Deluxe Corp (DLX) 2002 Q2 法說會逐字稿

Ladies and gentlemen thank you for standing by, welcome to the second quarter 2002 earnings conference call. At this time all participants are I a listen only mode. Later will conduct a question and answer session, instructions will be given at that time. If you should acquire assistants during the call please press zero and then star. As a reminder this conference is being recorded I would now like to turn the conference over to our host please go ahead.

Thank you and good morning everyone and welcome to Deluxe's second quarter investor conference call. Today you will here from Lawrence Mosner Chairman and Chief Executive officer, Douglas Treff our Chief Finical Officer. As in the past will take questions from analysts at the end of the prepared comments.

In accordance with regulation this conference call is open to all interested parties. A replay of the call will be available via telephone and Delux's web site and I will tell you how access the replay at the conclusion of teleconference.

Before I turn the call over to I will make a brief cautionary statement comments made to regarding earning estimates, and projects and statements regarding managements intentions and expectations regarding future performance are forward looking statements as defined in the Privates Securities Reform Act of 1995. As such these comments are necessarily to risks that could cause actual future results to differ materially to those projected. Additional information about various factors that could cause actual results to differ from those presented are contained in the news release that we issued this morning and in the company's quarterly report on Form-Q for the quarter ended March 31st 2002. With those items out of the way I'll now turn the call over to Larry Mosner.

Thanks and thanks to everyone for joining us today whether on the phone or via our web cast. As we stated in the release that came out his morning Delux reported second record results for the second in revenue . I'll share with some of the contributing factors to our great quarter as well as our expectations for the balance of 2002 but first Doug Treff our Chief Financial Officer will review the numbers, Doug?

Thanks Larry, as Larry just mentioned net income, EPS and revenue were up in the second quarter. Let's cover those items first. Net income went up 23 and a half percent or really $4 million to $54.7 million in the second quarter. Continued efficiencies and productivity improvements in cost of goods sold and SG&A led to gross margin, operating margin and net margin increases. EPS was up 34.9 percent to 85 cents from 63 cents in the second quarter last year primarily due to the higher net income combined with continued share repurchase activity. Revenue increased to $328.5 million in the second quarter compared to $318.6 million during the same quarter a year ago. The 3.1 percent increase in revenue was the result of a couple of factors. .

An increase in revenue per unit of 2.9 percent due to price increases enhanced services and the continued strength in license design. Two, the early buy out of one of our contracts I'll discuss that further in results of activity. Convergence activity is driven by bank mergers and acquisitions, which are done versus last year.

Gross margin increase to 66.3 percent of revenue for the quarter compared to 64.5 percent in 2001. The improvement was due to the contract buy out, the 2.9 percent increase in revenue per unit less convergence activity and the ongoing impact of productivity improvement in cost reductions efforts. Selling, general and administrative expense, SG&A declined as the percent of revenue to 39.4 percent compared to 41.2 percent in 2001. Driving SG&A down were a number of factors, continued order migration from mail to electronic processing. The increasing mix of orders coming through the Internet, process improvement and costs reductions in our call center and lower depreciation and amortization expense. As a result of improved gross margin and SG&A operating margin improved 430 basis points to 26.9 percent of revenue compared to 22.6 percent in the second quarter of 2001.

Earnings before interest, taxes, depreciation and amortization or EBITDA increased 11.2 percent to $103.9 million in the second quarter. Let's look at the quarters' results in each of our three business units. Financial services revenue increased 1.3 percent to $196.6 million while operating income increased 23.3 percent to $52.4 million. During the quarter we had an a early but out of one of our check printing contract, the effect of a buy out is one time positive impact on revenue and net income, none the less we always prefer to retain financial business. These buy out are occur periodically as a routine part of our business result of the acquisition of one finical clients by, by induction that is under contract with another check provider. As mentioned in our press realest this morning, the contract buy out contributed approximately $5 million of revenue and approximately $3 million net income.

