10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 16, 1998
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For quarterly period ending September 30, 1998
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or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the transition period from_____________________to_____________________
Commission file number: 1-7945
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DELUXE CORPORATION
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(Exact name of registrant as specified in its charter)
MINNESOTA 41-021-6800
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3680 Victoria St. N., St. Paul, Minnesota 55126-2966
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(Address of principal executive offices) (Zip Code)
(612) 483-7111
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes _X_ No ___
The number of shares outstanding of registrant's common stock, par value $1.00
per share, at November 2, 1998 was 80,443,689.
1
ITEM 1. FINANCIAL STATEMENTS
PART I. FINANCIAL INFORMATION
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
See Notes to Unaudited Consolidated Financial Statements
2
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands except per share amounts)
(Unaudited)
See Notes to Unaudited Consolidated Financial Statements
3
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
See Notes to Unaudited Consolidated Financial Statements
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The consolidated balance sheet as of September 30, 1998 and the consolidated
statements of income and cash flows for the quarters and the nine month periods
ended September 30, 1998 and 1997 are unaudited. In the opinion of management,
all adjustments necessary for a fair presentation of such financial statements
are included. Other than those discussed in the notes below, such adjustments
consist only of normal recurring items. Interim results are not necessarily
indicative of results for a full year.
The consolidated financial statements and notes are presented in accordance with
instructions for Form 10-Q and do not contain certain information included in
the Company's consolidated annual financial statements and notes.
2. As of September 30, 1998, the Company had uncommitted bank lines of credit of
$170 million available at variable interest rates. As of that date, there were
no amounts drawn on those lines. The Company also had a $150 million committed
line of credit available for borrowing and as support for commercial paper. As
of September 30, 1998, the Company had no commercial paper outstanding and no
indebtedness outstanding under its committed line of credit. Additionally, the
Company had a shelf registration in place for the issuance of up to $300 million
in medium-term notes. Such notes could be used for general corporate purposes,
including working capital, capital expenditures, possible acquisitions and
repayment or repurchase of outstanding indebtedness and other securities of the
Company. As of September 30, 1998, no such notes were issued or outstanding.
3. The following table reflects the calculation of basic and diluted earnings
per share (unaudited dollars and shares outstanding in thousands, except per
share amounts).
4. Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," which requires
disclosure of comprehensive income and its components in the Company's financial
statements. The Company's total comprehensive income for the quarter and nine
months ended September 30, 1998 was $3.0 million and $89.1 million,
respectively. The Company had a comprehensive loss of $67.9 million for the
quarter ended September 30, 1997, and had comprehensive income of $10.7 million
for the nine months ended September 30, 1997. The Company's comprehensive income
consists of net income, unrealized holding gains and losses on securities and
foreign currency translation adjustments.
5. During 1998, the Company will adopt Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," which revises employers' disclosures about pensions
and other postretirement benefit plans. The Company does not anticipate that the
effect of this pronouncement will have a material impact on reported operating
results.
6. During the third quarter of 1998, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which requires the disclosure of financial
and descriptive information about the reportable operating segments of the
Company. SFAS No. 131 also establishes standards for related disclosures about
products and services, geographic areas and major customers. The adoption of
SFAS No. 131 did not affect the Company's results of operations or financial
position. The Company has organized its business units into six reportable
operating segments based on the nature of the products and services offered by
each: Paper Payment Systems; Payment Protection Systems; Electronic Payment
Systems; Direct Response; Government Services; and Deluxe Direct. Paper
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Payment Systems provides check printing services to financial services companies
and markets checks and business forms directly to households and small
businesses. Payment Protection Systems provides payment protection, collection
and risk management services to financial institutions and retailers. Electronic
Payment Systems provides electronic funds transfer and other software services
to the financial and retail industries. The remaining businesses within Direct
Response, which are currently held for sale, provide direct marketing, customer
database management and related services to the financial industry and other
businesses. Government Services provides electronic benefits transfer services
to state governments. Deluxe Direct, which is currently held for sale, primarily
sells greeting cards, stationery and specialty paper products through direct
mail. All segments, with the exception of the Electronic Payment Systems
segment, operate primarily in the United States. The Electronic Payments Systems
segment operates both domestically and internationally. No single customer of
the Company accounted for more than 10% of net sales in 1998 or 1997.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies as presented in the Company's
notes to its consolidated annual financial statements. In evaluating segment
performance, management focuses on income from operations. This measurement
excludes special charges (e.g., restructuring charges, asset impairment charges,
charges to legal reserves, etc.), interest expense, investment income, income
tax expense and other non-operating items, such as gains or losses from asset
disposals. Corporate expenses are allocated to the segments as a fixed
percentage of segment revenues. This allocation includes expenses for various
support functions such as human resources, information services and finance. The
corresponding corporate asset balances are not allocated to the segments. Most
intersegment sales are based on current market pricing. Segment information for
the nine months ended September 30, 1998 and 1997 is as follows (in thousands):
6
Segment information reconciles to consolidated amounts as follows (in
thousands):
OPERATING INCOME INCLUDING SPECIAL CHARGES
1998 unallocated corporate expenses consist of corporate special charges (see
note 7), as well as charges for certain corporate liabilities which are not
allocated to the segments. 1997 unallocated corporate expenses consist primarily
of corporate special charges (see note 7).
