Deluxe Corp (DLX) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Deluxe Corporation Earnings Conference Call. My name is Carmen. I'll be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS) And now I would like to turn your presentation over to your host for today, Mr. Terry Peterson, Vice-President of Investor Relations and Chief Accounting Officer. Please proceed.

Thank you, Carmen. Welcome to Deluxe Corporations 2007 third 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 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, 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 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, and good morning, everyone. We're joining you today from our Kansas City check fulfillment and call center location, having spent some time here celebrating with the team as this represents our last site to implement our new flat check delivery package.

We had another solid quarter and are pleased with our financial performance and continued progress with our transformation. In addition to seeing growth in small business services, excluding the previously announced sale of the industrial packaging product line, we continue to see stabilization in the rate of revenue decline in financial services and direct checks and reported strong bottom-line results in all our segments.

Operating cash flow was better than expected, and we repurchased $3 million of common stock in the quarter. We made progress on our new revenue expansion initiatives, continue to execute on our $150 million cost reduction program and will finish the year ahead of plan, and announced today an incremental $75 million cost reduction initiative.

Earlier this month, we also repaid our $325 million debt on schedule. We have completed the fifth quarter of our ten-quarter, or inning, transformation journey. So even with these continued successes at the halfway point, we still have work to do.

In a few minutes I will 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 third quarter of $0.62, just over the top end of our previously announced outlook for the quarter.

Although revenues for the quarter were in the middle of our range, earnings benefited from continued traction in manufacturing efficiencies, further reductions in SG&A and a slightly favorable tax rate.

Operating cash flow remained strong and also exceeded our expectations. The strong earnings and continued progress with our working capital initiatives led to operating cash flow of $73 million for the quarter.

In the third quarter of 2006, we reported diluted earnings per share of $0.61. Earnings in 2007 were higher year-over-year, due to continued progress on our cost reduction initiatives, including a $6.3 million net reduction in SG&A expense. These savings were partially offset by a higher effective tax rate, which negatively impacted 2007 EPS by $0.04 as compared to the 2006 period.

Company wide, revenue totaled $388.6 million, down 2% from 2006. The prior year amount benefited from the industrial packaging product line, which was divested in the first quarter this year.

Gross margin for the quarter was 63.1% of revenue, up from 62.4% last year. Improvements in manufacturing productivity as a result of lean initiatives and favorable product mix contributed to a higher gross margin, despite higher delivery costs and continued implementation of our new flat check delivery packaging.

Selling, general and administrative expense was down $6.3 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 contributed to the year-over-year decline. Partly offsetting these declines was higher performance-based employee compensation and advertising expense.

As a percentage of revenue, SG&A decreased to 47.5% from 47.9% last year. As a result, operating income in the quarter was $60.7 million, up from $57.2 million last year.

Next, I will provide some highlights in each of our three business segments. In small business services, revenue of $225.8 million was down 3.5%, or $8.3 million versus 2006. As noted, 2006 revenues included the industrial packaging product line, which we sold in January 2007. Adjusting for this divestiture, revenue in the quarter grew at low single-digit rates, driven by the Johnson Group acquisition in October 2006 and a favorable Canadian exchange rate. We also experienced some softness in our contractor and retail vertical segments due to general economic conditions.

Operating income in this segment increased to $30.2 million, up from $24.5 million in 2006. The increase was driven by continued cost reductions, including lower manufacturing and selling costs, which more than offset increases in performance-based employee compensation. As a percentage of revenue, operating margin for the quarter was 13.4%, thus continuing our trend of delivering double-digit operating margins.

In financial services, revenue was $113 million, down less than 1% from third quarter last year. The current quarter reflected continued strong check volumes, which were essentially flat compared to last year. Financial services reported operating income of $16.7 million for the quarter or 14.8% of revenue, down slightly from 2006. The benefit of cost reduction initiatives was offset by higher performance-based employee compensation, increases in delivery costs, given higher postal rates, and investments being made to drive new revenue expansion platforms.

Finally, direct checks revenue totaled $49.8 million, down just 1% on a year-over-year basis. Revenue this quarter benefited from continued success in selling additional accessories, premium features and services, which nearly offset the impact of lower order volumes.

Operating income was $13.8 million, down $1.6 million from last year. The decrease was caused by the lower order volumes as well as higher manufacturing costs from the introduction of our new flat check delivery packaging last quarter. Also, higher advertising costs and performance-based employee compensation were offset by benefits from our cost reduction initiatives.

