Deluxe Corp (DLX) 2005 Q1 法說會逐字稿

Ladies and gentleman, thank you for standing by and welcome to the Deluxe Corporation first quarter 2005 earnings conference call. (Operator Instructions) I'd now like to turn the conference over to Stu Alexander. Please go ahead, sir.

Thank you, LeAnn. Good morning, everyone, and welcome to Deluxe Corporation's 2005 first 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 website. I'll tell you how to access the replay at the conclusion of our teleconference.

Before I turn the call over to Larry, I will make a brief cautionary statement. 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 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 annual report on Form 10K for the year ended December 31, 2004.

In addition, the financial and statistical information that we'll review during this call is addressed in greater detail in today's press release, which is posted on our website, www.deluxe.com, in the investor relations section and as was furnished to the SEC in the Form 8K filed this morning.

In particular, any non-GAAP financial measures mentioned during this call are reconciled for the comparable GAAP financial measures in the press release.

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

Thank you, Stu. As we communicated in this morning's press release, Deluxe had a good quarter, with earnings per share coming in at the high end of the range we provided in our guidance last quarter. In a few minutes, I'll discuss some of the business contributors, both from a consolidated and a business segment perspective.

But first, I'll turn the call over to Doug Treff, who will cover the financials. Doug.

Thank you, Larry. Earnings per share for the first quarter were $.78, meeting our previous guidance, and down from $.94 last year. Net income was $39m compared to $48m last year. The lower net income in EPS were due to the loss of a large financial institution client in late 2004, as well as continued pricing pressures in our financial services segment, higher interest expense and the gradual decline in personal check usage.

On the other hand, we saw positive benefits from our small business services segment. Specifically, the acquisition of NEBS is delivering results that are consistent with our expectations.

Consolidated revenue for the first quarter was $437m, up $128m, or 41.4% from last year. This includes $160m from NEBS.

Last quarter, we announced that we have combined NEBS and our former business services segment into small business services. The significance of the NEBS acquisition is that this growing business segment now represents more than 50% of our consolidated revenue.

We had a $32m revenue decline in our other businesses, which was driven by a 17% decline in unit volume. Partially offsetting the unit's decline was an 8.4% increase in revenue per unit.

For the quarter, gross margin was down slightly at 65.2% of revenue, compared to 65.4% of revenue last year. The fact that we were able to achieve a gross margin only slightly down from last year reflects an outstanding accomplishment. Let me provide you with some of the details.

NEBS has historically operated a lower gross margin business than Deluxe, between 7 and 8 points lower. We were able to narrow this difference. Checking net volumes declined 17% in the first quarter. While we were quickly able to reduce variable costs associated with the unit decline, more significant actions were required to (inaudible) after fixed costs. Our efforts included closing 6 plants during 2004. Our commitment to driving lean practices while maintaining high quality standards once again allowed us to deliver record productivity in our check printing facilities in the first quarter. Specifically, productivity increased 13% versus the first quarter last year, extending our trend of more than 5 years of double-digit productivity improvements. And finally, we continue to realize cost synergies from the NEBS integration in all segments of our business.

Selling, general and administrative expense, as a percentage of revenue, was 47.6% compared to 38.8% in the first quartet last year, due primarily to the acquisition of NEBS.

I would remind you that NEBS SG&A expense, as a percentage of revenue, is higher than Deluxe's because NEBS relies, to a greater degree, on direct marketing and a direct sales force to acquire and retain customers.

Excluding the effect of NEBS, we reduced SG&A expense compared to last year through our continued cross stake-out efforts. The ability of our customer care centers to drive higher revenues per unit helped productivity as well. As a result, our operating income decreased 6% to $77m. Our operating margin for the quarter 17.6% of revenue, compared to 26.5% a year ago, reflecting, in part, the higher SG&A expense in the NEBS business.

Now I will move on to the first quarter's results in our 3 business segments.

Small business services revenue increased $162m to $225m, $160m of which related to the NEBS acquisition. The remainder of the increase was due to 2 primary factors, higher volume from new business within the referral program we have with financial institutions and second, price increases.

Before continuing, I will add that small business services, excluding NEBS, posted higher revenue, even though the segment was also negatively affected by the client loss I mentioned.

