Deluxe Corp (DLX) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Deluxe Corporation 2005 second quarter earnings conference call. [OPERATOR INSTRUCTIONS]. Now I would like to turn the conference over to the host, Mr. Stuart Alexander, please go ahead.

Thank you, Nate. Welcome to the Deluxe Corporation 2005 Q2 investor conference call. Today you will hear from Larry Mosner, Chairman and Chief Executive Officer, and Doug Treff, our Chief Financial Officer. As in the past, Doug and Larry will take questions from analysts after the prepared comments. At that time, the operator will instruct you how to ask a question, if you're on the phone.

Those of you listening over the web can submit questions at anytime during the call. One additional minor change to the format of our call: all increases and decreases referred to in the prepared comments, will be comparisons to the same period in 2004 unless stated otherwise. In accordance with regulation FD this is open to all interested parties. A replay of the call will be available via telephone and Deluxe's web site. I will provide instructions for accessing 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 managements'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 which 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 company's format 10-Q for the quarter ended March 31.

In addition, the financial and statistical information that will be reviewed during this call is addressed in greater detail in today's press release which is posed on our web site, www.deluxe.com, in the investor relations section, and was furnished with the SEC in the form 8-K filed this morning. In particular any non-GAAP financial measures are reconciled to the corporate GAAP financial measures in the press release. Now I will turn the call over to Larry.

Thank you, Stu. As we communicated in this morning's press release, we are making steady progress integrating the NEBS business. NEBS is delivering the expected results we communicated to you when we announced the acquisition. The work we've done in the last year, and continue to do creates the foundation for a growth strategy that leverages the assets and strengths of our small business services segment as we serve both financial institutions and small businesses.

In a few minutes I will provide some details around our efforts, from both a consolidated and business segment perspective. First I will turn the call over to Doug Treff who will cover the financials. Doug?

We exceeded our previous guidance coming in with second quarters earnings per share of $0.83. We outperformed our guidance of $0.77 to $0.81 cents per share due to a couple of factors. Synergies from the NEBS integration that favorably affected all businesses and we received contract termination payments in the second quarter, a portion of which had been anticipated in the third quarter. Excluding the early payment EPS was within the range of our guidance.

Earnings per share for the second quarter last year were $0.91. Net income was $42 million compared to $46 million. Net income and EPS were lower due to the loss of a large financial institution client in late 2004 which I mentioned on previous calls, and incremental interest expense related to the acquisition of NEBS. These factors were partially offset by higher profits in our small business services segment. These profits resulted from the addition of NEBS operations and related acquisitions synergies from leveraging scale economies, improving productivity and embracing a shared services environment.

Deluxe's consolidated revenue was $434 million, up $125 million, or more than 40%. NEBS contributed an incremental $154 million. as you may recall, we acquired NEBS on June 25th of last year, and therefore our second quarter results in 2004 included only 5 days of NEBS operating results. We had a $29 million revenue decline in our other businesses which was driven by a 16.2% decline in unit volume, primarily the result of the major client loss, partially offset by $12 million of contract termination payments.

Gross margin for the quarter was 65.4% of revenue, compared to 66.7%. Historically, NEBS has prayed with a gross margin 7 to 8 points lower than Deluxe's business, arising from NEBS' product mix. At the same time our focus on operational excellence drove productivity increases in our plants and distribution centers. The increases were the result of driving lean practices through much of our organization while enhancing high quality standards.

One outcome of improved efficiency is our ability to do more with less. As a result we've reduced staffing 7% since the beginning of the year. We also realize the favorable impact from the contract termination payments and continue to monetize cost synergies from the NEBS integration in all segments of our business. Selling general and administrative expense as a percentage of revenue was 46.5%, compared to 40.8% last year, due primarily to the acquisition of NEBS.

As we have mentioned previously, NEBS SG&A expense as a percentage of revenue has historically been higher than Deluxe's because NEBS has relied to a greater degree on direct marking and direct sales force to acquire and retain customers. Excluding the affect of NEBS, we reduced SG&A expense in the rest of our business through continued cost take out efforts. As a result of all of these factors, our operating income was $82 million, an increase of 2.5%.

