UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2015 | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________________ to ________________________ | |
Commission file number: 1-7945
DELUXE CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota (State or other jurisdiction of incorporation or organization) | 41-0216800 (I.R.S. Employer Identification No.) |
3680 Victoria St. N., Shoreview, Minnesota (Address of principal executive offices) | 55126-2966 (Zip Code) |
(651) 483-7111
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þYes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).
þYes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer o | |
Non-accelerated filer o | Smaller reporting company o | |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No
The number of shares outstanding of registrant’s common stock, par value $1.00 per share, at April 20, 2015 was 49,930,204.
1
PART I − FINANCIAL INFORMATION
Item 1. Financial Statements.
DELUXE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share par value)
(Unaudited)
March 31, 2015 | December 31, 2014 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 58,319 | $ | 61,541 | ||||
Trade accounts receivable (net of allowances for uncollectible accounts of $4,508 and $4,335, respectively) | 94,361 | 113,656 | ||||||
Inventories and supplies | 38,100 | 39,411 | ||||||
Deferred income taxes | 10,295 | 10,159 | ||||||
Funds held for customers | 50,038 | 43,604 | ||||||
Other current assets | 43,831 | 50,519 | ||||||
Total current assets | 294,944 | 318,890 | ||||||
Deferred income taxes | 1,291 | 1,411 | ||||||
Long-term investments (including $2,144 and $2,384 of investments at fair value, respectively) | 46,137 | 46,451 | ||||||
Property, plant and equipment (net of accumulated depreciation of $346,279 and $348,530, respectively) | 85,258 | 87,623 | ||||||
Assets held for sale | 26,916 | 26,819 | ||||||
Intangibles (net of accumulated amortization of $397,142 and $388,308, respectively) | 210,255 | 207,180 | ||||||
Goodwill | 879,258 | 868,376 | ||||||
Other non-current assets | 121,581 | 131,641 | ||||||
Total assets | $ | 1,665,640 | $ | 1,688,391 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 75,227 | $ | 87,216 | ||||
Accrued liabilities | 220,889 | 219,121 | ||||||
Short-term borrowings | 318,000 | 160,000 | ||||||
Long-term debt due within one year | 1,013 | 911 | ||||||
Total current liabilities | 615,129 | 467,248 | ||||||
Long-term debt | 196,434 | 393,401 | ||||||
Deferred income taxes | 94,836 | 95,838 | ||||||
Other non-current liabilities | 79,495 | 84,407 | ||||||
Commitments and contingencies (Notes 12 and 13) | ||||||||
Shareholders’ equity: | ||||||||
Common shares $1 par value (authorized: 500,000 shares; outstanding: 2015 – 49,929; 2014 – 49,742) | 49,929 | 49,742 | ||||||
Additional paid-in capital | 11,648 | 4,758 | ||||||
Retained earnings | 660,264 | 629,335 | ||||||
Accumulated other comprehensive loss | (42,095 | ) | (36,338 | ) | ||||
Total shareholders’ equity | 679,746 | 647,497 | ||||||
Total liabilities and shareholders’ equity | $ | 1,665,640 | $ | 1,688,391 | ||||
See Condensed Notes to Unaudited Consolidated Financial Statements
2
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except per share amounts)
(Unaudited)
Quarter Ended March 31, | ||||||||
2015 | 2014 | |||||||
Product revenue | $ | 355,013 | $ | 345,664 | ||||
Service revenue | 78,604 | 61,291 | ||||||
Total revenue | 433,617 | 406,955 | ||||||
Cost of products | (123,739 | ) | (118,386 | ) | ||||
Cost of services | (28,942 | ) | (26,542 | ) | ||||
Total cost of revenue | (152,681 | ) | (144,928 | ) | ||||
Gross profit | 280,936 | 262,027 | ||||||
Selling, general and administrative expense | (195,378 | ) | (177,931 | ) | ||||
Net restructuring charges | (267 | ) | (3,300 | ) | ||||
Operating income | 85,291 | 80,796 | ||||||
Loss on early debt extinguishment | (8,917 | ) | — | |||||
Interest expense | (6,515 | ) | (9,567 | ) | ||||
Other income | 430 | 131 | ||||||
Income before income taxes | 70,289 | 71,360 | ||||||
Income tax provision | (24,349 | ) | (24,036 | ) | ||||
Net income | $ | 45,940 | $ | 47,324 | ||||
Comprehensive income | $ | 40,183 | $ | 45,455 | ||||
Basic earnings per share | 0.92 | 0.94 | ||||||
Diluted earnings per share | 0.91 | 0.93 | ||||||
Cash dividends per share | 0.30 | 0.25 | ||||||
See Condensed Notes to Unaudited Consolidated Financial Statements
3
DELUXE CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
(Unaudited)
Common shares | Common shares par value | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Total | ||||||||||||||||||
Balance, December 31, 2014 | 49,742 | $ | 49,742 | $ | 4,758 | $ | 629,335 | $ | (36,338 | ) | $ | 647,497 | |||||||||||
Net income | — | — | — | 45,940 | — | 45,940 | |||||||||||||||||
Cash dividends | — | — | — | (15,011 | ) | — | (15,011 | ) | |||||||||||||||
Common shares issued | 204 | 204 | 4,032 | — | — | 4,236 | |||||||||||||||||
Tax impact of share-based awards | — | — | 1,096 | — | — | 1,096 | |||||||||||||||||
Common shares retired | (17 | ) | (17 | ) | (1,093 | ) | — | — | (1,110 | ) | |||||||||||||
Fair value of share-based compensation | — | — | 2,855 | — | — | 2,855 | |||||||||||||||||
Other comprehensive loss | — | — | — | — | (5,757 | ) | (5,757 | ) | |||||||||||||||
Balance, March 31, 2015 | 49,929 | $ | 49,929 | $ | 11,648 | $ | 660,264 | $ | (42,095 | ) | $ | 679,746 | |||||||||||
See Condensed Notes to Unaudited Consolidated Financial Statements
4
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Quarter Ended March 31, | ||||||||||
2015 | 2014 | |||||||||
Cash flows from operating activities: | ||||||||||
Net income | $ | 45,940 | $ | 47,324 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||
Depreciation | 3,933 | 4,241 | ||||||||
Amortization of intangibles | 13,750 | 12,024 | ||||||||
Amortization of contract acquisition costs | 4,831 | 4,261 | ||||||||
Deferred income taxes | (1,215 | ) | (594 | ) | ||||||
Employee share-based compensation expense | 3,155 | 1,908 | ||||||||
Loss on early debt extinguishment | 8,917 | — | ||||||||
Other non-cash items, net | 808 | 2,336 | ||||||||
Changes in assets and liabilities, net of effect of acquisitions: | ||||||||||
Trade accounts receivable | 16,395 | 8,926 | ||||||||
Inventories and supplies | 1,409 | (585 | ) | |||||||
Other current assets | 5,082 | (1,703 | ) | |||||||
Non-current assets | 1,215 | (860 | ) | |||||||
Accounts payable | (10,851 | ) | (2,169 | ) | ||||||
Contract acquisition payments | (2,947 | ) | (1,355 | ) | ||||||
Other accrued and non-current liabilities | (12,719 | ) | (415 | ) | ||||||
Net cash provided by operating activities | 77,703 | 73,339 | ||||||||
Cash flows from investing activities: | ||||||||||
Purchases of capital assets | (9,512 | ) | (10,950 | ) | ||||||
Payments for acquisitions, net of cash acquired | (7,584 | ) | (2,866 | ) | ||||||
Other | 463 | 806 | ||||||||
Net cash used by investing activities | (16,633 | ) | (13,010 | ) | ||||||
Cash flows from financing activities: | ||||||||||
Net proceeds (payments) from short-term borrowings | 158,000 | (125 | ) | |||||||
Payments on long-term debt, including costs of debt reacquisition | (207,242 | ) | (203 | ) | ||||||
Payments for debt issue costs | (97 | ) | (939 | ) | ||||||
Proceeds from issuing shares under employee plans | 3,389 | 5,376 | ||||||||
Excess tax benefit from share-based employee awards | 1,260 | 1,401 | ||||||||
Payments for common shares repurchased | — | (31,930 | ) | |||||||
Cash dividends paid to shareholders | (15,011 | ) | (12,644 | ) | ||||||
Other | (150 | ) | — | |||||||
Net cash used by financing activities | (59,851 | ) | (39,064 | ) | ||||||
Effect of exchange rate change on cash | (4,441 | ) | (1,739 | ) | ||||||
Net change in cash and cash equivalents | (3,222 | ) | 19,526 | |||||||
Cash and cash equivalents, beginning of year | 61,541 | 121,089 | ||||||||
Cash and cash equivalents, end of period | $ | 58,319 | $ | 140,615 | ||||||
See Condensed Notes to Unaudited Consolidated Financial Statements
5
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Note 1: Consolidated financial statements
The consolidated balance sheet as of March 31, 2015, the consolidated statements of comprehensive income for the quarters ended March 31, 2015 and 2014, the consolidated statement of shareholders’ equity for the quarter ended March 31, 2015, and the consolidated statements of cash flows for the quarters ended March 31, 2015 and 2014 are unaudited. The consolidated balance sheet as of December 31, 2014 was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles (GAAP) in the United States of America. In the opinion of management, all adjustments necessary for a fair statement of the consolidated financial statements are included. Adjustments consist only of normal recurring items, except for any discussed in the notes below. Interim results are not necessarily indicative of results for a full year. The consolidated financial statements and notes are presented in accordance with instructions for Form 10-Q, and do not contain certain information included in our annual consolidated financial statements and notes. The consolidated financial statements and notes appearing in this report should be read in conjunction with the consolidated audited financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”).
