Deluxe Corporation — Q2 2013 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. Deluxe sells checks, forms, business products, marketing solutions and other services through Small Business Services, Financial Services and Direct Checks. Check usage continued to decline; the company is investing in services, digital capabilities and cost reductions. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Revenue | $381.4 | $371.0 | $769.0 | $749.0 |
| Gross profit / margin | $247.9 / 65.0% | $243.4 / 65.6% | $502.1 / 65.3% | $493.9 / 65.9% |
| Operating income | $82.5 | $73.6 | $160.2 | $151.6 |
| Net income | $48.2 | $42.3 | $94.0 | $86.3 |
| Diluted EPS | $0.94 | $0.82 | $1.83 | $1.68 |
| Operating cash flow | Not separately stated for the quarter | $102.1 | $99.9 |
Q2 revenue rose 2.8% and first-half revenue 2.7%. Service revenue increased to $48.6 million from $38.5 million in Q2 and to $96.3 million from $75.0 million in the first half; product revenue was nearly flat. Revenue per order increased 4.5% in Q2 and 5.5% in the first half, while order volume declined 1.6% and 2.7%, respectively. The first-half effective tax rate was 33.6%, versus 33.0%.
Cash, debt and liquidity. At June 30, cash and cash equivalents were $52.8 million; funds held for customers were $38.6 million, with related accrued customer funds of $38.1 million. Current assets were $229.8 million and current liabilities $202.2 million (current ratio approximately 1.14). Total debt was $642.4 million, down $10.1 million from year-end; cash less total debt was approximately $589.6 million. The company had $192.0 million available under its $200 million revolving credit facility and reported compliance with debt covenants. Debt fair value was reported at $682.8 million. Dividends were $0.25 per share per quarter.
First-half investing cash outflow was $45.7 million, including $35.1 million for acquisitions and $16.6 million for capital expenditures. Financing cash outflow was $47.1 million, including $32.0 million of share repurchases and $25.4 million of dividends. Cash increased $7.4 million to $52.8 million, including a $2.0 million adverse foreign-exchange effect.
Material changes and segment results
- Small Business Services revenue increased 8.0% in Q2 and 8.1% in the first half; operating income rose 20.8% and 10.1%, respectively. Growth reflected pricing, distributor-channel gains, marketing and other services, and acquisitions.
- Financial Services revenue declined 3.0% in Q2 and 3.4% in the first half as check orders fell and contract renewals faced pricing pressure. Operating income nevertheless rose 7.9% and 6.2%, supported by pricing and cost reductions.
- Direct Checks revenue fell 11.0% in Q2 and 10.4% in the first half amid declining check usage. Operating income decreased 4.2% and 5.4%; margins improved due to pricing and cost actions.
- Consolidated gross margin declined 0.6 percentage points in both comparison periods, reflecting a shift toward services and outsourced products and higher delivery and material costs. SG&A was down 1.9% in Q2 and essentially flat in the first half; lower compensation and cost savings offset acquisition, marketing and commission costs.
- Interest expense fell 15.8% in Q2 and 17.4% in the first half, primarily following debt refinancing and lower average debt. The first-half weighted-average debt balance declined 11.4% year over year.
Outlook, commentary and risks
- Management forecast 2013 revenue of $1.57–$1.59 billion and diluted EPS of $3.66–$3.76, including $0.06 per share for restructuring and transaction-related costs. The 2013 outlook included an estimated 34% effective tax rate.
- Management expected approximately $55 million in 2013 net cost reductions, with about $29 million realized by midyear. It forecast operating cash flow of $250–$260 million, capital expenditures of about $35 million and contract-acquisition payments of about $15 million.
- VerticalResponse was acquired in June for $27.3 million net of cash acquired, funded with cash on hand. Management expected approximately $12 million of incremental 2013 revenue and $0.06 per-share dilution in 2013. Purchase-price allocations were preliminary.
- Management expected Small Business Services revenue growth of 9–11%, Financial Services revenue decline of 2–3%, and Direct Checks revenue decline of 9–10% for 2013. It cited ongoing check-usage declines, Financial Services contract pricing pressure, delivery and material cost increases, and business-day timing as headwinds.
- Management believed operating cash flow and credit availability would be sufficient for the next 12 months, including debt service, dividends, capital spending and potential acquisitions. It planned to accumulate cash ahead of the $253.5 million October 2014 note maturity. The current dividend level was anticipated but remained subject to quarterly board approval.
- Restructuring charges were $2.5 million in the first half including charges classified in cost of revenue; the income statement’s restructuring line was $2.3 million. Most employee reductions were expected to finish by Q1 2014, with most severance paid by mid-2014. Environmental accruals were $8.4 million; management did not expect a material effect from environmental matters or identified litigation.
- The company held $37.8 million of cash and marketable securities in Canadian subsidiaries; repatriating it would incur an estimated $6 million U.S. tax liability. A one-percentage-point interest-rate change was estimated to affect first-half interest expense by $2.0 million, excluding hedge ineffectiveness. Management reported no significant changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether service and marketing-solutions growth can offset continued check-volume declines, particularly in Direct Checks and Financial Services.
- Delivery, material and service-mix pressures on gross margin, and whether the forecast $55 million of cost reductions is achieved without impairing growth.
- VerticalResponse’s realized revenue contribution, acquisition costs and final purchase-price allocation relative to management’s expectations.
- Cash generation and capital allocation against the October 2014 note maturity, including planned dividends, repurchases and potential acquisitions.
- Debt-covenant headroom, interest-rate exposure and the potential effects of hedge valuation changes on reported interest expense.
- Progress against the 2013 revenue, EPS and cash-flow guidance, which is forward-looking and subject to the risks described in the filing.