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DELUXE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) EXECUTIVE OVERVIEW We employ a multi-channel strategy to provide a suite of life-cycle driven solutions to our customers. We use printed and electronic marketing, a direct sales force, financial institution and telecommunication client referrals, purchased search results from online search engines, and independent distributors and dealers to promote and sell a wide range of customized products and services. Our Small Business Services segment provides products and services to over 4.5 million small business customers and our Direct Checks segment provides products and services to more than six million consumers. Through our Financial Services segment, we provide products and services to approximately 5,500 financial institution clients. We operate primarily in the United States. Small Business Services also has operations in Canada and portions of Europe. Our product and service offerings are comprised of the following: Checks - We remain one of the largest providers of checks in the United States, both in terms of revenue and the number of checks produced. Checks account for the majority of the revenue in our Financial Services and Direct Checks segments and represented 43.2% of our Small Business Services segment's revenue in 2013. Forms - Our Small Business Services segment is a leading provider of printed forms to small businesses, including deposit tickets, billing forms, work orders, job proposals, purchase orders, invoices and personnel forms. This segment also offers computer forms compatible with accounting software packages commonly used by small businesses. Forms sold by our Financial Services and Direct Checks segments include deposit tickets and check registers. Accessories and other products - Small Business Services offers products designed to provide small business owners with the customized documents necessary to efficiently manage their business including envelopes, office supplies, stamps and labels, as well as retail packaging supplies. Our Financial Services and Direct Checks segments offer checkbook covers and stamps. Marketing solutions - All three of our segments offer products and services that help small businesses and/or financial institutions promote their businesses and acquire customers. Our Small Business Services segment offers services designed to fulfill the sales and marketing needs of small businesses, including web design, hosting and other web services; search engine optimization; marketing services, including email, mobile, social media and other self-service marketing solutions; digital printing services; and logo design. In addition, Small Business Services offers products such as promotional products, postcards, brochures, apparel, greeting cards and business cards. Financial Services offers various customer acquisition programs, marketing communications services, and rewards and loyalty programs. Direct Checks provides package insert programs under which companies' marketing materials are included in our check packages. Other services - All three of our segments provide fraud protection and security services. In addition, our Small Business Services segment offers payroll services, and Financial Services provides financial institution profitability and risk management services. Throughout the past several years, we have focused on opportunities to increase revenue and operating income, while maintaining strong operating margins. These opportunities have included new product and service offerings, brand awareness and positioning initiatives, investing in technology for our service offerings, enhancing our internet capabilities, improving customer segmentation, adding new small business customers, and reducing costs. In addition, we invested in various 35 --------------------------------------------------------------------------------acquisitions that extend the range of products and services we offer to our customers, including marketing solutions and other services offerings. During the remainder of 2014, we will continue our focus in these areas, with an emphasis on profitable revenue growth, increasing revenue from our marketing solutions and other services offerings for small businesses and financial institutions, and assessing small to medium-sized acquisitions that complement our large customer bases, with a focus on marketing solutions and other services opportunities. Earnings for the first nine months of 2014, as compared to the first nine months of 2013, benefited from price increases in all three segments and continuing initiatives to reduce our cost structure, primarily within our fulfillment, sales and marketing, and information technology organizations. These increases in earnings were partially offset by volume reductions for our personal check businesses, due primarily to the continuing decline in check usage, as well as increased investments in revenue growth opportunities, including product and service enhancements. Our Strategies Details concerning our strategies were provided in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2013 (the "2013 Form 10-K"). We made no significant changes to our strategies during the first nine months of 2014. Consistent with our strategy, during the first nine months of 2014, we purchased the operations of several small business distributors for $7.8 million, net of cash acquired. We also purchased all of the outstanding capital stock of NetClime, Inc. for cash of $2.0 million, net of cash acquired, as well as selected assets of Gift Box Corporation of America (GBCA) for cash of $1.8 million. NetClime is a provider of website development software and GBCA is a supplier of retail packaging solutions, including gift boxes, bags, bows, ribbons and wraps. The results of operations of each of these businesses from their acquisition dates are included in our Small Business Services segment. On October 22, 2014, we acquired Wausau Financial Systems, Inc. (WFS) in an all cash transaction for approximately $90 million, net of cash acquired, funded by a draw on our credit facility. The purchase included specific tax attributes which are expected to generate approximately $4 million of incremental cash tax savings. WFS provides software-based solutions for receivables management, lockbox processing, remote deposit