Note 2: New accounting pronouncements
Recently adopted accounting pronouncements – In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This standard changes the criteria for determining which disposals should be presented as discontinued operations and modifies the related disclosure requirements. We adopted the new guidance on January 1, 2015, and it is applied prospectively. As such, we will apply this standard to any new disposals or new classifications of disposal groups as held for sale which occur on or after January 1, 2015.
Accounting pronouncements not yet adopted – In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The new standard provides revenue recognition guidance for any entity that enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets, unless those contracts are within the scope of other accounting standards. The new standard also expands the required financial statement disclosures regarding revenue recognition. The new guidance is effective for us on January 1, 2017, although the FASB has voted to propose a deferral of the effective date of the standard for one year. We are currently assessing the impact of this new standard on our consolidated financial statements, as well as the method of transition that we will use in adopting the new standard.
In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The new standard requires that a performance target that affects vesting and that could be achieved after the requisite service period should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. The new guidance is effective for us on January 1, 2016. We currently have share-based payment awards that fall within the scope of this standard. Our current accounting treatment is in compliance with the new standard, so we expect no impact on our consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs. The new standard requires that debt issuance costs related to a recognized debt liability be presented in the consolidated balance sheet as a direct reduction from the carrying amount of the debt liability. The new guidance is effective for us on January 1, 2016. As of March 31, 2015, we had debt issuance costs of $2,593 related to long-term debt and $1,804 related to short-term borrowings.
6
Note 3: Supplemental balance sheet information
Inventories and supplies – Inventories and supplies were comprised of the following:
(in thousands) | March 31, 2015 | December 31, 2014 | ||||||
Raw materials | $ | 5,674 | $ | 5,899 | ||||
Semi-finished goods | 8,535 | 8,990 | ||||||
Finished goods | 20,627 | 21,298 | ||||||
Supplies | 3,264 | 3,224 | ||||||
Inventories and supplies | $ | 38,100 | $ | 39,411 | ||||
Available-for-sale securities – Available-for-sale securities included within funds held for customers and other current assets were comprised of the following:
March 31, 2015 | ||||||||||||||||
(in thousands) | Cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||||||||
Canadian and provincial government securities | $ | 8,526 | $ | 21 | $ | — | $ | 8,547 | ||||||||
Canadian guaranteed investment certificate | 7,883 | — | — | 7,883 | ||||||||||||
Available-for-sale securities (funds held for customers)(1) | 16,409 | 21 | — | 16,430 | ||||||||||||
Canadian money market fund (other current assets) | 1,747 | — | — | 1,747 | ||||||||||||
Total available-for-sale securities | $ | 18,156 | $ | 21 | $ | — | $ | 18,177 | ||||||||
(1) Funds held for customers, as reported on the consolidated balance sheet as of March 31, 2015, also included cash of $33,608.
December 31, 2014 | ||||||||||||||||
(in thousands) | Cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||||||||
Canadian and provincial government securities | $ | 9,245 | $ | — | $ | (120 | ) | $ | 9,125 | |||||||
Canadian guaranteed investment certificate | 8,605 | — | — | 8,605 | ||||||||||||
Available-for-sale securities (funds held for customers)(1) | 17,850 | — | (120 | ) | 17,730 | |||||||||||
Canadian money market fund (other current assets) | 1,895 | — | — | 1,895 | ||||||||||||
Total available-for-sale securities | $ | 19,745 | $ | — | $ | (120 | ) | $ | 19,625 | |||||||
(1) Funds held for customers, as reported on the consolidated balance sheet as of December 31, 2014, also included cash of $25,874.
Expected maturities of available-for-sale securities as of March 31, 2015 were as follows:
(in thousands) | Fair value | |||
Due in one year or less | $ | 9,724 | ||
Due in two to five years | 5,983 | |||
Due in six to ten years | 2,470 | |||
Total available-for-sale securities | $ | 18,177 | ||
Further information regarding the fair value of available-for-sale securities can be found in Note 8: Fair value measurements.
7
Assets held for sale – Assets held for sale included the operations of small business distributors which we previously acquired and which consisted primarily of customer list intangible assets. We are actively marketing the distributors and expect the selling prices will exceed the carrying values. Net assets held for sale consisted of the following:
(in thousands) | March 31, 2015 | December 31, 2014 | Balance sheet caption | |||||||
Current assets | $ | 107 | $ | 687 | Other current assets | |||||
Intangibles | 25,926 | 25,926 | Assets held for sale | |||||||
Other non-current assets | 990 | 893 | Assets held for sale | |||||||
Accrued liabilities | (389 | ) | (1,058 | ) | Accrued liabilities | |||||
Non-current deferred income tax liabilities | (8,848 | ) | (8,774 | ) | Other non-current liabilities | |||||
Net assets held for sale | $ | 17,786 | $ | 17,674 | ||||||
Intangibles – Intangibles were comprised of the following:
March 31, 2015 | December 31, 2014 | |||||||||||||||||||||||
(in thousands) | Gross carrying amount | Accumulated amortization | Net carrying amount | Gross carrying amount | Accumulated amortization | Net carrying amount | ||||||||||||||||||
Indefinite-lived: | ||||||||||||||||||||||||
Trade name | $ | 19,100 | $ | — | $ | 19,100 | $ | 19,100 | $ | — | $ | 19,100 | ||||||||||||
Amortizable intangibles: | ||||||||||||||||||||||||
Internal-use software | 372,854 | (311,189 | ) | 61,665 | 364,229 | (303,340 | ) | 60,889 | ||||||||||||||||
Customer lists/relationships | 110,503 | (40,016 | ) | 70,487 | 106,218 | (40,097 | ) | 66,121 | ||||||||||||||||
Trade names | 69,281 | (38,673 | ) | 30,608 | 69,281 | (37,623 | ) | 31,658 | ||||||||||||||||
Software to be sold | 28,500 | (1,390 | ) | 27,110 | 28,500 | (601 | ) | 27,899 | ||||||||||||||||
Other | 7,159 | (5,874 | ) | 1,285 | 8,160 | (6,647 | ) | 1,513 | ||||||||||||||||
Amortizable intangibles | 588,297 | (397,142 | ) | 191,155 | 576,388 | (388,308 | ) | 188,080 | ||||||||||||||||
Intangibles | $ | 607,397 | $ | (397,142 | ) | $ | 210,255 | $ | 595,488 | $ | (388,308 | ) | $ | 207,180 | ||||||||||
Amortization of intangibles was $13,750 for the quarter ended March 31, 2015 and $12,024 for the quarter ended March 31, 2014. Based on the intangibles in service as of March 31, 2015, estimated future amortization expense is as follows:
(in thousands) | Estimated amortization expense | |||
Remainder of 2015 | $ | 36,242 | ||
2016 | 37,349 | |||
2017 | 25,004 | |||
2018 | 17,643 | |||
2019 | 14,885 | |||
8
