Deluxe Corp (DLX) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 Deluxe Corporation Earnings Conference Call. My name is Mary and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer 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 presentation over to your host for today's call, Mr. Jeff Johnson, Treasurer, Vice President of Investor Relations. Please proceed.

Thank you, Mary. Welcome to Deluxe Corporation's 2011 first quarter earnings call. I'm Jeff Johnson, Deluxe's Vice President of Investor Relations and Treasurer. Joining me on the call today are Lee Schram, Deluxe's Chief Executive Officer and Terry Peterson, Deluxe's Chief Financial Officer. Lee, Terry, and I will take questions from analysts after the prepared comments. At that time, the operator will instruct you how to ask a question.

In accordance with Regulation FD, this call is open to all interested parties. A replay of the call will be available via telephone and Deluxe's website. I will provide instructions for accessing the replay at the conclusion of our teleconference.

Before I begin, let me make this brief cautionary statement. Comments made today regarding financial estimates and projections and any other statements addressing management's intentions and expectations regarding the Company's future performance are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. As such, these comments are subject to risks and uncertainties which could cause actual results to differ materially from those projected. Additional information about various factors that could cause results to differ from those projected are contained in the news release that we issued this morning and in the Company's Form 10-K for the year ended December 31st, 2010.

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 News and Investor Relations section of our website, www.deluxe.com. 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.

Thank you, Jeff, and good morning, everyone. In a continued sluggish economic environment, we delivered another strong quarter and are off to a solid start to the year. We reported revenue at the top of our expected range, while adjusted earnings per share was above the high end of our range. Both Small Business Services and Direct Checks grew over the prior year. Checks and forms both performed well against our expectations and business services revenues grew 19% over the prior year. We had strong execution against our cost-reduction program.

Improved product mix drove better-than-expected EPS. Adjusted diluted EPS from continuing operations grew 3% over a strong prior year. We generated strong operating cash flow and we were not drawn on our credit facility as we ended the quarter.

We issued $200 million in new 8-year senior notes and repurchased almost 70% of our 2012 notes and $10 million of our 2014 notes.

In early April, we completed the acquisition of Banker's Dashboard to expand our financial services analytics and profitability services capability. We continued to invest in improved brand awareness to help better position our new business services offerings and drive future revenue growth. We also extended our process improvement and cost reduction initiatives while driving strong operating cash flow as we continue to transform Deluxe.

In a few minutes, I will discuss more details around our recent progress and next steps. But first, Terry will cover our financial performance.

Thank you, Lee. Earlier today we reported diluted earnings per share for the first quarter of $0.63, which included losses of $0.10 per share on long-term debt repurchases in the quarter and restructuring-related costs of $0.02. Excluding these costs, adjusted EPS from continuing operations of $0.75 was $0.02 favorable to the upper end of our previous outlook and 3% higher than the $0.73 reported in the first quarter of 2010. Favorable product mix drove better-than-expected EPS performance. The restructuring-related costs were primarily driven by infrastructure consolidations.

Revenue for the quarter came in at $350 million, which is right at the upper end of the range of our previous outlook. Revenue was up 4% from 2010 and was roughly flat on a sequential quarterly basis.

Small Business Services revenue of $200 million also grew 4% versus last year. While we continue to operate in a weak economic environment, we did deliver growth in Business Services, our Safeguard distributor channel, and Canada. And our core printing business benefited from a routine price increase.

Financial Services revenue of $88 million was down 13% versus the first quarter of last year, but was flat on a sequential quarterly basis with the fourth quarter of 2010. The impact of price increases and higher non-check services revenue was more than offset by the amortization of a 2009 contract settlement in the prior-year quarter and lower check orders. Excluding the impact of the contract settlement amortization, revenue in Financial Services declined less than 6% from the last year.

Direct Checks revenue totaled $61.8 million and was up 49% on a year-over-year basis due to the Custom Direct acquisition. Excluding the impact of the acquisition, Direct Checks revenue was down only 5% due to lower check orders.

Gross margin for the quarter was 65.6% of revenue, up slightly from 2010. Benefits from price increases, improvements in manufacturing productivity, delivery initiatives, and product mix were partly offset by increased delivery and material rates.

