Deluxe Corporation (NYSE: DLX) — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing also reports unaudited fourth-quarter results. Deluxe provides products and services to small businesses, financial institutions and consumers through Small Business Services, Financial Services and Direct Checks. Its strategy is to grow marketing solutions and other services while managing the continued decline in checks and printed forms.
Financial performance and key metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Revenue | $1.773 billion | $1.674 billion | +5.9% |
| Gross profit / gross margin | $1.134 billion / 63.9% | $1.068 billion / 63.8% | Margin +0.1 percentage point |
| Operating income / operating margin | $354.3 million / 20.0% | $332.6 million / 19.9% | Margin +0.1 percentage point |
| Net income | $218.6 million | $199.8 million | +9.4% |
| Diluted EPS | $4.36 | $3.96 | +10.1% |
| Operating cash flow | $307.9 million | $280.4 million | +$27.5 million |
| Cash and cash equivalents at year-end | $62.4 million | $61.5 million | +$0.9 million |
| Total debt at year-end | $631.3 million | $554.3 million | +$77.0 million |
Checks represented 49.3% of consolidated revenue, down from 52.0% in 2014. Marketing solutions and other services rose to 30.0% of revenue from 25.5%; service revenue itself was $320.8 million, or 18.1% of total revenue. Cost of revenue was 36.1% of revenue and SG&A was 43.7%, compared with 36.2% and 43.0%, respectively, in 2014.
Fourth quarter: Revenue was $463.5 million versus $448.5 million in Q4 2014; net income was $59.7 million versus $58.0 million. Diluted EPS was $1.20 versus $1.16. Q4 2015 included $3.1 million of restructuring charges and a $1.2 million reduction in income tax expense for discrete items.
Cash, liquidity and capital allocation: Investing activities used $251.1 million, including $213.0 million for acquisitions and $43.3 million for capital expenditures. Financing activities used $46.7 million. Deluxe paid $59.8 million in dividends and repurchased $60.0 million of shares during 2015. It had a $525 million revolving credit facility, with $434 million drawn and $78.3 million available at year-end; the facility expires in February 2019. Debt covenants were reported in compliance. The company redeemed $200 million of 7.0% notes in March 2015, recording an $8.9 million pretax early-extinguishment loss.
- Small Business Services: Revenue of $1.152 billion (+4.1%); operating income of $203.9 million (+8.9%); margin of 17.7%, up 0.8 percentage point.
- Financial Services: Revenue of $455.4 million (+16.4%); operating income of $91.5 million (+4.1%); margin of 20.1%, down 2.4 points. Acquisitions contributed materially to revenue, while acquisition results and contract renewal allowances pressured margin.
- Direct Checks: Revenue of $165.5 million (−6.2%); operating income of $58.9 million (+2.4%); margin of 35.6%, up 3.0 points. Cost reductions and higher revenue per order partly offset lower check order volume.
Material changes versus the prior comparable period
- Revenue growth was driven by $105 million of growth in marketing solutions and other services, including acquired businesses, price increases across all three segments, and distributor-channel expansion. These gains were partly offset by lower personal and business check volumes, Financial Services contract renewal allowances and an $11 million unfavorable foreign-exchange impact.
- Marketing solutions and other services increased to $532.5 million from $427.1 million; check revenue was nearly flat in dollars at $873.3 million, but its share of total revenue declined.
- Operating income increased with pricing and cost savings, but SG&A rose 7.7%, reflecting acquired-business expenses and growth investments. The company reported approximately $50 million of net cost reductions versus 2014.
- Operating cash flow improved, mainly from stronger operating results and lower interest payments. Acquisition spending more than doubled, from $105.0 million to $213.0 million.
- Total debt rose as borrowings under the credit facility funded acquisitions, debt actions and other capital uses. Interest expense nevertheless fell 44.4% to $20.3 million, reflecting lower average debt and lower-cost financing.
Outlook, commentary, risks and unusual items
For 2016, management forecast revenue of $1.835–$1.875 billion, diluted EPS of $4.75–$4.95, and operating cash flow of $315–$330 million. It expected Small Business Services revenue growth of 4%–7%, Financial Services growth of 6%–8%, and Direct Checks revenue decline of 7%–8%. Expected drivers include acquired-business contributions, digital and marketing-services growth, pricing and continued cost savings; expected offsets include secular check declines, contract renewal allowances, a sluggish economy, medical and material costs, delivery rates and continued growth investment.
Management expected approximately $50 million of additional net cost reductions in 2016, capital spending of about $43 million and contract acquisition payments of about $15 million. It expected a 33.8% effective tax rate and anticipated maintaining the current dividend level, subject to quarterly board approval. Management stated operating cash and credit availability should fund operations, dividends, capital expenditures, interest, periodic repurchases and possible small-to-medium-sized acquisitions.
- Structural and market risks: Continued check-use decline, technological displacement of forms, pricing pressure, direct-mail response rates, competition and uncertain small-business conditions could weigh on revenue and margins.
- Acquisition and impairment risks: Integration and expected returns from recent acquisitions are uncertain. Goodwill and the indefinite-lived trade name were 54.0% of total assets. The newly acquired Financial Services Commercial reporting unit had only about 13% estimated fair-value headroom in its 2015 impairment test, making it sensitive to forecast and discount-rate changes.
- Legal contingency: A supplier sought up to approximately $43 million in arbitration over a reseller agreement. The hearing had concluded; a decision was expected in March 2016. Deluxe had not accrued a loss because it was not considered probable or reasonably estimable, and the possible loss range was unclear.
- Other exposures: Cybersecurity, privacy and regulatory compliance, third-party technology providers, materials and delivery costs, financial-institution consolidation, environmental remediation and postretirement plan asset performance are identified risks. Recorded environmental accruals were $6.0 million; management did not expect significant net environmental cash outlays in the next five years.
- Unusual and accounting items: 2015 included the $8.9 million pretax debt-extinguishment loss and $6.2 million of total restructuring charges (including amounts classified in cost of revenue). The company adopted deferred-tax balance-sheet classification guidance prospectively; no material effect was reported.
Important facts for investors to verify
- Whether marketing-services growth and acquisitions can offset declining check and forms demand, and whether acquired businesses deliver expected revenue and returns.
- Progress against 2016 revenue, EPS, cash-flow and $50 million cost-savings guidance, including the margin impact of growth investments and acquisitions.
- Debt trajectory, refinancing and covenant headroom, and the company’s capacity to sustain dividends, repurchases and further acquisitions with only $78.3 million of year-end facility availability.
- Developments in the supplier arbitration, including the outcome and any resulting financial impact.
- Goodwill impairment sensitivity, particularly the Financial Services Commercial reporting unit’s limited headroom, alongside acquisition integration and forecast performance.
- That reported 2015 EPS includes the debt-extinguishment loss and restructuring costs, while Q4 included a discrete tax benefit; assess comparability with guidance and future periods accordingly.