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, 2000
---------------------------------------------
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
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(Exact name of registrant as specified in its charter)
MINNESOTA 41-0216800
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3680 Victoria St., N. Shoreview, Minnesota 55126-2966
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(Address of principal executive offices) (Zip Code)
(651) 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 October 26, 2000 was 72,555,533.
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Dollars in Thousands)
<TABLE>
<CAPTION>
September 30,
2000 December 31,
(Unaudited) 1999
------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 111,666 $ 140,465
Time deposit subject to compensating balance arrangement 10,000 --
Restricted custodial cash 4,837 3,429
Marketable securities 43,475 25,713
Trade accounts receivable, net of allowance for doubtful accounts of $4,246
and $5,814, respectively 131,330 115,775
Inventories:
Raw material 2,803 3,110
Semi-finished goods 6,660 7,245
Finished goods 1,052 1,261
Supplies 13,158 15,007
Deferred advertising 10,894 17,189
Deferred income taxes 19,108 14,206
Prepaid expenses and other current assets 37,971 75,349
------------ ------------
Total current assets 392,954 418,749
------------ ------------
LONG-TERM INVESTMENTS 65,267 40,846
RESTRICTED CASH 27,913 28,939
PROPERTY, PLANT AND EQUIPMENT
Land and land improvements 39,695 41,157
Buildings and building improvements 158,241 165,028
Machinery and equipment 416,076 448,445
------------ ------------
Total 614,012 654,630
Less accumulated depreciation 361,560 359,845
------------ ------------
Property, plant, and equipment - net 252,452 294,785
INTANGIBLES
Cost in excess of net assets acquired - net 138,585 51,705
Internal use software - net 174,693 142,465
Other intangible assets - net 15,294 15,154
------------ ------------
Total intangibles 328,572 209,324
------------ ------------
Total assets $ 1,067,158 $ 992,643
============ ============
</TABLE>
2
<PAGE>
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Dollars in thousands)
<TABLE>
<CAPTION>
September 30,
2000 December 31,
(Unaudited) 1999
------------ ------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 59,397 $ 60,876
Accrued liabilities:
Wages, including vacation pay 54,040 54,228
Employee profit sharing and pension 23,775 33,490
Accrued income taxes 44,576 28,405
Accrued rebates 27,158 28,281
Accrued contract losses 26,459 20,599
Other 89,474 111,330
Short-term debt 29,941 63,100
Long-term debt due within one year 102,802 4,357
------------ ------------
Total current liabilities 457,622 404,666
------------ ------------
LONG-TERM DEBT 12,770 115,542
DEFERRED INCOME TAXES 46,623 46,322
OTHER LONG-TERM LIABILITIES 9,183 8,805
MINORITY INTEREST IN NET ASSETS OF SUBSIDIARY 34,435 --
SHAREHOLDERS' EQUITY
Common shares - $1 par value (authorized 500,000,000 shares; issued:
2000 - 72,451,816 shares; 1999 - 72,019,898 shares) 72,452 72,020
Additional paid-in capital 41,997 --
Retained earnings 393,777 346,617
Unearned compensation -- (47)
Accumulated other comprehensive income (1,701) (1,282)
------------ ------------
Shareholders' equity 506,525 417,308
------------ ------------
Total liabilities and shareholders' equity $ 1,067,158 $ 992,643
============ ============
</TABLE>
See Notes to Unaudited Consolidated Financial Statements
3
<PAGE>
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
(Dollars in Thousands, Except per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET SALES $ 404,947 $ 417,114 $ 1,216,129 $ 1,239,033
Cost of sales 175,179 187,453 527,072 557,791
----------- ----------- ----------- -----------
GROSS MARGIN 229,768 229,661 689,057 681,242
Selling, general and administrative expense 152,543 156,296 478,462 452,718
----------- ----------- ----------- -----------
Income from operations 77,225 73,365 210,595 228,524
OTHER INCOME (EXPENSE)
Minority interest in subsidiary earnings (470) -- (470) --
Interest expense (3,206) (2,164) (10,455) (5,623)
Other income 5,486 6,483 6,025 10,606
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 79,035 77,684 205,695 233,507
PROVISION FOR INCOME TAXES 29,638 28,627 77,136 88,638
----------- ----------- ----------- -----------
NET INCOME $ 49,397 $ 49,057 $ 128,559 $ 144,869
=========== =========== =========== ===========
NET INCOME PER SHARE - BASIC $ 0.68 $ 0.65 $ 1.78 $ 1.86
NET INCOME PER SHARE - DILUTED $ 0.68 $ 0.65 $ 1.78 $ 1.85
CASH DIVIDENDS PER COMMON SHARE $ 0.37 $ 0.37 $ 1.11 $ 1.11
</TABLE>
See Notes to Unaudited Consolidated Financial Statements
4
<PAGE>
DELUXE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------
2000 1999
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 128,559 $ 144,869
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 33,248 41,026
Amortization of intangibles 37,078 20,785
Asset impairment charges -- 267
Stock purchase discount 2,184 3,640
Minority interest in earnings of subsidiary 470 --
Deferred income tax (4,797) --
Changes in assets and liabilities, net of effects from acquisitions and sales of
businesses:
Restricted cash (382) (19,747)
Trade accounts receivable (14,965) 10,321
Inventories 2,124 2,559
Accounts payable (1,805) 2,757
Other assets and liabilities 11,053 (67,508)
----------- -----------
Net cash provided by operating activities 192,767 138,969
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of marketable securities with maturities of more than 3 months 7,627 19,763
Purchases of marketable securities with maturities of more than 3 months (25,000) (17,915)
Purchases of capital assets (68,613) (78,722)
Payments for acquisitions, net of cash acquired (115,991) (35,666)
Net proceeds from sales of businesses, net of cash sold -- 25,106
Proceeds from sales of capital assets 14,841 50,824
Loans to others 32,500 (32,500)
Investment in time deposit to establish loan guarantee collateral (10,000) --
Other (6,705) 2,636
----------- -----------
Net cash used in investing activities (171,341) (66,474)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments) proceeds from short-term debt (33,591) 1,376
Payments on long-term debt (2,146) (9,554)
Net proceeds from issuance of subsidiary stock 64,459 --
Payments to retire common stock (1,093) (216,745)
Proceeds from issuing stock under employee plans 6,547 25,712
Cash dividends paid to shareholders (80,274) (86,385)
----------- -----------
Net cash used in financing activities (46,098) (285,596)
----------- -----------
NET CASH USED BY CERTAIN INTERNATIONAL OPERATIONS DURING DECEMBER 1999 (SEE
NOTE 10) (4,127) --
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (28,799) (213,101)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 140,465 268,389
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 111,666 $ 55,288
=========== ===========
</TABLE>
See Notes to Unaudited Consolidated Financial Statements
5
<PAGE>
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. The consolidated balance sheet as of September 30, 2000, the
consolidated statements of income for the quarters and nine months ended
September 30, 2000 and 1999, and the consolidated statements of cash flows for
the nine months ended September 30, 2000 and 1999 are unaudited. The amount
reflected as minority interest in net assets of subsidiary on the Company's
consolidated balance sheet as of September 30, 2000, and the amounts reflected
as minority interest in earnings of subsidiary on the Company's consolidated
statements of income for the quarter and nine months ended September 30, 2000,
represent the minority shareholders' proportionate share of the equity and net
earnings, respectively, of eFunds Corporation. In the opinion of management, all
adjustments necessary for a fair presentation of the Company's consolidated
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. 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, 1999.
2. The Company's total comprehensive income for the quarters ended
September 30, 2000 and 1999 was $49.3 million and $49.6 million, respectively.
Total comprehensive income for the nine months ended September 30, 2000 and 1999
was $128.1 million and $144.1 million, respectively. The Company's total
comprehensive income consists of net income, unrealized holding gains and losses
on securities and foreign currency translation adjustments.
3. The following table reflects the calculation of basic and diluted
earnings per share (dollars and shares outstanding in thousands, except per
share amounts):
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------- ------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income per share-basic:
Net income $ 49,397 $ 49,057 $128,559 $144,869
Weighted average shares outstanding 72,391 75,588 72,265 77,835
-------------------------------------------------------------------------------------------
Net income per share-basic $ 0.68 $ 0.65 $ 1.78 $ 1.86
===========================================================================================
Net income per share-diluted:
Net income $ 49,397 $ 49,057 $128,559 $144,869
-------------------------------------------------------------------------------------------
Weighted average shares outstanding 72,391 75,588 72,265 77,835
Dilutive impact of options 77 398 74 316
Shares contingently issuable 12 27 7 19
-------------------------------------------------------------------------------------------
Weighted average shares and potential
dilutive shares outstanding 72,480 76,013 72,346 78,170
-------------------------------------------------------------------------------------------
Net income per share-diluted $ 0.68 $ 0.65 $ 1.78 $ 1.85
===========================================================================================
</TABLE>
4. As of September 30, 2000, the Company had committed lines of credit for
$450.0 million available for borrowing and as support for commercial paper. The
average amount drawn on these lines during the first nine months of 2000 was
$25.0 million at a weighted-average interest rate of 6.26%. As of September 30,
2000, no amounts were outstanding under these lines of credit. The average
amount drawn on these lines during 1999 was $39.8 million at a weighted-average
interest rate of 6.39%. As of December 31, 1999, $60.0 million was outstanding
under these lines of credit at an interest rate of 6.39%. As of September 30,
2000, the Company had $25.0 million of commercial paper outstanding at an
interest rate of 6.54%. The average amount of commercial paper outstanding
during the first nine months of 2000 was $6.2 million at a weighted-average
interest rate of 6.57%. No commercial paper was issued during 1999.
The Company also had a $10.0 million credit facility, denominated in Indian
rupees, available to its Indian operations at the lender's prime interest rate.
