Deluxe Corporation (NYSE:DLX) Q2 2023 Earnings Call Transcript

Deluxe Corporation (NYSE:DLX) Q2 2023 Earnings Call Transcript August 5, 2023

Operator:

Operator: At this time, I would like to turn the conference over to your host, Vice President of Strategy and Investor Relations, Brian Anderson. Please go ahead.

Brian Anderson: Thank you, operator, and welcome to the Deluxe second quarter 2023 earnings call. Joining me on today’s call are Barry McCarthy, our President and Chief Executive Officer; and Chip Zint, our Chief Financial Officer. At the end of today’s prepared remarks, we will take questions. Before we begin, and as you see on the current slide, I’d like to remind everyone that comments made today regarding management’s intentions, projections, financial estimates or expectations of the company’s future strategy or performance are forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. Additional information about factors that will cause actual results to differ from projections is set forth in the press release we furnished today in our Form 10-K for the year ended December 31, 2022, and in other company SEC filings.

On the call today, we will discuss non-GAAP financial measures, including comparable adjusted revenue, adjusted and comparable adjusted EBITDA, adjusted and comparable adjusted EBITDA margin, adjusted EPS and free cash flow. In our press release, today’s presentation and our filings with the SEC, you will find additional disclosures regarding the non-GAAP measures, including reconciliations of these measures to the most comparable measures under U.S. GAAP. Within the materials, we are also providing reconciliations of GAAP EPS to adjusted EPS, which may assist with your modeling. Now I’ll turn it over to Barry.

Barry McCarthy: Thanks, Brian, and good morning, everyone. Before we begin, I’d like to introduce Brian Anderson, our new leader of Strategy and Investor Relations. Brian has been with Deluxe for nearly 4 years, serving in a number of important financial, operational and strategic roles. We look forward to leveraging his deep knowledge of Deluxe to further build our IR program. We’re pleased with the second quarter performance overall. We delivered both revenue and adjusted EBITDA dollar growth across all 4 operating segments, and we are in our third consecutive year of organic revenue growth. We’re very pleased to raise both full year 2023 revenue and earnings guidance based on these results and our momentum. As discussed in the first quarter, the company is now positioned to deliver revenue and adjusted EBITDA growth concurrently.

Before sharing a few additional recent business highlights, I’d like to start by addressing the broader macroeconomic environment. As a leading merchant processor, we regularly monitor broad consumer confidence and discretionary spending trends. After a slow start to the quarter, our merchant portfolio performance was roughly in line with card associations and other market reports, noting modestly improving consumer sentiment and discretionary spending volumes as the quarter unfolded. Importantly, we remain confident that our Merchant business can deliver mid-single-digit revenue growth for the full year, driven by new product features, ongoing pricing actions and a strong pipeline for new accounts and partnerships. Now I’ll on to some brief comments on the overall results.

For the second quarter, total reported revenue increased 1.5% to $572 million. This growth rate was impacted by several exits of nonstrategic businesses throughout 2022. On a comparable adjusted basis, total revenue increased 2.6%. As I mentioned earlier, we’re now on our third consecutive year of revenue growth on a comparable adjusted basis. Profits once again grew faster than revenue in the quarter, and we continue to look for opportunities to drive efficiency and our cost base while profitably investing for growth. Total adjusted EBITDA margins increased 90 basis points versus the second quarter of 2022. Adjusted EBITDA dollars increased 6.6%, while total comparable adjusted EBITDA dollars increased 7.2% as our operations continue to benefit both from responsible pricing actions and disciplined cost management.

While we don’t expect our growth rate from the back half to match the second quarter pace, combining our overall first half performance, trajectory and solid operating plan enable us to lift full year guidance, as I mentioned a moment ago. Chip will discuss in greater detail. Now for the segment revenue highlights. As a reminder, our Payments segment is structured with 2 distinct sets of attractive offerings. Our Merchant Services business helps small to midsized businesses, except credit card and debit cards. Our treasury management suite of solutions helps enterprises and midsized businesses manage their receivables and payables more efficiently. Overall, Payment’s revenue grew approximately 2% from the second quarter of 2022, slower than our long-term expectation.