SG&A expense increased $12.7 million in the quarter and was 45.9% of revenue compared to 44.2% of revenue in the same period last year. Increased SG&A associated with acquisitions, brand awareness campaigns, and investments in future revenue generating initiatives was partially offset by benefits from continuing to execute against our cost reduction initiatives. The first quarter of 2010 also included a $1.3 million tax-free gain from the maturity of the Company-owned life insurance policies.

Excluding restructuring-related costs, operating margin for the quarter of 19.7% was down from the 20.8% generated in 2010, but was above our expectations, with favorability coming from strong revenue performance, including favorable product mix.

All three segments delivered strong operating margins compared to expectations. Excluding restructuring costs, Small Business Services operating margin of 18.3% was up 2.9 percentage points over last year due to higher revenue from both price increases and growth in business services as well as continued progress with cost reduction initiatives.

Financial Services operating margin of 18.4% was down 5.4 points from 2010 due to the favorable contract settlement amortization in 2010 and lower volume, as well as higher investment spending in 2011.

Direct Checks operating margin of 26.4% decreased 11.8 points from 2010, reflecting the April 2010 acquisition of Custom Direct, but was in line with the fourth quarter margin as we continue to realize planned synergies from integrating this acquisition.

Turning to the balance sheet and cash flow statements, during the quarter we repaid the $7 million that was outstanding on our credit facility at the end of 2010. We also increased our cash and cash equivalents balance by $15 million. As previously announced, we leveraged the favorable high yield market in the first quarter just before the interest rates started to increase and opportunistically strengthened our capital structure. In March, we repurchased $195 million of our 2012 notes at a premium plus accrued interest and issued $200 million of new 7% notes due in 2019. We also repurchased $10 million of our 2014 notes at a slight premium. In addition, we repurchased $6 million of common shares to offset dilution from employee plans.

Cash provided by operating activities was $61.1 million. The increase from last year was due to stronger operating performance partially offset by higher interest and contract acquisition payments. Capital expenditures for the quarter were $8 million and depreciation and amortization expense was $20 million.

In early April, we purchased Banker's Dashboard for $35 million cash plus approximately 193,000 shares of restricted common stock. The purchase was funded with cash on hand and a draw on our credit facility. The acquisition is expected to be EPS neutral in 2011, after absorbing acquisition-related amortization expense.

Given our strong performance in the first quarter, we are improving our consolidated revenue outlook for the year to a range of $1.385 billion to $1.42 billion. At the high end of the range, we are only expecting a slight improvement in economic conditions in the second half of the year. Adjusted diluted earnings per share from continuing operations are expected to range from $2.90 to $3.10, excluding $0.17 related to losses on the repurchase of long-term debt and restructuring and transaction-related costs.

Although we now expect to incur a dilutive $0.05 per share due to higher interest expense, we have not changed the upper end of our EPS range. Improved operating performance, including our strong first quarter results, and a lower tax rate is expected to offset the added interest and the impact of higher shares outstanding.

There are several key factors that contribute to our full-year outlook versus 2010, including Small Business Services revenue is expected to increase in the low to mid single digits range as volume declines in core business products are expected to be offset by benefits from price increases, our eCommerce investments, and double-digit growth in our Business Services offerings.

We expect Financial Services revenue to decline in the low to mid single digits range, with check order declines of approximately 7% to 8%, driven by increases in other forms of electronic payments and lower revenue per order, which will be partially offset by a new large customer win, which is expected to begin contributing volume early in the third quarter, and increasing contributions from non-check revenue streams, including those from the recently-acquired Banker's Dashboard. Direct Checks revenue increased in the mid single digits, driven by a full-year impact of Custom Direct, partially offset by the declines in the continued weak economy; additional costs and expense reductions; employee merit increases, which we reinstated this year after a two-year freeze; increases in material and delivery rates; continued investments in revenue growth opportunities, including Business Services, brand awareness, direct response campaigns, web-to-print, and enhanced internet capabilities; an increase in interest expense of $0.05 per diluted share primarily due to the refinancing of $195 million of 5% notes due next year with $200 million of new 7% notes not due until 2019; an effective tax rate of approximately 33%; and higher average shares outstanding.

We expect to continue generating strong operating cash flows ranging between $215 million and $230 million in 2011, driven by stronger earnings, continued progress on working capital initiatives, and slightly lower contract acquisition payments, which we expect to be approximately $20 million. The increase from our previous outlook is due to lower expected tax payments.

