Deluxe Corp (DLX) 2003 Q2 法說會逐字稿

Welcome to the Deluxe Corporation second-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a Q&A session, with instructions given at that time. (CALLER INSTRUCTIONS ). As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Stu Alexander.

Good morning, everyone, and welcome to Deluxe Corporation's 2003 second-quarter investor conference call. Today, you'll hear from Larry Mosner, Chairman and Chief Executive Officer, and Doug Treff, our Chief Financial Officer. As in the past, Larry and Doug 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 web site, and I will tell you how to access the replay at the conclusion of our conference.

Before I turn the call over to Larry, I will make a brief cautionary statement. The comments made today 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 could cause actual results to differ from those presented are contained in the news release that we issued this morning and in the Company's quarterly report on form 10-Q for the quarter ended March 31, 2003. In addition, the financial and statistical information that we will review in this call is addressed in greater detail in today's press release, which is posted on our web site, www.deluxe.com, in the investor relations section, and was furnished to the SEC in the form 8-K filed today. In particular, any non-GAAP financial measures mentioned during this call are reconciled to their comparable GAAP financial measures in the press release. And with those items out of the way, I will now turn the call over to Larry Mosner.

Thanks to everyone on the line for joining us today. In my comments this morning, I will review some of the highlights of the second-quarter within all three of our business units. I will also comment on how we are managing through the continued softness in the economy and responding to increased pricing pressures in the client segments within Deluxe Financial Services. First, I will turn the call over to our CFO, Doug Treff, who will cover the second quarter's numbers. After our prepared comments, Doug and I will be happy to take your questions.

Thank you Larry. I will begin by covering the numbers for the second-quarter. We reported earnings, or EPS, of 80 cents on net income of $45 million, compared to EPS of 85 cents and net income of $55 million in 2002. Revenues decreased 5.8 percent from last year to $310 million. The decrease was driven by a 5.5 percent decline in unit volumes, which was the result of declining check usage combined with lower response rates and lengthening reorder cycles in the direct to consumer business. The decline in unit volume was partially offset by a 1.3 percent increase in revenue per unit, which was the result of improved product mix, additional value-added services and higher revenues from DeluxeSelect, partially offset by continuing pricing pressures in Financial Services.

Gross margin was 65.5 percent of revenue, compared to 66.3 percent last year. The primary contributors to the decline were a $5 million contract buyout in 2002 and this year's lower unit volumes. SG&A expense was 40.4 percent of revenue, compared to 39.4 percent in 2002. The percentage increase was primarily the result of the contract buyout I just mentioned. Expense declined $4.5 million in the quarter, due primarily to reduced spending in response to pricing pressures in a soft economic environment. As a result, operating income of $78 million, nearly 12% lower than last year. Operating margin for the quarter was 25.1 percent of revenue compared to 26.9 percent a year ago.

Interest expense increased nearly $4 million in the quarter. Both interest rates and debt levels contributed to the increase in interest expense. Our weighted average interest rate is approximately 200 basis points higher, related to the issuance of fixed rate long-term debt last December. In addition, our average debt level was $286 million higher in the second-quarter this year, as we continued to improve the capital structure of Deluxe by adding debt to the balance sheet.

Let's look at the second quarter's result in each of our three businesses, starting with Financial Services. Revenue decreased 11.7 percent to $174 million. Operating income decreased 31.9 percent to $36 million. The primary factor affecting both revenue and operating income was heightened price competition that results in greater product discounts as we renew contracts with financial institutions and seek to win additional business. Larry will touch on a few of the steps we are taking in response to these pressures in just a few minutes.

In Direct Checks, revenue was down 5.1 percent to $76 million. We are experiencing continued softness in response rates to our advertising and longer reorder cycles. In spite of the revenue decline, operating income for Direct Checks increased 10.9 percent to $23 million, due to an increase in average order size and productivity improvements.

In our Business Services segment, revenue increased 16 percent to $60 million, driven by higher revenue per unit and new business from our exclusive Microsoft Business alliance. Operating income in Business Services grew even faster than revenues, increasing 26.4 percent to $19 million. Revenue increases due to improved product mix and services contributed to the strong increase in operating income.

Let's move on to consolidated results for the first half of the year. Net income decreased 13.2 percent to $95 million, as a result of lower profitability associated with the revenue decline and higher interest expense. Revenue decreased 4.7 percent to $627 million, due to a unit decline of 6.6 percent, partially offset by an increase in revenue per unit of 2 percent. Gross margin decreased to 65.4 percent of revenue compared to 66 percent in 2002. The decrease was primarily due to lower unit volume.

SG&A was 39.5 percent of revenue compared to 39.1 percent in 2002. SG&A expense was lower by $9 million, due to reduced advertising expense and lower discretionary spending in response to the current business environment. As a result, operating income decreased $15 million to 163 million. Our interest expense increased $7 million compared to 2002. The reasons, as I mentioned in my comments about the quarter, were due to both higher interest rates and debt levels.

Here's how the three business segments performed in the first half of the year. In Financial Services, revenue was down 9.8 percent to $351 million, while operating income declined 27.6 percent to $73 million. In Direct Checks, revenue for the first half of the year was $157 million, down 2.6 percent. At the same time, operating income increased 26.7 percent to $55 million. In our third business segment, Business Services, revenue increased 10.9 percent to $119 million, and operating income increased 4.2 percent to $35 million.