Included in the results were $10 million of acquisition related amortization expense and $5 million of integration costs, which were more than offset by $16 million of contribution from NEBS. Operating margin for the quarter was 18.9% of revenue compared to 25.9% reflecting the NEBS lower margin business, our investment to realize future synergies, and lower check unit volumes.

Now I will move onto the second quarter's results in our three business segments. Small business services revenue increased $155 million to $224 million, nearly all of which related to the NEBS acquisition. Excluding NEBS, small business services posted higher revenue even though the segment was also affected by the FI client loss I mentioned.

Operating income for the small business services segment increased $3 million or nearly 16% to $22 million, included in the SBS results were the acquisition related amortization expense, and integration costs I just mentioned, which were more than offset by $16 million contribution from the NEBS businesses. During the quarter, we began allocating certain corporate costs of the NEBS portion of this segment.

NEBS implemented certain key applications of information technology systems and began utilizing some shared services functions. The shared services implementation effort was a successful result of months of planning and will allow us to strengthen the control environment, standardize profits, improve efficiencies and realize savings in SG&A. Thus the SBS segments bears a portion of the related costs. This change benefits our other two segments as NEBS now helps defray the costs of our shared services function. This allocation of cost had the affect of shifting $4.6 million of cost to SBS during the quarter and away from our other two segments.

Moving onto our financial services business, revenue was $149 million, a decrease of $20 million or 11.8%. As I mentioned, the client loss affected financial services results as did continued pricing precious and gradual decline in personal check usage. Within the payment industry, the number of personal checks being written continues to decline at a rate of 4 to 5% per year due to the growth of electronic payments.

Excluding the client loss, financial services unit decline was within this range. Both revenue and operating income in financial services were favorably affected by the contract termination payments. As I've explained to the past, we received these payments when a contract is modified or terminated prior to its expiration date. Most often this situation occurs as a result of FI merger and acquisition activity. This was the case with the second quarter payments we received.

Despite the revenue decrease, operating income in finance services decreased only $1 million to $40 million. In addition to the contract termination payments, operating income for this segment benefited from productivity improvement, synergies related to the integration of NEBS and cost management efforts which included closing 3 manufacturing plants. In addition financial services realized a benefit from a reallocation of corporate costs to small business services.

Now for second quarter results in our directed consumer business. Direct checks revenue was $61 million, decrease of $10 million as a result of lower unit volume. The decline in unit volume continues to be the result of lower consumer response rates to direct mail advertisements, longer reorder cycles resulting from the promotion strategies within the direct channel for multibox orders and fewer personal checks being written as consumers move to alternative payment methods. In addition to the ongoing conditions, there are a couple additional factors that are likely contributing to the lower unit volume. It is become more common for financial institution to offer free checks to their customers and this is new competition in the channel.

Despite the challenges, operating income was flat at $20 million. The lower unit volume was offset by higher revenue per unit, synergies related to NEBS and strong cost management included the consolidation of our check printing operations from two facilities into one late in 2004.

Now I will move onto results for the first half of the year. All comparisons again are to the first half of 2004. Earnings per share from $1.60 compared to $1.86. Revenue was up $254 million. NEBS contributed $314 million of the increase, most of which was due to the timing of the acquisition that took place in June of 2004. The decrease for other businesses was the result of a decline in unit volume and large part a result of the FI client loss.

Revenue decline was partially offset by increase in revenue per unit and the $12 million of contract term payments. Operating income for the first half of year was $158 million, a decrease of $4 million. Included in the 2005 results were $21 million acquisition related amortization expense and $8 million integration costs. Which were more than offset by $33 million of contributions from NEBS.

Now, to highlight a couple items were the balance sheet Other noncurrent assets increased from year end primarily due to contract acquisition costs related to financial institution contracts signed during the first quarter. Net debt, total net debt of cash increased $9 million from the end of 2004. This is primely due to $64 million of contract acquisition payments year-to-date and working capital outflow is related to employee performance based compensation and income taxes. Our total debt was $1.27 billion at the end of the second quarter and we expect it to be approximately $1.1 billion at year end.

