Deluxe Corporation (DLX) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome everyone to the Fourth Quarter 2018 Deluxe Corporation Earnings Conference Call. At this point, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference maybe recorded. I would now like to turn the conference over to our host for today, Ed Merritt, Treasurer and Vice President of Investor Relations. You may begin.

Thank you, Sonia and welcome everyone to Deluxe Corporation's fourth quarter 2018 earnings call. I'm Ed Merritt, Deluxe's 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 would like to remind you that comments made today regarding financial estimates, projections and management's intentions and expectations regarding the company's future performance are forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. As such, these comments are subject to risks and uncertainties which could cause actual results to differ materially from those projected. Additional information about various factors that could cause actual results to differ from 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, 2017. 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/investor. This information was also furnished to the SEC on the Form 8-K filed by the company this morning. Any references to non-GAAP financial measures are reconciled with a 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

Thank you, Ed and good morning, everyone. It's a privilege to be with you today at my first earnings call as President and CEO of Deluxe. Before we get started, I'd like to thank Lee Schram for his support during this transition and acknowledge his many vital contributions over nearly 13 years here. Along with all of us, I wish him the very best in his retirement, he deserves it. I'm honored to join Deluxe at this exciting and important time as we accelerate the ongoing transformation from a check printer to a technology-enabled solutions provider and continue to create value for our shareholders. In a few minutes, I'll share some of my background why I chose to become a Deluxer and some initial observations from my first few weeks here. I'll also provide a general sense of where I'm headed and outline some of urgent priorities for the coming month. Before I get to that, let me provide some highlights from 2018. I'll have Keith go into more details shortly. I'm pleased to report that we've delivered another year of strong revenue growth. In fact, 2018 marked a record for full year revenue and we continue to grow adjusted earnings per share and operating cash flow. Total fourth quarter revenue grew 6% year-over-year driven by financial services which increased 15% and by small business services which increased 4%. These increases on the top line were partially offset by Direct Checks which declined 8% in the quarter and underperformance within our data-driven marketing solution. Had data-driven marketing solutions delivered as expected, 2008 would have been a banner year. I'll address the challenges and opportunities in data-driven marketing in more detail in a few minutes. Checks and forms continue to perform well and I think it's important to note that the fundamental health of the company is very strong. In the fourth quarter we ended with 45% of our business growing revenue at a double-digit rate. It's clear that our strategy to transform Deluxe from a check and forms printer to a technology-enabled solutions provider is delivering positive financial results. With that, let me turn the call to Keith for additional details on 2018.