TOTAL ASSETS
Unallocated corporate assets consist primarily of cash, marketable securities,
long-term investments, deferred tax assets and long-term assets employed by the
corporate support groups.
DEPRECIATION AND AMORTIZATION EXPENSE
Segment depreciation and amortization expense includes only the expense
attributable to segment assets.
CAPITAL PURCHASES
Corporate capital purchases consist primarily of a new financial information
system (SAP) and various other information system enhancements.
Revenues are attributed to geographic areas based on the location of the assets
producing the revenues. The Company's operations by geographic area are as
follows (in thousands):
7. During the third quarter of 1998, the Company recorded pretax restructuring
charges of $39.5 million. The restructuring charges included costs associated
with the Company's initiative to reduce its selling, general and administrative
expenses (SG&A), the outsourcing of production of the Direct Response segment's
direct mail products, as well as the closing of additional check printing
plants. The Company anticipates eliminating approximately 800 SG&A positions
within sales and
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marketing, finance and accounting, human resources and information services.
Approximately 60 positions will be eliminated due to the outsourcing of direct
mail products production. The Company also plans to close additional check
printing plants over the next 18 months, affecting approximately 800 to 900
employees. The restructuring charges consisted of employee severance costs of
$31.2 million and $8.3 million for expected losses on the disposition of assets.
Expenses of $10.9 million were included in cost of sales; $21.1 million was
included in selling, general, and administrative and $7.5 million was included
in other expense in the consolidated statements of income for the quarter and
nine months ended September 30, 1998.
During the third quarter of 1997, the Company recorded pretax restructuring
charges of $24.5 million. The restructuring charges included additional costs
for the closing of 21 check printing plants, as announced in 1996, as well as
costs associated with the continued consolidation of the Company's core
businesses. The additional charge for plant closing costs represented amounts
which could not be recorded in 1996 because they did not meet the requirements
for accrual in that year due to the timeframe over which the plant closing plan
was expected to be completed. The restructuring charges consisted of employee
severance costs of $21.6 million and $2.9 million for expected losses on the
disposition of assets. Expenses of $7.7 million were included in cost of sales;
$13.9 million was included in selling, general, and administrative and $2.9
million was included in other expense in the consolidated statements of income
for the quarter and nine months ended September 30, 1997.
The Company's consolidated balance sheets reflect restructuring accruals of
$50.4 million and $39.5 million as of September 30, 1998 and December 31, 1997,
respectively, for employee severance costs and $10.9 million and $3.7 million as
of September 30, 1998 and December 31, 1997, respectively, for estimated losses
on asset dispositions. The majority of the severance costs are expected to be
paid out by early 2000 with cash generated from the Company's operations.
8. In October 1998 the Company announced that it had reached agreements in
principle to sell PaperDirect, Inc. ("PaperDirect"), the Social Expressions
component ("Social Expressions") of Current, Inc. and the remaining businesses
within the Company's Direct Response segment. The sales are currently expected
to close in the fourth quarter of 1998. These businesses, along with the
international component of the Electronic Payment Systems segment, are accounted
for in accordance with Statement of Financial Accounting Standards No. 121, "
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." These businesses contributed revenue of $52.6 million and $55.2
million in the third quarters of 1998 and 1997, respectively, and revenue of
$177.7 million and $171.9 million during the first nine months of 1998 and 1997,
respectively. They contributed operating losses of $1.6 million and $2.1 million
in the third quarters of 1998 and 1997, respectively, and losses of $3.5 million
and $6.2 million during the first nine months of 1998 and 1997, respectively.
The direct mail check printing business of Current, Inc. will remain with the
Company and its results of operations are included in the Paper Payment Systems
operating segment.
During the third quarter of 1997, the Company recorded a pretax impairment
charge of $99 million to write-down the carrying value of PaperDirect, Social
Expressions and the international operations of the Electronic Payment Systems
segment to their estimated fair values less costs to sell. This charge is
reflected in the goodwill impairment charge ($82.9 million) and in selling,
general and administrative expense ($16.1 million) in the consolidated
statements of income for the quarter and nine months ended September 30, 1997.
9. In August 1998, the Company completed the sale of its Card Services business
and the Company is currently in the process of outsourcing the production of its
direct mail products. These initiatives will not have a material impact on the
Company's reported operating results. The results of operation of these
businesses were included in the Direct Response operating segment.
10. During the third quarter of 1998, the Company recorded a charge of $36.4
million for losses on existing contracts of its Government Services segment.
These losses arose due to revenue shortfalls from initial projections and the
relatively fixed costs of this business. The contracts have varying terms
through 2006.
