Deluxe Corp (DLX) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Deluxe Business Advantage 2006 Second Quarter Earnings Call. [OPERATOR INSTRUCTIONS] I'd like to now turn the conference over to your host. Mr. Terry Peterson. Please, go ahead, sir.

Thank you, Keely. Welcome to the Deluxe Corporation's 2006 Second Quarter Earnings Conference Call. I'm Terry Peterson, Deluxe's Chief Financial Officer, Controller and Chief Accounting Officer. Joining me on the call today is Lee Schram, Deluxe's Chief Executive Officer. Both Lee and I will take questions from analysts after the prepared comments. At that time, the operator will instruct you how to ask a question. Because we're expecting a number of questions, we ask that you limit yourself to one question plus no more then one follow-up. You may reenter the queue, if you have additional questions.

In accordance with regulation FD, this call is opened to all interested parties. A replay of the call will be available via telephone and Deluxe's website. I will provide instructions for accessing the replay at the conclusion of our teleconference. Before I begin, let me make this brief cautionary statement. Comments made today regarding financial estimates and projections and any other statements addressing managements intentions and expectations regarding the company's 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 results to differ materially from those projected. Additional information about various factors that could cause actual results to differ from those projected, are contained in the news release that we issued this morning and on the company's Form 10-K for the year ended December 31st, 2005. In addition, the financial and statistical information that will be reviewed during this call is addressed in greater detail in today's press, which is posted on our website, www.deluxe.com. in the investor relations section, and was furnished to the SEC on the Form 8K filed this morning. In particular, any non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release. Now, I'll turn the call over to Lee Schram, Deluxe's CEO.

Thank you, Terry. And good morning everyone. To get right into it, we are disappointed with our second quarter financial performance and the fact that we had to take an impairment charge on a software project and reduce our earnings guidance, not only for the second quarter, but, also, for the total year. As I have been communicating with my team, however, in spite of these disappointments, there are a tremendous number of positives to build upon here at Deluxe. And although we have a lot of hard work ahead of us, I am confident that the blue prints that we're working on, which I will outline in a few minutes, will significantly improve our business and financial results and get Deluxe on the road back to greatness.

In my prepared comments, I plan on addressing top of [inaudible] topics based on calls that Terry and I have received from many of you over the last month. At the same time ,we want to ensure we leave enough time to address your questions. As I see it, there are five areas we must absolutely address. First, refine our small business services strategy. Second, improve our core check businesses. Third, significantly reduce our cost and expenses across the business with a strong focus on our shared-services functions. Fourth, continue to pay down our debt and generate strong cash flow. And finally, execute and deliver on our revised earnings commitment. I will provide the detail road map, but first, Terry will cover the financials.

Thanks, Lee. I'll begin with second quarter's results. Earlier today, we reported a loss per share for the second quarter of $0.05, which was slightly favorable to the guidance we issued on June 30th. Results for the quarter included the impact of a pretax, noncash asset impairment loss of $45 million, or $0.57 per share for the abandonment of a software project related to our order capture, billing and pricing systems. In the second quarter of 2005, we reported earnings-per-share of $0.83, which including one-time benefits of $0.15 per share for contract termination payments. Additionally, revenue declines in our personal check businesses, financial services and Direct Checks, contributed to lower earnings.

We also continued to incur expenses related to executing our growth plans in Small Business Services and we had higher manufacturing costs, as we closed two former NEBS facilities in the quarter and worked to achieve efficiency targets. Partially offsetting these factors were lower performance based compensation, lower amortizations and additional integration synergies from our 2004 acquisition of NEBS. Companywide, revenue was down 7% to $403 million. Revenue in our Small Business Services segment increased 4%, or $9 million compared to last year, due to a larger volume of orders, as well as higher revenue per order. But the increase was offset by lower revenue per order in financial services, contract termination payments of $12 million in 2005 and lower volume in Direct Checks. Financial service's order volume was down less than 1%, compared to the second quarter of last year and was up 3%, compared to last quarter, reflecting the impact of recent client wins. Gross margins for the quarter were 62.3% of revenue, down 3.1 percentage points from the previous year. The primary contributor to the decline was the impact of lower prices, including the effect of an unfavorable shift in product mix and financial services. Additionally, 2005's gross margin was positively impacted 1.1 points by the contract termination payments.

Finally, higher delivery in facility-related closure costs in SDS, along with bringing in-house the sourcing of some lower products for our safeguard distributors, contributed to the decrease. Selling, general and administrative expense was down $6 million. Higher costs associated with executing the SBS growth plan were offset by lower performance-based compensation, lower amortization expense and synergies from the NEBS integration. As a percentage of revenue, SG&A increased to 48.6%, compared to 46.5% last year, due primarily to lower revenue in Financial Services and Direct Checks. As a result of these factors, along with the $45 million asset impairment loss, our operating income was $10 million.

Now, I will move on to the quarter's results in each of our three business segments. We continue to see growth in Small Business Services. Revenue in this segment was up $9 million or 4%. The key reasons for the growth were: new customers that is come through our financial institution referral program called Deluxe Business Advantage or DBA, progress against our wallet share strategy where we are focused on selling more products and services to our existing customers and bringing in house the sourcing of some products for our safeguard distributors. We continue to refine our growth initiatives and anticipate mid single-digit revenue growth for the remainder of the year. Lee will provide details on some of our strategies in a few minutes.