Borrowings under this facility are due on demand. This facility is guaranteed by
the Company
6
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and this guarantee is collateralized by a $10.0 million time deposit account
maintained by the Company with the lending bank. The maturity date of this
deposit is December 28, 2000, at which time the collateral may be renewed or
replaced by agreement of both parties. The average amount drawn on this credit
facility during the first nine months of 2000 was $4.6 million at a
weighted-average interest rate of 15.77%. As of September 30, 2000, $4.9 million
was outstanding at an interest rate of 15.77%. The average amount drawn on this
credit facility during 1999 was $2.7 million at a weighted-average interest rate
of 15.81%. As of December 31, 1999, $3.1 million was outstanding at an interest
rate of 15.81%.
The Company had uncommitted bank lines of credit of $40.0 million available
at variable interest rates. The average amount drawn on these lines of credit
during the first nine months of 2000 was $44 thousand at a weighted-average
interest rate of 6.38%. The average amount drawn on these lines of credit during
1999 was $1.5 million at a weighted-average interest rate of 5.12%. As of
September 30, 2000 and December 31, 1999, 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, 2000 and December 31, 1999, no
such notes were issued or outstanding.
5. During 1997, a judgment was entered against the Company in the U.S.
District Court for the Western District of Pennsylvania. The case was brought
against the Company by Mellon Bank (Mellon) in connection with a potential bid
to provide electronic benefit transfer (EBT) services for the Southern Alliance
of States. In September 1997, the Company recorded a pretax charge of $40
million to reserve for this judgment and other related costs. In January 1999,
the United States Court of Appeals for the Third Circuit affirmed the judgment
of the district court and the Company paid $32.2 million to Mellon in February
1999. The portion of the reserve remaining after the payment of this judgment
($2.1 million) was reversed and is reflected in other income in the consolidated
statement of income for the nine months ended September 30, 1999.
6. During the third quarter of 1999, the Company entered into a $42.5
million sale-leaseback transaction whereby the Company sold five existing
facilities in Shoreview, Minnesota and leased back three of these facilities for
periods ranging from five to 10 years. Of the related leases, two were
classified as operating leases and one was classified as a capital lease. An
asset of $11.6 million was recorded for the capital lease and is reflected in
buildings and building improvements in the consolidated balance sheets as of
September 30, 2000 and December 31, 1999. The result of this sale was a $17.1
million gain, of which $10.6 million was deferred and is being amortized over
the lease terms in the case of the operating leases and over the life of the
capital asset in the case of the capital lease. $7.1 million and $8.7 million of
the deferred gain is reflected in other long-term liabilities in the September
30, 2000 and December 31, 1999 consolidated balance sheets, respectively. The
Company provided short-term financing for $32.5 million of the proceeds from
this sale. This amount was reflected in prepaid expenses and other current
assets in the December 31, 1999 consolidated balance sheet and was reflected as
loans to others in the consolidated statement of cash flows for the nine months
ended September 30, 1999. The loan was paid in full in January 2000.
7. The Company's consolidated balance sheets reflect restructuring accruals
of $5.1 million and $15.1 million as of September 30, 2000 and December 31,
1999, respectively, for employee severance costs and $1.1 million as of December
31, 1999, for estimated losses on asset dispositions.
During the second quarter of 2000, the Company recorded restructuring
charges of $1.4 million. These charges primarily related to the Paper Payment
Systems segment's transfer of certain data entry functions to the eFunds segment
and administrative reductions within the eFunds segment and assumed the
termination of approximately 185 employees, 30 of which were employed with the
eFunds segment. Additionally, the Company reversed $3.0 million of restructuring
charges relating to the Company's initiative to reduce selling, general and
administrative (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 severance program, employees are provided 60 days 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 this additional amount. In
certain situations, management decided to keep employees working for the 60 day
period and thus, a reduction in the restructuring reserves was required since
this pay was no longer severance, but an
7
<PAGE>
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.
During the first quarter of 1999, restructuring accruals of $2.0 million
were reversed. These reversals related to the Company's decision in 1999 to
retain the international operations of its eFunds segment. During the second
quarter of 1999, restructuring accruals of $4.2 million were reversed. These
amounts related to the Company's initiative to reduce SG&A expense and to
discontinue production of direct mail products. The excess accrual occurred and
was reversed when the Company determined that it was able to use a greater
portion of the direct mail production assets in its ongoing operations than was
originally anticipated. Additionally, excess accruals resulted from changes in
the SG&A expense reduction initiative due to the plan announced in April 1999 to
reorganize the Company into four independently operated business units. Also
during the second quarter of 1999, the Company recorded restructuring accruals
of $0.8 million for employee severance and $0.8 million for estimated losses on
asset dispositions related to the planned closing of one collections office and
planned employee reductions in another collections office within the Company's
collections business which was sold in December 1999. These accrual reversals
and the new restructuring accruals are reflected in the Company's consolidated
statement of income for the nine months ended September 30, 1999 as cost of
sales expense of $0.9 million, a reduction in SG&A expense of $3.2 million and
other income of $2.3 million.
The cumulative activity for the severance portion of the Company's
restructuring accruals as of September 30, 2000 is as follows (dollars in
millions):
<TABLE>
<CAPTION>
SG&A Reductions Collection Ctr
Check Printing & Direct Mail Closing/ Data Entry eFunds
Plant Closings(1) Production(2) Reductions Transfer Reductions Total
----------------- ------------- ---------- -------- ---------- -----
No. of No. of No. of No. of No. of No. of
employees employees employees employees employees employees
affected Amount affected Amount affected Amount affected Amount affected Amount affected Amount
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Original accrual 4,970 $ 68.0 860 $ 21.2 70 $ 0.8 155 $ 0.9 30 $ 0.4 6,085 $ 91.3
Severance paid (4,295) (59.6) (440) (10.8) (70) (0.7) (95) (0.5) (12) (0.2) (4,912) (71.8)
Adjustments to
accrual (545) (5.9) (330) (8.4) -- (0.1) -- -- -- -- (875) (14.4)
-------------------------------------------------------------------------------------------------------------------
Balance,
September 30,
2000 130 $ 2.5 90 $ 2.0 -- $ -- 60 $ 0.4 18 $ 0.2 298 $ 5.1
-------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes charges recorded in 1996 and 1998 for plans to close financial
institution check printing plants and charges recorded in 1996 and 1997 for
reductions in support functions at corporate operations and other businesses,
implementation of a new order processing and customer service system and
implementation of process improvements in the post-press phase of check
production. Implementation of the new order processing and customer service
system is expected to be delayed to early 2001 due to the fact that financial
institutions did not want to implement the system in late 1999 or early 2000 due
to the efforts they were expending on Year 2000 issues.
(2) Includes charges recorded in 1998 for the Company's initiatives to reduce
SG&A expense and discontinue production of direct mail products.
The majority of the remaining severance costs are expected to be paid by
early 2001 with cash generated from the Company's operations.
The remaining accrual for estimated losses on asset dispositions as of
December 31, 1999 related to charges recorded in 1996 and 1998 for plans to
close financial institution check printing plants. These plant closures were
completed during the first quarter of 2000. Through September 30, 2000, losses
of $15.0 million on the disposition of the assets of these plants were applied
against the restructuring reserves.
8. In February 2000, the Company acquired all of the outstanding shares of
Designer Checks for $97.0 million in cash. Designer Checks produces specialty
design checks and related products for direct sale to consumers and is included
in the Company's Paper Payment Systems segment. This acquisition was accounted
for under the purchase method of accounting. Accordingly, the consolidated
financial statements of the Company include the results of this business
subsequent to its acquisition date. The purchase price was allocated to the
assets acquired and liabilities assumed based on their fair values on
8
<PAGE>
the date of purchase. Total cost in excess of net assets acquired in the amount
of $88.8 million is being amortized over 15 years. The effect of this
acquisition was not material to the operations or financial position of the
Company.
9. In March 2000, the Company paid cash of $20.0 million for an
approximately 24% interest in a limited liability company that provides
automated teller machine (ATM) management services. This investment is being
accounted for under the equity method of accounting and is included in other
long-term investments in the Company's consolidated balance sheet as of
September 30, 2000. The difference of $20.0 million between the carrying value
of the investment and the underlying equity in the net assets of the limited
liability company is being accounted for in the same manner as goodwill and is
being amortized over 15 years. The Company's consolidated financial statements
reflect the impact of this investment subsequent to its acquisition date in
other income (expense) within the Company's eFunds segment.
The Company has agreed to make up to $35.0 million of cash available for
supplying ATMs managed by the limited liability company and had supplied $27.9
million of cash for this purpose as of September 30, 2000. This cash is
classified as long-term restricted cash on the Company's consolidated balance
sheet. The Company has also agreed to guarantee equipment leases of up to $3.0
million face value for Canadian customers of the limited liability company and
has indicated that, subject to the mutual agreement of the parties upon
definitive terms and conditions, the Company would be willing to work towards an
arrangement under which it would loan the limited liability company up to $12.0
million to enable it to undertake mutually agreed-upon acquisitions.
10. Effective January 1, 2000, certain of the international operations of
the eFunds segment which had previously reported their results of operations and
financial position on a one-month lag, changed their reporting dates to coincide
with the rest of the Company's subsidiaries. This change, which was made in
conjunction with the implementation of the Company's central accounting and
financial reporting system, will reflect the financial results of these
operations on a more timely basis and will improve operating and planning
efficiencies. The results of operations for this portion of the eFunds segment
for the month of December 1999 were excluded from the Company's consolidated
statements of income and were reflected as an adjustment to retained earnings
during the first quarter of 2000. These operations generated a net loss of $1.1
million in the month of December 1999.
11. During the second quarter of 2000, the Company recorded net charges of
$9.7 million for additional expected future losses on the contracts of the
eFunds segment's EBT business. This amount is reflected in cost of sales in the
Company's consolidated statement of income for the nine months ended September
30, 2000. In April 2000, the Company completed negotiations with the prime
contractor for a state coalition for which the Company provides EBT services.
