Deluxe Corp (DLX) 2003 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Deluxe Corporation first quarter 2003 earnings 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 to you at that time. If you should require any further assistance electric an operator please press zero then star and we will assist you off-line.

As a reminder this conference call is being recorded. I would now like to turn the conference over to your host, Stuart Alexander, please go ahead, sir.

And good morning, everyone, welcome to Deluxe corporations 2003 first quarter conference call.

Today we will hear from Larry Mosner, Chief Executive Officer and Doug Treff our CFO. As in the past they'll take questions from analysts at the end.

In accordance with regulations this conference call is open to all interested parties. A replay of the call will be available and I'll tell you how to access the play at the conclusion of our teleconference have conference.

Before I turn the calm over I'll make a brief cautionary statement. Comments made today statements regarding earnings estimates and projections and statements regarding management's intentions and expectations regarding future performance are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

As such, these comments are necessarily subject to risks and uncertainties that could cause actual future results to differ materially from those projected. Additional information about various factors that cause actual results to differ from those presented are contained in the news-release we issued this morning and the form10-K that ended December 31st of 2002. In addition, the financial and statistical information that well will review in this call is addressed in greater detail in today's press-release that is posted on our website www.deluxe.com in the Investor Relations section and also in the form 8-K that we file with the SEC today. In particular, any non-GAAP financial measures mentioned during this call are reconciled to the comparable GAAP financial measures in the press release.

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

Thank you, Stu (ph) and thank you to everyone joining us today.

In my comments this morning I'll talk about the impact the economy is having in our business and I will review some first quarter highlights that occurred throughout various parts of the company.

First I'll turn the call over to CFO, Doug Treff , who will cover the first quarter. After our prepared comments, Doug and I will be happy to take your questions.

Thank you, Larry.

For the quarter, net income was $50 million, down 8.4% from $55 million in the first quarter of 2002. Earnings per-share were down a penny to 83 cents from 84 sentence in the quarter of last year. Lower than anticipated revenues were the primary driver of the decrease. Revenue was $317 million in the quarter, down nearly 4% from $329 million in the first quarter last year. Contributing to the decline was a 7.6%decrease in unit volume, partially offset by a 4.4% increase in revenue per unit.

We experienced softer than expected revenue in all three of our business segments due to the continuing economic downturn. Gross margin was 65.4% of revenue for the quarter, slightly less than the 65.6% in 2002. The decline in unit volume and the affect of a postal increase in June of last year was nearly offset by the higher revenue per unit. Selling general and administrative expense or SG&A was 38.7% of revenues. SG&A declined $5 million from the first quarter of last year primarily due to lowering our discretionary selling with regards to softness in our business.

As a result of the above factors, operating margin was 26.7%, a .4 percentage point decrease from the first quarter last year.

Let's look at the quarters results in each of our three business units start with Financial Services: revenue was $177 million in the first quarter, down 7.8% from the first quarter of 2002; operating income and Financial Services was down 23% to $37 million; contributing to the revenue in operating income declines were three primary factors, softness in the economy, the timing of client gains and losses, and continued pricing pressures. As a result, we continue to watch our cost diligently, eliminating spending that is not valued by our clients and customers while we manage our investment spending to ensure future returns are tangible and realizable.

In business services, revenue was up more than 6% to $59 million. The improvement came as a result of increased revenue per unit and new business from the alliance we have with Microsoft. Operating income was down 13% to $16 million. Product mix, investments in new business development and transforming our customer care organization from a service to a selling environment were the reasons for the decline.

We continued to see healthy growth in revenues in our business services business. While at the same time we are investing to continue that profitable growth.

In our third business segment Direct Checks, first quarter revenue was flat to last year at $81 million. However, operating income increased 42% to $31 million Direct Checks was favorably impacted by lower advertising expense due to the timing of new customer acquisition and the lengthening of the reorder cycle. These changes had a significant short-term favorable short-term impact of approximately $6 million in the first quarter. Still we expect advertising expense for the full year to be comparable to last year. Continued productivity improvements in cost management efforts also contributed to direct checks favorable operating results.

