Deluxe Corp (DLX) 2002 Q4 法說會逐字稿

Ladies and Gentlemen, thank you for standing by. Welcome to the fourth quarter, 2002 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the call, please depress the zero then star. As a reminder, this conference is being recorded.

I'd like to turn the call over to our host, Mr. Stuart Alexander. Please go ahead, sir.

Thank you. Good morning everyone and welcome to Deluxe Corporations 2002 fourth quarter and year-end investor conference call.

Today, we'll hear from Larry Mosner, Chairman and Chief Executive Officer and Doug Treff our Chief Financial Officer. As in the past, they will take questions from analysts 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. I'll tell you how to access the replay at the conclusion of the teleconference.

Before I turn the call over to Larry, I'll make brief cautionary statement. Comments made today and regarding earnings estimates and projections and statements regarding managements intentions and expectations regarding future performance, our forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. As such, these comments are necessarily subjects to risks and uncertainties that could cause actual future results to differ materially from those projected. Additional information about various factors that can cause actual results to differ from those presented are contained in the news released that we issued this morning and in the companies on form 10Q for the quarter ended September 30th, 2002.

With those items out of the way, I'll now turn the call over to Larry Mosner.

Thanks, Stu. And thanks to everyone on the line for joining us today.

If you read our news release this morning, you already know that Deluxe reported record results in a number of areas. If you didn't see the release, I'm more than happy to share with you that record earnings per share both for the fourth quarter and full year 2002. Our full net income of $214 million was also a record. And we improved our operating margin in 2002, over the previous year.

I'll let Doug cover the rest of the financials for you. After which, I'll share some of the highlights from each of our three business segments and talk about the business outlook for the year ahead. At the close of our prepared comments, Doug and I will be happy to take your questions.

First, I'll turn the call over to Deluxe's CFO, Doug Treff.

Thank you, Larry.

We had a solid fourth quarter and outstanding full year. First, let's take a look at operating results for the fourth quarter.

Net income for the fourth quarter increased 9% to $52 million, compared to $48 million in 2001. Earnings per share for the quarter were 84 cents. A fourth quarter record and 15% increase over the 73 cents we reported in the fourth quarter of 2001. It was also nine cents above the top-end guidance of 79 cents per share, that we gave going into the quarter. Approximately eight cents per share of our reported results were the result of a lower tax rate, primarily due to favorable tax audits for the years 1996 through 1998. Partially offset by a valuation allowance established preferred tax assets not expected to be realized and to a lesser extent, an adjustment to post-employment medical benefits accrual.

Revenue decreased to $307 million in the fourth quarter, compared to $319 million last year. The 3.7% decrease in revenue was due to a 6.7% decline in units volume. We primarily attribute the unit decline to fewer checks being written in a soft economy. Retail sale was at the low end of expectations for the holiday season for most retailers.

In the fourth quarter, we were negatively impacted by the timing of financial institution gains and losses. We also continued to see softer response rates in our direct to the consumer business. The unit decline was partially offset by a revenue per unit increase of 3.1%. The increase was the result of an improvement in product mix.

Let's take a look at fourth quarter revenue in each of the three business units. In financial services, revenue decreased 7%. In direct checks, it decreased 2%. And in business services, revenue increased approximately 6%.

Moving on to other fourth quarter results, gross margin increased to 66% of revenue, compared to 64.8% in 2001. We attribute to the improvement to the increase in revenue per unit that was driven by the sale of products with higher margin. Selling general and administrative expense, or SG&A increased to 9.35% of revenue compared to 39.0% in the fourth quarter of 2001. While the percentage increase, the dollar amount of SG&A declined compared to last year. In fact, fourth quarter SG&A expense in dollars was the lowest it's been since the spinoff of e-funds two years ago. Operating margins expanded once again in the fourth quarter, this time increasing 26.4% of revenue, compared to 24.8% of revenue last year.

Here are a few more items to wrap up my comments about the quarter. Capital expenditures were just over $14 million. Earnings before interest, taxes, depreciation, and amortization, or EBITDA, was 31.1% of revenue, or $95 million, up slightly compared to last year. Our fourth quarter results capped a strong year for Deluxe.

Now for the year, diluted earnings per share were a record $3.36. On record, net income of $214.3 million. This equates to a 15.3% improvement in net income and 24.9% increase in EPS. Full year 2001 EPS was $2.69, a net income of $185.9 million dollars. Revenue increased slight slightly for the year to $1,284,000.000. The .4% increase was driven by a 4.4% increase in revenue per unit, offset by decline in unit volume of 3.7%. Although we gained new business in the first half of 2002, our full-year unit volume was down, due to the soft economy and fewer conversion programs. In fact, more than 40% of our unit decline for the year was the result of fewer conversions.

Breaking out revenue by business segment, financial services revenue decreased nearly 2%. The smallest decline in more than five years. Direct checks revenue increased 1.7%. And business services increased 7.2%.

Business services continues to grow at the fastest rate of our three businesses due to the continued growth in small business startups. Because we experience record net income and EPS in our 87-year history and revenues grew only slightly, the drivers of our strong operating results are evident in the gross margin and SG&A.

