Deluxe Corp (DLX) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Deluxe Corporation third-quarter earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to Terry Peterson. Please go ahead.

Thank you, Mary. Welcome to Deluxe Corporation's 2006 third-quarter earnings conference call. I'm Terry Peterson, Deluxe's Vice President of Investor Relations and Chief Accounting Officer. Joining me on the call today are Lee Schram, Deluxe's Chief Executive Officer, and Rick Greene, Deluxe's Chief Financial Officer. Lee, Rick, and I will take questions from analysts after the prepared comments. At that time, the operator will instruct you how to ask a question.

In accordance with Regulation FD, this call is open 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 management's 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-Q for the quarter ended June 30, 2006.

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 posted on our website, www.Deluxe.com, in the Investor Relations section. It was also furnished to the SEC on Form 8-K filed this morning. In particular, any non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release.

Now, I will turn the call over to Lee Schram, Deluxe's CEO.

Thank you, Terry. Good morning, everyone. We are pleased with our third-quarter financial performance as a first step in our journey in transforming Deluxe. Clearly, the blueprint that I outlined on our second-quarter earnings call is beginning to take hold. But we are in the early stages of our improvement plan, and we still have much work to do.

Since last quarter's call, I have spent considerable time meeting with employees, customers, key suppliers, bankers, and investors, continuing to learn about Deluxe and sharing our operational and strategic direction. Although these groups represent a variety of viewpoints, I walked away from every meeting energized by the consistency in feedback -- confirmation that our roadmap is the right one, that there are growth opportunities to pursue, that we can take on necessary cost and expense out of the business, and that we are investing in initiatives that our customers will value and that will ensure a successful future.

In the third quarter, we made progress in each of the five areas highlighted in our last call, including -- first, improving our core check businesses by retaining key clients, continuing to increase our new acquisition rate and starting the process simplification work; second, sharpening our focus and our small-business services strategy, where on a comparable days in a quarter basis, we showed the largest quarterly revenue increase since we acquired NEBS two years ago; third, starting to reduce our costs and expenses across the business with a strong focus on our shared services functions; fourth, continuing to increase cash flow and pay down debt with stronger performance than anticipated; and finally, executing and delivering on our revised earnings commitments.

I am also very pleased to have Rick Greene join our executive leadership team as our new CFO. Rick's strong operational and strategic skill sets will be instrumental in helping us lay the financial architecture to transform Deluxe.

I also want to publicly thank Terry Peterson for all his support and hard work as Interim CFO, and I am thrilled that he will continue in his current role as Controller and Chief Accounting Officer. In addition, Terry has agreed to head up Investor Relations, a key function he has also been leading on an interim basis.

I will discuss further in a few minutes more details around our current progress and next steps. But first, Rick will cover the financials.

Thanks, Lee. I'm very pleased to join you today to provide the details of our third-quarter performance. My first few weeks on the job have truly reaffirmed a number of the key attributes that attracted me to Deluxe, including the Company's strong reputation, its leading brands, and an enthusiastic workforce that is embracing change and improving performance. I look forward to being an integral part of the leadership team as we continue to accelerate Deluxe's transformation.

Earlier today, we reported earnings per share for the third quarter of $0.61, which was $0.16 favorable to the top end of the guidance we issued last quarter. As we stated in the earnings release, our results reflect better-than-expected operating performance in all three of our businesses, primarily related to lower than anticipated manufacturing costs as we began to realize efficiencies from prior plant closures sooner than expected.

Our SG&A expenses were also lower than expected, primarily in IT. Lastly, EPS benefited from a $0.06 per share contribution due to a lower tax rate related to onetime adjustments. On a full year basis, we expect our effective tax rate to be 33% for 2006.

In addition, our third-quarter performance resulted in better-than-expected operating cash flow. Stronger earnings combined with improved balance sheet management led to operating cash flow of $71 million for the quarter and debt paydown of $58 million.

In the third quarter of 2005, we reported earnings per share of $0.73. The primary contributors to the lower earnings year-over-year were revenue declines in our personal check businesses, more specifically, lower revenue per order in financial services and lower volume in direct checks. These are trends that have continued from recent quarters.

Companywide, revenue totaled $398 million, down 3.6% from 2005. Revenue in our small-business services segment increased 3.1% or $7 million compared to last year due to higher revenue per order. But, this increase was offset by the previously-mentioned declines in our personal check businesses.

Financial services order volume was up 4.1% compared to the third quarter of last year, the first time since the fourth quarter of 2003 that this segment has reported a year-over-year increase in order volume. Order volume in this segment was also up compared to each of the first two quarters of 2006 as we continue to benefit from incremental volume driven by recent client wins.