Thanks, Barry. We delivered fourth quarter revenue of $525 million, which as Barry mentioned represents a 6% increase over last year. Organic revenue which excludes acquisitions, FX and other non-comparable items was about flat. To underscore Barry's earlier point about the company's fundamental health, had data-driven marketing grown as expected, the company would've grown organic revenue in the quarter. As Barry also noted, we established an all-time revenue record of $1.998 billion, this exceeds the previous high of $1.981 billion set back in 1996, and we grew total revenue for the ninth consecutive year. Marketing solutions and other services revenue grew about 11% over the prior year and represented over 42% of full year revenue. Shifting to our segments, small business services revenue was $334 million and grew 3.6% in total or about flat organically. Financial Services revenue was $160 million and grew 15% on a reported basis or over 1% organically compared to the fourth quarter of last year. Financial Services check units declined slightly less than expected in the quarter at about 5% and about 6.5% for the full year. Direct Checks revenue was $31 million declining 8.3% from last year but ending better than our expectations. As Barry mentioned, we're making good progress on our strategy and we're intently focused on accelerating this transformation and increasing value for our shareholders. Our Marketing solutions and other services or MOS are central to our transformation and continue to grow. MOS grew to $238 million or about 45% of total revenue for the quarter, representing a 20% increase over last year, and an increase of 6% organically. MOS represented 42% of total revenue for the year ending at $840 million, and increased about 11% year-over-year or nearly 2% organically. Specifically, we delivered the following annual revenue by MOS category; small business marketing solutions ended the year at $292 million and was slightly better than our expectations, growing 12% year-over-year and about 2% organically. Web Services ended the year at $162 million and was in line with our expectations growing 23% year-over-year with a slight organic decline of about 1%. Data-driven marketing ended the year at $148 million declining 2% from the prior year and about 2% organically. Treasury management ended the year at $148 million growing 36% from the prior year in line with our expectations. However, revenue in the fourth quarter grew organically over 22% and about 7% for the year. Finally, fraud, security and other operational services ended the year at $90 million, in line with our expectations declining 12% from the prior year or about 8% organically. Check revenue ended the quarter at $198 million representing about 38% of total revenue. Forms and accessory ended at $89 million representing about 17% of total revenue. Gross margin for the quarter was 59% of revenue and declined by 240 basis points from 2017. The impact to margin from product and service mix, acquisitions and increased shipping and material costs were only partially offset by previous price increases and improvements in manufacturing productivity. SG&A expense increased $15.2 million from last year and represented 41.2% of revenue compared to 40.6% last year. Continued cost reduction initiatives and gains on asset sales were more than offset by additional SG&A expenses from acquisitions, a favorable legal settlement in the prior year, costs related to the CEO transition process, and higher average commission in the small business segment. Excluding non-GAAP adjustments, which I will discuss shortly, adjusted operating margin for the quarter was 18.6%, down to 240 basis points from 21% in 2017. The margin decline was driven primarily by the mix of product and service revenue and acquisitions, partially offset by previous price increases and continued cost reductions. Small Business Services adjusted operating margin was 18.8%, a decline of 130 basis points from 20.1% in 2017, driven by acquisitions, a higher average commission rate and increased material and shipping costs only partially offset by previous price increases and continued cost reduction initiatives. Financial Services adjusted operating margin of 15.2% was down 460 basis points from 2017. The continued benefits of cost reduction initiatives only partially offset check usage declines, check pricing allowances and higher shipping rates experienced in the quarter. Revenue underperformance of data-driven marketing also contributed to the margin compression. In addition, the [indiscernible] acquisition drove changes in product and service mix along with higher amortization expense. As a reminder, we had a benefit in 2017 from a legal settlement in the same period. Direct Checks adjusted operating margin of 34.1% increased 20 basis points from 2017 driven by cost management initiatives. Diluted earnings per share for the fourth quarter was $1.39 and includes aggregate non-GAAP adjustments of $0.15 per share. During the quarter, we recognized charges for restructuring and integration, transaction costs, and CEO transition costs of $0.16 per share and a benefit of $0.01 per share related to