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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 June 27, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to _______________
Commission file number 1-6352
JOHN H. HARLAND COMPANY
(Exact name of registrant as specified in its charter)
GEORGIA 58-0278260
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2939 Miller Rd.
Decatur, Georgia 30035
(Address of principal executive offices) (Zip code)
(770) 981-9460
(Registrant's telephone number, including area code)
(Not Applicable)
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( ).
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes (X) No ( ).
The number of shares of the registrant's common stock outstanding on July 25,
2003 was 27,988,554.
-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 .24
ITEM 4. CONTROLS AND PROCEDURES. . . . . . . . . . . . . . . . . . .25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . .26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . .26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . .27
EXHIBIT LIST . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29
-2-
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
------
(In thousands) June 27, December 31,
2003 2002
- ----------------------------------------------------------------------
(Unaudited)
Current Assets:
Cash and cash equivalents $ 6,950 $ 19,218
Accounts receivable - net 60,119 58,871
Inventories 16,762 18,191
Deferred income taxes 27,216 26,977
Other 17,220 15,568
- ----------------------------------------------------------------------
Total current assets 128,267 138,825
- ----------------------------------------------------------------------
Other Assets:
Investments 5,027 3,917
Goodwill - net 218,039 210,462
Intangible assets - net 18,695 14,127
Refundable contract payments 38,311 23,281
Other 23,865 25,860
- ----------------------------------------------------------------------
Total other assets 303,937 277,647
- ----------------------------------------------------------------------
Property, plant and equipment 349,688 340,684
Less accumulated depreciation
and amortization 217,595 206,469
- ----------------------------------------------------------------------
Property, plant and equipment - net 132,093 134,215
- ----------------------------------------------------------------------
Total $ 564,297 $ 550,687
======================================================================
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 June 27, December 31,
per share amounts) 2003 2002
- ----------------------------------------------------------------------
(Unaudited)
Current Liabilities:
Accounts payable $ 24,029 $ 22,599
Deferred revenues 64,521 53,311
Accrued liabilities:
Salaries, wages and employee benefits 23,855 31,039
Taxes 22,699 18,817
Other 20,968 21,320
- ----------------------------------------------------------------------
Total current liabilities 156,072 147,086
- ----------------------------------------------------------------------
Long-Term Liabilities:
Long-term debt, less current maturities 139,318 144,106
Other 25,552 25,501
- ----------------------------------------------------------------------
Total long-term liabilities 164,870 169,607
- ----------------------------------------------------------------------
Total liabilities 320,942 316,693
- ----------------------------------------------------------------------
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 6,559 5,245
Retained earnings 425,130 409,110
Accumulated other comprehensive
income (loss) 697 (330)
Unamortized restricted stock awards (6,709) (5,785)
- ----------------------------------------------------------------------
463,584 446,147
Less 9,958,615 and 9,544,064 shares
in treasury - at cost,
respectively 220,229 212,153
- ----------------------------------------------------------------------
Shareholders' equity 243,355 233,994
- ----------------------------------------------------------------------
Total $ 564,297 $ 550,687
======================================================================
See Notes to Condensed Consolidated Financial Statements.
-4-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
(Unaudited)
Three Month Period Ended Six Month Period Ended
(In thousands, except June 27, June 28, June 27, June 28,
per share amounts) 2003 2002 2003 2002
- ---------------------------------------------------------------------------
Sales:
Product sales $ 157,175 $ 157,569 $ 317,584 $ 316,885
Service sales 35,253 26,917 68,269 53,173
- ---------------------------------------------------------------------------
Total sales 192,428 184,486 385,853 370,058
Cost of sales:
Cost of products sold 87,134 89,047 175,745 180,176
Cost of services sold 11,793 9,683 22,775 18,900
- ---------------------------------------------------------------------------
Total cost of sales 98,927 98,730 198,520 199,076
Gross Profit 93,501 85,756 187,333 170,982
Selling, general and
administrative expenses 73,609 62,184 143,941 130,659
Amortization of other
intangibles 762 644 1,432 1,272
- ---------------------------------------------------------------------------
Income From Operations 19,130 22,928 41,960 39,051
- ---------------------------------------------------------------------------
Other Income (Expense):
Interest expense (1,414) (1,509) (2,884) (3,093)
Other - net (49) (299) 20 (314)
- ---------------------------------------------------------------------------
Total (1,463) (1,808) (2,864) (3,407)
- ---------------------------------------------------------------------------
Income Before Income Taxes 17,667 21,120 39,096 35,644
Income taxes 6,417 8,197 14,667 13,934
- ---------------------------------------------------------------------------
Net Income 11,250 12,923 24,429 21,710
Retained Earnings at
Beginning of Period 418,208 376,075 409,110 372,164
Cash Dividends (2,070) (2,208) (4,211) (4,402)
Issuance of treasury shares
under stock plans (2,258) (230) (4,198) (2,912)
- ---------------------------------------------------------------------------
Retained Earnings at
End of Period $ 425,130 $ 386,560 $ 425,130 $ 386,560
===========================================================================
Weighted Average Shares
Outstanding:
Basic 27,607 29,441 27,740 29,341
Diluted 28,258 31,069 28,331 30,838
===========================================================================
Earnings Per Common Share:
Basic $ 0.41 $ 0.44 $ 0.88 $ 0.74
Diluted $ 0.40 $ 0.42 $ 0.86 $ 0.70
===========================================================================
Cash Dividends Per
Common Share $ 0.075 $ 0.075 $ 0.15 $ 0.15
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
-5-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Month Period Ended
June 27, June 28,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------
Operating Activities:
Net income $ 24,429 $ 21,710
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 18,462 19,065
Amortization 10,342 8,614
Stock-based compensation 1,203 7,480
Tax benefits from stock-based compensation 1,019 2,512
Deferred income taxes (1,378) (832)
Other 515 434
Change in assets and liabilities net of effects
of businesses acquired:
Accounts receivable 81 1,082
Inventories and other current assets (1,492) 4,195
Deferred revenues 5,424 6,990
Accounts payable and accrued liabilities (3,161) (11,266)
Refundable contract payments (20,922) (5,256)
- -----------------------------------------------------------------------------
Net cash provided by operating activities 34,522 54,728
- -----------------------------------------------------------------------------
Investing Activities:
Purchases of property, plant and equipment (14,314) (18,727)
Proceeds from sale of property, plant and equipment 198 1,436
Payment for acquisition of businesses -
net of cash acquired (11,293) (10,803)
Long-term investments and other assets 1,190 (221)
- -----------------------------------------------------------------------------
Net cash used in investing activities (24,219) (28,315)
- -----------------------------------------------------------------------------
Financing Activities:
Purchases of treasury stock (19,138) (1,568)
Issuance of treasury stock 5,038 9,215
Dividends paid (4,211) (4,402)
Long-term debt - net (4,788) (28,029)
Other - net 528 (1,179)
- -----------------------------------------------------------------------------
Net cash used in financing activities (22,571) (25,963)
- -----------------------------------------------------------------------------
Changes in cash and cash equivalents (12,268) 450
Cash and cash equivalents at beginning of period 19,218 10,096
- -----------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 6,950 $ 10,546
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
-6-
JOHN H. HARLAND COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 27, 2003
(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 2002 financial
statements and notes to financial statements to conform to the 2003
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, 2002 ("2002 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 2002 Form 10-K.
