UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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| | | |
[X] | | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| | For the quarterly period ended | SeptemberJune 30, 20172018
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[ ] | | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ________________________ to ________________________ |
Commission file number: 1-7945
DELUXE CORPORATION
(Exact name of registrant as specified in its charter)
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| |
Minnesota (State or other jurisdiction of incorporation or organization) | 41-0216800 (I.R.S. Employer Identification No.) |
3680 Victoria St. N., Shoreview, Minnesota (Address of principal executive offices) | 55126-2966 (Zip Code) |
(651) 483-7111
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).
[X] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer [X] | Accelerated filer [ ] |
Non-accelerated filer [ ] (Do not check if a smaller reporting company) | Smaller reporting company [ ] |
| Emerging growth company [ ] |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
The number of shares outstanding of registrant’s common stock, par value $1.00 per share, as of OctoberJuly 18, 20172018 was 48,121,582.47,622,187.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
DELUXE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share par value)
(Unaudited)
| | | | September 30, 2017 | | December 31, 2016 | | June 30, 2018 | | December 31, 2017 |
ASSETS | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 53,410 |
| | $ | 76,574 |
| | $ | 68,594 |
| | $ | 59,240 |
|
Trade accounts receivable (net of allowances for uncollectible accounts of $2,808 and $2,828, respectively) | | 136,262 |
| | 152,649 |
| |
Trade accounts receivable, net of allowances for uncollectible accounts | | | 131,132 |
| | 149,844 |
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Inventories and supplies | | 40,929 |
| | 40,182 |
| | 43,233 |
| | 42,249 |
|
Funds held for customers | | 78,447 |
| | 87,823 |
| | 92,606 |
| | 86,192 |
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Other current assets | | 63,471 |
| | 41,002 |
| | 73,839 |
| | 55,441 |
|
Total current assets | | 372,519 |
| | 398,230 |
| | 409,404 |
| | 392,966 |
|
Deferred income taxes | | 2,839 |
| | 1,605 |
| | 1,778 |
| | 1,428 |
|
Long-term investments (including $1,729 and $1,877 of investments at fair value, respectively) | | 42,178 |
| | 42,240 |
| |
Property, plant and equipment (net of accumulated depreciation of $355,254 and $349,249, respectively) | | 83,253 |
| | 86,896 |
| |
Long-term investments | | | 43,172 |
| | 42,607 |
|
Property, plant and equipment (net of accumulated depreciation of $363,143 and $358,020, respectively) | | | 81,751 |
| | 84,638 |
|
Assets held for sale | | 8,689 |
| | 14,568 |
| | 3,822 |
| | 12,232 |
|
Intangibles (net of accumulated amortization of $481,667 and $435,756, respectively) | | 392,523 |
| | 409,781 |
| |
Intangibles (net of accumulated amortization of $497,117 and $444,933, respectively) | | | 386,143 |
| | 384,266 |
|
Goodwill | | 1,126,086 |
| | 1,105,956 |
| | 1,173,475 |
| | 1,130,934 |
|
Other non-current assets | | 151,893 |
| | 125,062 |
| | 193,699 |
| | 159,756 |
|
Total assets | | $ | 2,179,980 |
| | $ | 2,184,338 |
| | $ | 2,293,244 |
| | $ | 2,208,827 |
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| | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | |
| | |
| | |
| | |
|
Current liabilities: | | |
| | |
| | |
| | |
|
Accounts payable | | $ | 103,577 |
| | $ | 106,793 |
| | $ | 105,281 |
| | $ | 104,477 |
|
Accrued liabilities | | 255,542 |
| | 273,049 |
| | 245,719 |
| | 277,253 |
|
Long-term debt due within one year | | 41,966 |
| | 35,842 |
| | 765 |
| | 44,040 |
|
Total current liabilities | | 401,085 |
| | 415,684 |
| | 351,765 |
| | 425,770 |
|
Long-term debt | | 714,432 |
| | 722,806 |
| | 766,039 |
| | 665,260 |
|
Deferred income taxes | | 65,226 |
| | 85,172 |
| | 55,828 |
| | 50,543 |
|
Other non-current liabilities | | 48,692 |
| | 79,706 |
| | 44,476 |
| | 52,241 |
|
Commitments and contingencies (Notes 11 and 12) | |
|
| |
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| |
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| |
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Shareholders' equity: | | |
| | |
| | |
| | |
|
Common shares $1 par value (authorized: 500,000 shares; outstanding: September 30, 2017 – 48,120; December 31, 2016 – 48,546) | | 48,120 |
| | 48,546 |
| |
Common shares $1 par value (authorized: 500,000 shares; outstanding: June 30, 2018 – 47,623; December 31, 2017 – 47,953) | | | 47,623 |
| | 47,953 |
|
Retained earnings | | 947,261 |
| | 882,795 |
| | 1,076,683 |
| | 1,004,657 |
|
Accumulated other comprehensive loss | | (44,836 | ) | | (50,371 | ) | | (49,170 | ) | | (37,597 | ) |
Total shareholders’ equity | | 950,545 |
| | 880,970 |
| | 1,075,136 |
| | 1,015,013 |
|
Total liabilities and shareholders’ equity | | $ | 2,179,980 |
| | $ | 2,184,338 |
| | $ | 2,293,244 |
| | $ | 2,208,827 |
|
See Condensed Notes to Unaudited Consolidated Financial Statements
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except per share amounts)
(Unaudited)
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 | | 2018 | | 2017 |
Product revenue | | $ | 361,963 |
| | $ | 364,680 |
| | $ | 1,097,777 |
| | $ | 1,090,686 |
| | $ | 359,935 |
| | $ | 363,641 |
| | $ | 723,342 |
| | $ | 735,815 |
|
Service revenue | | 135,706 |
| | 94,240 |
| | 372,889 |
| | 278,174 |
| | 128,309 |
| | 121,591 |
| | 256,816 |
| | 237,183 |
|
Total revenue | | 497,669 |
| | 458,920 |
| | 1,470,666 |
| | 1,368,860 |
| | 488,244 |
| | 485,232 |
| | 980,158 |
| | 972,998 |
|
Cost of products | | (129,055 | ) | | (133,628 | ) | | (392,040 | ) | | (391,161 | ) | | (134,332 | ) | | (130,728 | ) | | (267,703 | ) | | (263,260 | ) |
Cost of services | | (63,862 | ) | | (32,642 | ) | | (159,250 | ) | | (99,246 | ) | | (55,869 | ) | | (48,640 | ) | | (111,256 | ) | | (95,422 | ) |
Total cost of revenue | | (192,917 | ) | | (166,270 | ) | | (551,290 | ) | | (490,407 | ) | | (190,201 | ) | | (179,368 | ) | | (378,959 | ) | | (358,682 | ) |
Gross profit | | 304,752 |
| | 292,650 |
| | 919,376 |
| | 878,453 |
| | 298,043 |
| | 305,864 |
| | 601,199 |
| | 614,316 |
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Selling, general and administrative expense | | (202,999 | ) | | (198,365 | ) | | (628,100 | ) | | (598,563 | ) | | (209,585 | ) | | (208,656 | ) | | (420,739 | ) | | (425,800 | ) |
Net restructuring charges | | (1,267 | ) | | (1,993 | ) | | (3,708 | ) | | (4,007 | ) | | (5,635 | ) | | (1,427 | ) | | (7,780 | ) | | (2,441 | ) |
Asset impairment charges | | (46,630 | ) | | — |
| | (54,880 | ) | | — |
| | — |
| | (2,954 | ) | | (2,149 | ) | | (8,250 | ) |
Operating income | | 53,856 |
|
| 92,292 |
| | 232,688 |
| | 275,883 |
| | 82,823 |
|
| 92,827 |
| | 170,531 |
| | 177,825 |
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Interest expense | | (5,708 | ) | | (4,855 | ) | | (15,795 | ) | | (15,281 | ) | | (6,130 | ) | | (5,258 | ) | | (11,708 | ) | | (10,087 | ) |
Other income | | 799 |
| | 742 |
| | 2,104 |
| | 1,335 |
| | 2,436 |
| | 1,250 |
| | 3,724 |
| | 2,312 |
|
Income before income taxes | | 48,947 |
| | 88,179 |
| | 218,997 |
| | 261,937 |
| | 79,129 |
| | 88,819 |
| | 162,547 |
| | 170,050 |
|
Income tax provision | | (20,146 | ) | | (29,516 | ) | | (73,551 | ) | | (86,783 | ) | | (18,922 | ) | | (29,240 | ) | | (39,003 | ) | | (53,405 | ) |
Net income | | $ | 28,801 |
| | $ | 58,663 |
| | $ | 145,446 |
| | $ | 175,154 |
| | $ | 60,207 |
| | $ | 59,579 |
| | $ | 123,544 |
| | $ | 116,645 |
|
Comprehensive income | | $ | 31,543 |
| | $ | 57,824 |
| | $ | 150,981 |
| | $ | 180,298 |
| | $ | 57,272 |
| | $ | 61,190 |
| | $ | 118,838 |
| | $ | 119,438 |
|
Basic earnings per share | | 0.60 |
| | 1.20 |
| | 3.00 |
| | 3.57 |
| | 1.26 |
| | 1.23 |
| | 2.58 |
| | 2.40 |
|
Diluted earnings per share | | 0.59 |
| | 1.19 |
| | 2.98 |
| | 3.55 |
| | 1.25 |
| | 1.22 |
| | 2.56 |
| | 2.38 |
|
Cash dividends per share | | 0.30 |
| | 0.30 |
| | 0.90 |
| | 0.90 |
| | 0.30 |
| | 0.30 |
| | 0.60 |
| | 0.60 |
|
See Condensed Notes to Unaudited Consolidated Financial Statements
DELUXE CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
(Unaudited)
| | | | Common shares | | Common shares par value | | Additional paid-in capital | | Retained earnings | | Accumulated other comprehensive loss | | Total | | Common shares | | Common shares par value | | Additional paid-in capital | | Retained earnings | | Accumulated other comprehensive loss | | Total |
Balance, December 31, 2016 | | 48,546 |
| | $ | 48,546 |
| | $ | — |
| | $ | 882,795 |
| | $ | (50,371 | ) | | $ | 880,970 |
| |
Balance, December 31, 2017 | | | 47,953 |
| | $ | 47,953 |
| | $ | — |
| | $ | 1,004,657 |
| | $ | (37,597 | ) | | $ | 1,015,013 |
|
Net income | | — |
| | — |
| | — |
| | 145,446 |
| | — |
| | 145,446 |
| | — |
| | — |
| | — |
| | 123,544 |
| | — |
| | 123,544 |
|
Cash dividends | | — |
| | — |
| | — |
| | (43,672 | ) | | — |
| | (43,672 | ) | | — |
| | — |
| | — |
| | (28,804 | ) | | — |
| | (28,804 | ) |
Common shares issued | | 435 |
| | 435 |
| | 12,906 |
| | — |
| | — |
| | 13,341 |
| | 490 |
| | 490 |
| | 16,677 |
| | — |
| | — |
| | 17,167 |
|
Common shares repurchased | | (709 | ) | | (709 | ) | | (12,053 | ) | | (37,308 | ) | | — |
| | (50,070 | ) | | (573 | ) | | (573 | ) | | (4,876 | ) | | (34,547 | ) | | — |
| | (39,996 | ) |
Other common shares retired | | (152 | ) | | (152 | ) | | (11,148 | ) | | — |
| | — |
| | (11,300 | ) | | (247 | ) | | (247 | ) | | (17,579 | ) | | — |
| | — |
| | (17,826 | ) |
Fair value of share-based compensation | | — |
| | — |
| | 10,295 |
| | — |
| | — |
| | 10,295 |
| |
Other comprehensive income | | — |
| | — |
| | — |
| | — |
| | 5,535 |
| | 5,535 |
| |
Balance, September 30, 2017 | | 48,120 |
| | $ | 48,120 |
| | $ | — |
| | $ | 947,261 |
| | $ | (44,836 | ) | | $ | 950,545 |
| |
Employee share-based compensation | | | — |
| | — |
| | 5,778 |
| | — |
| | — |
| | 5,778 |
|
Adoption of Accounting Standards Update No. 2014-09 (Note 2) | | | — |
| | — |
| | — |
| | 4,966 |
| | — |
| | 4,966 |
|
Adoption of Accounting Standards Update No. 2018-02 (Note 2) | | | — |
| | — |
| | — |
| | 6,867 |
| | (6,867 | ) | | — |
|
Other comprehensive loss | | | — |
| | — |
| | — |
| | — |
| | (4,706 | ) | | (4,706 | ) |
Balance, June 30, 2018 | | | 47,623 |
| | $ | 47,623 |
| | $ | — |
| | $ | 1,076,683 |
| | $ | (49,170 | ) | | $ | 1,075,136 |
|
See Condensed Notes to Unaudited Consolidated Financial Statements
DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
| | | | | Nine Months Ended September 30, | | | Six Months Ended June 30, |
| | | 2017 | | 2016 | | | 2018 | | 2017 |
Cash flows from operating activities: | Cash flows from operating activities: | | | | | Cash flows from operating activities: | | | | |
Net income | Net income | | $ | 145,446 |
| | $ | 175,154 |
| Net income | | $ | 123,544 |
| | $ | 116,645 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | Adjustments to reconcile net income to net cash provided by operating activities: | | |
| | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | |
| | |
|
Depreciation | Depreciation | | 12,013 |
| | 11,347 |
| Depreciation | | 7,823 |
| | 8,223 |
|
Amortization of intangibles | Amortization of intangibles | | 79,284 |
| | 56,364 |
| Amortization of intangibles | | 55,694 |
| | 51,828 |
|
Asset impairment charges | Asset impairment charges | | 54,880 |
| | — |
| Asset impairment charges | | 2,149 |
| | 8,250 |
|
Amortization of contract acquisition costs | | 14,685 |
| | 14,700 |
| |
Amortization of prepaid product discounts | | Amortization of prepaid product discounts | | 11,124 |
| | 9,588 |
|
Deferred income taxes | Deferred income taxes | | (20,587 | ) | | (1,477 | ) | Deferred income taxes | | (2,747 | ) | | (6,942 | ) |
Employee share-based compensation expense | Employee share-based compensation expense | | 11,149 |
| | 9,264 |
| Employee share-based compensation expense | | 5,757 |
| | 7,309 |
|
Other non-cash items, net | Other non-cash items, net | | (2,492 | ) | | 3,128 |
| Other non-cash items, net | | (7,543 | ) | | (2,983 | ) |
Changes in assets and liabilities, net of effect of acquisitions: | Changes in assets and liabilities, net of effect of acquisitions: | | |
| | |
| Changes in assets and liabilities, net of effect of acquisitions: | | |
| | |
|
Trade accounts receivable | Trade accounts receivable | | 19,140 |
| | 5,320 |
| Trade accounts receivable | | 16,670 |
| | 15,401 |
|
Inventories and supplies | Inventories and supplies | | 800 |
| | 176 |
| Inventories and supplies | | (1,245 | ) | | 637 |
|
Other current assets | Other current assets | | (16,692 | ) | | (2,379 | ) | Other current assets | | (12,435 | ) | | (2,779 | ) |
Non-current assets | Non-current assets | | (3,748 | ) | | (3,351 | ) | Non-current assets | | (3,400 | ) | | (1,776 | ) |
Accounts payable | Accounts payable | | (6,750 | ) | | (1,619 | ) | Accounts payable | | 2,858 |
| | (12,063 | ) |
Contract acquisition payments | | (20,003 | ) | | (17,190 | ) | |
Prepaid product discount payments | | Prepaid product discount payments | | (13,282 | ) | | (10,937 | ) |
Other accrued and non-current liabilities | Other accrued and non-current liabilities | | (41,229 | ) | | (41,316 | ) | Other accrued and non-current liabilities | | (38,031 | ) | | (28,823 | ) |
Net cash provided by operating activities | Net cash provided by operating activities | | 225,896 |
| | 208,121 |
| Net cash provided by operating activities | | 146,936 |
| | 151,578 |
|
Cash flows from investing activities: | Cash flows from investing activities: | | |
| | |
| Cash flows from investing activities: | | |
| | |
|
Purchases of capital assets | Purchases of capital assets | | (34,351 | ) | | (32,215 | ) | Purchases of capital assets | | (28,040 | ) | | (22,788 | ) |
Payments for acquisitions, net of cash acquired | Payments for acquisitions, net of cash acquired | | (125,417 | ) | | (64,637 | ) | Payments for acquisitions, net of cash acquired | | (90,205 | ) | | (77,553 | ) |
Proceeds from sales of marketable securities | Proceeds from sales of marketable securities | | 3,500 |
| | 1,635 |
| Proceeds from sales of marketable securities | | — |
| | 3,500 |
|
Proceeds from company-owned life insurance policies | | 1,293 |
| | 4,123 |
| |
Other | Other | | 873 |
| | 695 |
| Other | | 682 |
| | 739 |
|
Net cash used by investing activities | Net cash used by investing activities | | (154,102 | ) | | (90,399 | ) | Net cash used by investing activities | | (117,563 | ) | | (96,102 | ) |
Cash flows from financing activities: | Cash flows from financing activities: | | |
| | |
| Cash flows from financing activities: | | |
| | |
|
Proceeds from issuing long-term debt | Proceeds from issuing long-term debt | | 333,000 |
| | 169,000 |
| Proceeds from issuing long-term debt | | 908,000 |
| | 168,000 |
|
Payments on long-term debt | Payments on long-term debt | | (336,590 | ) | | (185,873 | ) | Payments on long-term debt | | (851,410 | ) | | (207,052 | ) |
Proceeds from issuing shares under employee plans | Proceeds from issuing shares under employee plans | | 8,218 |
| | 6,861 |
| Proceeds from issuing shares under employee plans | | 5,767 |
| | 5,914 |
|
Employee taxes paid for shares withheld | Employee taxes paid for shares withheld | | (6,816 | ) | | (2,333 | ) | Employee taxes paid for shares withheld | | (7,947 | ) | | (5,572 | ) |
Payments for common shares repurchased | Payments for common shares repurchased | | (50,070 | ) | | (44,944 | ) | Payments for common shares repurchased | | (39,996 | ) | | (30,068 | ) |
Cash dividends paid to shareholders | Cash dividends paid to shareholders | | (43,672 | ) | | (44,127 | ) | Cash dividends paid to shareholders | | (28,762 | ) | | (29,156 | ) |
Other | Other | | (1,281 | ) | | (1,634 | ) | Other | | (3,921 | ) | | (511 | ) |
Net cash used by financing activities | Net cash used by financing activities | | (97,211 | ) | | (103,050 | ) | Net cash used by financing activities | | (18,269 | ) | | (98,445 | ) |
Effect of exchange rate change on cash | Effect of exchange rate change on cash | | 2,253 |
| | 2,966 |
| Effect of exchange rate change on cash | | (1,750 | ) | | 1,175 |
|
Net change in cash and cash equivalents | Net change in cash and cash equivalents | | (23,164 | ) | | 17,638 |
| Net change in cash and cash equivalents | | 9,354 |
| | (41,794 | ) |
Cash and cash equivalents, beginning of year | Cash and cash equivalents, beginning of year | | 76,574 |
| | 62,427 |
| Cash and cash equivalents, beginning of year | | 59,240 |
| | 76,574 |
|
Cash and cash equivalents, end of period | Cash and cash equivalents, end of period | | $ | 53,410 |
| | $ | 80,065 |
| Cash and cash equivalents, end of period | | $ | 68,594 |
| | $ | 34,780 |
|
See Condensed Notes to Unaudited Consolidated Financial Statements
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Note 1: Consolidated financial statements
The consolidated balance sheet as of SeptemberJune 30, 20172018, the consolidated statements of comprehensive income for the quarters and ninesix months ended SeptemberJune 30, 20172018 and 20162017, the consolidated statement of shareholders’ equity for the ninesix months ended SeptemberJune 30, 20172018, and the consolidated statements of cash flows for the ninesix months ended SeptemberJune 30, 20172018 and 20162017 are unaudited. The consolidated balance sheet as of December 31, 20162017 was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles (GAAP) in the United States of America. In the opinion of management, all adjustments necessary for a fair statement of the consolidated financial statements are included. Adjustments consist only of normal recurring items, except for any discussed in the notes below. Interim results are not necessarily indicative of results for a full year. The consolidated financial statements and notes are presented in accordance with instructions for Form 10-Q and do not contain certain information included in our annual consolidated financial statements and notes. The consolidated financial statements and notes appearing in this report should be read in conjunction with the consolidated audited financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 20162017 (the “2016“2017 Form 10-K”).
Amounts within the cash flows from investing activities section of the consolidated statement of cash flows for the nine months ended September 30, 2016 have been modified to conform to the current year presentation. This change presents proceeds from sales of marketable securities separately. In the previous year, this item was included within the other caption.
Note 2: New accounting pronouncements
RecentlyThe following discusses the impact of each accounting standards update (ASU) adopted accounting pronouncementson January 1, 2018:
ASU No. 2014-09 – In January 2017,May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-04, Simplifying the Test for Goodwill Impairment. The standard removes Step 2 of the goodwill impairment test, which requires a company to perform procedures to determine the fair value of a reporting unit's assets and liabilities following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, a goodwill impairment charge will now be measured as the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. We elected to early adopt this standard on January 1, 2017 and applied this guidance when calculating the goodwill impairment charge discussed in Note 7: Fair value measurements.
Accounting pronouncements not yet adopted – In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The standard provides revenue recognition guidance for any entity that enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets, unless those contracts are within the scope of other accounting standards. In addition, the FASB subsequently issued several amendments to the standard. We adopted the standard and all the related amendments on January 1, 2018 using the modified retrospective method. We applied the new guidance to uncompleted contracts as of January 1, 2018 and recorded the cumulative effect of initially applying the standard as an adjustment to retained earnings, with the offset to other current assets, other non-current assets and deferred income tax liabilities. We have elected the practical expedient for contract modifications, allowing us to consider the impact of all contract modifications completed prior to January 1, 2018. We have also elected the practical expedient that allows us to disregard the effects of a financing component if the period between payment and performance will be 1 year or less. Election of these practical expedients did not have a significant impact on our results of operations or financial position. Prior periods have not been restated and continue to be reported under the accounting standards in effect for those periods. We do not expect the adoption of this guidance to have a material impact on our results of operations, financial position or cash flows on an ongoing basis. The standardnew guidance also expands the required financial statement disclosures regarding revenue recognition. Those disclosures appear below, while information regarding the disaggregation of revenue can be found in Note 14.
Our product revenue is recognized when control of the goods is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods. In most cases, control is transferred when products are shipped. We recognize the vast majority of our service revenue as the services are provided. Many of our check supply contracts with financial institutions provide for rebates on certain products. We record these rebates as reductions of revenue and as accrued liabilities on our consolidated balance sheets when the related revenue is recognized. Many of our financial institution contracts also require prepaid product discounts in the form of upfront cash payments we make to our financial institution clients. These prepaid product discounts are included in other non-current assets in our consolidated balance sheets and are amortized as reductions of revenue, generally on the straight-line basis, over the contract term. Sales tax collected concurrent with revenue-producing activities is excluded from revenue. Amounts billed to customers for shipping and handling are included in revenue, while the related shipping and handling costs are reflected in cost of products. We have elected the practical expedient that allows us to account for shipping and handling activities that occur after the customer has obtained control of a good as a fulfillment cost, and we accrue costs of shipping and handling when the related revenue is recognized. As part of our Financial Services rewards, incentive and loyalty programs, we receive payments from consumers or our clients for the products and services provided, including hotel stays, gift cards and merchandise, such as apparel, electronics and clothing. This revenue is recorded net of the related fulfillment costs.
Certain of our contracts for data-driven marketing solutions and treasury management outsourcing services within Financial Services have variable consideration that is contingent on either the success of the marketing campaign ("pay-for-performance") or the volume of outsourcing services provided. We recognize revenue for estimated variable consideration as
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
services are provided based on the most likely amount to be realized. Revenue is recognized to the extent that it is probable that a significant reversal of revenue will not occur when the contingency is resolved. Estimates regarding the recognition of variable consideration are updated each quarter. Typically, the amount of consideration for these contracts is finalized within 3 months, although pricing under certain of our outsourcing contracts may be based on annual volume commitments. Revenue recognized from these contracts was approximately $100,000 in 2017. Under the new standard, we have accelerated the recognition of a portion of this variable consideration.
Certain of our contracts for treasury management solutions result from the sale of bundled arrangements that may include hardware, software and professional services, as well as customization and modification of software, and specify the timing of customer billings over the course of the contract. Revenue for these contracts is recognized using a cost-based input method that depicts the transfer of services to the customer. The transaction price is allocated to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. When the revenue recognized for uncompleted contracts exceeds the amount of customer billings, a contract asset is reflected in our consolidated balance sheets within other current assets. The amount included in other current assets was $31,955 as of June 30, 2018 and $16,379 as of December 31, 2017. When the amount of customer billings for uncompleted contracts exceeds the revenue recognized, a contract liability is reflected in our consolidated balance sheets within accrued liabilities. The amount included in accrued liabilities was $1,509 as of June 30, 2018 and $2,233 as of December 31, 2017.
At times, a financial institution client may terminate its check supply contract with us prior to the end of the contract term. In many cases, the financial institution is contractually required to remit a contract termination payment. Such payments are recorded as revenue when the termination agreement is executed, provided that we have no further performance obligations and collection of the funds is assured. If we have further performance obligations following the execution of a contract termination agreement, we record the related revenue over the remaining service period.
Our payment terms vary by type of customer and the products or services offered. The time period between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. When a customer pays in advance for services, primarily for treasury management solutions and web hosting services, we defer the revenue and recognize it as the services are performed, generally over a period of less than 1 year. Deferred revenue is included in accrued liabilities and other non-current liabilities in our consolidated balance sheets. The decrease of $4,308 in deferred revenue for the six months ended June 30, 2018 was primarily driven by the recognition of $32,221 of revenue that was included in deferred revenue as of December 31, 2017, partially offset by cash payments received in advance of satisfying our performance obligations. In addition to the amounts included in March 2016, the FASB issued ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net),deferred revenue, we will recognize revenue in April 2016, the FASB issued ASU No. 2016-10, Identifying Performance Obligationsfuture periods related to remaining performance obligations for certain of our data-driven marketing and Licensing,treasury management solutions. Generally, these contracts have terms of 1 year or less and in May 2016, the FASB issued ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients. These standards are intendedmany have terms of 3 months or less. The amount of revenue related to clarify aspects of ASU No. 2014-09 and are effective for us upon adoption of ASU No. 2014-09. these unsatisfied performance obligations is not significant to our annual consolidated revenue.