Now for a few other items from our balance sheet and cash flow statement. Total debt net of cash increased $101 million from the end of the first quarter, the result of continued share repurchase, partially offset by cash flows from operating performance. We purchased 3.1 million shares during the second-quarter at an average price of $43.64 per share. That brings our total share repurchases through June 30 to 8.2 million shares. As of yesterday, there were still 2 million shares available under our 12 million share authorization announced last August.

Shareholders' equity is in a negative position as a result of our share repurchase activity. Cash provided by operating activities is down compared to last year, due to the following four factors -- contract acquisition payments to financial institutions are higher than last year; deferred advertising is up, primarily due to higher advertising spend and the timing of that spend; lower operating income; and the first interest payment on our $300 million notes issued in December 2002.

Moving on to capital expenditures, year-to-date CapEx was $10 million, and we anticipate spending less than $35 million on capital this year, down slightly from what we had previously indicated, in response to the current economic conditions and business environment. Capital spending will increase in the last half of this year, as we invest in projects with clearly identifiable benefits. These benefits will include revenue-generating capabilities, productivity improvements or cost takeout.

I will wrap up my portion of the call by commenting on earnings guidance. As the news release stated this morning, and consistent with the outlooks we provided at the start of the year and again after reporting first quarter results, we expect the second half of 2003 to be favorable on a year-over-year basis, and also to the first half of 2003. We expect our third quarter earnings per share to be in the range of 93-97 cents. Full year results should be approximately $3.50 per share. Both quarter and full year EPS exclude the impact of additional share repurchases subsequent to June 30. This is a slightly more conservative outlook than we gave following our first quarter results. It reflects our best assessment regarding the impact of the economy, pricing pressures and the likely loss of unit volume from a large client in the last half of the year. Now I will turn the call back to you, Larry.

As I mentioned a few minutes ago, in addition to covering business highlights, I will also talk about the continued softness in the economy, the competitive pricing environment and how we are dealing with it as a company.

I will begin with Deluxe Financial Services. Competitive pricing pressures in this segment have been increasing and broadening across all client segments. Competition always has been particularly intense in the major client category, and that has not changed. Changes are occurring, however, within the smaller client category, which consists of thousands of community banks and credit unions where we are seeing increased price discounts. As a result, we are likely to experience pressures on operating margins in this business for the foreseeable future. However, we are taking steps to mitigate the pressure that is putting on margins in DLX. For example, we are in the process of closing our Indianapolis facility. The check volume currently being produced in Indianapolis will be consolidated into our facility in Streetsboro (ph), Ohio.

In addition, our company-wide staffing is down by more than 200 since the end of the first quarter. We are also reducing and cutting some project spending in response to current business conditions. As mentioned in this morning's press release, it is likely that we will lose unit volume from a large client as a result of that client's decision to go to a single source supplier relationship with their primary check supplier. As a result, the client has indicated their intention to leave us before the contract expires. We have factored in the loss of the units and the revenue for the remainder of the year, but we have not included any assumptions regarding compensation for early termination of the contract, as this issue is yet to be resolved.

While DLX is contending with a number of challenges in its segment, there are a number of key initiatives designed to offset those issues. Our largest business segment rolled out its DeluxeSelect program on a nationwide basis during the second-quarter. You may remember from my comments in previous calls that we introduced DeluxeSelect to some of our largest financial institution clients at 2 separate expos, the first of which was held in April of 2002. We celebrated the program's first anniversary with 80 percent of our targeted financial institution clients having chosen DeluxeSelect, and thereby dramatically changing the way they manage their check programs. More than 1500 DLX clients are currently enrolled in the program. For those of you who are unfamiliar with this program, DeluxeSelect puts check writers directly in touch with Deluxe's customer service check experts on behalf of our financial institution clients. DeluxeSelect was built on Deluxe's exhaustive research into consumer check buying preferences. Our research showed that more than 75 percent of people prefer specialty check designs, but the vast majority will settle for basic checks simply because they are unaware of the variety of products available through their financial institution.

Through DeluxeSelect, customers are routed directly to Deluxe's advanced ordering channels, such as the Internet, an automated voice response unit and our industry-leading call centers. Once connected to our service and sales associates, end consumers are informed about all of their choices for check designs and related products. By relying on Deluxe's marketing expertise, a financial institution can focus more of its attention on meeting the other banking needs of its customers and eliminate many of its administrative burdens. The fact that so many of our clients have made this change in check program management validates the power of DeluxeSelect and the long-term viability of the paper check.

The ramp up for DeluxeSelect is relatively long, considering that once a financial institution is on the program, it could take 12-18 months or longer until the majority of the bank's customers are being served through DeluxeSelect. This is due to the length of the consumer's reorder cycle. While DeluxeSelect installation takes time, the initial numbers and uptick in revenues per unit are holding true to our pilots. In fact, we experienced record call volume last week related to the program. Currently, only about 5 percent of our DLX order volume has been impacted by DeluxeSelect. As a result, we have just begun to tap the benefits we expect to realize from the program. Several financial institutions have shared with us that the benefits DeluxeSelect has to offer are key in their decision-making process when considering a check supplier.

