Deluxe Corporation — 2019 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Unaudited results; dollar amounts below are in millions unless otherwise noted.
Business context
Deluxe reported three segments: Small Business Services, Financial Services and Direct Checks. Its offerings include checks and forms, marketing solutions, treasury management, web services and other technology-enabled services. Management is pursuing a “Trusted, Tech-Enabled Solutions Company” strategy, with plans to focus on Payments, Cloud, Promotional Products and Checks.
Financial results and year-over-year changes
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $494.0 | $488.2 | $993.1 | $980.2 |
| Gross profit | $291.5 | $298.0 | $590.9 | $601.2 |
| Operating income | $51.8 | $82.8 | $115.6 | $170.5 |
| Net income | $32.6 | $60.2 | $73.8 | $123.5 |
| Diluted EPS | $0.75 | $1.25 | $1.68 | $2.56 |
| Operating cash flow | Not separately stated | Not separately stated | $105.1 | $146.9 |
Q2 revenue rose 1.2%, but GAAP diluted EPS fell 40.0%. First-half revenue increased 1.3%, while diluted EPS fell 34.4%. Approximate gross margin declined to 59.0% from 61.0% in Q2 and to 59.5% from 61.3% for the first half. Operating margin declined to 10.5% from 17.0% in Q2 and to 11.6% from 17.4% for the first half.
Service revenue grew while product revenue declined: Q2 service revenue increased to $146.9 million from $128.3 million, while product revenue declined to $347.1 million from $359.9 million. Management attributed revenue growth principally to 2018 acquisitions and Small Business Services price increases, partly offset by secular check and forms declines, pricing allowances, and weaker organic treasury-management and web-services revenue. First-half orders declined 2.5%, while revenue per order rose 3.9%.
By segment, Q2 revenue was $308.5 million in Small Business Services (down 2.9%), $156.1 million in Financial Services (up 12.1%) and $29.4 million in Direct Checks (down 5.9%). Segment operating income declined in all three: Small Business Services to $34.7 million, Financial Services to $9.3 million and Direct Checks to $7.8 million. Financial Services revenue growth was primarily acquisition-driven, including $19.4 million from REMITCO in Q2, while organic treasury-management revenue declined.
Cash, debt and capital allocation
At June 30, cash and cash equivalents were $66.7 million; an additional $77.3 million of restricted cash and cash equivalents was included in funds held for customers and should not be treated as unrestricted liquidity. First-half operating cash flow was $105.1 million, down $41.8 million year over year. Capital expenditures were $32.3 million. Cash used for share repurchases was $78.9 million and dividends were $26.3 million.
Total debt was $951.0 million, all drawn on a floating-rate revolving facility, versus $911.9 million at year-end 2018. The weighted-average borrowing rate was 3.8%. The $1.15 billion facility matures in March 2023; net available borrowing capacity was $193.3 million after letters of credit. The company reported compliance with debt covenants. Shareholders’ equity was $894.1 million. The company repurchased 1.8 million shares for $78.9 million during the first half; $341.1 million remained under its repurchase authorization.
Outlook, management commentary and risks
- 2019 revenue guidance: $2.005–$2.045 billion; GAAP diluted EPS: $3.45–$3.75; adjusted diluted EPS: $6.65–$6.95. Adjusted EPS is a non-GAAP measure.
- 2019 operating cash flow guidance: $270–$285 million, versus $339.3 million in 2018. Planned capital expenditures are approximately $75 million. Management expects operating cash generation and available credit to fund operations for the next 12 months, including investment, dividends, interest and periodic buybacks.
- Management expects 2019 revenue contributions from acquisitions and modest data-driven marketing growth to more than offset continued check and forms declines and Financial Services pricing allowances. Planned technology-platform investment is $35–$40 million in 2019 and $30–$60 million in 2020.
- Restructuring and integration expense increased to $17.3 million in Q2 and $22.8 million for the first half, primarily reflecting systems integration, technology and efficiency initiatives. Management expects most employee reductions to be completed by year-end 2019 and most severance payments by mid-2020.
- Other earnings pressures included higher interest, medical, legal, shipping and material costs; CEO-transition costs were $7.4 million for the first half. Management estimated approximately $9 million of CEO-transition costs for 2019.
- Key risks include execution and cost of the strategic transformation and segment realignment; secular declines in check and forms usage; customer losses and pricing pressure; and variable interest rates. Litigation outcomes are inherently uncertain, although identified litigation liabilities were not material at filing. Environmental remediation accruals were $2.4 million.
Notable accounting and unusual items
Adoption of lease accounting on January 1, 2019 added operating lease assets and liabilities to the balance sheet; operating lease assets were $44.0 million and total operating lease liabilities were $45.8 million at June 30. The company also corrected the presentation of prior-period restricted-cash cash flows. It assessed the prior interim misstatement as not material; the revision did not affect assets, liabilities, equity, net income or operating cash flow.
Management disclosed that Q2 and first-half comparisons were affected by 2018 gains on business and customer-list sales ($3.9 million and $11.1 million, respectively), while 2018 also included an asset impairment charge. First-half 2019 cash flow included payment of $12.5 million of legal expenses accrued in the prior year.
Important facts for investors to verify
- Whether organic growth in treasury management, web services and other newer offerings can offset continuing check and forms declines.
- Progress toward 2019 revenue, GAAP and adjusted EPS, and operating-cash-flow guidance; review the adjusted EPS reconciliation and exclusions.
- Execution, timing and realized savings from restructuring and technology investments, including whether planned spending can be funded as expected.
- Debt, variable-rate exposure, covenant headroom and liquidity; distinguish unrestricted cash from customer funds and restricted cash.
- Drivers of falling segment margins, especially legal and medical costs, pricing allowances, acquisition-related costs and restructuring charges.
- Any material developments in litigation, environmental obligations, customer retention, or the strategic segment realignment.