2011 capital expenditures are expected to be approximately $35 million, down 20% from 2010. We plan to invest in key revenue growth initiatives and make other investments in order fulfillment and IT infrastructure.

Depreciation and amortization expense is now expected to be $72 million, including $23 million of acquisition-related amortization.

In the second quarter of 2011, we expect revenue to range from $340 million to $348 million. Adjusted diluted earnings per share are expected to range from $0.66 to $0.71, which includes $0.02 per share of higher interest expense as compared to our previous outlook. In comparison to 2010, the listed factors affecting our full-year outlook are similar to those affecting the second quarter, except the second quarter will not benefit from the new, national financial institution client since we are not expecting to start producing their checks until early third quarter and revenue in Financial Services is expected to be comparable to the last couple quarters.

In comparison to the first quarter, adjusted EPS is expected to be lower in the second quarter due primarily to three factors. First, historically, Direct Checks revenues are strongest in the first quarter, thus we expect a sequential revenue decline in this segment. Second, we expect to ramp the level of our brand awareness spend in the second quarter and lastly, higher interest expense.

Shifting to our capital structure, we expect to maintain our balanced approach of investing organically and through small to medium-sized acquisitions in order to drive our growth transformation. We also expect to maintain our current dividend level as well as repurchase shares to offset dilution. To the extent we generate cash flow in excess of these priorities, we plan to pay down debt in order to further strengthen our balance sheet. We believe our strong cash flow, strengthened balance sheet, and flexible capital structure position us well to continue advancing our transformation.

I will conclude my comments with an update on our costs and expense reduction initiatives. Overall, we had another solid quarter and remain on track for delivering our $65 million target for the year. These savings, again, will not necessarily be linear through the quarters, as we expect a larger percentage of the total year reductions in the second half of the year.

Our focus in sales and marketing for 2011 will continue to be on improving sales and marketing back end operations through process centralization, simplification, platform and tool consolidation, and leveraging eCommerce capabilities. In the first quarter, we announced that we will be closing our Phoenix call center, which we expect to be completed in the fourth quarter. We will also continue to improve the mix of paper catalog and online search engine marketing.

In fulfillment, we expect to continue our lean product standardization, spoilage reduction, and direct and indirect spend reduction initiatives, plus further consolidate our manufacturing technology platforms, enhance our strategic supplier sourcing arrangements and continue with other supply chain improvements and efficiencies.

We also expect to realize a full year's worth of savings from having installed our fully automated flat check package processing equipment in 2010, the last installation of which was completed in the fourth quarter. In the first quarter, we announced the closure of one of our smaller business products fulfillment sites, which will be consolidated into a larger site in the second half of the year.

Finally, for the Shared Services infrastructure, we expect to continue to reduce costs in all areas as more opportunities exist to centralize, streamline, standardize and improve efficiencies.

Now, I'll turn the call back to Lee.

Thank you, Terry. I will continue my comments with an update on what we are focused on overall and then highlight progress in each of our three segments. I will also include throughout a perspective on what we hope to accomplish during the balance of 2011.

In 2011, our primary focus is on revenue growth, as we now have what we believe is the best products and services portfolio in the history of the Company. Our improved solutions start with more differentiated technology-led check offers through investments in automated flat check packaging, digital printing, and online portals and dashboards. They also include enhanced internet and web-to-print capabilities and improved segmentation and distributor and dealer channel expansion. Finally, the most significant new solutions growth opportunity is new business services, including web services, logo design, search engine marketing, payroll, and fraud and security services, plus offers that help financial institutions with customer acquisition, regulatory compliance, and profitability. All new business services are expected to generate approximately $155 million to $165 million in revenue in 2011, up from approximately $122 million in 2010. So we expect to continue to build scale capability here.

We will continue to assess potential small to medium-sized acquisitions that complement our large customer basis with a focus on new business services. We also continue to refine our channel capabilities. In addition to financial institutions and direct to the consumer, we have strengthened our channels in small business to include online, retail, wholesale, distributors, dealers, and national accounts. Deluxe is now more capable of helping small businesses get and keep customers and helping small to midsize financial institutions with customer acquisition, regulatory compliance, and profitability offers. These new solutions and channels are driving new differentiated opportunities for us to execute on our strategic focus and will further enable us to deliver the best personalized customer experience while offering one of the broadest products and services portfolios in each market we serve.