Stock-Based Compensation
The Company accounts for employee stock-based compensation plans using the
recognition and measurement provisions of APB Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. If the Company
accounted for stock-based compensation using the fair value recognition
provisions of Financial Accounting Standards Board (the "FASB") Statement No.
123, "Accounting for Stock-Based Compensation", the Company's net income and
earnings per share for the three and six month periods ended June 27, 2003 and
June 28, 2002 would have changed to the pro forma amounts listed below:
Three Month Period Ended Six Month Period Ended
(In thousands, except June 27, June 28, June 27, June 28,
per share amounts) 2003 2002 2003 2002
- ------------------------------------------------------------------------
Net income:
As reported $11,250 $12,923 $24,429 $21,710
Add: stock-based
compensation expense
included in reported
net income, net of tax 370 284 734 4,563
Deduct: stock-based
compensation expense
determined under the fair
value based method for
all awards, net of tax (1,242) (4,555) (2,917) (7,655)
- ------------------------------------------------------------------------
Pro forma net income $10,378 $ 8,652 $22,246 $18,618
========================================================================
-7-
Three Month Period Ended Six Month Period Ended
June 27, June 28, June 27, June 28,
2003 2002 2003 2002
- ------------------------------------------------------------------------
Earnings per common share:
As reported
Basic $ 0.41 $ 0.44 $ 0.88 $ 0.74
Diluted $ 0.40 $ 0.42 $ 0.86 $ 0.70
Pro forma
Basic $ 0.38 $ 0.29 $ 0.80 $ 0.63
Diluted $ 0.37 $ 0.28 $ 0.79 $ 0.60
Pro forma compensation costs associated with options granted under the employee
stock purchase plan were estimated based on the discount from market value. The
following presents the estimated weighted average fair value of options granted
and the weighted average assumptions used under the Black-Scholes option pricing
model for the three and six month periods ended June 27, 2003 and June 28, 2002:
Three Month Period Ended Six Month Period Ended
June 27, June 28, June 27, June 28,
2003 2002 2003 2002
- ------------------------------------------------------------------------
Fair value per option $ 8.83 $14.42 $ 7.92 $10.76
Weighted average
assumptions:
Dividend yield 1.23% 0.97% 1.42% 1.21%
Expected volatility 40.28% 41.04% 41.10% 41.00%
Risk-free interest rate 3.53% 5.21% 4.02% 5.10%
Expected life (years) 5.0 6.9 5.2 5.8
Accounting Pronouncements
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
4, 44 and 64, Amendment to FASB Statement 13, and Technical Corrections" ("SFAS
145"). One of the major changes of SFAS 145 is to change the accounting for the
classification of gains and losses from the extinguishment of debt. The Company
adopted SFAS 145 on January 1, 2003 and uses 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. Adoption of SFAS 145 did not have a material effect on the
Company's financial position or results of operations.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 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. The Company adopted SFAS 146 on
January 1, 2003. Adoption of SFAS 146 did not have a material effect on the
Company's financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness
of Others" ("FIN 45"), which requires companies to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. FIN 45 provides specific guidance identifying the
characteristics of contracts that are subject to its guidance in its entirety
from those only subject to the initial recognition and measurement provisions.
The recognition and measurement provisions of FIN 45 are effective on a
prospective basis for guarantees issued or modified after December 31, 2002. The
Company adopted the recognition and measurement provisions of FIN 45 on January
1, 2003. Adoption of these provisions did not have a material effect on the
Company's financial position or results of operations.
-8-
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 provides accounting requirements
for business enterprises to consolidate related entities in which they are
determined to be the primary beneficiary as a result of their variable economic
interests. The interpretation provides guidance in judging multiple economic
interests in an entity and in determining the primary beneficiary. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. The Company adopted
certain provisions of FIN 46 during the first quarter of 2003 and this adoption
did not have a material effect on the Company's financial position or results of
operations. The Company believes that the adoption of the remaining provisions
of FIN 46 will not have a material effect on its financial position or results
of operations.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 requires that contracts with
comparable characteristics be accounted for similarly and is effective for
contracts entered into or modified after June 30, 2003. The Company does not
believe that the adoption of SFAS 149 will have a material effect on the
Company's financial position or results of operations.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS 150"). SFAS 150 requires that an issuer classify financial instruments
that are within its scope as a liability (or an asset in some circumstances)
instead of equity as previously classified. SFAS 150 is effective for financial
instruments entered into or modified after May 31, 2003. Adoption of SFAS 150
did not have a material effect on the Company's financial position or results of
operations.
3. Acquisitions
On June 3, 2003, Harland Financial Solutions, Inc. ("HFS"), a wholly owned
subsidiary of the Company, extended its core systems offering with the
acquisition of 100% of the equity of Premier Systems, Inc. ("PSI") for
approximately $11.3 million, net of cash acquired. PSI was a provider of core
processing service bureau deliverables that were based on HFS' widely used
ULTRADATA(R) System. With the addition of PSI, HFS now provides core processing
applications and services to more than 1,000 financial institutions. The
acquisition allows HFS to deliver its increasingly broad range of technological
solutions in an online service bureau environment.
The pro forma effects of the PSI acquisition were not material to the Company's
results of operations and are not reflected in the unaudited pro forma summary
indicated below.
On October 15, 2002, HFS acquired 100% of the equity in INTERLINQ Software
Corporation ("INTERLINQ") for approximately $23.0 million, net of cash acquired.