Merchant Services revenue increased just over 1%, mainly due to the early softness in processing volumes within discretionary spending categories, as mentioned earlier. The trends we’ve seen in our Merchant business are broadly in line with what we’ve seen from industry-wide data. We expect spending to stabilize, and we remain pleased with our partner development and overall sales pipeline activities. Treasury management grew 2.5% as improvements in software revenues were partially offset by softness in lockbox volume that we expect to continue for another quarter or two. During the quarter, our sales team signed BankUnited, a Florida-based leading financial institution with over $37 billion in assets to our Deluxe Payment Exchange Disbursements platform.

This solution will help BankUnited drive a strong B2B payments offering to its customer base and drive future growth. Moving on to our Data segments. We are particularly pleased with our standout performance in the segment. On a comparable adjusted basis, revenue in the Data segment increased a strong 8.4%. The data-driven marketing, or DDM business, posted record revenue and adjusted EBITDA during the quarter. As we’ve discussed previously, we’re working diligently to expand this business beyond its strong FI relationships. We focused on new and less interest rate sensitive industry verticals. And this quarter, we signed 3 new smart home brands as part of our 20 new logo wins during the quarter. In addition, we saw increased demand for our market services in support of banks, attracting low-cost deposits.

Specifically, we delivered a suite of campaigns for a top 10 FI, helping drive aggressive consumer and business deposit gathering. Finally, we closed on the sale of our North American Web hosting business as of June 29. The second quarter Data segment financials are reflective of these results through the closing date as we continue to reshape and simplify our portfolio over time. Shifting now to our Print businesses, comprised of our promotional solutions and check segments. Combined, the Print business has delivered a blended comparable adjusted revenue growth of 1% and EBITDA margins of 31% from the first half. Promotional Solutions had another solid quarter, improving comparable adjusted revenue 2.2% along with significantly improved margins, which Chip will discuss in a moment.

Finally, our Check business increased 1.4% year-over-year, better than our long-term expectations of mid-single-digit revenue decline. As we discussed on the last call, our first quarter results were impacted by our ERP system upgrade. Our production caught up and we shipped the carryover Q1 order backlog in addition to normal orders, helping to deliver this performance. For the first half, Check revenue was down 1.6% year-over-year, still better than our long-term expectations. Small business demand remained durable, and we benefited from our previous price actions. We held margins as expected in the mid-40s. Now on to the organization. We recently made some adjustments to our leadership team, realigning existing leaders from our Merchant and Data businesses into roles reporting directly to me.

These moves are fully aligned with our core strategic priorities and will allow for greater focus on the most critical growth platforms for the company. In summary, we’re now confident in our ability to deliver sustainable, positive operating leverage over the long term with some periods stronger than others. We’re very pleased our performance is enabling us to raise our full year guidance to reflect our momentum. Before passing this over to Chip, who will provide more details on our financial performance, capital allocation priorities and guidance, we once again thank my fellow Deluxers for their continued dedication to both our customers and our company’s success, enabling the strong second quarter and first half results.

Chip Zint: Thank you, Barry, and good morning, everyone. Let’s first go through the consolidated highlights for the quarter. On a reported basis, revenue increased 1.5% year-over-year, while total comparable adjusted revenue increased 2.6% to $571.7 million. We reported second quarter GAAP net income of $16.4 million or $0.37 per diluted share, down from $22.1 million or $0.50 per share in the second quarter of 2022. Adjusted EBITDA came in at $108.4 million, up 6.6% on a reported basis and up 7.2% on a comparable adjusted basis from last year. Comparable adjusted EBITDA margins were 19%, up 90 basis points year-over-year. Second quarter adjusted diluted EPS came in at $0.93, down from $0.99 in last year’s second quarter. This decrease was primarily driven by an $0.18 impact from higher interest expense, partially offset by improved operational performance.

Now turning to our segment details, starting with our growth businesses, Payments and Data. Payments grew second quarter revenue 1.9% year-over-year to $174.4 million with Merchant Services growing 1.3% and the balance of the Payments business increasing 2.5%. Growth for the Merchant business reflected some softer consumer discretionary spending levels discussed previously. Growth for the balance of the Payments segment, including our receivables and payable solutions, was strong, while our lockbox business experienced some volume softness. Payments adjusted EBITDA margins were 20.8%, up 40 basis points from the prior year. Operational improvements across our lockbox sites, as we indicated during last quarter’s call, drove second quarter margin improvement for the treasury management business, while Merchant Services margins were modestly challenged due to the volume softness noted previously.