Gross margin increased to 66.1% of revenue for the full year, compared to 64.5% in 2001. In fact, our gross margin has improved every year for more than five years now. The most recent improvement was the result of three primary factors. The 4.4% increase in revenue per unit driven by the sale of more licensed check design product and enhanced check services, such as secure mail and express delivery, and also price increases on various products and services in all three business segments.

Second, our continued focus on productivity improvement.

And finally, cost reductions.

As far as SG&A, our efforts in continuing to migrate customers and clients to the lower cost of internet channels, along with ongoing cost management resulted in improved SG&A of 39.2%. This compared to 40.2% in 2001. Lower depreciation and amortization also contributed to the improvement. It's worth noting that our SG&A spending in 2002 was the lowest in terms of dollars spent in at least five years. As a result, 2002's operating margin improved to 26.9% of revenue, compared to 23.6% of revenue a year ago. In fact, we believe our operating margin to be the highest in Deluxe's history.

Several other items worth noting in our record year include our intention to increase our debt -- I'm sorry. Earnings before interest, taxes, depreciation, and amortization, or EBITDA, were over $400 million, compared to 375 million in 2001. Capital expenditures were $47 million in 2002 compared to nearly $29 million a year ago. The increase over 2001 is the result of key investments we are making in both revenue-generating and cost reduction initiatives such as the distribution centers and call centers, as well as developments [INAUDIBLE] program. Cash flow from operating activities decreased 5% to $257 million. We completed the 14 million share repurchase program initiated in 2001 and through December 31st of 2002, we bought an additional 1.2 million shares under the 12 million share repurchase program authorized in 2002.

And as noted in today's earnings release, we have repurchased an additional 1.6 million shares during January to bring the total shares repurchase to date under the 12 million authorization to approximately 2.8 million shares. This results in 60,051,000 shares outstanding, as of today.

Before turning the calling over to Larry, I have a couple of additional items to cover. First, Deluxe's recent public debt offering. Early in December, we announced our intention to launch a public underwritten public offering of tenure senior unsecured notes. The debt offering was part of a financial strategy we announce said on August 5th of last year. If you follow Deluxe, you may recall that our financial strategy outline, our intention to increase our debt level up to a maximum of $700 million and the new 12 million share repurchase program I mentioned a moment ago. This strategy leverages Deluxe strong profitability and cash flow to maximize shareholder return. The debt offering allowed us to take advantage of the current low-interest rate environment and will reduce overall cost to capital. The response to the debt offering was tremendous, resulting in a fixed 5% coupon.

Now I'll turn the call over to Larry.

Thank you, Doug.

I have a number of comments in several areas today. I'll begin with a few words about checks, as they relate to the U.S. payments system in general. Then I'll cover highlights from our three business segments and finish up with comments on the following three general topics, enhancing shareholder value, Deluxe's growth strategy, and the outlook for 2003.

I'll begin by commenting on a couple of articles that were published in the last half of 2002. In August, the Federal Reserve reported that their most recent payment study indicated approximately 49 billion checks were written in the year 2000. Later, the fed revised that number to 42.5 billion.

Just to be clear, checks did not decline from 49 to 42 billion.

The fed indicated that their original count was in error. Then in late last year, the fed reported that they would be laying off some employees in their check processing center due to a reduction in paper check usage of approximately 3%. Hopefully technology and increased efficiencies also are contributing to the work force reduction.

I should also point out that the fed is not the only check processor. So it's possible the fed is also experiencing the decline in the percentage for checks that are processed through the Federal Reserve Bank. This news is not surprising. In fact, we've discussed in these calls before that check usage peaked in the late '90s and the numbers have been flat to decreasing slightly ever since. Still, checks are still the most-preferred noncash payment method in the United States, accounting for some 60% of all noncash payments. Other electronic payments have been growing rapidly, but they're a long way from replacing the check as Americans' favorite way to pay.

At Deluxe, we're being proactive in managing our response to this trend. We are delivering on our goal to drive more revenue from each check order transaction. And we continue to seek opportunities to develop noncheck revenue.

Let's move on to some highlights from our three business segments, starting with Deluxe Financial Services. DFS recently announced the availability of three new check designs. The first one commemorates Harley-Davidson's 100th year anniversary. It features a vintage motorcycle and the Harley-Davidson logo.

We're also proud to be able to celebrate another milestone of another of our existing license characters. Although he doesn't look like his age, Garfield, America's' favorite cartoon cat turns 25 this year. We're celebrating Garfield's birthday with a new check design called Garfield Paws 25th Anniversary, that features a foil stamped insignia.

The third new design in Financial Services is our Hero's Triumph package. The check features a painting of three firefighters raising the American flag at ground zero after the September 11th tragedies. Deluxe will contribute a portion of the proceeds from every Hero's Triumph purchased at The Bravest Fund and the New Jersey Media Group Disaster Relief Fund. These charitable organizations are dedicated to benefiting firefighters, police officers, emergency personnel and their families as well as others affected by the tragedy.

These new check packages are three more ways for check writers to express their personalities or to support a cause that is important to them. Our financial institution clients also benefit from our expanded product line because when they offered their customers greater choice, they enhance customer satisfaction and grow their check program revenue.

