form10q.htm


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 the quarterly period ended September 30, 2010
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________________________ to ________________________
 
Commission file number: 1-7945
 
 
DELUXE CORPORATION
(Exact name of registrant as specified in its charter)

Minnesota
 
41-0216800
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
3680 Victoria St. N., Shoreview, Minnesota
 
55126-2966
(Address of principal executive offices)
 
(Zip Code)
 
(651) 483-7111
(Registrant’s telephone number, including area code) 
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 þ Yes  o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).
þ Yes  o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
     
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  þ No

The number of shares outstanding of registrant’s common stock, par value $1.00 per share, at October 25, 2010 was 51,303,808.
 


 
1

 
 
PART I − FINANCIAL INFORMATION
 
 
Item 1. Financial Statements.
 
DELUXE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share par value)
(Unaudited)
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
             
ASSETS
           
Current Assets:
           
Cash and cash equivalents
  $ 21,091     $ 12,789  
Trade accounts receivable (net of allowances for uncollectible accounts of $4,197 and $4,991, respectively)
    61,624       65,564  
Inventories and supplies
    21,886       22,122  
Deferred income taxes
    11,209       10,841  
Funds held for customers
    40,848       26,901  
Other current assets
    23,913       21,282  
Total current assets
    180,571       159,499  
Long-Term Investments (including $2,073 and $2,231 of investments at fair value, respectively)
    36,917       39,200  
Property, Plant, and Equipment (net of accumulated depreciation of $337,376 and $335,415, respectively)
    119,569       121,797  
Assets Held for Sale
    4,527       4,527  
Intangibles (net of accumulated amortization of $398,929 and $362,201, respectively)
    163,174       145,910  
Goodwill
    725,450       658,666  
Other Non-Current Assets
    94,643       81,611  
Total assets
  $ 1,324,851     $ 1,211,210  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current Liabilities:
               
Accounts payable
  $ 63,584     $ 60,640  
Accrued liabilities
    155,849       156,408  
Short-term debt
    30,000       26,000  
Total current liabilities
    249,433       243,048  
Long-Term Debt
    749,278       742,753  
Deferred Income Taxes
    46,531       24,800  
Other Non-Current Liabilities
    77,196       83,399  
Commitments and Contingencies (Notes 11, 12 and 15)
               
Shareholders’ Equity:
               
Common shares $1 par value (authorized: 500,000 shares; outstanding: 2010 – 51,302; 2009 – 51,189)
    51,302       51,189  
Additional paid-in capital
    61,486       58,071  
Retained earnings
    139,981       60,768  
Accumulated other comprehensive loss
    (50,356 )     (52,818 )
Total shareholders’ equity
    202,413       117,210  
Total liabilities and shareholders’ equity
  $ 1,324,851     $ 1,211,210  
 
See Condensed Notes to Unaudited Consolidated Financial Statements
 
 
2

 
 
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(Unaudited)
 
   
Quarter Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenue
  $ 367,633     $ 332,297     $ 1,050,749     $ 1,003,887  
Cost of goods sold, including restructuring charges
    121,433       121,911       361,736       378,135  
Gross Profit
    246,200       210,386       689,013       625,752  
                                 
Selling, general and administrative expense
    157,589       153,999       466,319       464,085  
Net restructuring charges
    103       1,838       2,011       1,953  
Asset impairment charges
                      24,900  
Operating Income
    88,508       54,549       220,683       134,814  
                                 
Gain on early debt extinguishment
                      9,834  
Interest expense
    (11,207 )     (11,495 )     (33,250 )     (35,542 )
Other income (expense)
    383       170       (1,017 )     734  
Income Before Income Taxes
    77,684       43,224       186,416       109,840  
                                 
Income tax provision
    26,512       14,669       67,846       41,004  
Income From Continuing Operations
    51,172       28,555       118,570       68,836  
                                 
Net Loss From Discontinued Operations
    (372 )           (771 )      
Net Income
  $ 50,800     $ 28,555     $ 117,799     $ 68,836  
                                 
Basic Earnings Per Share:
                               
Income from continuing operations
  $ 0.99     $ 0.56     $ 2.31     $ 1.34  
Net loss from discontinued operations
    (0.01 )           (0.02 )      
Basic earnings per share
    0.99       0.56       2.29       1.34  
                                 
Diluted Earnings Per Share:
                               
Income from continuing operations
  $ 0.99     $ 0.56     $ 2.30     $ 1.34  
Net loss from discontinued operations
    (0.01 )           (0.01 )      
Diluted earnings per share
    0.98       0.56       2.28       1.34  
                                 
Cash Dividends Per Share
  $ 0.25     $ 0.25     $ 0.75     $ 0.75  
                                 
Total Comprehensive Income
  $ 52,369     $ 31,908     $ 120,261     $ 79,008  
 
See Condensed Notes to Unaudited Consolidated Financial Statements

 
3

 
 
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
   
Nine Months Ended
 
   
September 30,
 
   
2010
   
2009
 
Cash Flows From Operating Activities:
           
Net income
  $ 117,799     $ 68,836  
Adjustments to reconcile net income to net cash provided by operating activities of continuing operations:
               
Net loss from discontinued operations
    771        
Depreciation
    15,728       17,174  
Amortization of intangibles
    38,935       33,794  
Asset impairment charges
          24,900  
Amortization of contract acquisition costs
    14,696       18,523  
Deferred income taxes
    7,164       7,565  
Employee share-based compensation expense
    4,548       5,498  
Gain on early debt extinguishment
          (9,834 )
Other non-cash items, net
    9,024       11,573  
Changes in assets and liabilities, net of effects of acquisitions and discontinued operations:
               
Trade accounts receivable
    1,889       1,420  
Inventories and supplies
    (294 )     933  
Other current assets
    (249 )     (3,351 )
Non-current assets
    1,974       4,486  
Accounts payable
    (2,502 )     2,054  
Contract acquisition payments
    (13,837 )     (17,941 )
Other accrued and non-current liabilities
    (25,162 )     (15,422 )
Net cash provided by operating activities of continuing operations
    170,484       150,208  
                 
Cash Flows From Investing Activities:
               
Purchases of capital assets
    (31,613 )     (35,006 )
Payments for acquisitions, net of cash acquired
    (98,621 )     (30,825 )
Purchases of customer lists
    (70 )     (1,639 )
Purchases of marketable securities
    (8 )     (4,575 )
Proceeds from sales of marketable securities
    1,970       914  
Proceeds from life insurance policies
    5,782        
Other
    (1,805 )     (1,813 )
Net cash used by investing activities of continuing operations
    (124,365 )     (72,944 )
                 
Cash Flows From Financing Activities:
               
Net proceeds (payments) on short-term debt
    4,000       (14,700 )
Payments on long-term debt
          (22,627 )
Payments for debt issue costs, credit facility
    (2,361 )      
Change in book overdrafts
    (1,595 )     (4,577 )
Proceeds from issuing shares under employee plans
    3,078       1,972  
Excess tax benefit from share-based employee awards
    396       37  
Payments for common shares repurchased
    (2,999 )     (1,319 )
Cash dividends paid to shareholders
    (38,586 )     (38,452 )
Net cash used by financing activities of continuing operations
    (38,067 )     (79,666 )
                 
Effect Of Exchange Rate Change On Cash
    250       1,453  
Cash Used By Operating Activities Of Discontinued Operations
          (470 )
Cash Used By Investing Activities Of Discontinued Operations
          (30 )
                 
Net Change In Cash And Cash Equivalents
    8,302       (1,449 )
Cash And Cash Equivalents:     Beginning Of Period
    12,789       15,590  
End Of Period
  $ 21,091     $ 14,141  

See Condensed Notes to Unaudited Consolidated Financial Statements

 
4

 

DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 1: Consolidated financial statements

The consolidated balance sheet as of September 30, 2010, the consolidated statements of income for the quarters and nine months ended September 30, 2010 and 2009 and the consolidated statements of cash flows for the nine months ended September 30, 2010 and 2009 are unaudited. The consolidated balance sheet as of December 31, 2009 was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles (GAAP) in the United States of America. In the opinion of management, all adjustments necessary for a fair statement of the consolidated financial statements are included. Adjustments consist only of normal recurring items, except for any discussed in the notes below. 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 our annual consolidated financial statements and notes. The consolidated financial statements and notes appearing in this report should be read in conjunction with the consolidated audited financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”).