Now, I will move on to our Direct Checks business segment. Knowing that convenience is a primary driver for the Direct Check customer, Checks Unlimited and Designer Checks are continuing to focus on making the order experience fast and easy. One way in which we are making this happen is by encouraging first-time customers to place their orders via the phone. Historically, the percentage of first-time phone orders was 4 percent. More recently, we have been able to increase this to more than 15 percent. Continued process improvements, special phone offers and improved selling techniques have increased our ability to take these incremental orders while simultaneously maximizing revenue per order. Beginning in August, print advertisements for both Designer Checks and Checks Unlimited will actively solicit the customer to phone in their initial order.

One final item in our direct to consumer business segment. Response rates continue to be a challenge for the direct response and direct-mail industries, and our Direct Check segment is no exception. However, we continue to focus on the lifetime value as we allocate dollars to new customer acquisition efforts.

And now for highlights from our Business Services segment. A week from today, Deluxe's Streetsboro, Ohio facility will receive the 2003 Governor's Excellence Award for their successful efforts at reducing work-related injuries and the costs associated with them. The Streetsboro environmental, safety, security and health - or ESS&H -- committee achieved outstanding results with a number of programs and initiatives. For instance, they developed a return to work program that gets employees back to work more quickly after a work-related injury. They identified potential contributors to injuries and eliminated them, and they are being more proactive in communicating safety messages to all employees. Not only has Streetsboro reduced injury-related costs, but their efforts also align to our business alignment model, particularly in the areas of people, cost management and transformation. The Streetsboro facility will celebrate their award by hosting the media and a number of other guests and dignitaries, including representatives from the Governor's office. Congratulations to all of our Streetsboro employees.

In other DBS news, the percentage of orders coming in via the Internet compared to the prior year is up more than 25 percent. We attribute the improvement to a couple of key factors -- first, a recently redesigned web site that incorporates industry best practices. DBS strives to maximize the customer experience by customer-focused design and usability, all resulting in better sales, increased brand loyalty and satisfied customers; and second, continually working to improve our presence on the Internet. For instance, if someone goes online and enters business checks on their favorite search engine, we want the DBS web sites to be in the top 5 or 10 results. We are seeing improved results in this area. We are also improving our online presence with weekly e-mail campaigns as well as paid advertisements on (indiscernible) Overture and Booksmart.

In one last piece of DBS related news, the Minnesota-based portion of DBS's customer care organization teamed up with Etalk (ph) Corporation to host a best practices seminar for several large Twin Cities-based companies. Etalk is the global leader of performance impact solutions for contact centers. In plainer language, Etalk provides our call centers with the technology that allows them to monitor calls, thereby ensuring a consistently high level of service for our customers and clients. The conference addressed the topic of implementing a quality program within your contact centers. I had the opportunity to open the conference and talk about the number one goal within our customer care organization, and that being unparalleled customer experience.

As a corporation, we serve millions of customers on behalf of our financial institution clients. We also connect with the millions of small-business customers who purchase checks and forms through Deluxe Business Services. Through the combination of people and technology, we are able to enhance how we serve our clients and customers; in fact, it was this very customer care organization that was rated among the top 3 percent of all call centers nationwide for performance and technology in an independent study by the Grady Group last year. It was an honor to share some of our world-class practices with other companies during this conference.

When I opened the call today, I mentioned that I wanted to comment on how we are managing through the continued softness in the economy. I will do so by drawing from an article I ran across the other day. It was published by Hay (ph) Insight, a division of the Hay Group, a professional services firm that helps organizations get the most from their people. The article was about managing through economic uncertainty, and more specifically, about both the differences and the similarities between how the most admired companies handle the uncertainty and how their peers do it. I won't outline the entire article that's available online, but I will share these four conclusions with you.

The most admired companies first encouraged teamwork and collaboration, especially within the executive team. Second, they refused to compromise long-term objectives for short-term demands. Third, they focus outwardly on customers and markets. And finally, they achieved success through people -- that is, they develop and retain talent and foster high levels of employee engagement.

While Deluxe was not asked to participate in the research that went into this article, I can state with confidence that based on the four characteristics I just mentioned, I believe Deluxe would fall into the most admired group, and here is why. The Hay Group concluded that companies in this category encourage teamwork and collaboration, especially within the executive team. I have talked on previous calls about Deluxe's leadership team and what a joy it is to work with these individuals. Each member of the team practices the shared values you have heard me talk about before -- openness, trust and integrity, innovation, partnering for the common goal, recognition and celebration, respect and dignity for all, and quality.

While I am on that subject, I would like to publicly welcome Lou-Ann Wagner (ph) to the executive leadership team and to her new role as Senior Vice President of Human Resources. Lou-Ann celebrated 25 years with the Company just last year and has held many positions during her tenure. Most recently, she was Vice President of Manufacturing Operations for our Financial Services business segment; in fact, Lou-Ann was a critical leader in adopting the cellular manufacturing structure I have talked about so often.

