
2001 to $30.2 million in 2002. The increase was principally due to the
acquisitions of EdVISION in July 2002 and Scanning Systems in October 2001 (see
Note 3 to Condensed Consolidated Financial Statements included in this report).
Internal growth in field services also contributed to the sales increase.
Increases in sales of scannable forms were offset by reduced sales of optical
mark reading equipment due to a trend in data collection methods from optical
mark reading to imaging and direct input methods.
-16-
Consolidated gross profit increased by 9.9% from $81.7 million in the third
quarter of 2001 to $89.8 million in the third quarter of 2002, and increased as
a percentage of sales from 45.5% in 2001 to 47.3% in 2002. The improvement was
due to the increase in sales, cost management and productivity improvement
initiatives and a favorable change in sales mix. As a percentage of sales,
Printed Products gross margin was 39.4% in 2002 compared to 37.4% in 2001.
Printed Products gross profit increased $3.3 million due to the increase in
sales and to increased efficiency from process improvements and new technology.
Printed Products gross margin increase was negatively impacted by a decrease in
check volumes in 2002. Software & Services gross profit increased 9.6% from 2001
due to the acquisition of Easy Systems and higher sales in core system
applications and lending products and services. As a percentage of sales,
Software & Services gross profit decreased to 68.4% in 2002 from 69.5% in 2001
due primarily to a change in sales mix. Scantron's gross profit increased by
19.6% from 2001 primarily due to acquisitions, change in sales mix and improved
margins in existing products and services. As a percentage of sales, Scantron's
gross profit was essentially flat at 58.5% in 2002 compared to 58.7% in 2001.
Consolidated selling, general and administrative expenses ("SG&A") increased by
$4.4 million or 7.7% in the third quarter of 2002 from 2001. These expenses as a
percentage of sales were 32.4% in 2002 compared to 31.7% in 2001. The increase
in SG&A expenses was due to the impact of acquired operations, higher expenses
for customer care infrastructure initiatives in Printed Products, the move of
customer service activities in-house which were provided by an outsource
provider in prior years and increased marketing expenditures. Third quarter 2001
SG&A included a $2.4 million charge for stock-based compensation costs related
to the accelerated vesting of certain restricted stock awards as a result of the
Company's favorable stock price performance.
Amortization of intangibles decreased to $0.9 million in the third quarter of
2002 compared to $3.7 million in the third quarter of 2001. The primary reason
for the decrease was the elimination in 2002 of goodwill amortization pursuant
to a new accounting standard. Effective January 1, 2002, the Company adopted
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). In accordance with SFAS 142, goodwill and
indefinite-lived intangible assets are no longer amortized but will be assessed
for impairment on at least an annual basis (see Note 4 to Condensed Consolidated
Financial Statements included in this report).
Consolidated income from operations increased $6.5 million from $21.0 million in
the third quarter of 2001 to $27.5 million in the third quarter of 2002 due to
the increase in gross profit and the elimination of goodwill amortization in
2002, partially offset by the increase in SG&A expenses.
Other Income (Expense) decreased by $8.5 million from an expense of $9.9 million
in 2001 to an expense of $1.4 million in 2002 primarily due to a write-down of
$7.8 million in the third quarter of 2001 of the Company's equity investment in
Netzee, Inc. The decrease was also due to lower interest expense which decreased
$0.6 million from 2001 due to lower interest rates in 2002 compared with 2001
and also to a decrease in debt levels outstanding during 2002 compared with
2001.
Consolidated income before income taxes increased $15.0 million from $11.1
million in the third quarter of 2001 to $26.1 million in the third quarter of
2002 due to increased income from operations, the write-down of an equity
investment in the third quarter of 2001 and lower interest expense.