Operating income for this segment increased $5m to $25m. Of this, NEBS contributed operating income of $4m after including $10m of acquisition related amortization expense and $3m of integration costs.

I will take a moment to say that our integration progress is going very well. We have been able to validate the synergy assumptions that we made when we pursued this acquisition and believe there is additional opportunity that will pay off longer term.

Our manufacturing and supply chain organizations continue to identify and capitalize on various efficiency opportunities. Here are a couple of examples. Procurements has leveraged volume purchasing activity to lower costs in all segments of our business, and we closed 6 plants in 2004. But more importantly, consolidation is allowing us to adopt a center of excellence approach within our manufacturing organization. So, instead of duplicating functions across multiple sites, we are combining standardized processes, integrating products and forming specialized teams to more efficiently serve both internal and external clients.

Overall these, and the other integration actions we've already taken, will produce annualized savings of more than $30m.

Moving on to our financial services business, revenues decreased 14%, or $24m, to $145m. The large financial institution client loss affected financial services results, as did continued pricing pressure and a decline in check usage. Larry will discuss the competitive environment for check printing contracts in a moment.

Operating income in financial services decreased $9m to $32m. We were able to partially offset the revenue decline with our cost management efforts during the past year, which including closing 4 manufacturing plants in this business segment.

And now, for the first quarters results in our direct to the consumer business. Direct Checks revenue decreased 13% from last year to $67m, as a result of lower unit volume. The same situations discussed in the past were the cause of the decline in unit volume, mainly lower consumer response rates to direct mail advertisements, longer reorder cycles resulting from promotional strategies for multi-box orders and fewer personal checks being written as consumers move to alternative payment methods.

Operating income decreased 4.8% to $20m. The lower unit volume was partially offset by higher revenue per unit, productivity improvements and strong cross management efforts as exemplified by the consolidation of our Direct Checks printing operations into a single facility late in 2004.

I will highlight a few other items from our balance sheet and cash flow statements. Other non-current assets increased $61m from year-end, primarily due to contract acquisition costs related to financial institution contracts signed during the quarter. Significantly, we renewed a contract with a major financial institution partner, and won 3 other key accounts. When we have the business (inaudible) a contract completely on board in the first quarter of next year, we will have replaced a majority of the unit volume represented by the recent client loss. As discussed in our Form 10K for the ended December 31st, 2004, the allocation of the NEBS purchase price for the assets acquired and liabilities assumed was finalized during the fourth quarter of 2004. This allocation resulted in good will of $499m.

Net debt, total debt, net of cash, decreased $6m from the end of 2004. Our total debt was $1.2b at the end of the quarter. We currently expect to pay down approximately $150m of debt during 2005, as this is our focus from a capital management standpoint.

A look at the cash flow statement shows that cash provided by operating activities was $32m for the quarter, compared to $49m last year. The decrease was due primarily to the payment of employee incentive compensation related to our 2004 operating performance and a higher contract acquisition payment.

Contract acquisition payments in the first quarter were $15m, compared to $6m last year. These payments are prepaid product discounts, amortized over the life of the contract.

And related to the recent contract wins, contract acquisition payments will be higher for the year. As a result, we now anticipate operating cash flow in 2005 to be approximately $235m.

Capital expenditures for the quarter were $12m. The most significant single project underway this year is the upgrade to portions of our call center and order capture technology. We continue to leverage our common SAP systems to provide superior tools that best serve our clients and customers. We still expect our capital spending in 2005 to be approximately $45m.

We anticipate depreciation and amortization to be approximately $110m for the year, including acquisition related amortization of $40m.

As stated in our press release this morning, we expect our second quarter earnings per share to be in the range of $.77 to $.81, with full year EPS of approximately $3.30.

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

Thank you, Doug. As Doug mentioned, we're pleased with the progress we have made integrating the NEBS business. We've accomplished a lot in less than a year in terms of both bringing the physical pieces together and mapping out a strategy for the future. I will discuss our progress, as well as share highlights from our 3 business segments in a few minutes. But I'll begin my remarks today with some general news.

The changes that have occurred in our business during the last year have resulted in 3 business segments that look slightly different from last year at this time. Because of these changes, it seemed like a perfect time to rethink our business alignment model and its various components.