federal tax reform. Adjusted diluted EPS was $1.54 and ended near the high-end of our outlook driven by lower spending that was partially offset by the flow-through profit impact of lower data-driven marketing revenue. Turning to the balance sheet and cash flow statement, we were drawn $910 million on our credit facility at the end of the year with the increase primarily due to higher share repurchases and acquisitions. Cash provided by operating activities for the year was $339 million. Capital expenditures were $62 million. Depreciation and amortization expense was about $54 million, and acquisition amortization expense was about $77 million. Moving onto our 2019 outlook. Now that we are adjusting our go-forward planning architecture to provide you with a more transparent view of the business. This outlook excludes the impact from forward-looking M&A activity and any benefits from gains on asset sales. Barry will discuss more full in a moment, but we will pause on further acquisitions during the first half of 2019 to focus on driving enhanced returns from our current businesses. While this temporarily slow our revenue and profit growth rate, we believe it is important to the strategic direction of the company. This will allow us to focus on scaling our sales and product innovation capabilities as we continue to transition to a technology-enabled solutions provider. We expect to have a challenging first quarter as a result of some non-comparable items versus last year but we expect the full year outlook to be solid. For the first quarter we expect revenue to range from $490 million to $505 million and adjusted diluted EPS to be in the range of $1.05 to $1.15 per share. The first quarter of 2018 results included $7.2 million from gains on asset sales. Our guidance for the first quarter does not include any benefit from gains on asset sales. Additionally, treasury management had a very strong Q1 2018. Although we had record orders in the second half of 2018, we expect a slower rollout to the start of 2019 with the ramp over the balance of the year. In addition, we expect higher acquisition amortization and medical expenses, the highest tax rate of the year, and revenue volume declines in Direct Checks, all putting pressure on adjusted diluted EPS. Turning to our full year 2019 outlook. To give you some directional perspective we expect full year consolidated revenue to grow low single digits and we expect to see full year improvement in GAAP diluted EPS. In 2018 we delivered adjusted EPS of $5.69 which includes $0.25 from gains on assets sales. For 2019 we are not assuming any benefit from gains on asset sales. After this adjustment, we expect to see a slight year-over-year improvement in adjusted diluted EPS. This outlook is before taking into account incremental investments we are evaluating to accelerate our growth. We are looking for opportunities to self-fund these investments in the current year. However, there may be timing differences which might impact this outlook. As I mentioned earlier, the acquisition pause will make our planned growth appear to slow slightly but will provide an even better upside for long-term growth as we close on future acquisitions. We will provide greater visibility into our full year plans including earnings and cash flow projections on our April call. We expect to make modest intro investments in sales and product innovation, and we'll continue to focus on cost management throughout 2019 and beyond to deliver significant structural improvements. We will provide additional color on all of this in April. Shifting to our capital structure, we expect to maintain our balanced approach of investing organically and through acquisitions to drive growth transformation. As I mentioned earlier, acquisitions will no longer be included in our outlook. In December, we closed on the acquisition of MyCorporation, which helps new businesses with incorporation, compliance, and other services. We believe this acquisition will be a great source of new customers and complements our strategy of developing new channels to source small business customers. This also provides cross-sell opportunities into other Deluxe services. The acquisition was funded through a draw [ph] on our credit facility and we expect it to be slightly accretive in 2019. In terms of other capital allocation priorities, we expect to continue paying a quarterly dividend. If you recall, last year our Board of Directors authorized a new $500 million share repurchase program. During the fourth quarter, we repurchased $80 million of our common stock bringing the full year 2018 share repurchases total to $200 million. In 2019 we expect to repurchase additional common stock beginning as early as this quarter. To the extent we generate excess cash, we plan to reduce the amount outstanding against our credit facility. We ended 2018 with $910 million drawn on our credit facility, and on January 22 we expanded that credit facility by $200 million. The proceeds are to be used for general corporate purposes, giving us more flexibility and financial capacity as we continue to execute our transformation. Now, I'll turn the call back to Barry.