Going back to the Hay Group article -- another way teamwork and collaboration manifest themselves at Deluxe is through the cellular manufacturing to which I just referred. In the cellular approach to production, a group of individuals work together to get the work out, rather than each one working on separate and specific tasks. This teamwork is paying off with increased productivity, improved quality and a higher level of job satisfaction for employees.

In the Hay Group's second conclusion, they stated that companies that made their list refused to compromise long-term objectives for short-term demands. You have heard me talk, probably more than you care to remember, about Deluxe's business alignment model. Developed several years ago, the alignment model gives the entire company a singular and ongoing focus. It provides our values, our vision and our business objectives. It really helps us stay focused on what is important to our business and to our shareholders. Having our business objectives spelled out for everyone to see helps us avoid the flavor of the day approach.

The third conclusion from the article was that the most admired companies focus outwardly on customers and markets. At Deluxe, we engage in the most extensive research in the area of consumer check payment preferences. We also strive to be the model business partner to our clients.

The fourth and last way the Hay Group separates the best companies from the average is they achieve success through people. I found it particularly interesting that the Hay Group puts a great deal of significance on employee engagement, because that very subject has been one of our top priorities in the past few years, and it was the theme of our 2001 annual report.

About three years ago, we began polling our employees to find out what to level they were engaged. The first survey's results were good, particularly when benchmarked against industry norms. (indiscernible) to acknowledge that our employee engagement has improved in the two subsequent surveys. The improvement is even more meaningful when you consider that the struggling economy has caused many companies' scores to drop.

As a reference point, the survey defines engagement as the extent to which employees say positive things about the organization, are likely to stay with the organization and exert extra effort to serve the organization. By acting on those areas that employees tell us need attention, we are able to continually find ways to make Deluxe a better place to work.

The bottom line here is that we have a smaller, more highly focused and engaged team of employees who have demonstrated their ability to deliver results in great times as well as in average times.

I will wrap up my prepared commons this morning with a brief business outlook. The first half of the year presented some challenges to our business, and those challenges have not abated. However, as stated in the press release this morning, and as shared with you as far back as late last year, comparisons in the last half of 2003 should be more favorable for us. We also are encouraged by the slightly positive prognostications coming from economic experts.

From a trading perspective, our unit decline is slowing from the 7.6 percent decline you saw in the first quarter, and we think that units will be up modestly on a year-over-year basis in the last half of the year. As always, we continue to demonstrate our passion for creating shareholder value by the actions that we take in each of our three businesses. Thank you for taking the time to join us for the call this morning. Now, Doug and I will be happy to take your questions.

(CALLER INSTRUCTIONS)

Do we not have anyone in queue?

One moment. Cliff Josephie (ph) with HD Brous (ph).

Just a couple of items on the balance sheet. Can you give me what the contract acquisition costs were, and also the deferred advertising costs?

We're looking those up right now, so we'll have them for you here.

The other item is on the guidance for Q3 and also for the balance of the year -- what type of revenues are you looking at?

For the balance of the year?

Yes. To get to those EPS numbers.

As we had commented, we will see the last half of the year favorable compared to the year before, on both the revenue line as well as the operating income line. And as I commented, we will see units up slightly.

So you should do (indiscernible) off of 320 million this quarter in revenue? You have done 307, 317 and 310 the last 3 quarters. Is that because some new contract is coming on?

I think that what happens is you have got the timing of new contracts and the loss of existing contracts. You have also -- even retaining the customer you will have repricing on a new contract with even a current customer, so that many times when we do that -- as (indiscernible) were in this business -- the contracts were running anywhere from 3 to 5, and some are even 6 to 7 years in length. So what you have is that decision being made for the contract, and then sometimes it might be 3, 4, 6 months after you have that bidding before the contract actually -- the units begin to change and convert from the former supplier to the new supplier.

So if you just think of that -- (indiscernible) every year you have got a percentage of your business that is rolling in or rolling off, based upon the retention gain or gaining the new customer or losing a customer. And sometimes those happen through no fault of -- no decision on our part. For example, if one of our existing customers buys another bank and it is a non-Deluxe customer, many times that will roll into our existing contract. Or the converse -- somebody who is a competitor of ours has a -- servicing a bank, and if they buy a bank that is a Deluxe customer, we could lose that account simply because that bank was acquired by a bank that was serviced by another competitor -- a competitor of ours. So we monitor those as best we can as we take a look at our ability to retain (indiscernible) the customers, and then put those into our outlook.

You got those contract acquisition costs and deferred advertising costs for me yet?

Yes. The balance at 6/30 for our contract acquisition costs was $85 million. That is up $14 million compared to March 31. The deferred advertising balance was $28 million, and that's up $2 million compared to the first quarter.

How much did the change in the amortization policy benefit you in the quarter? (indiscernible) you gave that out for what it benefited you last quarter?

I don't have that with me, that will be provided in the Q, but it was a third factor behind productivity improvements, and in terms of the impact on the operating income for Direct Checks.

But it was a benefit?

It was a benefit, correct.

One other question on those. It's misleading to me in the 10-Q, so I just want to understand it better. You say you went from an amortization period -- you shortened the amortization period from an average of 18 months to a maximum of 18 months, so I would think that the amortization would go up and the SG&A would go up, but you said that the SG&A came down. There was something in there -- I don't recall exactly what it was -- something about a revised pattern of amortization?