A look at the cash flow statement shows cash provided by operating activities was $45 million compared to $124 million last year. The decrease was due primarily to higher contract acquisition payments, and higher employee performance based compensation related to our 2004 operating performance. As a result of higher contract acquisition payments and changes in working capital, we now expect cash from operating activities to be approximately $220 million for the full year.

Contract acquisition payments in the first six months of the year were $64 million compared to $9 million last year. These payments are prepaid product discounts related to financial institution contracts that are amortized over the life of the contract. Capital expenditures were $26 million for the first half of the year. The most significant single project underway this year is the upgrade of major call center and order capture technologies. We continue to leverage our SAP systems infrastructure to deliver superior tools for serving up clients and customers. Larry will talk about that in a couple minutes.

We expect our capital spending in 2005 to be approximately $50 million. We anticipate depreciation and amortization to be approximately $110 million for the year, including acquisition related amortization of $40 million. I'll wrap up my prepared comments with EPS guidance. We expect third quarter earnings per share to be between $0.72 and $0.76 and full year earnings per share to be still approximately $3.30. We are currently in the process of updating our strategic plan and we will be completing our 2006 annual operating plan during the fourth quarter. As has been our practice, we anticipate providing 2006 guidance when we report our year end results in late January.

I look forward to taking your questions but now I will turn the call back to Larry.

Thank you, Doug. I'll cover a number of topics in my prepared comments today. Starting with our progress integrating the NEBS business into our small business services segment. I will share other SBS highlights, as well as items from financial services and direct checks. Then I will wrap up with general business news and outlook for the second half of 2005.

It was only 13 months ago that we acquired New England Business Service. As we stayed in this morning's press release, our integration plan is on schedule, and we continue to achieve the synergies and cost savings we anticipated prior to the acquisition. Here are a few examples: One of our most comprehensive and far reaching tasks was to understand the multiple NEBS and Deluxe businesses. We looked at product breadth, brand strength, distribution channels, competitive strengths, market position and small business expertise.

Results of this in-depth study provided the foundation for us to to develop a strategic plan that leverages the strengths across the entire small business services organization. This strategy will enable us to generate growth within our impressive customer base of more than 6 million small businesses. We began to implement this strategy early in the second quarter, when we launched our Deluxe business advantage program. I'll provide more details about this program in a few minutes.

Another accomplishment is that we've integrated our small business services marketing organizations and as a result have improved advertising efficiencies. In addition, we've consolidated our database marketing resources which is enabling us to be more effective at targeting customers and also improving our modeling capabilities.

During the next two quarters, we expect to test and introduce a number of marketing and sales initiatives designed to increase the acquisition rate of available first time buyers in each channel and build wallet share within our existing customer base. As we've moved forward with this complex integration we've become more confident in our ability to create a powerful presences in the small business marketplace. I would like to thank all our employees for their hard work and dedication to this goal.

Moving onto the information technology area, we have transitioned the legacy NEBS commuter systems that supported human resources, finance, and payroll to our SAP infrastructure. At the moment we are in a very active stage of consolidated our supply chain and manufacturing operations.

Because of our success implementing SAP software modules in multiple areas of the company, we were able to retire the NEBS supply chain software that handle procurement in inventory management. We knew implementing these systems would be a major strategic deliverable within our overall integration process, and also important to our internal controls. The project was an accident example of the way our employees have partnered to bring the many pieces onto a common SAP platform.

I will transition from integration news to other items from our small business services segment by talking about a product launch. You've heard me talk about Deluxe's efforts to develop services that help financial institution, small businesses and customers to prevent and deal with fraud and identity theft. Our latest is called Fraud Blocker, a service we launched in June to customers of the NEBS family of brands.

Fraud Blocker is a close relative of our fraud defense service launched in 2003. Both Fraud Blocker and Fraud Defense screen check orders using Deluxe's proprietary software that compared the orders common in fraudulent orders in a matter of seconds. Orders are run against a database of known fraudulent account information.

Phone orders pass-through an additional filter, the customer service agent taking the call. Our agents are trained to listen for suspicious situations and when something doesn't sound right to them they pull the orders from the fulfillment process for further analysis. Deluxe employees who work in our fraud detection department tell us that consumers are appreciative of the service, and it is no wonder given identity fraud and theft are the fastest growing crimes in the U. S. The Federal Trade Commission estimates the annual price tag of identity theft to be more than $50 billion. We are proud of our fraught prevention services and have a patent pending on the process.