11. During the third quarter of 1997, the Company recorded a $40 million pretax
charge to reserve for an adverse judgement against one of the Company's
subsidiaries. The charge also reserves for potential legal and other related
costs. The Company has appealed from this judgement and has thus classified this
obligation as other long-term liabilities in the consolidated balance sheet.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Company Profile
During the third quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which requires the disclosure of financial
and descriptive information about the reportable operating segments of the
Company. The Company has organized its business units into six operating
segments based on the nature of the products and services offered by each: Paper
Payment Systems;
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Payment Protection Systems; Electronic Payment Systems; Direct Response;
Government Services; and Deluxe Direct. Paper Payment Systems provides check
printing services to financial services companies and markets checks and
business forms directly to households and small businesses. Payment Protection
Systems provides payment protection, collection and risk management services to
financial institutions and retailers. Electronic Payment Systems provides
electronic funds transfer and other software services to the financial and
retail industries. The remaining businesses within Direct Response, which are
currently held for sale, provide direct marketing, customer database management
and related services to the financial industry and other businesses. Government
Services provides electronic benefits transfer services to state governments.
Deluxe Direct, which is currently held for sale, primarily sells greeting cards,
stationery and specialty paper products through direct mail. All segments, with
the exception of the Electronic Payment Systems segment, operate primarily in
the United States. The Electronic Payments Systems segment operates both
domestically and internationally.
Results of Operations - Quarter and Nine Months Ended September 30, 1998
Compared to the Quarter and Nine Months Ended September 30, 1997
Net sales were $470 million for the third quarter of 1998, up .6% from the third
quarter of 1997 when sales were $467 million. Net sales were $1,434 million for
the first nine months of 1998, up .9% from the comparable period in 1997 when
sales for the first nine months were $1,421 million. Paper Payment Systems
revenue was flat in the third quarter of 1998 versus the third quarter of 1997.
Revenues for the first nine months of 1998 were down 1.0% from the first nine
months of 1997 due to lower volume for the financial institution check printing
business. This decrease was partially offset by increased volume for direct mail
checks and small business products. Payment Protection Systems revenue was up
11.4% over the third quarter of 1997 and 12.4% over the first nine months of
1997 due to increased volume for all product lines. Electronic Payment Systems
revenue was up 7.0% for the quarter and 11.4% for the first nine months of 1998
versus the same periods in 1997. The increase was due to higher volume arising
from an increased customer base and increased transaction volume. Direct
Response revenue was down 8.1% from the third quarter of 1997 and 6.8% from the
first nine months of 1997 due to lower volume and the sale of the Card Services
business in the third quarter of 1998. Government Services revenue was up 53.7%
over the third quarter of 1997 and 62.7% over the first nine months of 1997 due
to increased volume from existing contracts, as well as the addition of new
contracts in 1998. Deluxe Direct revenue was down 17.7% for the quarter and 9.5%
for the first nine months of 1998 due primarily to divestitures.
Cost of sales increased $32.1 million, or 14.4%, from the third quarter of 1997,
and increased $28.6 million, or 4.3%, from the first nine months of 1997.
Included in the 1998 third quarter results was a charge of $47.1 million for
check printing plant closings and accrued losses on contracts of the Government
Services segment. Included in the 1997 third quarter results was a charge of
$7.7 million related to the continued consolidation of check printing plants.
With these charges removed, cost of sales decreased $7.2 million, or 3.4%, from
the third quarter of 1997, and decreased $10.7 million, or 1.6%, from the first
nine months of 1997. Paper Payment Systems cost of sales decreased 10.2% for the
quarter and 8.6% for the first nine months of 1998 versus 1997, excluding the
impact of restructuring charges in both years. This decrease is due primarily to
savings realized from plant consolidation and productivity improvements within
the financial institution check printing business. Payment Protection Systems
cost of sales increased 20.3% over the third quarter of 1997 and 17.5% over the
first nine months of 1997 due to the increased sales volume and increased
depreciation, rent and salaries expense due to the growth of the segment.
Electronic Payment Systems cost of sales increased 10.7% for the quarter and
10.0% for the first nine months of 1998 versus 1997 due to the increased sales
volume. Additionally, information systems cost increased due to the year 2000
issues, the need to pay higher wages to retain technical personnel, and
increased equipment costs related to a new data center. Direct Response cost of
sales was down 20.2% for the quarter and 5.7% for the first nine months of 1998
versus 1997, excluding the impact of restructuring charges in 1998. These
decreases are due to the lower sales volume, the sale of the Card Services
business and the outsourcing of production of direct mail products. Government
Services cost of sales increased 40.6% over the third quarter of 1997 and 45.7%
over the first nine months of 1997, excluding special charges in 1998. The
increase was due to the increased sales volume. Because many of the costs of
this business are fixed, cost of sales increased at a lower rate than did
revenue. Deluxe Direct cost of sales decreased 12.7% for the quarter and 6.0%
for the first nine months of 1998 versus 1997 due primarily to divestitures,
which decrease was partially offset by increased information systems costs in
1998.
