UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2016 | |
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 October 19, 2016 was 48,596,289.
1
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
DELUXE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share par value)
(Unaudited)
September 30, 2016 | December 31, 2015 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 80,065 | $ | 62,427 | ||||
Trade accounts receivable (net of allowances for uncollectible accounts of $3,161 and $4,816, respectively) | 117,761 | 123,654 | ||||||
Inventories and supplies | 41,474 | 41,956 | ||||||
Funds held for customers | 92,170 | 53,343 | ||||||
Other current assets | 41,038 | 42,605 | ||||||
Total current assets | 372,508 | 323,985 | ||||||
Deferred income taxes | 1,749 | 1,238 | ||||||
Long-term investments (including $1,868 and $2,091 of investments at fair value, respectively) | 41,893 | 41,691 | ||||||
Property, plant and equipment (net of accumulated depreciation of $349,856 and $344,785, respectively) | 83,667 | 85,732 | ||||||
Assets held for sale | 13,966 | 13,969 | ||||||
Intangibles (net of accumulated amortization of $451,214 and $407,747, respectively) | 313,878 | 285,311 | ||||||
Goodwill | 989,641 | 976,415 | ||||||
Other non-current assets | 123,846 | 113,812 | ||||||
Total assets | $ | 1,941,148 | $ | 1,842,153 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 86,835 | $ | 87,575 | ||||
Accrued liabilities | 240,637 | 228,423 | ||||||
Long-term debt due within one year | 951 | 1,045 | ||||||
Total current liabilities | 328,423 | 317,043 | ||||||
Long-term debt | 616,790 | 627,973 | ||||||
Deferred income taxes | 80,754 | 81,076 | ||||||
Other non-current liabilities | 65,234 | 70,992 | ||||||
Commitments and contingencies (Notes 11 and 12) | ||||||||
Shareholders’ equity: | ||||||||
Common shares $1 par value (authorized: 500,000 shares; outstanding: September 30, 2016 – 48,586; December 31, 2015 – 49,019) | 48,586 | 49,019 | ||||||
Retained earnings | 851,420 | 751,253 | ||||||
Accumulated other comprehensive loss | (50,059 | ) | (55,203 | ) | ||||
Total shareholders’ equity | 849,947 | 745,069 | ||||||
Total liabilities and shareholders’ equity | $ | 1,941,148 | $ | 1,842,153 | ||||
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 September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Product revenue | $ | 364,680 | $ | 361,781 | $ | 1,090,686 | $ | 1,075,692 | ||||||||
Service revenue | 94,240 | 78,035 | 278,174 | 233,616 | ||||||||||||
Total revenue | 458,920 | 439,816 | 1,368,860 | 1,309,308 | ||||||||||||
Cost of products | (133,628 | ) | (132,594 | ) | (391,161 | ) | (384,590 | ) | ||||||||
Cost of services | (32,642 | ) | (26,708 | ) | (99,246 | ) | (83,332 | ) | ||||||||
Total cost of revenue | (166,270 | ) | (159,302 | ) | (490,407 | ) | (467,922 | ) | ||||||||
Gross profit | 292,650 | 280,514 | 878,453 | 841,386 | ||||||||||||
Selling, general and administrative expense | (198,365 | ) | (189,641 | ) | (598,563 | ) | (575,110 | ) | ||||||||
Net restructuring charges | (1,993 | ) | (1,505 | ) | (4,007 | ) | (2,738 | ) | ||||||||
Operating income | 92,292 | 89,368 | 275,883 | 263,538 | ||||||||||||
Loss on early debt extinguishment | — | — | — | (8,917 | ) | |||||||||||
Interest expense | (4,855 | ) | (4,387 | ) | (15,281 | ) | (15,322 | ) | ||||||||
Other income | 742 | 919 | 1,335 | 2,174 | ||||||||||||
Income before income taxes | 88,179 | 85,900 | 261,937 | 241,473 | ||||||||||||
Income tax provision | (29,516 | ) | (28,983 | ) | (86,783 | ) | (82,553 | ) | ||||||||
Net income | $ | 58,663 | $ | 56,917 | $ | 175,154 | $ | 158,920 | ||||||||
Comprehensive income | $ | 57,824 | $ | 52,680 | $ | 180,298 | $ | 150,190 | ||||||||
Basic earnings per share | 1.20 | 1.14 | 3.57 | 3.18 | ||||||||||||
Diluted earnings per share | 1.19 | 1.13 | 3.55 | 3.16 | ||||||||||||
Cash dividends per share | 0.30 | 0.30 | 0.90 | 0.90 | ||||||||||||
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, 2015 | 49,019 | $ | 49,019 | $ | — | $ | 751,253 | $ | (55,203 | ) | $ | 745,069 | |||||||||||
Net income | — | — | — | 175,154 | — | 175,154 | |||||||||||||||||
Cash dividends | — | — | — | (44,127 | ) | — | (44,127 | ) | |||||||||||||||
Common shares issued | 403 | 403 | 11,079 | — | — | 11,482 | |||||||||||||||||
Common shares repurchased | (733 | ) | (733 | ) | (13,351 | ) | (30,860 | ) | — | (44,944 | ) | ||||||||||||
Other common shares retired | (103 | ) | (103 | ) | (6,230 | ) | — | — | (6,333 | ) | |||||||||||||
Fair value of share-based compensation | — | — | 8,502 | — | — | 8,502 | |||||||||||||||||
Other comprehensive income | — | — | — | — | 5,144 | 5,144 | |||||||||||||||||
Balance, September 30, 2016 | 48,586 | $ | 48,586 | $ | — | $ | 851,420 | $ | (50,059 | ) | $ | 849,947 | |||||||||||
See Condensed Notes to Unaudited Consolidated Financial Statements
4
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months Ended September 30, | ||||||||||
2016 | 2015 | |||||||||
Cash flows from operating activities: | ||||||||||
Net income | $ | 175,154 | $ | 158,920 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||
Depreciation | 11,347 | 12,006 | ||||||||
Amortization of intangibles | 56,364 | 42,425 | ||||||||
Amortization of contract acquisition costs | 14,700 | 14,059 | ||||||||
Deferred income taxes | (1,477 | ) | (945 | ) | ||||||
Employee share-based compensation expense | 9,264 | 8,774 | ||||||||
Loss on early debt extinguishment | — | 8,917 | ||||||||
Other non-cash items, net | 3,128 | 1,197 | ||||||||
Changes in assets and liabilities, net of effect of acquisitions: | ||||||||||
Trade accounts receivable | 5,320 | 13,970 | ||||||||
Inventories and supplies | 176 | (1,368 | ) | |||||||
Other current assets | (2,379 | ) | 2,377 | |||||||
Non-current assets | (3,351 | ) | (560 | ) | ||||||
Accounts payable | (1,619 | ) | (12,547 | ) | ||||||
Contract acquisition payments | (17,190 | ) | (9,843 | ) | ||||||
Other accrued and non-current liabilities | (41,316 | ) | (18,234 | ) | ||||||
Net cash provided by operating activities | 208,121 | 219,148 | ||||||||
Cash flows from investing activities: | ||||||||||
Purchases of capital assets | (32,215 | ) | (29,549 | ) | ||||||
Payments for acquisitions, net of cash acquired | (64,637 | ) | (50,933 | ) | ||||||
Proceeds from company-owned life insurance policies | 4,123 | 3,973 | ||||||||
Other | 2,330 | 805 | ||||||||
Net cash used by investing activities | (90,399 | ) | (75,704 | ) | ||||||
Cash flows from financing activities: | ||||||||||
Proceeds from short-term borrowings | — | 50,000 | ||||||||
Proceeds from issuing long-term debt | 169,000 | 276,500 | ||||||||
Payments on long-term debt, including costs of debt reacquisition | (185,873 | ) | (375,291 | ) | ||||||
Proceeds from issuing shares under employee plans | 6,861 | 5,492 | ||||||||
Excess tax benefit from share-based employee awards | — | 1,816 | ||||||||
Employee taxes paid for shares withheld | (2,333 | ) | (1,236 | ) | ||||||
Payments for common shares repurchased | (44,944 | ) | (46,996 | ) | ||||||
Cash dividends paid to shareholders | (44,127 | ) | (44,965 | ) | ||||||
Other | (1,634 | ) | (378 | ) | ||||||
Net cash used by financing activities | (103,050 | ) | (135,058 | ) | ||||||
Effect of exchange rate change on cash | 2,966 | (7,032 | ) | |||||||
Net change in cash and cash equivalents | 17,638 | 1,354 | ||||||||
Cash and cash equivalents, beginning of year | 62,427 | 61,541 | ||||||||
Cash and cash equivalents, end of period | $ | 80,065 | $ | 62,895 | ||||||
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 September 30, 2016, the consolidated statements of comprehensive income for the quarters and nine months ended September 30, 2016 and 2015, the consolidated statement of shareholders’ equity for the nine months ended September 30, 2016, and the consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015 are unaudited. The consolidated balance sheet as of December 31, 2015 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, 2015 (the “2015 Form 10-K”).