As far as our earnings outlook, we expect second quarter diluted earnings per-share to be in the range of 78 to 82 cents per-share. And full year EPS be at least $3.50 per-share, excluding the impact of additional share repurchases after March 31st. For the year, we expect unit volume revenue and operating income all to be comparable to last year due to the beneficial impact of client wins that will impact the second half of this year.

I'll wrap up my comments with a few other highlights from the first quarter.

Capital expenditures were $5.5 million compared to$9 million a year ago. The drop was a result of managing project spend, particularly closely due to the soft economy. We are planning to increase our capital spending through the remainder of the year and, therefore, anticipate spending approximately $40 million on capital in 2003.

Earnings before interest, taxes and depreciation and amortization or EBITA were down 4% from last year to $99.5 million. As Stu mentioned, the reconciliation of EBITA operating income can be found in the press release we issued this morning.

Cash used by operating activities in the first quarter was $6 million versus cash provided by all rating activities of $35 million last year. The primary contributors to the change were three things: higher contract acquisition payments, an increase in accounts receivable due to the timing of client and customer payments, and higher contributions to the Voluntary employee Beneficiary Association or VEBA trust that we use to fund employee medical and severance payments.

We increased our net debt position by approximately $231 million in the third quarter which puts our short and long-term debt at$420 million bring us more than halfway toward our target debt level of $700 million.

My final comment has to do with the status of our share repurchase program. As you are aware, in August of 2002, Deluxe's Board of Directors authorized a12 million share repurchase program. During the first quarter, we aggressively continued to repurchase our stock, buying back 5.1 million shares. Through yesterday, we have repurchased approximately 7.6 million shares under the12 million share program.

I look forward to taking your questions in a few minutes, but first I'll turn the call back to Larry.

Thanks, Doug.

The last time we gathered for one of our quarterly earnings releases, war with Iraq was only a threat. Since then, the possibility of war has become a reality. Although there have been some positive and dramatic turns in the last few weeks, most experts predict that it will be a long time before we can call things in Iraq over.

I would like to express my appreciation and send regards to all the military personnel who have been called into service and particularly to those Deluxe employees who are away from their families and jobs in order to serve our country. The war is only one of the factors contributing to an economy that continues to struggle. Unemployment is up, economic output is down and so is consumer confidence. As I mentioned in this morning's press release, these factors have made their way to Deluxe.

However, we are managing our business through these external challenges. Our business alignment model which I have talked about on many occasions along with the financial strategy we announced in August of 2002 allow us to remain very positive about the future.

Although check usage within the payments industry will most likely decline three to 4% this year due to the growth of electronic payments and the impact of the weak economy, we expect Deluxe's full year unit volume to be flat to up slightly as a result of new business gains that will take effect in the second half of the year.

I comment on the issue of corporate governance on previous calls and I it in my letter to shareholders in the annual report. Once again I would like to comment on this topic.

Deluxe has been recently recognized for a number of its business practices. Earlier this month, business ethic's magazine recognized Deluxe as the 20th best corporate citizen in America. "Business Ethic's Magazine" publishes its list every March and basis its rankings on service to seven stakeholder groups. Naturally, we're proud of this commendation. Some of the best known and respected corporation in America appear on the list. It's also significant that the stakeholder groups "Business Ethic's Magazine" uses in its rankings are the same ones we focus on.

This recognition confirms the importance of our company's shared values. Of the measurements used by the magazine, Deluxe scored among the highest nationally in areas among employees -- involving employees. We pride ourselves in maintaining a balance between delivering unparalleled value to our clients and customers, meeting the expectations of our stakeholders and creating an engaging environment for all our employees.

In addition to the business ethics ranking, Deluxe also received high marks for its corporate governance practices from Institutional Shareholders Services or ISS. ISS is the world's leading provider of corporate proxy voting and governance services, analyzing proxies and issuing vote recommendations for more than10,000 U.S. and 12,000 non-U.S. share holder meetings annually.

