Deluxe Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; compared with Q1 2016 unless otherwise noted. Deluxe provides checks, forms, marketing solutions and other services through Small Business Services, Financial Services and Direct Checks. Amounts below are in U.S. dollars; financial statement amounts are in millions unless indicated.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Revenue | $487.8; +6.2% | $459.3 |
| Gross profit / margin | $308.6 / 63.3% | $295.0 / 64.2% |
| Operating income / margin | $85.5 / 17.5% | $92.6 / 20.2% |
| Net income | $57.1 | $58.1 |
| Diluted EPS | $1.16 | $1.18 |
| Operating cash flow | $74.3 | $72.7 |
| Cash and cash equivalents | $85.5 at March 31 | $76.6 at December 31 |
| Total debt | $739.5 at March 31 | $758.6 at December 31 |
| Revolver availability | $97.7 at March 31 | — |
Revenue growth reflected approximately $38 million of acquired-business revenue and price increases, partly offset by lower check and forms volumes and Financial Services pricing allowances. Orders declined 3.0%, while revenue per order increased 9.5%. Marketing solutions and other services grew to 35.3% of revenue from 31.3%; checks declined to 45.6% from 48.7%.
Operating income fell despite higher revenue. Higher acquisition-related amortization and expenses, growth investments, legal costs, compensation and medical costs, and increased material and delivery costs weighed on results. A $6.8 million gain on sales of two businesses partly offset these pressures. Gross and operating margins declined year over year. The quarter also included a $5.3 million impairment charge on a small business distributor held for sale. The effective tax rate was 29.7%, versus 33.6% in Q1 2016.
Cash provided by operations was $74.3 million; investing used $15.8 million and financing used $50.0 million. Financing included $15.0 million of share repurchases and $14.6 million of dividends. Debt was predominantly floating-rate: the $417 million revolver and $321.8 million term loan mature in February 2019. The company reported compliance with debt covenants. Customer funds held, reported separately from corporate cash, totaled $90.2 million.
Segments and material changes
- Small Business Services: Revenue $308.1 million, up 6.2%; operating income $52.6 million, up 2.8%; margin 17.1% versus 17.6%. Acquisitions, pricing and the $6.8 million sale gain helped; declining product volumes, investments and the impairment charge pressured results.
- Financial Services: Revenue $140.8 million, up 10.6%; operating income $20.4 million, down 23.7%; margin 14.5% versus 21.0%. Marketing and other services and acquisitions drove revenue growth, while pricing allowances, lower check volume, legal expenses and higher costs reduced profitability.
- Direct Checks: Revenue $38.8 million, down 7.0%; operating income $12.5 million, down 15.2%; margin 32.2% versus 35.3%, reflecting declining check orders and higher delivery and material costs.
Outlook, risks and unusual items
- 2017 revenue guidance: $1.945–$1.975 billion. Segment outlook: Small Business Services growth of 3%–5%; Financial Services growth of 15%–17%; Direct Checks decline of approximately 9%.
- 2017 diluted EPS guidance: $5.06–$5.21, including $0.09 per share for the Q1 impairment and also reflecting restructuring and acquisition transaction costs. Expected annual effective tax rate is approximately 32.5%.
- Management expects $330–$350 million of operating cash flow, approximately $45 million of capital spending and approximately $23 million of contract acquisition payments in 2017. It expects about $45 million in net cost reductions versus 2016 and says cash flow plus revolver availability should fund operations and planned capital returns for the next 12 months.
- Management cited secular declines in checks and forms, competition and pricing pressure, financial-institution client factors, data-security risks, acquisition execution and economic conditions. It reported no significant change in disclosed risk factors during Q1.
- In April 2017, after quarter-end, Deluxe acquired RDM Corporation for approximately $70 million net of cash acquired, funded with cash and revolver borrowings. Management included approximately $19 million of RDM revenue in its 2017 outlook.
- Other notable items: the $5.3 million impairment; the $6.8 million gain on business sales; and a $2.5 million Financial Services legal settlement and related expenses. Environmental remediation accruals were $3.1 million; management said identified litigation reserves were not material but cautioned that adverse rulings could have material effects.
Investor verification priorities
- Separate organic growth from acquisition contributions and check the sustainability of marketing-solutions growth against continued check and forms declines.
- Track Financial Services profitability, pricing allowances, customer losses and the expected impact of RDM integration.
- Assess whether the planned $45 million of cost reductions can offset ongoing cost inflation and growth investments without impairing revenue growth.
- Monitor floating-rate debt, February 2019 maturities, revolver capacity and debt covenant headroom, particularly after the RDM acquisition.
- Verify the realization of 2017 revenue, EPS and cash-flow guidance, including the effects of unusual gains, impairment, restructuring, legal costs and tax-rate changes.