Thank you, Keith. As I mentioned at the beginning of the call, I'm very optimistic about the compelling opportunities ahead for Deluxe. Although I've only been in the position for a few weeks, I've spent that time talking to customers, learning the business, listening to our leaders and meeting hundreds of our teammates at many of our sites, and I've looked at our acquisitions and current strategy. Overall, I believe the company is on a solid path, but I recognize we have a work to do to achieve our full potential. Importantly, I'm even more optimistic about our future now than I was when I joined Deluxe just a few weeks ago. Before I talk about our plans for the coming month, I want to share with you what I saw in Deluxe, why I joined, and how my background positions me well for leading the company into the future. I enthusiastically came to Deluxe because I believe the company is significantly under-appreciated. We have an impressive collection of assets. For example, our Small Business Services segment has a base of 4.8 million loyal clients and Financial Services adds another 4,600 financial institution partners. On customer counts alone, Deluxe compares favorably with top tier global technology companies with 45% of our business already growing double-digits. While our current PE multiple looks more like a traditional printer than a technology company, I believe that the consequence of the market's not yet recognizing our transformation is already underway. Completing the picture, the company has a strong balance sheet with low leverage. Our ability to generate consistent cash flow enables up to not only pay a solid dividend but also invest in the business and repurchase stock. Deluxe is uniquely positioned for growth and increased shareholder value and we're focused on doing so with urgency. To that point, we need to significantly accelerate change in everything we do. These changes won't happen overnight, and I'm sure we'll face difficult decisions, but I'm competent I can lead the company to unlock greater potential. I'm confident because I've tackled similar challenges before. I've spent 14 years at First Data running almost every business at the company in financially challenging condition. I delivered record performance in each role including several turnarounds in both, domestic and global businesses. Earlier in my career, I ran the ATM and data business at Wells Fargo and started a micropayments company in the Silicon Valley with a successful exit. I turned around the payments business at VeriSign leading to it's acquisition by PayPal. I began my career at P&G in field sales and sales management and later at headquarters and product and brand planning roles. The bottom-line is that I understand enterprise selling and product management, and I know how to deliver a winning innovation cycle. I've also had the great fortune to have worked for and learn from legendary leaders who remain mentors today. And importantly, I have worked at each of our major segments over my career; small business, financial institutions, and the large enterprises. While I've only been on the job for a few weeks I do have clarity on what needs to be done, and I have an intent sense of urgency to do so. Let me walk you through my immediate focus areas. First, we will expand enterprise selling and sales capability to accelerate profitable organic revenue growth. This will unlock the full potential of the company and allow us to serve our clients holistically. Second, we will expand our strategy, product management and innovation capabilities to ensure we are competing effectively in the targeted growth markets and to give the sales organization new and better solutions to sell. Third, we will rigorously examine our expense structure with the objective of eliminating unnecessary structural costs to both, enhance margin and self-fund needed growth investments. Nothing is untouchable and we will consider all options. Finally, we need to reinvigorate our culture and structure to put greater focus on clients and accelerate our speed of execution, and we're taking immediate action on this. Our Top 75 leaders [indiscernible] to help us chart the course for what we are calling our New Day. And early in February we will host hundreds of clients for our Deluxe Financial Exchange where we expect to build on our partnerships and learn more about our clients emerging needs. As we've mentioned earlier, we will pause additional acquisitions during the first half of 2019 to allow us to better integrate the key acquisitions from last year and work on scaling our strategy, sales and product efforts. As Keith indicated, this will temporarily slow our revenue and profit growth but we will have a stronger and more scalable company going forward and will be better positioned to deliver new organic solutions and more easily integrate future acquisitions to take advantage of our scale. In addition, we have plans to engage one of the world's foremost management consulting firms to help us stress task [ph] our current strategic plan and identify additional opportunities to maximize shareholder return; this will include sales, product management and strategic alliances. In April, when we are next together for our first quarter earnings release, I'll share more specifics about our direction, plans and strategy. I look forward to providing you an update at that time. Before taking questions, there are a few key points I would like to touch on in advance. First, despite record revenue, we did not meet our organic revenue growth expectations, primarily due to underperformance in the data-driven marketing business. Macro factors like higher interest rates negatively impacted this business specifically within the mortgage arena but we've had other good customer wins and our pay-for-performance model is gaining traction. While there are some positive signs in the data-driven marketing space, I know there is much more work to be done. For 2019 we anticipate demand from our largest financial institutions to help them grow customer deposits, new business banking relationships and to develop new mover [ph] initiative; all sweet spots for us. Treasury management solutions made strong progress in 2018, we're growing revenue, signing new multi-year clients and integrating [indiscernible]. In the Small Business segment web services grew 23% in 2018. We're pleased about the recent acquisition of MyCorporation, which enables us to provide corporation services to small businesses. Capturing clients at business formation we believe will enable us to cross-sell existing products and services such as logo design, web design, web hosting, email marketing, payroll services, and more. Finally, before I open the call up for questions I'd like to take this opportunity to thank all my Deluxe teammates for their hard work and dedication. A company is only as good as it's people and we have great people. I'm proud to wear the Deluxe jersey and call myself a Deluxer. I hope you've now heard my strong sense of urgency, bias traction and optimism for our future. There is clearly work to be done but the future of our company has never been brighter. Now Keith, Ed and I will open the call for questions.