INTERLINQ was a leading provider of mortgage loan origination, production and
servicing solutions. As part of the acquisition, the Company acquired in-process
research and development costs totaling $3.0 million, which were immediately
expensed following the acquisition. These costs represented the fair value of
certain acquired research and development projects that were determined not to
have reached technological feasibility. As a result of the acquisition, the
Company believes HFS has a leadership position in the mortgage loan origination
market and good growth opportunity in the mortgage servicing market.
On September 20, 2002, HFS 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
-9-
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. The acquisition was completed to build on
the HFS leadership position in the financial institutions market and add
additional value for SPARAK's existing customers, as well as for other community
banks nationwide.
On July 24, 2002, Scantron Corporation ("Scantron"), a wholly owned subsidiary
of the Company, acquired 100% of the equity in EdVISION Corporation ("EdVISION")
for approximately $28.8 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 the related growth
targets are achieved, to the extent such payments are ultimately made. EdVISION
was a leading provider of curriculum development and assessment tools for the
education industry. This acquisition expands Scantron's ability to offer
advanced testing and assessment tools in the education market.
On May 28, 2002, HFS acquired 100% of the equity in Easy Systems, Inc. ("Easy
Systems") 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 addition of Easy Systems allows HFS
to offer financial institutions proven and leading-edge solutions to help them
strengthen customer relationships while improving operations.
The combined purchase price for assets acquired through acquisitions in 2002
totaled $94.5 million, net of cash acquired.
The following unaudited pro forma summary presents information as if the
acquisitions of the businesses acquired in 2002 occurred on January 1, 2002:
Three Month Period Ended Six Month Period Ended
(In thousands, except June 28, June 28,
per share amounts) 2002 2002
- ----------------------------------------------------------------------
Net sales $ 195,780 $ 392,650
Net income $ 11,577 $ 17,549
Earnings per common share:
Basic $ 0.39 $ 0.59
Diluted $ 0.37 $ 0.56
The unaudited pro forma summary for the periods presented includes adjustments
for increased amortization of intangible assets and increased interest expense.
The pro forma summary also includes the write-off of acquired in-process
research and development costs totaling $3.0 million. 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 period presented or of future results.
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.
4. Goodwill and Intangible Assets
Under the FASB Statement No. 142, "Goodwill and Other Intangibles," 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.
-10-
The changes in the carrying amounts of goodwill by business segment for the six
month period ended June 27, 2003 are as follows:
Printed Software &
(In thousands) Products Services Scantron Consolidated
- ------------------------------------------------------------------------
Balances as of
December 31, 2002 $ 24,709 $142,099 $ 43,654 $210,462
Goodwill acquired
during 2003 - 7,256 - 7,256
Purchase price
allocation adjustments - 332 (11) 321
- ------------------------------------------------------------------------
Balances as of
June 27, 2003 $ 24,709 $149,687 $ 43,643 $218,039
========================================================================
Intangible assets with definitive lives were comprised of the following:
(In thousands) June 27, 2003 December 31, 2002
- ------------------------------------------------------------------------
Gross Net Gross Net
Carrying Accum. Carrying Carrying Accum. Carrying
Amount Amort. Amount Amount Amort. Amount
- ------------------------------------------------------------------------
Developed
technology $24,661 $ (9,222) $15,439 $25,467 $ (7,460) $18,007
Customer
lists 32,033 (16,829) 15,204 26,033 (15,587) 10,446
Trademarks 3,800 (309) 3,491 3,800 (119) 3,681
Content 2,300 (212) 2,088 2,300 (97) 2,203
- ------------------------------------------------------------------------
Total $62,794 $(26,572) $36,222 $57,600 $(23,263) $34,337
========================================================================
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 sales caption on the statements of income.
Aggregate amortization expense for intangible assets totaled $4.2 million and
$3.5 million for the six month periods ended June 27, 2003 and June 28, 2002,
respectively.
The estimated future intangible amortization expense as of June 27, 2003 is as
follows:
For the years ending December 31,
(In thousands) Year Amount
- ------------------------------------------------------------------------
Remaining 2003 $ 4,604
2004 8,249
2005 5,835
2006 5,368
2007 4,619
Thereafter 7,547
- ------------------------------------------------------------------------
Total $36,222
========================================================================
5. Income Taxes
The Company's consolidated effective income tax rates were 37.5% and 39.1% for
the first six months of 2003 and 2002, respectively. The lower effective income
tax rate for the first six months of 2003 resulted primarily from the release of
a $0.4 million valuation allowance related to the utilization of capital loss
carryforwards, a reduction in the effective state rate and a reduction in
certain estimated permanent tax differences compared to the first six months of
2002. The effective tax rate for the first six months of 2002 included favorable
adjustments related to prior years.
-11-
6. Inventories
As of June 27, 2003 and December 31, 2002, inventories consisted of the
following:
June 27, December 31,
(In thousands) 2003 2002
- ----------------------------------------------------------------------
Raw materials $ 13,981 $ 15,593
Work in progress 796 414
Finished goods 1,985 2,184
- ----------------------------------------------------------------------
Total $ 16,762 $ 18,191
======================================================================
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 August 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 June 27, 2003 the Company had $139.3 million in outstanding cash borrowings,
$5.1 million in outstanding letters of credit and $180.6 million available for
borrowing under the Credit Facility. The average interest rate in effect on
outstanding cash borrowings at June 27, 2003, including the effect of the
Company's interest rate hedging program, was 3.42%.
The Company uses derivative financial instruments to manage interest rate risk.
The Company recognizes all derivatives at fair value as either assets or
liabilities in the statements of financial position. 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 August 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 June 27,
2003, the notional principal amount of interest rate swaps outstanding was $83
million and the average fixed rate in effect on the Company's interest rate swap
agreements, including the Company's credit margin, was 4.40%. The net change in
fair value of the swaps at June 27, 2003 is reported in other comprehensive
income (see Note 8). The swaps are highly effective and no significant amounts
for hedge ineffectiveness were reported in net income during the six month
periods ended June 27, 2003 and June 28, 2002.