The new guidance is effective for us on January 1, 2018. We are currently in the process of analyzing each of our revenue streams in accordancerequires that certain costs incurred to obtain contracts be recognized as assets and amortized consistent with the new guidance. We have completedtransfer of goods or services to the evaluation of our checks, formscustomer. As such, we are now deferring sales commissions related to obtaining check supply and accessories revenue streamstreasury management solution contracts within Financial Services. These amounts are included in other non-current assets and we do not expect the applicationare amortized as selling, general and administrative (SG&A) expense. Amortization of these standards to those revenue streams to have a material impactamounts on our results of operations or financial position. We continue to make progress in the evaluation of our various marketing solutions and other services revenue streams. We currently anticipate that we will adoptstraight-line basis approximates the standards using the modified retrospective method. This method requires the standard to be applied to existing and future contracts astiming of the effective date, with an adjustmenttransfer of goods or services to opening retained earningsthe customer. Generally, these amounts are being amortized over periods of 3 to 6 years. We elected the practical expedient allowing us to expense sales commissions as incurred when the amortization period would have been 1 year or less.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in the year of adoption for thethousands, except per share amounts)
The cumulative effect of the change. In addition, we will disclosechanges made to our unaudited consolidated balance sheet as of January 1, 2018 for the amount by which each financial statement line item is affected in the current reporting period by the applicationadoption of the new revenue guidance was as compared withfollows:
|
| | | | | | | | | | | | |
(in thousands) | | Balance as of December 31, 2017 | | Adjustments due to ASU No. 2014-09 | | Balance as of January 1, 2018 |
Other current assets | | $ | 55,441 |
| | $ | 960 |
| | $ | 56,401 |
|
Total current assets | | 392,966 |
| | 960 |
| | 393,926 |
|
Other non-current assets | | 159,756 |
| | 5,733 |
| | 165,489 |
|
Total assets | | $ | 2,208,827 |
| | $ | 6,693 |
| | $ | 2,215,520 |
|
| | | | | | |
Deferred income taxes | | $ | 50,543 |
| | $ | 1,727 |
| | $ | 52,270 |
|
Retained earnings | | 1,004,657 |
| | 4,966 |
| | 1,009,623 |
|
Total liabilities and shareholders' equity | | $ | 2,208,827 |
| | $ | 6,693 |
| | $ | 2,215,520 |
|
The impact of adoption of the new revenue guidance thaton our unaudited consolidated statements of comprehensive income for the quarter and six months ended June 30, 2018 and on our unaudited consolidated balance sheet as of June 30, 2018 was in effect before the change.as follows:
|
| | | | | | | | | | | | |
(in thousands) | | As reported | | Effect of adoption | | Balance without adoption of ASU No. 2014-09 |
| | Quarter Ended June 30, 2018 |
Service revenue | | $ | 128,309 |
| | $ | (33 | ) | | $ | 128,276 |
|
Total revenue | | 488,244 |
| | (33 | ) | | 488,211 |
|
Cost of services | | (55,869 | ) | | 129 |
| | (55,740 | ) |
Total cost of revenue | | (190,201 | ) | | 129 |
| | (190,072 | ) |
Gross profit | | 298,043 |
| | 96 |
| | 298,139 |
|
Selling, general and administrative expense | | (209,585 | ) | | (1,567 | ) | | (211,152 | ) |
Operating income | | 82,823 |
| | (1,471 | ) | | 81,352 |
|
Income before income taxes | | 79,129 |
| | (1,471 | ) | | 77,658 |
|
Income tax provision | | (18,922 | ) | | 380 |
| | (18,542 | ) |
Net income | | $ | 60,207 |
| | $ | (1,091 | ) | | $ | 59,116 |
|
| | | | | | |
| | Six Months Ended June 30, 2018 |
Service revenue | | $ | 256,816 |
| | $ | (568 | ) | | $ | 256,248 |
|
Total revenue | | 980,158 |
| | (568 | ) | | 979,590 |
|
Cost of services | | (111,256 | ) | | 384 |
| | (110,872 | ) |
Total cost of revenue | | (378,959 | ) | | 384 |
| | (378,575 | ) |
Gross profit | | 601,199 |
| | (184 | ) | | 601,015 |
|
Selling, general and administrative expense | | (420,739 | ) | | (1,051 | ) | | (421,790 | ) |
Operating income | | 170,531 |
| | (1,235 | ) | | 169,296 |
|
Income before income taxes | | 162,547 |
| | (1,235 | ) | | 161,312 |
|
Income tax provision | | (39,003 | ) | | 319 |
| | (38,684 | ) |
Net income | | $ | 123,544 |
| | $ | (916 | ) | | $ | 122,628 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
|
| | | | | | | | | | | | |
(in thousands) | | As reported | | Effect of adoption | | Balance without adoption of ASU No. 2014-09 |
| | June 30, 2018 |
Other current assets | | $ | 73,839 |
| | $ | (1,146 | ) | | $ | 72,693 |
|
Total current assets | | 409,404 |
| | (1,146 | ) | | 408,258 |
|
Other non-current assets | | 193,699 |
| | (6,783 | ) | | 186,916 |
|
Total assets | | $ | 2,293,244 |
| | $ | (7,929 | ) | | $ | 2,285,315 |
|
Accrued liabilities | | 245,719 |
| | (319 | ) | | 245,400 |
|
Total current liabilities | | 351,765 |
| | (319 | ) | | 351,446 |
|
Deferred income taxes | | 55,828 |
| | (1,727 | ) | | 54,101 |
|
Retained earnings | | 1,076,683 |
| | (5,883 | ) | | 1,070,800 |
|
Total liabilities and shareholders' equity | | $ | 2,293,244 |
| | $ | (7,929 | ) | | $ | 2,285,315 |
|
ASU No. 2016-01 – In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The standard is intended to improve the recognition, measurement, presentation and disclosure of financial instruments. The guidance is effective for usWe adopted this standard on January 1, 2018. We do not expect the application of thisThis standard to have a significanthad no impact on our results of operations or financial position. Our financial statement disclosures in Note 7 related to financial instruments have been modified to comply with the new standard.
In February 2016, the FASB issued ASU No. 2016-02, 2016-16Leasing. The standard is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities for virtually all leases and by
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
requiring the disclosure of key information about leasing arrangements. The guidance is effective for us on January 1, 2019 and requires adoption using a modified retrospective approach. We are currently assessing the impact of this standard on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. The standard introduces new guidance for the accounting for credit losses on instruments within its scope, including trade and loans receivable and available-for-sale debt securities. The guidance is effective for us on January 1, 2020 and requires adoption using a modified retrospective approach. We do not expect the application of this standard to have a significant impact on our results of operations or financial position.
– In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory. The standard requires recognition of the tax effects resulting from the intercompany sale of an asset when the transfer occurs. Previously, the tax effects were deferred until the transferred asset was sold to a third party. The guidance is effective for usWe adopted this standard on January 1, 20182018. No adjustment was required to opening retained earnings, and requires adoption using a modified retrospective approach. Wewe do not expect the application of this standard to have a significant impact on our results of operations or financial position.position going forward.
ASU No. 2017-01 –In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business. The standard revises the
definition of a business, which affects many areas of accounting such as business combinations and disposals and goodwill impairment. The revised definition of a business will likely result in more acquisitions being accounted for as asset acquisitions, as opposed to business combinations. The guidance is effective for usWe adopted this standard on January 1, 2018, and is required to be applied prospectivelyapplying the guidance to transactions occurring on or after the effectivethis date.
ASU No. 2017-07 – In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The standard requires that the service cost component of net periodic benefit expense be recognized in the same statement of comprehensive income caption(s) as other compensation costs, and requires that the other components of net periodic benefit expense be recognized in the non-operating section of the statement of comprehensive income. In addition, only the service cost component of net periodic benefit expense is eligible for capitalization when applicable. The guidance is effective for usWe adopted this standard on January 1, 2018. The reclassification of the other components of our net periodic benefit expense will beincome was applied on a retrospective basis. As such, we will usehave revised our results of operations for previous periods. We utilized the practical expedient for adoption outlinedallowing us to use the amount previously disclosed in our postretirement benefits footnote as the standard, annualbasis for revising prior periods. As there is no service cost associated with our plans, we reclassified the entire amount of our net periodic benefit income of $2,016 for 2017, $1,841 for 2016 and $2,697 for 2015 will be reclassified from total cost of revenue and selling, general and administrative (SG&A)SG&A expense to other income in our consolidated statements of comprehensive income. This represents the entire amountIn addition, we no longer include any portion of our net periodic benefit income in amounts capitalized for inventory or internal-use software, as there is no service cost associated with our plans. The guidance allowing only the service cost component of net periodic benefit expense to be capitalized will be adopted on a prospective basis, and we dois eligible for capitalization. This change did not expect this change to have a significant impact on our results of operations or financial position.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
The impact of the revision on our unaudited consolidated statements of comprehensive income for the quarter and six months ended June 30, 2017 was as follows:
|
| | | | | | | | | | | | |
(in thousands) | | As previously reported | | Effect of adoption | | As revised |
| | Quarter Ended June 30, 2017 |
Cost of products | | $ | (130,591 | ) | | $ | (137 | ) | | $ | (130,728 | ) |
Cost of services | | (48,623 | ) | | (17 | ) | | (48,640 | ) |
Total cost of revenue | | (179,214 | ) | | (154 | ) | | (179,368 | ) |
Selling, general and administrative expense | | (208,306 | ) | | (350 | ) | | (208,656 | ) |
Operating income | | 93,331 |
| | (504 | ) | | 92,827 |
|
Other income | | 746 |
| | 504 |
| | 1,250 |
|
Net income | | $ | 59,579 |
| | $ | — |
| | $ | 59,579 |
|
| | | | | | |
| | Six Months Ended June 30, 2017 |
Cost of products | | $ | (262,986 | ) | | $ | (274 | ) | | $ | (263,260 | ) |
Cost of services | | (95,388 | ) | | (34 | ) | | (95,422 | ) |
Total cost of revenue | | (358,374 | ) | | (308 | ) | | (358,682 | ) |
Selling, general and administrative expense | | (425,100 | ) | | (700 | ) | | (425,800 | ) |
Operating income | | 178,833 |
| | (1,008 | ) | | 177,825 |
|
Other income | | 1,304 |
| | 1,008 |
| | 2,312 |
|
Net income | | $ | 116,645 |
| | $ | — |
| | $ | 116,645 |
|
ASU No. 2017-09 – In May 2017, the FASB issued ASU No. 2017-09, Scope of Modification Accounting. The standard provides guidance about which changes to the terms or conditions of a share-based payment award require modification accounting, which may result in a different fair value for the award. The guidance is effective for usWe adopted this standard on January 1, 2018, and it is required to bebeing applied prospectively to awards modified on or after the effectivethis date. Historically, modifications to our share-based payment awards have been rare.infrequent. As such, we do not expect the application of this standard to have a significant impact on our results of operations or financial position.
ASU No. 2018-02 – In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The standard allows companies to make an election to reclassify from accumulated other comprehensive income to retained earnings the stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the "2017 Act"). We elected to early adopt this standard on January 1, 2018, applying it in the period of adoption. As such, a reclassification from accumulated other comprehensive loss to retained earnings of $6,867 was recorded during the quarter ended March 31, 2018. This represents the effect of the change in the United States federal corporate income tax rate on the gross deferred tax amount at the date of enactment of the 2017 Act related to items remaining in accumulated other comprehensive loss. Our policy is to release stranded income tax effects from accumulated other comprehensive loss when the circumstances upon which they are premised cease to exist.
In March 2018, the FASB issued ASU No. 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 118. The standard added to the FASB Codification the guidance provided by the SEC in December 2017 regarding the accounting for the 2017 Act. We complied with SAB No. 118 when preparing our annual consolidated financial statements for the year ended December 31, 2017. Reasonable estimates were used in determining several of the components of the impact of the 2017 Act, including our 2017 deferred income tax activity and the amount of post-1986 foreign deferred earnings subject to the repatriation toll charge. We are still analyzing certain aspects of the 2017 Act and refining our calculations, which could potentially affect the measurement of our deferred tax balances and the amount of the repatriation toll charge liability, and ultimately cause us to revise our initial estimates in future periods. In addition, changes in interpretations, assumptions and guidance regarding the 2017 Act, as well as the potential for technical corrections, could have a material impact on our effective tax rate in future periods. During the quarter ended June 30, 2018, we recorded an increase in income tax expense of $441 as we refined our accounting for the 2017 Act, and during the six months ended June 30, 2018, we recorded an increase in income tax expense of $131.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
In order to complete our accounting for the 2017 Act, which we expect to finalize by the fourth quarter of 2018, the following specific items need to be completed or addressed:
issuance of state-by-state guidance regarding conformity with or decoupling from the 2017 Act;
finalize the calculation of post-1986 foreign deferred earnings, which are subject to the repatriation toll charge, and determine our ability to beneficially claim a foreign tax credit resulting from the income inclusion; and
where pertinent, adjust to clarifications and guidance regarding other aspects of the 2017 Act, including those related to the deductibility of executive compensation.
Accounting pronouncements not yet adopted – In February 2016, the FASB issued ASU No. 2016-02, Leasing. The standard is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities for virtually all leases and by requiring the disclosure of key information about leasing arrangements. In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which amends narrow aspects of the guidance in ASU No. 2016-02. Both standards are effective for us on January 1, 2019 and require adoption using a modified retrospective approach. We have established an implementation team to evaluate and identify the impact of the standard on our financial position, results of operations and cash flows. We are currently assessing our leasing arrangements, evaluating the impact of practical expedients and accounting policy elections, and implementing software to meet the reporting requirements of the standard. We are not able to quantify the impact of the standard at this time.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. The standard introduces new guidance for the accounting for credit losses on instruments within its scope, including trade and loans receivable and available-for-sale debt securities. The guidance is effective for us on January 1, 2020 and requires adoption using a modified retrospective approach. We do not expect the application of this standard to have a significant impact on our results of operations or financial position.
Note 3: Supplemental balance sheet information
Allowance for uncollectible accounts – Changes in the allowance for uncollectible accounts for the six months ended June 30, 2018 and 2017 was as follows:
|
| | | | | | | | |
| | Six Months Ended June 30, |
(in thousands) | | 2018 | | 2017 |
Balance, beginning of year | | $ | 2,884 |
| | $ | 2,828 |
|
Bad debt expense | | 1,470 |
| | 1,635 |
|
Write-offs, net of recoveries | | (1,383 | ) | | (1,346 | ) |
Balance, end of period | | $ | 2,971 |
| | $ | 3,117 |
|
Inventories and supplies – Inventories and supplies were comprised of the following:
| | (in thousands) | | September 30, 2017 | | December 31, 2016 | | June 30, 2018 | | December 31, 2017 |
Raw materials | | $ | 7,702 |
| | $ | 5,861 |
| | $ | 7,131 |
| | $ | 7,357 |
|
Semi-finished goods | | 8,322 |
| | 7,990 |
| | 7,787 |
| | 7,635 |
|
Finished goods | | 21,716 |
| | 23,235 |
| | 25,348 |
| | 24,146 |
|
Supplies | | 3,189 |
| | 3,096 |
| | 2,967 |
| | 3,111 |
|
Inventories and supplies | | $ | 40,929 |
| | $ | 40,182 |
| | $ | 43,233 |
| | $ | 42,249 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Available-for-sale debt securities – Available-for-sale debt securities included within funds held for customers were comprised of the following:
| | | | September 30, 2017 | | June 30, 2018 |
(in thousands) | | Cost | | Gross unrealized gains | | Gross unrealized losses | | Fair value | | Cost | | Gross unrealized gains | | Gross unrealized losses | | Fair value |
Funds held for customers:(1) | | | | | | | | | | | | | | | | |
Domestic money market fund | | $ | 10,000 |
| | $ | — |
| | $ | — |
| | $ | 10,000 |
| | $ | 10,000 |
| | $ | — |
| | $ | — |
| | $ | 10,000 |
|
Canadian and provincial government securities | | 9,091 |
| | — |
| | (424 | ) | | 8,667 |
| | 8,747 |
| | — |
| | (464 | ) | | 8,283 |
|
Canadian guaranteed investment certificates | | 8,018 |
| | — |
| | — |
| | 8,018 |
| | 7,614 |
| | — |
| | — |
| | 7,614 |
|
Available-for-sale securities | | $ | 27,109 |
| | $ | — |
| | $ | (424 | ) | | $ | 26,685 |
| |
Available-for-sale debt securities | | | $ | 26,361 |
| | $ | — |
| | $ | (464 | ) | | $ | 25,897 |
|
(1) Funds held for customers, as reported on the consolidated balance sheet as of SeptemberJune 30, 20172018, also included cash of $51,762.$66,709.
| | | | December 31, 2016 | | December 31, 2017 |
(in thousands) | | Cost | | Gross unrealized gains | | Gross unrealized losses | | Fair value | | Cost | | Gross unrealized gains | | Gross unrealized losses | | Fair value |
Funds held for customers:(1) | | | | | | | | | | | | | | | | |
Domestic money market fund | | $ | 6,002 |
| | $ | — |
| | $ | — |
| | $ | 6,002 |
| | $ | 17,300 |
| | $ | — |
| | $ | — |
| | $ | 17,300 |
|
Canadian and provincial government securities | | 8,320 |
| | — |
| | (228 | ) | | 8,092 |
| | 9,051 |
| | — |
| | (393 | ) | | 8,658 |
|
Canadian guaranteed investment certificates | | 7,440 |
| | — |
| | — |
| | 7,440 |
| | 7,955 |
| | — |
| | — |
| | 7,955 |
|
Available-for-sale securities | | $ | 21,762 |
| | $ | — |
| | $ | (228 | ) | | $ | 21,534 |
| |
Available-for-sale debt securities | | | $ | 34,306 |
| | $ | — |
| | $ | (393 | ) | | $ | 33,913 |
|
(1) Funds held for customers, as reported on the consolidated balance sheet as of December 31, 20162017, also included cash of $66,28952,279.
Expected maturities of available-for-sale debt securities as of SeptemberJune 30, 20172018 were as follows:
| | (in thousands) | | Fair value | | Fair value |
Due in one year or less | | $ | 18,564 |
| | $ | 20,588 |
|
Due in two to five years | | 4,255 |
| | 3,578 |
|
Due in six to ten years | | 3,866 |
| | 1,731 |
|
Available-for-sale securities | | $ | 26,685 |
| |
Available-for-sale debt securities | | | $ | 25,897 |
|
Further information regarding the fair value of available-for-sale debt securities can be found in Note 7.
Assets held for sale – Assets held for sale as of SeptemberJune 30, 20172018 included 2 providersa provider of printingprinted and promotional products, that were classified as held for sale during the third quarter of 2017.a small business distributor and a small business customer list. Assets held for sale as of December 31, 20162017 included the operations2 providers of a small business distributor thatprinted and promotional products, 1 of which was sold during the second quarter of 20172018, and a provider2 small business distributors, 1 of printed and promotional products thatwhich was sold during the first quarter of 2017.2018. Also during the ninesix months ended SeptemberJune 30, 2017,2018, we sold the operations of an additionalcertain small business distributorcustomer lists that previously did not meet the requirements to be reported as assets held for sale in the consolidated balance sheets, as well as a small business distributor and assets associated with certain custom printing activities that were classified as held for sale during the second quarter of 2017.sheets. We determined that these businessesthe assets sold would be better positioned for long-term growth if they were managed independently.by independent distributors. Subsequent to the sales, thesethe businesses and customer lists are owned by independent distributors that are part of our Safeguard®Safeguard® distributor network. As such, our revenue is not impacted by these sales, and the impact to our costs is not significant. We entered into aggregate notes receivable of $24,497$22,715 in conjunction with these sales (non-cash investing activity), and we recognized aggregate net gains within SG&A expense of $1,924 for$3,862 during the quarter ended SeptemberJune 30, 20172018 and $8,703 for$11,089 during the ninesix months ended SeptemberJune 30, 2017. The gains are included in2018. During the quarter ended March 31, 2017, we sold a provider of printed and promotional products and a small business distributor, realizing an aggregate net gain of $6,779 within SG&A expense in the consolidated statementsstatement of comprehensive income.income for the six months ended June 30, 2017.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
During the first quarter of 2017, we recorded a pre-tax asset impairment charge of $5,296 related to a small business distributor that was sold during the second quarter of 2017. This impairment charge reduced the carrying value of the business to its estimated fair value less costs to sell, as we negotiated the sale of the business. During the second quarter of 2017, we recorded an additional pre-tax asset impairment charge of $2,954 as we finalized the sale of this business, resulting in a total pre-tax asset impairment charge of $8,250 for the six months ended June 30, 2017.
The businesses sold during 2017,2018, as well as those held for sale as of SeptemberJune 30, 2017,2018, were included in our Small Business Services segment, and their net assets consisted primarily of intangible assets. During the first six months of 2017, we recorded aggregate pre-tax asset impairment charges of $8,250 related to the small business distributor sold during the second quarter of 2017. The impairment charges reduced the carrying value of the business to its fair value less costs to sell, as we finalized the sale of the business.
We are actively marketing the remaining assets held for sale, and we expect the selling prices will equal or exceed their current carrying values. Net assets held for sale consisted of the following:
|
| | | | | | | | | | |
(in thousands) | | September 30, 2017 | | December 31, 2016 | | Balance sheet caption |
Current assets | | $ | 4 |
| | $ | 3 |
| | Other current assets |
Intangibles | | 6,401 |
| | 14,135 |
| | Assets held for sale |
Goodwill | | 2,081 |
| | — |
| | Assets held for sale |
Other non-current assets | | 207 |
| | 433 |
| | Assets held for sale |
Accrued liabilities | | (621 | ) | | (146 | ) | | Accrued liabilities |
Deferred income tax liabilities | | — |
| | (5,697 | ) | | Other non-current liabilities |
Net assets held for sale | | $ | 8,072 |
| | $ | 8,728 |
| | |
|
| | | | | | | | | | |
(in thousands) | | June 30, 2018 | | December 31, 2017 | | Balance sheet caption |
Current assets | | $ | — |
| | $ | 4 |
| | Other current assets |
Intangibles | | 3,390 |
| | 8,459 |
| | Assets held for sale |
Goodwill | | 416 |
| | 3,566 |
| | Assets held for sale |
Other non-current assets | | 16 |
| | 207 |
| | Assets held for sale |
Net assets held for sale | | $ | 3,822 |
| | $ | 12,236 |
| | |
Intangibles – Intangibles were comprised of the following:
| | | | September 30, 2017 | | December 31, 2016 | | June 30, 2018 | | December 31, 2017 |
(in thousands) | | Gross carrying amount | | Accumulated amortization | | Net carrying amount | | Gross carrying amount | | Accumulated amortization | | Net carrying amount | | Gross carrying amount | | Accumulated amortization | | Net carrying amount | | Gross carrying amount | | Accumulated amortization | | Net carrying amount |
Indefinite-lived intangibles: | | | | | | | | | | | | | | | | | | | | | | | | |
Trade name | | $ | 19,100 |
| | $ | — |
| | $ | 19,100 |
| | $ | 19,100 |
| | $ | — |
| | $ | 19,100 |
| | $ | 19,100 |
| | $ | — |
| | $ | 19,100 |
| | $ | 19,100 |
| | $ | — |
| | $ | 19,100 |
|
Amortizable intangibles: | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
|
Internal-use software | | 407,844 |
| | (335,112 | ) | | 72,732 |
| | 385,293 |
| | (310,195 | ) | | 75,098 |
| | 380,969 |
| | (303,099 | ) | | 77,870 |
| | 359,079 |
| | (284,074 | ) | | 75,005 |
|
Customer lists/relationships(1) | | 337,985 |
| | (109,495 | ) | | 228,490 |
| | 308,375 |
| | (76,276 | ) | | 232,099 |
| | 355,384 |
| | (146,115 | ) | | 209,269 |
| | 343,589 |
| | (121,729 | ) | | 221,860 |
|
Trade names(1) | | 38,761 |
| | (20,595 | ) | | 18,166 |
| | 68,261 |
| | (40,857 | ) | | 27,404 |
| | 50,107 |
| | (22,833 | ) | | 27,274 |
| | 36,931 |
| | (19,936 | ) | | 16,995 |
|
Technology-based intangibles | | | 39,000 |
| | (10,053 | ) | | 28,947 |
| | 31,800 |
| | (6,400 | ) | | 25,400 |
|
Software to be sold | | 36,900 |
| | (10,147 | ) | | 26,753 |
| | 34,700 |
| | (7,050 | ) | | 27,650 |
| | 36,900 |
| | (13,317 | ) | | 23,583 |
| | 36,900 |
| | (11,204 | ) | | 25,696 |
|
Technology-based intangibles | | 31,800 |
| | (4,783 | ) | | 27,017 |
| | 28,000 |
| | — |
| | 28,000 |
| |
Other | | 1,800 |
| | (1,535 | ) | | 265 |
| | 1,808 |
| | (1,378 | ) | | 430 |
| | 1,800 |
| | (1,700 | ) | | 100 |
| | 1,800 |
| | (1,590 | ) | | 210 |
|
Amortizable intangibles | | 855,090 |
| | (481,667 | ) |
| 373,423 |
|
| 826,437 |
|
| (435,756 | ) |
| 390,681 |
| | 864,160 |
| | (497,117 | ) |
| 367,043 |
|
| 810,099 |
|
| (444,933 | ) |
| 365,166 |
|
Intangibles | | $ | 874,190 |
| | $ | (481,667 | ) |
| $ | 392,523 |
|
| $ | 845,537 |
|
| $ | (435,756 | ) |
| $ | 409,781 |
| | $ | 883,260 |
| | $ | (497,117 | ) |
| $ | 386,143 |
|
| $ | 829,199 |
|
| $ | (444,933 | ) |
| $ | 384,266 |
|
(1) During the thirdfirst quarter of 2017,2018, we recorded a pre-tax asset impairment charge of $14,752$2,149 for one of our trade names.customer lists. Further information can be found in Note 7.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Amortization of intangibles was $27,45628,228 for the quarter ended SeptemberJune 30, 20172018, $19,27326,273 for the quarter ended SeptemberJune 30, 20162017, $79,284$55,694 for the ninesix months ended SeptemberJune 30, 20172018 and $56,364$51,828 for the ninesix months ended SeptemberJune 30, 2016.2017. Based on the intangibles in service as of SeptemberJune 30, 20172018, estimated future amortization expense is as follows:
| | (in thousands) | | Estimated amortization expense | | Estimated amortization expense |
Remainder of 2017 | | $ | 28,333 |
| |
2018 | | 93,153 |
| |
Remainder of 2018 | | | $ | 47,873 |
|
2019 | | 72,877 |
| | 84,662 |
|
2020 | | 54,692 |
| | 65,171 |
|
2021 | | 44,412 |
| | 50,832 |
|
2022 | | | 36,379 |
|
During the ninesix months ended SeptemberJune 30, 2017,2018, we acquired internal-use software in the normal course of business. We also acquired intangible assets in conjunction with acquisitions (Note 6). The following intangible assets were acquired during the ninesix months ended SeptemberJune 30, 2017:2018:
| | (in thousands) | | Amount | | Weighted-average amortization period (in years) | | Amount | | Weighted-average amortization period (in years) |
Customer lists/relationships(1) | | | $ | 21,887 |
| | 4 |
Internal-use software | | $ | 27,065 |
| | 3 | | 21,573 |
| | 3 |
Customer lists/relationships | | 50,184 |
| | 8 | |
Trade names | | 9,795 |
| | 6 | | 13,700 |
| | 7 |
Software to be sold | | 2,200 |
| | 5 | |
Technology-based intangibles | | 800 |
| | 3 | | 7,200 |
| | 5 |
Acquired intangibles | | $ | 90,044 |
| | 6 | | $ | 64,360 |
| | 4 |
(1) Includes the purchase of a customer list for $650 that did not qualify as a business combination.