Note 2: New accounting pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This guidance requires new disclosures and clarifies some existing disclosure requirements regarding fair value measurements. The disclosures required under this guidance are included in Note 5, with the exception of disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements. Those disclosures, if applicable to us, will be effective for our quarterly report on Form 10-Q for the quarter ending March 31, 2011.

In February 2010, the FASB issued Accounting Standards Update No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements. This guidance removes the requirement to disclose the date through which subsequent events have been evaluated in both issued and revised financial statements for companies that file financial statements with the Securities and Exchange Commission (SEC). This new guidance was effective immediately. We evaluate subsequent events through the date our financial statements are filed with the SEC.


Note 3: Supplemental balance sheet information

Inventories and supplies – Inventories and supplies were comprised of the following:

(in thousands)
 
September 30,
2010
   
December 31,
2009
 
Raw materials
  $ 4,543     $ 4,048  
Semi-finished goods
    8,480       8,750  
Finished goods
    5,469       5,602  
Total inventories
    18,492       18,400  
Supplies, primarily production
    3,394       3,722  
Inventories and supplies
  $ 21,886     $ 22,122  

 
5

 

Marketable securities – Available-for-sale marketable securities included within funds held for customers and other current assets were comprised of the following:

   
September 30, 2010
 
(in thousands)
 
Cost
   
Gross unrealized gains
   
Gross unrealized losses
   
Fair value
 
Corporate investments:
                       
Money market securities
  $ 1,962     $     $     $ 1,962  
Funds held for customers:(1)
                               
Money market securities
    4,906                   4,906  
Canadian and provincial government securities
    4,963       75             5,038  
Marketable securities – funds held for customers
    9,869       75             9,944  
Total marketable securities
  $ 11,831     $ 75     $     $ 11,906  

(1) Funds held for customers, as reported on the consolidated balance sheet as of September 30, 2010, also included cash and cash equivalents of $30,904.

   
December 31, 2009
 
(in thousands)
 
Cost
   
Gross unrealized gains
   
Gross unrealized losses
   
Fair value
 
Corporate investments:
                       
Money market securities
  $ 3,667     $     $     $ 3,667  
Funds held for customers:(1)
                               
Money market securities
    9,522                   9,522  
Total marketable securities
  $ 13,189     $     $     $ 13,189  

(1) Funds held for customers, as reported on the consolidated balance sheet as of December 31, 2009, also included cash and cash equivalents of $17,379.

Expected maturities of available-for-sale securities as of September 30, 2010 were as follows:

(in thousands)
 
Fair value
 
Due in one year or less
  $ 6,996  
Due in one to three years
    2,109  
Due in three to five years
    346  
Due after five years
    2,455  
Total marketable securities
  $ 11,906  

Further information regarding the fair value of marketable securities can be found in Note 5: Fair value measurements.

 
6

 

Intangibles – Intangibles were comprised of the following:

   
September 30, 2010
   
December 31, 2009
 
(in thousands)
 
Gross carrying amount
   
Accumulated amortization
   
Net carrying amount
   
Gross carrying amount
   
Accumulated amortization
   
Net carrying amount
 
Indefinite-lived:
                                   
Trade name
  $ 19,100     $     $ 19,100     $ 19,100     $     $ 19,100  
Amortizable intangibles:
                                               
Internal-use software
    373,109       (306,875 )     66,234       341,822       (285,181 )     56,641  
Customer lists/relationships
    71,079       (38,146 )     32,933       55,745       (25,777 )     29,968  
Trade names
    59,361       (21,139 )     38,222       51,861       (20,375 )     31,486  
Distributor contracts
    30,900       (25,945 )     4,955       30,900       (24,594 )     6,306  
Other
    8,554       (6,824 )     1,730       8,683       (6,274 )     2,409  
Amortizable intangibles
    543,003       (398,929 )     144,074       489,011       (362,201 )     126,810  
Intangibles
  $ 562,103     $ (398,929 )   $ 163,174     $ 508,111     $ (362,201 )   $ 145,910  

Total amortization of intangibles was $14.2 million for the quarter ended September 30, 2010 and $10.7 million for the quarter ended September 30, 2009. Amortization of intangibles was $38.9 million for the nine months ended September 30, 2010 and $33.8 million for the nine months ended September 30, 2009. Based on the intangibles in service as of September 30, 2010, estimated future amortization expense is as follows:

(in thousands)
     
Remainder of 2010
  $ 15,291  
2011
    41,026  
2012
    21,778  
2013
    11,842  
2014
    7,998  

Goodwill – Changes in goodwill during the nine months ended September 30, 2010 were as follows:

(in thousands)
 
Small Business Services
   
Financial Services
   
Direct Checks
   
 
Total
 
Balance, December 31, 2009:
                       
Goodwill
  $ 596,429     $     $ 82,237     $ 678,666  
Accumulated impairment charges
    (20,000 )                 (20,000 )
      576,429             82,237       658,666  
Acquisition of Custom Direct, Inc. (see Note 7)
                65,843       65,843  
Acquisition of Cornerstone Customer Solutions, LLC (see Note 7)
          897             897  
Currency translation adjustment
    44                   44  
Balance, September 30, 2010:
                               
Goodwill
    596,473       897       148,080       745,450  
Accumulated impairment charges
    (20,000 )                 (20,000 )
    $ 576,473     $ 897     $ 148,080     $ 725,450  

 
7

 

Other non-current assets – Other non-current assets were comprised of the following:

(in thousands)
 
September 30,
2010
   
December 31,
2009
 
Contract acquisition costs (net of accumulated amortization of $94,840 and $107,971, respectively)
  $ 55,159     $ 45,701  
Deferred advertising costs
    15,738       14,455  
Other
    23,746       21,455  
Other non-current assets
  $ 94,643     $ 81,611  

See Note 15 for discussion of the risks associated with the recoverability of contract acquisition costs. Changes in contract acquisition costs during the first nine months of 2010 and 2009 were as follows:

   
Nine Months Ended September 30,
 
(in thousands)
 
2010
   
2009
 
Balance, beginning of year
  $ 45,701     $ 37,706  
Additions(1)
    24,388       31,380  
Amortization
    (14,696 )     (18,523 )
Write-offs
    (234 )      
Balance, end of period
  $ 55,159     $ 50,563  

(1) Contract acquisition costs are accrued upon contract execution. Cash payments made for contract acquisition costs were $13,837 for the nine months ended September 30, 2010 and $17,941 for the nine months ended September 30, 2009.