The Company's consolidated effective income tax rates were 38.8% and 54.3% for
the three-month periods ended September 27, 2002 and September 28, 2001,
respectively. The lower effective rate in 2002 resulted primarily from a $1.3
million valuation allowance in 2001 for a portion of the capital loss tax
benefit related to the write-down of the investment in Netzee and the
elimination of goodwill amortization, most of which was nondeductible for tax
purposes. Also affecting the tax rate in 2002 were state tax credits and
adjustments related to prior years due to the conclusion of an IRS examination
for the years 1996 through 1998 that were recorded during the quarter.
-17-
The Company's net income for the third quarter of 2002 was $16.0 million
compared to $5.1 million for 2001. Basic and diluted earnings per share were
$0.55 and $0.53, respectively, for the third quarter of 2002 compared to basic
and diluted earnings per share of $0.17 for the same period in 2001. Included in
the third quarter of 2001 were amortization of goodwill, charges for the
write-down of the investment in Netzee, compensation costs associated with
accelerated vesting of certain restricted stock grants and severance costs
related to a plant consolidation. Adjusting for these items, diluted earnings
for the third quarter of 2001 were $0.51 per share on a comparable basis with
2002.
RESULTS OF OPERATIONS YEAR TO DATE 2002 VERSUS 2001
Consolidated net sales were $559.7 million for the nine months ended September
27, 2002 compared to $558.1 million for the nine months ended September 28,
2001.
Printed Products sales totaled $387.6 million and $398.0 million for the first
nine months of 2002 and 2001, respectively. Lower volumes in traditional check
printing operations, which decreased 8.2% in 2002 from 2001, accounted for a
majority of the decrease in Printed Product sales. The volume decline was
primarily attributable to the loss of certain large customers in 2001 and a
decline in orders received from a direct check marketer. The impact of these two
factors was moderated by an improvement of 4.5% in average price per unit
primarily due to lower volume with the direct check marketer that is less
favorably priced and also to price increases. Sales in direct marketing also
decreased due to the general economic slowdown which resulted in lower credit
card promotions and fewer openings of brokerage accounts. Partially offsetting
those sales decreases were sales in computer checks and related products which
increased in 2002 compared to 2001 due to a fulfillment program for a software
customer initiated in late 2001 and increases in commercial referral business
from financial institutions.
Software & Services sales for the first nine months increased from $89.5 million
in 2001 to $93.8 million in 2002. The sales increase was due in part to the
acquisition of Easy Systems in May 2002 (see Note 3 to Condensed Consolidated
Financial Statements included in this report) and also to increased sales in
core systems applications, customer relationship management applications and
branch automation applications. The increase in sales was partially offset by
decreases in sales of mortgage lending and business intelligence solutions
primarily due to a major customer that decided to bring software development
in-house in late 2001. Sales of lending and account opening software
applications were lower in 2002 compared to 2001 primarily due to a trend of a
higher proportion of term license agreements during 2001 and the first six
months of 2002 whereby revenue recognition is deferred from the current period
into future periods. This trend changed during the third quarter of 2002 with a
higher proportion of book and ship sales which are recognized as revenue when
shipped. The change in the third quarter was not significant enough to offset
the effect of higher term license sales during the first six months of 2002.
Scantron's sales for the first nine months increased approximately 11.3% from
$71.5 million in 2001 to $79.6 million in 2002. The increase was due in part to
the Scanning Systems and EdVISION acquisitions made by Scantron during 2001 and
2002 (see Note 3 to Condensed Consolidated Financial Statements included in this
report), internal growth in field services and growth in sales of imaging
products. Increases in sales of scannable forms were offset by reduced sales of
optical mark reading equipment due to a trend in data collection methods from
optical mark reading to imaging and direct input methods.