For those of you listening in via our webcast, pictures of the three designs I just mentioned are contained in the slide show.

DFS announced another change that will start appearing in each and every check package we mail out. I'm talking about the newly designed checkbook register. While the register might not be as exciting as our new check designs, it's as important as the checks it accompanies. The new register was developed in response to consumers' changing record keeping needs. Here's how.

Today there were a number of different ways to make deposits and withdrawals, such as automatic payments, ATM transactions and debit card purchases. The new check register lets customers account for these differences by providing more writing space. The layout also make its easier for people to record all types of payments, including noncheck transactions. It's important to point out that this redesign was based on exhaustive consumer research, and not on a whim. We know people love their checkbooks for a variety of reasons, including record keeping. The new register is more powerful too that lets consumers track their payments from check writing to various electronic or automated payments.

With product news covered, I want to move on and proved you an update on our Deluxe Select program. The initiative we announced in the Spring of 2002.

As I mentioned a couple of minutes ago, maximizing the revenue from each check order transaction is a key component of our overall strategy. And Deluxe Select is critical to this strategy. Deluxe Select also offers obvious benefits to our financial institution clients. As you've heard me state in previous calls, Deluxe Select is about partnering with our financial institution clients so that both of use focus on what each does best. For those of you who are less familiar with our Deluxe Select program, it's built on our exhaustive research into consumer check buying preferences, which revealed a significant gap between the plain checks many customers use and the customized designs they would prefer to use if presented with a choice. In addition to marketing checks directly to consumers on behalf of financial institutions, Deluxe Select also enables us to provide effective marketing and customer support, directly to a financial institution's customers. Deluxe uses its advanced ordering channels. The internet, world class call centers, in package materials and other strategies to let consumers know about the products available to them. Deluxe offers the broadest variety of check designs, including the most sought-after licensed image designs on the market today. By letting consumers know what is available in marketing to them appropriately, Deluxe is able to enhance customer satisfaction and open new revenue streams for financial institutions.

How are our financial institution clients responding to this exciting new program?

The numbers tell us that our clients are understanding the value within the Deluxe Select program. Of the 225 financial institutions that attended the two Deluxe Expos we held in 2002, approximately half of them joined the program on the spot. And by the end of the year, the vast majority of the original 225 had come on board.

How is Deluxe Select performing against expectation?

Well, it's delivering the lift in revenue for order that we expectate, which is good news for our financial institution clients and good news of course for Deluxe. On orders that are coming through a Deluxe Select channel, we are seeing the same per transaction lift in revenue that we saw in the early pilots.

Now I'd like to cover a few highlights from the Direct Checks business segment. In the fourth quarter, Direct Checks reported the highest operating profit both in terms of actual dollars and percentage in their history. This is a tremendous accomplishment, considering the soft response rates direct marketers are currently experiencing. As we've shared with you in the past, the number of Direct Check customers ordering via the internet is continuing to grow.

And back in the fourth quarter, 23% of Direct Check's orders came in through this channel, the highest level on record. Direct Checks all completed an update to the computer system that supports its prining operation. You may recall that our DFS and DBS business segments successfully made the same upgrade about one year ago.

Let's move on to our third and last business segment. Deluxe Business Services. In early December, DBS announced that it had become the exclusive provider of business checks and forms for users of Microsoft Business Solutions, Business Applications. The alliance is an extension of a relationship announced last August, through which DBS became the exclusive supplier of checks and forms for Microsoft Money. The new marketing alliance allows small and midsized business customers access to the full range of products offer by Deluxe Business Services, including checks, forms, business cards, stationery, and other accessories. This alliance extends to many many products in the Microsoft Business Solutions Suite.

Microsoft chose Deluxe because it saw us as the best company to meet its customers needs. More specifically because of our marketing expertise, technological edge, and our dedication to serving our customers. The alliance is set up so that Microsoft customers interact with Deluxe through an integrated co-branded multibranded approach that includes specialized call center support, marketing communication materials, and a dedicated internet solution. This marks the first time Microsoft business customers have the opportunity of ordering checks, supplies, and forms on line.

With highlights from the three business unit covers, I'll move on to a few corporate topics. First, enhancing shareholder value. As Doug mentioned, early last fall, we announced a business strategy that is intended to enhance our shareholder value and also support our business strategy.

This financial strategy includes leveraging Deluxe's financial strength and lowering our cost of capital by taking on debt, up to $700 million. The $300 million debt offering that Doug mentioned takes us one step closer to that target. The strategy also includes a 12 million share repurchase authorization that follows the 14 million share repurchased program we completed in 2002. Share repurchases continue to be cash flow positive on a per share basis. And we bench mark including possible acquisitions against the return rate of share repurchases.

While on the subject of acquisitions, I want to assure you that they still are part of our growth strategy. As we've stated before, any acquisition would have to be strategic to one or more of our businesses and also accretive to earnings and cash flow. The other two elements of our plan for growth are items I've already touched on. Growing a share in the markets in which we're already doing business by leveraging several competitive advantages and by adding more value to what we do. And developing noncheck revenue.