During the quarter ended June 30, 2016, we identified an error in the balance sheet presentation of borrowings under our credit facility and the related asset for debt issuance costs. These amounts were previously presented as current items in our consolidated balance sheets, and we determined that they should have been presented as non-current. This change also corrects the presentation of the cash flows associated with borrowings under our credit facility. Previously these cash flows were presented on a net basis. The change in the balance sheet presentation requires that they be presented on a gross basis.
We assessed the materiality of this error on prior periods' financial statements in accordance with the Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 99, Materiality, codified in Accounting Standards Codification (ASC) 250, Presentation of Financial Statements. We concluded that the error was not material to any prior annual or interim period and therefore, amendments of previously filed reports are not required. In accordance with ASC 250, we have corrected the error for all prior periods presented by revising the consolidated financial statements appearing herein. Periods not presented herein will be revised, as applicable, in future filings. The revisions had no impact on total assets, total liabilities, shareholders' equity, net income or net cash used by financing activities.
The impact of this revision on our unaudited consolidated balance sheet as of December 31, 2015 was as follows:
December 31, 2015 | ||||||||||||
(in thousands) | As Previously Reported | Adjustment | As Revised | |||||||||
Other current assets | $ | 44,608 | $ | (2,003 | ) | $ | 42,605 | |||||
Total current assets | 325,988 | (2,003 | ) | 323,985 | ||||||||
Other non-current assets | 111,809 | 2,003 | 113,812 | |||||||||
Short-term borrowings | 434,000 | (434,000 | ) | — | ||||||||
Total current liabilities | 751,043 | (434,000 | ) | 317,043 | ||||||||
Long-term debt | 193,973 | 434,000 | 627,973 | |||||||||
The impact of this revision on our unaudited consolidated statement of cash flows for the nine months ended September 30, 2015 was as follows:
Nine Months Ended September 30, 2015 | ||||||||||||
(in thousands) | As Previously Reported | Adjustment | As Revised | |||||||||
Proceeds from short-term borrowings | $ | 159,000 | $ | (109,000 | ) | $ | 50,000 | |||||
Proceeds from issuing long-term debt | — | 276,500 | 276,500 | |||||||||
Payments on long-term debt, including costs of debt reacquisition | (207,791 | ) | (167,500 | ) | (375,291 | ) | ||||||
6
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Note 2: New accounting pronouncements
Recently adopted accounting pronouncements – In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 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. We adopted this standard on January 1, 2016. As our accounting treatment for these awards was in compliance with the new guidance, adoption of this standard had 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 standard requires that debt issuance costs related to a recognized debt liability be presented in the consolidated balance sheets as a direct reduction from the carrying amount of the debt liability. We adopted this standard on January 1, 2016, applying it retrospectively. The consolidated balance sheet as of December 31, 2015 reflects the reclassification of debt issuance costs of $2,249 from other non-current assets to long-term debt. The amount of debt issuance costs included in long-term debt as of September 30, 2016 was $1,906. In August 2015, the FASB issued ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements – Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting. This standard adds SEC paragraphs pursuant to the SEC Staff announcement at the June 18, 2015 Emerging Issues Task Force (EITF) meeting about the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. Under this guidance, the SEC Staff would not object to presenting such costs as an asset and subsequently amortizing the deferred costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings under the arrangement. Debt issuance costs of $1,528 as of September 30, 2016 and $2,003 as of December 31, 2015 related to our line-of-credit arrangement. We continue to include these costs within other non-current assets, amortizing them over the term of the arrangement.
In April 2015, the FASB issued ASU No. 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. The standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If the arrangement does include a software license, the software license element of the arrangement should be accounted for in the same manner as the acquisition of other software licenses. We adopted this standard on January 1, 2016, applying it prospectively to all arrangements entered into or materially modified on or after January 1, 2016. Adoption of this standard did not have a significant impact on our results of operations or financial position.
In May 2015, the FASB issued ASU No. 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or its Equivalent). Under the standard, investments measured at net asset value (NAV) as a practical expedient for fair value are excluded from the fair value hierarchy. As such, they are not assigned a fair value measurement level in financial statement disclosures of fair value. This standard was effective for us on January 1, 2016. It impacts the disclosures included in our Annual Report on Form 10-K regarding the plan assets of our postretirement benefit plan. As such, we will reflect this new guidance in the disclosures included in our Form 10-K for the year ending December 31, 2016, applying the guidance retrospectively to all periods presented.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory. The standard requires that inventory within the scope of the guidance be measured at the lower of cost or net realizable value. Previously, inventory was measured at the lower of cost or market. We elected to early adopt this standard on January 1, 2016, applying it prospectively. Application of this standard did not have a significant impact on our results of operations or financial position.
In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments. When recording the purchase price allocation for a business combination in the financial statements, an acquirer may record preliminary amounts when measurements are incomplete as of the end of a reporting period. When the required information is received to finalize the purchase price allocation, the preliminary amounts are adjusted. These adjustments are referred to as measurement-period adjustments. This standard eliminates the requirement to restate prior period financial statements for measurement-period adjustments. Instead, it requires that the cumulative impact of a measurement-period adjustment be recognized in the reporting period in which the adjustment is identified. We adopted this standard on January 1, 2016, applying it prospectively. Application of this standard did not have a significant impact on our results of operations or financial position.
