Business Context and Reporting Period
Company: Deluxe Corporation
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and six months ended June 30, 1999
Business Overview: Deluxe operates seven segments including Paper Payment Systems, Payment Protection Systems, Electronic Payment Systems, Government Services, and iDLX Technology Partners. The company is undergoing significant restructuring, including the sale of its collections business (National Revenue Corporation) and the discontinuation of direct mail product production.
Key Financial Metrics
| Metric (Dollars in Thousands) | Q2 1999 | Q2 1998 | 6 Months 1999 | 6 Months 1998 |
|---|---|---|---|---|
| Net Sales | $407,841 | $474,791 | $821,918 | $963,761 |
| Income from Operations | $76,176 | $68,026 | $153,823 | $139,543 |
| Net Income | $47,386 | $42,255 | $94,999 | $85,826 |
| Diluted EPS | $0.61 | $0.52 | $1.20 | $1.06 |
| Cash from Operations (6 Mo) | N/A | $108,577 | $100,075 | |
| Cash & Equivalents (End Period) | $87,355 | $126,607 | $87,355 | $126,607 |
| Short-Term Debt | $26,448 | $0 | $26,448 | $0 |
| Long-Term Debt | $105,163 | $106,321 | $105,163 | $106,321 |
Margins (6 Months 1999 vs 1998):
- Gross Margin: 56.1% (vs 54.0%)
- Operating Margin: 18.7% (vs 14.5%)
- Effective Tax Rate: 38.5% (vs 40.2%)
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 14.1% in Q2 and 14.7% for the six months ended June 30, 1999. This is primarily attributed to the 1998 sale of the Deluxe Direct Response and Deluxe Direct segments and the discontinuation of direct mail production.
- Profitability Increase: Despite lower sales, Net Income increased 12.1% in Q2 and 10.7% for the six-month period. This was driven by improved operating margins (18.7% vs 14.5%) due to cost reductions, plant closings, and the removal of lower-margin businesses.
- Liquidity Shift: Working capital turned negative ($24.2 million) compared to a positive $167.9 million at year-end 1998. The current ratio dropped from 1.4 to 0.9. This was caused by significant cash outflows for share repurchases ($199.9 million) and acquisitions ($35.7 million net), partially offset by operating cash flow.
- Debt Utilization: The company utilized its uncommitted bank lines of credit, resulting in $26.4 million of short-term debt outstanding as of June 30, 1999, compared to zero at December 31, 1998.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Strategic Reorganization: The company announced the creation of a new "eFunds" business unit combining electronic payment and protection services. It also plans to reduce the corporate support group and move resources to operating units.
- Cost Reductions: Continued efforts to close financial institution check printing plants and reduce SG&A expenses are expected to improve profitability.
- Share Repurchases: The Board authorized the repurchase of up to 10 million shares. As of June 30, 1999, 4.2 million shares had been purchased.
- Year 2000 Readiness: The project is 98% complete overall and 100% complete for mission-critical areas. Contingency planning is 75% complete. Total expected project costs are $28.5 million, with $22.6 million incurred through June 30, 1999.
Risks and Contingencies
- Government Services Contract Loss: The prime contractor for several state switching services notified Deluxe it does not intend to renew. While a $36.4 million reserve was recorded in 1998, management expects to record an additional accrual as negotiations conclude.
- Legal Proceedings: A $32.2 million judgment against a subsidiary (DEPS) was paid in February 1999. The Supreme Court denied further review in June 1999.
- Restructuring: Remaining restructuring accruals total $35.6 million ($30.2 million for severance, $5.4 million for asset disposition losses). Future restructuring charges may occur due to the new business model implementation.
- Competition: Intense competition in check printing and alternative payment methods (debit cards, electronic payments) poses a risk to long-term volume and pricing power.
Investor Verification Checklist
- Government Services Accrual: Verify the final amount of the additional accrual required for the non-renewal of state switching contracts.
- Share Repurchase Impact: Monitor the remaining $199.9 million cash outflow for stock buybacks and its effect on liquidity and working capital.
- Year 2000 Costs: Confirm that total remediation costs remain within the $28.5 million budget and that no material operational disruptions occur post-January 1, 2000.
- Restructuring Execution: Track the timeline for check printing plant closures and the realization of projected SG&A savings.
- eFunds Integration: Assess the revenue and profit growth of the newly formed eFunds business unit against the 20% annual growth target for 2000-2001.