Prior to this, the Company and the prime contractor were operating without a
binding, legally enforceable contract. The Company increased its accrual for
expected future losses on long-term service contracts by $12.2 million to
reflect the fact that the Company now had a definitive agreement with this
contractor. Although the Company believed that it did not have a legal
obligation to provide services to this coalition, the states included in this
coalition did not have alternate means of delivering benefits under their
entitlement programs. As a result, the Company believed it could not terminate
the provision of services during its contract negotiations with the prime
contractor because any unilateral decision to do so would have subjected the
Company to a substantial risk of litigation by the coalition states, as well as
potential claims by the prime contractor. The execution of the contract allowed
the Company to avoid the possibility that its future losses associated with the
provision of these services would be larger than the charge the Company recorded
if the prime contractor ultimately prevailed on all of the points pursued by it
during negotiations. 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.
12. In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES, which provides guidance on accounting for derivatives
and hedge transactions. This statement is effective for the Company on January
1, 2001. The Company anticipates that the effect of this pronouncement will not
have a material impact on the Company's reported operating results or financial
position.
13. In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS,
which provides guidance in applying generally accepted accounting principles to
revenue recognition in financial statements. Application of this SAB did not
have a material impact on the Company's reported operating results or financial
position.
9
<PAGE>
14. In January 2000, the Company announced that its board of directors
approved a plan to combine its Electronic Payment Systems, Professional Services
and Government Services segments into a separate, independent, publicly traded
company called eFunds Corporation (eFunds). As a result, the Company modified
its internal management reporting in the first half of 2000 and restated its
segment information for prior years to conform to the current operating
structure which presents the business units as two operating segments based on
the nature of the products and services offered by each: Paper Payment Systems
and eFunds. Paper Payment Systems provides checks and related products to
financial institutions, consumers and small businesses. eFunds provides
transaction processing, ATM outsourcing services, decision support and risk
management products and services to financial institutions, retailers,
electronic funds transfer networks, e-commerce providers and government agencies
and offers information technology consulting and business process management
services both on a stand-alone basis and as a complement to its electronic
payments business. In December 1999, the Company sold its collections business.
The results of this business are not included in the Company's segment
information, but are included in the Company's reconciliations to consolidated
amounts. The Company's segments operate primarily in the United States. The
eFunds segment also has some international operations.
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, 1999. In evaluating segment
performance, management focuses on income from operations and earnings before
interest, income taxes, depreciation and amortization (EBITDA). The income from
operations measurement utilized by management excludes special charges (e.g.,
certain restructuring charges, asset impairment charges, certain one-time
charges that management believes are not reflective of on-going operations,
etc.).
During 1999, holding company expenses were allocated to the segments as a
fixed percentage of segment revenues. This allocation included expenses for
various support functions such as human resources, information services and
finance and included depreciation and amortization expense related to holding
company assets. The corresponding corporate asset balances were also allocated
to the segments. During 2000, the majority of the costs for these support
functions were incurred directly by the operating segments. The remaining
holding company expenses were allocated to the segments based on estimates of
the costs which would have been incurred by the operating segments if they were
stand-alone, independent entities. Intersegment sales are generally based on
current market pricing.
Prior to the Company's acquisition of the remaining 50% interest in
HCL-Deluxe, N.V. in April 1999, the results of this business were recorded under
the equity method of accounting. As such, the Company recorded its 50% ownership
of the joint venture's results of operations prior to the acquisition in other
expense in the consolidated statements of income. To be consistent with internal
management reporting, the entire results of the joint venture for the
pre-acquisition period are reflected in the business segment information for the
eFunds segment as if the business had been a consolidated entity.
Segment information for the quarter and nine months ended September 30,
2000 and 1999 is as follows (dollars in thousands):
10
<PAGE>
<TABLE>
<CAPTION>
QUARTER ENDED PAPER PAYMENT TOTAL
SEPTEMBER 30, 2000 SYSTEMS eFUNDS SEGMENTS
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales to external customers $ 314,581 $ 90,366 $ 404,947
Intersegment sales -- 13,637 13,637
Operating income excluding special
charges 77,208 7,717 84,925
Special charges -- 1,338 1,338
Operating income including special
charges 77,208 6,379 83,587
EBITDA 95,649 14,132 109,781
Depreciation and amortization expense 17,523 7,719 25,242
Segment assets 541,396 406,553 947,949
Capital purchases 13,890 11,912 25,802
---------------------------------------------------------------------------------------------
<CAPTION>
QUARTER ENDED PAPER PAYMENT TOTAL
SEPTEMBER 30, 1999 SYSTEMS eFUNDS SEGMENTS
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales to external customers $ 311,519 $ 77,419 $ 388,938
Intersegment sales -- 2,476 2,476
Operating income excluding special
charges 76,069 1,331 77,400
Special charges -- -- --
Operating income including special
charges 76,069 1,331 77,400
EBITDA 92,962 4,232 97,194
Depreciation and amortization expense 15,391 5,771 21,162
Segment assets 512,586 266,305 778,891
Capital purchases 16,842 9,345 26,187
---------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED PAPER PAYMENT TOTAL
SEPTEMBER 30, 2000 SYSTEMS eFUNDS SEGMENTS
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales to external customers $ 954,979 $ 261,150 $1,216,129
Intersegment sales -- 44,078 44,078
Operating income excluding special
charges 235,396 17,426 252,822
Special (recoveries) charges (2,128) 13,912 11,784
Operating income including special
charges 237,524 3,514 241,038
EBITDA 286,459 24,587 311,046
Depreciation and amortization expense 49,063 21,152 70,215
Segment assets 541,396 406,553 947,949
Capital purchases 40,642 27,935 68,577
---------------------------------------------------------------------------------------------
<CAPTION>
NINE MONTHS ENDED PAPER PAYMENT TOTAL
SEPTEMBER 30, 1999 SYSTEMS eFUNDS SEGMENTS
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales to external customers $ 927,178 $ 220,525 $1,147,703
Intersegment sales -- 4,118 4,118
Operating income excluding special
charges 228,274 8,393 236,667
Special charges -- 898 898
Operating income including special
charges 228,274 7,495 235,769
EBITDA 270,478 23,265 293,743
Depreciation and amortization expense 43,069 16,726 59,795
Segment assets 512,586 266,305 778,891
Capital purchases 50,553 26,063 76,616
---------------------------------------------------------------------------------------------
</TABLE>
Segment information reconciles to consolidated amounts as follows (dollars
in thousands):
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------- -------------
NET SALES TO EXTERNAL CUSTOMERS 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total segment net sales to external customers $ 404,947 $ 388,938 $ 1,216,129 $ 1,147,703
Divested businesses not included in segments -- 28,176 -- 94,736
eFunds pre-acquisition elimination -- -- -- (3,406)
-----------------------------------------------------------------------------------------------------------------
Total consolidated net sales to external
customers $ 404,947 $ 417,114 $ 1,216,129 $ 1,239,033
-----------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------- -------------
OPERATING INCOME INCLUDING SPECIAL CHARGES 2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total segment operating income $ 83,587 $ 77,400 $ 241,038 $ 235,769
Divested businesses not included in segments -- (597) -- 978
eFunds pre-acquisition elimination -- -- -- 1,234
Unallocated holding company expenses (6,362) (3,438) (30,443) (9,457)
--------------------------------------------------------------------------------------------------------
Total consolidated operating income $ 77,225 $ 73,365 $ 210,595 $ 228,524
--------------------------------------------------------------------------------------------------------
</TABLE>
Holding company expenses consisted primarily of charges for certain
liabilities that are not allocated to the segments.
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------- -------------
DEPRECIATION AND AMORTIZATION EXPENSE 2000 1999 2000 1999
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total segment depreciation and amortization
expense $ 25,242 $ 21,162 $ 70,215 $ 59,795
Divested businesses not included in segments -- -- -- 2,081
eFunds pre-acquisition elimination -- -- -- (143)
Unallocated holding company expense 62 26 111 78
----------------------------------------------------------------------------------------------------
Total consolidated depreciation and amortization
expense $ 25,304 $ 21,188 $ 70,326 $ 61,811
----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
September 30,
-------------
TOTAL ASSETS 2000 1999
-----------------------------------------------------------------------------------
<S> <C> <C>
Total segment assets $ 947,949 $ 778,891
Assets of divested businesses not included in
segments -- 87,838
Unallocated holding company assets 119,209 141,834
-----------------------------------------------------------------------------------
Total consolidated assets $1,067,158 $1,008,563
-----------------------------------------------------------------------------------
</TABLE>
Unallocated holding company assets consist primarily of cash, investments
and deferred tax assets relating to holding company activities.
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------- -------------
CAPITAL PURCHASES 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total segment capital purchases $ 25,802 $ 26,187 $ 68,577 $ 76,616
Divested businesses not included in segments -- 920 -- 2,212
eFunds pre-acquisition elimination -- -- -- (145)
Holding company capital purchases 19 23 36 39
---------------------------------------------------------------------------------------------------------
Total consolidated capital purchases $ 25,821 $ 27,130 $ 68,613 $ 78,722
---------------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE>
Revenues are attributed to geographic areas based on the location of the
assets and employees producing the revenues. The Company's operations by
geographic area are as follows (dollars in thousands):
<TABLE>
<CAPTION>
NET SALES TO EXTERNAL CUSTOMERS
Quarter Ended Nine Months Ended LONG-LIVED ASSETS
September 30, September 30, September 30,
-------------------------------------------------------------------------------------------------------
2000 1999 2000 1999 2000 1999
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
United States $ 400,676 $ 411,997 $1,203,424 $1,223,630 $ 245,600 $ 310,790
Foreign countries 4,271 5,117 12,705 15,403 6,852 5,595
-------------------------------------------------------------------------------------------------------
Total consolidated $ 404,947 $ 417,114 $1,216,129 $1,239,033 $ 252,452 $ 316,385
-------------------------------------------------------------------------------------------------------
</TABLE>
15. In January 2000, the Company announced that its board of directors
approved a plan to operate the Company's eFunds segment as a separate,
independent, publicly traded company to be called eFunds Corporation. eFunds
issued 5.5 million shares of its common stock to the public in June 2000. Prior
to the initial public offering (IPO), the Company owned 40 million, or 100%, of
eFunds' total outstanding shares. Subsequent to the IPO, the Company continues
to own 40 million shares of eFunds common stock, representing 87.9% of eFunds'
total outstanding common 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. The Company also recorded charges of
$7.2 million for payments which must be made to certain officers of the Company
under change of control and executive employment agreements. These charges are
reflected in SG&A expense in the Company's consolidated statement of income for
the nine months ended September 30, 2000.