Consolidated gross profit increased by 3.2% from $250.9 million to $258.8
million in the first nine months of 2002 from the same period in 2001 and
increased as a percentage of sales from 44.9% in 2001 to 46.2% in 2002. Printed
Products gross profit decreased 1% in 2002 from 2001 due to lower volumes in
checks and direct marketing. As a percentage of sales, Printed Products gross
margin was 38.6% in 2002 compared to 38.0% in 2001 due to price increases, a
change in sales mix and increased efficiency from process improvements and new
technology. In 2001, Printed Products gross margin was negatively impacted by
$0.5 million of severance costs related to a plant consolidation. Software &
Services' gross profit, as a percent of sales, increased to 68.7% in 2002 from
67.0% in 2001. Scantron's gross profit increased by 13.5% from 2001 and
increased as a percentage of sales to 56.4% in 2002 from 55.3% in 2001 due to
efficiencies realized from acquisitions and improved margins in existing
products and services.
-18-
Consolidated SG&A expenses increased by $13.9 million or 7.9% in the first nine
months of 2002 compared to the first nine months of 2001. These expenses as a
percentage of sales were 34.0% in 2002 compared to 31.6% in 2001. The increase
was due primarily to stock-based compensation that totaled $8.2 million in 2002
compared to $3.7 million in 2001. The increase in stock-based compensation was
primarily due to a $6.0 million charge related to accelerated vesting of certain
restricted stock grants in the first quarter of 2002, net of the resulting
reduction of amortization expense for the first nine months of 2002. These
grants vested as a result of the Company's favorable stock price performance.
Stock-based compensation in the third quarter of 2001 included a charge of $2.4
million for accelerated vesting of restricted stock awards. SG&A was unfavorably
impacted in 2002 by the move of customer service activities in-house which were
provided by an outside provider in prior years, increases in marketing
expenditures, higher expenses for customer care infrastructure initiatives,
upgrade expenses for the Company's ERP system, severance expenses related to
management reductions in 2002 and the impact of acquisitions.
Amortization of intangibles decreased $8.5 million to $2.2 million in the first
nine months of 2002 compared to $10.7 million in 2001, primarily due to the
elimination of goodwill amortization in 2002.
Consolidated income from operations increased $2.7 million to $66.6 million for
the first nine months of 2002 from $63.9 million in 2001 due to the increase in
gross profit and the elimination of goodwill amortization in 2002, partially
offset by increases in stock-based compensation and other SG&A expenses in 2002.
Other Income (Expense) decreased by $11.1 million from an expense of $15.9
million in 2001 to an expense of $4.8 million in 2002. The decrease was
primarily due to a $7.8 million write-down in 2001 of the Company's equity
investment in Netzee and to decreased interest expense. Interest expense was
lower in 2002 due to lower interest rates and lower levels of debt outstanding
in 2002 compared with 2001.
Consolidated income before income taxes increased $13.8 million to $61.8 million
in 2002 compared to $48.0 million in 2001.
The Company's consolidated effective income tax rates were 39.0% and 45.2% for
the nine-month periods ended September 27, 2002 and September 28, 2001,
respectively. The decrease in the effective income tax rate was primarily due to
the impact of SFAS 142 which eliminated goodwill amortization in 2002, most of
which was nondeductible for tax purposes, and to a $1.3 million valuation
allowance included in 2001 for a portion of the capital loss tax benefit related
to the write-down of the investment in Netzee. Also affecting the tax rate in
2002 were state tax credits and adjustments related to prior years due to the
conclusion of an IRS examination for the years 1996 through 1998 that were
recorded during the nine months ended September 27, 2002.
The Company's net income for the first nine months of 2002 was $37.7 million
compared to $26.3 million for 2001. Basic and diluted earnings per share were
$1.29 and $1.23, respectively, for the first nine months of 2002 compared to
basic and diluted earnings per share of $0.90 and $0.88, respectively, for the
same period in 2001. Included in 2002 were charges for accelerated vesting of
stock grants and the write-down of an investment which reduced diluted earnings
by $0.13 per share net of the resulting reduction of amortization expense for
the period. Included in 2001 were amortization of goodwill, charges for the
write-down of the investment in Netzee, costs associated with accelerated
vesting of stock-based compensation and severance costs related to a plant
consolidation. Adjusting for these items, comparable diluted year-to-date
earnings for 2001 were $1.40 per share.