Information regarding acquired intangibles does not include measurement-period adjustments recorded during the ninesix months ended SeptemberJune 30, 20172018 for changes in the estimated fair values of intangibles acquired during 20162017 through acquisitions. Information regarding these adjustments can be found in Note 6.
Goodwill – Changes in goodwill during the six months ended June 30, 2018 were as follows:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Total |
Balance, December 31, 2017: | | | | | | | | |
Goodwill, gross | | $ | 706,568 |
| | $ | 324,239 |
| | $ | 148,506 |
| | $ | 1,179,313 |
|
Accumulated impairment charges | | (48,379 | ) | | — |
| | — |
| | (48,379 | ) |
Goodwill, net of accumulated impairment charges | | 658,189 |
| | 324,239 |
|
| 148,506 |
|
| 1,130,934 |
|
Goodwill resulting from acquisitions | | 40,209 |
| | — |
| | — |
| | 40,209 |
|
Measurement-period adjustments for prior year acquisitions (Note 6) | | 853 |
| | 2,763 |
| | — |
| | 3,616 |
|
Adjustment of assets held for sale | | 218 |
| | — |
| | — |
| | 218 |
|
Currency translation adjustment | | (1,502 | ) | | — |
| | — |
| | (1,502 | ) |
Balance, June 30, 2018: | | |
| | |
| | |
| | |
|
Goodwill, gross | | 746,346 |
| | 327,002 |
| | 148,506 |
| | 1,221,854 |
|
Accumulated impairment charges | | (48,379 | ) | | — |
| | — |
| | (48,379 | ) |
Goodwill, net of accumulated impairment charges | | $ | 697,967 |
| | $ | 327,002 |
|
| $ | 148,506 |
|
| $ | 1,173,475 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Goodwill – Changes in goodwill during the nine months ended September 30, 2017 were as follows:
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Total |
Balance, December 31, 2016: | | | | | | | | |
Goodwill, gross | | $ | 684,261 |
| | $ | 293,189 |
| | $ | 148,506 |
| | $ | 1,125,956 |
|
Accumulated impairment charges | | (20,000 | ) | | — |
| | — |
| | (20,000 | ) |
Goodwill, net of accumulated impairment charges | | 664,261 |
| | 293,189 |
|
| 148,506 |
|
| 1,105,956 |
|
Impairment charge (Note 7) | | (28,379 | ) | | — |
| | — |
| | (28,379 | ) |
Goodwill resulting from acquisitions | | 22,966 |
| | 30,583 |
| | — |
| | 53,549 |
|
Measurement-period adjustments for previous acquisitions (Note 6) | | 30 |
| | (2,160 | ) | | — |
| | (2,130 | ) |
Sale of small business distributor | | (1,000 | ) | | — |
| | — |
| | (1,000 | ) |
Reclassification to assets held for sale | | (2,484 | ) | | — |
| | — |
| | (2,484 | ) |
Currency translation adjustment | | 574 |
| | — |
| | — |
| | 574 |
|
Balance, September 30, 2017: | | |
| | |
| | |
| | |
|
Goodwill, gross | | 704,347 |
| | 321,612 |
| | 148,506 |
| | 1,174,465 |
|
Accumulated impairment charges | | (48,379 | ) | | — |
| | — |
| | (48,379 | ) |
Goodwill, net of accumulated impairment charges | | $ | 655,968 |
| | $ | 321,612 |
|
| $ | 148,506 |
|
| $ | 1,126,086 |
|
Other non-current assets – Other non-current assets were comprised of the following:
| | (in thousands) | | September 30, 2017 | | December 31, 2016 | | June 30, 2018 | | December 31, 2017 |
Contract acquisition costs | | $ | 66,631 |
| | $ | 65,792 |
| |
Loans and notes receivable from Safeguard distributors | | 43,904 |
| | 21,313 |
| | $ | 67,430 |
| | $ | 44,276 |
|
Prepaid product discounts(1) | | | 63,017 |
| | 63,895 |
|
Postretirement benefit plan asset | | 28,840 |
| | 23,940 |
| | 43,535 |
| | 39,849 |
|
Deferred advertising costs | | 5,987 |
| | 7,309 |
| | 5,240 |
| | 6,135 |
|
Deferred sales commissions(2) | | | 6,783 |
| | — |
|
Other | | 6,531 |
| | 6,708 |
| | 7,694 |
| | 5,601 |
|
Other non-current assets | | $ | 151,893 |
| | $ | 125,062 |
| | $ | 193,699 |
| | $ | 159,756 |
|
(1) In our prior year financial statements, we referred to this asset as contract acquisition costs.
(2) Amortization of deferred sales commissions was $1,350 for the six months ended June 30, 2018.
Changes in contract acquisition costsprepaid product discounts during the ninesix months ended SeptemberJune 30, 20172018 and 20162017 were as follows:
| | | | Nine Months Ended September 30, | | Quarter Ended June 30, |
(in thousands) | | 2017 | | 2016 | | 2018 | | 2017 |
Balance, beginning of year | | $ | 65,792 |
| | $ | 58,792 |
| | $ | 63,895 |
| | $ | 65,792 |
|
Additions(1) | | 15,651 |
| | 23,471 |
| | 10,296 |
| | 8,310 |
|
Amortization | | (14,685 | ) | | (14,700 | ) | | (11,124 | ) | | (9,588 | ) |
Other | | (127 | ) | | (75 | ) | | (50 | ) | | (101 | ) |
Balance, end of period | | $ | 66,631 |
| | $ | 67,488 |
| | $ | 63,017 |
| | $ | 64,413 |
|
(1) Contract acquisition costsPrepaid product discounts are generally accrued upon contract execution. Cash payments made for contract acquisition costsprepaid product discounts were $20,003$13,282 for the ninesix months ended SeptemberJune 30, 2018 and $10,937 for the six months ended June 30, 2017 and $17,190 for the nine months ended September 30, 2016.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Accrued liabilities – Accrued liabilities were comprised of the following:
| | (in thousands) | | September 30, 2017 | | December 31, 2016 | | June 30, 2018 | | December 31, 2017 |
Funds held for customers | | $ | 77,397 |
| | $ | 86,799 |
| | $ | 91,556 |
| | $ | 85,091 |
|
Deferred revenue | | 34,567 |
| | 48,049 |
| | 43,939 |
| | 47,021 |
|
Employee profit sharing/cash bonus | | 25,560 |
| | 27,760 |
| | 20,462 |
| | 31,312 |
|
Acquisition-related liabilities(1) | | 25,346 |
| | 12,763 |
| |
Prepaid product discounts due within one year(1) | | | 12,915 |
| | 11,670 |
|
Acquisition-related liabilities(2) | | | 11,080 |
| | 23,878 |
|
Customer rebates | | 14,256 |
| | 16,281 |
| | 10,895 |
| | 11,508 |
|
Contract acquisition costs due within one year | | 13,508 |
| | 12,426 |
| |
Wages, including vacation | | 12,381 |
| | 8,640 |
| |
Restructuring due within one year (Note 8) | | | 4,686 |
| | 4,380 |
|
Income tax | | 6,890 |
| | 19,708 |
| | 1,555 |
| | 17,827 |
|
Restructuring due within one year (Note 8) | | 1,549 |
| | 4,181 |
| |
Other | | 44,088 |
| | 36,442 |
| | 48,631 |
| | 44,566 |
|
Accrued liabilities | | $ | 255,542 |
| | $ | 273,049 |
| | $ | 245,719 |
| | $ | 277,253 |
|
(1) Consists of holdback paymentsIn our prior year financial statements, we referred to this liability as contract acquisition costs due at future dates and liabilities for contingent consideration. Further information regarding liabilities for contingent consideration can be found in Note 7.within one year.
Other non-current liabilities – Other non-current liabilities were comprised of the following:
|
| | | | | | | | |
(in thousands) | | September 30, 2017 | | December 31, 2016 |
Contract acquisition costs | | $ | 24,348 |
| | $ | 29,855 |
|
Acquisition-related liabilities(1) | | 2,415 |
| | 19,390 |
|
Other | | 21,929 |
| | 30,461 |
|
Other non-current liabilities | | $ | 48,692 |
| | $ | 79,706 |
|
(1)(2) Consists of holdback payments due at future dates and liabilities for contingent consideration. Further information regarding liabilities for contingent consideration can be found in Note 7.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Other non-current liabilities – Other non-current liabilities were comprised of the following:
|
| | | | | | | | |
(in thousands) | | June 30, 2018 | | December 31, 2017 |
Prepaid product discounts(1) | | $ | 17,379 |
| | $ | 21,658 |
|
Other | | 27,097 |
| | 30,583 |
|
Other non-current liabilities | | $ | 44,476 |
| | $ | 52,241 |
|
(1) In our prior year financial statements, we referred to this liability as contract acquisition costs.
Note 4: Earnings per share
The following table reflects the calculation of basic and diluted earnings per share. During each period, certain stock options, as noted below, were excluded from the calculation of diluted earnings per share because their effect would have been antidilutive.
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands, except per share amounts) | | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 | | 2018 | | 2017 |
Earnings per share – basic: | | | | | | | | | | | | | | | | |
Net income | | $ | 28,801 |
| | $ | 58,663 |
| | $ | 145,446 |
| | $ | 175,154 |
| | $ | 60,207 |
| | $ | 59,579 |
| | $ | 123,544 |
| | $ | 116,645 |
|
Income allocated to participating securities | | (176 | ) | | (491 | ) | | (961 | ) | | (1,445 | ) | | (228 | ) | | (379 | ) | | (515 | ) | | (785 | ) |
Income available to common shareholders | | $ | 28,625 |
| | $ | 58,172 |
|
| $ | 144,485 |
| | $ | 173,709 |
| | $ | 59,979 |
| | $ | 59,200 |
|
| $ | 123,029 |
| | $ | 115,860 |
|
Weighted-average shares outstanding | | 48,081 |
| | 48,493 |
| | 48,217 |
| | 48,634 |
| | 47,594 |
| | 48,255 |
| | 47,675 |
| | 48,287 |
|
Earnings per share – basic | | $ | 0.60 |
| | $ | 1.20 |
| | $ | 3.00 |
| | $ | 3.57 |
| | $ | 1.26 |
| | $ | 1.23 |
| | $ | 2.58 |
| | $ | 2.40 |
|
| | | | | | | | | | | | | | | | |
Earnings per share – diluted: | | |
| | |
| | | | | | |
| | |
| | | | |
Net income | | $ | 28,801 |
| | $ | 58,663 |
| | $ | 145,446 |
| | $ | 175,154 |
| | $ | 60,207 |
| | $ | 59,579 |
| | $ | 123,544 |
| | $ | 116,645 |
|
Income allocated to participating securities | | (175 | ) | | (487 | ) | | (956 | ) | | (1,436 | ) | | (228 | ) | | (378 | ) | | (514 | ) | | (781 | ) |
Re-measurement of share-based awards classified as liabilities | | 53 |
| | (64 | ) | | 7 |
| | 230 |
| | (90 | ) | | (41 | ) | | (176 | ) | | (46 | ) |
Income available to common shareholders | | $ | 28,679 |
| | $ | 58,112 |
|
| $ | 144,497 |
| | $ | 173,948 |
| | $ | 59,889 |
| | $ | 59,160 |
|
| $ | 122,854 |
| | $ | 115,818 |
|
Weighted-average shares outstanding | | 48,081 |
| | 48,493 |
| | 48,217 |
| | 48,634 |
| | 47,594 |
| | 48,255 |
| | 47,675 |
| | 48,287 |
|
Dilutive impact of potential common shares | | 296 |
| | 455 |
| | 331 |
| | 427 |
| | 183 |
| | 325 |
| | 222 |
| | 349 |
|
Weighted-average shares and potential common shares outstanding | | 48,377 |
| | 48,948 |
|
| 48,548 |
| | 49,061 |
| | 47,777 |
| | 48,580 |
|
| 47,897 |
| | 48,636 |
|
Earnings per share – diluted | | $ | 0.59 |
| | $ | 1.19 |
| | $ | 2.98 |
| | $ | 3.55 |
| | $ | 1.25 |
| | $ | 1.22 |
| | $ | 2.56 |
| | $ | 2.38 |
|
Antidilutive options excluded from calculation | | 266 |
| | 223 |
| | 266 |
| | 223 |
| | 529 |
| | 451 |
| | 529 |
| | 451 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Note 5: Other comprehensive income
Reclassification adjustments – Information regarding amounts reclassified from accumulated other comprehensive loss to net income was as follows:
|
| | | | | | | | | | | | | | | | | | |
Accumulated other comprehensive loss components | | Amounts reclassified from accumulated other comprehensive loss | | Affected line item in consolidated statements of comprehensive income |
| | Quarter Ended June 30, | | Six Months Ended June 30, | | |
(in thousands) | | 2018 | | 2017 | | 2018 | | 2017 | | |
Amortization of postretirement benefit plan items: | | | | | | | | | | |
Prior service credit | | $ | 355 |
| | $ | 355 |
| | $ | 711 |
| | $ | 711 |
| | Other income |
Net actuarial loss | | (721 | ) | | (909 | ) | | (1,442 | ) | | (1,819 | ) | | Other income |
Total amortization | | (366 | ) | | (554 | ) | | (731 | ) | | (1,108 | ) | | Other income |
Tax benefit | | 45 |
| | 165 |
| | 400 |
| | 330 |
| | Income tax provision |
Total reclassifications, net of tax | | $ | (321 | ) | | $ | (389 | ) | | $ | (331 | ) | | $ | (778 | ) | | Net income |
|
| | | | | | | | | | | | | | | | | | |
Accumulated other comprehensive loss components | | Amounts reclassified from accumulated other comprehensive loss | | Affected line item in consolidated statements of comprehensive income |
| | Quarter Ended September 30, | | Nine Months Ended September 30, | | |
(in thousands) | | 2017 | | 2016 | | 2017 | | 2016 | | |
Amortization of postretirement benefit plan items: | | | | | | | | | | |
Prior service credit | | $ | 355 |
| | $ | 355 |
| | 1,066 |
| | 1,066 |
| | (1) |
Net actuarial loss | | (909 | ) | | (949 | ) | | (2,728 | ) | | (2,848 | ) | | (1) |
Total amortization | | (554 | ) | | (594 | ) | | (1,662 | ) | | (1,782 | ) | | (1) |
Tax benefit | | 167 |
| | 181 |
| | 497 |
| | 544 |
| | (1) |
Total reclassifications, net of tax | | $ | (387 | ) | | $ | (413 | ) | | $ | (1,165 | ) | | $ | (1,238 | ) | | |
(1) Amortization of postretirement benefit plan items is included in the computation of net periodic benefit income as presented in Note 10. Net periodic benefit income is included in cost of revenue and SG&A expense in the consolidated statements of comprehensive income, based on the composition
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
of our workforce. A portion of net periodic benefit income is capitalized as a component of labor costs and is included in inventories and intangibles in our consolidated balance sheets.
Accumulated other comprehensive loss – Changes in the components of accumulated other comprehensive loss during the ninesix months ended SeptemberJune 30, 20172018 were as follows:
| | (in thousands) | | Postretirement benefit plans, net of tax | | Net unrealized loss on marketable securities, net of tax(1) | | Currency translation adjustment | | Accumulated other comprehensive loss | | Postretirement benefit plans | | Net unrealized loss on marketable debt securities, net of tax(1) | | Currency translation adjustment | | Accumulated other comprehensive loss |
Balance, December 31, 2016 | | $ | (35,684 | ) | | $ | (213 | ) | | $ | (14,474 | ) | | $ | (50,371 | ) | |
Other comprehensive (loss) income before reclassifications | | — |
| | (130 | ) | | 4,500 |
| | 4,370 |
| |
Balance, December 31, 2017 | | | $ | (26,829 | ) | | $ | (322 | ) | | $ | (10,446 | ) | | $ | (37,597 | ) |
Other comprehensive loss before reclassifications | | | — |
| | (69 | ) | | (4,968 | ) | | (5,037 | ) |
Amounts reclassified from accumulated other comprehensive loss | | 1,165 |
| | — |
| | — |
| | 1,165 |
| | 331 |
| | — |
| | — |
| | 331 |
|
Net current-period other comprehensive income (loss) | | 1,165 |
| | (130 | ) | | 4,500 |
| | 5,535 |
| | 331 |
| | (69 | ) | | (4,968 | ) | | (4,706 | ) |
Balance, September 30, 2017 | | $ | (34,519 | ) | | $ | (343 | ) | | $ | (9,974 | ) | | $ | (44,836 | ) | |
Adoption of ASU No. 2018-02 | | | (6,867 | ) | | — |
| | — |
| | (6,867 | ) |
Balance, June 30, 2018 | | | $ | (33,365 | ) | | $ | (391 | ) | | $ | (15,414 | ) | | $ | (49,170 | ) |
(1) Other comprehensive loss before reclassifications is net of income tax benefit of $45.$24.
Note 6: Acquisitions
We periodicallyregularly complete business combinations that align with our business strategy. The assets and liabilities acquired are recorded at their estimated fair values, and the results of operations of each acquired business are included in our consolidated statements of comprehensive income from their acquisition dates. Transaction costs related to acquisitions are expensed as incurred and are included in SG&A expense in the consolidated statements of comprehensive income. Transaction costs were not significant to our consolidated statements of comprehensive income for the quarters or ninesix months ended SeptemberJune 30, 20172018 and 2016.2017. The acquisitions completed during the ninesix months ended SeptemberJune 30, 20172018 were cash transactions, funded by cash on hand and/or use of our revolving credit facility. We completed these acquisitions primarily to increase our mix of marketing solutions and other services revenue, to add logo and web services capabilities, and to reach new customers.
20172018 acquisitions – In February 2017,June 2018, we acquired selected assets of Panthur Pty Ltd (Panthur)Velocity Servers, Inc., an Australian webdoing business as ColoCrossing, a data center solutions, cloud hosting and domain registration service provider. The allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in goodwill of $1,198 that is not deductible for tax purposes. The acquisition resulted in goodwill as we expect to utilize Panthur's platform as we selectively expand into foreign markets. The operations of this business from its acquisition date are included within our Small Business Services segment.
In April 2017, we acquired all of the equity of RDM Corporation (RDM) of Canada, ainfrastructure colocation provider of remote deposit capture software, hardware and digital imaging solutions for financial institutions and corporate clients.dedicated hosting services. The preliminary allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in tax-deductible goodwill of $30,583 that is not deductible for tax purposes.$10,300. The acquisition resulted in goodwill as it enhances our suite of treasury management solutions, strengthening our value proposition and improving our market position. Wewe expect to finalize the allocation of the purchase price by the end of 2017 when our valuation of several of the acquired assets and liabilities is completed. The operations of this business from its acquisition date are included within our Financial Services segment.
In July 2017, we acquired all of the equity of Digital Pacific Group Pty Ltd (Digital Pacific), and in September 2017, we acquired all of the equity of j2 Global Australia Pty Ltd, doing business as Web24. Both businesses are based in Australia and provide web hosting and domain registration services. The preliminary allocations of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in goodwill of $21,768 that is not deductible for tax purposes. The goodwill resulted from our acquisition of enhanced web hosting capabilities as we selectively expand into foreign markets. We expect to finalize the allocations of the purchase price by the end of 2017 when our valuation of several of the acquired assets and liabilities is completed. The operations of these businesses from their acquisition dates are included within our Small Business Services segment.
accelerate revenue growth
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
by bringing colocation services into our portfolio of hosting products and services. The operations of this business from its acquisition date are included in our Small Business Services segment. We expect to finalize the allocation of the purchase price in the first half of 2019 when our valuation of the acquired intangible assets is completed, as well as the valuation of various other assets acquired and liabilities assumed.
In March 2018, we acquired all of the equity of Logomix Inc. (Logomix), a self-service marketing and branding platform that helps small businesses create logos and custom marketing products. The preliminary allocation of the purchase price based upon the estimated fair values of the assets acquired and liabilities assumed resulted in nondeductible goodwill of $29,909. The acquisition resulted in goodwill as we expect to accelerate revenue growth by combining our capabilities with Logomix's platform. The operations of this business from its acquisition date are included in our Small Business Services segment. We expect to finalize the allocation of the purchase price by the end of 2018 when our valuation of the acquired intangible assets is completed, as well as the valuation of various other assets acquired and liabilities assumed.
Also during the ninesix months ended SeptemberJune 30, 2017,2018, we acquired the operations of several2 small business distributors whichthat are included in our Small Business Services segment. The assets acquired consisted primarily of customer list intangible assets. We expect to finalize the allocations of the purchase price by the end of 2017 when our valuation of the acquired intangible assets is completed, as well as the determination of the related estimated useful lives. As these small business distributors were previously part of our Safeguard distributor network, our revenue was not impacted by these acquisitions, and the impact to our costs was not significant.
In June 2018, we entered into a definitive agreement to acquire a treasury management business that we expect will deliver approximately $36,000 of revenue in 2018. The regulatory conditions related to the acquisition have been satisfied, and we anticipate that the acquisition will close during the third quarter of 2018.
Information regarding goodwill by reportable segment and the useful lives of acquired intangibles and goodwill by reportable segment can be found in Note 3. Information regarding the calculation of the estimated fair values of the acquired intangibles can be found in Note 7. As our acquisitions were immaterial to our reported operating results both individually and in the aggregate, pro forma results of operations are not provided. The following illustrates the preliminary allocation, as of SeptemberJune 30, 2017,2018, of the aggregate purchase price for the above acquisitions to the assets acquired and liabilities assumed:
| | (in thousands) | | 2017 acquisitions | | 2018 acquisitions |
Net tangible assets acquired and liabilities assumed(1) | | $ | 5,123 |
| | $ | (4,791 | ) |
Identifiable intangible assets: | | | | |
Customer lists/relationships | | 50,184 |
| | 21,237 |
|
Trade name | | 9,795 |
| |
Software to be sold | | 2,200 |
| |
Trade names | | | 13,700 |
|
Technology-based intangible | | 800 |
| | 7,200 |
|
Internal-use software | | 445 |
| |
Total intangible assets | | 63,424 |
| | 42,137 |
|
Goodwill | | 53,549 |
| | 40,209 |
|
Total aggregate purchase price | | 122,096 |
| | 77,555 |
|
Liabilities for holdback payments | | (4,562 | ) | |
Net cash paid for 2017 acquisitions | | 117,534 |
| |
Liabilities for holdback payments and contingent consideration | | | (4,015 | ) |
Net cash paid for 2018 acquisitions | | | 73,540 |
|
Holdback payments for prior year acquisitions | | 7,883 |
| | 16,665 |
|
Payments for acquisitions, net of cash acquired of $27,282 | | $ | 125,417 |
| |
Payments for acquisitions, net of cash acquired of $1,645 | | | $ | 90,205 |
|
(1) Net tangible assetsliabilities acquired consisted primarily of accounts receivable, marketable securities, inventory and accrued liabilities of RDM.Logomix deferred income taxes.
During the ninesix months ended SeptemberJune 30, 2017,2018, we finalized the purchase accounting for the acquisitions of BNBS, Inc., Payce, Inc., PTM Document Systems, Inc.RDM Corporation, Digital Pacific Group Pty Ltd and Data Support Systems,Impact Marketing Specialists, Inc., which were acquired in 2016, and we adjusted2017. We also recorded adjustments related to the purchase accounting for First Manhattan Consulting Group,j2 Global Australia Pty Ltd, doing business as Web24, and SY Holdings, LLC, (FMCG Direct),doing business as managed.com, which waswere also acquired in December 2016.during 2017. We expect to finalize the purchase accounting for FMCG Direct bythese acquisitions in the endthird quarter of 20172018 when our valuation of certain miscellaneous receivablesproperty, plant and liabilitiesequipment, as well as the acquired customer list intangible assets, is completed.finalized. Further information regarding these acquisitions can be found under the caption “Note 5: Acquisitions” in the Notes to Consolidated Financial Statements appearing in the 2016our 2017 Form 10-K. These measurement-period adjustments resulted in a decreasean increase in goodwill of $2,130$3,616 during the ninesix months ended SeptemberJune 30, 2017,2018, with the offset to various assets and liabilities, including other current assets, accounts payable and intangibles, including an increase of $3,000 in acquired technology-based intangibles and a decrease of $1,924 in customer list intangibles.
During the nine months ended September 30, 2016, we completed the following acquisitions:
In February 2016, we acquired selected assets of Category 99, Inc., doing business as MacHighway®, a web hosting and domain registration service provider.
In March 2016, we acquired selected assets of New England Art Publishers, Inc., doing business as Birchcraft Studios, a supplier of personalized invitations, holiday cards, all-occasion cards and social announcements.
In April 2016, we acquired selected assets of 180 Fusion LLC, a digital marketing services provider.
In June 2016, we acquired selected assets of L.A.M. Enterprises, Inc., a provider of printed and promotional products.
In June 2016, we acquired selected assets of Liquid Web, LLC, a web hosting services provider.
In June 2016, we acquired selected assets of National Document Solutions, LLC, a provider of printing, promotional products, office products, scanning and document management solutions.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
the offset to various assets and liabilities, including deferred revenue, deferred income taxes and other long-term liabilities, as well as a decrease of $910 in customer list intangibles and an increase in internal-use software of $1,000.
2017 acquisitions – During the six months ended June 30, 2017, we completed the following acquisitions:
In July 2016,February 2017, we acquired selected assets of Inkhead, Inc., a provider of customized promotional products.Panthur Pty Ltd, an Australian web hosting and domain registration service provider.
In August 2016, we acquired selected assets of BNBS, Inc., doing business as B&B Solutions, a provider of printing, promotional and office products and services.
In September 2016,April 2017, we acquired all of the equity of Payce, Inc.,RDM Corporation of Canada, a provider of payroll processing, payroll tax filingremote deposit capture software, hardware and related payroll services.digital imaging solutions for financial institutions and corporate clients.
We acquired the operations of several small business distributors, all of which were previously part of our Safeguard distributor network.
Payments for acquisitions, net of cash acquired, as presented on the consolidated statement of cash flows for the ninesix months ended SeptemberJune 30, 2016,2017, included payments of $63,103$72,470 for these acquisitions and $1,534$5,083 for holdback payments for prior year acquisitions. Further information regarding our 20162017 acquisitions can be found under the caption “Note 5: Acquisitions” in the Notes to Consolidated Financial Statements appearing in the 2016our 2017 Form 10-K.
Note 7: Fair value measurements
Annual asset impairment analyses – We evaluate the carrying value of goodwill and our indefinite-lived trade name as of July 31 of each year and between annual evaluations if events occur or circumstances change that would indicate a possible impairment. Our policy on impairment of indefinite-lived intangibles and goodwill, which is included under the caption "Note 1: Significant accounting policies" in the Notes to Consolidated Financial Statements appearing in the 2016 Form 10-K, explains our methodology for assessing impairment of these assets.