Ultimately our fraud detection services benefit consumers and small businesses, but our financial constitution clients also are pleased with fraud blocker and fraud defense because FIs typically absorbs much of the costs associated with fraud and identity theft, and it helps them enhance customer satisfaction, because they can offer a powerful service that helps prevent a crime that can disrupt a business or an individual's life.

The way these services benefit customers and clients of both our financial services and small business services segments is a perfect example of the important interdependence between the two segments. The degree to which we are able to align these two businesses and then capitalize on the resulting synergies is a key element of our strategy. More specifically, SBS will rely on financial services to acquire and maintain relationships with financial institutions by targeting products and services for demand deposit account holders. Similarly, financial services will rely on the small business expertise that SBS has developed to serving its millions of small business customers as a tool for gaining and retaining contracts with financial institutions.

Ultimately, we will increase our relevance to our customers and clients, thereby strengthening our role as a trusted business partner. A few minutes ago I referenced the Deluxe business advantage program that we launched in late April. Here are the details: DBA is another example of the connectedness between financial services and SBS. As I shared with you last quarter, DBA provides financial instutions with unparalleled resources for serving small business customers. These customers are served by Deluxe's product experts in an efficient and effective way. In turn it allows financial institution employees to spend time on programs in which they are the experts.

The Deluxe Business Advantage program reflects Deluxe's long standing commitment to helping financial institutions meet their key objectives, such as increased revenue, enhanced customer satisfaction, improved security and greater operational efficiency. Deluxe Business Advantage not only increases revenue for our financial institution clients but also generates sales leads for their other products and services. All of this is possible because Deluxe Business Advantage leverages the national direct sales and distributor sales forces that were part of NEBS.

Integrating these capabilities with our financial services sales force improves our competitive position by providing financial institutions with more ways to increase satisfaction and loyalty with small business customers. Given the competitive financial services marketplace, FIs are eager for products and services that give them an edge. We were able to develop and deliver this program quickly because we have been successful at combining and leveraging the knowledge and expertise of the various Deluxe and NEBS brands during the integration process.

This combination of talent and industry leadership provides us with a platform for growth in the small business market. As proof our financial institution clients have responded to the program even better than we expected. Another soon to be launched service generating excitement within our FI clients is the Deluxe Detect Service, the result of a relationship between Deluxe and primary payment systems. Deluxe defect is a new relationship screening tool that enables financial institutions to reduce fraud at the new accounts desk by providing identity verification and reliable risk assessment in realtime.

Financial institution risk and retail managers are asking for improved data integrity to identify high risk individuals quickly and accurately and at the same time help them open more accounts with greater confidence. We've listened to client request for faster and reliable decision-making support when establishing new consumer relationships, and created what we believe is the most comprehensive offering by any supplier in our channel. We don't expect to launch Deluxe detect officially to all of our clients until later this year, the financial institution who know about it or have helped us with the pilot are very pleased with what it can do for their customers. This service will enhance the spectrum of product offerings in the financial services segment.

Moving onto other highlights. In last quarter's call, I referenced a major win for financial services. We acquired the business from the State Employees Credit Union or SECU, which is based in Raleigh, North Carolina, and with more than 1 million members it is the second largest credit union in the United States.

This new relationship is based on Deluxe and SECU's shared commitment to superior service. SECU is focused on improving consumer experiences with the help of Deluxe's enhanced products and services. Demand deposit accounts, the industries's determine for checking and savings accounts, are at the heart of relationships between financial institution and their customers. A representative from SECU confirmed this when she said the check program is an essential part of our member relations.

I have one more business win to tell you about. Fifth Third bank has chosen Deluxe as its provider of checks and related services. In fact, we have already begun receiving orders from them. Located in Cincinnati, Ohio, Fifth Third selected Deluxe because they believe we provide the best solutions to help them provide their customers with quality products and superior service..