7
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. The standard is intended to simplify various aspects of the accounting and presentation of share-based payments. We elected to early adopt this standard as of January 1, 2016. Adoption of this standard had the following impacts on our consolidated financial statements:
• | Consolidated statements of comprehensive income – The new standard requires that the tax effects of share-based compensation be recognized in the income tax provision. Previously, these amounts were recognized in additional paid-in capital. Net tax benefits related to share-based compensation awards of $234 for the quarter ended September 30, 2016 and $1,745 for the nine months ended September 30, 2016 were recognized as reductions of income tax expense in the consolidated statements of comprehensive income. These tax benefits reduced our effective income tax rate 0.3 points for the quarter ended September 30, 2016 and 0.7 points for the nine months ended September 30, 2016. In addition, in calculating potential common shares used to determine diluted earnings per share, GAAP requires us to use the treasury stock method. The new standard requires that assumed proceeds under the treasury stock method be modified to exclude the amount of excess tax benefits that would have been recognized in additional paid-in capital. These changes were applied on a prospective basis and resulted in an increase in diluted earnings per share of $0.03 for the nine months ended September 30, 2016. These changes had no impact on diluted earnings per share for the quarter ended September 30, 2016. |
In recording share-based compensation expense, the standard allows companies to make a policy election as to whether they will include an estimate of awards expected to be forfeited or whether they will account for forfeitures as they occur. We have elected to include an estimate of forfeitures in the computation of our share-based compensation expense. As this treatment is consistent with previous guidance, this election had no impact on our consolidated financial statements.
• | Consolidated statements of cash flows – The standard requires that excess tax benefits from share-based employee awards be reported as operating activities in the consolidated statements of cash flows. Previously, these cash flows were included in financing activities. We elected to apply this change on a prospective basis, resulting in an increase in net cash provided by operating activities and in net cash used by financing activities of $2,069 for the nine months ended September 30, 2016. |
The standard requires that employee taxes paid when an employer withholds shares for tax-withholding purposes be reported as financing activities in the consolidated statements of cash flows. Previously, these cash flows were included in operating activities. This change was required to be applied on a retrospective basis. As such, the consolidated statement of cash flows for the prior period was restated. This change resulted in an increase in net cash provided by operating activities and in net cash used by financing activities of $2,333 for the nine months ended September 30, 2016 and $1,236 for the nine months ended September 30, 2015.
In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. The standard is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. We elected to early adopt this standard as of July 1, 2016. As our consolidated statement of cash flows presentation was in compliance with the new guidance, adoption of this standard had no impact on our consolidated financial statements.
Accounting pronouncements not yet adopted – In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The 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 standard also expands the required financial statement disclosures regarding revenue recognition. The new guidance is effective for us on January 1, 2018. In addition, in March 2016, the FASB issued ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), in April 2016, the FASB issued ASU No. 2016-10, Identifying Performance Obligations and Licensing, and in May 2016, the FASB issued ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients. These standards are intended to clarify aspects of ASU No. 2014-09 and are effective for us upon adoption of ASU No. 2014-09. We are currently assessing the impact of these standards on our consolidated financial statements, as well as the method of transition that we will use in adopting the new guidance.
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The standard is intended to improve the recognition, measurement, presentation and disclosure of financial
8
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
instruments. The guidance is effective for us on January 1, 2018. We do not expect the application of this standard to have a significant impact on our results of operations or financial position.
In February 2016, the FASB issued ASU No. 2016-02, Leasing. The standard is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities for virtually all leases and by requiring the disclosure of key information about leasing arrangements. The guidance is effective for us on January 1, 2019, and requires adoption using a modified retrospective approach. We are currently assessing the impact of this standard on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. The standard introduces new guidance for the accounting for credit losses on instruments within its scope, including trade and loans receivable and available-for-sale debt securities. The guidance is effective for us on January 1, 2020, and requires adoption using a modified retrospective approach. We do not expect the application of this standard to have a significant impact on our results of operations or financial position.
Note 3: Supplemental balance sheet information
Inventories and supplies – Inventories and supplies were comprised of the following:
(in thousands) | September 30, 2016 | December 31, 2015 | ||||||
Raw materials | $ | 5,593 | $ | 5,719 | ||||
Semi-finished goods | 8,857 | 8,208 | ||||||
Finished goods | 23,937 | 24,955 | ||||||
Supplies | 3,087 | 3,074 | ||||||
Inventories and supplies | $ | 41,474 | $ | 41,956 | ||||
Available-for-sale securities – Available-for-sale securities included within funds held for customers and other current assets were comprised of the following:
September 30, 2016 | ||||||||||||||||
(in thousands) | Cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||||||||
Funds held for customers:(1) | ||||||||||||||||
Canadian and provincial government securities | $ | 8,491 | $ | — | $ | (43 | ) | $ | 8,448 | |||||||
Canadian guaranteed investment certificates | 7,618 | — | — | 7,618 | ||||||||||||
Available-for-sale securities | $ | 16,109 | $ | — | $ | (43 | ) | $ | 16,066 | |||||||
(1) Funds held for customers, as reported on the consolidated balance sheet as of September 30, 2016, also included cash of $76,104. This cash included amounts related to FISC Solutions, which was acquired in December 2015. This business provides cash receipt processing services. A portion of the cash receipts are remitted to our clients the business day following receipt. As such, the amounts on-hand are reported as funds held for customers in the consolidated balance sheets, with a corresponding liability included in accrued liabilities. The asset and liability of $18,743 were recorded as acquisition measurement-period balance sheet adjustments during 2016. In addition, this cash included $12,532 related to the September 2016 acquisition of Payce, Inc., a payroll services provider (see Note 6).
9
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
December 31, 2015 | ||||||||||||||||
(in thousands) | Cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||||||||
Canadian and provincial government securities | $ | 7,932 | $ | — | $ | (91 | ) | $ | 7,841 | |||||||
Canadian guaranteed investment certificates | 7,226 | — | — | 7,226 | ||||||||||||
Available-for-sale securities (funds held for customers)(1) | 15,158 | — | (91 | ) | 15,067 | |||||||||||
Canadian money market fund (other current assets) | 1,616 | — | — | 1,616 | ||||||||||||
Available-for-sale securities | $ | 16,774 | $ | — | $ | (91 | ) | $ | 16,683 | |||||||
(1) Funds held for customers, as reported on the consolidated balance sheet as of December 31, 2015, also included cash of $38,276.
Expected maturities of available-for-sale securities as of September 30, 2016 were as follows:
(in thousands) | Fair value | |||
Due in one year or less | $ | 9,629 | ||
Due in two to five years | 4,190 | |||
Due in six to ten years | 2,247 | |||
Available-for-sale securities | $ | 16,066 | ||
Further information regarding the fair value of available-for-sale securities can be found in Note 8.