Accrued liabilities – Accrued liabilities were comprised of the following:
 
(in thousands)
 
September 30,
2010
   
December 31,
2009
 
Funds held for customers
  $ 40,605     $ 26,901  
Employee profit sharing and pension
    26,022       36,594  
Customer rebates
    22,859       21,861  
Interest
    15,817       5,227  
Contract acquisition payments due within one year
    9,883       2,795  
Wages, including vacation
    8,763       5,272  
Deferred revenue
    7,614       23,720  
Restructuring due within one year (see Note 8)
    2,021       11,151  
Other
    22,265       22,887  
Accrued liabilities
  $ 155,849     $ 156,408  


Note 4: Derivative financial instruments

In September 2009, we entered into interest rate swaps with a notional amount of $210.0 million to hedge against changes in the fair value of a portion of our ten-year bonds due in 2012. We entered into these swaps, which we designated as fair value hedges, to achieve a targeted mix of fixed and variable rate debt, where we receive a fixed rate and pay a variable rate based on the London Interbank Offered Rate (LIBOR). Changes in the fair value of the interest rate swaps and the related long-term debt are included in interest expense in the consolidated statements of income. When the change in the fair value of the interest rate swaps and the hedged debt are not equal (i.e., hedge ineffectiveness), the difference in the changes in fair value affects the reported amount of interest expense in our consolidated statements of income. Hedge ineffectiveness was not significant for the quarters or nine months ended September 30, 2010 and 2009. The fair value of the interest rate swaps was an asset of $6.6 million as of September 30, 2010, which is included in other non-current assets on the consolidated balance sheet. As of December 31, 2009, the fair value of the interest rate swaps was a liability of $0.2 million, which is included in other non-current liabilities on the consolidated balance sheet. See Note 5 for further information regarding the fair value of these instruments.

 
8

 

Note 5: Fair value measurements

2010 acquisition – During April 2010, we acquired all of the outstanding stock of Custom Direct, Inc. (see Note 7). With the exception of goodwill and deferred income taxes, we were required to measure the fair value of the net identifiable tangible and intangible assets and liabilities acquired. The identifiable net assets acquired (excluding goodwill) were comprised primarily of a customer list, internal-use software and trade names. The fair value of the customer list was estimated using the multi-period excess earnings method. Assumptions used in this calculation included a same-customer revenue growth rate and an estimated annual customer retention rate. The customer retention rate was based on estimated re-order rates, as well as management’s estimates of the costs to obtain and retain customers. The calculated fair value of the customer list was $15.0 million, which is being amortized over 1.3 years using an accelerated method. The fair value of the internal-use software was estimated using a cost of reproduction method. The primary components of the software were identified and the estimated cost to reproduce the software was calculated based on estimated time and labor rates derived from our historical data from previous upgrades of similar size and nature. The calculated fair value of the internal-use software was $12.6 million, which is being amortized on the straight-line basis over a weighted average useful life of 4.7 years. The fair value of the trade names was estimated using a relief from royalty method, which calculates the cost savings associated with owning rather than licensing the trade names. An assumed royalty rate was applied to forecasted revenue and the resulting cash flows were discounted. The assumed royalty rate was based on market data and an analysis of the expected margins for Custom Direct’s operations. The calculated fair value of the trade names was $8.9 million, which is being amortized on the straight-line basis over 10 years.

2010 asset impairment analysesWe evaluate the carrying value of our indefinite-lived trade name and goodwill as of July 31st of each year and between annual evaluations if events occur or circumstances change that would indicate a possible impairment. During the quarter ended September 30, 2010, we completed the annual impairment analyses of our indefinite-lived trade name and goodwill. The calculated fair value of the indefinite-lived trade name was estimated to be $24.1 million as of the measurement date, compared to its carrying value of $19.1 million. In our analysis of goodwill, the estimated fair value of each reporting unit as of the measurement date exceeded its carrying amount. As such, no impairment charges were recorded as a result of our 2010 annual impairment analyses. See further information regarding our impairment analyses in Note 15.

2009 asset impairment analysesDuring the quarter ended March 31, 2009, we experienced continued declines in our stock price, as well as a continuing negative impact of the economic downturn on our expected operating results. Based on these indicators of potential impairment, we completed impairment analyses of our indefinite-lived trade name and goodwill as of March 31, 2009.

The estimate of fair value of our indefinite-lived trade name is based on a relief from royalty method, which calculates the cost savings associated with owning rather than licensing the trade name. An assumed royalty rate is applied to forecasted revenue and the resulting cash flows are discounted. If the estimated fair value is less than the carrying value of the asset, an impairment loss is recognized. During the quarter ended March 31, 2009, we recorded a non-cash asset impairment charge in our Small Business Services segment of $4.9 million related to our indefinite-lived trade name.

A two-step approach is used in evaluating goodwill for impairment. First, we compare the fair value of the reporting unit to which the goodwill is assigned to the carrying amount of its net assets. In calculating fair value, we use the income approach. The income approach is a valuation technique under which we estimate future cash flows using the reporting unit’s financial forecast from the perspective of an unrelated market participant. Future estimated cash flows are discounted to their present value to calculate fair value. During the quarter ended March 31, 2009, the carrying value of the net assets of one of our reporting units exceeded the estimated fair value. As such, the second step of the goodwill impairment analysis required that we compare the implied fair value of the goodwill to its carrying amount. In calculating the implied fair value of the goodwill, we measured the fair value of the reporting unit’s assets and liabilities, excluding goodwill. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities, excluding goodwill, is the implied fair value of the reporting unit’s goodwill. Significant intangible assets of the reporting unit identified for purposes of this impairment analysis included the indefinite-lived trade name discussed above and a distributor contract intangible asset. The fair value of the distributor contract was measured using the income approach, including adjustments for an estimated distributor retention rate based on historical experience. As a result of our analysis, we recorded a non-cash asset impairment charge during the quarter ended March 31, 2009 in our Small Business Services segment of $20.0 million related to goodwill.

 
9

 

Information regarding the nonrecurring fair value measurements completed during the quarter ended March 31, 2009 was as follows:

         
Fair value measurements using
       
(in thousands)
 
Fair value as of measurement date
   
Quoted prices in active markets for identical assets
(Level 1)
   
Significant other observable inputs
(Level 2)
   
Significant unobservable inputs
(Level 3)
   
Impairment charge
 
Goodwill(1)
  $ 20,245     $     $     $ 20,245     $ 20,000  
Indefinite-lived trade name(2)
    19,100                   19,100       4,900  
Total impairment charges
                                  $ 24,900  

(1) Represents the implied fair value of the goodwill assigned to the reporting unit for which we were required to calculate this amount.

(2) Represents the fair value determined from the event-driven impairment analysis completed during the quarter ended March 31, 2009.

Recurring fair value measurements – We held, as corporate investments, available-for-sale marketable securities of $2.0 million as of September 30, 2010 and $3.7 million as of December 31, 2009. These investments are included in other current assets on the consolidated balance sheets. The fair value of these assets is determined based on quoted prices in active markets for identical assets. Because of the short-term nature of the underlying investments, the cost of these securities approximates their fair value. The cost of securities sold is determined using the average cost method. No gains or losses on sales of marketable securities were realized during the quarters or nine months ended September 30, 2010 and 2009.

Funds held for customers included available-for-sale marketable securities of $9.9 million as of September 30, 2010 and $9.5 million as of December 31, 2009. The fair value of these assets is determined based on quoted prices in active markets for identical assets. Unrealized gains and losses, net of tax, are included in other comprehensive loss on the consolidated balance sheets. Realized gains and losses are included in revenue on the consolidated statements of income and were not significant for the quarter and nine months ended September 30, 2010 and 2009. The cost of securities sold is determined using the average cost method.

