Business Context and Reporting Period
Company: Deluxe Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: Deluxe operates three primary segments: Small Business Services (58.0% of revenue), Financial Services (28.7% of revenue), and Direct Checks (13.3% of revenue). The company provides checks, forms, and related products to small businesses, financial institutions, and consumers. The reporting period reflects ongoing challenges from declining check usage, pricing pressure in the Financial Services segment, and significant strategic investments in Small Business Services.
Key Financial Metrics
| Metric (in thousands) | Q3 2006 | Q3 2005 | 9 Months 2006 | 9 Months 2005 |
|---|---|---|---|---|
| Revenue | $398,087 | $412,501 | $1,212,476 | $1,284,297 |
| Gross Profit | $248,358 | $263,253 | $755,103 | $832,205 |
| Gross Margin | 62.4% | 63.8% | 62.3% | 64.8% |
| Operating Income | $57,250 | $71,328 | $119,361 | $229,814 |
| Net Income | $31,163 | $37,134 | $53,463 | $118,562 |
| Diluted EPS | $0.61 | $0.73 | $1.03 | $2.33 |
| Cash from Operations (9M) | $172,390 (vs. $113,598 in 2005) | |||
| Total Debt | $1,064,262 (Sep 30, 2006) vs. $1,166,510 (Dec 31, 2005) | |||
| Cash & Equivalents | $9,251 (Sep 30, 2006) |
Material Changes vs. Prior Period
- Revenue Decline: Consolidated revenue decreased 3.5% in Q3 and 5.6% for the nine months ended September 30, 2006, compared to the prior year. This was driven by lower prices and unfavorable product mix in Financial Services and volume declines in Direct Checks due to falling check usage and lower marketing response rates.
- Asset Impairment: A non-cash asset impairment loss of $44.7 million was recorded in the second quarter of 2006 related to the abandonment of a major internal-use software project. This significantly impacted operating income for the nine-month period.
- Operating Income Compression: Operating income for the nine months dropped 48% year-over-year, primarily due to the impairment charge, revenue declines, and increased investments in Small Business Services growth strategies.
- Debt Reduction: Total debt decreased by $102.2 million during the first nine months of 2006, driven by payments on long-term debt and reduced commercial paper usage.
- Cash Flow Improvement: Operating cash flow increased by $58.8 million year-over-year, largely due to a $51.3 million decrease in contract acquisition payments and reduced contributions to the VEBA trust.
Guidance, Outlook, and Risks
- 2006 Outlook: Management expects 2006 earnings to decrease from 2005 levels.
- Revenue: Estimated between $1.630 billion and $1.638 billion.
- Diluted EPS: Estimated between $1.74 and $1.78.
- Operating Cash Flow: Estimated between $235 million and $245 million.
- Capital Spending: Estimated at approximately $45 million.
- Dividend Reduction: The quarterly dividend was reduced by 37.5% to $0.25 per share in Q3 2006 to accelerate debt paydown and improve financial flexibility.
- Cost Reduction Initiatives: The company is pursuing aggressive cost reduction and business simplification plans targeting at least $150 million in annual cost savings by the end of 2008. This includes closing the Syracuse, NY call center in Q1 2007.
- Credit Rating Downgrades: In October 2006, S&P lowered the long-term debt rating to BB- (negative outlook), and Moody's lowered it to Ba2 (negative outlook). Consequently, the commercial paper market is currently unavailable, and the company is relying on committed lines of credit.
- Acquisition: In October 2006, Deluxe acquired Johnson Group, Inc. for approximately $17.5 million to expand capabilities in custom printing and web-to-print services.
Investor Verification Checklist
- Software Project Abandonment: Verify the rationale and future impact of the $44.7 million impairment charge regarding the order capture and billing system replacement.
- Check Usage Trends: Monitor the rate of decline in personal and business check usage and its correlation with revenue in the Financial Services and Direct Checks segments.
- Debt Maturity Wall: Assess the company's strategy for repaying the $325 million senior notes maturing in October 2007, especially given the recent credit rating downgrades and loss of commercial paper access.
- Cost Savings Realization: Track the progress of the $150 million cost reduction target, specifically the closure of the Syracuse facility and IT infrastructure consolidation.
- Small Business Services Growth: Evaluate the return on investment for the "Deluxe Business Advantage" program and sales force expansion, which are currently offsetting profitability.