Assets held for sale – Assets held for sale as of September 30, 2016 and December 31, 2015 included the operations of a small business distributor that we previously acquired. This business is included in our Small Business Services segment and the assets acquired consisted primarily of a customer list intangible asset. We are actively marketing the business and expect the selling price will exceed its carrying value. Net assets held for sale consisted of the following:
(in thousands) | September 30, 2016 | December 31, 2015 | Balance sheet caption | |||||||
Current assets | $ | 4 | $ | 3 | Other current assets | |||||
Intangibles | 13,533 | 13,533 | Assets held for sale | |||||||
Other non-current assets | 433 | 436 | Assets held for sale | |||||||
Accrued liabilities | (112 | ) | (366 | ) | Accrued liabilities | |||||
Deferred income tax liabilities | (5,775 | ) | (5,777 | ) | Other non-current liabilities | |||||
Net assets held for sale | $ | 8,083 | $ | 7,829 | ||||||
10
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Intangibles – Intangibles were comprised of the following:
September 30, 2016 | December 31, 2015 | |||||||||||||||||||||||
(in thousands) | Gross carrying amount | Accumulated amortization | Net carrying amount | Gross carrying amount | Accumulated amortization | Net carrying amount | ||||||||||||||||||
Indefinite-lived intangibles: | ||||||||||||||||||||||||
Trade name | $ | 19,100 | $ | — | $ | 19,100 | $ | 19,100 | $ | — | $ | 19,100 | ||||||||||||
Amortizable intangibles: | ||||||||||||||||||||||||
Internal-use software | 410,231 | (336,356 | ) | 73,875 | 375,037 | (310,665 | ) | 64,372 | ||||||||||||||||
Customer lists/relationships | 239,972 | (67,366 | ) | 172,606 | 202,682 | (54,990 | ) | 147,692 | ||||||||||||||||
Trade names | 65,481 | (40,029 | ) | 25,452 | 64,881 | (36,325 | ) | 28,556 | ||||||||||||||||
Software to be sold | 28,500 | (6,141 | ) | 22,359 | 28,500 | (3,765 | ) | 24,735 | ||||||||||||||||
Other | 1,808 | (1,322 | ) | 486 | 2,858 | (2,002 | ) | 856 | ||||||||||||||||
Amortizable intangibles | 745,992 | (451,214 | ) | 294,778 | 673,958 | (407,747 | ) | 266,211 | ||||||||||||||||
Intangibles | $ | 765,092 | $ | (451,214 | ) | $ | 313,878 | $ | 693,058 | $ | (407,747 | ) | $ | 285,311 | ||||||||||
Amortization of intangibles was $19,273 for the quarter ended September 30, 2016 and $14,686 for the quarter ended September 30, 2015. Amortization of intangibles was $56,364 for the nine months ended September 30, 2016 and $42,425 for the nine months ended September 30, 2015. Based on the intangibles in service as of September 30, 2016, estimated future amortization expense is as follows:
(in thousands) | Estimated amortization expense | |||
Remainder of 2016 | $ | 18,260 | ||
2017 | 65,293 | |||
2018 | 51,235 | |||
2019 | 37,788 | |||
2020 | 31,737 | |||
During the nine months ended September 30, 2016, we acquired internal-use software in the normal course of business. We also acquired intangible assets in conjunction with acquisitions (Note 6). The following intangible assets were acquired during the nine months ended September 30, 2016:
(in thousands) | Amount | Weighted-average amortization period (in years) | ||||
Internal-use software | $ | 34,970 | 4 | |||
Customer lists/relationships | 48,982 | 7 | ||||
Trade names | 600 | 5 | ||||
Acquired intangibles | $ | 84,552 | 6 | |||
11
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Goodwill – Changes in goodwill during the nine months ended September 30, 2016 were as follows:
(in thousands) | Small Business Services | Financial Services | Direct Checks | Total | ||||||||||||
Balance, December 31, 2015: | ||||||||||||||||
Goodwill, gross | $ | 671,295 | $ | 176,614 | $ | 148,506 | $ | 996,415 | ||||||||
Accumulated impairment charges | (20,000 | ) | — | — | (20,000 | ) | ||||||||||
Goodwill, net of accumulated impairment charges | 651,295 | 176,614 | 148,506 | 976,415 | ||||||||||||
Acquisition of 180 Fusion (Note 6) | 575 | — | — | 575 | ||||||||||||
Acquisition of Inkhead (Note 6) | 4,421 | — | — | 4,421 | ||||||||||||
Acquisition of Payce (Note 6) | 7,979 | — | — | 7,979 | ||||||||||||
Adjustment for acquisition of Datamyx (Note 6) | — | 172 | — | 172 | ||||||||||||
Currency translation adjustment | 79 | — | — | 79 | ||||||||||||
Balance, September 30, 2016: | ||||||||||||||||
Goodwill, gross | 684,349 | 176,786 | 148,506 | 1,009,641 | ||||||||||||
Accumulated impairment charges | (20,000 | ) | — | — | (20,000 | ) | ||||||||||
Goodwill, net of accumulated impairment charges | $ | 664,349 | $ | 176,786 | $ | 148,506 | $ | 989,641 | ||||||||
Other non-current assets – Other non-current assets were comprised of the following:
(in thousands) | September 30, 2016 | December 31, 2015 | ||||||
Contract acquisition costs | $ | 67,488 | $ | 58,792 | ||||
Loans and notes receivable from distributors | 21,531 | 23,957 | ||||||
Postretirement benefit plan asset | 20,260 | 16,250 | ||||||
Deferred advertising costs | 6,660 | 7,500 | ||||||
Other | 7,907 | 7,313 | ||||||
Other non-current assets | $ | 123,846 | $ | 113,812 | ||||
Changes in contract acquisition costs during the nine months ended September 30, 2016 and 2015 were as follows:
Nine Months Ended September 30, | ||||||||
(in thousands) | 2016 | 2015 | ||||||
Balance, beginning of year | $ | 58,792 | $ | 74,101 | ||||
Additions(1) | 23,471 | 4,828 | ||||||
Amortization | (14,700 | ) | (14,059 | ) | ||||
Other | (75 | ) | (3,458 | ) | ||||
Balance, end of period | $ | 67,488 | $ | 61,412 | ||||
(1) Contract acquisition costs are accrued upon contract execution. Cash payments made for contract acquisition costs were $17,190 for the nine months ended September 30, 2016 and $9,843 for the nine months ended September 30, 2015.
