Deluxe Corp (DLX) 2007 Q2 法說會逐字稿

Welcome to the Deluxe Corporation 2007 second quarter earnings conference call. All participants are in a listen-only mode. We will conduct a Q & A session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Terry Peterson, Vice President Investor Relations. Please proceed, sir.

Thank you.

Welcome to Deluxe Corporation's 2007 second quarter earnings 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 risk 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 31, 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 in the investor relations section of our website, www.deluxe.com, and was furnished to the SEC on the 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'll turn the call over to Lee Schram, Deluxe's CEO.

Thank you, Terry, and good morning, everyone.

We had another strong quarter and are pleased with our financial performance and continued progress as we maintain momentum with our transformation. We, again, fired on all cylinders, having performed well compared with our key objectives for 2007. We are particularly pleased that after adjusting for the previously-announced sale of the industrial packaging product line, we grew revenue for the second consecutive quarter. In addition to seeing growth in small business services, we continue to see stabilization in the rate of decline of our core check revenues. We also reported strong bottom line results on all our segments and operating cash flow was better than expected.

We continued to execute on our $150 million cost reduction plan, and remain on track here; progressed on our new loyalty, retention, monitoring and protection offers; had a strong new customer acquisition rate in our small businesses services segment; and successfully completed a $200 million senior unsecured note offering at attractive rates. We also added three new board members with deep financial industry and small business experience.

We have now completed the fourth quarter of our ten quarter, or inning, transformational journey. So even with these continued successes, we still have work to do. In a few minutes I'll discuss more details around our recent progress and next steps, but first, Rick will cover our financial performance.

Thanks, Lee.

Earlier today, we reported diluted earnings per share for the second quarter of $0.69, which exceeded our previous expectations for the quarter of $0.52 to $0.56. As noted in the earnings release, our results reflect better than anticipated revenue performance in each of our business segments, coupled with lower manufacturing costs and SG&A expense. In particular, our Financial Services segment exceeded expectations, as revenue increased 0.5% over the prior year, and margins benefited from both our Q1 price increase actions and one-time benefits from the favorable resolution of recent contract negotiations. Our enterprise-wide cost reduction initiatives delivered better than expected results this quarter due to the acceleration of IT-related savings. The timing of investment spending and several key initiatives also contributed to the favorable results.

Operating cash flow remains strong, and also exceeded our expectations. The stronger earnings and continued progress with our working capital initiatives led to operating cash flow of $35.7 million for the quarter. While our credit facilities were completely paid down, total debt increased, given the successful placement of $200 million of senior unsecured notes in anticipation of our October bond maturity.

In the second quarter of 2006, we reported a diluted loss per share of $0.05, which included a pre-tax asset impairment loss of $44.7 million, or $0.57 per share. Also contributing to the higher earnings year over year was a $7.2 million reduction in SG&A expense and improved gross margin. Companywide, revenue totaled $400 million, down less than 1% from 2006. Adjusting for the divestiture of the industrial packaging product line completed in the first quarter, total revenues actually grew in the quarter. Gross margin for the quarter was 64.3% of revenue, up nearly 2 percentage points from last year.

Improvements in manufacturing productivity, including the closing of two facilities in mid-2006, as well as favorable product mix in SBS contributed to higher gross margin. Selling, general and administrative expense was down $7.2 million in the quarter. We continue to benefit from many of our cost reduction initiatives, particularly in the areas of call center productivity and information technology infrastructure. In addition, lower amortization and other expenses due to a software project written off in mid-2006 and one-time investments made last year associated with the SBS growth strategy contributed to the year over year decline. Partly offsetting these declines was increased performance-based employee compensation.

As a percentage of revenue, SG&A decreased to 47.4% from 48.8% last year. As a result, operating income in the quarter was $67.5 million, up $57.7 million from last year. Next, I will provide some highlights in each of our three business segments.

In Small Business Services, revenue of $230 million was down 1.3%, or $3.1 million, versus 2006. As noted, 2006 revenues included the industrial packaging product line, which we sold in late January 2007. Putting this aside, revenue in the quarter grew at low single digit rates driven by the Johnson Group acquisition in October 2006 and stronger check volume. Operating income in this segment increased to $30 million, up from $1.3 million in 2006. Last year's results included $18.3 million of the asset impairment loss allocated to this segment. Additionally, the increase was driven by continued cost reductions, including lower sales and marketing expense and lower manufacturing costs. As a percentage of revenue, operating margin for the quarter was 13%, marking the fourth consecutive quarter of double digit margin performance.

In Financial Services, revenue was $118 million, up 0.5% from the second quarter last year. The current quarter benefited from a full quarter's worth of price increases instituted earlier this year, and one-time benefits from the resolution of contract negotiations. Financial Services reported operating income of $23.2 million for the quarter, or 19.7% of revenue. The increase of $30.7 million from the prior year was due to the revenue favorability; $26.4 million of the asset impairment loss allocated to this segment last year; lower amortization; and the benefit of cost reduction initiatives.