Gross margin for the quarter was 62.3% of revenue, down 1.4 percentage points from the previous year. The decline stems from the impact of lower revenue per order in financial services, including the effect of unfavorable shift in product mix and higher overall product delivery costs.

Selling, general and administrative expense was down $1 million. Higher customer care costs and commissions associated with increased volume in SBS and severance costs were more than offset by lower amortization expense and numerous cost savings. The most significant of which was from lower spending in IT.

As a percentage of revenue, SG&A increased to 48% compared to 46.5% last year due primarily to lower revenue in our personal checks businesses. As a result of these factors, operating income in the quarter was $57 million compared to $71 million last year.

Now, I will move on to some highlights in each of our three business segments. In small-business services, we continued to see growth. Revenue in this segment was up $7 million or 3.1%, driven by higher revenue per order and a higher number of first-time buyers. We estimate that because there was one less business day in the quarter compared to last year, our revenue growth in this business was negatively impacted by approximately 2 percentage points.

On a comparable number of days basis, this segment reported its largest growth year-over-year since we acquired NEBS more than two years ago. We continue to expect mid-single-digit revenue growth in the fourth quarter of this year.

Operating income in this segment increased to $25 million, up from $23 million in 2005. The increase was driven by revenue growth, lower marketing and manufacturing costs as well as lower amortization expense and numerous SG&A cost savings. As a percentage of revenue, operating margin for the quarter was 10.7%, up from 10.1% reported last year and a low of 5.1% reported in the first quarter of this year. We continue to leverage and refine the initiatives we have launched to grow our SBS segment.

Moving on to financial services, revenue was $114 million, down 9.5% due to lower revenue per order, partially offset by the increase in volume. Revenue per order continues to be lower due to winning and renewing contracts at lower price levels and an unfavorable shift in product mix. Our financial services segment reported operating income of $17 million for the quarter, a decrease of $11 million from last year.

In our direct-to-the-consumer business, direct checks revenue was down 16.7% to $50 million as a result of lower order volume. Volume in this segment is down primarily due to the decline in personal check usage, lower reorder volumes, and reduced advertising spend in recent quarters. This resulted in a $5 million decline in operating income. As we discussed on last quarter's call, we intend to modestly increase our advertising spend in the upcoming months as we work to regain volume in this business.

Turning now to the balance sheet. Other current assets decreased by $29 million from the end of 2005. Most of this decrease stems from our decision earlier in the year to reduce the level at which we pre-fund medical, dental and severance claims. Reductions in accounts receivable also contributed to the decline.

Other long-term assets decreased in the third quarter as we liquidated $5 million of Company-owned life insurance policies. Also, during the quarter, we sold another idle facility and recognized a small gain. We have also entered into agreements to sell the remaining two facilities currently held for sale and expect them to close in the fourth quarter.

Total debt has decreased $103 million from the end of 2005. Our debt was $1.1 billion at the end of the quarter. We plan to continue paying down our debt in the last quarter of 2006. And for the year, we expect the range to be $135 million to $145 million with the aim of improving our overall financial strength and flexibility.

Looking at our cash flow statement, cash provided by operating activities for the first nine months of the year increased $58 million to $172 million. The increase was due to a $51 million decrease in contract acquisition payments, lower performance-based compensation payments related to 2005's operating performance, the timing of medical and severance benefit payments which was $24 million favorable, lower income tax payments and other working capital improvements. These factors were partially offset by the lower earnings.

Capital expenditures were $34 million for the first nine months of the year. We expect our capital spending in 2006 to be approximately $45 million, driven by investments in our SBS call center expansion to handle anticipated revenue growth from our Deluxe Business Advantage program, strategic selling and cost reduction initiatives and other projects that will add capabilities and increase synergies, primarily in manufacturing. Depreciation and amortization expense for 2006 is expected to be approximately $85 million, including $34 million of acquisition-related amortization.

Looking ahead, we expect our fourth-quarter revenue to range from $418 million to $426 million and diluted earnings per share to range from $0.71 to $0.75. On a full year basis, this would result in revenue that is between $1.63 billion and $1.638 billion and diluted earnings per share of $1.74 to $1.78, including the impact of the $0.59 asset impairment loss we recorded in the second quarter. Our expectations for the year also reflect a $0.14 benefit from the sale of an underperforming outsourced payroll services contract in October.

We expect operating cash flows to range between $235 million and $245 million for the year, up from $178 million reported in 2005 despite lower earnings. The increase is driven by a reduction of at least $45 million in contract acquisition payments, lower performance-based employee compensation payments, and other working capital improvements.