12
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Accrued liabilities – Accrued liabilities were comprised of the following:
(in thousands) | September 30, 2016 | December 31, 2015 | ||||||
Funds held for customers | $ | 90,960 | $ | 52,366 | ||||
Deferred revenue | 32,418 | 48,119 | ||||||
Employee profit sharing/cash bonus | 24,771 | 40,683 | ||||||
Customer rebates | 17,077 | 18,900 | ||||||
Contract acquisition costs due within one year | 11,980 | 9,045 | ||||||
Wages, including vacation | 11,260 | 5,731 | ||||||
Restructuring due within one year (Note 9) | 2,648 | 3,864 | ||||||
Other | 49,523 | 49,715 | ||||||
Accrued liabilities | $ | 240,637 | $ | 228,423 | ||||
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 September 30, | Nine Months Ended September 30, | |||||||||||||||
(dollars and shares in thousands, except per share amounts) | 2016 | 2015 | 2016 | 2015 | ||||||||||||
Earnings per share – basic: | ||||||||||||||||
Net income | $ | 58,663 | $ | 56,917 | $ | 175,154 | $ | 158,920 | ||||||||
Income allocated to participating securities | (491 | ) | (386 | ) | (1,445 | ) | (1,054 | ) | ||||||||
Income available to common shareholders | $ | 58,172 | $ | 56,531 | $ | 173,709 | $ | 157,866 | ||||||||
Weighted-average shares outstanding | 48,493 | 49,396 | 48,634 | 49,592 | ||||||||||||
Earnings per share – basic | $ | 1.20 | $ | 1.14 | $ | 3.57 | $ | 3.18 | ||||||||
Earnings per share – diluted: | ||||||||||||||||
Net income | $ | 58,663 | $ | 56,917 | $ | 175,154 | $ | 158,920 | ||||||||
Income allocated to participating securities | (487 | ) | (384 | ) | (1,436 | ) | (1,049 | ) | ||||||||
Re-measurement of share-based awards classified as liabilities | (64 | ) | (114 | ) | 230 | (67 | ) | |||||||||
Income available to common shareholders | $ | 58,112 | $ | 56,419 | $ | 173,948 | $ | 157,804 | ||||||||
Weighted-average shares outstanding | 48,493 | 49,396 | 48,634 | 49,592 | ||||||||||||
Dilutive impact of potential common shares | 455 | 366 | 427 | 391 | ||||||||||||
Weighted-average shares and potential common shares outstanding | 48,948 | 49,762 | 49,061 | 49,983 | ||||||||||||
Earnings per share – diluted | $ | 1.19 | $ | 1.13 | $ | 3.55 | $ | 3.16 | ||||||||
Antidilutive options excluded from calculation | 223 | 255 | 223 | 255 | ||||||||||||
13
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
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 September 30, | Nine Months Ended September 30, | |||||||||||||||||
(in thousands) | 2016 | 2015 | 2016 | 2015 | ||||||||||||||
Amortization of postretirement benefit plan items: | ||||||||||||||||||
Prior service credit | $ | 355 | $ | 355 | 1,066 | 1,066 | (1) | |||||||||||
Net actuarial loss | (949 | ) | (780 | ) | (2,848 | ) | (2,340 | ) | (1) | |||||||||
Total amortization | (594 | ) | (425 | ) | (1,782 | ) | (1,274 | ) | (1) | |||||||||
Tax benefit | 181 | 113 | 544 | 339 | (1) | |||||||||||||
Total reclassifications, net of tax | $ | (413 | ) | $ | (312 | ) | $ | (1,238 | ) | $ | (935 | ) | ||||||
(1) Amortization of postretirement benefit plan items is included in the computation of net periodic benefit income. Additional details can be found in Note 10.
Accumulated other comprehensive loss – Changes in the components of accumulated other comprehensive loss during the nine months ended September 30, 2016 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, 2015 | $ | (38,822 | ) | $ | (114 | ) | $ | (16,267 | ) | $ | (55,203 | ) | ||||
Other comprehensive income before reclassifications | — | 40 | 3,866 | 3,906 | ||||||||||||
Amounts reclassified from accumulated other comprehensive loss | 1,238 | — | — | 1,238 | ||||||||||||
Net current-period other comprehensive income | 1,238 | 40 | 3,866 | 5,144 | ||||||||||||
Balance, September 30, 2016 | $ | (37,584 | ) | $ | (74 | ) | $ | (12,401 | ) | $ | (50,059 | ) | ||||
(1) Other comprehensive income before reclassifications is net of income tax expense of $14.
Note 6: Acquisitions
We periodically complete business combinations that align with our business strategy. The assets and liabilities acquired are recorded at their estimated fair values and the results of operations of each acquired business are included in our consolidated statements of comprehensive income from their acquisition dates. Transaction costs related to acquisitions were expensed as incurred and were not significant to the consolidated statements of comprehensive income for the quarters or nine months ended September 30, 2016 and 2015.
During the nine months ended September 30, 2016, we completed the following acquisitions which are included within our Small Business Services segment and for which the allocation of the purchase price to the assets acquired and liabilities assumed has been finalized:
• | In February 2016, we acquired selected assets of Category 99, Inc., doing business as MacHighway®, a web hosting and domain registration service provider. |
14
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
• | In March 2016, we acquired selected assets of New England Art Publishers, Inc., doing business as Birchcraft Studios, a supplier of personalized invitations, holiday cards, all-occasion cards and social announcements. |
• | In June 2016, we acquired selected assets of L.A.M. Enterprises, Inc., a provider of printed and promotional products. |
During the nine months ended September 30, 2016, we completed several acquisitions which are included within our Small Business Services segment and for which we expect to finalize the allocation of the purchase price by the end of 2016 when our valuation of all of the acquired assets and liabilities is completed, as well as the determination of the estimated useful lives of the acquired customer lists. These acquisitions were as follows:
• | In April 2016, we acquired selected assets of 180 Fusion LLC, a digital marketing services provider. The preliminary allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in tax-deductible goodwill of $575. The acquisition resulted in goodwill as we expect it will enhance our Small Business Services product set by providing valuable marketing tools to our customers, thus, enhancing customer acquisition and loyalty. |
• | In June 2016, we acquired selected assets of Liquid Web, LLC, a web hosting services provider. |
• | In June 2016, we acquired selected assets of National Document Solutions, LLC, a provider of printing, promotional products, office products, scanning and document management solutions. |
• | In July 2016, we acquired selected assets of Inkhead, Inc., a provider of customized promotional products. The preliminary allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in tax-deductible goodwill of $4,421. The acquisition resulted in goodwill as it enables us to diversify our promotional product offerings and bring these offerings to our customer base. |
• | In August 2016, we acquired selected assets of BNBS, Inc., doing business as B&B Solutions, a provider of printing, promotional and office products and services. |
• | In September 2016, we acquired all of the outstanding capital stock of Payce, Inc., a provider of payroll processing, payroll tax filing and related payroll services. The preliminary allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in tax-deductible goodwill of $7,979. The acquisition resulted in goodwill as we expect Payce's expertise, customer mix and operational strength to enhance our existing portfolio of small business services. |
Also during the nine months ended September 30, 2016, we acquired the operations of several small business distributors which are included in our Small Business Services segment. The assets acquired consisted primarily of customer list intangible assets. As these distributors were previously part of our Safeguard® distributor network, our revenue was not impacted by these acquisitions and the impact to our costs was not significant. We expect to finalize the allocations of the purchase price by the end of 2016 when our valuations of the acquired customer lists are completed, including the determination of the related estimated useful lives.
