Business context and reporting period
Deluxe Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018. The company operates Small Business Services, Financial Services and Direct Checks. Its strategy emphasizes growing marketing solutions and other services (MOS) while addressing secular declines in checks and forms.
Key financial results
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $493.2 | $497.7 | $1,473.3 | $1,470.7 |
| Gross profit | $295.6 | $304.6 | $896.8 | $918.9 |
| Operating income (loss) | $(17.3) | $53.4 | $153.2 | $231.2 |
| Net income (loss) | $(31.1) | $28.8 | $92.5 | $145.4 |
| Diluted EPS | $(0.67) | $0.59 | $1.93 | $2.98 |
| Operating cash flow | Not separately stated | Not separately stated | $219.1 | $225.9 |
Q3 gross margin was 59.9%, down from 61.2%; nine-month gross margin was 60.9%, down from 62.5%. Q3 operating margin was (3.5%), versus 10.7%; nine-month operating margin was 10.4%, versus 15.7%.
Nine-month product revenue declined to $1,076.1 million from $1,097.8 million, while service revenue increased to $397.2 million from $372.9 million. Orders fell 7.9% in Q3 and 5.5% year to date; revenue per order rose 7.6% and 6.1%, respectively.
Financial position and liquidity
At September 30, 2018, cash and cash equivalents were $57.9 million; total debt was $890.9 million, up $181.6 million from year-end 2017. Debt was primarily floating-rate revolver borrowings at a 3.2% rate. The $950 million revolving facility matures in March 2023; $50.8 million remained available after letters of credit, with capacity to increase commitments by up to $475 million. The company reported compliance with debt covenants and expects to remain compliant over the next 12 months.
Nine-month investing cash outflow was $231.9 million, including $190.4 million for acquisitions and $42.6 million of capital expenditures. Financing cash flow was $12.6 million provided, including $120.0 million of share repurchases and $42.9 million of dividends. Management expects operating cash flow and available credit to support operations and planned capital needs for the next 12 months.
Material changes versus the prior comparable period
- Q3 revenue declined 0.9%; nine-month revenue increased 0.2%. Acquisitions and Small Business Services price increases offset declining check and forms volumes, lower Financial Services data-driven marketing revenue, and the loss of Verizon as a Deluxe Rewards customer.
- Q3 included $99.2 million of asset impairment charges, compared with $46.6 million a year earlier. The charges included $78.2 million of Small Business Services goodwill, $19.1 million for the Safeguard trade name and $1.9 million of Financial Services customer lists. Nine-month impairment charges totaled $101.3 million versus $54.9 million.
- Nine-month interest expense rose 20.0% to $19.0 million, reflecting higher average borrowing rates and debt. Operating cash flow declined $6.8 million, while acquisition spending increased $65.0 million.
- MOS rose to 40.9% of nine-month revenue from 37.9%; checks fell to 41.5% from 43.9%.
Outlook, management commentary and risks
Management forecast 2018 revenue of $1.995–$2.005 billion and diluted EPS of $3.24–$3.31, including net charges of $2.39 per share, primarily for impairments, restructuring and CEO transition costs, partly offset by tax reform benefits. Segment revenue expectations were Small Business Services growth of 3%–4%, Financial Services growth of 1%–2%, and Direct Checks decline of approximately 10%.
Management projected 2018 operating cash flow of $350–$355 million, capital spending of approximately $60 million, and prepaid product discount payments of approximately $25 million. It expected approximately $55 million of net cost reductions versus 2017 and an annual effective tax rate of approximately 30%, including an estimated six-point impact from the goodwill impairment.
Key operating risks include continued check and forms declines, financial-institution pricing pressure, higher materials and delivery costs, acquisition and integration execution, data security, and retaining key employees. Management cited expected growth in MOS and acquisitions as partial offsets. The CEO transition was estimated to cost approximately $11 million, with about $6 million expected in 2018 and $5 million in 2019. The successor was scheduled to become CEO on November 26, 2018.
Other notable items: the company was still refining certain Tax Cuts and Jobs Act estimates, including the repatriation toll charge; it expected to finalize the accounting in Q4 2018. Adoption of the new revenue standard had no significant overall effect. Environmental accruals were $2.7 million; recorded legal liabilities were not material, although management cautioned that litigation outcomes are uncertain.
Important facts for investors to verify
- Whether MOS growth and acquisitions can offset continuing declines in checks, forms and orders, particularly in Financial Services and Direct Checks.
- Whether the impairment assessment assumptions and projected performance for Small Business Services Web Services remain supportable; reported fair-value headroom was approximately $63 million, or 22%.
- Whether the 2018 revenue, EPS, cash-flow and cost-savings outlook is achieved, including the stated effects of impairment, restructuring, CEO transition and tax estimates.
- Debt, variable-rate exposure and revolver availability: a one-percentage-point rate change would have affected nine-month interest expense by an estimated $5.7 million.
- Acquisition integration, customer retention, restructuring execution, and any developments in litigation, environmental matters or tax-reform calculations.