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EX-31.2 - EX-31.2 - HARLAND CLARKE HOLDINGS CORP | y02512exv31w2.htm |
EX-31.1 - EX-31.1 - HARLAND CLARKE HOLDINGS CORP | y02512exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
or
o | 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: 333-133253
HARLAND CLARKE HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
Delaware | 84-1696500 | |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) | ||
2939 Miller Road, Decatur, GA | 30035 | |
(Address of principal executive offices) | (Zip code) |
(770) 981-9460
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
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 þ No o *
Yes þ No o *
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.:
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
Yes o No þ
As of September 30, 2009, there were 100 shares of the registrants common stock outstanding, with
a par value of $0.01 per share. All outstanding shares are owned by a subsidiary of M & F Worldwide
Corp.
* | The registrant is not subject to the filing requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934. The registrant is a voluntary filer. |
HARLAND CLARKE HOLDINGS CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended September 30, 2009
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended September 30, 2009
i
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
Harland Clarke Holdings Corp. and Subsidiaries
Consolidated Balance Sheets
(in millions, except share and per share data)
Consolidated Balance Sheets
(in millions, except share and per share data)
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 140.9 | $ | 64.6 | ||||
Accounts receivable (net of allowances of $3.2 and $2.8) |
127.4 | 128.8 | ||||||
Inventories |
34.0 | 38.4 | ||||||
Income taxes receivable |
0.4 | 8.0 | ||||||
Deferred tax assets |
21.0 | 21.0 | ||||||
Prepaid expenses and other current assets |
56.8 | 42.6 | ||||||
Total current assets |
380.5 | 303.4 | ||||||
Property, plant and equipment |
343.5 | 318.7 | ||||||
Less accumulated depreciation |
(178.2 | ) | (141.1 | ) | ||||
Property, plant and equipment, net |
165.3 | 177.6 | ||||||
Goodwill |
1,465.8 | 1,465.5 | ||||||
Other intangible assets, net |
1,254.2 | 1,328.3 | ||||||
Contract acquisition payments, net |
35.0 | 39.8 | ||||||
Other assets |
65.1 | 77.2 | ||||||
Total assets |
$ | 3,365.9 | $ | 3,391.8 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 47.2 | $ | 54.4 | ||||
Deferred revenues |
113.5 | 103.8 | ||||||
Current maturities of long-term debt |
19.7 | 19.8 | ||||||
Accrued liabilities: |
||||||||
Salaries, wages and employee benefits |
53.9 | 68.4 | ||||||
Income and other taxes payable |
21.2 | 13.9 | ||||||
Customer incentives |
26.2 | 25.7 | ||||||
Payable to parent |
| 0.7 | ||||||
Other current liabilities |
43.1 | 54.7 | ||||||
Total current liabilities |
324.8 | 341.4 | ||||||
Long-term debt |
2,244.5 | 2,370.8 | ||||||
Deferred tax liabilities |
436.4 | 435.7 | ||||||
Other liabilities |
77.5 | 77.6 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity: |
||||||||
Common stock 200 shares authorized; par value $0.01;
100 shares issued and outstanding at September 30, 2009
and December 31, 2008 |
| | ||||||
Additional paid-in capital |
157.0 | 157.0 | ||||||
Retained earnings |
135.9 | 27.2 | ||||||
Accumulated other comprehensive loss |
(10.2 | ) | (17.9 | ) | ||||
Total stockholders equity |
282.7 | 166.3 | ||||||
Total liabilities and stockholders equity |
$ | 3,365.9 | $ | 3,391.8 | ||||
See Notes to Consolidated Financial Statements
1
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Consolidated Statements of Income
(in millions)
(unaudited)
Consolidated Statements of Income
(in millions)
(unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Product revenues, net |
$ | 354.3 | $ | 376.3 | $ | 1,069.3 | $ | 1,131.4 | ||||||||
Service revenues, net |
71.4 | 77.7 | 221.4 | 224.5 | ||||||||||||
Total net revenues |
425.7 | 454.0 | 1,290.7 | 1,355.9 | ||||||||||||
Cost of products sold |
208.2 | 230.3 | 640.2 | 690.2 | ||||||||||||
Cost of services provided |
36.4 | 40.7 | 114.3 | 116.9 | ||||||||||||
Total cost of revenues |
244.6 | 271.0 | 754.5 | 807.1 | ||||||||||||
Gross profit |
181.1 | 183.0 | 536.2 | 548.8 | ||||||||||||
Selling, general and administrative expenses |
90.3 | 110.8 | 291.4 | 340.4 | ||||||||||||
Restructuring costs |
4.3 | 1.4 | 29.0 | 6.7 | ||||||||||||
Operating income |
86.5 | 70.8 | 215.8 | 201.7 | ||||||||||||
Interest income |
0.2 | 0.3 | 0.8 | 1.9 | ||||||||||||
Interest expense |
(32.6 | ) | (45.2 | ) | (106.3 | ) | (139.7 | ) | ||||||||
Gain on early extinguishment of debt |
0.5 | | 62.0 | | ||||||||||||
Other expense, net |
| | | (0.2 | ) | |||||||||||
Income before income taxes |
54.6 | 25.9 | 172.3 | 63.7 | ||||||||||||
Provision for income taxes |
20.9 | 10.4 | 63.7 | 26.4 | ||||||||||||
Net income |
$ | 33.7 | $ | 15.5 | $ | 108.6 | $ | 37.3 | ||||||||
See Notes to Consolidated Financial Statements
2
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Consolidated Statements of Cash Flows
(in millions)
(unaudited)
Consolidated Statements of Cash Flows
(in millions)
(unaudited)
Nine Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Operating activities |
||||||||
Net income |
$ | 108.6 | $ | 37.3 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation |
43.7 | 50.8 | ||||||
Amortization of intangible assets |
77.1 | 73.2 | ||||||
Amortization of deferred financing fees |
5.4 | 5.9 | ||||||
Gain on early extinguishment of debt |
(62.0 | ) | | |||||
Deferred income taxes |
(3.7 | ) | (25.4 | ) | ||||
Asset impairments |
0.1 | 1.0 | ||||||
Changes in operating assets and liabilities, net of effect of businesses acquired: |
||||||||
Accounts receivable |
0.5 | (19.3 | ) | |||||
Inventories |
4.5 | 0.2 | ||||||
Prepaid expenses and other assets |
(13.2 | ) | 3.6 | |||||
Contract acquisition payments, net |
4.8 | 6.9 | ||||||
Accounts payable and accrued liabilities |
(23.8 | ) | (4.0 | ) | ||||
Deferred revenue |
10.8 | 8.1 | ||||||
Income and other taxes |
14.5 | 19.1 | ||||||
Payable to parent |
(0.7 | ) | (2.1 | ) | ||||
Other, net |
4.4 | 0.7 | ||||||
Net cash provided by operating activities |
171.0 | 156.0 | ||||||
Investing activities |
||||||||
Purchase of Data Management |
| (223.3 | ) | |||||
Investment in related party notes receivable |
| (14.4 | ) | |||||
Net repayments of related party notes receivable |
5.2 | 1.6 | ||||||
Proceeds from sale of property, plant and equipment |
0.5 | 3.5 | ||||||
Capital expenditures |
(31.0 | ) | (38.1 | ) | ||||
Capitalized interest |
(0.2 | ) | (0.5 | ) | ||||
Other, net |
(3.2 | ) | (3.1 | ) | ||||
Net cash used in investing activities |
(28.7 | ) | (274.3 | ) | ||||
Financing activities |
||||||||
Dividend to parent |
| (65.0 | ) | |||||
Purchase of notes |
(50.6 | ) | | |||||
Borrowings on credit agreement |
| 62.0 | ||||||
Repayments of credit agreements and other borrowings |
(15.4 | ) | (77.1 | ) | ||||
Net cash used in financing activities |
(66.0 | ) | (80.1 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
76.3 | (198.4 | ) | |||||
Cash and cash equivalents at beginning of period |
64.6 | 239.7 | ||||||
Cash and cash equivalents at end of period |
$ | 140.9 | $ | 41.3 | ||||
Supplemental disclosure of cash paid for: |
||||||||
Interest, net of amounts capitalized |
$ | 103.3 | $ | 119.7 | ||||
Income taxes, net of refunds |
55.7 | 33.8 |
See Notes to Consolidated Financial Statements
3
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements
(dollars in millions)
(unaudited)
(dollars in millions)
(unaudited)
1. Description of Business and Basis of Presentation
Harland Clarke Holdings Corp. (Harland Clarke Holdings and, together with its subsidiaries,
the Company) is a holding company that conducts its operations through its direct and indirect,
wholly owned operating subsidiaries and was incorporated in Delaware on October 19, 2005. On
December 15, 2005, CA Investment Corp., an indirect wholly owned subsidiary of M & F Worldwide
Corp. (M & F Worldwide) purchased 100% of the capital stock of Novar USA Inc. (Novar) and was
renamed Clarke American Corp. (Clarke American) which was the successor by merger to Novar, which
indirectly wholly owned the operating subsidiaries of the Clarke American business. On May 1, 2007,
the Company completed the acquisition of John H. Harland Company (Harland) and changed its name
on May 2, 2007 from Clarke American to Harland Clarke Holdings.
The Company has organized its business and corporate structure along the following three
business segments: Harland Clarke, Harland Financial Solutions and Scantron.
The Harland Clarke segment offers checks and related products, forms and treasury supplies,
and related delivery and fraud prevention services. It also provides specialized marketing and
contact center services to its financial and commercial institution clients. Harland Clarkes
marketing offerings include turnkey marketing solutions, checkbook messaging and e-mail marketing.
Through its contact centers, Harland Clarke provides financial institutions with both inbound and
outbound support for their clients, including sales and ordering services for checks and related
products and services, customer care, banking support and marketing services.
The Harland Financial Solutions segment provides financial technology products and services
including lending and mortgage origination and servicing applications, business intelligence
solutions, customer relationship management software, Internet banking solutions, mobile banking,
branch automation solutions and core processing systems and services, principally targeted to
community banks and credit unions.
The Scantron segment provides testing and assessment solutions to schools in North America,
offers specialized data management solutions to educational, commercial and governmental entities
worldwide and collects and manages survey information for a wide variety of Fortune 1000 and other
organizations. Scantrons products and services include scannable forms, scanning equipment, survey
services, testing software and related services, and field maintenance services.
The consolidated financial statements include the accounts of the Company and its
majority-owned subsidiaries after the elimination of all material intercompany accounts and
transactions. The Company has consolidated the results of operations and accounts of businesses
acquired from the date of acquisition.
The Company and each of its existing subsidiaries, other than unrestricted subsidiaries and
certain immaterial subsidiaries, are guarantors and may also be co-issuers under the 2015 Senior
Notes (as hereinafter defined) (see Note 11). The Company is a holding company and has no
independent assets and no operations at September 30, 2009. The guarantees and the obligations of
the subsidiaries of the Company are full and unconditional and joint and several.
The accompanying consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States for interim financial information and
with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. The results of operations for interim periods are not necessarily
indicative of the results that may be expected for the full fiscal year. These consolidated
financial statements should be read in conjunction with the consolidated financial statements and
accompanying notes included in the Companys Annual Report on Form 10-K for the year ended December
31, 2008. All terms used but not defined elsewhere herein have the meaning ascribed to them in the
Companys 2008 Annual Report on Form 10-K.
Subsequent Events
The Company has considered subsequent events through November 6, 2009, the date of issuance,
in preparing the consolidated financial statements and notes thereto.
4
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
2. Summary of Significant Accounting Policies
Reference is made to the significant accounting policies of the Company described in the notes
to the consolidated financial statements included in the Companys Annual Report on Form 10-K for
the year ended December 31, 2008.
Use of Estimates
The preparation of the financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Actual results could differ
from those estimates.
Recently Adopted Accounting Pronouncements
The Company adopted new accounting guidance for business combinations on January 1, 2009.
Under the new guidance, an acquiring entity is required to recognize all the assets acquired and
liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions.
The new guidance changed the accounting treatment for certain specific items, including acquisition
costs, noncontrolling interests, acquired contingent liabilities, in-process research and
development, restructuring costs associated with a business combination, deferred tax valuation
allowances changes, and income tax uncertainties after the acquisition date. The new guidance also
includes a substantial number of new disclosure requirements and its effect will vary for each
acquisition.
The Company adopted new guidance for disclosures about derivative instruments and hedging
activities on January 1, 2009. The new guidance requires enhanced disclosures about the effects of
derivative instruments and hedging activities on an entitys financial condition, financial
performance and cash flows. The new guidance increases disclosure requirements but does not have an
impact on the Companys consolidated financial condition, results of operations or cash flows.
In April 2009, the Financial Accounting Standards Board (FASB) issued new guidance requiring
disclosures about fair value of financial instruments for interim reporting periods of publicly
traded companies as well as in annual financial statements. The Company adopted the new guidance
effective April 1, 2009 (see Note 15). The new guidance increases disclosure requirements but does
not have an impact on the Companys consolidated financial condition, results of operations or cash
flows.
In May 2009, the FASB issued new guidance regarding subsequent events. The new guidance
introduces the concept of financial statements being available to be issued and requires the
disclosure of the date through which an entity has evaluated subsequent events and the basis for
that date, that is, whether that date represents the date the financial statements were issued or
were available to be issued. The new guidance does not result in significant changes in the
subsequent events that the Company reportseither through recognition or disclosurein its
financial statements. The Company adopted the new guidance effective for the quarter ended June 30,
2009.
