Deluxe Corp (DLX) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. The conference will begin momentarily. Please continue to hold. Thank you for your patience.

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter 2002 earnings conference. At this time, all lines are in the listen-only mode. Later, there will be an opportunity for questions. Instructions will be given at this time. If you should require assistance during the call, please press zero and then star, and as a reminder this conference is being recorded. I would like now to turn the conference over to the host, vice president of investor relations, Mr. Stuart Alexander. Please go ahead.

Thank you, Kathy. Good morning, everyone. Welcome to Deluxe corporation's third quarter 2002 investor conference call. Today, you'll hear from Larry Mosner, and Doug Treff, our chief financial officer. They will take questions at the end of the prepared comments. In accordance with regulation FD, this conference call is open to all interested parties. A replay of the call will be available via telephone and Deluxe's website and I'll tell you how to access the replay at the conclusion of the teleconference. Before I turn the call over to Larry, I will make a break brief cautionary statements. Comments made and statements regarding management's regarding future performance are forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. As such, these are subject to risk and uncertainties that can cause actual future results to differ materially from those projected. Additional information are contained in the news release that we issued this morning and in the company's quarterly report on form 10-K for the quarter ended June 30, 2002. With those items out of the way, I turn the call over to Larry Mosner.

Thank you, Stu, and thanks to everyone for joining us today. As in the past, we make these quarterly calls available via telephone and on the website at Deluxe.com. We're doing something different this quarter by providing slides on the web cast. We hope those of you who follow Deluxe will find them to be a worth wile addition. I have one more introductory comment before we move on to the financials. We're coming to you this morning from downtown Chicago, where we are attending the second DeluxeSelect Expo sponsored by our financial services business unit. I'll say more about our new DeluxeSelect program later in the comments, as well as provide some of the highlights if our three business segments. But first, Doug Treff, our CFO, will review the numbers. Doug?

