10-Q 1 deluxe013671_10q.txt DELUXE CORPORATION FORM 10-Q 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, 2001 --------------------------------------------------- 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 ---------------------- DELUXE CORPORATION -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) MINNESOTA 41-0216800 -------------------------------------------- --------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 3680 Victoria St. N., Shoreview, Minnesota 55126-2966 -------------------------------------------- --------------------------------- (Address of principal executive offices) (Zip Code) (651) 483-7111 -------------------------------------------------------------------------------- (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 October 19, 2001 was 66,356,550. Item I. Financial Statements PART I. FINANCIAL INFORMATION DELUXE CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED SEPTEMBER 30, DECEMBER 31, 2001 2000 ---- ---- (DOLLARS IN THOUSANDS) Current Assets: Cash and cash equivalents .................................... $ 5,250 $ 80,732 Marketable securities ........................................ 10,620 18,458 Trade accounts receivable (net of allowances for doubtful accounts of $1,433 and $1,415, respectively) ............... 49,201 46,332 Inventories .................................................. 10,469 10,560 Supplies ..................................................... 11,945 12,578 Deferred advertising ......................................... 17,780 17,089 Deferred income taxes ........................................ 6,729 6,877 Prepaid expenses ............................................. 21,818 20,115 Other current assets ......................................... 5,943 6,997 ---------- ---------- Total current assets ....................................... 139,755 219,738 Investments ....................................................... 37,943 35,555 Property, plant, and equipment (net of accumulated depreciation of $313,333 and $295,812, respectively) ........................... 155,980 173,956 Intangibles (net of accumulated amortization of $107,406 and $75,355, respectively) ........................................ 204,138 222,798 Other long-term assets ............................................ 33,187 8,392 ---------- ---------- Total assets ........................................... $ 571,003 $ 660,439 ========== ========== Current Liabilities: Accounts payable ............................................... $ 43,816 $ 43,161 Accrued liabilities: Wages and vacation pay ....................................... 35,387 36,191 Employee profit sharing and pension .......................... 23,524 21,872 Accrued income taxes ......................................... 56,856 27,065 Accrued rebates .............................................. 24,140 24,968 Other ........................................................ 64,031 62,214 Short-term debt ................................................ 102,900 -- Long-term debt due within one year ............................. 1,353 100,672 ---------- ---------- Total current liabilities ................................... 352,007 316,143 Long-term debt .................................................... 10,455 10,201 Deferred income taxes ............................................. 60,712 60,712 Other long-term liabilities ....................................... 7,011 10,575 Shareholders' Equity: Common shares $1 par value (authorized: 500,000,000 shares; issued: 2001 - 66,187,510; 2000 - 72,555,474) ................................................. 66,188 72,555 Additional paid-in capital ..................................... -- 44,243 Retained earnings .............................................. 74,597 146,243 Unearned compensation .......................................... (69) (60) Accumulated other comprehensive income ......................... 102 (173) ---------- ---------- Total shareholders' equity ................................. 140,818 262,808 ---------- ---------- Total liabilities and shareholders' equity .............. $ 571,003 $ 660,439 ========== ==========
See Notes to Unaudited Consolidated Financial Statements 2 DELUXE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED UNAUDITED QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------- ------------- 2001 2000 2001 2000 ---- ---- ---- ---- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenue ............................................. $ 323,533 $ 316,084 $ 957,107 $ 959,911 Cost of goods sold ............................... 111,060 113,208 339,971 341,272 ---------- ---------- ---------- ---------- Gross Profit ........................................ 212,473 202,876 617,136 618,639 Selling, general and administrative expense ..... 129,006 129,944 393,142 404,361 ---------- ---------- ---------- ---------- Operating Income .................................... 83,467 72,932 223,994 214,278 Other (expense) income ........................... (160) 3,694 209 1,953 ---------- ---------- ---------- ---------- Income from Continuing Operations Before Interest and Taxes ............................................ 83,307 76,626 224,203 216,231 Interest expense ................................. (990) (2,936) (3,219) (9,654) Investment (loss) income ......................... (601) 652 (313) 2,647 ---------- ---------- ---------- ---------- Income from Continuing Operations Before Income Taxes ............................................ 81,716 74,342 220,671 209,224 Provision for income taxes ...................... 30,654 27,378 82,818 77,593 ---------- ---------- ---------- ---------- Income from Continuing Operations ................... 51,062 46,964 137,853 131,631 Income (Loss) from Discontinued Operations .......... -- 2,433 -- (3,072) ---------- ---------- ---------- ---------- Net Income .......................................... $ 51,062 $ 49,397 $ 137,853 $ 128,559 ========== ========== ========== ========== Basic Net Income per Share: Income from continuing operations ................ $ .76 $ .65 $ 1.98 $ 1.82 Income (loss) from discontinued operations ....... -- .03 -- (.04) ---------- ---------- ---------- ---------- Basic Net Income per Share .......................... $ .76 $ .68 $ 1.98 $ 1.78 ========== ========== ========== ========== Diluted Net Income per Share: Income from continuing operations ................ $ .75 $ 0.65 $ 1.97 $ 1.82 Income (loss) from discontinued operations ....... -- .03 -- (.04) ---------- ---------- ---------- ---------- Diluted Net Income per Share ........................ $ .75 $ .68 $ 1.97 $ 1.78 ========== ========== ========== ========== Cash Dividends per Share ............................ $ .37 $ .37 $ 1.11 $ 1.11 Total Comprehensive Income .......................... $ 51,246 $ 49,343 $ 138,128 $ 128,141
See Notes to Unaudited Consolidated Financial Statements 3 DELUXE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2001 2000 ---- ---- (DOLLARS IN THOUSANDS) Cash Flows from Operating Activities: Net income .................................................................. $ 137,853 $ 128,559 Adjustments to reconcile net income to net cash provided by operating activities of continuing operations: Loss from discontinued operations ....................................... -- 3,072 Depreciation ............................................................ 23,840 24,338 Amortization of intangibles ............................................. 33,869 24,488 Share purchase discount ................................................. 925 1,426 Deferred income taxes ................................................... -- (1,388) Changes in assets and liabilities, net of effects from acquisitions and discontinued operations: Trade accounts receivable ........................................... (3,315) (1,722) Inventories ......................................................... 92 2,124 Accounts payable .................................................... 4,457 (14,487) Accrued wages, employee profit sharing and pension .................. 1,676 (7,566) Restructuring accruals .............................................. (2,076) (10,451) Other assets and liabilities ........................................ 11,288 28,840 ---------- ---------- Net cash provided by operating activities of continuing operations .......... 208,609 177,233 ---------- ---------- Cash Flows from Investing Activities: Proceeds from sales of marketable securities ................................ 37,990 7,627 Purchases of marketable securities .......................................... (30,000) (25,000) Purchases of capital assets ................................................. (22,281) (40,678) Payments for acquisitions, net of cash acquired ............................. -- (95,991) Proceeds from sales of capital assets ....................................... 1,452 14,434 Loan to others .............................................................. -- 32,500 Other ....................................................................... (3,807) (7,212) ---------- ---------- Net cash used by investing activities of continuing operations .............. (16,646) (114,320) ---------- ---------- Cash Flows from Financing Activities: Net borrowings (payments) on short-term debt ................................ 102,900 (35,000) Payments on long-term debt .................................................. (101,213) (639) Change in book overdrafts ................................................... (3,802) (7,360) Payments to retire shares ................................................... (231,620) -- Proceeds from issuing shares under employee plans ........................... 43,762 6,547 Cash dividends paid to shareholders ......................................... (77,472) (80,274) ---------- ---------- Net cash used by financing activities of continuing operations .............. (267,445) (116,726) ---------- ---------- Net Cash Used by Discontinued Operations ....................................... -- (35,348) ---------- ---------- Net Decrease in Cash and Cash Equivalents ...................................... (75,482) (89,161) Cash and Cash Equivalents at Beginning of Period ............................... 80,732 124,435 ---------- ---------- Cash and Cash Equivalents at End of Period ..................................... $ 5,250 $ 35,274 ========== ==========