In October 2000, the Company announced that it plans to distribute all of
its shares of eFunds common stock to its shareholders through a spin-off
transaction rather than by an exchange offer, or split-off, as had been
previously announced. The 40 million shares of eFunds common stock currently
owned by the Company will now be distributed on a designated distribution date
to every Deluxe shareholder of record on a designated record date. Each
shareholder will receive a fixed number of eFunds shares for each Deluxe share
owned. Because the Company is planning to spin-off eFunds, the issuance of
eFunds common stock in June 2000 was treated as a capital transaction under the
guidance of Staff Accounting Bulletin No. 51, ACCOUNTING FOR SALES OF STOCK BY A
SUBSIDIARY.
The Company's plans for a spin-off are subject to receiving confirmation
from the Internal Revenue Service (IRS) that the spin-off will be tax-free to
the Company and to its shareholders for U.S. federal income tax purposes. The
Company has the sole discretion to determine whether to proceed with the
spin-off and to determine the timing and other aspects of the transaction.
Subject to these conditions, the Company plans to complete the spin-off on or
before December 31, 2000. The Company has submitted a request to the IRS for
confirmation that the spin-off will be tax-free to the Company and to its
shareholders for U.S. federal income tax purposes. The Company cannot be certain
when or whether it will receive this confirmation from the IRS, or that the
distribution by the Company will be completed. If consummated, the Company would
recognize the distribution of eFunds stock as a reduction of retained earnings
and would reflect eFunds results of operations as discontinued operations in the
Company's consolidated financial statements. If the Company does not complete
the spin-off, it will continue to control eFunds and the Company and eFunds may
not realize the anticipated benefits from the separation of the two companies.
In connection with the eFunds' IPO and the planned spin-off, the Company
and eFunds have entered into various agreements that address the allocation of
assets and liabilities between them and that define their relationship after the
separation. The agreements relate to matters such as consummation of the IPO and
the distribution of eFunds stock, registration rights for the Company,
intercompany loans, information technology consulting, business process
management services, indemnification, data sharing, real estate matters, tax
sharing and transition services. For transition services, eFunds will compensate
the Company for providing services and will negotiate for third-party rates
after the transition arrangements terminate. The transition period varies
depending on the agreement, but many transition services will terminate upon the
distribution of eFunds stock. Some of the transition agreements may be extended
beyond the initial transition period. Additionally, the Company has agreed to
indemnify eFunds for future losses arising from any litigation based on the
conduct
14
<PAGE>
of the EBT and medical eligibility verification businesses prior to eFunds' IPO
in June 2000, and from future losses on identified loss contracts in excess of
the Company's $29.2 million accrual for contract losses as of April 30, 2000.
The indemnification obligation does not apply to losses covered by the existing
reserves. The maximum amount of litigation and contract losses for which the
Company will indemnify eFunds is $14.6 million. Prior to the spin-off, any
indemnification payments to eFunds will be treated as capital contributions.
After the spin-off, any indemnification payments to eFunds will be recorded as
other expense in the Company's consolidated statements of income. Through
September 30, 2000, no such indemnification payments have been made.
16. In August 2000, the Company announced an e-commerce growth strategy
that is intended to leverage the Company's personalization and information
management competencies from its core check printing business into other
profitable revenue growth opportunities. The first outcome of this strategy was
PlaidMoon.com, an Internet-based business concept that allowed consumers to
design and purchase personalized items. In October 2000, the Company announced
that it is repositioning its PlaidMoon.com business concept within its Paper
Payment Systems segment. Instead of being a stand-alone business as had been
planned, PlaidMoon.com will be folded into existing businesses. The
PlaidMoon.com web site will be inactive while it is being repositioned. The
Company is currently evaluating to what extent the long-lived assets and
employees of this business will be utilized by the Company's Paper Payment
Systems segment. It is possible that this evaluation could result in asset
impairment and restructuring charges in the fourth quarter of 2000.
17. In October 2000, the Company announced that by the beginning of 2001 it
will begin outsourcing the eFunds segment's consumer voice inquiry operations
relating to Chex Systems records. Approximately 300 eFunds employees are
impacted by this decision. Although some of these employees may not find other
positions within eFunds, the Company does not expect to record a significant
restructuring charge in the fourth quarter of 2000 as a result of this
initiative.
18. Certain prior period amounts have been reclassified to conform with the
current year presentation. These changes had no impact on previously reported
results of operations or shareholders' equity.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Company Profile
We have organized our businesses into two operating segments based on the
nature of the products and services offered by each: Paper Payment Systems and
eFunds. Paper Payment Systems provides checks and related products to financial
institutions, consumers and small businesses. eFunds provides transaction
processing, automated teller machine (ATM) outsourcing services, decision
support and risk management products and services to financial institutions,
retailers, electronic funds transfer networks, e-commerce providers and
government agencies and offers information technology consulting and business
process management services both on a stand-alone basis and as a complement to
its electronic payments business. In December 1999, we sold our collections
business, NRC Holding Corporation and its subsidiaries. Our segments operate
primarily in the United States. The eFunds segment also has some international
operations.
In January 2000, we announced that our board of directors approved a plan
to combine the businesses within the eFunds segment into a separate,
independent, publicly traded company called eFunds Corporation. eFunds issued
5.5 million shares to the public in June 2000. Prior to this initial public
offering (IPO), we owned 40 million, or 100%, of eFunds' total outstanding
shares. Subsequent to the IPO, we continue to own 40 million eFunds shares,
representing 87.9% of eFunds' total outstanding shares. eFunds' proceeds from
the IPO totaled $71.5 million ($64.5 million, net of offering expenses).
In October 2000, we announced that we plan to distribute all of our shares
of eFunds common stock to our shareholders through a spin-off transaction rather
than by an exchange offer, or split-off, as had been previously announced. The
40 million shares of eFunds common stock which we currently own will now be
distributed on a designated distribution date to every Deluxe shareholder of
record on a designated record date. Each shareholder will receive a fixed number
of eFunds shares for each Deluxe share owned. Our plans for a spin-off are
subject to confirmation from the Internal Revenue Service (IRS) that the
spin-off will be tax-free to us and to our shareholders for U.S. federal income
tax purposes. We have the sole discretion to determine whether to proceed with
the spin-off and to determine the timing and other aspects of the transaction.
Subject to these conditions, we plan to complete the spin-off on or before
December 31, 2000. We have submitted a request to the IRS for confirmation that
the spin-off will be tax-free to us and to our shareholders for U.S. federal
income tax purposes. We
15
<PAGE>
cannot be certain when or whether we will receive this confirmation from the
IRS, or that the distribution will be completed. If consummated, we would
recognize the distribution of eFunds stock as a reduction of retained earnings
and would reflect eFunds results of operations as discontinued operations in our
consolidated financial statements. If we do not complete the spin-off, we will
continue to control eFunds and we and eFunds may not realize the anticipated
benefits from the separation of the two companies.
In connection with eFunds' IPO and the planned spin-off, we have entered
into various agreements with eFunds that address the allocation of assets and
liabilities between us and that define our relationship after the separation.
These agreements relate to matters such as consummation of the IPO and the
distribution of eFunds stock, our registration rights, intercompany loans,
information technology consulting, business process management services,
indemnification, data sharing, real estate matters, tax sharing and transition
services. An intercompany loan which we have made to eFunds matures at the
earlier of December 31, 2000 or the completion of the spin-off. For transition
services, eFunds will compensate us for providing services and will negotiate
third-party rates after the transition arrangements terminate. The transition
period varies depending on the agreement, but many transition services will
terminate upon the distribution of eFunds stock. Some of the transition
agreements may be extended beyond the initial transition period.
We presently plan to exit the electronic benefits transfer (EBT) and
medical eligibility verification businesses when our current contractual
commitments expire in 2006. During the wind-down period, we intend to continue
to take steps to improve the profitability of the current business, although the
revenues of this business may decline as existing contracts expire.
Additionally, we have agreed to indemnify eFunds for future losses arising from
any litigation based on the conduct of these businesses prior to eFunds' IPO in
June 2000, and from future losses on identified loss contracts in excess of our
$29.2 million accrual for contract losses as of April 30, 2000. The
indemnification obligation does not apply to losses covered by the existing
reserves. The maximum amount of litigation and contract losses for which we will
indemnify eFunds is $14.6 million. Prior to the completion of the spin-off, any
indemnification payments to eFunds will be treated as capital contributions.
After completion of the spin-off, any indemnification payments to eFunds will be
recorded as other expense in our consolidated statements of income. Through
September 30, 2000, no such indemnification payments have been made.
Results of Operations - Quarter and Nine Months Ended September 30, 2000
Compared to the Quarter and Nine Months Ended September 30, 1999
NET SALES - Net sales decreased $12.2 million, or 2.9%, to $404.9 million
during the third quarter of 2000 from $417.1 million during the third quarter of
1999 and decreased $22.9 million, or 1.8%, to $1,216.1 million during the first
nine months of 2000 from $1,239.0 million during the first nine months of 1999.
