Deluxe Corporation — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021. Figures below are in millions of dollars unless noted. The company reports Payments, Cloud Solutions, Promotional Solutions and Checks.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Revenue | $478.2 (+16.5%) | $410.4 | $919.5 (+2.5%) | $896.8 |
| Gross profit / margin | $271.6 / 56.8% | $248.1 / 60.5% | $534.4 / 58.1% | $532.5 / 59.4% |
| Operating income (loss) | $26.4 | $24.3 | $62.4 | $(40.3) |
| Net income (loss) | $12.1 | $14.9 | $36.5 | $(48.8) |
| Diluted EPS | $0.28 | $0.35 | $0.85 | $(1.18) |
| Adjusted EBITDA / margin | $97.5 / 20.4% | $83.8 / 20.4% | $188.0 / 20.4% | $167.2 / 18.6% |
| Adjusted diluted EPS | $1.25 | $1.15 | $2.51 | $2.24 |
Q2 revenue growth reflected recovery in several businesses, new customers, and the June 1 acquisition of First American Payment Systems. First American contributed $27.3 million of Q2 revenue and $5.1 million of Payments adjusted EBITDA. Q2 net income and GAAP diluted EPS fell year over year, principally due to $15.8 million of acquisition transaction costs and prior-year pandemic-related cost savings. The adjusted measures exclude specified items and are non-GAAP.
For the first half, operating income and net income improved substantially versus 2020, largely because the prior-year period included $99.0 million of asset impairment charges. First-half operating cash flow was $83.8 million, down from $109.6 million; free cash flow (operating cash flow less capital expenditures) was $37.2 million versus $82.6 million. Capital expenditures were $46.6 million versus $27.1 million.
Segments and material changes
- Payments: Q2 revenue $103.3 million (+43.2%) and adjusted EBITDA $21.2 million (+36.0%), including First American. First-half revenue rose 22.5%; margins declined as investments increased.
- Cloud Solutions: Q2 revenue $68.1 million (+26.3%); first-half revenue was nearly flat at $130.3 million. Data-driven marketing recovered, while exited product lines reduced first-half revenue by $12.4 million.
- Promotional Solutions: Q2 revenue $135.0 million (+14.4%); first-half revenue declined 0.5%. Recovery and lower bad-debt expense improved adjusted EBITDA, partly offset by lower PPE sales and secular business-forms decline.
- Checks: Q2 revenue $171.8 million (+3.3%), but adjusted EBITDA fell 3.1%. First-half revenue declined 2.8%, reflecting the continuing secular decline in check volumes.
Service revenue was 34.2% of first-half revenue, compared with 32.0% a year earlier. Consolidated Q2 gross margin declined 3.7 percentage points, and total cost of revenue rose faster than revenue, reflecting business mix and the acquisition. Q2 interest expense increased 54.4% to $9.5 million, with higher borrowing costs and the new 8.0% notes among the drivers.
Acquisition, debt and liquidity
Deluxe acquired all of First American for $956.7 million, net of acquired cash, funded with cash on hand and new debt. The preliminary purchase allocation included $736.3 million of goodwill; valuations remain subject to adjustment. First American’s results are included in Payments from the acquisition date.
At June 30, total debt was $1.833 billion net of discounts and issuance costs ($1.855 billion principal), versus $840.0 million at year-end; net debt was $1.670 billion. Debt included a $1.155 billion secured term loan, $200 million drawn on a $500 million revolver, and $500 million of 8.0% senior unsecured notes due 2029. The notes have an effective interest rate of 8.3%. Cash and cash equivalents were $163.3 million; revolver availability was $292.5 million; reported liquidity was $455.8 million. The company reported compliance with debt covenants and expected to remain compliant over the next 12 months. It prepaid $24 million of term-loan debt in July.
Six-month financing included $25.9 million of dividends paid. Management expected to continue regular quarterly dividends, subject to board approval. The company reported $124.7 million of restricted cash and cash equivalents in addition to cash and cash equivalents; customer funds are not equivalent to unrestricted corporate cash.
Outlook, commentary and risks
- For 2021, management raised expected revenue growth to 10%–12% from its prior 0%–2% estimate, reflecting First American. It forecast adjusted EBITDA margin of 20%–21%, with Q4 expected to be stronger than Q3, and an adjusted annual effective tax rate of approximately 25%.
- Management expected capital expenditures of $95–$105 million, continued quarterly dividends, and sufficient operating cash flow, cash on hand and revolver availability to fund operations and debt service for the next 12 months. Forecasts assume continued economic recovery and are exposed to COVID-19, including the Delta variant, supply constraints, labor availability and inflation.
- The company expected 2021 revenue growth in the low-single digits for Promotional Solutions; low-20% adjusted EBITDA margin for Payments; and mid-single-digit second-half revenue growth in Cloud Solutions. Checks remained in secular decline, though new business was expected to moderate the historical decline rate.
- Management cited continuing integration work and an approximately $40 million expected 2021 SG&A savings benefit, plus $1 million in cost-of-revenue savings, from employee reductions and other actions. Most reductions were expected to be completed in Q3, with most severance paid by year-end.
- COVID-19 effects remain uncertain and could lead to additional impairment or credit-loss charges. A pending FTC investigation involving certain First American subsidiaries could result in enforcement actions, fines or operational changes; no related liability or holdback asset was recorded because the amount could not be reasonably estimated. Indemnification is limited to an escrow holdback.
- In Q2, Deluxe corrected prior-period goodwill impairment calculation errors it judged not material to previously issued statements. The filing revises relevant comparative figures: 2019 impairment charges and losses increased, and 2020 annual diluted EPS was revised from $0.19 to $0.11. No Q2 2021 impairment charge was recorded.
Most important facts for investors to verify
- Whether First American integration, customer retention and anticipated growth benefits support the raised 2021 revenue outlook.
- Debt repayment capacity, interest expense, covenant headroom and the effect of the acquisition’s leverage on capital allocation and dividends.
- Whether cash conversion recovers after the year-over-year declines in operating cash flow and free cash flow, alongside planned elevated capital spending.
- How COVID-19, supply-chain and labor constraints, inflation, and secular declines in checks and business forms affect the outlook and asset values.
- Developments in the FTC investigation and whether the limited indemnity holdback is sufficient for any resulting losses.
- The final purchase-price allocation for First American and any future disclosures concerning the corrected goodwill impairment calculations.