For 2023, we continue to expect to see mid-single-digit payments revenue growth and adjusted EBITDA margins in the low to mid-20% range. On a reported basis, data’s revenue increased 5.1% from the second quarter of 2022 to $72.1 million. Comparable adjusted revenue increased 8.4% year-over-year, driven by strong data-driven marketing results. As Barry mentioned, the Deluxe Web hosting business has now been fully divested as of June 29. Data’s adjusted EBITDA margins in the quarter decreased 80 basis points year-over-year to 24.7%. On a comparable adjusted basis, EBITDA margins declined 120 basis points. For the second half of 2023, inclusive of the sale of the Web hosting business, we expect data adjusted EBITDA margins in the mid- to high teens.

For the full year, we continue to expect low single-digit revenue growth on a comparable adjusted basis, and we also expect to see blended adjusted EBITDA margins in the low to mid-20% range for the full year. Turning now to our Print businesses, promo and checks. Promotional Solutions second quarter revenue was $138.8 million, flat with last year on a reported basis. Promo’s comparable adjusted revenue increased 2.2%, driven by new sales wins, pricing actions and adjusting for $3.5 million of divested revenue from multiple 2022 business exits. Promo’s adjusted EBITDA margin increased 480 basis points year-over-year to 15.3% as we returned to mid-teens levels following last year’s challenging second quarter. As a reminder, through a combination of pricing actions, improvements in operations, supply chain and cost structure, the business has stabilized significantly over the last few quarters.

For 2023, we continue to expect to see low single-digit comparable adjusted revenue growth and adjusted EBITDA margins in the mid-teens. Check second quarter revenue increased 1.4% from last year to $186.4 million, benefiting from some timing impacts relating to the catch-up of ERP-related issues. Checks also benefited from resilient demand and the continued positive impact of responsible price actions. Second quarter adjusted EBITDA margins were a solid 44.8%, essentially flat year-over-year. On a year-to-date basis, Checks revenue was down 1.6% year-over-year with margins at 43.9%. For 2023, we now expect low to mid-single-digit revenue declines and adjusted EBITDA margins in the mid-40% range, consistent with our long-term expectations. Turning now to our balance sheet and cash flow.

We ended the quarter with a net debt level of $1.63 billion, down from $1.66 billion compared to the first quarter. Our net debt to adjusted EBITDA ratio was 3.8 times at the end of the quarter, down from four times at the end of the first quarter, and our long-term strategic target remains approximately three times. I would also like to mention that in the second quarter, we completed an additional 3-year floating to fixed interest rate swap at a fixed interest rate of 4.25% beginning on June 20, 2023. This swap carried an initial notional amount of approximately $300 million. The swap will amortize over a 3-year life, making about 75% of our total debt fixed rate. By increasing our fixed debt ratio, we are now better insulated against ongoing variability from potential rate hikes, including the one announced last week.

Free cash flow, defined as cash provided by operating activities less capital expenditures, was $23.7 million, which compares to $13.5 million in the second quarter of 2022. On a year-to-date basis, we remain slightly behind our plan, but the second quarter represented a significant improvement from the first quarter and prior year. Our Board approved a regular quarterly dividend of $0.30 per share on all outstanding shares. The dividend will be payable on September 5, 2023, to all shareholders of record as of market closing on August 21, 2023. To reiterate my comments from the last call around capital allocation, we are responsibly investing the significant free cash flow generated by our core Print businesses into our Payments and Data businesses that we believe can generate more robust growth over time.

Our priorities for capital allocation are clear: reducing our debt and net leverage to a level below three times, funding high-return internal investments and paying our dividend. We facilitate a rigorous annual planning process, ensuring all investments have a compelling business case and target returns above a 15% hurdle rate. We returned value to shareholders through our dividend, which is currently $0.30 per share per quarter and equates to a very attractive roughly 7% yield. We continue to review the dividend with our Board, and our current focus is to grow out of that high yield through improving business performance. Importantly, we remain focused on further accelerating our rate of debt paydown through continued improved EBITDA and free cash flow generation so that we can get back below three times levered.

As an example, the completion of our previously referenced ERP upgrade will serve as a foundation for continued operational efficiency and unlock new opportunities to further improve our cost structure. Turning now to guidance. Today, we are raising our full year 2023 expectations for revenue and earnings, keeping in mind all figures are approximate and reflect the impact of the Web hosting divestiture, which closed on June 29. As detailed further within today’s press release, we are increasing our guidance, now expecting revenue of $2.18 billion to $2.22 billion, adjusted EBITDA of $400 million to $415 million, adjusted EPS of $3.10 to $3.40 and free cash flow of $80 million to $100 million, which is unchanged from our previous guidance. We are raising our guidance based off our strong start to the year and continued progress in yielding operational efficiencies.