Thank you, Larry. I'll start with the third quarter's performance. Net income was up 3% to $53 million compared to $51 million in the third quarter of 2001. Earnings per share were up 10.7% to 83 cents from 75 cents in 2001 primarily due to the impact of share repurchases and improved operating margins in direct checks in business services. Revenue was $320 million in the third quarter compared to $324 million during the same quarter a year ago. The $1.4% decrease in revenue was a result of lower unit volume, primarily due to fewer conversion programs in the software economy. As you're probably aware, it's driven by the need to replace checks after one financial institution merges with or acquires another. These factors contributed to a 7.3% decline in unit volume which was partially offset by 6.4% increase in revenue per unit. Gross margin increased to 66.3% of revenue for the quarter, compared to 65.6% in 2001. The improvement was due to the 6.4% increase in revenue per unit and continued productivity improvements. Selling general and administrative expense or SG & A declined as a percent of revenue to 39% compared to 39.5% in 2001. As a result of improved gross margin in SG & A operating margin improved 160 bases points to 27.1% of revenue compared to 25.5% of revenue in the third quarter of 2001. Let's look at quarters results in each of the three business segments, starting with financial services. Deluxe financial services revenue decreased 4.5% to $189 million in the third quarter compared to $198 million in the same period of 2001. Operating income decreased 7% to $47 million from $50 million in 2001. The primary reasons for the increase were weak economy and the significant decline in unit volume from conversion programs during the quarter versus the year earlier period. Consolidation in the financial services industry has been down lately, possibly related to the weak economy. Another contributor to the DFS decline in revenue was increase competitive pressure. Let's move on to direct checks revenue which increased slightly to $76 million in the third quarter compared to $75 million in 2001. As we noted during our second quarter conference call, response rates like many other direct-mail business have been declining. Not only response rates declining in our direct checks business, but marketing expenses also are going up as a result of fewer new customer acquisition vehicles. In spite of these challenges, operating income in the direct checks segment increased almost 24% to $22 million from $17 million in 2001. Driving the strong improvement were higher revenue per unit, a change in accounting for goodwill that had a 1.5 million dollar impact on the third quarter, and continued migration of order volume to the Internet. And now, a recap of our final business segment, business services. Revenue increased more than 6% to $55 million in the third quarter compared to $51 million in 2001. Operating income increased more than 19% to $19 million from $16 million in 2001. The primary reasons for the improvement were increases in both unit volume and revenue per unit. With the numbers for third quarter covered, let's take a look at nine-month consolidated results. Net income increased 17% to $162 million compared to $138 million for the first nine months last year. EPS increased 28% to $2.53 diluted per share, compared to $1.97 in the same nine-month period of 2001. Revenue increased to $977 million compared to $960 million in 2001. The 1.8% increase was the result of a 4.8% increase in revenue per unit offset by a unit volume decline of 2.8%. Primarily due to a couple of factors that I have already touched on. Fewer conversion units, and the drop-off in direct mail response rates. The consolidated nine-month revenue increase broke out as follows across the three business segments. Financial services revenue was slack, revenue and direct checks increased 3% and business services increased almost 8%. Let's move on to gross margin. For the first nine months of 2002, it increased to 66.1% of revenue compared to 64.4% in 2001. The improvement was due to the increase in revenue per unit and our continued focus on cost reduction and productivity improvements. SG & A for the first two months of 2002 improved 39.1% of revenue, compared to 40.7% in 2001. Factors driving the improvement were a shift toward electronic and Internet orders, lower depreciation and amortization and strong cost management. As a result, operating margin improved to 27% of revenue for the first nine months compared to 23.2% a year ago. During the first three quarters of 2002, earnings before interest, taxes, depreciation and amortization or EBITDA were up 10% to $308 million, compared to $281 million for the same nine-month period the year before. The last financials I'll cover are from a balance sheet and cash flow statements. Short-term debt remained flat during the quarter. The result of renewed share repurchase activity offset by strong operating results that generated healthy cash flows. In addition, other long-term assets increased by $22 million during the quarter, primarily as a result of up-front contract acquisition costs related to winning or retaining financial services business. Cash flow from operating activities was $177 million in the first nine months of 2002 compared to $209 million in 2001. Free cash flow, cash remaining from operating active it's the after capital expenditures an dividend payments was approximately $81 million compared to $109 million in 2001. The primary reason for the difference is that we did not make an estimated federal income tax payment in the third quarter of 2001 due to tax legislation that extended estimated payments on a one-time basis in the last year's fourth quarter. Excluding the timing of the estimated tax payment, free cash flow would have been flat versus 2001. Capital expenditures were $27 million for the nine-month period. We continued to invest in areas of the business that will reduce costs or positively impact revenue productivity and quality. We anticipate spending approximately $35 million on capital this year. My final comment this morning relates to our share repurchase program. If you followed Deluxe, you know that in August we announced that our board of directors had authorized a $12 million share repurchase program. Subsequently, we announced that we adopted a rule 10-B-5-1 plan under the securities and exchange act of 1934. The rule 10-B-5-1 plan will allow us to repurchase shares when we will be prevented to do so under the self-imposed trader blackout laws. We expect to make them during the window trading periods you will remember that we utilized the plan in conjunction with a $14 million share repurchase program initiated in January of 2001 and completed earlier this year. Taking advantage of the rule gives us the flexibility to continue share repurchases in an orderly and systematic manner. We believe the stock repurchase program will enhance shareholder value as we leverage the strong profitability and cash flow generating capabilities in the company. We also believe that Deluxe is under leveraged. We believe our steady cash flows put us in a position to increase our debt level up to $700 million and still maintain a strong A investment grade rating. The use of debt will lower our overall cost to capital and as a result increase returns on capital invested. We expect that the debt will be a combination of both long and short-term borrowings. Since announcing our new share repurchase authorization on August 5th, we have repurchased approximately 900,000 shares at a cost of $40 million. I look forward to taking your questions in a few minutes, but first, I'll turn the call over to Larry.

