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| MFW > SEC Filings for MFW > Form 10-K on 27-Feb-2009 | All Recent SEC Filings |
27-Feb-2009
Annual Report
The following discussion should be read in conjunction with Item 6. "Selected Financial Data" and the M & F Worldwide consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
Overview of Business
M & F Worldwide Corp. ("M & F Worldwide" and, together with its subsidiaries, the "Company") is a holding company that conducts its operations through its indirect, wholly owned subsidiaries, Harland Clarke Holdings, formerly known as Clarke American, and Mafco Worldwide. As a result of the acquisition of Harland, which was completed on May 1, 2007, the Company's business and corporate structure was reorganized along the following four business segments: Harland Clarke (which consists of the combined check business and related products and services of Clarke American and Harland), Harland Financial Solutions, Scantron and Licorice Products.
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 Clarke's 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 and banking support, and marketing services.
The Harland Financial Solutions segment, which is composed of operations acquired from Harland, provides products and services including lending and mortgage origination and servicing applications, business intelligence solutions, customer relationship management software, branch automation solutions and core processing systems and services, principally targeted to community banks and credit unions.
The Scantron segment, which is composed of operations acquired from Harland and the Data Management Acquisition (as defined below), provides testing and assessment solutions to schools in North America, offers specialized data collection solutions to educational, commercial and governmental entities worldwide and collects and manages survey information for a wide variety of Fortune 1000 and other organizations. Scantron's products and services include scannable forms, scanning equipment, survey services, testing software and related services, and field maintenance services.
The Licorice Products segment, which is operated by Mafco Worldwide, produces a variety of licorice products from licorice root, intermediary licorice extracts produced by others and certain other ingredients. Approximately 66% of Mafco Worldwide's licorice product sales are to the worldwide tobacco industry for use as tobacco flavor enhancing and moistening agents in the manufacture of American blend cigarettes, moist snuff, chewing tobacco and pipe tobacco. In addition, Mafco Worldwide manufactures and sells natural products for use in the tobacco industry. Mafco Worldwide also sells licorice to confectioners, food processors, cosmetic companies and pharmaceutical manufacturers for use as flavoring or masking agents, including its Magnasweet brand flavor enhancer, which is used in various brands of chewing gum, energy bars, non-carbonated beverages, lip balm, chewable vitamins, aspirin and other products. Mafco Worldwide sells licorice root residue as garden mulch under the name Right Dress.
The Transaction Holdings Acquisition
On December 31, 2008, Harland Clarke Corp. acquired Transaction Holdings for total cash consideration of $8.2 million, subject to post-closing working capital adjustments. 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 Company's 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 at Harland Clarke Holdings.
The Harland Acquisition
On May 1, 2007, the Company consummated an agreement and plan of merger with Harland, pursuant to which a wholly owned subsidiary of the Company merged with and into Harland, with Harland continuing after the merger as the surviving corporation and as a wholly owned subsidiary of Clarke American (the "Harland Acquisition"). The cash consideration paid was $52.75 per share, or a total of approximately $1,423.0 million, for the outstanding equity of Harland. Subsequent to the completion of the Harland Acquisition, Clarke American was renamed Harland Clarke Holdings on May 2, 2007.
To fund the purchase price in the Harland Acquisition, to refinance Harland Clarke Holdings' and Harland's prior existing indebtedness, and to pay the fees and expenses for the Harland Acquisition and the related financings:
• Harland Clarke Holdings entered into a $1,800.0 million senior secured term loan facility and a $100.0 million revolving credit facility; and
• Harland Clarke Holdings issued $305.0 million aggregate principal amount of senior floating rate notes due 2015 and $310.0 million aggregate principal amount of 9.50% senior fixed rate notes due 2015.
The Harland Acquisition and related financing transactions have greatly increased the Company's revenues, cost of revenues, selling, general and administrative expenses and interest expense. As a result of the application of purchase accounting under Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," the Company's depreciation and amortization expense has also increased significantly.