Turning to the balance sheet and cash flow statement, total debt at the end of the quarter was $1.1 billion, compared to $1 billion at the end of 2006. Cash proceeds from the successful $200 million senior unsecured no-issuance, completed in May, remained in short-term investments at the end of the quarter. On October 1st, we fully repaid our $325 million obligation on 3.5% notes, utilizing proceeds from liquidating short-term investments and available capacity on our committed lines of credit.

Cash provided by operating activities for the first nine months of the year remain strong at $177.7 million. The 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, income taxes and performance-based compensation.

Looking ahead, we expect fourth quarter consolidated revenue to range from $416 million to $423 million and diluted earnings per share to range from $0.76 to $0.81. On a full year basis, this would result in a revenue range of $1.608 to $1.615 billion and diluted earnings per share of $2.75 to $2.80.

Compared to third quarter performance, key drivers for our fourth quarter outlook include seasonal sales, primarily in our small business services segment; lower delivery costs in our financial services segment from a full implementation of our new flat check delivery packaging solution; continued execution of 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 effective tax rate of approximately 35%.

We expect operating cash flows to range between $240 million and $250 million for the year, a shift to the upper portion of the range previously communicated due to the favorability in the third quarter results and the lower contract acquisition payments. We expect contract acquisition payments to be approximately $15 million.

Capital expenditures in 2007 are forecasted to be approximately $30 million with investment focused on driving manufacturing productivity, business simplification and non-check revenue growth. Depreciation and amortization expense is expected to be approximately $70 million, including $29 million of acquisition-related amortization.

Now that we have cleared another important hurdle earlier this month with the repayment of our $325 million debt obligation, we plan to resume paying down our credit facilities and for the year expect the range of debt pay-down to be between $190 million and $200 million, which should further strengthen our credit ratios and enhance financial flexibility.

As we continue to generate strong operating cash flow, we will continue to focus on effectively deploying excess cash to drive long-term value. In fact, during the third quarter, we repurchased 100,000 shares for approximately $3 million.

Looking ahead, our priorities for uses of free cash flow include investing both organically and with tuck-in acquisitions to augment growth and paying down our credit facilities. We will also consider other opportunities to create shareholder value, which include share repurchases and evaluating our dividend level.

As you may recall, our new debt agreement does limit our ability to make restricted payments for items such as share repurchases and higher dividend amounts. As we continue to generate a sufficient level of net income, our flexibility to make restricted payments will increase over time.

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

Thanks, Rick. I will continue my comments with an update on new revenue growth platforms and enablers, then highlight continued progress in each of our three segments and close with an update on our cost reduction program.

In the quarter we made further progress in the three major growth categories I introduced on the second quarter call. First, customer transaction solutions, which includes most of our revenue today for core checks and office management products, but also potential opportunities with stored value cards and new small business services. Second, customer acquisition loyalty and retention solutions, which include such offerings as our Impression Suite and DeluxeCalling. And finally, customer monitoring and protecting solutions, which includes identity theft protection and other fraud prevention tools.

We also progressed on several key enablers, including improving our e-commerce capability, where we recently introduced a new deluxe.com website, which will serve as a platform baseline. We also made progress with improving analytics and focusing more crisply on key vertical segments and merchandising, both for small businesses and financial institutions.

In addition, we recently hired an experienced marketer to drive a makeover of our various brands linked to our e-commerce merchandising and improve external communications initiatives. I will incorporate examples of these potential new revenue opportunities and key enablers throughout my segment updates.

Now shifting to our segments. In small business services, we had another solid quarter of new customer acquisitions driven by our Deluxe Business Advantage program and continue to expand custom color products through the Johnson Group acquisition. We are pleased that we were able to grow revenue in the quarter on a year-over-year basis, excluding the industrial packaging sale.

And while revenue in the quarter was down slightly from the second quarter, there was one less business day in the third quarter, which essentially means that we maintained revenue on a sequential basis. Still, we did see some signs of softness in our contractor and retail verticals that may be driven by economic conditions. So we are closely monitoring that situation.

As we move forward, we remain focused on acquiring new customers and increasing our share of wallet, where we believe we can sell more personalized forms and related products as well as higher growth solutions, including custom full color digital web to print and promotional products. In the quarter, we made progress in expanding our e-commerce capability, but we have much more work to do here.

We also initiated the first wave of an extensive vertical segmentation pilot with retailers, contractors and other professional services, with the objective of learning how to merchandise more effectively as well as understanding what products and services fit better with small business life-cycle stages.

The second, more extensive pilot will be in the fourth quarter, and we will share feedback on our next call as to how this may positively impact us in 2008.