Finally, in Direct Checks, revenue totaled $52 million, down only 1.1% from last year. Revenue this quarter benefited from continued success in selling additional accessories, premium features and services. From a rate perspective, revenue was negatively impacted by a higher mix of initial orders with introductory pricing. Operating income was $14.3 million, down $1.7 million from last year. The decrease was caused by higher manufacturing costs as we ramped the implementation of innovative new product delivery packaging designed to mitigate the impact of postal rate increases and enhance product security. The higher mix of orders with introductory pricing also reduced operating income in 2007 versus 2006.

Turning to the balance sheet and cash flow statement. During the quarter, we issued $200 million of long-term notes. Total debt at the end of the quarter was $1.1 billion, compared to $1 billion at the end of 2006. We are investing the cash proceeds from this note issuance in short-term investments until the funds are used to retire debt in October. Cash provided by operating activities for the first six months of the year remained strong at $104.7 million. The modest increase from 2006 was due to improved operating performance and progress with working capital initiatives, partly offset by higher payments for medical and severance benefits, taxes and performance-based compensation.

Looking ahead, we expect our third quarter consolidated revenue to range from $386 million to $394 million and diluted earnings per share to range from $0.57 to $0.61. While we anticipate another strong quarter of year over year improvement, we do not expect as strong a performance sequentially in the third quarter as compared to the second quarter due to several factors.

First, we expect lower revenue and commensurate earnings per share due to the one-time contract resolution benefits in Financial Services not expected to repeat in the third quarter, and higher concession rates as the year progresses. The third quarter also is historically weaker than the second quarter in our Direct Checks business. Second, a full quarter of higher delivery expense driven by the increased standard A and flat rates that will not be offset by improved efficiencies and lower costs until we complete our full roll-out of auto flats packaging in the fourth quarter. And finally, while we expect another strong quarter of progress with the $150 million cost reduction initiative, the third quarter incremental savings will be lower given the stronger than expected pull-forward results in the second quarter. Plus, we will see some increased investment spending on new, noncheck revenue solutions and key enablers.

Given our continuing positive momentum, we are also raising our full year outlook. On a full-year basis, we expect revenue to range from 1.6 to $1.62 billion and diluted earnings per share to range from $2.70 to $2.80. Excluding the impact of the divestiture of our industrial packaging product line, the revenue range assumes an encouraging low single digit growth rate relative to 2006.

There are several key factors that contribute to our total year 2007 outlook, including, low single digit growth in our Small Businesses Services segment, excluding the impact of eliminating approximately $50 million in revenue from the divestiture of the industrial packaging product line; Continued revenue pressure in Financial Services and Direct Checks, although the rates of decline are expected to ease to single digit levels lower than the 2006 and 2005 rates of decline; Focused execution on the previously-announced $150 million cost and expense reduction initiatives net of investment. Again, these net savings will not be linear on a quarterly basis. And an ongoing effective tax rate of approximately 34 to 35%, which translates to about 35 to 36% for the full year, given our higher first quarter rate.

The slight decrease in our overall tax rate for the year versus our prior outlook, is driven mostly by income from tax-free investments and discreet events recorded in the second quarter. We expect operating cash flows to range between $235 million and $250 million for the year, slightly higher than the $239 million reported in 2006. While 2007 will benefit from higher earnings and additional working capital improvements, they will be mostly offset by the one-time benefit of $35 million in 2006, related to a decision to lower the level of prefunding our medical and severance payments and higher tax payments.

We still expect contract acquisition payments to be approximately $20 million. Capital expenditures in 2007 are now forecasted to be approximately $30 million, with investment focused on driving manufacturing productivity, business simplification and noncheck revenue growth. Depreciation and amortization expense is still expected to be approximately $70 million, including $29 million of acquisition-related amortization. We plan to continue paying down our debt, and for the year, expect the range of paydown to be 185 to $200 million, which should further strengthen our credit ratios and enhance financial flexibility.

In closing, a few comments on capital structure in our financing activity. Our successful placement of $200 million of senior unsecured notes during the quarter, along with continued strong cash flow, positions us well to repay our October maturity of $325 million of 3.5% bonds. The additional long-term capital also provides financial flexibility to facilitate execution of our growth initiatives. Looking ahead, our priorities for uses of cash flow include repaying the October 2007 obligation; investing both organically and with tuck-in acquisitions to augment growth; as well as, we will continue to evaluate all options for delivering value to our shareholders, including share repurchase opportunities and our dividend policy.

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

Thank you, Rick.

I will continue my comments with an update on the building blocks that I introduced on the first quarter call for revenue growth, then highlight continued progress in each of our three segments, and close with an update on our cost reduction program.

In the quarter, we took steps to better frame revenue growth opportunities, grouping them into three major categories -- Customer transaction solutions; customer acquisition retention loyalty and growth solutions; and customer monitoring and protection solutions.