The business alignment model, or BAM as we call it, consists of the values that represent how we do our work and how we interact with one another. It contains a corporate vision that guides our direction and the objectives that define what our work is.

Everyone connected to Deluxe, from our Board of Directors to each front line employee, is accountable for making decisions consistent with our business alignment model. Everything we do at all levels of the Company is mapped to this model. We invest time in our business alignment model because it keeps everyone focused on the same things and because it's the right thing to do.

I suppose we could have imposed the BAM on the NEBS family of companies and their individual cultures, but we believe that would have been the wrong thing to do. And that's what led to the updated business alignment model, a new and improved, more powerful BAM.

In re-engineering our business alignment model, we brought people together from all of the business and brands to ensure that their various cultures were represented. While I certainly don't want to minimize the time and effort this team put into their assignment, their work was made infinitely easier because the separate cultures had so much in common from the beginning.

We published the updated business alignment model within the Company, and employees will participate in the Company-wide rollout beginning next month. Those of you who are viewing the slides on the webcast have a visual representation of the model. For those of you on the telephone, I'll briefly describe the elements.

At the top are the shared values of openness, trust and integrity, recognition and celebration, respect and dignity for all, customer focus, (inaudible) for the common goal and innovation.

The next piece is the corporate vision, that Deluxe will grow by enabling our financial institution and small business customers to be more competitive.

And finally, the 5 objectives that describe how we go about our work -- growing revenue, growing client and customer loyalty, making sure we have engaged people, managing our costs and transforming the organization.

The business alignment model applies to all businesses and brands within our 3 business segments. Each segment provides its respective employees with additional direction and I'll share some examples in just moment.

But first I will cover highlights from our 3 business segments, starting with small business services.

Since the NEBS acquisition, we have been defining and formalizing our direction small business services should take. Our goal is to be the leading resource to small businesses by providing personalized products and services that help them manage and build their business. This statement will direct our behavior as we fulfill the value proposition of providing small business customers with the opportunity to buy when, where and how they want, from experts who know their business, understand their needs and can simplify their office operations. More specifically, what this means for our small business customers is that they can place an order 24/7 from virtually anywhere via our websites, catalogs, call centers or one of our field sales representatives; and whether talking face to face or on the phone, the sales associate will be professional, knowledgeable and focused on the business person's needs.

This will require parts of our business, some of our brands, to retool their marketing approach, specifically, a move from being product driven to being market driven. The difference is in focus. Product driven companies are more internally focused, developing products and services from within and only then looking for ways customers might need, or want, these offerings.

Market driven companies, on the other hand, are more externally focused. They identify opportunities within their markets and then capitalize on them. Because they're focused on what's happening with our customers right now, they're in a better position to recognize customer's changing needs and thus address these needs. Our small business services segment is becoming more market driven by increasing our level of customer intimacy.

Teams within our small business services marketing and analytics groups are busy working on customer segmentation; in other words, grouping our customers by their primary business focus such as retail, construction or dentistry. We further segment customers into tiers according to criteria such as how much they purchase during a period of time, how often they place orders, which products they used and the type of order channel they prefer to use.

As we pursue our goals, we will measure our success against 3 key cornerstones -- first, customer acquisition, both in terms of how successful we are at acquiring customers and how economically we do so. Conversion and retention is the second cornerstone.

Acquiring customers is the important first step. Equally important is converting that customer from a one time to a two time buyer and then retaining them over time in order to build lifetime value.

The third cornerstone for success is wallet share; in other words, how much of any given customer's business can we acquire within the products and services we offer? While it may seem like a fairly simple task to sell a customer envelopes if we're already selling them checks, the reality is quite different. Gaining a larger share of our small business customer's wallet represents a very significant opportunity, and challenge, for us.

I will move on to our financial services segment by starting with an update on the competitive environment, something we've been talking about for quite some time. While the competition in this segment is still very challenging, we continue to focus on retaining and growing our financial institution client base. We believe we come to the table with the strongest suite of products and services that are designed to do 2 things -- help financial institutions open more accounts with confidence with products like Deluxe Detect (ph) and ID Theft Block, and grow their revenue and customer loyalty. This is where our Deluxe Select and Deluxe Business Advantage programs come into play. More about that in a minute.