Thank you, Doug. In my opening comments I mentioned that Stu, Doug and I are are coming to you from Chicago today. We're here to attend the second DeluxeSelect Expo, a two-day event that show cases DeluxeSelect. A new program being offered by our financial services business unit. The Expo uses both group and one-on-one presentations to introduce our financial institution guests to an innovative marketing concept can help them uncover new revenue opportunities through their check programs. But that's not all. DeluxeSelect also enhances their customer service. What is DeluxeSelect? In a word, it's about choice. It's about letting end consumers know the hundreds of choices available to them when they order checks and related products. Our research shows that most consumers would prefer to use distinctive or decorative checks, but often they are unaware of the options, so they default to plain blue checks. You probably heard me talk about closing the preference gap. Well that's what DeluxeSelect does. It closes the gap between what customers prefer and what they use. The DeluxeSelect program is built on Deluxe's unparalleled knowledge of consumer check preferences, and our unique marketing capabilities. The program puts the right products in the hands of consumers, which leads to increased customer satisfaction and stronger revenue streams, both for Deluxe and for our financial institution clients. When banks and credit unions participate in DeluxeSelect, they allow us to interact directly with their consumers through our various marketing channels. Naturally, we do so on their behalf. Results from the DeluxeSelect program show that financial institutions can boost their revenue per check order by as much as 50%, and, at the same time, increase customer satisfaction. At this, our second Expo, we have more than 150 financial institutions in attendance. We're confident that they will be as impressed with the program as the 90 or so financial institutions who attended the first Expo last April. Before moving on from DeluxeSelect, I want to tell you about a sweeps stakes that's tied to the DeluxeSelect program. We launched our check out the magic Disney theme sweepstake earlier this month. The campaign offers our participating financial institution clients their customers and their employees the chance to win travel and merchandise awards. What a great opportunity for our clients to enhance customer satisfaction and employee morale. The Disney theme is a natural since our Disney checks are among the most popular licensed image designs that we offer. And when the sweepstakes is over at the end of December, some terrific prizes will be awarded. The grand prize is a five-night, Disney theme trip for four to New York city. It includes round-trip air travel, hotel accommodations, broad-way theater ticket, backstage passes and airport transfers. Other sweepstakes winners will be able to choose from more than 1700 name-brand merchandise items. The concept of choice that's behind the DeluxeSelect program is ringing true with our clients, and is helping us to acquire and retain business. For instance, DeluxeSelect was a key reason national commerce financial out of Memphis Tennessee chose Deluxe to manage all three of its bank brands. Although one of the NCF brand, central Carolina bank, has been a Deluxe client for many years, NCF saw the potential of DeluxeSelect and brought there other two brands to us. NCF expects to improve consistency and service by going with a single-source check printer supplier and we couldn't agree more. Another major financial institution regionally chose Deluxe as the single source check supplier. Prior to the decision the bank had a dual source supplier relationship, but for many reasons, not the least of which was the DeluxeSelect program, they chose to console date suppliers and awarded Deluxe the business. We will be there sole provider beginning in February of 2003. The next news item from Deluxe financial services is about an alliance we have established with digital insight. A leading E-finance enabler. Through this alliance, we will integrate the one for the Internet into digital insights access Internet banking platform. Here's the translation. Deluxe's one for the Internet reduces costs for our financial institution clients by simplifying and automating the check ordering process. It allows us to manage the entire check order, freeing up our clients resources and improving order accuracy. The Deluxe digital inside alliance will give financial institutions single sign-on capability for their Internet banking services, providing end users seamless access to check orders from Deluxe. This newly established relationship is based on a shared commitment from Deluxe and digital insight. Both of us are committed to providing maximum value to the financial institutions we served, in meeting the E-finance needs of end users. The partnership will allow our DSF business unit to help us enhance the Internet banking services and the alliance will also allow our shared clients the opportunity to improve customer service and develop new revenue streams through their Internet banking channels. Now, let's move on to Deluxe's business services division. As Doug mentioned, DBS had a great quarter. Both revenue and operating income were up. In August, we announced that Deluxe business services was chosen to be the new exclusive supplier of checks and forms for Microsoft money 2003. The announcement coincided with the release of Microsoft money 2003. This alliance gives users of Microsoft money 2003 access to checks and forms through Deluxe business services, such as business and consumer checks. Software compatible checks and forms, business cards, stationery and accessories. Money 2003 customers will be able to order products through Deluxe's advanced ordering channels, including the Internet and our world-class call centers. Microsoft said that it selected Deluxe because of our dedication to providing consumers with superb customer service, and that the alliance reflects Microsoft's commitment to empowering money customers with the best tools and resources for managing there small business and personal finances. We look forward to expanding our partnership with Microsoft in the future. Let's move on to our last business unit. Direct checks also had a good quarter, posting a respectable increase and a modest increase in revenue. The results are even more significant when you consider the softness in response rates and higher marketing costs in the direct to consumer piece of our business. As we explained on the second quarter call, direct checks relies on other businesses and cooperative mailers to insert our promotional materials into their advertisements. This is our primary method of acquiring new customers. Unfortunately, consumer response to the direct mail ads has declined, while our research tells us that we're not the only company that's experiencing this trend, it's frustrating nevertheless. However, we continue to explore new advertising opportunities such as the Internet and other partnerships to replace traditional media sources. I'll close my comments about direct checks with news about a new check design launched by both ore checks unlimited and designer checks brands. Entitled American heroes, a design features a beautiful full-color illustration of three firefighters raising the American flag at ground zero in New York city. In fact, the illustration is the same one that appears on the new postage stamp. A portion of the proceeds from the sale of these checks benefits the bravest funds which supports families impacted by the September 11th tragedy. This new design is just one of several cause-related check designs Deluxe offers. As we look ahead to the fourth quarter, we anticipate that revenue and net income will fall short of last year's performance. We also anticipate that the fourth quarter earnings per share will range from 70 to 75 cents and a full-year will range from $3.23 to $3.28 per share. In terms of net income and earns per share, we expect 2002 to be one of the best years ever. It doesn't mean that the quarter will be without challenges. There are a number of things we're keeping our eyes on, such as the weak economy, the soft response rates in the direct channel, the slowdown in consolidations between financial institutions and increased competitive pressure. At the same time, we will be investing in key long-term revenue initiatives like DeluxeSelect that will enable us to serve the financial institution segment unlike any of the competitors and investing in cost saving technology initiatives. Before we move on to the Q&A, I'd like to share a final piece of news. Last week, we announced that Deluxe is ranked 153rd on the information week 500 listing, a ranking of the nation's largest and most innovative users of information technology. The information is based on how companies prioritize and approach I.T. investments as well as the implementation and application of I.T. resources. The list represents nearly one third of U.S.-based companies with revenues exceeding $1 billion annually. Deluxe is included on the list because of our technologically advanced ordering and service channels, coupled with our use of technology and manufacturing, and other areas of customer service. Pardon my boldness if I say pretty impressive for a company in a mature industry and a company that prints a product whose death was predicted four years ago. I invite you to read the complete press release on our website. For now, though, let's move on the your questions.