We have elected to account for a long-term investment in domestic mutual funds under the fair value option for financial assets and financial liabilities. Realized and unrealized gains and losses, as well as dividends earned by the investment, are included in selling, general and administrative (SG&A) expense in our consolidated statements of income. This investment corresponds to a liability under an officers’ deferred compensation plan which is not available to new participants and is fully funded by the investment in mutual funds. The liability under the plan equals the fair value of the investment in mutual funds. Thus, as the value of the investment changes, the liability changes accordingly. As changes in the liability are reflected within SG&A expense in the consolidated statements of income, the fair value option of accounting for the investment in mutual funds allows us to net changes in the investment and the related liability in the statements of income. The fair value of this investment is included in long-term investments in the consolidated balance sheets. The long-term investment caption on our consolidated balance sheets also includes life insurance policies which are recorded at their cash surrender values. The cost of securities sold is determined using the average cost method. Unrealized gains recognized on the investment in mutual funds were not significant during the quarter and nine months ended September 30, 2010. We recognized net unrealized gains of $0.2 million during the quarter ended September 30, 2009 and $0.3 million during the nine months ended September 30, 2009. Realized gains and losses recognized during the quarters and nine months ended September 30, 2010 and 2009 were not significant.

The fair value of interest rate swaps (see Note 4) is determined at each reporting date by means of a pricing model utilizing readily observable market interest rates. The change in fair value is determined as the change in the present value of estimated future cash flows discounted using the LIBOR rate applicable to the interest rate swaps. During the quarter ended September 30, 2010, we recognized a gain on these derivative instruments of $1.8 million, which was largely offset by a loss of $1.7 million related to an increase in the fair value of the hedged long-term debt. During the nine months ended September 30, 2010, we recognized a gain on these derivative instruments of $6.8 million, which was partially offset by a loss of $6.3 million related to an increase in the fair value of the hedged long-term debt. During the quarter and nine months ended September 30, 2009, we recognized a gain on these derivative instruments of $0.4 million, which was offset by a loss of $0.4 million related to an increase in the fair value of the hedged long-term debt. These changes in fair value are included in interest expense in the consolidated statements of income for the quarter and nine months ended September 30, 2010 and 2009.

 
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Information regarding recurring fair value measurements completed during each period was as follows:

         
Fair value measurements using
 
(in thousands)
 
Fair value as of September 30, 2010
   
Quoted prices in active markets for identical assets
(Level 1)
   
Significant other observable inputs
(Level 2)
   
Significant unobservable inputs
(Level 3)
 
Marketable securities – funds held for customers
  $ 9,944     $ 9,944     $     $  
Marketable securities – corporate investments
    1,962       1,962              
Long-term investment in mutual funds
    2,073       2,073              
Derivative assets
    6,648             6,648        
 
         
Fair value measurements using
 
(in thousands)
 
Fair value as of December 31, 2009
   
Quoted prices in active markets for identical assets
(Level 1)
   
Significant other observable inputs
(Level 2)
   
Significant unobservable inputs
(Level 3)
 
Marketable securities – funds held for customers
  $ 9,522     $ 9,522     $     $  
Marketable securities – corporate investments
    3,667       3,667              
Long-term investment in mutual funds
    2,231       2,231              
Derivative liabilities
    152             152        

Fair value measurements of other financial instruments – The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate fair value.

Cash and cash equivalents, cash and cash equivalents included within funds held for customers, and short-term debt – The carrying amounts reported in the consolidated balance sheets approximate fair value because of the short-term nature of these items.

Long-term debt – The fair value of long-term debt is based on quoted prices for identical liabilities when traded as assets in an active market (Level 1 fair value measurement). The fair value of long-term debt included in the table below does not reflect the impact of hedging activity. The carrying amount of long-term debt includes the change in fair value of hedged long-term debt.

The estimated fair values of these financial instruments were as follows:

   
September 30, 2010
   
December 31, 2009
 
(in thousands)
 
Carrying amount
   
Fair value
   
Carrying amount
   
Fair value
 
Cash and cash equivalents
  $ 21,091     $ 21,091     $ 12,789     $ 12,789  
Cash and cash equivalents – funds held for customers
    30,904       30,904       17,379       17,379  
Short-term debt
    30,000       30,000       26,000       26,000  
Long-term debt
    749,278       746,680       742,753       719,283  

 
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Note 6: Earnings per share

The following table reflects the calculation of basic and diluted earnings per share from continuing operations. During each period, certain options, as noted below, were excluded from the calculation of diluted earnings per share because their effect would have been antidilutive.

   
Quarter Ended
September 30,
   
Nine Months Ended
September 30,
 
(in thousands, except per share amounts)
 
2010
   
2009
   
2010
   
2009
 
Earnings per share – basic:
                       
Income from continuing operations
  $ 51,172     $ 28,555     $ 118,570     $ 68,836  
Income allocated to participating securities
    (267 )     (214 )     (627 )     (527 )
Income available to common shareholders
  $ 50,905     $ 28,341     $ 117,943     $ 68,309  
                                 
Weighted-average shares outstanding
    51,171       50,900       51,120       50,812  
Earnings per share – basic
  $ 0.99     $ 0.56     $ 2.31     $ 1.34  
                                 
Earnings per share – diluted:
                               
Income from continuing operations
  $ 51,172     $ 28,555     $ 118,570     $ 68,836  
Income allocated to participating securities
    (265 )     (214 )     (625 )     (527 )
Re-measurement of share-based awards classified as liabilities
    2       131       53       67  
Income available to common shareholders
  $ 50,909     $ 28,472     $ 117,998     $ 68,376  
                                 
Weighted-average shares outstanding
    51,171       50,900       51,120       50,812  
Dilutive impact of options and employee stock purchase plan
    191       149       197       76  
Weighted-average shares and potential dilutive shares outstanding
    51,362       51,049       51,317       50,888  
                                 
Earnings per share – diluted
  $ 0.99     $ 0.56     $ 2.30     $ 1.34  
                                 
Antidilutive options excluded from calculation
    2,357       2,173       2,357       2,173  

Earnings per share amounts for continuing operations, discontinued operations and net income, as presented on the consolidated statements of income, are calculated individually and may not sum due to rounding differences.

Note 7: Acquisitions and discontinued operations

During April 2010, we acquired all of the outstanding stock of Custom Direct, Inc. (Custom Direct), a leading provider of direct-to-consumer checks, in a cash transaction for $97.9 million, net of cash acquired. We funded the acquisition with our credit facility. The results of operations of this business from its acquisition date are included in our Direct Checks segment. The preliminary allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in goodwill of $65.8 million. We believe this acquisition resulted in the recognition of goodwill as we expect Custom Direct to contribute to our strategy of optimizing cash flows in our Direct Checks segment. Transaction costs related to this acquisition were expensed as incurred and were not significant to our consolidated statements of income for the nine months ended September 30, 2010.

 
12

 

The allocation of the purchase price to the acquired assets and liabilities is preliminary pending completion of the valuation of current income taxes receivable and deferred income taxes, as well as our analysis of the establishment of reserves for uncertain income tax positions. Our preliminary allocation of the purchase price includes current income taxes receivable of $10.8 million and net deferred tax liabilities of $12.5 million. The following illustrates our preliminary allocation of the Custom Direct purchase price to the assets acquired and liabilities assumed:

(in thousands)
     
Cash and cash equivalents
  $ 24  
Other current assets
    13,141  
Intangibles
    36,487  
Goodwill
    65,843  
Other non-current assets
    5,082  
Current liabilities
    (8,685 )
Non-current liabilities
    (13,947 )
Total purchase price
    97,945  
Less: cash acquired
    (24 )
Purchase price, net of cash acquired
  $ 97,921  

Acquired intangible assets included a customer list valued at $15.0 million with a useful life of 1.3 years, internal-use software valued at $12.6 million with a weighted-average useful life of 4.7 years, and trade names valued at $8.9 million with a useful life of 10 years. The software and the trade name are being amortized using the straight-line method, while the customer list is being amortized using an accelerated method. Further information regarding the calculation of the estimated fair values of these assets can be found in Note 5.