15
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
As our acquisitions were not significant to our operating results both individually and in the aggregate, pro forma results of operations are not provided. The following illustrates the preliminary allocation as of September 30, 2016 of the aggregate purchase price for the above acquisitions to the assets acquired and liabilities assumed:
(in thousands) | 2016 acquisitions | |||
Net tangible assets acquired and liabilities assumed | $ | (784 | ) | |
Identifiable intangible assets: | ||||
Customer lists/relationships | 48,982 | |||
Internal-use software | 10,250 | |||
Trade names | 600 | |||
Total intangible assets | 59,832 | |||
Goodwill | 12,975 | |||
Total aggregate purchase price | 72,023 | |||
Liabilities for holdback payments | (6,900 | ) | ||
Non-cash consideration(1) | (2,020 | ) | ||
Net cash paid for 2016 acquisitions | 63,103 | |||
Holdback payments for prior year acquisitions | 1,534 | |||
Payments for acquisitions, net of cash acquired | $ | 64,637 | ||
(1) Consists of pre-acquisition amounts owed to us by certain of the acquired businesses.
Further information regarding the calculation of the estimated fair values of the intangibles acquired can be found in Note 8.
During the quarter ended September 30, 2016, we finalized purchase accounting for the acquisition of Datamyx LLC, which was acquired in October 2015. Further information regarding this acquisition can be found under the caption “Note 5: Acquisitions” in the Notes to Consolidated Financial Statements appearing in the 2015 Form 10-K. The adjustments recorded during the quarter ended September 30, 2016 increased goodwill $172 from the preliminary amount recorded as of December 31, 2015, with the offset to various assets and liabilities, primarily property, plant and equipment and other current assets.
During the nine months ended September 30, 2015, we acquired selected assets of Range, Inc., a marketing services provider; Verify Valid LLC, a provider of electronic check payment services; Tech Assets, Inc., a provider of shared hosting websites to small businesses using cPanel web hosting technology; and FMC Resource Management Corporation, a marketing services provider, as well as the operations of eight small business distributors, five of which were previously part of our Safeguard distributor network. The assets acquired consisted primarily of customer list intangible assets and goodwill. Payments for acquisitions, net of cash acquired, as presented on the consolidated statement of cash flows for the nine months ended September 30, 2015, included payments of $46,796 for these acquisitions and $4,137 for holdback payments for prior year acquisitions. Further information regarding our 2015 acquisitions can be found under the caption “Note 5: Acquisitions” in the Notes to Consolidated Financial Statements appearing in the 2015 Form 10-K.
Note 7: Derivative financial instruments
We have entered into interest rate swaps, which we designated as fair value hedges, to hedge against changes in the fair value of a portion of our long-term debt. At the time we entered into these swaps in 2012, we were targeting a 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-current liabilities in the consolidated balance sheets and was $109 as of September 30, 2016 and $4,842 as of December 31, 2015. As the short-cut method is being used to account for these hedges, the consolidated balance sheets included a decrease in long-term debt of $109 as of September 30, 2016 and $4,842 as of December 31, 2015 due to fair value adjustments.
16
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Note 8: Fair value measurements
Annual asset impairment analyses – We evaluate the carrying value of goodwill and our indefinite-lived trade name as of July 31 of each year and between annual evaluations if events occur or circumstances change that would indicate a possible impairment. Our policy on impairment of indefinite-lived intangibles and goodwill, which is included under the caption "Note 1: Significant accounting policies" in the Notes to Consolidated Financial Statements appearing in the 2015 Form 10-K, explains our methodology for assessing impairment of these assets. In completing the 2016 annual goodwill impairment analysis, we elected to perform a qualitative assessment for all of our reporting units to which goodwill is assigned, with one exception. We elected to perform a quantitative analysis for our Financial Services Commercial reporting unit as the previous quantitative analysis completed as of July 31, 2015 indicated that the estimated fair value of this reporting unit exceeded its carrying value by approximately 13%. This relatively small percentage was primarily due to the fact that the reporting unit had been recently acquired.
Our qualitative analysis evaluated factors including, but not limited to, economic, market and industry conditions, cost factors and the overall financial performance of the reporting units. We also considered the quantitative analysis we completed as of July 31, 2014. In completing the 2016 qualitative analysis, we noted no changes in events or circumstances which would have required us to complete the two-step quantitative goodwill impairment analysis for any of the reporting units analyzed. The quantitative analysis completed for the Financial Services Commercial reporting unit indicated that its estimated fair value exceeded its carrying value by approximately 49% as of July 31, 2016. Total goodwill for this reporting unit was approximately $45,000 as of September 30, 2016. In completing the 2016 annual impairment analysis of our indefinite-lived trade name, we elected to perform a quantitative assessment which indicated that the calculated fair value of the asset exceeded its carrying value of $19,100 by approximately $32,000 as of July 31, 2016. We recorded no impairment charges as a result of our 2016 annual impairment analyses.
2016 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. Information regarding the acquisitions completed during the nine months ended September 30, 2016 can be found in Note 6. The identifiable net assets acquired during the nine months ended September 30, 2016 were comprised primarily of customer lists with an aggregate fair value of $48,982 and internal-use software with an aggregate fair value of $10,250. Fair value of the customer lists 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. A portion of the fair value of the acquired software 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 the acquirees. The fair value of the remainder of the software was estimated using the relief from royalty method, which calculates the cost savings associated with owning rather than licensing the technology. Assumed royalty rates were applied to projected revenue for the remaining useful life of the software to estimate the royalty savings. Information regarding the useful lives of acquired intangibles can be found in Note 3.
Recurring fair value measurements – Funds held for customers included available-for-sale marketable securities (Note 3). These securities consisted of a mutual fund investment that invests in Canadian and provincial government securities, as well as investments in Canadian guaranteed investment certificates (GICs) with maturities of one year or less. 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 GICs approximated cost due to their 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 or nine months ended September 30, 2016 and 2015.
Other current assets as of December 31, 2015 included available-for-sale marketable securities (Note 3). These securities were sold during the first quarter of 2016, and consisted of a Canadian money market fund that was not traded in an active market. As such, the fair value of this investment was 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 approximated their fair value. No gains or losses on sales of these marketable securities were realized during the nine months ended September 30, 2016 and 2015.
17
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
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 selling, general and administrative (SG&A) expense in the consolidated statements of comprehensive income. This investment corresponds to a liability under an officers’ deferred compensation plan that 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 comprehensive income. The cost of securities sold is determined using the average cost method. During the nine months ended September 30, 2016 and 2015, net realized gains were not significant. We recognized net unrealized losses of $160 during the nine months ended September 30, 2016 and $333 during the nine months ended September 30, 2015.
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. Our interest rate swaps relate to our long-term debt due in 2020 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, the changes in the fair value of the derivative and related long-term debt are equal.