Operating income for the quarter decreased to $1 million from $22 million in 2005. The biggest driver is that $18 million of the overall $45 million asset-impairment loss was related to this segment. I've already mention that costs related to our revenue growth, as well as higher manufacturing costs, affected SPS's results. Our CustomerCare Organization continues to hire and train to accommodate additional volume from our Deluxe Business Advantage program and the addition of new financial institution business. We've also increased our sales force as part of our integrated sales strategy. We expect to improve operating margin in Small BusinessServices over the longer term as we continue to leverage and refine the initiative we've launched to grow this business.

Now, I will move on to results within Financial Services. Revenue was $117 million, down 21.5%. The two most significant contributors were this year's lower prices and contract termination payments of $12 million in 2005. Prices were lower due to renewing contracts at lower prices, the loss of some higher margin volumes, an unfavorable shift in product mix and the effect of winning business at lower price levels. As I mentioned earlier, order volume was down less then 1% compared to last year, but is increased compared to each of the last three quarters. We expect to see our share of the FI channel grow this year, due to some recent business wins, and the beginning next quarter we expect to report year-over-year growth in order volumes. Financial Services had an operating loss of $7 million for the quarter, a decrease of $47 million from last year. The drivers of the decline were: the remaining $27 million of the asset-impairment loss related to this segment, the decline in prices and the contract termination payments in 2005.

And now for second quarter results in our direct to the consumer business, Direct Checks' revenue was down 13.1% to $53 million, due to a decline in unit volume, resulting primarily from the decline in personal check usage, lower response rates and lower reorder volumes. This resulted in a $4 million decline in operating income. We intend to modestly increase our advertising spend in the upcoming months as we strive to regain volume in this business. Lee will elaborate on this in a few moments. Looking at our balance sheet, total debt increased $45 million -- I'm sorry, total debt decreased $45 million from the end of 2005. Our debt was $1.1 billion at the end of the quarter. We will continue to pay down our debt in the last half of 2006 in the range of another 45 to $60 million, with the aim of improving our financial profile and overall financial strength and flexibility.

Looking at our cash flow statements, cash provided by operating activities for the first six months of the year increased $52 million to $101 million. The increase was due to a $51 million decrease in contract acquisition payments, performance-based compensation payments related to 2005's operating performance were lower and, also, the timing of medical and severance benefit payments which was $25 million favorable. This favorability will decline some throughout the year. These factors were partially offset by lower earnings. Capital expenditures were $28 million for the first six months of this year. We expect our capital spending in 2006 to be approximately $50 million as we invest in our SBS call-center expansion to handle anticipated revenue growth from our DBA program, strategic selling and cost reduction initiatives and other projects that will add capabilities and increased synergies primarily in manufacturing. Depreciation and amortization expense is expected to be nearly $85 million, including $34 million of acquisition-related amortization. In discontinued operations, we've sold a facility during the quarter and collected nearly $3 million while reporting a small gain. Next I will provide revenue and earnings guidance for the third quarter and the year.

We expect our third quarter revenue to range from $395 million to $405 million and diluted earnings-per-share to range from $0.41 to $0.45. On a full-year basis, revenue is expected to be between $1.63 billion and $1.65 billion, and diluted earnings-per-share, including the impact of the $0.57 asset-impairment loss recorded in the second quarter, is expected to be between $1.41 and $1.51. We expect operating cash flows to be between $195 million and $210 million for the year, up from $178 million reported in 2005 Despite lower earnings, the increase will be driven by a reduction of at least $40 million in contract acquisition payments, lower performance-based employee compensation payments and other working capital improvement. The reduction from our first quarter in our earnings guidance for the year reflects challenges in each of our three segments, although the majority is attributed to Small Business Services and Financial Services. Key factors contributing to the change are as follows: In SBS, while we are achieving revenue growth overall, the product mix is unfavorable and our overall growth rate is less then we had expected. We have reflected this trend in our guidance for the year. In addition, our manufacturing costs are higher than expected. We closed the remaining two printing facilities during the quarter, and in doing so, have found that it will take longer than expected to realize targeted efficiency rates because of product complexities. This is also led to higher delivery costs as we shift production between facilities.

The balance of the year will also reflect efforts to refine our SPS business model and the benefits of bringing more banks and branches on to our Deluxe Business Advantage program. Our Financial Services segment continues to report lower margins because of pricing pressure and an unfavorable shift in product mix. We have identified opportunities to simplify this business model and reduce its cost structure. Our outlook for the year reflects investments to start this work, as well as the unfavor revenue trends. Finally, our Direct Checks segment is experiencing lower reorder sales because of lengthening reorder cycles and lower retention rates. Our guidance for the year reflects these trends, a modest increase in our marketing spend, so we can regain market share lost in recent years. Before I conclude my prepared remarks, I would like to take a moment to address our announcement regarding the dividend change. Although our cash flows continue to be strong, it is important for us to improve our financial strength and flexibility in order to invest and achieve our longterm goal. Although the adjusted yield and payout ratio remains strong at the new level, the importance of the dividend to our many longterm shareholders weighed heavily in our decision-make process. I will join Lee in taking your questions in a few minutes, but first, I'll turn the call back to him.