During March 2010, we purchased substantially all of the assets of Cornerstone Customer Solutions, LLC (CCS) in a cash transaction for $0.7 million. CCS is a full-service, marketing solutions provider specializing in the development and execution of analytics-driven direct marketing programs. The results of operations of this business from its acquisition date are included in our Financial Services segment. The allocation of the purchase price based upon the fair values of the assets acquired and liabilities assumed resulted in tax deductible goodwill of $0.9 million. We believe this acquisition resulted in the recognition of goodwill as we are offering these strategic and tactical marketing solutions to our financial institution clients. Transaction costs related to this acquisition were expensed as incurred and were not significant to our consolidated statement of income for the nine months ended September 30, 2010.

Net loss from discontinued operations for the quarter and nine months ended September 30, 2010 represents an additional loss on the disposal of a previously divested business.

Note 8: Restructuring charges

Net restructuring charges for each period consisted of the following components:

   
Quarter Ended
September 30,
   
Nine Months Ended
September 30,
 
(in thousands)
 
2010
   
2009
   
2010
   
2009
 
Severance accruals
  $ 384     $ 1,424     $ 3,591     $ 2,401  
Severance reversals
    (686 )     (645 )     (2,238 )     (2,222 )
Operating lease obligations
                415       865  
Operating lease reversals
    (72 )           (380 )     (19 )
Net restructuring (reversals) accruals
    (374 )     779       1,388       1,025  
Other costs
    476       1,432       1,185       3,586  
Net restructuring charges
  $ 102     $ 2,211     $ 2,573     $ 4,611  

2010 restructuring charges – During the quarter and nine months ended September 30, 2010, the net restructuring accruals included severance charges related to employee reductions in various functional areas as we continue our cost reduction initiatives. Net restructuring accruals for the nine months ended September 30, 2010 also included employee reductions resulting from the acquisition of Custom Direct in April 2010 (see Note 7). The restructuring accruals included severance benefits for approximately 40 employees for the quarter ended September 30, 2010 and severance benefits for approximately 115 employees for the nine months ended September 30, 2010. These charges were reduced by the reversal of restructuring accruals as fewer employees received severance benefits than originally estimated. Other restructuring costs, which were expensed as incurred, included items such as equipment moves, training and travel related to our restructuring activities. The net restructuring charges were reflected as net restructuring charges of $0.1 million within operating expenses in the consolidated statement of income for the quarter ended September 30, 2010. For the nine months ended September 30, 2010, the net restructuring charges were reflected as net restructuring charges of $0.6 million within cost of goods sold and net restructuring charges of $2.0 million within operating expenses in the consolidated statement of income.

 
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2009 restructuring charges – During the quarter and nine months ended September 30, 2009, the net restructuring accruals included severance charges related to employee reductions in various functional areas as we continued our cost reduction initiatives. Net restructuring accruals for the nine months ended September 30, 2009 also included operating lease obligations on two manufacturing facilities which were closed during 2009. The restructuring accruals included severance benefits for 50 employees for the quarter ended September 30, 2009 and severance benefits for 131 employees for the nine months ended September 30, 2009. These charges were reduced by the reversal of restructuring accruals as fewer employees received severance benefits than originally estimated. Other restructuring costs, which were expensed as incurred, included items such as equipment moves, training and travel related to our restructuring activities. The net restructuring charges were reflected as net restructuring charges of $0.4 million within cost of goods sold and net restructuring charges of $1.8 million within operating expenses in the consolidated statement of income for the quarter ended September 30, 2009. For the nine months ended September 30, 2009, the net restructuring charges were reflected as net restructuring charges of $2.7 million within cost of goods sold and net restructuring charges of $1.9 million within operating expenses in the consolidated statement of income.

Restructuring accruals – Restructuring accruals of $2.1 million as of September 30, 2010 are reflected in the consolidated balance sheet as accrued liabilities of $2.0 million and other non-current liabilities of $0.1 million. Restructuring accruals of $11.5 million as of December 31, 2009 are reflected in the consolidated balance sheet as accrued liabilities of $11.2 million and other non-current liabilities of $0.3 million. The majority of the employee reductions are expected to be completed by early 2011. We expect most of the related severance payments to be fully paid by mid-2011, utilizing cash from operations. The remaining payments due under operating lease obligations will be paid through May 2013. As of September 30, 2010, approximately 75 employees had not yet started to receive severance benefits. Further information regarding our restructuring accruals can be found under the caption “Note 8: Restructuring charges” in the Notes to Consolidated Financial Statements appearing in the 2009 Form 10-K.

As of September 30, 2010, our restructuring accruals, by company initiative, were as follows:

(in thousands)
 
2007 initiatives
   
2008 initiatives
   
2009 initiatives
   
2010 initiatives
   
Total
 
Balance, December 31, 2009
  $ 64     $ 2,175     $ 9,253     $     $ 11,492  
Restructuring charges
          516       99       3,391       4,006  
Restructuring reversals
    (64 )     (957 )     (1,415 )     (182 )     (2,618 )
Payments, primarily severance
          (1,429 )     (6,928 )     (2,396 )     (10,753 )
Balance, September 30, 2010
  $     $ 305     $ 1,009     $ 813     $ 2,127  
                                         
Cumulative amounts:
                                       
Restructuring charges
  $ 7,181     $ 27,536     $ 11,015     $ 3,391     $ 49,123  
Restructuring reversals
    (1,503 )     (5,842 )     (1,563 )     (182 )     (9,090 )
Payments, primarily severance
    (5,678 )     (21,389 )     (8,443 )     (2,396 )     (37,906 )
Balance, September 30, 2010
  $     $ 305     $ 1,009     $ 813     $ 2,127  

 
14

 

As of September 30, 2010, the components of our restructuring accruals, by segment, were as follows:

   
Employee severance benefits
   
Operating lease obligations
       
(in thousands)
 
Small Business Services
   
Financial Services
   
Direct Checks
   
Corporate
   
Small Business Services
   
Total
 
Balance, December 31, 2009
  $ 4,745     $ 1,053     $ 116     $ 4,781     $ 797     $ 11,492  
Restructuring charges
    383       151       2,173       884       415       4,006  
Restructuring reversals
    (873 )     (166 )     (116 )     (1,083 )     (380 )     (2,618 )
Payments
    (3,944 )     (860 )     (1,990 )     (3,445 )     (514 )     (10,753 )
Balance, September 30, 2010
  $ 311     $ 178     $ 183     $ 1,137     $ 318     $ 2,127  
                                                 
Cumulative amounts for current initiatives(1) :
                                               
Restructuring charges
  $ 15,247     $ 5,842     $ 2,648     $ 23,585     $ 1,801     $ 49,123  
Restructuring reversals
    (2,248 )     (1,279 )     (125 )     (5,045 )     (393 )     (9,090 )
Inter-segment transfer
    1,552       739       61       (2,352 )            
Payments
    (14,240 )     (5,124 )     (2,401 )     (15,051 )     (1,090 )     (37,906 )
Balance, September 30, 2010
  $ 311     $ 178     $ 183     $ 1,137     $ 318     $ 2,127  

(1) Includes accruals related to our cost reduction initiatives for 2007 through 2010.

Note 9: Pension and other postretirement benefits

We have historically provided certain health care benefits for a large number of retired employees. In addition to our retiree health care plan, we also have a supplemental executive retirement plan in the United States. We previously had a pension plan that covered certain Canadian employees which was settled during the quarter ended March 31, 2009. Further information regarding our postretirement benefit plans can be found under the caption “Note 12: Pension and other postretirement benefits” in the Notes to Consolidated Financial Statements appearing in the 2009 Form 10-K. See Note 15 for discussion of the risks associated with the plan assets of our postretirement benefit plan.