1999 third quarter sales included $28.2 million of sales from our collections
business which was sold in December 1999, while sales for the first nine months
of 1999 included sales of $94.7 million from this business. With these sales
excluded, net sales increased 4.1% during the third quarter of 2000 and 6.3%
during the first nine months of 2000.
Paper Payment Systems net sales increased $3.1 million, or 1.0%, to
$314.6 million in the third quarter of 2000 from $311.5 million in the third
quarter of 1999. Net sales increased $27.8 million, or 3.0%, to $955.0 million
in the first nine months of 2000 from $927.2 million in the first nine months of
1999. These increases were due, in part, to the acquisition in February 2000 of
Designer Checks which contributed revenues of $14.6 million during the third
quarter of 2000 and $41.3 million during the first nine months of 2000.
Additionally, the segment experienced volume increases in its business forms and
direct checks businesses for the first nine months of 2000 and had increased
revenue per unit for all businesses. A price increase for postage and new
services within its financial institution checks business and a price increase
for phone reorders in its direct checks business contributed to the increase in
revenue per unit. Partially offsetting these improvements was a decrease in
volume for the financial institution checks business due to lost customers. The
loss of business was due primarily to competitive pricing requirements that fell
below the segment's revenue and profitability per unit targets.
eFunds net sales increased $24.1 million, or 30.2%, to $104.0 million in
the third quarter of 2000 from $79.9 million in the third quarter of 1999. Net
sales increased $84.9 million, or 38.5%, to $305.2 million in the first nine
months of 2000 from $220.3 million in the first nine months of 1999. On a full
year pro forma basis, assuming our April 1999 acquisition of the remaining 50%
interest in HCL-Deluxe, N.V occurred on January 1, 1999, net sales increased
$80.6 million, or 35.9%, to $305.2 million in the first nine months of 2000 from
$224.6 million in the first nine months of 1999. These increases were due to
increased transaction processing volumes, offset to some extent by lower fees
for new customers and customers renewing their agreements, increased account
verification inquiry volumes coupled with a price increase, expanded collection
16
<PAGE>
service product offerings and increased utilization of these services. In
September 2000, the eFunds segment entered into a new ATM deployment agreement
that resulted in additional revenue. Additionally, the segment initiated
business process management and information technology consulting services for
our Paper Payment Systems segment in 2000. Excluding intersegment sales on a pro
forma basis, assuming our April 1999 acquisition of the remaining 50% interest
in HCL-Deluxe, N.V. occurred on January 1, 1999, eFunds net sales increased
$13.0 million, or 16.7%, to $90.4 million in the third quarter of 2000 from
$77.4 million in the third quarter of 1999 and increased $40.7 million, or
18.4%, to $261.2 million in the first nine months of 2000 from $220.5 million in
the first nine months of 1999. Partially offsetting these increases, was
slightly lower revenue for the EBT portion of this segment due to the expiration
of one contract.
GROSS MARGIN - Gross margin increased $0.1 million to $229.8 million for
the third quarter of 2000 from $229.7 million for the third quarter of 1999.
Gross margin increased $7.9 million, or 1.1%, to $689.1 million for the first
nine months of 2000 from $681.2 million for the first nine months of 1999. As a
percentage of net sales, gross margin increased to 56.7% for the third quarter
of 2000 from 55.1% for the third quarter of 1999 and increased to 56.7% for the
first nine months of 2000 from 55.0% for the first nine months of 1999. Cost of
sales for the first nine months of 2000 included net charges of $9.7 million for
additional expected future losses on the contracts of the eFunds segment's EBT
business. In April 2000, we completed negotiations with the prime contractor for
a state coalition for which eFunds provides EBT services. Previously, we were
operating without a binding, legally enforceable contract with this contractor.
We increased our accrual for expected future losses on long-term service
contracts by $12.2 million to reflect the fact that we now had a definitive
agreement with this contractor. Although we believed that we did not have a
legal obligation to provide services for the coalition, the states included in
the coalition did not have alternate means of delivering benefits under their
entitlement programs. As a result, we believed we could not terminate the
provision of services during our contract negotiations with the prime contractor
because any unilateral decision to do so would have subjected us to a
substantial risk of litigation by the coalition states, as well as potential
claims by the prime contractor. The execution of this contract allowed us to
avoid the possibility that future losses associated with the provision of these
services would be larger than the charge we recorded if the prime contractor
ultimately prevailed on all of the points pursued by it during negotiations.
Partially offsetting this charge was the reversal of $2.5 million of previously
recorded contract loss accruals resulting from productivity improvements and
cost savings from lower than anticipated telecommunications and interchange
expenses. Excluding the net charges of $9.7 million, our gross margin percentage
would have been 57.5% for the first nine months of 2000. The improvement in
gross margin percentage was partially due to the sale of our collections
business in December 1999. This business had a gross margin percentage of 15.3%
for the third quarter of 1999 and 25.1% for the first nine months of 1999.
Paper Payment Systems gross margin percentage increased to 64.5% for the
third quarter of 2000 from 62.8% for the third quarter of 1999 and increased to
64.8% for the first nine months of 2000 from 62.2% for the same period in 1999.
These increases were due to cost reductions realized from closing financial
institution check printing plants, continuing process improvements within all
businesses and the loss of lower margin customers within the financial
institution checks business. The last of the scheduled check printing plant
closings was completed during the first quarter of 2000, and we consolidated two
facilities into one at the end of the second quarter. We plan to continue our
process improvements and focus on increasing sales of higher margin products
during the remainder of 2000.
eFunds gross margin percentage was 39.0% for the third quarter of 2000 and
38.9% for the third quarter of 1999. For the first nine months of 2000, eFunds
gross margin percentage decreased to 37.3% from 37.8% for the same period in
1999. Cost of sales for the first nine months of 2000 included net charges of
$9.7 million for additional expected future losses on the contracts of the
segment's EBT business. Excluding these charges, eFunds' gross margin percentage
would have been 40.5% for the first nine months of 2000, showing improvement
over 1999. The improvement was due to a shift toward electronic customer
inquiries in the account verification business which generate higher margins,
increased utilization of existing infrastructure, less reliance on
sub-contractors, an increasing portion of work being performed at the India
facilities where margins are higher and the implementation of cost containment
measures within the segment's EBT business. Partially offsetting these
improvements was the new ATM deployment agreement entered into in September
2000. In the third quarter, this agreement exhibited a slight loss.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSE - SG&A expense decreased
$3.8 million, or 2.4%, to $152.5 million during the third quarter of 2000 from
$156.3 million during the third quarter of 1999. SG&A expense increased $25.8
million, or 5.7%, to $478.5 million during the first nine months of 2000 from
$452.7 million during the first nine months of 1999. As a percentage of net
sales, SG&A expense increased to 37.7% during the third quarter of 2000 as
17
<PAGE>
compared to 37.5% during the third quarter of 1999 and increased to 39.3% during
the first nine months of 2000 as compared to 36.5% during the first nine months
of 1999. SG&A expense for the first nine months of 2000 included net
restructuring reversals of $1.6 million, charges of $7.2 million for payments
due to certain officers under change of control and executive employment
agreements, as well as additional charges of $7.2 million for administrative
costs relating to the planned spin-off of the eFunds segment. SG&A expense for
the first nine months of 1999 included net restructuring reversals of $3.2
million. Additionally, the increase in SG&A expense was due to a number of other
factors including the HCL-Deluxe, N.V. and Designer Checks acquisitions, as well
as increased marketing and infrastructure expenses for new and existing
products. These increases were partially offset by the sale of our collections
business in December 1999. The collections business had $4.9 million and $22.8
million of SG&A expense in the third quarter and first nine months of 1999,
respectively.
Paper Payment Systems SG&A expense increased 5.1% in the third quarter of
2000 from the third quarter of 1999 and increased 9.3% for the first nine months
of 2000 from the first nine months of 1999. This reflects increased spending on
Internet commerce infrastructure and additional capabilities for new ventures,
as well as increased marketing expenses for the direct checks business as it
continues to emphasize new customer acquisition. Additionally, the segment
experienced increased SG&A expense due to the acquisition of Designer Checks in
February 2000. Partially offsetting these increases were decreased data entry
costs at the direct checks business due to an improved order entry system, the
continuing roll-out of a new order entry and customer service system at the
financial institution checks business, as well as the net reversal of $2.1
million of restructuring charges in the second quarter of 2000.
eFunds SG&A expense increased 14.8% in the third quarter of 2000 from the
third quarter of 1999 and increased 48.0% for the first nine months of 2000 from
the first nine months of 1999. The increases in SG&A expense were due to several
factors, including the acquisitions of an electronic check conversion company in
February 1999 and HCL-Deluxe, N.V. in April 1999, additional promotional
advertising geared toward creating brand awareness, infrastructure investments
and costs associated with the separation from Deluxe. Additionally, in the first
quarter of 1999 the segment reversed $2.0 million of restructuring accruals from
prior periods related to the decision to retain the international operations of
this segment, reducing SG&A expense for the first nine months of 1999. As a
percentage of net sales, SG&A expense decreased to 32.8% during the third
quarter of 2000 compared to 37.2% during the third quarter of 1999 and increased
to 36.2% during the first nine months of 2000 compared to 33.8% during the first
nine months of 1999.
OTHER INCOME (EXPENSE) - Other income decreased $2.5 million to $1.8
million during the third quarter of 2000 from $4.3 million during the third
quarter of 1999. Other expense was $4.9 million during the first nine months of
2000 compared to other income of $5.0 million during the first nine months of
1999. The decreases were due primarily to higher interest expense and lower
investment income, gains on facility and equipment sales in 1999, as well as the
fact that results for the first nine months of 1999 included the reversals of
$2.1 million of reserves for legal proceedings and $2.3 million of restructuring
reserves.