Thank you, Terry. Before I discuss the hard work ahead of us, I want to publicly thank Terry for all his support and hard work, particularly over the last several weeks. Terry has been wearing multiple hats, any one of which, by itself, is a full-time responsibility. His ability to jump in and handle responses to our June 30th external release was invaluable to me and provided me the much-needed time to focus on building the foundational architecture for the road ahead. Terry has made the choice to continue in the interim CFO position, and then be a strong number two, in the role controller and chief accounting officer when we have a new CFO. As an aside, we are in the middle of that interviewing process right now.

I will begin my comments with a couple of questions that some people have asked me outright and others have thought about but probably chose not to vocalize. What have you found at Deluxe, and can we make the company great again? I will attempt to answer them by walking you through what I call the Deluxe enterprise strategic model that we're currently working very hard on. It starts with a focus on Deluxe at the enterprise level. Because as I remind my team, we have one stock price and not one for each business unit. This model drives clear focus and accountability down into the company with a management and financial architecture that generates revenue and provides a more cost-effective structure through a rigorous, cost and expense benchmarking and efficient destination framework and process. There will be clear accountability for who drives revenue and who drives cost of expenses. Our immediate and short term focus is on these key items: meeting our customers needs, building on our market-leading brands, simplifying our business models and processes, becoming easier to do business with, aggressively reducing our cost and expense structure and paying down our debt and generating strong cash flow. I will provide details on how we execute here shortly. Our short to medium-term focus will be on growing outside of our core, via adjacentcies, and in the longer term, we will focus on more transformational growth. We will leverage what I I believe are three of our key competitive enterprise advantages: integrated marketing, printing capabilities, and our relationships, both with financial institutions and millions of small business customers. Our operating model guiding principal also focus on five key areas: execution, clear accountability, simplification, speed and decison-making and a sense of urgency for change. Before I review our immediate short term focus actions, let me first frame the five key areas for our operating model. First, execution, which to me, simply means making commitments and then doing what it takes to ensure we get things done, whether that be, for example, in delivering something for a customer, a product program or a financial forecast. The second area of focus is in creating clear accountability. We will have a business model where it will be much easier to understand who does what, and then once agreed upon and aligned, I will hold people accountable to ensure things get done. Deluxe's collaborative culture is a positive. But we must balance collaboration with speed, execution and clear accountability. The third area is simplifying our business. This includes simplifying our business model so we become easier to do business with for our customers. Areas for simplification include: product rationalization, streamline the electronic channels and easily supported and maintained infrastructure, and finally, simplified processes and a shared-services infrastructure, both of which increase standardization, target achieving benchmarks and allow for faster decision-making as we head towards the efficient destination within each functional area. The fourth area is speed and decision-making. Both the speed at which the world is moving and the maturity of our core product demands that we act decisively. The fifth area is in improving our sense of urgency for change. This area is tightly linked with speed and decision-making in that we must act quickly and that we must quickly identify areas and initiatives likely to provide benefits, assign resources to drive results as quickly as possible and embrace change to achieve the ambitious goals we will be setting for ourselves. Having covered the five guiding principles of our operating model, I'm now going to review our key immediate to short term performance improvement action. Starting with Small Business Services, we need to refine or sharpen our focus. Our strategies of acquiring and retaining customers and driving wallet share, both of which positively progressed again in the second quarter, will be further enhanced and improved by applying data analitics and performance tools to tier customers and optimize our contact strategy. While these strategies remain our key area of focus areas, we also will be refining our go-to-market sales and marketing strategy. It is critical right now that we sync up the level and pace of investment with results in growth. Furthermore, we will be consolidating brands and multiple channels to leverage our broad product breadth, as well as further integrating Sales and Marketing within Small Business Services and Financial Services. We also will look to prune current product platforms to allow us to focus on products and services that move the needle more quickly. As I mentioned at the very beginning of the call, we must absolutely improve our core check businesses. For Financial Services we must simplify our processes to better meet the needs of our customers, take complexity out of the business and reduce our cost and expense structure. It all starts with business-model simplification, including streamlining our call center and check fulfillingment activities, redesigning services into standardized flexible modules, eliminating multiple systems and work [inaudible] and strengthening our go-to-market capabilities and processes by applying lean principals. A plus in our Financial Services segment is that we will build on the momentum right now from all-time high retention rates, higher acquisition rates and the recent successful onboarding of US Bank, additional branches at Citibank, and other financial institutions as we continue to focus on reducing external complexity to meet the changing demands of our customers. In Direct Checks, our direct to consumer check business, over the last several years the industry has struggled with response rates and promotional costs. In the process, we have overlooked opportunities in this business. We will address these challenges by making modest marketing investments to drive top line performance improvement. We believe these actions will help slow the rate of natural consumer-driven check decline and, actually, allow us to gain share in this important direct-to-consumer channel. As we execute on the plans I have just outlined over