Unit volume was lower and revenue per unit higher due to fewer conversation programs compared to a year ago. Finical services operating income increased significantly as the result of a number of factors, the contract buy out, lower deprecation and expense, the efficiently to continue migration order processing, improve productivity in our call centers, and the conversion to lean in our manufacturing environment and continued cost management efforts.

Direct check also had a strong quarter, revenue increase six and a half percent to $79.9 million while operating income increased 31.1 percent to $21.1 million. Both revenue per unit and unit volume increase for this business segment, also contributing to the operating margin expansion where a change and accounting for good will continued migration to the internet channel and process improvements. While the numbers I have just covered show a strong performance, we see a softening in direct mil response rates with in the directs check business and we anticipate this softening to impact this business in the last half of the year.

Our research indicate that we are not the only direct response business this trend. Here is why, direct checks relies on other business and comporting mailers to inset our promotional materials into their advertisements this is our primary method for acquiring new customers. Unfortunate consumer response to these direct mail ad's has , we continuing to explore new advertisement opportunities such as the internet, as well as other partnerships to replace the traditional media sources.

Finally I will cover the second quarter results for business service. Revenue increase four point eight percent, $52 million compared to $49.6 million in 2001. The increase would have due to conversion activity. Operating income and business services increase 11.3 percent $14.8 million from $13.3 million in 2001. Increases in revenue per unit and unit volume contributed to these results.

Next I will summaries consolidated results for the first six months of the year. Net income increased 25.9 percent to $109.3 million compared to $86.8 million for the first six months last year. EPS increased 38 and a half percent to a $1, 69 per diluted share compared to a $1, 22 in 2001. Revenue increased to $657.4 million compared to $635.3 million for the same six month period a year ago. The three and a half percent increase was a result of four percent increase in revenue per unit, offset by unit volume decline by half a percent, primary due to lower response rates a direct check and lower conversion activity.

We saw revenue increase in all three of our business in the first six months of 2002. Financial services was up two percent. Direct checks was up 3.7 percent and business services was up 8.7 percent. Gross margin increased to 66 percent of revenue for the first six months of 2002 compared to 63.8 percent in 2001. The increase was due to an increase in revenue per unit, the continuing impact of our productivity improvements from primarily from the conversion to in cellular manufacturing, reduced spoilage and cost management effort.

SG&A for the first six months of 2002 improved to 39.1 percent of revenue, a decline of 210 basis points from 41.2 percent in 2001. It was also in second quarter SG&A has been driven down by continuing orders from mail to electronic channel. An increase in mix in orders coming through the Internet. Other process improvements in our call centres and selling activities in our. Lower depreciation and amortization extent and cross management effort. Gross margin expansion and SG&A improvement produced an operating margin increase of 490 basis points to 27 percent of revenue for the first six months of 2002 compared to 22.1 percent a year ago. For the same period EBITDA increased more than 15 percent over last year to $207.4 million.

I'll wrap up my portion of the call with comments related to our balance sheet and cash flow statement. Short-term debt increased approximately $30 million dollars in the second quarter due primarily to the impact of repurchasing the remaining two million shares authorized under the 14 million shares repurchase program. Even with total debt of approximately $200 million our credit ratios remain extremely strong, our debt to EBITDA ratio for the last 12 months 0.5 and interest cover ratio for the first six months of the year stands at 85 .

Cash flow from operating activities increased 33 percent to $121.4 million in the first six months in 2002 compared to $91.3 million in 2001. Cash flow, the cash remaining from operating activities after capital expenditure and dividend payments increased to $57.1 million more than doubling from the first half of last year. Second quarter capital expenditures were $8.1 million for six months they were $17.2 million. We continue to invest in areas of the business that will reduce costs or positively impact revenue, productivity and quality. We anticipate spending less than million on capital this year. My final comment this morning relates to share repurchase program as we stated in the press release we have completed the $14 million share repurchase program authorised by our board in January of 2001.