PROVISION FOR INCOME TAXES - Our effective tax rate for the third quarter
of 2000 was 37.5% compared to 36.9% for the third quarter of 1999. Our effective
tax rate for the first nine months of 2000 was 37.5% compared to 38.0% for the
first nine months of 1999. The decreased rate for the first nine months of the
year was due primarily to decreased state tax expense resulting from various tax
reduction initiatives.
NET INCOME - Net income for the third quarter of 2000 increased $0.3
million, or 0.7%, to $49.4 million from $49.1 million for the third quarter of
1999. Net income decreased $16.3 million, or 11.3%, to $128.6 million for the
first nine months of 2000 from $144.9 million for the first nine months of 1999.
Our improved gross margin was offset by increased SG&A expense related to
Internet commerce spending and other infrastructure investments, increased
marketing expenses within the direct checks and eFunds businesses, increased
goodwill amortization due to acquisitions and costs of the planned eFunds
separation.
Liquidity, Capital Resources and Financial Condition
As of September 30, 2000, we had cash and cash equivalents of $111.7
million. In addition, we had a $10.0 million time deposit pledged as collateral
to support our guarantee of a credit facility available to our Indian
operations. The maturity date of this deposit is December 28, 2000, at which
time the collateral may be renewed or replaced by the agreement of both parties.
We also had $4.8 million of restricted cash that we temporarily hold in
custodial accounts on behalf of clients and had supplied $27.9 million of
restricted cash to ATMs deployed by us. We have agreed with the company who
manages this
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ATM base to make up to $35.0 million of cash available for this purpose. We have
also agreed to guarantee equipment leases of up to $3.0 million face value for
Canadian customers of this company and we have indicated that, subject to mutual
agreement of the parties upon definitive terms and conditions, we would be
willing to work towards an arrangement under which we would loan this company up
to $12.0 million to enable it to undertake mutually agreed-upon acquisitions.
These obligations will continue to be eFunds' obligations upon completion of the
separation of eFunds from Deluxe.
Our working capital on September 30, 2000 was a negative $64.7 million
compared to a positive $14.1 million on December 31, 1999. The current ratio on
September 30, 2000 and December 31, 1999 was 0.9 to 1 and 1.0 to 1,
respectively. The decreases in working capital and the current ratio were
primarily due to the fact that formerly long-term debt of $100.0 million is
payable in February 2001. Thus, the debt is included in current liabilities on
the consolidated balance sheet at September 30, 2000. Cash provided by
operations represents our primary source of working capital and the source for
financing capital expenditures and paying cash dividends. We believe that cash
generated from operations and from our current credit facilities is sufficient
to sustain our existing operations.
Cash provided by operating activities was $192.8 million during the first
nine months of 2000 compared to $139.0 million during the first nine months of
1999. The increase in 2000 was primarily due to the payment of $32.2 million in
February 1999 resulting from a judgment in a lawsuit involving the eFunds
segment and the increase in restricted cash in 1999. Partially offsetting these
items was an increase in eFunds accounts receivable in 2000 due to increased
sales volume, as well as the fact that 1999 operating cash flow reflected a
large decrease in accounts receivable. As the result of a management plan to
drive a reduction in accounts receivable and maximize working capital, we saw a
significant decrease in accounts receivable in 1999 due to an increase in
Automated Clearing House (ACH) processing of cash receipts within the Paper
Payment Systems segment.
Cash used in investing activities was $171.3 million during the first nine
months of 2000 compared to $66.5 million during the same period in 1999. The
most significant use of cash for investing activities was the payment of $116.0
million during the first nine months of 2000 to complete the acquisition of
Designer Checks and to purchase an investment interest in a limited liability
company. We paid $35.7 million during the first nine months of 1999 to complete
two acquisitions. Purchases of capital assets totaled $68.6 million during the
first nine months of 2000 and $78.7 million during the same period in 1999.
Sources of investing cash flows were the sales of businesses and capital assets.
These activities generated investing cash inflows of $14.8 million during the
first nine months of 2000 and $75.9 million during the same period in 1999.
Additionally, during the first nine months of 1999, we used $32.5 million of
cash to provide short-term financing on sales of facilities. We collected that
cash in early 2000. We estimate that capital expenditures, including the capital
expenditures of eFunds, will be approximately $90.0 to $100.0 million in 2000.
Cash used in financing activities was $46.1 million during the first nine
months of 2000 and $285.6 million during the same period in 1999. During the
first nine months of 1999, we used cash of $216.7 million to repurchase our
common stock. Additionally, we used cash of $116.0 million during the first nine
months of 2000 and $95.9 million during the first nine months of 1999 to repay
debt and pay dividends to shareholders. The primary sources of cash from
financing activities were the sale of approximately 12% of eFunds shares to the
public in June 2000 and the issuance of shares to employees under our stock
purchase plan. The sale of eFunds common stock provided cash of $64.5 million in
2000. Common stock issued to employees generated financing cash inflows of $6.5
million during the first nine months of 2000 and $25.7 million during the same
period in 1999. Additionally, during the first nine months of 1999, we had net
short-term borrowings of $1.4 million.
As of September 30, 2000, we had committed lines of credit for $450.0
million available for borrowing and as support for commercial paper. The average
amount drawn on these lines during the first nine months of 2000 was $25.0
million at a weighted-average interest rate of 6.26%. As of September 30, 2000,
no amounts were outstanding under these lines of credit. The average amount
drawn on these lines during 1999 was $39.8 million at a weighted-average
interest rate of 6.39%. As of December 31, 1999, $60.0 million was outstanding
under these lines of credit at an interest rate of 6.39%. As of September 30,
2000, we had $25.0 million of commercial paper outstanding at a weighted-average
interest rate of 6.54%. The average amount of commercial paper outstanding
during the first nine months of 2000 was $6.2 million at a weighted-average
interest rate of 6.57%. No commercial paper was issued during 1999.
We also had a $10.0 million credit facility, denominated in Indian rupees,
available to our Indian operations at the lender's prime interest rate.
Borrowings under this facility are due on demand. This facility is guaranteed by
us and this guarantee is collateralized by a $10.0 million time deposit account
maintained by us with the lending bank. The maturity date
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of this deposit is December 28, 2000, at which time the collateral may be
renewed or replaced by agreement of both parties. The average amount drawn on
this line during the first nine months of 2000 was $4.6 million at a
weighted-average interest rate of 15.77%. As of September 30, 2000, $4.9 million
was outstanding at an interest rate of 15.77%. The average amount drawn on this
line during 1999 was $2.7 million at a weighted-average interest rate of 15.81%.
As of December 31, 1999, $3.1 million was outstanding at an interest rate of
15.81%.
We had uncommitted bank lines of credit of $40.0 million available at
variable interest rates. The average amount drawn on these lines of credit
during the first nine months of 2000 was $44 thousand at a weighted-average
interest rate of 6.38%. The average amount drawn on these lines of credit during
1999 was $1.5 million at a weighted-average interest rate of 5.12%. As of
September 30, 2000 and December 31, 1999, 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. These notes could be used for general corporate
purposes, including working capital, capital expenditures, possible acquisitions
and repayment or repurchase of our outstanding indebtedness and securities. As
of September 30, 2000 and December 31, 1999, no notes were issued or outstanding
under this shelf registration.
Outlook/Recent Developments
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES, which provides guidance on accounting for derivatives
and hedge transactions. This statement is effective for us on January 1, 2001.
We anticipate that the effect of this pronouncement will not have a material
impact on our reported operating results or financial position.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS,
which provides guidance in applying generally accepted accounting principles to
revenue recognition in financial statements. Application of this SAB did not
have a material impact on our reported operating results or financial position.
In August 2000, we announced an e-commerce growth strategy that is intended
to leverage the personalization and information management competencies from our
core check printing business into other profitable revenue growth opportunities.
This strategy involves increased expense and investment in the development of
Internet commerce capabilities for both new ventures and existing
infrastructure. We expect to continue these expenditures into 2001 to create
additional opportunities to offer new types of customized products to
individuals and small businesses and to enhance our Internet ordering
capabilities.
One outcome of our e-commerce growth strategy was PlaidMoon.com, an
Internet-based business concept that allowed consumers to design and purchase
personalized items. In October 2000, we announced that we are scaling back and
repositioning our PlaidMoon.com business concept within our Paper Payment
Systems segment. Instead of being a stand-alone business as had been planned,
PlaidMoon.com will be folded into existing businesses. The PlaidMoon.com web
site will be inactive while it is being repositioned. We are currently
evaluating to what extent the long-lived assets and employees of this business
will be utilized by the Company's Paper Payment Systems segment. It is possible
that this evaluation could result in asset impairment and restructuring charges
in the fourth quarter of 2000.
As we move into 2001, we intend to focus on retaining our existing
customers and obtaining new customers in the direct channel. We intend to invest
in our core check business to retain our financial institution customer base. At
the same time we will target new customers by offering higher levels of quality
and service than our competitors. In the direct checks business, we plan to
increase promotional spending to obtain new customers.
In October 2000, we announced that by the beginning of 2001 we will begin
outsourcing the eFunds segment's consumer voice inquiry operations relating to
Chex Systems records. Approximately 300 eFunds employees are impacted by this
decision. Although some of these employees may not find other positions within
eFunds, we do not expect to record a significant restructuring charge in the
fourth quarter of 2000 as a result of this initiative.
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Item 3. Quantitative and Qualitative Disclosure About Market Risk
As of September 30, 2000, we had an investment portfolio of fixed income
securities, excluding those classified as cash and cash equivalents, of $43.5
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.