ISS compared Deluxe to other companies in these eight categories. Board of Directors, audit, charter and by law provisions, laws of the state of incorporation, executive and director compensation, qualitative factors, ownership and direct education. Based on its corporate quotient model, ISS ranked Deluxe in the top ten firms for corporate governance.

I would like to share one more award Deluxe received this past month. United Way of America honored with a Spirit of America summit award. We won the national award for the major gifts portion of our company-wide 2002 United Way campaign. We're proud of this recognition because the 2002 campaign was particularly successful. The number of Deluxe employees donating at the leadership level which is gifts of $1000 or more grew 110%over the previous year. This recognition reflects the passion of the entire Deluxe family for giving back to the communities where we work and we live and it reflects our corporate shared values.

Bryan Gallagher, President and CEO of America had this to say about our effort. "Deluxe corporation's unique major gifts program gives employees at every level of the organization an opportunity to be a community leader by investing in United Way."

Having shared these corporate-wide highlights, let's move on to the news from our three business segments.

First, Deluxe Financial Services. Earlier this week, DFS announced it will become the sole provider of checks, check-related products and marketing support to Sell-trust (ph), a financial institution with more than 700 banking locations. Sell-trust headquartered in Birmingham, Alabama, chose Deluxe for several reasons. Our broad selection of check products, our knowledge of consumer check preferences, our leading technology channeled and our marketing expertise.

DFS's exclusive Deluxe Select program was a key differentiator in the vender selection process. Sell-trust (ph) will take full advantage of Deluxe Select which is designed to a give financial institution customers an opportunity to get the products and check designs they prefer by speaking directly with Deluxe sales associates. The connection between the end consumer and Deluxe is made on behalf of the financial institution. Sell-trust was impressed with Deluxe employees and the way in which they interact with end consumers.

One Sell-trust executive said, "We found that Deluxe has instilled its vision for unparalleled customer service among its employees. They are amazingly engaged in their jobs and we've seen that engagement demonstrated throughout the entire Deluxe organization."

Another financial institution, Banknorth has enrolled in the Deluxe Select program. It has migrated the customers to the Deluxe Select program in the past few months giving them access to Deluxe's ordering channels such as our industry leading call-centers and the Internet. By turning over the check ordering process to Deluxe, two key things happen. Bank north frees its own critical resources for other areas of customer service and Banknorth gives its customers the opportunity to get the check products they need and prefer from Deluxe, the check experts. A Banknorth executive stated they are already seeing a significant change in their customer's check ordering behaviors as a result of the Deluxe Select program.

We believe that Deluxe Select will continue to be a differentiation with financial institutions when selecting their check supplier.

Moving on to Deluxe Business Services. I'd like to provide an update on fraud defense by Deluxe, a service DBS launched to its small business customers in early January. Broad defense is defined to protect small businesses from check-order fraud and reduce the risks of identity theft during the check ordering process.

There are a number of account behaviors or triggers, if you will, that help identify a possible fraudulent order. Fraud defense screens business check orders against these triggers to ensure that someone else is not using a business' identity to fraudulently order checks. The program features include, a complex matrix to screen each order and evaluate account information, order behavior and contact information. Suspect orders are identified for further investigation. Also included is expert evaluation with a highly trained team of fraud defense specialists who why is a variety of fraud detection techniques and tamper evident packaging.

If fraud is detected, Deluxe immediately alerts the business' financial institution and works with the bank or credit union to determine the appropriate follow up. In the short time fraud defense has been in place, we've canceled a number of orders that were known to be fraudulent.

Fraud Defense by Deluxe is a proprietary program for which Deluxe is seeking patent protection. Not only do small business customers find peace of mind finding fraud defense is at work when they order products from DBS, but our business partners also see the value in this important service. Microsoft recently opted to make fraud defense available to their software customers.