the immediate to short term time frame, we see opportunities to grow outside of the core via adjacentcy. The key to growth will be leveraging Deluxe's strengths in integrated marketing, printing capabilities and our relationships across the enterprise. I will now try to give a little more color in each of our three business segments. In Small Business Services, we see opportunities to extend our current portfolio through new products and services like custom full-color digital and web-to-print printing and promotional products, as well as targeting vertical segmentation. In Financial Services, we recently completed some rigorous financial institution client surveys to validate some of our new products and services that we believe will strengthen relationships that financial institutions have with their customers. For example, we will continue to work with the Knowledge Exchange series, the elements of which develop solutions to meet issues most critical to financial institutions. We see opportunities to help financial institutions grow their business with solutions to provide proven results to acquire, retain and grow market share. An example would be the welcome home tool kit, which has invariably improved financial institutions customer loyalty, retention and cross-selling effectiveness. In Direct Checks, we see opportunities to offer their business customers more products through improved call-center processes. In addition to these actions in each of our segments, there is a significant opportunity to reduce our cost and expenses across the business with the strong focus on our shared-services functions, as well as our go-to-market processes. These functions include: manufacturing, supply chain, information technology, finance, real estate and human resources, as well as our sales and marketing organizations. Previously, many of these functions were both embedded directly in the businesses, as well as at the corporate level. We have now completed the work of identifying where all the functions are in the enterprise and how much their total cost is, and we are aligning them to outside stringent benchmarks, as well as putting them on a road map toward their efficient destination. To give some further color and examples: In our manufacturing and supply chain areas, the supply chain has new leadership, and these teams are creating much stronger linkage, opportunities to improve sourcing, SKU reduction, product standardization, order fulfillment realignment and also, reduce indirect spending. As an example, our centralized supply chain resources are involved in only approximately 25% of our indirect spend today. So there's opportunity to expand our coverage and our focus across the whole enterprise. For information technology, which represents a very large area of opportunity for us, for both process improvement and cost reductions, we will better standardize our applications, lower the cost of our data centers, eliminate and/or improve our main frame and server utilization and reduce the cost of our networking and voice communications. For finance, we will be further standardizing our internal processes in reporting, adopting best practices, reducing redundancies and increasing efficiencies, while ensuring we maintain the strong internal controls and processes already in place. For real estate, because it is all about assett utilization, we will take advantage of the strong approach to lien by reducing capacity where feasible, enforcing space standards and more efficiently managing and aggressively disposing of vacant facilities. Moving on to sales and marketing for SBS and Financial Services. Currently, our sales people, call centers and marketing are more segmented by business unit, and therefore, we see opportunities to simplify our sales process, leverage our people more efficiently and effectively, generate significant expense savings, make it easier for our financial institution clients and small-business customers to do business with us,and in the process, become easier to do business with ourselves. Within human resources, we'll continue to refine our model and work to attract and retain the talent needed to drive our strategy. We also know that even though unpopular at times, we have to ensure that our whole benefit's program is in line with our competition in the market and make the tough decisions that's necessary. An example of an extremely tough decision recently, although very common in today's marketplace, is our modification of our retireee medical benefits plan to ensure our plan and result in cost, were in line with current market practices. Using current 2006 total year guidance as a baseline, the total of what I've outlined or highlighted thus far as far as costs and expense reduction opportunities, is approximately $150 million that we expect to take out of the business by the end of 2008 net of required investments. It is important to note that you should not simply add this total to our current earnings guidance over the next two and a half years, as there will be some offsetting affects due to concessions, and imprint material and delivery increases, to name a few. You should also not expect these reductions to be linear through the period, as there will be an investment and then a ramp-up that will occur. Before moving on to your questions, I will recap by posing some questions that may be on your mind. Am I glad I came to Deluxe? Absolutely. Do we have significant challenges facing us? Definitely. As you can see from my comments, we have a lot of hard work ahead of us. But the good news is, is that we are finding a lot of areas for tangible, short-term improvement, and I am confident there will be much more to come. I am also encouraged by our numerous competitive strengths, including market-leading brands, strong integrated marketing and printing capabilities and the like. But the thing that I'm most excited about, an energised, passionate and enthusiastic group of employees that know we need to change and want to be part of moving Deluxe into the future. We also know that our credibility is on the line and that we have to start delivering consistently-improved financial performance every quarter. We believe that we are working on the right issues and that if we start to execute better, we will gain momentum, improve our operational and financial performance, improve credibility and position ourselves to take steps, once again, to becoming a great company. Operator, now Terry and I will take your questions.

[OPERATOR INSTRUCTIONS] Our first question will come from the line of John Kraft of D.A. Davidson. Please, go ahead.

Hi, Lee and Terry.

Hi, John.

You guys have your work cut out for you, clearly. The $150 million in cost-structure reductions that you're talking about, Lee, you said it's not linear. Do you have a goal for 2007, and as far as, additionally, what sort of idea -- What sort of required investment are you thinking it would require?