The confidence we have in our strategy has been validated by some of our clients. As Doug mentioned, financial services recently acquired business from 3 large U.S. financial institutions that had not been Deluxe clients. 2 of these financial institutions rank among the top 10 U.S. banks and the other client is 1 of the larges credit unions in the country. In addition, Deluxe recently renewed its relationship with another top ranked financial institution.

These successes showcase a very positive trend as we forge new relationships with the key players in the banking industry, while maintaining our market leadership position. These achievements would not have been possible without the commitment and dedication of our financial services and small business services employees. In fact, one of the acquisitions was the culmination of more than 2 years of preparation and an extended RFP process.

In other news, we launched the Deluxe Business Advantage, or DBA program, to financial institutions just last week at the Knowledge Exchange Expo in Orlando, Florida. DBA is a fast and easy way for financial institutions to refer small business customers to Deluxe for business checks and other product needs. The Deluxe Business Advantage program simplifies the business check program for our financial institution clients and provides them with additional Deluxe resources to serve small business customers.

When we piloted the program, we saw a number of positive results, the most significant ones being an increase in the number of business check orders placed by new business accounts, higher revenue earned from the program by our FI clients, and third, that our field sales force is able to uncover additional FI products and services small businesses are interested in, and then refer these leads back to our FI clients.

Another benefit of Deluxe Business Advantage is in the branch training we provide, along with a simplified referral process through a single point of contact to improve operational efficiency. Ultimately, our Deluxe Business Advantage program is about helping financial institutions build customer satisfaction and loyalty by arming them with more ways to serve business customers, which is increasingly critical in the competitive market place. In fact, we believe this program already is helping us distinguish ourselves from the competition and that was a factor in the recent business wins Doug and I talked about.

We launched the DBA program at our most recent Knowledge Exchange Expo. As I've discussed on previous calls, the Expos are for financial executives and are designed to help financial institutions effectively orchestrate the customer experience by providing a unique forum that fosters innovation and partnership among those who attend. The Expos are extensions of the Deluxe knowledge exchange series, which features information and ongoing events for financial institution executives to network and develop innovative solutions to shared business challenges.

The response from the financial executives we invite has grown with each event. Since we introduced the program in 2003, more than 1,400 financial institutions have participated. At last week's 2-day meeting, there were more than 350 financial institutions executives in attendance, representing 190 financial institutions across the country. One attendee said this about his experience, "The overall experience with Deluxe the past 2 days has been amazing. If everyone in that room does something that we learned today, the industry will be changed forever."

Before moving on to Direct Checks, I want to take a minute to talk about how the strategies for financial services and small business services support each other. As I mentioned, the direction within SBS is to add to, and expand, the breadth of the relationships it has with small businesses. Success will depend upon gaining access to small business customers and increasing our share of wallet. Concurrently, financial services will focus on growing relationships with financial institutions. Developing new products and services to meet their needs will be critical, particularly given the maturity of the paper check.

We believe the potential for success within these businesses is considerable. However, the real value will come from aligning these 2 segments and then capitalizing on the resulting synergies. Put another way, the more demand deposit accounts we can access by acquiring and maintaining relationships with financial institutions, the greater opportunity for small business services to reach more customers. Conversely, the better we are at servicing the small business customer, the higher the likelihood of gaining and retaining contracts with financial institutions. This strategy will require us to deliver products, services and experiences that increase our relevance to our customers and clients, thereby strengthening our role as a trusted business partner.

Now I will move on and talk about our third business segment, Direct Checks. Having consolidated the Edison facility in 2004, Direct Checks is focusing and executing their strategy of maximizing the lifetime customer value. This business segment is applying the lean concepts introduced to our other businesses a few years ago. The advantage Direct Checks has is being able to learn from the experience of those who pioneered the changes. As a reminder, lean principles reduce waste by eliminating processes that offer little or no customer value. Direct Checks began its lean journey in 2004, with training and an introduction to how manufacturing cells are designed. Because lean is more of a cultural change, evolutionary in nature and something with no true beginning or end, we adopted a rolling implementation plan; in other words, planning only about 3 to 6 months out. This allows us to use our actual experience to set the pace of how we proceed on specific tasks. It also allows for more flexibility in the plan because of the shorter scope. Direct Checks began implementing the cells in April and they expect to complete the initial phase by June. Managers are encouraged by employees' positive attitudes, flexibility and early results.