See Notes to Unaudited Consolidated Financial Statements 4 DELUXE CORPORATION NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. The condensed consolidated balance sheet as of September 30, 2001, the condensed consolidated statements of income for the quarters and nine months ended September 30, 2001 and 2000, and the consolidated statements of cash flows for the nine months ended September 30, 2001 and 2000, are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the Company's consolidated financial statements are included. Other than any 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. The consolidated financial statements and notes appearing in this Report should be read in conjunction with the Company's consolidated audited financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. 2. On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended by SFAS No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that all derivatives, including those embedded in other contracts, be recognized as either assets or liabilities and that those financial instruments be measured at fair value. The accounting for changes in the fair value of derivatives depends on their intended use and designation. The Company has reviewed the requirements of SFAS No. 133 and has determined that it currently has no free-standing or embedded derivatives. Adoption of this standard did not have an impact on the Company's reported results of operations or financial position. 3. In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, BUSINESS COMBINATIONS, which addresses accounting and financial reporting for business combinations. This statement is effective in its entirety for the Company on January 1, 2002. The Company has not yet determined the impact this statement will have on its results of operations or financial position. 4. In June 2001, the FASB issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, which addresses accounting and financial reporting for goodwill and intangible assets. Under this new statement, goodwill and intangible assets with indefinite lives are no longer amortized, but are subject to impairment testing on at least an annual basis. This statement is effective in its entirety for the Company on January 1, 2002. As of September 30, 2001, the net book value of the Company's goodwill was $83.8 million, and goodwill amortization expense for the first nine months of 2001 was $4.6 million. The Company has not yet determined the impact this statement will have on its results of operations or financial position. 5. In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which addresses accounting and financial reporting for the impairment or disposal of long-lived assets. This statement is effective for the Company on January 1, 2002. The Company does not expect that adoption of this standard will have a material effect on its results of operations or financial position. 6. The Company capitalizes certain contract acquisition costs related to signing or renewing contracts with its financial institution clients. These costs, which primarily consist of cash payments made to the financial institutions, are generally amortized as a reduction of revenue on a straight-line basis over the contract term and are included in other long-term assets in the Company's consolidated balance sheets. The Company evaluates the carrying value of contract acquisition costs in accordance with its impairment of long-lived assets policy as presented in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. 5 7. The following table reflects the calculation of basic and diluted earnings per share from continuing operations (dollars and shares in thousands, except per share amounts):
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------- ------------- 2001 2000 2001 2000 -------- -------- -------- -------- Income from continuing operations per share-basic: Income from continuing operations ......... $ 51,062 $ 46,964 $137,853 $131,631 Weighted average shares outstanding ....... 67,228 72,391 69,521 72,265 -------- -------- -------- -------- Income from continuing operations per share-basic ............................. $ 0.76 $ 0.65 $ 1.98 $ 1.82 ======== ======== ======== ======== Income from continuing operations per share-diluted: Income from continuing operations ......... $ 51,062 $ 46,964 $137,853 $131,631 Weighted average shares outstanding ....... 67,228 72,391 69,521 72,265 Dilutive impact of options ................ 844 81 505 78 Shares contingently issuable .............. 60 12 37 7 -------- -------- -------- -------- Weighted average shares and potential dilutive shares outstanding ............. 68,132 72,484 70,063 72,350 -------- -------- -------- -------- Income from continuing operations per share-diluted ........................... $ 0.75 $ 0.65 $ 1.97 $ 1.82 ======== ======== ======== ========
During the third quarter of 2001 and 2000, options to purchase 56,442 and 5.3 million common shares, respectively, were outstanding but were not included in the computation of diluted earnings per share. During the first nine months of 2001 and 2000, options to purchase a weighted-average of 1.8 million and 5.4 million common shares, respectively, were outstanding but were not included in the computation of diluted earnings per share. The exercise prices of the excluded options were greater than the average market price of the Company's common shares during the respective periods. 8. Certain amounts reported in 2000 have been reclassified to conform with the 2001 presentation. These changes had no impact on previously reported net income or shareholders' equity. 9. Inventories were comprised of the following (dollars in thousands): SEPTEMBER 30, DECEMBER 31, 2001 2000 ---- ---- Raw materials ......................... $ 2,450 $ 2,879 Semi-finished goods ................... 7,082 6,504 Finished goods ........................ 937 1,177 -------- -------- Total ............................... $ 10,469 $ 10,560 ======== ======== 10. As of September 30, 2001, the Company had committed lines of credit for $350.0 million available for borrowing and as support for its $300.0 million commercial paper program. No amounts were drawn on these lines during the first nine months of 2001. The average amount drawn on these lines during 2000 was $18.8 million at a weighted-average interest rate of 6.26%. As of September 30, 2001 and December 31, 2000, no amounts were outstanding under these lines of credit. The average amount of commercial paper outstanding during the first nine months of 2001 was $73.6 million at a weighted-average interest rate of 4.17%. As of September 30, 2001, $102.9 million was outstanding at a weighted-average interest rate of 3.21%. The average amount of commercial paper outstanding during 2000 was $6.2 million at a weighted-average interest rate of 6.56%. No commercial paper was outstanding as of December 31, 2000. The Company had uncommitted bank lines of credit for $50.0 million available at variable interest rates. The average amount drawn on these lines of credit during the first nine months of 2001 was $1.8 million at a weighted-average interest rate of 4.26%. 6 The average amount drawn on these lines of credit during 2000 was $33,000 at a weighted-average interest rate of 6.38%. As of September 30, 2001 and December 31, 2000, no amounts were outstanding under these lines of credit. The Company has a shelf registration in place for the issuance of up to $300.0 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, 2001 and December 31, 2000, no such notes were issued or outstanding. 11. The Company's consolidated balance sheets reflect restructuring accruals of $1.0 million and $3.1 million as of September 30, 2001 and December 31, 2000, respectively, for employee severance costs. The status of these restructuring accruals as of September 30, 2001 was as follows (dollars in millions):
CHECK PRINTING PLANT CLOSINGS/OTHER(1) SG&A REDUCTIONS(2) PLAIDMOON(3) 2001 REDUCTIONS(4) TOTAL ------------------------------------------------------------------------------------------------------ NO. OF NO. OF NO. OF NO. OF NO. OF EMPLOYEES EMPLOYEES EMPLOYEES EMPLOYEES EMPLOYEES AMOUNT AFFECTED AMOUNT AFFECTED AMOUNT AFFECTED AMOUNT AFFECTED AMOUNT AFFECTED ------------------------------------------------------------------------------------------------------ Balance, December 31, 2000 . $ 0.8 70 $ 1.5 40 $ 0.8 35 $ -- -- $ 3.1 145 Restructuring charges .... -- -- -- -- -- -- 0.6 46 0.6 46 Severance paid ........... (0.5) (35) (0.9) (25) (0.6) (34) (0.2) (33) (2.2) (127) ------------------------------------------------------------------------------------------------------ Balance, June 30, 2001 ..... 0.3 35 0.6 15 0.2 1 0.4 13 1.5 64 Restructuring charges .... -- -- -- -- -- -- 0.7 89 0.7 89 Restructuring reversals .. -- (15) (0.3) (13) (0.1) -- -- -- (0.4) (28) Severance paid ........... (0.1) (1) (0.2) (2) (0.1) (1) (0.4) (43) (0.8) (47) ------------------------------------------------------------------------------------------------------ Balance, September 30, 2001 $ 0.2 19 $ 0.1 -- $ -- -- $ 0.7 59 $ 1.0 78 ======================================================================================================