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press the one on your touch tone phone. You'll hear a tone indicating you have been placed in queue. You may remove yourself by pressing the pound key. If you're using a speakerphone, please pick up your handset before dialing. One moment, please, for our first question. Our first question comes from chuck Ross with insight investments. Please Go ahead.

Hello. Good quarter. Can you talk about check volume? Obviously, that was an ugly unit decline in the third quarter. How does that compare versus the industry maybe for the quarter or for the nine months?

I would say that the industry as we have said before, Chuck, is going to continue to see a unit decline in personal checks written. And we have not altered our forecast here in this particular quarter. We had built in some increased -- or more than what we experienced in the conversion area which is when, as you know, one financial institution merges with another. And so the units produced is different than units -- or written, checks written. And so we have not changed our outlook for the long term forecast for check unit decline, and we think that it affected our third quarter and we think it will affect our fourth quarter here. But on a long-term basis, have not altered our forecast.

Do you feel like you've lost share in the third quarter?

No, I don't think so. And we think that we might have on an absolute basis, but we wouldn't know until we see all the results which will find out next year because we see that in the historical perspective. But we feel strongly about our ability to increase our share of the whole check market based upon the value that we can bring to the financial institution and whether they be banks or credit unions.

But you're saying longer term you still expect check units to decline for the industry, and, therefore, you'll be pretty close, you know, 2% to 4%, I think that's the kind of number we have talked about in the past?

Correct.

So no real change there?

No.

And can you talk of about pricing environment? That of course you mentioned that a couple of times.

Yeah, the pricing environment, as was see as with the small unit decline in the market. We are very, very -- making it very aggressive on the pricing in the sense of making sure that we continue to service our financial institution and we retain our customers. Pricing is only one component of that, but we have seen some increased pricing pressures there from our perspective. We continue to work with our financial institutions, our current customers as well as ones that we would like to gain on the value that Deluxe can bring to them, based upon our technology that we talked about that I talked about in the quality of our product and services in the innovation W programs like DeluxeSelect that we're experiencing in our DeluxeSelect Expo today.

Great. In the past, I don't think the economy has had much of an impact on you. Why is it different this quarter and how do you -- how do you know it's that and versus just less checks being written out there?

Yeah. It is difficult to separate the total impact of fewer checks written from economic impact versus other payment alternative impact. But what we had -- you're correct, chuck, in that we have said in previous conversations that the economy has an impact, but it is not a major one. However, as we looked to the general economic forecast going back at the start of the year, we felt that there would be strengthening the general economy. At this time in 2002. And we're not seeing that strengthening and not sure when that is going to happen. So there is a factor on economic impact in our results. It just isn't a major one. The reason we're commenting on it, because it is a factor combined with the other things that we have commented on.

And what portion of your volume is normally from the conversion, national institution conversions?