There's other factors. If the amount of the spend was identical and the timing of the spend was identical, that would be accurate; however, we have other factors. The timing of the spend was different in the second quarter and in the first half of this year as compared to last year.

The timing of the spend, meaning at what point in the quarter?

At what point in the quarter, and also related to the fourth-quarter spending coming into the year -- those amounts were different in the fourth-quarter of 2002 compared to the fourth-quarter of 2001. And those ending balances which lead into the year affect the expense amortization in the current year period.

Patrick Donahue with Northland Securities.

With the competitive environment, are you increasing your customer acquisition assumptions, such as volume discounts?

Yes. In other words -- let me put it this way. The contract acquisition costs are really a prepaid discount. So in other words, contract acquisition cost is really the same as a product discount, it is just a different way of accounting for that. And we account those based over the life of the contract, and those get as a reduction of revenue when we realize the volume from the client. So what we do in our forecast is forecast the product discount rate for all of our businesses, and we put that into our models. And yes, we have seen that (indiscernible) do forecast it to go up. Offsetting that would be the things we can do to mitigate that, both on the cost side, as well as things that we can do to sell additional product or services around the check portion of that. That is where DeluxeSelect comes in, in our ability to sell them designed or licensed product at a higher price point than the blue plain check, or to sell them a checkbook cover or a stamp -- return address stamp or other things that we can do to provide a greater level of customer satisfaction by better meeting their needs during that transaction.

Could you give us a feel at all? You made the statement that you are forecasting that the volume discount will continue to go up. Can you give us a feel for how much that would go up, or when would you expect that to plateau? Could you give us a feel for the average volume discount at current?

It's very difficult. We would not provide that, simply because it is -- varies by different types of banks, varies by timing, and it also is something that we would not release -- (indiscernible) reflected in our numbers that we released, but we would not do it just from a competitive standpoint.

Have you seen pressure on the length of contracts at all? For example, the banks obviously want shorter contract. Are you giving out shorter contracts at this time, or are you keeping that pretty consistent?

Actually we see a lengthening -- pretty much stable, but probably tending to be a little bit longer, and the banks are interested in many times securing a 3, 5 and we have seen 6 or 7 year contract. But those would not be the norm. We would still be in the 3-5, but with a tendency - maybe a little bit of lengthening in it, because it is an issue that they would like to resolve and not have to go through a whole RFD (ph) process on a frequent basis. If they can get the contract that meets their needs, then I think that they are very satisfied with the long-term or multi-year agreement.

Just a couple of questions to follow up on Cliff's questions. Can you give us guidance on what you will spend in 2003 for contract acquisitions? You're 85 million year-to-date, correct? Do you have a feeling for where you'll be at the end of the year?

It's really difficult to forecast that number, and the reason for that is if we go into an acquisition situation where we don't have a current contract, that the probability of winning it, the uncertainty there is greater than if we have an existing contract. So there's a lot of swing between whether we win or whether we lose and the size of the contracts that come up. In addition, there is sometimes a variation in timing as to when contracts are renewed or when those RFT processes occur. As a result, we don't provide that guidance, and it is a number that can vary somewhat significantly, depending upon which bids come up.

What is the amortization of the capitalized acquisition cost during the quarter and year-to-date?

Just hold a second and we'll get that for you. Year-to-date, the amortization is $11.8 million.

I don't know if I missed this before, but as of today, how many shares are outstanding? Have you done any buybacks since June 30?

We have done additional buybacks since June 30, and we have repurchased 8.8 million shares year-to-date.

Nick Fiskin (ph) with Stephens Inc.

If you look at your comments when you released first quarter, I'm wondering what has changed in the last three months, given that you said unit volume rev and op income was supposed to be flat?

Are you talking about for the outlook for this year?

Yes -- I'm talking about you guided flat op income, unit volume and revenue for this year, and that has changed today. And I am wondering what's changed in the last three months?

One is, as we have commented here, we have been notified by a bank; that was not in our forecast before. And as you know, that can make a big difference based upon the size of that bank. So that would be a primary driver here, as well as I think just as we have gone through the 3 quarters, the economy has stayed soft, which has not changed. But the other is, as we have worked through contracts in that period of time and negotiations (indiscernible) retaining or trying to get them, is we have seen that the private discounts level has gone up a little bit higher than what we had originally had in our thinking.

The reason that you lost the bank -- can you give us a little background? You gave us some background -- can you give us a little more background on that?

The bank decided to go single supplier, and they made that decision and did not put it out to RFP (ph). They made the decision because the other person who has that has the majority, the vast majority, of that and wanted (indiscernible) have to go through -- my assumption on my part, they just didn't want to go through a conversion process where the majority of their customers would be converted to a new supplier.

What's the size of that revenue loss?

We don't comment on any particular size of particular customers, but it is enough for us to change our forecast.

Doug, on the three cost-saving initiatives -- closing down Indiana, cutting staffing by 200 people and then cutting, it sounded like, some R&D -- what is the annual savings from those three initiatives?

I don't have the answer to that at my fingertips here. That is something we could pull together for you. But in terms of the longer-term impact, those activities we have undertaken are ongoing in nature. While we don't close plants real frequently, the other cost take out measures or productivity enhancements that we do are ongoing. We have reflected those 3 efforts in our guidance for the rest of the year, and they would certainly be reflected in any guidance that we reported or provided for 2004.