-19-
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Cash flows provided by operating activities of $97.8 million for the first nine
months of 2002 decreased $11.8 million compared to $109.6 million for the first
nine months of 2001 due primarily to changes in working capital. Those changes
primarily consisted of an income tax refund received in 2001 and improvement in
2001 in the collection of past due accounts receivable. Other sources of cash
were $13.9 million from increased borrowings and $10.5 million from proceeds
received for common stock issued under the Company's stock option and employee
stock purchase plans. The primary uses of funds in the first nine months of 2002
were for the acquisition of new businesses, capital expenditures, refundable
customer contract payments, dividend payments to shareholders and purchases of
treasury stock.
In March 2000, the Company's Board of Directors authorized the purchase of up to
2.9 million shares of the Company's outstanding common stock. Shares purchased
under this program may be held in treasury, used for acquisitions, used to fund
the Company's stock benefit and compensation plans or for other corporate
purposes. During the first nine months of 2002, the Company purchased 203,600
shares of its common stock under this authorization at a cost of approximately
$5.4 million. As of September 27, 2002, a total 648,746 shares have been
purchased under the share purchase authorization at an average cost of $22.34
per share.
Purchases of property, plant and equipment totaled $26.3 million in the first
nine months of 2002, compared to $34.2 million in 2001. Capital expenditures
during both periods were primarily for digital printing equipment and customer
care infrastructure initiatives in Printed Products. At the end of the third
quarter, the Company was fully operational with digital printing technology in
all of its domestic personal check imprint operations. The Company's customer
care infrastructure initiatives focus on improving systems that support sales,
marketing and customer service to ensure exceptional service and added
functionality for the Company's call centers. The Company currently estimates it
will spend approximately $60.0 million on customer care infrastructure
initiatives over a four-year period ending in 2004 with a majority of the
expenditures being incurred by the end of 2003. The total anticipated
expenditures include capital expenditures of approximately $38.0 million.
Through September 27, 2002, $26.6 million has been expended on these
initiatives, of which $19.4 million was capitalized. Total capital expenditures
for the Company are currently expected to be approximately $33-$35 million in
2002.
As of September 27, 2002, the Company's accumulated other comprehensive income
(loss) totaled ($0.5) million and consisted of net unrealized gains on
investments, net unrealized losses on cash flow hedging instruments and foreign
currency translation adjustments. In June 2002, the Company's equity investment
in Netzee was written down by $0.3 million to its market value due to the
Company's evaluation that the decline in the value of Netzee stock was other
than temporary.
The Company has a $325.0 million revolving Credit Facility with a syndicate of
banks. The Credit Facility matures in 2004 and may be used for general corporate
purposes, including acquisitions, and includes both direct borrowings and
letters of credit. As of September 27, 2002, direct borrowings totaled $138.0
million under the facility. There were $5.3 million in outstanding letters of
credit, which were issued under the Credit Facility, leaving $181.7 million
available for borrowings at September 27, 2002.
On September 27, 2002, the Company had $22.5 million in cash and cash
equivalents. The Company believes that its current cash position, funds from
operations and the availability of funds under the Credit Facility will be
sufficient to meet anticipated requirements for working capital, dividends,
capital expenditures and other corporate needs for the foreseeable future.
Management is not aware of any condition that would materially alter this trend.
The following table aggregates the Company's contractual obligations and
commitments with definitive payment terms which will require significant
-20-
cash outlays in the future. The annual commitment amounts as of September 27,
2002 are (in millions):
Contractual Payments Due by Period
Obligations -----------------------------------------------------------
and Commitments Total 2003 2004 2005 2006 2007+
- -----------------------------------------------------------------------------
Long-term debt $138.1 $ 0.1 $ 138.0 $ - $ - $ -
Leases 82.0 13.9 11.7 10.7 9.5 36.2
Acquisition related
contingent payments 4.0 - 2.0 2.0 - -
- -----------------------------------------------------------------------------
Total $224.1 $ 14.0 $ 151.7 $ 12.7 $ 9.5 $ 36.2
=============================================================================
The Company believes that it possesses sufficient unused debt capacity and
access to capital markets to pursue additional acquisition opportunities.
ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board issued Statement No. 145
("SFAS 145"), "Rescission of FASB Statements 4, 44 and 64, Amendment to FASB
Statement 13, and Technical Corrections". One of the major changes of this
statement is to change the accounting for the classification of gains and losses
from the extinguishment of debt. Upon adoption, the Company will follow APB 30,
Reporting the Results of Operations--Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions in determining whether such extinguishment of debt may
be classified as extraordinary. The provisions of this statement related to the
rescission of FASB Statement 4 are effective for fiscal years beginning after
May 15, 2002. The Company does not believe the adoption of SFAS 145 will have a
material effect on the Company's financial position or results of operations.
In June 2002, the Financial Accounting Standards Board issued Statement No. 146
("SFAS 146"), Accounting for Costs Associated with Exit or Disposal Activities.
This Statement requires recording costs associated with exit or disposal
activities at their fair values when a liability has been incurred. Under
previous guidance, certain exit costs were accrued upon management's commitment
to an exit plan, which is generally before an actual liability has been
incurred. Adoption of this Statement is required with the beginning of fiscal
year 2003. The Company has not yet completed its evaluation of the impact of
adopting this Statement.
OUTLOOK
The Company believes that its financial position continues to be strong and
expects a positive cash flow from operations in all business segments in 2002.
The Company projects an increase in the Printed Products segment's profits
during the last quarter of 2002 compared with the same period in 2001 due to
price increases and the implementation of new technology and process
improvements. The Company anticipates the Software & Services segment's
profitability will continue to improve during the last quarter of 2002 due
primarily to the elimination of goodwill amortization. The Scantron segment is
also projected to increase sales and profits during the last quarter in 2002
through internal growth and the impact of acquisitions.
With the current soft economy, the loss of a major customer, the current level
of spending on customer care infrastructure and recent pricing trends in Printed
Products, the Company is cautious about its outlook for 2003. In addition to
these factors the Company is not projecting its direct marketing business to
increase from current levels in the near term. Accordingly, the Company does not
expect 2003 earnings to exceed expected 2002 earnings after taking into account
unusual charges of approximately $0.22 per share in 2002 which includes a
preliminary estimate of $0.10 per share for an expected in-process research and
development charge related to the fourth quarter acquisition of INTERLINQ (see
Note 13 to Condensed Consolidated Financial Statements included in this report).
-21-
CRITICAL ACCOUNTING POLICIES
The Company has identified certain of its accounting policies as critical to its
business operations and the understanding of its results of operations. These
policies include revenue recognition, impairment of long-lived assets, goodwill
and other intangibles, software and other development costs and income taxes.
The Company considers its revenue recognition policy as critical to its reported
results of operations primarily in its Software and Services segment. For a
portion of its sales, this segment utilizes estimates of efforts to complete a
project in percentage of completion calculations to recognize revenue from
licensing of software with significant amounts of tailoring and/or
customization. Due to uncertainties inherent in these estimates, actual results,
including the amounts of revenue and expenses recognized, could differ from
those estimates.
The Company reviews investments, long-lived assets and certain intangibles for
impairment when events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Any impairment losses are reported in
the period in which the recognition criteria are first applied based on the fair
value of the asset. In the third quarter of 2001 and in the second quarter of
2002, the Company recorded charges of $7.8 million and $0.3 million,
respectively, before income taxes for a write-down of an equity investment.
The Company makes estimates and assumptions regarding future cash flows in its
review of the carrying values of goodwill and other intangibles to assess
recoverability. If these estimates and assumptions change in the future, the
Company may be required to record impairment charges for these assets not
previously recorded. The Company analyzes its goodwill for impairment on an
annual basis. In 2002, the Company engaged an independent valuation firm to
perform a goodwill impairment test. Based upon the analysis, there was no
impairment of goodwill.
