Deluxe Corporation (NYSE: DLX) — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Amounts below are in U.S. dollars; financial statements are unaudited. Deluxe operates Small Business Services, Financial Services and Direct Checks.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $493.6 million | $493.2 million | $1,486.6 million | $1,473.3 million |
| Gross profit | $289.9 million | $295.6 million | $880.8 million | $896.8 million |
| Gross margin | 58.7% | 59.9% | 59.2% | 60.9% |
| Operating income (loss) | $(340.7) million | $(17.3) million | $(225.1) million | $153.2 million |
| Net income (loss) | $(318.5) million | $(31.1) million | $(244.7) million | $92.5 million |
| Diluted EPS | $(7.49) | $(0.67) | $(5.65) | $1.93 |
| Adjusted diluted EPS (non-GAAP) | $1.71 | $1.74 | $4.88 | $5.01 |
Q3 revenue was nearly flat year over year; nine-month revenue increased 0.9%. Service revenue grew, while product revenue declined. For the first nine months, services were 29.8% of revenue versus 27.0% a year earlier. Gross margin contracted as service mix, acquired-business costs, shipping and material rates, medical costs, and restructuring costs weighed on results.
Operating results included $391.0 million of Q3 goodwill and intangible-asset impairments, versus $99.2 million in Q3 2018. The 2019 charges comprised $357.7 million of goodwill and $33.2 million of other intangible assets. Nine-month restructuring and integration expense was $49.1 million versus $12.9 million. Interest expense rose to $27.3 million for the nine months from $19.0 million.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $208.0 million, down from $219.1 million. Investing cash outflow was $49.9 million, compared with $231.9 million, largely reflecting the absence of the substantial 2018 acquisitions. Financing cash outflow was $153.9 million.
- At September 30, cash and cash equivalents were $73.5 million. A further $78.6 million of restricted cash and cash equivalents was included in funds held for customers and should not be treated as unrestricted liquidity.
- Total debt was $924.0 million, all drawn under the revolving credit facility. The facility commitment was $1.15 billion, with $220.3 million available after outstanding letters of credit. The facility matures in March 2023; the weighted-average rate on debt at quarter-end was 3.3%.
- A July 2019 interest-rate swap fixed the rate on $200 million of borrowings at 1.798% plus the credit-facility spread. The company reported compliance with debt covenants and expected to remain compliant over the next 12 months.
- Shareholders’ equity declined to $525.5 million from $915.4 million at year-end 2018. The balance sheet reflects impairment charges, dividends and share repurchases. The company repurchased 2.6 million shares for $118.5 million during the first nine months.
Changes, outlook and management commentary
- Impairment testing found Small Business Services Web Services goodwill fully impaired and Financial Services Data-Driven Marketing goodwill partially impaired. Management cited underperformance against expectations, a decision to exit certain customer contracts, large customers bringing some services in-house, and a sustained share-price decline. Goodwill fell to $800.3 million from $1.16 billion at December 31, 2018.
- Management attributed pressure on underlying results to secular declines in check and forms usage, lower organic web-services and treasury-management revenue, Financial Services check-pricing allowances, and higher costs. 2018 acquisitions and Small Business Services price increases supported revenue; cost-reduction initiatives partly offset expense increases.
- For 2019, management expected consolidated revenue at the low end of its prior $2.005–$2.045 billion outlook and adjusted diluted EPS at the low end of its prior $6.65–$6.95 range. It forecast operating cash flow of $270–$285 million and capital expenditures of approximately $75 million. Management said cash generation and facility availability should fund operations and planned uses for the next 12 months. The EPS outlook is non-GAAP and was not reconciled to GAAP EPS because of uncertainty around reconciling items.
- The “New Deluxe” strategy emphasizes organic growth, integration and standardization of operations and technology, and a shift to four focus areas: Payments, Cloud, Promotional Products and Checks. Planned technology-platform investment was $40–$45 million in 2019 and $30–$60 million in 2020. Management intended to realign reporting under the new structure in early 2020 and anticipated maintaining the current dividend, subject to quarterly board approval.
- Restructuring and integration programs were expanded. Most employee reductions were expected to be completed in 2019, with most severance paid by mid-2020. The filing also disclosed minimum payments of $49.8 million for certain software-as-a-service and professional-services contracts and a further approximately $30 million professional-services contract, with payment terms still being negotiated.
- Risks include execution and cost of the strategic realignment, continued check-and-forms declines, loss of customers or further in-sourcing, and sensitivity of impairment estimates to forecasts and discount rates. The company disclosed environmental, self-insurance and litigation exposures; recorded legal liabilities were not material, but unfavorable litigation outcomes could have a material effect in the period incurred.
Important facts for investors to verify
- Whether revenue and adjusted EPS finish 2019 near the low end of guidance, and whether operating cash flow reaches the $270–$285 million outlook.
- Whether organic trends improve in Web Services and Treasury Management and whether declines in checks and forms continue.
- Whether the impairment assumptions remain supportable; the filing identifies forecast revenue, expenses and discount rates as sensitive valuation inputs and warns further impairments are possible.
- Debt covenant headroom, refinancing and interest-rate exposure, and the company’s ability to fund technology investment, dividends and buybacks from cash generation.
- Execution, timing and total cost of the New Deluxe realignment, including the disclosed technology and professional-services commitments.