On a comparable adjusted basis, we see 2023 revenue growing between 0% and 2% and comparable adjusted EBITDA between negative 1% to positive 3% growth. Adjusted EPS, while a substantial improvement from our original guidance is still expected to decline year-over-year due to the full year impact of rising interest rates, incremental depreciation and amortization and an estimated $0.15 impact from the recently closed divestiture. We remain confident in our full year free cash flow guide and believe it remains prudent to hold the prior range based on our year-to-date results. Also, in order to assist with your modeling, our guidance assumes the following: interest expense of $120 million to $125 million; an adjusted tax rate of 26%; depreciation and amortization of $165 million, of which acquisition amortization is approximately $75 million; an average outstanding share count of 43.7 million shares and capital expenditures of approximately $100 million.

Among other things, this guidance is subject to prevailing macroeconomic conditions, including consumer spending, interest rates, labor supply issues, inflation and the impact of divestitures. To summarize, we are encouraged with our second quarter results and believe we have solid momentum heading into the second half of the year. In addition to continued revenue growth, our laser focus on increasing operational efficiencies will help us grow EBITDA, continue to improve free cash flow, pay down debt and further lower our leverage ratio.

Operator: We are now ready to take questions.

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Q&A Session

Operator: [Operator Instructions] Your first question is from the line of Lance Vitanza with TD Cowen.

Lance Vitanza: Hey guys. Thanks for taking my questions. Congratulations on the nice quarter. I had 3 questions, if I can squeeze them all in. The first is — and I know, Barry, you talked about Merchant Services, Merchant acquisition being somewhat influenced by the underlying consumer sentiment and consumer spending and the like. But I was wondering if there was anything else there to call out because the numbers did seem a touch soft. And then could you just clarify, I think you said you’d expect to get back to mid-single-digit revenue growth in that line. But was it in by the second half or by the end of the year, what was the sort of the timeframe there for getting back to that mid-single-digit growth?

Barry McCarthy : Sure. So let me just give you a little more color commentary there. Our acquisition of new merchants and our activations in that business are solid and continue to be solid and very pleased with how we’re developing partners. What we saw at the beginning of the second quarter was just a softness in discretionary spending categories that improved modestly as the quarter unfolded. And that’s exactly the same pattern that we’ve seen in lots of economic forecast that’s also in the card associations data. So then as far as the year goes along, we believe that we’re going to be able to deliver the full year mid-single-digit growth for the entire year because we’re just pretty confident in the portfolio, its ability to perform. And even though there was that April first part of the quarter softness, we’ve seen some improvement, and I feel good about how the full year will play out.

Lance Vitanza : Great. No, that’s actually super helpful. I appreciate the clarification. And then somewhat related on the Data Solutions, where the revenue growth was actually, was quite robust. I would have expected that to more closely match the performance in Merchant acquisition because both would seem to be driven by consumer spending and sentiment to a certain extent. But could you help me untangle the drivers there? And what was it that enabled Data Solutions to kind of chug through whatever slowness we might have had in the early part of the quarter?

Barry McCarthy : Appreciate the question. And I think it really highlights, Lance, the success we’ve had in expanding across and into new market verticals. So as we mentioned in our comments, we were able to secure and win some business in categories that are not interest rate sensitive at all. We also had significant wins in some more traditional financial institution channels. But we also had a really nice win with a top 10 FI, who launched a program to gain new — gather new deposits, both for business and consumer accounts. And I think it just goes to show that this business and how we’ve diversified the business really allows us to pivot to whatever the market need is at that moment in time, and we’ve been able to capitalize on that.

Banks are looking for gathering deposits, so we are able to shift and help banks do that. At the same time, we’re able to expand into new market verticals to provide us different avenues of growth. And we think it just really shows that the investment and our commitment to that space is producing results, and we’re proud of that.

Lance Vitanza: Great. Okay. And then the last one for me is actually on the balance sheet. A nice job there. Could you remind us, is that — do you have a target for how quickly — and I apologize if you said this on the call and I missed it, but how quickly you expect to delever over time? I think at one point, you had talked about a half a turn a year, but I don’t know if that’s still current or if I’m recollecting that correctly?