We operate internationally, and so we are subject to potentially adverse
movements in foreign currency rate changes. We have not entered into foreign
exchange forward contracts to reduce our exposure to foreign currency rate
changes on intercompany foreign currency denominated balance sheet positions. As
of September 30, 2000, we have borrowed $4.9 million on a line of credit
denominated in Indian rupees. The rupee-denominated funds borrowed are used
exclusively by the business within India to pay for expenses denominated in
Indian rupees.
We are exposed to foreign exchange risk to the extent of adverse
fluctuations in the Indian rupee and British pound. We do not believe that a
change in the Indian rupee or British pound exchange rates of 10% would result
in a material impact on our future earnings, financial position or cash flows.
Historically, the effect of movements in these exchange rates has been
immaterial to our consolidated results.
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PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its annual shareholders' meeting on August 4, 2000.
59,636,620 shares were represented (82.46% of the 72,322,238 shares
outstanding and entitled to vote at the meeting). Four items were considered at
the meeting and the results of the voting were as follows:
1. Election of Directors:
The nominees listed in the proxy statement were: John A. Blanchard
III, Lawrence J. Mosner, Barbara B. Grogan, Stephen P. Nachtsheim,
Calvin W. Aurand, Jr., Donald R. Hollis, Robert C. Salipante, Ronald
E. Eilers. The results were as follows:
Election of Directors For Withhold
--------------------- --- --------
John A. Blanchard III 53,064,561 6,572,059
Lawrence J. Mosner 53,283,420 6,353,200
Barbara B. Grogan 53,305,749 6,330,871
Stephen P. Nachtsheim 53,325,033 6,311,587
Calvin W. Aurand, Jr. 53,302,392 6,334,228
Donald R. Hollis 53,318,556 6,318,064
Robert C. Salipante 52,696,061 6,940,559
Ronald E. Eilers 53,307,899 6,328,721
2. Adoption of the Deluxe Corporation 2000 Annual Incentive Plan:
For: 41,312,593
Against: 17,285,432
Abstain: 1,038,595
3. Adoption of the Deluxe Corporation 2000 Stock Incentive Plan:
For: 35,411,767
Against: 23,191,244
Abstain: 1,033,609
4. Ratification of the selection of Deloitte & Touche LLP as independent
auditors:
For: 59,007,979
Against: 343,792
Abstain: 284,849
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, letters to shareholders and in oral statements
made by the Company's representatives, the words or phrases "should result,"
"are expected to," "targeted," "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
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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
Amendment No. 2 to its Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 2000.
Earnings Estimates. 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 regarding the
Company's future performance reflects various assumptions. 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. As a result, there can be no assurance that
the Company's performance will be consistent with any management forecasts or
that the variation from such forecasts will not 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 and services, when evaluating the Company's prospective results of
operations.
In addition, representatives of the Company may occasionally comment
publicly 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.
Separation of eFunds. The Company has announced that it plans to
distribute all of its shares of eFunds common stock to its shareholders through
a spin-off transaction rather than by an exchange offer, or split-off, as had
been previously announced. The 40 million shares of eFunds common stock
currently owned by the Company will now be distributed on a designated
distribution date to every Deluxe shareholder of record on a designated record
date. Each shareholder will receive a fixed number of eFunds shares for each
Deluxe share owned. The Company has requested confirmation from the Internal
Revenue Service (IRS) that the spin-off will be tax-free to the Company and to
its shareholders for U.S. federal income tax purposes. The Company has the sole
discretion to determine whether to proceed with the spin-off and to determine
the timing and other aspects of the transaction. Subject to these conditions,
the Company plans to complete the separation of eFunds on or before December 31,
2000. However, the timing of the proposed spin-off and may be affected by
actions of the IRS and, assuming the Company receives the desired confirmation
that the spin-off will be tax-free to the Company and to its shareholders for
U.S. federal income tax purposes, completion of the spin-off could occur
during 2001 rather than during the fourth quarter of 2000. The timing of the
spin-off, if consummated, could have an adverse impact on the Company's ability
to meet profitability and operating earnings targets. Once the split-off occurs,
the results of eFunds will no longer be included in the Company's consolidated
results of operations. Additionally, the Company will incur additional costs
associated with the separation and spin-off of eFunds. These costs will be
expensed in future periods and may adversely affect the Company's ability to
achieve expected levels of profitability
The Company's intentions with respect to eFunds are subject to further
risks and uncertainties, including the ability of eFunds to successfully manage
and complete the integration of three businesses into eFunds, the potential that
the separation
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of the two companies may disrupt one or more of Deluxe's businesses and customer
relationships, and the uncertainty of obtaining confirmation from the IRS, which
is a necessary condition of the spin-off. There can be no assurance that the
separation of the Company and eFunds will result in increased value to the
Company's shareholders for many reasons, including prevailing market conditions
and potential dispositions by holders of the common stock of either company
following the spin-off or that the separation will achieve the desired levels of
efficiency or cost savings in the Company's operations.
The Company cannot be certain that the spin-off will be completed. If the
Company does not complete the separation of eFunds, it will continue to control
eFunds and the Company and eFunds may not realize the anticipated benefits from
the separation of the two companies.
Tax Risks Associated with the Spin-Off of eFunds. The Company has requested
confirmation from the IRS that, for U.S. federal income tax purposes, the
spin-off will be generally tax-free to the Company and to its shareholders. This
confirmation, if received, will be premised on a number of representations and
undertakings made by Deluxe and 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 the Company and to its
shareholders who receive eFunds shares if the IRS determines that any of the
representations made are incorrect or untrue in any respect, or if any
undertakings made are not complied with. If the Company completes the spin-off
and, notwithstanding such confirmation, the spin-off is held to be taxable, both
the Company and its shareholders who receive eFunds shares could be subject to a
material amount of taxes. eFunds will be liable to the Company for any such
taxes incurred by the Company 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
the Company for a portion of any taxes incurred by the Company 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 eFunds or the Company.
eFunds may not, however, have adequate funds to perform its indemnification
obligations. Further, eFunds indemnification obligations are only for the
benefit of the Company and not individual shareholders.
Recent Strategic Initiatives. The Paper Payment Systems segment is
developing and evaluating plans and launching initiatives for future growth.
These plans and initiatives will involve increased expense and investment in the
development of Internet commerce capabilities for both new ventures and existing
infrastructure. There can be no assurance that the amount of this investment
will not exceed the Company's expectations and result in materially increased
levels of expense. Also, as these Internet commerce initiatives involve new
technologies and business methods, are dependent on product and service
innovations and serve new or developing markets, there is no assurance that they
will achieve targeted revenue, profit or cash flow levels or result in positive
returns on the Company's investment. Further, Internet commerce is rapidly
evolving and there is no assurance that the Company's products and services will
achieve acceptance or be competitive with the current or future offerings of
existing or emerging competitors. Internet commerce is also a recent phenomenon
and may not continue to expand as a medium of commerce.
One of the outcomes of this e-commerce strategy was PlaidMoon.com, an
Internet-based business concept that allowed consumers to design and purchase
personalized items. The Company has announced that it is scaling back and
repositioning its PlaidMoon.com business concept within its Paper Payment
Systems segment. Instead of being a standalone business as had been planned,
PlaidMoon.com will be folded into existing businesses. The PlaidMoon.com web
site will be inactive while it is being repositioned. There can be no assurance
that PlaidMoon.com, when repositioned within the Company's other operations,
will achieve desired levels of revenue, profit or cash flow or that reductions
in costs associated with the scaling back or repositioning of PlaidMoon.com or
the suspension of its operations will favorably affect future financial results.
Acquisitions. The Company may consider undertaking one or more significant
acquisitions. The Company cannot predict whether any acquired products,
services, technologies or businesses will contribute to its revenues or earnings
to any material extent. Additionally, 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
goodwill and other intangible assets, and thus, could adversely affect the
Company's business, results of operations and financial condition. Additionally,
the success of any acquisition would depend upon the Company's ability to
effectively integrate the acquired businesses into the Company. 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 the Company has limited or no direct prior experience;
potential loss of key employees of acquired
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businesses or of the Company; potential exposure to unknown liabilities; and
possible loss of customers of the Company or of the acquired businesses.
Tax Limitations on Issuance or Acquisitions of the Company's Shares. The
Company may be limited in the amount of the Company's shares that it can acquire
or issue because the acquisition or issuance of the Company's shares may cause
the planned spin-off of eFunds to be taxable to the Company under Section 355(e)
of the Internal Revenue Code. As a result of such possible adverse tax
consequences, following the spin-off, the Company may be restricted in its
ability to effect certain acquisitions, to issue or repurchase the Company's
shares or to enter into other transactions that would result in a change of
control of the Company.
Consumer Privacy Protection. Laws and regulations relating to consumer
privacy protection could harm the Company's ability to collect and use data,
increase its operating costs or otherwise harm its business. There is an
increasing public concern over consumer privacy rights. The Congress and state
legislatures have adopted and are considering adopting laws and regulations
restricting the purchase, sale and sharing of personal information about
consumers.
The Gramm-Leach-Bliley Act (the Act) imposes significant new consumer
privacy requirements on any entity engaged in the business of providing
financial services, including entities that provide services to financial
institutions. The Act requires covered companies 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.
In addition, the Act requires covered companies to give an opt-out notice
to consumers before sharing consumer information with third parties. The opt-out
notice requirement in the Act is subject to several exceptions for credit
reporting and fraud prevention purposes. Although the Company believes these
exceptions apply to its eFunds segment, government agencies could interpret
their regulations in a manner that could expand the scope of the Act in ways
which could adversely affect eFunds' businesses. In addition, uncertainty over
the scope of the regulations could make financial institutions unwilling to
share consumer-related information with the Company.
Regulations promulgated pursuant to the Act may also limit the Company's
ability to use its direct checks business data in its other businesses,
including the other e-commerce and direct to consumer businesses within the
Paper Payment Systems segment. The impact of the Act and regulations issued
under the Act could have the effect of increasing the Company's 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. The Company is 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 the Company's
business, results of operations and 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 the Company's websites and decrease the demand for the Company's products or
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.