John, I'll tell you, if I kind of frame where we're at in the process right now is -- I'm very confident we've identified $150 million that we can take out. What we're working really hard on right now and I guess the way I would frame it is that we've really -- We've got a lot of initiatives going right now, and I would say everything pretty much inside of Deluxe right now is under review. And, so, the challenge we're trying to figure out exactly how this going to flow out, is that we've got some investments in certain areas that will give us reductions and then investments in other areas that are dependent on some of the pieces as we try to frame and get the cost reductions out. We know we owe you that, and we know that over time we'll try to come out with a quarterly perspective on how we're performing against that. We're going to try real hard to in the future be able to give you some framing on how better to think about it. But right now, John, the challenge that I have is because I have so many moving parts that I'm trying to figure out exact dependencies and when they'll play out as far as investments and cost takeout, I really can't nail down a clear view and clearly, this is something Terry and I talked about and knew would come up on the call. But, probably, at this point in time the best I'm going to be able to do in terms of trying to frame that out. To the second point in your question, John. The way we're looking at it is, we've framed in the both in what we expect to spend on capital in the $50 million for the year. That thinking is framed in the net $150 that we've got out there, as well as other investments that we need to make and other actions that we're going to have to take in effect, to net that all together. So, it's really a total framing exercise and that's really the way I--Terry and I really prefer to look at it at this point.

That's fair, and I know you will let us know as you get more information. The second question about the debt, you said that in Q4 you'll pay down, what, 40 or 50 or something, you said. Obviously, there's a [traunch] due in September, I believe. I guess I'm thinking more about '07. You have a bigger [traunch] due in '07. Do you have an idea of whether or not or how much you'll be able to pay down in '07?

John, I'm sorry. John, this is Terry. We do have the $50 million that is coming due now in September, which we'll likely satisfy that obligation with our current resources, both cash flow, as well as availability in our credit line. Regarding the 2007 maturities, we do have a number of option that we believe we have available to us and we continually evaluate our best options for our debt that is outstanding, and we will certainly, as we start to move closer to those maturities, we'll start to announce more publicly what our plans are in terms of how we plan to satisfy that debt obligation.

John, this is Lee, again. I'll just add to Terry's comments. I've been very impressed with the treasury function here and with Terry's leadership and just getting the team rallied around. What our capital structure looks likes right now, obviously, John, all the things we've got in the gates ahead that we've got to get ourself through, and I believe we athought very clearly through and we have -- I think we have a lot of alternatives that are available to us, and what we're trying to do is keep flexible and think flexible as we try to work through that process.

Okay. Good enough. Thanks.

Thank you, John.

[ Operator ] Thank you. And our next question will come from the line of Phillip Olesen of UBS. Please, go ahead.

Thanks. It's actually just a bit of a follow-up question. I think the market would probably like a lot more insight into your current thoughts as it pertainins to liquidity. I think there are growing concerns about your ability to address upcoming debt maturities, realizing that the '07 maturity is slightly more then a year away, but there seems to be a fair amount of execution risk as it pertains to the core operating strategy. So, realizing that you, maybe, haven't fully identified these specific actions, I think maybe you owe it to the market to provide us a little bit more insight as to what your current thoughts are. What are those options opened to you? And at what point in time do you think you'll be in a position to actually start to execute on some of those options?

Phillip, this is Terry. You know, we have strong confidence in our cash flows. The guidance that we put out this year is $195 to $210 million. That's up from $178 million that we did generate last year. So, we still have an enormous confidence in our cash flow generation ability. We also still believe that we have numerous options available to us, and as we start to firm up our cash flow numbers for next year and what we'll be generating there, we believe we will have the information and we'll be able to have the options to go after the most attractive source for satisfying that obligation. But, again, we still see continually strong cash flows coming from this business and that provides us with, we believe, a number of options.

I guess juat as a follow-up then, it sounds like the articulation of the plan is probably not something that you'd be prepared to do until next year? Is that fair? Once you get a better sense of what your '07 business plan looks like?

Certainly, we'll provide the appropriate information when we have more information to share. It's nothing we'll hold back, but certainly, as we start to fine-tune our plans and such for next year, we would expect that we'd have more information to share with the public.

Phillip, this is Lee. I think you got a very fair question. I think the way to think about where Terry and I are at right now is that we have a number of initiatives in play, and I would say we have a lot of confidence in what we're doing right now and what we've laid out on the table here. What we're trying - as far as the reductions and where we're going from a financing standpoint. What we're trying to do a good job of right now is really being thoughtful about what are our best alternatives. And then, like I said, I've seen the treasury function here hustling very quite well right now. And I think as we get through another -- put another quarter under our belt and get into the fourth quarter as we start framing guidance for 2007 at that time, clearly we're going to be working these issues, and we'll have ourselves better lined up. But I think the important take-away today is we're confident that the cash flow numbers that we're putting out there right now for the balance of the year and options and alternatives we have available for ourself are positive for us.

Okay. If I can sneak in one more question, for you, Lee. In the prepared remarks, you talked about short-term growth focus, maybe expanding into adjacent markets, and you laid out some of the options there. You also mentioned longer term, the focus is on transformational growth opportunities. I would love, maybe, some insight into where you see those opportunities currently.