During the quarter ended March 31, 2015, we acquired internal-use software in the normal course of business. We also acquired internal-use software and other intangible assets in conjunction with acquisitions (Note 6). The following intangible assets were acquired during the quarter ended March 31, 2015:
(in thousands) | Amount | Weighted-average amortization period (in years) | ||||
Internal-use software | $ | 8,868 | 5 | |||
Customer lists/relationships | 8,199 | 8 | ||||
Acquired intangibles | $ | 17,067 | 6 | |||
Goodwill – Changes in goodwill during the quarter ended March 31, 2015 were as follows:
(in thousands) | Small Business Services | Financial Services | Direct Checks | Total | ||||||||||||
Balance, December 31, 2014: | ||||||||||||||||
Goodwill, gross | $ | 654,007 | $ | 85,863 | $ | 148,506 | $ | 888,376 | ||||||||
Accumulated impairment charges | (20,000 | ) | — | — | (20,000 | ) | ||||||||||
Goodwill, net of accumulated impairment charges | 634,007 | 85,863 | 148,506 | 868,376 | ||||||||||||
Adjustment for acquisition of Wausau Financial Systems, Inc. (Note 6) | — | (164 | ) | — | (164 | ) | ||||||||||
Acquisition of Verify Valid, LLC (Note 6) | 11,190 | — | — | 11,190 | ||||||||||||
Currency translation adjustment | (144 | ) | — | — | (144 | ) | ||||||||||
Balance, March 31, 2015: | ||||||||||||||||
Goodwill, gross | 665,053 | 85,699 | 148,506 | 899,258 | ||||||||||||
Accumulated impairment charges | (20,000 | ) | — | — | (20,000 | ) | ||||||||||
Goodwill, net of accumulated impairment charges | $ | 645,053 | $ | 85,699 | $ | 148,506 | $ | 879,258 | ||||||||
Other non-current assets – Other non-current assets were comprised of the following:
(in thousands) | March 31, 2015 | December 31, 2014 | ||||||
Contract acquisition costs | $ | 68,918 | $ | 74,101 | ||||
Postretirement benefit plan asset | 24,188 | 24,243 | ||||||
Loans and notes receivable from distributors | 11,957 | 14,583 | ||||||
Deferred advertising costs | 7,893 | 8,922 | ||||||
Other | 8,625 | 9,792 | ||||||
Other non-current assets | $ | 121,581 | $ | 131,641 | ||||
9
Changes in contract acquisition costs during the quarters ended March 31, 2015 and 2014 were as follows:
Quarter Ended March 31, | ||||||||
(in thousands) | 2015 | 2014 | ||||||
Balance, beginning of year | $ | 74,101 | $ | 35,421 | ||||
Additions(1) | 1,907 | 425 | ||||||
Amortization | (4,831 | ) | (4,261 | ) | ||||
Other | (2,259 | ) | (110 | ) | ||||
Balance, end of period | $ | 68,918 | $ | 31,475 | ||||
(1) Contract acquisition costs are accrued upon contract execution. Cash payments made for contract acquisition costs were $2,947 for the quarter ended March 31, 2015 and $1,355 for the quarter ended March 31, 2014.
Accrued liabilities – Accrued liabilities were comprised of the following:
(in thousands) | March 31, 2015 | December 31, 2014 | ||||||
Funds held for customers | $ | 49,274 | $ | 42,944 | ||||
Deferred revenue | 43,183 | 48,514 | ||||||
Income taxes | 24,320 | 5,393 | ||||||
Customer rebates | 17,526 | 20,550 | ||||||
Performance-based compensation | 14,918 | 38,259 | ||||||
Contract acquisition costs due within one year | 10,353 | 9,815 | ||||||
Restructuring due within one year (Note 9) | 2,318 | 4,276 | ||||||
Other | 58,997 | 49,370 | ||||||
Accrued liabilities | $ | 220,889 | $ | 219,121 | ||||
10
Note 4: Earnings per share
The following table reflects the calculation of basic and diluted earnings per share. During each period, certain stock options, as noted below, were excluded from the calculation of diluted earnings per share because their effect would have been antidilutive.
Quarter Ended March 31, | ||||||||
(dollars and shares in thousands, except per share amounts) | 2015 | 2014 | ||||||
Earnings per share – basic: | ||||||||
Net income | $ | 45,940 | $ | 47,324 | ||||
Income allocated to participating securities | (293 | ) | (200 | ) | ||||
Income available to common shareholders | $ | 45,647 | $ | 47,124 | ||||
Weighted-average shares outstanding | 49,699 | 50,228 | ||||||
Earnings per share – basic | $ | 0.92 | $ | 0.94 | ||||
Earnings per share – diluted: | ||||||||
Net income | $ | 45,940 | $ | 47,324 | ||||
Income allocated to participating securities | (291 | ) | (198 | ) | ||||
Re-measurement of share-based awards classified as liabilities | 179 | (8 | ) | |||||
Income available to common shareholders | $ | 45,828 | $ | 47,118 | ||||
Weighted-average shares outstanding | 49,699 | 50,228 | ||||||
Dilutive impact of potential common shares | 408 | 456 | ||||||
Weighted-average shares and potential common shares outstanding | 50,107 | 50,684 | ||||||
Earnings per share – diluted | $ | 0.91 | $ | 0.93 | ||||
Antidilutive options excluded from calculation | 265 | 281 | ||||||
11
Note 5: Other comprehensive income
Reclassification adjustments – Information regarding amounts reclassified from accumulated other comprehensive loss to net income was as follows:
Accumulated other comprehensive loss components | Amounts reclassified from accumulated other comprehensive loss | Affected line item in consolidated statements of comprehensive income | ||||||||
Quarter Ended March 31, | ||||||||||
(in thousands) | 2015 | 2014 | ||||||||
Amortization of loss on interest rate locks(1) | $ | — | $ | (429 | ) | Interest expense | ||||
Tax benefit | — | 168 | Income tax provision | |||||||
Amortization of loss on interest rate locks, net of tax | — | (261 | ) | Net income | ||||||
Amortization of postretirement benefit plan items: | ||||||||||
Prior service credit | 355 | 355 | (2) | |||||||
Net actuarial loss | (780 | ) | (854 | ) | (2) | |||||
Total amortization | (425 | ) | (499 | ) | (2) | |||||
Tax benefit | 114 | 140 | (2) | |||||||
Amortization of postretirement benefit plan items, net of tax | (311 | ) | (359 | ) | (2) | |||||
Total reclassifications, net of tax | $ | (311 | ) | $ | (620 | ) | ||||
(1) Relates to interest rate locks which terminated in October 2014 in conjunction with the maturity of the related debt. See the caption "Note 6: Derivative financial instruments" in the Notes to Consolidated Financial Statements appearing in the 2014 Form 10-K.
(2) Amortization of postretirement benefit plan items is included in the computation of net periodic benefit income. Additional details can be found in Note 10: Postretirement benefits.
Accumulated other comprehensive loss – Changes in the components of accumulated other comprehensive loss were as follows:
(in thousands) | Postretirement benefit plans, net of tax | Net unrealized loss on marketable securities, net of tax(1) | Currency translation adjustment | Accumulated other comprehensive loss | ||||||||||||
Balance, December 31, 2014 | $ | (32,405 | ) | $ | (125 | ) | $ | (3,808 | ) | $ | (36,338 | ) | ||||
Other comprehensive income (loss) before reclassifications | — | 104 | (6,172 | ) | (6,068 | ) | ||||||||||
Amounts reclassified from accumulated other comprehensive loss | 311 | — | — | 311 | ||||||||||||
Net current-period other comprehensive income (loss) | 311 | 104 | (6,172 | ) | (5,757 | ) | ||||||||||
Balance, March 31, 2015 | $ | (32,094 | ) | $ | (21 | ) | $ | (9,980 | ) | $ | (42,095 | ) | ||||
(1) Other comprehensive income before reclassifications is net of income tax expense of $36.