In conjunction with our annual strategic planning process during the third quarter of 2017, we made various changes to our internal reporting structure. As a result, we reassessed our operating segments and determined that no changes were required in our reportable operating segments. We also reassessed our previously determined reporting units and concluded that a realignment of a portion of our reporting units was required. As such, we reallocated the carrying value of goodwill to our revised reporting units based on their relative fair values. We analyzed goodwill for impairment immediately prior to this realignment by performing qualitative analyses for our Small Business Services reporting units and quantitative analyses for our Financial Services and Direct Checks reporting units. The qualitative analyses evaluated factors including, but not limited to, economic, market and industry conditions, cost factors and the overall financial performance of the reporting units. We also considered the last quantitative analysis we completed. In completing these assessments, we noted no changes in events or circumstances that indicated that it was more likely than not that the fair value of any reporting unit was less than its carrying amount, with the exception of our Small Business Services Safeguard reporting unit. The analysis of this reporting unit, which incorporated the results of the annual strategic planning process, indicated lowered projected long-term revenue growth and profitability levels resulting from changes in market trends and the mix of products and services sold, including the continuing decline in check and forms usage. As a result, we completed impairment analyses of the long-term assets of this reporting unit, excluding goodwill, and concluded that these assets were not impaired. We then completed the quantitative analysis of the reporting unit, utilizing the income approach outlined under the caption "Note 1: Significant accounting policies" in the Notes to Consolidated Financial Statements appearing in the 2016 Form 10-K. This quantitative analysis indicated that this reporting unit's goodwill was fully impaired and resulted in a non-cash pre-tax goodwill impairment charge of $28,379 during the quarter ended September 30, 2017. In accordance with ASU No. 2017-04, which we adopted on January 1, 2017, the impairment charge was measured as the amount by which the reporting unit's carrying value exceeded its estimated fair value. Further information regarding this accounting pronouncement can be found in Note 2.
Immediately subsequent to the realignment of our reporting unit structure, we completed a quantitative analysis for all of our reporting units to which goodwill is assigned. This quantitative analysis as of July 31, 2017 indicated that the estimated fair values of our reporting units exceeded their carrying values by approximate amounts between $64,000 and $1,405,000, or by amounts between 36% and 314% above the carrying values of their net assets.
In completing the 2017 annual impairment analysis of our indefinite-lived trade name, we elected to perform a quantitative assessment which indicated that the calculated fair value of the asset exceeded its carrying value of $19,100 by approximately $16,000 as of July 31, 2017.
Non-recurring asset impairment analyses – During the first quarter of 2018, we recorded a pre-tax asset impairment charge of $2,149 related to a Small Business Services customer list intangible asset. Based on changes in the customer base of one of our small business distributors, we determined that the customer list asset was impaired and had an estimated fair market value of $0 (level 3 fair value measurement) as of March 31, 2018.
During the six months ended June 30, 2017, we recorded aggregate pre-tax asset impairment charges of $8,250 related to a small business distributor that was classified as held for sale in the consolidated balance sheets prior to its sale during the second quarter of 2017. The impairment charges were calculated based on on-going
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
ongoing negotiations for the sale of the business and reduced its carrying value to its fair value less costs to sell of approximately $3,500 (level 3 fair value measurement) by reducing the carrying value of the related customer list intangible asset. Further information regarding assets held for sale can be found in Note 3.
During the quarter ended September 30, 2017, we decided that we would no longer utilize our Small Business Services NEBS® trade name in the marketplace, and we recorded a pre-tax asset impairment charge of $14,752 to write down the remaining book value of this trade name to a fair value of $0. Also during the quarter ended September 30, 2017, we recorded pre-tax asset impairment charges of $3,499 related to other long-lived assets within Small Business Services, primarily internal-use software related to an order capture system. During the third quarter of 2017, we signed a contract for customer relationship management services that resulted in our decision to no longer utilize a portion of this software. As such, the remaining net book value of the assets was written down to a fair value of $0.
Information regarding these non-recurring asset impairment analyses is as follows:
|
| | | | | | | | | | | | | | | | | | | | |
| | | | Fair value measurements using | | |
| | Fair value as of measurement date | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs | | Impairment charge |
(in thousands) | | | (Level 1) | | (Level 2) | | (Level 3) | |
Trade name | | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 14,752 |
|
Assets held for sale | | 3,500 |
| | — |
| | — |
| | 3,500 |
| | 8,250 |
|
Other | | — |
| | — |
| | — |
| | — |
| | 3,499 |
|
Total | | | | | | | | | | $ | 26,501 |
|
20172018 acquisitions – For all acquisitions, we are required to measure the fair value of the net identifiable tangible and intangible assets and liabilities acquired. Information regarding the acquisitions completed during the ninesix months ended SeptemberJune 30, 20172018 can be found in Note 6. The identifiable net assets acquired during the ninesix months ended SeptemberJune 30, 20172018 were comprised primarily of customer list intangible assets, trade names and trade names.a technology-related intangible asset. The estimated fair values of the RDM, Digital Pacifictrade names and Web24the technology-related asset were calculated using the relief from royalty method, which calculates the cost savings associated with owning rather than licensing the trade name or the technology. Assumed royalty rates were applied to projected revenue for the estimated remaining useful lives of the assets to estimate the royalty savings.
The estimated fair values of the Logomix and ColoCrossing customer list intangibleslists were calculated using the multi-period excess earnings method. This valuation model estimates revenues and cash flows derived from the asset and then deducts portions of the cash flow that can be attributed to supporting assets, such as a brand name or fixed assets, that contributed to the generation of the cash flows. The resulting cash flow, which is attributable solely to the customer list asset, is then discounted at a rate of return commensurate with the risk of the asset to calculate a present value. The estimated fair value of the remainder of ourother acquired customerscustomer lists was calculated by discounting the estimated cash flows expected to be generated by the assets. Key assumptions used in the calculations included same-customer revenue growth rates and estimated customer retention rates based on the acquirees' historical information. The estimated fair values of the Digital Pacific and Web24 trade names were calculated using the relief from royalty method, which calculates the cost savings associated with owning rather than licensing the trade name. An assumed royalty rate is applied to forecasted revenue and the resulting cash flows are discounted.
Recurring fair value measurements – Funds held for customers included cash equivalents and available-for-sale marketabledebt securities (Note 3). The cash equivalents consisted of a money market fund investment that is traded in an active market. Because of the short-term nature of the underlying investments, the cost of this investment approximates its fair value. Available-for-sale marketabledebt securities consisted of a mutual fund investment that invests in Canadian and provincial government securities and investments in Canadian guaranteed investment certificates (GICs) with maturities of 1 year. The mutual fund is not traded in an active market and its fair value is determined by obtaining quoted prices in active markets for the underlying securities held by the fund. The fair value of the GICs approximated cost due to their relatively short duration. Unrealized gains
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
and losses, net of tax, are included in accumulated other comprehensive loss in the consolidated balance sheets. The cost of securities sold is determined using the average cost method. Realized gains and losses are included in revenue in the consolidated statements of comprehensive income and were not significant for the quarters or ninesix months ended SeptemberJune 30, 20172018 and 20162017.
We have elected to account for long-term investments in domestic mutual funds under the fair value option for financial assets and financial liabilities. The fair value option provides companies an irrevocable option to measure many financial assets and liabilities at fair value with changes in fair value recognized in earnings. The investments are included in long-term investments in the consolidated balance sheets. Long-term investments also include the cash surrender val
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
ues of company-owned life insurance policies. Realized and unrealized gains and losses, as well as dividends earned by the mutual fund investments, are included in SG&A expense in the consolidated statements of comprehensive income. These investments correspond to a liability under an officers’ deferred compensation plan that is not available to new participants and is fully funded by the mutual fund investments. The liability under the plan equals the fair value of the mutual fund investments. Thus, as the value of the investments changes, the value of the liability changes accordingly. As changes in the liability are reflected within SG&A expense in the consolidated statements of comprehensive income, the fair value option of accounting for the mutual fund investments allows us to net changes in the investments and the related liability in the statements of comprehensive income. The cost of securities sold is determined using the average cost method. The fair value of the mutual fund investments is determined by obtaining quoted prices in active markets for the mutual funds. Net unrealized losses recognized during the nine months ended September 30, 2017 and net realized gains recognized during the nine months ended September 30, 2017 and September 30, 2016 were not significant. We recognized net unrealized losses of $160 during the nine months ended September 30, 2016.
We have recorded liabilities for contingent consideration related to certain of our acquisitions, primarily the acquisitions of Verify Valid and a small business distributor during 2015 and the acquisition of Data Support Systems, Inc. during 2016. Further information regarding these acquisitions can be found under the caption “Note 5: Acquisitions” in the Notes to Consolidated Financial Statements appearing in the 2016 Form 10-K. Under the Verify Valid and Data Support Systems agreements, there are no maximum amounts of contingent payments specified, although payments are based on a percentage of the revenue or operating income generated by the business. The fair value of accrued contingent consideration is remeasured each reporting period. Increases or decreases in projected revenue, gross profit or operating income, as appropriate, and the related probabilities of achieving the forecasted results, may result in a higher or lower fair value measurement. Changes in fair value resulting from changes in the timing, amount of, or likelihood of contingent payments are included in SG&A expense in the consolidated statements of comprehensive income. Changes in fair value resulting from accretion for the passage of time are included in interest expense in the consolidated statements of comprehensive income.
Changes in accrued contingent consideration during the ninesix months ended SeptemberJune 30, 20172018 were as follows:
|
| | | | |
(in thousands) | | Nine Months Ended September 30, 2017 |
Balance, December 31, 2016 | | $ | 4,682 |
|
Change in fair value | | 1,028 |
|
Settlements | | (1,249 | ) |
Balance, September 30, 2017 | | $ | 4,461 |
|
|
| | | | |
(in thousands) | | Six Months Ended June 30, 2018 |
Balance, December 31, 2017 | | $ | 3,623 |
|
Acquisition date fair value | | 100 |
|
Change in fair value | | 457 |
|
Payments | | (863 | ) |
Balance, June 30, 2018 | | $ | 3,317 |
|
Information regarding recurringthe fair value measurements completed during each periodvalues of our financial instruments was as follows:
| | | | | | Fair value measurements using | | | | Fair value measurements using |
| | Fair value as of September 30, 2017 | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs | | June 30, 2018 | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
(in thousands) | | | (Level 1) | | (Level 2) | | (Level 3) | | Carrying value | | Fair value | | (Level 1) | | (Level 2) | | (Level 3) |
Measured at fair value through net income: | | | | | | | | | | | |
Accrued contingent consideration | | | $ | (3,317 | ) | | $ | (3,317 | ) | | $ | — |
| | $ | — |
| | $ | (3,317 | ) |
Measured at fair value through comprehensive income: | | | | | | | | | | | |
Cash equivalents (funds held for customers) | | $ | 10,000 |
| | $ | 10,000 |
| | $ | — |
| | $ | — |
| | 10,000 |
| | 10,000 |
| | 10,000 |
| | — |
| | — |
|
Available-for-sale marketable securities (funds held for customers) | | 16,685 |
| | — |
| | 16,685 |
| | — |
| |
Long-term investments in mutual funds | | 1,729 |
| | 1,729 |
| | — |
| | — |
| |
Accrued contingent consideration | | (4,461 | ) | | — |
| | — |
| | (4,461 | ) | |
Available-for-sale debt securities (funds held for customers) | | | 15,897 |
| | 15,897 |
| | — |
| | 15,897 |
| | — |
|
Amortized cost: | | | | | | | | | | | |
Cash | | | 68,594 |
| | 68,594 |
| | 68,594 |
| | — |
| | — |
|
Cash (funds held for customers) | | | 66,709 |
| | 66,709 |
| | 66,709 |
| | — |
| | — |
|
Loans and notes receivable from Safeguard distributors | | | 69,879 |
| | 60,397 |
| | — |
| | — |
| | 60,397 |
|
Long-term debt(1) | | | 765,000 |
| | 765,000 |
| | — |
| | 765,000 |
| | — |
|
(1) Amounts exclude capital lease obligations.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
|
| | | | | | | | | | | | | | | | |
| | | | Fair value measurements using |
| | Fair value as of December 31, 2016 | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
(in thousands) | | | (Level 1) | | (Level 2) | | (Level 3) |
Cash equivalents (funds held for customers) | | $ | 6,002 |
| | $ | 6,002 |
| | $ | — |
| | $ | — |
|
Available-for-sale marketable securities (funds held for customers) | | 15,532 |
| | — |
| | 15,532 |
| | — |
|
Long-term investments in mutual funds | | 1,877 |
| | 1,877 |
| | — |
| | — |
|
Accrued contingent consideration | | (4,682 | ) | | — |
| | — |
| | (4,682 | ) |
|
| | | | | | | | | | | | | | | | | | | | |
| | | | Fair value measurements using |
| | December 31, 2017 | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
(in thousands) | | Carrying value | | Fair value | | (Level 1) | | (Level 2) | | (Level 3) |
Measured at fair value through net income: | | | | | | | | | | |
Accrued contingent consideration | | $ | (3,623 | ) | | $ | (3,623 | ) | | $ | — |
| | $ | — |
| | $ | (3,623 | ) |
Measured at fair value through comprehensive income: | | | | | | | | | | |
Cash equivalents (funds held for customers) | | 17,300 |
| | 17,300 |
| | 17,300 |
| | — |
| | — |
|
Available-for-sale debt securities (funds held for customers) | | 16,613 |
| | 16,613 |
| | — |
| | 16,613 |
| | — |
|
Amortized cost: | | | | | | | | | | |
Cash | | 59,240 |
| | 59,240 |
| | 59,240 |
| | — |
| | — |
|
Cash (funds held for customers) | | 52,279 |
| | 52,279 |
| | 52,279 |
| | — |
| | — |
|
Loans and notes receivable from Safeguard distributors | | 46,409 |
| | 44,650 |
| | — |
| | — |
| | 44,650 |
|
Long-term debt(1) | | 707,386 |
| | 707,938 |
| | — |
| | 707,938 |
| | — |
|
(1) Amounts exclude capital lease obligations.
Our policy is to recognize transfers between fair value levels as of the end of the reporting period in which the transfer occurred. There were no transfers between fair value levels during the ninesix months ended SeptemberJune 30, 2017.2018.
Note 8: Restructuring and Chief Executive Officer transition costs
Fair value measurements of other financial instrumentsRestructuring charges – The following methods and assumptions were used to estimate the fair value ofNet restructuring charges for each class of financial instrument for which it is practicable to estimate fair value.
Cash and cash included within funds held for customers – The carrying amounts reported in the consolidated balance sheets approximate fair value becauseperiod consisted of the short-term nature of these items.following components:
Loans and notes receivable from Safeguard distributors – We have receivables for loans made to certain of our Safeguard distributors. In addition, we have acquired the operations of several small business distributors, which we then sold to our Safeguard distributors. In most cases, we entered into notes receivable upon the sale of the assets. The fair value of these loans and notes receivable is calculated as the present value of expected future cash flows, discounted using an estimated interest rate based on published bond yields for companies of similar risk.
Long-term debt – Information regarding the composition of our long-term debt can be found in Note 11. The carrying amounts reported in the consolidated balance sheets for amounts drawn under our revolving credit facility and our term loan facility, excluding unamortized debt issuance costs, approximate fair value because our interest rates are variable and reflect current market rates. |
| | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands, except number of employees) | | 2018 | | 2017 | | 2018 | | 2017 |
Severance accruals | | $ | 3,804 |
| | $ | 1,240 |
| | $ | 4,648 |
| | $ | 2,348 |
|
Severance reversals | | (95 | ) | | (119 | ) | | (230 | ) | | (518 | ) |
Operating lease obligations | | — |
| | 23 |
| | — |
| | 23 |
|
Net restructuring accruals | | 3,709 |
| | 1,144 |
|
| 4,418 |
|
| 1,853 |
|
Other costs | | 2,662 |
| | 313 |
| | 4,275 |
| | 597 |
|
Net restructuring charges | | $ | 6,371 |
| | $ | 1,457 |
|
| $ | 8,693 |
|
| $ | 2,450 |
|
Number of employees included in severance accruals | | 80 |
| | 20 |
| | 105 |
| | 50 |
|
The estimated fair valuesnet restructuring charges are reflected in the consolidated statements of these financial instruments werecomprehensive income as follows:
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2018 | | 2017 | | 2018 | | 2017 |
Total cost of revenue | | $ | 736 |
| | $ | 30 |
| | $ | 913 |
| | $ | 9 |
|
Operating expenses | | 5,635 |
| | 1,427 |
| | 7,780 |
| | 2,441 |
|
Net restructuring charges | | $ | 6,371 |
| | $ | 1,457 |
|
| $ | 8,693 |
|
| $ | 2,450 |
|
|
| | | | | | | | | | | | | | | | | | | | |
| | | | Fair value measurements using |
| | September 30, 2017 | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
(in thousands) | | Carrying value | | Fair value | | (Level 1) | | (Level 2) | | (Level 3) |
Cash | | $ | 53,410 |
| | $ | 53,410 |
| | $ | 53,410 |
| | $ | — |
| | $ | — |
|
Cash (funds held for customers) | | 51,762 |
| | 51,762 |
| | 51,762 |
| | — |
| | — |
|
Loans and notes receivable from Safeguard distributors | | 45,820 |
| | 41,987 |
| | — |
| | — |
| | 41,987 |
|
Long-term debt(1) | | 754,580 |
| | 755,250 |
| | — |
| | 755,250 |
| | — |
|
(1) Amounts exclude capital lease obligations.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
|
| | | | | | | | | | | | | | | | | | | | |
| | | | Fair value measurements using |
| | December 31, 2016 | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
(in thousands) | | Carrying value | | Fair value | | (Level 1) | | (Level 2) | | (Level 3) |
Cash | | $ | 76,574 |
| | $ | 76,574 |
| | $ | 76,574 |
| | $ | — |
| | $ | — |
|
Cash (funds held for customers) | | 66,289 |
| | 66,289 |
| | 66,289 |
| | — |
| | — |
|
Loans and notes receivable from Safeguard distributors | | 23,278 |
| | 21,145 |
| | — |
| | — |
| | 21,145 |
|
Long-term debt(1) | | 756,963 |
| | 758,000 |
| | — |
| | 758,000 |
| | — |
|
(1) Amounts exclude capital lease obligations.
Note 8: Restructuring charges
Net restructuring charges for each period consisted of the following components:
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended September 30, | | Nine Months Ended September 30, |
(in thousands, except number of employees) | | 2017 | | 2016 | | 2017 | | 2016 |
Severance accruals | | $ | 1,248 |
| | $ | 1,824 |
| | $ | 3,596 |
| | $ | 3,870 |
|
Severance reversals | | (78 | ) | | (198 | ) | | (596 | ) | | (666 | ) |
Operating lease obligations | | — |
| | — |
| | 23 |
| | — |
|
Net restructuring accruals | | 1,170 |
| | 1,626 |
|
| 3,023 |
|
| 3,204 |
|
Other costs | | 72 |
| | 432 |
| | 669 |
| | 939 |
|
Net restructuring charges | | $ | 1,242 |
| | $ | 2,058 |
|
| $ | 3,692 |
|
| $ | 4,143 |
|
Number of employees included in severance accruals | | 30 |
| | 55 |
| | 80 |
| | 120 |
|
The net restructuring charges are reflected in the consolidated statements of comprehensive income as follows:
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | | 2017 | | 2016 | | 2017 | | 2016 |
Total cost of revenue | | $ | (25 | ) | | $ | 65 |
| | $ | (16 | ) | | $ | 136 |
|
Operating expenses | | 1,267 |
| | 1,993 |
| | 3,708 |
| | 4,007 |
|
Net restructuring charges | | $ | 1,242 |
| | $ | 2,058 |
|
| $ | 3,692 |
|
| $ | 4,143 |
|
During the quarters and ninesix months ended SeptemberJune 30, 20172018 and September 30, 20162017, the net restructuring accruals included severance charges related to employee reductions across functional areas as we continued to reduce costs, primarily within our sales, and marketing information technology and fulfillment functions. These charges were reduced by the reversal of restructuring accruals recorded in previous periods, as fewer employees received severance benefits than originally estimated. Other restructuring costs, which were expensed as incurred, included items such as information technology costs, employee and equipment moves, training and travel related to our restructuring and integration activities.
Restructuring accruals of $1,549$4,686 as of SeptemberJune 30, 20172018 and $4,1814,380 as of December 31, 20162017 are reflected in the consolidated balance sheets as accrued liabilities. The majority of the employee reductions are expected to be completed in 2017,by the end of 2018, and we expect most of the related severance payments to be paid by mid-2018,mid-2019, utilizing cash from operations. As of SeptemberJune 30, 20172018, approximately 1070 of the employees included in our restructuring accruals had not yet started to receive severance benefits.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Accruals for our restructuring initiatives, summarized by year, were as follows:
| | (in thousands) | | 2015 initiatives | | 2016 initiatives | | 2017 initiatives | | Total | | 2018 initiatives | | 2017 initiatives | | 2016 initiatives | | Total |
Balance, December 31, 2016 | | $ | 80 |
| | $ | 4,101 |
| | $ | — |
| | $ | 4,181 |
| |
Balance, December 31, 2017 | | | $ | — |
| | $ | 4,348 |
| | $ | 32 |
| | $ | 4,380 |
|
Restructuring charges | | 41 |
| | 485 |
| | 3,093 |
| | 3,619 |
| | 4,530 |
| | 118 |
| | — |
| | 4,648 |
|
Restructuring reversals | | (42 | ) | | (461 | ) | | (93 | ) | | (596 | ) | | (5 | ) | | (220 | ) | | (5 | ) | | (230 | ) |
Payments | | (79 | ) | | (3,999 | ) | | (1,577 | ) | | (5,655 | ) | | (555 | ) | | (3,530 | ) | | (27 | ) | | (4,112 | ) |
Balance, September 30, 2017 | | $ | — |
| | $ | 126 |
| | $ | 1,423 |
| | $ | 1,549 |
| |
Balance, June 30, 2018 | | | $ | 3,970 |
| | $ | 716 |
| | $ | — |
| | $ | 4,686 |
|
Cumulative amounts: | | |
| | | | | | |
| | |
| | | | | | |
|
Restructuring charges | | $ | 6,246 |
| | $ | 7,683 |
| | $ | 3,093 |
| | $ | 17,022 |
| | $ | 4,530 |
| | $ | 7,340 |
| | $ | 7,801 |
| | $ | 19,671 |
|
Restructuring reversals | | (972 | ) | | (742 | ) | | (93 | ) | | (1,807 | ) | | (5 | ) | | (381 | ) | | (750 | ) | | (1,136 | ) |
Payments | | (5,274 | ) | | (6,815 | ) | | (1,577 | ) | | (13,666 | ) | | (555 | ) | | (6,243 | ) | | (7,051 | ) | | (13,849 | ) |
Balance, September 30, 2017 | | $ | — |
|
| $ | 126 |
| | $ | 1,423 |
| | $ | 1,549 |
| |
Balance, June 30, 2018 | | | $ | 3,970 |
|
| $ | 716 |
| | $ | — |
| | $ | 4,686 |
|
The components of our restructuring accruals, by segment, were as follows:
| | | | Employee severance benefits | | Operating lease obligations | | | | Employee severance benefits | | Operating lease obligations | |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Corporate(1) | | Small Business Services | | Financial Services | | Total | | Small Business Services | | Financial Services | | Direct Checks | | Corporate(1) | | Small Business Services | | Total |
Balance, December 31, 2016 | | $ | 1,183 |
| | $ | 1,341 |
| | $ | 7 |
| | $ | 1,650 |
| | $ | — |
| | $ | — |
| | $ | 4,181 |
| |
Balance, December 31, 2017 | | | $ | 789 |
| | $ | 1,398 |
| | $ | 140 |
| | $ | 2,049 |
| | $ | 4 |
| | $ | 4,380 |
|
Restructuring charges | | 1,315 |
| | 876 |
| | — |
| | 1,405 |
| | 23 |
| | — |
| | 3,619 |
| | 697 |
| | 3,680 |
| | — |
| | 271 |
| | — |
| | 4,648 |
|
Restructuring reversals | | (199 | ) | | (89 | ) | | (4 | ) | | (304 | ) | | — |
| | — |
| | (596 | ) | | (48 | ) | | (39 | ) | | (3 | ) | | (140 | ) | | — |
| | (230 | ) |
Payments | | (1,979 | ) | | (1,628 | ) | | (3 | ) | | (2,032 | ) | | (13 | ) | | — |
| | (5,655 | ) | | (810 | ) | | (1,250 | ) | | (134 | ) | | (1,914 | ) | | (4 | ) | | (4,112 | ) |
Balance, September 30, 2017 | | $ | 320 |
| | $ | 500 |
|
| $ | — |
|
| $ | 719 |
|
| $ | 10 |
| | $ | — |
|
| $ | 1,549 |
| |
Cumulative amounts(2): | | |
| | |
| | |
| | |
| | |
| | | | |
| |
Balance, June 30, 2018 | | | $ | 628 |
| | $ | 3,789 |
|
| $ | 3 |
|
| $ | 266 |
|
| $ | — |
| | $ | 4,686 |
|
Cumulative amounts:(2) | | | |
| | |
| | |
| | |
| | |
| | |
|
Restructuring charges | | $ | 6,162 |
| | $ | 4,228 |
| | $ | 143 |
| | $ | 6,069 |
| | $ | 367 |
| | $ | 53 |
| | $ | 17,022 |
| | $ | 5,333 |
| | $ | 7,782 |
| | $ | 286 |
| | $ | 6,188 |
| | $ | 82 |
| | $ | 19,671 |
|
Restructuring reversals | | (869 | ) | | (248 | ) | | (6 | ) | | (684 | ) | | — |
| | — |
| | (1,807 | ) | | (402 | ) | | (114 | ) | | (9 | ) | | (611 | ) | | — |
| | (1,136 | ) |
Inter-segment transfer | | 41 |
| | (14 | ) | | — |
| | (27 | ) | | — |
| | — |
| | — |
| |
Payments | | (5,014 | ) | | (3,466 | ) | | (137 | ) | | (4,639 | ) | | (357 | ) | | (53 | ) | | (13,666 | ) | | (4,303 | ) | | (3,879 | ) | | (274 | ) | | (5,311 | ) | | (82 | ) | | (13,849 | ) |
Balance, September 30, 2017 | | $ | 320 |
| | $ | 500 |
|
| $ | — |
|
| $ | 719 |
|
| $ | 10 |
| | $ | — |
|
| $ | 1,549 |
| |
Balance, June 30, 2018 | | | $ | 628 |
| | $ | 3,789 |
|
| $ | 3 |
|
| $ | 266 |
|
| $ | — |
| | $ | 4,686 |
|
(1) As discussed in Note 14, corporate costs are allocated to our business segments. As such, the net corporate restructuring charges are reflected in the business segment operating income presented in Note 14 in accordance with our allocation methodology.
(2) Includes accruals related to our cost reduction initiatives for 20152016 through 2017.2018.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Chief Executive Officer (CEO) transition costs – In April 2018, we announced the upcoming retirement of Mr. Lee Schram, our CEO. Mr. Schram will continue to serve as CEO during the transition process and will remain employed under the terms of a transition agreement through March 1, 2019. Under the terms of the transition agreement, if Mr. Schram remains employed through March 1, 2019, assists with the transition, and complies with certain covenants, we will provide to Mr. Schram certain benefits, including a transition bonus in the amount of $2,000, accelerated vesting of certain restricted stock unit awards and continued vesting and settlement of a pro-rata portion of outstanding performance share awards to the extent such awards are earned based on the attainment of certain performance goals. We anticipate the modifications to Mr. Schram's share-based payment awards will result in expense of $2,088, which will be recognized through March 2019.