Transaction solutions, which represents most of our revenue today, focuses on helping our customers manage the transactional elements of their daily operations and includes core check and office management products, as well as potential opportunities with stored value cards and new small business services. Acquisition retention loyalty and growth solutions focuses on helping our customers sustain and grow their business, and includes such offerings as our Impressions Suite, Welcome Home Toolkit, and Deluxe Calling. Finally, monitoring and protection solutions help our customers protect their reputation, and include identification theft protection and other fraud protection tools.

We have also identified several key enablers to be more fully developed, including increasing our e-commerce capability; improving analytics; and focusing more crisply on key vertical segments in merchandising, both for small businesses and financial institutions. I will incorporate examples of all these potential new revenue opportunities and key enablers throughout my segment update.

Now shifting to our segments. In Small Business Services, we had another strong customer acquisition quarter driven by our Deluxe Business Advantage program, and we continue to be pleased with revenues from the Johnson Group acquisition. As we move forward, we are using the external research referenced on our first quarter call to improve the conversion rate of new customers to repeat buyers, and also expand the products and services they purchase from Deluxe. In other words, increasing our share of wallet. We believe we can sell more personalized forms and related products, as well as higher growth solutions, including custom, full-color digital and web-to-print and promotional products.

The key enablers driving this potential growth include e-commerce, more focused vertical segmentation, and improved merchandising. For e-commerce, we plan on increasing, over time, the percentage of revenue from an improved channel experience, and have hired a seasoned leader to drive this forward. For vertical segmentation, we will be launching more specific initiatives targeted directly at retail, contractors, professional services and healthcare. For merchandising, we plan on improving direct marketing advertising by targeting life-cycle programs that assist small business with starting, building and growing their business.

In Financial Services, we continue to proactively extend several contracts with existing national customers. Unit volumes decreased less than 0.5%. Our retention rates remain at all-time highs in excess of 90%, and our new acquisition rates remained strong. We also continued to simplify our processes and take complexity out of the business, while reducing our cost and expense structure. In addition to our strong core check revenue, we made progress in the second quarter in advancing new noncheck opportunities, realizing increased revenue over the first quarter from new transaction, retention, loyalty, monitoring and protection solutions.

To give some more color here, seven out of ten initial pilots for our suite of customer loyalty and retention programs known as Impressions are moving forward. And we have another 14 customers coming on board. We also began nine additional pilots in the third quarter with another new loyalty program that allows financial institutions to target consumer lifestyle changes, such as marriage, the birth of a child, and planning for college. For our Deluxe Calling program, which helps financial institutions establish relationships with indirect borrowers, we added four new customers since the first quarter, we'll launch a pilot in August with a very large financial institution, and now have seven customers on the program, plus a growing opportunity pipeline. We have a new business partner that will help us simplify the administration of our stored value gift card program, and now are focused on readying ourselves for the upcoming holiday season with a significantly enriched stored value card program. And finally, in the monitoring and protection space, we increased our implementations and enrollments significantly over the first quarter and are starting to see a meaningful ramp in opportunity pipelines.

Again, it is still too early to understand whether all these new product offerings can have a meaningful impact on our future revenue, but we continue to be encouraged with our progress. We advanced work in the quarter on targeting which segments represent the best opportunity for these new solutions which, depending on the offer, may be national, state, metro, suburban or neighborhood banks. We also made progress improving our analytic capability, critical for many of these new financial institution offers. In the second half of the year, we plan to spend considerable time framing the market opportunity and revenue potential of these new solutions, as well as start building out the key enablers I highlighted earlier.

Finally, in Direct Checks, we reported only a slight revenue decline in the second quarter. Clearly, our decision to invest modestly in freestanding insert impressions, as well as our strategy of selling additional products, premium price features and accessories continues to take hold. As an example of a new product offering in this channel, we just introduced holiday greeting cards which historically have been sold primarily to small businesses.

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 are targeting $150 million in savings by the end of 2008, net of required investments, using as a baseline the full year 2006 outlook we provided last July. Overall, we had another solid quarter, delivering a little more than expected at this point on our percentage of targeted cost reductions. At the halfway point in the year, we believe we have delivered approximately 40% of the total $150 million, or an incremental 30% this year in addition to the 10% achieved in 2006, and that we are solidly on track to achieve the higher end of this year's committed range of the 50 to 55%. The primary driver of the higher percentage achieved is the timing of information technology reductions. You may also recall that we had indicated we expect around 50 to 60% of this to directly benefit the bottom line. In the second quarter, a greater percentage actually fell to the bottom line, principally due to the pull-forward of cost reductions from later in the year.

Here are some highlights of the key cost reduction activities for the second quarter and continued areas of opportunity for the balance of the year, in addition to the ongoing savings that are accruing each quarter from previously-implemented actions.

In our go-to-market sales and marketing, we progressed realigning sales and marketing backend operations to more efficiently support our frontline field sales and customer care centers, and expect continued progress through the balance of the year, in addition to continuing to refine our channel management structure.