Let's move on and take a look at the year ahead. Our outlook is based on the following economic assumptions.

First, employment growth will be slow to recover. And two, personal consumption will be slightly below normal. We also anticipate less conversion activity as a result of fewer mergers and acquisitions among financial institutions. And we expect longer reorder periods for checks until consumer spending picks up.

How do we expect these economic conditions to impact 2003 results?

We anticipate that both revenue and operating profit in 2003 to be flat to slightly higher than 2002. At this time being we expect first quarter earnings per share to be in the range of 83 to 88 cents.

In full year, earnings per share to be at least $3.40 per share, excluding the impact of additional share repurchases, but including the interest expense on the $300 million of 10-year notes.

I have just a couple more topics before going to questions. First, I'd like to thank our shareholders for the confidence and trust they have placed in us. I realize the last few years have not been easy ones in the world of investing. Yet today, we are reporting record net income and earnings per share. At the same time, I'm proud to be able to say that at Deluxe, we are committed to transparency and financial statements and disclosures. We have adopted best practice processes in our corporate reporting and corporate governing procedures. In fact, institutional shareholder services most recently ranked Deluxe in the top 10 firms for corporate government's practices.

There's one more important thank you I want to extend. And that's to the more than 6,000 Deluxers. I thank you for being terrific employees, for the hard work you've put in the job over the past year. And I thank you for being wonderful people.

Most of you on today's call probably don't know that there is a Deluxe employee volunteer group at each of our facilities. Deluxe employees volunteer time and give money to help others in their communities. Efforts range from meals on wheels to reading to children to helping build homes for Habitat for Humanity. I thank each and every one of you for your selfless efforts and for our companies great year.

Now, Doug and I would be happy to take questions.

Ladies and Gentlemen, if you wish to ask a question, please depress the 1 on the touch-tone phone. You will hear a tone to indicate that you have been placed in queue. You may remove yourself from queue at any time by depressing the pound key. If you are using a speaker phone, please depress the handset before pressing the numbers. One moment please for the first question.

And our first question comes from the line of Lee Shafer with Lou Beyer Research. Please go ahead.

Good morning, Larry and Doug. Congratulations on an excellent year. A couple of things.

Larry, you touched on this. But I want to make sure you understand, where are you with the implementation of Deluxe Select? How many of the 225 banking companies you mentioned were actually up and running on the program, say, by the end of Q4?

Lee, I don't have a hard number for you. But I think what we were experiencing, I think I share said with you in the last call is we're seeing very, very positive response and acceptance of Deluxe Select, both by existing customers as well as prospective customers. And we see it truly as a way to add value to them.

What we are seeing is that from those that we have converted is the same results that we had said on the uplift. In fact, even a little better than what we had seen in the pilots.

And a very, very positive response from those financial institutions with which the quality that their customers are receiving from our customer care centers. The people in our -- that are answering the calls and working with them to determine what their needs are and what their wants are and then providing them with product and service to fulfill that to increase the satisfaction for the end consumer.

We're also still seeing that the key issue for implementation is getting in the bank's queue for making the conversions within their systems to connect with the VRU as well as with the internet. And so those are the -- those are the real things. And that has stressed out a little bit. We're continuing to work with them. We have the resources, but to continue to drive as quickly as we can.

So those are the conditions around the Deluxe Select. And we don't see any reason here why that strategy should take any turn from what we have already given as direction.

Okay. All right. The other major thing that I'm curious about. I want to make precisely sure that I understand the reasons for unit volume decline Q4. If you look, conversion activity is a big part of that. But I want to make sure I understand the other factors. Could you elaborate on that for me?

Sure. I think that there are two other primary ones. One is just the general level of checks written from an economic. And the other is just the timing of gains and losses in terms of banks coming on to us or leaving us. We have made some major wins, but those won't be coming on until the first part of this year in the first half. And then, like with all of us, we have also some losses, but we've already experienced some of those losses in this last half. But we, for -- and that's on the, as you've seen in the results, that's the Deluxe Financial Services Business, which is the biggest drop.

Right.

And then we also still see soft response rates in our direct segment.

Right. One final question. Please comment on the competitive landscape pricing, et cetera, in the small bank, community bank segment. That's my understanding that that segment is experiencing more price competition for more aggressive competitors than you've experienced in the more recent past.

Yeah, I think that the pricing pressures continue, Lee, across the all of the segments. And I think that's just the nature of a mature business and with overall, as we've said, the number of checks written have been on a gradual flat or slow decline for the last few years. And I think as those things happen, those pricing will continue to -- we'll see continued pricing pressure. And we see it across all of the segments of the business, Lee.

Okay. Thanks, Larry.

Sure.

We do have a question from the line of Chuck Ross with Inside Investment. Your line is open.

Good morning.

Back to check volume because my guess is that is a -- one of the key reasons why your stock is down here this morning. Can you tell us what you expect for Deluxe's check volume in '03? You must have some sort of assumption on that?