Having completed the Harland Acquisition, the Company is focused on improving operating margins by reducing selling general and administrative expenses, shared services costs and cost of sales.
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 written has declined and is expected to continue 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. Checks written remain one of the largest forms of non-cash payment in the United States. A 2007 study by the Federal Reserve analyzing check writing patterns determined that the number of checks written declined 4.1% over the period from 2003 to 2006. Whereas in the past, Harland Clarke had experienced declines in check volumes generally consistent with the Federal Reserve study, in recent periods Harland Clarke is experiencing check unit declines slightly higher than those reflected in the Federal Reserve study. Harland Clarke is unable to determine at this time whether such slight declines above Federal Reserve estimates are attributable to timing issues, decreased openings of checking accounts, underlying differences in measurement methodologies, recent economic and financial market difficulties, and/or a further acceleration in check unit declines. Harland Clarke is focused on growing its business through the addition of a variety of
non-check-related products and services and optimizing its existing catalog of offerings to better serve its customers.
The financial institution outsourcing services industry is highly competitive and fragmented with quality and breadth of service offerings and strength of customer relationships among the key competitive factors. Within this category, Harland Clarke competes with large outsourcing service providers that offer a wide variety of services including those that compete with Harland Clarke's primary offerings - specifically payment services, marketing services, and teleservices. There are also other competitors that specialize in providing one or more of these services.
The Harland Clarke segment's 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 segment's operating results may be negatively affected by slow or negative growth of, or downturns in, the United States economy. Business confidence affects a portion of the Harland Clarke segment. In addition, if Harland Clarke's financial institution customers fail or merge with other financial institutions, Harland Clarke may lose any or all revenue from such financial institutions and/or experience further pricing pressure, which would negatively affect Harland Clarke's 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 technology budgets of our clients and prospects. Economic downturns in one or more of the countries in which we do business could result in reductions in the information technology, or IT, budgets for some portion of our clients and potentially longer lead-times for acquiring Harland Financial Solutions products and services. In addition, if Harland Financial Solutions' financial institution customers fail or merge with other financial institutions, Harland Financial Solutions may lose any or all revenue 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 characterized 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 requires that we continually improve our existing products and create new products while at the same time controlling our 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. There are also other competitors that offer one or more specialized products or services that compete with Harland Financial Solutions. Some of our competitors have advantages over Harland Financial Solutions due to their significant worldwide presence, longer operating and product development 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 Scantron's on-line testing products. Educational funding changes may also reduce the rate of consumption of Scantron's forms and purchase of additional hardware to process these forms. Economic slowdown in the United States may negatively affect education budgets and spending, which would have an adverse impact on Scantron's operating results.
Data collection for non-testing applications such as surveys 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. Changes in the overall economy can impact the demand for surveys as companies look for ways to adjust their expenditures.
Mafco Worldwide
Developments and trends within the tobacco industry may have a material effect on the operations of Mafco Worldwide. Worldwide consumption of American blend cigarettes has declined approximately 2% to 3% per year for the past five years; however, this decline has accelerated recently to approximately 5%. Changing public attitudes toward tobacco products, an increase in excise and other taxes on cigarettes and a constant expansion of tobacco regulations in a number of countries have contributed significantly to this worldwide decline in consumption. Consumption of chewing tobacco and moist snuff is concentrated primarily in the United States. Domestic consumption of chewing tobacco products has declined by approximately 5% per year over the past five years. Moist snuff consumption has increased approximately 6% per year over the past five years due at least in part to the shift away from cigarettes and other types of smoking and smokeless tobacco.
Producers of tobacco products are subject to regulation in the United States at the federal, state and local levels, as well as in foreign countries. The United States Senate and House of Representatives each have pending legislation that would provide greater regulatory oversight for the manufacture of tobacco products including proposals that could grant government agencies the ability to regulate tobacco product additives. Such legislation, if enacted, could potentially limit the type or quantity of additives that may be used in the manufacture of tobacco products in the United States Together with changing public attitudes toward tobacco products, a constant expansion of tobacco regulations worldwide has been a major cause for the decline in consumption. Moreover, the trend is toward increasing regulation of the tobacco industry. Restrictive foreign tobacco legislation has been on the rise in recent years as well, including restrictions on where tobacco may be sold and used, warning labels and other graphic packaging images, product constituent limitations and a general increase in taxes.