Oh, it's a small percentage, but when you get some major conversions like we did last third quarter and fourth quarter, if you remember we've commented that we have major gains in the third and fourth quarter last year. So our earlier comments this year was that we would be circling around on that and in this third and fourth quarter, so we are forecasting lower performance. So it is a factor in terms of -- but it isn't a high percentage of the total units.

Are you talking like under 10%?

Oh, yes.

And when you're looking at your fourth quarter, what kind of unit in the price change do you expect? What's the assumption inherent in --

We would not give you a specific forecast. But we do see continued opportunities to drive revenue per unit increases, and that's really the whole strategy that we have had for our period of time and really accelerating now with our DeluxeSelect program. You see that in the numbers, even though there's been a unit decline, it was very in a major way partially offset by our ability to drive per unit.

Thank you.

Thank you. We'll now move on to Lee shave with blue fire research. Please go ahead.

Good morning, gentlemen. I just want to follow-up on a little bit on DeluxeSelect. Of the 90 or so people, Larry, who received the introduction to the program in April, where do you stand with respect to having those good clients of your firm sign up for the program?

We have over 90% of them signed on the program, Lee. And so we feel very, very confident and the remaining 10% is a good chunk of that, major percentage of that is still a potential opportunity. People who are just not ready to make a decision, yes or no. So we feel very good about that and therefore we feel that we are -- our forecast here is based upon the current Deluxe Expo that we're experiencing as we sit here, we will have similar results coming out of that based upon the response from our first. What we are seeing though is that the length of time to sign -- not sign them up, but to implement the DeluxeSelect is stretching out a little bit. Not from our resources, but getting into the queue for hook up with VRU with web-based and getting the technology done and getting in the technology queue of the financial institution. But the results that we -- where we have had this implemented are equaling or exceeding the numbers that we have forecasted and have shared with our financial institutions. So we're getting good acceptance and good results, nothing that changes any of our outlook. In fact, if anything, it strengthens our resolve and what we think are going to be the benefits.

Make sure I understand, of the people that have implemented your revenue lift per order has exceeded what you did in the pilot?

I said equaled or exceeded, yes.

Okay. Excellent.

And that's based upon a sizable sample, and we will continue to monitor that because it's a team effort for us.

Okay. Let me just follow up again on the revenue increases in the -- in the financial institution, the revenue increases and the other two segments on a per unit basis, what are the factors aside from pricing? Was it a higher percentage of licensed design, for instance?

I think that -- well, you named one of them. Certainly a higher percentage of licensed product. In other words, the basic marketing principles that we're talking about in DeluxeSelect are applied to our direct check business and in our Deluxe business services business unit, it is being also driven by a broader assortment of product and services that we have added. For example, stationery and business cards, and so we will drive higher order value through additional product and additional services that we're bringing to them. So it is our intent to test and as many things that meets the needs of the customers as we possibly can to continue to drive that average order value up at the same time increasing customer satisfaction.

Okay. And finally, I noted that SG & A came in less than I had anticipated. It seemed to me that with the DeluxeSelect and these types of initiatives, are there some specific factors that led to lower SG & A than -- or should we expect a lower trend line going forward?

I would not -- I'd be cautious about forecasting a lower trend line, because I think your basic premise of you expected it to be higher is then the reduction that we had here is probably an accurate one. Because we will have increased spending in initiatives to support our DeluxeSelect and other cost saving initiatives that we think will bring value to customers and also enable us to -- reduce our cost to produce. So I think your observation is a sound one, Lee.

Okay. Thanks, Larry.

Sure.

Thank you. Our next question comes from Nick with Stephens incorporated. Please go ahead.

Hi. Good morning, everyone.

Good morning.

A few questions. Doug, can you give us a cap ex for '01, please?

The cap ex for '01 was $27 million.

And where are you spending the money this year specifically?

This year, I would say the incremental spend since we anticipate spending $35 million for the full year is going into two of the areas that Larry has alluded to already in the conversation. One is going into DeluxeSelect and in that broadly defined, meaning some of the infrastructure to interface with banks and to provide revenue enhancing opportunities for us. And secondly, we continue to invest in productivity improvement types of initiatives that are both information technology and non-information technology related.

What would be an example of the latter?

Our printing technology. Investments that we would make there to make ourselves more cost effective in our printing process.

Okay. In the press release, you guys speak about four reasons for the sequential decline in earnings. And I'm wondering is any one of them -- does any one of them stand out, and if not can you rank the four, please? The four being weak economy, soft response rate, slowdown and consolidation and then increased competitive pressure.