Pension and postretirement benefit expense for the quarters ended September 30, 2010 and 2009 consisted of the following components:

   
Postretirement benefit plan
   
Pension plan
 
(in thousands)
 
2010
   
2009
   
2010
   
2009
 
Interest cost
  $ 1,820     $ 2,188     $ 45     $ 51  
Expected return on plan assets
    (1,806 )     (1,489 )            
Amortization of prior service credit
    (936 )     (936 )            
Amortization of net actuarial losses
    1,352       1,388             (1 )
Total periodic benefit expense
  $ 430     $ 1,151     $ 45     $ 50  

 
15

 

Pension and postretirement benefit expense for the nine months ended September 30, 2010 and 2009 consisted of the following components:

   
Postretirement benefit plan
   
Pension plans
 
(in thousands)
 
2010
   
2009
   
2010
   
2009
 
Interest cost
  $ 5,461     $ 6,372     $ 135     $ 212  
Expected return on plan assets
    (5,419 )     (4,430 )           (58 )
Amortization of prior service credit
    (2,807 )     (2,879 )            
Amortization of net actuarial losses
    4,055       6,994             10  
Total periodic benefit expense
    1,290       6,057       135       164  
Settlement loss
                      402  
Net periodic benefit expense
  $ 1,290     $ 6,057     $ 135     $ 566  
 
Note 10:  Income tax provision

Our effective tax rate for continuing operations for the nine months ended September 30, 2010 was 36.4%, compared to our 2009 annual effective tax rate of 35.9%. Our 2010 effective tax rate included discrete items which increased our tax rate by 0.4 points, as well as lower tax credits in 2010 for research and development as Federal tax law providing credits for increasing research and development costs expired on December 31, 2009. The discrete items in 2010 consisted primarily of a $3.4 million charge resulting from a reconciliation bill, formerly known as the Health Care and Education Reconciliation Act, which was signed into law in March 2010 and requires that certain tax deductions after 2012 be reduced by the amount of the Medicare Part D subsidy payments. Prior to this law change, the subsidy was to be disregarded in all future years when computing tax deductions. This resulted in a reduction in the deferred tax asset associated with our postretirement benefit plan. Partially offsetting the impact of this unfavorable discrete item were discrete credits to income tax expense related to adjustments to accruals for uncertain tax positions.

Our 2009 effective tax rate included the non-deductible portion of the goodwill impairment charge recorded during the quarter ended March 31, 2009 (see Note 5), which increased our effective tax rate 2.9 percentage points. Our 2009 effective tax rate also included favorable adjustments related to receivables for prior year tax returns, which lowered our effective tax rate 2.2 percentage points.

Note 11: Debt

Total debt outstanding was comprised of the following:

(in thousands)
 
September 30,
2010
   
December 31,
2009
 
5.0% senior, unsecured notes due December 15, 2012, net of discount, including cumulative change in fair value of hedged debt: 2010 - $6,095 increase; 2009 - $254 decrease
  $ 286,014     $ 279,533  
5.125% senior, unsecured notes due October 1, 2014, net of discount
    263,264       263,220  
7.375% senior, unsecured notes due June 1, 2015
    200,000       200,000  
Long-term portion of debt
    749,278       742,753  
Amounts drawn on credit facilities
    30,000       26,000  
Total debt
  $ 779,278     $ 768,753  

Our senior, unsecured notes include covenants that place restrictions on the issuance of additional debt, the execution of certain sale-leaseback agreements and limitations on certain liens. Discounts from par value are being amortized ratably as increases to interest expense over the term of the related debt.

In May 2007, we issued $200.0 million of 7.375% senior, unsecured notes maturing on June 1, 2015. The notes were issued via a private placement under Rule 144A of the Securities Act of 1933. These notes were subsequently registered with the SEC via a registration statement which became effective on June 29, 2007. Interest payments are due each June and December. The notes place a limitation on restricted payments, including increases in dividend levels and share repurchases. This limitation does not apply if the notes are upgraded to an investment-grade credit rating. Principal redemptions may be made at our election at any time on or after June 1, 2011 at redemption prices ranging from 100% to 103.688% of the principal amount. In addition, at any time prior to June 1, 2011, we may redeem some or all of the notes at a price equal to 100% of the principal amount plus accrued and unpaid interest and a make-whole premium. If we sell certain of our assets or experience specific types of changes in control, we must offer to purchase the notes at 101% of the principal amount. Proceeds from the offering, net of offering costs, were $196.3 million. These proceeds were subsequently used on October 1, 2007 as part of our repayment of $325.0 million of unsecured notes plus accrued interest. The fair value of the notes issued in May 2007 was $205.5 million as of September 30, 2010, based on quoted prices for identical liabilities when traded as assets.

 
16

 

In October 2004, we issued $275.0 million of 5.125% senior, unsecured notes maturing on October 1, 2014. The notes were issued via a private placement under Rule 144A of the Securities Act of 1933. These notes were subsequently registered with the SEC via a registration statement which became effective on November 23, 2004. Interest payments are due each April and October. Proceeds from the offering, net of offering costs, were $272.3 million. These proceeds were used to repay commercial paper borrowings used for the acquisition of New England Business Service, Inc. in 2004. During the quarter ended March 31, 2009, we retired $11.5 million of these notes, realizing a pre-tax gain of $4.1 million. As of September 30, 2010, the fair value of the $263.5 million remaining notes outstanding was $255.1 million, based on quoted prices for identical liabilities when traded as assets.

In December 2002, we issued $300.0 million of 5.0% senior, unsecured notes maturing on December 15, 2012. These notes were issued under our shelf registration statement covering up to $300.0 million in medium-term notes, thereby exhausting that registration statement. Interest payments are due each June and December. Principal redemptions may be made at our election prior to the stated maturity. Proceeds from the offering, net of offering costs, were $295.7 million. These proceeds were used for general corporate purposes, including funding share repurchases, capital asset purchases and working capital. During the quarter ended March 31, 2009, we retired $19.7 million of these notes, realizing a pre-tax gain of $5.7 million. As of September 30, 2010, the fair value of the $280.3 million remaining notes outstanding was $286.1 million, based on quoted prices for identical liabilities when traded as assets. As discussed in Note 4, during September 2009, we entered into interest rate swaps with a notional amount of $210.0 million to hedge a portion of these notes. The fair value of long-term debt disclosed here does not reflect the impact of these fair value hedges. The carrying amount of long-term debt has increased $6.1 million since the inception of the interest rate swaps due to changes in the fair value of the hedged long-term debt.

As of December 31, 2009, we had a $275.0 million committed line of credit which was scheduled to expire in July 2010. During March 2010, we cancelled this line of credit and executed a new $200.0 million credit facility, which expires in March 2013. Borrowings under the credit facility are collateralized by substantially all of our assets. Our commitment fee ranges from 0.40% to 0.50% based on our leverage ratio. The credit agreement governing the credit facility contains customary covenants regarding limits on levels of subsidiary indebtedness and capital expenditures, liens, investments, acquisitions, certain mergers, certain asset sales outside the ordinary course of business, and change in control as defined in the agreement. The agreement also contains financial covenants regarding our leverage ratio, interest coverage and liquidity.