We also offered retention agreements to certain members of our management team under which each employee will be entitled to receive a cash bonus equal to his or her annual base salary or up to 1.5 times his or her annual base salary if he or she remains employed during the retention period, generally from July 1, 2018 to December 31, 2019, and complies with certain covenants. The retention bonus will be paid to an employee if his or her employment is terminated without cause before the end of the retention period. In addition, we are incurring costs related to the CEO transition process, such as executive search fees, travel and board of directors fees. CEO retirement and transition costs included within SG&A expense for the quarter and six months ended June 30, 2018 totaled $1,530, including the impact of modifications to Mr. Schram’s share-based payment awards.
Note 9: Income tax provision
Our effective income tax rate for the quarter ended September 30, 2017 was 41.2% compared to our annual effective income tax rate for 2016 of 32.6%. The significant change in the effective tax rate for the third quarter of 2017 was due primarilyon pre-tax income reconciles to the non-deductible portion of the goodwill impairment charge recorded during the quarter. The entire income tax effect of this item was reflected in our income tax provision for the third quarter of 2017 and resulted in an increase in our third quarter 2017 effectiveUnited States federal statutory tax rate of 7.1 points. 21% for 2018 and 35% for 2017 as follows:
|
| | | | | | |
| | Six Months Ended June 30, 2018 | | Year Ended December 31, 2017 |
Income tax at federal statutory rate | | 21.0 | % | | 35.0 | % |
State income tax expense, net of federal benefit | | 3.3 | % | | 2.7 | % |
Goodwill impairment charge | | — |
| | 1.5 | % |
Impact of the 2017 Act | | 0.1 | % | | (6.6 | %) |
Qualified production activities deduction | | — |
| | (3.2 | %) |
Net tax benefit of share-based compensation | | (1.1 | %) | | (1.6 | %) |
Other | | 0.7 | % | | (1.4 | %) |
Effective tax rate | | 24.0 | % | | 26.4 | % |
Further information regarding the asset impairment chargeimpact on our financial statements of the 2017 Act can be found in Note 7.2 and under the caption “Note 9: Income tax provision” in the Notes to Consolidated Financial Statements appearing in our 2017 Form 10-K.
Note 10: Postretirement benefits
We have historically provided certain health care benefits for a portion of our retired U.S.United States employees. In addition to our retiree health care plan, we also have a supplemental executive retirement plan in the United States. Further information regarding our postretirement benefit plans can be found under the caption “Note 12: Postretirement benefits” in the Notes to Consolidated Financial Statements appearing in our 2017 Form 10-K.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
regarding our postretirement benefit plans can be found under the caption “Note 12: Postretirement benefits” of the Notes to Consolidated Financial Statements appearing in the 2016 Form 10-K.
Postretirement benefit income for each period consisted of the following components:
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2018 | | 2017 | | 2018 | | 2017 |
Interest cost | | $ | 656 |
| | $ | 724 |
| | $ | 1,313 |
| | $ | 1,448 |
|
Expected return on plan assets | | (1,934 | ) | | (1,782 | ) | | (3,868 | ) | | (3,564 | ) |
Amortization of prior service credit | | (355 | ) | | (355 | ) | | (711 | ) | | (711 | ) |
Amortization of net actuarial losses | | 721 |
| | 909 |
| | 1,442 |
| | 1,819 |
|
Net periodic benefit income | | $ | (912 | ) | | $ | (504 | ) | | $ | (1,824 | ) | | $ | (1,008 | ) |
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | | 2017 | | 2016 | | 2017 | | 2016 |
Interest cost | | $ | 724 |
| | $ | 780 |
| | $ | 2,172 |
| | $ | 2,339 |
|
Expected return on plan assets | | (1,782 | ) | | (1,834 | ) | | (5,346 | ) | | (5,501 | ) |
Amortization of prior service credit | | (355 | ) | | (355 | ) | | (1,066 | ) | | (1,066 | ) |
Amortization of net actuarial losses | | 909 |
| | 949 |
| | 2,728 |
| | 2,848 |
|
Net periodic benefit income | | $ | (504 | ) | | $ | (460 | ) | | $ | (1,512 | ) | | $ | (1,380 | ) |
Effective January 1, 2018, we adopted ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,which required us to reclassify postretirement benefit income from cost of revenue and SG&A expense to other income in our consolidated statements of comprehensive income. Further information can be found in Note 2.
Note 11: Debt
Debt outstanding was comprised of the following:
| | (in thousands) | | September 30, 2017 | | December 31, 2016 | | June 30, 2018 | | December 31, 2017 |
Amount drawn on revolving credit facility | | $ | 450,000 |
| | $ | 428,000 |
| | $ | 765,000 |
| | $ | 413,000 |
|
Amount outstanding under term loan facility | | 305,250 |
| | 330,000 |
| | — |
| | 294,938 |
|
Capital lease obligations | | 1,818 |
| | 1,685 |
| | 1,804 |
| | 1,914 |
|
Long-term debt, principal amount | | 757,068 |
| | 759,685 |
| | 766,804 |
| | 709,852 |
|
Less unamortized debt issuance costs | | (579 | ) | | (927 | ) | | — |
| | (471 | ) |
Less current portion of long-term debt | | (42,057 | ) | | (35,952 | ) | | (765 | ) | | (44,121 | ) |
Long-term debt | | 714,432 |
| | 722,806 |
| | 766,039 |
| | 665,260 |
|
| | | | | |
Current portion of amount drawn under term loan facility | | 41,250 |
| | 35,063 |
| | — |
| | 43,313 |
|
Current portion of capital lease obligations | | 807 |
| | 889 |
| | 765 |
| | 808 |
|
Long-term debt due within one year, principal amount | | 42,057 |
| | 35,952 |
| | 765 |
| | 44,121 |
|
Less unamortized debt issuance costs | | (91 | ) | | (110 | ) | | — |
| | (81 | ) |
Long-term debt due within one year | | 41,966 |
| | 35,842 |
| | 765 |
| | 44,040 |
|
Total debt | | $ | 756,398 |
| | $ | 758,648 |
| | $ | 766,804 |
| | $ | 709,300 |
|
In March 2018, we entered into a revolving credit facility in the amount of $950,000, subject to increase under the credit agreement to an aggregate amount not exceeding $1,425,000. The credit facility matures in March 2023. Our previous credit facility agreement was terminated contemporaneously with our entry into the new credit facility and was repaid utilizing proceeds from the new credit facility. Our quarterly commitment fee ranges from 0.175% to 0.35% based on our leverage ratio. As of June 30, 2018, $765,000 was drawn on our revolving credit facility at a weighted-average interest rate of 3.24%. As of December 31, 2017, $413,000 was drawn on our previous revolving credit facility at a weighted-average interest rate of 2.98%. Our previous credit facility agreement also included a term loan facility. As of December 31, 2017, $294,938 was outstanding under the term loan facility at a weighted-average interest rate of 2.99%. This amount was repaid in March 2018, utilizing proceeds from the new revolving credit facility.
There are currently no limitations on the amount of dividends and share repurchases under the terms of our credit agreement. However, if our leverage ratio, defined as total debt less unrestricted cash to EBITDA, should exceed 2.75 to one, there would be an annual limitation on the amount of dividends and share repurchases under the terms of this agreement.repurchases.
As of September 30, 2017, we had a $525,000 revolving credit facility that matures in February 2019. Our quarterly commitment fee ranges from 0.20% to 0.40% based on our leverage ratio. As of September 30, 2017, $450,000 was drawn on our revolving credit facility at a weighted-average interest rate of 2.69%. As of December 31, 2016, $428,000 was drawn on our revolving credit facility at a weighted-average interest rate of 2.22%.
During 2016, we amended the credit agreement governing our credit facility to include a variable rate term loan facility in the aggregate amount of $330,000. We borrowed the full amount during the fourth quarter of 2016 using the proceeds to retire our senior notes due in 2020 and to partially fund the acquisition of FMCG Direct in December 2016. The term loan facility matures in February 2019 and requires periodic principal payments throughout the term of the loan. Interest is paid weekly and we may prepay the term loan facility in full or in part at our discretion. Amounts repaid may not be reborrowed. As of September 30, 2017, $305,250 was outstanding under the term loan facility at a weighted-average interest rate of 2.70%. As of December 31, 2016, $330,000 was outstanding under the term loan facility at a weighted-average interest rate of 2.27%.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Borrowings under the credit agreement are collateralized by substantially all of our personal and intangible property. The credit agreement governing our credit facility contains customary covenants regarding limits on levels of subsidiary indebtedness and capital expenditures, liens, investments, acquisitions, certain mergers, certain asset sales outside the ordinary course of business, and change in control as defined in the agreement. The agreement also containsrequires us to maintain certain financial covenants regarding ourratios, including a maximum leverage ratio of 3.5 and a minimum ratio of consolidated earnings before interest coverage and liquidity.taxes to consolidated interest expense, as defined in the credit agreement, of 3.0.
Daily average amounts outstanding under our current and previous credit facility were as follows:
| | (in thousands) | | Nine Months Ended September 30, | | Year Ended December 31, 2016 | | Six Months Ended June 30, 2018 | | Year Ended December 31, 2017 |
Revolving credit facility: | | | | | | | | |
Daily average amount outstanding | | $ | 441,894 |
| | $ | 417,219 |
| | $ | 599,182 |
| | $ | 436,588 |
|
Weighted-average interest rate | | 2.48 | % | | 1.93 | % | | 3.01 | % | | 2.55 | % |
Term loan facility: | | | | | | | | |
Daily average amount outstanding | | $ | 320,118 |
| | $ | 52,381 |
| | $ | 128,331 |
| | $ | 315,862 |
|
Weighted-average interest rate | | 2.51 | % | | 1.52 | % | | 2.97 | % | | 2.57 | % |
As of SeptemberJune 30, 20172018, amounts were available for borrowing under our revolving credit facility as follows:
| | (in thousands) | | Total available | | Total available |
Revolving credit facility commitment | | $ | 525,000 |
| | $ | 950,000 |
|
Amount drawn on revolving credit facility | | (450,000 | ) | | (765,000 | ) |
Outstanding letters of credit(1) | | (10,361 | ) | | (10,128 | ) |
Net available for borrowing as of September 30, 2017 | | $ | 64,639 |
| |
Net available for borrowing as of June 30, 2018 | | | $ | 174,872 |
|
(1) We use standby letters of credit to collateralize certain obligations related primarily to our self-insured workers’ compensation claims, as well as claims for environmental matters, as required by certain states. These letters of credit reduce the amount available for borrowing under our revolving credit facility.
The aggregate debt maturities for our revolving line of credit and our term loan facility as of September 30, 2017 were as follows:
|
| | | | |
(in thousands) | | Debt maturities |
Remainder of 2017 | | $ | 10,313 |
|
2018 | | 43,313 |
|
2019 | | 701,624 |
|
Total | | $ | 755,250 |
|
In addition to amounts outstanding under our credit facility, we had capital lease obligations of $1,818$1,804 as of SeptemberJune 30, 20172018 and $1,685$1,914 as of December 31, 20162017 related to information technology hardware. The lease obligations will be paid through JuneNovember 2021. The related assets are included in property, plant and equipment in the consolidated balance sheets. Depreciation of the leased assets is included in depreciation expense in the consolidated statements of cash flows.
Note 12: Other commitments and contingencies
Indemnifications – In the normal course of business, we periodically enter into agreements that incorporate general indemnification language. These indemnificationsindemnification provisions generally encompass third-party claims arising from our products and services, including, without limitation, service failures, breach of security, intellectual property rights, governmental regulations and/or employment-related matters. Performance under these indemnities would generally be triggered by our breach of the terms of the contract. In disposing of assets or businesses, we often provide representations, warranties and/or indemnities to cover
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
various risks, including, for example, unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities and legal matters related to periods prior to disposition. We do not have the ability to estimate the potential liability from such indemnities because they relate to unknown conditions. However, we do not believe that any liability under these indemnities would have a material adverse effect on our financial position, annual results of operations or annual cash flows. We have recorded liabilities for known indemnifications related to environmental matters.
Environmental matters – We are currently involved in environmental compliance, investigation and remediation activities at some of our current and former sites, primarily printing facilities of our Financial Services and Small Business Services segments that have been sold. Remediation costs are accrued on an undiscounted basis when the obligations are either known or considered probable and can be reasonably estimated. Remediation or testing costs that result directly from the sale of an asset
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
and whichthat we would not have otherwise incurred are considered direct costs of the sale of the asset. As such, they are included in our measurement of the carrying value of the asset sold.
Accruals for environmental matters were $2,7172,383 as of SeptemberJune 30, 20172018 and $3,2062,646 as of December 31, 20162017, primarily related to facilities that have been sold.. These accruals are included in accrued liabilities and other non-current liabilities in the consolidated balance sheets. Accrued costs consist of direct costs of the remediation activities, primarily fees that will be paid to outside engineering and consulting firms. Although recorded accruals include our best estimates, our total costs cannot be predicted with certainty due to various factors, such as the extent of corrective action that may be required, evolving environmental laws and regulations and advances in environmental technology. Where the available information is sufficient to estimate the amount of the liability, that estimate is used. Where the information is only sufficient to establish a range of probable liability and no point within the range is more likely than any other, the lower end of the range is recorded. We do not believe that the range of possible outcomes could have a material effect on our financial condition, results of operations or liquidity. Environmental expense was $195not significant for the ninequarters or six months ended SeptemberJune 30, 2018 and 2017. The consolidated statement of comprehensive income for the nine months ended September 30, 2016 included a benefit from environmental matters of $1,759, as we reversed a portion of the liability for one of our sold facilities. During the second quarter of 2016, we determined that it was no longer probable that a portion of the estimated environmental remediation costs for this location would be incurred.
We purchased an insurance policy during 2002 that covers up to $10,000 of third-party pollution claims through 2032 at certain owned, leased and divested sites. We also purchased an insurance policy during 2009 that covers up to $15,000 of third-party pollution claims through April 2019 at certain other sites. These policies cover liability for claims of bodily injury or property damage arising from pollution events at the covered facilities, as well as remediation coverage should we be required by a governing authority to perform remediation activities at the covered sites. No accruals have been recorded in our consolidated financial statements for any of the events contemplated in these insurance policies. We do not anticipate significant net cash outlays for environmental matters during 2017.2018.
Self-insurance – We are self-insured for certain costs, primarily workers' compensation claims and medical and dental benefits for active employees and those employees on long-term disability. The liabilities associated with these items represent our best estimate of the ultimate obligations for reported claims plus those incurred, but not reported, and totaled $7,480$7,195 as of SeptemberJune 30, 20172018 and $6,999$7,679 as of December 31, 2016.2017. These accruals are included in accrued liabilities and other non-current liabilities in the consolidated balance sheets. Our workers' compensation liability is recorded at present value. The difference between the discounted and undiscounted liability was not significant as of SeptemberJune 30, 20172018 or December 31, 2016.2017.
Our self-insurance liabilities are estimated, in part, by considering historical claims experience, demographic factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future events and claims differ from these assumptions and historical trends.
Litigation – Recorded liabilities for legal matters were not material to our financial position, results of operations or liquidity during the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, and we do not believe that any of the currently identified claims or litigation will materially affect our financial position, results of operations or liquidity upon resolution. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, it may cause a material adverse impact on our financial position, results of operations or liquidity forin the period in which the ruling occurs or in future periods.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
Note 13: Shareholders’ equity
During the ninesix months ended SeptemberJune 30, 2017,2018, we repurchased a total of 709573 thousand shares for $50,070. A portion of these$39,996. These share repurchases were completed under an outstanding authorization from our board of directors to purchase up to 10 million shares of our common stock. As of December 31,in May 2016 65 thousand shares remained available for purchase under this authorization and we completed the purchase of all of these remaining shares during the quarter ended March 31, 2017.
The remainder of the share repurchases completed during the nine months ended September 30, 2017 were completed under an additional authorization from our board of directors for the repurchase of up to $300,000 of our common stock, effective at the conclusion of the previous authorization.stock. This additional authorization has no expiration date, and $254,656$199,731 remained available for purchase under this authorization as of SeptemberJune 30, 2017.2018.
Note 14: Business segment information
We operate 3 reportable business segments: Small Business Services, Financial Services and Direct Checks. Our business segments are generally organized by type of customer served and reflect the way we manage the company. Small Business Services promotes and sells products and services to small businesses via direct response mail and internet advertising; referrals from financial institutions, telecommunications clients and other partners;others; networks of Safeguard distributors and independent dealers; a direct sales force that focuses on selling to and through major accounts; and an outbound telemarketing
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
group. Financial Services' products and services are sold primarily through a direct sales force whichthat executes product and service supply contracts with our financial institution clients, nationwide, including banks, credit unions and financial services companies. In the case of check supply contracts, once the financial institution relationship is established, consumers may submit their check orders through their financial institution or over the phone or internet. Direct Checks sells products and services directly to consumers using direct marketing, including print advertising and search engine marketing and optimization strategies. All 3 segments operate primarily in the United States.States, although Small Business Services also has operations in Canada, Australia and portions of Europe.Europe, and Financial Services has operations in Canada.
Our product and service offerings are comprised of the following:
Checks – We remain one of the largest providers of checks in the United States. During 2016,2017, checks represented 39.1%39% of our Small Business Services segment's revenue, 53.8%43% of our Financial Services segment's revenue and 84.1%84% of our Direct Checks segment's revenue.
Marketing solutions and other services (MOS) – We offer products and services designed to meet our customers' sales and marketing needs, as well as various other service offerings. During 2017, MOS represented 34% of our Small Business Services segment's revenue, 55% of our Financial Services segment's revenue and 11% of our Direct Checks segment's revenue. Our MOS offerings generally consist of the following:
Small business marketing solutions – Our marketing products utilize digital printing and web-to-print solutions to provide printed marketing materials and promotional solutions, such as postcards, brochures, retail packaging supplies, apparel, greeting cards and business cards. Our web
Web services – These service offerings for small businesses include hosting and domain name services; logo and web design; hosting and other web services; search engine marketing and optimization; and payroll services.
Data-driven marketing programs, including email, mobilesolutions – These Financial Services offerings include outsourced marketing campaign targeting and social media. We also offerexecution and marketing analytics solutions that help our customers grow revenue through strategic targeting, lead optimization, retention and cross-selling services.
Treasury management solutions – These Financial Services solutions include remote deposit capture, receivables management, payment processing, and paperless treasury management, as well as software, hardware and digital imaging solutions.
Fraud, security, risk management and operational services – These service offerings include fraud protection and security services, online and offline payroll services, and electronic checks ("eChecks"). Our Financial Services segment also offers a suite of financial technology ("FinTech") solutions. These solutions include data-driven marketing solutions, including outsourced marketing campaign targeting and execution; treasury management solutions; and digital engagement solutions, including loyalty and rewards programs.
Forms, accessories and other products – Our Small Business Services segment provides printed forms to small businesses, including deposit tickets, billing forms, work orders, job proposals, purchase orders, invoices and personnel forms. This segment also offersforms, as well as computer forms compatible with accounting software packages commonly used by small businesses. Forms sold by our Financial Services and Direct Checks segments include deposit tickets and check registers.
Accessories and other products – Small Business Services also offers products designed to supply small business owners with theother customized documents necessary to efficiently manage their business,products, including envelopes, office supplies, ink stamps and labels. Our Financial Services and Direct Checks segments offer deposit tickets, check registers, checkbook covers, labels and ink stamps.
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
The following tables present revenue disaggregated by our product and service offerings:
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, 2018 |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Consolidated |
Checks | | $ | 119,786 |
| | $ | 57,591 |
| | $ | 26,196 |
| | $ | 203,573 |
|
Marketing solutions and other services: | | | | | | | | |
Small business marketing solutions | | 69,442 |
| | — |
| | — |
| | 69,442 |
|
Web services | | 40,850 |
| | — |
| | — |
| | 40,850 |
|
Data-driven marketing solutions | | — |
| | 37,327 |
| | — |
| | 37,327 |
|
Treasury management solutions | | — |
| | 28,558 |
| | — |
| | 28,558 |
|
Fraud, security, risk management and operational services | | 6,588 |
| | 12,596 |
| | 3,444 |
| | 22,628 |
|
Total MOS | | 116,880 |
| | 78,481 |
| | 3,444 |
| | 198,805 |
|
Forms, accessories and other products | | 81,076 |
| | 3,243 |
| | 1,547 |
| | 85,866 |
|
Total revenue | | $ | 317,742 |
| | $ | 139,315 |
| | $ | 31,187 |
| | $ | 488,244 |
|
| | | | | | | | |
| | Six Months Ended June 30, 2018 |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Consolidated |
Checks | | $ | 242,719 |
| | $ | 115,642 |
| | $ | 55,550 |
| | $ | 413,911 |
|
Marketing solutions and other services: | | | | | | | | |
Small business marketing solutions | | 136,204 |
| | — |
| | — |
| | 136,204 |
|
Web services | | 78,226 |
| | — |
| | — |
| | 78,226 |
|
Data-driven marketing solutions | | — |
| | 74,467 |
| | — |
| | 74,467 |
|
Treasury management solutions | | — |
| | 57,758 |
| | — |
| | 57,758 |
|
Fraud, security, risk management and operational services | | 13,104 |
| | 24,903 |
| | 7,301 |
| | 45,308 |
|
Total MOS | | 227,534 |
| | 157,128 |
| | 7,301 |
| | 391,963 |
|
Forms, accessories and other products | | 163,803 |
| | 7,186 |
| | 3,295 |
| | 174,284 |
|
Total revenue | | $ | 634,056 |
| | $ | 279,956 |
| | $ | 66,146 |
| | $ | 980,158 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
|
| | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, 2017 |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Consolidated |
Checks | | $ | 120,173 |
| | $ | 62,351 |
| | $ | 29,193 |
| | $ | 211,717 |
|
Marketing solutions and other services: | | | | | | | | |
Small business marketing solutions | | 63,168 |
| | — |
| | — |
| | 63,168 |
|
Web services | | 30,090 |
| | — |
| | — |
| | 30,090 |
|
Data-driven marketing solutions | | — |
| | 36,157 |
| | — |
| | 36,157 |
|
Treasury management solutions | | — |
| | 29,045 |
| | — |
| | 29,045 |
|
Fraud, security, risk management and operational services | | 6,610 |
| | 16,712 |
| | 3,747 |
| | 27,069 |
|
Total MOS | | 99,868 |
| | 81,914 |
| | 3,747 |
| | 185,529 |
|
Forms, accessories and other products | | 82,834 |
| | 3,480 |
| | 1,672 |
| | 87,986 |
|
Total revenue | | $ | 302,875 |
| | $ | 147,745 |
| | $ | 34,612 |
| | $ | 485,232 |
|
| | | | | | | | |
| | Six Months Ended June 30, 2017 |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Consolidated |
Checks | | $ | 244,310 |
| | $ | 127,726 |
| | $ | 61,854 |
| | $ | 433,890 |
|
Marketing solutions and other services: | | | | | | | | |
Small business marketing solutions | | 122,677 |
| | — |
| | — |
| | 122,677 |
|
Web services | | 60,334 |
| | — |
| | — |
| | 60,334 |
|
Data-driven marketing solutions | | — |
| | 68,231 |
| | — |
| | 68,231 |
|
Treasury management solutions | | — |
| | 51,819 |
| | — |
| | 51,819 |
|
Fraud, security, risk management and operational services | | 13,243 |
| | 33,323 |
| | 8,003 |
| | 54,569 |
|
Total MOS | | 196,254 |
| | 153,373 |
| | 8,003 |
| | 357,630 |
|
Forms, accessories and other products | | 170,434 |
| | 7,440 |
| | 3,604 |
| | 181,478 |
|
Total revenue | | $ | 610,998 |
| | $ | 288,539 |
| | $ | 73,461 |
| | $ | 972,998 |
|
Product revenue is recognized at a point in time. Total MOS revenue included product revenue of $70,496 and service revenue of $128,309 for the quarter ended June 30, 2018 and product revenue of $135,147 and service revenue of $256,816 for the six months ended June 30, 2018. The majority of our service revenue is recognized over time as services are provided.
The following tables present our revenue disaggregated by geography, based on where items are shipped or services are performed.
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Total |
Quarter Ended June 30, 2018: | | | | | | | | |
United States | | $ | 290,863 |
| | $ | 134,040 |
| | $ | 31,187 |
| | $ | 456,090 |
|
Foreign, primarily Canada and Australia | | 26,879 |
| | 5,275 |
| | — |
| | 32,154 |
|
Total revenue | | $ | 317,742 |
| | $ | 139,315 |
| | $ | 31,187 |
| | $ | 488,244 |
|
Six Months Ended June 30, 2018: | | | | | | | | |
United States | | $ | 580,822 |
| | $ | 269,206 |
| | $ | 66,146 |
| | $ | 916,174 |
|
Foreign, primarily Canada and Australia | | 53,234 |
| | 10,750 |
| | — |
| | 63,984 |
|
Total revenue | | $ | 634,056 |
| | $ | 279,956 |
| | $ | 66,146 |
| | $ | 980,158 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
|
| | | | | | | | | | | | | | | | |
(in thousands) | | Small Business Services | | Financial Services | | Direct Checks | | Total |
Quarter Ended June 30, 2017: | | | | | | | | |
United States | | $ | 283,522 |
| | $ | 142,540 |
| | $ | 34,612 |
| | $ | 460,674 |
|
Foreign, primarily Canada and Australia | | 19,353 |
| | 5,205 |
| | — |
| | 24,558 |
|
Total revenue | | $ | 302,875 |
| | $ | 147,745 |
| | $ | 34,612 |
| | $ | 485,232 |
|
Six Months Ended June 30, 2017: | | | | | | | | |
United States | | $ | 572,666 |
| | $ | 283,334 |
| | $ | 73,461 |
| | $ | 929,461 |
|
Foreign, primarily Canada and Australia | | 38,332 |
| | 5,205 |
| | — |
| | 43,537 |
|
Total revenue | | $ | 610,998 |
| | $ | 288,539 |
| | $ | 73,461 |
| | $ | 972,998 |
|
The accounting policies of the segments are the same as those described in the Notes to Consolidated Financial Statements included in the 2016our 2017 Form 10-K. We allocate corporate costs for our shared services functions to our business
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
segments, including costs of our executive management, human resources, supply chain, finance, information technology and legal functions. Generally, whereWhere costs incurred are directly attributable to a business segment, primarily within the areas of information technology, supply chain, finance and legal, those costs are charged directly to that segment. Because we use a shared services approach for many of our functions, certainDuring 2017, costs arethat were not directly attributable to a business segment. These costs aresegment were allocated to our businessthe segments based on segment revenue, as revenue isrevenue. Effective January 1, 2018, we completed a measuremore detailed analysis of our corporate costs and were able to allocate substantially all of the relative size and magnitudecosts directly to our business segments. The costs that were not directly attributable to a business segment, primarily certain human resources costs, were allocated to the segments based on the number of each segment and indicates the level of corporate shared services consumed byemployees in each segment. This change in our allocation methodology did not have a significant impact on the operating results of our business segments. Corporate assets are not allocated to the segments and consistconsisted primarily of property, plantlong-term investments and equipment; internal-use software; and inventories and suppliesassets related to our corporate shared services functions of manufacturing, information technology and real estate, as well as long-term investments.including property, plant and equipment; internal-use software; and inventories and supplies.
