Deluxe Corporation
Q1 2019 Earnings Call Transcript

Published: 25 Apr 2019

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the First Quarter 2019 Deluxe Corporation Earnings Conference Call. [Operator Instructions]. As a reminder, today's program is being recorded. And now I would like to introduce your host for today's program, Ed Merritt, Treasurer and Vice President of Investor Relations. Please go ahead, sir.

[Ed Merritt:]

Thank you, Jonathan, and welcome, everyone, to Deluxe Corporation's First Quarter 2019 Earnings Call. I'm Ed Merritt, Treasurer and Vice President of Investor Relations. Joining me on today's call is Barry McCarthy, our President and Chief Executive Officer; and Keith Bush, our Chief Financial Officer. At the end of today's prepared remarks, Barry, Keith and I will take questions. I'd like to remind you that comments made today regarding financial estimates, projections and management's intentions and expectations regarding the company's strategy and future performance are forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. These comments are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Additional information about factors that could cause actual results to differ from the projections are contained in the press release that we issued this morning as well as in the company's Form 10-K for the year ended December 31, 2018. Portions of the financial and statistical information that will be reviewed during this call are addressed in more detail in today's press release, which is posted on our Investor Relations website at deluxe.com. This information was also furnished to the SEC on Form 8-K filed by the company this morning. Any references to non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release or as part of our presentation during this call. Now I'll turn the call over to Barry.

[Barry McCarthy:]

Thanks, Ed, and good morning, everyone. We have an extraordinary amount of content to cover today. We're going to recap our first quarter results, provide an update on our focus areas since the last call, introduce some enhanced financial metrics, provide our financial outlook for the remainder of the year and update you on our strategy for the new Deluxe to become a trusted tech-enabled solutions company. This is all consistent with my commitment to provide transparency on our transformation. Not all of our calls will be this long, with this much content. Let's get started with the first quarter results. We had a good start to the year, and I'm pleased to report that we delivered $499 million of revenue in the quarter, squarely within the range we expected. Total first quarter revenue grew 1.5% year-over-year. We delivered diluted earnings per share of $0.93 and revised adjusted diluted earnings per share of $1.54, at the top end of our range after excluding the additional non-GAAP items, which will be discussed later. All segments performed at the levels we expected. Before I get into the details on our strategy and progress, let me turn the call over to Keith for some additional color on the quarter.

[Keith Bush:]