Their goal is to generate additional revenue and improve operational efficiency so they can focus the resources on the overall needs of their customers. I will wrap up my discussion of our financial services segment with a couple items related to our knowledge exchange series. If you have listened to previous calls you heard me describe our knowledge exchange program as a collection of live expos, web-based seminars, newsletters, and a general sharing of information that is of interest to financial institutions. A knowledge exchange series plays a significant role in differentiating ourselves from the competition. In fact, as a result of another successful expo this past April, we're launching a small business collaborative, a group of financial institution executives who will join forces to explore opportunities to enhance the customer experience for small businesses.

Now I will move on to some general business news. Deluxe is featured in the recently published book, "Indispensible: How To Become the Company That Your Customers Can't Live Without", by Joe Callaway. As the publisher states, "Indispensible gets straight to the heart of how market readers create customer loyalty and market differentiation." In a fairly lengthy interview with Chuck Phelps, President of our financial services business segment, Mr. Callaway explores how Deluxe is taking checks beyond a commodity and developing other products, services, and programs, that are important to our clients. In the process, we hope to establish ourselves, as the author put it, "as the indispensable knowledge resource for the industry."

Moving onto highlights from our manufacturing shared services organization, even though we are combining and repositioning print jobs across a number of facilities as a result of the integration, the situation that can disrupt the normal manufacturing routine, we were able to improve second quarter productivity in a number of areas. Average feet per minute, up time, units per hour, and cost per document. Our ability to continue to find areas to improve is part of Deluxe's innovative culture and also the result of having been in business a very long time. In fact, two of our facilities recently celebrated 25 years of operation. The Maryville plant in Maryville, Missouri, and the Chicago Center in Illinois. Maryville prints a wide range of products including labels and greeting cards, and our Chicago center produces base stocks, and prints personalized checks and prints other documents.

We'll finish up this section with the first of several awards. For the second time in three years Deluxe has been named one of the 50 best manufacturing companies by Industry Week magazine. In the August issue that announces the top 50, the author wrote, "It is evident that this is a deafers group of manufacturers that have mastered their markets."

Industry Week scores companies by using a formula that factors in revenue growth, profit margins, return on equity, return on assets and assets turnover and inventory turns. The publication weighs these six criteria with the most recent year accounting for 50% of the total score. We are proud to be recognized in this way. It validates our business strategy and recognized the work our employees have done, particularly in the areas of lien and cellular supply chain ensured services.

In other recognition news the Kansas City plant received the 2004 excellence in manufacturing award from the Kansas City manufacturing network last month. This organization recognizes manufacturing businesses that have excelled in their industry, provided a good quality of life for their employees, exhibited good community involvement, and displayed strong business stabiltiy and growth within the community.

The Kansas City printing facility was one of 5 companies in their metropolitan area to be honored this with excellence award. Given the Kansas City has more than 1200 manufacturing companies, this ranking puts the Deluxe facility in the top half a percent.

Moving onto our Direct Checks location in Colorado Springs. This facility received three awards for supporting enlisted military personnel. A national committee for employer support of the Guard and Reserve, or ESGR, presented three Direct Checks employees with the Above and Beyond award, the Patriotic Employer award and Patriot award. The ESGR is a liaison between reservists and employers.

We are particularly proud of these awards because we are nominated for them by an employee who is a sergeant in Colorado's Army National Guard. He appreciated the support he received when his battalion was activated in January of 2003. I congratulate the employees whose efforts are the reason we received all this recognition.

I will close my comments with a business outlook for the rest of 2005. As Doug said earlier, we remain committed to full year earnings per share of approximately $3.30. Between now and year end we will continue to focus on the NEBS integration. Of course as well as the improvements underway in our information technology systems and the work within our shared services functions.

We believe there is potential for long-term growth within small business services and that it is founded on our large number of small business customers and the symbiotic relationship between SBS and Financial Services. We further believe these growth opportunities will more than offset the check unit declines we expect to in Financial Services and Direct Checks, as a result of fewer personal checks being written by consumers.

Now, Doug and I will take your questions.

Operator, would you please provide our callers with instructions for asking questions?

Thank you. Those of you viewing the web cast can submit questions at any time. [ OPERATOR INSTRUCTIONS ] Our first question comes from the line of Mark Rider from Partner R E. Please go ahead with your question.