-12-
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 six month
periods ended June 27, 2003 and June 28, 2002 was as follows (in thousands):
Three Month Period Ended Six Month Period Ended
June 27, June 28, June 27, June 28,
(In thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------
Net income: $11,250 $12,923 $24,429 $21,710
Other comprehensive
Income (loss):
Foreign exchange
translation adjustments 474 (290) 527 (718)
Unrealized gains (losses)
on investments, net
of ($595), $117, ($1,111),
and $245 in tax (provisions)
benefits 911 (1,780) 63 (3,549)
Changes in fair value of
cash flow hedging
instruments, net of ($123),
$224, ($280) and ($76) in
tax (provisions) benefits 193 (351) 438 119
Reclassification for
investment write-down
included in net income - 303 - 303
- ------------------------------------------------------------------------
Comprehensive income $12,828 $10,805 $25,457 $17,865
========================================================================
-13-
9. Earnings per Common Share
The computation of basic and diluted earnings per share for the six month
periods ended June 27, 2003 and June 28, 2002 is as follows:
Three Month Period Ended Six Month Period Ended
(In thousands, except June 27, June 28, June 27, June 28,
per share amounts) 2003 2002 2003 2002
- ------------------------------------------------------------------------
Computation of basic
earnings per common
share:
Numerator
Net Income $ 11,250 $ 12,923 $ 24,429 $ 21,710
- ------------------------------------------------------------------------
Denominator
Average weighted shares
outstanding 27,494 29,348 27,630 29,250
Average weighted deferred
shares outstanding under
non-employee directors
compensation plan 113 93 110 91
- ------------------------------------------------------------------------
Shares outstanding for
basic earnings per share
calculation 27,607 29,441 27,740 29,341
- ------------------------------------------------------------------------
Basic earnings
per share $ 0.41 $ 0.44 $ 0.88 $ 0.74
========================================================================
Computation of diluted
earnings per common
share:
Numerator
Net Income $ 11,250 $ 12,923 $ 24,429 $ 21,710
- ------------------------------------------------------------------------
Denominator
Basic weighted average
shares outstanding 27,607 29,441 27,740 29,341
Dilutive effect of stock
options and restricted
stock 651 1,628 591 1,497
- ------------------------------------------------------------------------
Shares outstanding for
diluted earnings per
share calculation 28,258 31,069 28,331 30,838
- ------------------------------------------------------------------------
Diluted earnings
per share $ 0.40 $ 0.42 $ 0.86 $ 0.70
========================================================================
10. Business Segments
The Company operates its business in three segments. The Printed Products
segment ("Printed Products") includes checks and direct marketing activities and
analytical services 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, compliance and
closing applications, database marketing software, core processing applications
and services and business intelligence solutions. The Scantron segment
("Scantron") represents products and services sold by the Company's Scantron
-14-
subsidiary including scanning equipment and software, scannable forms, survey
solutions, curriculum development, testing and assessment tools and field
maintenance services. Scantron sells these products and services to the
education, commercial and financial institution markets. In 2003, the Company
transferred its analytical services business unit from Software & Services to
Printed Products and also transferred certain support activities to Printed
Products from corporate operations. Accordingly, prior period results have been
restated to conform to the 2003 presentation.
The Company's operations are located primarily in the United States and Puerto
Rico. There were no significant intersegment sales during the six month periods
ended June 27, 2003 and June 28, 2002. 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 referenced 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, all of which are considered
corporate items. Prior to 2003, certain incentive compensation for segment
management was considered to be a corporate item. Corporate assets consist
primarily of cash and cash equivalents, investments and other assets not
employed in production. Total assets of each business segment did not change
materially from the amount disclosed in the 2002 Form 10-K.
Selected summarized financial information for the three and six month periods
ended June 27, 2003 and June 28, 2002 were as follows:
Business Segment
-------------------------------
Printed Software &
Products Services Scantron Corporate & Consoli-
(In thousands) Eliminations dated
- -----------------------------------------------------------------------------------
Three month period ended
June 27, 2003:
Net sales $ 123,088 $ 42,291 $ 27,418 $ (369) $ 192,428
Income (loss) 16,986(1) 3,577(1) 5,217 (8,113) 17,667
Three month period ended
June 28, 2002:
Net sales $ 129,054 $ 30,276 $ 25,598 $ (442) $ 184,486
Income (loss) 19,838 2,937 7,204 (8,859) 21,120
Six month period ended
June 27, 2003:
Net sales $ 250,982 $ 82,231 $ 53,432 $ (792) $ 385,853
Income (loss) 37,767(1) 7,876(1) 9,064 (15,611) 39,096
Six month period ended
June 28, 2002:
Net sales $ 260,434 $ 61,066 $ 49,491 $ (933) $ 370,058
Income (loss) 41,055 6,540 13,373 (25,324) 35,644
(1) Includes certain incentive compensation costs of $906,000 and $663,000 for
Printed Products and Software & Services, respectively, for the three month
period ended June 27, 2003 and $1,804,000 and $1,327,000, respectively, for the
six month period ended June 27, 2003 that was included in Corporate prior to
January 1, 2003.
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.
-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, direct marketing activities and
analytical services marketed primarily to financial institutions.
The Software and Services segment ("Software & Services") is focused on the
financial institution market and includes lending and mortgage origination,
compliance and closing applications, database marketing software, core
processing applications and services and business intelligence solutions.
The Scantron segment ("Scantron") includes scanning equipment and software,
scannable forms, survey solutions, curriculum development, testing and
assessment tools and field maintenance services. Scantron sells these products
and services to the education, commercial and financial institution markets.
In 2003, the Company transferred a business unit from Software & Services to
Printed Products and also transferred certain support activities to Printed
Products from corporate operations. Accordingly, prior period results have been
restated to conform to the 2003 presentation.
CRITICAL ACCOUNTING POLICIES
In the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 2002 (the "2002 Form 10-K"), the Company's most critical accounting policies
and estimates upon which its financial status depends were identified as those
relating to revenue recognition, impairment of long-lived assets, goodwill and
other intangibles, software and other developmental costs, income taxes and
stock-based compensation. The Company believes there were no significant changes
in the status of its accounting policies during the six month period ended June
27, 2003 to warrant further disclosure. Please see the 2002 Form 10-K for
additional disclosure with respect to the Company's critical accounting
policies.
RESULTS OF OPERATIONS - SECOND QUARTER OF 2003 VERSUS SECOND QUARTER OF 2002
Consolidated net sales increased 4.3% to $192.4 million in the second quarter of
2003 from $184.5 million in the second quarter of 2002. Sales increases in the
Software & Services and Scantron segments more than offset a decrease in Printed
Products sales. Sales of products, which consist of checks and related products,
direct marketing products, software licensing sales, scanning equipment and
scannable forms and other products decreased 0.3% to $157.2 million in the
second quarter of 2003 from $157.6 million in the second quarter of 2002. Sales
of services, which consist of software maintenance services, field maintenance
services, analytical and consulting services as well as online service bureau
offerings and other services increased 31.2% to $35.3 million in the second
quarter of 2003 from $26.9 million in the second quarter of 2002.