In financial services, we continued again this quarter to proactively extend several check contracts with existing national customers. Order volumes in the quarter basically were flat year-over-year. Our retention rates remain in excess of 90%, and new acquisition rates remain strong, especially in the credit union space.

We continued to simplify our processes and take complexity out of the business while reducing our cost and expense structure. I also had more financial institution customer visits this quarter than any other quarter since I've been at Deluxe.

In addition to our strong core check revenue, we made progress in the third quarter in advancing new non-check revenue expansion opportunities. To give some more color here, we advanced pilots for our suite of customer loyalty and retention programs known as Impressions.

For DeluxeCalling, which helps financial institutions establish relationships with indirect borrowers by engaging our world-class call centers to introduce customers to their financial institution, we launched the pilot in September with a very large financial institution and executed some new business generation scripts, extending our initial indirect lending capability with several new financial institutions. We completed most of the migrations to our new partner for our stored value gift card program and are ready for the upcoming holiday season with a significantly enriched program.

Finally, in the monitoring and protection space, we continued to increase implementations and enrollments. Again, it is still too early to understand whether all of these initiatives can have a meaningful impact on our future revenue, but we are making progress. In the fourth quarter, we will continue to frame the market opportunity and revenue potential of these new solutions and expect to have better clarity here as we work through many pilots over the balance of 2007 and, as a result, determine how much of these new opportunities can impact us in 2008.

Finally, in direct checks, we reported a 1% revenue decline in the third quarter. Our investments in free-standing insert Impressions focus on selling additional products, such as holiday greeting cards, premium-priced features and accessories and the expected November release of stored value gift cards will continue to enhance results. We also announced in the third quarter an exclusive long-term licensing arrangement with Warner Brothers to bring classic cartoons and new characters to personal check customers starting in 2008.

In addition to these actions in each of our segments, here is an update on our costs and expense reduction initiative, where today we announced an incremental $75 million in anticipated savings on top of the previously announced $150 million cost reduction initiative.

Overall, we had another solid quarter, delivering a little more than expected at this point on our percentage of targeted cost reductions. In addition to the 10% achieved in 2006, we believe we are now on track to deliver an additional 60% this year, or slightly better than the high end of the committed range of 50% to 55% for 2007.

You may recall that we indicated around 50% to 60% of these savings were expected to directly benefit the bottom line. In the third quarter the actual percentage fell slightly below this range, primarily due to higher delivery and new check product packaging implementation costs. In the fourth quarter, we also expect to fall slightly below the 50% to 60% range, primarily due to investments in non-check revenue pilots.

The balance of the $150 million in cost reductions, or approximately 30% or $45 million, is expected in 2008. We expect the incremental $75 million in cost reductions announced today to be realized in 2008 and 2009 and primarily to be achieved within our sales and marketing support operations, fulfillment, including manufacturing and supply chain, and our shared services infrastructure.

Here are some highlights of the key cost reduction initiatives for the third quarter and continued areas of opportunity as we move forward, in addition to the ongoing savings that are occurring each quarter from previously implemented actions. In our go-to-market sales and marketing, our focus is on realigning sales and marketing backend operations and refining our channel management structure through process centralization, simplifying business processes, platform and tool consolidation and leveraging e-commerce and vertical segmentation capabilities.

For fulfillment, we had another strong quarter on lean productivity improvements and indirect spend reductions. And we also continued our implementation of the new flat check delivery package. As of October, all direct checks and financial services customers will receive the benefits of this innovative new package.

For the balance of 2007 and into 2008, we expect to continue our lean product standardization and direct -- indirect spend initiatives, plus work on realigning to a common manufacturing platform and reducing skews. We also just hired a new, well-regarded Chief Procurement Officer to help drive supply chain improvements and efficiencies.

Finally, for shared services infrastructure, we continue to make good progress in information technology driven by data center cost reductions and other system utilization, networking and voice communication efficiencies. In the third quarter, we also signed a new performance-based contract with our primary outsourced IT services provider. We expect to continue to reduce costs in each of the areas mentioned, as well as better rationalize and standardize applications in technology and more strategically align IT capability and delivery with our business segment's needs.

For our other shared services infrastructure functions, including finance, human resources, real estate and legal, we continue to standardize more of our internal processes and improve efficiencies, which included completing the off-shoring of much of our financed transaction processing activities during the quarter. Opportunities still exist to centralize, streamline, standardize and improve efficiencies in these functions. As an example, this year we expect to eliminate 12% of our real estate footprint.