During the second quarter of , two million shares and as a result completed the full 14 million share authorization, over the course of this program a total of $464 million dollars with return share holders at an average share price of $33 and 13 cents. Let me anticipate a question many of you are pondering, what now? Our board of directors and the management team are committed to maximizing shareholder value, now past action has demonstrated that commitment. We have spun of a business at the end of '02 to unleash the value of two different types of companies; over the past 18 months we have returned more then $600 million to share holders through cash given in from share repurchase, therefore we assure that we are evaluating options that will continue to create value for fellow shareholders. I'll now turn the call back to you .

Thanks for those comments. Once again I'm proud and excited to be able to come to you with such good news across all three of our businesses, particularly given these challenging times. There are several highlights to share with your today. Let's look at our three business segments separately.

First, financial services. In late April, financial services introduced a program called Deluxe Select. We talked about it on our last call and have issued a number of releases since then. But for those of you who may be unfamiliar with the program, I'll offer a very brief recap.

The Deluxe Select program is designed to serve end consumers on behalf of our bank and credit union clients. Deluxe Select is built on our exhaustive market research and unparalleled knowledge of consumer behaviors and preferences when it comes to their check related needs. We expect the program to help us close the preference gap between the check designs end consumers want and the typically plainer ones they use.

As our clients' customers interact directly with our professional sales associates, or order their checks via the Web, Deluxe is able to help our financial institution clients strengthen their brand with their customers. Here are some very preliminary results of the Deluxe Select program introduction. We received very enthusiastic feedback from our clients who attended the program launch event back in April. A number of clients signed up for the Deluxe Select program on the spot. Others have come aboard since. Over two-thirds of the financial institutions that attended the inaugural event have committed to the program, and we've begun the implementation process with these clients. We've begun to see the effects of the program launch in terms of added calls per week.

However, typically, there's a fair amount of setup time required between a financial institution signing on for the program and their customers actually being on the program. It will be late this year and into 2003 before we can measure the strength of the results or see any meaningful impact on revenue. Finally, based on the early level of enthusiasm from our financial institution clients, we will be introducing the Deluxe Select program to another group of clients later this year. We'll keep you updated about the results of the Deluxe Select program.

Let's move on to an ongoing initiative within financial services. Lean manufacturing concepts and cellular manufacturing. On our last call in April, I spent some time talking about both. They are significant contributors to our higher gross margin in the first six months of the year. When a company initiates lean concept, it embarks on a mission to eliminate all manufacturing processes that have no value to the customer. At Deluxe, we've eliminated literally hundreds of these non-value added steps. Some of them appear to be insignificant, but when added together, have equated to considerable time and financial savings.

This initiative has no end date. We will always be alert for ways to remove unnecessary processes and streamline our check printing production. As far as cellular manufacturing concepts, you're likely aware that we're moving from a linear manufacturing environment to a cellular in each of our financial services printing facilities. In the cellular work structure, employees are empowered to make business decisions affecting their work . They're cross-training for more than one function, which generally makes the work more interesting.

Here's where we stand on the cellular conversion process within our premium facilities. Approximately half of our financial services premium facilities have completed their conversion to cellular layouts. The remaining new sites are prep work such as adopting lean principals and training new employees, and will finish up with the physical move to cellular next year. The lean and cellular manufacturing initiatives have had a tremendously positive impact on our metrics. For instance we have reduced time, or put it another way, we've cut the time that elapses between receiving the order in our facilities, and getting it out the door. We have improved our service levels, and we have reduced are cost per unit, increased our units per hour and reduced spoilage.

Financial institutions are choosing Deluxe as their vendor for check and related services based on our World Class Call Centers, our Deluxe select program and other valued value added services and the superior quality of our MICR printed products, just to name a few reasons. What we would do, each plan comes to us with a slightly different set of needs, our breadth of products and services along with our reputation in the industry make us obvious choice to meet their needs. Now I'll move on and talk about our direct checks business segment. As most of you know, the two brands within this business segment are Checks Unlimited and Designer Checks. Both businesses connect with our customers via direct mail, the phone and the Internet.