Selling, general and administrative (SG&A) expenses decreased $8.4 million, or
3.8%, from the third quarter of 1997, and decreased $6.4 million, or 1.1%, from
the first nine months of 1997. Included in 1998 third quarter results was a
$22.0 million charge primarily for severance related to the Company's initiative
to reduce SG&A expenses. Included in 1997 third quarter results was a charge
totaling $39.6 million related to check printing plant consolidation, job
reductions and the write-down of impaired assets. With these charges removed,
SG&A expenses increased $9.1 million, or 5.1%, from the third quarter of 1997,
and increased $11.1 million, or 2.0%, from the first nine months of 1997. Paper
Payment Systems SG&A expenses increased 9.7% from the third quarter of 1997 and
1.5% from the first nine months of 1997 due to increased amortization expense
for the segment's new customer service system. Payment Protection Systems SG&A
expense increased 16.4% for the quarter and 20.8% for the first nine months of
1998 versus 1997, excluding special charges in 1998. These increases were due
primarily to increased information systems and marketing costs reflecting the
Company's investment in this segment.
9
Electronic Payment Systems SG&A expenses increased 14.3% over the third quarter
of 1997 and 15.1% over the first nine months of 1997, excluding special charges
in both years, due primarily to increased sales and marketing costs. Direct
Response SG&A expenses decreased 11.0% for the quarter and 4.1% for the first
nine months of 1998 versus 1997, with special charges excluded in both years,
due to lower amortization expense due to asset write-offs in the third quarter
of 1997. Government Services SG&A expenses increased 17.8% for the quarter and
14.6% for the first nine months of 1998 versus 1997 due to costs associated with
additional contracts in 1998. Deluxe Direct SG&A expenses decreased 23.5% from
the third quarter of 1997 and 18.8% from the first nine months of 1997,
excluding special charges in 1997, due to divestitures and reduced marketing
expenses.
Other income increased $49.8 million from the third quarter of 1997 and $48.9
million from the first nine months of 1997. 1997 third quarter results include
charges of $49.8 million relating to legal proceedings and asset impairments.
During 1997, a judgement was entered against one of the Company's subsidiaries
in conjunction with a potential bid to provide electronic benefit transfer
services for the Southern Alliance of States. The majority of this amount is
expected to be paid in 1999 if the Company is unsuccessful in its attempt to
obtain a reversal of this judgment on appeal.
The Company's effective tax rate decreased to 41.3% for the first nine months of
1998 versus 59.5% for the first nine months of 1997. The decrease is due to
higher pretax income in 1998 combined with a higher base of non-deductible
expenses in 1997 consisting primarily of the goodwill impairment charge. With
the effect of the special charges removed in both years, the Company's effective
tax rate was 40.2% for the first nine months of 1998 and 40.6% for the first
nine months of 1997.
Net income was $2.8 million for the third quarter of 1998 compared to a net loss
of $67.5 million for the third quarter of 1997. Net income for the first nine
months of 1998 was $88.7 million compared to $11.4 million for the first nine
months of 1997. 1998 third quarter results include after-tax charges of $43.7
million for severance related to the Company's initiative to reduce its SG&A
expenses, the outsourcing of production of its direct mail products, the closing
of additional check printing plants and accrued losses on contracts of its
Government Services segment. The 1997 third quarter results include after-tax
charges of $112.3 million for asset impairments related to its businesses held
for sale, an unfavorable legal decision and severance reserves related to
continued consolidation of check printing plants and consolidation of the
Company's core businesses. With these charges removed, net income was $46.5
million for the third quarter of 1998, or 9.9% of sales, compared to $44.8
million, or 9.6% of sales, for the third quarter of 1997. Net income, excluding
special charges, was $132.4 million, or 9.2% of sales, for the first nine months
of 1998, compared to $123.7 million, or 8.7% of sales, for the first nine months
of 1997. The increase for both periods is attributable to the changes discussed
above.
Financial Condition - Liquidity
Cash provided by operations was $178.1 million for the first nine months of 1998
compared with $198.2 million for the first nine months of 1997. Cash from
operations represents the Company's primary source of working capital for
financing capital expenditures and paying cash dividends. The Company's working
capital on September 30, 1998 was $80.5 million compared to $131.1 million on
December 31, 1997. The Company's current ratio was 1.2 to 1 on September 30,
1998, and 1.3 to 1 on December 31, 1997.
Financial Condition - Capital Resources
Purchases of capital assets totaled $88.5 million for the first nine months of
1998 compared to $68.6 million during the comparable period one year ago. The
increase represents investments in a new financial information system, a new
customer interface system, as well as other strategic initiatives designed to
improve productivity and profitability. As of September 30, 1998, the Company
had uncommitted bank lines of credit of $170 million available at variable
interest rates. As of that date, there were no amounts drawn on those lines. The
Company also had a $150 million committed line of credit available for borrowing
and as support for commercial paper. As of September 30, 1998, the Company had
no commercial paper outstanding and no indebtedness outstanding under its
committed line of credit. Additionally, the Company had a shelf registration in
place for the issuance of up to $300 million in medium-term notes. Such notes
could be used for general corporate purposes, including working capital, capital
expenditures, possible acquisitions and repayment or repurchase of outstanding
indebtedness and other securities of the Company. As of September 30, 1998, no
such notes were issued or outstanding. Cash dividends totaled $89.9 million for
the first nine months of 1998 compared to $91.3 million for the first nine
months of 1997.