As I have been indicating for several quarters, 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 close to 60%, or beyond the high-end of the previously committed 50% to 55% range of the $150 million in 2007, we still have work to complete to determine how much of the cost reductions will be offset at the bottom line beyond 2007.

As we are making investments expected to increase revenue and earnings over time in e-commerce, vertical segmentation and merchandising for [CDS], or for SBS in loyalty, retention, monitoring and protection solutions in FS and in new products, features and accessories for direct checks.

As you can see, we made solid progress in the quarter. But we still have a lot of work and opportunities ahead of us. We expect continued strong progress in the fourth quarter as well, not only in our cost reductions initiatives but also on our new revenue offers and key enablers. We are confident that as we continue to execute in the fourth quarter, we can close the year with strong progress and financial returns.

Now Rick, Terry and I will take your questions.

Carmen?

(OPERATOR INSTRUCTIONS) And the first question comes from the line of Charles Strauzer from CJS Securities. Please proceed, sir.

Good morning.

Good morning, Charlie.

Rick, could we just start with you for a couple of housekeeping questions, if I could? One is if I look at Q4, kind of what should we think about for interest expense now that we have debt pay-down and additional pay-downs coming?

Yes, as we have completed the debt pay-down on the $325 million, which is, as you recall, was 3.5% notes, the interest expense now -- and we do have a modest draw on the credit facility at this time. But with the lower debt levels, we would see our interest expense decline just slightly versus what you've seen in the third quarter overall, but not really a very material reduction in total there, Charlie.

Great. And then as you look at the segments for Q4, a sequential direction, if you could, by each segment. Should we see sequential improvement in each segment, or is there some variability there?

No, not a great deal of variability. I mean, we continue to focus on delivering double-digit operating margins in our small business services segment. We do have the seasonality, given the increases from our holiday cards in the small business services segment, but again double-digit operating margins there.

Financial services -- again, we're focused on continuing to drive low double-digit operating margins. And within the direct check segment, continuing to maintain operating margins around that 30% level, give or take one or two points there.

Got it, great. And then if you could, can you talk a little bit about kind of the next 12 months, any contracts coming up for renewal that we should pay attention to?

Charlie, this is Lee. In the FS space?

In the FS space, yes.

Yes, the way I would look at it is we've got to mention, we had a lot of -- with a couple of contracts in the national space that we already extended in the third quarter. This is something over the last -- I think we've mentioned the last three quarters now that we've been targeting to do this. And really the whole line of thinking here is to, again, create that continued annuity stream.

And there are a couple of contracts that are decent size -- they're not significant -- that will come up in the 2008 timeframe, and obviously, we're working to try to see what we can do to get those locked in for a longer period of time. But it's not anything significant rolling in as we close out '07 and then as we move into 2008.

Great. And then, Lee, you touched upon web to print a little bit. Can you expand a little bit more on the rollout of web to print? I know that's one of the things that you had talked about as potential opportunity down the road. Is that continuing to roll out through the small business segment at all?

Yes, we think obviously the acquisition that we made with the Johnson Group back in October last year, we've had these guys now about a year, and we're pleased with the progress we've made in that space. But we still believe that the whole digital and web to print is going to be a bigger play for us, as I mentioned in my script, as we move forward.

And Charlie, the way I would think about it is what we're trying to do is continue to take what we acquired from the Johnson Group and then build that capability out, both in the way we go to market through the various channels that we have as well as the way we use our improvements that we're working on in the e-commerce space, and then really pulling all that together in a very networked and a very tight way. And we're excited about it. We think it can be a bigger revenue-generating opportunity as we move forward.

Excellent. Thank you very much.

Thanks, Charlie.

And the next question comes from the line of Jamie Clement. Please proceed, sir.

Good morning, gentlemen.

Good morning.

Hey, Jamie.

With respect to the incremental $75 million of cost, I know that you described a little bit where the buckets that those costs would be coming from. But from a percentage basis perspective, you previously identified kind of go-to-market fulfillment and then your shared services infrastructure. Compared to the $150 million, should we similar percentages coming out of those buckets with respect to the $75 million?

Yes, the way I would look at it is we're a little more targeted this time in the go-to-market, Jamie. A little bit more is really the backend more of the operations piece of the sales and marketing, whereas the first, the $150 million, also included some more of the complete channel piece of that.

But I would say other than that, yes, it's very much focused on continued improvements that we think we can get in fulfillment through manufacturing and supply chain. I'll mention that, as I mentioned in my [text], we're real excited. I think we've got a real player in a new Chief Procurement Officer, which we think is going to help in that space as well.