Yes, we do. I think that from our perspective, we would see -- let me start out with the overall check industry. We would see continued gradual decline in that. We would see our check unit volume being consistent with the guidance we've given on the revenue, which would be flat to slightly up, based upon some of the wins we have and our anticipation of being able to be very, very competitive on bringing value to financial institutions and anticipated even increasing our share of the check segment of the payment industry.

If your revenues are flat to slightly up, some of that is from price increase. I mean, there's two components there. There's price increase and units. And I'm trying to get at what you assume units will be.

My comments are on the units side as well. I said I think we'll see that probably being around the flat -- it could be slightly down or slightly up. Don't see a big deviation for unit volume for 2003.

Okay. Then you expect unit prices to be flattish also?

As you get into -- there's offsetting. We've got the Deluxe Select, which is increasing, but you also have increasing price pressures on the others. And a lot of our gains have been into the major market segment. And your major market segment, the bigger banks have lower pricing than do the community bank segments.

So part of it is the shift in the makeup of our volume of business with a higher percentage being in the mega bank segment.

Okay. And with what happened there in the fourth quarter, maybe you could give us some guidance as to what the tax rate will be in '03?

This is Doug. We anticipate the tax rate will be approximately 38% for 2003.

Okay. And depreciation, amortization?

We're looking at DNA of approximately $60 million for the year.

60?

60, correct.

How does that go up and your Cap Ex is below that?

Because the timing of some of the depreciation and amortization that we have, it relates to the length of the service life of the asset you're placing into service.

Okay. So based on that, then, it sounds like EBITDA is probably going to be up a little bit, you know, the 410 kind of range? Am I -- does that sound reasonable?

We anticipate it will be up. Correct.

Okay. Last year -- I look back at last year's conference call, fourth quarter conference call. And at that time, you had estimated '02's operating profit was going to be flat. And of course, you were up 14%. So that's excellent, well above your expectations.

Do you see that kind of scope for performance this year? Do you think there's maybe not by that margin, but do you think you've got a reasonable shot at beating your expectations again?

Chuck, I -- it would be our pleasure to be able to end this year and be able to report that kind of overachievement.

Yeah.

However, when we give guidance, we truly are trying to give you the best information that we have, and the best guidance that we have.

Sure.

At the same time, during the course of the year, we continue to try to drive our organization. And we've got terrific engagement from all of our employees and terrific support from all of the Deluxers who continually try to find new ways to either increase revenue or to manage costs either in the cost of goods or on the SG&A side.

I think what we saw in 2002 was a very, very good execution on the cost side of our business, investments that we made to reduce costs are working -- are transitioned to cellular and lean manufacturing was very, very good. And exceeded our expectations when we started that. Our productivity and our call centers was above what we thought it was going to be. Our conversion from a service environment to a selling environment went more smoothly and worked for us.

So, like with anything, sometimes the opportunities we see them probably being smaller in 2003 for significant cost takeouts. But at the same time, I'd look back every year, and we think that, and find new ways to do it. However, I think that is true. I think our target is to certainly meet or exceed that guidance to you. But that's our best thinking at this time.

Okay. Doug, I missed the number of shares outstanding right now. What is that?

That number is 60,051,000.

Okay. Given how many shares you've bought in January, it looks like you had about 1.2 million options get exercised? Is that correct?

No. That is not correct. That is overstated?

Okay. Well, if you've got 61.05 now. And you had 61.44 at the end of December, and you brought back 1.6 in January -- in other words, if you take December 31 at 61.44 and you subtract 1.6 --

You get 59.8.

Oh. I'm sorry. Okay. I guess I better redo my math.

Lastly, on the last conference call, I think someone asked whether you expected to hit that $700 million in debt during your career, and everyone kind of chuckled. But then I look back. And here in the fourth quarter, your net debt actually went down. Sounds like a good goal, but you're certainly not making any progress towards it.

Can you talk about any kind of time frame you can expect to get there?

Chuck, I think that's a good question, a real fair question about the rate of repurchase in the fourth quarter. We actually were blacked out associated with being in the process of filing registration statements, perspective supplements for our debt offering. As a result, we had taken ourselves out of the market and therefore share repurchase was lower than it otherwise would have been. I think the -- you have an indication in January that as the prices at these levels, we have purchased consistently and aggressively.

Right. I'm surprised you had to take yourself out for the debt offering. I thought with your -- what is it? 10-B-5 program, you could be in the market all the time, no matter what.

The 10-B-51 is set up for those predefined blackout periods, and those typically surround our quarter-end and year-end and earnings release time frames. But other periods, it does not apply to those that are self-imposed.

I'll give someone else a chance. Thanks a lot, guys.

Thank you.

Our next question comes from the line of Shane Glen with Dorehty and Company. Please go ahead.

Good morning, gentlemen.

Good morning.

I glanced at the release this morning. And they indicated in their 2003 guidance that it would be impacted by the loss of a major customer, and it wasn't really clear to me. I didn't go into the release in detail whether or not it was in the print and products division or where that was.

But I was kind of curious if you had seen any gains of any major customers out here recently? Or you expect to gain some here during the first part of this year? And secondly, I was also going to ask, as it relates to, you know, the repurchase program and the potential change in taxation rules for dividends, is there any considerations internally on what impact it may have on your repurchase program?