We are an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and the sharing of assets. Therefore, we do not represent that these segments, if operated independently, would report the operating income and other financial information shown.
The following is our segment information as of and for the quarters ended September 30, 2017 and 2016:
|
| | | | | | | | | | | | | | | | | | | | | | |
| | | | Reportable Business Segments | | | | |
(in thousands) | | | | Small Business Services | | Financial Services | | Direct Checks | | Corporate | | Consolidated |
Total revenue from external customers: | | 2017 | | $ | 306,408 |
| | $ | 157,407 |
| | $ | 33,854 |
| | $ | — |
| | $ | 497,669 |
|
| | 2016 | | 298,931 |
| | 123,033 |
| | 36,956 |
| | — |
| | 458,920 |
|
Operating income: | | 2017 | | 13,213 |
| | 29,347 |
| | 11,296 |
| | — |
| | 53,856 |
|
| | 2016 | | 50,670 |
| | 28,708 |
| | 12,914 |
| | — |
| | 92,292 |
|
Depreciation and amortization expense: | | 2017 | | 14,502 |
| | 15,935 |
| | 809 |
| | — |
| | 31,246 |
|
| | 2016 | | 13,315 |
| | 8,876 |
| | 868 |
| | — |
| | 23,059 |
|
Asset impairment charges: | | 2017 | | 46,630 |
| | — |
| | — |
| | — |
| | 46,630 |
|
| | 2016 | | — |
| | — |
| | — |
| | — |
| | — |
|
Total assets: | | 2017 | | 1,051,076 |
| | 692,511 |
| | 159,526 |
| | 276,867 |
| | 2,179,980 |
|
| | 2016 | | 1,075,661 |
| | 434,374 |
| | 160,624 |
| | 270,489 |
| | 1,941,148 |
|
Capital asset purchases: | | 2017 | | — |
| | — |
| | — |
| | 11,563 |
| | 11,563 |
|
| | 2016 | | — |
| | — |
| | — |
| | 10,031 |
| | 10,031 |
|
| | | | | | | | | | | | |
The following is our segment information as of and for the nine months ended September 30, 2017 and 2016: |
| | | | | | | | | | | | |
| | | | Reportable Business Segments | | | | |
(in thousands) | | | | Small Business Services | | Financial Services | | Direct Checks | | Corporate | | Consolidated |
Total revenue from external customers: | | 2017 | | $ | 917,406 |
| | $ | 445,946 |
| | $ | 107,314 |
| | $ | — |
| | $ | 1,470,666 |
|
| | 2016 | | 877,384 |
| | 374,511 |
| | 116,965 |
| | — |
| | 1,368,860 |
|
Operating income: | | 2017 | | 120,633 |
| | 76,500 |
| | 35,555 |
| | — |
| | 232,688 |
|
| | 2016 | | 150,776 |
| | 84,467 |
| | 40,640 |
| | — |
| | 275,883 |
|
Depreciation and amortization expense: | | 2017 | | 42,158 |
| | 46,709 |
| | 2,430 |
| | — |
| | 91,297 |
|
| | 2016 | | 38,195 |
| | 26,888 |
| | 2,628 |
| | — |
| | 67,711 |
|
Asset impairment charges: | | 2017 | | 54,880 |
| | — |
| | — |
| | — |
| | 54,880 |
|
| | 2016 | | — |
| | — |
| | — |
| | — |
| | — |
|
Total assets: | | 2017 | | 1,051,076 |
| | 692,511 |
| | 159,526 |
| | 276,867 |
| | 2,179,980 |
|
| | 2016 | | 1,075,661 |
| | 434,374 |
| | 160,624 |
| | 270,489 |
| | 1,941,148 |
|
Capital asset purchases: | | 2017 | | — |
| | — |
| | — |
| | 34,351 |
| | 34,351 |
|
| | 2016 | | — |
| | — |
| | — |
| | 32,215 |
| | 32,215 |
|
DELUXE CORPORATION
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
The following is our segment information as of and for the quarters ended June 30, 2018 and 2017:
|
| | | | | | | | | | | | | | | | | | | | | | |
| | | | Reportable Business Segments | | | | |
(in thousands) | | | | Small Business Services | | Financial Services | | Direct Checks | | Corporate | | Consolidated |
Total revenue from external customers: | | 2018 | | $ | 317,742 |
| | $ | 139,315 |
| | $ | 31,187 |
| | $ | — |
| | $ | 488,244 |
|
| | 2017 | | 302,875 |
| | 147,745 |
| | 34,612 |
| | — |
| | 485,232 |
|
Operating income: | | 2018 | | 58,642 |
| | 13,980 |
| | 10,201 |
| | — |
| | 82,823 |
|
| | 2017 | | 54,521 |
| | 26,609 |
| | 11,697 |
| | — |
| | 92,827 |
|
Depreciation and amortization expense: | | 2018 | | 16,154 |
| | 15,422 |
| | 800 |
| | — |
| | 32,376 |
|
| | 2017 | | 13,439 |
| | 16,161 |
| | 814 |
| | — |
| | 30,414 |
|
Asset impairment charges: | | 2018 | | — |
| | — |
| | — |
| | — |
| | — |
|
| | 2017 | | 2,954 |
| | — |
| | — |
| | — |
| | 2,954 |
|
Total assets: | | 2018 | | 1,165,781 |
| | 662,076 |
| | 157,649 |
| | 307,738 |
| | 2,293,244 |
|
| | 2017 | | 1,042,694 |
| | 697,900 |
| | 159,246 |
| | 268,915 |
| | 2,168,755 |
|
Capital asset purchases: | | 2018 | | — |
| | — |
| | — |
| | 14,006 |
| | 14,006 |
|
| | 2017 | | — |
| | — |
| | — |
| | 11,767 |
| | 11,767 |
|
| | | | | | | | | | | | |
The following is our segment information as of and for the six months ended June 30, 2018 and 2017: |
| | | | | | | | | | | | |
| | | | Reportable Business Segments | | | | |
(in thousands) | | | | Small Business Services | | Financial Services | | Direct Checks | | Corporate | | Consolidated |
Total revenue from external customers: | | 2018 | | $ | 634,056 |
| | $ | 279,956 |
| | $ | 66,146 |
| | $ | — |
| | $ | 980,158 |
|
| | 2017 | | 610,998 |
| | 288,539 |
| | 73,461 |
| | — |
| | 972,998 |
|
Operating income: | | 2018 | | 117,541 |
| | 31,954 |
| | 21,036 |
| | — |
| | 170,531 |
|
| | 2017 | | 106,782 |
| | 46,854 |
| | 24,189 |
| | — |
| | 177,825 |
|
Depreciation and amortization expense: | | 2018 | | 31,592 |
| | 30,316 |
| | 1,609 |
| | — |
| | 63,517 |
|
| | 2017 | | 27,656 |
| | 30,774 |
| | 1,621 |
| | — |
| | 60,051 |
|
Asset impairment charges: | | 2018 | | 2,149 |
| | — |
| | — |
| | — |
| | 2,149 |
|
| | 2017 | | 8,250 |
| | — |
| | — |
| | — |
| | 8,250 |
|
Total assets: | | 2018 | | 1,165,781 |
| | 662,076 |
| | 157,649 |
| | 307,738 |
| | 2,293,244 |
|
| | 2017 | | 1,042,694 |
| | 697,900 |
| | 159,246 |
| | 268,915 |
| | 2,168,755 |
|
Capital asset purchases: | | 2018 | | — |
| | — |
| | — |
| | 28,040 |
| | 28,040 |
|
| | 2017 | | — |
| | — |
| | — |
| | 22,788 |
| | 22,788 |
|
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) includes the following sections:
Executive Overview that discusses what we do, our operating results at a high level and our financial outlook for the year.year;
Consolidated Results of Operations, Restructuring and CEO Transition Costs, and Segment Results that includes a more detailed discussion of our revenue and expenses.expenses;
Cash Flows and Liquidity, Capital Resources and Other Financial Position Information that discusses key aspects of our cash flows, capital structure and financial position.position;
Off-Balance Sheet Arrangements, Guarantees and Contractual Obligations that discusses our financial commitments.commitments; and
Critical Accounting Policies that discusses the policies we believe are important to understanding the assumptions and judgments underlying our financial statements.
You shouldPlease note that this MD&A discussion contains forward-looking statements that involve risks and uncertainties. Known material risks are discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 20162017 (the "2016"2017 Form 10-K") and are incorporated into this Item 2 of this report on Form 10-Q as if fully stated herein. Although we have attempted to compile a comprehensive list of these important factors, we want to caution you that other factors may prove to be important in affecting future operating results. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or combination of factors may have on our business. You areWe further cautionedcaution you not to place undue reliance on those forward-looking statements because they speak only of our views as of the date the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The Private Securities Litigation Reform Act of 1995 (the Reform Act)"Reform Act") provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information. We are filing this cautionary statement in connection with the Reform Act. When we use the words or phrases “should result,” “believe,” “intend,” “plan,” “are expected to,” “targeted,” “will continue,” “will approximate,” “is anticipated,” “estimate,” “project,” “outlook,” "forecast" or similar expressions in this Quarterly Report on Form 10-Q, in future filings with the Securities and Exchange Commission, in our press releases and in oral statements made by our representatives, they indicate forward-looking statements within the meaning of the Reform Act.
Our unaudited consolidated statements of comprehensive income for the quarter and six months ended June 30, 2017 have been revised to reflect the adoption of Accounting Standards Update (ASU) No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. In accordance with this standard, we reclassified the entire amount of our net periodic benefit income from cost of revenue and selling, general and administrative (SG&A) expense to other income in our consolidated statements of comprehensive income. This revision had no impact on net income.
EXECUTIVE OVERVIEW
Checks – We remain one of the largest providers of checks in the United States. During 2016, checks represented 39.1% of ouroperate 3 reportable business segments: Small Business Services, segment's revenue, 53.8% of our Financial Services segment's revenue and 84.1% of our Direct Checks segment's revenue.
Marketing solutions and other services – We offer products and services designed to meet our customers' sales and marketing needs, as well as various other service offerings. Our marketing products utilize digital printing and web-to-print solutions to provide promotional solutions such as postcards, brochures, retail packaging supplies, apparel, greeting cards and business cards. Our web services offerings include logo and web design; hosting and other web services; search engine optimization; and marketing programs, including email, mobile and social media. We also offer fraud protection and security services, online and offline payroll services, and electronic checks ("eChecks"). Our Financial Services segment also offers a suite of financial technology ("FinTech") solutions. These solutions include data-driven marketing solutions, including outsourced marketing campaign targeting and execution; treasury management solutions; and digital engagement solutions, including loyalty and rewards programs.
Forms – Our Small Business Services segment is a leading provider of printed forms to small businesses, including deposit tickets, billing forms, work orders, job proposals, purchase orders, invoices and personnel forms. This segment also offers computer forms compatible with accounting software packages commonly used by small businesses. Forms sold by our Financial Services and Direct ChecksChecks. Our business segments include deposit ticketsare generally organized by type of customer served and check registers.reflect the way we manage the company. Information regarding our product and service offerings can be found under the caption "Note 14: Business segment information" in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Accessories and other products – Small Business Services offers products designed to provide small business owners with the customized documents necessary to efficiently manage their business, including envelopes, office supplies, stamps and labels. Our Financial Services and Direct Checks segments offer checkbook covers and stamps.
ThroughoutOver the past several years, we have focused on opportunities to increase revenue and operating income while maintaining strong operating margins, despite the continuing secular decline in check and forms usage. These opportunities have included new product and service offerings, brand awareness and positioning initiatives, investing in technology for our service offerings, enhancing our information technology capabilities and infrastructure, improving customer segmentation, extending the reach of our sales channel reach,channels, and reducing costs. In addition, we invested in various acquisitions that extend the range of products and services we offer to our customers, primarily marketing solutions and other services (MOS) offerings. Information about our acquisitions can be found under the captions "Note 6: Acquisitions" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report and under the caption "Note 5: Acquisitions" ofin the Notes to Consolidated Financial Statements appearing in the 2016our 2017 Form 10-K. During the remainder of 2017,2018, we plan to continue our focus in these areas, with an emphasis on profitable revenue growth and increasing the mix of MOS revenue, primarily data-driven marketing solutions, treasury management solutions and other services revenue.web services. We also plan to continue to assess small-to-medium-sized acquisitions that complement our large customer bases, with a focus on marketing solutions and other services.MOS offerings. A more detailed discussion of our business strategies can be found under the caption "Business Segments" appearing in Item 1 of the 2016our 2017 Form 10-K.
Earnings for the first ninesix months of 2017,2018, as compared to the first ninesix months of 2016, decreased2017, increased due to pre-tax asset impairment charges of $54.9 milliona lower effective income tax rate in 2017, volume reductions for personal and business checks and forms2018, largely due primarily to the continuing decline in checkTax Cuts and forms usage, investments in revenue growth opportunities, and increased performance-based compensation, medical and legal costs, as well as higher material and delivery rates in 2017. These decreases in earnings were partially offset byJobs Act of 2017 (the "2017 Act"), the benefit of price increases and continuing initiatives to reduce our cost structure, primarily within our sales, marketing and fulfillment organizations, and aggregateas well as lower asset impairment charges in 2018. In addition, we recognized gains of $8.7 million from the salesales of businesses and customer lists within Small Business Services of $11.1 million, compared to gains recognized in the first half of 2017 of $6.8 million. These increases in earnings were partially offset by volume reductions for personal and business checks and forms due primarily to the continuing secular decline in check and forms usage, lower Deluxe Rewards revenue driven primarily by the
loss of Verizon Communications Inc. as a customer, higher restructuring costs, and continued pricing allowances within Financial Services.
Business Challenges/Market Risks
Our business, consolidated results of operations, financial condition and cash flows could be adversely affected by various risks and uncertainties. We have disclosed all known material risks in Item 1A of our 20162017 Form 10-K, including discussion of the declining market for checks and business forms, competition, factors affecting our financial institution clients, data security risks, risks related to acquisitions, and the impact of economic conditions.conditions and the ability to attract and retain key employees. All of these factors could cause our actual results to differ materially from the statements we make from time to time regarding our expected future results, including, but not limited to, forecasts regarding estimated revenue, marketing solutions and other servicesMOS revenue, earnings per share, cash provided by operating activities and expected cost savings. There were no significant changes in these factors during the first nine monthshalf of 2017.2018.
Cost Reduction Initiatives
We anticipate that we will realize net cost reductions of approximately $45.0$55.0 million in 2017,2018, as compared to our 20162017 results of operations, primarily from our sales, marketing and fulfillment organizations. Approximately 70%75% of these savings are expected to impact selling, general and administrative (SG&A)SG&A expense, with the remaining 30%25% affecting cost of revenue. Further information regarding our cost reduction initiatives can be found in the MD&A section of the 2016our 2017 Form 10-K.
Outlook for 20172018
We anticipate that consolidated revenue will be between $1.965$2.045 billion and $1.975$2.065 billion for 2017,2018, compared to $1.8491.966 billion for 2016.2017. In Small Business Services, we expect revenue to increase approximatelybetween 4% and 5% compared to 20162017 revenue of $1.1961.240 billion. Volume declines in coreprinted business products and our strategic decision to eliminate certain low margin business are expected to be more than offset by growth in our online, dealer and major accounts channels, price increases, increased revenue from our marketing solutions and other servicesMOS offerings and continued small-to-medium-sized tuck-in acquisitions. In Financial Services, we expect revenue to increase between 18%8% and 19%9% compared to 20162017 revenue of $500.0585.3 million. We expect increased revenue from marketing solutions and other services,MOS, including data-driven marketing solutions and treasury management solutions, as well as continued small-to-medium-sized tuck-inadditional acquisitions. Our outlook includes incrementalIn June 2018, we entered into a definitive agreement to acquire a treasury management business that we expect will deliver approximately $36.0 million of revenue fromin 2018. The regulatory conditions related to the acquisitions of FMCG Directacquisition have been satisfied, and Data Support Systems inwe anticipate that the fourthacquisition will close during the third quarter of 2016 and RDM Corporation in the second quarter2018. We are also projecting revenue of 2017.approximately $21.0 million from additional acquisitions. We expect these revenue increases to be partially offset by year-over-year secular check order declines of approximately 5% and an7%, the expected loss of approximately $9.0$11.0 million in Deluxe Rewards revenue driven byprimarily due to the loss of Verizon Communications Inc. as a customer, as well as pricing adjustments. We alsoand we expect some impact
from pricing pressure in our check programs. In Direct Checks, we expect revenue to decline approximately 9%11% compared to 20162017 revenue of $153.3140.5 million, driven primarily by secular check order volume declines resulting from reduced check usage.
We expect that 20172018 diluted earnings per share will be between $4.37$5.23 and $4.42,$5.35, including charges of $0.88$0.45 per share primarily related to restructuring, transaction and Chief Executive Officer (CEO) transition costs, as well as the asset impairment charge recorded in the first quarter of 2018. This estimate of diluted earnings per share for 2018 compares to $4.72 for 2017, which included total net charges of $0.55 per share related to the asset impairment charges as well asand restructuring costs and transaction costs, related to acquisitions. This compares to $4.65 for 2016, which included total charges of $0.32 per share related topartially offset by a loss on early debt extinguishment inbenefit from federal tax reform under the fourth quarter of 2016, as well as restructuring costs and transaction costs related to acquisitions.2017 Act. We expect that the benefits of additional cost reduction activities will be partially offset by the continuing secular decline in check and forms usage, and continued investments in revenue growth opportunities, including brand awareness,technology and integrations, primarily in data-driven marketing, solutionstreasury management, and otherweb services, offers,as well as investments in data-driven marketing and enhanced internet capabilities.treasury management talent, technology and process improvements to accelerate strategic sales and drive more development innovation. We also expect material costs and delivery rates to increase. We estimate that our annual effective tax rate for 20172018 will be approximately 32.5%, compared to 32.6% for 2016.24.5%.
We anticipate that net cash provided by operating activities will be between $340.0$360.0 million and $345.0$370.0 million in 2018, compared to $338.4 million in 2017, compared to $319.3 million in 2016, driven by stronger operating performanceearnings, lower income tax payments and lower interest payments,medical costs, partially offset by higher income tax and medicalinterest payments. We anticipate contract acquisition payments for prepaid product discounts of approximately $26.0$27.0 million in 2017,2018, and we estimate that capital spending will be approximately $45.0$55.0 million in 2017,2018, as we continue to invest in key revenue growth initiatives and order fulfillment and information technology infrastructure.
We believe that cash generated by operating activities, along with availability under our revolving credit facility, will be sufficient to support our operations for the next 12 months, including dividend payments, capital expenditures, required debt principal and interest payments, and periodic share repurchases, as well as small-to-medium-sizedlikely acquisitions. As of June 30, 2018, $174.9 million was
available for borrowing under our revolving credit facility. We expect to maintain a disciplined approach to capital deployment that focuses on our need to continue investing in initiatives to drive revenue growth, including small-to-medium-sized acquisitions. We anticipate that our board of directors will maintain our current dividend level. However, dividends are approved by the board of directors on a quarterly basis, and thus are subject to change. As of September 30, 2017, $64.6 million was available for borrowing under our revolving credit facility. To the extent we generate excess cash, we plan to opportunistically repurchase common shares and/or reduce the amount outstanding under our credit facility agreement.facility.
CONSOLIDATED RESULTS OF OPERATIONS
Consolidated Revenue
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands, except per order amounts) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Total revenue | | $ | 497,669 |
| | $ | 458,920 |
| | 8.4 | % | | $ | 1,470,666 |
| | $ | 1,368,860 |
| | 7.4 | % | | $ | 488,244 |
| | $ | 485,232 |
| | 0.6 | % | | $ | 980,158 |
| | $ | 972,998 |
| | 0.7 | % |
Orders(1) | | 12,595 |
| | 12,912 |
| | (2.5 | %) | | 37,643 |
| | 39,173 |
| | (3.9 | %) | | 11,951 |
| | 12,162 |
| | (1.7 | %) | | 23,960 |
| | 25,048 |
| | (4.3 | %) |
Revenue per order | | $ | 39.51 |
| | $ | 35.54 |
| | 11.2 | % | | $ | 39.07 |
| | $ | 34.94 |
| | 11.8 | % | | $ | 40.85 |
| | $ | 39.90 |
| | 2.4 | % | | $ | 40.91 |
| | $ | 38.85 |
| | 5.3 | % |
(1) Orders is our company-wide measure of volume and includes both products and services.
The increase in total revenue for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, was driven primarily by incremental revenue from acquired businesses of approximately $51.8$17.2 million for the thirdsecond quarter of 20172018 and $136.4$34.8 million for the first nine monthshalf of 2017,2018, as well as Small Business Services price increases in all of our segments.increases. Information regarding our acquisitions can be found under the caption "Note 6: Acquisitions" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report and under the caption "Note 5: Acquisitions" ofin the Notes to Consolidated Financial Statements appearing in the 2016our 2017 Form 10-K. These increases in revenue were partially offset by lower order volume for both personal and business checks, as well as forms and accessories sold by Small Business Services. In addition, Financial Services Deluxe Rewards revenue declineddecreased $3.6 million for the second quarter of 2018 and $7.4 million for the first six months of 2018 due to the loss of Verizon Communications Inc. as a customer, and revenue was negatively impacted by continued pricing allowances within Financial Services.
Service revenue represented 25.4%26.2% of total revenue for the first nine monthshalf of 20172018 and 20.3%24.4% for the first nine monthshalf of 2016.2017. As such, the majority of our revenue is generated by product sales. We do not manage our business based on product versus service revenue. Instead, we analyze our products and services based on the following categories:
|
| | | | | | | | | | | | |
| | Quarter Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
Checks | | 42.4 | % | | 46.9 | % | | 43.9 | % | | 47.8 | % |
Marketing solutions and other services | | 40.2 | % | | 33.5 | % | | 37.9 | % | | 32.5 | % |
Forms | | 10.4 | % | | 11.8 | % | | 10.8 | % | | 11.6 | % |
Accessories and other products | | 7.0 | % | | 7.8 | % | | 7.4 | % | | 8.1 | % |
Total revenue | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
|
| | | | | | | | | | | | |
| | Quarter Ended June 30, | | Six Months Ended June 30, |
| | 2018 | | 2017 | | 2018 | | 2017 |
Checks | | 41.7 | % | | 43.6 | % | | 42.2 | % | | 44.6 | % |
Marketing solutions and other services: | | | | | | | | |
Small business marketing solutions | | 14.2 | % | | 13.0 | % | | 13.9 | % | | 12.6 | % |
Web services | | 8.4 | % | | 6.2 | % | | 8.0 | % | | 6.2 | % |
Data-driven marketing solutions | | 7.6 | % | | 7.4 | % | | 7.6 | % | | 7.0 | % |
Treasury management solutions | | 5.9 | % | | 6.0 | % | | 5.9 | % | | 5.4 | % |
Fraud, security, risk management and operational services | | 4.6 | % | | 5.6 | % | | 4.6 | % | | 5.6 | % |
Total MOS | | 40.7 | % | | 38.2 | % | | 40.0 | % | | 36.8 | % |
Forms, accessories and other products | | 17.6 | % | | 18.2 | % | | 17.8 | % | | 18.6 | % |
Total revenue | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
The number of orders decreased for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, driven by the impact of the continuing secular decline in check and forms usage, partially offset by growth in marketing solutions and other services,MOS, including the impact of acquisitions. Revenue per order increased for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, primarily due to the benefit of Small Business Services price increases and favorable product and service mix, partially offset by the impact of Financial Services continued pricing allowances.allowances in Financial Services.
Consolidated Cost of Revenue
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Total cost of revenue | | $ | 192,917 |
| | $ | 166,270 |
| | 16.0 | % | | $ | 551,290 |
| | $ | 490,407 |
| | 12.4 | % | | $ | 190,201 |
| | $ | 179,368 |
| | 6.0 | % | | $ | 378,959 |
| | $ | 358,682 |
| | 5.7 | % |
Total cost of revenue as a percentage of total revenue | | 38.8 | % | | 36.2 | % | | 2.6 | pts. | | 37.5 | % | | 35.8 | % | | 1.7 | pts. | | 39.0 | % | | 37.0 | % | | 2.0 | pts. | | 38.7 | % | | 36.9 | % | | 1.8 | pts. |
Cost of revenue consists primarily of raw materials used to manufacture our products, shipping and handling costs, third-party costs for outsourced products and services, payroll and related expenses, information technology costs, depreciation and amortization of assets used in the production process and in support of ourdigital service offerings, and related overhead.
The increase in total cost of revenue for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, was primarily attributable to the increase in revenue, including incremental costs of acquired businesses of approximately $31.4$7.5 million for the thirdsecond quarter of 20172018 and $80.0$15.1 million for the first nine monthshalf of 2017.2018. In addition, delivery rates and material costs increased in 2017, and results for the first nine months of 2016 included a benefit of $2.1 million related to an adjustment to our environmental remediation liabilities.2018. Partially offsetting these increases in total cost of revenue was the impact of lower order volume for both personal and business checks, as well as forms and accessories sold by Small Business Services, and favorable product mix.Services. In addition, total cost of revenue decreased due to manufacturing efficiencies and other benefits resulting from our continued cost reduction initiatives of approximately $3.0$4.0 million for the thirdsecond quarter of 20172018 and $9.0$6.0 million for the first nine monthshalf of 2017.2018. Total cost of revenue as a percentage of total revenue increased in both periods, as compared to 2017, in large part due to the increase in service revenues.
Consolidated Selling, General & Administrative Expense
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
SG&A expense | | $ | 202,999 |
| | $ | 198,365 |
| | 2.3 | % | | $ | 628,100 |
| | $ | 598,563 |
| | 4.9 | % | | $ | 209,585 |
| | $ | 208,656 |
| | 0.4% | | $ | 420,739 |
| | $ | 425,800 |
| | (1.2%) |
SG&A expense as a percentage of total revenue | | 40.8 | % | | 43.2 | % | | (2.4 | ) pts. | | 42.7 | % | | 43.7 | % | | (1.0 | ) pts. | | 42.9 | % | | 43.0 | % | | (0.1) pts. | | 42.9 | % | | 43.8 | % | | (0.9) pts. |
The increase in SG&A expense was virtually unchanged for the thirdsecond quarter of 2017,2018, as compared to the thirdsecond quarter of 2016,2017. The small SG&A increase was driven primarily bydue to incremental costs of acquired businesses of approximately $15.5$8.2 million, as well as investments in various revenue growth opportunities, including increased spending on brand awareness initiatives, as well as an increase in performance-based compensationhigher benefits expense driven primarily by the timing of approximately $1.3vacations, CEO transition costs of $1.5 million and increased medical costs in 2017.a higher average Small Business Services commission rate. These increases in SG&A expense were partially offset by various expense reduction initiatives of approximately $9.0$11.5 million, primarily within our sales and marketing organizations,organizations. Also, during the second quarter of 2018, we recognized gains from sales of a business and a $1.9 million gain from the sale of businessescustomer lists within our Small Business Services segment.of $3.9 million. Further information regarding the businessthese asset sales can be found in the discussion of assets held for sale under the caption "Note 3:
Supplemental balance sheet information" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
The increasedecrease in SG&A expense for the first nine monthshalf of 2017,2018, as compared to the first nine months of 2016, was driven primarily by incremental operating expenses of acquired businesses of approximately $49.9 million, as well as investments in various revenue growth opportunities, including higher financial institution commission rates, as well as an increase in performance-based compensation of approximately $2.5 million. In addition, Financial Services incurred legal settlement and expenses of $2.5 million in the first quarterhalf of 2017, and medical costs increased in 2017. These increases were partially offset bywas due to various expense reduction initiatives of approximately $24.0$21.0 million, primarily within our sales and marketing organizations and an $8.7a $2.8 million gaindecrease in medical costs. Also, during the first half of 2018, we recognized gains from the salesales of businesses and customer lists within our Small Business Services segment.of $11.1 million, compared to gains recognized in the first half of 2017 of $6.8 million. Further information regarding the businessthese asset sales can be found in the discussion of assets held for sale under the caption "Note 3: Supplemental balance sheet information" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. These decreases in SG&A expense were partially offset by incremental costs of acquired businesses of $17.0 million, a higher average Small Business Services commission rate and CEO transition costs of $1.5 million.