Phillip, right now, being very honest with you, clearly, what I'm riveting the whole Deluxe team right now on is our short and medium-term performance. I think what we clearly laid out and provided some examples for short term what we're doing -- And there's some really exciting things, short and medium-term we could focus on. The challenge right now is we have to start delivering and start performing shorter term. I think if we do that, we start executing over the next ten quarters or so, the opportunities are going to open themselves up for us to build off of things that we're doing on the current actions that we have and then, also, lead to more, what I call more transformational growth things, are going to really start to play out. Clearly, I came in here with some ideas on what I thought we could do, and we're going to get into those over the longer term. Right now, our clear focus has to be on the next eight to ten quarters or so on delivering the short term initiatives, what I call the short and medium-term initiatives that we really need to get done to get this business back where it needs to be and really performing and starting to, hopefully, get some topline growth there and moving more, again, toward that transformational growth space. When we're ready to do that, Phillip, we'll start putting things more out there. Right now it would purely be a distraction for us, and it would take away from the focus that we have.

Thanks a lot.

[ Operator ] Thank you. And our next question will come from the line of John Patrick Walsh of Wachovia Securities. Please, go ahead.

Yes. A couple of things, I guess one of the things I wanted to get a better sense of and kind of address already. The $150 million in cost savings in terms of how you're thinking about that relative to the SG&A line, what kind of break down between the two do you expect there? And I guess to the extent that you're going to reign in some of your SG&A, obviously, that's a kind of reversal strategy from the prior management team. Those guys were kind of thinking the investments they're making, they were going to result in better topline growth back half of the year. Just trying to get a sense from you as to how much that potentially could negatively impact the topline plan for the company as you pull back the SG&A investments.

Let me try to address your question in a couple of questions within that. I think, obviously, they are good questions here. As far as what I call geography on the P&L as far as where is the savings going to come out as far as the $150 million, wether tha's in the COGS line or in the SG&A line, right now, what we're really focused on, John, is, again, getting that total bucket of opportunities framed as best we possibly can. And we haven't yet completely concerned ourself, I guess, is a fair word, with how much of that actually goes into the costline and how much of that actually goes into the SG&A line. I mean, clearly, John, the trend is going to be that we're going to have a lower SG&A structure over time. I can tell you that. But as far as trying to be specific at this point in time of how much is cost and how much is SG&A, we just haven't gotten that. The important thing right now for us is to really nail down that 150, make sure we understand it's solid and then go to work on executing to make that happen. So, that's how I would frame it.

Okay. And I guess, also, you mentioned the potential for some topline benefit around the US Bank coming on board. Could you give us a sense of what type of revenue we might be able to expect there incrementally and then, also, if I understand you guys are kind of bidding out for the [Goldman] West contract related to Wachovia Securities, and how are those discussions going? Are you still in the running for that contract there as well?

John, first of all, to address your question on previous management and I want to make sure I cover this clearly. I am not trying to, what I would call, dislodge the strategy that we had that I think Rich and his team are beginning to execute better and better as far as putting investment dollars into our Small Business Services group. We're actually doing that right now, and we'll continue to do that. There's an opportunity, John, to get smarter and sharpen the focus on how we do it. And what we have to be able to do internally and then be able to eventually get out externally and share in the marketplace is, when we put a dollar of SG&A into the business and that business, how much will that drive in terms of topline revenue growth? We've got to get ourself smarter and smarter and this is what I mean by sharpening the focus, to be able to really identify that and how effectively we do that because that will provide, obviously, return on the business and, obviously, a return for shareholders as well. So, that piece is probably the most important part. As far as US Bank, and you mentioned Wachovia, I would frame it best, John, by saying we're not going to get into specific dollars, and we've got guidelines when we deal with banks and take deals in terms of what we can and can't share, and I will simply say that the US Bank deal is going quite well right now. And I have had the opportunity to meet several of the top leaders at US Bank, and they just share our enthusiasm and the great partnering that we have today, and I'm very proud of my sales team and everybody that's worked this account. When you go in there and meet these people and you see the smiles on their face, it's pretty impressive. As far as the comment around Wachovia, I will simply leave it as: We're, obviously, still in the running there and we're very interested in winning that business.

Okay. Last question. You had indicated you shut down a couple of facilities during the quarter. What's your expectation for the back half of the year in terms of how many additional facilities might be shut down and any potential cash charges around those potential closures?

Right now, I think there's three vacant facilities that we have, and we have not built any guidance, any gains or dales, in effect, John, into the guidance that we have out on the street right now.

Okay. Thank you very much.

Thank you, John.

[ Operator ] Our next question will come from the line of Mike Hamillton of RBC Dain. Please, go ahead.

Good morning.

Good morning, Mike.

Could you speak broadly to what you see as the challenges in getting the Deluxe culture where you want it and what think you're going to need to address in that line?

