Business Context and Reporting Period
Company: Deluxe Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: Deluxe operates three segments: Small Business Services (57.7% of revenue), Financial Services (29.4%), and Direct Checks (12.9%). The company provides checks, printed forms, marketing materials, and web services to small businesses, financial institutions, and consumers.
Key Financial Metrics
| Metric (in thousands) | Q3 2008 | Q3 2007 | 9 Months 2008 | 9 Months 2007 |
|---|---|---|---|---|
| Revenue | $366,188 | $388,636 | $1,115,150 | $1,192,341 |
| Gross Profit | $213,601 | $245,138 | $676,869 | $756,731 |
| Gross Margin | 58.3% | 63.1% | 60.7% | 63.5% |
| Operating Income | $30,283 | $60,722 | $146,414 | $197,177 |
| Net Income | $13,760 | $32,160 | $73,694 | $103,363 |
| Diluted EPS | $0.27 | $0.62 | $1.43 | $1.99 |
| Cash from Operations (9mo) | $145,375 | $177,742 | ||
| Total Debt | $885,470 (Sep 30, 2008) | |||
| Cash & Equivalents | $18,013 (Sep 30, 2008) |
Material Changes vs. Prior Period
- Revenue Decline: Revenue decreased 5.8% in Q3 and 6.5% for the nine months ended September 30, 2008, compared to 2007. This was driven by unfavorable economic conditions affecting Small Business Services, declining check usage in Financial Services and Direct Checks, and lower revenue per order in Financial Services.
- Profitability Compression: Operating income dropped 50% in Q3 and 25.7% for the nine-month period. Gross margins contracted due to restructuring charges, higher supply costs, and pricing pressure.
- Restructuring Charges: The company recorded $21.6 million in restructuring charges for Q3 2008 (including $12.6M in COGS and $9.0M in SG&A) and $23.3 million for the nine-month period. These charges relate to facility closures (Greensboro, North Wales, Thorofare) and workforce reductions (1,220 employees) to reduce annual costs by $250 million by 2010.
- Asset Impairments: A non-cash asset impairment charge of $9.7 million was recorded in Q3 2008, primarily related to indefinite-lived trade names in the Small Business Services segment due to economic downturns.
- Acquisitions: Deluxe acquired Hostopia.com Inc. for $99.4 million (net of cash) in August 2008, along with three smaller acquisitions (PartnerUp, Logo Mojo, Yoffi) totaling $5.6 million.
Guidance, Outlook, and Risks
2008 Full-Year Outlook
- Revenue: Expected between $1.490 billion and $1.505 billion (down from $1.606 billion in 2007).
- Diluted EPS: Expected between $2.07 and $2.17 (down from $2.76 in 2007).
- Operating Cash Flow: Expected between $185 million and $200 million.
- Capital Spending: Estimated at approximately $30 million.
Management Commentary
Management anticipates continued economic softness in Small Business Services and a mid-single-digit revenue decline. In Financial Services, check usage is expected to decline 4-5% annually. In Direct Checks, revenue decline is expected in the high single digits. Cost reduction initiatives and price increases in Direct Checks are expected to partially offset these declines.
Risks and Contingencies
- Market Risks: Continued economic deterioration could trigger further goodwill or intangible asset impairments. The fair value of the Safeguard distributor reporting unit exceeded its carrying value by only $1.6 million.
- Financial Services Exposure: Bank failures or consolidations could lead to lost contracts or unrecoverable contract acquisition costs ($41.5 million outstanding).
- Pension Plan Assets: Significant declines in equity markets have reduced the fair value of postretirement benefit and pension plan assets, which may increase future benefit expenses upon year-end remeasurement.
- Debt Covenants: Share repurchases are limited by debt covenants related to 2015 notes; the company expects to pay down credit facility borrowings with excess cash.
Investor Verification Checklist
- Asset Impairment Sensitivity: Verify the assumptions used in the goodwill and trade name impairment tests, specifically the discount rates and royalty rates, given the narrow margin of safety for the Safeguard reporting unit.
- Contract Acquisition Costs: Assess the recoverability of the $41.5 million in contract acquisition costs given the instability in the financial services industry and potential client failures.
- Restructuring Execution: Monitor the timeline and cost savings realization of the announced facility closures and workforce reductions to ensure the projected $250 million in savings are achieved.
- Pension Funding Status: Review the year-end remeasurement of pension and postretirement plan assets to quantify the potential impact on future operating expenses.
- Check Usage Trends: Validate the long-term secular decline in check usage and its specific impact on the Financial Services and Direct Checks segments.