12
Note 6: Acquisitions
In January 2015, we acquired selected assets of Range, Inc., a marketing services provider, in a cash transaction for $3,600. Transaction costs related to the acquisition were expensed as incurred and were not significant to the consolidated statement of comprehensive income for the quarter ended March 31, 2015. The results of operations of this business from its acquisition date are included in our Small Business Services segment. We expect to finalize the allocation of the purchase price in the second quarter of 2015 when we complete our valuation of the acquired customer list. The net assets acquired consisted primarily of a customer list with a preliminary value of $3,906 and a useful life of eight years, which is being amortized using the straight-line method. Further information regarding the calculation of the estimated fair value of the customer list can be found in Note 8.
In January 2015, we acquired all of the outstanding capital stock of a small business distributor in a cash transaction for $511, net of cash acquired, plus non-cash consideration of $3,564 related to our receivables from the distributor prior to its acquisition. Transaction costs related to the acquisition were expensed as incurred and were not significant to the consolidated statement of comprehensive income for the quarter ended March 31, 2015. The results of operations of the distributor are included in our Financial Services segment from its acquisition date, as its customers consist primarily of financial institutions. We expect to finalize the allocation of the purchase price by the third quarter of 2015 when our valuation of certain assets and liabilities is finalized, including, but not limited to, intangibles and deferred income taxes. We also plan to finalize the estimated useful life of intangibles by the third quarter of 2015. The net assets acquired consisted primarily of a customer list with a preliminary fair value of $4,293 and a preliminary useful life of eight years, which is being amortized using the straight-line method. Further information regarding the calculation of the estimated fair value of the customer list can be found in Note 8.
In February 2015, we acquired selected assets of Verify Valid, LLC, a provider of electronic check payment services, in a cash transaction for $3,447. The preliminary allocation of the purchase price based upon the estimated fair value of the assets acquired and liabilities assumed resulted in tax-deductible goodwill of $11,190. The acquisition resulted in goodwill as Verify Valid's technology enables us to diversify our payment product and service offerings and bring these offerings to our customer base. Transaction costs related to the acquisition were expensed as incurred and were not significant to the consolidated statement of comprehensive income for the quarter ended March 31, 2015. The results of operations of this business from its acquisition date are included in our Small Business Services segment. We expect to finalize the allocation of the purchase price by the third quarter of 2015 when our valuation of acquired software and its useful life, as well as the valuation of contingent consideration, is finalized. Net assets acquired consisted primarily of internal-use software with a preliminary value of $1,900 and a preliminary useful life of 5 years, which is being amortized using the straight-line method. In connection with this acquisition, we are required to make annual contingent payments over a period of up to eight years, subject to the business achieving specified revenue thresholds. The preliminary fair value of the liability for contingent payments recognized upon acquisition was $8,340, and is included in accrued liabilities and other non-current liabilities in the consolidated balance sheet. There is no maximum amount of contingent payments specified in the agreement. Further information regarding the calculation of the estimated fair value of the internal-use software and the contingent payments can be found in Note 8.
In October 2014, we acquired all of the outstanding capital stock of Wausau Financial Systems, Inc. (Wausau), a provider of software-based solutions for receivables management, lockbox processing, remote deposit capture and paperless branch solutions to financial institutions, utilities, government agencies and telecommunications companies. During the first quarter of 2015, we adjusted the valuation of certain income tax accounts and decreased goodwill $164 from the December 31, 2014 amount. The acquisition resulted in goodwill as Wausau provides new access into the commercial and treasury side of financial institutions through a strong software-as-a-service (SaaS) technology offering. We expect to finalize the allocation of the purchase price by mid-2015, when our valuation of deferred income taxes is finalized.
As our acquisitions were immaterial to our operating results both individually and in the aggregate, pro forma results of operations are not provided.
Note 7: Derivative financial instruments
We have entered into interest rate swaps to hedge against changes in the fair value of a portion of our long-term debt. We entered into these swaps, which we designated as fair value hedges, to achieve a targeted mix of fixed and variable rate debt, where we receive a fixed rate and pay a variable rate based on the London Interbank Offered Rate (LIBOR). The interest rate swaps related to our long-term debt due in 2020 have a notional amount of $200,000 and meet the criteria for using the short-cut method for a fair value hedge based on the structure of the hedging relationship. As such, changes in the fair value of the derivatives and the related long-term debt are equal. The fair value of these interest rate swaps was included in other non-
13
current liabilities in the consolidated balance sheets and was $5,097 as of March 31, 2015 and $8,067 as of December 31, 2014. As the short-cut method is being used to account for these hedges, the decrease in long-term debt due to fair value adjustments was also $5,097 as of March 31, 2015 and $8,067 as of December 31, 2014.
During the quarter ended March 31, 2014, we also held interest rate swaps related to our long-term debt which matured in October 2014. The short-cut method was not used for these interest rate swaps. As such, changes in the fair value of the interest rate swaps and the related long-term debt were not equal (i.e., hedge ineffectiveness) and were included in interest expense in the consolidated statement of comprehensive income. Information regarding hedge ineffectiveness during the quarter ended March 31, 2014 is presented in Note 8.
Note 8: Fair value measurements
2015 acquisitions – For all acquisitions, we are required to measure the fair value of the net identifiable tangible and intangible assets and liabilities acquired, excluding goodwill and deferred income taxes. The identifiable net assets acquired during the quarter ended March 31, 2015 were comprised primarily of customer lists associated with the acquisitions of a small business distributor and Range, Inc., as well as internal-use software associated with the acquisition of Verify Valid, LLC (Note 6). The aggregate fair value of the acquired customer lists was $8,199 and was estimated by discounting the estimated cash flows expected to be generated by the assets. Assumptions used in the calculations included same-customer revenue growth rates and estimated customer retention rates based on the acquirees' historical information. The fair value of the acquired internal-use software was $1,900 and was estimated using the cost of reproduction method. The primary components of the software were identified and the estimated cost to reproduce the software was calculated based on data provided by acquiree.
In connection with the acquisition of VerifyValid, LLC, we are required to make annual contingent payments over a period of up to eight years, subject to the business achieving specified revenue thresholds. The fair value of the liability for contingent payments recognized upon acquisition was $8,340, and was estimated by discounting to present value the probability-weighted contingent payments expected to be made utilizing an appropriate discount rate. Assumptions used in this calculation included the discount rate and various probability factors. This liability is re-measured each reporting period and changes in the fair value are included in selling, general and administrative (SG&A) expense in the consolidated statements of comprehensive income. Changes in the fair value of contingent consideration can result from changes in the timing, amount of, or likelihood of the applicable contingent payments.
Recurring fair value measurements – Funds held for customers included available-for-sale marketable securities (Note 3). These securities consisted of a mutual fund investment which invests in Canadian and provincial government securities and investments in six-month Canadian guaranteed investment certificates (GIC's). The mutual fund is not traded in an active market and its fair value is determined by obtaining quoted prices in active markets for the underlying securities held by the fund. The fair value of the GIC's approximated cost due to thier relatively short duration. Unrealized gains and losses, net of tax, are included in accumulated other comprehensive loss in the consolidated balance sheets. The cost of securities sold is determined using the average cost method. Realized gains and losses are included in revenue in the consolidated statements of comprehensive income and were not significant for the quarters ended March 31, 2015 and 2014.
Other current assets included available-for-sale marketable securities (Note 3). These securities consisted of a Canadian money market fund which is not traded in an active market. As such, the fair value of this investment is determined by obtaining quoted prices in active markets for the underlying securities held by the fund. Because of the short-term nature of the underlying investments, the cost of these securities approximates their fair value. The cost of securities sold is determined using the average cost method. No gains or losses on sales of these marketable securities were realized during the quarters ended March 31, 2015 and 2014.