Year 2000 Readiness Disclosure
General Approach and State of Readiness. In 1996, the Company initiated a
company wide program to prepare its computer systems, applications, embedded
chip equipment and third-party suppliers/customers for the year 2000. The year
2000 issue affects the Company and most of the other companies and governmental
agencies in the world. Historically, certain computer programs were written
using two digits rather than four to define the applicable year. As a result,
some programs may recognize a date which uses the two digits
10
"00" as 1900 rather than the year 2000, which may cause them to, among other
things, generate erroneous data, lose data elements and possibly fail.
The Company is using a multi-phase approach in conducting its year 2000
remediation efforts. These phases are: assessment; analysis and formulation of
remediation strategy; solution implementation; testing; and certification using
internally developed criteria. The Company has divided its internal readiness
review between "mission critical" systems and equipment and other assets. The
project is organized around nine types of computerized assets. The asset types
include internally developed applications, product-to-market software and
systems, third-party purchased software, data centers, networks, environmental
systems, purchased hardware (including embedded chip and desktop equipment),
third party assessment and external interfaces. During 1997, the Company
performed assessment and prioritization of all affected areas, defined
appropriate resolution strategies and began execution of those strategies. The
compliance strategies included renovation, replacement and retirement of systems
and equipment.
As of September 1998, the overall project is approximately 75% complete and
approximately 80% complete with respect to areas identified as "mission
critical."
The testing phase is expected to be complete for mission critical components
within all asset types by the end of 1998, at which point, the overall project
is expected to be approximately 90% complete. Certification of critical assets
in all internal categories should be 95% complete by the end of 1998 and
certification is expected to be 95% complete across all internal categories by
June of 1999. Also during 1999, the project focus will shift toward completion
of customer and vendor testing and contingency execution.
As part of its year 2000 review, the Company has also assessed the readiness of
its facilities with respect to embedded chip equipment. Included in this effort
was all plant manufacturing equipment, HVAC systems, building security systems,
PCs and other office equipment such as printers, faxes and copy machines. The
most frequent method of achieving compliance in this area is replacement of
non-compliant systems and equipment. This effort was approximately 75% complete
at September 30, 1998 and is scheduled for completion by September of 1999.
Another area of focus for the Company is the year 2000 readiness of its
significant suppliers and customers, both from the standpoint of technology and
product/service provision. These external organizations have been contacted and
have provided responses to year 2000 assessment requests. Site visits and action
plans are being developed as appropriate, based on the importance of the
organizations to the Company's ability to provide products and services.
Overall, this category was approximately 75% complete as of the end of September
1998, and this effort is expected to be complete by March 1999.
Costs. The Company expects to incur project expenses of approximately $26.5
million over the life of its year 2000 project, consisting of both internal
staff costs and consulting expenses, with $12.6 having been incurred through
September 30, 1998. Funds for the initiative are provided from a separate budget
of $26.5 million for the remediation of all affected systems. The Company's SAP
software implementation costs and other capital expenditures associated with the
replacement or improvement of affected systems are not included in these cost
estimates. The Company has not deferred any material information technology
project as a result of the initiative.
Risk and Contingency. Because of the nature of the Company's business, the year
2000 issue would, if unaddressed, pose a material business risk for the Company.
Business operations may be at risk, as well as customer information interfaces
and the provision of products/services. The risk is further increased by the
potential for the Company to fall out of compliance with policies set by the
Federal Financial Institution Examination Council, National Credit Union Agency
and other Federal and regional regulatory bodies.
The Company presently believes that with the planned modifications to existing
systems and the replacement or retirement of other systems, the year 2000
compliance issue will be resolved in a timely manner and will not pose
significant operational problems for the Company. The Company has prioritized
its renovation efforts to focus first on its mission critical internal systems
and the Company believes it is presently on schedule to complete this component
of its remediation efforts before the relevant year 2000 failure dates are
reached.
In addition to the planned modifications, replacements and retirements, the
Company has developed risk mitigation processes and created contingency plans in
an effort to limit the inherent risk of the Year 2000 issue. Manual fall-back
processes and procedures have been identified and put in place, particularly in
cases where vendor equipment or services begin to demonstrate the potential to
be unavailable in a timely manner. The Company is also preparing plans to deploy
internal teams to repair problems as they arise when the century rolls over.
Ongoing audit reviews are scheduled during the latter part of 1999 and into 2000
to ensure that compliance control processes continue to be in use. In addition,
the Company is enhancing its existing business resumption plans and believes its
existing liability insurance programs should mitigate its loss exposure in the
event that operational problems do arise.
This discussion should be read in conjunction with the disclosures contained in
"Item 5 -- Risk Factors and Cautionary Statements -- Year 2000 Readiness
Disclosure," which appears in Part II of this Quarterly Report on Form 10-Q.
11
Outlook
Throughout the remainder of 1998 and 1999, the Company will continue its efforts
to reduce costs and improve productivity throughout the organization. At the
same time, the Company will continue to invest in major infrastructure
improvements. The Company also expects to continue its efforts to complete its
divestiture program by selling its remaining non-strategic businesses so it can
focus on its growth opportunities.
