Deluxe Corporation — Q3 2014 Form 10-Q
Business context and period. This unaudited filing covers the quarter and nine months ended September 30, 2014; dollar amounts below are in millions unless noted. Deluxe sells checks, forms, business products and marketing and other services through Small Business Services, Financial Services and Direct Checks. Management says interim results are not necessarily indicative of full-year results.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|
| Revenue | $413.2 | $398.1 | $1,225.6 | $1,167.1 |
| Gross profit / margin | $263.1 / 63.7% | $255.9 / 64.3% | $784.6 / 64.0% | $758.0 / 64.9% |
| Operating income | $76.7 | $79.7 | $242.5 | $239.9 |
| Net income | $44.4 | $46.9 | $141.8 | $140.9 |
| Diluted EPS | $0.88 | $0.92 | $2.80 | $2.75 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $203.4 | $184.0 |
- Quarterly revenue increased 3.8%, while operating income fell 3.7% and net income fell 5.3%. Nine-month revenue rose 5.0% and net income rose 0.6%.
- Gross margin declined 0.6 percentage points in Q3 and 0.9 points for the nine-month period. Management cited mix shift toward lower-margin services and outsourced products, and higher delivery and material costs; price increases and cost reductions partly offset these pressures.
- For the nine months, investing cash outflow was $40.4 million, including $29.6 million of capital spending and $12.1 million for acquisitions. Financing cash outflow was $93.4 million, including $60.1 million of share repurchases and $42.6 million of dividends. Cash increased by $66.9 million to $188.0 million.
- At September 30, total debt was $644.6 million, including $254.3 million due within one year; shareholders’ equity was $604.2 million. The company reported $337.3 million available on its $350 million credit facility and compliance with its debt covenants. The filing states that cash and credit availability should support operations for the next 12 months.
Segment results
| Segment | Q3 revenue, year-over-year | Q3 operating income, year-over-year | Nine-month revenue, year-over-year | Nine-month operating income, year-over-year |
|---|
| Small Business Services | $284.6 million, +7.2% | $43.2 million, down 6.6% | $828.3 million, +8.2% | $135.6 million, +3.5% |
| Financial Services | $85.7 million, down 0.9% | $18.8 million, essentially flat | $263.3 million, +2.6% | $62.8 million, down 0.9% |
| Direct Checks | $42.9 million, down 7.1% | $14.7 million, +0.5% | $134.0 million, down 7.4% | $44.1 million, down 3.0% |
Material changes, outlook and risks
- Revenue growth reflected price increases, acquisitions, distributor-channel growth and marketing and other services. Service revenue was 15.1% of nine-month revenue versus 13.0% a year earlier. Check and forms usage continued to decline; company-wide orders fell 1.4% for the nine months, while revenue per order rose 6.5%.
- Q3 included a $6.5 million impairment charge for Small Business Services’ search engine marketing and optimization business after projected revenue and cash flows weakened; the related intangible assets were written down to zero. Nine-month restructuring charges were $8.5 million in operating expenses, plus $0.3 million in cost of revenue. Management expected most employee reductions to be completed by year-end and most severance payments by mid-2015.
- Management raised its estimated 2014 net cost reductions to $60 million, after realizing approximately $48 million to date. Its 2014 outlook was revenue of $1.657–$1.665 billion, diluted EPS of $3.86–$3.92 (including $0.22 per share for restructuring, impairment and acquisition transaction costs), operating cash flow of $278–$285 million, and capital spending of approximately $40 million.
- Outlook assumptions include continued check-order declines, pricing pressure in Financial Services, and higher material and delivery costs, partly offset by price increases, cost savings and growth in services and distributor channels. Management cited ongoing investment in growth opportunities and a sluggish economy among factors that could weigh on results.
- The $253.5 million notes matured October 1, 2014 and were repaid using $125.0 million of cash and an initial $135 million credit-facility draw; total payment including accrued interest was $260.0 million. On October 22, Deluxe acquired Wausau Financial Systems for approximately $90 million, funded through the facility. Management forecast Wausau revenue of approximately $12 million in 2014 and $80 million in 2015; the deal was expected to be slightly EPS-dilutive in 2015 before turning slightly accretive in Q4.
- Other disclosed exposures include $8.1 million of environmental accruals and interest-rate sensitivity: a one-percentage-point rate change would have changed nine-month interest expense by an estimated $3.0 million, excluding hedge ineffectiveness. Management reported no significant change to the risk factors in its 2013 Form 10-K.
Most important facts for investors to verify
- Whether service and marketing-solutions growth can offset continued declines in check and forms volumes, particularly in Direct Checks and Financial Services.
- Whether cost reductions reach the $60 million 2014 estimate and counter lower gross margins, input-cost inflation and growth investments.
- Actual Wausau contribution and integration results versus management’s revenue and EPS forecasts, and the effect of acquisition-related borrowing on debt and liquidity.
- Whether the 2014 revenue, EPS and operating-cash-flow outlook is achieved; these are management estimates, not guarantees.
- Potential changes in environmental remediation costs, interest rates, covenant headroom and cash available after debt service, dividends, repurchases and acquisitions.
