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Rating Action:

MOODY'S ASSIGNS RATINGS TO CLARKE AMERICAN (B1 SR. SECURED CREDIT FACILITY; B2 SR NOTES); OUTLOOK IS STABLE

15 Nov 2005
MOODY'S ASSIGNS RATINGS TO CLARKE AMERICAN (B1 SR. SECURED CREDIT FACILITY; B2 SR NOTES); OUTLOOK IS STABLE

Approximately $655 Million of Debt Securities Affected

New York, November 15, 2005 -- Moody's Investors Service assigned ratings to Clarke American Corp.'s ("Clarke") debt to be issued in connection with M&F Worldwide Corp.'s ("M&F") $800 million acquisition of the company from a subsidiary of Honeywell International Inc. ("Honeywell"; A2/Prime-1). This is the first time Moody's has rated debt issued by Clarke. The ratings reflect the company's high leverage and significant business risk associated with the company's core check printing operations due to the ongoing erosion in demand for checks as consumers and businesses shift to electronic payment formats. The ratings outlook is stable.

Moody's assigned the following ratings:

-B1 rating to the $480 million guaranteed senior secured credit facility consisting of:

$40 million revolver maturing five years from closing

$440 million term loan B maturing six years from closing

- B2 rating to the $175 million guaranteed senior unsecured notes maturing eight years from closing

- B1 Corporate Family Rating

- SGL-2 Speculative-Grade Liquidity Rating

The ratings reflect Clarke's high leverage, significant level of business risk, limited product diversity and a concentrated customer base. Debt at closing of the acquisition will represent a high 4.8x EBITDA (calculated including operating leases and Moody's other standard adjustments). Moody's is concerned that the decline in physical check demand (averaging approximately 4% per year) as consumers adopt less costly and more convenient alternative payment forms such as electronic transfers and debit and credit cards will continue and ultimately accelerate, thereby raising the risk of erosion in Clarke's revenue base. This can prompt investments outside traditional areas of expertise in an effort to find alternative revenue sources. Declining check demand also sustains excess industry capacity and downward pressure on check product prices. Clarke's significantly higher leverage than its two primary and financially stronger competitors provides less flexibility to manage these business risks.

Revenue concentration in printed checks and related services is high while the financial institution division constitutes a greater share of revenues (84%) than competitors. Clarke is more exposed to the price and volume pressures arising from the increase in customer bargaining power accompanying financial industry consolidation. Customer concentration is high with 43% of revenues derived from the 10 largest financial institution clients and Bank of America ("BofA"; senior unsecured Aa2/stable) accounting for a significant portion of sales. As evidence, one client has chosen not to renew its contract with Clarke expiring at the end of 2005. Moody's believes BofA's effective preclusion from any additional large bank acquisitions due to the national 10% deposit ceiling could affect a traditional contributor to Clarke's revenue growth.

In addition to interest from the proposed debt offerings, several factors will potentially influence Clarke's cash flow in the near term. Clarke will have a significant cash tax burden (subject to generating taxable income) that will limit the EBITDA to cash flow conversion. Management expects to increase growth-related capital expenditures in the next few years to enhance customer relationship tools, call routing capabilities and client web site interconnectivity. While a near term drag on cash flow, these investments should enhance longer-term revenue potential. Term loan amortization ($15 million in 2006) will step up by $5 million per year through maturity, increasing the company's vulnerability to operating shortfalls and diminishing flexibility to meet customer requests for up-front contract acquisition or renewal payments should cash flow fall short of management's projections.

The ratings more favorably reflect the company's strong market position in the check printing business and management's historical capability to grow revenues notwithstanding the pressure from declining check volumes and prices. While the check printing industry is mature and has undergone considerable consolidation, the remaining participants have demonstrated an ability to reduce costs. This has translated into sizable market positions and a good track record of cash flow generation. Clarke believes its focus on helping financial institution clients grow deposit accounts creates a more value added relationship that improves customer retention. Integration into financial institutions' Internet and phone check ordering systems creates frequent contact with the end users of checks. Clarke expects to continue to opportunistically leverage this interaction to offer enhanced delivery and service options (which account for a significant source of earnings) that increase average order size and to provide direct marketing services on behalf of financial institutions.

Clarke also benefits from its long-standing relationship with BofA whose traditional focus on retail client base expansion supplemented by acquisitions has contributed significantly to Clarke's revenue growth. Clarke became BofA's sole source check supplier in 2003.

The SGL-2 rating reflects the company's "good" liquidity position. Clarke will have a minimal cash balance at closing with internal liquidity provided by free cash flow after interest, taxes, and capital expenditures of $25-30 million in 2006. None of the company's top 10 clients have a contract expiring within the next 12 months (except, as previously mentioned, the client that is not renewing its' contract at the end of 2005), which diminishes the likelihood of a spike in contract renewal payments. Revenues are slightly lower than average in the calendar fourth quarter but otherwise exhibit little seasonal fluctuation. Working capital swings traditionally fall within a $10-12 million range. Moody's expects free cash flow to satisfy the scheduled $15 million term loan amortization in 2006.