We have elected to account for a long-term investment in domestic mutual funds under the fair value option for financial assets and financial liabilities. The fair value option provides companies an irrevocable option to measure many financial assets and liabilities at fair value with changes in fair value recognized in earnings. The investment is included in long-term investments in the consolidated balance sheets. Long-term investments also include the cash surrender values of company-owned life insurance policies. Realized and unrealized gains and losses, as well as dividends earned by the mutual fund investment, are included in SG&A expense in the consolidated statements of comprehensive income. This investment corresponds to a liability under an officers’ deferred compensation plan which is not available to new participants and is fully funded by the investment in mutual funds. The liability under the plan equals the fair value of the investment in mutual funds. Thus, as the value of the investment changes, the value of the liability changes accordingly. As changes in the liability are reflected within SG&A expense in the consolidated statements of comprehensive income, the fair value option of accounting for the investment in mutual funds allows us to net changes in the investment and the related liability in the statements of
14
comprehensive income. The cost of securities sold is determined using the average cost method. During the quarters ended March 31, 2015 and 2014, net realized gains were not significant. We recognized net unrealized losses of $187 during the quarter ended March 31, 2015 and $149 during the quarter ended March 31, 2014.
The fair value of interest rate swaps (Note 7) is determined at each reporting date by means of a pricing model utilizing readily observable market interest rates. The change in fair value is determined as the change in the present value of estimated future cash flows discounted using the LIBOR rate. The interest rate swaps related to our long-term debt due in 2020 meet the criteria for using the short-cut method for a fair value hedge based on the structure of the hedging relationship. As such, the changes in the fair value of the derivative and related long-term debt are equal. The short-cut method was not used for our other interest rate swaps which terminated with the maturity of the related long-term debt in October 2014. Changes in the fair value of the interest rate swaps, as well as changes in the fair value of the hedged debt, are included in interest expense in the consolidated statements of comprehensive income and were as follows:
Quarter Ended March 31, | ||||||||
(in thousands) | 2015 | 2014 | ||||||
Gain from derivatives | $ | 2,970 | $ | 2,042 | ||||
Loss from change in fair value of hedged debt | (2,970 | ) | (1,992 | ) | ||||
Net decrease in interest expense | $ | — | $ | 50 | ||||
Information regarding recurring fair value measurements completed during each period was as follows:
Fair value measurements using | ||||||||||||||||
Fair value as of March 31, 2015 | Quoted prices in active markets for identical assets | Significant other observable inputs | Significant unobservable inputs | |||||||||||||
(in thousands) | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Available-for-sale marketable securities (funds held for customers) | $ | 16,430 | $ | — | $ | 16,430 | $ | — | ||||||||
Available-for-sale marketable securities (other current assets) | 1,747 | — | 1,747 | — | ||||||||||||
Long-term investment in mutual funds | 2,144 | 2,144 | — | — | ||||||||||||
Derivative liabilities | (5,097 | ) | — | (5,097 | ) | — | ||||||||||
Accrued contingent consideration | (8,340 | ) | — | — | (8,340 | ) | ||||||||||
Fair value measurements using | ||||||||||||||||
Fair value as of December 31, 2014 | Quoted prices in active markets for identical assets | Significant other observable inputs | Significant unobservable inputs | |||||||||||||
(in thousands) | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Available-for-sale marketable securities (funds held for customers) | $ | 17,730 | $ | — | $ | 17,730 | $ | — | ||||||||
Available-for-sale marketable securities (other current assets) | 1,895 | — | 1,895 | — | ||||||||||||
Long-term investment in mutual funds | 2,384 | 2,384 | — | — | ||||||||||||
Derivative liabilities | (8,067 | ) | — | (8,067 | ) | — | ||||||||||
Our policy is to recognize transfers between fair value levels as of the end of the reporting period in which the transfer occurred. There were no transfers between fair value levels during the quarter ended March 31, 2015.
Fair value measurements of other financial instruments – The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate fair value.
Cash, cash included within funds held for customers and short-term borrowings – The carrying amounts reported in the consolidated balance sheets approximate fair value because of the short-term nature of these items.
15
Loans and notes receivable from distributors – We have receivables for loans made to certain of our Safeguard® distributors. In addition, we have acquired the operations of several small business distributors which we then sold to our Safeguard distributors. In most cases, we entered into notes receivable upon the sale of the assets to the distributors. The fair value of these loans and notes receivable is calculated as the present value of expected future cash flows, discounted using an estimated interest rate based on published bond yields for companies of similar risk.
Long-term debt – The fair value of long-term debt is based on significant observable market inputs other than quoted prices in active markets. The fair value of long-term debt included in the table below does not reflect the impact of hedging activity. The carrying amount of long-term debt includes the change in fair value of hedged long-term debt.
The estimated fair values of these financial instruments were as follows:
Fair value measurements using | ||||||||||||||||||||
March 31, 2015 | Quoted prices in active markets for identical assets | Significant other observable inputs | Significant unobservable inputs | |||||||||||||||||
(in thousands) | Carrying value | Fair value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Cash | $ | 58,319 | $ | 58,319 | $ | 58,319 | $ | — | $ | — | ||||||||||
Cash (funds held for customers) | 33,608 | 33,608 | 33,608 | — | — | |||||||||||||||
Loans and notes receivable from distributors | 13,986 | 13,104 | — | — | 13,104 | |||||||||||||||
Short-term borrowings | 318,000 | 318,000 | 318,000 | — | — | |||||||||||||||
Long-term debt(1) | 194,903 | 217,540 | — | 217,540 | — | |||||||||||||||
(1) Amounts exclude capital lease obligations.
Fair value measurements using | ||||||||||||||||||||
December 31, 2014 | Quoted prices in active markets for identical assets | Significant other observable inputs | Significant unobservable inputs | |||||||||||||||||
(in thousands) | Carrying value | Fair value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Cash | $ | 61,541 | $ | 61,541 | $ | 61,541 | $ | — | $ | — | ||||||||||
Cash (funds held for customers) | 25,874 | 25,874 | 25,874 | — | — | |||||||||||||||
Loans and notes receivable from distributors | 16,915 | 15,765 | — | — | 15,765 | |||||||||||||||
Short-term borrowings | 160,000 | 160,000 | 160,000 | — | — | |||||||||||||||
Long-term debt(1) | 391,933 | 419,000 | — | 419,000 | — | |||||||||||||||
(1) Amounts exclude capital lease obligations.
16
Note 9: Restructuring charges
Net restructuring charges for each period consisted of the following components:
Quarter Ended March 31, | ||||||||
(in thousands) | 2015 | 2014 | ||||||
Severance accruals | $ | 743 | $ | 1,545 | ||||
Severance reversals | (524 | ) | (310 | ) | ||||
Net restructuring accruals | 219 | 1,235 | ||||||
Other costs | 45 | 2,297 | ||||||
Net restructuring charges | $ | 264 | $ | 3,532 | ||||
The net restructuring charges are reflected in the consolidated statements of comprehensive income as follows:
Quarter Ended March 31, | ||||||||
(in thousands) | 2015 | 2014 | ||||||
Total cost of revenue | $ | (3 | ) | $ | 232 | |||
Operating expenses | 267 | 3,300 | ||||||
Net restructuring charges | $ | 264 | $ | 3,532 | ||||
During the quarters ended March 31, 2015 and March 31, 2014, the net restructuring accruals included severance charges related to employee reductions across functional areas as we continue to reduce costs. The restructuring accruals included severance benefits for approximately 40 employees during both periods. These charges were reduced by the reversal of restructuring accruals recorded in previous years, as fewer employees received severance benefits than originally estimated. Other restructuring costs, which were expensed as incurred, included items such as information technology costs, employee and equipment moves, training and travel related to our restructuring activities.
Restructuring accruals of $2,318 as of March 31, 2015 and $4,276 as of December 31, 2014 are reflected in the consolidated balance sheet in accrued liabilities. The majority of the employee reductions are expected to be completed in the third quarter of 2015, and we expect most of the related severance payments to be paid by the first quarter of 2016, utilizing cash from operations. As of March 31, 2015, approximately 20 employees had not yet started to receive severance benefits. Further information regarding our restructuring accruals can be found under the caption “Note 8: Restructuring charges” in the Notes to Consolidated Financial Statements appearing in the 2014 Form 10-K.
