Deluxe Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Deluxe Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode, and today's call is being recorded. 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.

Thank you, Operator, and welcome to the Deluxe Third 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 seen on the current slide, I'd like to remind everyone that comments made today regarding management's intentions, projections, financial estimates, and expectations about 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 may 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 31st, 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.

Thanks, Brian, and good morning, everyone. We have some important updates to share today, so our prepared remarks are a little longer than usual. We have two primary topics we'd like to cover this morning. First, our solid third quarter and year-to-date performance and increased 2023 earnings guidance. the launch of an exciting enterprise-wide initiative to deliver $100 million of incremental run rate free cash flow and $80 million of increased comparable adjusted EBITDA with the results ramping through 2025. We call this initiative Project North Star. North Star will begin delivering an increased adjusted EBITDA in Q4 of this year. First, A few comments regarding quarter and year-to-date performance. Our overall third quarter performance met our expectations and was consistent with the increased full-year guidance we provided last quarter. CHIP will provide both reported and comparable adjusted numbers, but I will focus here on comparable adjusted results, which we believe best reflect the underlying business performance given our divestitures. For the third quarter, total revenue was flat year over year at $538 million, while EBITDA expanded 3% to $102 million. Year to date through the third quarter, our total revenue has grown 1%, while EBITDA has expanded by 4%, demonstrating our continued ability to drive efficiency in our cost base while delivering profitable growth. For perspective, we're on track to deliver our first full year of concurrent organic revenue and EBITDA growth in more than a decade. Further, in the third quarter, we delivered our third straight quarter of operating leverage with profit growing faster than revenue. 2023 will also be our third consecutive year of organic revenue growth. On guidance, we are reiterating our 2023 revenue range, which we raised during our second quarter call. We've also increased our full-year EBITDA and adjusted EPS guidance to reflect both our year-to-date performance as well as in-year impacts from the North Star initiative. Chip will provide more details during his comments. Overall, we're pleased with our execution through the third quarter of the year. to provide some brief comments regarding our operating segments. Overall, payment segment revenue was flat in the third quarter, below our expectations of mid-single-digit revenue growth. The result was primarily impacted by some continued softness within the lockbox portion of our B2B payments business. You will recall we signaled volume softness in this area during last quarter's call. In addition, this line of business was lapping a challenging prior year comp during the third quarter. On a more positive note, revenue growth improved during the third quarter for the other half of our payments business, merchant services, increasing sequentially to just over 2%. You will recall that macroeconomic factors, including discretionary consumer spending trends, have impacted year-to-date processing volume within this business. We continue to actively monitor related reports, noting some recent improvement within retail spending trends, while the overall economic outlook remains somewhat uncertain. As a reminder, our merchant services business also has a strong presence across several less discretionary areas, which continue to perform well. Year-to-date, through the third quarter, merchant services revenue growth was roughly 3.5%. and we remain confident that the merchant business will deliver mid single digit revenue growth for the full year. Here's an example of why. We achieved an important milestone during the quarter in merchant services that will help further accelerate our growth in the fourth quarter and beyond via a win with Fulton Financial Corporation. Fulton has more than 200 banking center locations expanding five states across the mid-Atlantic and northeastern United States with more than $27 billion in assets. This expanded relationship alone could generate a few points of incremental growth next year for merchant services. We won the business because of our superior customer support, robust and reliable platform, and our omni-channel capabilities. Fulton represents a significant milestone for our business, demonstrating successful expansion into the middle market for our merchant services offerings. The win is another example of the scalability of our competitive product offerings across both SMB and commercial markets, and further validates our ability to cross-sell merchant services to an existing deluxe customer. You will recall bank cross-selling was one of the core investment theses for the first American acquisition. The Lux has 4,000 financial institution customers, providing us with plenty of fertile ground to harvest for merchant services. Moving now to our strong third quarter results for the data solution segment. We are particularly pleased with the continued exceptional performance within this segment as revenue increased over 24%. These results accompanied more than a 45% growth of EBITDA during the quarter, and were driven by a continuation of robust campaign execution across many of our FI partners. We have continued to see strong demand for our data-driven marketing services in support of banks seeking low-cost deposits, as we noted in the last quarter, in addition to expansion of their business banking account offerings. We also continued our expansion into non-FI and other less interest rate sensitive market verticals. Shifting now to our print businesses comprised of our promotional solutions and check segments. Combined, these businesses generate more than $1.2 billion in annual revenue with an EBITDA margin rate in the low 30s. On a blended basis, these businesses decline at low single-digit rates and in many cases have recurring or reoccurring characteristics. Consistent with expectations on a year-to-date basis, the combined print businesses have seen revenue declines of less than 1%, while EBITDA margins have expanded by 50 basis points to just over 31.5%. In the promotional solutions portion of our print business, third quarter revenue declined 7.5%. We did see some demand softness during the quarter, and we executed a previously planned site closure impacting some of our production. We have also shifted our focus and resources within this area toward products that are more reoccurring in nature with generally better margins and lower customer acquisition costs. On a year-to-date basis, EBITDA for the promo segment improved more than 15% on revenue growth just under 1% versus 2022. Finally, our check business continued to deliver strong results with third quarter revenue declining 1%, slower than the market and better than our expectations. Margins in the check business have also sustained within the mid-40s expected level, And EBITDA grew by 1% during the quarter, helping to contribute to our overall EBITDA leverage across the enterprise results. We are pleased our check business continues to perform well and much better than many have expected. We are winning market share, and our investments and production efficiency are working. The strength and predictability of this cash flow gives us even more confidence we have plenty of runway to complete our transformation into a payments and data company. In summary, despite some third quarter specific headwinds, our year-to-date performance reflecting revenue growth of 1% and EBITDA growth of 4% demonstrate the scaling power of our business. Our wins highlight our competitiveness and will help us deliver sustained performance going forward. Now to our second topic, Project North Star. First, a little background. As we have noted throughout this year, the luck is at an inflection point where our payments and data businesses together are able to outpace the secular decline within our print businesses. We have changed the company's trajectory and are now in our third consecutive year of organic revenue growth and we are on track to deliver full-year operating leverage in 2023 for the first time in more than a decade. Next, we need to accelerate this performance to further drive shareholder value creation by expanding our EBITDA growth trajectory, driving increased free cash flow, and more rapidly paying down debt and improving our leverage ratio. We have combined our execution plans into an integrated program we call Project North Star. North Star will increase our run rate cash flow by $100 million and comparable adjusted EBITDA incremental $80 million ramping through 2025. We will deploy the improved cash flow to pay down debt and improve our leverage ratio, consistent with our stated capital allocation priorities. Importantly, North Star is not a change of our strategy of investing this cash flow from our print businesses into our payments and data businesses. Rather, the initiative integrates our plans to drive executional certainty. The program incorporates clear hurdle rates and required returns on invested capital. Our planning for this critical initiative has been underway for several months. and we're leveraging external expertise from best-in-class consulting and advisory resources to reinforce our rigorous approach to driving this value. I have five main points to highlight on North Star. One, we're taking a portfolio approach to de-risk our execution on these multi-year outcomes. The program is comprised of more than a dozen separate work streams designed to work together to deliver the total value. Two, North Star is sequenced to focus on cash generation, so our early initiatives prioritize rapid time to value and high ROIC, which enables us to fund investment in complex longer-term initiatives consistent with our multi-year planning horizon. Three, North Star is a balanced mix a structural cost reduction via org design, process and operational improvements, in addition to work streams to drive revenue growth. Four, North Star is comprehensive in scale. We have already involved over 100 of our current leaders in driving change across the organization. In doing this, North Star is adding executional certainty to our company-wide objectives, and acting as a change agent for our talent and culture. Five, as part of Northstar, we have already taken significant action to reorganize Deluxe teams. We have combined like-for-like capabilities, reduced management layers, and consolidated core operations to run the company more efficiently and create the ability to invest in high-impact talent to accelerate our growth businesses. These steps initiated during the third quarter will contribute approximately $10 million of incremental run rate adjusted EBITDA to our forecasted fourth quarter outlook. Finally, to provide more details about our strategy and Northstar specifically, we will be hosting an investor day in New York on December 5th. During this session, we will provide additional detail regarding the North Star Initiative and share related guidance ranges for the next few years. The Deluxe Leadership Team will provide insights into our current solutions, attractive growth prospects, and the linkages across the portfolio of offerings for the North Star outcomes. Brian will provide additional details regarding this event at the end of today's call. Before passing this over to Chip, I want to again thank my fellow Deluxers for their continued commitment to our customers' success. By helping our customers to do more, Deluxers have changed the company's trajectory, delivering sustained organic revenue and EBITDA growth. We are all proud of our momentum and look forward to the exciting future and benefits Northstar will yield.