Deluxe Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unaudited interim results; dollar figures below are in millions unless stated otherwise.
Business context
Deluxe provides checks, forms, marketing solutions and other services through Small Business Services, Financial Services and Direct Checks. Management’s strategy emphasizes profitable revenue growth, expanding marketing and service offerings, acquisitions, and cost reductions. Check usage continues to decline.
Financial performance
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $439.8 | $413.2 | $1,309.3 | $1,225.6 |
| Gross profit | $280.5 | $263.1 | $841.4 | $784.6 |
| Operating income | $89.4 | $76.7 | $263.5 | $242.5 |
| Net income | $56.9 | $44.4 | $158.9 | $141.8 |
| Diluted EPS | $1.13 | $0.88 | $3.16 | $2.80 |
| Operating margin | 20.3% | 18.6% | 20.1% | 19.8% |
- Q3 revenue rose 6.4%; nine-month revenue rose 6.8%. Marketing solutions and other services, price increases and acquisitions drove growth. Q3 orders declined 1.8%, while revenue per order increased 8.4%.
- For the first nine months, service revenue was 17.8% of total revenue, up from 15.1%. Checks’ share of revenue fell to 50.4% from 53.7%, while marketing solutions and other services rose to 29.0% from 23.7%.
- Q3 gross margin was approximately 63.8% versus 63.7%; nine-month gross margin was approximately 64.3% versus 64.0%. SG&A increased 8.0% in Q3 and 9.1% year to date, including acquisition costs and growth investments.
- Nine-month operating cash flow was $217.9 versus $203.4. Capital spending was $29.5; operating cash flow less capital spending was approximately $188.4. Cash and cash equivalents were $62.9 at September 30.
- Total debt was $518.5, down from $554.3 at year-end 2014. Debt included $269.0 drawn on the credit facility and a $50.0 short-term bank loan. The $350.0 facility had $68.3 available after borrowings and letters of credit. Current liabilities exceeded current assets, in part because $319.0 of short-term borrowings were classified as current.
- Dividends paid in the first nine months were $45.0; the quarterly dividend was $0.30 per share. The company repurchased 772,300 shares for $47.0 during the period.
Material changes and unusual items
- In March 2015, Deluxe retired $200.0 of 7.0% senior notes using credit-facility borrowings and a short-term bank loan. The transaction generated an $8.9 pretax early-extinguishment loss. Lower borrowing costs helped reduce nine-month interest expense to $15.3 from $28.7.
- 2015 acquisitions included eight small-business distributors and selected assets of several service and technology businesses. Net cash paid for acquisitions was $50.9 in the first nine months. Acquisition-related amortization weighed on Financial Services’ margin.
- On October 16, 2015, after quarter-end, Deluxe acquired Datamyx for approximately $160.0 cash and expanded its credit facility to $525.0. At the acquisition date, $428.0 was drawn. Management expected Datamyx to add about $7.0 of Q4 revenue and dilute EPS by about $0.06, including about $0.02 of transaction costs.
- Restructuring charges were $3.2 for the first nine months, versus $8.8 in 2014. Management expected most employee reductions to be completed in Q4 2015 and related severance payments by mid-2016.
Outlook, commentary and risks
- 2015 guidance: revenue of $1.765–$1.775 billion; diluted EPS of $4.31–$4.37, including $0.20 per share of specified charges; operating cash flow of $300–$305 million; and capital spending of approximately $40 million.
- Management was on track for approximately $50 million in net cost reductions in 2015. It expected Small Business Services revenue growth of 4%–5%, Financial Services growth of 15%–16%, and Direct Checks revenue decline of about 6%.
- Key operating pressures include secular declines in personal and business check usage, lower search marketing revenue in a reduced business line, contract renewal allowances, and higher delivery, materials and medical costs. Growth investments and acquisition costs may also affect margins.
- Management believed operating cash flow and credit availability would cover the next 12 months’ operating needs, debt service, dividends, capital spending and planned repurchases or acquisitions. It reported compliance with debt covenants at September 30.
- The Financial Services Commercial reporting unit’s estimated fair value exceeded carrying value by approximately 13%; management noted that changes in forecasts could reduce this cushion and lead to goodwill impairment. Environmental remediation accruals were $7.2; the company did not expect the range of outcomes to materially affect financial condition, results or liquidity. The filing reported no significant changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether 2015 revenue, EPS and operating-cash-flow guidance was achieved, and how Datamyx performed relative to its disclosed Q4 expectations.
- How much reported growth came from acquisitions, pricing and service mix versus underlying volume; particularly the continued declines in check orders.
- Whether the expanded credit facility and post-quarter acquisition materially changed leverage, interest expense, liquidity or covenant headroom.
- Whether management realized the expected $50 million cost reductions without impairing customer retention or future revenue growth.
- Whether Financial Services Commercial’s impairment cushion, acquisition-related valuations and environmental exposures changed materially after quarter-end.