PART II. OTHER INFORMATION
Item 5. Other Information
RISK FACTORS AND CAUTIONARY STATEMENTS
When used in this Quarterly Report on Form 10-Q and in future filings by the
Company with the Securities and Exchange Commission (the "Commission"), in the
Company's press releases and in oral statements made by the Company's
representatives, the words or phrases "should result," "are expected to," "will
continue," "will approximate," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements are necessarily subject to certain risks and uncertainties, including
those discussed below, that could cause actual results to differ materially from
the Company's historical experience and its present expectations or projections.
Caution should be taken not to place undue reliance on any such forward-looking
statements, which speak only as of the date made. The factors listed below could
affect the Company's financial performance and could cause the Company's actual
results for future periods to differ from any opinions or statements expressed
with respect thereto. Such differences could be material and adverse.
The Company will not undertake and specifically declines any obligation to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances occurring after
the date of such statements or to reflect the occurrence of anticipated or
unanticipated events. This discussion supersedes the discussion in the Company's
current Report on Form 8-K/A, which was filed with the Commission on October 22,
1998.
Earnings Estimates; Cost Reductions. From time to time, representatives of the
Company may make predictions or forecasts regarding the Company's future
results, including estimated earnings or earnings from operations. Any forecast,
including the Company's current statement that it expects fourth quarter
earnings to fall between $.65 and $.71 per share (and between $2.29 and $2.35
per share for 1998, after excluding the $70 million pre-tax special charge taken
by the Company in the third quarter) and to achieve at least 11 to 15 percent
annual growth in earnings in1999 and 2000, regarding the Company's future
performance reflects various assumptions, including assumptions regarding the
timing of certain anticipated divestitures (See "Sale of Businesses"). These
assumptions are subject to significant uncertainties, and, as a matter of
course, many of them will prove to be incorrect. Further, the achievement of any
forecast depends on numerous factors (including those described in this
discussion), many of which are beyond the Company's control. In addition, it is
not expected that the earnings growth projected for 1999 and 2000 will be
representative of results that may be achieved in subsequent years.
As a result, there can be no assurance that the Company's performance will be
consistent with any management forecasts and the variation from such forecasts
may be material and adverse. Investors are cautioned not to base their entire
analysis of the Company's business and prospects upon isolated predictions, but
instead are encouraged to utilize the entire available mix of historical and
forward-looking information made available by the Company, and other information
affecting the Company and its products, when evaluating the Company's
prospective results of operations.
In addition, representatives of the Company may occasionally comment on the
perceived reasonableness of published reports by independent analysts regarding
the Company's projected future performance. Such comments should not be
interpreted as an endorsement or adoption of any given estimate or range of
estimates or the assumptions and methodologies upon which such estimates are
based. Generally speaking the Company does not make public its own internal
projections, budgets or estimates. Undue reliance should not be placed on any
comments regarding the conformity, or lack thereof, of any independent estimates
with the Company's own present expectations regarding its future results of
operations. The methodologies employed by the Company in arriving at its own
internal projections and the approaches taken by independent analysts in making
their estimates are likely different in many significant respects. Although the
Company may presently perceive a given estimate to be reasonable, changes in the
Company's business, market conditions or the general economic climate may have
varying effects on the results obtained through the use of differing analyses
and assumptions. The Company expressly disclaims any continuing responsibility
to advise analysts or the public markets of its view regarding the current
accuracy of the published estimates of outside analysts. Persons relying on such
estimates should pursue their own independent investigation and analysis of
their accuracy and the reasonableness of the assumptions on which they are
based.
12
Sale of Businesses. The Company has a continuing intention to divest the
remaining businesses comprising its Deluxe Direct segment (Social Expressions
and PaperDirect) and has announced its intention to divest its Direct Response
business unit. Although the Company has entered into non-binding letters of
intent providing for the sale of these businesses with potential buyers,
definitive divestiture agreements have not yet been negotiated. A failure to
reach agreement on the exact terms of one or more of the planned divestitures
could delay the anticipated sales. Such a failure or a failure by the Company to
achieve the expected sales prices for the businesses to be divested could result
in further write-offs by the Company, some of which could be significant. In
addition, a delay in the execution of these sales could cause the Company to
incur continued operating losses from the businesses sought to be divested,
disrupt or otherwise adversely affect the operations of those businesses or
require the Company to make unanticipated investments in them. Any such delay
would also postpone the receipt and use by the Company of the proceeds expected
to be generated thereby.
Timing and Amount of Anticipated Cost Reductions. With regard to the results of
the Company's ongoing cost reduction efforts (including the Company's current
review of its Selling, General and Administrative cost levels), there can be no
assurance that the projected $100 million of pre-tax annual cost savings will be
fully realized or will be achieved within the time periods expected. The
implementation of the printing plant closures upon which some of the anticipated
savings depend is, in large part, dependent upon the successful development of
the software needed to streamline the check ordering process and redistribute
the resultant order flow among the Company's remaining printing plants. The
Company has previously experienced unanticipated delays in the planned roll-out
of its on-line ordering system. Although the Company expects to again begin
converting customers to this new system in the fourth quarter of 1998 and
believes that the delays it has experienced will not materially affect its
current plant closing schedule, there can be no assurances such will be the case
or that additional sources of delays will not be encountered because of the
complexities inherent in the development of software products as sophisticated
as those needed to accomplish this task. Any such event could adversely affect
the planned consolidation of the Company's printing facilities and the
achievement of the expected productivity improvements and delay the realization
or reduce the amount of the anticipated expense reductions.