(1) Includes charges related to implementing a new order processing and customer service system. (2) Includes charges related to the Company's initiative to reduce selling, general and administrative (SG&A) expense. (3) Includes charges recorded in 2000 relating to the scaling-back and repositioning of PlaidMoon. (4) Includes charges recorded in 2001 relating to reductions within all business segments. During the third quarter of 2001, the Company recorded restructuring accruals of $0.7 million for employee severance primarily relating to customer service employees within the Business Services segment and mail center employees within the Financial Services segment. These reductions are expected to affect approximately 89 employees and are expected to be completed during the fourth quarter of 2001. Additionally, the Company reversed $0.4 million of previously recorded restructuring accruals due to higher employee attrition than anticipated. During the second quarter of 2001, the Company recorded restructuring accruals of $0.6 million for employee severance related to various reductions within the Direct Checks segment. These reductions were completed in the third quarter of 2001 and affected 46 employees. These restructuring charges and reversals are reflected in SG&A expense in the Company's consolidated statements of income for the quarter and nine months ended September 30, 2001. During the second quarter of 2000, the Company recorded restructuring accruals of $1.0 million within continuing operations as a result of the outsourcing of certain data entry functions. This outsourcing affected approximately 155 employees and was completed during 2000. Additionally, the Company reversed $3.0 million of restructuring accruals within continuing operations relating to the Company's initiative to reduce SG&A expense. This was due to higher attrition than anticipated and the reversal of "early termination" payments to a group of employees. Under the Company's current severance practices, employees are provided some period of advance notice prior to being terminated. In certain situations, the Company asks the employees to leave immediately because they may have access to crucial infrastructure or information. In these cases, severance includes an additional amount for wages which would have been received during the notice period. In this situation, management subsequently decided to keep employees working for the notice period and thus, a reduction in the restructuring reserves was required since this pay was no longer severance, but an operating expense. These new restructuring charges and reversals are reflected in SG&A expense in the Company's consolidated statement of income for the nine months ended September 30, 2000. 12. During 2000, the Company operated two business segments: Paper Payment Systems and eFunds. On December 29, 2000, the Company disposed of the eFunds segment via a spin-off transaction. For 2001, the Company has re-organized its remaining businesses into three business segments: Financial Services, Direct Checks and Business 7 Services. Financial Services sells checks and related products and services through financial institutions. Direct Checks sells checks and related products directly to consumers through direct mail and the Internet. Business Services sells checks, forms and related products to small businesses through financial institutions and directly to customers via direct mail and the Internet. All three segments operate only in the United States. Prior year segment information has been revised to reflect this new organization. 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 the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Corporate expenses have been allocated to the segments based on segment revenues. This allocation includes expenses for various support functions such as executive management, human resources and finance and includes depreciation and amortization expense related to corporate assets. The corresponding corporate asset balances have not been allocated to the segments. Corporate assets consist primarily of cash, investments and deferred tax assets relating to corporate activities. The Company is an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and the sharing of assets. Therefore, the Company does not represent that these segments, if operated independently, would report the operating income and other financial information shown. The following is the Company's segment information for the third quarter and first nine months of 2001 and 2000 (dollars in thousands): Quarters Ended September 30, 2001 and 2000 ------------------------------------------
FINANCIAL DIRECT BUSINESS CORPORATE AND SERVICES CHECKS SERVICES UNALLOCATED CONSOLIDATED -------- ------ -------- ----------- ------------ Revenue: 2001 $197,329 $74,765 $51,439 $ -- $323,533 2000 199,417 68,953 47,714 -- 316,084 Operating income: 2001 48,474 17,481 17,512 -- 83,467 2000 40,319 17,117 15,496 -- 72,932 Depreciation and amortization expense: 2001 12,592 3,845 1,454 -- 17,891 2000 12,897 3,447 1,124 -- 17,468 Total assets: 2001 297,794 143,473 36,089 93,647 571,003 2000 323,308 149,127 42,011 458,028 972,474 Purchases of capital assets: 2001 3,088 1,288 577 226 5,179 2000 7,724 1,239 276 4,670 13,909
8 Nine Months Ended September 30, 2001 and 2000 ---------------------------------------------
FINANCIAL DIRECT BUSINESS CORPORATE AND SERVICES CHECKS SERVICES UNALLOCATED CONSOLIDATED -------- ------ -------- ----------- ------------ Revenue: 2001 $576,695 $229,902 $150,510 $ -- $957,107 2000 609,835 210,358 139,718 -- 959,911 Operating income: 2001 121,176 54,287 48,531 -- 223,994 2000 128,935 43,278 42,065 -- 214,278 Depreciation and amortization expense: 2001 41,793 11,664 4,252 -- 57,709 2000 36,489 8,949 3,388 -- 48,826 Total assets: 2001 297,794 143,473 36,089 93,647 571,003 2000 323,308 149,127 42,011 458,028 972,474 Purchases of capital assets: 2001 15,106 4,917 1,920 338 22,281 2000 23,921 4,281 999 11,477 40,678
Corporate and Unallocated assets as of September 30, 2000, includes net assets of discontinued operations of $299.8 million. Corporate and Unallocated purchases of capital assets includes activity related to the Company's PlaidMoon project, which was scaled-back and repositioned into the other segments in the fourth quarter of 2000. 13. In January 2001, the Company's Board of Directors approved a plan to purchase up to 14 million shares of the Company's common stock. At that time, it was announced that these repurchases would be completed within a 12- to 18-month period. Through September 30, 2001, the Company has spent $231.6 million to repurchase 8.3 million shares. The Company's shareholders' equity declined from $262.8 million at December 31, 2000 to $140.8 million at September 30, 2001 primarily as a result of these share repurchases and the required accounting treatment for them. Changes in the Company's shareholders' equity through September 30, 2001 were as follows (dollars in thousands):
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED UNEARNED COMPREHENSIVE SHARES CAPITAL EARNINGS COMPENSATION INCOME TOTAL ------ ------- -------- ------------ ------ ----- Balance, December 31, 2000 $72,555 $ 44,243 $ 146,243 $(60) $(173) $ 262,808 Net income 137,853 137,853 Cash dividends (77,472) (77,472) Common stock issued 1,907 47,308 49,215 Common stock repurchased (8,265) (91,328) (132,027) (231,620) Other common stock retired (9) (223) (232) Unearned compensation (9) (9) Unrealized gain on marketable securities 275 275 --------------------------------------------------------------------------------------- Balance, September 30, 2001 $66,188 $ -- $ 74,597 $(69) $ 102 $ 140,818 =======================================================================================
9 14. Discontinued operations represents the results of the Company's eFunds segment, which was disposed of via a spin-off transaction on December 29, 2000. Revenue and loss from discontinued operations for the quarter and nine months ended September 30, 2000, were as follows (dollars in thousands):
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, 2000 SEPTEMBER 30, 2000 ------------------ ------------------ Revenue from external customers ....................... $ 90,366 $261,150 Pre-tax income from operations of discontinued operations before measurement date .................. 7,124 6,355 Pre-tax costs of spin-off ............................. (2,431) (9,885) Income tax provision (benefit) ........................ 2,260 (458) -------- -------- Income (loss) from discontinued operations .......... $ 2,433 $ (3,072) ======== ========