Recently Issued Accounting Pronouncements
In August 2009, the FASB issued new guidance for measuring liabilities at fair value. The new
guidance provides clarification that in circumstances in which a quoted price in an active market
for the identical liability is not available, an entity is required to measure fair value using
certain valuation techniques. It also clarifies that an entity is not required to adjust the fair
value of a liability for the existence of a restriction that prevents the transfer of the
liability. The new guidance is effective for the first reporting period after its issuance, which
is the fourth quarter of 2009 for the Company. The new guidance is not expected to have a
significant impact on the Companys consolidated financial condition, results of operations or cash
flows.
In October 2009, the FASB issued new guidance for certain arrangements that include software
elements. The new guidance removes non-software components of tangible products and software
components of tangible products that have software components essential to the functionality of the
tangible product from the scope of software revenue recognition.
5
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
In October 2009, the FASB issued new guidance for multiple-deliverable revenue arrangements.
The new guidance requires entities to allocate revenue in a multiple-deliverable arrangement within
the scope of the guidance using estimated selling prices based on a selling price hierarchy. It
also eliminates the residual method of revenue allocation and requires revenue to be allocated
using the relative selling price method. In addition, the new guidance significantly expands
qualitative and quantitative disclosure requirements for multiple-deliverable arrangements.
The new guidance for certain arrangements that include software elements and
multiple-deliverable revenue arrangements is effective for fiscal years beginning on or after June
15, 2010. The guidance may be applied retrospectively for all periods presented, or prospectively
to all arrangements entered into or materially modified after the adoption date. Early adoption is
permitted provided that the guidance is retroactively applied to the beginning of the year of
adoption. The Company is currently evaluating the impact of the new guidance on its consolidated
financial condition and results of operations.
3. Acquisitions
Acquisition of Transaction Holdings
On December 31, 2008, the Companys wholly owned subsidiary, Harland Clarke Corp., acquired
100% of the equity of Transaction Holdings Inc. (Transaction Holdings) for total cash
consideration of $8.2 (the Transaction Holdings Acquisition). Transaction Holdings produces
personal and business checks, payment coupon books and promotional checks and provides direct
marketing services to financial institutions as well as individual consumers and small businesses.
Transaction Holdings results of operations have been included in the Companys operations
since December 31, 2008, the date of the Transaction Holdings Acquisition. The allocation of the
purchase price is complete and resulted in identified intangible assets of $9.0, goodwill of $2.5
and $2.6 of net deferred tax liabilities.
The pro forma effects on the results of operations for the Transaction Holdings Acquisition
were not material and are not included in the pro forma information presented below.
Acquisition of Data Management
On February 22, 2008, the Companys indirect wholly owned subsidiary, Scantron Corporation,
purchased all of the limited liability membership interests of Data Management I LLC (Data
Management) from NCS Pearson for $218.7 in cash, after giving effect to working capital
adjustments of $1.6 (the Data Management Acquisition). Data Managements results of operations
have been included in the Companys operations since February 22, 2008, the date of the Data
Management Acquisition. Fees and expenses of $4.6 related to the Data Management Acquisition were
capitalized in the purchase price. The capitalized fees and expenses include $2.0 paid to
MacAndrews & Forbes Holdings Inc. (which, as of September 30, 2009, beneficially owned
approximately 43.4% of the outstanding M & F Worldwide common stock) in February 2008 for its
services related to sourcing, analyzing, negotiating and executing the Data Management Acquisition.
The acquisition combined complementary products and services of Scantron and Data Management,
resulting in an expanded offering of products and services to their respective customers. The
Company financed the Data Management Acquisition and related fees and expenses with cash on hand.
6
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
The following table summarizes the fair values of the assets acquired and liabilities assumed
at the Data Management Acquisition date:
Accounts receivable |
$ | 15.9 | ||||||
Inventories |
7.5 | |||||||
Property, plant and equipment |
25.5 | |||||||
Goodwill |
116.2 | |||||||
Other intangible assets: |
||||||||
Customer relationships |
$ | 65.4 | ||||||
Trademarks and tradenames |
2.4 | |||||||
Patented technology and software |
7.5 | |||||||
Total other intangible assets |
75.3 | |||||||
Other assets |
0.6 | |||||||
Total assets acquired |
241.0 | |||||||
Deferred revenues |
7.6 | |||||||
Other liabilities |
10.1 | |||||||
Net assets acquired |
$ | 223.3 | ||||||
The above purchase price allocation is complete. Goodwill in the amount of approximately
$114.5 and intangible assets in the amount of approximately $75.3 related to Data Management are
deductible for tax purposes. The principal factor affecting the purchase price, which resulted in
the recognition of goodwill, was the fair value of the going-concern element of Data Management,
which included the assembled workforce and synergies that were expected to be achieved.
As a result of the Data Management Acquisition, the Company adopted formal plans to terminate
certain employee functions and exit duplicative facilities. The Company recorded $2.5 of severance
and severance-related costs for the termination of certain Data Management employees in the above
purchase price allocation. See Note 13 for additional disclosures regarding restructuring.
As part of the application of purchase accounting, inventory of Data Management was increased
by $0.4 due to a fair value adjustment. The amount of the inventory fair value adjustment was
expensed as additional non-cash cost of products sold as the related inventory was sold (of which
$0.0 and $0.4 was expensed during the three and nine months ended September 30, 2008,
respectively).
Also as part of the application of purchase accounting, deferred revenue of Data Management
was decreased by $1.4 due to a fair value adjustment. This non-cash fair value adjustment results
in lower revenue being recognized over the related earnings period (of which $0.0 and $0.2 was
reflected as reduced revenues during the three and nine months ended September 30, 2009,
respectively, and $0.3 and $0.7 was reflected as reduced revenues during the three and nine months
ended September 30, 2008, respectively).
Pro Forma Financial Information
The financial information in the table below summarizes the results of operations of the
Company, on a pro forma basis, as though the Data Management Acquisition had occurred as of the
beginning of the period presented. The pro forma financial information is presented for
informational purposes only and is not indicative of the results of operations that would have been
achieved if the transaction had taken place at the beginning of the period presented, nor does it
purport to represent results of operations for future periods.
Pro Forma | ||||
Nine Months Ended | ||||
September 30, 2008 | ||||
Net revenues |
$ | 1,373.2 | ||
Operating income |
203.3 | |||
Net income |
38.3 | |||
Depreciation and amortization (excluding amortization of deferred financing fees) |
125.7 |
7
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
In the pro forma information above, the results prior to the Data Management Acquisition were
adjusted to include the pro forma impact of the adjustment of amortization of intangible assets and
depreciation of fixed assets based on the purchase price allocation and to reflect the impact of
income taxes with respect to the pro forma adjustments, utilizing an estimated effective tax rate
of 39%.
The pro forma information above includes the impact of the non-recurring fair value
adjustments to inventory and deferred revenue resulting from the application of purchase accounting
of $1.1 for the nine months ended September 30, 2008.
The pro forma information also gives effect to certain identified cost savings totaling $0.8
in the nine months ended September 30, 2008 as if they had been implemented in their entirety at
the beginning of the period presented. These cost savings pertain to the termination of certain
Data Management employees for which the related liability was recognized in the purchase price
allocation. There can be no assurance that all of such cost savings will be accomplished during any
particular period, or at all.
The pro forma information does not include adjustments for additional expected cost savings
resulting from the termination of certain of the Companys historical employees, the closure of
certain of the Companys historical facilities, procurement savings or the elimination of certain
duplicate corporate costs to the extent not yet realized in the Companys operating results. There
can be no assurance that all of such cost savings will be accomplished during any particular
period, or at all.
4. Inventories
Inventories consist of the following:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Finished goods |
$ | 10.5 | $ | 13.3 | ||||
Work-in-process |
9.9 | 9.5 | ||||||
Raw materials |
13.6 | 15.6 | ||||||
$ | 34.0 | $ | 38.4 | |||||
5. Assets Held For Sale
At September 30, 2009 and December 31, 2008, assets held for sale consist of the Harland
Clarke segments printing facility and operations support facility in Atlanta, Georgia. These
facilities were closed in 2008 as part of the Companys plan to exit duplicative facilities related
to an acquisition. Subsequent to these facilities classification as assets held for sale, there
have been significant changes in the real estate market. The Company continues to make appropriate
changes to the marketing plan and believes these facilities will be sold within twelve months.
Assets held for sale are included in prepaid expenses and other current assets on the accompanying
consolidated balance sheets.
Assets held for sale consist of the following:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Land |
$ | 1.0 | $ | 1.0 | ||||
Buildings and improvements |
1.8 | 1.7 | ||||||
$ | 2.8 | $ | 2.7 | |||||
6. Goodwill and Other Intangible Assets
The change in carrying amount of goodwill for the nine months ended September 30, 2009 is as
follows:
Balance as of December 31, 2008 |
$ | 1,465.5 | ||
Adjustments to goodwill |
(0.1 | ) | ||
Effect of exchange rate changes |
0.4 | |||
Balance as of September 30, 2009 |
$ | 1,465.8 | ||
8
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Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Useful lives, gross carrying amounts and accumulated amortization for other intangible assets
are as follows:
Gross Carrying Amount | Accumulated Amortization | |||||||||||||||||||
Useful Life | September 30, | December 31, | September 30, | December 31, | ||||||||||||||||
(in years) | 2009 | 2008 | 2009 | 2008 | ||||||||||||||||
Amortized intangible assets: |
||||||||||||||||||||
Customer relationships |
3 - 30 | $ | 1,230.4 | $ | 1,230.6 | $ | 237.9 | $ | 170.2 | |||||||||||
Trademarks and tradenames |
2 - 15 | 8.4 | 8.3 | 1.9 | 1.1 | |||||||||||||||
Software and other |
2 - 10 | 63.4 | 60.6 | 25.7 | 18.2 | |||||||||||||||
Patents and patents pending |
3 - 20 | 20.0 | 19.6 | 3.5 | 2.3 | |||||||||||||||
1,322.2 | 1,319.1 | 269.0 | 191.8 | |||||||||||||||||
Indefinite-lived intangible assets: |
||||||||||||||||||||
Trademarks and tradenames |
201.0 | 201.0 | | | ||||||||||||||||
Total other intangibles |
$ | 1,523.2 | $ | 1,520.1 | $ | 269.0 | $ | 191.8 | ||||||||||||
Amortization expense was $25.8 and $77.1 for the three and nine months ended September 30,
2009, respectively, and $24.7 and $73.2 for the three and nine months ended September 30, 2008,
respectively.
Estimated aggregate amortization expense for intangible assets through December 31, 2013 is as
follows:
Three months ending December 31, 2009 |
$ | 25.7 | ||
Year ending December 31, 2010 |
100.4 | |||
Year ending December 31, 2011 |
93.3 | |||
Year ending December 31, 2012 |
86.4 | |||
Year ending December 31, 2013 |
76.3 |
During 2008, the Company experienced declines in customer revenues from Alcott Routon
operations and assessed the customer relationship intangible asset for impairment. As a result, the
Company calculated the estimated fair value and wrote off the customer relationship intangible
asset, which was in excess of fair value. The associated impairment charge of $0.5 was included in
selling, general and administrative expenses in the accompanying consolidated statements of income
for the nine months ended September 30, 2008.