Accruals for our restructuring initiatives, summarized by year, were as follows:
(in thousands) | 2012 initiatives | 2013 initiatives | 2014 initiatives | 2015 initiatives | Total | |||||||||||||||
Balance, December 31, 2014 | $ | 32 | $ | 128 | $ | 4,116 | $ | — | $ | 4,276 | ||||||||||
Restructuring charges | — | — | 66 | 677 | 743 | |||||||||||||||
Restructuring reversals | — | (9 | ) | (515 | ) | — | (524 | ) | ||||||||||||
Payments | (32 | ) | (67 | ) | (1,975 | ) | (103 | ) | (2,177 | ) | ||||||||||
Balance, March 31, 2015 | $ | — | $ | 52 | $ | 1,692 | $ | 574 | $ | 2,318 | ||||||||||
Cumulative amounts: | ||||||||||||||||||||
Restructuring charges | $ | 8,012 | $ | 7,629 | $ | 8,206 | $ | 677 | $ | 24,524 | ||||||||||
Restructuring reversals | (1,363 | ) | (1,005 | ) | (1,157 | ) | — | (3,525 | ) | |||||||||||
Payments | (6,649 | ) | (6,572 | ) | (5,357 | ) | (103 | ) | (18,681 | ) | ||||||||||
Balance, March 31, 2015 | $ | — | $ | 52 | $ | 1,692 | $ | 574 | $ | 2,318 | ||||||||||
17
The components of our restructuring accruals, by segment, were as follows:
Employee severance benefits | Operating lease obligations | |||||||||||||||||||||||||||
(in thousands) | Small Business Services | Financial Services | Direct Checks | Corporate | Small Business Services | Direct Checks | Total | |||||||||||||||||||||
Balance, December 31, 2014 | $ | 1,412 | $ | 1,848 | $ | — | $ | 984 | $ | 32 | $ | — | $ | 4,276 | ||||||||||||||
Restructuring charges | 250 | 385 | — | 108 | — | — | 743 | |||||||||||||||||||||
Restructuring reversals | (273 | ) | (55 | ) | — | (196 | ) | — | — | (524 | ) | |||||||||||||||||
Payments | (700 | ) | (1,048 | ) | — | (397 | ) | (32 | ) | — | (2,177 | ) | ||||||||||||||||
Balance, March 31, 2015 | $ | 689 | $ | 1,130 | $ | — | $ | 499 | $ | — | $ | — | $ | 2,318 | ||||||||||||||
Cumulative amounts(1): | ||||||||||||||||||||||||||||
Restructuring charges | $ | 8,693 | $ | 7,170 | $ | 585 | $ | 7,464 | $ | 442 | $ | 170 | $ | 24,524 | ||||||||||||||
Restructuring reversals | (1,572 | ) | (630 | ) | (59 | ) | (1,107 | ) | (157 | ) | — | (3,525 | ) | |||||||||||||||
Inter-segment transfer | — | — | (25 | ) | 25 | — | — | — | ||||||||||||||||||||
Payments | (6,432 | ) | (5,410 | ) | (501 | ) | (5,883 | ) | (285 | ) | (170 | ) | (18,681 | ) | ||||||||||||||
Balance, March 31, 2015 | $ | 689 | $ | 1,130 | $ | — | $ | 499 | $ | — | $ | — | $ | 2,318 | ||||||||||||||
(1) Includes accruals related to our cost reduction initiatives for 2012 through 2015.
Note 10: Postretirement benefits
We have historically provided certain health care benefits for a large number of retired U.S. employees. In addition to our retiree health care plan, we also have a supplemental executive retirement plan in the United States. Further information regarding our postretirement benefit plans can be found under the caption “Note 12: Postretirement benefits” in the Notes to Consolidated Financial Statements appearing in the 2014 Form 10-K.
Postretirement benefit income for each period consisted of the following components:
Quarter Ended March 31, | ||||||||
(in thousands) | 2015 | 2014 | ||||||
Interest cost | $ | 859 | $ | 1,138 | ||||
Expected return on plan assets | (1,958 | ) | (2,183 | ) | ||||
Amortization of prior service credit | (355 | ) | (355 | ) | ||||
Amortization of net actuarial losses | 780 | 854 | ||||||
Net periodic benefit income | $ | (674 | ) | $ | (546 | ) | ||
Note 11: Income tax provision
Our effective tax rate for the quarter ended March 31, 2015 was 34.6%, compared to our 2014 annual effective tax rate of 32.8%. Our 2014 tax rate included a number of discrete credits to income tax expense which collectively reduced our effective tax rate 0.9 points and which related primarily to state income tax credits. Our 2015 tax rate included a number of minor discrete charges to income tax expense which collectively increased our effective tax rate 0.4 points. Also contributing to the increase in our effective tax rate in 2015 was the expiration of the federal research and development credit on December 31, 2014. Accordingly, our 2015 effective tax rate does not include the impact of this tax credit.
18
Note 12: Debt
Debt outstanding was comprised of the following:
(in thousands) | March 31, 2015 | December 31, 2014 | ||||||
7.0% senior notes due March 15, 2019 | $ | — | $ | 200,000 | ||||
6.0% senior notes due November 15, 2020(1) | 194,903 | 191,933 | ||||||
Long-term portion of capital lease obligations | 1,531 | 1,468 | ||||||
Long-term portion of debt | 196,434 | 393,401 | ||||||
Amount drawn on credit facility | 243,000 | 160,000 | ||||||
Short-term bank loan | 75,000 | — | ||||||
Capital lease obligations due within one year | 1,013 | 911 | ||||||
Total debt | $ | 515,447 | $ | 554,312 | ||||
(1) Includes decrease due to cumulative change in fair value of hedged debt of $5,097 as of March 31, 2015 and $8,067 as of December 31, 2014.
Our senior notes include covenants that place certain restrictions on the issuance of additional debt and limitations on certain liens. If our ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) to interest expense, as defined in such instruments, falls below two to one, there would be additional limitations on our ability to issue additional debt. The notes due in 2020 also include limitations on our ability to issue redeemable stock and preferred stock, make loans and investments, and consolidate, merge or sell all or substantially all of our assets. Absent certain defined events of default under our debt instruments, and as long as our ratio of EBITDA to interest expense is in excess of two to one, our debt covenants do not restrict our ability to pay cash dividends at our current rate. There are currently no limitations on the amount of dividends and share repurchases under the terms of our credit facility agreement or our short-term bank loan. However, if our leverage ratio, defined as total debt less unrestricted cash to EBITDA, should exceed 2.75 to one, there would be an annual limitation on the amount of dividends and share repurchases under the terms of these agreements.
Long-term debt – In November 2012, we issued $200,000 of 6.0% senior notes maturing on November 15, 2020. The notes were issued via a private placement under Rule 144A of the Securities Act of 1933. These notes were subsequently registered with the Securities and Exchange Commission (SEC) via a registration statement which became effective on April 3, 2013. Interest payments are due each May and November. The notes are guaranteed by certain of our subsidiaries and place a limitation on restricted payments, including share repurchases and increases in dividend levels. The limitation on restricted payments does not apply if the notes are upgraded to an investment-grade credit rating. Financial information for the guarantor subsidiaries can be found in Note 16. At any time prior to November 15, 2015, we may on one or more occasions redeem up to 35% of the original principal amount of the notes with the proceeds of one or more equity offerings at a redemption price of 106% of the principal amount of the notes, together with accrued and unpaid interest. At any time prior to November 15, 2016, we may also redeem some or all of the notes at a price equal to 100% of the principal amount plus accrued and unpaid interest and a make-whole premium. At any time on or after November 15, 2016, we may redeem some or all of the notes at prices ranging from 100% to 103% of the principal amount. If at any time we sell certain of our assets or experience specific types of changes in control, we must offer to purchase all of the outstanding notes at 101% of the principal amount. We classify payments for early redemption premiums as financing activities in our consolidated statements of cash flows. Proceeds from the offering, net of offering costs, were $196,340. These proceeds were used to retire our senior notes which were due in June 2015. The fair value of the notes issued in November 2012 was $217,540 as of March 31, 2015, based on quoted prices that are directly observable. As discussed in Note 7, we have entered into interest rate swaps to hedge these notes.
In March 2011, we issued $200,000 of 7.0% senior notes maturing on March 15, 2019. The notes were issued via a private placement under Rule 144A of the Securities Act of 1933. These notes were subsequently registered with the SEC via a registration statement which became effective on January 10, 2012. Proceeds from the offering, net of offering costs, were $196,195. These proceeds were used to retire a portion of our senior, unsecured notes due in 2012. In March 2015, we retired all of these notes, realizing a loss on early debt extinguishment of $8,917 during the quarter ended March 31, 2015. This retirement was funded utilizing our credit facility and a short-term bank loan.
