DLX

Business Context and Reporting Period

Company: Deluxe Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: Deluxe Corporation provides personalized printed items, promotional products, and financial services to small businesses and financial institutions. The company operates through three segments: Small Business Services (SBS), Financial Services, and Direct Checks. SBS is the largest segment by revenue and operating income. The company serves over six million small business customers and approximately 7,000 financial institutions.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenue decreased 2.0% primarily due to the sale of the industrial packaging product line in January 2007 ($48 million impact), lower order volume in Direct Checks, and lower revenue per order in Financial Services due to pricing pressure.
• Profitability Improvement: Operating income increased significantly (34.9%) driven by cost reduction initiatives, lower amortization of acquisition-related intangibles, and the absence of the $44.7 million non-cash asset impairment loss recorded in 2006 related to a software project abandonment.
• Segment Performance:
  • Small Business Services: Revenue declined 3.2% (excluding packaging sale), but operating income surged 50.4% due to cost savings and the absence of 2006 impairment charges.
  • Financial Services: Revenue was flat (-0.2%), but operating income increased 59.4% due to volume gains and cost efficiencies.
  • Direct Checks: Revenue declined 0.8% and operating income fell 3.3% due to declining check usage and lower direct mail response rates.
• Debt Reduction: Total debt decreased by $171.7 million. The company issued $200 million in 7.375% senior notes in May 2007 and used proceeds to repay $325 million of maturing 3.5% notes in October 2007.

Guidance, Outlook, and Risks

2008 Outlook:

• Revenue: Expected to be between $1.56 billion and $1.61 billion (near flat vs. 2007). Growth in SBS is expected in very low single digits, while Financial Services and Direct Checks are expected to decline.
• Earnings Per Share: Diluted EPS expected between $3.00 and $3.20.
• Operating Cash Flow: Expected between $230 million and $250 million.
• Capital Spending: Estimated at approximately $30 million.

Management Commentary: Management is executing aggressive cost reduction initiatives targeting $225 million in annual savings by 2009. Approximately $105 million has been realized through 2007. The company is investing in e-commerce and new product lines to offset declining check usage.

Key Risks:

• Declining Check Usage: The check printing industry is mature; check volume is declining 4-5% annually for individuals and 2-4% for small businesses due to electronic payment alternatives.
• Pricing Pressure: Consolidation among financial institutions has increased negotiating leverage, leading to lower prices and demands for up-front contract acquisition payments.
• Direct Mail Response: Declining consumer response rates to direct mail advertising impact the Direct Checks and SBS segments.
• Economic Conditions: Softness in the small business sector and general economic conditions may negatively impact revenue, particularly in the first half of 2008.

Investor Verification Checklist

• Check Usage Trends: Verify the rate of decline in check volume and the effectiveness of new non-check products in offsetting this trend.
• Cost Reduction Realization: Monitor progress toward the $225 million annual cost savings target and the impact on operating margins.
• Financial Institution Contracts: Assess the impact of financial institution consolidation on pricing power and the frequency of up-front contract acquisition payments.
• Direct Mail Efficiency: Review customer acquisition costs and response rates for the Direct Checks segment.
• Debt Covenants: Confirm continued compliance with debt covenants, specifically the EBITDA to interest expense ratio, given the high debt load relative to equity.