Direct Checks' websites continue to add tremendous value to the company. Approximately 19 percent of Direct Checks' sales are now generated via the Internet, up nearly 35 percent from a year ago. Because the web is interactive, our websites are a wonderful way for our customers to visualize how their checks will look, whether they choose one of our many license packages or another way of expressing their personalities. Currently, and now for some highlights from our third business segment, Business Services. As you've heard me say on previous calls, one of our business strategies is to expand in the products and services that are adjacent to our core products, one such adjacent product, was introduced in early June by our businesses services group. Business Services now offers their customers business cards, stationary and envelopes. The launch coincided with the distribution of 400,000 new catalogues and has generated a lot of enthusiasm within the organization because we believe our customers need for these essential business products will impact their revenue. Already, businesses are showing a willingness to buy their stationary products from Deluxe.

Right.

Foreign events in the business world compel me once again to address the issue of accounting in business practices. Our Board of Directors, Doug and I, as well as the entire leadership team, respect and appreciate the confidence and trust our shareholders have placed in us. I'm proud to be able to say that the vast majority of proposals being put forth by regulators in an effort to ensure the integrity of reported financial results and instill confidence in American corporate governance as a result of recent events, already are practiced voluntarily at Deluxe and have been for some time. We are committed to transparency on our financial statements and disclosures. Deluxe makes real money, our earnings linked to our cash flows and are not merely paper products. I communicated this sentiment to the shareholders at our annual meeting in May and am repeating it now.

Both management and the Board of Directors believe that our actions must be and are governed by the letter of the law. Even further, we hold ourselves accountable to the spirit of the law. This philosophy is carried through to employees with our shared values. Simply put, our values leave no room for discretion when it comes to honesty and ethical behaviour. We understand our obligations to the owners of the company, the shareholders, and we take our financial reporting responsibilities very seriously. We are committed to communicating the shareholders accordingly, whether through SEC filings, press releases or conference calls such as this. Before I discuss the outlook for the rest of the year, I have one non-financial comment to make. I want to thank all Deluxers for the greater quarter.

Not only are Deluxe employees dedicated to the work we all do, but they are also committed to the people in or near the communities in they work. Our Colorado Springs and Phoenix employees, along with the Deluxe Corporation found , have pitched in with time and money to assist the fire-fighters and those people affected by this summer's wild fires in Colorado and Arizona. Before we go to Q&A, let's look ahead to the rest of the year. Deluxe's first two quarters of 2002 were simply outstanding and will contribute to what we expect to be a record year. The success of the first months confirms that Americans still love their checks.

In fact, according to statistics published by the Federal Reserve and the Check Payments Systems Association, checks remain the dominant form of non-cash payments. Consumer's pay by check two-thirds more often than all forms of electronic payments combined. The check's continued popularity equates to the average American household writing 25 of them per month. The check is and continues to be America's favourite way to pay. Now, about Deluxe's outlook for the balance of 2002. As I have said previously, we do not appear to be quite as strong for the first half for several reasons. First, the anniversary of share gains from last year that positively impacted the second half of 2001 results.

Second, an increased investment in both revenue-generating programs such as Deluxe and the timing of our investments in cost management initiatives related to technology and data infrastructure. Third, the impact of the postal rating for each went into effect at the end of June. Fourth, the fact that the contract payment both Doug and I have talked about fell in the second quarter, rather than in the last half of the year as originally expected.

And fifth, the impact of softer response rates in our direct checks business. Still, we do expect 2002 to be a record year, both for net income and for earnings per share. In the third quarter, we anticipate earnings per share to be in the range of 76 cents to 79 cents, and for the full year we anticipate earnings per share to be at least three dollars and fifteen cents per share. Thanks for joining our call today and now Doug and I will take your questions.

Thank you, ladies and gentlemen. If you wish to ask a question, please press the one on your touch-tone phone. You will hear a tone, indicating that you have placed in queue. You may remove yourself from queue at any time by pressing the pound key. One moment please, for the first question. As this question comes from the line of with Henry Partner, please go ahead.