We had capital lease obligations of $2,544 as of March 31, 2015 and $2,379 as of December 31, 2014 related to information technology hardware. The lease obligations will be paid through December 2018. The related assets are included in property, plant and equipment in the consolidated balance sheets. Depreciation of the leased assets is included in depreciation expense in the consolidated statements of cash flows.
19
Short-term debt – In March 2015, we entered into a $75,000 short-term variable rate bank loan. The weighted-average interest rate on this loan during the first quarter of 2015 was 1.51%. Under the terms of the credit agreement, we must repay any principal amount outstanding greater than $50,000 on September 5, 2015, and any remaining principal amount must be repaid by March 3, 2016. We may prepay the loan in whole or in part at our discretion. Interest payments are due at the end of each quarter. Proceeds from this loan, net of offering costs were $74,903 and were used, along with a draw on our credit facility, to retire all $200,000 of our 7.0% senior notes which were scheduled to mature on March 15, 2019.
As of March 31, 2015, we had a $350,000 credit facility, which is scheduled to expire in February 2019. Our commitment fee ranges from 0.20% to 0.40% based on our leverage ratio. Borrowings under the credit facility are collateralized by substantially all of our personal and intangible property.
The credit agreements governing our credit facility and our short-term bank loan contain customary covenants regarding limits on levels of subsidiary indebtedness and capital expenditures, liens, investments, acquisitions, certain mergers, certain asset sales outside the ordinary course of business, and change in control as defined in the agreement. The agreements also contain financial covenants regarding our leverage ratio and interest coverage, and our credit facility agreement also contains a financial covenant regarding liquidity.
Daily average amounts outstanding under our credit facility were as follows:
(in thousands) | Quarter Ended March 31, 2015 | Year Ended December 31, 2014 | ||||||
Daily average amount outstanding | $ | 174,900 | $ | 43,675 | ||||
Weighted-average interest rate | 1.64 | % | 1.63 | % | ||||
As of March 31, 2015, $243,000 was drawn on our credit facility at a weighted-average interest rate of 1.64%. As of December 31, 2014, $160,000 was drawn on our credit facility at a weighted-average interest rate of 1.63%. As of March 31, 2015, amounts were available for borrowing under our credit facility as follows:
(in thousands) | Total available | |||
Credit facility commitment | $ | 350,000 | ||
Amount drawn on credit facility | (243,000 | ) | ||
Outstanding letters of credit(1) | (12,953 | ) | ||
Net available for borrowing as of March 31, 2015 | $ | 94,047 | ||
(1) We use standby letters of credit primarily to collateralize certain obligations related to our self-insured workers’ compensation claims, as well as claims for environmental matters, as required by certain states. These letters of credit reduce the amount available for borrowing under our credit facility.
Note 13: Other commitments and contingencies
Indemnifications – In the normal course of business, we periodically enter into agreements that incorporate general indemnification language. These indemnifications encompass third-party claims arising from our products and services, including service failures, breach of security, intellectual property rights, governmental regulations and/or employment-related matters. Performance under these indemnities would generally be triggered by our breach of the terms of the contract. In disposing of assets or businesses, we often provide representations, warranties and/or indemnities to cover various risks including, for example, unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities and legal fees related to periods prior to disposition. We do not have the ability to estimate the potential liability from such indemnities because they relate to unknown conditions. However, we have no reason to believe that any possible liability under these indemnities would have a material adverse effect on our financial position, annual results of operations or annual cash flows. We have recorded liabilities for known indemnifications related to environmental matters.
Environmental matters – We are currently involved in environmental compliance, investigation and remediation activities at some of our current and former sites, primarily printing facilities of our Financial Services and Small Business Services segments which have been sold. Remediation costs are accrued on an undiscounted basis when the obligations are either known or considered probable and can be reasonably estimated. Remediation or testing costs that result directly from the
20
sale of an asset and which we would not have otherwise incurred are considered direct costs of the sale of the asset. As such, they are included in our measurement of the carrying value of the asset sold.
Accruals for environmental matters were $7,597 as of March 31, 2015 and $7,942 as of December 31, 2014, primarily related to facilities which have been sold. These accruals are included in accrued liabilities and other non-current liabilities in the consolidated balance sheets. Accrued costs consist of direct costs of the remediation activities, primarily fees which will be paid to outside engineering and consulting firms. Although recorded accruals include our best estimates, our total costs cannot be predicted with certainty due to various factors such as the extent of corrective action that may be required, evolving environmental laws and regulations and advances in environmental technology. Where the available information is sufficient to estimate the amount of the liability, that estimate is used. Where the information is only sufficient to establish a range of probable liability and no point within the range is more likely than any other, the lower end of the range is recorded. We do not believe that the range of possible outcomes could have a material effect on our financial condition, results of operations or liquidity. Expense reflected in the consolidated statements of comprehensive income for environmental matters was $293 for the quarter ended March 31, 2015 and $269 for the quarter ended March 31, 2014.
As of March 31, 2015, $2,332 of the costs included in our environmental accruals were covered by an environmental insurance policy which we purchased during 2002. The insurance policy covers up to $12,911 of remediation costs, of which $10,579 had been paid through March 31, 2015. This insurance policy does not cover properties acquired subsequent to 2002. However, costs included in our environmental accruals for such properties were not material as of March 31, 2015. We do not anticipate significant net cash outlays for environmental matters in 2015. The insurance policy also covers up to $10,000 of third-party claims through 2032 at certain owned, leased and divested sites. We consider the realization of recovery under the insurance policy to be probable based on the insurance contract in place with a reputable and financially-sound insurance company. As our environmental accruals include our best estimates of these costs, we have recorded receivables from the insurance company within other current assets and other non-current assets based on the amounts of our environmental accruals for insured sites.
We also have an additional environmental site liability insurance policy providing coverage on facilities which we acquired subsequent to 2002. This policy covers liability for claims of bodily injury or property damage arising from pollution events at the covered facilities. The policy also provides remediation coverage should we be required by a governing authority to perform remediation activities at the covered sites. The policy provides coverage of up to $15,000 through April 2019. No accruals have been recorded in our consolidated financial statements for any of the events contemplated in this insurance policy.
Self-insurance – We are self-insured for certain costs, primarily workers' compensation claims and medical and dental benefits. The liabilities associated with these items represent our best estimate of the ultimate obligations for reported claims plus those incurred, but not reported. The liability for workers' compensation, which totaled $4,046 as of March 31, 2015 and $4,040 as of December 31, 2014, is accounted for on a discounted basis. The difference between the discounted and undiscounted workers' compensation liability was not significant as of March 31, 2015 or December 31, 2014. We record liabilities for medical and dental benefits for active employees and those employees on long-term disability. Our liability for active employees is not recorded on a discounted basis as we expect the benefits to be paid in a relatively short period of time. Our liability for those employees on long-term disability is accounted for on a discounted basis. Our total liability for these medical and dental benefits totaled $2,206 as of March 31, 2015 and $2,361 as of December 31, 2014. The difference between the discounted and undiscounted medical and dental liability was not significant as of March 31, 2015 or December 31, 2014.
Our self-insurance liabilities are estimated, in part, by considering historical claims experience, demographic factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future events and claims differ from these assumptions and historical trends.
Note 14: Shareholders’ equity
We have an outstanding authorization from our board of directors to purchase up to 10,000 shares of our common stock. This authorization has no expiration date, and 1,962 shares remained available for purchase under this authorization as of March 31, 2015. We did not repurchase any shares during the quarter ended March 31, 2015.
21
Note 15: Business segment information
We operate three reportable business segments: Small Business Services, Financial Services and Direct Checks. Our business segments are generally organized by type of customer served and reflect the way we manage the company. Small Business Services promotes and sells products and services to small businesses via direct response mail and internet advertising, referrals from financial institutions and telecommunications clients, Safeguard distributors, a network of local dealers, a direct sales force which focuses on major accounts, and an outbound telemarketing group. Financial Services' products and services are sold primarily through a direct sales force, which executes product and service supply contracts with our financial institution clients nationwide, including banks, credit unions and financial services companies. In the case of check supply contracts, once the financial institution relationship is established, consumers may submit their check orders through their financial institution or over the phone or internet. Direct Checks sells products and services directly to consumers using direct marketing, including print advertising and search engine marketing and optimization strategies. All three segments operate primarily in the United States. Small Business Services also has operations in Canada and portions of Europe.