Net Restructuring Charges
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Net restructuring charges | | $ | 1,267 |
| | $ | 1,993 |
| | $ | (726 | ) | | $ | 3,708 |
| | $ | 4,007 |
| | $ | (299 | ) | | $ | 5,635 |
| | $ | 1,427 |
| | $ | 4,208 |
| | $ | 7,780 |
| | $ | 2,441 |
| | $ | 5,339 |
|
We recorded net restructuring charges related to the cost reduction initiatives discussed under Executive Overview. The net charges for each period related primarily to costs of our restructuring and integration activities such as employee severance
benefits, information technology costs, employee and equipment moves, training and travel. Further information can be found under Restructuring and CEO Transition Costs.
Asset Impairment Charges
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Asset impairment charges | | $ | 46,630 |
| | $ | — |
| | $ | 46,630 |
| | $ | 54,880 |
| | $ | — |
| | $ | 54,880 |
| | $ | — |
| | $ | 2,954 |
| | $ | (2,954 | ) | | $ | 2,149 |
| | $ | 8,250 |
| | $ | (6,101 | ) |
During the thirdfirst quarter of 2018, we recorded a pre-tax asset impairment charge of $2.1 million related to a Small Business Services customer list intangible asset. Based on changes in the customer base of one of our small business distributors, we concluded that the customer list asset was impaired and had a fair market value of $0 as of March 31, 2018.
During the first quarter of 2017, we recorded a pre-tax asset impairment chargescharge of $46.6 million within Small Business Services related to goodwill, the discontinued NEBS trade name and other non-current assets, primarily internal-use software. Further information regarding these charges can be found under the caption "Note 7: Fair value measurements" of the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. During the nine months ended September 30, 2017, we also recorded pre-tax asset impairment charges of $8.3$5.3 million related to a small business distributor that was sold during the second quarter of 2017. Further information regarding these chargesThis impairment charge reduced the carrying value of the business to its estimated fair value less costs to sell, as we negotiated the sale of the business. During the second quarter of 2017, we recorded an additional pre-tax asset impairment charge of $3.0 million as we finalized the sale of this business, resulting in a total pre-tax asset impairment charge of $8.3 million for the six months ended June 30, 2017.
Interest Expense
|
| | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Interest expense | | $ | 6,130 |
| | $ | 5,258 |
| | 16.6% | | $ | 11,708 |
| | $ | 10,087 |
| | 16.1% |
Weighted-average debt outstanding | | 746,875 |
| | 761,546 |
| | (1.9%) | | 729,378 |
| | 765,935 |
| | (4.8%) |
Weighted-average interest rate | | 3.0 | % | | 2.5 | % | | 0.5 pts. | | 3.0 | % | | 2.4 | % | | 0.6 pts. |
The increase in interest expense for the second quarter and first half of 2018, as compared to the same periods in 2017, was primarily driven by our higher weighted-average interest rate during 2018, partially offset by the lower weighted-average debt level in each period.
Income Tax Provision
|
| | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Income tax provision | | $ | 18,922 |
| | $ | 29,240 |
| | (35.3%) | | $ | 39,003 |
| | $ | 53,405 |
| | (27.0%) |
Effective income tax rate | | 23.9 | % | | 32.9 | % | | (9.0) pts. | | 24.0 | % | | 31.4 | % | | (7.4) pts. |
The decrease in our effective tax rate for the second quarter and first half of 2018, as compared to the same periods in 2017, was driven in large part by the impact of federal tax reform under the 2017 Act. This legislation lowered the federal statutory tax rate 14.0 points, effective January 1, 2018. Partially offsetting this decrease in our tax rate was the elimination of the production activities deduction for 2018, favorable adjustments in 2017 related to the tax basis in a small business distributor held for sale, a lower federal benefit of state income taxes due to the lower federal tax rate, and a lower benefit from the tax effects of share-based compensation. A comparison of our effective tax rate for the first half of 2018, as compared to our annual effective tax rate for 2017, can be found in the discussion of assets held for sale under the caption "Note 3: Supplemental balance sheet information" of9: Income tax provision" in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Interest Expense
|
| | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change |
Interest expense | | $ | 5,708 |
| | $ | 4,855 |
| | 17.6 | % | | $ | 15,795 |
| | $ | 15,281 |
| | 3.4 | % |
Weighted-average debt outstanding | | 759,084 |
| | 613,244 |
| | 23.8 | % | | 763,802 |
| | 618,644 |
| | 23.5 | % |
Weighted-average interest rate | | 2.7 | % | | 3.0 | % | | (0.3 | ) pts. | | 2.5 | % | | 3.0 | % | | (0.5 | ) pts. |
The increase in interest expense for the third quarter and first nine months of 2017, as compared to the same periods in 2016, was primarily driven by our higher weighted-average debt level during 2017, partially offset by the lower weighted-average interest rate. The reduction in our weighted-average interest rate for both periods resulted from the fourth quarter 2016 retirement of long-term notes that carried a higher interest rate.
Income Tax Provision
|
| | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change |
Income tax provision | | $ | 20,146 |
| | $ | 29,516 |
| | (31.7 | %) | | $ | 73,551 |
| | $ | 86,783 |
| | (15.2 | %) |
Effective income tax rate | | 41.2 | % | | 33.5 | % | | 7.7 | pts. | | 33.6 | % | | 33.1 | % | | 0.5 | pts. |
The increase in our effective tax rate for the third quarter of 2017, as compared to the third quarter of 2016, was due primarily to the non-deductible portion of the goodwill impairment charge recorded during the quarter. The entire income tax effect of this item was reflected in our income tax provision for the third quarter of 2017 and resulted in an increase in our third quarter 2017 effective tax rate of 7.1 points. In addition, our 2017 tax rate increased due to a number of minor items.
The increase in our effective tax rate for the first nine months of 2017, as compared to the first nine months of 2016, was also due primarily to the impact of the third quarter goodwill impairment charge, which increased our effective tax rate for the first nine months of 2017 by 1.1 points. Partially offsetting this increase in our effective tax rate was the favorable impact of the asset impairment charges recorded during the first six months of 2017 related to a small business distributor that was sold during the second quarter of 2017. These impairment charges reduced the book basis of the assets relative to our tax basis in the stock of the small business distributor. In addition, tax benefits related to stock-based compensation were $3.3 million for the first nine months of 2017, compared to $1.7 million for the first nine months of 2016. We expect that our annual effective tax rate for 20172018 will be approximately 32.5%24.5%.
RESTRUCTURING AND CEO TRANSITION COSTS
Restructuring charges – We have recorded expenses related to our restructuring activities, including accruals consisting primarily of employee severance benefits, as well as costs that are expensed when incurred, including information technology costs, employee and equipment moves, training and travel. Our restructuring activities are driven by our cost reduction and integration initiatives, and includeincluding employee reductions in various functional areas, as well as the closing of facilities. During 2017, we closed a retail packaging sales location, a fulfillment facility, housing general office space and during 2016, we closed a printing facility, a call center, 2 warehouses and a facility housing general office space. administrative facilities.
Restructuring costs have been reduced by the reversal of severance accruals when fewer employees receive severance benefits than originally estimated.
Net restructuring charges for each period were as follows:
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands, except number of employees) | | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 | | 2018 | | 2017 |
Severance accruals | | $ | 1,248 |
| | $ | 1,824 |
| | $ | 3,596 |
| | $ | 3,870 |
| | $ | 3,804 |
| | $ | 1,240 |
| | $ | 4,648 |
| | $ | 2,348 |
|
Severance reversals | | (78 | ) | | (198 | ) | | (596 | ) | | (666 | ) | | (95 | ) | | (119 | ) | | (230 | ) | | (518 | ) |
Operating lease obligations | | — |
| | — |
| | 23 |
| | — |
| | — |
| | 23 |
| | — |
| | 23 |
|
Net restructuring accruals | | 1,170 |
| | 1,626 |
| | 3,023 |
| | 3,204 |
| | 3,709 |
| | 1,144 |
| | 4,418 |
| | 1,853 |
|
Other costs | | 72 |
| | 432 |
| | 669 |
| | 939 |
| | 2,662 |
| | 313 |
| | 4,275 |
| | 597 |
|
Net restructuring charges | | $ | 1,242 |
| | $ | 2,058 |
| | $ | 3,692 |
| | $ | 4,143 |
| | $ | 6,371 |
| | $ | 1,457 |
| | $ | 8,693 |
| | $ | 2,450 |
|
Number of employees included in severance accruals | | 30 |
| | 55 |
| | 80 |
| | 120 |
| | 80 |
| | 20 |
| | 105 |
| | 50 |
|
The majority of the employee reductions included in our restructuring accruals are expected to be completed in 2017,by the end of 2018, and we expect most of the related severance payments to be paid by mid-2018,mid-2019, utilizing cash from operations.
As a result of our employee reductions and facility closings, we expect to realize cost savings of approximately $2.0$3.0 million in total cost of revenue and $15.0$14.0 million in SG&A expense in 2017,2018, in comparison to our 20162017 results of operations, which representsrepresent a portion of the estimated $45.0$55.0 million of total net cost reductions we expect to realize in 2017.2018. Expense reductions consist primarily of labor costs. Information about the other initiatives driving our cost savings can be found in the MD&A section of the 2016our 2017 Form 10-K.
CEO transition costs – In April 2018, we announced the upcoming retirement of Mr. Lee Schram, our CEO. Mr. Schram will continue to serve as CEO during the transition process and will remain employed under the terms of a transition agreement through March 1, 2019. Under the terms of the transition agreement, if Mr. Schram remains employed through March 1, 2019, assists with the transition, and complies with certain covenants, we will provide to Mr. Schram certain benefits, including a transition bonus in the amount of $2.0 million. In addition, modifications were made to certain of his share-based payment awards. We also offered retention agreements to certain members of our management team under which each employee will be entitled to receive a cash bonus equal to his or her annual base salary or up to 1.5 times his or her annual base salary if he or she remains employed during the retention period, generally from July 1, 2018 to December 31, 2019, and complies with certain covenants. In addition, we are incurring costs related to the CEO transition process, such as executive search fees, travel and board of directors fees. CEO retirement and transition costs included within SG&A expense for the quarter and six months ended June 30, 2018, totaled $1.5 million. We estimate that CEO transition costs will total approximately $11.0 million. Expense of approximately $6.0 million is expected to be recorded in 2018 and approximately $5.0 million is expected to be recorded in 2019. Mr. Schram's transition bonus will be paid in the first quarter of 2019 and the majority of the management retention bonuses will be paid in the first quarter of 2020, utilizing cash from operations.
Further information regarding our restructuring chargesand CEO transition costs can be found under the caption “Note 8: Restructuring charges” ofand Chief Executive Officer transition costs” in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
SEGMENT RESULTS
Additional financial information regarding our business segments appears under the caption “Note 14: Business segment information” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Small Business Services
This segment's products and services are promoted through direct response mail and internet advertising; referrals from financial institutions, telecommunications clients and other partners;others; networks of Safeguard distributors and independent dealers; a direct sales force that focuses on selling to and through major accounts; and an outbound telemarketing group. Results for this segment were as follows:
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Total revenue | | $ | 306,408 |
| | $ | 298,931 |
| | 2.5 | % | | $ | 917,406 |
| | $ | 877,384 |
| | 4.6 | % | | $ | 317,742 |
| | $ | 302,875 |
| | 4.9 | % | | $ | 634,056 |
| | $ | 610,998 |
| | 3.8 | % |
Operating income | | 13,213 |
| | 50,670 |
| | (73.9 | %) | | 120,633 |
| | 150,776 |
| | (20.0 | %) | | 58,642 |
| | 54,521 |
| | 7.6 | % | | 117,541 |
| | 106,782 |
| | 10.1 | % |
Operating margin | | 4.3 | % | | 17.0 | % | | (12.7 | ) pts. | | 13.1 | % | | 17.2 | % | | (4.1 | ) pts. | | 18.5 | % | | 18.0 | % | | 0.5 | pts. | | 18.5 | % | | 17.5 | % | | 1.0 | pts. |
The increase in total revenue for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, was driven by incremental revenue from acquired businesses of approximately $12.7$17.1 million for the thirdsecond quarter of 20172018 and $47.7$29.2 million for the first nine monthshalf of 2017,2018, as well as the benefit of price increases. Information about our acquisitions can be found under the caption “Note 6: Acquisitions” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report and under the caption "Note 5: Acquisitions" ofin the Notes to Consolidated Financial Statements appearing in the 2016our 2017 Form 10-K. These increases in revenue were partially offset by lower order volume, primarily related to checks, forms and accessories, as secular check and forms usage continues to decline, as well as the strategic decision to eliminate low margin business.decline.
The decreaseincrease in operating income for the thirdsecond quarter of 2017,2018, as compared to the thirdsecond quarter of 2016,2017, was primarily due to pre-taxdriven by price increases, benefits of our cost reduction initiatives and a reduction in asset impairment charges of $46.6 million related to goodwill, the discontinued NEBS trade name and other non-current assets, primarily internal-use software. These charges reduced operating margin 15.2 points for the third quarter of 2017.$3.0 million. Further information regarding thesethe asset impairment charges can be found under the caption "Note 7: Fair value measurements" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. In addition, we recognized gains from sales of a business and customer lists in the second quarter of 2018 of $3.9 million. Further information regarding these asset sales can be found under the caption "Note 3: Supplemental balance sheet information" in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. The results of acquired businesses contributed operating income of $1.5 million for the second quarter of 2018, including acquisition-related amortization, but resulted in a 0.6 point decrease in operating margin. Partially offsetting these increases in operating income was impacted by the lower order volume for checks, forms and accessories; investmentsaccessories, driven by the continuing secular decline in various revenue growth opportunities, including increased spending on brand awareness initiatives;check and forms usage, higher benefits expense driven primarily by the timing of vacations, and higher performance-based compensation, medical costs andaverage commission, material and delivery rates. Partially offsetting these decreasesrates in 2018. In addition, restructuring charges increased $1.0 million for the second quarter of 2018, driven by our integration activities.
The increase in operating income werefor the first half of 2018, as compared to the first half of 2017, was primarily driven by price increases, and benefits of our cost reduction initiatives as well asand a $1.9 million gain from the sale of businessesreduction in 2017. The results of acquired businesses resulted in a slight increase in operating income for the third quarter of 2017, including acquisition-related amortization, but resulted in a 0.7 point decrease in operating margin for the third quarter of 2017.
The decrease in operating income for the first nine months of 2017, as compared to the first nine months of 2016, was primarily due to pre-tax asset impairment charges of $54.9$6.1 million related to goodwill, the discontinued NEBS trade name, a small business distributor that was sold during the second quarter of 2017, and other non-current assets, primarily internal-use software. These charges reduced operating margin 6.0 points for the first nine monthshalf of 2017.2018. Further information regarding thesethe asset impairment charges can be found under the caption "Note 7: Fair value measurements" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. In addition, we recognized gains from sales of businesses and customer lists in 2018 of $11.1 million, compared to gains of $6.8 million in 2017. Further information regarding these asset sales can be found under the caption "Note 3: Supplemental balance sheet information" in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. The results of acquired businesses contributed operating income of $2.3 million for the first half of 2018, including acquisition-related amortization, but resulted in a 0.5 point decrease in operating margin. In addition, medical costs decreased as compared to 2017. Partially offsetting these increases in operating income was impacted by lower order volume for checks, forms and accessories; investmentsaccessories, driven by the continuing secular decline in various revenue growth opportunities, includingcheck and forms usage, and higher financial institutionaverage commission, rates; higher performance-based compensation, medical costs and material and delivery rates; and a $1.4rates in 2018. In addition, restructuring charges increased $1.6 million benefit in 2016 related to an adjustment to our environmental remediation liabilities. Partially offsetting these decreases in operating income were price increases and benefits of our cost reduction initiatives, as well as an $8.7 million gain from the sale of businesses in 2017. The results of acquired businesses resulted in a slight increase in operating income for the first nine monthshalf of 2017, including acquisition-related amortization, but resulted in a 1.0 point decrease in operating margin for the first nine months of 2017.
2018, driven by our integration activities.
Financial Services
Financial Services' products and services are sold primarily through a direct sales force, which executes product and service supply contracts with our financial institution clients, nationwide, including banks, credit unions and financial services companies. In the case of check supply contracts, once the financial institution relationship is established, consumers may submit their check orders through their financial institution or over the phone or internet. Results for this segment were as follows:
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Total revenue | | $ | 157,407 |
| | $ | 123,033 |
| | 27.9 | % | | $ | 445,946 |
| | $ | 374,511 |
| | 19.1 | % | | $ | 139,315 |
| | $ | 147,745 |
| | (5.7%) | | $ | 279,956 |
| | $ | 288,539 |
| | (3.0%) |
Operating income | | 29,347 |
| | 28,708 |
| | 2.2 | % | | 76,500 |
| | 84,467 |
| | (9.4 | %) | | 13,980 |
| | 26,609 |
| | (47.5%) | | 31,954 |
| | 46,854 |
| | (31.8%) |
Operating margin | | 18.6 | % | | 23.3 | % | | (4.7 | ) pts. | | 17.2 | % | | 22.6 | % | | (5.4 | ) pts. | | 10.0 | % | | 18.0 | % | | (8.0) pts. | | 11.4 | % | | 16.2 | % | | (4.8) pts. |
The increasedecrease in total revenue for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, was driven by growthlower check order volume due to the continued secular decline in marketing solutions and other services of approximately $38.0check usage. In addition, Deluxe Rewards revenue decreased $3.6 million for the thirdsecond quarter of 20172018 and $85.8$7.4 million for the first ninesix months of 2017, including incremental revenue from acquired businesses of approximately $39.1 million for the third quarter of 2017 and $88.7 million for the first nine months of 2017. These increases in marketing solutions and other services revenue were partially offset by a decrease in Deluxe Rewards revenue of approximately $2.0 million for the third quarter of 2017 and $5.0 million for the first nine months of 2017 driven primarily by2018 due to the loss of Verizon Communications Inc. as a customer, as well asand revenue was negatively impacted by continued pricing adjustments. Further information about our acquisitions can be found underallowances. These decreases in revenue were partially offset by incremental treasury management solutions revenue of $5.6 million for the caption “Note 6: Acquisitions”first half of 2018 from the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1acquisition of this report and under the caption "Note 5: Acquisitions" of the Notes to Consolidated Financial Statements appearingRDM Corporation in the 2016 Form 10-K. In addition,second quarter of 2017 and increased revenue benefited from price increases. Partially offsetting these revenue increases was lower check order volume duedata-driven marketing solutions as we continue to the continued decline in check usage, as well as the impact of continued pricing allowances.focus on growing this business.
The increasedecrease in operating income for the thirdsecond quarter of 2017,2018, as compared to the thirdsecond quarter of 2016,2017, was primarily due to the impact of price increasesthe decline in Deluxe Rewards revenue, continued pricing allowances, lower check order volume, higher employee benefits expense driven by the timing of vacations, and the benefitincreased delivery rates in 2018. In addition, restructuring charges were $4.0 million higher than in 2017 driven by our cost reduction and integration initiatives. Partially offsetting these decreases in operating income were benefits of our continuing cost reduction initiatives. Partially offsetting these increases in operating income were lower check order volume; continued pricing allowances; the decline in Deluxe Rewards revenue; and higher performance-based compensation, medical costs and material and delivery rates. While the impact of acquired businesses was positive to operating income for the third quarter of 2017, including acquisition-related amortization, operating margin decreased 2.7 points for 2017 due to acquired businesses.
The decrease in operating income for the first nine monthshalf of 2017,2018, as compared to the first nine monthshalf of 2016,2017, was primarily due to the impact of the decline in Deluxe Rewards revenue, lower check order volume;volume, continued pricing allowances; higher performance-based compensation, medical costsallowances, and increased material and delivery and material rates in 2017;2018. In addition, restructuring charges were $4.6 million higher than in 2017 driven by our cost reduction and integration initiatives. Partially offsetting these decreases in operating income were benefits of our continuing cost reduction initiatives, lower legal costs due to legal settlement and expenses of $2.5 million in the first quarter of 2017; the decline in Deluxe Rewards revenue;2017, and an increase of $1.4 million in transaction costs related to acquisitions. Partially offsetting these decreases in operating income were price increases and the benefit of our continuing cost reduction initiatives. While the impact of acquired businesses was positive to operating income for the first nine months of 2017, including acquisition-related amortization, operating margin decreased 2.7 points for the first nine months of 2017 due to acquired businesses.lower medical costs.
Direct Checks
Direct Checks sells products and services directly to consumers using direct marketing, including print advertising and search engine marketing and optimization strategies. Direct Checks sells under various brand names, including Checks Unlimited®Unlimited®, Designer Checks®Checks®, Checks.com®, Check Gallery®Gallery®, The Styles Check Company®Company®, and Artistic Checks®Checks®, among others. Results for this segment were as follows:
| | | | Quarter Ended September 30, | | Nine Months Ended September 30, | | Quarter Ended June 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
Total revenue | | $ | 33,854 |
| | $ | 36,956 |
| | (8.4 | %) | | $ | 107,314 |
| | $ | 116,965 |
| | (8.3 | %) | | $ | 31,187 |
| | $ | 34,612 |
| | (9.9%) | | $ | 66,146 |
| | $ | 73,461 |
| | (10.0%) |
Operating income | | 11,296 |
| | 12,914 |
| | (12.5 | %) | | 35,555 |
| | 40,640 |
| | (12.5 | %) | | 10,201 |
| | 11,697 |
| | (12.8%) | | 21,036 |
| | 24,189 |
| | (13.0%) |
Operating margin | | 33.4 | % | | 34.9 | % | | (1.5 | ) pts. | | 33.1 | % | | 34.7 | % | | (1.6 | ) pts. | | 32.7 | % | | 33.8 | % | | (1.1) pts. | | 31.8 | % | | 32.9 | % | | (1.1) pts. |
The decrease in revenue for the thirdsecond quarter and first nine monthshalf of 2017,2018, as compared to the same periods in 2016,2017, was primarily due to athe reduction in orders stemming from the continued secular decline in check usage. For the first nine months of
2017, the volume decline was partially offset by higher revenue per order, driven by price increases and various sales initiatives.
The decrease in operating income for the thirdsecond quarter and first nine months of 2017,2018, as compared to the same periods in 2016,second quarter of 2017, was due primarily to the lower order volume, higher employee benefits expense driven primarily by the timing of vacations, and increased delivery and material costs in 2017.2018. These decreases in operating income were partially offset by benefits from our cost reduction initiatives, including lower advertising expense driven by changes in circulation intended to maximize response rates.
The decrease in operating income for the first half of 2018, as compared to the first half of 2017, was due primarily to the lower order volume and increased delivery costs in 2018. These decreases in operating income were partially offset by
benefits from our cost reduction initiatives, including lower advertising expense driven by changes in circulation intended to maximize response rates, as well as lower medical costs.
CASH FLOWS AND LIQUIDITY
As of SeptemberJune 30, 20172018, we held cash and cash equivalents of $53.468.6 million. The following table shows our cash flow activity for the ninesix months ended SeptemberJune 30, 20172018 and 20162017, and should be read in conjunction with the consolidated statements of cash flows appearing in Item 1 of this report.
| | | | Nine Months Ended September 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change |
Net cash provided by operating activities | | $ | 225,896 |
| | $ | 208,121 |
| | $ | 17,775 |
| | $ | 146,936 |
| | $ | 151,578 |
| | $ | (4,642 | ) |
Net cash used by investing activities | | (154,102 | ) | | (90,399 | ) | | (63,703 | ) | | (117,563 | ) | | (96,102 | ) | | (21,461 | ) |
Net cash used by financing activities | | (97,211 | ) | | (103,050 | ) | | 5,839 |
| | (18,269 | ) | | (98,445 | ) | | 80,176 |
|
Effect of exchange rate change on cash | | 2,253 |
| | 2,966 |
| | (713 | ) | | (1,750 | ) | | 1,175 |
| | (2,925 | ) |
Net change in cash and cash equivalents | | $ | (23,164 | ) | | $ | 17,638 |
|
| $ | (40,802 | ) | | $ | 9,354 |
| | $ | (41,794 | ) |
| $ | 51,148 |
|
The $17.8$4.6 million increasedecrease in net cash provided by operating activities for the first nine monthshalf of 2017,2018, as compared to the first nine monthshalf of 2016,2017, was primarily due to the impact of the continuing secular decline in check and forms usage, as well as an increase of $2.3 million in prepaid product discount payments and a $1.9 million increase in interest payments. These decreases in operating cash generated by operations, the timing of accounts receivable collections, a $12.0 million decrease in payments for performance-based compensation, and the payment in 2016 of an incentive related to a 2013 acquisition. These increases in net cash provided by operating activitiesflow were partially offset by an $18.0the timing of payables and a $1.9 million increasereduction in income tax payments, as well as higher contract acquisition and interest payments.
Included in net cash provided by operating activities were the following operating cash outflows:
| | | | Nine Months Ended September 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change |
Income tax payments | | $ | 112,013 |
| | $ | 93,993 |
| | $ | 18,020 |
| | $ | 63,655 |
| | $ | 65,588 |
| | $ | (1,933 | ) |
Performance-based compensation payments(1) | | 20,772 |
| | 32,821 |
| | (12,049 | ) | | 21,717 |
| | 20,738 |
| | 979 |
|
Contract acquisition payments | | 20,003 |
| | 17,190 |
| | 2,813 |
| |
Prepaid product discount payments | | | 13,282 |
| | 10,937 |
| | 2,345 |
|
Interest payments | | 14,372 |
| | 12,274 |
| | 2,098 |
| | 11,057 |
| | 9,127 |
| | 1,930 |
|
Incentive payment related to previous acquisition | | — |
| | 5,434 |
| | (5,434 | ) | |
Severance payments | | 5,642 |
| | 4,275 |
| | 1,367 |
| | 4,108 |
| | 4,455 |
| | (347 | ) |
(1) Amounts reflect compensation based on total company performance.