Hi. So during the first half of 2005, you generated cash flow from operations of 45 million. I am just wondering how I can get comfortable that you will get to 220 million for the full year.

Mark, this is Doug Treff. Let me take that question. The first half of our year had two significant factors that resulted in a lower cash flow from operating activities. One was the employee incentive compensation payments that I spoke about related to the 2004 performance and the other one was the contract acquisition payments which were $64 million in the first half of the year.

We anticipate for the rest of the year that we will have a very small amount of contract acquisition payments, and as such the cash flow will be very consistent with both the earnings outlook and therefore there won't be extraordinary liability payments or contract acquisition payments. So consistent with our history and consistent with our earnings you should be comfortable with that $220 million number.

Okay. And the -- I notice your other current liabilities dropped pretty significantly from 281 to 222. Is that basically the payments of these contract acquisition payments?

That is part of it, yes. That's one part of it. Part of it is also related to employee profit sharing and pension payments in the first half of the year. And then a portion of it there is a reclassification from short-term to long-term debt is in there too.

Okay. So just if I take the 220 million cash flow from operations and subtract out the 50 million of Capex you are talking about and then dividend of about 80, I am getting to about 90 million of cash that you will generate this year and you are talking about bringing the debt from 1.244 billion to 1.1 billion. It looks like there's a shortfall there. Is that the expectation you will sell PremiumWare and is that the difference?

Yes, PremiumWare is a majority of that difference. The other portion of it is our cash balance at the end of the second quarter was higher than normal due to the receipt of a payment late in the day on June 30th. And that cash balance should decline as well to normal levels.

Okay. And just can you talk about your plans just for debt reduction over the next few years? I know in the last press release you put a statement that said you expected your cash flow to be greater in '06 and '05 than in '07, '06. I was wondering if you could confirm that's still the case, and then talk about what your plans are for debt reduction in ensuing years.

Let me take the question related to what we said last time, related to '06 compared to '05. We still feel the same way about the long-term prospects of the business, that hasn't changed at all. We are in the process of working through our strategic plans, thinking through the specific initiatives to drive growth in 2006, and given the timing of that, given that we'll be working on our annual operating plan this fall as well, we didn't want to go out with information that was not yet fully thought through. But our feelings have not changed at all in that way.

Related to debt reduction long-term, we are focused at this time on debt reduction, that is the case. We want to have a debt level consistent with our triple B plus rating. We are focused on that. We continue to realize synergies in the business we expected at the time of the acquisition of New England Business Service. We continue to work on initiatives that will drive growth for next year and we're very confident of that fact. So that will be a priority, debt reduction.

In addition as we've said in the past, we will consider acquisitions at an appropriate time to either build out capabilities in particular spaces to expand our assortment of products and services, or create new market opportunities for us in adjacent spaces. That, though, is really at this time secondary to our debt reduction focus.

Is there anything that you are looking at currently? On the M&A front?

We are always in the process of examining the opportunities consistent with what we've said is that if we look at things it would be in opportunities that would leverage our competencies adjacent to our spaces and would be accretive to cash flow and earnings. We don't comment on anything specific to that, but we have been very consistent in those criteria for the last four or 5 years is how we do the trade offs and make decisions.

The goal is that I assume to still maintain your current credit ratings?

Yes.

Thank you.

Did they answer your question, Mr. Rider.

Yes, thank you.

Our next question is John Kraft from D.A. Davidson.

Good morning, gentlemen.

Good morning, John.

I want to follow on a couple gram previous questions. Doug, can you quantify regarding the contract acquisition payments, can you quantify very small, I mean, what might we expect over the next couple quarters?

Anticipate it will be less than $10 million for the rest of the year.

Total?

Right.

Okay. And the status of the PremiumWare divestiture, how are the bids coming in, are you liking those?

We continue to move along in that process and that's progressing nicely. We anticipate that we'll be able to close that hopefully here in the third quarter.

Okay. And the margins in the financial services, Doug, you said before should be 20ish, this quarter was better due to the termination fee. Going forward in Q3 and Q4, is 20 a good number to use for that segment margins?

Let me piggy back on a comment that I made in my prepared comments and that has to do with our guidance earlier in January, was that we would anticipate that the margin would decline 4 to 6 percentage points from 2004. Now we believe it will be at the low end of that range.