And then the balance of it again, Jamie, would be in the infrastructure. Again, with IT being the lead there, but also finance, HR, legal and real estate.

Okay. One question specifically about the FS segment and as it relates to the fourth quarter. When I think of delivery costs, I would think of postal price increases, but I would also think of the flat packaging change. Obviously, the postal price increases, that's going to be with you. But it would seem to me in looking at how financial services operating income has trended, I mean to hit your guidance it would seem like we would need to see that number ramp up in the fourth quarter.

And I think in your prepared remarks, you alluded to the you expected delivery costs to kind of come down a little bit. Can you talk a little bit more about that?

Yes, you're on the right -- you read it well, Jamie. You're on the right track here. I think what's really happened through the year is we got the postal increase May the 14th or something like that, and so we kind of had a half of quarter in Q2, where we had higher rates and then kind of the comparable rates we had. And then Q3, I think we kind of said on our last call was going to be the worst quarter, where we had pretty much the full hit.

And then we're actually again thrilled to be in Kansas City for this call and to be with the team here as they've made the transition. They're the last fulfillment site to make the transition. So we expect the cost to get -- to come down more in the fourth quarter. And I think you've read it right. And obviously, therefore, if we can keep the rest of the business in check, we have an opportunity to improve the margins.

I will tell you, though, that if you listen to my comments as well, we are investing in some of these pilot programs, and there is some cost that's going into that as well.

Sure. No, that's understandable. And last question and then I'll get back into queue. Lee, you alluded to having a lot of visits over the last couple of months from some of your financial institution customers. You've been with the Company a relatively limited amount of time, but from your perspective, has the nature of those visits, with your customers, to Deluxe changed over the last couple of years?

What are they looking for? What are you hearing from them? I know that there's a little bit of a push-pull, but sort of, from your perspective, what do they want most out of their relationship with Deluxe these days?

I think, first of all, Jamie, they want to know that the -- they want to know that we're going to be a solid player in the check space. Some of the visits obviously are around making sure that they are -- they have the continued confidence in our ability to deliver on the check program, and I believe they have that confidence and are continuing to expand that confidence.

And then it really cones down to what other things that we can do for them. And are we hitting the mark with some of the initiatives that we're talking about publicly, around monitoring and protection, around loyalty and retention, and helping them solve problems with their customers?

And then the last piece that we're talking to them about is what we believe, again, is a sweet spot opportunity between the financial institution and their small business customers. And that -- obviously that's something that we think plays well, Jamie, into our space.

And those are the things that we're talking about. And what I'm trying to do is make sure that they -- I'm listening to them and hearing how Deluxe can help them as we move forward.

Okay, great. Thanks a lot for your time.

You bet, thank you.

And the next question comes from the line of John Kraft from D.A. Davidson. Please proceed.

Good morning.

Hi, John.

Lee, I wanted to follow up on some previous comments that you made regarding some larger contracts that you proactively renewed early. What are you doing to do that? Is that involving some discounting?

Really what we're trying to do, John, is get out and expand our reach, so to speak, within those accounts and show them that Deluxe can be not only a great check provider but really, again, reach into some of these other areas.

And what we're trying to do, obviously, is -- no, I'm not trying to raise the discount level as I move forward. I mean, I'm not saying there's not some negotiation that goes into the process. But the real intent of what we're trying to do is get out and solidify the relationship that we have by reaching into other areas that we think we can help the financial institution, and that's really the focus that we have when we're trying to work through and extend the contracts.

And it would be the more we have the ability to do that, the more confidence the FI has that we can not only deliver a strong check program, John, but continue to get into some of these other areas.

So it's not inconsistent with your being able to continue to push pricing increases through?

Well, what we've been able to do, John, as you know, is we have a lot of contracts where we can and can't increase price. But really, the opportunity where we raised price early this year was really around the delivery area.

Okay. And then, Rick, back to the contract acquisition payments. Obviously, they're tracking way down. Is that a secular shift in just the way the industry is pricing, given that there's been obviously a bunch of changes in the players?

It's really a combination of both. Changes in the way that we're trying to restructure these contracts, and we're not necessarily down on a year-over-year basis, but we're really flat as compared to the contract acquisition payment levels last year.

As we've noted previously, this has been a year where there has not been a large number of contracts coming due or really up for competition that would provide opportunity to have contract acquisition payments. So that, combined with our efforts -- and I think these are efforts that are going on across the industry to really restructure the way these contracts are established -- and looking at other ways, whether it's rebates more on a quarterly basis or baking in the actual pricing, what would have been given on an up-front basis from a cash standpoint, just working those differently has created that. We're flat year-over-year and at the levels that we mentioned about $15 million for this year.