In January 2015, we decided that two company-owned small business distributors will no longer be managed as part of our Small Business Services segment. Because their customers consist primarily of financial institutions, we determined that the businesses would be better positioned for long-term growth if they were managed as part of our Financial Services segment. As such, the results of operations of these businesses are included in the Financial Services segment beginning in 2015. Our business segment results for prior periods have been restated to reflect this change. Restated amounts for revenue and operating income for each quarter of 2014 and full year 2013 were as follows:
(in thousands) | Revenue | Operating income | ||||||
Small Business Services: | ||||||||
First quarter 2014 | $ | 266,510 | $ | 43,397 | ||||
Second quarter 2014 | 267,695 | 48,788 | ||||||
Third quarter 2014 | 278,268 | 42,948 | ||||||
Fourth quarter 2014 | 294,032 | 52,093 | ||||||
Total 2014 | $ | 1,106,505 | $ | 187,226 | ||||
Total 2013 | $ | 1,036,268 | $ | 175,420 | ||||
Financial Services: | ||||||||
First quarter 2014 | $ | 92,446 | $ | 21,823 | ||||
Second quarter 2014 | 94,565 | 22,277 | ||||||
Third quarter 2014 | 92,072 | 19,133 | ||||||
Fourth quarter 2014 | 112,046 | 24,675 | ||||||
Total 2014 | $ | 391,129 | $ | 87,908 | ||||
Total 2013 | $ | 357,142 | $ | 82,811 | ||||
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 40.7% of our Small Business Services segment's revenue in 2014.
Marketing solutions and other services – All three of our segments offer products and services that help small businesses and/or financial institutions promote their businesses and acquire customers, as well as provide various other service offerings. 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, retail packaging supplies, apparel, greeting cards and business cards, as well as service offerings, including fraud protection and security, and payroll services. Financial Services offers various customer acquisition programs, marketing communications services, rewards and loyalty programs, fraud protection and security services, financial institution profitability and risk management services, supply chain management expertise, and a suite of financial technology solutions that integrates receivables, accelerates deposits and
22
payments, and eliminates paper. Our Direct Checks segment provides fraud protection and security services, as well as package insert programs under which companies' marketing materials are included in our check packages.
Forms – Our Small Business Services segment provides 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 provides products designed to supply small business owners with the customized documents necessary to efficiently manage their business including envelopes, office supplies, stamps and labels. Our Financial Services and Direct Checks segments offer checkbook covers and stamps.
The accounting policies of the segments are the same as those described in the Notes to Consolidated Financial Statements included in the 2014 Form 10-K. We allocate corporate costs for our shared services functions to our business segments, including costs of our executive management, human resources, supply chain, finance, information technology and legal functions. Generally, where costs incurred are directly attributable to a business segment, primarily within the areas of information technology, supply chain and finance, those costs are charged directly to that segment. Because we use a shared services approach for many of our functions, certain costs are not directly attributable to a business segment. These costs are allocated to our business segments based on segment revenue, as revenue is a measure of the relative size and magnitude of each segment and indicates the level of corporate shared services consumed by each segment. Corporate assets are not allocated to the segments and consist of property, plant and equipment, internal-use software, inventories and supplies related to our corporate shared services functions of manufacturing, information technology and real estate, as well as long-term investments.
We are an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and the sharing of assets. Therefore, we do not represent that these segments, if operated independently, would report the operating income and other financial information shown.
The following is our segment information as of and for the quarters ended March 31, 2015 and 2014:
Reportable Business Segments | ||||||||||||||||||||||
(in thousands) | Small Business Services | Financial Services | Direct Checks | Corporate | Consolidated | |||||||||||||||||
Total revenue from external | 2015 | $ | 276,966 | $ | 111,540 | $ | 45,111 | $ | — | $ | 433,617 | |||||||||||
customers: | 2014 | 266,510 | 92,446 | 47,999 | — | 406,955 | ||||||||||||||||
Operating income: | 2015 | 49,448 | 20,410 | 15,433 | — | 85,291 | ||||||||||||||||
2014 | 43,397 | 21,823 | 15,576 | — | 80,796 | |||||||||||||||||
Depreciation and amortization | 2015 | 10,209 | 5,990 | 1,484 | — | 17,683 | ||||||||||||||||
expense: | 2014 | 11,346 | 3,202 | 1,717 | — | 16,265 | ||||||||||||||||
Total assets: | 2015 | 953,165 | 277,994 | 163,301 | 271,180 | 1,665,640 | ||||||||||||||||
2014 | 928,118 | 103,767 | 166,501 | 365,946 | 1,564,332 | |||||||||||||||||
Capital asset purchases: | 2015 | — | — | — | 9,512 | 9,512 | ||||||||||||||||
2014 | — | — | — | 10,950 | 10,950 | |||||||||||||||||
Note 16: Supplemental guarantor financial information
Our long-term notes due in 2020 (Note 12), as well as obligations under our credit facility, are jointly and severally guaranteed on a full and unconditional basis, subject to the release provisions described herein, by certain 100%-owned subsidiaries. The subsidiary guarantees with respect to our long-term notes are subject to release upon the occurrence of certain events: the sale of all or substantially all of a subsidiary's assets, when the requirements for defeasance of the guaranteed securities have been satisfied, when the subsidiary is declared an unrestricted subsidiary, or upon satisfaction and discharge of the indenture.
The following condensed supplemental consolidating financial information reflects the summarized financial information of Deluxe Corporation, the guarantors on a combined basis and the non-guarantor subsidiaries on a combined
23
basis. Separate financial statements of the guarantors are not presented because the guarantors are jointly, severally, fully and unconditionally liable under the guarantees, subject to the release provisions described herein, and we believe that the condensed consolidating financial statements presented are sufficient to provide an understanding of the financial position, results of operations and cash flows of the guarantors.
We are an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and the sharing of assets. Therefore, we do not represent that the financial information presented is indicative of the financial position, results of operations or cash flows which the entities would have reported if they had operated independently. The condensed consolidating financial statements should be read in conjunction with our consolidated financial statements.
24
Deluxe Corporation
Condensed Consolidating Balance Sheet
(Unaudited)
March 31, 2015 | ||||||||||||||||||||
(in thousands) | Deluxe Corporation | Guarantor subsidiaries | Non-guarantor subsidiaries | Eliminations | Total | |||||||||||||||
ASSETS | ||||||||||||||||||||
Current assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 6,817 | $ | 2,009 | $ | 49,508 | $ | (15 | ) | $ | 58,319 | |||||||||
Trade accounts receivable, net | — | 82,940 | 11,421 | — | 94,361 | |||||||||||||||
Inventories and supplies | — | 33,346 | 4,754 | — | 38,100 | |||||||||||||||
Deferred income taxes | 9,096 | 1,189 | 10 | — | 10,295 | |||||||||||||||
Funds held for customers | — | — | 50,038 | — | 50,038 | |||||||||||||||
Other current assets | 7,336 | 32,951 | 3,544 | — | 43,831 | |||||||||||||||
Total current assets | 23,249 | 152,435 | 119,275 | (15 | ) | 294,944 | ||||||||||||||
Deferred income taxes | 2,067 | — | 1,291 | (2,067 | ) | 1,291 | ||||||||||||||
Long-term investments | 38,776 | 7,361 | — | — | 46,137 | |||||||||||||||
Property, plant and equipment, net | 4,696 | 74,947 | 5,615 | — | 85,258 | |||||||||||||||
Assets held for sale | — | 3,102 | 23,814 | — | 26,916 | |||||||||||||||
Intangibles, net | 1,367 | 206,761 | 2,127 | — | 210,255 | |||||||||||||||
Goodwill | — | 877,685 | 1,573 | — | 879,258 | |||||||||||||||
Investments in consolidated subsidiaries | 1,319,928 | 88,254 | — | |||||||||||||||||