Deluxe Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise noted. Dollar amounts below are in millions, except per-share data. Deluxe provides products and services to small businesses, financial institutions and consumers; checks remain a significant offering, alongside marketing solutions and other services.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $459.3 | $433.6 | +5.9% |
| Gross profit / margin | $295.0 / 64.2% | $280.9 / 64.8% | Margin down 0.6 pts. |
| Operating income / margin | $92.6 / 20.2% | $85.3 / 19.7% | Income +8.6% |
| Net income | $58.1 | $45.9 | +26.5% |
| Diluted EPS | $1.18 | $0.91 | +29.7% |
| Operating cash flow | $72.7 | $78.5 | Down $5.9 |
Revenue growth reflected higher prices, a $23 million increase in marketing solutions and other services (including acquisitions), and favorable mix, partly offset by lower personal and business check volumes and Financial Services contract renewal allowances. Company-wide orders fell 1.4%, while revenue per order rose 7.4%. Service revenue was 20.3% of sales, versus 18.1%.
Small Business Services revenue rose 4.8% to $290.3 million and operating income increased 3.4% to $51.2 million; margin eased to 17.6% from 17.9%. Financial Services revenue increased 14.1% to $127.2 million and operating income rose 30.9% to $26.7 million; margin improved to 21.0% from 18.3%. Direct Checks revenue declined 7.4% to $41.8 million and operating income fell 4.3% to $14.8 million; margin increased to 35.3% from 34.2%.
Liquidity, debt and capital
- Cash and cash equivalents were $71.0 million at March 31, up from $62.4 million at year-end. Cash generated from operations was $72.7 million; investing used $21.0 million and financing used $46.7 million.
- Total debt was $615.1 million, down from $629.0 million at December 31. This included $416.0 million drawn on the credit facility at a 1.89% weighted-average rate and $200 million principal of 6.0% senior notes due 2020. Net availability under the $525 million facility was $96.3 million. The company reported compliance with debt covenants.
- Q1 dividends were $0.30 per share; $14.7 million was paid. Deluxe repurchased 277,800 shares for $15.0 million. In May 2016, the board authorized an additional $300 million of repurchases.
- Cash flow from operations was lower year over year, primarily due to higher contract acquisition payments, income taxes and an acquisition-related incentive payment; lower interest payments partly offset these uses.
Outlook, management commentary and risks
- For 2016, management expected revenue of $1.845–$1.875 billion, diluted EPS of $4.84–$4.99, operating cash flow of $320–$330 million and capital spending of approximately $43 million. The EPS outlook included $0.01 per share of Q1 restructuring and acquisition transaction costs. Expected annual effective tax rate was approximately 33%.
- Management was on track to achieve approximately $50 million in net cost reductions in 2016 versus 2015, with about 65% expected in SG&A and the balance in cost of revenue. It cited price increases and cost reductions as Q1 earnings drivers, partly offset by check-volume declines and investment in growth.
- Management anticipated Small Business Services revenue growth of 4%–6%, Financial Services growth of 9%–10%, and Direct Checks decline of 7%–8%. Check usage declines remain a structural headwind; growth plans emphasize marketing solutions, service offerings, e-commerce and distribution channels.
- Other pressures cited include a sluggish economy, medical and material costs, delivery rates, competition for financial institution contracts and foreign exchange. Management said cash generation and facility availability should support the next 12 months, including dividends, investment, repurchases and potential acquisitions.
- Q1 included acquisitions of MacHighway, Birchcraft Studios and four small-business distributors; purchase-price allocations were preliminary. The $8.9 million loss on early debt extinguishment recorded in Q1 2015 did not recur. A supplier’s arbitration claim seeking up to approximately $43 million was rejected in March 2016. Environmental remediation accruals were $5.6 million; the company said it did not expect significant net environmental cash outlays in 2016. It cautioned that litigation outcomes remain uncertain.
- Early adoption of share-based payment guidance reduced Q1 tax expense by $0.5 million and increased EPS by $0.01. The company said there were no significant changes to its disclosed risk factors during the quarter.
Important facts for investors to verify
- Whether marketing solutions and services growth can offset continuing declines in check and forms usage, particularly in Direct Checks.
- Progress against the $50 million cost-reduction target and the extent to which savings offset inflation, acquisition costs and growth investments.
- Delivery of 2016 revenue, EPS and operating-cash-flow guidance, including the assumptions for contract renewal allowances and acquisition contributions.
- Debt, interest-rate and liquidity exposure: $416 million was drawn on the credit facility, with $96.3 million available; verify covenant headroom and future cash needs.
- Q1 restructuring presentation: the income statement reports $0.879 million of restructuring charges in operating expenses, while the note reports $0.868 million net charges overall after an $0.011 million reduction in cost of revenue.
- Potential cash and tax effects of acquisitions, contingent consideration, environmental obligations and any future share repurchases; the filing notes that repatriating all Canadian cash could incur approximately $6 million of federal tax.