For fulfillment, we had another strong quarter on lean productivity improvements, product standardization and indirect spend reduction. And we have also implemented a new, auto flat check delivery package for our direct-to-consumer business that will also be implemented later this year for our financial institution customers. We are thought leaders, in being first to market a flat check package that not only helps combat the postal service rate increase, but provides our customers with a more weather-resistant and securities-conscious package. Samples surveys show greater than a 90% customer satisfaction rate with the new package. For the balance of 2007, we expect to continue our lean product standardization and indirect spend initiatives, plus more work on realigning to a common manufacturing platform and reducing skews.

Finally, for shared services infrastructure, we made better than expected progress in information technology, driven by pulling forward data center cost reductions and other system utilization, networking and voice communications efficiencies. We expect to continue to reduce costs in each of these areas over the balance of 2007, as well as more strategically align IT capability and delivery with our business segments needs. For our shared services infrastructure functions, including finance, human resources, real estate and legal, we continue to standardize more of our internal processes and improve efficiencies. For example, we began outsourcing some additional finance transaction processing activities in June, and plan to continue our efficiency and cost reduction initiatives in all areas in the second half of the year.

As I have been indicating for several quarters, and clearly seen this quarter, reductions will not necessarily be linear through 2008, with investments and reductions being lumpy. Although we remain solidly on track and, again, expect to deliver at the higher end of the 50 to 55% range of the $150 million in 2007.

As you can see, we made terrific progress in the quarter, but we still have a lot of work ahead of us. We expect continued strong performance in the third quarter as well. The good news is that Rick and I continue to find areas to work and that need improvement. We also expect to progress not only on our cost reduction initiatives, but also on our new revenue offers and key enablers. Clearly, we have had a strong first half of the year, and I am confident that as we continue to execute, we can deliver a full year of strong progress and financial returns in 2007.

Now Rick, Terry and I will take your questions.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of John Kraft with D.A. Davidson. Please proceed, sir.

Good morning, Lee and Rick.

Hi, John.

Good morning.

Congratulations so far. It looks good. Rick, just wanted to clarify one of your comments. You said something about a one-time contract resolution in the quarter. Can you elaborate a little bit?

Yes, I'm not going to go specifically into those. But as we have had the opportunity to resolve some ongoing contract negotiations with some of our customers, we benefited in being able to successfully come to conclusion on those negotiations and, as such, really gain some benefit from the fact that we had expected larger concession rates and negotiated those to not have to incur such a large rate there.

Okay. Okay, that's fair.

Let me add to that. Think of it like this. What we are trying to clearly do here, and we're really jumping on this thing the last couple of quarters we mentioned is, we are really trying to get, with the customers that are coming due either the second half of this year or into 2008, and we are trying to sit down with them and really lock in our current agreements for longer periods of time. And part of what's starting to happen is, because we are bringing more to the table -- more creativity, more thought leadership around new solutions, ideas, the flat package that we've come up with -- what we believe is starting to happen is we are getting more confidence in our customers that they are looking at Deluxe as more of a strategic partner, rather than just purely being a check provider.

Well, okay. So speaking of that, I guess, you also talked about just price increases in the printing. Can you clarify that, I guess, a little bit more? I mean that specifically had been in the small bank market in the past, am I correct?

What we did, John, we actually said this on the call in the first quarter. Late in the first quarter, we instituted a price increase pretty much across-the-board. Now, it depends on the types of checks and check accessories and so on and so forth. But we did implement -- it wasn't like we took a price increase the same percentage across-the-board everywhere. It was thoughtful -- it had a lot of integrity in terms of the thought process and how we did it. What happened, John, is we actually got a benefit, which to some extent we expected, in the second quarter from having a full quarter's worth of price increase, rather than the first quarter where we only had less than the quarter impact.

Sure. Sure. And kind of looking toward your guidance, even if we assume the high end of your Q3 numbers, Q4 looks to be a pretty significant ramp. And there has been some seasonality, I guess really only in the small business segment. Can you talk a bit about why there is seasonality there?

I think the way to think about it, there is a ramp, John. But I think the things that we are starting to do, we mentioned a couple on the call, we even introduced holiday cards now into the direct-to-consumer business. But holiday cards is a big piece of the ramp in small business in the fourth quarter. The tax forms start to kick in. It's kind of a Q4-Q1 impact, but that starts to kick in. And then we also expect the stored value card program that we're really starting to -- we believe we're make something progress here through the financial institution segment or our FS segments, are really start to be able to contribute as well. So those would be the primary drivers, John, of why we expect the -- a little bit more of a ramp from a seasonality perspective.

Okay. Understood. That's it for me. By the way, nice timing on the issuance of your debt. It looks like, obviously, that was pretty smart.

Thanks so much, John.

And your next question comes from the line of Jamie Clement with Sidoti & Company. Please proceed.

Lee, Rick, Terry, good morning.

Hey, Jamie.