7. Business Segment Information
The Companys businesses are organized along three reportable segments together with a
corporate group for certain support services. The Companys operations are aligned on the basis of
products, services and industry. The acquired Transaction Holdings operation is included in the
Harland Clarke segment. The acquired Data Management operations are included in the Scantron
segment. Management measures and evaluates the reportable segments based on operating income. The
current segments and their principal activities consist of the following:
| Harland Clarke segment Provides checks and related products, direct marketing and contact center services to financial and commercial institutions, as well as to individual consumers and small businesses. This segment operates in the United States and Puerto Rico. | ||
| Harland Financial Solutions segment Provides core processing, retail and lending solutions to financial and other institutions. This segment operates primarily in the United States, Israel and Ireland. | ||
| Scantron segment Provides data management solutions, testing and assessment products and services as well as field maintenance services which are sold primarily to educational and commercial customers. This segment operates in the United States and Canada. |
9
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Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Selected summarized financial information for the three months ended September 30, 2009 and
2008 was as follows:
Harland | ||||||||||||||||||||
Harland | Financial | Corporate | ||||||||||||||||||
Clarke(1) | Solutions | Scantron | and Other | Total | ||||||||||||||||
Product revenues, net: |
||||||||||||||||||||
Three months ended September 30, 2009 |
$ | 303.7 | $ | 17.1 | $ | 33.5 | $ | | $ | 354.3 | ||||||||||
Three months ended September 30, 2008 |
321.6 | 19.1 | 35.6 | | 376.3 | |||||||||||||||
Service revenues, net: |
||||||||||||||||||||
Three months ended September 30, 2009 |
$ | 1.3 | $ | 50.8 | $ | 19.3 | $ | | $ | 71.4 | ||||||||||
Three months ended September 30, 2008 |
1.1 | 53.7 | 22.9 | | 77.7 | |||||||||||||||
Intersegment revenues: |
||||||||||||||||||||
Three months ended September 30, 2009 |
$ | | $ | | $ | 0.1 | $ | (0.1 | ) | $ | | |||||||||
Three months ended September 30, 2008 |
| | 0.1 | (0.1 | ) | | ||||||||||||||
Operating income (loss): |
||||||||||||||||||||
Three months ended September 30, 2009 |
$ | 69.4 | $ | 9.5 | $ | 11.1 | $ | (3.5 | ) | $ | 86.5 | |||||||||
Three months ended September 30, 2008 |
57.0 | 8.0 | 9.0 | (3.2 | ) | 70.8 | ||||||||||||||
Depreciation and amortization (excluding
amortization of deferred financing fees): |
||||||||||||||||||||
Three months ended September 30, 2009 |
$ | 26.8 | $ | 6.5 | $ | 6.4 | $ | | $ | 39.7 | ||||||||||
Three months ended September 30, 2008 |
28.0 | 7.2 | 6.1 | | 41.3 | |||||||||||||||
Capital expenditures (excluding capital leases): |
||||||||||||||||||||
Three months ended September 30, 2009 |
$ | 5.3 | $ | 1.3 | $ | 1.4 | $ | | $ | 8.0 | ||||||||||
Three months ended September 30, 2008 |
6.1 | 1.0 | 4.3 | | 11.4 |
Selected summarized financial information for the nine months ended September 30, 2009 and
2008 was as follows:
Harland | ||||||||||||||||||||
Harland | Financial | Corporate | ||||||||||||||||||
Clarke(1) | Solutions | Scantron(2) | and Other | Total | ||||||||||||||||
Product revenues, net: |
||||||||||||||||||||
Nine months ended September 30, 2009 |
$ | 923.1 | $ | 52.4 | $ | 93.8 | $ | | $ | 1,069.3 | ||||||||||
Nine months ended September 30, 2008 |
980.1 | 58.5 | 92.8 | | 1,131.4 | |||||||||||||||
Service revenues, net: |
||||||||||||||||||||
Nine months ended September 30, 2009 |
$ | 3.3 | $ | 154.4 | $ | 63.7 | $ | | $ | 221.4 | ||||||||||
Nine months ended September 30, 2008 |
3.4 | 159.4 | 61.7 | | 224.5 | |||||||||||||||
Intersegment revenues: |
||||||||||||||||||||
Nine months ended September 30, 2009 |
$ | | $ | | $ | 0.5 | $ | (0.5 | ) | $ | | |||||||||
Nine months ended September 30, 2008 |
0.3 | | 0.4 | (0.7 | ) | | ||||||||||||||
Operating income (loss): |
||||||||||||||||||||
Nine months ended September 30, 2009 |
$ | 172.6 | $ | 28.1 | $ | 24.6 | $ | (9.5 | ) | $ | 215.8 | |||||||||
Nine months ended September 30, 2008 |
173.4 | 20.8 | 19.2 | (11.7 | ) | 201.7 | ||||||||||||||
Depreciation and amortization (excluding
amortization of deferred financing fees): |
||||||||||||||||||||
Nine months ended September 30, 2009 |
$ | 81.5 | $ | 20.0 | $ | 19.3 | $ | | $ | 120.8 | ||||||||||
Nine months ended September 30, 2008 |
85.2 | 21.7 | 17.1 | | 124.0 | |||||||||||||||
Capital expenditures (excluding capital leases): |
||||||||||||||||||||
Nine months ended September 30, 2009 |
$ | 21.7 | $ | 3.4 | $ | 5.9 | $ | | $ | 31.0 | ||||||||||
Nine months ended September 30, 2008 |
26.9 | 3.4 | 7.8 | | 38.1 |
(1) | Includes results of the acquired Transaction Holdings business from the date of acquisition. | |
(2) | Includes results of the acquired Data Management business from the date of acquisition. |
10
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Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
8. Comprehensive Income
Total comprehensive income for the three and nine months ended September 30, 2009 and 2008 was
as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net income |
$ | 33.7 | $ | 15.5 | $ | 108.6 | $ | 37.3 | ||||||||
Other comprehensive income (loss): |
||||||||||||||||
Foreign currency translation adjustments |
0.5 | (1.6 | ) | 0.7 | (0.6 | ) | ||||||||||
Changes in fair value of cash flow
hedging instruments, net of tax
(benefit) provision of $(0.3), $1.9,
$3.7 and $3.6 |
(0.3 | ) | 2.9 | 5.8 | 5.6 | |||||||||||
Unrealized gain (loss) on investments,
net of tax provision (benefit) of $0.6,
$, $0.8 and $ |
0.9 | (0.1 | ) | 1.2 | | |||||||||||
Comprehensive income |
$ | 34.8 | $ | 16.7 | $ | 116.3 | $ | 42.3 | ||||||||
9. Postretirement Defined Benefit Plans
The Company currently sponsors unfunded defined benefit postretirement plans that cover
certain salaried and nonsalaried employees who were formerly employees of Harland. One plan
provides health care benefits and the other provides life insurance benefits. The medical plan is
contributory and contributions are adjusted annually based on actual claims experience. For
retirees who retired from Harland prior to December 31, 2002 with twenty or more years of service
at December 31, 2000, the Company currently contributes approximately 50% of the cost of providing
the medical plan. For all other retirees, the Companys intent is that the retirees provide the
majority of the actual cost of providing the medical plan. The life insurance plan is
noncontributory for employees who retired from Harland by December 31, 2002.
Net periodic postretirement costs for these plans were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Interest cost |
$ | 0.3 | $ | 0.3 | $ | 0.8 | $ | 0.7 | ||||||||
Net amortization |
| | | | ||||||||||||
Net postretirement benefit cost |
$ | 0.3 | $ | 0.3 | $ | 0.8 | $ | 0.7 | ||||||||
10. Income Taxes
The Company is subject to taxation in the United States and various state and foreign
jurisdictions. The statute of limitations for the Companys federal and state tax returns for the
tax years 2005 through 2008 generally remain open. In addition, open tax years related to foreign
jurisdictions remain subject to examination but are not considered material.
The Internal Revenue Service previously commenced examinations of Novar USA Inc., a
predecessor of Harland Clarke Holdings, for the tax year 2005. The Internal Revenue Service
recently completed examinations of Harland for the tax years 2005 through May 1, 2007 and for
Harlands amended tax returns filed for claims of research and development credits relating to tax
years 2002 through 2005. In connection with completion of the audits, Harland settled its research
and development credit claims with the Internal Revenue Service. This resulted in a $5.9 reduction
of the accrual for the Companys uncertain tax positions, of which $3.4 (inclusive of interest) was
recorded as a benefit in the tax provision for the nine months ended September 30, 2009.
11
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
11. Long-Term Debt
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
$1,900.0 Senior Secured Credit Facilities |
$ | 1,759.5 | $ | 1,773.0 | ||||
Senior Floating Rate Notes due 2015 |
227.4 | 305.0 | ||||||
9.50% Senior Fixed Rate Notes due 2015 |
271.3 | 310.0 | ||||||
Capital lease obligations and other indebtedness |
6.0 | 2.6 | ||||||
2,264.2 | 2,390.6 | |||||||
Less: current maturities |
(19.7 | ) | (19.8 | ) | ||||
Long-term debt, net of current maturities |
$ | 2,244.5 | $ | 2,370.8 | ||||
$1,900.0 Senior Secured Credit Facilities
On April 4, 2007, the Company and substantially all of its subsidiaries as co-borrowers
entered into a credit agreement (the Credit Agreement). The Credit Agreement provides for a
$1,800.0 senior secured term loan (the Term Loan), which was fully drawn on May 1, 2007 and
matures on June 30, 2014. The Company is required to repay the Term Loan in equal quarterly
installments in aggregate annual amounts equal to 1% of the original principal amount. In addition,
the Credit Agreement requires that a portion of the Companys excess cash flow be applied to prepay
amounts borrowed, as further described below. The Credit Agreement also provides for a $100.0
revolving credit facility (the Revolver) that matures on June 28, 2013. The Revolver includes an
up to $60.0 subfacility in the form of letters of credit and an up to $30.0 subfacility in the form
of short-term swing line loans. The weighted average interest rate on borrowings outstanding under
the Term Loan was 2.8% at September 30, 2009. As of September 30, 2009, there were no outstanding
borrowings under the Revolver and there was $87.5 available for borrowing (giving effect to the
issuance of $12.5 of letters of credit).
Under certain circumstances, the Company is permitted to incur additional term loan and/or
revolving credit facility indebtedness in an aggregate principal amount of up to $250.0. In
addition, the terms of the Credit Agreement and the 2015 Senior Notes (as defined below) allow the
Company to incur substantial additional debt.
Loans under the Credit Agreement bear, at the Companys option, interest at:
| A rate per annum equal to the higher of (a) the prime rate of Credit Suisse and (b) the Federal Funds rate plus 0.50%, in each case plus an applicable margin of 1.50% per annum for revolving loans and for term loans; or | ||
| A rate per annum equal to a reserve-adjusted LIBOR rate, plus an applicable margin of 2.50% per annum for revolving loans and for term loans. |
The Credit Agreement has a commitment fee for the unused portion of the Revolver and for
issued letters of credit of 0.50% and 2.63%, respectively. Interest rate margins and commitment
fees under the Revolver are subject to reduction in increments based upon the Company achieving
certain consolidated leverage ratios.
The Company and each of its existing and future domestic subsidiaries, other than unrestricted
subsidiaries and certain immaterial subsidiaries, are guarantors and may also be co-borrowers under
the Credit Agreement. In addition, the Companys direct parent, CA Acquisition Holdings, Inc., is a
guarantor under the Credit Agreement. The senior secured credit facilities are secured by a
perfected first priority security interest in substantially all of the Companys, each of the
co-borrowers and the guarantors tangible and intangible assets and equity interests (other than
voting stock in excess of 65.0% of the outstanding voting stock of each direct foreign subsidiary
and certain other excluded property).
The Credit Agreement contains customary affirmative and negative covenants including, among
other things, restrictions on indebtedness, liens, mergers and consolidations, sales of assets,
loans, acquisitions, restricted payments, transactions with affiliates, dividends and other payment
restrictions affecting subsidiaries and sale-leaseback transactions. The Credit Agreement requires
the Company to maintain a maximum consolidated leverage ratio for the benefit of lenders under the
Revolver only. The Company has the right to prepay the Term Loan at any time without premium or
penalty, subject to certain breakage costs, and the Company may also reduce any unutilized portion
of the Revolver at any time, in minimum principal amounts set forth in the Credit Agreement. The
Company is required to prepay the Term Loan with 50% of excess cash flow (as defined in the Credit
Agreement, commencing in 2009 with respect to the fiscal year 2008, with certain reductions set
forth in the Credit Agreement, based on achievement and maintenance of leverage ratios) and 100% of
the net proceeds of certain issuances, offerings or placements of debt
12
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
obligations of the Company or any of its subsidiaries (other than permitted debt). No such
excess cash flow payment is required to be paid in 2009. Each such prepayment will be applied first
to the next eight unpaid quarterly amortization installments on the term loans and second to the
remaining amortization installments on the term loans on a pro rata basis.
The Credit Agreement also contains certain customary affirmative covenants and events of
default. Such events of default include, but are not limited to: non-payment of amounts when due;
violation of covenants; material inaccuracy of representations and warranties; cross default and
cross acceleration with respect to other material debt; bankruptcy and other insolvency events;
certain ERISA events; invalidity of guarantees or security documents; and material judgments. Some
of these events of default allow for grace periods.
If a change of control (as defined in the Credit Agreement) occurs, the Company will be
required to make an offer to prepay all outstanding term loans under the Credit Agreement at 101%
of the outstanding principal amount thereof plus accrued and unpaid interest, and lenders holding a
majority of the revolving credit commitments may elect to terminate the revolving credit
commitments in full. The Company is also required to offer to prepay outstanding term loans at 100%
of the principal amount to be prepaid, plus accrued and unpaid interest, with the proceeds of
certain asset sales under certain circumstances.
Under the terms of the Credit Agreement, the Company was required to ensure that, until no
earlier than May 1, 2009, at least 40% of the aggregate principal amount of its long-term
indebtedness bear interest at a fixed rate, either by its terms or through entering into hedging
agreements within 180 days of the effectiveness of the Credit Agreement. In order to comply with
this requirement, the Company entered into interest rate derivative arrangements described in
Interest Rate Hedges below.
Senior Notes due 2015
On May 1, 2007, the Company issued $305.0 aggregate principal amount of Senior Floating Rate
Notes due 2015 (the Floating Rate Notes) and $310.0 aggregate principal amount of 9.50% Senior
Fixed Rate Notes due 2015 (the Fixed Rate Notes and, together with the Floating Rate Notes, the
2015 Senior Notes). The 2015 Senior Notes mature on May 15, 2015. The Fixed Rate Notes bear
interest at a rate per annum of 9.50%, payable on May 15 and November 15 of each year. The Floating
Rate Notes bear interest at a rate per annum equal to the Applicable LIBOR Rate (as defined in the
indenture governing the 2015 Senior Notes (the Indenture)) plus 4.75%, payable on February 15,
May 15, August 15 and November 15 of each year. The interest rate on the floating rate notes was
6.0% at September 30, 2009. The Senior Notes are unsecured and are therefore effectively
subordinated to all of the Companys senior secured indebtedness, including outstanding borrowings
under the Credit Agreement. The Company and each of its existing subsidiaries, other than
unrestricted subsidiaries and certain immaterial subsidiaries, are guarantors and may also be
co-issuers under the 2015 Senior Notes.