During the second quarter of 2000, the Company's discontinued operations recorded net charges of $9.7 million for expected future losses on the long-term service contracts of its electronic benefits transfer (EBT) business. In April 2000, the Company completed negotiations with the prime contractor for a state coalition for which the Company's discontinued operations provided EBT services. Prior to this, the Company and the prime contractor were operating without a binding contract. The Company increased its accrual for expected future losses on long-term service contracts by $12.2 million to reflect the fact that there was now a definitive agreement with this contractor. Partially offsetting this charge was the reversal of $2.5 million of previously recorded contract loss accruals. These reversals resulted from productivity improvements and cost savings from lower than anticipated telecommunications and interchange expenses. In June 2000, the Company's eFunds segment sold 5.5 million shares of its common stock to the public. Prior to this initial public offering (IPO), the Company owned 40 million, or 100%, of eFunds total outstanding shares. Subsequent to the IPO, the Company continued to own 40 million shares of eFunds, representing 87.9% of eFunds total outstanding shares. Proceeds from the offering, based on the offering price of $13.00 per share, totaled $71.5 million ($64.5 million, net of offering expenses). The difference of $30.5 million between the net proceeds from the offering and the carrying amount of the Company's investment in eFunds was recorded as additional paid-in capital. No tax expense or deferred tax was provided on this amount, as the Company disposed of its ownership in eFunds via a tax-free spin-off transaction in December 2000. In conjunction with the spin-off of eFunds, the Company has agreed to indemnify eFunds for future losses arising from any litigation based on the conduct of eFunds' EBT and medical eligibility verification businesses prior to eFunds' IPO in June 2000, and from certain future losses on identified loss contracts. The contractual maximum amount of litigation and contract losses for which the Company will indemnify eFunds is $14.6 million. Through September 30, 2001, no amounts have been paid or claimed under this indemnification agreement. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations COMPANY PROFILE During 2000, we operated two business segments: Paper Payment Systems and eFunds. On December 29, 2000, we disposed of the eFunds segment via a spin-off transaction. For 2001, we have re-organized our remaining businesses into three business segments: Financial Services, Direct Checks and Business Services. Financial Services sells checks and related products and services through financial institutions. Direct Checks sells checks and related products directly to consumers through direct mail and the Internet. Business Services sells checks, forms and related products to small businesses through financial institutions and directly to customers via direct mail and the Internet. All three segments operate only in the United States. 10 RESULTS OF OPERATIONS - QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2000 The following table presents, for the periods indicated, selected statement of income data (dollars in thousands):
QUARTER ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 2001 2000 2001 2000 ---- ---- ---- ---- % OF % OF % OF % OF $ REVENUE $ REVENUE $ REVENUE $ REVENUE ---------------------------------------- ---------------------------------------- Revenue ..................... $323,533 -- $316,084 -- $957,107 -- $959,911 -- Gross profit ................ 212,473 65.7% 202,876 64.2% 617,136 64.5% 618,639 64.4% Selling, general and administrative expense .... 129,006 39.9% 129,944 41.1% 393,142 41.1% 404,361 42.1% Operating income ............ 83,467 25.8% 72,932 23.1% 223,994 23.4% 214,278 22.3%
REVENUE - Revenue increased $7.4 million, or 2.4%, to $323.5 million in the third quarter of 2001 from $316.1 million in the third quarter of 2000. Units for the third quarter were up 3.9% as compared to 2000, while revenue per unit was down 1.5%. The increase in revenue was due to growth within the Direct Checks and Business Services segments. Direct Checks revenue increased due to higher volume resulting from increased units per order, as well as price increases. Business Services volume increased as this business continued to benefit from financial institution referrals and stronger customer retention results. Additionally, a third quarter 2001 price increase contributed to this business' increased revenue. Partially offsetting these increases was a decrease in revenue for the Financial Services segment. This segment continued to experience competitive pricing pressure and a client mix shift toward larger financial institutions which, due to their volumes, generally pay lower average prices per unit than smaller accounts. Additionally, third quarter results included a higher amount of conversion work for several financial institutions. While this caused an increase in volume as compared to 2000, conversions are a lower priced product, causing a decrease in revenue per unit. Revenue for the first nine months of 2000 decreased $2.8 million, or 0.3%, to $957.1 million from $959.9 million in 2000. Units for the first nine months of 2001 were down 1.0% as compared to 2000, while revenue per unit was up 0.7%. The decrease in revenue was primarily due to continued competitive pricing pressure within the Financial Services segment, as well as the resulting volume decline due to the loss of financial institution clients. Additionally, the segment experienced a client mix shift toward larger financial institutions which, due to their volumes, generally pay lower average prices per unit than smaller accounts. The decrease in this segment was partially offset by growth in our other two segments. Direct Checks revenue increased due to higher volume resulting from increased units per order, price increases and the acquisition of Designer Checks in February 2000. Business Services revenue increased as this business continued to benefit from financial institution referrals and stronger customer retention results. Additionally, price increases in the third quarter of 2000 and 2001 contributed to this business' increased revenue. GROSS PROFIT - Gross profit increased $9.6 million to $212.5 million in the third quarter of 2001 from $202.9 million in the third quarter of 2000. As a percentage of revenue, gross margin increased to 65.7% in the third quarter of 2001 from 64.2% in the third quarter of 2000. The increase was due to printing and distribution center productivity improvements and other cost management efforts primarily within the Financial Services segment, as well as the price increases within the Direct Checks and Business Services segments. Partially offsetting these increases was continued pricing pressure within the Financial Services segment. Gross profit decreased $1.5 million to $617.1 million in the first nine months of 2001 from $618.6 million in 2000. As a percentage of revenue, gross margin was 64.5% in the first nine months of 2001 as compared to 64.4% in 2000. The effect of continued pricing pressure within the Financial Services segment, as well as higher delivery costs for this business were offset by price increases within the Direct Checks and Business Services segments and productivity improvements within the Financial Services segment. 11 SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSE - SG&A expense decreased $0.9 million, or 0.7%, to $129.0 million in the third quarter of 2001 from $129.9 million in the third quarter of 2000 and decreased $11.3 million, or 2.8%, to $393.1 million in the first nine months of 2001 from $404.4 million in the first nine months of 2000. As a percentage of revenue, SG&A expense decreased to 39.9% in the third quarter of 2001 from 41.1% in the third quarter of 2000, and decreased to 41.1% in the first nine months of 2001 from 42.1% in the first nine months of 2000. The improvements were primarily due to reduced spending resulting from on-going cost management efforts across all businesses, reduced e-commerce spending and administrative cost reductions due to the spin-off of eFunds on December 29, 2000. Partially offsetting these decreased expenses were total net restructuring charges of $0.9 million recorded in the second and third quarters of 2001 related to reductions within all segments. These reductions are expected to affect a total of 135 employees and are expected to be completed in the fourth quarter of 2001. By comparison, the first nine months of 2000 included net restructuring reversals of $2.0 million within the Financial Services segment, consisting of a $1.0 million charge for the outsourcing of certain data entry functions, offset by reversals of $3.0 million relating to our initiative to reduce SG&A expense. The outsourcing of data entry functions was completed in 2000 and affected approximately 155 employees. The restructuring reversals resulted from higher than anticipated attrition and the reversal of early termination payments to a group of employees. INTEREST EXPENSE - Interest expense decreased $1.9 million to $1.0 million in the third quarter of 2001 from $2.9 million in the third quarter of 2000 and decreased $6.5 million to $3.2 million in the first nine months of 2001 from $9.7 million in the first nine months of 2000. The decreases were due to our lower debt levels and interest rates. During the first nine months of 2001, we had weighted-average debt outstanding of $91.9 million at a weighted-average interest rate of 4.96%. During the first nine months of 2000, we had weighted-average debt outstanding of $131.2 million at a weighted-average interest rate of 8.02%. In February 2001, we paid off our $100.0 million of unsecured and unsubordinated notes which carried interest at 8.55%. PROVISION FOR INCOME TAXES - Our effective tax rate in the third quarter of 2001 was 37.5% compared to 36.8% in the third quarter of 2000. Our effective tax rate in the first nine months of 2001 was 37.5% compared to 37.1% in the first nine months of 2000. INCOME FROM CONTINUING OPERATIONS - Income from continuing operations in the third quarter of 2001 increased $4.1 million, or 8.7%, to $51.1 million from $47.0 million in the third quarter of 2000. Income from continuing operations increased $6.3 