Now for an update on our financing activity. In September, we paid off our $50 billion of 2.75% bonds with cash flow generated during the quarter. Our next debt maturity is in the fourth quarter of 2007 when $325 million of 3.5% bonds come due. We're developing a strategy to repay this obligation through a combination of cash flow generated from the operations of the business, availability on our existing credit facilities and some replacement funding.

Since our last call, Lee, Terry and I have met with numerous bankers, and we're confident that we have viable options for addressing the upcoming maturity. In addition, relationships with our existing bankers remain very good, and they have expressed strong interest in helping us with the partial refinancing.

To conclude my comments, I would like to congratulate Deluxe's treasury team for winning the 2006 Pinnacle Award in the strategy category earlier this month. The Pinnacle Award is sponsored by the Association for Financial Professionals and Wachovia Corporation and symbolizes excellence in treasury and finance.

I will join Lee and Terry in taking your questions in a few minutes. But first, I will turn the call back to Lee.

Thank you, Rick. I will begin my comments with an update on the Deluxe enterprise strategic model that I introduced on our second-quarter earnings call and that we are currently continuing to work on very hard.

As a reminder, it starts with a focus at Deluxe at the enterprise level. Because -- and as I keep reminding my team -- we have one stock price and not one for each business unit. It drives clear focus and accountability down into the Company with a financial and management architecture that generates revenue and provides a more cost-effective structure for a rigorous cost and expense benchmarking and efficient destination framework and process. There will be clear accountability for who drives revenue, cost and expenses.

Our immediate and short-term focus continues to be on our customers, our market-leading brands, simplifying our business models and processes, becoming easier to do business with, aggressively reducing costs and expenses and improving cash flow and paying down debt. We're focused on leveraging our three key competitive enterprise advantages -- integrative marketing; printing capabilities; and our customer relationships, both with financial institutions and millions of small businesses. We are also using our five core operating principles -- execution, clear accountability, simplification, speed in decision-making and a sense of urgency for change -- as our guidepost.

I would like to provide an update on progress on our immediate and short-term actions. First, at the enterprise level and then for each -- and then for each of our three segments. We made progress in the quarter, framing and building out a model to better integrate field sales, marketing and call centers across the entire organization as well as continued product standardization initiatives. We will complete this framing work in the fourth quarter and initiate execution plans.

In our small-business services segment, we continue to stay focused on acquiring and retaining customers and increasing our share of the $2000 spent annually by the average small business on products and services we offer. In the third quarter, on a comparable days in a quarter basis, we showed the largest quarterly revenue increase since we acquired NEBS two years ago. We improved our data analytics and performance tools and started to reduce some of our duplicative mailings. We also did more work in line with our strategy to capture more of the available $2000 wallet share I just mentioned by segmenting higher margin and higher growth opportunities from lower margin and lower growth opportunities.

In addition to higher margin check and form opportunities, we're focused on higher growth opportunities in retail, holiday cards, medical, promotional products, and custom full-color printing. As I indicated on our second-quarter earnings call, we see opportunities to extend our current portfolio through new products and services like custom, full-color, digital and Web-to-print printing.

Today, we announced that we acquired The Johnson Group and its affiliated companies. This exciting acquisition allows us to expand our footprint in the custom, full-color, digital and Web-to-print space for our small-business customers and also provides opportunities longer term across the enterprise, specifically with financial institutions in the literature management space.

We're simply thrilled to have found such a strategic partner. And we welcome The Johnson Group employees to the Deluxe family.

We further indicated that we would look to prune our lower margin current product platforms to allow us to again focus on products and services that move the needle more quickly. As Rick highlighted, we just completed in October the sale of an underperforming outsourced payroll services contract, which will help fund The Johnson Group acquisition.

In our financial services segment, we started the work of simplifying our processes and taking complexity out of the business, while reducing our cost and expense structure. We indicated that we would focus on streamlining our call centers and check fulfillment sites.

On August 17, we announced the closure of our Syracuse call center, which we expect to complete in the first quarter of 2007. We also initiated work on redesigning services into standardized modules, eliminating multiple system and work streams, reducing financial institution branch responsibilities and connectivity options, and strengthening our go-to-market capabilities and processes by applying lean principles.

We continue to have all-time high retention rates and higher acquisition rates. In addition, we retained the Washington Mutual business, increased the number of states at Wachovia and started to produce checks for BancorpSouth in early October. To help offset the decline in our core check business and build relevant solutions for the future for our financial institution clients, we initiated our first pilots for customer loyalty solutions using our integrated marketing capabilities as a differentiator for demand generation and marketing campaign management.

Also beginning in mid-October to improve the awareness of our new anti-fraud and security products, we're featuring our ID TheftBlock anti-fraud product on CNN's Airport Network. This provides great exposure at more than 2,000 locations in 44 of the nation's busiest airports, reaching a potential audience of nearly 22 million viewers.