The company is expected to have a $2 million draw on the $40 million revolver at closing but otherwise minimal usage to smooth working capital flows. Moody's anticipates the company will maintain compliance with bank covenants, which are expected to be based on a cushion to the projections provided to the bank group. Because substantially all assets are pledged to the bank facility, Moody's believes the potential for asset sales to provide incremental liquidity is low.

Honeywell acquired Clarke through its purchase of Novar plc ("Novar") in March 2005, at which time Honeywell identified Clarke as a non-core asset to be sold. M&F's acquisition of Clarke will include the assumption of guarantees of certain derivative contracts relating to Novar's Indalex aluminum business, which Honeywell is also in the process of disposing. As part of the merger agreement, Honeywell will indemnify Clarke, M&F and other related parties for any potential liability arising from the guarantees. The merger agreement provides that such guarantees will be either supported by a letter of credit and/or transferred to a non-acquired entity. If the guarantees are not transferred to a non-acquired entity, the indemnification will be supported by a letter of credit for up to $60 million, which M&F believes should cover any potential liability on the guarantees. Payment on the guarantee, if requested by the counterparty, will be made directly by Honeywell or by drawing on the letter of credit. Moody's believes the indemnity and letter of credit reduce the likelihood that Clarke will be responsible for performance of the guarantees. M&F will complete the transaction by acquiring Novar USA, Inc., which is Honeywell's subsidiary containing the operations of what will be Clarke (currently housed in Novar USA, Inc.'s subsidiary Security Printing, Inc.) and the guarantees discussed above. Moody's ratings considered the audit for Security Printing, Inc. and are subject to a review of the audit for Novar USA, Inc.

Ronald Perelman controls an investment company that holds 38% of the common stock of publicly-traded M&F. M&F will fund the $203 million equity portion of the $800 million purchase price for Clarke from cash on hand ($94 million at September 30, 2005) and through a dividend from its indirect wholly-owned subsidiary Mafco Worldwide Corporation ("Mafco"). Moody's ratings assume that this contribution to Clarke will be made in non-redeemable common stock as currently envisioned. Mafco will finance the dividend with borrowings under a new credit facility. Clarke is significantly larger than Mafco and will be M&F's largest operating subsidiary. Because the debt of Clarke and Mafco will not contain cross guarantee, cross collateralization or cross default provision, Moody's ratings for Clarke do not incorporate Mafco's operations or debt. The credit agreement and indenture will include restrictions on Clarke's ability to pay dividends, repurchase shares, issue additional debt and transact with affiliates. Moody's ratings are subject to review of final terms and conditions of the credit agreement and indenture.

The stable ratings outlook anticipates that Clarke will continue to develop products and services that moderate its vulnerability to declines in printed check volumes and prices. Moody's also expects that Clarke will utilize cash flow to pay down debt and will not engage in transactions that increase leverage at Clarke or its immediate parent holding company.

The ratings or outlook could be lowered if deterioration in check industry price or volume conditions, loss of market share or debt-financed transaction raises Clarke's debt-to-EBITDA sustainably above 5.0x.

Debt reduction through free cash flow or an equity offering that lowers debt-to-EBITDA to 4.0x along with stable revenue and operating margin trends could result in a favorable change in Clarke's rating or outlook.

The senior secured credit facilities are guaranteed on a senior secured basis by all of the borrower's domestic subsidiaries and Clarke's direct parent, CA Acquisition Holdings, Inc. ("CAH"), which is a wholly-owned subsidiary of M&F. The facilities are not guaranteed by M&F. Collateral consists of a first priority lien on substantially all tangible and intangible assets of the borrowers and guarantors. The capital stock of the borrower and domestic subsidiaries as well as 66% of the stock of any future first tier foreign subsidiaries is also included in the security package. The blanket guarantee and collateral structure provides senior secured creditors with the first claim on the cash flow and assets in a distress scenario. The senior secured facilities constitute over 70% of outstanding debt and, accordingly, are rated at the B1 corporate family rating. Term loan amortization and the 75% excess cash flow sweep provide greater assurance that the bulk of the company's cash flow will be used to reduce debt. Financial covenants will include maximum senior consolidated leverage, maximum total consolidated leverage and minimum consolidated interest coverage ratios that provide senior creditors negotiating leverage should the company's credit metrics fall short of expectations.

The notes are Clarke's senior unsecured obligations and are supported by senior unsecured guarantees from all direct and indirect operating subsidiaries. The notes will not be guaranteed by CAH or M&F. Only the bank credit facility will restrict CAH's business activities including the ability to issue debt. The company has indicated no current plans to issue debt at CAH and an offering at that level could adversely affect ratings. The B2 rating on the notes are one notch below the corporate family rating reflecting the effective subordination to a material amount of secured debt.

Clarke, headquartered in San Antonio, TX, is a provider of check and check-related products and services and of direct marketing services to financial institutions, businesses and consumers in the United States. Annual revenues approximate $610 million.

New York
John E. Puchalla
Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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