capture and paperless branch solutions to financial institutions, utilities, government agencies and telecommunications companies. The results of this business will be included in our Financial Services segment. In 2014, we anticipate that WFS will contribute revenue of approximately $12 million, will be $0.01 dilutive to earnings per share and will generate positive operating cash flow. In 2015, we estimate that WFS will contribute revenue of approximately $80 million and be $0.04 dilutive to earnings per share, turning slightly accretive to earnings per share in the fourth quarter of 2015. Cost Reduction Initiatives As discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the 2013 Form 10-K, we anticipated that we would realize net cost reductions of approximately $55 million in 2014, as compared to our 2013 results of operations. To date, we have realized approximately $48 million of net cost reductions primarily from our sales, marketing, fulfillment and information technology organizations, and we have increased our estimate of 2014 net cost reductions to $60 million. Approximately 70% of these savings will impact selling, general and administrative (SG&A) expense, with the remaining 30% affecting total cost of revenue. Outlook for 2014 We anticipate that consolidated revenue will be between $1.657 billion and $1.665 billion for 2014, compared to $1.585 billion for 2013. In Small Business Services, we expect revenue to increase between 7% and 8% compared to 2013 revenue of $1.050 billion, as volume declines in core business products and the impact of unfavorable foreign exchange rate changes are expected to be more than offset by benefits from our e-commerce investments, price increases and growth in our distributor, dealer and major accounts channels and in our marketing solutions and other services offerings. The anticipated revenue increase includes incremental revenue from the VerticalResponse acquisition in June 2013 and the GBCA acquisition in May 2014. In Financial Services, we expect revenue to increase approximately 5% compared to 2013 revenue of $343.2 million. We expect that year-over-year check order declines of approximately 6%, as well as pricing pressure on contract renewals, will be offset by continued growth in non-check revenue, including incremental revenue from the Acton Marketing acquisition in August 2013, the Destination Rewards acquisition in December 2013 and the WFS acquisition in October 2014. Additionally, we expect Financial Services revenue to benefit from higher revenue per order, a full year of revenue from a new large financial institution client acquired in the third quarter of 2013, and a quarter of revenue from a new client recently 36 --------------------------------------------------------------------------------acquired. In Direct Checks, we expect revenue to decline approximately 8% compared to 2013 revenue of $191.4 million, driven by check order volume declines. We expect that 2014 diluted earnings per share will be between $3.86 and $3.92, including $0.22 per share for restructuring, an asset impairment charge and transaction costs related to acquisitions, compared to $3.65 for 2013, which also included total charges of $0.22 per share related to restructuring, an asset impairment charge and transaction costs related to acquisitions. We expect that the benefits of additional cost reduction activities and lower fourth quarter interest expense will be partially offset by a continued sluggish economy, increases in material costs and delivery rates, as well as continued investments in revenue growth opportunities, including brand awareness, marketing solutions and other services offers, and enhanced e-commerce capabilities. We estimate that our annual effective tax rate for 2014 will be approximately 34.0%, compared to 33.6% for 2013. A number of discrete credits to income tax expense in 2013 collectively reduced our 2013 tax rate by 0.7 points. We anticipate that net cash provided by operating activities will be between $278 million and $285 million in 2014, compared to $262 million in 2013, driven by higher earnings, lower contributions to our trust used to fund medical benefits, and lower performance-based compensation payments, partially offset by higher income tax payments. We anticipate contract acquisition payments of approximately $19 million in 2014, and we estimate that capital spending will be approximately $40 million in 2014, as we continue to invest in key revenue growth initiatives, as well as order fulfillment and information technology infrastructure. We believe that cash generated by operating activities, along with availability under our credit facility, will be sufficient to support our operations for the next 12 months, including required interest and principal payments, dividend payments, capital expenditures and possible small-to-medium-sized acquisitions. We are focused on a disciplined approach to capital deployment that focuses on our need to continue investing in initiatives to drive revenue growth, including small-to-medium-sized acquisitions and continued expansion of our distributor channel. In April 2014, our board of directors increased our quarterly dividend amount from $0.25 per share to $0.30 per share. Dividends are approved by the board of directors on a quarterly basis, and thus are subject to change. In February 2014, we increased the amount available for borrowing under our credit facility from $200.0 million to $350.0 million, along with extending the term of the agreement from February 2017 to February 2019. In October 2014, $253.5 million of our senior notes matured. We used cash on hand and an initial borrowing of $135.0 million under our credit facility to meet this debt obligation. We may also, from time to time, consider retiring outstanding debt through open market repurchases, privately negotiated transactions or other means. We also utilized our credit facility to fund the entire amount paid for the acquisition of WFS in October 2014. We expect to reduce the amount drawn on our credit facility during the fourth quarter of 2014 using cash generated by operations. BUSINESS CHALLENGES/MARKET RISKS Details concerning business challenges/market risks were provided in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the 2013 Form 10-K. There were no significant changes in these items during the first nine months of 2014. |