Thanks, Barry. We delivered first quarter revenue of $499 million, which represents a 1.5% increase over last year. Organic revenue, which excludes acquisitions, FX and other noncomparable items, declined about 2.7%. Shifting to our current business segments. Small business services revenue was $313.1 million and declined about 1% in total or about 1.9% organically. Financial services revenue was $154.4 million and grew nearly 10% in total, but declined about 2.7% organically. Direct Checks revenue was $31.6 million and declined 9.7% year-over-year, slightly better than our expectations. Barry will outline our strategy framework to become a trusted, tech-enabled solutions company in a few minutes, which will lead to a realignment of our business later in the year. But for now, I want to provide revenue by product category, which conforms to what we have provided in the past. Our largest group of products and services is marketing solutions and other services, or MOS, which delivered revenue of over $214 million, ending at 43% of total revenue. Check revenue ended the quarter at $201 million, representing about 40% of total revenue. And forms and accessories delivered $83.5 million, representing about 17% of total revenue. SG&A expense increased approximately 300 basis points from last year. About 150 basis points of the increase resulted from gains on asset sales in last year's results, and about 110 basis points of the increase resulted from CEO transition costs this year. The remaining expense increase was related to acquisition and other expenses, only partially offset by efficiency and cost savings. Adjusted diluted EPS and adjusted EBITDA, which we will discuss shortly, normalized the impact of these charges, which we believe provides additional helpful metrics you can use to analyze our results. Diluted earnings per share for the first quarter was $0.93 and includes aggregate, non-GAAP adjustments of $0.61 per share. Moving on to adjusted diluted EPS. As a result of input from many of you, we have slightly modified our calculation of adjusted diluted earnings per share to exclude additional items that we believe are not representative of our core operations. Adjusted diluted EPS will now exclude acquisition-related amortization, stock-based compensation expense, certain legal related expenses and gains or losses on asset sales. A complete reconciliation from diluted EPS to adjusted diluted EPS is included in our earnings release. Excluding $0.61 of non-GAAP adjustments, adjusted diluted EPS for the first quarter was $1.54 per share compared to $1.60 per share in the first quarter of 2018. We've applied the same non-GAAP adjustments to adjusted EBITDA. We believe adjusted EBITDA provides transparency into our operations and is useful in evaluating our operating performance compared to other companies. Importantly, the use of adjusted EBITDA is consistent with how technology companies manage their businesses and how we will manage our company moving forward, as we move towards becoming a trusted tech-enabled solutions company. A reconciliation of adjusted EBITDA is included in our earnings release. Adjusted EBITDA for the first quarter was $113.7 million compared to $121.6 million in the first quarter of 2018. The change in adjusted EBITDA is the result of higher SG&A discussed earlier and the greater mix of service revenue resulting from acquisitions. In addition, we continued to see the impact of commission structures entered into in 2018. We are also experiencing some inflationary pressure in materials and shipping costs and increased medical expenses that have not fully been offset by cost-saving activity. Now moving on to the balance sheet and cash flow statement. As previously reported on January 22, 2019, we expanded our credit facility by $200 million, with total availability now at $1.15 billion. At the end of the quarter, we were drawn $946 million on the credit facility, with the increase from the beginning of the year primarily due to $50 million of common stock repurchases in the first quarter. Moving to free cash flow, which is defined as cash provided by operating activities minus capital expenditures. Cash provided by operating activities was $45.4 million and capital expenditures were $14.6 million, resulting in free cash flow of $30.8 million. Free cash flow this year included outflows of over $12 million for payments toward a legal matter and over $5 million of prepaid product discounts. To the extent we generate excess cash, we plan to reduce the amount outstanding against our credit facility. I know we've thrown a lot at you already. Before moving to our 2019 and full year outlook, I want to note we are affirming our previous 2019 revenue and EPS outlook. We expect second quarter revenue to be in the range of $490 million to $505 million. We expect adjusted diluted EPS to be in the range of $1.55 to $1.65 per share. For the full year, we expect revenue to be between $2 billion and 2.5 - $2.05 billion, which is in line with our previous outlook for a low single-digit increase over 2018. We expect adjusted diluted EPS in the range of $6.65 per share to $6.95 per share. On our last earnings call, our outlook called for a slight improvement in full year adjusted diluted EPS before incremental investments needed to accelerate our transformation. To reiterate, our current outlook is consistent with the previous outlook. To help reconcile the two, our current outlook of $6.65 to $6.95 per share includes approximately $5 million or $0.09 per share of incremental investment spend as well as the impact of the new non-GAAP adjustments, which were not included in the previous outlook. Additionally, we expect to incrementally invest between $30 million and $60 million in each of the next two years to build out our technology platforms. These will likely be a combination of capital and expense items, and support our IT integration and business transformation related to sales, finance and human resources. These investments are still being scoped and quantified and are not in our current adjusted diluted EPS outlook. We believe we have structural savings that will largely self-fund our future investments. However, due to the speed at which we intend to integrate our systems and technology to drive our transformation, we expect timing differences will impact our ability to fully self-fund through efficiency savings alone. As we noted on our last earnings call, we will continue our acquisition pause throughout the first half of the year. This will allow us time to complete the integration of previous acquisitions and ensure we have a foundation for future acquisitions. To be clear, acquisitions will be an important element of our growth, and we expect smart acquisitions will augment our strategy when appropriate going forward. Now I'll turn the call back to Barry.

[Barry McCarthy:]

