Deluxe Corporation — Q1 2019 Form 10-Q
Reporting period: Quarter ended March 31, 2019. Deluxe provides products and services through Small Business Services, Financial Services and Direct Checks. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $499.1 | $491.9 | +1.5% |
| Gross profit / margin | $299.4 / 60.0% | $303.2 / 61.6% | Margin down 1.6 pts. |
| Operating income / margin | $63.8 / 12.8% | $87.7 / 17.8% | Income down 27.3% |
| Net income | $41.2 | $63.3 | Down 35.0% |
| GAAP diluted EPS | $0.93 | $1.31 | Down 29.0% |
| Adjusted diluted EPS (non-GAAP) | $1.54 | $1.60 | Down 3.8% |
| Operating cash flow | $45.4 | $80.8 | Down $35.4 |
| Capital expenditures | $14.6 | $14.0 | Up $0.6 |
Product revenue declined to $350.5 million from $363.4 million; service revenue increased to $148.5 million from $128.5 million. Service revenue was 29.8% of total revenue, versus 26.1% a year earlier. Orders fell 2.4%, while revenue per order rose 3.9% to $42.57.
Segment revenue and operating income: Small Business Services $313.1 million and $44.7 million (revenue down 1.0%; operating income down 24.1%); Financial Services $154.4 million and $10.3 million (revenue up 9.8%; operating income down 43.0%); Direct Checks $31.6 million and $8.8 million (revenue down 9.5%; operating income down 18.4%). Segment margins were 14.3%, 6.6% and 27.9%, respectively.
Balance sheet, debt and liquidity
- At March 31, 2019, cash and cash equivalents were $61.5 million; an additional $77.0 million of restricted cash was included in funds held for customers. Total assets were $2.322 billion and shareholders’ equity was $897.6 million.
- Total debt was $946.0 million, all drawn on a floating-rate revolving facility, at a weighted-average rate of 3.8%. Net availability under the $1.15 billion facility was $198.1 million after borrowings and letters of credit. The facility matures in March 2023.
- The company reported compliance with debt covenants. The agreement requires a maximum leverage ratio of 3.5 and minimum interest coverage of 3.0; dividends and repurchases may be limited if leverage exceeds 2.75.
- Financing activity included $50.0 million of share repurchases and $13.1 million of cash dividends. The company repurchased about 1.0 million shares; $370.0 million remained under its authorization.
- Operating cash flow was lower year over year, reflecting, among other factors, payment of $12.5 million in prior-year accrued legal expenses, payment timing, higher interest and medical costs, and increased integration spending. The filing says cash from operations plus available facility capacity should fund the next 12 months’ operations and planned uses.
Material changes and unusual items
- Revenue growth reflected $28.6 million of incremental acquired-business revenue and Small Business Services price increases. These were offset by continuing check and forms declines, one fewer business day (about $5 million of consolidated revenue impact), Financial Services check pricing allowances, and a roughly $3 million decline in treasury management revenue excluding acquisitions.
- Profitability was pressured by higher service-related costs, acquired-business costs, delivery, material and medical costs, higher commissions, and increased interest expense. Cost-reduction initiatives partially offset these pressures; management cited an approximately $11 million benefit from ongoing initiatives.
- Q1 2018 included a $7.2 million gain from sales of small businesses and customer lists and a $2.1 million impairment charge. Q1 2019 included $5.5 million of CEO transition costs and higher restructuring and integration costs. Restructuring and integration expense was $6.3 million in total, including $0.8 million in cost of revenue and $5.5 million in operating expenses.
- Interest expense rose 66.7% to $9.3 million, with higher average debt and rates contributing. A 1 percentage-point change in weighted-average rates would have changed Q1 interest expense by an estimated $2.3 million.
- Deluxe adopted the lease accounting standard on January 1, 2019. This added lease assets and liabilities to the balance sheet; comparative periods were not restated and income and cash flow effects were not significant. The 2018 cash flow statement was revised for restricted-cash presentation; management said the prior-period misstatement was not material and the revision did not affect net income or operating cash flow.
Outlook, strategy and risks
- 2019 guidance: revenue of $2.00–$2.05 billion; GAAP diluted EPS of $4.33–$4.63; adjusted diluted EPS of $6.65–$6.95; effective tax rate of about 25%; and operating cash flow of $325–$340 million. Management expected check and forms declines and Financial Services pricing allowances to be more than offset by acquired revenue and modest growth in treasury management and data-driven marketing.
- Expected 2019 capital expenditures were approximately $75 million. Management anticipated maintaining the current dividend level, subject to quarterly board approval, and said excess cash could support opportunistic repurchases or debt reduction. Possible acquisitions were contemplated in the second half of 2019; none were completed in Q1.
- The strategy is to transform into a technology-enabled solutions provider, integrate prior acquisitions, standardize technology platforms and pursue organic growth in Payments and Cloud. Management planned $30–$60 million of technology-platform investment in each of the next two years; these investments were excluded from 2019 outlook and were intended to be funded by savings and free cash flow, although timing could limit self-funding.
- Management highlighted secular declines in checks and forms, competitive pressure and Financial Services pricing allowances. Other risks include floating-rate debt, execution and integration costs, uncertain future prepaid product discounts, and potential adverse litigation outcomes. Recorded litigation liabilities were described as not material; environmental accruals were $2.6 million, with no significant 2019 net cash outlays anticipated.
- In April 2019, Deluxe entered software-as-a-service contracts requiring minimum payments of $29.2 million, including $25.1 million payable in 2020 and 2021.
Important facts for investors to verify
- Whether service and acquired-business growth can offset continued check, forms and accessories declines, including the performance of treasury management excluding acquisitions.
- Whether margins and cash generation recover as projected, given Q1 operating cash flow of $45.4 million and lower operating profitability.
- Progress against 2019 guidance and the treatment and scale of excluded items in adjusted EPS, including restructuring, acquisition amortization and CEO transition costs.
- Debt, floating-rate exposure, covenant headroom and remaining facility availability as repurchases, dividends and strategic investments proceed.
- Delivery and funding of the planned technology transformation, integration savings and the additional SaaS commitments.