Printed Products sales decreased 4.6% to $123.1 million in the second quarter of
2003 from $129.1 million in the second quarter of 2002. Volume in domestic
imprint check printing operations decreased 9.0%, which accounted for a majority
of the sales decrease. The volume decrease was attributable primarily to losses
of large customers, lower volumes from a direct check marketer and general
market volume decline, partially offset by gains in the community bank and
credit union markets. The impact of the volume decline was moderated by an
improvement in the average price per unit of 5.0% due primarily to a price
increase implemented in July 2002 and to lower volume from customers that are
less favorably priced. Sales in computer checks and related products also
decreased in the second quarter of 2003 compared to the second quarter of 2002
due primarily to the loss of business with a software company in late 2002 and
lower computer checks and fulfillment sales for small business software
-16-
accounts. Sales in direct marketing activities decreased in the second quarter
of 2003 compared to the second quarter of 2002 due primarily to the general
economic slowdown, which resulted in a decline in large mass mail jobs and fewer
openings of brokerage accounts, partially offset by an increase in statement
mailings.
Software & Services product sales increased 32.9% to $19.4 million in the second
quarter of 2003 from $14.6 million in the second quarter of 2002. Sales of
services in Software & Services increased 45.9% to $22.9 million in the second
quarter of 2003 from $15.7 million in the second quarter of 2002. The increase
in sales was due primarily to acquisitions made in 2002 and 2003 (see Note 3 to
the Condensed Consolidated Financial Statements included in this report), which
accounted for $11.7 million of the increase in sales. Excluding the impact of
acquisitions, sales increases in lending products and services were
substantially offset by decreases in core processing and business intelligence
solutions. The increase in lending products and services was primarily due to
higher book and ship sales, higher maintenance revenue and the impact of
subscription and loan block deals over the past year. Core processing sales were
unfavorably impacted in 2003 due to implementation delays by customers. Business
intelligence solutions sales were unfavorably impacted in 2003 by lower data
appends by customers. At June 27,2003, Software & Services backlog was $71.3
million, an increase of 119.8% from the backlog at June 28, 2002. Approximately
$27.1 million or 38.0% of the backlog at June 27, 2003 is expected to be
realized during the remainder of 2003 and $44.2 million or 62.0% is expected to
be realized in 2004 and beyond due to the long-term nature of service contracts.
The backlog increase was due primarily to acquisitions and stronger bookings.
Excluding the impact of acquisitions, backlog increased 10.9% from the backlog
at June 28, 2002.
Scantron product sales increased 6.7% to $15.9 million in the second quarter of
2003 from $14.9 million in the second quarter of 2002. Scantron sales of
services increased 7.5% to $11.5 million in the second quarter of 2003 from
$10.7 million in the second quarter of 2002. The increases were due primarily to
the acquisition of EdVISION in July 2002 (see Note 3 to the Condensed
Consolidated Financial Statements included in this report) and increases in
imaging product sales and survey services sales partially offset by reduced
sales of optical mark reading equipment and custom forms due to a trend in data
collection methods moving from optical mark reading to imaging and other direct
input methods.
Consolidated gross profit increased 9.0% to $93.5 million in the second quarter
of 2003 from $85.8 million in the second quarter of 2002, and increased as a
percentage of sales from 46.5% in the second quarter of 2002 to 48.6% in 2003.
The improvements were due to increased sales, cost management and productivity
improvement initiatives and a favorable change in sales mix.
Printed Products gross profit in the second quarter of 2003 increased 0.4%
compared to the second quarter of 2002 and, as a percentage of sales, was 40.6%
in the second quarter of 2003 compared to 38.5% in the second quarter of 2002.
The gross profit and margin increases were due primarily to an increase in the
average price per unit and lower manufacturing costs per unit in its domestic
imprint check operations resulting from operating efficiencies gained from
digital printing technology and process improvements. Printed Products gross
profit was unfavorably impacted in the second quarter of 2003 by a decrease in
check volumes and by decreases in gross profit in computer checks and related
products and direct marketing operations due to decreases in sales.
Software & Services gross profit in the second quarter of 2003 increased 35.1%
over the second quarter of 2002 due to acquisitions and higher sales in lending
products. As a percentage of sales, Software & Services gross profit decreased
to 68.4% in the second quarter of 2003 from 70.7% in the second quarter of 2002,
due primarily to a change in sales mix and the impact of acquired operations.
Scantron gross profit in the second quarter of 2003 increased 0.2% over the
second quarter of 2002, due primarily to an acquisition that was substantially
offset by an unfavorable change in sales mix. As a percentage of sales, Scantron
-17-
gross profit decreased to 53.5% in the second quarter of 2003 from 57.1% in the
second quarter of 2002, due to lower margins associated with acquired product
lines and an unfavorable change in sales mix.
Consolidated selling, general and administrative expenses ("SG&A") increased
$11.4 million, or 18.4%, in the second quarter of 2003 from the second quarter
of 2002. These expenses as a percentage of sales were 38.3% in the second
quarter of 2003 up from 33.7% in the second quarter of 2002. The increase was
due primarily to the impact of acquisitions, increased expenses in the selling,
marketing, customer service and general management areas of Printed Products and
increased product development costs and selling expenses for Scantron related to
new products and the development of a national sales force for those products.
Amortization of other intangibles increased to $0.8 million in the second
quarter of 2003 compared to $0.6 million in the second quarter of 2002 due
primarily to acquired operations.
Consolidated income from operations decreased $3.8 million to $19.1 million in
the second quarter of 2003 from $22.9 million in the second quarter of 2002, due
primarily to greater increases in SG&A than gross profit.
Other Income (Expense) decreased $0.3 million to an expense of $1.5 million in
the second quarter of 2003 from an expense of $1.8 million in the second quarter
of 2002. The decrease was due primarily to a write-down of $0.3 million in the
second quarter of 2002 on the Company's equity investment in Netzee, Inc. and
lower interest rates during the second quarter of 2003 compared with the second
quarter of 2002, partially offset by higher levels of borrowings during the
second quarter of 2003 compared to the second quarter of 2002.
Consolidated income before income taxes decreased $3.4 million to $17.7 million
in the second quarter of 2003 from $21.1 million in the second quarter of 2002,
due to decreased income from operations.