As I discussed on last quarter's call, in late December, DBS announced that it had become the exclusive providers of business checks and forms for users of Microsoft business solutions, business applications. This marketing alliance allows small and small mid-size business customers access to the full range of products offered by Deluxe Business Services, including checks, forms, business cards, stationery and other accessories. And the alliance extends to many products in the Microsoft Business Solutions Suite.

The relationship between DBS and Microsoft is an extension of the one that was announced last August in which DBS became the exclusive supplier of checks and forms of Microsoft Money. Because of Microsoft's decision to make our fraud defense service available to its software customers, all the orders that come into Deluxe as a result of this alliance have the advantage of being screened for fraud.

Now, let's move on to our Direct Checks business segment. This segment had its best quarter ever in terms of operating profit. Some was the result of lower advertising expense in the quarter, however, productivity improvements as well as cost management contributed to their favorable results.

We've talked in the past about soft response rates that most direct response businesses are experiencing. Direct Checks continues to experience this softness. In response to this industry issue, Direct Checks has been a adjusting its advertising spending and testing new approaches to new customer acquisition.

For example, Direct Checks plans to test programs for the Hispanic market. The U.S. Hispanic market is currently at 40 million and is expected to grow 1.7 million each year. Recently, Direct Checks co-sponsored an annual event hosted by the Hispanic chamber of commerce, an organization that inspire lead and give support to Hispanic entrepreneurs. It is a great way for Direct Checks to extend their support to the community.

I'll conclude my comments with two brief items. First, our 2002 annual report was mailed to shareholders along with proxy materials. The annual report features photographs of employees from across the company. These employees are representative of more than 6000 outstanding Deluxers across the country who deliver on Deluxe's quality and service commitments to our clients and customers daily. Deluxers truly are the primary drivers of Deluxe's success.

And second, our shareholder meeting will be held on April 29th at 1:30 in the afternoon. Once again we're holding the meeting in our (inaudible) facility in Minnesota. Many of the share holders who attend are former Deluxe employees and look for the opportunity to reconnect with Deluxers.

Those of you outside the twin cities can attend on the web cast at www.deluxe.com.

Now, Doug and I will be glad to take your questions.

Ladies and gentlemen, if you would like to ask a question, please depress the one on your touch-tone phone. You will hear a tone indicating that you have been placed in queue and you may remove yourself from the queue at any time by depressing the pound key.

Once again to ask a question, please depress the one on your touch-tone phone.

our first question is from Patrick Donahue (ph) from Blue Fire Research. Please go ahead.

Good morning and congratulations on a nice quarter.

Say, can you give us how many banks have signed on with Deluxe Select to date?

Yes. There are over 300 banks that have signed on.

Nothing has changed either strategically or in the execution since our last call -- that we are seeing very, very good sign on and acceptance. We are also seeing, though, the continuation of the time -- lengthening of the time from the time they make the decision to the time of implementation because of just getting in the bank's queue to be put on the Internet or to be put on VRU.

So it's really a technology issue, nothing has changed from the strategy or the positive response --results once we have it implemented.

What is your average implementation time running at currently?

I don't even -- you know, it varies by bank. Pat, I would be guessing and so I would rather not guess. We will try to find that information and see if we can provide some guidance there.

Okay, that is fine. How much of your year-over-year growth in business services can be attributed to the Microsoft business alliance?

Oh, it would be -- I'm trying to think the growth on a percentage basis, it would be -- I'd say to do the math on it.

A couple of million dollars?

It is probably a couple of million dollars in terms of that. So it might be 4%, something like that.

Okay. Okay. And can you -- can any of the year-over-year volume decline be attributed to the timing of conversions?

Conversions are a factor, but it's not the major factor like it was in some past -

But this quarter it is not significant?

Yeah, it's not a significant factor in this particular quarter (inaudible) however, we quarter -- However, we have commented on that in our past calls and in those calls it was a major factor. This quarter it is not.

Okay. And my final question, can you give us any commentary on the stability of check use at point of sell?