The daily average amount outstanding under our credit facilities during the nine months ended September 30, 2010 was $60.9 million at a weighted-average interest rate of 3.18%. As of September 30, 2010, $30.0 million was outstanding at a weighted-average interest rate of 3.31%. During 2009, the daily average amount outstanding under our line of credit was $69.3 million at a weighted-average interest rate of 0.76%. As of December 31, 2009, $26.0 million was outstanding at a weighted-average interest rate of 0.67%. As of September 30, 2010, amounts were available for borrowing under our credit facility as follows:

(in thousands)
 
Total Available
 
Credit facility commitment
  $ 200,000  
Amounts drawn on credit facility
    (30,000 )
Outstanding letters of credit
    (9,313 )
Net available for borrowing as of September 30, 2010
  $ 160,687  

Absent certain defined events of default under our debt instruments, and as long as our ratio of earnings before interest, taxes, depreciation and amortization to interest expense is in excess of two to one, our debt covenants do not restrict our ability to pay cash dividends at our current rate.

 
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Note 12:  Other commitments and contingencies

Information regarding indemnifications, environmental matters, self-insurance and litigation can be found under the caption “Note 14: Other commitments and contingencies” in the Notes to Consolidated Financial Statements appearing in the 2009 Form 10-K.  No significant changes in these items occurred during the nine months ended September 30, 2010.

Note 13: Shareholders’ equity

We have an outstanding authorization from our board of directors to purchase up to 10 million shares of our common stock. This authorization has no expiration date, and 6.2 million shares remained available for purchase under this authorization as of September 30, 2010. During the quarter and nine months ended September 30, 2010, we repurchased 0.2 million shares for $3.0 million. The terms of our $200.0 million notes maturing in 2015 place a limitation on restricted payments, including increases in dividend levels and share repurchases. The terms of our $200.0 million credit facility also limit our ability to increase dividends or repurchase shares above certain levels.

Changes in shareholders’ equity during the nine months ended September 30, 2010 were as follows:

   
Common shares
   
Additional
         
Accumulated other
   
Total
 
   
Number
   
Par
   
paid-in
   
Retained
   
comprehensive
   
shareholders’
 
(in thousands)
 
of shares
   
value
   
capital
   
earnings
   
loss
   
equity
 
Balance, December 31, 2009
    51,189     $ 51,189     $ 58,071     $ 60,768     $ (52,818 )   $ 117,210  
Net income
                      117,799             117,799  
Cash dividends
                      (38,586 )           (38,586 )
Common shares issued
    331       331       3,474                   3,805  
Tax impact of share-based awards
                (715 )                 (715 )
Common shares repurchased
    (167 )     (167 )     (2,832 )                     (2,999 )
Other common shares retired
    (53 )     (53 )     (850 )                 (903 )
Fair value of share-based  compensation
    2       2       4,338                   4,340  
Amortization of postretirement prior service credit, net of tax
                            (1,741 )     (1,741 )
Amortization of postretirement net actuarial losses, net of tax
                            2,515       2,515  
Amortization of loss on
derivatives, net of tax(1)
                            990       990  
Net unrealized gain on marketable securities, net of tax
                            51       51  
Currency translation adjustment
                            647       647  
Balance, September 30, 2010
    51,302     $ 51,302     $ 61,486     $ 139,981     $ (50,356 )   $ 202,413  

(1) Relates to interest rate locks executed in 2004 and 2002. See “Note 6: Derivative financial instruments” in the Notes to Consolidated Financial Statements appearing in the 2009 Form 10-K.

 
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Accumulated other comprehensive loss was comprised of the following:

(in thousands)
 
September 30,
2010
   
December 31,
2009
 
Postretirement and defined benefit pension plans:
           
Unrealized prior service credit
  $ 16,237     $ 17,978  
Unrealized net actuarial losses
    (67,813 )     (70,328 )
Postretirement and defined benefit pension plans, net of tax
    (51,576 )     (52,350 )
Loss on derivatives, net of tax
    (4,851 )     (5,841 )
Unrealized gain on marketable securities, net of tax
    51        
Currency translation adjustment
    6,020       5,373  
Accumulated other comprehensive loss
  $ (50,356 )   $ (52,818 )
 
Note 14: Business segment information
 
We operate three reportable business segments: Small Business Services, Financial Services and Direct Checks. Small Business Services sells personalized printed products, which include business checks, printed forms, promotional products, marketing materials and related services, as well as retail packaging supplies and a suite of business services, including web design and hosting, fraud protection, payroll, logo design, search engine marketing and business networking, to small businesses. These products and services are sold through direct response marketing, referrals from financial institutions and telecommunications companies, independent distributors and dealers, the internet and sales representatives. Financial Services’ products and services for financial instituations include comprehensive check programs for both personal and business checks, fraud prevention and monitoring services, customer acquisition campaigns, marketing communications, and services intended to enhance the financial institution customer experience, such as customer loyalty programs. These products and services are sold through multiple channels, including a direct sales force. Direct Checks sells personal and business checks and related products and services directly to consumers through direct response marketing and the internet. All three segments operate primarily in the United States. Small Business Services also has operations in Canada and portions of Europe.
 
The accounting policies of the segments are the same as those described in the Notes to Consolidated Financial Statements included in the 2009 Form 10-K. We allocate corporate costs for our shared services functions to our business segments, including costs of our executive management, human resources, supply chain, finance, information technology and legal functions. Generally, where costs incurred are directly attributable to a business segment, primarily within the areas of information technology, supply chain and finance, those costs are reported in that segment’s results. Because we use a shared services approach for many of our functions, certain costs are not directly attributable to a business segment. These costs are allocated to our business segments based on segment revenue, as revenue is a measure of the relative size and magnitude of each segment and indicates the level of corporate shared services consumed by each segment. Corporate assets are not allocated to the segments and consist of property, plant and equipment, internal-use software, inventories and supplies related to our corporate shared services functions of manufacturing, information technology and real estate, as well as long-term investments and deferred income taxes.

We are an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and the sharing of assets. Therefore, we do not represent that these segments, if operated independently, would report the operating income and other financial information shown.

 
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The following is our segment information as of and for the quarters ended September 30, 2010 and 2009:

       
Reportable Business Segments
             
(in thousands)
     
Small Business Services
   
Financial Services
   
Direct Checks
   
Corporate
   
Consolidated
 
Revenue from external customers:
 
2010
  $ 206,572     $ 102,614     $ 58,447     $     $ 367,633  
   
2009
    193,874       98,947       39,476             332,297  
Operating income:
 
2010
    45,298       27,157       16,053             88,508  
   
2009
    23,279       18,482       12,788             54,549  
Depreciation and amortization expense:
 
2010
    11,099       2,911       5,369             19,379  
   
2009
    12,466       2,691       1,057             16,214  
Total assets:
 
2010
    779,588       65,054       181,982       298,227       1,324,851  
   
2009
    796,642       59,545       95,694       291,707       1,243,588  
Capital asset purchases:
 
2010
                      10,547       10,547  
   
2009
                      11,269       11,269  

The following is our segment information as of and for the nine months ended September 30, 2010 and 2009:

 
     
Reportable Business Segments
             
(in thousands)
     
Small Business Services
   
Financial Services
   
Direct Checks
   
Corporate
   
Consolidated
 
Revenue from external customers:
 
2010
  $ 592,063     $ 302,307     $ 156,379     $     $ 1,050,749  
   
2009
    579,095       301,422       123,370             1,003,887  
Operating income:
 
2010
    104,843       71,178       44,662             220,683  
   
2009
    37,240       57,332       40,242             134,814  
Depreciation and amortization expense:
 
2010
    34,230       8,880       11,553             54,663  
   
2009
    39,967       7,887       3,114             50,968  
Asset impairment charges:
 
2010
                             
   
2009
    24,900                         24,900  
Total assets:
 
2010
    779,588       65,054       181,982       298,227       1,324,851  
   
2009
    796,642       59,545       95,694       291,707       1,243,588  
Capital asset purchases:
 
2010
                      31,613       31,613  
   
2009
                      35,006       35,006  
 
Note 15: Market risks
 
Due to the downturn in the U.S. economy, including the liquidity crisis in the credit markets, as well as failures and consolidations of companies within the financial services industry since 2008, we have identified certain market risks which may affect our future operating performance.