Thanks, Keith. I've now been the CEO of Deluxe for almost five months, and we've made substantial progress reviewing our strategy and operations during that time. Before I outline our future strategy, I want to provide a brief update on the four new day areas of focus I discussed on our last earnings call. First, sales. We've launched a national search for an enterprise chief revenue officer and hope to give you an update on that search soon. We believe we have significant opportunity to sell more to our existing customers; they value our relationship and would deepen that relationship if they know more about our extensive offerings. Accordingly, we're in the final stages of selecting a new enterprise-wide CRM tool and expect to begin the initial scoping very soon. We're confident having a single view of our customer will be critical to unlocking our potential. Second, products and innovation. We've added a new role and hired a Vice President of Strategy and Planning, Amanda Parrilli, who has joined us from Home Depot. Earlier in her career, she had executive roles at Citi and First Data. Amanda has been in her role for about eight weeks and is off to a great start. We've also begun to build out enterprise innovation and product development teams, with processes to ensure we are all well-positioned to translate the insights we gain from customers into tangible, innovative products and services that address their needs. Third, efficiency. Our teams have identified millions of dollars of savings from a structural redesign of our systems architecture, a rationalization of our real estate footprint and many other items. I won't provide specifics in this area yet, but we have identified the areas where we need to become more efficient and are taking action to realize these savings. We'll be hearing more details on this as we progress through the year. And the fourth area of initial focus was culture. We've hired a new Chief Human Resources Officer, Jane Elliott, who most recently was the CHRO at Global Payments. We're glad to have Jane on board to guide our HR activities and help shape our culture. We've initiated a process of education and communication to ensure that every employee understands the importance of our customers and the shareholders. And we've made substantial progress breaking down our internal silos. Our end goal is to develop a culture to fully transform the company from its check printing and manufacturing legacy into a trusted technology-enabled solutions provider. During our last earnings call, I told you we had engaged one of the world's foremost management consulting firms to help us assess our current business and strategic direction. We have now completed the first phase of that review. Our strategic assessment validated what we consider our core competencies and key assets. For example, over the past 10-plus years, Deluxe has done a great job acquiring companies to diversify revenue beyond printed checks and forms. The collection of these assets provides us a great foundation, upon which we will transform into a trusted tech-enabled solutions company. Let me summarize our key competencies and assets. First, we have a fantastic base of existing customers and partners. We're a leading provider of solutions to nearly 5 million small businesses and 4,600 financial institutions. We host more than 4 million websites for small businesses directly and through partners and serve 180 of the top 200 financial institutions. Next, we're a proven, trusted partner in the markets where we operate and are one of the few organizations that leading financial institutions trust with sensitive, personally identifiable information, also referred to as PII. Third, we have a highly respected brand which we can leverage. As I said earlier, our customers want to do more business with us and consolidate spending with fewer, more strategic partners. Fourth, we're a cost-efficient service provider. We produce solutions at massive scale with great security and reliability at low cost with continuous improvement. For perspective on our scale, we ship over 100,000 secure packages every day. Fifth, we have an extensive catalog of products and services that creates a unique advantage when compared to less diversified competitors, and we have an extremely dedicated workforce eager to win. Finally, this is supported by solid financial structure with low leverage and high cash flow. Deluxe has a great foundation of competencies and assets. The primary strategic questions are

[Operator:]

[Operator Instructions]. Our first question comes from the line of Jamie Clement from Buckingham Research.

[James Clement:]

Barry, congratulations on providing just as much content as Lee used to provide. Yes. So one thing you mentioned, and I'm curious about this. Because, obviously, in the general scheme of things, you're not a gigantic company. And as you think about partnerships and alliances versus M&A, what do you think the partner on the other side of the table, based on what you've seen so far in your tenure at Deluxe, what do you think they value most about Deluxe in a partnership?

[Barry McCarthy:]

Jamie, I started the conversation talking about our core competencies and our key assets, and we truly have unmatched distribution with 5 million small businesses and 4,800 financial institutions that we can reach and that we talk to every year. So I think our partners, and potential partners, will highly value our ability to reach into that market segment in a very efficient way. I also said we are a trusted brand. We truly are a trusted brand. There are very few organizations on the planet that gets - that have PII data, that banks share in order to run a business. We're one of those. And so our trusted brand, our incredible reach to reach small businesses, enterprises and financial institutions, we think is a very compelling opportunity for any partner that wants to get to those markets.

[James Clement:]

Okay. Okay, and if I could just - if I could just transfer over to kind of - to guidance and the enhanced metrics and those kinds of things. I think there's a fair amount of confusion this morning. And it always happens when companies changing things up. I had thought that like what you guys said, so basing on the 2018 adjusted EPS number, which when originally reported, so before the legal charge, was I think $5.69? And then there was about 1/4, about $0.25 on the asset sales to knock out of that? Am I on the right track, Keith?

[Keith Bush:]

So the way we're looking at that is the original $5.56, after taking into account all of these adjustments, is $6.88.

[James Clement:]

See, that's where I'm - that's - I'm looking at it the other way, and I think this is why we're a little confused. So like the reported number for 2018 was, I think, $5.69. So less $0.25, that's $5.44. And I thought like - I think - I thought like your preliminary guidance - and obviously preliminary, we didn't take it as like rock solid, full-on guidance, because there was a lot of work to be done, but that you all thought you'd grow off of that number. If I knock out like what looks like your assumption for stock comp and for intangible amortization from your new guidance framework, it looks like the midpoint of that range is like $5.20. Is that right? So in other words, what I'm saying is it sounded like initially you all thought you could grow slightly off of a $5.40-something number. And now the number is lower, and I'm just curious, like I didn't know if that was increased investment spending? That part of this is maybe some of the $30 million to $60 million that you've already identified? I just - there just seems to be some confusion this morning.

[Keith Bush:]

Jamie, I think the other piece to factor in here is before the additional investments that we're...

[James Clement:]

Yes, that's what I was asking. Yes, exactly. That's what I'm asking.

[Keith Bush:]

Right. So we've got - we included about $5 million of additional investments in our current guidance that was not there previously. So we've guided before. Now our guidance includes it. So that really explains that differential.

[James Clement:]

And then so - but going forward, then we should potentially focus on the $30 million to $60 million, some of which may be capitalized, some of which may be expensed in addition to this, right? Is that what - how you're framing this?

