Deluxe Corporation — Q1 2018 Form 10-Q
Reporting period: Quarter ended March 31, 2018; interim financial statements are unaudited. Deluxe sells checks, forms, marketing solutions and other services through Small Business Services, Financial Services and Direct Checks.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $491.9 million | $487.8 million | +0.9% |
| Gross profit / margin | $303.2 million / 61.6% | $308.5 million / 63.2% | Gross profit down 1.7% |
| Operating income / margin | $87.7 million / 17.8% | $85.0 million / 17.4% | +3.2% |
| Net income | $63.3 million | $57.1 million | +11.0% |
| Diluted EPS | $1.31 | $1.16 | +12.9% |
| Operating cash flow | $80.8 million | $74.3 million | +$6.4 million |
Service revenue increased to $128.5 million from $115.6 million; product revenue declined to $363.4 million from $372.2 million. MOS (marketing solutions and other services) represented 39.3% of revenue, up from 35.3%; checks declined to 42.7% from 45.6%. Orders fell 6.8%, while revenue per order rose 8.2% to $40.97.
Cash and cash equivalents were $67.7 million at quarter-end. Total debt was $742.5 million, up from $709.3 million at December 31, 2017. The new $950 million revolving facility had $740.6 million drawn and $199.1 million available after letters of credit. Current liabilities were $375.6 million and current assets $399.9 million. Funds held for customers are reported separately and should not be assumed to be freely available corporate cash.
Material changes and drivers
- Revenue growth reflected acquisitions, Small Business Services price increases and growth in MOS, partly offset by declining check and forms volumes and Financial Services pricing allowances.
- Operating income improved despite lower gross profit. SG&A fell 2.8%, reflecting cost reductions, lower certain employee and legal costs, and $7.2 million of gains on business sales; acquired businesses added costs.
- Net income benefited from a lower effective tax rate: 24.1% versus 29.7% in Q1 2017, largely due to U.S. tax reform. Interest expense increased 15.5% to $5.6 million, primarily due to higher borrowing rates.
- Segment revenue and operating income: Small Business Services $316.3 million and $58.9 million, up 2.7% and 12.7%; Financial Services $140.6 million and $18.0 million, revenue essentially flat and operating income down 11.2%; Direct Checks $35.0 million and $10.8 million, down 10.0% and 13.3%.
- Investing cash outflow was $66.9 million, including $52.4 million net acquisition payments and $14.0 million of capital purchases. Financing cash outflow was $4.6 million; the quarter included $20.0 million of share repurchases and $14.4 million of dividends.
Outlook, commentary and risks
- For 2018, management forecast revenue of $2.065–$2.085 billion, diluted EPS of $5.34–$5.54, operating cash flow of $360–$380 million, capital spending of about $55 million and an effective tax rate of about 25%.
- The EPS outlook includes $0.26 per share of specified restructuring, integration, acquisition transaction and Q1 impairment charges. It excludes costs related to the CEO succession process and obligations announced April 26, 2018.
- Management expected about $50 million in net 2018 cost reductions versus 2017, and approximately $27 million of prepaid product discount payments. The company said operating cash flow and credit availability should fund operations, dividends, capital spending, interest, share repurchases and likely acquisitions over the next 12 months.
- Management highlighted secular declines in check and forms usage, competitive and pricing pressure, higher material costs and delivery rates, and ongoing investment needs. The Financial Services outlook also cited expected check-order declines of about 7% and approximately $10 million of lost Deluxe Rewards revenue, primarily related to Verizon.
- Q1 acquisitions included Logomix and two small business distributors; preliminary aggregate purchase price was $53.4 million. A $2.1 million impairment was recorded on a Small Business Services customer-list intangible, attributed to market changes including declining check and forms usage. Business sales generated $7.2 million in aggregate net gains.
- The company adopted the new revenue recognition standard on January 1, 2018 using the modified retrospective method. It increased opening retained earnings by $5.0 million; the reported Q1 net income impact was a $0.2 million increase. Management did not expect a material ongoing impact. Tax-reform accounting estimates remained under review and could change.
- The new revolving credit facility matures in March 2023. The company reported compliance with debt covenants. Environmental, self-insurance and litigation matters were disclosed; management did not expect them to materially affect financial condition, results or liquidity, while noting that litigation outcomes remain uncertain.
Important facts for investors to verify
- Whether MOS growth and pricing can offset continued check and forms volume declines, especially in Financial Services and Direct Checks.
- Progress toward the 2018 revenue, EPS, cash-flow and cost-reduction outlook, including the effect of CEO transition costs excluded from EPS guidance.
- Debt, floating-rate exposure and covenant headroom; a one-percentage-point rate change was estimated to affect Q1 interest expense by $1.8 million.
- Acquisition integration, final purchase accounting and returns on acquired businesses, alongside planned acquisition spending and share repurchases.
- Final tax-reform accounting and the impacts of adopting revenue recognition rules, including estimates for variable consideration and contract assets.
- Customer retention and prepaid discount commitments, and the resolution and potential costs of environmental, self-insurance and litigation contingencies.