Economic conditions – As discussed in Note 5, during the quarter ended March 31, 2009, we completed impairment analyses of goodwill and our indefinite-lived trade name due to indicators of potential impairment. We recorded a goodwill impairment charge of $20.0 million in our Small Business Services segment related to one of our reporting units, as well as an impairment charge of $4.9 million in our Small Business Services segment related to an indefinite-lived trade name. The annual impairment analyses completed during the quarter ended September 30, 2010 indicated that the calculated fair values of our reporting units’ net assets exceeded their carrying values by amounts between $43 million and $546 million, or by amounts between 55% and 442% above the carrying values of their net assets. The calculated fair value of our indefinite-lived trade name exceeded its carrying value of $19.1 million by $5.0 million based on the analysis completed during the quarter ended September 30, 2010. Due to the ongoing uncertainty in market conditions, which may continue to negatively impact our expected operating results or share price, we will continue to monitor whether additional impairment analyses are required with respect to the carrying value of goodwill and the indefinite-lived trade name.

 
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Postretirement benefit plan – The fair value of the plan assets of our postretirement benefit plan is subject to various risks, including credit, interest and overall market volatility risks. During 2008, the equity markets experienced a significant decline in value. As such, the fair value of our plan assets decreased significantly during the year, resulting in a $29.9 million increase in the unfunded status of our plan as compared to the end of the previous year. This affected the amounts reported in the consolidated balance sheet as of December 31, 2008 and also contributed to an increase in postretirement benefit expense of $2.4 million in 2009, as compared to 2008. As of December 31, 2009, the fair value of our plan assets had partially recovered, contributing to an $11.8 million improvement in the unfunded status of our plan as compared to December 31, 2008. If the equity and bond markets decline in future periods, the funded status of our plan could again be materially affected. This could result in higher postretirement benefit expense in the future, as well as the need to contribute increased amounts of cash to fund the benefits payable under the plan, although our obligation is limited to funding benefits as they become payable. We did not use plan assets to make benefit payments during the first nine months of 2010 or during 2009. Rather, we used cash provided by operating activities to make these payments.

Financial institution clients – Continued turmoil in the financial services industry, including further bank failures and consolidations, could have a significant impact on our consolidated results of operations if we were to lose a significant amount of business and/or we were unable to recover the value of an unamortized contract acquisition cost or account receivable. As of September 30, 2010, unamortized contract acquisition costs totalled $55.2 million, while liabilities for contract acquisition costs not paid as of September 30, 2010 were $19.3 million. The inability to recover amounts paid to one or more of our larger financial institution clients could have a significant negative impact on our consolidated results of operations.

The consolidation of financial institutions may also impact our results of operations. In the past we have acquired new clients as financial institutions that were not our clients consolidated with our clients. When two of our financial institution clients consolidate, the increase in general negotiating leverage possessed by the consolidated entity could result in a new contract which is not as favorable to us as those historically negotiated with the clients individually. However, we may also generate non-recurring conversion revenue when obsolete checks have to be replaced after one financial institution merges with or acquires another. Conversely, we have also lost financial institution clients when they consolidated with financial institutions which were not our clients. If we were to lose a significant amount of business in this manner, it could have a significant negative impact on our consolidated results of operations. In such situations, we have typically collected contract termination payments and we may be able to do so in similar circumstances in the future.


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

EXECUTIVE OVERVIEW

Our business is organized into three segments: Small Business Services, Financial Services and Direct Checks. Our Small Business Services segment generated 56.3% of our consolidated revenue for the first nine months of 2010. This segment has sold personalized printed products, which include business checks, printed forms, promotional products, marketing materials and related services, as well as retail packaging supplies and a suite of business services, including web design and hosting, fraud protection, payroll, logo design, search engine marketing and business networking, to over four million small businesses in the last 24 months. These products and services are sold through direct response marketing, referrals from financial institutions and telecommunications companies, independent distributors and dealers, the internet and sales representatives. Our Financial Services segment generated 28.8% of our consolidated revenue for the first nine months of 2010. This segment’s products and services for financial instituations include comprehensive check programs for both personal and business checks, fraud prevention and monitoring services, customer acquisition campaigns, marketing communications, and services intended to enhance the financial institution customer experience, such as customer loyalty programs. These products and services are sold through multiple channels, including a direct sales force, to 6,400 financial institution clients nationwide, including banks, credit unions and financial services companies. Our Direct Checks segment generated 14.9% of our consolidated revenue for the first nine months of 2010, including Custom Direct, Inc., which was acquired in April 2010. This segment is the nation’s leading direct-to-consumer check supplier, selling under various brand names including Checks Unlimited®, Designer® Checks, Checks.com, Check Gallery®, The Styles Check Company®, and Artistic Checks®, among others. Through these brands, we sell personal and business checks and related products and services directly to consumers using direct response marketing and the internet. We operate primarily in the United States. Small Business Services also has operations in Canada and portions of Europe.

 
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We have continued to see the negative impact of the economic environment on our results of operations for the first nine months of 2010. The severe downturn in the economy and the turmoil in the financial services industry continue to affect our operating results. Demand has fallen for many of our Small Business Services products as we believe small business owners have reduced their discretionary spending. Additionally, we believe interruptions and consumer uncertainty related to financial institution consolidations and failures have led to reduced check orders from several of our financial institution clients, and financial institution consolidations have also impacted our operating results. In July 2010, we finalized a contract settlement with a large financial institution that previously acquired one of our clients and recently chose to consolidate its check printing business with another provider. We had been producing checks for a minority portion of this client’s customers. This business transitioned during the third quarter of 2010 and we received contract termination payments of $24.6 million, which were included as revenue of $12.1 million in Small Business Services and $12.5 million in Financial Services. We expect revenue from a new financial institution client which began generating revenue during the third quarter of 2010 will offset the revenue lost from the contract termination.

During this difficult economic environment, we have accelerated many of our cost reduction actions, and we have identified additional opportunities to improve our cost structure. We believe we have taken appropriate steps to position ourselves for sustainable growth as the economy recovers, including accelerating our brand awareness and positioning initiatives, investing in technology for new service offerings, enhancing our internet capabilities, improving customer segmentation and adding new small business customers. We have invested in acquisitions that we believe offer higher growth business services, extend our direct-to-consumer offerings, improve our operating cash flow, and bring analytics-driven deposit acquisition marketing programs to our financial institution clients. We are focused on capitalizing on transformational opportunities available to us in this difficult environment and believe that we will be positioned to deliver strong margins once the economy recovers.

Our earnings for the first nine months of 2010, as compared to the first nine months of 2009, benefited from the following:

 
·
Asset impairment charges of $24.9 million in the first quarter of 2009 within Small Business Services related to goodwill and an indefinite-lived trade name;
 
·
Revenue of $24.6 million from a contract settlement executed during the third quarter of 2010;
 
·
Continuing initiatives to reduce our cost structure, primarily within manufacturing, sales and marketing and information technology;
 
·
Recognition of deferred revenue from a Financial Services contract termination settlement executed in the fourth quarter of 2009; and
 
·
Price increases in Small Business Services and Financial Services.

These benefits were partially offset by the following:

 
·
Reduced volume for our personal check businesses due to the continuing decline in check usage, turmoil in the financial services industry, including bank failures, and continued economic softness;
 
·
Lower volume in Small Business Services due primarily to declines in check and forms usage, as well as changes in our customers’ buying patterns, we believe, as a result of the continued economic downturn;
 
·
Pre-tax gains of $9.8 million in the first quarter of 2009 from the retirement of long-term notes;