The Company's consolidated effective income tax rates were 36.3% and 38.8% for
the second quarters of 2003 and 2002, respectively. The lower effective income
tax rate for the second quarter of 2003 resulted primarily from the release of a
valuation allowance related to the utilization of capital loss carryforwards, a
reduction in the effective state rate and a reduction in certain estimated
permanent tax differences compared with the second quarter of 2002. The
effective tax rate for the second quarter of 2002 included favorable adjustments
related to prior years.
The Company's net income in the second quarter of 2003 was $11.3 million
compared to $12.9 million in the second quarter of 2002. Basic and diluted
earnings per share were $0.41 and $0.40, respectively, for the second quarter of
2003 compared to basic and diluted earnings per share of $0.44 and $0.42,
respectively, for the same period in 2002.
RESULTS OF OPERATIONS YEAR TO DATE 2003 VERSUS YEAR TO DATE 2002
Consolidated net sales increased 4.3% to $385.9 million for the six months ended
June 27, 2003 compared to $370.1 million for the six months ended June 28, 2002.
Sales increases in the Software & Services and Scantron segments more than
offset a decrease in Printed Products sales. Sales of products increased 0.2% to
$317.6 million for the first six months of 2003 from $316.9 million for the
first six months of 2002. Sales of services, which consist of software
maintenance services, field maintenance services, analytical and consulting
services as well as online service bureau offerings and other services increased
28.4% to $68.3 million for the first six months of 2003 from $53.2 million for
the first six months of 2002.
-18-
Printed Products sales totaled $251.0 million and $260.4 million for the first
six months of 2003 and 2002, respectively, a decrease of $9.4 million, or 3.6%.
Lower volumes in domestic imprint check printing operations, which decreased
8.5% for the first six months of 2003 compared to the first six months of 2002,
accounted for a majority of the decrease in Printed Product sales. The volume
decline was primarily attributable to losses of large customers, lower volumes
from a direct check marketer and general market volume decline, partially offset
by gains in the community bank and credit union markets. The impact of the
volume decline was moderated by an improvement of 6.4% in average price per unit
primarily due to a price increase implemented in July 2002 and lower volume from
customers that are less favorably priced. Sales in computer checks and related
products also decreased for the first six months of 2003 compared to the first
six months of 2002 due primarily to the loss of business with a software company
in late 2002 and lower computer checks and fulfillment sales for small business
software accounts. Sales in direct marketing decreased due to the general
economic slowdown, which resulted in lower credit card promotions and fewer
openings of brokerage accounts.
Software & Services sales for the first six months increased $21.1 million, or
34.7%, from $61.1 million in 2002 to $82.2 million in 2003. Sales increases were
due primarily to acquisitions made in 2002 and 2003 (see Note 3 to the Condensed
Consolidated Financial Statements included in the report). Excluding the impact
of acquisitions, sales increases in lending products and services were more than
offset by decreases in core processing and business intelligence solutions. The
increase in lending products and services was primarily due to higher book and
ship sales, higher maintenance revenue and the impact of subscription and loan
block contracts over the past year. Core processing sales were unfavorably
impacted in 2003 due to implementation delays by customers. Business
intelligence solutions sales were unfavorably impacted by the combination of a
large book and ship sale in 2002 and weak customer relationship management sales
and data appends in 2003.
Scantron sales for the first six months increased approximately 7.9% from $49.5
million for the first six months of 2002 to $53.4 million for the first six
months of 2003. The increase was due primarily to the acquisition of EdVISION in
July 2002 (see Note 3 to Condensed Consolidated Financial Statements included in
this report), increases in sales of imaging products, scannable forms and
internal growth in field services, which were partially offset by reduced sales
of optical mark reading equipment and custom forms due to a trend in data
collections from optical mark reading to imaging and direct input methods.
Consolidated gross profit of $187.3 million for the first six months of 2003
increased $16.3 million, or 9.5%, from $171.0 million in the same period in
2002, and increased as a percentage of sales from 46.2% in 2002 to 48.6% in
2003.
Printed Products gross profit increased 2.1% for the first six months of 2003
from the first six months of 2002 and as a percentage of sales was 40.6% for the
first six months of 2003 compared to 38.3% for the first six months of 2002.
Increases in gross profit in domestic imprint check printing operations were due
primarily to an increase in the average price per unit and lower manufacturing
costs per unit resulting from operating efficiencies gained from digital
printing technology and process improvements, as well as increases in gross
profit from analytical services. The aforementioned improvements were partially
offset by decreases in gross profit from computer checks and related products
and in direct marketing activities due to decreases in sales.
Software & Services gross profit for the first six months of 2003 increased
30.8% over the first six months of 2002, due primarily to acquisitions and
higher sales in lending products. As a percentage of sales, Software & Services
gross profit decreased to 69.3% for the first six months of 2003 from 71.4% for
the first six months of 2002 due primarily to the impact of acquired operations
and a change in sales mix.
-19-
Scantron gross profit increased by 2.9% for the first six months of 2003
compared to the first six months of 2002 due primarily to an acquisition
substantially offset by an unfavorable change in sales mix. As a percentage of
sales, Scantron gross profit decreased from 56.0% for the first six months of
2002 to 53.4% for the first six months of 2003 due to lower margins associated
with acquired product lines, an unfavorable change in sales mix and to
unfavorable costs and production inefficiencies experienced during a facility
relocation that occurred during the first quarter of 2003.
Consolidated SG&A increased by $13.3 million, or 10.2%, from $130.7 million in
the first six months of 2002 to $143.9 million in the first six months of 2003.
These expenses as a percentage of sales were 37.3% in 2003 compared to 35.3% in
2002. The increase was due primarily to the impact of acquisitions, increases in
Printed Products SG&A and increases in Scantron product development and selling
expenses partially offset by decreases in stock-based compensation expense.
Stock-based compensation totaled $1.2 million in the first six months of 2003
compared to $7.5 million in the first six months of 2002. The decrease in
stock-based compensation was primarily due to a $6.9 million charge in 2002
related to accelerated vesting of certain restricted stock grants in the first
quarter of 2002. These grants vested as a result of the Company's favorable
stock price performance. Printed Products SG&A increased in 2003 over 2002 due
to selling and marketing activities, customer care initiatives and certain other
initiatives.
Amortization of other intangibles increased to $1.4 million for the first six
months of 2003 compared to $1.3 million for the first six months of 2002 due
primarily to acquired operations.
Consolidated income from operations increased $2.9 million, or 7.4%, to $42.0
million for the first six months of 2003 from $39.1 million for the first six
months of 2002 due primarily to the increase in gross profit, partially offset
by increases in SG&A.
