Business Context and Reporting Period
Company: Deluxe Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2002
Business Overview: Deluxe operates three segments: Financial Services (checks for financial institutions), Direct Checks (direct-to-consumer), and Business Services (small business checks and forms). The company is a leading check printer in the United States.
Key Financial Metrics
| Metric | Q2 2002 | Q2 2001 | 6 Months 2002 | 6 Months 2001 |
|---|---|---|---|---|
| Revenue | $328.5 million | $318.6 million | $657.4 million | $635.3 million |
| Gross Profit | $217.9 million | $205.6 million | $433.7 million | $405.1 million |
| Gross Margin | 66.3% | 64.5% | 66.0% | 63.8% |
| Operating Income | $88.3 million | $71.9 million | $177.4 million | $140.1 million |
| Net Income | $54.7 million | $44.3 million | $109.3 million | $86.8 million |
| Diluted EPS | $0.85 | $0.63 | $1.69 | $1.22 |
| Cash & Equivalents | $5.2 million | $6.1 million (Q2 2001) | Balance Sheet: $5.2 million (June 30, 2002) | |
| Short-term Debt | $191.6 million | $150.0 million (Dec 31, 2001) | Balance Sheet: $191.6 million (June 30, 2002) | |
| Operating Cash Flow | N/A (Quarterly) | $121.4 million | $91.3 million |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 3.1% in Q2 and 3.5% for the six months ended June 30, 2002, compared to 2001. Growth was driven by a 4.5% increase in revenue per unit (due to price increases and a $5.0 million contract buyout in Financial Services) which offset a 1.4% decline in unit volume.
- Profitability: Net income rose 23.5% in Q2 and 25.9% for the six-month period. Gross margins improved due to higher revenue per unit and cost reduction initiatives (lean manufacturing).
- Accounting Change: Adoption of SFAS No. 142 eliminated goodwill amortization, contributing approximately $1.0 million to Q2 net income and $2.0 million to the six-month net income compared to the prior year.
- Share Repurchases: The company completed a 14 million share repurchase program (costing $463.8 million) by June 30, 2002. This reduced the share count, significantly boosting EPS, but resulted in a retained earnings deficit of $7.7 million.
- Debt Levels: Short-term debt (commercial paper) increased from $150.0 million at year-end 2001 to $191.6 million at June 30, 2002, to fund share repurchases and operations.
Guidance, Outlook, and Risks
- 2002 Outlook: Management expects full-year 2002 diluted EPS to be at least $3.15. Q3 2002 diluted EPS is projected in the range of $0.76 to $0.79. Revenue is expected to be up modestly from 2001.
- Capital Strategy: In August 2002, the board approved a new plan to repurchase up to 12 million shares and a strategy to increase leverage, raising debt levels up to a maximum of $700 million. This led to a credit rating downgrade from A+ to A by one agency.
- Capital Expenditures: Expected to spend less than $40.0 million on capital assets in 2002.
- Risks:
- Industry Decline: The check printing industry is mature and declining due to alternative payment methods (credit/debit cards, electronic payments).
- Competition: Intense pricing pressure from competitors and alternative payment systems.
- Marketing Costs: Softening direct mail response rates and increased advertising costs in the Direct Checks segment.
- Regulatory: Potential impact of consumer privacy laws (Gramm-Leach-Bliley Act) and sales tax collection obligations in new jurisdictions.
Investor Verification Checklist
- Debt Capacity: Verify the company's ability to service increased debt levels (targeting $700 million) given the current interest rate environment and cash flow generation.
- Share Count Impact: Confirm the dilutive impact of employee stock plans versus the accretive impact of the new 12 million share repurchase authorization.
- Direct Mail Trends: Monitor the effectiveness of new advertising channels (Internet) to replace declining direct mail response rates in the Direct Checks segment.
- Contract Renewals: Assess the risk of losing major financial institution clients due to consolidation and pricing pressure in the Financial Services segment.
- Retained Deficit: Review the implications of the retained earnings deficit position on future dividend sustainability and financial covenants.