Dave, let me take the first one. This is Larry. On the contracts. And then I'll ask Doug to pick up that question on the repurchase and the potential change in dividend taxation.

First of all, we -- most of our check contracts are written for three to five-year periods. So we get every year a period of contracts that will come to conclusion or potential conclusion and many banks go through an RFP process to determine their next service provider and business partner. And our goal, and based upon our statement strategy in earlier comments is certainly to compete aggressively to not only retain the customers that we currently have, but to gain new customers and on balance, I think we've seen that we have been able to do that.

Certainly, we -- there is, as we have all of our resources trying to do both of those, retain and gain customers. There are some that are in the prospect now that may be not have final decisions made. And we won't know until the bank makes a decision. But it is part of our strategy to win some of those. And we have last year. We would anticipate and in our forward look, are some of those going our way.

So we see that as continuing part of our major strategies to continually retain and gain. So it means that we will be a bigger share of the market.

Larry, if I could just follow up real quickly. Is there something that is, you know, you're currently looking at or in the process of negotiating that would be in addition above and beyond what you would normally see in your normal course of business?

No. It is, you know, these things happen on a regular basis. Now, what -- the other factor that comes in here, sometimes -- or note sometimes, it goes to a conversion activity is when bank A acquires bank B, where they merge. If -- depending on which way that goes, if a Deluxe bank is being be acquired by a competitor check provider bank, our goal is to try to retain that. But many times, the banks are going to single sourcing and that we would lose that business, not because of necessarily what we have done or the quality of our product or service. But they want to stay with a single service provider. So they would merge that in, and then the opportune time for us to go after that business would be when that contract expires and to aggressively try to gain that back. Not only what we lost, but also the business that we didn't have to begin with.

So that is another factor in the contract. So some of those happened without a contract termination date during the course of that year.

Okay.

Shane, this is Doug. I'll respond to the Bush tax proposal and the impact on dividends.

We have been studying the Bush proposal and the potential impact it might have on us and how we might interpret that, versus the financial strategy that we've laid out. I think it's too early to speculate on the final outcome of that, and to talk specifically how we might change our perspective, if at all, based on that, what will become some form of legislation, most likely.

I would go back and say that the financial strategy that we announced in August is intended to be a long-term financial strategy and not to be adjusted real quickly.

That being said, we will continue to modify the financial strategy as appropriate to maximize shareholder value. If the mix of dividends share repurchase, if the tax legislation affected that, then we would reconsider that and modify it. But at this point in time, we continue to hold to the financial strategy that we've articulated and continue to repurchase shares.

Okay. And one thing if I may follow-up if I may. Your guidance of 2003, I assume when you say, that includes the assumption of no share repurchases. Is that from your share count as reported at the end of the fourth quarter?

That's correct.

Okay. And also sends a net interest number.

Correct.

Okay. Thank you very much.

We do have a question from the line of David Drury with Blackbird Research. Your line is open.

Yes, good morning gentlemen. I'm trying to reconcile your change in balance. I've got the cash flows statement and net income and the beginning value. Could you just run me through that? Hello?

Yes. Okay.

I'm sorry. Thanks.

I mean, it looks like you began with 60.1 million of shareholders' equity. You made 52.3. That gets you to 112.4. And ending balance of 64.3. I think I know some of the entries, but I'm missing a few, I think.

You know, actually, David, this may be something we can follow up on. The major components that factor in there are the shares that we've repurchased, dividends we've paid out, the shares issued related to the exercise of stock options. Those are the primary things that are flowing through, through the shareholders' equity.

Actually, I was thinking that was it. And you guys do a really good job of providing the cash flow statement in the press release. And it looks like you paid 22.8 of dividends, repurchased net of issuance for shares of option related 50.5. That leaves 35.1 million dollars. And I can't make it reconcile to the current shareholders' equity. Looks like something else. I mean, how is you shareholders' equity changing so much? It looks like it's vaporizing.

David, what we'll do is, we'll come back at the end of this call with greater information on that. We'll work through that.

Could I just ask one last question about -- it sound said like there's been a dramatic increase in the return on equites. But it looks like a lot of it is driven by repurchase of stock and decreases in shareholders' equity.

Can you give us -- perhaps there was some target debt-to-cap at some point, you could just revisit? To what extent is the increase in debt and subsequent cash going to be used to fund repurchases versus fund ongoing operation?

Good question, David. The financial strategy that we announced in August, we did establish a maximum debt level target of up to $700 million. $700 million, if you look at that debt level in relation to our EBITDA, would be one and three quarters times our annual EBITDA, assuming a $400 million level. So that's a realistic target. But right now, we've set the dollar amount as our target.

The reason our shareholders equity and return shareholders equity is so high is that associated with the spinoff of e-funds, we contributed capital to that business, fully spun off of business, to existing Deluxe shareholders and significant shareholders equity went with that as a result, lowering our shareholders equity at that time.

Okay. But a lot of the decline is probably due to the buy-back, isn't it?

Correct. And the remainder is due to primarily a share repurchase.