Oh, I would order those -- those are ordered in the order that we believe they're most significantly impacting the business. So no one of them stands out as significantly greater than the last one. But the beginning of the list is we believe having more significant impact on the business than the fourth one on the list.

So to follow up on an earlier question, when you say the weak economy, what exactly does that translate into weakness in your fundamentals?

For example, for us, it's just been checks written. I mean, that's translated for us is the economic is our people spending as much, are they taking on new accounts or spending things on -- that would cause them to write another check? So that's the impact on us. And as we have briefly said as we have looked back over the history, it is a factor, but it is not one that would drive significant swings in our total -- in the total check industry or on our numbers. But it is a factor.

Okay. Doug, you mentioned some up-front cash payments, and I wanted to clarify what exactly those were for. In your commentary.

What we have seen is a dynamic in some of the contracts, some of the more significant relationships with financial institutions, a component of winning that three to five-year contract has been significant or partial up-front payments. And we as Larry alluded to or mentioned in his comments, we did win a sizable contract that was -- we had a one contract that was a significant contributor, a supplier or financial institution that went from dual source to a sole supplier. And that was a significant contributor to that increase in long -- other long-term assets.

Can you quantify that payment was?

We don't quantify individual amounts. In aggregate, we saw our long-term asset goes up $22 million related to contract acquisition costs from the second quarter to the third quarter.

Okay. And on that dual source or single source that large contract, you said it starts in February, at the beginning of February or the end of February?

I'm not certain personally, but could be the beginning of the month.

Okay.

But most of those things, there is a transition period. But in this particular one we're going to be making -- starting that major transition in that month of February. It should be completed in a relatively short period of time.

Like 30 days or so?

Well, as fast as we can get that done, but yes, versus a phase-in over, you know, several months as the people normally transition their checks.

And then the last question, and for 2003 -- or actually 2002 earnings are going to be up roughly 20%. If you guys report 3.75. 80% of that due to operating efficiencies and slight increase in revenue and 20% because of the repurchase program. Can you guide us as to where you see earnings for 2003?

I will answer that one, Nick, and at this point in time, I would say we're not in a position to give you any guidance on 2003. Specifically. We're still in the midst of our annual operating plan, and still making -- trying to make sure we take enough time to understand the current economic climate, what is happening with the total check units to as best we're able to do. However, I would say that we -- as we have said previous, we still feel very strongly that we can continue to drive increased revenue and profits over the next several years from our core business. But we would be able to give you some guidance, probably in the end of January when we finish and get approval on our annual plan and have a better sense of maybe the fourth quarter here.

So no initial cut, if you can maintain that -- those growth rates?

I think that what we would say is at this point it's just too -- we don't want to put any forecast in there. I would say to you we're going to continue to invest where we think that we can drive increased revenue and continue to invest where we see opportunities to use technology, to reduce our costs. And to improve our service levels where there is a payback to the client and to the customer and to Deluxe and the shareholders. So feel very, very strongly of our ability to continue to manage that.

Great. Thank you very much.

Thank you. If there are any further questions, please press one now. We do have a follow-up from chuck with insight investments. Please go ahead.

Hi. I think back at -- one of the investor conferences you had back in February, you talked about expecting units in the financial institution unit to actually turn around and grow again. Can you address that at all?

Well, let me make sure I am clear as to the comment, and this is I think what we said is in our financial institutions segment we have over the last several years seen some pretty significant decreases. And we had looked at this year as the opportunity to slow that decline and potentially flatten that with the expectation for the future to be able to through increased share generation on the unit side, to be able to possibly generate unit increases in that particular segment. But it would come from share since the total industry is in decline.

Understood.

Yeah. Does that clarify it?

It does. I guess the question is, do you still feel that way? Obviously, that was eight months ago and so far we're not seeing that at all.

I would say to you in a very short way, yes, we still feel very strongly about that.

Okay. In the -- can you tell us what you expect for the fourth quarter EBITDA that translates into the net income line?

Actually, we don't provide specific things on that. But when you translate the guidance associated with the EBS you'll come out with a number and that's the reasonable estimate.

Okay. I know you don't want to talk about '03. Can you talk at all about the direction of cap ex whether you keep it at the current level or increased?

At this time, we'd just as soon wait until we put the whole plan together and defer the answer until the January call. But I would love to provide that guidance at that time.