I'll tell you, Mike, coming in here, one of the things that attracted me to Deluxe was the Deluxe way-share values, and I found that people really live the values here, or they try to live the values, and if you come to any of our facilities, they're well highlighted in terms of the facility, and well-defined and, I think, well-taken by employees. And what I would argue right now is, I'm not going to change the Deluxe way-share values. I like them. I think they're great for us. I think the way to think about it is, the devil's always in the details, Mike, and if you think about the, for example, the honesty and integrity way-shared value, I think you got to put it in the context of - I keep telling people that colaboration is great. We're a very colaborative company, but sometimes it's okay to put an issue in the middle of the table and have good dialogue and banter around it. In effect, if you don't do that, then you can look at that first way-shared value and say, am I really having honesty and integrity in the way I'm approaching that particular challenge or issue our whatever. So, it's just reminding them of the great values that we have, which I believe in and really tweaking them and just getting people framed and more focused around it. The other thing that I laid out on the operating principals is, I think they're suplemental, Mike, to the way-share values. If you dig underneath the details of the way-share values, you'll find words like "Accountability" and you find words of execution. We just need to draw those out here a little bit more, and I'm not trying to imply that Deluxeers don't want to execute and don't want to be accountable, but I think it is just pinching them and making sure that they understand that in order to really execute well and deliver what we need to do in the future better, we just got to make sure that those things bubble up to the surface a little bit better. I'm very proud of the way we operate and the shared values. I think they're terrific.

Could you give us a walk-through of '07 on the FI side in terms of timing of any major contracts that are going to be rolling out? Contracts that you hold currently?

I guess the way I would look at it right now is that we're -- I think we mentioned on the last call, Mike, that the US Bank contract went on-line in March and is starting to roll-out. We mentioned on the call here today that we have additional Citibank branches that we've now taken onboard, and they've started late in the second quarter. And as far as where we're heading, we don't anticipate going into the second half of the year and into next year, a significant amount of new acquisition or new renewal opportunities. It doesn't mean there's not some out there. John, mentioned that Wachovia is one of them, but the amount, Mike, is less then some of the ones as far as the big opportunities, are less then what we've seen.

I mean more from the standpoint of what you're on now that's coming up for rebid.

I'm not sure I follow the question.

Current business that is going to be up for rebid in '07.

I think the only significant one really that's out there right now is Washington mutual. That would be the only one.

Fair enough. Thank you.

Thank you, Mike.

[ Operator ] Thank you. The next question will come from the line of Lori [Bilker] of Dillon Reed Capital Management. Please, go ahead.

Hi. A couple questions. First, I think you said this separately from the whole $150 million plan, and I think you've said it in past quarters is that you're adding additional marketing spend into Direct Checks. Number one, is that separate, and how much do you guys think that will be in the next several quarters?

Lori, this is Lee. Actually, on the current comments, prepared comments, we did mention that we're going to add some modest investments and marketing in the Direct Checks business, and that has already, Lori, included in the guidance that we provided as far as anything that we would do this year and we are planning on spend yet this year.

Okay. And then, also, can you just discuss the, what discussions you've had with rating agencies since the announcement on June 30th with S&P downgrading you and [inaudible] keeping you on review and as well as Moody's putting you on review?

Lori, this is Terry. I'll take that question. We have had regular discussions with both of the rating agencies both S&P and Moody's, and we've talked to them about our strategies. We're still focused on growing our SPS segment of the business. We're still focused on gaining our share in our financial institution segment, and we've talked to them about our focus on taking costs out of the business and continuing to generate strong cash flows. So, we've had dialogue along those lines, and we'll be continuing on with our dialogue, certainly, over the upcoming months here.

Okay. Thanks.

Thank you, Lori.

Thanks, Lori.

[ Operator ] Thank you, our next question comes from the line of Hardin Bethea of DePrince, Race and Zollo. Please, go ahead.

Hi, guys.

Good morning, Hardin.

One question, again, I know you're going to get a lot of these on the cost-savings target. But you said using '06 guidance as a baseline, I guess, what part of '06 guidance or -- If I back into operating income, excluding the nonrecurring impairment charge, is that what I'm supposed to use as a baseline?

That's exactly it, Hardin. That gives you a rough order of magnitude.

And then, just to be clear, Lee, on your expectations for realization of this goal over the time frame you've indicated. In your comments related to the segment results or segment performance going forward, I think there was an indication that the guidance might include some spending in the second half of '06 without a benefit. Can you identify that spending in particular?

Hardin, you're absolutely right. That's the way I laid it out. We're planning on levels of investments in the second half of 2006, which is included in our current guidance in order to help us to generate that collective $150 million over the next two and a half years. So, as far as identifying something specific, I'm not prepared to share that at this point in time other then to say that if you look back at the initiatives that I laid out in the places, and think of it in terms of areas that I think we can get growth, and some of those were mentioned. For example, Lori just asked about the Direct Checks business. We put that investment in. Areas where we think we can get cost out through the words around complexity, reduction and simplification and process improve. We assigned some level of investment across the enterprise to make sure we're able to get those benefits in terms of the costs that we expect to take out. So, the best way to frame it, I think, is to think that currently, baked into the guidance that we've given for the second half of the year is exactly that -- Those investments that are going to help us longterm to get at the 150.

Is it fair to assume the cost of those initiatives are greater then the benefits in '06?

I'm not prepared to answer that at this point.

Okay. And then, I guess the follow-up question would be unrelated, but, asset sales or potential real estate transactions, can you kind of identify what opportunities there is to monetize those assets?