Let me ask one last question. What were the options strike on the shares that were issued buy the company that resulted in cash-end flows? If you're issuing -- if the options are struck at 50% of the stock price, then that would -- in issuing them and subsequently repurchasing those back in the open market would reduce shareholders equity. And it looks like that must be happening.

We do -- the average dollar value of the stock options exercised -- I can't speak to that exactly, although we do have a history. And that's near the mid-20s.

Okay. Okay. Very good. Thank you.

You're welcome.

We do have a question from the line of Ross Taylor with [CACKS] and Associates. Your line is open.

Thank you. I really was interested more in the consolidation trends inside the industry. Has the industry basically reached the stabilization point? Or are there things out there that you see that would fit inside your organization at this time?

Ross, are you talking within the payments industry, within the check part of that?

Both, actually. I was looking at the company as a whole.

Well, there are -- in the check part of our business, it certainly has consolidated over the years today, where you have three major providers in the financial institution segment of that business. And of those three, we would be the largest.

In the direct to consumer part of the business, again, there are three primary providers that account for the -- almost all of the business. And again, we would be the largest in that part of the business.

And our business services segment -- business unit, it is much more fragmented. And because of the nature of the product and the breadth of product offerings there. But we are a major player in that segment. But it's much more fragmented. And that probably has a -- that particular business unit in the market in which it plays, there's probably great opportunity for some consolidation plays than there is in the others.

And in that market -- two things. On the consumer side, is your share prohibitive to further acquisitions? And on the business service side, is it a situation where you have specific areas or sectors that you feel you would benefit from improving? Or is it more of an opportunistic type of thing?

I'm not sure. I think that certainly we have to meet all of the requirements in terms of any acquisitions that we would make. And our strategy is to leverage our core competencies. Our strategy is to really leverage our core. But not only companies that are in our core area, which is check side of the business, but to look at companies that are adjacent to that core that would be synergistic with and leverage our core competencies as a company and be able to grow that way, which we think is a much higher probability of growth through acquisition than in our core.

And how would you define? When you define your core competencies in this area, how would you define them?

First of all, I think we are very, very good at direct marketing and providing a very, very high level of customer service. Our call centers, as we have state in previous calls are ranked world class, in the top 3% not only in their industry, but in all the businesses. And that's from an outside firm, Brady Group has evaluated them.

So we feel that we can continue to leverage those resources. And we certainly have our technology is very, very good. And leveraging our technology advantages and to not only increase revenue opportunities, but also to manage our costs. So those are really very, very key areas of of core competency for us.

Okay. Thank you very much.

This is Doug. I would like to go back to David Drury and answer your question.

David, in terms of the roll-forward of shareholders equity. From the end of the third quarter to the end of the year, shareholders equity at 9/30 was 60 million dollars. We had net income that added to that of $52 million. We had share repurchase of approximately $26 million, issue said dividends of approximately $23 million, which gets us to the end being $64 million.

So if you have any further follow-up on that, David, let me know. But that roll-forward works from our calculations.

Thank you. Ladies and Gentlemen, if you wish to ask a question, please depress the 1 at this time.

We have a question from the line of Andrew Jones with North Star Partners. Please go ahead.

Good morning.

Good morning.

My first question was on the bank conversions on the impact in the volume decline in the quarter. I think in the third quarter you said that the lower activity from bank conversions accounted for about half of volume declines. Could you tell us what it was in the fourth quarter?

It was less than the -- the number that Doug quoted to you was a little over 40% for the year. My guess for the fourth quarter, it was roughly maybe half of that.

Half -- 20% of the volume decline in fourth quarter is due to that?

Yes.

Okay. And could you talk about -- you had mentioned that some of the capital spending is on cost savings kind of efforts. And you guys have made great strides in driving the operating margins up.

My question is whether you see more opportunity to increase the operating margins, or that you're just, to try to sustain them, given that the business is fairly flattish, that you need to spend the money on those kinds of things, and maybe just kind of what kind of projects you can do to try to improve the margins.

I think, Andrew, we have not completed our conversion yet to cool cellular and lean manufacturing, so we'll see continued work in that area. We're also making some improvements in our printing process and the whole manufacturing process, where we think we can continue to take out cost and improve productivity. And we will continue to look at, even in our call centers. In some cases, we have moved through technology advances just to faster, new computers being able to bring up screens faster. And we look at every expenditure that we make on whether it is going to -- what is the return going to be on that, on a economic value return and compare that against project to project. And will evaluate it against, as we said earlier, to share repurchase. And we think -- we made some of that, and we have been able to do that. Because if we have room for activity in the call center, it means you don't need as many seats in the call center to handle the same level of calls.

So we -- I think you implied in your question, what I took was there might be a slowing in that. And I would agree with that. But I still see the ability to invest and get a good return on that investment to improve our productivity across the organization.

I guess really what I was trying to ask was whether there was opportunity to drive the operating margins higher. You know, 27% operating margin seems to me to be very strong.

If you want to look at the bottom line, we still think that there is room there for improvement and operating margin.

Great. And I think on the last call, you guys said you were operating at about 60% of capacity.

Is that an important number? I mean, it sounds kind of low. Is there a big opportunity to consolidate locations? Or would that not be a large cost savings or worth the dislocation to do it?