million, or 4.7%, to $137.9 million in the first nine months of 2001 from $131.6 million in the first nine months of 2000. The improvements were due to the increases in operating income and the decrease in interest expense discussed above. DISCONTINUED OPERATIONS - Income from discontinued operations was $2.4 million in the third quarter of 2000. In the first nine months of 2000 discontinued operations generated a loss of $3.1 million. This represents the results of our eFunds segment, which was disposed of via a spin-off transaction on December 29, 2000, as well as the costs of the spin-off. The results of discontinued operations for the first nine months of 2000 included net charges of $9.7 million for expected future losses on the long-term service contracts of eFunds' electronic benefits transfer (EBT) business. In April 2000, eFunds completed negotiations with the prime contractor for a state coalition for which it provided EBT services. Prior to this, eFunds and the prime contractor were operating without a binding contract. eFunds increased its accrual for expected future losses on long-term service contracts by $12.2 million to reflect the fact that there was now a definitive agreement with this contractor. Partially offsetting this charge was the reversal of $2.5 million of previously recorded contract loss accruals. These reversals resulted from productivity improvements and cost savings from lower than anticipated telecommunications and interchange expenses. Loss from discontinued operations for the first nine months of 2000 also included charges of $7.2 million for payments due under executive employment agreements due to the spin-off of eFunds. LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION We believe that the most important measures of our financial strength are the ratios of earnings before interest and taxes (EBIT) to interest expense and free cash flow to debt. EBIT to interest expense was 69.6 and 22.4 for the first nine months of 2001 and 2000, respectively. Free cash flow to debt on a 12-month trailing basis through September 30, 2001 was 131.2%. For the year ended December 31, 2000 this ratio was 88.3%. Free cash flow represents cash flow from operating activities less purchases of capital assets and dividend payments. 12 As of September 30, 2001, we had cash and cash equivalents of $5.3 million, as well as marketable securities of $10.6 million. The following table shows our cash flow activity for the first nine months of 2001 and 2000 and should be read in conjunction with our consolidated statements of cash flows (dollars in thousands):
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2001 2000 ---- ---- Continuing operations: Cash provided by operating activities .............. $ 208,609 $ 177,233 Cash used by investing activities .................. (16,646) (114,320) Cash used by financing activities .................. (267,445) (116,726) --------- --------- Cash used by continuing operations ................. (75,482) (53,813) Cash used by discontinued operations ............... -- (35,348) --------- --------- Net decrease in cash and cash equivalents ........ $ (75,482) $ (89,161) ========= =========
Cash provided by operating activities represents our primary source of working capital and the source for financing capital expenditures and paying cash dividends. We believe that cash provided by operating activities, as well as cash available from our current credit facilities and commercial paper program, is sufficient to sustain our existing operations, provide cash for share repurchases and fund possible acquisitions. During the first nine months of 2001, earnings before interest, taxes, depreciation and amortization (EBITDA) were $281.9 million. These operating cash inflows were utilized primarily to make 2000 employee profit sharing and pension contributions, to fund Financial Services contract acquisition costs, to pre-fund our trust for employee medical costs and to make income tax payments. Cash on hand at year-end, cash provided by operating activities during the first nine months of 2001, the net issuance of $102.9 million of commercial paper and cash receipts of $43.8 million from stock issued under employee stock purchase plans enabled us to spend $231.6 million on share repurchases, to make payments on long-term debt of $101.2 million, to pay dividends of $77.5 million and to purchase $22.3 million of capital assets during the first nine months of 2001. As of September 30, 2001, we had committed lines of credit for $350.0 million available for borrowing and as support for our $300.0 million commercial paper program. No amounts were drawn on these lines during the first nine months of 2001. The average amount drawn on these lines during 2000 was $18.8 million at a weighted-average interest rate of 6.26%. As of September 30, 2001 and December 31, 2000, no amounts were outstanding under these lines of credit. The average amount of commercial paper outstanding during the first nine months of 2001 was $73.6 million at a weighted-average interest rate of 4.17%. As of September 30, 2001, $102.9 million was outstanding at a weighted-average interest rate of 3.21%. The average amount of commercial paper outstanding during 2000 was $6.2 million at a weighted-average interest rate of 6.56%. No commercial paper was outstanding as of December 31, 2000. We had uncommitted bank lines of credit for $50.0 million available at variable interest rates. The average amount drawn on these lines of credit during the first nine months of 2001 was $1.8 million at a weighted-average interest rate of 4.26%. The average amount drawn on these lines of credit during 2000 was $33,000 at a weighted-average interest rate of 6.38%. As of September 30, 2001 and December 31, 2000, no amounts were outstanding under these lines of credit. We have a shelf registration in place for the issuance of up to $300.0 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. As of September 30, 2001 and December 31, 2000, no such notes were issued or outstanding. In conjunction with the spin-off of eFunds, we have agreed to indemnify eFunds for future losses arising from any litigation based on the conduct of eFunds' EBT and medical eligibility verification businesses prior to eFunds' initial public offering in June 2000, and from certain future losses on identified loss contracts. The contractual maximum amount of litigation and contract losses for which we will indemnify eFunds is $14.6 million. Through September 30, 2001, no amounts have been paid or claimed under this indemnification agreement. 13 RECENT DEVELOPMENTS In January 2001, we announced that our board of directors approved a stock repurchase program, authorizing the repurchase of up to 14 million shares of Deluxe common stock. At that time, we announced that we expected to complete these repurchases over a 12- to 18- month period. In May 2001 we adopted a plan under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. This plan permits us to purchase shares at times when we ordinarily would not be in the market because of self-imposed trading blackout periods, such as the days or weeks immediately preceding our quarterly earnings releases. Our Rule 10b5-1 plan authorizes our securities brokers to purchase up to 4 million shares in aggregate during our black-out periods for the 2001 fiscal year reporting period and is part of the 14 million share repurchase program. We also expect to continue to make open market purchases during our normal trading windows. Under the share repurchase program, we have spent $231.6 million to repurchase 8.3 million shares through September 30, 2001. Our shareholders' equity declined from $262.8 million at December 31, 2000 to $140.8 million at September 30, 2001 primarily as a result of these share repurchases and the required accounting treatment for them. The resulting decrease in shares outstanding resulted in a $0.07 increase in diluted income from continuing operations per share for the third quarter of 2001 and a $0.10 per share increase for the first nine months of 2001. We funded these repurchases by utilizing cash generated from operations and by issuing commercial paper. As of September 30, 2001, $102.9 million of commercial paper was outstanding. If the remaining 5.7 million shares are purchased within the 12- to 18- month timeframe originally anticipated, our reported shareholders' equity could move to a negative position. The market value of the Company's shareholders' equity was $2.3 billion as of September 30, 2001, calculated at the September 28, 2001 closing market price of $34.54 per share with 66.2 million shares outstanding. In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, BUSINESS COMBINATIONS, which addresses accounting and financial reporting for business combinations. This statement is effective for us in its entirety on January 1, 2002. We have not yet determined the impact this statement will have on our results of operations or financial position. In June 2001, the FASB issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, which addresses accounting and financial reporting for goodwill and intangible assets. Under this new statement, goodwill and intangible assets with indefinite lives are no longer amortized, but are subject to impairment testing on at least an annual basis. This statement is effective for us in its entirety on January 1, 2002. As of September 30, 2001, the net book value of our goodwill was $83.8 million, and goodwill amortization expense for the first nine months of 2001 was $4.6 million. We have not yet determined the impact this statement will have on our results of operations or financial