Thank you. [Operator Instructions] Our first question comes from Charlie Strauzer of CJS Securities. Your line is open.

I just had a couple of quick questions for you all this morning. Just been -- you look at the initial guidance that you're giving out, I'd appreciate it's only a couple of weeks since you're in there. But if you look at the revenue assumptions this year, is that breaking in any organic growth into that assumption for the full year?

So what is in that forecast; I think most important thing which is a difference in our planning architecture is that we are -- we've taken two things specifically out going forward. So we are not assuming or planning any gains on sale, and we are not assuming any new acquisition; so we're trying to give you the most transparent view of the business as we can. I think if you're specifically asking about organic growth, I think we're forecasting very, very modest increase in organic growth but to that -- the numbers you've seen is what were our first-pass and how we're thinking about full year.

And then when we look at the Q1 guidance, and you talked about the EPS for Q1 versus the -- I'm sorry, to the full year guidance for EPS, you're talking about on the adjusted side, it said using a base of $5.69 for this past year, or is it more $5.44 we should be using against as that kind of base?

Yes, you're thinking about it right. The $5.69 is our reported basis and that did include $0.25 of being on sale benefit. So we have not included any gain on sale benefit in our 2019 guidance, so you would be working from that lower number.

So assuming some modest growth off the lower number is what you're trying to say?

Correct.

And then, just thinking broadly vary just a little bit more on terms of the strategy here; obviously data-driven marketing was a little bit disappointing this past year. Are the fixes that you think you can employ there to kind of get that turn back around again?

From what I know today it's a really nice business and an opportunity for us to continue to grow. We have some terrific assets and I know the teams have plans in place that we expect will help improve performance for the year. So it's an area over the coming weeks I intend to invest time, to work with those teams to accelerate our growth.

And our next question comes from Jamie Clement of Buckingham.

Barry, comments from you about improving sales force processes, becoming more customer-centric if you will across the organization, obviously if you look at your small business customers, radically, radically, radically different group of customers than your financial institution customers but are there any kind of common themes or big picture thoughts initially that you have here thematically across the two that we can kind of look forth in terms of progress going forward?

I'm here only a few weeks into this, I can only give you really…

Totally acknowledged, totally acknowledged.

I can give you my thoughts philosophically and what I'm thinking about. And as I look at our company, I really see a company of companies, we have many fantastic assets that we have not leveraged more holistically. So I stand by it, putting together an integrated catalog that we can present to customers, especially enterprise class customers including financial institutions. We have an opportunity to distribute and sell our existing book of business to our existing clients. I agree with you that the small business opportunity is different than enterprise or FI [ph] opportunity but believe that these are opportunity to present multiple solutions to our small business clients and that's one of the reasons we're pleased about MyCorporation acquisition because it puts us at the very beginning of a business formation and at that moment in time a business is not only needing to incorporate but they are going to need all of the many other services that we can provide. And we think we're really well positioned, especially for ecommerce, mobile commerce merchants going forward with our ability to host website, design website, do logo design, etcetera. And if we can present more solutions to a customer, in this case small businesses at the time of formation, we believe an opportunity in that scenario for cross-sell as well.

So just curious for your thoughts on the macro, it's one number but the small business sentiment data has deteriorated a little bit over the last couple of months, you got the small business administration shutdown with the government shutdown. Are you all seeing -- what are you involved, hearing or what are your feelings on the macro backdrop here over the last couple of months?

Jamie, I read all the same things that you read but let me tell you how I think about it relative to our business. And so we have a very sturdy business because the services that we provide to small businesses are really foundational to their ongoing operations. Even if there is a lobe [ph] on the small business environment, businesses generally don't turn off their website, they generally don't start trying to find new customers. And those are places that are sweet spots for us where we've got a nice footprint. So immediate term, we like our -- the durability of starting us off our solution and I think that gives us data protection regardless of what's happening in the macro environment.

Just on guidance and I think you all mentioned -- obviously, we'll wait for the next earnings release for more of a comprehensive 2019 guide. But I'm noticing your presentation, you're looking for an organic revenue decline of about 2% in the first quarter. Does data-driven marketing have to turnaround in 2019 for you all to transition from a minus 2% to positive as the year goes by or do you feel like there is enough juice in the other aspects of the business to turn positive?

I think it's just important that we do make acknowledge that data-driven marketing is in this wobble [ph] and we are giving it attention to move through. But when you're looking at the first quarter of 2019 it's also important to recognize that that quarter last year was a really strong quarter for treasury management and they wrapped up 2018 with an incredible year. So in the first quarter of 2019 we're rebuilding our pipeline and we're feeling the effect of that. But we most certainly need to be focused on the data-driven marketing tips [ph] as well to ramp up that growth.

Thank you. And we have time for one more question, and that will be coming from Chris McGinnis of Sidoti & Company.

So I guess just -- I know it's early, I know it's been stressed already on the call. But I guess when you look at the three lines of business in terms of SI and small business and direct checks, so anything that excites you more about one or other that you'd feel more confident in kind of helping drive that transformation; maybe we could just start there if you don't mind? Thanks.

Let me tell you what I think is sort of most exciting about our company and our prospects, and it really comes down to our incredible customer footprint. So with 4.8 million small businesses, 4,600 banks and financial institutions, we already have relationships with an enviable portfolio of businesses. And embedded in that we have many enterprise relationship so we think can be expanded beyond just traditional small business or financial institutions. So I start from a place that -- with strong relationship with customers that like us and customers that want us to succeed. We just need to find a way to take the product and service we already have and deliver it to them at an easier way to consume, and in a way that can extend the relationship we have. And I made the comments earlier that an early observation is that we really operate much like a company of companies and if we can become a more integrated enterprise and sell the entire suite of what we offer, we just have huge opportunity even within the footprint we've already got which can help us lead to organic growth which will also help our margins, and that we can do -- we can make the company stronger with the things we've already got. So I wouldn't highlight any one product over another because I think we have multiple place here. The biggest thing we got to do which is why it's the first initiative on our new day program as we've got to scale our sales and distribution capability to reach our customers better and more holistically.

And then just one last question; because you're buying through the quarter, should we get maybe end of year share account just for that purpose going forward? Thank you.

Yes, we're going to need to wait until the 10-K to provide that information.

Thank you very much. And good luck in Q1.

Thank you. And I would now like to turn the call back over to Barry McCarthy for any further remarks.

Well, thank you all for your participation and questions today. I'd like to give you a small summary. First, I plan to spend much of my time in the coming weeks on improving the effectiveness of the sales organization, driving the development and delivery of innovative new products and services, reviewing the structure of our organization and process which will reduce cost, and enhancing our culture so we can forge stronger partnerships with our clients to support their needs. And second, by our April earnings call I'll have an additional 90 days under my belt, I'd be in a better position to provide more detailed insights into our strategic direction and how I see our company transforming to achieve profitable organic revenue growth for the long-term. So now I'll turn the call back to Ed for some final comments.

Thanks, Barry. Before we conclude today's call, I'd like to remind you that Deluxe management will be participating at the following conferences in the first quarter. On March 11 and 12 we'll be in New York at the Susquehanna Tech Summit, and on March 19 and 20 we'll be in New York at the Telsey Advisory Group Investor Conference. Thanks for joining us, and that concludes the Deluxe fourth quarter 2018 earnings call.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may all disconnect. Everyone, have a great day.