Over the years, there has been substantial litigation between tobacco product manufacturers and individuals, various governmental units and private health care providers regarding increased medical expenditures and losses allegedly caused by use of tobacco products. In part, as a result of settlements in certain of this litigation, the cigarette companies have significantly increased the wholesale price of cigarettes in order to recoup the cost of the settlements. Since 1999, cigarette consumption in the United States has decreased due to the higher prices of cigarettes, the increased emphasis on the health effects of cigarettes and the continuing restrictions on smoking areas.
The tobacco industry, including cigarettes and smokeless tobacco, has been subject to federal, state, local and foreign excise taxes for many years. In recent years, federal, state, local and foreign governments have increased or proposed increases to such taxes as a means of both raising revenue and discouraging the consumption of tobacco products. In February 2009, the Federal State Children's Health Insurance Program (SCHIP) was enacted. The additional taxes imposed by SCHIP may lead to an accelerated decline in tobacco products sold in the United States. This bill is being funded by raising the federal tax on cigarettes to $1.00 per pack from the current $0.39 per pack tax and by significantly increasing federal taxes on cigars and other tobacco products. Other proposals to increase taxes on tobacco products are also pending in both the United States and in foreign countries. A significant reduction in consumption of cigarettes and other tobacco products could have a material adverse effect on Mafco Worldwide.
Critical Accounting Policies and Estimates
The Company reviews its accounting policies on a regular basis. The Company makes estimates and judgments as part of its financial reporting that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to accounts receivable, investments, intangible assets, pensions
and other postretirement benefits, income taxes, contingencies and litigation, as well as other assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that it believes reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Results may differ from these estimates due to actual outcomes being different from the assumed outcomes. The Company believes the following critical accounting policies affect its more significant judgments and estimates.
Revenue Recognition - The Company considers its revenue recognition policy as critical to its reported results of operations primarily in its Harland Financial Solutions and Scantron segments. Revenue is recognized in accordance with the provisions of Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-9, "Software Revenue Recognition, with Respect to Certain Transactions," and clarified by Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements," SAB 104, "Revenue Recognition," and Emerging Issues Task Force ("EITF") Issue 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables." The application of these pronouncements requires judgment, including, amongst other things, whether a software arrangement includes multiple elements, whether any elements are essential to the functionality of any other elements, and whether vendor-specific objective evidence ("VSOE") of fair value exists for those elements. Customers receive certain elements of the Company's products and services over time.
Changes to the elements in a software arrangement or in the Company's ability to identify VSOE for those elements could materially impact the amount of earned and unearned revenue reflected in the financial statements.
For software license agreements that do not require significant modification or customization of the software, the Company recognizes software license revenue when persuasive evidence of an arrangement exists, delivery of the product has occurred, the license fee is fixed and determinable and collection is probable. The Company's software license agreements include multiple products and services or "elements." None of these elements are deemed to be essential to the functionality of the other elements. SOP 97-2, as amended by SOP 98-9, generally requires revenue earned on software arrangements involving multiple elements to be allocated proportionally to each element based on VSOE of fair value. Fair value is determined for license fees based upon the price charged when sold separately. In the event that the Company determines that VSOE does not exist for one or more of the delivered elements of a software arrangement, but does exist for all of the undelivered elements, revenue is recognized using the residual method allowed by SOP 98-9. Under the residual method, a residual amount of the total arrangement fee is recognized as revenue for the delivered elements after the established fair value of all undelivered elements has been deducted.