The carrying value of the Company's net deferred tax assets assumes the Company
will be able to generate sufficient future taxable income in certain tax
jurisdictions, based on estimates and assumptions. The Company may be required
to record additional valuation allowances against its deferred tax assets
resulting in additional income tax expense if these estimates and assumptions
change in the future.
RISK FACTORS AND CAUTIONARY STATEMENTS
When used in this report and in subsequent filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and in
written or oral statements made by authorized representatives of the Company,
the words or phrases "believe," "should result," "are expected to," "will
continue," "is anticipated," "estimate," "project" or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements are
necessarily subject to certain risks and uncertainties, including, but not
limited to, those discussed below that could cause actual results to differ
materially from the Company's historical experience and its present expectations
or projections. Caution should be taken not to place undue reliance on any such
forward-looking statements, which speak only as of the date such statements are
made and which may or may not be based on historical experiences and/or trends
which may or may not continue in the future. The Company does not undertake and
specifically declines any obligation to update any forward-looking statements to
reflect events or circumstances occurring after the date of such statements or
to reflect the occurrence of unanticipated events.
Various factors may affect the Company's financial performance, including, but
not limited to, those factors discussed below which could cause the Company's
actual results for future periods to differ from any opinions, statements or
projections expressed with respect thereto. Such differences could be material
and adverse. Many variables will impact the ability to achieve sales levels,
improve service quality, achieve production efficiencies and reduce expenses in
Printed Products. These include, but are not limited to, the continuing upgrade
of the Company's customer care infrastructure and systems used in the Company's
manufacturing, sales, marketing, customer service and call center operations.
-22-
Several factors outside the Company's control could negatively impact check
revenues. These include the continuing expansion of alternative payment systems
such as credit cards, debit cards and other forms of electronic commerce or
on-line payment systems. Check revenues could also be adversely affected by
continued consolidation of financial institutions, competitive check pricing and
the impact of governmental laws and regulations. There can be no assurances that
the Company will not lose significant customers or that any such losses could be
offset by the addition of new customers.
While the Company believes substantial growth opportunities exist in the
Software & Services segment, there can be no assurances that the Company will
achieve its revenue or earnings growth targets. The Company believes there are
many risk factors inherent in its software business, including but not limited
to the retention of employee talent and customers. Also, variables exist in the
development of new software products, including the timing and costs of the
development effort, product performance, functionality, product acceptance,
competition, and general changes in economic conditions or U.S. financial
markets.
Several factors outside of the Company's control could affect results in the
Scantron segment. These include the rate of adoption of new electronic data
collection, changes in testing and assessment methods which could negatively
impact current forms, or reductions in scanner sales and related service
revenue. The Company continues to develop products and services that it believes
offer state of the art electronic data collection, testing and assessment
solutions. However, variables exist in the development of new testing methods
and technologies, including the timing and costs of the development effort,
product performance, functionality, market acceptance, adoption rates,
competition and the funding of education at the federal, state and local level,
all of which could have an adverse impact on the Company's business.
As a matter of due course, the Company and its subsidiaries are subject to
various Federal and State tax examinations. The Company believes that it is in
compliance with the various Federal and State tax regulations imposed and such
returns and reports filed with respect to such tax regulations are materially
correct. The results of these various Federal and State tax examinations could
produce both favorable and unfavorable adjustments to the Company's total tax
expense either currently or on a deferred basis. At such time when a favorable
or unfavorable adjustment is known, the effect on the Company's consolidated
financial statements is recorded.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
All financial instruments held by the Company are held for purposes other than
trading. The Company is exposed to primarily two types of market risks: interest
rate and equity price.