You would have to, however, take into account, John, the allocation of service corporate costs from financial services to the small business services segment. And that added some dollars. The total affect shifted to small business was 4.6 million. The lion's share of that came from financial services.

It would be approximately 4% client margin but you have to take into account that allocation change. So that will reduce -- that will actually be a more favorable impact on financial services for the full year.

Sure. Obviously that 4.6 million shift is a big part of the decline in the small business margins?

That is a contributing factor, yes, it is.

Okay. Anything in -- one time expected in next quarter that might contribute to a sequentially down earnings number?

No. The factors that are really driving the sequential difference from Q2 to Q3 relate to the contract termination payments that we received, that's the primary driver. It has to do with timing of project investments but not nonrecurring items, no.

And Fifth Third should come online in Q3?

Yes.

Okay. Fully? It will be finished in Q3?

During the period it will be close to that, yes.

Okay. Good enough. Thank you, guys.

Thank you. Next question comes from the line of [Jason Crow] from Bank of Tokyo, please go ahead with your question.

Good morning. Gentleman, I had a question about the balance sheet. When did you plan to have or what are your goals when you plan to have a positive equity position?

A positive equity position for Deluxe would depend upon the earnings stream in the future. Currently our shareholders' deficit stands at $124 million and that -- if we did not do any further share repurchase then I would anticipate that that would turn positive next year.

Okay. Do you have any plans to repurchase any significant amount of shares in the second half of this year?

We have an authorization that remains in force, yet our focus at this time is to pay down debt.

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

Thank you, Jason.

This is Stu. I have a question that's come in from a participant on our website that I will need to read. Small business services and finance services segments have long-term strategic plans that are well articulated. What are the longer term plans for the Direct Check segment, specifically, how can management address consumer response rates to advertising?

I will take that, thanks Stu. Our direction for our direct check business is to maximize the lifetime value of our customers and to continue to explore and test ways of increasing or slow the decline of the decrease in response rates.

Our decrease in response rates is very consistent with what is happening in the whole direct marking industry. So it is not unique to Deluxe. And our Direct Check team has just done a terrific job of managing their costs and exploring and testing new products, new services that they could sell to increase the revenue per order as well as to improve the efficiency of their advertising dollars that are spent. So that they are in better channels and can positively influence response rates.

Next question.

Would you like to neighboring the next audio question?

Yes.

Next question comes from [Sam McCloudy] from Silver Peak Capital Management.

Good morning, gentlemen.

Good morning.

A couple of questions. On the contract termination payment, that all goes into finance services revenue. How does that affect operating income, does all of that go into operating income?

Yes, it does, Sam.

It would be 28 without that?

What would be 28?

The operating income for financial services instead of 40 it would be 28?

That would be correct.

Okay. Another question on -- let's see here. How does that drop to earnings. What is the affect of that?

The affect of that would be it would be tax affected.

Okay. Okay. And you said the unit volume decline in Direct Checks was about 4 to 5%, is that correct?

We said unit volume decline in Financial Services was 4 to 5%, excluding the loss of the large client last year.

Okay. What would the decline in Direct Checks be?

We don't provide specific guidance by segment, typically. But it was higher than the overall decline of personal checks which we estimate to be 4 to 5%.

Okay. So if from what I recall pricing increased but revenues down 14% in Direct Checks so I assume its checks volumes decreasing substantially more than 4 to 5%, is that reasonable?

Increasing greater than 4 to 5%, you are correct.

Okay. But fairly significantly though?

It is higher, yes, than that.

The other factor is response rates in addition -- are affecting the unit volumes there, that's what's contributing to that decline.

Okay. Also, in terms of free cash flow in the first six months it is negative 22 down from 73 last year. So that's a decline of 95, but it looks like the decline in 2 Q was about 70, that was most of the decline, get -- yet you said it is declining because of the contract acquisition costs and employee compensation costs but didn't both of those take place in the first quarter?

The employee compensation cost did take place in Q1. The contract acquisition payments were actually made in Q2.

So the entire 64 was in 2 Q.

That's not accurate. Approximately two-thirds of it was made in Q2.