Finally in direct checks, our direct-to-consumer check business, last quarter, we indicated that we would make modest marketing investments to improve direct checks' order volumes and revenue. During the third quarter, we executed an agreement that will secure increased marketing impressions with freestanding inserts starting early next year.

In addition to these actions in each of our segments, I would like to provide an update on the previously-announced cost and expense reduction initiative where we're targeting $150 million in savings by the end of 2008, net of required investments. Once again, the baseline for these anticipated savings is the annual guidance for 2006 that we provided on our second-quarter call.

As a reminder, the primary targeted functions for savings include our go-to-market sales and marketing; fulfillment including manufacturing of supply chain; and our shared-services infrastructure, including information technology, finance, human resources, and real estate. Again, our goal is to move these key functions closer to stringent benchmarks as well as putting them all on a roadmap toward their efficient destination.

Here is some further color on our progress. First, go-to-market sales and marketing, which represents approximately 15 to 20% of the $150 million. We brought resources together across all of our segments and framed the opportunity to leverage our people, processes and locations more effectively and efficiently to generate significant expense savings and to make it easier for our financial institution clients and small-business customers to do business with us.

Second, for fulfillment, which represents approximately 35 to 40% of the $150 million, we made progress in the quarter on lean initiatives, product standardization, improving our sourcing, SKU reduction and order fulfillment realignment. We were also able to initially get some cost reductions from centralizing and leveraging our indirect spend organization.

Finally, for shared-services infrastructure, which represents approximately 40 to 45% of the $150 million, we made progress in information technology, the area we expect to realize the greatest percentage of infrastructure savings in lowering our data center costs, improving mainframe and server utilization and reducing the cost of our networking and voice communications.

With much of the work still ahead of us, I am delighted that we have added Mike Degeneffe as our new CIO. Mike comes to Deluxe with considerable experience in transforming and integrating IT resources and systems to enterprise strategies. Mike's expertise will be invaluable as we continue to drive our IT cost structure lower and position IT strategically for the future.

For finance, we initially framed our opportunities around standardizing internal processes and reporting, adopting best practices, reducing redundancies and increasing efficiencies, while again ensuring we maintain the strong internal controls and processes already in place. For human resources, we started to refine our support model, strengthen our processes around attracting and retaining talent and continue to focus on ensuring our benefit structures are in line with competition.

For real estate, which is all about asset utilization, we indicated that we would more aggressively begin to dispose of vacant facilities. And in the quarter, we sold our Dallas facility. We're very close to selling both our vacant Pittsburgh and Peterborough facilities.

We will also benefit from the Syracuse call center closure as it helps us better align existing capacity with our needs. More opportunity exists to consolidate facilities and to enforce space standards. In total, roughly one-third of the $150 million will impact cost of goods sold and two-thirds SG&A.

As a reminder, it is important to note that there will be some offsetting effects to these cost and expense reductions due to continued pricing pressure and imprint material and delivery increases to name a few. Reductions will also not be linear through the period, as there will be investments and then more of a ramp-up that will occur.

As you can see from my comments, we made progress but we still have a lot of work ahead of us. The good news is that I am continuing to find a lot of areas to work on and that need improvement. I also continue to like our opportunities to better position our market leading brands, create stronger integrated marketing and printing capabilities. And every day, I am more excited about our energized, passionate and enthusiastic group of employees that know we need to continue to change and want to be part of positively moving Deluxe into the future.

We know that one quarter of positive improved results does not make a streak, that our credibility continues to be on the line and that we need to deliver consistently quarter after quarter. We believe that we are working on the right issues. And that as we continue to execute our plans, we will gain momentum, further improve our operational and financial performance and put Deluxe back on the path to greatness.

Now Mary, Rick, Terry and I will take questions.

(Operator Instructions). Philip Olesen.

Actually, I had two quick questions. First, recognizing that you haven't given '07 guidance but given some of the improved momentum in the third quarter, kind of the commentary with respect to the fourth quarter, would it be a stretch to assume that you could actually see EBITDA or cash -- or yes, specifically EBITDA stabilize in '07?

And secondly, I appreciate the commentary with respect to kind of some of the refinancing initiatives. Just maybe a little bit more detail specifically in terms of the timing for you to kind of formally implement the plan and as it pertains to kind of the third component, so it is cash, existing bank lines and then new financing. At this point in time, would that be -- is it assumed that that would be a public market financing, or would you -- do you think you would get better execution going back to the bank market?

This is Lee. Let me try to address the first half of the question, and then I will let Rick take the second piece. As far as 2007 guidance, we're going to put out that guidance at the end of the fourth-quarter call. So I really would like to not make any comments on where things are heading from a 2007 standpoint until we get through the fourth quarter this year and put the guidance out in January. And that's really our current plan at this point. I will let Rick take the financing question.