Does the guidance include any cost to close Indiana?

Yes it does.

It was included in the second quarter.

Just a further comment to make sure we are clear. We had included -- took out all the revenue from the one client that was notified as to (indiscernible) we acquire the termination contract, and we also took all the profit out of -- that went with that revenue. What we have not included is any final settlement of that for them leaving early. So that could be upside this year or next year, depending upon when we settle that.

When does the contract expire?

It would expire next year.

Going back to the guidance that the previous two callers have asked about -- if I look at the 93, 97 that you're guiding to for this quarter, how much of that is -- of that -- what kind of EPS impact benefit are you getting from the repurchase program? What I am getting at is -- are you guiding to a net income increase in Q3 over Q3 last year?

We are not guiding to a net income increase over last year. One of the major differences that we have relates to the increased interest expense from the long-term debt and the higher debt levels.

So if I back out that, are you guiding to an increase if you back out the increased interest expenses?

We will see higher operating income. To your question, the income from operations will be higher in the last half of the year.

Along those lines, you're saying that unit volume is going to be up year-over-year --

It will be about flat to maybe slightly up. It will be right around flat, and that is a major change from our fourth, first and second quarter.

Because if I look at the last five quarters, it has been a negative number. I am wondering how you guys are going to increase that if you are including the loss of this big client?

There are other wins in there. As we have said, you've got a continual pattern of wins and losses, and again, we do put out notification of wins, but only when the bank is a partner with us and wants to share that. So our guidance to you is a net of all that.

Lee Schaefer with Blue Fire Research.

the question I have for you, Larry, is back on DeluxeSelect. My sense is that you have been very effective in talking to your own clients about the benefits of DeluxeSelect and enrolling them, but it would appear to me that it has not been a particularly effective way to get clients from your competitors. I wonder if you would speak to that issue for a second?

In my prepared comments and in prior, I think that it has been very effective for us in helping us burst open the door. And second, there are several customers that we have gained where DeluxeSelect was truly the deciding factor. And --

(indiscernible) are these brand new relationships? In other words, are these ones that you had already had a relationship?

No no. These are customers that we had been doing zero business with; now we are doing business with them. So again, consistent with our strategy and approach and the way we have talked about this on prior calls and would be consistent is, our approach to retaining and gaining customers is to demonstrate to the financial institution of our ability to add value to them through better servicing their customers with product and service. And really it is through the value proposition versus just price. So I think that that's our strategy, and like with everything else, the value is in the eye of the bank. And they are making that determination of whether to retain or to switch the business to a new provider. But it has been very effective for us in having discussions, where before we might not have had them as in earnest, and in the fact that it's helpdesking new customers where we have had no business before.

Have you found that by talking about DeluxeSelect and talking about outsourcing merchandising that you are having discussions at a different level of the client organizations; i.e. you are out of the purchasing and at the VP level or executive level?

We find that that varies by bank, but yes, to answer your question very directly, we are finding that there are several banks who see the value in that. And it does open the door to a new and higher level of discussion, where not only are they looking at the check program, but they are also saying what else could you, Deluxe, do for us on our behalf in servicing our customers. And those conversations are just beginning to take place, and that was part of our strategy is -- if we can gain the confidence and trust of the bank in properly handling their customer relationships as they talk to us about the check part of that, are there other things that they might look to us to do? So we're beginning to have some of those discussions.

Charles Ross with Insight Investments.

The termination fee which you will likely get from the large client who is leaving -- can you give us a bigger than a breadbox feel for what that upside is?

No, not at all. It's one of those issues -- we just can't comment about any of those.

You mentioned pricing becoming more difficult with smaller financial institutions -- can you talk about why? What's causing that?

Like with most things, it is a competitive environment, and the banks are looking for ways where they can increase their bottom lines, and are looking to their partners or service providers to help them in that -- in their quest to add value and bottom-line performance for them.

But that's always been true.

But at the same time, what you have got is an overall personal check volume that is decreasing checks written at about three or four percent a year. So when you have got that kind of an environment, the intensity of that kind of a competitive pressure, I think it picks up.

Doug, with the guidance you have given, I am kind of backing into an EBITDA estimate of down about 1-1.5 percent from 2002. Can you tell me whether I am in the range there?

I think you are in a range. You are close to the range.

Harry (indiscernible) with Tutor.

Doug, I apologize -- in terms of forward guidance, should we be using the average share count from the quarter because it represents the halfway point of the year of the roughly 58? Or do you think we should be using the 53.7, which was the shares outstanding at the end of the quarter?

If you are doing a quarterly model it would be best to use the 53.7, in terms of shares outstanding going into the future quarter. As you look at the full year, what is important, though, is to understand the impact of average shares by quarter on calculating the full year total.

I'm sorry -- all I was asking -- I apologize -- to get to your guidance for the year, I'm assuming because we are halfway through and it will be a decelerating rate of buyback, albeit a strong buyback nonetheless, we should be using somewhere around 57-58 -- is your embedded assumption?

I don't have the exact number that we -- it's lower than that. It's less than that.