In addition, the achievement of the targeted level of cost savings is dependent
upon the successful execution of a variety of other cost reduction strategies
throughout the Company's operations. These additional efforts include the
consolidation of the Company's purchasing process and certain administrative and
sales support organizations, the disposition of unprofitable or low-margin
businesses, headcount reductions and other efforts. The optimum means of
realizing many of these strategies is still being evaluated by the Company.
Unexpected delays, complicating factors and other hindrances are common in the
implementation of these types of endeavors and can arise from a variety of
sources, some of which are likely to have been unanticipated. In addition, the
Company may incur additional charges against its earnings in connection with
future programs. A failure to timely achieve one or more of the Company's
primary cost reduction objectives could materially reduce the benefit to the
Company of its cost savings programs and strategies or substantially delay the
full realization of their expected benefits.
Further, there can be no assurance that increased expenses attributable to other
areas of the Company's operations or to increases in raw material, labor,
equipment or other costs will not offset some or all of the savings expected to
be achieved through the cost reduction efforts. Competitive pressures and other
market factors may also require the Company to share the benefit of some or all
of any savings with its customers or otherwise adversely affect the prices it
receives or the market for its products. As a result, even if the expected cost
reductions are fully achieved in a timely manner, such reductions are not likely
to be fully reflected by commensurate gains in the Company's net income, cash
position, dividend rate or the price of its Common Stock.
Other Dispositions and Acquisitions. In connection with its ongoing
restructuring, the Company may also consider divesting or discontinuing the
operations of various business units and assets and the Company may undertake
one or more significant acquisitions. Any such divestiture or discontinuance
could result in write-offs by the Company, some or all of which could be
significant. In addition, a significant acquisition could result in future
earnings dilution for the Company's shareholders.
Effect of Financial Institution Consolidation. There is an ongoing trend towards
increasing consolidation within the banking industry that has resulted in
increased competition and consequent pressure on check prices. This
concentration greatly increases the importance to the Company of retaining its
major customers and attracting significant additional customers in an
increasingly competitive environment. Although the Company devotes considerable
efforts towards the development of a competitively priced, high quality suite of
products for the financial services and retail industries, there can be no
assurance that significant customers will not be lost or that any such loss can
be counterbalanced through the addition of new customers or by expanded sales to
the Company's remaining customers.
Capital Expense Reductions. The Company has announced that it expects that its
1998 capital spending budget should decline from previous estimates due in part
to the application of a new methodology for evaluating the Company's projected
return on various forms of investment. The use of this methodology represents a
revised analytic approach by the Company and the long-term benefits to be
derived therefrom cannot presently be precisely determined.
13
Raw Material Postage Costs and Delivery Costs. Increases in the price of paper
and the cost of postage can adversely affect the profitability of the Company's
printing and mail order business. Events such as the 1997 UPS strike can also
adversely impact the Company's margins by imposing higher delivery costs.
Competitive pressures and overall trends in the marketplace may have the effect
of inhibiting the Company's ability to reflect increased costs of production or
delivery in the retail prices of its products.
Competition. Although the Company believes it is the leading check printer in
the United States, it faces considerable competition from other smaller
companies in both its traditional marketing channel to financial institutions
and from direct mail marketers of checks. From time to time, one or more of
these competitors reduce the prices of their products in an attempt to gain
market share. The corresponding pricing pressure placed on the Company has
resulted in reduced profit margins in the past and similar pressures can
reasonably be expected in the future, although the timing and amount of reduced
profits that may result from such pressure is unascertainable.
Check printing is, and is expected to continue to be, an essential part of the
Company's business and the principal source of its operating income for at least
the next several years. A wide variety of alternative payment delivery systems,
including credit cards, debit cards, smart cards, ATM machines, direct deposit
and electronic and other bill paying services, home banking applications and
Internet-based retail services, are in various stages of maturity or development
and additional systems will likely be introduced. The Company believes that
there will continue to be a substantial market for checks for the foreseeable
future, although a reduction in the volume of checks used by consumers is
expected. The rate and the extent to which alternative payment methods will
achieve consumer acceptance and replace checks cannot, however, be predicted
with certainty. A surge in the popularity of any of these alternative payment
methods could have material, adverse effect on the demand for the Company's
primary products and its account verification, payment protection and collection
services. The creation of these alternative payment methodologies has also
resulted in an increased interest in transaction processing as a source of
revenue, which has led to increased competition for the Company's transaction
processing businesses.
Debit Bureau. The Company has recently announced alliances with several entities
that are intended to offer decision support tools and information to retailers
and financial institutions that offer or accept direct debit-based products,
such as checking accounts, ATM cards and debit cards. To date, this effort has
primarily been directed towards the creation of the supporting data warehouse
and research regarding the utility and value of the data available to the
Company for use in this area. There can be no assurance that this effort will
result in the introduction of a significant number of new products or services
or the generation of incremental revenues or profits in material amounts. In any
event, the continued development of the debit bureau is expected to require a
significant level of investment by the Company.