: Thank you. Good morning. Excellent results with congratulations. I just have a couple of quick questions. One related to the buy out payment how much annual revenue would that kind of a contract have represented if they paid five million cash to terminate early.

we would not respond to that because that is proprietary information and this is a small industry very, very competitive and we would not want to provide that kind of insight for our competitors into our contract.

: OK I can appreciate that thank you. Secondly with respect to Delux select more than two thirds have signed to date of the 100 institutions that heard the first roll out what is your sense of those that have not. What are the objections or the things that you need to knock down to move that very impressive start to an even higher response rate?

: so far no one has said no so it's really a matter of the institutions having an opportunity to go back and discuss it within their respective organizations and how in there and how they either want to implement it within their organizations and it's more of a question of how do they do it and when versus will they or not. I would say it's uniformly been across everybody even those who haven't signed on yet highly appreciated and endorse but they haven't no one has said no let me just put it that way.

: OK.

: We remain optimistic that we will get a good percentage of those and we're so encouraged as I said in my comments we're planning a second round of introduction of that through another of clients this fall.

: OK thank you very much Larry.

: Thanks Lee.

Our next question comes from the line of please go ahead.

Hi in the quarter financial check business can you talk a little about share and it seems you've got some little pricing power I think after you know in the last year or two or three there's been a little kind of price war going on just overall pricing and what's going on with the competition and kind of the environment as you see it going on as it relates to pricing, thanks.

this is Larry I would say that on share we are certainly the largest and we'll just leave it at that and however it still is a very competitive industry and we're facing competition all the time, good competition. We are from a Delux out business based upon the value that we bring to the customers not just on price but on the quality of our product, the quality of the services, programs like Delux Select, our technology, technology so that they we can serve their customers the way their customers would like to be served whether that's through the Internet, whether it's voice response units, whether it's mail, whether it be in person so we really are waging our marketing efforts totally on the value that we bring. Of course you've got to have a competitive price but that's the perspective that we are bringing to our client.

: Well I guess then taking from your comments that oh, and speaking to some of your competitors well there's not a whole lot of them but that is it safe to say that the pricing rationality has kind of come back to the industry, it sounds like is that safe to say do you think?

I wouldn't let me put it this way, it's still very, very competitive pricing arena because there is banks get larger and bank A and bank B go together let me just say even if we have both sides of that provider to bank A and bank B when they come together certainly if the prices are different then they might be, they are certainly not going to pay the higher they will go to the lower and then also they will say we now have more leverage so we lower price. So it is the real driving source here is the consolidation of the financial inductions market, and that is driving the competitive prices as low as our competitors.

Thank you very much.

Our next question come from the line of with Stephens incorporated, please go ahead.

Hi this I s with Stephens. Congrat's on the quarter.

Thanks .

Can you quantify the softening directly mail response rates please?

No I wouldn't quantify those for you only in the sense that again it is very, very what I would say information in a very competitive industry, but we have seen reduction in the response rate this is being a trend that has being there for several years. And it is not just our's we are talking about comments about the industry we are talking about the direct response industry in general. And two factors are going on there one is the reduced response rates which is the rate at which people respond to a advertisement piece. And the other is the cost of acquiring customers are there for increasing not only the response rate where but some of the cost or the opportunities are being reduced as many of those traditional places that we would have placed ad's no longer have the same circulation that they had before, or some of them have gone out of business.

So those are some of the dynamics as to a projection of how that might be we would say that is going to continue for a period of time but it's just a yellow warning light for us and we are just going to alert the as slow as the to what we are seeing currently.

Kind of tagging along with that last callers question, in terms of the competitiveness out there the fact that American's no longer for sale seeing any increased competitors from there stand point to prove that they should on that company?

No, I mean I just wouldn't comment on that American is a very, very good competitor and the fact that that they are no longer, information haven't seen any impact on the market as a result of that and it's a pretty recent announcement.

