Deluxe Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Amounts below are U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
Deluxe provides checks, forms, marketing solutions and other services to small businesses, financial institutions and consumers through Small Business Services, Financial Services and Direct Checks. The company is shifting its mix toward marketing solutions and services while facing continuing declines in check and forms usage. Acquisitions contributed substantially to reported growth.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | First 9 months 2017 | First 9 months 2016 |
|---|---|---|---|---|
| Revenue | $497.7 | $458.9 | $1,470.7 | $1,368.9 |
| Gross profit | $304.8 | $292.7 | $919.4 | $878.5 |
| Operating income | $53.9 | $92.3 | $232.7 | $275.9 |
| Net income | $28.8 | $58.7 | $145.4 | $175.2 |
| Diluted EPS | $0.59 | $1.19 | $2.98 | $3.55 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $225.9 | $208.1 |
Quarterly revenue grew 8.4%; nine-month revenue grew 7.4%. Operating margin fell to 10.8% from 20.1% in Q3 and to 15.8% from 20.1% year to date. Gross margin was approximately 61.2% in Q3 (63.8% prior year) and 62.5% for nine months (64.2% prior year). Q3 earnings included $46.6 million of asset impairment charges; nine-month charges totaled $54.9 million. The nine-month effective tax rate was 33.6%; Q3’s was 41.2%, elevated mainly by the non-deductible portion of the goodwill impairment.
Cash, debt and liquidity: Cash and cash equivalents were $53.4 million at September 30, versus $76.6 million at year-end 2016. Total debt was $756.4 million, predominantly floating rate, with a weighted-average rate of 2.7%; debt was down $2.3 million from year-end. The revolving facility had $64.6 million available after outstanding borrowings and letters of credit. Revolver and term-loan maturities are concentrated in February 2019. Management reported compliance with debt covenants and expected compliance over the next 12 months.
Nine-month investing cash outflow was $154.1 million, including $125.4 million for acquisitions and $34.4 million for capital expenditures. Financing cash outflow was $97.2 million, including $50.1 million of share repurchases and $43.7 million of dividends. The company repurchased 709,000 shares during the nine months. Shareholders’ equity was $950.5 million at period-end.
Material changes versus prior comparable periods
- Service revenue rose to $135.7 million in Q3 from $94.2 million; product revenue declined to $362.0 million from $364.7 million. For the first nine months, service revenue was $372.9 million versus $278.2 million.
- Management attributed revenue growth primarily to acquisitions and price increases, partly offset by lower order volumes and Financial Services pricing allowances. Acquisitions added approximately $51.8 million of Q3 revenue and $136.4 million for the first nine months.
- Q3 impairment charges included $28.4 million for full impairment of goodwill in the Small Business Services Safeguard reporting unit, $14.8 million for the discontinued NEBS trade name and $3.5 million for other long-lived assets. Nine-month impairment also included $8.3 million related to a distributor sold in Q2.
- Financial Services revenue increased 27.9% in Q3 and 19.1% year to date, but nine-month operating income declined 9.4%. Small Business Services revenue rose 2.5% in Q3, while operating income fell 73.9%, mainly due to impairment. Direct Checks revenue fell 8.4% in Q3 and operating income fell 12.5%.
- Operating cash flow increased $17.8 million year to date. Acquisition spending increased $60.8 million versus the prior-year period.
Outlook, management commentary and risks
- 2017 revenue guidance was $1.965–$1.975 billion; diluted EPS guidance was $4.37–$4.42, including $0.88 per share of asset impairment charges and restructuring and acquisition transaction costs.
- Management forecast 2017 operating cash flow of $340–$345 million, capital spending of approximately $45 million and contract acquisition payments of approximately $26 million. The company anticipated about $45 million of net cost reductions versus 2016.
- Management expected Small Business Services revenue to increase about 4%, Financial Services revenue to increase 18%–19%, and Direct Checks revenue to decline about 9%. The outlook reflected acquisitions and service growth, offset by declining check orders, the loss of Verizon as a Deluxe Rewards customer, and pricing pressure.
- Management said operating cash generation and revolving-credit availability should support operations, dividends, capital expenditures, required debt service, repurchases and tuck-in acquisitions over the next 12 months. It anticipated maintaining the current dividend, subject to quarterly board approval.
- Key risks include secular check and forms declines, competition and pricing pressure, dependence on financial institution clients, data security, acquisition execution and economic conditions. The company also disclosed environmental remediation, self-insurance and litigation exposures; recorded legal liabilities were not material, though an unfavorable ruling could have a material effect.
- Revenue recognition guidance was scheduled for adoption January 1, 2018; the company was still assessing the effects for marketing solutions and services. Lease accounting guidance was scheduled for adoption in 2019, with impact still under assessment.
Important facts for investors to verify
- Whether service and marketing-solutions growth can offset continuing declines in checks, forms and orders, and how much growth is acquisition-driven.
- Whether the 2017 revenue, EPS, operating-cash-flow and cost-reduction outlook was achieved, particularly after impairment and restructuring costs.
- Whether Small Business Services performance and goodwill impairment assumptions remain supportable given lowered Safeguard growth and profitability expectations.
- Liquidity and refinancing plans for the $701.6 million of stated 2019 debt maturities, including covenant headroom and exposure to variable rates.
- Whether acquisition integration, customer retention, Financial Services pricing allowances and the Verizon Rewards customer loss affect margins or guidance.
- Future share repurchases, dividends and acquisition spending relative to cash generation and available revolving-credit capacity.