Sure. Regarding the financing question, for the maturity in 2007, we're continuing to evaluate our financing options, as I mentioned in my prepared comments, and have a variety of options available to us, whether that's in the bank market, under our existing credit facilities or additional long-term debt. From a timing perspective, right now, we expect to execute something in late Q1 or early Q2 of 2007. And certainly, cash flow generated this year and next year will be a factor as we look at dialing in the exact timing of that.

This is Lee again. I think some other things to add on top of what Rick's highlighted is one of the things that Terry and I and then when we added Rick did in the quarter was spent a considerable amount of time getting out with both potential investors and investors as well as with the bankers.

And I can tell you with -- and I think as Rick said in his script, we have a pretty high degree of confidence that we have a number of alternatives that we can work through as far as where to get financing resources. I'm very comfortable at this point in time. I think one of the other things that is encouraging is in the third quarter, we were able to improve our cash flow position and also get at more of paying down some more of our debt.

So, I think if you ask me my confidence level from exiting the second-quarter earnings call to my confidence level of exiting the third-quarter conference call, I've got a lot more confidence now that we've got gotten out and really created the relationships, solidified the relationships and that there's a lot of things and potential financing vehicles that are available to us that I think we're going to be able to choose from so to speak.

So, what we're doing is working through them. We're being thoughtful about it. We're trying to introduce Rick to the process now since he has just gotten on board and really just doing a lot of hard work to make sure that the things -- the vehicles that are out there are things that we think make sense for us and then making sure that we -- in the end, we're going to make the right decision.

Lionel Jolivot.

Congratulations in the quarter. First question, it seems you are moving ahead relatively nicely in terms of cost reduction. I am just wondering you have a major headwind that you're facing as the continued decline in pricing, particularly in your financial services business. I'm just wondering how long will it be before we start to see some stabilization on this front.

This is Lee. Let me try to give you some color here. Clearly, you're on track here. It was mentioned in our release and our comments, the decline in terms of the financial services business is sitting there. And I think you can expect that the question is around are we seeing an increase in the rate of decline? I would say we're not seeing an increase in the rate of decline, but the decline will continue.

Therefore, what we've got to do is get focused on -- number one important thing is winning and acquiring new customers in that space is important to us. I mentioned some names in my prepared comments that I think are going to be helpful for us.

But the other key in the financial institution space is what I highlighted around an opportunity in the customer loyalty space. And we started some pilots in the early October time frame that are going to go for probably three or four months before we'll be able to draw any conclusions as far as will we be able to get these into something that will start gaining some traction in 2007. But, clearly, that is our plan at this point in time. We are excited that the pilots that we've started seem to be progressing quite well at this point.

The other thing that is very important is the continued growth in our small-business services. And, we had a solid quarter in Q3. Given our earnings guidance, we expect to have a solid quarter within that total revenue guidance in the fourth quarter. And I think the focus we have in that space now, as I mentioned in my prepared comments as well, is how do we get more focused on the higher margin, higher growth opportunities?

Again, I mentioned in the second-quarter call the importance of looking at opportunities, not only within what we've got in our toolkit today but also in things like the custom, portfolio or digital and Web print space. That's why we're really excited about the acquisition of The Johnson Group because we see that as an opportunity in that particular part of the small-business market right now to get some double-digit growth.

So I think the way you've got think about it is -- yes, we see that continuing decline sitting there. I think we've been consistent with providing that feedback. But there is opportunities to retain and acquire new within that space to help offset the rate of the decline, opportunities to get into some other areas to sell in the financial services business to our financial institution clients as well as really work that small-business focus that we have been in effect getting after so far.

Then, on the same topic if I look at your contract acquisition costs, I think you spent roughly $16 million so far this year. And I think your guidance -- your prior guidance was something like $35 million for the full year. Does it just mean that you were very conservative and that you will very likely come inside of those guidance or should we expect a big payment in Q4?

No, I think what you are seeing is -- and I think we mentioned this on the second-quarter call and kind of consistent here -- I think what you are seeing is we're just -- the number of significant deals that are out there that have been generating these high contract acquisition payments are starting to go down. And so, what we're trying to do as best we can is really forecast where we see the trend going.

But we definitely have seen a reduction. The guidance that we have out there at this point in time, I wouldn't say it's conservative. I think it just fits where we're comfortable with in terms of where we see the trend right now.

And just last thing on the financing side, you talked a little bit about the upcoming maturities in '07. I'm just wondering, given your amount of free cash flow you're generating and given the fact that your 5.125 senior notes due in 2014 are trading at a pretty [lowderoff] price, which I think it's in the low 80s. Would it make sense for you to buy back some of these bonds in the open market just to reduce the total debt even faster?