I just want to go back on that. The share repurchases that we have on our outlook are only through June 30.

I understand that. I'm very cognizant of it. I appreciate it. Next question -- you all have done a really good job in terms of leveraging up the balance sheet, borrowed money very cheaply, etc. If I have done this correctly, as the crow flies you are around 500 million? I think your target was to work your way towards 700 million? Could a reasonable person conclude that, therefore, when you are finished with this first buyback, there's probably another -- there's room for roughly 200 million of incremental leverage as you see fit?

We will move forward to conclude the 2 million share repurchase that's still outstanding, and we will continue to -- we are planning to continue to operate under the financial strategy that we articulated last August. That being said, we still have conversations every time we approach the end of a program with our Board as to what the right thing to do is. Is it share repurchase? Is it investment? Is it acquisition? How should we best maximize value for shareholders. And all other things being equal, I think it's fair to understand that we will continue to execute according to our financial strategy, but that only (indiscernible) things understood. So it's something we evaluate as we approach the end of each program.

I apologize for my own ignorance. You are doing a great job on cost cuts, cost saves as well. If we were to look out over the next two years, with the suggestion -- I'm not saying you have it, but for the purpose of discussion -- that business trends stay completely flat with where they are today, just ballpark -- how much absolute dollar cost savings do you think you could generate from the existing infrastructure over that two year period?

It's greater than zero.

Is it less than 100?

We will not give you -- we still feel -- I'm not trying to be cute or anything, but we would not want to provide insight, just from a competitive perspective, as to what those might look like. Cost management is -- if you have looked at our business alignment model -- is certainly one of our objectives, and we work on that every single day day, both how we can be more productive and efficient in our organization. Let me put it this way -- we still feel that, as Doug commented in our CapEx, that we have within our site additional ways that we can improve productivity and reduce our costs within the cost of goods, as well as within our SG&A area. We are dedicated to -- truly are dedicated to get every single dollar of that that we possibly can without adversely impacting our ability to serve our customers and clients according to our contractual agreements with them.

Pro forma for the closing of the plant that you announced -- could you offer any guidance at all as to what the current capacity utilization of your pro forma existing manufacturing base will be?

We are probably in about the 60 percent capacity utilization range. We have shared that in prior, and so that move was more a move of -- it affects our ability to -- on cost, but it was driven more from the transition of our business check from an FI through model -- going through the financial institution -- into our business -- Deluxe Business Services model, our business referral. And we can handle that, based upon that marketing change, more cost effectively in our Streetsboro facility that services our business segment than we can in our Deluxe Financial Services segment. So it does both, but it was really started driven by the change in how the business is being generated versus just a pure cost takeout.

Andrew Jones with Northstar Partners.

One question that I had was to speak to the second-quarter cash flow. It looks like the cash flow from operating activities by looking at the abbreviated statement was greater than net income in the quarter, yet the balance sheet items look to be fairly stable with some of your asset items up that would have consumed cash flow. I'm curious what is driving that, or maybe I am missing something?

I will respond to that. Cash flow was positive in the second-quarter, you're correct, if we look at just the quarter. That was -- I will have to get -- I am not going to give you an answer right now, specifically, because the way we have broken it out here is the year-to-date cash flow, and I would not want to speak to individual pieces until I have had a chance to dig into the details more fully.

John Craft (ph) with DA Davidson.

A couple of follow-ups to some of the previous callers. The loss -- going back to the loss of volume from this large client. How many bank customers do you have that are this dual source sort of structure?

I don't know if I have got a good number for you, but --

Roughly.

It's probably a small. Most of them are single source (indiscernible). It's the major ones that have had dual sourced, and the trend has been for the major banks to go towards a single source supplier relationship as they are looking at ways where they can be more effective in managing their costs -- internal costs. So (indiscernible) there has been a trend more to the single, but it isn't something that is a major portion of our contracts.

It seems like in the past you have had pretty good luck actually winning some of those dual source contracts.

We have.

Are there, what, a couple dozen of those? What would be just a rough --

I'm not even going to speculate, because I would just be doing that. For example, we have got almost 10,000 relationships, and I just don't have at my fingertips the answer to that. It is not a reluctance to try to respond, it is just I don't want to give you incorrect information.

Let me ask a more general industry question. You just mentioned that you were expecting industry-wide that the check volume should decrease by three percent, I think, is what you said. Is that changing, or has that been pretty consistent for you? Some of the other providers have given maybe a little higher estimates of industry-wide declines, (inaudible)

When you say the other providers, you're talking about the other check printers?

Yes. I've heard some other folks talking about three, maybe five percent or so industry-wide check volume declines.

First of all, the number I am sharing with you is a number on checks written. And there are several different sources where one might be able to get that, but this is a number that has been -- it's agreed to and understood within the Check Payment Systems Association, which is an association that includes all of the competitors. As we take a look at the market, we are all in agreement that we see the check writing at about 3-4 percent. That has been corroborated by other external markets and studies that look at all payment options, electronic as well as paper and cash.

I guess maybe more specifically, have you noticed that changing at all?

Yes. That has certainly gone up. A few years ago it was still increasing, up until probably 1999 and even 2000 maybe. And since then it has been declining in that 1-2, 2-3. And right now we are seeing it at about a 3-4 percent.