[Keith Bush:]

That's how we're framing it.

[Operator:]

Our next question comes from the line of Charlie Strauzer from CJS Securities.

[Charles Strauzer:]

Just to kind of takeoff where Jamie was left off there and just to further clarify. So the $5 million incremental, I think you said it was a $0.09 hit versus the prior guidance. Is that the way to think about it?

[Keith Bush:]

So the way I'm - the way we're thinking about is it translates in our current guidance, is $0.09. So that $5 million is about $0.09.

[James Clement:]

Right. So an apples-to-apples basis you take the $0.09 back out of there. And then the $30 million to $60 million you're taking about in incremental investments in each of the next two years, is it $30 million to $60 million each year? Or $30 million to $60 million total over the next two years?

[Keith Bush:]

Yes. The way to think about that is each year. And that spend has not yet initiated. So we are in the process of evaluating how - what form that will take in terms of either capital or expense and how that will roll through our cash flow and our financials. But that spend has not yet initiated.

[Charles Strauzer:]

So should we factor that into our models as we plan out the new kind of way to think about the EPS range. So the EPS range of $6.65, $6.95, does not include that. But should we start to think about that in our numbers?

[Keith Bush:]

That is - when you're thinking about that, think about that over the next 8 quarters or the next 24 months. So that is going to - that's an elongated tail there. The other thing I would just, I think, to be aware of is many of these investments are investments in core systems that at some point we needed to make those investments. What we're doing is accelerating the timing of those investments and bringing them online in a rational way.

[Charles Strauzer:]

And is that why - I think we see the CapEx is up $15 million year-over-year to $75 million from $60 million, is that the way to think about that as well?

[Keith Bush:]

Correct.

[Charles Strauzer:]

And that's basically baked into this $30 million to $60 million of incremental, is that correct as well?

[Keith Bush:]

So the capital investments that are currently in our outlook are before giving effect for this additional incremental investments.

[Charles Strauzer:]

Got it. So that's on top of the CapEx guidance you've already given?

[Keith Bush:]

Yes, correct. What we will do is we will maintain a disciplined process as we have historically done in thinking about how we invest cash back into our business. So we will take a look at all of the planned investments that are in our current outlook and we'll prioritize that against our future expected - expectations, so that we're putting the right investments in and in the right sequence. And so there's the potential that a portion of that will be funded through remainder of year capital.

[Charles Strauzer:]

Understood. And then just how should we think about too on the share repurchases in the EPS guidance? Is that - are you expecting more share repurchases? And kind what's the rough sense of the share count we should be using?

[Ed Merritt:]

Yes. This is Ed, Charlie. We typically don't provide any EPS - or any outlook on share repurchases. We bought quite a few shares last year. We did buy $50 million in the first quarter. We'll continue to monitor that, but we just don't typically provide any kind of a projection on when we will and will not be in the market for share repurchases.

[Operator:]

We have time for one last question, and the question comes from Chris McGinnis from Sidoti & Company.

[Christopher McGinnis:]

I guess, just one question around the - your talk around acquisitions. Obviously, it's paused now. It sounded like maybe in the earlier comments that maybe that would open back up in the second half of the year. But given kind of the talk around the strategy, it seems like that would be better made for maybe next year, or even later out. Can you just maybe tighten that up a little bit of the acquisition strategy and with the - with kind of the new focus around the new Deluxe?

[Barry McCarthy:]

Absolutely. So we signaled at the Q4 earnings of the first half of this year and reiterating that now. We will not be making any acquisitions in the first half of the year. So it allows us not only to do the work we've shared with you, but finish this thing up on some of the things that we are already working on from an integration perspective. We are signaling to you that we are open to acquisitions again in the back half of this year and going into the future. I think the most important thing to think about there is we'll be very focused in the two areas that we are calling out for our growth, which are payments and cloud. We think both of those leverage our competencies and assets very well and give us additional growth opportunity in markets with good PEs, high growth potential, et cetera.

[Operator:]

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Barry McCarthy for any further remarks.

[Barry McCarthy:]

Well, thank you all for your participation and questions today. In summary, Deluxe has a strong foundation of core competencies and assets we can leverage to accelerate organic growth. We plan to leverage these assets and compete in four primary areas

[Ed Merritt:]

Thanks, Barry. Before we conclude today's call, I would just like to mention that Deluxe management will be participating at the following conferences in the second quarter. On May 21 and 22, we'll be in New York at the Needham Emerging Technology Conference. And on June 5th and 6th, we will be in New York at the RW Baird 2019 Global Consumer Technology and Services Conference. Thanks for joining us, and that concludes the Deluxe First Quarter 2019 Earnings Call.

[Operator:]

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.