We -- that is an accurate number. 60 to 65% is our utilization over manufacturing. The biggest issue that we have there, Andrew, is our cost of getting product from manufacturing to the end consumer is a major factor in our total cost structure.

In addition, we have service level requirements with our financial institutions. And so the locations of our facilities are in very good locations. They're very close to bulk mail centers. We're able to get product through our facilities in very short order, and into the bulk mail system and USPS. I'm talking about financial institutions to meet the service level requirements.

So there might be opportunities for consolidations. But the offset to that is you do that and increase your transportation cost of moving that product from that manufacturing facility a longer distance, across more postal zones. So there is probably not a lot of economic value to be added in reduced number of facilities.

Okay. And lastly, could I just ask about the options? Did you tell us how many options were exercised last year and how many you guys have issue said this year and whether or not you expect to expense those options or what your position is on that?

I'll talk to the expensing of stock options issue. It's something we clearly have on our radar screen. And we anticipate an exposure draft coming out soon from the sales beyond that. We look at our compensation and evaluate our compensation philosophy at the same time. We will adopt any guidance that FASB establishes. Or intent is not to expense stock options at this time, although it is something we have looked at.

What we have done from a disclosure perspective, where we are required to disclose on an annual basis, we have made the determination to enhance transparency to disclose impact on a quarterly basis in our 10-Q filings.

Okay. And do you have a number for the amount of options that were exercise said this your?

Yes. There were just over one million options exercised in 2002.

And as you guys issued new options for last year as well?

The options that we issue said last year, Andrew, were issued at -- in March and were about $47, I think. Or $48. Between $47 and $48. Don't have the exact number.

Our issuance of options and our overhang is both on a total shares authorized for grant as well as actually granted is below the median on both levels for both our -- for general industry as well as our peer group. Our overhanging total is about 15% and on issued basis, it lists about a little over 5%.

How many options were issued in March? And is that kind of once a year you do that?

Yeah. It's about 1.2 million, I believe it was.

The number of options issued in the last few years has been this kind of same number, a million last year, I think a million, two the year before. If it's a million two this year, with the stock prices being so much higher, is options becoming a bigger part of compensation? Or how should we think of that?

I think probably keep it on the same level. Andrew, just to give it perspective, if one looks back over the history of the last 10,12 years, there was about a 10-year period where options had zero value literally. And once we made the spin of e-funds back in December 29th of 2000, we -- and since that period of time, the -- from December of 2000 to today, we have seen -- and during 2001 and 2002, and probably an acceleration of the options being exercised for that period of 10 years where they weren't all under water.

So I think the go-forward exercise rate will probably -- will ease from what we saw definitely in 2001 and even maybe what we've seen in 2002.

Okay. Thank you.

Sure.

We have a question from the line of Patrick Donahue with Blue Fire Research. Your line is open.

What was the approximate percentage of customized check orders in terms of unit volume, versus the plain designs for the 2002?

Patrick, I don't even want -- I can't come up with that number off the top of my head, I'd have to go ask somebody to get that.

Sure. That was just more out of curiosity.

Let me put it this way, there is definitely good potential there. That is our whole strategy of Deluxe Select that there is a lower percentage -- or there are more people with, if you would, the Blue Safety Check, when they really prefer a customized, or licensed design. And that gap is a significant one. But I can't come up with the numbers of last year's units.

Okay. Thank you. That's what I'm trying to get my hands around is the opportunity for cross-selling.

Next question, is there a specific project that will account for the five million pickup that you expect in capital expenditures for 2003?

We have several key projects that we are looking at right now and have on our radar screen. That Support Deluxe -- well, both of our -- two key things that we -- that we use in determining.

One is, if we have an opportunity to invest, where we can increase revenue. And the other is reduced cost. So those are the two drivers. And for 2003, we have opportunities in both areas. And our biggest opportunity for expense reduction as we move forward will be in our I.T. area.

Okay.

And so those are keyed up and we're going through the process of making sure that before we spend any dollars, that indeed, we've done all the necessary work and detailed analysis to make sure that before spending the dollars, the return will be realize said.

Okay. And finally, just to verify, for the Q1 guidance, that is also based on the Q4 share balance, and not the most recent 60 million share balance.

That's correct.

Okay. Thank you.

And gentlemen, there are no further questions at this time. Please continue.

This is a reminder that a replay of that call will be available until February 6, 2003 by dialing 320-365-3844. And when instructed, provide the access code 671059. The recording will also be available on Deluxe's website, www.deluxe.com.

In addition, Deluxe will hold an investors conference in New York City on February 11th. Both Larry and Doug along with other members of our companies executive leadership team will be presenting. If you are interested in attending the noontime conference which will beheld at the New York Stock Exchange, please register via one of two ways, by calling 651-483-7878 or send an e-mail to ir@deluxe.com. Please respond by February 4th and be aware that the Stock Exchange requires registration and seating is limited.

If you are unable to attend, the conference the presentation will be available live and as replay on our website, www.deluxe.com. Thank you for joining us today. And we look forward to seeing many of you in a couple of weeks.

Ladies and Gentlemen, that does conclude our conference for today.

Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.