Competition. Although the Company believes it is the leading check printer
in the United States, it faces considerable competition from other smaller
companies in its traditional sales channel to financial institutions, from
direct mail sellers of checks and increasingly, from Internet-based sellers of
checks. From time to time, some of the Company's competitors have reduced the
prices of their products in an attempt to gain volume. The corresponding pricing
pressure placed on the Company has resulted in reduced profit margins for the
Company's check printing business in the past and similar pressures can
reasonably be expected in the future. The Company has also experienced some loss
of business due to its refusal to meet competitive prices that fell below the
Company's revenue per unit and profitability per unit targets. Similar pressures
may result in margin reductions in the future, particularly since the Company
does not believe that it can continue to achieve cost reductions of a magnitude
similar to those it has achieved in recent years. The Company can provide no
assurance that it will
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be able to compete effectively against current and future competitors. Continued
competition could result in price reductions, reduced margins and loss of
customers.
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, electronic and other bill paying services, home banking applications
and Internet-based payment services, are in various stages of maturity or
development and additional systems will likely be introduced. The Company
primarily sells checks for personal and small business use and believes that
there will continue to be a substantial demand for these checks for the
foreseeable future. However, according to Company estimates, growth in total
checks written by individuals and small businesses, the primary purchasers of
the Company's checks, was flat in 1999 and the total number of personal,
business and government checks written in the United States has been in decline
since 1997. The Company believes that the individual and small business segments
of the check industry will eventually decline due to the increasing use of
alternative payment methods. 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 the Company's business, results of
operations and prospects.
The introduction of the alternative payment methodologies described above
has also resulted in an increased interest by third parties in transaction
processing, authorization and verification, as well as other methods of
effecting electronic payments, as a source of revenue. This increased interest
level has led to increased competition for the Company's transaction processing
and authorization businesses. The payment processing industry is characterized
by continuously evolving technology and intense competition. Many participants
in the industry have substantially greater financial, technical and marketing
resources, greater name recognition and a larger installed customer base than
the Company. In addition to current competitors, the Company expects substantial
competition from established and new companies as the e-commerce and Internet
markets continue to develop and expand. There can be no assurance that the
Company's competitors and potential competitors will not succeed in developing
and marketing technologies, services or products that are more accepted in the
marketplace than those offered or envisioned by the Company. Such a development
could result in the loss of significant customers by the Company's eFunds
segment, render the Company's technology and proposed products obsolete or
noncompetitive or otherwise materially hinder the achievement of the growth
targets established for this business unit. Initiatives that may be undertaken
by the Company in connection with Internet commerce-based activities would be
particularly susceptible to these types of competitive risks and the rapid
development and deployment of Internet technologies, products and services may
present unanticipated competitive risks to the Company's current business that
may be material and adverse.
Effect of Financial Institution Consolidation. Mergers, acquisitions and
personnel changes at financial institutions may adversely affect the Company's
business, financial condition and results of operations. 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 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 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 the Company's remaining
customers.
Intellectual Property. Despite efforts by the Company to protect its
intellectual property, third parties may infringe or misappropriate the
Company's 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 the Company's business and ability to compete. The Company relies on a
combination of trademarks, software and know-how. The Company may be required to
spend significant resources to protect its trade secrets and monitor and police
its intellectual property rights.
Third parties may assert infringement claims against the Company 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 participants in Internet commerce. Claims for infringement of
these patents are increasingly becoming a
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subject of litigation. If the Company becomes subject to an infringement claim,
it may be required to modify its products, services and technologies or obtain a
license to permit its continued use of those rights. The Company 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 the Company's business,
operating results and prospects as a result of lost business, increased expense
or being barred from offering its products or implementing its systems or other
business methods. In addition, future litigation relating to infringement claims
could result in substantial costs to the Company and a diversion of management
resources. Adverse determinations in any litigation or proceeding could also
subject the Company to significant liabilities and could prevent the Company
from using or offering some of its products, services or technologies.
Software Defects, Development Delays and Installation Difficulties. All of
the Company's businesses use sophisticated software and computing systems.
Additionally, the Company's eFunds segment often encounters delays when
developing new products and services. The software underlying eFunds' products
and services has occasionally contained and may in the future contain undetected
errors or defects when first introduced or when new versions are released. The
Company may experience difficulties in installing or integrating its
technologies on platforms used by its customers or in new environments, such as
the Internet. Errors or delays in the processing of check orders or electronic
transactions 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.
Although the eFunds segment attempts to limit its potential liability for
warranty claims through disclaimers and limitation-of-liability provisions in
its license and client agreements, the Company cannot be certain that these
measures will be successful in limiting its liability.
Conditions in India. The Company's eFunds segment employs approximately 680
people in India in its software development and business process management
facilities. Political and economic conditions in India could adversely affect
the Company's operations.
The Company's Indian software development and business process management
operations qualify for certain tax incentives. Such incentives generally provide
us with a complete exemption from Indian tax on business income generated
through these facilities through the end of 2008. The Company cannot be certain
that these tax benefits will be continued in the future at their current levels
or at all. If these tax benefits were reduced or eliminated, the Company's taxes
in future periods would likely increase.
Increased Production and Delivery Costs. The Company's contracts with
financial institution customers typically have a term of several years or more
and do not allow the Company to pass through increased production costs to the
financial institutions. Increases in production costs such as labor and paper
could adversely affect the Company's profitability. In addition, events such as
the 1997 United Parcel Services strike can also adversely impact the Company's
margins by imposing higher delivery costs. Competitive pressures may have the
effect of inhibiting the Company's ability to reflect these increased costs in
the prices of its products.
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 could result in production
delays and loss of business.
Environmental Matters. The Company's check printing plants are subject to
many existing and proposed federal and state regulations designed to protect the
environment. In some instances, the Company has owned and operated its check
printing plants prior to the enactment of environmental regulations. The Company
has sold former check printing plants to third parties and in most instances has
agreed to indemnify the current owner of the facility for on-site environmental
liabilities. Although the Company is 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 its check printing
plants, it could be required to spend material amounts for environmental
compliance in the future.
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Sales and Other Taxes. In accordance with current federal, state and local
tax laws, and the constitutional limitations thereon, the Company currently
collects sales, use or similar taxes in state and local jurisdictions where the
Company's direct checks and business forms businesses have a physical presence.
One or more state or local jurisdictions may seek to impose sales tax collection
obligations on the Company and other out-of-state companies which engage in
remote or online commerce. Further, tax laws 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 assert that the Company must collect sales or other
taxes beyond its current practice, it could have a material adverse affect on
the Company's business.
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
----------- ----------- ----------------
2.1 Initial Public Offering and Distribution *
Agreement, dated as of March 31, 2000, by and
between Deluxe and eFunds (incorporated by
reference to Exhibit 2.1 to the Registration
Statement on Form S-1 filed by eFunds with the
Securities and Exchange Commission (the
"Commission") on April 4, 2000, Registration No.
333-33992).
3.1 Articles of Incorporation (incorporated by *
reference to Exhibit 3(A) 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
(the "September 1999 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 Indenture, relating to up to $150,000,000 of debt *
securities (incorporated by reference to Exhibit
4.1 to the Company's Registration Statement on
Form S-3 (33-32279) filed with the Commission on
November 24, 1989).
4.3 Amended and Restated Credit Agreement, dated as of *
July 8, 1997, among the Company, Bank of America
National Trust and Savings Association, as agent,
and the other financial institutions party thereto
related to a $150,000,000 committed line of credit
(incorporated by reference to Exhibit 4.3 to the
Company's Annual Report on Form 10-K for the year
ended December 31, 1997).
4.4 Credit Agreement, dated as of August 30, 1999 (the *
"August 30, 1999 Credit Agreement"), among the
Company, Bank of America, N.A. as the sole and
exclusive administrative agent,
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and the other financial institution party thereto
related to a $500,000,000 revolving credit
agreement (incorporated by reference to Exhibit
4.4 to the September 1999 10-Q).
4.5 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).
10.1 Deluxe Corporation 2000 Annual Incentive Filed herewith
Plan
10.2 Deluxe Corporation 2000 Stock Incentive Plan Filed herewith
10.3 Deluxe Corporation 2000 Employee Stock Filed herewith
Purchase Plan
10.4 Extension of the August 30, 1999 Credit Filed herewith
Agreement, entered into as of August 14,
2000.
10.5 Amendment to Amended and Restated Credit Filed herewith
Agreement dated July 8, 1997, entered into
as of August 14, 2000.
10.6 Severance agreement with Ronald E. Eilers Filed herewith
dated August 19, 1998.
12.4 Statement re: computation of ratios Filed herewith
27.6 Financial Data Schedule for the nine months Filed herewith
ended September 30, 2000
--------------------
*Incorporated by reference
(b) Reports on Form 8-K: None
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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 8, 2000 /s/ J. A. Blanchard III
-------------------------------------
J.A. Blanchard III, President
and Chief Executive Officer
(Principal Executive Officer)
Date: November 8, 2000 /s/ Lois M. Martin
-------------------------------------
Lois M. Martin
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
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INDEX TO EXHIBITS
Exhibit No. Description Page Number
----------- ----------- -----------
10.1 Deluxe Corporation 2000 Annual Incentive Plan
10.2 Deluxe Corporation 2000 Stock Incentive Plan
10.3 Deluxe Corporation 2000 Employee Stock Purchase Plan
10.4 Extension of the August 30, 1999 Credit Agreement,
entered into as of August 14, 2000
10.5 Amendment to Amended and Restated Credit Agreement
dated July 8, 1997, entered into as of August 14,
2000
10.6 Severance agreement with Ronald E. Eilers dated
August 19, 1998
12.4 Statement re: computation of ratios
27.6 Financial Data Schedule for the Nine Months Ended
September 30, 2000
31