The Indenture contains customary restrictive covenants, including, among other things,
restrictions on the Companys ability to incur additional debt, pay dividends and make
distributions, make certain investments, repurchase stock, incur liens, enter into transactions
with affiliates, enter into sale and lease back transactions, merge or consolidate and transfer or
sell assets. The Company must offer to repurchase all of the 2015 Senior Notes upon the occurrence
of a change of control, as defined in the Indenture, at a purchase price equal to 101% of their
aggregate principal amount, plus accrued and unpaid interest. The Company must also offer to
repurchase the 2015 Senior Notes with the proceeds from certain sales of assets, if it does not
apply those proceeds within a specified time period after the sale, at a purchase price equal to
100% of their aggregate principal amount, plus accrued and unpaid interest.
In August 2007, the Company closed an offer to exchange publicly registered 2015 Senior Notes
with substantially equivalent terms for the 2015 Senior Notes originally issued, with $614.5 of the
total $615.0 principal amount of the 2015 Senior Notes exchanged.
13
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Gain on Early Extinguishment of Debt
During the nine months ended September 30, 2009, the Company extinguished debt with a total
principal amount of $116.2 by purchasing 2015 Senior Notes in individually negotiated transactions
for an aggregate purchase price of $50.6, resulting in a gain of $62.0 after the write-off of $3.6
of unamortized deferred financing fees related to the extinguished debt.
Capital Lease Obligations and Other Indebtedness
The Company has outstanding capital lease obligations and other indebtedness with principal
balances totaling $6.0 and $2.6 at September 30, 2009 and December 31, 2008, respectively. These
obligations have imputed interest rates ranging from 6.0% to 8.5% and have required payments,
including interest, of $0.4 remaining in 2009, $1.4 in 2010, $1.1 in 2011, $1.1 in 2012 and $1.1 in
2013. During the nine months ended September 30, 2009, the Company entered into a capital lease and
other indebtedness totaling $5.1 and, accordingly, such non-cash transaction amounts have been
excluded from the consolidated statement of cash flows.
Interest Rate Hedges
The Company uses hedge transactions, which are accounted for as cash flow hedges, to limit the
Companys risk on a portion of the Companys variable-rate debt.
During February 2006, the Company entered into interest rate hedge transactions in the form of
three-year interest rate swaps with a total notional amount of $150.0, which became effective on
July 1, 2006 and were accounted for as cash flow hedges. The hedges expired on June 30, 2009. The
hedges were designed to swap the underlying variable rate for a fixed rate of 4.992%. The purpose
of the hedge transactions was to limit the Companys risk on a portion of its variable interest
rate under a prior credit facility. On May 1, 2007, the Companys prior credit facilities were
repaid in full. The Company redesignated the swaps as a hedge against the variable interest rate on
a portion of its Term Loan. The Company amortized the fair value of the derivative liability of
$0.4 as of May 1, 2007 in interest expense in the consolidated statements of income over the
remaining life of the derivative contract using the straight-line method.
During June 2007, the Company entered into interest rate derivative transactions in the form
of a two-year interest rate swap with a notional amount of $255.0 and a three-year interest rate
swap with a notional amount of $255.0, which became effective on June 29, 2007. The two-year hedge,
which expired on June 30, 2009, swapped the underlying variable rate for a fixed rate of 5.323% and
the three-year hedge swaps the underlying variable rate for a fixed rate of 5.362%. During August
2007, the Company entered into an additional interest rate derivative transaction in the form of a
two-year interest rate swap with a notional amount of $250.0, which became effective on September
28, 2007. The hedge, which expired on September 28, 2009, swapped the underlying variable rate for
a fixed rate of 4.977%.
During June 2009, the Company entered into an interest rate derivative transaction in the form
of a three-year interest rate swap with a notional amount of $350.0, which became effective on June
30, 2009. This hedge swaps the underlying variable rate for a fixed rate of 2.353%. During
September 2009, the Company entered into an additional interest rate derivative transaction in the
form of a three-year interest rate swap with a notional amount of $250.0, which became effective on
September 30, 2009. This hedge swaps the underlying variable rate for a fixed rate of 2.140%.
The following presents the fair values of these derivative instruments and the classification
in the consolidated balance sheets.
September 30, | December 31, | |||||||||||
Derivatives designated as cash flow hedging instruments: | Balance sheet classification | 2009 | 2008 | |||||||||
Interest rate swaps |
Other current liabilities | $ | 9.2 | $ | 13.8 | |||||||
Other liabilities | 8.9 | 13.7 |
See Note 15 for information regarding the valuation of these derivative instruments.
14
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
These derivative instruments had no ineffective portions during the three and nine months
ended September 30, 2009. Accordingly, no amounts were required to be reclassified from accumulated
other comprehensive loss to the consolidated statements of income due to ineffectiveness. The
following presents the effect of these derivative instruments (effective portion) on other
comprehensive income and amounts reclassified from accumulated other comprehensive loss into
interest expense.
Loss reclassified from | ||||||||||||||||
accumulated other | ||||||||||||||||
Loss recognized in other | comprehensive loss | |||||||||||||||
comprehensive income | into interest expense | |||||||||||||||
Three Months | Nine Months | Three Months | Nine Months | |||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||
September 30, | September 30, | September 30, | September 30, | |||||||||||||
Derivatives designated as cash flow hedging instruments: | 2009 | 2009 | 2009 | 2009 | ||||||||||||
Interest rate swaps |
$ | 8.3 | $ | 15.8 | $ | 7.7 | $ | 25.2 |
The Company expects to reclassify approximately $22.2 into net income as additional
interest expense during the twelve months ending September 30, 2010.
The following presents the balances and net changes in the accumulated other comprehensive
loss related to these derivative instruments, net of income taxes.
Nine Months | ||||
Ended | ||||
September 30, | ||||
2009 | ||||
Balance at the beginning of the period |
$ | 16.8 | ||
Amount reclassified to income, net of tax benefit of $9.8 |
(15.4 | ) | ||
Net change in fair value of interest rate swaps, net of tax benefit of $6.2 |
9.6 | |||
Balance at end of period |
$ | 11.0 | ||
See Note 8 for additional information regarding the effect of these derivative instruments on
other comprehensive income.
12. Commitments and Contingencies
Honeywell Indemnification
Certain of the intermediate holding companies of the predecessor of the Company had issued
guarantees on behalf of operating companies formerly owned by these intermediate holding companies,
which operating companies are not part of the Companys businesses. In the stock purchase agreement
executed in connection with the acquisition of the Company by M & F Worldwide, Honeywell agreed to
use its commercially reasonable efforts to assume, replace or terminate such guarantees and
indemnify M & F Worldwide and its affiliates, including the Company and its subsidiaries, with
respect to all liabilities arising under such guarantees.
Other
In June 2008, Kenneth Kitson, purportedly on behalf of himself and a class of other alleged
similarly situated commercial borrowers from the Bank of Edwardsville, an Illinois-based community
bank (BOE), filed in a Madison County, Illinois state court an amended complaint that re-asserted
previously filed claims against BOE and added claims against Harland Financial Solutions, Inc.
(HFS). Mr. Kitsons complaint alleges, among other things, that HFSs Laser Pro software
permitted BOE to generate loan documents that were deceptive and usurious in that they failed to
disclose properly the effect of the 365/360 method of calculating interest. HFS removed the
action to the United States District
Court for the Southern District of Illinois. In February 2009, the District Court entered an
order granting with prejudice HFSs motion to dismiss the claims that Mr. Kitson brought against
it. In August 2009, Mr. Kitson, individually and as class representative, and BOE agreed to settle
and dismiss with prejudice all claims. Separately but concurrently, BOEs warranty claim against
HFS was settled, in exchange for, among other things, payment by HFS of $0.2. The class
15
Table of Contents
Harland Clarke Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
settlement agreement has been preliminarily approved by the District Court and the fairness
hearing is scheduled for January 25, 2010. HFSs settlement payment remains in escrow pending this
approval.
Various other legal proceedings, claims and investigations are pending against the Company,
including those relating to commercial transactions, product liability, environmental, safety and
health matters, employment matters and other matters. Most of these matters are covered by
insurance, subject to deductibles and maximum limits and by third-party indemnities. In the opinion
of management, based upon the information available at this time, the outcome of the matters
referred to above will not have a material adverse effect on the Companys financial position or
results of operations.
13. Restructuring
Harland Clarke and Corporate
During the second quarter of 2007, as a result of the Harland acquisition, the Company adopted
a plan to restructure the Harland Clarke segment and Corporate, focused on improving operating
margins through consolidating facilities and reducing duplicative expenses. The Companys plan
primarily included workforce rationalization, facility closures, consolidation of certain redundant
outsourcing and the reduction of consulting and other professional services.
In addition to restructuring liabilities recorded in the Harland acquisition purchase
accounting, the Company also adopted plans during 2008 and 2009 to realize incremental synergies in
the Harland Clarke segment by further consolidating printing plants, contact centers and selling,
general and administrative functions. The Company also recorded restructuring liabilities in
connection with the Transaction Holdings Acquisition of $1.5 in 2008. The liabilities were reduced
by $0.6 in 2009, which is reflected as non-cash utilization in the table below.
The Company expensed $1.7 and $17.0 for severance and severance-related costs and $1.7 and
$4.8 for facilities closures and other costs during the three and nine months ended September 30,
2009, respectively, and expensed $0.5 and $0.9 for severance and severance-related costs and $0.1
and $0.5 for facilities closures and other costs during the three and nine months ended September
30, 2008, respectively. The Company expects to incur in future periods an additional $5.4 for costs
related to these plans. Ongoing lease commitments related to these plans continue through 2013.
The following table details the components of the Companys restructuring accruals under its
plans established since 2007 related to the Harland Clarke segment and Corporate for the nine
months ended September 30, 2009 and 2008:
Established in | ||||||||||||||||||||||||
Acquisition | ||||||||||||||||||||||||
Beginning | Purchase | Paid in | Non-Cash | Ending | ||||||||||||||||||||
Balance | Accounting | Expensed | Cash | Utilization | Balance | |||||||||||||||||||
Nine months ended September 30, 2009: |
||||||||||||||||||||||||
Severance and severance-related |
$ | 7.4 | $ | | $ | 17.0 | $ | (19.1 | ) | $ | | $ | 5.3 | |||||||||||
Facilities closures and other costs |
2.3 | | 4.8 | (1.8 | ) | (4.0 | ) | 1.3 | ||||||||||||||||
Total |
$ | 9.7 | $ | | $ | 21.8 | $ | (20.9 | ) | $ | (4.0 | ) | $ | 6.6 | ||||||||||
Nine months ended September 30, 2008: |
||||||||||||||||||||||||
Severance and severance-related |
$ | 8.5 | $ | 1.5 | $ | 0.9 | $ | (7.7 | ) | $ | | $ | 3.2 | |||||||||||
Facilities closures and other costs |
2.9 | (0.5 | ) | 0.5 | (1.5 | ) | | 1.4 | ||||||||||||||||
Total |
$ | 11.4 | $ | 1.0 | $ | 1.4 | $ | (9.2 | ) | $ | | $ | 4.6 | |||||||||||
In addition to the amounts disclosed in the table above, the Company also incurred other
expenses related to the facility closures, including inventory write-offs, training, hiring and
travel.
Harland Financial Solutions
During the second quarter of 2007, as a result of the Harland acquisition, the Company adopted
a plan to restructure the Harland Financial Solutions segment, focused on improving operating
margins primarily through consolidating facilities and rationalizing the workforce.
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Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
During the second quarter of 2008, the Company implemented and completed a plan to restructure
certain selling, general and administrative functions within the Harland Financial Solutions
segment. The plan focused on improving operating margins through reducing selling, general and
administrative expenses by leveraging the Companys shared services capabilities. During the first
quarter of 2009, the Company initiated a multi-year plan to reorganize certain operations and sales
and support functions within the Harland Financial Solutions segment. The plan, which is expected
to be completed by the end of 2011, focuses on moving from a product-centric organization to a
functional organization in order to enhance customer support.
The Company expensed $0.9 and $3.1 for severance and severance-related costs and $0.0 and $1.0
for facilities closures and other costs during the three and nine months ended September 30, 2009,
respectively, and expensed $0.1 and $3.0 for severance and severance-related costs during the three
and nine months ended September 30, 2008. The Company currently expects to incur additional costs
of $0.3 related to these plans, which is subject to refinement as the reorganization progresses.
The following table details the Companys restructuring accruals related to the Harland
Financial Solutions segment for the nine months ended September 30, 2009 and 2008:
Established in | ||||||||||||||||||||
Acquisition | ||||||||||||||||||||
Beginning | Purchase | Paid in | Ending | |||||||||||||||||
Balance | Accounting | Expensed | Cash | Balance | ||||||||||||||||
Nine months ended September 30, 2009: |
||||||||||||||||||||
Severance and severance-related |
$ | 1.4 | $ | | $ | 3.1 | $ | (3.0 | ) | $ | 1.5 | |||||||||
Facilities and other costs |
0.7 | | 1.0 | (0.8 | ) | 0.9 | ||||||||||||||
Total |
$ | 2.1 | $ | | $ | 4.1 | $ | (3.8 | ) | $ | 2.4 | |||||||||
Nine months ended September 30, 2008: |
||||||||||||||||||||
Severance and severance-related |
$ | 0.7 | $ | | $ | 3.0 | $ | (2.3 | ) | $ | 1.4 | |||||||||
Facilities and other costs |
1.7 | (0.1 | ) | | (0.5 | ) | 1.1 | |||||||||||||
Total |
$ | 2.4 | $ | (0.1 | ) | $ | 3.0 | $ | (2.8 | ) | $ | 2.5 | ||||||||
Scantron
During the first quarter of 2008, as a result of the Data Management Acquisition, the Company
adopted plans to restructure the Scantron segment. These plans focused on improving operating
margins through consolidating manufacturing and printing operations and reducing duplicative
selling, general and administrative expenses through workforce rationalization, consolidation of
certain redundant outsourcing and the reduction of consulting and other professional services.