Given that, then, would you sort of expect over the next few years that that decline might pick up?

It could. That's one of the things. We don't see a big drop off as we look into the future; we see it still in the low single digits, as far as a per annual change. It's pretty -- change in the payment industry is -- what has happened is that there has truly been an explosion in the number of total types of payments, driven by the number of new electronic type of transactions -- credit cards, debit cards, smart cards, online payment, etc. So when one looks at a graph of the total payments that are happening, you see a rapid rise, with checks having grown slightly and then begin to moderate a little bit. So checks still represent 60 percent of all non-cash payments, so it is still the largest single type of payments outside the cash transaction.

Jack (indiscernible) with (indiscernible) Investments.

Just to follow-up on a couple of earlier questions on operating income and EBITDA -- looking at your (technical difficulty) income line for the first six months, it's down about 8.4 percent. Your comment on EBITDA earlier, saying that you would make up all but -- nearly make up all of the difference on EBITDA in the second half. Would that apply also to operating income? Do you expect operating income to be essentially flat to slightly down for the year? In other words, are you going to make up most of the difference?

Yes. We would see -- operating income would be flat to slightly down.

A broader question with the understanding that you would not want to make a long-term revenue projection. I would like to ask you if you would comment what you see as the organic growth in the check printing business going forward, looking out five, ten years as you see your business? And I would ask you to assume here that the economy returns to some sort of moderate growth. I don't think we are going to see really strong growth here, but we get maybe a little beyond where we are into the 3, 4 percent GDP growth sort of thing. Under a normalized economic situation, what do you think -- looking out 5 to 10 years, what kind of organic growth is there in the check printing business?

I think we'll see -- in the pure check part of it we will see decline. We take what I just commented about personal checks being written declining, that I don't think we will see growth in the pure check part of it. That doesn't mean that there aren't additional revenue opportunities through related products and services around the check transaction that (indiscernible). And that's part of our DeluxeSelect strategy, is to use that and build a very strong relationship with the bank and its customers to provide that opportunity. So we don't see organic growth coming in the check business.

But presumably there is organic growth in the industry of which you are a part, because the industry is providing other services.

If you were talking about the total number of payments, I think you would see that, but we do not participate in that. Debit cards will continue to grow, and debit cards is the fastest increasing part of that. And most of that is coming out of the credit card side of the business, in terms of number of transactions. But we see a slow decline in the number of checks written. I'm not sure if that --

That's fine. Your strategy, then, of course, is to grow the business faster than the organic growth -- faster than the decline or to offset the decline in the business.

(multiple speakers) and I'm sure if you have had the chance to listen to (indiscernible) prior calls or whatever, that --

I'm new, so go ahead.

-- what we have is, from our perspective, is to maximize the check opportunities in terms of value, profitability in that segment. As well as then look at space that is adjacent to the check in product or services that we can provide to the financial institutions or the end consumer, and to grow it by looking at that adjacent space, either in new products, new channels, forward integration, backward integration. And some of that (indiscernible) eventually, meaning a company acquisition that would help us fulfill that. So we feel very confident of our -- we have got a very strong core in that we have the opportunity to leverage our core competencies in our core space into other space product or service that's adjacent to it.

Gene Fox with Cardinal Capital Management.

Most of my questions were answered, and I don't know how much color you can give. It seems that per your forecast, you are going out of this year with a fair amount of business momentum relative to competitive wins. I was wondering if you could give us a little color as to how -- what the relationship that is with your new DeluxeSelect program, and how much momentum that gives you in the marketplace relative to market share and relative to competitive position as we start looking out into next year?

First of all, I won't provide any insight into next year at all. When we provide that guidance, it will probably be in the January timeframe as we come to our year end and work through our next year's operating plan, internally as well as with our Board of Directors. So I won't provide any insight there. I will say to you, though, that DeluxeSelect -- as Lee Schaefer had asked the question -- we feel gives us an additional competitive advantage to open the door, and a chance to talk with customers that we don't have today, as well as retain. But everyone is a one off discussion and negotiation, and we have got to meet the needs of the bank, and it's got to be a good deal -- it works for them as works for us -- and there are several different things that can happen in that process that is very difficult to generalize as to how those discussions might translate into the future. But we feel that we are well positioned.

I just wasn't sure how much, given the wins that you have had in the second half, that you consider that to be a result of DeluxeSelect providing you with maybe an additional competitive advantage to take market share in the marketplace going forward.

I think the issue here is those contracts -- most of the time you don't have an opportunity until that contract comes due. And we track those, as do our competitors, as to when the contract come due -- the ones we have as well as the ones we don't have -- and try to make sure as we approach those discussions that we are well positioned to have meaningful discussions and provide our best offer when we respond to those requests for our proposals.

How about if I recharacterize it? Do you believe you are at least maintaining if not gaining market share in the marketplace today?

I think that is a fair statement.

Thanks.

This is a reminder that a replay of this call will be available until July 24 by dialing 320-365-3844; when instructed, provide the access code 689-848. The recording will also be available on Deluxe's web site, www.deluxe.com. We would like to thank you for joining us today.

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.

(CONFERENCE CALL CONCLUDED)