This is Terry Peterson. Regarding opportunities or possibilities of us buying back either the 12 or the 14 bonds right now is not -- it's not how we are looking to use our free cash flow at this current time. We were focused on paying down our current debt as well as preparing ourselves for the 2007 maturity. So, that is not an expected use of our free cash flow over the next year.

John Kraft.

Congratulations on the progress so far. Specific to a couple of the contracts you mentioned, Lee, Wachovia and WaMu, the -- I guess specific to the Wachovia, the incremental business there, can you characterize sort of what the percent split was in that dual source contract? And I guess for both of them, when will there be or when will the contract acquisition payments hit?

John, I can't comment on the size of the specifics on increasing the number of states that we got with Wachovia. That's not something I am at liberty to be able to provide in terms of any additional color.

But as far as the WaMu deal, as you know, that is our business today. So, what we expect is to be able to continue the business as we go forward. I don't want to get into the length of the contract either other than to say I will give you some comfort I think in that it is a long enough contract right now that clearly it's going to give us some nice -- a nice view of where we can look for volumes to come out of there into the future. So, I think that's the best way I can frame it.

I think the thing that -- the way you should think about the biggest opportunity the rest of the year though is really in the BancorpSouth opportunity. And this is a really exciting opportunity. It was actually my first visit when I joined Deluxe was to go down and meet the BancorpSouth team. This is just something we're really excited about.

We've been preparing really hard over the last several months to make sure that we were ready to go here. We have actually now started that contract. That actually will give us some additional scale and lift in the fourth quarter because it's new business for us.

This is Terry. Regarding the timing of that contract acquisition payment for WaMu, again, we don't comment specifically on payments with or terms within specific contracts. But we did provide guidance for our full year on the contract acquisition payments, which we did indicate it would be $45 million less than last year.

And the BancorpSouth, was that also a Deluxe Business Advantage win as well?

Yes.

Okay, good. And then, The Johnson Group acquisition, just trying to clarify the wording that the payment that you made as part of the transaction or is that the full amount or is there more that you'll be paying for that?

That's the price that we paid for the company.

And then the small-business services, you cited some first-time buyers. Is it fair to say that those buyers are -- would be new business from the Deluxe Business Advantage program through the financial services vendors -- or I am sorry -- your partners?

It's some of that as well as it's just new business that we got away from the program, right? So you both have new business that we worked through the Deluxe Business Advantage program, but it's also customers that we've acquired so to speak outside that particular program.

Okay, I guess what I'm trying to find is a good way to kind of quantify your success in that program. As far as I'm concerned that's an opportunity that's pretty significant. Is there a way to quantify the number of maybe banks that have bought in and how that tracks quarter-over-quarter or anything that might give us some help understanding that?

We really don't look at it that way. I think the way to -- obviously, that's an important metric. But I think the way we tend to look at it is, how are we doing on new acquisitions? And then, how are we doing on increasing the wallet share piece of it? And then how are we doing on -- we kind of look at it then as, what have we retained after the first wave of initial business?

To be honest with you, we are getting better since I got on board here of trying to generate metrics around each one of those. I'm not yet comfortable that I want to start getting out and releasing that information or metrics around that. But I do believe that something as we get better at this that we will start to try to give a little more guidance as we go through the calls.

But honestly, I just ask that you give me an opportunity to continue to get a little bit more refined on that. But I think the important takeaway I want to leave with you is we are absolutely focused on looking at the business from new acquisitions and then what drives that wallet share story. And then, once we have gotten the initial deal, what's the expectation in terms of getting additional business? And then not just for one particular product if that's what they initially ordered, but we're trying to get more into that toolkit or toolset around additional wallet share.

Okay, that's fair. And moving to Rick and Terry I guess. Operating margin targets, if I look at the small-business services and sequentially at least over the last couple of quarters, exing out some charges, their margins have increased pretty nicely 5% to 8% to 10%. And then, if I look at the financial services, it's been pretty steady at 17 and then falling to 15.

I guess with the SBS first, is there a target that is reasonable over say the next few quarters and with financial services? Is maybe 15% a better -- a more fair run rate?

Clearly, the way I would leave it with you -- this is Lee again. I think the way to think about it is that we're clearly expecting to get this into a consistent double-digit operating income performance. I really believe this is a huge leap for us in the quarter to be able to get out of the 5 to 8% and get into the 10 to 11% range.

I think one of the things though, I want to hold a little bit of caution over -- not caution in a bad way -- just before giving you a view of how that is going to solidify in the future is, if you go back to the comments I made in my prepared remarks, what we're working on right now is how do we work that sales and marketing leverage in both the leverage of the field sales, the leverage of the inbound and the outbound call center people.