position. In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which addresses accounting and financial reporting for the impairment or disposal of long-lived assets. This statement is effective for us on January 1, 2002. We do not expect that adoption of this standard will have a material effect on our results of operations or financial position. As a result of the terrorist attacks of September 11, we did not suffer the loss of any employees or assets. Our express delivery was impacted because the country's air delivery system was shut down. As a result, some of our customers may have experienced an interruption in delivery. Orders within our Business Services segment slowed somewhat immediately following September 11, but they returned to normal levels by the end of the month. OUTLOOK As of yet, the slowing United States economy has had little impact on our results of operations and we do not expect to see an impact in the last quarter of the year, assuming no further deterioration in the economy. While we cannot predict what impact a prolonged war on terrorism will have on the United States economy, our plan is to watch expenses, continue to invest in our business and make capital expenditures when they will increase productivity or profitably increase revenue. We currently expect that our fourth quarter earnings per share will be between $.65 and $.68, excluding the impact of any further share repurchases we might make in the fourth quarter. 14 We continue to take steps throughout the company that are directly related to our business strategy. Our strategy is: - We will leverage our core competencies of personalization, direct marketing and e-commerce to expand the opportunities in our existing businesses. - We will invest in our existing businesses by adding services and expanding product offerings. - We will consider acquisitions that leverage our core competencies and that are accretive to earnings and cash flow per share. - We will invest in technology and processes that will lower our cost structure and enhance our revenue opportunities. In line with this strategy, we expanded our product offerings by introducing a new line of Disney check packages. Additionally, both Direct Checks and Business Services have had success in leveraging our e-commerce capabilities. Internet orders for Direct Checks increased over 80% during the first nine months of 2001 as compared to 2000, while Business Forms Internet orders more than doubled during the same period. We continue to invest in our businesses, particularly as it relates to our use of the Internet. We currently are developing a browser application-based solution to allow clients to inquire and purchase our check products from their desktops. We will provide software modifications, upgrades, fixes, etc. to our financial institution clients remotely, allowing our customers ease of use. Additionally, we are continuing to build an electronic order processing capability for multiple channels. We also continue to invest in areas of the business where we can increase productivity and reduce costs. We anticipate total capital purchases of $35.0 million to $40.0 million in 2001. While the check printing industry is mature, our existing leadership position in the marketplace contributes to our financial strength. Although we don't anticipate significant growth in operating income in 2001, we believe that our business strategy will enable us to increase shareholder value. Item 3. Quantitative and Qualitative Disclosure About Market Risk We are exposed to changes in interest rates primarily as a result of the borrowing and investing activities used to maintain liquidity and fund business operations. We do not engage in speculative or leveraged transactions, nor do we hold or issue financial instruments for trading purposes. We continue to utilize commercial paper to fund working capital requirements and share repurchases. We also have various lines of credit available, as well as a shelf registration for the issuance of up to $300.0 million in medium-term notes. The nature and amount of debt outstanding can be expected to vary as a result of future business requirements, market conditions and other factors. As of September 30, 2001, we had $102.9 million of commercial paper outstanding at a weighted-average interest rate of 3.21%. The carrying value of this debt approximates its fair value due to its short-term duration. Other than capital lease obligations, we had no long-term debt outstanding as of September 30, 2001. As of September 30, 2001, we had an investment portfolio of fixed income securities of $10.6 million. These securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. However, we have the ability to hold these fixed income investments until maturity and therefore would not expect to recognize an adverse impact on income or cash flows. PART II - OTHER INFORMATION Item 1. Legal Proceedings Other than routine litigation incidental to its business, there are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or to which any of the Company's property is subject. 15 Item 5. Other Information CAUTIONARY STATEMENTS The Private Securities Litigation Reform Act of 1995 ("the Reform Act") provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information. We are filing this cautionary statement in connection with the Reform Act. When we use the words or phrases "should result," "believe", "intend", "plan", "are expected to," "targeted," "will continue," "will approximate," "is anticipated," "estimate," "project" or similar expressions in this Quarterly Report on Form 10-Q, in future filings with the Securities and Exchange Commission ("the Commission"), in our press releases and in oral statements made by our representatives, they indicate forward-looking statements within the meaning of the Reform Act. We want to caution you that any forward-looking statements made by us or on our behalf are subject to uncertainties and other factors that could cause them to be wrong. Some of these uncertainties and other factors are listed under the caption "Risk Factors" below (many of which have been discussed in prior filings with the Commission). Although we have attempted to compile a comprehensive list of these important factors, we want to caution you that other factors may prove to be important in affecting future operating results. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or combination of factors may have on our business. You are further cautioned not to place undue reliance on those forward-looking statements because they speak only of our views as of the date the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. RISK FACTORS THE PAPER CHECK INDUSTRY OVERALL IS A MATURE INDUSTRY AND IF THE INDUSTRY DECLINES FASTER THAN EXPECTED, OUR BUSINESS COULD BE HARMED. Check printing is, and is expected to continue to be, an essential part of our business and the principal source of our operating income. We primarily sell checks for personal and small business use and believe that there will continue to be a substantial demand for these checks for the foreseeable future. However, according to our estimates, growth in total checks written by individuals and small businesses declined slightly in 2000 compared to 1999, and the total number of personal, business and government checks written in the United States has been in decline since 1997. We believe that checks written by individuals and small businesses will continue to decline due to the increasing use of alternative payment methods, including credit cards, debit cards, smart cards, automated teller machines, direct deposit, electronic and other bill paying services, home banking applications and Internet-based payment services. However, the rate and the extent to which alternative payment methods will achieve consumer acceptance and replace checks cannot be predicted with certainty. A surge in the popularity of any of these alternative payment methods could have a material, adverse effect on the demand for checks and a material, adverse effect on our business, results of operations and prospects. WE FACE INTENSE COMPETITION IN ALL AREAS OF OUR BUSINESS. Although we believe we are the leading check printer in the United States, we face considerable competition. In addition to competition from alternative payment systems, we also face considerable competition from other check printers in our traditional sales channel through financial institutions, from direct mail sellers of checks and from sellers of business checks and forms. Additionally, we face competition from check printing software vendors, and increasingly, from Internet-based sellers of checks to individuals and small businesses. From time to time, some of our competitors have reduced the prices of their products in an attempt to gain volume. The corresponding pricing pressure placed on us has resulted in reduced profit margins in the past and similar pressures can reasonably be expected in the future. We cannot assure you that we will be able to compete effectively against current and future competitors. Continued competition could result in price reductions, reduced margins and loss of customers. CONSOLIDATION AMONG FINANCIAL INSTITUTIONS MAY ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS. Financial institutions have been undergoing large-scale consolidation, causing the number of financial institutions to decline. Margin pressures arise from this consolidation when merged entities seek not only the most favorable prices formerly offered to the predecessor institutions, but also additional discounts due to the greater volume represented by the combined entity. This 16 concentration greatly