Interest Rate Risk
The Company is exposed to interest rate risk on its variable rate debt. At
September 27, 2002, the Company had outstanding variable rate debt of $138.0
million. In order to manage its exposure to fluctuations in interest rates, the
Company has entered into interest rate swap agreements, which allow it to raise
funds at floating rates and effectively swap them into fixed rates. At September
27, 2002, the notional principal amount of interest rate swaps outstanding was
$122 million. The Company believes that its interest rate risk at September 27,
2002 was minimal. These derivative financial instruments are viewed as risk
management tools and are entered into for hedging purposes only. The Company
does not use derivative financial instruments for trading or speculative
purposes.
The fair value of the swaps, which represent what the Company would have to pay
to terminate the swaps, reflected a loss of $2.3 million ($1.4 million net of
income taxes) at September 27, 2002. The fair value of the swaps was recognized
on the balance sheet in other liabilities with a corresponding charge to
accumulated other comprehensive income, a component of shareholders' equity.
Charges and credits to other comprehensive income for interest rate swap
agreements that are not terminated early will net to zero over the term of the
agreements.
-23-
Equity Price Risk
The fair value of the Company's investments is primarily affected by
fluctuations in the market price for the common stock of Bottomline
Technologies, Inc. and Netzee Inc. The change in market value has been accounted
for as a component of other comprehensive income until management determines
that an other than temporary decline in market value has occurred at which time
a loss is recognized in current earnings. In June 2002, the Company's management
determined that the decline in Netzee's market value was other than temporary.
The investment was written down to its market value resulting in a recognized
loss of $0.3 million. The following presents the Company's investment in
Bottomline and Netzee reflecting the high and low closing market prices for the
nine months ended September 27, 2002 (in thousands):
Carrying
Value(a) High(b) Low(b)
- -------------------------------------------------------------------------
Investment in:
Bottomline $ 1,734 $ 6,250 $ 2,293
Netzee 138 1,540 138
(a) Based on market value as of September 27, 2002.
(b) Based on quoted market prices for these items.
Item 4. Controls and Procedures
Within the 90 days prior to this report, the Company evaluated, under the
supervision and with the participation of its management, including the Chief
Executive Officer and Chief Financial Officer, the effectiveness of the design
and operation of the Company's disclosure controls and procedures pursuant to
Securities Exchange Act of 1934 Rule 13a-14 and Rule 13a-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company that is required
to be included in its periodic Securities and Exchange Commission filings. There
have been no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
this evaluation.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
* Indicates exhibit previously filed with the Securities and Exchange Commission
as indicated in parentheses and incorporated herein by reference.
Exhibit Description of the Exhibit
3.1 * Amended and Restated Articles of Incorporation (Exhibit B to
registrant's Proxy Statement dated March 12,1999).
3.2 * Bylaws, as amended through February 1, 1999 (Exhibit 3.2 to
registrant's Annual Report on Form 10-K for the year
ended December 31, 1998).
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.
11.1 Computation of Per Share Earnings.+
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
There were no reports filed on Form 8-K for the quarterly period ended September
27, 2002.
-25-
- --------
+ Data required by SFAS No. 128, "Earnings Per Share," is provided in Note 9 to
the Condensed Consolidated Financial Statements included in this report.
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
11/11/2002 /s/ J. Michael Riley
Date: _________________ By:_____________________________
J. Michael Riley
Vice President and Controller
(Duly Authorized Officer and
Chief Accounting Officer)
CERTIFICATIONS
I, Timothy C. Tuff, certify that:
1. I have reviewed this quarterly report on Form 10-Q of John H.
Harland Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
-26-
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 11, 2002
/s/ Timothy C. Tuff
-----------------------
Timothy C. Tuff
Chairman and
Chief Executive Officer
-27-
I, Charles B. Carden, certify that:
1. I have reviewed this quarterly report on Form 10-Q of John H.
Harland Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 11, 2002
/s/ Charles B. Carden
-----------------------
Charles B. Carden
Vice President and
Chief Financial Officer