Deluxe Corporation — Q3 2016 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2016. Deluxe sells checks, forms, marketing solutions and other services through Small Business Services, Financial Services and Direct Checks. Results are unaudited; interim performance is not necessarily indicative of full-year results.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $458.9M | $439.8M | $1,368.9M | $1,309.3M |
| Operating income | $92.3M | $89.4M | $275.9M | $263.5M |
| Net income | $58.7M | $56.9M | $175.2M | $158.9M |
| Diluted EPS | $1.19 | $1.13 | $3.55 | $3.16 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $208.1M | $219.1M |
Q3 revenue rose 4.3% year over year; nine-month revenue rose 4.5%. Service revenue grew to $94.2M in Q3 from $78.0M, and to $278.2M for nine months from $233.6M. Nine-month gross profit was $878.5M versus $841.4M; gross margin was approximately 64.2% versus 64.3%. Operating margin was approximately 20.1% for both nine-month periods. The Q3 effective tax rate was 33.5%; the nine-month rate was 33.1%, compared with 34.2% in 2015.
Orders declined 2.2% in Q3 and 2.3% for nine months, while revenue per order rose 6.7% and 7.0%, respectively. Management attributed growth primarily to marketing and other services, acquisitions and prior price increases; lower check and forms volume partly offset those gains.
Segments and material changes
- Small Business Services: Q3 revenue increased 3.4% to $298.9M, but operating income declined 2.3% to $50.7M and margin fell to 17.0% from 18.0%. Nine-month revenue increased 3.4%; operating income increased 0.8%.
- Financial Services: Q3 revenue rose 10.9% to $123.0M and operating income rose 22.9% to $28.7M; margin expanded to 23.3% from 21.1%. Nine-month revenue rose 11.7% and operating income 21.9%. Growth included Datamyx and FISC Solutions acquisitions.
- Direct Checks: Q3 revenue declined 7.5% to $37.0M and operating income declined 8.6% to $12.9M. Nine-month revenue fell 7.1% and operating income 9.1%, chiefly due to declining check usage.
SG&A increased 4.1% for nine months, partly reflecting acquired businesses and growth investments, while expense reductions and lower incentive compensation offset some increases. Restructuring charges were $4.1M for nine months versus $3.2M. The prior-year period included an $8.9M loss on early debt extinguishment; none was recorded in the first nine months of 2016.
Cash flow, debt and liquidity
Nine-month operating cash flow was $208.1M, down $11.0M year over year, mainly due to higher income-tax and contract-acquisition payments and a prior-acquisition incentive payment. Investing used $90.4M, including $64.6M for acquisitions and $32.2M for capital assets. Financing used $103.1M, including $44.9M in share repurchases and $44.1M in dividends. Cash and cash equivalents were $80.1M at September 30, 2016, up from $62.4M at year-end 2015.
Total debt was $617.7M, down $11.3M from year-end; shareholders’ equity was $849.9M. The $525M revolving facility had $418M drawn and $94.2M available after letters of credit. The company reported compliance with debt covenants and expected to remain compliant for the next 12 months. Funds held for customers were $92.2M, with corresponding customer liabilities; these balances are not equivalent to unrestricted cash.
Outlook, commentary and risks
- For 2016, management forecast revenue of $1.850B–$1.860B, diluted EPS of $4.78–$4.83, operating cash flow of $315M–$320M, and capital spending of approximately $43M. EPS guidance included about $0.17 per share of expected debt-extinguishment, restructuring and acquisition-related charges.
- Management expected approximately $50M in net cost reductions versus 2015, was on track to achieve them, and planned continued investment in profitable growth, marketing solutions and small-to-medium-sized acquisitions.
- Management expected 2016 revenue growth of 4%–5% in Small Business Services and 9%–10% in Financial Services, while Direct Checks revenue was expected to decline approximately 8%. Secular declines in check usage, contract renewal allowances and foreign exchange were cited as offsets to growth.
- In October 2016, Deluxe gave notice to redeem its $200M of 6.0% senior notes due 2020 on November 15 at 103% of principal, using its expanded credit facility as needed; it expected an approximately $0.11 per-share extinguishment loss and planned to terminate related interest-rate swaps. It also acquired Data Support Systems for estimated cash payments of $21M, subject to adjustments and contingent consideration.
- Key exposures include continued check-volume declines, execution of growth investments and acquisitions, delivery and material-cost increases, interest-rate sensitivity, environmental and self-insurance estimates, and potential unfavorable litigation outcomes. A supplier arbitration claim seeking up to approximately $43M was rejected in Deluxe’s favor in March 2016. Environmental accruals were $3.3M; management said the possible outcomes were not expected to materially affect financial condition, results or liquidity.
The company corrected prior balance-sheet and cash-flow presentation of credit-facility borrowings and related debt issuance costs. Management concluded the prior-period error was not material; the correction did not affect total assets, liabilities, equity, net income or net financing cash flow.
Important facts for investors to verify
- Whether the company achieved its 2016 revenue, EPS, operating-cash-flow and cost-reduction guidance, including the expected debt-redemption charge.
- Whether marketing-services growth and acquisitions can offset persistent check and forms volume declines, particularly in Direct Checks.
- Debt-facility utilization, covenant headroom and the completed refinancing/redemption terms after the reporting date.
- Acquisition integration, purchase-price allocations and the expected returns on recent acquisitions and growth investments.
- Cash-flow conversion and the effects of taxes, contract-acquisition payments, dividends and share repurchases; distinguish customer funds from unrestricted cash.