Couple of questions. Regarding Direct Checks and the new packaging and some of the delivery costs, can you help -- can run through that again a little bit slower in terms of how you expect the costs to look as the year progresses? It didn't sound like this was exactly a one-time thing that you dealt with this quarter. But is there going to be some moderation of costs associated with at least the change in the packaging over time?

Jamie, that's a great question. I tried to provide clarity, but let's see if we can add to the clarity here. What's happened is that we -- we have been working this for quite some time. We shouldn't be expected, as a management team, to just accept a rate increase from anybody, let alone the postal service. What we have been working through is how do we -- how do we partner with the postal service and work this rate increase issue? And what we have been doing is out -- we just can't do that without getting out with our customers and trying to make sure that they understand why we are making the change. So what we did is we started with the -- some testing with the direct-to-consumer part of the business and then went out and started partnering more with our large financial institution clients and trying to get them -- listen to them and work with them and take their ideas and really put it into a different package and take that back to the postal service and try to lock in on that. So what's happened, Jamie, is we kicked it off in the quarter in our direct-to-consumer business. So when the postal rates increased, I think it was May 14th?

May 14th, yes.

When they went up May 14th, we were ready to go. So we are able to take that rate and get a benefit in terms of the lower cost of the package. Now, what's going to happen, though, is that we don't yet have it in place until later this year for our financial institution clients. So what's going to happen is there's going to be a higher delivery cost, and we don't like it but it is where we are right now, kind of across-the-board in the financial institution space. Because you are going to have a whole quarter's worth of cost increase rather than kind of, literally, almost a half quarter from the May 14th. If you think about the May 14th. But what we are also working on is, when we get this in place, we do expect -- again, across the whole company -- we expect to be able to have some cost reductions that will accrue not only into the financial institution or financial service segment, but because we are doing this holistically across the company, we expect there to be a benefit in the direct-to-consumer business as well.

Jamie, I would also add that, as is typical anytime you implement a new production process, in this case really on the backend of our process for packaging and shipping the product out the door, you have a bit of a learning curve getting your labor force and your team focused and working on implementing the new process, and then, over time, you become more efficient with that process. And so as -- we've only had, really, a couple of months now of operating with this new packaging, that we would expect, over time, as we bring our lean techniques and productivity focus to the process, we will get better and continue to reduce the cost overall.

Okay. Changing gears a little bit. And thanks very much for that. Lee, you have been with -- you've with Deluxe for three more months and, I'm sure, gotten a little bit more perspective. At the end of this year, with the debt pay down that you guys target, even without making outrageous assumption from an earnings perspective, it looks like you're going to be probably operating it at net debt to EBITDA of maybe less than two and a half times. Being with the company a little longer, have you maybe taken a look outside the company? Are there perhaps in some acquisitions out there that you guys would consider? Are there areas of focus that you think you guys might want to look into that perhaps you weren't aware of three or six months ago?

Yes, Jamie, I tell you, we are -- as I've said on other calls, I think you should always be looking organically and then externally for opportunities to improve your business. And we have continued our review of both. And I got into some more color today around some of the new organic areas that we are focused on, but we are also much more refined in our external look, so to speak, in terms of what might help us as we continue to progress the company.

I'll be very clear. I'm delighted with the work that we're doing now, but I also came to the company because I not only -- I believe the company can grow. And I believe we will grow. And I believe as we execute over time -- and the question is how long that will take and I can't really get all that nailed yet as we work through this, but I think it will happen. I think we'll do that along the lines of what Rick said. We will have organic investments that we need to make along the way and we'll have acquisitive-oriented things. I think more in the tuck-in type of acquisitions to help enable the company as we move forward. But I would say, Jamie, yes, we've absolutely got more clarity and more visibility. And I mean, the great thing is Rick and I have also been together for three more months. So as we get stronger, as we get to know our teams better, the areas of opportunity -- yes, I think the clarity has gotten better. But we are still wrestling with how these new things that we're looking at can help us and how we build these out, and then what's organic, what's acquisitive-oriented. We just need more time, in all honesty.

No, that's very fair. That's very fair. Thanks a lot for your time.

Appreciate it, Jamie.

Thank you.

And your next question comes from the line of Charles Strauzer with CJS Securities. Please proceed.

Good morning.

Hi, Charlie.

Good morning.

Most of my questions have been answered. Just picking up where Jamie left off and, Lee, maybe it is best for you to just kind of take this one. Being in the company now well over a year, and you look at the cost program that you have implemented of $150 million, when you kind of go through the various buckets, are you finding new areas of cost saving that could potentially be emerging or is it pretty much the same things that you identified pretty early on?