OK, and then lastly you said the focuses to increase shareholder value with the free cash flow and I am wonder since the board decided not to there must be some thing that more attractive or some thing that could be more attractive in most likely be acquisitioned, can you give us a update on you acquisition and more what verticals you are look for a acquisition?

First let me just comment on some of your comments you have made assumption a couple of assumptions there that are not correct, one the board has not the made the determination not to do an additional share repurchase that was a statement we made so I want to correct that and from our perspective we're continuing to evaluate alternatives certainly share repurchase is among those alternatives for us. As to acquisitions our strategy remains the same that we would make acquisitions that they leverage our core competencies and if they are accretive to our earnings and to our cash flow.

So your second assumption was in there that we must be looking or something going on there I would not support that however with a general statement that we're always looking for an acquisition that would fit into our space and our criteria and the good news is we certainly have the from a financial standpoint to do all of those things.

Oh well let me step back then why didn't you the repurchase program then?

I just said we're continuing to evaluate various options so.

OK, well thank you.

Sure.

Our next question comes from the line of please go ahead.

Yes I'd like to add my congratulations to a great quarter. I realize it's early on in your Delux Select program but I'd like to ask a couple of questions about it. In one of your news releases you mentioned that there is a possible 50 percent increase in check order revenue to your financial institution clients do you have any to those clients?

Again is there a benefit from several aspects one is the revenue and one is customers almost across the board because they have people in place to take the mail from customers or take a call from the customer and in turn place that order with us either by electronically by data input or placing a call to us or by sending us a file with Delux Select those processes or reduced or eliminated so there is a cost savings and I would not quantify that for you simply because again for the same reasons I cited earlier of competitor information but there certainly are plus savings.

: What about potential margin differentials between the the traditional way and financial services you checks and Delux Select the impact to Delux.

The what we have said is certainly two things happened one is the average order size goes up because of higher value product being sold to the end consumer of the financial institution on their behalf and third, second is we do sell other products or services along with that for example the opportunity to sell check book cover or different type face or font or whatever it might be and so those would be driving the order size up and many times those also carry higher margins so therefore would have an impact on the average margin of the whole order ...

OK, but you don't have a specific difference between, in terms, a number for difference in margins?

Yeah, , again I'm going to say that we've -- I appreciate your input ...

That's fine, yes, I understand.

Because, again, it's a very competitive market ...

Absolutely, I understand.

We just don't share that kind of information.

During -- one more question, during the process, is there a typical contract length -- contract length that you're signing with these customers?

Most of the time, in today's market, our contracts with financial institutions run in the three to five year range, and so this would be just a part of -- an amendment to an existing contract or on part of a contract renewal with a bank or it's a new customer for us, signing and making that part of our contract.

So it doesn't alter the traditional length of contract terms that we currently are experiencing.

Great, thank you very much.

Sure, .

If there are any additional questions, please press the one at this time. We have a question from the line of with , please go ahead.

Thank you, good morning, everybody. Just a quick question, in terms of the waiting period relative to the spin-off, is there any regulatory approval that is still pending, and upon which then you'll make your next action? Or is it your expectation that to maintain a conservative posture that you're just going to wait two years, regardless.

This is Doug. I'll link back into Larry's comments in part. There is no regulatory approval spending at this point in time. Certainly, the spin off of at the December 2000 date poses for us particular constraints that we're factoring into the evaluation of what the next steps are. So it's something that we need to be cognizant of, and we'll weigh in at the factor as we make those determinations.

OK, that's what I was driving at. OK. Thank you.

Once again, ladies and gentlemen, if there are any additional questions, please press the one at this time. We have no further questions at this time, please continue.

OK, thank you, . This is a reminder that a replay of this call will be available until July 25th by dialing 320-365-3844, and when instructed, you need zero nine. The recorder will also be available for one week on Deluxe's Web site, www.deluxe.com. Thank you for joining us today.

Thank you. Ladies and gentlemen, this concludes our conference for today, and thank you for using AT&T Executive Teleconference. You may now disconnect.