Okay. And as far as the direct segment, you've obviously been investing and focusing on that, investing in marketing. Is the goal simply to stabilize that, or could we actually see a pick-up in that business?

The way I -- John, the way I would look at this is that we've been trying to - I came into the company and I basically inherited a business that was going down about 14%, 15% and it was making close to right around 30 points of operating income, and it's a -- pound for pound, that would be the highest business that we would have from an op income perspective.

And I just felt like being the market share leader, we weren't being as aggressive at our potential reach that we could be. And so we basically put in a little bit more advertising money into this. And what we're trying to continue to work through is how can we extend our reach to the consumer not only through check and then the other packaging and other accessories and now extending into holiday greeting cards, which we sell to our small business customers?

And this -- I mentioned that in November we're going to try to again extend that reach to the stored value gift card. We're trying to figure out how do we take a great asset that we have and a great team of people in that business and really extend it out into other areas that consumers can buy products and services from us.

How strong can this get? Don't know yet, John, is the way I would describe it. But clearly, we're pleased with the improvement that we have seen in the segment.

And do you anticipate any seasonality? It doesn't look like there's been much in the past.

In direct checks?

Yes.

Actually, the first quarter is normally our biggest business. Yes, I think we told on the first quarter, after the first quarter that normally we kind of see this bump up, and it's kind of normal. And it seems to be normal within that segment in the industry that, I don't know, maybe people after they're writing a lot of checks after the holidays or something seem to want to re-up at that point in time. But that's probably the most seasonal quarter that we have.

Okay, that's fair. By the way, that wasn't us. Just last question, the '08 guidance, when do you anticipate providing that?

After the fourth quarter, John, in the end of January timeframe.

Great, thanks.

You bet. You bet, John.

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

Good morning.

Hi, Mike.

A couple of detail questions. First, as we look out into the fourth quarter, what kind of tax rate are you using at this stage?

As we've said earlier, we're projecting approximately a 35% tax rate for the full year.

Thanks. My perception on fourth quarter, I'd anticipated a little bit more gross margin lift than I think what your guidance suggests. Realizing it's hard to analyze my numbers, is your expectation that we're going to see some cost restructuring hitting, or is it concerns on the consumer that leads you to be a little bit cautious on outlook on some of the more seasonal products?

Mike, I think as far as what we did in the third quarter and what we did for there for the full year and the fourth quarter, we think we're on track with basically where we had our guidance. Not only delivering -- certainly delivering on Q3, but delivering now for the full year within the range that we had.

Now we did mention that we expect to put some money into non-check related pilots and trying to drive the future revenue piece, and that's probably where your model may be a little bit off from our model. That's the only thing I can think of.

Thanks. Could you comment on what was in other income in third quarter?

Mike, it was -- the other income included investment income from the investments while we were waiting to repay the debt maturity on October 1.

So you've got interest income in there. Okay.

That's correct.

Last one, as we look at a world in FS where things are becoming basically a duopoly here, what's your sense of what you are seeing in pricing and what customers, at least the larger customers are looking for?

Okay, I want to -- Mike, I want to stay consistent with what I've said all along here. And that is Rick and I have built our forecast for this year all along that the continued pricing that we've seen and the concessions that we've seen in terms of that going down are being more aggressive. We've continued to build our plan and, therefore, our cost structure to assume that.

We're not out there purposely trying to be -- being more aggressive on price. But in the end, I believe that when you're running commoditized businesses and segments that the customer will dictate that over time. And I think what we're continuing to try to do is be planful and smart about watching that trend and making sure that Rick and I are building the cost structure of the Company that is in support of that. And that is, again, part of the reason why we're staying after the additional $75 million that we announced today.

Yes, thanks for those insights. Last, you called out Canadian currency impact. Is it worth noting on what you saw top line or operating income?

It's a little bit. It's a little bit, Mike. And the problem is -- we were out at the dinner last night, we were actually talking about this again. I mean, we've gone from a 0.73 rate over time all the way now to a 1.02 or something.

So, yes, it's starting -- it's starting to have a -- you've got a $78 million, $75 million business, you can do the math. We publicly released that segment or that Canadian sized business. I mean, it's just starting to have a little bit of an impact. We thought we should disclose it.

Yes. Thanks again for the help and the insights. That's it for me.

You bet, Mike.