The way I would look at it, Charlie, is we are laser-focused on the 150. When you've got an organization that Rick and I have in many respects got upside down at this point. I mean, we are trying to change a culture and getting a culture more accustomed to looking at growth potential, as well as at the same time doing efficiency improvements cost takeout, what we're trying to do, Charlie, is stay laser-focused on the 150. Would Rick and I be remiss to not look at other opportunities that come up as things progress? Sure. That is our job to always do that. But I don't want to take our eye off the ball of that 150. Because if we sway all over and we lack the focus as we're trying to change the company and the culture of the company, it gets -- it's distracting and it's hard for us to make sure we've got everybody in line on it. And let me tell you, it isn't Rick and I that are doing this. It is the great people of Deluxe that are out there doing the work and implementing these programs. They're the ones that deserve the credit.

That's fair enough. And then could you talk a little bit about the segment margins in Direct Checks? Obviously, those came down a bit in the quarter. Are you still kind of sticking with kind of the 30% range for the year for that segment?

Charlie, I -- we obviously knew this would come up. It was a little bit of a blip. I have been saying 1 to 2% up and down. And the thinking behind it is primarily, we didn't know exactly how this thing was going to play out with our packaging change and the cost increase that we've had in the short-term. And we also -- what's also really been encouraging is because we have stemmed the rate of decline in the top line, what Rick articulated is that we've got initial orders. And initial orders -- it's well-known in this market, it's the way it works -- initial orders don't drive the profitability factor to the extent that reorders do. So it's really right in line. It's just that it is kind of like we got a little bit more revenue than we expected, I guess, and therefore, it kind of impacted the profit. But we still believe that plus or minus 1 to 2% is a very good -- from that 30, is a very, very good and tight indicator.

Excellent. And then just, lastly, Rick, I think I may have missed this. CapEx for the year. What should we assume there?

As I noted in my guidance, as I noted in my comments, we are now forecasting approximately $30 million for the year.

Got it. And is there any particularly large one-time projects embedded in that number? Just to remind me.

No significant one-time projects. As I mentioned, we remain focused on projects that are improving our manufacturing productivity. The auto flat packaging, as we mentioned, that we implemented in our Direct Checks business and will be rolling out now for the rest of our financial institution customers, is an example of that as a project to offset the postal rate increases, as well as enhance product security there. But we are also focused on business simplification, as well as investment to drive noncheck revenue growth.

Excellent. Rick and Terry, thanks for agreeing to coming to our conference. We look forward to seeing you next month.

Looking forward to it, Charlie.

Thank you, Charlie.

And your next question comes from the line of [Kelly Bergen] with Wachovia Securities. Please proceed.

Hi, everyone.

Hi Kelly.

Quick question for you on the Financial Services side. X the one-time impact from the contract negotiations, would the organic rate of growth be somewhere in the down single digits, mid single digits? Can you define that for us?

Single digits is probably a good indicator, yes.

And then on the Direct Check side, this flat packaging you are introducing, did you say you are the first to market on that?

Yes, we believe we are in our segment, meaning the check industry segment.

Okay. And you said that that will be introduced in Financial Services, did you say in the fourth quarter?

Yes, later this year, yes.

Okay. My last question would just be if there is any particular reaction to note in the financial institutions space since the closing of the Clarke American Harland merger. I know it is still early on, but are you seeing anything in particular?

I think there's the question that Rick and Terry and I continue to get is, it generally hones in all around this what's going to happen in pricing. And what I continue to say, and I think Rick's right with me on this, is that we are assuming that the pricing pressure that we have been seeing all along on the recent history here is going to continue. It's really early at this point. And because there's no -- there's been no significant deals that are kind of pending or out there, it's really hard to say that, in two months since their deal got closed, there's been any real changes. I will tell you that I -- we have not seen a change in the pricing on deals that are out there, in more the lower national tier or the community segment. And I can only imagine, what they are focused on right now is what they said they were going to go get done, and we'll let them work that and we'll do the things that we think we need to do to get stronger in the space. Which we absolutely believe that we're executing well on and that we'll continue to execute on.

Okay. Thanks.

And your next question comes from the line of Mike Hamilton with RBC / Dain. Please proceed.

Good morning, everyone. Nice quarter.

Hi, Mike.

Could you help me out and walk through the accounting of the contract adjustments? It sounds to me like, basically, revenue enhancement, no cost hit. I just want to be clear that I'm understanding how it's hitting the P&L.

Yes, that's right. I'm sorry, Mike, this is Terry. It is a benefit to revenue, in this case, and it has no cost associated with it, no direct cost, so it goes straight to U.S. margins and operating margins.

And It sounds to me like, basically for that kind of adjustment, it's really related to prior periods.

Not necessarily. There is a few things that made this up. We had the -- the contract that we settled, and then in the past we've had, in this same category, we've had contract termination payments. It's just very similar to that. We had a couple of very, very small ones in this quarter, too, and those I recognized when -- as revenue when we settled those contracts in negotiations.

Fair enough. Thanks. Did you have any other contracts under negotiation that have a potential for the back half of the year?

We're looking at each other. None that we can think of.

Fair enough. My other question's related to small business. And that's how you are thinking as you are refining your model on net customer addition. It is a business where it is much easier to measure customers coming on board than customers going out the back door. How are you addressing that as you are getting your arms around small business?