As discussed in Note 3, the Company recorded $2.5 of severance and severance-related costs for
the termination of certain former Data Management employees in purchase accounting. In addition to
these restructuring liabilities recorded in purchase accounting for the Data Management
Acquisition, the Company expensed $2.2 for severance and severance-related costs and $0.1 of
facilities and other costs for the consolidation of certain printing operations during the nine
months ended September 30, 2008, of which $0.7 was expensed during the three months ended September
30, 2008. The Company completed substantially all of the planned employee terminations and
consolidation of printing and manufacturing operations related to the Data Management Acquisition
as of March 31, 2009.
The Company expensed $0.0 and $2.8 for severance and severance-related costs related to
further consolidation of operations and elimination of certain selling, general and administrative
expenses, and $0.0 and $0.3 for facilities closures and other costs during the three and nine
months ended September 30, 2009, respectively.
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Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
The following table details the components of the Companys restructuring accruals related to
the Scantron segment for the nine months ended September 30, 2009 and 2008:
Established in | ||||||||||||||||||||||||
Acquisition | ||||||||||||||||||||||||
Beginning | Purchase | Paid in | Non-Cash | Ending | ||||||||||||||||||||
Balance | Accounting | Expensed | Cash | Utilization | Balance | |||||||||||||||||||
Nine months ended September 30, 2009: |
||||||||||||||||||||||||
Severance and severance-related |
$ | 1.0 | $ | | $ | 2.8 | $ | (2.9 | ) | $ | (0.1 | ) | $ | 0.8 | ||||||||||
Facilities and other costs |
| | 0.3 | | (0.3 | ) | | |||||||||||||||||
Total |
$ | 1.0 | $ | | $ | 3.1 | $ | (2.9 | ) | $ | (0.4 | ) | $ | 0.8 | ||||||||||
Nine months ended September 30, 2008: |
||||||||||||||||||||||||
Severance and severance-related |
$ | | $ | 2.5 | $ | 2.2 | $ | (3.4 | ) | $ | | $ | 1.3 | |||||||||||
Facilities and other costs |
| | 0.1 | (0.1 | ) | | | |||||||||||||||||
Total |
$ | | $ | 2.5 | $ | 2.3 | $ | (3.5 | ) | $ | | $ | 1.3 | |||||||||||
In addition to the amounts disclosed in the table above, the Company also incurred other
expenses related to the initiatives including inventory write-offs, training, hiring, relocation
and travel.
Restructuring accruals for all of the segments plans are reflected in other current
liabilities and other liabilities in the accompanying consolidated balance sheets. The Company
expects to pay the remaining severance, facilities and other costs related to the segments
restructuring plans through 2013.
14. Transactions with Related Parties
Notes Receivable
During the third quarter of 2008, the Company acquired the senior secured credit facility and
outstanding note of Delphax Technologies, Inc. (Delphax), the supplier of Imaggia printing
machines and related supplies and service for the Harland Clarke segment. The senior secured credit
facility is comprised of a revolving credit facility of up to $14.0 and a term loan of $0.5,
subject to borrowing limitations set forth therein, that mature in September 2011. The senior
secured credit facility is collateralized by a perfected security interest in substantially all of
Delphaxs assets. The revolving facility has a borrowing base calculated based on Delphaxs
eligible accounts receivable and inventory. The senior secured credit facility has an interest rate
of Wells Fargo N.A. Prime plus 2.5%, payable quarterly. The note, which has a principal amount of
$7.0, matures in September 2012, and bears interest at an annual rate of 12.0%, payable quarterly
either in cash, or in a combination of cash and up to 25% Delphax stock. As part of this
transaction, the Company also received 250,000 shares of Delphax common stock from the previous
holder of the Delphax note.
The outstanding balances on the senior secured credit facility and the note are included in
other assets in the accompanying consolidated balance sheets. During the nine months ended
September 30, 2009, the Company received $15.0 in payments and released $9.8 in draws on the
revolver, bringing the principal balance of the debt to $7.0 at September 30, 2009. Interest income
of $0.2 and $0.7 was recorded during the three and nine months ended September 30, 2009,
respectively. Interest income of $0.3 was recorded during the three months ended September 30,
2008.
Other
The Company expensed $0.7 and $2.0 during the three and nine months ended September 30, 2009,
respectively, and $0.7 and $2.0 during the three and nine months ended September 30, 2008,
respectively, for services provided to the Company by M & F Worldwide. The amounts are reflected in
selling, general and administrative expenses and payable to parent.
During the nine months ended September 30, 2008, the Company paid a cash dividend of $65.0 to
M & F Worldwide as permitted by restricted payment baskets within the Companys debt agreements.
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Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
Notes to Consolidated Financial Statements (Continued)
(dollars in millions)
(unaudited)
As discussed in Note 3, the Company paid $2.0 in February 2008 to MacAndrews & Forbes Holdings
Inc. for its services related to sourcing, analyzing, negotiating and executing the Data Management
Acquisition.
15. Financial Instruments
The carrying amounts for cash and cash equivalents, trade accounts receivable, accounts
payable and accrued liabilities approximate fair value. The estimated fair value of long-term debt
at September 30, 2009 and December 31, 2008 was approximately $1,918.6 and $1,096.3, respectively,
based on bid prices available at these respective dates. The carrying value of long-term debt at
September 30, 2009 and December 31, 2008 was $2,264.2 and $2,390.6, respectively.
The Company measures fair value using a three-tier fair value hierarchy, which prioritizes the
inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs
such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in
active markets that are either directly or indirectly observable; and Level 3, defined as
unobservable inputs in which little or no market data exists, therefore requiring an entity to
develop its own assumptions.
As of September 30, 2009 and December 31, 2008, the Company held two types of financial
instruments subject to valuation on a recurring basis, marketable securities and interest rate
swaps. The marketable securities are included in other assets in the accompanying consolidated
balance sheets. The interest rate swaps are included in other current liabilities and other
liabilities in the accompanying consolidated balance sheets. Fair values as of September 30, 2009
and December 31, 2008 were as follows:
Balance at | ||||||||||||||||
September 30, 2009 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Marketable securities |
$ | 2.2 | $ | 2.2 | $ | | $ | | ||||||||
Liability for interest rate swaps |
18.1 | | 18.1 | |
Balance at | ||||||||||||||||
December 31, 2008 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Marketable securities |
$ | 0.2 | $ | 0.2 | $ | | $ | | ||||||||
Liability for interest rate swaps |
27.5 | | 27.5 | |
Fair value of interest rate swaps is based on forward-looking interest rate curves as provided
by the counterparties, adjusted for the Companys credit risk.
The Companys marketable securities are classified as available-for-sale and are reported at
their fair values (quoted market price), which were as follows:
Gross | Gross | |||||||||||||||
Unrealized | Unrealized | |||||||||||||||
Amortized Cost | Gains | Losses | Fair Value | |||||||||||||
Balance at September 30, 2009: |
||||||||||||||||
Equity securities |
$ | 0.3 | $ | 2.0 | $ | (0.1 | ) | $ | 2.2 | |||||||
Balance at December 31, 2008: |
||||||||||||||||
Equity securities |
$ | 0.3 | $ | 0.1 | $ | (0.2 | ) | $ | 0.2 |
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion regarding our financial condition and results of operations for the
three and nine months ended September 30, 2009 and 2008 should be read in conjunction
with the more detailed financial information contained in our consolidated financial statements and
their notes included elsewhere in this quarterly report.
Overview of Business
Harland Clarke Holdings Corp. (Harland Clarke Holdings and, together with its subsidiaries,
the Company) is a holding company that conducts its operations through its direct and indirect
wholly owned subsidiaries and was incorporated in Delaware on October 19, 2005. On December 15,
2005, CA Investment Corp., an indirect wholly owned operating subsidiary of M & F Worldwide Corp.
(M & F Worldwide) purchased 100% of the capital stock of Novar USA Inc. (Novar) and was renamed
Clarke American Corp., which was the successor by merger to Novar, which indirectly wholly owned
the operating subsidiaries of the Clarke American Corp. business. On May 1, 2007, the Company
completed the acquisition of John H. Harland Company (Harland) and changed its name on May 2,
2007 from Clarke American Corp. to Harland Clarke Holdings. The Companys businesses are organized
along three business segments together with a corporate group for certain support services.
The Harland Clarke segment offers checks and related products, forms and treasury supplies,
and related delivery and fraud prevention services. It also provides specialized marketing and
contact center services to its financial and commercial institution clients. Harland Clarkes
marketing offerings include turnkey marketing solutions, checkbook messaging and e-mail marketing.
Through its contact centers, Harland Clarke provides financial institutions with both inbound and
outbound support for their clients, including sales and ordering services for checks and related
products and services, customer care, banking support and marketing services.
The Harland Financial Solutions segment provides financial technology products and services
including lending and mortgage origination and servicing applications, business intelligence
solutions, customer relationship management software, Internet banking solutions, mobile banking,
branch automation solutions and core processing systems and services, principally targeted to
community banks and credit unions.
The Scantron segment provides testing and assessment solutions to schools in North America,
offers specialized data management solutions to educational, commercial and governmental entities
worldwide and collects and manages survey information for a wide variety of Fortune 1000 and other
organizations. Scantrons products and services include scannable forms, scanning equipment, survey
services, testing software and related services and field maintenance services.
The Transaction Holdings Acquisition
On December 31, 2008, the Companys wholly owned subsidiary, Harland Clarke Corp., acquired
Transaction Holdings Inc. (Transaction Holdings) for total cash consideration of $8.2 million
(the Transaction Holdings Acquisition). Transaction Holdings produces personal and business
checks, payment coupon books, promotional checks and provides direct marketing services to
financial institutions, as well as individual consumers and small businesses.
The Data Management Acquisition
On February 22, 2008, the Companys indirect wholly owned subsidiary, Scantron Corporation,
purchased all of the limited liability membership interests of Data Management I LLC (Data
Management) from NCS Pearson for $218.7 million in cash, after giving effect to working capital
adjustments of $1.6 million (the Data Management Acquisition). Data Management designs,
manufactures and services scannable data collection products, including printed forms, scanning
equipment and related software, and provides survey consulting and tracking services, including
medical device tracking, as well as field maintenance services to corporate and governmental
clients. The Company financed the Data Management Acquisition and related fees and expenses with
cash on hand.
With these and previous acquisitions, the Company is focused on improving operating margins by
reducing selling, general and administrative expenses, shared services costs and cost of sales.
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Economic and Other Factors Affecting the Businesses of the Company
Harland Clarke
While total non-cash payments including checks, credit cards, debit cards and other
electronic forms of payment are growing, the number of checks printed continues to decline.
Harland Clarke believes the number of checks printed is driven by the number of checks written, the
number of new checking accounts opened and reorders reflecting changes in consumers personal
situations, such as name or address changes. In recent quarters, Harland Clarke has experienced
check unit declines at a higher rate than in the past, as evidenced by recent period-over-period
declines in Harland Clarke revenue, which are discussed in more detail in this report. Harland
Clarke is unable to determine at this time whether these higher rates of decline are attributable
to recent economic and financial market difficulties, the depth and length of the economic
recession, higher unemployment, decreased openings of checking accounts, decreased consumer
spending and/or a further acceleration in the use of alternative non-cash payments. Harland Clarke
expects that check unit volume will continue to decline at rates that are higher than it had
previously experienced in recent years, resulting in a corresponding decrease in check revenues and
depending on the nature and the relative magnitude of the causes for the decreases, such decreases
may not be mitigated when overall economic conditions improve. Harland Clarke is focused on growing
its non-check related products and services, including marketing services, and optimizing its
existing catalog of offerings to better serve its clients, as well as managing its costs, overhead
and facilities to reflect the declines in check unit volumes. Harland Clarke does not believe that
revenues from non-check related products and services will fully offset revenue declines from
declining check unit volumes. In the future, Harland Clarke may not be able to mitigate the revenue
declines from declining check unit volumes through cost management, which could negatively affect
Harland Clarkes margins.
The financial institution outsourcing services industry is highly competitive and fragmented.
Quality and breadth of service offerings and strength of customer relationships are among the key
competitive factors. Within this category, Harland Clarke competes with large outsourcing service
providers that offer a wide variety of services, and some compete with Harland Clarkes primary
offerings specifically payment services, marketing services and teleservices. Other competitors
specialize in providing one or more of these services.
The Harland Clarke segments operating results are also affected by consumer confidence and
employment. Consumer confidence directly correlates with consumer spending, while employment also
affects revenues through the number of new checking accounts being opened. The Harland Clarke
segments operating results have been negatively affected by slow or negative growth of, or
downturns in, the United States economy. Business confidence also affects a portion of the Harland
Clarke segment. In addition, as Harland Clarkes financial institution customers fail or merge with
other financial institutions, Harland Clarke may lose some or all revenues from such financial
institutions and/or experience further pricing pressure, which would negatively affect Harland
Clarkes operating results.