And as we work that model and we have been -- I can say the Deluxers are just working extremely hard on this model right now. As we prepare to implement it in the fourth quarter, we're going to then have to consider how will the revenues scale and then the cost and expense takeout really impact that business as well as how it will impact the financial services business.

We are attempting to model it, but we just need to get more work through the quarter before we're really going to get comfortable with understanding exactly where that is. But I think the net of it is -- yes, I would assume that clearly our goals are to get this into the double digits. And obviously, we don't want to go back from there. Our goal would be to solidify it within that space.

Mike Hamilton.

Thanks for all the insights. I was hoping, Lee, as you have started to assess the small-business side, if you could walk through your thoughts of how you anticipate the business is going to play through an economic cycle, both in terms of what drivers you find are going to be the keys to your thinking and kind of how you anticipate trying to play through a cycle?

I think one of the best things about the small business is that when you think of the core fundamentals of the business, it really still does involve checks and forms. And as we have communicated publicly in the past, although we see the personal side of the check decline probably 4 or 5 or 6%, we clearly see the business side in the small business more along the lines of 1 to 2%.

So, the positive thing is we still have a nice foothold, and people are still -- small businesses are still writing checks and still using our forms. I think the key then on top of that and what we're really working hard on right now is, how do we look at the rest of what is in that toolkit? And what we're trying to really sort out is we want to be at the more I would say the top end of those opportunities in the small-business space rather than the bottom end of the opportunities.

Why is that important? It is important exactly along the lines of what your question is. And that is, we want to be more relevant if small businesses are pushed for whatever reason. We want to make sure we are in that upper half of that -- I call it the better part of the 2000 than the lower part of the 2000.

And that is really what we're focusing on, and that's also why we were excited about again our acquisition of The Johnson Group. Because what I find when I was out in the quarter with meeting with small-business customers, they're asking us more and more, can you do this custom, full-color spread or feature or whatever? And even some of our distributors in the small-business space are asking us the same question.

So, it's giving me the confidence that that is a sweet spot opportunity. Obviously, we've got to go execute and perform. But, that's how I would think about it, and that's why we're focusing and really segmenting as I mentioned in my prepared comments the way to look at the model.

I appreciate it. One more detail question related to fourth-quarter guidance. If I heard correctly, expectation of mid-single-digit, year-over-year growth on small business, with your revenue range, I draw the implication that you expect an acceleration of the decline in top line and financial services from third-quarter quarter level. In other words, a decline of more than the 9.1 shown there. Is that a correct read of the dynamic here?

I will let you do the math as best you can. We're not going to get into the --

You aren't disagreeing with the assessment of -- I just want to make sure the small-business outlook that you're talking about was -- that I picked up correctly what you were saying there?

You picked up correctly. I just want you to be careful between the small business -- I mean the FS business and our direct-to-consumer business as well.

Correct, correct. Thank you.

Hardin Bethea.

One question maybe for Lee -- in terms of the commentary about the cost savings plan for 2008, is there any additional color you can provide from the base in the base guidance in the second quarter of '06? How much of that $150 would be realizable in '07 versus '08?

Again, I think the way you need to think about this is that I'm not going to provide that guidance today -- additional guidance on it. Here's why. Again, we are still working through the exact timing of some of the -- some of that $150 and when it will play out.

Here's why that's really important. They're going to be opportunities to get cost out where we can take them right off the table more quickly. There's going to be others that require an investment and then the cost takeout will come.

What we're really, again, working really hard on -- and we got a lot tighter and a lot better in the third quarter -- is really nailing down those cycles and those timing of investments versus when the reductions then will pay off for us. But because we still have a number of them that we're wrestling with exactly when the timings are going to occur, I don't think I can give you a well, here is exactly how much is going to come out along the way.

I think what we've tried to provide today because I think we have listened to a lot of the feedback that has come in through Terry is, give us a little better feel for where it's coming from and give us a little bit better feeling from -- I use the words "the geography plays on the P&L, where it's coming from." And that's really what we try to do here. And I think, right now, it's just again what I am most comfortable with in terms of where we got it sitting.

The investment you speak of, is that something you're going to talk about in each quarter it's realized so that investors can kind of see for themselves or kind of look at what's underneath the investment and savings in any particular quarter to get a sense for how the rest of the business is doing?

Yes, I think what we will aim to try to do as we get better at this is to -- as we get in a rhythm around where we are with this and again, we are -- I can tell you we are already after this. We've already seen some progress. We have clearly commented on that in the third quarter. We're going to continue to see some more progress in the fourth quarter. I think we will try as we get this buttoned down better to do that.