Yes, I think the -- in my comments I commented that we have seen this year our forecast is that the check in total as that segment of the payment industry will decline in the 3 to 4% range which is probably a percent up from what we had said in prior calls. But we think that that is driven more by the economy than necessarily the conversion into the electronic side. And we have-- that is our current outlook so we feel that it has not changed dramatically from prior forecast that we have commented on.

Okay. Thank you.

Our next question is from the line of Shane Glenn from Dougherty & Company (ph). Please go ahead.

Good morning, gentlemen.

I was wondering if you could put that - the customer acquisition of Sell-trust in some of the ones you have had in recent past and obviously it is a very impressive customer acquisition for you and are you working on to the extent you can tell us working on any additional types of customers that we might see this year and, if so, is any of that built into the expectations that you've -- the projections that you have given us?

First of all, we don't comment on any volume relative to a particular bank. In fact, we don't comment usually on these unless the bank wants us to -- puts out a press-release and agrees on that and that is why we feel free to talk about the South-trust (ph) relationship in this particular comment here as well as Bank-north.

So it is a sizeable bank. It is a well-respected bank and we are very, very proud to be partners with them on the check program. As to future built into our outlook, we would build in those things -- we take a look at the total number of banks that are either up for renewal or up for either with us or competition and then we do assumptions on that and make that into our plan but we certainly -- and we have got those in our forward-looking numbers but nothing that we don't put it in until we actually know and have a contract in terms of talk about that. So there could be some upside but there could also be downside because you win some and you lose some, especially as you have banks that are bought by another bank. And that -- we don't know that in our forecast but we do make some assumptions.

Said another way, Shane, the confidence level that we have and the forecast that we provided for the year is a high degree of confidence in those numbers.

Okay, fair enough. And kind of on that - on that issue. When making your projections and I apologize if you've answered this before, obviously you assume no share repurchases. As far as free cash is concerned, do you just assume you're paying down debt?

For purposes of our projections, yes. Our projections do not anticipate future share re-purchase. Although from a practical standpoint we continue down that path toward the12 million share program. Our projections do not assume that we use cash to buy back shares so, therefore, we would continue to build cash. That is what the assumptions would have built into it.

Okay. And can you tell us what your interest expense assumption is for 2003?

I think it's -- it's helpful for you to use 5%for the 300 million that we issued last December, and then to use an appropriate A 1 P 1 commercial paper rate and currently we're less than 2%interest on that.

Okay, thank you very much.

Our next question is from the line of Chuck Rough (ph) from Inside Investments. Please go ahead.

Hi, guys. Congratulations on the recognition regarding corporate governance. That stuff definitely matters and it is good to see.

Can you talk about -- in your condensed cash flow statement you have got an operating activities were actually a cash use of 6 million --$6 million. What -- what happened there? Why is that?

There are several factors that contribute to that and let me break it into a couple of category, three categories for you. Net income was down $4.6 million and then there was some working capital requirements and there are some long-term investments. Working capital was affected and there was a greater use of cash. That related to an increase in our accounts receivables and that has more to do with our quarter end cut off and when we received payments from financial institutions.

Secondly or the third factor then relates to contract acquisition costs which as you would expect were significant in the first quarter consuming more cash than it did a year ago.)) Okay. Last year I think, you know, for the year contract acquisition costs were a $35 million cash use.

Right. What do you expect that to be this year?

We have not provided any guidance on that externally and we typically don't but I do anticipate it will be in excess of that number.

By, you know, can you give me bigger than a bread box? Is it -

It will be bigger than a bread box, yes. It would be a significant increase over that number.

All right.

But again, Chuck, the reason I'm -- I can't give you more specific number is that as accounts come up, the retention aspect or getting a new account, we don't know whether we will win or lose those bids. So it is difficult to predict, particularly some of those larger accounts.

Sure, okay. Can you -- you talked about the amortizing expense being down in Direct Checks. Why wouldn't we expect to feel that going forward and why will it be coming right back up and finish flat for the year. I know you talked about it and I heard that but I'm wondering if you can, you know, provide a little more detail on what is going on there?