Harland Financial Solutions
Harland Financial Solutions operating results are affected by the overall demand for our
products, software and related services which is based upon the information technology budgets of
our clients and prospects. Economic downturns in one or more of the countries in which we do
business and enhanced regulatory burdens, including through increased fees and assessments charged
to financial institutions by the FDIC and NCUA in the wake of the financial crisis, could result in
reductions in the information technology budgets for some portion of our clients and potentially
longer lead-times for acquiring Harland Financial Solutions products and services. In addition, as
Harland Financial Solutions financial institution customers fail or merge with other financial
institutions, Harland Financial Solutions may lose some or all revenues from such financial
institutions and/or experience further pricing pressure, which would negatively affect Harland
Financial Solutions operating results.
The markets for our Harland Financial Solutions products are affected by technological change,
evolving industry standards, regulatory changes in client requirements and frequent new product
introductions and enhancements. The markets for providing technological solutions to financial
institutions and other enterprises require that we continually improve our existing products and
create new products, while controlling costs to remain price competitive.
The market for providing technological solutions to financial institutions is highly competitive
and fragmented. Harland Financial Solutions competes with several domestic and international
companies. Some competitors offer one or more specialized products or services that compete with
Harland Financial Solutions. Certain competitors have advantages over Harland Financial Solutions
due to their significant worldwide presence, longer operating and product development
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Harland Clarke Holdings Corp. and Subsidiaries
history, larger installed client base, and substantially greater financial, technical and marketing
resources. In response to competition, Harland Financial Solutions has been required in the past,
and may be required in the future, to furnish additional discounts to clients, otherwise modify
pricing practices, or offer more favorable payment terms or more favorable contractual
implementation terms.
Scantron
While the number of tests given annually in K-12 and higher education markets continues to
grow, the demand for Optical Mark Reader paper based testing has declined and is expected to
continue to decline. Changes in educational funding can affect the rate at which schools adopt new
technology thus slowing the decline for paper based testing but also slowing the demand for
Scantrons on-line testing products. Educational funding changes may also reduce the rate of
consumption of Scantrons forms and purchase of additional hardware to process these forms.
Scantrons education-based customers may turn to lower cost solutions for paper-based forms and
hardware in furtherance of addressing their budget needs. A weak economy in the United States may
negatively affect education budgets and spending, which would have an adverse impact on Scantrons
operating results. Data collection is also experiencing a conversion to non-paper based methods of
collection. Scantron believes this trend will also continue as the availability of these
alternative technologies becomes more widespread. While Scantrons non-paper data collection
business could benefit from this trend, Scantrons paper-based data collection business could be
negatively affected by this trend. Changes in the overall economy can impact the demand for data
collection as companies look for ways to adjust their expenditures.
Asset Impairments
Changes in estimates and assumptions used in the Companys financial projections resulting
from the factors discussed above for any of the Companys business segments could have a material
impact on the fair value of goodwill, indefinite-lived intangible assets or other long-lived assets
in future periods, which may result in material asset impairments, as more fully described in Item
1A, Risk Factors Weak economic conditions and further acceleration of check unit declines may
continue to have an adverse effect on our revenues and profitability and could result in impairment
charges.
Restructuring
The Company has taken restructuring actions in the past in an effort to achieve manufacturing
and contact center efficiencies and other cost savings. Past restructuring actions have related to
both acquisitions and ongoing cost reduction initiatives and have included manufacturing plant
closures, contact center closures and workforce rationalization. The Company anticipates future
restructuring actions, where appropriate, to realize process efficiencies, to continue to align our
cost structure with business needs and remain competitive in the marketplace. The Company expects
to incur severance and severance-related costs, facilities closures costs and other costs such as
inventory write-offs, training, hiring and travel in connection with future restructuring actions.
Consolidated Operating Results
The Company has organized its businesses along three reportable segments together with a
corporate group for certain support services. The Companys operations are aligned on the basis of
products, services and industry. Management measures and evaluates the reportable segments based on
operating income.
Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
The operating results for the three months ended September 30, 2009, as reflected in the
accompanying consolidated statements of income and described below, include the operating results
of the acquired Transaction Holdings business in the Harland Clarke segment from December 31, 2008,
the date of the Transaction Holdings Acquisition.
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Net Revenues:
Three Months Ended September 30, | ||||||||
$ in millions | 2009 | 2008 | ||||||
Consolidated Net Revenues: |
||||||||
Harland Clarke segment |
$ | 305.0 | $ | 322.7 | ||||
Harland Financial Solutions segment |
67.9 | 72.8 | ||||||
Scantron segment |
52.9 | 58.6 | ||||||
Eliminations |
(0.1 | ) | (0.1 | ) | ||||
Total |
$ | 425.7 | $ | 454.0 | ||||
Net revenues decreased by $28.3 million, or 6.2%, to $425.7 million in the 2009 period from
$454.0 million in the 2008 period.
Net revenues for the Harland Clarke segment decreased by $17.7 million, or 5.5%, to $305.0
million in the 2009 period from $322.7 million in the 2008 period. The decrease was primarily due
to volume declines from check and related products, which the Company believes was partially
affected by the economic downturn. Declines in volumes were partially offset by increased revenues
per unit.
Net revenues for the Harland Financial Solutions segment decreased by $4.9 million, or 6.7%,
to $67.9 million in the 2009 period from $72.8 million in the 2008 period. Net revenues from the
enterprise solutions product lines decreased $3.0 million in the 2009 period compared to the 2008
period. The decrease was primarily due to declines in license, hardware and professional services
revenues. Additionally, there was a decrease in early termination fees in the 2009 period as
compared to the 2008 period. Net revenues from the risk management product lines decreased $1.4
million in the 2009 period compared to the 2008 period. The decrease was primarily due to declines
in lending products. The Company believes the declines were partially affected by the economic
downturn, which has negatively affected information technology purchases by financial institutions.
Net revenues for the Scantron segment decreased by $5.7 million, or 9.7%, to $52.9 million in
the 2009 period from $58.6 million in the 2008 period. The decrease was primarily due to volume
declines in hardware and forms products and a decrease in service and maintenance revenues. The
Company believes these product lines and services were partially affected by the economic downturn.
Cost of Revenues:
Three Months Ended September 30, | ||||||||
$ in millions | 2009 | 2008 | ||||||
Consolidated Cost of Revenues: |
||||||||
Harland Clarke segment |
$ | 186.1 | $ | 206.1 | ||||
Harland Financial Solutions segment |
30.3 | 32.2 | ||||||
Scantron segment |
28.3 | 32.8 | ||||||
Eliminations |
(0.1 | ) | (0.1 | ) | ||||
Total |
$ | 244.6 | $ | 271.0 | ||||
Cost of revenues decreased by $26.4 million, or 9.7%, to $244.6 million in the 2009 period
from $271.0 million in the 2008 period.
Cost of revenues for the Harland Clarke segment decreased by $20.0 million, or 9.7%, to $186.1
million in the 2009 period from $206.1 million in the 2008 period. The decrease was primarily due
to lower volumes, which resulted in decreases in delivery, materials, and other variable overhead
costs. Labor costs also decreased due to cost reduction and restructuring activities. Decreases in
travel expenses and depreciation also contributed to the decrease in cost of revenues. These
decreases were partially offset by inflation in delivery and materials expenses, as well as an
increase in the amortization of intangible assets of $1.1 million. Cost of revenues as a percentage
of revenues for the Harland Clarke segment was 61.0% in the 2009 period as compared to 63.9% in the
2008 period.
Cost of revenues for the Harland Financial Solutions segment decreased by $1.9 million, or
5.9%, to $30.3 million in the 2009 period from $32.2 million in the 2008 period. The decrease was
primarily due to lower hardware and other
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third-party costs related to volume declines. Labor cost decreases related to cost reduction
activities and decreases in depreciation and amortization also contributed to the decrease in cost
of revenues. Cost of revenues as a percentage of revenues for the Harland Financial Solutions
segment was 44.6% in the 2009 period as compared to 44.2% in the 2008 period.
Cost of revenues for the Scantron segment decreased by $4.5 million, or 13.7%, to $28.3
million in the 2009 period from $32.8 million in the 2008 period. The decrease was primarily due to
volume declines and cost reductions related to the Data Management Acquisition, in addition to
other restructuring activities. Cost of revenues as a percentage of revenues for the Scantron
segment was 53.5% in the 2009 period as compared to 56.0% in the 2008 period.
Selling, General and Administrative Expenses:
Three Months Ended September 30, | ||||||||
$ in millions | 2009 | 2008 | ||||||
Consolidated Selling, General and Administrative Expenses: |
||||||||
Harland Clarke segment |
$ | 46.1 | $ | 59.0 | ||||
Harland Financial Solutions segment |
27.2 | 32.5 | ||||||
Scantron segment |
13.5 | 16.1 | ||||||
Corporate |
3.5 | 3.2 | ||||||
Total |
$ | 90.3 | $ | 110.8 | ||||
Selling, general and administrative expenses decreased by $20.5 million, or 18.5%, to $90.3
million in the 2009 period from $110.8 million in the 2008 period.
Selling, general and administrative expenses for the Harland Clarke segment decreased by $12.9
million, or 21.9%, to $46.1 million in the 2009 period from $59.0 million in the 2008 period. The
decrease was primarily due to labor cost reductions and lower integration-related and travel
expenses. Selling, general and administrative expenses as a percentage of revenues for the Harland
Clarke segment was 15.1% in the 2009 period as compared to 18.3% in the 2008 period.
Selling, general and administrative expenses for the Harland Financial Solutions segment
decreased by $5.3 million, or 16.3%, to $27.2 million in the 2009 period from $32.5 million in the
2008 period. The decrease was primarily due to labor cost reductions, a reduction in compensation
expense related to an incentive agreement for an acquisition and reductions in occupancy and travel
expenses. Selling, general and administrative expenses in the 2009 and 2008 periods included
charges of $0.8 million and $2.1 million, respectively, for compensation expense related to an
incentive agreement for an acquisition. Selling, general and administrative expenses as a
percentage of revenues for the Harland Financial Solutions segment was 40.1% in the 2009 period as
compared to 44.6% in the 2008 period.
Selling, general and administrative expenses for the Scantron segment decreased $2.6 million,
or 16.1%, to $13.5 million in the 2009 period from $16.1 million in the 2008 period. The decrease
was primarily due to cost reductions related to the Data Management Acquisition, in addition to
other restructuring activities and a decrease in integration-related expenses. Selling, general and
administrative expenses as a percentage of revenues for the Scantron segment was 25.5% in the 2009
period as compared to 27.5% in the 2008 period.
Corporate selling, general and administrative expenses increased $0.3 million, or 9.4%, to
$3.5 million in the 2009 period from $3.2 million in the 2008 period. The increase was primarily
due to higher professional fees.
Restructuring Costs
During 2007 and 2008, as a result of acquisition activity, the Company adopted plans to
restructure its businesses. These plans focused on improving operating margins through
consolidating facilities and reducing duplicative expenses, such as selling, general and
administrative, executive and shared services expenses. As a result of the economic downturn and
the sales decline experienced in recent periods, the Company adopted further restructuring plans
during 2008 and 2009 to strengthen operating margins and leverage incremental synergies within the
printing plants, contact
centers and selling, general and administrative areas by leveraging the Companys shared
services capabilities and reorganizing certain operations and sales and support functions.
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During the 2009 period, the Company recorded restructuring costs of $3.4 million for the
Harland Clarke segment and $0.9 million for the Harland Financial Solutions segment related to
these plans. During the 2008 period, the Company recorded restructuring costs of $0.6 million for
the Harland Clarke segment, $0.1 million for the Harland Financial Solutions segment and $0.7
million for the Scantron segment related to these plans.
Interest Income
Interest income was $0.2 million in the 2009 period as compared to $0.3 million in the 2008
period. The decrease in interest income was primarily due to lower interest rates on investments in
cash equivalents in the 2009 period as compared to the 2008 period, partially offset by higher cash
balances available for investment in cash equivalents in the 2009 period as compared to the 2008
period.
Interest Expense
Interest expense was $32.6 million in the 2009 period as compared to $45.2 million in the 2008
period. The decrease in interest expense was due to lower effective interest rates and also a
decrease in total debt outstanding.
Gain on Early Extinguishment of Debt
During the 2009 period, the Company extinguished debt with a total principal amount of $1.5
million by purchasing 2015 Senior Notes in individually negotiated transactions for an aggregate
purchase price of $0.9 million, resulting in a gain of $0.5 million after the write-off of $0.1
million of unamortized deferred financing fees related to the extinguished debt.
Provision for Income Taxes
The Companys effective tax rate was 38.3% in the 2009 period and 40.2% in the 2008 period.
The change was primarily due to a benefit from the domestic production activities deduction in the
2009 period.
Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008
The operating results for the nine months ended September 30, 2009, as reflected in the
accompanying consolidated statements of income and described below, include the operating results
of the acquired Transaction Holdings business in the Harland Clarke segment from December 31, 2008,
the date of the Transaction Holdings Acquisition. The operating results for the Scantron segment
include Data Management operations from February 22, 2008, the date of the Data Management
Acquisition.
Net Revenues:
Nine Months Ended September 30, | ||||||||
$ in millions | 2009 | 2008 | ||||||
Consolidated Net Revenues: |
||||||||
Harland Clarke segment |
$ | 926.4 | $ | 983.8 | ||||
Harland Financial Solutions segment |
206.8 | 217.9 | ||||||
Scantron segment |
158.0 | 154.9 | ||||||
Eliminations |
(0.5 | ) | (0.7 | ) | ||||
Total |
$ | 1,290.7 | $ | 1,355.9 | ||||
Net revenues decreased by $65.2 million, or 4.8%, to $1,290.7 million in the 2009 period from
$1,355.9 million in the 2008 period. The Data Management Acquisition accounted for an increase of
$14.6 million in net revenues.
