Deluxe Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Financial statements are unaudited. Deluxe provides products and services to small businesses, financial institutions and consumers; its three segments are Small Business Services, Financial Services and Direct Checks.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $450.6 million | $435.9 million | $909.9 million | $869.5 million |
| Operating income | $90.9 million | $88.9 million | $183.6 million | $174.2 million |
| Net income | $58.4 million | $56.1 million | $116.5 million | $102.0 million |
| Diluted EPS | $1.18 | $1.11 | $2.36 | $2.02 |
| Operating margin | 20.2% | 20.4% | 20.2% | 20.0% |
Q2 revenue rose 3.4%; first-half revenue rose 4.7%. Service revenue grew to $90.8 million in Q2 from $77.0 million and to $183.9 million for the first half from $155.6 million. Marketing solutions and other services, acquisitions and prior price increases supported growth; declining check and forms orders and Financial Services contract renewal allowances partly offset it. Company-wide orders fell 3.5% in Q2 and 2.4% for the first half, while revenue per order increased 7.1% and 7.2%, respectively.
For the first half, gross profit was $585.8 million versus $560.9 million; gross margin was approximately 64.4% versus 64.5%. SG&A was $400.2 million, up 3.8%, and operating income increased 5.4%. Net income and EPS also benefited from the absence of the $8.9 million early-debt-extinguishment loss recorded in first-half 2015. The 2016 adoption of share-based-payment accounting guidance increased diluted EPS by $0.03 for the first half.
Segments, Q2 year over year: Small Business Services revenue increased 2.1% to $288.2 million and operating income rose 1.5% to $49.0 million. Financial Services revenue increased 10.2% to $124.2 million and operating income rose 13.8% to $29.0 million. Direct Checks revenue declined 6.5% to $38.2 million and operating income declined 14.5% to $13.0 million, primarily reflecting lower check-order volume, higher delivery and material costs, and increased advertising and restructuring costs.
Cash flow, debt and liquidity
First-half operating cash flow was $128.3 million, down from $146.9 million. Management attributed the decline principally to higher tax and contract-acquisition payments and a $5.4 million acquisition-related incentive payment, partly offset by improved operating performance and lower interest payments. Investing cash outflow was $45.5 million, including $22.2 million of capital spending and $28.5 million for acquisitions. Financing cash outflow was $79.5 million, including $30.0 million of share repurchases and $29.4 million of dividends. Cash and cash equivalents ended the period at $69.6 million.
Total debt was $613.8 million, down $15.2 million from year-end 2015. The company had drawn $413.0 million under its $525.0 million credit facility; $99.2 million remained available after letters of credit. The facility expires in February 2019. Deluxe reported compliance with debt covenants and expected to remain compliant over the next 12 months. Canadian subsidiaries held $62.0 million of cash; management estimated a $6.5 million federal tax liability if all of it were repatriated at once.
Outlook, commentary and notable items
- 2016 revenue guidance: $1.855–$1.875 billion; diluted EPS guidance: $4.87–$4.97, including $0.03 per share of restructuring and acquisition-related transaction costs.
- Management expected approximately $50 million of net cost reductions in 2016, and said it was on track. It forecast operating cash flow of $320–$330 million, capital spending of approximately $43 million, and contract-acquisition payments of approximately $20 million.
- Management anticipated 2016 revenue growth of 5%–6% in Small Business Services and 9%–10% in Financial Services, but a 7%–8% decline in Direct Checks. It cited continuing secular check-volume declines, a sluggish economy, medical, material and delivery cost increases, and investment spending as factors that could offset savings and growth.
- The board authorized up to an additional $300 million of share repurchases, effective after the existing authorization is exhausted. Management anticipated maintaining the current dividend, subject to quarterly board approval.
- The company corrected prior-period presentation of credit-facility borrowings and related debt-issuance costs: borrowings were reclassified from current to non-current, and borrowing cash flows were presented gross rather than net. Management concluded the prior error was not material; the revision did not affect total assets, liabilities, equity, net income or net financing cash flow.
- First-half restructuring charges were $2.0 million. Most employee reductions were expected to be completed by Q4 2016, with most related severance paid by Q1 2017. A $1.9 million environmental-liability benefit was recorded after management determined part of a remediation estimate was no longer probable.
- A supplier arbitration claim seeking up to approximately $43 million was rejected in March 2016. Environmental remediation accruals were $3.4 million. Management said recorded legal liabilities were not material but cautioned that litigation and indemnification outcomes remain uncertain.
Key facts for investors to verify
- Whether service and marketing-solutions growth can continue to offset declining check and forms orders, particularly in Direct Checks.
- Progress against 2016 revenue, EPS, cash-flow and $50 million cost-reduction guidance, including the effect of acquisitions and ongoing investment spending.
- Cash-flow conversion and working-capital demands, especially taxes, contract-acquisition payments, customer funds and incentive payments.
- Debt levels, available credit, covenant compliance, interest-rate exposure and the pace of repurchases and dividends.
- Final purchase-price allocations and acquired-asset assumptions, as well as developments in environmental, litigation and other contingent obligations.