Liabilities for contingent consideration relate to acquisitions completed during 2015. Information concerning these acquisitions can be found under the caption "Note 5: Acquisitions" in the Notes to Consolidated Financial Statements included in the 2015 Form 10-K. Under the agreement related to the acquisition of Verify Valid, we are required to make annual contingent payments over a period of up to eight years, based on the revenue generated by the business. A specified payment percentage for each year is applied to the revenue generated by the business in that year to determine the amount of the payment. There is no maximum amount of contingent payments specified in the agreement. Under the agreement related to the acquisition of a small business distributor, we are required to make annual contingent payments over a period of up to three years, based on the gross profit generated by the business. A specified payment percentage for each year is applied to the gross profit generated by the business in that year to determine the amount of the payment. The maximum contingent payment in any year of the agreement is $925. The fair value of the liabilities for contingent payments is estimated by discounting to present value the probability-weighted contingent payments expected to be made. Assumptions used in the calculations include the discount rate, projected revenue or gross profit based on our most recent internal forecast, and factors indicating the probability of achieving the forecasted revenue or gross profit. The liabilities are remeasured each reporting period. Increases or decreases in projected revenue or gross profit and the related probabilities may result in a higher or lower fair value measurement. Changes in fair value resulting from changes in the timing, amount of, or likelihood of contingent payments are included in SG&A expense in the consolidated statements of comprehensive income. Changes in fair value resulting from accretion for the passage of time are included in interest expense in the consolidated statements of comprehensive income.
Information regarding recurring fair value measurements completed during each period was as follows:
Fair value measurements using | ||||||||||||||||
Fair value as of September 30, 2016 | 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) | $ | 16,066 | $ | — | $ | 16,066 | $ | — | ||||||||
Long-term investment in mutual funds | 1,868 | 1,868 | — | — | ||||||||||||
Derivative liabilities | (109 | ) | — | (109 | ) | — | ||||||||||
Accrued contingent consideration | (4,276 | ) | — | — | (4,276 | ) | ||||||||||
18
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Fair value measurements using | ||||||||||||||||
Fair value as of December 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) | $ | 15,067 | $ | — | $ | 15,067 | $ | — | ||||||||
Available-for-sale marketable securities (other current assets) | 1,616 | — | 1,616 | — | ||||||||||||
Long-term investment in mutual funds | 2,091 | 2,091 | — | — | ||||||||||||
Derivative liabilities | (4,842 | ) | — | (4,842 | ) | — | ||||||||||
Accrued contingent consideration | (5,861 | ) | — | — | (5,861 | ) | ||||||||||
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 nine months ended September 30, 2016.
Changes in accrued contingent consideration during the nine months ended September 30, 2016 were as follows:
(in thousands) | Nine Months Ended September 30, 2016 | |||
Balance, December 31, 2015 | $ | 5,861 | ||
Change in fair value | (448 | ) | ||
Payments | (1,137 | ) | ||
Balance, September 30, 2016 | $ | 4,276 | ||
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 and cash included within funds held for customers – The carrying amounts reported in the consolidated balance sheets approximate fair value because of the short-term nature of these items.
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 carrying amounts reported in the consolidated balance sheets for the amount drawn on our credit facility approximates fair value because our interest rate is variable and reflects current market rates. The fair value of our long-term notes due in 2020 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 or debt issuance costs. The carrying amount of long-term debt includes the change in fair value of hedged long-term debt, as well as unamortized debt issuance costs related to our notes due in 2020 (Note 11).
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DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
The estimated fair values of these financial instruments were as follows:
Fair value measurements using | ||||||||||||||||||||
September 30, 2016 | 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 | $ | 80,065 | $ | 80,065 | $ | 80,065 | $ | — | $ | — | ||||||||||
Cash (funds held for customers) | 76,104 | 76,104 | 76,104 | — | — | |||||||||||||||
Loans and notes receivable from distributors | 23,329 | 21,290 | — | — | 21,290 | |||||||||||||||
Long-term debt(1) | 615,985 | 624,758 | — | 624,758 | — | |||||||||||||||
(1) Amounts exclude capital lease obligations.
Fair value measurements using | ||||||||||||||||||||
December 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 | $ | 62,427 | $ | 62,427 | $ | 62,427 | $ | — | $ | — | ||||||||||
Cash (funds held for customers) | 38,276 | 38,276 | 38,276 | — | — | |||||||||||||||
Loans and notes receivable from distributors | 25,745 | 23,383 | — | — | 23,383 | |||||||||||||||
Long-term debt(1) | 626,909 | 641,000 | — | 641,000 | — | |||||||||||||||
(1) Amounts exclude capital lease obligations.
Note 9: Restructuring charges
Net restructuring charges for each period consisted of the following components:
Quarter Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(in thousands, except number of employees) | 2016 | 2015 | 2016 | 2015 | ||||||||||||
Severance accruals | $ | 1,824 | $ | 1,443 | $ | 3,870 | $ | 3,493 | ||||||||
Severance reversals | (198 | ) | (282 | ) | (666 | ) | (976 | ) | ||||||||
Operating lease obligations | — | 88 | — | 88 | ||||||||||||
Net restructuring accruals | 1,626 | 1,249 | 3,204 | 2,605 | ||||||||||||
Other costs | 432 | 489 | 939 | 551 | ||||||||||||
Net restructuring charges | $ | 2,058 | $ | 1,738 | $ | 4,143 | $ | 3,156 | ||||||||
Number of employees included in severance accruals | 55 | 50 | 120 | 200 | ||||||||||||
20
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
The net restructuring charges are reflected in the consolidated statements of comprehensive income as follows:
Quarter Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(in thousands) | 2016 | 2015 | 2016 | 2015 | ||||||||||||
Total cost of revenue | $ | 65 | $ | 233 | $ | 136 | $ | 418 | ||||||||
Operating expenses | 1,993 | 1,505 | 4,007 | 2,738 | ||||||||||||
Net restructuring charges | $ | 2,058 | $ | 1,738 | $ | 4,143 | $ | 3,156 | ||||||||
During the nine months ended September 30, 2016 and September 30, 2015, the net restructuring accruals included severance charges related to employee reductions across functional areas as we continue to reduce costs, primarily within our sales and marketing, information technology and fulfillment functions. These charges were reduced by the reversal of restructuring accruals recorded in previous periods, 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 $2,648 as of September 30, 2016 and $3,864 as of December 31, 2015 are included in accrued liabilities in the consolidated balance sheets. The majority of the employee reductions are expected to be completed by the fourth quarter of 2016, and we expect most of the related severance payments to be paid by mid-2017, utilizing cash from operations. The remaining payments due under operating lease obligations will be paid by the end of 2016. As of September 30, 2016, approximately 25 employees had not yet started to receive severance benefits.