Before closing with my business outlook, I would like to thank the Direct Checks folks for successfully completing the consolidation of the work from the Anniston, Alabama, facility.

I will close with a few comments about our business outlook. During the remaining 3 quarters of 2005, we expect small business services to begin building share of wallet. As far as our financial services segment, we will invest in this business to bring greater value to the relationships we have with our financial institution clients, and we plan to remain the lowest cost producers so that we can strengthen our leadership position. And in Direct Checks, our strategy is to continue to maximize the lifetime value of our customer relationships.

Looking beyond the rest of this year, we anticipate both revenue and profits to grow within our small businesses services segment as a result of 4 primary things -- a larger customer base, a greater emphasis on being market focused, expanded products and services and additional cost synergies. We expect performance in this segment to drive Deluxe's consolidated revenue, operating profit and cash flows higher in 2006 than what we will report in 2005 and we anticipate 2007 to be higher than 2006.

Now Doug and I will take your questions.

Thank you. (Operator Instructions) One moment, please. And our fist question is from the line of John Kraft from D.A. Davidson. Please go ahead.

Hi Larry, Doug and Stu.

Hello, John. How are you doing?

I'm doing okay. Larry, I just wanted to clarify when you were talking about your 3 recent contract wins. One is Fifth Third, which you announced. One is a top 10 bank that you expect to convert in Q1 of '06 and one is the large credit union?

Correct.

Am I correct -- okay. And regarding the contract payments, Doug, you said that you expect them to be higher. Is that higher for the year-over-year or higher than what?

Higher for year-over-year, but what I was really focusing on was higher than the guidance that we had previously provided, and as such, would affect the cash flow from operating activities guidance we had previously provided.

And you had previously said $40m? What was that? Could you remind me?

We had previously indicated that our contract acquisition payments would be about what they were in 2003, or around $48m. We now anticipate that they'll be $20 to $25m higher than that.

Okay. And can you tell me what the payment was to Fifth Third?

No, we aren't able to disclose that.

Okay. And then just walking through the numbers, your uses of cash here -- the cash flow from operations of $235m and the CapEx and debt and all that, I'm not quite adding up to $235. Was the rest of it coming from your line or what did I miss in there?

I'm not following your question, John. Is a difference in terms of our operating cash flow; the $235 is consistent with the guidance we had provided earlier and in our 10K of operating cash flow for the year, adjusted primarily for the contract acquisition payment.

Okay. But I mean if I pay out the $45m in CapEx and the $150m in debt and the $80m in dividends, I'm getting a little shy of the -- or I have --

Oh. There are a couple of other pieces that you need to take into account there. One is the anticipated sale of Premium Ware which we hope -- we anticipate will conclude this year and then secondly, you -- from funds that would be incoming related to the exercise of options.

Okay. And as for kind of a big picture industry question, declines in checks, are there any changes there, still 4 to 5%?

John, I think that is a good number to use. We still are using 4 to 5. The Fed study had it at 4.3 and when one adjusts for electronic conversion, it really was a 3.9% decrease. So, adding something to that would put us in the 4 to 5% range, John.

John Kraft. Okay. And then, Doug, the margin in financial services was better than we expected and better than what, I think, you expected. Are you still expecting about 20% for the year, or do you think we could be a bit above that?

We were favorable in the first quarter to what we had anticipated and there are some good things related to that. We could see improvement over what we had previously indicated.

Okay. How about the revenue down $110m, is that maybe a bit conservative, or is that still fair?

I think that's still fair.

Okay. Good enough. Thanks, guys.

Thanks, John.

(Operator Instructions) And we have no questions. I'll turn the conference back over to Mr. Larry Mosner. Please go ahead.

Yes, this is Stu. I'd like to give a reminder that a replay of this call will be available until May 5th by dialing 320-365-3844. When instructed, provide the access code 778724. The add-in presentation and the Company slides are also archived in the Investor Relations section of Deluxe's website www.deluxe.com. In addition, management will present at the D.A. Davidson Company's 7th Annual Financial Services Investor conference in Seattle on May 4th, 2005, at 11:00 a.m. Pacific Time. This event will also be web cast at www.deluxe.com/investors. Again, we would like to thank you for joining us today and have a good afternoon.

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