increases the importance of retaining our major customers and attracting significant additional customers in an increasingly competitive environment. Although we devote considerable efforts towards the development of a competitively priced, high quality suite of products and services for the financial services industry, 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 our remaining customers. FORECASTS INVOLVING FUTURE RESULTS REFLECT VARIOUS ASSUMPTIONS THAT MAY PROVE TO BE INCORRECT. From time to time, our representatives make predictions or forecasts regarding our future results, including but not limited to, forecasts regarding estimated revenues, earnings or earnings per share. Any forecast regarding our future performance reflects various assumptions which are subject to significant uncertainties, and, as a matter of course, may prove to be incorrect. Further, the achievement of any forecast depends on numerous factors which are beyond our control. As a result, we cannot assure you that our performance will be consistent with any management forecasts or that the variation from such forecasts will not be material and adverse. You are cautioned not to base your entire analysis of our business and prospects upon isolated predictions, and are encouraged to use the entire available mix of historical and forward-looking information made available by us, and other information affecting us and our products and services, including the risk factors discussed here. In addition, our representatives may occasionally comment publicly on the perceived reasonableness of published reports by independent analysts regarding our 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. The methodologies we employ in arriving at our own internal projections and the approaches taken by independent analysts in making their estimates are likely different in many significant respects. We expressly disclaim any responsibility to advise analysts or the public markets of our views regarding the current accuracy of the published estimates of outside analysts. If you are relying on these estimates, you should pursue your own independent investigation and analysis of their accuracy and the reasonableness of the assumptions on which they are based. UNCERTAINTIES EXIST REGARDING OUR SHARE REPURCHASE PROGRAM. In January 2001, we announced that our board of directors had approved the repurchase of up to 14 million shares of our common stock. At that time, we indicated that we expected to be able to complete these purchases over a 12- to 18-month period. Stock repurchase activities are subject to certain pricing restrictions, stock market forces, management discretion and various regulatory requirements. As a result, there can be no assurance as to the timing and/or amount of shares that we may repurchase under this share repurchase program. INCREASED PRODUCTION AND DELIVERY COSTS COULD ADVERSELY AFFECT OUR OPERATING RESULTS. Increases in production costs such as labor, paper and delivery could adversely affect our profitability. In addition, events such as the 1997 United Parcel Services strike can also adversely impact our margins by imposing higher delivery costs. Competitive pressures in the check printing industry may inhibit our ability to reflect any of these increased costs in the prices of our products. OUR STRATEGIC INITIATIVES MAY COST MORE THAN ANTICIPATED AND MAY NOT BE SUCCESSFUL. We are developing and evaluating plans and launching initiatives for future growth, including the development of additional products and services and the expansion of Internet commerce capabilities. These plans and initiatives will involve increased levels of investment. There can be no assurance that the amount of this investment will not exceed our expectations and result in materially increased levels of expense. The new products and services we develop may not meet acceptance in the marketplace. Also, Internet commerce initiatives involve new technologies and business methods and serve new or developing markets. There is no assurance that these initiatives will achieve targeted revenue, profit or cash flow levels or result in positive returns on our investment. Internet commerce is also a relatively recent phenomenon and may not continue to expand as a medium of commerce. 17 WE MAY EXPERIENCE SOFTWARE DEFECTS THAT COULD HARM OUR BUSINESS AND REPUTATION. We use sophisticated software and computing systems. We may experience difficulties in installing or integrating our technologies on platforms used by our customers or in new environments, such as the Internet. Errors or delays in the processing of check orders or other difficulties could result in lost customers, delay in market acceptance, additional development costs, diversion of technical and other resources, negative publicity or exposure to liability claims. ECONOMIC CONDITIONS WITHIN THE UNITED STATES COULD HAVE AN ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS. Although the recent slow-down in the United States economy has had little impact on our results of operations thus far, a prolonged general slow-down in the economy could negatively affect our business. Such a slow-down could reduce consumers' use of check products and business forms, resulting in revenue shortfalls. To mitigate any such shortfalls, we may have to increase our marketing and sales efforts, which would result in increased expense. We may also have to take steps to further decrease our cost structure. We can provide no assurance that we would be able to sustain our current levels of profitability in such a situation. THE SPIN-OFF OF eFUNDS CORPORATION MAY NOT RESULT IN INCREASED SHAREHOLDER VALUE IN THE LONG-TERM. In December 2000, we completed the spin-off of eFunds Corporation (eFunds). There can be no assurance that the spin-off of eFunds will result in increased value to our shareholders in the long-term for many reasons or that the separation will achieve the desired levels of efficiency or cost savings in our operations. WE FACE UNCERTAINTY WITH RESPECT TO FUTURE ACQUISITIONS. We have acquired complementary businesses in the past as part of our business strategy and may pursue acquisitions of complementary businesses in the future. We cannot predict whether suitable acquisition candidates can be acquired on acceptable terms or whether any acquired products, technologies or businesses will contribute to our revenues or earnings to any material extent. A significant acquisition could result in the potentially dilutive issuance of equity securities, the incurrence of contingent liabilities or debt, or additional amortization expense relating to acquired intangible assets, and thus, could adversely affect our business, results of operations and financial condition. Additionally, the success of any acquisition would depend upon our ability to effectively integrate the acquired businesses into ours. The process of integrating acquired businesses may involve numerous risks, including among others, difficulties in assimilating operations and products, diversion of management's attention from other business concerns, risks of operating businesses in which we have limited or no direct prior experience, potential loss of our key employees or key employees of acquired businesses, potential exposure to unknown liabilities and possible loss of our customers or customers of the acquired businesses. WE FACE RESTRICTIONS ON OUR ABILITY TO ACQUIRE OR ISSUE DELUXE SHARES. Under Section 355(e) of the Internal Revenue Code, the spin-off of eFunds could be taxable if 50% or more of our shares are acquired as part of a plan or series of transactions that include the spin-off. For this purpose, any acquisitions of our shares within two years before or after the spin-off are presumed to be part of such a plan, although we may be able to rebut that presumption. As a result of the possible adverse U.S. federal income tax consequences, we may be restricted in our ability to affect certain acquisitions, to issue our shares or to execute other transactions that would result in a change of control of Deluxe. Section 355(e) of the Internal Revenue Code is not expected to place limitations on the stock repurchase program we announced in January 2001. WE DEPEND ON A LIMITED SOURCE OF SUPPLY FOR OUR PRINTING PLATE MATERIAL AND THE UNAVAILABILITY OF THIS MATERIAL COULD HAVE AN ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS. Our check printing operations utilize a paper printing plate material that is available from only a limited number of sources. We believe we have a reliable source of supply for this material and that we maintain an inventory sufficient to avoid any production disruptions in the event of an interruption of its supply. In the event, however, that our current supplier becomes unwilling or unable to supply the required printing plate material at an acceptable price and we are unable to locate a suitable alternative source within a reasonable time frame, we would be forced to convert our facilities to an alternative printing process. Any such conversion would require the unanticipated investment of significant sums and could result in production delays and loss of business. 