Accruals for our restructuring initiatives, summarized by year, were as follows:
(in thousands) | 2014 initiatives | 2015 initiatives | 2016 initiatives | Total | ||||||||||||
Balance, December 31, 2015 | $ | 176 | $ | 3,688 | $ | — | $ | 3,864 | ||||||||
Restructuring charges | — | 78 | 3,792 | 3,870 | ||||||||||||
Restructuring reversals | (111 | ) | (465 | ) | (90 | ) | (666 | ) | ||||||||
Payments | (65 | ) | (2,989 | ) | (1,366 | ) | (4,420 | ) | ||||||||
Balance, September 30, 2016 | $ | — | $ | 312 | $ | 2,336 | $ | 2,648 | ||||||||
Cumulative amounts: | ||||||||||||||||
Restructuring charges | $ | 8,242 | $ | 6,205 | $ | 3,792 | $ | 18,239 | ||||||||
Restructuring reversals | (1,444 | ) | (923 | ) | (90 | ) | (2,457 | ) | ||||||||
Payments | (6,798 | ) | (4,970 | ) | (1,366 | ) | (13,134 | ) | ||||||||
Balance, September 30, 2016 | $ | — | $ | 312 | $ | 2,336 | $ | 2,648 | ||||||||
21
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
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 | Financial Services | Total | |||||||||||||||||||||
Balance, December 31, 2015 | $ | 1,023 | $ | 884 | $ | — | $ | 1,859 | $ | 56 | $ | 42 | $ | 3,864 | ||||||||||||||
Restructuring charges | 1,979 | 768 | 135 | 929 | 59 | — | 3,870 | |||||||||||||||||||||
Restructuring reversals | (255 | ) | (50 | ) | (2 | ) | (359 | ) | — | — | (666 | ) | ||||||||||||||||
Payments | (1,457 | ) | (922 | ) | (85 | ) | (1,811 | ) | (103 | ) | (42 | ) | (4,420 | ) | ||||||||||||||
Balance, September 30, 2016 | $ | 1,290 | $ | 680 | $ | 48 | $ | 618 | $ | 12 | $ | — | $ | 2,648 | ||||||||||||||
Cumulative amounts(1): | ||||||||||||||||||||||||||||
Restructuring charges | $ | 7,704 | $ | 5,027 | $ | 171 | $ | 4,940 | $ | 344 | $ | 53 | $ | 18,239 | ||||||||||||||
Restructuring reversals | (1,455 | ) | (361 | ) | (4 | ) | (637 | ) | — | — | (2,457 | ) | ||||||||||||||||
Inter-segment transfer | 41 | (14 | ) | — | (27 | ) | — | — | — | |||||||||||||||||||
Payments | (5,000 | ) | (3,972 | ) | (119 | ) | (3,658 | ) | (332 | ) | (53 | ) | (13,134 | ) | ||||||||||||||
Balance, September 30, 2016 | $ | 1,290 | $ | 680 | $ | 48 | $ | 618 | $ | 12 | $ | — | $ | 2,648 | ||||||||||||||
(1) Includes accruals related to our cost reduction initiatives for 2014 through 2016.
Note 10: Postretirement benefits
We have historically provided certain health care benefits for a portion of our 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 2015 Form 10-K.
Postretirement benefit income for each period consisted of the following components:
Quarter Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(in thousands) | 2016 | 2015 | 2016 | 2015 | ||||||||||||
Interest cost | $ | 780 | $ | 859 | $ | 2,339 | $ | 2,578 | ||||||||
Expected return on plan assets | (1,834 | ) | (1,958 | ) | (5,501 | ) | (5,875 | ) | ||||||||
Amortization of prior service credit | (355 | ) | (355 | ) | (1,066 | ) | (1,066 | ) | ||||||||
Amortization of net actuarial losses | 949 | 780 | 2,848 | 2,340 | ||||||||||||
Net periodic benefit income | $ | (460 | ) | $ | (674 | ) | $ | (1,380 | ) | $ | (2,023 | ) | ||||
22
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
Note 11: Debt
Debt outstanding was comprised of the following:
(in thousands) | September 30, 2016 | December 31, 2015 | ||||||
6.0% senior notes due November 15, 2020, principal amount | $ | 200,000 | $ | 200,000 | ||||
Less unamortized debt issuance costs | (1,906 | ) | (2,249 | ) | ||||
Cumulative change in fair value of hedged debt (Note 7) | (109 | ) | (4,842 | ) | ||||
6.0% senior notes, carrying value | 197,985 | 192,909 | ||||||
Amount drawn on credit facility | 418,000 | 434,000 | ||||||
Long-term portion of capital lease obligations | 805 | 1,064 | ||||||
Long-term portion of debt | 616,790 | 627,973 | ||||||
Capital lease obligations due within one year | 951 | 1,045 | ||||||
Total debt | $ | 617,741 | $ | 629,018 | ||||
Our senior notes due in 2020 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. 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 this agreement.
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 SEC via a registration statement that 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 15. Proceeds from the offering, net of offering costs, were $196,340. These proceeds were used to retire our senior notes that were due in June 2015. In October 2016, we issued a notice to redeem all of these notes on November 15, 2016 at a redemption price of 103% of the principal amount. The fair value of these notes was $206,758 as of September 30, 2016, based on quoted prices that are directly observable. As discussed in Note 7, we entered into interest rate swaps to hedge these notes.
In March 2011, we issued $200,000 of 7.0% senior notes that were scheduled to mature 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 that 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 nine months ended September 30, 2015, consisting of a contractual call premium and the write-off of related debt issuance costs. This retirement was funded utilizing our credit facility and a short-term bank loan that we have since repaid.
We had capital lease obligations of $1,756 as of September 30, 2016 and $2,109 as of December 31, 2015 related to information technology hardware. The lease obligations will be paid through August 2020. 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.
As of September 30, 2016, we had a $525,000 revolving credit facility, which is scheduled to expire in February 2019. Our quarterly commitment fee ranges from 0.20% to 0.40% based on our leverage ratio. As of September 30, 2016, $418,000 was drawn on our revolving credit facility at a weighted-average interest rate of 1.95%. As of December 31, 2015, $434,000
23
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
was drawn on our revolving credit facility at a weighted-average interest rate of 1.89%. In September 2016, we amended the credit agreement governing our credit facility to include a new term loan facility in the aggregate principal amount of $200,000 in order to retire our senior notes due in 2020, which we expect to redeem on November 15, 2016. The term loan facility will be fully drawn on the date that it is funded and amounts repaid may not be reborrowed. Interest will be calculated at a variable rate and will be paid quarterly. Aggregate principal payments of $21,250 will be due in 2017 and $26,250 will be due in 2018, with the remainder due in February 2019 at the expiration of the credit agreement. We may prepay the term loan in full or in part at our discretion.
All borrowings under our credit agreement are collateralized by substantially all of our personal and intangible property. The credit agreement governing our credit facility contains 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 agreement also contains financial covenants regarding our leverage ratio, interest coverage and liquidity.
In March 2015, we entered into a $75,000 short-term variable rate bank loan. Proceeds from this loan, net of related costs, were $74,880 and were used, along with a draw on our credit facility, to retire all $200,000 of our 7.0% senior notes that were scheduled to mature on March 15, 2019. During December 2015, we elected to repay this loan in full.
Daily average amounts outstanding under our credit facility and short-term borrowings were as follows:
(in thousands) | Nine Months Ended September 30, 2016 | Year Ended December 31, 2015 | ||||||
Revolving credit facility: | ||||||||
Daily average amount outstanding | $ | 416,814 | $ | 270,063 | ||||
Weighted-average interest rate | 1.91 | % | 1.66 | % | ||||
Short-term bank loan: | ||||||||
Daily average amount outstanding | $ | — | ||||||