Net cash used by investing activities for the first nine monthshalf of 20172018 was $63.7$21.5 million higher than the first nine monthshalf of 2016,2017, driven primarily by an increase of $60.8$12.7 million in payments for acquisitions. Further information about our acquisitions can be found under the caption “Note 6: Acquisitions” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. In addition, purchases of capital assets increased $5.3 million as we continue to invest in key revenue growth initiatives and order fulfillment and information technology infrastructure, and we had proceeds of $3.5 million in 2017 from life insurance policiesthe redemption of marketable securities which were $2.8 million lower than 2016.acquired as part of the acquisition of RDM Corporation in April 2017.
Net cash used by financing activities for the first nine monthshalf of 20172018 was $5.880.2 million lower than the first nine monthshalf of 2016,2017, due primarily to a net decrease in payments on long-term debt of $13.3 million and a $1.4 million increase in cash proceeds from the exercise of stock options.$95.6 million. Partially offsetting these decreasesthis decrease in cash used by financing activities was a $5.1$9.9 million increase in share repurchases and a $4.5 million$3.0 increase in employee taxes paidpayments for shares withhelddebt issuance costs related to stock-based compensation activity.the revolving credit agreement executed in March 2018.
Significant cash outflows,transactions, excluding those related to operating activities, for each period were as follows:
| | | | Nine Months Ended September 30, | | Six Months Ended June 30, |
(in thousands) | | 2017 | | 2016 | | Change | | 2018 | | 2017 | | Change |
Payments for acquisitions, net of cash acquired | | $ | 125,417 |
| | $ | 64,637 |
| | $ | 60,780 |
| | $ | (90,205 | ) | | $ | (77,553 | ) | | $ | (12,652 | ) |
Payments for common shares repurchased | | 50,070 |
| | 44,944 |
| | 5,126 |
| | (39,996 | ) | | (30,068 | ) | | (9,928 | ) |
Cash dividends paid to shareholders | | 43,672 |
| | 44,127 |
| | (455 | ) | | (28,762 | ) | | (29,156 | ) | | 394 |
|
Purchases of capital assets | | 34,351 |
| | 32,215 |
| | 2,136 |
| | (28,040 | ) | | (22,788 | ) | | (5,252 | ) |
Employee taxes paid for shares withheld | | 6,816 |
| | 2,333 |
| | 4,483 |
| | (7,947 | ) | | (5,572 | ) | | (2,375 | ) |
Net change in debt | | 3,590 |
| | 16,873 |
| | (13,283 | ) | | 56,590 |
| | (39,052 | ) | | 95,642 |
|
Proceeds from issuing shares under employee plans | | | 5,767 |
| | 5,914 |
| | (147 | ) |
We anticipate that net cash provided by operating activities will be between $340.0$360.0 million and $345.0$370.0 million in 2018, compared to $338.4 million in 2017, compared to $319.3 million in 2016, driven by stronger operating performanceearnings, lower income tax payments and lower interest payments,medical costs, partially offset by higher income tax and medicalinterest payments. We anticipate that net cash provided by operating activities in 20172018, along with availability under our revolving credit facility, will be utilized for dividend payments, capital expenditures of approximately $45.0$55.0 million periodic share repurchases and small-to-medium-sizedinterest payments, as well as likely acquisitions. We intend to focus our capital spending on key revenue growth initiatives and investments in order fulfillment and information technology infrastructure. As of SeptemberJune 30, 2017, $64.62018, $174.9 million was available for borrowing under our revolving credit facility. To the extent we generate excess cash, we plan to opportunistically repurchase common shares and/or reduce the amount outstanding under our credit facility agreement.facility.
As of SeptemberJune 30, 2017,2018, our foreign subsidiaries located in Canada held cash and cash equivalents of $30.5$47.4 million. This amount decreased $36.1 million from December 31, 2016, as we utilized Canadian cash to fund a portion of the acquisition of RDM Corporation in the second quarter of 2017. Deferred income taxes have not been recognized on unremitted earnings of our foreign subsidiaries, as these amounts are intended to be reinvested indefinitely in the operations of those subsidiaries. If we were to repatriate all of the Canadianour foreign cash and cash equivalents into the United States at one time, we estimate we would incur a federalwithholding tax liability of approximately $4.0 million, based on current federal tax law.$2.0 million.
We believe that cash generated by operating activities, along with availability under our revolving credit facility, will be sufficient to support our operations for the next 12 months, including dividend payments, capital expenditures, required debt principal and interest payments, and periodic share repurchases, as well as small-to-medium-sizedlikely acquisitions.
CAPITAL RESOURCES
Our total debt was $756.4$766.8 million as of SeptemberJune 30, 20172018, a decreasean increase of $2.357.5 million from December 31, 20162017. Further information concerning our outstanding debt can be found under the caption “Note 11: Debt” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Our capital structure for each period was as follows:
| | | | September 30, 2017 | | December 31, 2016 | | | | June 30, 2018 | | December 31, 2017 | | |
(in thousands) | | Amount | | Weighted- average interest rate | | Amount | | Weighted- average interest rate | | Change | | Amount | | Weighted- average interest rate | | Amount | | Weighted- average interest rate | | Change |
Fixed interest rate | | $ | 1,818 |
| | 2.0 | % | | $ | 1,685 |
| | 2.0 | % | | $ | 133 |
| | $ | 1,804 |
| | 2.0 | % | | $ | 1,914 |
| | 2.0 | % | | $ | (110 | ) |
Floating interest rate | | 754,580 |
| | 2.7 | % | | 756,963 |
| | 2.2 | % | | (2,383 | ) | | 765,000 |
| | 3.2 | % | | 707,386 |
| | 3.0 | % | | 57,614 |
|
Total debt | | 756,398 |
| | 2.7 | % | | 758,648 |
| | 2.2 | % | | (2,250 | ) | | 766,804 |
| | 3.2 | % | | 709,300 |
| | 3.0 | % | | 57,504 |
|
Shareholders’ equity | | 950,545 |
| | |
| | 880,970 |
| | |
| | 69,575 |
| | 1,075,136 |
| | |
| | 1,015,013 |
| | |
| | 60,123 |
|
Total capital | | $ | 1,706,943 |
| | |
| | $ | 1,639,618 |
| | |
| | $ | 67,325 |
| | $ | 1,841,940 |
| | |
| | $ | 1,724,313 |
| | |
| | $ | 117,627 |
|
During the first nine monthshalf of 2017,2018, we repurchased a total of 0.70.6 million shares for $50.1$40.0 million. We hadThese share repurchases were completed under an outstanding authorization from our board of directors to purchase up to 10 million shares of our common stock. We completed the purchase of all of the remaining shares under this authorization during the first quarter of 2017. Inin May 2016 our board of directors approved an additional authorization for the repurchase of up to $300.0 million of our common stock, effective at the conclusion of the previous authorization.stock. This additional authorization has no expiration date, and $254.7$199.7 million remained
available for purchase under this authorization as of SeptemberJune 30, 2017.2018. Information regarding changes in shareholders' equity can be found in the consolidated statement of shareholders' equity appearing in Item 1 of this report.
As of September 30, 2017,
In March 2018, we hadentered into a $525.0 millionnew revolving credit facility thatin the amount of $950.0 million, subject to increase under the credit agreement to an aggregate amount not exceeding $1,425.0 million. The credit facility matures in February 2019.March 2023. Our previous credit facility agreement was terminated contemporaneously with our entry into the new credit facility and was repaid utilizing proceeds from the new revolving credit facility. Our quarterly commitment fee ranges from 0.20%0.175% to 0.40%0.35% based on our leverage ratio. During 2016, we amended the credit agreement governing ourOur previous credit facility to includeagreement also included a variable rate term loan facility in the aggregate amountfacility. As of $330.0 million. We borrowed the full amount during the fourth quarter of 2016 using the proceeds to retire our senior notes due in 2020 and to partially fund the acquisition of FMCG Direct in December 2016. The term loan facility matures in February 2019 and requires periodic principal payments throughout the term of the loan. Interest is paid weekly and we may prepay31, 2017, $294.9 million was outstanding under the term loan facilityfacility. This amount was repaid in full or in part at our discretion. Amounts repaid may not be reborrowed.March 2018, utilizing proceeds from the new revolving credit facility.
Borrowings under our credit agreement are collateralized by substantially all of our personal and intangible property. The credit agreement governing the credit facility contains customary covenants regarding limits on levels of subsidiary indebtedness and capital expenditures, liens, investments, acquisitions, certain mergers, certain asset sales outside the ordinary course of business, and change in control as defined in the agreement. The agreement also containsrequires us to maintain certain financial covenants regarding ourratios, including a maximum leverage ratio of 3.5 and a minimum ratio of consolidated earnings before interest coverage and liquidity.taxes to consolidated interest expense, as defined in the credit agreement, of 3.0. We were in compliance with all debt covenants as of SeptemberJune 30, 20172018, and we expect to remain in compliance with all debt covenants throughout the next 12 months.
As of SeptemberJune 30, 20172018, amounts were available for borrowing under our revolving credit facility as follows:
| | (in thousands) | Total available | Total available |
Revolving credit facility commitment | $ | 525,000 |
| $ | 950,000 |
|
Amount drawn on revolving credit facility | (450,000 | ) | (765,000 | ) |
Outstanding letters of credit(1) | (10,361 | ) | (10,128 | ) |
Net available for borrowing as of September 30, 2017 | $ | 64,639 |
| |
Net available for borrowing as of June 30, 2018 | | $ | 174,872 |
|
(1) We use standby letters of credit to collateralize certain obligations related primarily to our self-insured workers’ compensation claims, as well as claims for environmental matters, as required by certain states. These letters of credit reduce the amount available for borrowing under our revolving credit facility.
OTHER FINANCIAL POSITION INFORMATION
Information concerning items comprising selected captions on our consolidated balance sheets can be found under the caption "Note 3: Supplemental balance sheet information" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Acquisitions – The impact of acquisitions on our consolidated balance sheet as of SeptemberJune 30, 20172018 can be found under the caption “Note 6: Acquisitions” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Contract acquisition costsPrepaid product discounts – Other non-current assets include contract acquisition costsprepaid product discounts of our Financial Services segment. These costs which are essentially pre-paid product discounts, are recorded as non-current assets upon contract execution and are amortized, generally on the straight-line basis, as reductions of revenue over the related contract term. Changes in contract acquisition costsprepaid product discounts during the ninesix months ended SeptemberJune 30, 20172018 and 20162017 can be found under the caption "Note 3: Supplemental balance sheet information" ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. Cash payments for contract acquisition costsprepaid product discounts were $20.013.3 million for the first nine monthshalf of 20172018 and $17.2$10.9 million for the first nine monthshalf of 2016.2017. We anticipate cash payments of approximately $26.0$27.0 million for the year ending December 31, 2017.2018.
The number of checks being written has been declining, which has contributed to increased competitive pressure when attempting to retain or acquire clients. Both the number of financial institution clients requesting contract acquisitionprepaid product discount payments and the amount of the payments has fluctuated from year to year. Although we anticipate that we will selectively continue to make contract acquisitionthese payments, we cannot quantify future amounts with certainty. The amount paid depends on numerous factors, such as the number and timing of contract executions and renewals, competitors’ actions, overall product discount levels and the structure of up-front product discount payments versus providing higher discount levels throughout the term of the contract.
Liabilities for contract acquisition paymentsprepaid product discounts are recorded upon contract execution. These obligations are monitored for each contract and are adjusted as payments are made. Contract acquisitionPrepaid product discount payments due within the next year are included in accrued liabilities in our consolidated balance sheets. These accruals were $13.512.9 million as of SeptemberJune 30, 20172018 and $12.4 $11.7
million as of December 31, 20162017. Accruals for contract acquisitionprepaid product discount payments included in other non-current liabilities in our consolidated balance sheets were $24.3$17.4 million as of SeptemberJune 30, 20172018 and $29.9$21.7 million as of December 31, 20162017.
OFF-BALANCE SHEET ARRANGEMENTS, GUARANTEES AND CONTRACTUAL OBLIGATIONS
It is not our general business practice to enter into off-balance sheet arrangements or to guarantee the performance of third parties. In the normal course of business, we periodically enter into agreements that incorporate general indemnification language. These indemnificationsindemnification provisions generally encompass third-party claims arising from our products and services, including, without limitation, service failures, breach of security, intellectual property rights, governmental regulations and/or employment-related matters. Performance under these indemnities would generally be triggered by our breach of terms of the contract. In disposing of assets or businesses, we often provide representations, warranties and/or indemnities to cover various risks, including, for example, unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities and legal matters related to periods prior to disposition. We do not have the ability to estimate the potential liability from such indemnities because they relate to unknown conditions. However, we do not believe that any liability under these indemnities would have a material adverse effect on our financial position, annual results of operations or annual cash flows. We have recorded liabilities for known indemnifications related to environmental matters. Further information regarding our environmental liabilities, as well as liabilities related to self-insurance and litigation, can be found under the caption “Note 12: Other commitments and contingencies” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in the Item 1 of this report.
We are not engaged in any transactions, arrangements or other relationships with unconsolidated entities or other third parties that are reasonably likely to have a material effect on our liquidity or on our access to, or requirements for, capital resources. In addition, we have not established any special purpose entities nor did we enter into any material related party transactions during the first nine monthshalf of 20172018 or during 2016.2017.
A table of our contractual obligations was provided in the MD&A section of the 2016our 2017 Form 10-K. There were no significant changes in these obligations during the first nine monthshalf of 2017.2018, with the exception of the execution of our new revolving credit facility. Previously, amounts outstanding under our credit facility were scheduled to mature in February 2019. Under the new agreement, amounts outstanding are scheduled to mature in March 2023. As of June 30, 2018, $765.0 million was outstanding under our credit facility.
CRITICAL ACCOUNTING POLICIES
A description of our critical accounting policies was provided in the MD&A section of the 2016our 2017 Form 10-K. There were no changes in these policies during the first nine monthshalf of 2017.
During the third quarter of 2017, we completed the annual impairment analysis of goodwill and our indefinite-lived trade name. In conjunction with our annual strategic planning process during the quarter, we made various changes to our internal reporting structure. As a result, we reassessed our operating segments and determined that no changes were required in our reportable operating segments. We also reassessed our previously determined reporting units and concluded that a realignment of a portion of our reporting units was required. As such, we reallocated the carrying value of goodwill to our revised reporting units based on their relative fair values. We analyzed goodwill for impairment immediately prior to this realignment by performing qualitative analyses for our Small Business Services reporting units and quantitative analyses for our Financial Services and Direct Checks reporting units. The qualitative analyses evaluated factors including, but not limited to, economic, market and industry conditions, cost factors and the overall financial performance of the reporting units. We also considered the last quantitative analysis we completed. In completing these assessments, we noted no changes in events or circumstances that indicated that it was more likely than not that the fair value of any reporting unit was less than its carrying amount,2018, with the exception of our Small Business Services Safeguard reporting unit. The analysis of this reporting unit, which incorporated the results of the annual strategic planning process, indicated lowered projected long-term revenue growth and profitability levels resulting from changes in market trends and the mix of products and services sold, including the continuing decline in check and forms usage. recognition.
As a result, we completed impairment analyses of the long-term assets of this reporting unit, excluding goodwill, and concluded that these assets were not impaired. We then completed the quantitative analysis of the reporting unit, utilizing the income approach outlineddiscussed under the caption "Note 1: Significant“Note 2: New accounting policies"pronouncements” in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report, effective January 1, 2018, we implemented ASU No. 2014-09, Revenue from Contracts with Customers, and related amendments. Under the 2016 Form 10-K.new guidance, our product revenue is recognized when control of the goods is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods. In most cases, control is transferred when products are shipped. We recognize the vast majority of our service revenue as the services are provided. Many of our financial institution contracts require prepaid product discounts in the form of cash payments we make to our financial institution clients. These prepaid product discounts are included in other non-current assets in our consolidated balance sheets and are amortized as reductions of revenue, generally on the straight-line basis, over the contract term. Sales tax collected concurrent with revenue-producing activities is excluded from revenue. Amounts billed to customers for shipping and handling are included in revenue, while the related costs incurred for shipping and handling are reflected in cost of products and are accrued when the related revenue is recognized. As part of our Financial Services rewards, incentive and loyalty programs, we receive payments from consumers or our clients for the products and services provided, including hotel stays, gift cards and merchandise such as apparel, electronics and clothing. This quantitative analysis indicatedrevenue is recorded net of the related fulfillment costs.
When a customer pays in advance for services, primarily for treasury management solutions and web hosting services, we defer the revenue and recognize it as the services are performed, generally over a period of less than 1 year. Certain of our contracts for data-driven marketing solutions and treasury management outsourcing services within Financial Services have variable consideration that this reporting unit's goodwill was fully impaired and resulted in a non-cash pre-tax goodwill impairment chargeis contingent on either the success of $28.4 million during the quarter ended September 30, 2017. In accordance with Accounting Standards Update No. 2017-04, which we adopted onmarketing campaign ("pay-for-performance") or the volume of outsourcing services provided. We recognize revenue for estimated variable consideration as
January 1, 2017,services are provided based on the impairment charge was measured asthe most likely amount to be realized. Revenue is recognized to the extent that it is probable that a significant reversal of revenue will not occur when the contingency is resolved. Typically, the amount by whichof consideration for these contracts is finalized within 3 months, although pricing under certain of our outsourcing contracts may be based on annual volume commitments. Revenue recognized from these contracts was approximately $100.0 million in 2017.
Certain of our contracts for treasury management solutions result from the reporting unit's carrying value exceeded its estimated fair value. This impairment assessment is sensitive to changes in forecasted cash flows,sale of bundled arrangements that may include hardware, software and professional services, as well as our selected discount ratecustomization and modification of 9%. Changes insoftware. Revenue for these contracts is recognized using a cost-based input method that depicts the reporting unit's forecast assumptions and estimates could materially affecttransfer of services to the estimationcustomer. The transaction price is allocated to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin.
At times, a financial institution client may terminate its check supply contract with us prior to the end of the fair valuecontract term. In many cases, the financial institution is contractually required to remit a contract termination payment. Such payments are recorded as revenue when the termination agreement is executed, provided that we have no further performance obligations and collection of this reporting unit.the funds is assured. If we have further performance obligations following the execution of a contract termination agreement, we record the related revenue over the remaining service period.
Immediately subsequentCertain costs incurred to obtain contracts are required to be recognized as assets and amortized consistent with the transfer of goods or services to the realignmentcustomer. As such, we defer sales commissions related to obtaining check supply and treasury management solution contracts within Financial Services. These amounts are included in other non-current assets and are amortized as SG&A expense. Amortization of our reporting unit structure, we completed a quantitative analysis for allthese amounts on the straight-line basis approximates the timing of our reporting unitsthe transfer of goods or services to which goodwill is assigned. This quantitative analysisthe customer. Generally, these amounts are being amortized over periods of 3 to 6 years. We expense sales commissions as of July 31, 2017 indicated thatincurred when the estimated fair values of our reporting units exceeded their carrying values by approximate amounts between $64.0 million and $1.4 billion,amortization period would have been 1 year or by amounts between 36% and 314% above the carrying values of their net assets.less.
In completingAccounting for customer contracts can be complex and may involve the annual impairment analysisuse of various techniques to estimate total contract revenue and to allocate the transaction price to each performance obligation. Estimates related to variable consideration are based on various assumptions to project the outcome of future events. We review and update our indefinite-lived trade name,contract-related estimates regularly, and we electeddo not anticipate that revisions to performour estimates would have a quantitative assessment. This assessment indicated that the calculated fair valuematerial effect on our results of the asset exceeded its carrying value of $19.1 million by approximately $16.0 million as of July 31, 2017. In this analysis, we assumed a discount rate of 10.0% and a royalty rate of 1.0%. A one-half percentage point increase in the discount rate would reduce the indicated fair value of the asset by approximately $2.0 million and a one-half percentage point decrease in the royalty rate would reduce the indicated fair value of the asset by approximately $17.0 million.operations, financial position or cash flows.
Information regarding other accounting pronouncements adopted during the first nine monthshalf of 20172018 and those not yet adopted can be found under the caption “Note 2: New accounting pronouncements” ofin the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to changes in interest rates primarily as a result of the borrowing activities used to support our capital structure, maintain liquidity and fund business operations. We do not enter into financial instruments for speculative or trading purposes. The nature and amount of debt outstanding can be expected to vary as a result of future business requirements, market conditions and other factors. As of SeptemberJune 30, 20172018, our total debt was comprised of the following:
| | (in thousands) | | Carrying amount | | Fair value(1) | | Weighted-average interest rate | | Carrying amount | | Fair value(1) | | Weighted-average interest rate |
Amount drawn on revolving credit facility | | $ | 450,000 |
| | $ | 450,000 |
| | 2.7 | % | | $ | 765,000 |
| | $ | 765,000 |
| | 3.2 | % |
Amount outstanding under term loan facility | | 304,580 |
| | 305,250 |
| | 2.7 | % | |
Capital lease obligations | | 1,818 |
| | 1,818 |
| | 2.0 | % | | 1,804 |
| | 1,804 |
| | 2.0 | % |
Total debt | | $ | 756,398 |
| | $ | 757,068 |
| | 2.7 | % | | $ | 766,804 |
| | $ | 766,804 |
| | 3.2 | % |
(1) The carrying amountsamount reported in the consolidated balance sheets for amounts drawn under our revolving credit facility and our term loan facility, excluding unamortized debt issuance costs, approximateapproximates fair value because our interest rates are variable and reflect current market rates. Capital lease obligations are presented at their carrying amount.
Amounts drawn on our revolving credit facility and our term loan facility mature in February 2019.March 2023. During the first quarter of 2018, we executed a new revolving credit facility. Further information regarding the credit facility can be found under the caption "Note 11: Debt" in the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report. Our capital lease obligations are due through JuneNovember 2021.
Based on the daily average amount of outstanding variable rate debt in our portfolio, a one percentage point change in our weighted-average interest rates would have resulted in a $5.73.6 million change in interest expense for the first nine monthshalf of 2017.2018.
We are exposed to changes in foreign currency exchange rates. Investments in, loans and advances to foreign subsidiaries and branches, as well as the operations of these businesses, are denominated in foreign currencies, primarily the Canadian dollar.and Australian dollars. The effect of exchange rate changes is not expected to have a minimalsignificant impact on our earnings and cash flows, as our foreign operations represent a relatively small portion of our business. We have not entered into hedges against changes in foreign currency exchange rates.
Item 4. Controls and Procedures.
(a) Disclosure Controls and Procedures —– As of the end of the period covered by this report, SeptemberJune 30, 20172018 (the “Evaluation Date”"Evaluation Date"), we carried out an evaluation, under the supervision and with the participation of management,
including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”"Exchange Act")). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in applicable rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
(b) Internal Control Over Financial Reporting —There– There were no changes in our internal control over financial reporting identified in connection with our evaluation during the quarter ended SeptemberJune 30, 20172018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
We record provisionsaccruals with respect to identified claims or lawsuits when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Claims and lawsuits are reviewed quarterly and provisions are taken or adjusted to reflect the status of a particular matter. We believe the recorded reserves in our consolidated financial statements are adequate in light of the probable and estimable outcomes. Recorded liabilities were not material to our financial position, results of operations or liquidity, and we do not believe that any of the currently identified claims or litigation will materially affect our financial position, results of operations or liquidity upon resolution. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, it may cause a material adverse impact on our financial position, results of operations or liquidity in the period in which the ruling occurs or in future periods.
Item 1A. Risk Factors.
Our risk factors are outlined in Item 1A of our Annual Report on2017 Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”).10-K. There have been no significant changes to these risk factors since we filed our 2017 Form 10-K, except with regard to our credit facility. In March 2018, we executed a new credit facility that matures in March 2023. Our previous credit facility, which was terminated contemporaneously with our entry into the 2016 Form 10-K.new credit facility, would have matured in February 2019.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The following table shows purchases of our own equity securities, based on trade date, that were completed during the thirdsecond quarter of 2017:2018:
|
| | | | | | | | | | | | | | |
Period | | Total number of shares purchased | | Average price paid per share | | Total number of shares purchased as part of publicly announced plans or programs | | Maximum approximate dollar value of shares that may yet be purchased under the plans or programs |
July 1, 2017 – July 31, 2017 | | — |
| | $ | — |
| | — |
| | $ | 274,658,061 |
|
August 1, 2017 – August 31, 2017 | | 202,400 |
| | 68.83 |
| | 202,400 |
| | 260,726,148 |
|
September 1, 2017 – September 30, 2017 | | 87,900 |
| | 69.05 |
| | 87,900 |
| | 254,656,500 |
|
Total | | 290,300 |
| | 68.90 |
| | 290,300 |
| | 254,656,500 |
|
|
| | | | | | | | | | | | | | |
Period | | Total number of shares purchased | | Average price paid per share | | Total number of shares purchased as part of publicly announced plans or programs | | Maximum approximate dollar value of shares that may yet be purchased under the plans or programs |
April 1, 2018 – April 30, 2018 | | — |
| | $ | — |
| | — |
| | $ | 219,730,907 |
|
May 1, 2018 – May 31, 2018 | | 164,966 |
| | 68.12 |
| | 164,966 |
| | 208,493,327 |
|
June 1, 2018 – June 30, 2018 | | 130,058 |
| | 67.37 |
| | 130,058 |
| | 199,730,908 |
|
Total | | 295,024 |
| | 67.79 |
| | 295,024 |
| | 199,730,908 |
|
In August 2003, our board of directors approved an authorization to purchase up to 10 million shares of our common stock. We completed the purchase of all of the remaining shares under this authorization during February 2017. In May 2016, our board of directors approved an additional authorization for the repurchase of up to $300.0 million of our common stock, effective at the conclusion of our previous authorization.stock. This additional authorization has no expiration date, and $254.7$199.7 million remained available for purchase under this authorization as of SeptemberJune 30, 2017.2018.
While not considered repurchases of shares, we do at times withhold shares that would otherwise be issued under equity-based awards to cover the withholding taxes due as a result of the exercising or vesting of such awards. During the quarter ended SeptemberJune 30, 2017,2018, we withheld 16,43147,586 shares in conjunction with the vesting and exercise of equity-based awards.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
|
| | | | |
Exhibit Number | | Description | | Method of Filing |
3.1 | | | | * |
3.2 | | | | * |
4.1 | | | | * |
|
| | | | |
Exhibit Number | | Description | | Method of Filing |
10.1 | | | | * |
10.2 | | | | * |
31.1 | | | | Filed herewith |
31.2 | | | | Filed herewith |
32.1 | | | | Furnished herewith |
101 | | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of SeptemberJune 30, 20172018 and December 31, 2016,2017, (ii) Consolidated Statements of Comprehensive Income for the quarters and ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, (iii) Consolidated Statement of Shareholders' Equity for the ninesix months ended SeptemberJune 30, 2017,2018, (iv) Consolidated Statements of Cash Flows for the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, and (v) Condensed Notes to Unaudited Consolidated Financial Statements | | Filed herewith |
___________________
* Incorporated by reference
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
| |
| DELUXE CORPORATION (Registrant) |
| |
Date: OctoberJuly 27, 20172018 | /s/ Lee Schram |
| Lee Schram Chief Executive Officer (Principal Executive Officer) |
| |
Date: OctoberJuly 27, 20172018 | /s/ Keith A. Bush |
| Keith A. Bush Senior Vice President, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |