Deluxe Corporation (NYSE: DLX) — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. Financial statement amounts below are in millions of dollars unless stated otherwise. Comparisons are with the corresponding 2020 periods; 2020 figures include a disclosed revision to goodwill impairment accounting.
Business context and results
Deluxe operates Payments, Cloud Solutions, Promotional Solutions and Checks. On June 1, 2021, it acquired First American Payment Systems for $956.7 million net of cash acquired, adding in-store, online and mobile payment services to Payments. First American contributed $82.5 million of Q3 revenue and $16.3 million of Q3 segment adjusted EBITDA.
- Revenue: Q3 revenue was $532.1 million, up 21.1%; nine-month revenue was $1,451.6 million, up 8.6%. Acquisition contributions were significant. Service revenue represented 37.5% of nine-month revenue versus 32.0% in 2020.
- Profit: Q3 net income was $12.5 million versus $29.4 million; diluted EPS was $0.28 versus $0.70. Nine-month net income was $49.0 million versus a revised net loss of $19.4 million; diluted EPS was $1.13 versus a revised loss of $0.48. Nine-month adjusted diluted EPS was $3.62 versus $3.70.
- Margins and adjusted EBITDA: Q3 gross profit was $288.0 million, or 54.1% of revenue, versus $265.0 million, or 60.3%. Nine-month gross margin was 56.7% versus 59.7%. Q3 adjusted EBITDA was $102.7 million, essentially flat year over year, while margin declined to 19.3% from 23.3%. Nine-month adjusted EBITDA rose 7.8% to $290.7 million; margin was 20.0% versus 20.2%.
- Cash flow: Nine-month operating cash flow was $149.2 million versus $166.8 million. Capital spending was $81.1 million versus $42.7 million, and free cash flow was $68.1 million versus $124.1 million.
- Debt and liquidity: September 30 debt carrying value was $1,776.2 million ($1,796.6 million principal), versus $840.0 million at year-end 2020; net debt was $1,655.1 million. Cash and equivalents were $121.1 million, with $312.5 million available on the revolving facility and reported liquidity of $433.6 million. The company reported compliance with debt covenants.
- Dividend: The company paid $0.90 per share in dividends during the first nine months. Q3 dividends were $0.30 per share.
Material changes versus 2020
- Payments revenue grew sharply with First American; excluding the acquisition, management also cited growth in core digital payments, receivables management and lockbox processing.
- Checks revenue fell 2.3% in Q3 and 2.7% for the nine months, reflecting secular declines. Promotional Solutions revenue increased modestly, but Q3 segment adjusted EBITDA fell 17.7%, with inflation and unfavorable mix among the pressures.
- Cloud Solutions benefited from growth in data-driven marketing, while exited web and hosted product lines reduced revenue. Promotional Solutions and Checks also faced continuing pressure from declining forms/check volumes.
- Q3 interest expense increased to $21.5 million from $5.1 million, primarily reflecting acquisition financing, including $500 million of 8.0% senior notes. Q3 SG&A also included acquisition-related costs and higher operating costs.
- Nine-month 2021 results benefited from the absence of $101.7 million of 2020 asset impairment charges. Restructuring and integration expense declined to $41.1 million from $57.8 million for the nine months.
Outlook, commentary and risks
- Management’s 2021 outlook was revenue growth of 10%–12%, adjusted EBITDA margin of 20.0%–21.0%, and an adjusted annual effective tax rate of approximately 25%. Capital expenditure guidance was $95–$105 million. Management expected to continue the regular quarterly dividend and said available cash, operating cash generation and facility capacity should support operations and debt service for the next 12 months.
- Segment commentary included anticipated low-20% full-year Payments adjusted EBITDA margin; mid-single-digit Q4 Cloud Solutions revenue growth and low-to-mid-20% Q4 margin; mid-teens Q4 Promotional Solutions margin; and a low-single-digit full-year Checks revenue decline. Management expected some inflationary pressure to be offset by future price increases.
- Management cited COVID-19 uncertainty, supply-chain constraints, labor availability and inflation as factors that could affect its outlook. The filing also identifies secular declines in checks and forms, integration execution, and the risk of future impairment or credit-loss charges.
- Three First American subsidiaries were subject to an ongoing FTC investigation concerning possible violations of consumer-protection and credit-reporting laws. The outcome and potential exposure were not estimable; acquisition indemnification is limited to a holdback.
- The company disclosed errors in prior goodwill impairment calculations. It concluded the errors were not material to previously issued statements and revised the comparative figures presented; the revision increased 2020 nine-month net loss by $3.6 million and reduced year-end 2020 goodwill by $33.9 million.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Litigation reserves were not material, though the filing cautions that adverse rulings could have a material effect.
Important facts for investors to verify
- Whether First American integration, growth and synergies progress as expected, and whether the FTC investigation results in penalties, operational changes or other liabilities.
- Whether revenue and adjusted EBITDA outlook is achieved, particularly given inflation, supply-chain and labor pressures and declining checks/forms volumes.
- Debt repayment capacity, covenant headroom and interest costs; note the substantial increase in leverage following the acquisition and the 8.0% notes.
- Cash conversion and capital spending trends: nine-month free cash flow declined materially year over year.
- The impact of the disclosed goodwill impairment calculation revision and the status of final purchase-price allocation, which remained preliminary.