I just again would respectfully ask that I think we've given what I am comfortable with right now -- color around where it's coming from and with a very high degree of confidence as well as where it's going to hit the P&L. And I think we've got to now work through the timings and the investments as I mentioned. I think it's (technical difficulty) better asset. I will try to be better for the investor here as we move forward.

That's fair enough.

[Sean Boyd].

Just a couple of things. I want to go back to a question earlier that was going into the segments and drilling down on those margins. You guys gave us some great commentary on small-business services and what you're trying to target there on the operating margins and the double digits. Can you just speak to financial services and to direct checks on that same basis, given that we are still slightly declining on the margin line on both of those?

I think the way to -- let me try to take the direct checks piece of the business first. We are clearly trying to balance the level of investment that we think we need to make. And again, the modest level of investment with cost takeout that we're trying to basically get to in order to match or meet or make the investments happen. So, I think that's the thinking. And then I will let you play with the model from that standpoint.

I think the way to think about FS is we've got the decline in the revenue side of the core check part of the business. And, we are making investments in the areas like the customer loyalty that I mentioned. Again, I'm back to the timing of how we make those investments.

As we simplify the business and get cost out, I can't give you an exact precision as to how that is going to play out and when it's going to -- I'm just not in a position I'm very comfortable being able to get to that point yet simply because we are still trying to work through it. Again, I mentioned that all the cost takeouts and then how we are building up that leverage capability within the enterprise to then think about how does that play out for the small-business segment and for the financial services segment.

So, still feeling those out. Another question is just can you guys provide the breakdown on the D&A by segment?

We will have additional information in our 10-K on that. But, on an interim basis, we typically do not provide that breakdown. We do indicate though that within the $85 million for the full year, $34 million of that is related to the intangibles with the NEBS acquisition. So certainly all that hits in the small-business services segment.

All right. Just last thing on the debt situation, it certainly seems like you guys have got plenty of options open to you here. I don't think that's a concern at all. The only question I do have is, do you have any debt to EBITDA covenants or interest coverage covenants that you're up against right now?

We have -- we have the one financial covenant, which is the EBIT to interest covenant. And you know as we state quarterly in our 10-Q and again right now, we're comfortable with that covenant level.

Congratulations on the progress so far.

Todd Morgan.

Thanks for all your insights so far. I had four quick things to hopefully follow up. If I'm -- just again just doing the math on the contract payments this year -- 25 million, is that the right number to look at if I am basing it on your comments? Secondly --

That is accurate, Todd.

Secondly is I think you also talked about capital expenditures of $45 million this year. I think earlier in the year, you talked about a number closer to $50 million. Is that just me hearing things differently or is that really just a timing difference issue?

That is correct. We've lowered that expectation by about $5 million.

Thirdly, the last year I think in Q4, there was one of the issues that had come up was sort of stock-outs on some of the holiday card sales. Can you talk about what might be different this year to try and avoid that?

Just while I'm here, the last thing -- financial services this quarter 4.1% growth on a volume basis is a good sign. Can you give us any sense of what that number looks like ex the new customers that you've brought on? What's really the core number? Is that any different than what it has been?

This is Lee. No, we're not going to give you any guidance on the 4.1% increase as we go forward. That's not something that we're -- I'm comfortable trying to lay out there at this point in time.

On the question on the holiday cards, it's a great question. And as for myself walking in here, I heard some of the painful stories around the fourth quarter last year. I can say it's one of the things I've continued to follow up on.

I think what I'm really excited about is that we have introduced into a couple of our other fulfillments sites the ability to be able to produce holiday cards. I can tell you so far, from everything we're seeing -- because we're actually now into making the cards -- everything continues to be very positive at this point.

The places that we have historically manufactured them here are working well as well. So, I think we are -- knock on wood -- but I think we're going to have a strong season this year.

There are no further questions at this time.

Let me just close with a couple of quick thoughts. I think the way to think about it is clearly, we continue to be energized and passionate about what lies ahead for us. I mentioned on the last quarter call and I will say it again, every key process and area inside Deluxe continues to be scrutinized. And we're getting at all data, we're listening to the data and then what we're trying to do is put an aggressive improvement action plan in place.

At this point, it's all about sharpening our focus in small-business services, improving the core check businesses, taking cost and expense out of the Company, generating strong cash flow, paying down debt and executing and delivering against our commitments.

I thank you for participating and for your questions today. We're going to get back to work. And again, we will be back to report another progress update for you at the end of the fourth quarter.

This is a reminder that a replay of this call will be available until November 2 by dialing 320-365-3844. When instructed, provide the access code 844332. The audio presentation and the accompanying slides are archived in the Investor Relations section of Deluxe's website at www.Deluxe.com. Again, thank you for joining us and have a good afternoon.

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