And the next question comes from the line of Piyush Sharma from Longbow Research. Please proceed.

Good morning, guys.

Hi, Piyush.

Good morning.

Couple of questions. I know that you guys did mention about the check volumes for financial services and for direct checks. How did that volume look for small business?

Small business, we've been public, Piyush, in basically saying that we see this 4% to 5% market rate of decline overall in the financial services space. But we actually believe that the decline is more around 2% to 3% in the small businesses services segment. Because a couple of reasons, small businesses still are not as -- collectively are not as electronified as larger businesses, and then they also tend to use checks as an audit trail for where expenses and when they're maintaining their books.

So I would say that the rate of decline that we see is lower in the small business services segment.

When I look through your incremental $75 million cost reduction initiatives, I know that on your $150 million, you guys said that 50% to 60% of that will flow though the bottom line start to finish. How much of this is expected to flow through to the bottom line?

As I mentioned in my script, Piyush, we're right now building out our operating plan for '08, and we're trying to look at all these drivers between the core business and then the amount that we're investing in these pilots and some of these enabling capabilities for us. And what we're still trying to determine is how much of that is going to fall through the bottom line. And honestly, at this point in time, we're still trying to get that all nailed down.

Okay. And this question is for Lee. You did mention that you launched a pilot with a major financial institution in September on your customer loyalty programs. Can you give me some more color on what exactly that is about, what you're trying to achieve, what is your overall mandate?

Absolutely. It's -- this one is that I mention specific to DeluxeCalling, Piyush. And we think we're on to something here. We think we have, with several customers, and we've been public about the Boeing Employee Credit Union, where we've been able to get in and create a relationship that Deluxe is helping to extend the indirect lending that the Boeing credit union is trying to do for their employees. And what we're trying to do is take that now and extend it into other indirect lending opportunities.

And in the quarter, we started a pilot and cannot release the name of the large financial institution, but it's to do just that. It's to take and help them create a relationship for their indirect lending -- loan customers. And we use -- they use Deluxe to create, use our call center to be able to create that capability.

And you say, well, why don't they do it themselves? And this is what the Boeing Employee Credit Union found is they were trying to do it themselves, and we asked if we could give it a shot. And we actually performed significantly better because we do have world class call centers, and this is the same thing that we're doing for this large national customer.

Great. And then, finally, just couple of household questions. If you could give me the working capital numbers for payable, receivables and inventory for the quarter?

Piyush, we will have those published on our balance sheet when we file the 10-Q in just a few days here.

Fair enough.

I don't have those handy right in front of me here.

Yes.

Our two finance guys are saying, looking at each other, "We don't have that yet."

All right, guys. Thanks a lot.

Thank you, Piyush.

And the next question comes from the line of Todd Morgan from CIBC World Markets. Please proceed.

Hi, this is [Grant Gandy] for Todd Morgan. Good morning.

Morning.

Hi, can you talk a little bit more about the drivers behind stabilization and direct checks? And I think your advertising expenses went up. Have you been spending more advertising for the direct checks?

Yes, I mean basically what we did at the beginning of this year, we increased our percentage of the available free standing inserts in the marketplace, and we also looked at how we're spending the balance of our advertising dollars. And we believe that the more times we put our name in front of a consumer, the more likely they're going to purchase our checks versus somebody else.

And then what we've also done is we've built out other capabilities. So we've added other products and services, fraud services products. We've added accessory type of products. I mentioned and we started offering holiday greeting cards, and I said in November we're going to actually extend an offer, the stored value gift card.

So what we're trying to do is solidify the core through the small amount of advertising increases that we made there and then add other products and services to the equation, and that's really what's helping to drive the improved top line performance.

Okay. Thank you. And also, can you kind of clarify the product and accessories? Is that the gift cards, greetings? Does that fall under financial --

Let me give you a good example. You can get on the phone, and the consumer would like to order a box of checks. And we would say, would you like a stamper with that? Would you like fraud and security protection on your checking account? So we're adding accessories and new products. And again, we've mentioned now the holiday greeting cards and the potential to add to the -- that segment line with the stored value gift card.

Okay. And final question here. About the buyback, was that kind of an opportunistic thing or is that part of a plan? I know you're kind of limited as to how much you can buy back, but --

Well said. I mean, we just could not believe, honestly, when the price went to where it did, and we just felt that it was prudent at that point in time to take advantage of that window and that opportunity. And that's what we went out and did.

Okay. So you think you'll continue, if the opportunity is there, up to your limit of share repurchases?