And I think that's all I have.

Thank you, Sam.

Thank you very much.

Thank you. Next question comes from the line of [Mark Yukelson] from Sagamore Hill Capital Management Please go ahead with your question.

Just a few questions. Can you quickly go over the timing of the new contracts in the Financial Services segment?

Meaning?

When -- are there three or four new big contracts you talked about and --?

Both of them are now coming on stream.

So there's -- from also as reported last period, another major win however was not going to come on until the start of the second quarter of 2006, we are at the end of the first quarter 2006. So there's three big new customers that you brought on?

Well, three that we have won the business, two that are coming on, one that will come on.

Right. Okay. And then in terms of the contract termination payment, can you throw out a little color on the details behind that?

Sure. The contract termination payments were not the result of RFPs, they were the result of financial institution acquisitions merger activity between two banks. We held one of those contracts, the contract termination payment in one situation related to that bank completely going to a competitor, and in another case was related to losing -- two cases was related to losing a portion of those payments. A portion of the bank business and still retaining a portion of that business.

Right. And I guess was that anticipated in the guidance that you had given before the quarter?

Yes, it was. It was anticipated in the first quarter guidance that we provided.

Okay, and then on the integration expenses, just what are you thinking about for the second half?

Mark, just let me clarify that last comment I made. It was anticipated in the guidance for the full year. A portion of those payments were not anticipated in Q2. A portion was anticipated in Q3. I wanted to clarify that for you.

Okay. What do you anticipate for -- what are you including for the integration expenses and guidance implied for the second half?

Mark, we're just talking through that. I don't have that at my hands, but I would, from a projection standpoint, it is factored into the numbers and given -- I'm not able to provide you with that specificity in terms of the certain costs. The run rate we are at is a reasonable guideline as you look out into the future.

All right. Do you anticipate the integration expenses continuing beyond the end of the year?

We anticipate integration expenses continuing beyond the end of the year, the dollar of them will vary depending on specific initiatives that we pursue.

Mark, this is Larry, we also, in addition expect the specific synergies to go beyond and extend into the future years as well. There is costs but there are also additional synergies we anticipate in those out years.

Okay. And just in terms of the performance of NEBS, can you provide -- you've sold some of their businesses, just what organic growth is and total small businesses segment.

Sure. That's a good question. The performance of NEBS has been consistent with our expectations. The revenues are approximately flat to slightly up. We are realizing strong synergies even beyond what we had anticipated, and we're expecting to see growth and it is reflected in our outlook here in Q3 and Q4. And further growth next year.

Okay. My last question, when you look at your cash flow -- free cash flow expectations for the year, how does NEBS fit in to that, is it performing in line with your expectations with free cash flow.

Absolutely it is. It is a positive contributor.

That's it for me. Thank you.

Mark.

Thank you. Our next question comes from the line of [John Rodan] from Glenview Capital Management.

Thank you for your time. I am sorry if I missed this earlier in the call. Could you give some big picture comments on the health of the overall check business competition. We obviously you said your up front payments were 64 million in the first half of this year versus 9 million last year. Could you just give us big picture comments about the check market?

I will go back and state that we would -- what Doug included in the prepared comments and reiterated in answering some of the questions, that is we see the unit decline within the personal check side of the check segment of the payments industry at about 4 to 5%, which is very consistent with our past statements and expectations. We do see continuing price competition and do not see that abating in -- based upon our view. So the outlook that we see today is very consistent with the outlook that we have talked about on the last several calls.

Thank you.

Thank you. [OPERATOR INSTRUCTIONS].

If there are no more calls?

There is no further questions. Please continue.

Thank you, Nate. Thank you to everyone on the call for your interest in Deluxe. I hope you'll be able to join us on October 27 when we report our third quarter earnings. Between now and then, we will continue with our work to execute our strategy of leveraging the assets and strengths of our three business segments to serve end-consumers financial institution and small businesses. Stu.

Thank you, Larry. This is a reminder a replay of the call will be available until August 4th by dialing 320-365-3844, when instructed provide access code 789108. In addition, the audio presentation and the Company slides are archived in Investor Relations section of the Deluxe's web site. Thank you for joining us today and have a good afternoon.

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