Other Income (Expense) decreased by $0.5 million from an expense of $3.4 million
for the first six months of 2002 to an expense of $2.9 million for the first six
months of 2003. The decrease was due primarily to a write-down of $0.3 million
in the second quarter of 2002 on the Company's equity investment in Netzee, Inc.
Interest expense decreased $0.2 million from 2002 primarily due to lower
interest rates during the first six months of 2003 compared with the first six
months of 2002.
Consolidated income before income taxes increased $3.5 million to $39.1 million
for the first six months of 2003 compared to $35.6 million for the first six
months of 2002 due to increased income from operations and lower other expense.
The Company's consolidated effective income tax rates were 37.5% and 39.1% for
the first six months of 2003 and 2002, respectively. The lower effective income
tax rate for the first six months of 2003 resulted primarily from the release of
a valuation allowance related to the utilization of capital loss carryforwards,
a reduction in the effective state rate and a reduction in certain estimated
permanent tax differences compared to the first six months of 2002. The
effective tax rate for the first six months of 2002 included favorable
adjustments related to prior years.
The Company's net income for the first six months of 2003 was $24.4 million
compared to $21.7 million for the first six months of 2002. Basic and diluted
earnings per share were $0.88 and $0.86, respectively, for the first six months
of 2003 compared to basic and diluted earnings per share of $0.74 and $0.70,
respectively, for the same period in 2002. The results for 2002 included a $6.9
million pre-tax charge for accelerated vesting of stock grants.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Cash flows provided by operating activities decreased $20.2 million to $34.5
million in the first six months of 2003 from $54.7 million in the first six
months of 2002 due primarily to upfront contract incentive payments made in the
second quarter of 2003. The primary uses of funds in the first six months of
2003 were for refundable customer contract payments, purchases of treasury
stock, capital expenditures, acquisition of a new business, repayment of
long-term debt and dividend payments to shareholders.
-20-
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 six months of 2003, the Company purchased 833,932
shares of its common stock pursuant to this authorization at a cost of
approximately $19.1 million, or an average cost per share of $22.95. As of June
27, 2003, a total of 2,586,378 shares had been purchased under the share
purchase authorization at an average cost of $21.63 per share. In January 2003,
the Company's Board of Directors authorized the repurchase of an additional 3.0
million shares, upon completion of the existing authorization.
Purchases of property, plant and equipment totaled $14.3 million and $18.7
million in the first six months of 2003 and 2002, respectively. Capital
expenditures in the first six months of 2003 were primarily for customer care
infrastructure initiatives. 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 $42 million. Through June 27, 2003, $38.2 million
has been expended on these initiatives, of which $27.2 million was capitalized.
Total capital expenditures for the Company are currently expected to be
approximately $32 to $37 million in 2003.
The Company has entered into a contract with a customer that contains provisions
which call for future payments to the customer if the Company does not meet
certain performance measures. The contract also contains provisions that call
for the reduction or elimination of the Company's payment obligations if the
customer does not meet certain performance requirements. The Company does not
anticipate any payments pursuant to these contract provisions at this time.
As of June 27, 2003, the Company's accumulated other comprehensive income was
$0.7 million and consisted of net unrealized gains on investments, cash flow
hedging instruments and foreign currency translation adjustments.
The Company has a $325.0 million revolving Credit Facility with a syndicate of
banks. The Credit Facility matures in August 2004 and may be used for general
corporate purposes, including acquisitions, and includes both direct borrowings
and letters of credit. During the first six months of 2003, the Company repaid
$4.8 million of its outstanding long-term debt. As of June 27, 2003, direct
borrowings totaled $139.3 million under the Credit Facility, compared to $144.0
million as of December 31, 2002. There were $5.1 million in outstanding letters
of credit, which were issued under the Credit Facility, leaving $180.6 million
available for borrowings at June 27, 2003.
On June 27, 2003, the Company had $7.0 million in cash and cash equivalents. The
Company believes that its current cash position, funds from operations, the
availability of funds under the Credit Facility and available additional
borrowing capacity 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 Company believes that it possesses sufficient unused debt capacity and
access to capital markets to pursue additional acquisition opportunities.
-21-
ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board (the "FASB") issued
Statement No. 145, "Rescission of FASB Statements 4, 44 and 64, Amendment to
FASB Statement 13, and Technical Corrections" ("SFAS 145"). One of the major
changes of SFAS 145 is to change the accounting for the classification of gains
and losses from the extinguishment of debt. The Company adopted SFAS 145 on
January 1, 2003 and uses 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. Adoption of SFAS 145
did not have a material effect on the Company's financial position or results of
operations.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 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. The Company adopted SFAS 146 on
January 1, 2003. Adoption of SFAS 146 did not have a material effect on the
Company's financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness
of Others" ("FIN 45"), which requires companies to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. FIN 45 provides specific guidance identifying the
characteristics of contracts that are subject to its guidance in its entirety
from those only subject to the initial recognition and measurement provisions.
The recognition and measurement provisions of FIN 45 are effective on a
prospective basis for guarantees issued or modified after December 31, 2002. The
Company adopted the recognition and measurement provisions of FIN 45 on January
1, 2003. Adoption of these provisions did not have a material effect on the
Company's financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 provides accounting requirements
for business enterprises to consolidate related entities in which they are
determined to be the primary beneficiary as a result of their variable economic
interests. The interpretation provides guidance in judging multiple economic
interests in an entity and in determining the primary beneficiary. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. The Company adopted
certain provisions of FIN 46 during the second quarter of 2003 and this adoption
did not have a material effect on the Company's financial position or results of
operations. The Company believes that the adoption of the remaining provisions
of FIN 46 will not have a material effect on its financial position or results
of operations.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 requires that contracts with
comparable characteristics be accounted for similarly and is effective for
contracts entered into or modified after June 30, 2003. The Company does not
believe that the adoption of SFAS 149 will have a material effect on the
Company's financial position or results of operations.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS 150"). SFAS 150 requires that an issuer classify financial instruments
that are within its scope as a liability (or an asset in some circumstances)
instead of equity as previously classified. SFAS 150 is effective for financial
instruments entered into or modified after May 31, 2003. Adoption of SFAS 150
did not have a material effect on the Company's financial position or results of
operations.
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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 2003.