18 WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY. Despite our efforts to protect our intellectual property, third parties may infringe or misappropriate our intellectual property or otherwise independently develop substantially equivalent products and services. The loss of intellectual property protection or the inability to secure or enforce intellectual property protection could harm our business and ability to compete. We rely on a combination of trademark and copyright laws, trade secret protection and confidentiality and license agreements to protect our trademarks, software and know-how. We may be required to spend significant resources to protect our trade secrets and monitor and police our intellectual property rights. Third parties may assert infringement claims against us in the future. In particular, there has been a substantial increase in the issuance of patents for Internet-related systems and business methods, which may have broad implications for all participants in Internet commerce. Claims for infringement of these patents are increasingly becoming a subject of litigation. If we become subject to an infringement claim, we may be required to modify our products, services and technologies or obtain a license to permit our continued use of those rights. We may not be able to do either of these things in a timely manner or upon reasonable terms and conditions. Failure to do so could seriously harm our business, operating results and prospects as a result of lost business, increased expense or being barred from offering our products or implementing our systems or other business methods. In addition, future litigation relating to infringement claims could result in substantial costs and a diversion of management resources. Adverse determinations in any litigation or proceeding could also subject us to significant liabilities and could prevent us from using or offering some of our products, services or technologies. WE ARE DEPENDENT UPON eFUNDS FOR CERTAIN SIGNIFICANT INFORMATION TECHNOLOGY NEEDS. We have entered into an agreement with eFunds for the provision of software development, maintenance and support services through March 31, 2005. In the event that eFunds is not able to provide adequate information technology services, we would be adversely affected. Although we believe that information technology services are available from numerous sources, a failure to perform by eFunds could cause a disruption in our business while we obtain an alternative source of supply. LEGISLATION RELATING TO CONSUMER PRIVACY PROTECTION COULD HARM OUR BUSINESS. We are subject to regulations implementing the privacy requirements of a new federal financial modernization law known as The Gramm-Leach-Bliley Act ("the Act"). The Act requires us to develop and implement policies to protect the security and confidentiality of consumers' nonpublic personal information and to disclose these policies to consumers before a customer relationship is established and annually thereafter. These regulations could have the effect of increasing our expenses and otherwise foreclosing future business initiatives. The Act does not prohibit state legislation or regulations that are more restrictive on the collection and use of data. More restrictive legislation or regulations have been introduced in the past and could be introduced in the future in Congress and the states. We are unable to predict whether more restrictive legislation or regulations will be adopted in the future. Any future legislation or regulations could have a negative impact on our business, results of operations or prospects. Laws and regulations may be adopted in the future with respect to the Internet or e-commerce covering issues such as user privacy. New laws or regulations may impede the growth of the Internet. This could decrease traffic to our websites and decrease the demand for our products and services. Additionally, the applicability to the Internet of existing laws governing property ownership, taxation, libel and personal privacy is uncertain and may remain uncertain for a considerable length of time. THE INTERNAL REVENUE SERVICE (IRS) MAY TREAT THE SPIN-OFF OF eFUNDS AS TAXABLE TO US AND TO OUR SHAREHOLDERS IF REPRESENTATIONS MADE TO THE IRS WERE INACCURATE OR IF UNDERTAKINGS MADE TO THE IRS OR THE REQUIREMENTS OF THE INTERNAL REVENUE CODE ARE NOT FULFILLED. We have received confirmation from the IRS that, for U.S. federal income tax purposes, the spin-off of eFunds is tax-free to us and to our shareholders, except to the extent that cash was received in lieu of fractional shares. This confirmation is premised on a number of representations and undertakings made by us and by eFunds to the IRS, including representations with respect to each company's intention not to engage in certain transactions in the future. The spin-off may be held to be taxable to us and to our shareholders who received eFunds shares if the IRS determines that any of the representations made are incorrect or untrue in any 19 respect, or if any undertakings made are not complied with. If the spin-off is held to be taxable, both Deluxe and our shareholders who received eFunds shares could be subject to a material amount of taxes. eFunds will be liable to us for any such taxes incurred to the extent such taxes are attributable to specific actions or failures to act by eFunds, or to specific transactions involving eFunds following the spin-off. In addition, eFunds will be liable to us for a portion of any taxes incurred if the spin-off fails to qualify as tax-free as a result of a retroactive change of law or other reason unrelated to the action or inaction of either us or eFunds. eFunds may not, however, have adequate funds to perform its indemnification obligations and such indemnification obligations are only for the benefit of Deluxe and not individual shareholders. WE MAY BE SUBJECT TO ENVIRONMENTAL RISKS. Our check printing plants are subject to many existing and proposed federal and state regulations designed to protect the environment. In some instances, we owned and operated our check printing plants before the environmental regulations came into existence. We have sold former check printing plants to third parties and in most instances have agreed to indemnify the current owner of the facility for on-site environmental liabilities. Although we are not aware of any fact or circumstance which would require the future expenditure of material amounts for environmental compliance, if environmental liabilities are discovered at our check printing plants, we could be required to spend material amounts for environmental compliance in the future. WE MAY BE SUBJECT TO SALES AND OTHER TAXES WHICH COULD HAVE ADVERSE EFFECTS ON OUR BUSINESS. In accordance with current federal, state and local tax laws, and the constitutional limitations thereon, we currently collect sales, use or other similar taxes in state and local jurisdictions where our direct-to-consumer businesses have a physical presence. One or more state or local jurisdictions may seek to impose sales tax collection obligations on us and other out-of-state companies which engage in remote or online commerce. Further, tax law and the interpretation of constitutional limitations thereon, are subject to change. In addition, any new operations of these businesses in states where they do not presently have a physical presence could subject shipments of goods by these businesses into such states to sales tax under current or future laws. If one or more state or local jurisdictions successfully asserts that we must collect sales or other taxes beyond our current practices, it could have a material, adverse affect on our business. Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are filed as part of this report: Exhibit Method of Number Description Filing ------ ----------- ------ 3.1 Articles of Incorporation (incorporated by * reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990). 3.2 Bylaws (incorporated by reference to Exhibit 3.2 * to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999). 4.1 Amended and Restated Rights Agreement, dated as of * January 31, 1997, by and between the Company and Norwest Bank Minnesota, National Association, as Rights Agent, which includes as Exhibit A thereto, the form of Rights Certificate (incorporated by reference to Exhibit 4.1 to the Company's Amendment No. 1 on Form 8-A/A-1 (File No. 001-07945) filed with the Commission on February 7, 1997). 4.2 Amendment No. 1 to Amended and Restated Rights * Agreement, entered into as of January 21, 2000, between the Company and Norwest Bank Minnesota, National Association as Rights Agent (incorporated by reference to Exhibit 4.1 to the Company's Amendment No. 1 to its Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2000). 20 4.3 Indenture, relating to up to $300,000,000 of debt * securities (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-3 (33-62041) filed with the Commission on August 23, 1995). 4.4 Credit Agreement dated as of August 24, 2001, Filed among the Company, Bank One, N.A. as herewith administrative agent, The Bank of New York as syndication agent and the other financial institutions party thereto, related to a $350,000,000 revolving credit agreement. 12.3 Statement re: computation of ratios. Filed herewith ------------------- *Incorporated by reference (b) Reports on Form 8-K: None. 21 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: October 29, 2001 /s/ Lawrence J. Mosner ----------------------------------- Lawrence J. Mosner, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: October 29, 2001 /s/ Douglas J. Treff ----------------------------------- Douglas J. Treff Senior Vice President and Chief Financial Officer (Principal Financial Officer) 22 INDEX TO EXHIBITS Exhibit No. Description Page Number ----------- ----------- ----------- 4.4 Credit Agreement dated as of August 24, 2001, among the Company, Bank One, N.A. as administrative agent, The Bank of New York as syndication agent and the other financial institutions party thereto, related to a $350,000,000 revolving credit agreement. 12.3 Statement re: computation of ratios 23