Deluxe Corporation — FY2018 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2018; the filing also presents fourth-quarter results. Deluxe provides small-business marketing and web services, financial-institution technology and payment solutions, and checks, forms and related products through Small Business Services, Financial Services and Direct Checks. The company is transitioning from check printing toward technology-enabled marketing and financial services.
Key financial metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $1,998.0 million | $1,965.6 million |
| Gross profit / margin | $1,206.3 million / 60.4% | $1,222.8 million / 62.2% |
| Operating income / margin | $231.2 million / 11.6% | $329.2 million / 16.7% |
| Net income | $149.6 million | $230.2 million |
| Diluted EPS | $3.16 | $4.72 |
| Cash from operations | $339.3 million | $338.4 million |
| Capital expenditures | $62.2 million | $47.5 million |
| Cash and cash equivalents | $59.7 million | $59.2 million |
| Total debt | $911.9 million | $709.3 million |
Figures are in U.S. dollars. At year-end, current assets were $450.0 million and current liabilities were $392.1 million. Separately reported customer funds are restricted for customer obligations; they should not be treated as freely available corporate cash. The revolving facility had $29.8 million available at year-end; in January 2019, its commitment increased by $200 million to $1.15 billion. The company reported compliance with its debt covenants.
Revenue rose 1.7%, while orders fell 4.9% and revenue per order increased 6.9%. MOS products and services grew to 42.0% of revenue from 38.4%; checks fell to 40.6% from 43.3%. Fourth-quarter revenue was $524.7 million, net income $57.2 million and diluted EPS $1.25. Third-quarter net loss of $31.1 million reflected the impairment charges.
Material changes versus the prior year
- Profitability declined substantially: operating income fell 29.8% and net income fell 35.0%. Results included $101.3 million of non-cash impairment charges, compared with $54.9 million in 2017.
- Revenue growth was supported by approximately $86.7 million of acquired-business revenue and prior price increases, partly offset by declining check and forms volumes, Financial Services check pricing allowances, and the loss of a Deluxe Rewards customer. The Verizon customer loss reduced 2018 Rewards revenue by about $11 million.
- Cost of revenue grew 6.6%, faster than revenue, and gross margin contracted 1.8 percentage points. Management cited acquisition mix, higher materials and delivery costs, and a greater service-revenue mix; cost-reduction initiatives partly offset these pressures.
- Debt increased $202.6 million, principally reflecting borrowing to fund acquisitions and share repurchases. Share repurchases totaled $200 million in 2018, versus $65 million in 2017.
- Segment revenue and operating income diverged: Small Business Services revenue rose 3.5% while operating income fell 34.0%; Financial Services revenue was nearly flat while operating income fell 30.8%; Direct Checks revenue fell 9.3% and operating income fell 11.0%.
Outlook, management commentary and risks
- Management forecast low-single-digit consolidated revenue growth in 2019, including contributions from 2018 acquisitions and excluding additional acquisitions. It expected 2019 EPS to increase from 2018 and to be slightly higher than 2018 EPS after excluding specified charges and asset-sale gains. These are forward-looking expectations, not guarantees.
- Management did not plan acquisitions in the first half of 2019, prioritizing integration of 2018 acquisitions and scaling strategy, sales and product efforts. It expected treasury-management revenue growth, while anticipating continued check and forms declines, Financial Services pricing allowances, and pressure from higher materials, delivery rates and interest expense.
- Management reported approximately $50 million in net cost savings in 2018 and expected further reductions in 2019. It anticipated maintaining the current dividend, subject to quarterly board approval, and using excess cash for share repurchases and/or debt reduction.
- Key business risks include secular declines in check and forms usage, competitive pricing and financial-institution contract renewals, execution and integration of numerous acquisitions, customer and marketing-cycle variability, and dependence on technology, data providers and cybersecurity. Variable-rate debt exposes earnings and cash flow to rising interest rates.
- Goodwill was $1.16 billion, or 50.4% of total assets. The 2018 impairment included a $78.2 million Small Business Services goodwill charge and a $19.1 million Safeguard trade-name write-off. Further impairments could result if forecasts, strategy or market conditions weaken.
- The CEO retired and Barry McCarthy became CEO in November 2018. CEO-transition costs were $7.2 million in 2018; management estimated about $8 million for 2019. Legal reserves were reported as not material, although the filing cautions that litigation outcomes are uncertain. Environmental accruals were $2.8 million.
- The California Consumer Privacy Act was scheduled to take effect January 1, 2020; the company was assessing its impact. The company also disclosed that a 2018 quarterly cash-flow presentation misstatement was not material and did not affect net income or operating cash flow.
Important facts for investors to verify
- Whether organic growth in MOS and treasury management can offset falling check and forms volume and sustain the 2019 outlook.
- Whether acquired businesses meet operating expectations and can be integrated without further margin deterioration or impairment charges.
- How much liquidity remains after the January 2019 facility increase, and whether debt, interest expense and covenant headroom remain manageable.
- Whether reported cost savings persist after restructuring and integration costs, CEO-transition expenses and planned growth investments.
- Whether key Financial Services contracts renew on acceptable pricing and terms, and whether customer losses or in-house marketing decisions affect revenue.
- The assumptions supporting goodwill valuations and the status of the disclosed cash-flow presentation correction in subsequent filings.