Deluxe Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Financial statements are unaudited. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context
Deluxe operates Small Business Services, Financial Services, and Direct Checks, selling printed products, checks, and related business and financial-marketing services. It acquired direct-to-consumer check provider Custom Direct in April 2010 for approximately $97.9 million net of cash acquired; results are included in Direct Checks. It also acquired Cornerstone Customer Solutions in March.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $367.6 | $332.3 | $1,050.7 | $1,003.9 |
| Gross profit / margin | $246.2 / 67.0% | $210.4 / 63.3% | $689.0 / 65.6% | $625.8 / 62.3% |
| Operating income | $88.5 | $54.5 | $220.7 | $134.8 |
| Net income | $50.8 | $28.6 | $117.8 | $68.8 |
| Diluted EPS | $0.98 | $0.56 | $2.28 | $1.34 |
- Q3 revenue rose 10.6%; nine-month revenue rose 4.7%. Q3 orders fell 2.4% and nine-month orders fell 5.1%, while revenue per order increased.
- Operating margin was approximately 24.1% in Q3 versus 16.4% a year earlier, and 21.0% for nine months versus 13.4%. Gross-margin improvement reflected higher revenue per order, manufacturing efficiencies, cost reductions, and product mix.
- Nine-month operating cash flow from continuing operations was $170.5 million, compared with $150.2 million. Investing used $124.4 million, including $98.6 million for acquisitions; financing used $38.1 million. Cash increased $8.3 million to $21.1 million.
- At September 30, total debt was $779.3 million, including $30.0 million drawn on the credit facility. The $200 million facility had $160.7 million available after outstanding letters of credit. Long-term debt maturities begin in December 2012. Shareholders’ equity was $202.4 million.
- The quarterly dividend remained $0.25 per share. The company paid $38.6 million in dividends during the first nine months.
Material changes and unusual items
- A $24.6 million termination settlement with a financial institution contributed $12.1 million to Small Business Services and $12.5 million to Financial Services revenue in Q3. Management said a new client’s revenue was expected to offset the lost business.
- Custom Direct contributed $20.5 million of Q3 revenue and $38.8 million for the nine-month period. Its acquisition increased goodwill by $65.8 million. Management expected about $60 million of 2010 revenue, more than $15 million of operating cash flow, and neutral 2010 EPS impact, including acquisition-related costs and amortization.
- Year-to-date comparisons also benefited from the absence of 2009 asset impairment charges of $24.9 million and a $9.8 million gain on early debt extinguishment. The 2010 period included a $3.4 million tax charge related to health-care legislation. Q3 net income included a $0.4 million loss from discontinued operations.
- Goodwill and indefinite-lived trade-name impairment reviews in 2010 resulted in no impairment charges.
Outlook, management commentary, and risks
- For 2010, management forecast continuing-operations revenue of $1.397–$1.405 billion and diluted EPS of $2.93–$3.00. EPS guidance included the settlement benefit, the health-care-related tax charge, and restructuring costs.
- Management forecast operating cash flow of $220–$226 million and capital spending of slightly more than $40 million for 2010. It expected the current credit facility and operating cash flow to cover operations, capital spending, debt service, dividends, and possible small-to-medium acquisitions over the next 12 months; the board was expected to maintain the current dividend, subject to quarterly approval.
- The company continued to face weak economic conditions, declining check and forms usage, reduced small-business discretionary spending, financial-institution failures and consolidation, competitive pricing pressure, and higher delivery costs. Management cited cost reduction, pricing, business services, and acquisitions as offsets, and targeted at least $325 million in annual cost-structure reductions versus its 2006 baseline by the end of 2010.
- Key exposures include the recoverability of $55.2 million in unamortized contract acquisition costs and the risk of losing financial-institution clients as they consolidate. Postretirement plan assets are exposed to market volatility. The company reported compliance with debt covenants and no significant changes in disclosed litigation or other contingencies.
Important facts for investors to verify
- How much of reported growth and margin improvement reflects the nonrecurring $24.6 million settlement, prior-year impairment differences, or acquired revenue, versus underlying demand and pricing?
- Whether the new financial-institution client offsets the terminated business, and whether management’s revenue, EPS, and cash-flow guidance is achieved.
- Custom Direct’s actual cash generation, integration costs, tax-attribute benefits, and purchase-price allocation, which was preliminary.
- Whether check-usage declines, financial-institution consolidation, or weaker economic conditions affect client retention and contract acquisition cost recoverability.
- Debt-facility availability and covenant compliance, and whether cash generation supports planned investment, debt reduction, and dividends.