Net revenues for the Harland Clarke segment decreased by $57.4 million, or 5.8%, to $926.4
million in the 2009 period from $983.8 million in the 2008 period. The decrease was primarily due
to volume declines from check and related products, which the Company believes was partially
affected by the economic downturn, as well as one less production day in the 2009 period. Declines
in volumes were partially offset by increased revenues per unit.
Additionally, there was $0.7 million of revenue for contract termination fees in the 2009
period compared to $2.3 million in the 2008 period.
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Net revenues for the Harland Financial Solutions segment decreased by $11.1 million, or 5.1%,
to $206.8 million in the 2009 period from $217.9 million in the 2008 period. Net revenues from the
enterprise solutions product lines decreased $9.5 million in the 2009 period compared to the 2008
period. The decrease was primarily due to declines in license, hardware and professional services
revenues. Additionally, there was a decrease in early termination fees in the 2009 period as
compared to the 2008 period. Net revenues from the risk management product lines decreased $1.0
million in the 2009 period compared to the 2008 period. The decrease was primarily due to declines
in mortgage products, partially offset by organic growth in lending products. The Company believes
the declines were partially affected by the economic downturn, which has negatively affected
information technology purchases by financial institutions.
Net revenues for the Scantron segment increased by $3.1 million, or 2.0%, to $158.0 million in
the 2009 period from $154.9 million in the 2008 period. The Data Management Acquisition accounted
for an increase of $14.6 million. The remaining $11.5 million decrease was a result of volume
declines in hardware and forms products, partially offset by organic growth in software products.
The Company believes the hardware and forms product lines were partially affected by the economic
downturn.
Cost of Revenues:
Nine Months Ended September 30 | ||||||||
$ in millions | 2009 | 2008 | ||||||
Consolidated Cost of Revenues: |
||||||||
Harland Clarke segment |
$ | 577.4 | $ | 625.6 | ||||
Harland Financial Solutions segment |
89.8 | 93.1 | ||||||
Scantron segment |
87.8 | 89.1 | ||||||
Eliminations |
(0.5 | ) | (0.7 | ) | ||||
Total |
$ | 754.5 | $ | 807.1 | ||||
Cost of revenues decreased by $52.6 million, or 6.5%, to $754.5 million in the 2009 period
from $807.1 million in the 2008 period. The Data Management Acquisition accounted for an increase
of $9.4 million in cost of revenues.
Cost of revenues for the Harland Clarke segment decreased by $48.2 million, or 7.7%, to $577.4
million in the 2009 period from $625.6 million in the 2008 period. The decrease was primarily due
to lower volumes, which resulted in decreases in delivery, materials, and other variable overhead
expenses, and one less production day in the 2009 period. Labor costs also decreased due to cost
reduction and restructuring activities. Decreases in travel expenses and depreciation also
contributed to the decrease in cost of revenues. These decreases were partially offset by inflation
in delivery and materials expenses, as well as an increase in the amortization of intangible assets
of $3.1 million. Cost of revenues as a percentage of revenues for the Harland Clarke segment was
62.3% in the 2009 period as compared to 63.6% in the 2008 period.
Cost of revenues for the Harland Financial Solutions segment decreased by $3.3 million, or
3.5%, to $89.8 million in the 2009 period from $93.1 million in the 2008 period. The decrease was
primarily due to lower hardware and other third-party costs related to volume declines. Decreases
in telecom, travel, depreciation and other overhead costs also contributed to the decrease in cost
of revenues. Cost of revenues as a percentage of revenues for the Harland Financial Solutions
segment was 43.4% in the 2009 period as compared to 42.7% in the 2008 period.
Cost of revenues for the Scantron segment decreased by $1.3 million, or 1.5%, to $87.8 million
in the 2009 period from $89.1 million in the 2008 period. The Data Management Acquisition accounted
for an increase of $9.4 million. The remaining $10.7 million decrease was primarily due to volume
declines and cost reductions related to the Data Management Acquisition, in addition to other
restructuring activities. Cost of revenues as a percentage of revenues for the Scantron segment was
55.6% in the 2009 period as compared to 57.5% in the 2008 period.
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Selling, General and Administrative Expenses:
Nine Months Ended September 30, | ||||||||
$ in millions | 2009 | 2008 | ||||||
Consolidated Selling, General and Administrative Expenses: |
||||||||
Harland Clarke segment |
$ | 154.6 | $ | 183.4 | ||||
Harland Financial Solutions segment |
84.8 | 101.0 | ||||||
Scantron segment |
42.5 | 44.3 | ||||||
Corporate |
9.5 | 11.7 | ||||||
Total |
$ | 291.4 | $ | 340.4 | ||||
Selling, general and administrative expenses decreased by $49.0 million, or 14.4%, to $291.4
million in the 2009 period from $340.4 million in the 2008 period.
Selling, general and administrative expenses for the Harland Clarke segment decreased by $28.8
million, or 15.7%, to $154.6 million in the 2009 period from $183.4 million in the 2008 period. The
decrease was primarily due to labor cost reductions and decreases in integration-related and travel
expenses. Selling, general and administrative expenses as a percentage of revenues for the Harland
Clarke segment was 16.7% in the 2009 period as compared to 18.6% in the 2008 period.
Selling, general and administrative expenses for the Harland Financial Solutions segment
decreased by $16.2 million, or 16.0%, to $84.8 million in the 2009 period from $101.0 million in
the 2008 period. The decrease was primarily due to labor cost reductions, a reduction in
compensation expense related to an incentive agreement for an acquisition and reductions in
occupancy, travel and depreciation expenses. Selling, general and administrative expenses in the
2009 and 2008 periods included charges of $2.9 million and $7.2 million, respectively, for
compensation expense related to an incentive agreement for an acquisition. Selling, general and
administrative expenses as a percentage of revenues for the Harland Financial Solutions segment was
41.0% in the 2009 period as compared to 46.4% in the 2008 period.
Selling, general and administrative expenses for the Scantron segment decreased $1.8 million,
or 4.1%, to $42.5 million in the 2009 period from $44.3 million in the 2008 period. The Data
Management Acquisition accounted for an increase of $3.3 million, which was more than offset by a
$5.1 million decrease, primarily due to cost reductions related to the Data Management Acquisition,
in addition to other restructuring activities, and a decrease in integration-related expenses. In
the 2009 period, the Scantron segment incurred approximately $1.3 million in one-time expenses
related to a contractual obligation owing to a former employee upon termination of employment.
Selling, general and administrative expenses as a percentage of revenues for the Scantron segment
was 26.9% in the 2009 period as compared to 28.6% in the 2008 period.
Corporate selling, general and administrative expenses decreased $2.2 million, or 18.8%, to
$9.5 million in the 2009 period from $11.7 million in the 2008 period, primarily due to lower
professional fees.
Restructuring Costs
During 2007 and 2008, as a result of acquisition activity, the Company adopted plans to
restructure its businesses. These plans focused on improving operating margins through
consolidating facilities and reducing duplicative expenses, such as selling, general and
administrative, executive and shared services expenses. As a result of the economic downturn and
the sales decline experienced in recent periods, the Company adopted further restructuring plans
during 2008 and 2009 to strengthen operating margins and leverage incremental synergies within the
printing plants, contact centers and selling, general and administrative areas by leveraging the
Companys shared services capabilities and reorganizing certain operations and sales and support
functions.
During the 2009 period, the Company recorded restructuring costs of $21.8 million for the
Harland Clarke segment, $4.1 million for the Harland Financial Solutions segment and $3.1 million
for the Scantron segment related to these plans. During the 2008 period, the Company recorded
restructuring costs of $1.4 million for the Harland Clarke segment, $3.0 million for the Harland
Financial Solutions segment and $2.3 million for the Scantron segment related to these plans.
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Interest Income
Interest income was $0.8 million in the 2009 period as compared to $1.9 million in the 2008
period. The decrease in interest income was primarily due to higher average cash
equivalents balances in the 2008 period as compared to the 2009 period and lower interest rates on
investments in cash equivalents in the 2009 period as compared to the 2008 period, partially offset
by higher interest income on notes receivable from a related party in the 2009 period.
Interest Expense
Interest expense was $106.3 million in the 2009 period as compared to $139.7 million in the
2008 period. The decrease in interest expense was due to lower effective interest rates and also a
decrease in total debt outstanding.
Gain on Early Extinguishment of Debt
During the 2009 period, the Company extinguished debt with a total principal amount of $116.2
million by purchasing 2015 Senior Notes in individually negotiated transactions for an aggregate
purchase price of $50.6 million, resulting in a gain of $62.0 million after the write-off of $3.6
million of unamortized deferred financing fees related to the extinguished debt.
Other Expense, Net
Other expense, net was $0.0 million in the 2009 period as compared to $0.2 million in the 2008
period. The expense in the 2008 period was attributable to a $0.3 million write-down of an equity
investment due to an other-than-temporary decline in its market value, partially offset by
non-recurring miscellaneous income.
Provision for Income Taxes
The Companys effective tax rate was 37.0% in the 2009 period and 41.4% in the 2008 period.
The change was primarily due to the effects of a net reduction in reserves for uncertain tax
positions in the 2009 period.
Liquidity and Capital Resources
Cash Flow Analysis
The Companys net cash provided by operating activities during the nine months ended September
30, 2009 was $171.0 million as compared to $156.0 million during the nine months ended September
30, 2008. The increase in net cash provided by operating activities of $15.0 million was due to an
increase in cash flow from operations partially offset by changes in working capital. Working
capital was negatively affected by lower incentive compensation and interest accruals in addition
to higher spare parts inventories.
The Companys net cash used in investing activities was $28.7 million during the nine months
ended September 30, 2009 as compared to $274.3 million during the nine months ended September 30,
2008. The decrease in cash used in investing activities was primarily due to the Data Management
Acquisition and an investment in related party notes receivable in the 2008 period, decreased
capital expenditures in the 2009 period and increased net repayments on related-party notes
receivable in the 2009 period.
The Companys net cash used in financing activities was $66.0 million during the nine months
ended September 30, 2009 as compared to $80.1 million during the nine months ended September 30,
2008. The decrease in net cash used in financing activities was primarily due to a $65.0 million
dividend paid to M & F Worldwide in the 2008 period. The 2009 period included cash used to
extinguish $116.2 million principal amount of 2015 Senior Notes for an aggregate purchase price of
$50.6 million.
The Companys Consolidated Contractual Obligations and Commitments
Estimated future cash payments for interest on the Companys outstanding long-term debt
decreased from $929.2 million as of December 31, 2008 to $493.3 million as of September 30, 2009,
primarily due to the impact of a decrease in interest rates on the Companys floating rate debt as
well as the extinguishment of $116.2 million principal amount of 2015 Senior Notes during the nine
months ended September 30, 2009. The estimate for future interest payments assumes
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Harland Clarke Holdings Corp. and Subsidiaries
that interest rates on the Companys floating rate debt remain constant with September 30,
2009 market rates. Other contractual obligations and commitments have not changed materially since
December 31, 2008. See the Companys Annual Report on Form 10-K for the year ended December 31,
2008 with respect to the Companys other contractual obligations and commitments.
Liquidity Assessment
The Company believes that its cash and cash equivalents, borrowings available under its credit
agreement (as further discussed in Note 11 to the Companys consolidated financial statements
included in this quarterly report on Form 10-Q) and anticipated cash flow from operating activities
will be sufficient to meet the Companys expected operating needs, investment and capital spending
requirements and debt service requirements for the foreseeable future.
In addition to normal operating cash, working capital requirements and service of
indebtedness, the Company also requires cash to fund capital expenditures, make contract
acquisition payments to financial institution clients and enable cost reductions through
restructuring projects as follows:
| Capital Expenditures. The Companys capital expenditures are primarily related to infrastructure investments, internally developed software, cost reduction programs, marketing initiatives and other projects that support future revenue growth. During the nine months ended September 30, 2009 and 2008, the Company incurred $31.0 million and $38.1 million of capital expenditures and $0.2 million and $0.5 million of capitalized interest, respectively. | ||
| Contract Acquisition Payments. During the nine months ended September 30, 2009 and 2008, the Company made $31.3 million and $30.7 million of contract acquisition payments to its clients, respectively. | ||
| Restructuring/Cost Reductions. Restructuring accruals and purchase accounting reserves have been established for anticipated severance payments, costs related to facilities closures and other expenses related to the planned restructuring or consolidation of some of the Companys historical operations, as well as related to the Data Management Acquisition and the Transaction Holdings Acquisition. During the nine months ended September 30, 2009 and 2008, the Company made $27.6 million and $15.5 million of payments for restructuring, respectively. |
The Company may also, from time to time, seek to use its cash to make acquisitions or
investments, and also to retire or purchase its outstanding debt in open market purchases, in
privately negotiated transactions, or otherwise. Such retirement or purchase of debt may be funded
from the operating cash flows of the business or other sources and will depend upon prevailing
market conditions, liquidity requirements, contractual restrictions and other factors, and the
amounts involved may be material. During the nine months ended September 30, 2009, the Company
extinguished debt with a total principal amount of $116.2 million by purchasing 2015 Senior Notes
in individually negotiated transactions for an aggregate purchase price of $50.6 million.