Hardin, I think the way to think about it, again, as I mentioned we have three current vacant facilities that my real estate head is working very hard to dispose of, and those are on the radar at this point in time. and I also mentioned -- I think there are some opportunities here to prune, I use the words "prune" because it doesn't mean get rid of everything because I don't believe that's needed here, but there are some pruning opportunities as we look top-to-bottom in all of the products and service that we have out in the marketplace. And at this point in time, we're going through that exercise to really frame which once are the keepers, so to speak, and which ones are at the bottom end where if we put a little more investment in them, the ones, again I use the words "Move the needle" allow us to drive more topline revenue growth more quickly, and if I get rid of some of the distractions, and if those distractions take complexity out of the business, then that's going to help us a lot. So, that's the best way I would frame it at this point.

Is that it, Mr. Bethea?

Yes. Thank you.

[ Operator ] Thank you. Our next question will come from the line of Earl Fisher of SFE Investment. Please, go ahead.

Hello, Terry. It was nice of you to see us a couple of weeks ago. Mr. Schram, you've been complementing Terry rather correctly, I think. But what I get nervous is about is, you've only be there a couple of months, and Terry's been, maybe, two or three years, and why don't you just make it attractive for him this to stay on as your CFO? That's very important, I think, because I don't want to be listening to another talk of two new people next time. Next question I have, and then I'll sit back and listen is, how much of a pay-down are we talking about coming in 2007 that you have to do with your loan? I'll sit back and wait. Thanks.

Earl, this is Terry. Regarding the pay-down. The maturity for 2007 is $325 million. That's coming due in the early part of fourth quarter for the year. That's your earlier part. I do appreciate your support and comments around my capabilities as the interim CFO here. As Lee mentioned, I think I also talked to you a little bit about, I really have made the decision, more from a personal standpoint then professional, but again, I do thank you for your support.

Earl, the other comment I would have for you, I would say, I have a lot of confidence in Terry, and even when we get the CFO in here, whoever he or she may be, Terry will continue to sit on my executive leadership team. And he adds great insight, and he'll be a big part of our process going forward, and I'm excited about that.

As I told you earlier, Earl, I'm not planning on going anywhere. So, I'll still be here.

Okay. Thanks, guys.

We have time for one more question.

[ Operator ] Thank you. Our final question will come from the line of Gregory [Chawako] from Goldman Sachs. Please, go ahead.

Thanks, I made it just under the wire here it seems like. I was just hoping on a follow-up with regard to the $325 million coming due next year. I was wondering if there's any covenants in the credit facilities, which we should be aware of that would, potentially, make those facilities unavailable? And if you could give any color with regards to whether you're holding any conversations with your lenders and any impact that the agency actions might have with those conversations with your lenders.

I'll go ahead and take that, Greg. The only financial covenant that we have is with our two credit facilities, the aggregate $50 million of available credit. And the one financial covenant is an EBIDT to coverage ratio of 3:1. And we are still well above that threshold right now and expect to remain in compliance with that covenant. Regarding our discussions, we have discussions regularly with our lending group and our lead bank in that group. So, we do talk about plans and needs and such on a regular basis with them. So, our communication is constant.

Okay. And rating agencies and thoughts from that perspective as it relates to the lenders, are they keying in on that at all? Is there any discussion related to what the agencies might decide to do?

We've had some preliminary discussions with the rating agencies, and I think as both have indicated in their external releases, they both are reviewing the facts and circumstances and certainly, they'll be having more information to review following this announcement. But that will be ongoing quite a bit throughout the next month or so.

Okay. And then just a quick follow-up. Given that the EBIT to interest is a covenant and given that the 2.75 coupon paper of $50 million is coming due now in September and then you have the 3.5% coupon in the '07, ho will that impact your interest costs? Will you still have a large amount of room with regards to that EBIT to interest measure? What do you expect your interest cost to be going forward as it relates to relative to those two coupon payments?

Certainly both of those facilities are very favorable rates to us, especially in light of current market rates. So, to the extent that we, again, as we stated earlier, we're focused on paying down the debt as well. There will be some offset to the higher rates, just because we'll have lower debt amount outstanding. So, we've certainly factored that into both the guidance that we provided and as we begin to look at 2007.

Great. Thank you, very much.

Thank you, Greg. And thank you, Operator. Let me just close with a few words. I think as you can tell, we're very energized and passionate about attacking the challenges that we have ahead of us right now. I would say that every process and area is under thorough review right now inside of Deluxe. And the way I would frame it is, we're gathering and getting it all the data. We're listening to it. And then we're putting aggressive improvement action plans in place. At this point, I think it's all about refining the Small Business Services strategy, improving the core check businesses, taking cost and expense out of the company, paying down debt and generating strong cash flow and executing and delivering against our commitments. I really thank you for your participation and questions today. And we're going to get back to work and we'll be back to provide a progress report to you at the end of the third quarter . And now, Terry's going to wrap up with the replay information.

Thank you, Lee. This is a reminder, that a replay of this call will be available until August 3rd by dialing 320-365-3844. When instructed, provide the access code 834563. The audio presentation and the accompanying slides are archived in the Investor Relations section of Deluxe's website. www.deluxe.com. Again, thank you for join us. Have a good afternoon.

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