HCL Joint Venture. There can be no assurance that the software, transaction
processing services and products and software development services proposed to
be offered by the Company's joint venture with HCL Corporation of New Delhi,
India will achieve market acceptance in either the United States or India. In
addition, the Company has no operational experience in India and only limited
international exposure to date. Operations in foreign countries are subject to
numerous potential obstacles including, among other things, cultural
differences, political unrest, export controls, governmental interference or
regulation (both domestic and foreign), currency fluctuations, personnel issues
and varying competitive conditions. There can be no assurance that one or more
of these factors, or additional causes or influences, many of which are likely
to have been unanticipated and beyond the ability of the Company to control,
will not operate to inhibit the success of the venture. As a result, there can
be no assurance that the HCL joint venture will generate significant revenues or
profits or provide an adequate return on any investment by the Company.
Limited Source of Supply. The Company's check printing business utilizes a paper
printing plate material that is available from only a limited number of sources.
The Company believes it has a reliable source of supply for this material and
that it maintains an inventory sufficient to avoid any production disruptions in
the event of an interruption of its supply. In the event, however, that the
Company's current supplier becomes unwilling or unable to supply the required
printing plate material at an acceptable price and the Company is unable to
locate a suitable alternative source within a reasonable time frame, the Company
would be forced to convert its facilities to an alternative printing process.
Any such conversion would require the unanticipated investment of significant
sums and there can be no assurance that the conversion could be accomplished
without production delays.
Seasonality. A significant portion of the revenues and earnings of the Company's
Deluxe Direct segment is dependent upon its results of operations during the
fourth quarter. As a result, the results reported for this segment during the
first three quarters of any given year are not necessarily indicative of those
which may be expected for the entire year.
Year 2000 Readiness Disclosure. In 1996, the Company initiated a companywide
program to prepare its computer systems, applications and embedded chip
equipment and third-party suppliers/customers for the year 2000. See "Item 2 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Readiness Disclosure" which appears in Part I of this
Quarterly Report on Form 10-Q.
14
Although the Company presently believes that with the planned modifications to
existing systems and the replacement or retirement of other systems, the year
2000 compliance issue will be resolved in a timely manner and will not pose
significant operational problems for the Company, there can be no absolute
assurances in this regard. The Company's business operations, as well as its
ability to provide products and services to its customers without undue delay or
interruption, could be at risk in the event unanticipated year 2000 issues
arise. In addition, there can be no absolute assurances that unanticipated
expenses related to the Company's ongoing year 2000 compliance efforts will not
be incurred. As previously noted, the Company has communicated with its key
suppliers and customers to determine their year 2000 readiness and the extent to
which the Company is vulnerable to any third party year 2000 issues. There can
be no guarantee that the systems of other companies on which the Company's
systems rely will be converted in a timely manner or in a manner that is
compatible with the Company's systems. A failure by such a company to convert
their systems in a timely manner or a conversion that renders such systems
incompatible with those of the Company could have a material adverse effect on
the Company and there can be no assurance that the Company's contingency plans
will adequately mitigate the effects of any third party noncompliance. In
addition, it is unrealistic to assume that the Company could remain unaffected
if the year 2000 issue results in a widespread economic downturn. Also, it is
possible that the Company's insurance carriers could assert that its existing
liability insurance programs do not cover liabilities arising out of any
operational problems associated with the advent of the year 2000.
NEW 14a-4 NOTICE DEADLINE
Under the Company's amended Bylaws, the Company's Board of Directors may exclude
proposals (including director nominations) from consideration at its annual
shareholders' meeting if such proposals are not submitted on or before a date
(the "Notice Date") at least 120 days prior to the date the Company's proxy
statement was released to shareholders in connection with the previous year's
annual meeting of shareholders. In addition, the proxies solicited by the
Company's Board of Directors may confer discretionary authority upon the persons
named therein to vote upon any matter submitted for consideration at any regular
meeting of shareholders (without discussion of the matter in the Company's proxy
statement) if the Company does not receive proper notice of such matter prior to
the Notice Date. The Notice Date applicable to the Company's 1999 annual meeting
of shareholders is December 2, 1998.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this report:
Exhibit No. Description Method of Filing
- ----------- ----------- ----------------
3.1 Bylaws of Deluxe Corporation (as amended
October 30, 1998) Filed herewith
12.3 Computation of Ratio of Earnings to Fixed
Charges Filed herewith
27.1 Financial Data Schedule Filed herewith
(b) The registrant did not, and was not required to, file
any reports on form 8-K during the quarter for which this report is filed.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DELUXE CORPORATION
(Registrant)
Date November 13, 1998 /s/ J.A. Blanchard III
------------------- --------------------------------
J.A. Blanchard III, President
and Chief Executive Officer
(Principal Executive Officer)
Date November 13, 1998 /s/ Thomas W. VanHimbergen
------------------- --------------------------------
Thomas W. VanHimbergen
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer)
16
INDEX TO EXHIBITS
Exhibit No. Description Page Number
- ----------- ----------- -----------
3.1 Bylaws of Deluxe Corporation (as amended October 30, 1998)
12.3 Computation of Ratio of Earnings to Fixed Charges
27.1 Financial Data Schedule
17