Cash Flow Risks
The Companys ability to meet its debt service obligations and reduce its total debt will
depend upon its ability to generate cash in the future which, in turn, will be subject to general
economic, financial, business, competitive, legislative, regulatory and other conditions, many of
which are beyond the Companys control. The Company may not be able to generate sufficient cash
flow from operations or borrow under its credit facility in an amount sufficient to repay debt or
fund other liquidity needs. As of September 30, 2009, the Company had $87.5 million of availability
under its revolving credit facility (after giving effect to the issuance of $12.5 million of
letters of credit). The Company may also use its revolving credit facility to fund potential future
acquisitions or investments. If future cash flow from operations and other capital resources is
insufficient to pay the Companys obligations as they mature or to fund its liquidity needs, the
Company may be forced to reduce or delay business activities and capital expenditures, sell assets,
obtain additional debt or equity capital, or restructure or refinance all or a portion of its debt
on or before maturity. The Company may not be able to accomplish any of these alternatives on a
timely basis or on satisfactory terms, if at all. In addition, the terms of the Companys existing
and future indebtedness may limit its ability to pursue any of these alternatives.
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Critical Accounting Policies and Estimates
There was no material change to the Companys Critical Accounting Policies and Estimates
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2008 as filed
on February 27, 2009 with the United States Securities and Exchange Commission (SEC), which is
available on the SECs website at www.sec.gov.
See Note 2 to the consolidated financial statements included elsewhere in this quarterly
report on Form 10-Q regarding the impact of recent accounting pronouncements adopted by the Company
on the Companys financial condition and results of operations.
Forward-Looking Statements
This quarterly report on Form 10-Q for the quarter ended September 30, 2009, as well as
certain of the Companys other public documents and statements and oral statements, contains
forward-looking statements that reflect managements current assumptions and estimates of future
performance and economic conditions. When used in this quarterly report on Form 10-Q, the words
believes, anticipates, plans, expects, intends, estimates or similar expressions are
intended to identify forward-looking statements, although not all forward-looking statements
contain such identifying words. All forward-looking statements speak only as of the date of this
quarterly report on Form 10-Q. Although the Company believes that its plans, intentions and
expectations reflected in or suggested by the forward-looking statements are reasonable, such
plans, intentions or expectations may not be achieved. Such forward-looking statements are made in
reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The Company cautions investors that any forward-looking statements are subject to risks and
uncertainties that may cause actual results and future trends to differ materially from those
projected, stated or implied by the forward-looking statements. In addition, the Company encourages
investors to read the summary of the Companys critical accounting policies and estimates included
in the Companys Annual Report on Form 10-K for the year ended December 31, 2008 under the heading
Managements Discussion and Analysis of Financial Condition and Results of Operations Critical
Accounting Policies and Estimates.
In addition to factors described in the Companys SEC filings and others, the following
factors could cause the Companys actual results to differ materially from those expressed in any
forward-looking statements made by the Company:
| our substantial indebtedness; | ||
| further adverse changes in or worsening of general economic and market conditions, including the depth and length of the economic recession and higher unemployment, which could result in more rapid declines in product sales of and/or pricing pressure on the Harland Clarke and Scantron segments, and reductions in information technology budgets, which could result in adverse impacts on the Harland Financial Solutions segment; | ||
| our ability to generate sufficient cash in the future that affects our ability to make payments on our indebtedness; | ||
| our ability to incur substantially more debt that could exacerbate the risks associated with our substantial leverage; | ||
| covenant restrictions under our indebtedness that may limit our ability to operate our businesses and react to market changes; | ||
| increases in interest rates; | ||
| the maturity of the paper check industry, including a faster than anticipated decline in check usage due to increasing use of alternative payment methods, decreased consumer spending and other factors, and our ability to grow non-check related product lines; | ||
| consolidation among financial institutions; | ||
| adverse changes, or failures or consolidation of the large financial institution clients on which we depend, resulting in decreased revenues and/or pricing pressure; |
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| intense competition in all areas of our businesses; | ||
| our ability to successfully manage future acquisitions; | ||
| our ability to implement any or all components of our business strategy; | ||
| interruptions or adverse changes in our vendor or supplier relationships; | ||
| increased production and delivery costs; | ||
| fluctuations in the costs of raw materials and other supplies; | ||
| our ability to attract, hire and retain qualified personnel; | ||
| technological improvements that may reduce our competitive advantage over some of our competitors; | ||
| our ability to protect customer data from account data security breaches; | ||
| changes in legislation relating to consumer privacy protection which could harm our business; | ||
| contracts with our clients relating to consumer privacy protection which could restrict our business; | ||
| our ability to protect our intellectual property rights; | ||
| our reliance on third-party providers for certain significant information technology needs; | ||
| software defects that could harm our businesses and reputation; | ||
| sales and other taxes which could have adverse effects on our businesses; | ||
| environmental risks; | ||
| the ability of our Harland Financial Solutions segment to achieve organic growth; | ||
| regulations governing the Harland Financial Solutions segment; | ||
| our ability to develop new products for our Scantron segment; | ||
| future warranty or product liability claims which could be costly to resolve and result in negative publicity; | ||
| government and school clients budget deficits, which could have an adverse impact on our Scantron segment; | ||
| softness in direct mail response rates; | ||
| lower than expected cash flow from operations; | ||
| unfavorable foreign currency fluctuations; | ||
| the loss of one of our significant customers; | ||
| work stoppages and other labor disturbances; | ||
| unanticipated internal control deficiencies or weaknesses; and | ||
| weak economic conditions and declines in the financial performance of our business that may result in material impairment charges. |
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The Company encourages investors to read carefully the risk factors described in the Companys
Annual Report on Form 10-K for the year ended December 31, 2008 and in this quarterly report on
Form 10-Q in the section entitled Risk Factors for a description of certain risks that could,
among other things, cause actual results to differ from these forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk |
The Company has exposure to market risk from changes in interest rates and foreign currency
exchange rates, which could affect its business, results of operations and financial condition. The
Company manages its exposure to these market risks through its regular operating and financing
activities.
At September 30, 2009, the Company had $1,759.5 million of term loans outstanding under its
credit agreement, $12.5 million of letters of credit outstanding under its revolving credit
facility, $227.4 million of floating rate senior notes and $271.3 million of 9.50% fixed rate
senior notes. All of these outstanding loans bear interest at variable rates, with the exception of
the $271.3 million of fixed rate senior notes. Accordingly, the Company is subject to risk due to
changes in interest rates. The Company believes that a hypothetical 10% increase or decrease in
interest rates applicable to its floating rate debt outstanding at September 30, 2009 would have
resulted in an increase or decrease in its interest expense for the nine months ended September 30,
2009 of approximately $1.4 million, excluding the impact of the interest rate derivative
transactions discussed below.
In order to manage its exposure to fluctuations in interest rates on a portion of the
outstanding variable rate debt, the Company entered into interest rate derivative transactions in
2007 and 2009 in the form of swaps for the Company with notional amounts totaling $855.0 million
currently outstanding, as further described in the notes to the consolidated financial statements
included elsewhere in this quarterly report. The Companys derivatives currently swap the
underlying variable rate for fixed rates ranging from 2.140% to 5.362%.
Item 7A of the Companys Annual Report on Form 10-K for the year ended December 31, 2008
presents additional quantitative and qualitative disclosures about exposure to risk in foreign
currency exchange rates. There have been no material changes to the disclosures regarding foreign
currency exchange rates as of September 30, 2009.
Item 4. Controls and Procedures |
(a) Disclosure Controls and Procedures. The Companys management, with the participation of
the Companys Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Companys disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end
of the period covered by this report. Based on such evaluation, the Companys Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of such period, the
Companys disclosure controls and procedures are effective.
(b) Internal Control Over Financial Reporting. There have not been any changes in the
Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the quarter ended September 30, 2009 that have materially
affected, or are reasonably likely to materially affect, the Companys internal control over
financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings |
In June 2008, Kenneth Kitson, purportedly on behalf of himself and a class of other alleged
similarly situated commercial borrowers from the Bank of Edwardsville, an Illinois-based community
bank (BOE), filed in a Madison County, Illinois state court an amended complaint that re-asserted
previously filed claims against BOE and added claims against Harland Financial Solutions, Inc.
(HFS). Mr. Kitsons complaint alleges, among other things, that HFSs Laser Pro software
permitted BOE to generate loan documents that were deceptive and usurious in that they failed to
disclose properly the effect of the 365/360 method of calculating interest. HFS removed the
action to the United States District Court for the Southern District of Illinois. In February 2009,
the District Court entered an order granting with prejudice
HFSs motion to dismiss the claims that Mr. Kitson brought against it. In August 2009, Mr.
Kitson, individually and as class representative, and BOE agreed to settle and dismiss with
prejudice all claims. Separately but concurrently, BOEs warranty claim against HFS was settled, in
exchange for, among other things, payment by HFS of $0.2 million. The class
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Harland Clarke Holdings Corp. and Subsidiaries
settlement agreement has been preliminarily approved by the District Court and the fairness
hearing is scheduled for January 25, 2010. HFSs settlement payment remains in escrow pending this
approval.
Various legal proceedings, claims and investigations are pending against the Company,
including those relating to commercial transactions, product liability, environmental, safety and
health matters, employment matters and other matters. Most of these matters are covered by
insurance, subject to deductibles and maximum limits, and by third-party indemnities. In the
opinion of management, based upon the information available at this time, the outcome of the
matters referred to above will not have a material adverse effect on the Companys financial
position or results of operations.
Item 1A. Risk Factors |
There was no material change to the Companys risk factors as disclosed in the Companys
Annual Report on Form 10-K for the year ended December 31, 2008 during the three months ended
September 30, 2009, other than the risk factor set forth below.
Weak economic conditions and further acceleration of
check unit declines may continue to have an adverse effect on the Companys revenues and profitability and could result in impairment charges.
The Company has substantial intangible assets, including substantial goodwill arising from
previous acquisitions. Goodwill and other intangible assets determined to have an indefinite life
are not amortized, but are tested for impairment annually in the fourth quarter, or when events or
changes in circumstances indicate that the assets might be impaired. No
event or change in circumstances has occurred to date in 2009 that required an interim impairment
test. The Company also has a
significant amount of property, plant and equipment and amortizable intangible assets, such as
customer relationships, which are tested for impairment whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. The impairment test processes are more
fully described in Critical Accounting Policies in the Companys Annual Report on Form 10-K.
The annual impairment evaluations for goodwill and indefinite-lived intangible assets involve
significant estimates and assumptions made by management regarding specific business and operating
factors as well as discount rates. Changes in estimates and assumptions, as well as the occurrence
of various events or changes in circumstances, could have a material impact on the fair value of
goodwill or indefinite-lived intangible assets in future periods, which in turn may result in
material asset impairments. Similar considerations apply to any impairment evaluation of our
property, plant and equipment and amortizable intangible assets as well as our determinations as to
whether interim impairment tests are necessary.
During the fourth quarter of 2009, the Company will be updating its long-range business plans
and forecasts, which will include financial projections that will be incorporated in the annual
impairment tests. Estimated revenue growth rates for all reporting units may be lower than past
projections due to the various factors discussed in this report, including, but not limited to, the
following:
| the continued adverse economic environment, which may negatively affect future revenue and margins as a result of lower demand and pricing pressure; and | ||
| check unit declines that have continued at a higher rate than in the past and are expected to continue to decline at higher rates than in recent years, which may negatively affect future revenue for our Harland Clarke segment. |
Depending on the nature of these factors and the expected relative magnitude and permanency of
their effects, the Companys businesses may not be able to achieve previous levels of performance
even when overall economic conditions improve. Although the Companys revenues have declined in
2009, the Company has experienced higher operating margins in 2009 as compared to 2008 due to
restructuring and cost-reduction activities. However, benefits from future cost-reduction and
containment activities may not be sufficient to fully offset possible future decreases in revenues
and margins. As a result, future impairment tests may result in a determination that there have
been material asset impairments. Any asset impairment would be reported as a non-cash operating
loss, would have a negative effect on the Companys earnings and could have a negative impact on
the market prices of the Companys outstanding securities.
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Harland Clarke Holdings Corp. and Subsidiaries
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
There was no event of default upon senior securities during the three months ended September
30, 2009.
Item 4. Submission of Matters to a Vote of Security Holders
There was no matter submitted to a vote of security holders during the three months ended
September 30, 2009.
Item 5. Other Information
No additional information need be presented.
Item 6. Exhibits
31.1 | Certification of Charles T. Dawson, Chief Executive Officer, dated November 6, 2009. |
|
31.2 | Certification of Peter A. Fera, Jr., Chief Financial Officer, dated November 6, 2009. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HARLAND CLARKE HOLDINGS CORP. |
|||||
Date: November 6, 2009 | By: | /s/ Peter A. Fera, Jr. | |||
Peter A. Fera, Jr. | |||||
Executive Vice President and Chief Financial Officer (Principal Financial Officer) |
|||||
Date: November 6, 2009 | By: | /s/ J. Michael Riley | |||
J. Michael Riley | |||||
Vice President and Controller
(Principal Accounting Officer) |
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EXHIBIT INDEX
31.1 | Certification of Charles T. Dawson, Chief Executive Officer, dated November 6, 2009. |
|
31.2 | Certification of Peter A. Fera, Jr., Chief Financial Officer, dated November 6, 2009. |