Implementation services are generally for installation, training, implementation and configuration. These services are not considered essential to the functionality of the related software. VSOE of fair value is established by pricing used when these services are sold separately. Generally revenue is recognized when services are completed. On implementations for outsourced data processing services, revenue is deferred and recognized over the life of the outsourcing arrangement. On certain larger implementations, revenue is recognized based on milestones during the implementation. Milestones are triggered by tasks completed or based on labor hours. Estimates of efforts to complete a project are used in the percentage-of-completion calculation. Due to uncertainties inherent in these estimates, actual results could differ from these estimates.
Maintenance fees are deferred and recognized ratably over the maintenance period, which is usually twelve months. VSOE of fair value is determined based on contract renewal rates.
Outsourced data processing services and other transaction processing services are recognized in the month the transactions are processed or the services are rendered.
The Company recognizes product and service revenue when persuasive evidence of a non-cancelable arrangement exists, products have been shipped and/or services have been rendered, the price is fixed or determinable, collectibility is reasonably assured, legal title and economic risk is transferred to the customer and an economic exchange has taken place. Revenues are recorded net of any applicable discounts, contract
acquisition payments amortization, accrued incentives and allowances for sales returns. Deferred revenues represent amounts billed to the customer in excess of amounts earned.
Title for product sales may pass to customers upon leaving the Company's facilities, upon receipt at a specific destination (such as a shipping port) or upon arrival at the customer's facilities, depending on the terms of the contractual agreements for each customer. Title for product sales to domestic customers typically passes when the product leaves the Company's facilities. Title for product sales to international customers typically passes either when the product is delivered to a shipping port or when the product is delivered to the customer's facilities.
Revenues for direct response marketing services are recognized from the Company's fixed price direct mail and marketing contracts based on the proportional performance method for specific projects.
Inventories - The majority of the Company's inventories consists of licorice raw materials. Licorice raw materials have an indefinite life as long as they are kept dry; therefore the Company has not been required to establish an obsolescence reserve for licorice. A reserve for the value of the products has not been necessary based on the Company's lower of cost or market analysis. The Company determines cost by average costing or the first-in, first-out method. The Company also ensures that storage facilities where the raw materials are inventoried are properly safeguarded and maintained to preserve its characteristics.
Income Taxes - The Company estimates its actual current tax liability together with temporary differences resulting from differing treatment of items, such as net operating losses and depreciation, for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities. The Company must assess the likelihood that it will recover deferred tax assets from future taxable income and, to the extent it believes that recovery is not likely, establish a valuation allowance. To the extent the Company establishes a valuation allowance or increases this allowance in a period, it must include and expense the allowance within the tax provision in the consolidated statement of operations. Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets.
As part of the process of preparing its consolidated financial statements, the Company is required to calculate the amount of income tax in each of the jurisdictions in which it operates. On a regular basis, the amount of taxable income is reviewed by various federal, state and foreign taxing authorities. As such, the Company routinely provides reserves for items that it believes could be challenged by these taxing authorities. On January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48 ("FIN 48"), which prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.
Long-Lived Assets - The Company assesses the impairment of property, plant and equipment and amortizable intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors the Company considers important that could trigger an impairment review include the following:
• Significant underperformance relative to expected historical or projected future operating results;
• Significant changes in the manner of use of these assets or the strategy for the Company's overall business; and
• Significant negative industry or economic trends.
When the Company determines that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more indicators of impairment, it measures the impairment based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in the Company's current business model. Significant assumptions requiring judgment are required to determine future cash flows, including but not limited to the estimated remaining useful life of the asset, future revenue streams and future expenditures to maintain the existing service potential of the asset. The Company re-evaluates the useful life of these assets at least annually to determine if events and
circumstances continue to support their recorded useful lives. Assets held for sale are carried at the lower of carrying amount or fair value, less estimated costs to sell such assets.
Goodwill and Acquired Intangible Assets - Goodwill represents the excess of cost (purchase price) over the fair value of net assets acquired. Acquired intangibles are recorded at fair value as of the date acquired. Goodwill and other intangibles 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, such as a significant adverse change in the business climate.
The goodwill impairment test is a two-step process, which requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of the Company's . . .
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