I think I'll go back to what Rick said in his view. I mean, we're trying to get the balance between paying the credit facility down, so to speak. And we're putting money into -- organically into new initiatives, and we're still out looking at tuck-in acquisitions that we think can make sense to help augment the growth that we're trying to drive. And then we're -- yes, we'll still look at -- we mentioned we'll still look at the share repurchase. We'll still look at our dividend rate yield as well.

Okay. Thank you.

You're welcome.

And the next question comes from the line of [Beth Hully] from [Woodland Partners]. Please proceed.

Good morning Lee, Rick and Terry.

Hi, Beth.

I have two questions. One is, Lee, you talked about hiring this Chief Procurement Officer. Can you tell us a little bit more about this individual, and have they started? Where did they come from?

Yes, they've started. It's a lady. She's been with us a couple of weeks. What I guess -- safely, what I can tell you is that she is fairly well known in the Twin Cities. She's had a lot of experience at larger public companies.

And you may ask, Beth, why would she come to Deluxe? I think it's a significant opportunity to really run the whole supply chain. She had pieces of the supply chain, and now she has an opportunity to run the whole thing. And we're just thrilled to have her.

So she started several weeks ago?

Yes.

Okay. Great. And then the other thing I wanted to ask is, your share repurchase, I think it was Rick alluded to -- can you talk about what the restraint -- constraints are in terms of your debt levels and maybe the constraints in terms of the debt agreements in terms of a repurchase?

Sure, Beth. As you recall, when we raised the debt, the $200 million of senior unsecured notes, those came along with some non-investment grade type covenants. The most important that affects us in this case is a restricted payments basket that builds over time for which share repurchases are one item that would go against this restricted payments basket.

The basket contractually began at $15 million and then builds over time with 50% of net income as we continue to progress over time. Any dividends that we pay out or other restrictive payments, like a share repurchase, go against that basket as well.

So we are limited to the extent that that basket continues to grow, and we have to be careful to ensure that we continue to have the right levels for the dividend. But as we expect net income to continue to grow, the basket will grow and will give us the flexibility in the future should we decide that we want to do any further share repurchase.

So as you pay down that debt, though, right, that it should be less and less of an issue? Right?

No, paying down our existing debt doesn't go against -- doesn't really impact this restricted payments basket. It's really just for payments we would want to make in terms of any share repurchase or if we increase the level of the dividend that we wanted to pay out.

Okay, so let me ask it this way. As you continue to generate cash flow going forward to the tune of over $240 million to $250 million, the issue about that restricted payment for that basket should go away, correct?

The generation of operating cash flow and any pay down of debt that we have does not impact the restricted payments basket.

Okay.

Now payments basket grows by 50% of net income, it allows us to continue to fund the dividend that we have and would allow for other types of restricted payments, such as a share repurchase.

Okay. Well, I guess I'm slightly confused, but you know what, I can follow up off line. It just seems to me that given your cash generation levels, that your debt should come down and then this restricted payment issues should eventually go away.

Yes. No, Beth -- and I can certainly follow up with you after the call, too, and we can talk in more specifics there, too. But the basket is simply just a very simple mechanical calculation. It starts out at $15 million when the debt was issued.

Yes.

It goes up every time we generate quarterly net income, by 50% of the net income, and then it goes down for any defined restricted payments. So that would include dividends, increases in dividends and share repurchases, and there's a couple other less frequent items that are also included in that. So just a very mechanical calculation that tells you what your availability is.

Okay. And then -- okay. So, and Terry, I'll follow up off line. So what's the total amount of share authorization you have for repurchase? Is there a million shares, is that right?

We still have an existing authorization that today is about 7.8 million shares authorized and outstanding.

Okay. Okay. All right. Great, all right. That's really helpful. Thank you very much.

Thank you.

And we have no final questions. I would like to turn the call back over to Mr. Lee Schram for closing remarks.

Okay, we're pleased with our continued solid performance. But as we head into what we call our middle innings of our transformational journey, we still have a lot of work to do. Our objective is to continue to execute and improve our performance each day and deliver against our commitments.

We thank you for your participation and your questions today, and we're going to get back to work. And we look forward to providing another positive report on our next earnings call.

Thank you, Lee. This is a reminder that a replay of this call will be available until November 1st by dialing 888-286-8010. When instructed, provide the access code 98860328. The accompanying slides are archived in the investor relations section of Deluxe's website at www.deluxe.com. Again, thank you for joining us. Have a good day.

This concludes your presentation for today, ladies and gentlemen. You may now disconnect. Have a wonderful week.