Okay. And I'm going to give one more shot at this. Can you at least tell us whether you think '03 EBITDA will grow or, you know -- let's put it this way. Your shareholders need to have some confidence that EBITDA is going to stay on track, and it would help us greatly if you could give us some confidence that you think EBITDA will at least grow slightly, you know? If you can't say that it will, then we certainly can't.

Chuck, let me respond to it this way. I believe the company's best predictor has to do with how it did in the past and how it executed the business strategy historically. I think you have seen the company continue to expand margins, to be able to manage businesses in a difficult economic environment, to be able to gain share at certain points in time. And that growth or that business -- those business results aren't necessarily consistent quarter to quarter, all the time in companies. But we are very much committed to seeing revenue and operating income grow over the next several years as Larry mentioned. So specifically related to next year, EBATA, our operating margin will increase, I'm not specifically giving that guidance for what we said earlier, but we anticipate over the next several years that that will occur.

Okay. Thanks.

Thank you. We now have a question from Andrew Jones, north star partners. Please go ahead.

Good morning.

Good morning.

In terms of judging the business segment performance, do you guys have consistently grown the operating margins through this year, but the pieces within that seem to bounce around and I was curious whether you think we should focus on the pieces or on the whole thing when you measure it. Also, if you can talk to the impact of technology spending -- use of technology on the margin, whether there's been much of a factor.

I would concentrate on the whole, rather than the piece parts because I think you get a better trend line that way. And don't run the risk of trying to misinterpret maybe what might be happening on some of the piece parts. On the technology side, I think one of the things that we have been very successful at is using technology to help us make sure that we continue to provide a high level of service to our customers, a high quality product as well as to make sure that we provide a very cost efficient, effective operation. We continually look at ways to improve productivity, because we know that in the business that we're in that's just a given for us to do. And we have done that as one of the things we talked about in past calls is our ability to use lean manufacturing, cellular manufacturing to provide higher quality product at the same time reducing our costs. Same thing on our call centers. As we use technology, whether it be switching or in fact the speed of the PCs themselves to be able to do -- to make an investment where we can handle fewer calls -- or more calls in less time, which means that there are fewer seats you need in the call center. We use all of those and evaluate them on a regular basis to make sure that we are as cost effective and efficient as we possibly can be.

Do you think that the operating margins can be sustained if -- in the third quarter, you have a slight revenue decline versus the prior year, and you had operating margin, you know, substantial improvement year over year, but also more importantly they have held up around 27% for the year.

Again, I would say as we take a look, we will give more guidance I think on -- and we'll try to provide guidance on the revenue in the operating profit line and without necessarily commenting on the subcomponents of those pieces. Certainly, it would be our desire to keep operating margins as high as we possibly can. And look at how we can do that in managing the piece parents of that. But I will not want to give you any indication of forecast on that.

I mean in general, you have not been a high revenue growth company, yet you had significant operating margin improvements. So in general, is the business such that you've kind of got it maxed out now I guess is my question, and then to improve you need to have revenue growth to leverage or do you see the opportunities in general to continue to have margin improvement?

I think we continue to see opportunities to increase our productivity and efficiencies. Yes, some of the big opportunities are behind us. But I think as always if someone assumes that, well, they're all gone is when you get into trouble, we haven't assumed that they're not all gone. So we evaluate that on a regular basis and continue to find new ways to improve productivity and efficiencies. So at the same time, we are working very actively to try to increase it will revenue per unit as well as the total revenue through things like with DeluxeSelect and marketing programs to address not only the operating margins, but also the top line.

So you're getting essentially an improved mix of business?

Yes. Absolutely.

A second question, just, you know, obviously the stock price is down. I was scratching my head trying to find out what people are disappointed about. I thought from the guidance that you guys gave after the second quarter, your third quarter was better than that. The implied guidance for the fourth quarter had been 70 cents and now you're talking about 75 cents. What do you think people are disappointed with?

I don't know. Maybe you can tell us. But I think people have expectations. I think what we concentrate on is we cannot control the market. What we can control is our ability to manage our business, the top line and the cost structure and the bottom line and our relationships with our customers. And so we feel very strongly that if we do that day in and day out that the stock price will reflect that over a long period of time. The short term fluctuations are that and so we make sure that we are giving you the best guidance and respond to your questions and inquiries in an honest and open manner with some insight as to how we feel about the business is what the role that we should be playing and the rest of it we sometimes scratch our head just like you are.