Several areas, Mike. The number one thing, obviously, is getting new customers through our -- focusing on our Deluxe Business Advantage program. We had another strong quarter there. What we are really, as I said in my comments, what we are really now getting, I think, a lot smarter. Back to, I forget who asked the earlier question, you have been here another three months. What we are really learning is that we've got to win in that share of wallet. Once that customer becomes our customer, how do we get them to buy more from us?

And what we're focused on is, how do we do that? We think there is opportunities, again, as I mentioned, Mike, through e-commerce, through targeting verticals better than we do, and doing a better job at how we merchandise or do our advertising, whatever media we do that in, to them. I mean, we are absolutely spending more time on this right now and see this as -- it's going to be work. This isn't going to be easy to get this all sorted out and refined. But we are getting outside help to look at it. We are getting more resources internally. Rick and I are a lot stronger to understanding what we are trying to do here. So that's what I can tell you we're focused on at this point.

Last one for you. You mentioned in your comments that you expect higher concession rates as year progresses. Is there anything that has changed? Or is that basically the same kinds of things we have seen historically in FS contracts?

I think, Mike, it's the same thing we have seen. I think what we have been very consistent on is we are not expecting -- we're not planning for an expectation that the pricing pressure is going to weaken. You know, do we hope it does? Well, obviously, we would love for that to be the case. But as I have been, I think, very public and consistent, not only on the calls but when we have been out, is that it's very important that Rick and I be smart about how we are being planned for in the company for this.

Because what tends to happen, again, Mike, is if you don't continue to think that way, what you do is you tend to put costs back into your company because you kind of tend to kick your feet up. And Rick and I aren't focused on that. I've also been very consistent, we are not trying to cause problems in that area. At this point in time, it is just natural to assume that that progression is going to occur and that's how we have been planfully doing it.

Yes. Well, excellent job on the tactical approach. Thanks. And that's it for me.

Thank you, Mike.

And your next call comes from the line of [Piyush Sharma] with Longbow Research.

A couple of questions on gross margins here. One, can you elaborate the mix benefit that you mentioned that had on gross margins? Also, what was the impact on higher shipping costs in the quarter?

The mix impact really relates to, and as Lee mentioned, we had a good quarter in our Small Business Services segment from acquisition of new customers that come through the Deluxe Business Advantage Pipeline there, in terms of how we get customers. Typically, when we see, when those customers are coming onboard new, one of the -- a higher percentage of the products that they order are checks. So, really, across our Small Business Services segment, we had a favorable mix of check volume which has favorable impact to our gross margins overall.

Can you repeat your second question again?

Second question was on delivery costs. It is not something that -- we are not going to give exact numbers for what the change in our delivery is. I think the way you need to think about it, where we are and then where we are going here is, and what Rick's tried to do in the guidance is say, we are going to have some expected volumes from the second quarter to the third quarter in the FS and Direct Checks business. And then the delivery is going to have impact on the 150. Those are the reasons for kind of the -- the 69 to the 57 to 61 guidance difference. I think you need to think of it as it is in those numbers, in terms of the movement and delivery.

That is helpful. And, secondly, Lee mentioned about lifecycle programs in the Small Business segment. If you can give me some sort of framework of what that is exactly and how you are going about it, that would be great.

It is actually in the Financial Services segment, lifestyle. What we are finding when we are out looking at helping -- trying to help a financial institution again solve one of their challenges, and that's retaining and keeping and keeping that loyalty with their consumer, their clients, we believe there is an opportunity to target better what we call and they call "lifestyle changes." You know, when you are heading towards a retirement or you're planning for a college education or a new addition to your family, those can require very specific things to think about for those life events. So what we are doing is working with, again, we mentioned nine pilots that we've gotten, these various type of programs. Obviously, we hope it is something -- hopeful that this will lead to bigger opportunities for us, but it is just too early for us to tell. So that's really what we are talking about in that lifestyle space.

Okay. Thanks, guys. That is all the questions I had.

Thank you.

And your next question comes from the line of Adam Spielman with PPM America.

Thanks for taking the question. Just a quick question. When you kind of look at what you've accomplished on the cost savings and just stepping back from the absolute numbers and looking at -- if I kind of back into some EBITDA guidance, from your EPS guidance, it looks like it is close to that $350 million number, over close to 22% margins. Is that -- is there anything that prevents you, you think, from increasing that? How do you feel about that kind of level of where you are on your business?

Increasing it, Adam, from where?

From, say, 22%.

From where we are today? You are getting into moving into '08 and beyond, we are not in a position where we are going to put out a guidance or talk about guidance. But, obviously, we expect the company to continue to improve. So it would be -- it would be -- I think where you're thinking, where you're heading is that 22 that you use in our model, we would expect that to have an opportunity to improve if we can continue to improve the company.