Yeah, we begin to see softness in response rates late last year and as a result we adjusted the timing of our advertising spend. We still remain committed to and we annually target a number on new customer acquisition. And that is important to sustain the business. New customer acquisition leads to reorders and following - in following years so we do intend to continue to spend at a level comparable last year to ensure that we keep and maintain a healthy and profitable business in future years. So it is more of a timing issue related to the investment than it is a question of whether or not we would want to spend the money. We want to continue to keep the business at the level it is and continue to grow the profitability.

So what I think you're saying is, in the first quarter, you pulled back because of -- due to the way the world was. You didn't feel it would be useful and -- in your, you know, if the world gets back to a little bit more towards normal here in the rest of the year then the advertising money will be useful to spend.

Actually, Chuck, we had begun to spend less in the fourth quarter and because we amortized that advertising spend over a maximum of 18 months, we're feeling the lighter amortization in the first quarter of that.

All right. Maybe you could help me under stand the changes in your outlook over the past couple of months and January 30th, I think you talked about '03 being, you know, basically doing as well or slightly better than '02 than last month you talked about the first quarter being lighter than expectations and I -- I think that translated into approximately the first quarter having EBITA of approximately $10 million less than you had thought originally. Now we're back to expecting'03 operating profit to be flat and I guess I'm just confused by how -- by that progression. Can you help me understand kind of what happened over those -- that time period?

Sure, Chuck. This is Larry.

Let me comment on that. It goes to one of the previous questions as to outlook for bank contracts. We have won some contracts that with will begin to affect the last half of this year.

There are two things one, we had a very, very strong last half of '01 and a very strong first half of 2002. Right now, if you were going back into last year, we except the unfavorability of the year to year compare sons in the last half of '02 and we're seeing those unfavorabilities in the first half.

What has changed here is the firming of some wins that we now can put into our forecast that will affect the last half of this year and that is why in the comments here we're saying we think our units will be flat to slightly up for the year, even though they're down in the first quarter.

So a number -- basically your contract wins look better today than you would have expected even just a few months back?

Yes. In other words, they're actually in the processes of trying to gain them.

Okay. In here -- in this expectation then is-- for the last -- for the next three quarters you expect revenues per unit to be down. Can you talk about that?

Oh, basically the driver of that is as we win the major accounts, the large banks, the revenue per unit in those contracts is less than we find in the community banks or in the credit union market. So we have found and won several accounts that are very large which has lower per unit pricing. So it is a matter of the mix of large banks to the total mix that is adversely - not adversely affecting but it's affecting the revenue per unit. Feel very positive for us as a company to have those units and to have the ability then to impact the revenue per unit through the Deluxe Select process.

Uh-huh, okay. Great. Thanks, guys.

And ladies and gentlemen, once again if you do have a question, please press the one at this time. We have a follow-up from Patrick Donahue. Please go ahead.

I have two questions, on the fraud protection program.

Can you give us the feel for the number of clients that you have so far for fraud defense?

That is something that the majority of our clients, we bring that in and we have a very, very high acceptance rate on that so almost all of our customers are in that.

Okay. And how is that priced?

It is priced at a dollar .95 for each checking account.

In other words, if a customer calls in and orders checks on one account, it is $1.95. If they have a second, separate account number that would be another $1.95 charge.

It is up to the end user to sign up for it and it is just offered by the banks, okay.

It is all packaged together. Deluxe Business Services -- and it is an automatic, yes.

Okay, excellent, thank you.

And we have no further questions.

This is a reminder that a replay of this call will be available until made night by calling the number and when instructed provide the access code 680107. The recording also be available for one week on Deluxe website. www.deluxe.com.

As a reminder as Larry indicated, Deluxe will hold its annual shareholders meeting on Tuesday, April 29th in Minnesota. That meeting also will be webcast on Deluxe.com. Thank you for joining us today.

Ladies and gentlemen, that does conclude your conference. Thank you.