One last question, please. Just the question of the target capital structure, you and Doug went over that. The target capital structure something we will see achieved before Doug retires, or is that something that's more --

I can safely say, yes. Doug is a young guy. Doug, you want to --

Yes. Andrew, that was a good question. The target capital structure that we have put out there, certainly we are on track to move that direction. Our intent is to continue to repurchase shares in the open market. We are buying on a continual basis when we're in blackout periods or when we're in trading windows, and we look at the current price of the stock, we long -- we look long term, we understand at the market there will be volatility in our stock price in the market. But we are committed on a steady basis to repurchasing shares. We have not identified a specific time frame over which we'll conclude the share repurchase, but with the announcement of the financial strategy on August 5th, announcing this targeted capital structure, I think it's appropriate to conclude that we anticipate the debt levels will increase as a result of share repurchase.

The announced amount of share repurchase, even if you did all that with the cash you generate, you're still not at the targeted capital structure, how do you weigh the idea of doing something like a Dutch tender where you would get there more quickly, but you probably pay a higher per share price perhaps versus the cost of going a couple of years with a less than optimal capital structure and the higher cost of capital that that implies?

Good question. Those are things that we do look at. We analyze those, evaluate those and develop the financial strategy. We worked with outside advisers, and we continue to discuss those and look at those and evaluate all the options. Because I think the factors that you looked at, weighing a higher than optimal capital or cost of capital against the price that you would need to pay to accelerate share repurchase beyond the rate which we're currently moving, those are the factors we need to take into account.

Thank you. Congratulations on the quarter, by the way.

Thank you.

We have a question from Harry Noodleman from Tudor investments.

Hi, guys. Just a couple of quick questions, please to the extent that you announced the plan August 5th and it's kind of towards the middle of October, has it been some sort of regulatory issue or in negotiation with the banks? What would be the biggest impediment to at least putting some marginal debt on the books? To get the process started.

You're saying in terms of going out of debt offering?

I'm assuming that you'd like to increase the debt like $700 million over time.

Correct.

A combination of short and long term debt. So far you we're flat. And you guys are running a great business. I'm curious if there's some sort of hurdle you had to get through, be it the board or the bank? Is there something that's blocking with the rates being so low particularly over the last six to eight weeks?

No. We take a long-term view of this as the stock price is lower, we'll be more aggressive around share repurchase.

I'm more focused on the on the refinance side.

Oh, on that side, certainly we're aware that interest rates are very low level. We will look at the current debt level, and probably anticipate doing something over the next one or two quarters.

Okay. Just an observation if I may maybe placate some of the other people on the call. Your after tax funding against your interest expense, it's time to start borrowing. That's just a no-brainer.

Yep.

An observation. What is the current capacity utilization of the company?

Of your fixed asset base.

In terms of our production?

Yep.

I would say we're in the 60% range.

So which will drive better efficiency, closing some facility or -- I mean, because obviously then you have material room for improvement, and I respect that you all work very disciplined and diligently to accomplish that. Can you just kind of walk us through since it's not optimal what is the next level there?

Yeah. I think -- we continually evaluate that. I think that if you look back over the last several years and you probably have, at one time we had over 65 facilities supporting our financial institution. We now got down to nine. It's a combination of facility capacity as well as location of facilities to honor the service level agreements we have with our financial institutions.

Okay.

The ability to get the check package into the mail. And so it is location and then size of those facilities. One of the things that we have been able to do that is positively impacted our business on the bottom line is to continually drive improvements with our Deluxe value add measurement and not only manage the PNL, but also the balance sheet and we have been very successful in dramatically reducing the amount of inventory we need to support our business and so when that inventory goes down, it also increases our ability to increase capacity in our facilities. So as we have got more space, but it really is driven by the balancing of that with the location and service levels.

Okay. That's terrific. Thank you all very much.

Thank you.

We now have a follow-up with Andrew Jones from north star partners. Please go ahead.

Doug, what do you think would cost you guys to borrow ten year money if you were to go out and raise $2 million or $3 million? What would you guess you would have to pay in this environment?

Given our credit rating where we are today, probably 5%, 5.5%.

Great. Thank you.

Thank you. If there are any final question, please press one now. Okay. We have no further questions, gentlemen. Please go ahead with your closing remarks.

Thank you, Kathy. This is just a remind their the replay of the call will be available until October 24, by dealing 320-635-6844. Provide the access code 653385. An audio recording will be available on Deluxe's website, WWW.Deluxe.com. I want to thank everyone for joining us today. Have a great weekend.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and for using AT&T executive teleconference. You may now disconnect.