Deluxe Corporation — Q2 2015 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and six months ended June 30, 2015, with comparisons to the same 2014 periods. Deluxe sells products and services to small businesses, financial institutions and consumers through Small Business Services, Financial Services and Direct Checks. Its offerings include checks, marketing solutions and other services, forms, and accessories. Checks remain a significant business, while management is pursuing growth in services and digital offerings.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $435.9 million (+7.5%) | $405.4 million | $869.5 million (+7.0%) | $812.4 million |
| Gross profit / margin | $279.9 million / 64.2% | $259.5 million / 64.0% | $560.9 million / 64.5% | $521.5 million / 64.2% |
| Operating income / margin | $88.9 million / 20.4% | $85.0 million / 21.0% | $174.2 million / 20.0% | $165.8 million / 20.4% |
| Net income | $56.1 million | $50.1 million | $102.0 million | $97.4 million |
| Diluted EPS | $1.11 | $0.99 | $2.02 | $1.92 |
Revenue growth reflected stronger marketing solutions and other services, acquisitions, distributor-channel growth and price increases. For the first half, service revenue was 17.9% of total revenue versus 15.0% a year earlier. Orders rose 5.2% and revenue per order rose 1.7%. These gains were partly offset by declines in personal and business check volumes and Financial Services contract renewal allowances.
Q2 operating income rose despite a lower operating margin: SG&A increased 9.5%, faster than revenue growth, as acquisition costs and investments in growth offset savings. For the first half, operating income increased 5.1%; SG&A rose 9.7%. Cost of revenue as a share of revenue improved modestly in both periods. Q2 net income and EPS increased year over year; first-half results included an $8.9 million pretax loss on early debt extinguishment.
Segment performance
- Small Business Services: Q2 revenue increased 5.5% to $282.3 million, while operating income declined 1.2% to $48.2 million and margin fell to 17.1% from 18.2%. First-half revenue rose 4.7% and operating income 6.0%.
- Financial Services: Q2 revenue grew 19.2% to $112.7 million, principally reflecting Wausau and services growth; operating income rose 14.5% to $25.5 million. Margin declined to 22.6% from 23.6%, partly due to Wausau acquisition-related amortization. First-half revenue rose 19.9%, while operating income rose 4.1%.
- Direct Checks: Q2 revenue declined 5.2% to $40.9 million, but operating income increased 9.0% to $15.1 million and margin improved to 37.0%. First-half revenue fell 5.6%, while operating income rose 3.8%.
Cash flow, debt and liquidity
- First-half operating cash flow was $146.0 million, up from $125.8 million. Investing used $54.8 million, including $35.8 million for acquisitions and $19.3 million for capital assets. Financing used $84.2 million; cash increased $3.4 million to $64.9 million.
- Total debt was $503.8 million at June 30, down $50.5 million from year-end. The company retired $200 million of 7.0% notes in March, funded with credit-facility borrowings and a $75 million short-term bank loan. At quarter-end, $233 million was drawn on the $350 million credit facility; net borrowing availability was $104.3 million.
- Current assets were $312.3 million and current liabilities $601.9 million, including $308 million of short-term borrowings. Cash and funds held for customers are distinct balance-sheet items; funds held for customers should not be treated as unrestricted corporate liquidity.
- Cash dividends were $0.30 per share for the quarter and $0.60 per share for the first half. No shares were repurchased in the first half of 2015.
Outlook, commentary and risks
Management reaffirmed its 2015 outlook: revenue of $1.76–$1.78 billion, diluted EPS of $4.35–$4.45 (including $0.15 per share for the debt-extinguishment loss, restructuring and acquisition transaction costs), and operating cash flow of $300–$310 million. It expected approximately $40 million of capital spending and $15 million of contract acquisition payments. Management said it was on track for approximately $50 million of net cost reductions in 2015, with about $25 million realized through June 30.
Management expects growth in Small Business Services and Financial Services, while forecasting Direct Checks revenue to decline 6%–7%. It cited continuing check-use declines, a sluggish economy, medical, materials and delivery-cost increases, contract renewal allowances, foreign exchange, and execution of growth investments as factors that could affect results. It expects cash from operations and credit-facility availability to fund operations, dividends, capital spending, debt service, planned second-half share repurchases and potential acquisitions. The company reported compliance with debt covenants and expected to remain compliant over the next 12 months.
Other notable items include acquisitions of small-business distributors, Range and Verify Valid; Verify Valid contingent payments are based on revenue for up to eight years and have no stated maximum. Environmental remediation accruals were $7.7 million; management did not expect the range of possible outcomes to materially affect financial condition, results or liquidity. The filing reported no significant changes to previously disclosed risk factors and no material related-party transactions.
Most important facts for investors to verify
- Whether the 2015 revenue, EPS, cash-flow and cost-reduction guidance was achieved, and how much growth came from acquisitions versus organic activity.
- Whether service growth and pricing can offset secular declines in check and forms usage without sustained margin pressure.
- Debt maturities, short-term loan repayment requirements, credit-facility availability and covenant headroom as borrowing needs evolve.
- The eventual purchase-price allocations and performance of recent acquisitions, including Verify Valid’s uncapped revenue-based contingent payments.
- Actual cash requirements for contract acquisition payments, restructuring, dividends, planned repurchases and environmental remediation.
- Potential tax consequences if the $54.8 million of Canadian cash and marketable securities were repatriated; management estimated approximately $7 million of U.S. tax if all were repatriated at once.