The Company projects the Printed Products segment's profits will be down in 2003
due to the soft economy, losses of certain large customers, the current level of
spending on customer care infrastructure, order entry systems and marketing
activities, and recent pricing trends in Printed Products, which in certain
circumstances includes significant upfront contract incentive payments. In
addition to these factors the Company is not projecting its direct marketing
business to increase from current levels in the near term. The Company
anticipates the Software & Services segment's profitability will continue to
improve steadily in 2003 as it completes the integration of its 2003 and 2002
acquisitions. The Company is projecting the Scantron segment's profits will be
down in 2003, primarily reflecting the impact of state education budget
reductions on the sales of its new technology products and the continued sales
decline of optimal mark reading equipment and related custom forms resulting
from a shift to imaging and other direct methods of data collection.
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.
Several factors outside the Company's control could negatively impact check
revenues. These include the continuing expansion of alternative payment systems
such as credit cards, debit cards and other forms of electronic commerce or
on-line payment systems. Check revenues may continue to be adversely affected by
continued consolidation of financial institutions, competitive check pricing
(which in certain circumstances may include significant upfront contract
incentive payments) and the impact of governmental laws and regulations. There
can be no assurances that the Company will not lose additional customers or that
any such loss could be offset by the addition of new customers.
-23-
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 talented employees 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, the Company's ability to integrate acquired companies and general
changes in economic conditions or U.S. financial markets.
Several factors outside of the Company's control could affect results in the
Scantron segment. These include the rate of adoption of new electronic data
collection, testing and assessment methods, which could negatively impact
current forms, 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, and the Company's ability to integrate
acquired companies, 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 that
the returns and reports filed with respect to such tax regulations are
materially correct. The results of these 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 June
27, 2003, the Company had outstanding variable rate debt of $139.3 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 June 27, 2003, the
notional principal amount of interest rate swaps outstanding was $83.0 million.
The Company believes that its interest rate risk at June 27, 2003 was minimal.
The impact on quarterly results of operations of a hypothetical one-point
interest rate change on the outstanding debt as of June 27, 2003 would be
approximately $140,000. 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 $1.5 million ($0.9 million net of
income taxes) at June 27, 2003. 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.
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. The change in market value has been accounted for as a
-24-
component of other comprehensive income. The following presents the Company's
investment in Bottomline reflecting the high and low closing market prices for
the six month period ended June 27, 2003:
Carrying
(In thousands) Value(a) High(b) Low(b)
- ----------------------------------------------------------------------
Investment in Bottomline $ 4,032 $ 4,082 $ 2,591
(a) Based on market value as of June 27, 2003
(b) Based on quoted market prices.
Item 4. Controls and Procedures
The Company's disclosure controls and procedures are designed to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that such information is accumulated
and communicated to management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
As of the end of the period covered by this report, the Company evaluated, under
the supervision and with the participation of 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
Exchange Act 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 that is required to be included in the Company's periodic
SEC filings. There have been no significant changes in the Company's internal
controls during the period covered by this report that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting.
-25-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of business, the Company is subject to various legal
proceedings and claims. The Company believes that the ultimate outcome of these
matters will not have a material effect on its financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders of the Company was held on April 24,
2003.
(b) At the Annual Meeting William S. Antle III, Robert J. Clanin, John D.
Johns, and Eileen M. Rudden were elected for three-year terms expiring
in 2006. The Directors whose terms continued after the Annual Meeting
are Richard K. Lochridge, John J. McMahon, Jr., G. Harold Northrop,
Larry L. Prince, Jesse J. Spikes and Timothy C. Tuff.
(c) A brief description of each matter voted upon and the results of the
voting are as follows:
Election of Directors for Three-Year Term:
William S. Antle III
Voting for 23,706,021
Withheld 76,810
Robert J. Clanin
Voting for 20,062,108
Withheld 3,720,723
John D. Johns
Voting for 20,068,694
Withheld 3,714,137
Eileen M. Rudden
Voting for 20,081,856
Withheld 3,700,975
-26-
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit Description
3.1 * Amended and Restated Articles of Incorporation (Exhibit B to
registrant's Proxy Statement dated March 12, 1999).
3.2 * Amended and Restated Bylaws, as amended through December 19, 2002
(Exhibit 3.2 to registrant's Annual Report on Form 10-K for the year
ended December 31, 2002).
4.1 * Rights Agreement, dated as of December 17, 1998, between registrant
and First Chicago Trust Company of New York (Exhibit 4.1 to
registrant's Registration Statement on Form 8-A dated July 1, 1999).
4.2 See Articles IV, V and VII of registrant's Amended and Restated
Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V and
VIII of registrant's Bylaws, filed as Exhibit 3.2.
11.1 Computation of Per Share Earnings.+
31.1 Certification Pursuant to Form of Rule 13a-14(a), as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Form of Rule 13a-14(a), as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Indicates exhibit previously filed with the Securities and Exchange Commission
as indicated in parentheses and incorporated herein by reference.
(b) Reports on Form 8-K
The Registrant filed a Report on Form 8-K on April 23, 2003 including its Press
Release for the quarter ended March 28, 2003, as well as the transcript of its
conference call on April 23, 2003 discussing its first quarter results.
- --------
+ Data required by SFAS No. 128, "Earnings Per Share," is provided in Note 9 to
the Condensed Consolidated Financial Statements included in this report.
-27-
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
JOHN H. HARLAND COMPANY
Date: August 8, 2003 By: /s/ J. Michael Riley
-----------------------------
J. Michael Riley
Vice President and Controller
(Duly Authorized Officer and
Chief Accounting Officer)
-28-
EXHIBIT LIST
Exhibit Description
3.1 * Amended and Restated Articles of Incorporation (Exhibit B to
registrant's Proxy Statement dated March 12, 1999).
3.2 * Amended and Restated Bylaws, as amended through December 19, 2002
(Exhibit 3.2 to registrant's Annual Report on Form 10-K for the year
ended December 31, 2002).
4.1 * Rights Agreement, dated as of December 17, 1998, between registrant
and First Chicago Trust Company of New York (Exhibit 4.1 to
registrant's Registration Statement on Form 8-A dated July 1, 1999).
4.2 See Articles IV, V and VII of registrant's Amended and Restated
Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V and
VIII of registrant's Bylaws, filed as Exhibit 3.2.
11.1 Computation of Per Share Earnings.+
31.1 Certification Pursuant to Form of Rule 13a-14(a), as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Form of Rule 13a-14(a), as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Indicates exhibit previously filed with the Securities and Exchange Commission
as indicated in parentheses and incorporated herein by reference
- --------
+ Data required by SFAS No. 128, "Earnings Per Share," is provided in Note 9 to
the Condensed Consolidated Financial Statements included in this report.
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