Deluxe Corporation — Q1 2014 Form 10-Q
Business context and reporting period. The unaudited quarter ended March 31, 2014. Deluxe sells checks, forms, business products, marketing solutions and other services through Small Business Services, Financial Services and Direct Checks. Checks remain a significant business, while the company is expanding marketing and service offerings.
Financial performance
- Revenue: $407.0 million, up 5.0% from $387.6 million. Service revenue was $61.3 million, or 15.1% of revenue, versus 12.3% a year earlier. Orders fell 6.1%, while revenue per order rose 11.9% to $32.52.
- Profit: Gross profit was $262.0 million, up 3.1%; gross margin declined to 64.4% from 65.6%. Operating income was $80.8 million versus $77.7 million; operating margin was approximately 19.9% versus 20.1%. Net income was $47.3 million versus $45.9 million. Diluted EPS was $0.93 versus $0.89.
- Cash flow: Operating cash flow was $73.3 million versus $51.5 million. Capital expenditures were $11.0 million; operating cash flow less capital expenditures was $62.4 million. Investing cash use was $13.0 million and financing cash use was $39.1 million. Cash increased $19.5 million to $140.6 million.
- Debt and liquidity: Total debt was $643.2 million, including $254.5 million of 5.125% notes due October 1, 2014. Cash and cash equivalents were $140.6 million. The amended credit facility provides $350.0 million of capacity, with $341.1 million net available; no facility borrowings were outstanding. The company reported compliance with debt covenants.
- Capital returns: The company repurchased 622,558 shares for $31.9 million and paid $12.6 million in dividends during the quarter. The board raised the quarterly dividend to $0.30 per share in April, from $0.25.
Material changes and management commentary
- Small Business Services revenue rose 8.7% to $269.8 million and operating income rose 12.9% to $43.6 million. Financial Services revenue increased 2.3% to $89.1 million, but operating income declined 5.7% to $21.6 million. Direct Checks revenue fell 7.9% to $48.0 million and operating income fell 3.8% to $15.6 million.
- Management attributed revenue growth to price increases, marketing and other services, acquisitions and Small Business Services distributor growth. Lower personal-check order volumes and Financial Services contract pricing pressure were offsets. Gross margin declined with a mix shift toward lower-margin services and outsourced products, and higher delivery and material costs.
- Restructuring charges totaled $3.5 million, including $3.3 million in operating expenses and $0.2 million in cost of revenue, versus $1.4 million total a year earlier. Approximately 40 employees were included in current-quarter severance accruals; most reductions were expected to be completed by mid-2014.
- Q1 operating cash flow benefited from working-capital movements, lower employee bonus payments and lower medical-benefit funding. Management said the increase was partly offset by higher income-tax payments.
Outlook, risks and contingencies
- 2014 outlook: Revenue of $1.62–$1.65 billion; diluted EPS of $3.90–$4.05, including $0.07 per share of restructuring costs; operating cash flow of $270–$280 million; and capital expenditures of approximately $40 million. Management expected approximately $55 million in net cost reductions versus 2013 and reported approximately $15 million realized to date.
- Management expected Small Business Services revenue growth of 6%–8%, Financial Services revenue roughly flat, and Direct Checks revenue down approximately 10%. It cited continuing check-use declines, a sluggish economy, medical, material and delivery cost increases, and ongoing investment needs as offsets to growth and savings.
- The company expected to use cash and its credit facility to address the $253.5 million principal amount of notes maturing in October 2014. It said cash from operations and credit availability should support operations and planned commitments for the next 12 months.
- Environmental remediation accruals were $8.3 million; management did not anticipate significant net cash outlays for these matters in 2014. The filing describes indemnification and self-insurance exposures and says currently identified litigation reserves were not material. The company reported no significant changes to the risk factors in its 2013 Form 10-K.
- Foreign subsidiaries held $45.6 million of cash and marketable securities. Management estimated that repatriating the Canadian balance to the U.S. at once would incur approximately $6 million of U.S. tax.
Important facts for investors to verify
- How the October 2014 notes will be repaid or refinanced, and the resulting cash, debt and interest position.
- Whether forecast revenue, EPS, operating cash flow and $55 million of cost reductions are achieved, and whether savings offset cost inflation and lower check volumes.
- Whether service and marketing-solutions growth can continue without further pressure on gross margin, and whether Financial Services pricing pressure persists.
- Future share repurchases and dividend payments relative to debt maturity funding, investment needs and credit-facility covenant thresholds.
- Updates to environmental remediation, self-insurance and other contingencies, including whether estimates or expected cash requirements change.