Okay. Then when we just kind of look at your debt pay down, it is pretty substantial this year, and clearly, in light of what is going on in some of the debt markets, it looks perhaps more advantageous to have a strong balance sheet. But over, say, over a few years, how do you envision using that -- that financial capacity? If there is not some kind of large acquisition, what would you do?

Yes, as we mentioned, we will pay down this year, in terms of the guidance, 185 to $200 million of debt paydown here. And then -- and, really, the big focus item we have is the October maturity of the $325 million that we have to take care of. Beyond that, we will continue to pay down debt to the extent that we can. And then, the uses of the free cash flow that I mentioned previously, we will look at opportunities to invest organically and/or through tuck-in acquisitions. As Lee mentioned, we are getting a lot more clarity around opportunities that can help augment capability and help to drive some of the growth initiatives. Right now, we are probably looking more from a tuck-in nature as opposed to large scale acquisitions at the time.

And then, beyond that, we continue to look regularly at opportunities to enhance shareholder value. We do still have 8 million shares -- approximately 8 million shares outstanding that authorized for share repurchase. That is an opportunity for us. And we look quarterly with our board at our dividend policy in terms of where the yield is, and is that an opportunity as well to return shareholder value.

Do you have a longer-term bias in terms of increasing the dividend versus just sticking with periodic share repurchases?

We'll look at the opportunities as they present themselves. In the near term, we don't -- we have mentioned that we don't anticipate any significant change in our dividend policy. But, as we get further beyond and we continue to generate strong cash flow, we have to look at the best opportunity to drive shareholder value.

And then a final question. In terms of your Small Business segment and just thinking about overall economic strength, we have definitely heard from a number of companies about real estate markets, places like Florida and California and Nevada, and the weaknesses definitely trickle through to all kinds of other businesses. Are you seeing any kinds of indications from any of your businesses about any overall kind of economic weakness?

Based on the numbers and where we are, we've continued to perform. And we do have a rate -- overall rate decline of growth year on year. But that's more, we think, focused on the fact that last year, Adam, we are bringing on a lot more of the big banks and getting the DBA program kicked off. But for the ones that are in there now, we're still that same strength in the DBA program. And there are products, sometimes product categories, within small business that move around a little bit and we are always trying to figure out what does that trend mean. But, as of right now, I can't comment to Florida or housing. No, I can't comment to that.

Thank you.

Thanks, Adam.

And your final question comes from the line of Todd Morgan with CIBC World Markets. Please proceed.

Thank you. Good morning.

Good morning.

Good job on the costs this quarter. I was going to come back with two questions. First of all, on the contract adjustment. My understanding, I think from your comments, is that was a revenue enhancement. Is there any sort of cash flow impact, contract acquisition payment or anything like that?

Yes there is cash flow implications from that and it's all reflected in our guidance.

Okay. So, in other words, there is a revenue -- a positive revenue number, and then you are netting off that cash receipt against the contract acquisition payments that you would normally book. Is that right?

It is a combination of the cash received as well as cash outflow avoidance.

Okay.

I think one thing that is really important here and for everybody else, this isn't a big thing here. This is a relatively small amount that we are talking about. We did feel it was important enough because it wasn't in our guidance before to be able to talk to it today. I want to be clear. This is not some big, enormous windfall here.

It is an accumulation of several very small items -- smaller item. It is not any one large items that is driving this. And in the past, we have had large items but that is not the case here. It is just a series of smaller ones and they just added up a little bit.

Okay, that's fair. But I guess these are all part of the customers that are staying with you. They're not customers that are necessarily exiting. This is a like renewal or an extension of your contract arrangements with them. Is that right?

There are a couple within that mix of items in there that relate to customers that we have -- that we're no longer servicing, the check programs with. And, typically, when that happens, it's several months or even quarters later when we come to final terms in the final settlement. So in this case, yes, the payments reflected are related to small customers we lost awhile ago.

Okay. Okay. Secondly then, if I try and look at a same store revenue basis netting out the sales, acquisitions, the contract items, I think -- the continuing revenues are down a little bit, right?

No, we actually would have -- adjust a little bit of growth.

But not including the acquisitions, right? If you are adjusting for the acquisitions, right.

There would have been growth.

There would have been growth, absolutely.

All right. Well, then, that's pretty good news overall then. Good luck. Thanks a lot.

Thank you, Todd.

Thank you.

Okay, let me -- let me just try to make a couple of closing comments. Clearly, we are pleased with the first half of 2007. We continue to be energized and passionate about attacking the work ahead of us. And I will say that we have a lot of work to do, but our objective is to continue to execute and improve our performance each day and make sure that we deliver on our improved commitments. We thank you for participating today and for your questions. We are going to get back to work, and we will look forward to providing another positive progress report on our next earnings call.

Thank you, Lee.

This is a reminder that a replay of this call will be available until August 2nd by dialing 888-286-8010. When instructed, provide the access code 88180261. 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.

Thank you for your attendance in today's presentation. This concludes the conference. You may now disconnect. Good day.