The refinancing is leverage-neutral and improves interest coverage slightly.
The transaction will refinance the company's most expensive debt and extend
its maturity profile.
The rating on Shoreview, Minn.-based customized printed products provider
Deluxe Corp. reflects the intermediate- and long-term risks the company's
business segments face. In Standard & Poor's Ratings Services' view, Deluxe
has a "weak" business risk profile, based on our criteria,, principally
because of the significant risk of continued secular declines and the keen
competition in the check-printing sector. Check-printing accounted for 61% of
its 2011 fiscal year revenue. We believe these trends will put downward
pressure on Deluxe's organic revenue and EBITDA margin over the intermediate
term. Relative low leverage underpins our view of Deluxe's financial risk
profile as "significant" based on our criteria. In 2012, we expect revenue and
EBITDA to grow at a mid-single-digit percentage rate, mainly due to a contract
win, growth in small business services, and recent acquisitions that we expect
will offset organic declines in check printing.
Deluxe is one of the largest U.S. providers of checks. The company has three
segments: Direct Checks (DC), Small Business Services (SBS), and Financial
Services (FS). We believe the decline in check usage due to the continued
adoption of electronic payment methods will continue to affect all three
segments. We expect check volume declines will continue at a mid-single-digit
percent rate, in-line with recent trends. According to a Federal Reserve study
released in December 2010, the number of checks written in the U.S. declined
by approximately 6.1% per year between 2006 and 2009. We also expect the FS
segment will continue to face pressure from consolidation among financial
Under our base-case scenario, we expect full-year 2012 revenue and EBITDA will
increase at a mid-single-digit percent rate, respectively, reflecting a recent
check printing contract win, growth in small business services, and benefits
from recent acquisitions, partially offset by a continued decline in check
orders .In 2013, We expect revenue and EBITDA to be flat to slightly up as
benefits from the recent acquisition are offset by declines in check orders.
Our rating incorporates our expectation of limited margin improvement in 2013
as we believe cost reductions will be more difficult to implement in 2013.
The company's operating performance for the three months ended Sep 30, 2012
was above our expectations. Revenue increased 6.5%, as benefits from
acquisitions, price increases, and growth in the small business service
segment were partially offset by lower check order volume. We estimate that
organic revenue increased by about 4%. For the same period, EBITDA increased
6.5% due to cost cutting and revenue growth. The EBITDA margin declined to
23.4% for the twelve months ended Sep 30, 2012 from 23.8% in the same period
last year. The margin decline resulted from tough comparisons with the
previous year, when the company received high-margin revenue from a contract
settlement. Deluxe's debt to EBITDA decreased to 2.1x as of Sep. 30, 2012 from
2.5x in the same period last year, mainly due to the higher EBITDA base and a
lower debt balance. The company's adjusted leverage is under the indicative
debt-to-EBITDA financial risk ratio range of between 3x and 4x that
characterizes a significant risk profile, based on our criteria.
Although we believe Deluxe's leverage will stay below 3x over the intermediate
term, leverage could drift higher in the event of acquisitions or if secular
operating trends worsen. EBITDA coverage of interest increased to 8x for the
12 months ended Sep. 30, 2012, from 7.1x in the same period a year ago. Pro
forma for the refinancing, interest coverage was in the high 8x area as of
Sept. 30, 2012. Our base-case scenario indicates that the company's credit
metrics will improve for the full year 2012, incorporating our expectation of
revenue and EBITDA growth and repayment of the notes maturing in December
2012. We expect leverage to decline below 2.0x by year end. In 2013, we expect
lease adjusted leverage to remain largely primarily due to our expectation of
relatively flat revenue and EBITDA growth. We expect interest coverage to
improve to over 9x due to lower interest payments. The company converted 42.2%
of EBITDA to discretionary cash flow for the fiscal year ended Sep. 30, 2012,
and we expect it will continue to convert more than 35% of its EBITDA to
discretionary cash flow in fiscal 2013. We believe Deluxe will use a
meaningful portion of its discretionary cash flow for tuck-in acquisitions.
In our view, Deluxe has "adequate" sources of liquidity to more than cover its
needs over the next 12 months. Relevant expectations and assumptions
incorporated into our liquidity analysis are as follows:
-- We expect the company's sources of liquidity over the next 12 months
will exceed its uses by 1.2x or more.
-- We also expect net sources of liquidity to be positive over the next
12 months under a scenario of a 15% drop in EBITDA.
-- We believe the company will have sufficient covenant headroom for
EBITDA to decline by 15% without breaching its covenants.
-- We view the company as having good relationships with its banks and a
satisfactory standing in the credit markets.
-- Because of Deluxe's access to its revolving credit facility, we
believe it will be able to absorb low-probability, high-impact shocks.
As of Sep. 30, 2012, Deluxe's sources of liquidity included $191.4 million of
availability under its $200 million revolver, and $105.6 million of cash on
hand. We expect discretionary cash flow generation of between $145 million and
$160 million in 2012 and between $145 million to $165 in 2013. We anticipate
capital expenditures of roughly $35 million and dividends of about $50 million
in 2012 and 2013. Near-term debt maturities are manageable with cash flow and
the revolving credit facility. About $85 million of debt matures in December
2012, which the company can repay with cash flow or with borrowings from its
revolving credit facility.
As of Sep. 30, 2012, the company had an adequate cushion of compliance with
its leverage and interest coverage covenants. The financial covenants do not
tighten for the remaining life of the facility.
Deluxe's guaranteed senior notes due 2015 and guaranteed senior notes due 2019
have an issue-level rating of 'BB-' (the same as the corporate credit rating)
with a recovery rating of '4'. The '4' recovery rating indicates our
expectation of average (30%-50%) recovery for noteholders in the event of a
payment default. Deluxe's senior notes due 2012 and notes due 2014 have an
issue-level rating of 'B' (two notches below the corporate credit rating) with
a recovery rating of '6'. The '6' recovery rating indicates our expectation of
negligible (0%-10%) recovery for noteholders in the event of a payment
default. (For the recovery analysis, see Standard & Poor's recovery report on
Deluxe Corp., published on RatingsDirect on March 30, 2012).
The stable rating outlook reflects our expectation that Deluxe will maintain
sufficient flexibility within its financial profile to accommodate potential
weakness in operating performance and make additional acquisitions. Although
unlikely over the near term, the rating could come under pressure if the
company adopts a more aggressive financial policy, experiences significant
deterioration in its operating performance or makes a sizable debt-funded
acquisition that drives leverage over 4x. More specifically, a large,
debt-financed acquisition, coupled with client losses, lower check volume and
pressure on small businesses, could reduce Deluxe's discretionary cash flow
and elevate its leverage to over 4x, at which point we would likely lower the
We would consider a higher rating if Deluxe successfully diversifies its
business away from check printing and into a business with solid growth
prospects, while preserving its EBITDA margin and credit metrics. We do not
consider an upgrade likely over the near term.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008