In addition to the items just mentioned, in order to accelerate revenue growth, we are continuing to invest more in brand awareness and positioning. We started last year through test and learn brand awareness and direct response advertisements including radio, online, television, and our small business hero mobile tour events. Based on our learnings, we are expanding but refining our focus. We continued to invest in the first quarter and as planned will ramp advertising starting more in the second quarter and through the third quarter, primarily through network and national public radio, but also in the second quarter through television advertising on CNN and Headline News. In addition, we will advertise on Entrepreneur.com, Martha Stewart, Money, Business Week, fastcompany.com, time.com, and others. Further, we will also invest in events where small businesses actively participate and we will continue with Project Rev, our year-long marketing lab sponsored by Deluxe designed to build marketing expertise for small businesses.

We expect all of these activities to help us drive revenue growth over time as the economy improves. We are getting better and better at measuring our return performance from these brand initiatives and this will determine the size and extent of investment levels over time.

Now shifting to our segments, in Small Business Services, as expected, we did not see any notable improvements as the economic climate for small businesses remains sluggish. We had strong performance, however, especially later in the quarter as revenue came in at the high end of our expectations and grew 4% in the quarter. Checks and forms were strong. Our results from targeted customer segmentation in the call center improved. We increased new customers from our financial institution Deluxe Business Advantage referral program and through our direct response campaigns. Response rates increased from better balanced and enriched content in online and print-based spend. Average order value and conversion rates remain strong. Our Safeguard distributor channel and Canada showed organic revenue growth over the prior year. We also saw growth in web, logo, and payroll services. In the quarter, we won nine North America and Europe wholesale web services deals and also continued to expand additional value-add services on top of our core retail web services offer.

We began to see some revenue expansion in the search engine marketing space through signing up new media partners and introducing a retail offer that included roughly 20% of existing Deluxe customers. We continued to closely monitor the small business market and even though optimism indices rose the first two months of the year, they took a step back in March and remain choppy in recessionary territory. We are not seeing the surge that could lead to economic growth.

Small businesses are beginning to hire, although they remain cautious here. And capital investment spending, although improving, remains low. They continue to spend less, scrutinize purchases more, and experience tight cash flow. Less than 10% of small businesses believe that business conditions will improve over the next 6 months.

In summary, although an improving trend, current optimism indices are still below end-of-2007 levels. The good news is that increasing sales continues to be a small business owner's number one pain point and we now offer many products and services to help them here. As the economy recovers with the transformative changes we are making to deliver more business services offerings that help small businesses get and keep customers, Deluxe is better positioned as that indispensible partner for growth.

Our focus for the balance of 2011 is on acquiring new customers, increasing our share of wallet through our enhanced Shop Deluxe eCommerce site, growing distributor and channel partners, implementing web-to-print offers and improving segmentation. We will continue to improve the efficiency and effectiveness of our inbound, outbound and online customer touch points to maximize revenue scale capability.

In new business services, we expect to continue to gain new customers through our teleco-focused, wholesale, web services model, including South America expansion; add customers and services in our retail model; add marketing services, payroll services and logo customers; and continue to expand our search engine marketing customer base. We also will look for opportunities to add more business services on our unified technology platform.

In Financial Services, we continue to proactively extend contracts and still have only two smaller-sized national accounts due in 2012 that we continue to work to extend. Again this quarter, we saw strong overall new acquisition rates and our retention rates remain strong on deals pending in the current year in excess of 90%. We are still finalizing contract terms and migration plans for a new large national financial institution that we now expect will start early in the third quarter that is included in our outlook.

We did receive word in the first quarter that we did not win one of the other large national competitive opportunities we had been pursuing. While commending us on our value proposition and differentiated offer, the financial institution said they could not afford the disruption of a migration, given other internal competing priorities. There still remain a significant number of competitive opportunities through 2012.

In the quarter, we did see the rate of decline of checks perform right in the range of our forecasted rate of around 7% to 8%. We also simplified our processes and took complexity out of the business while reducing our cost and expense structure. In the quarter, we announced the expected closure in the fourth quarter of our Phoenix call center. Our new transformed customer self service portal and dashboard tools introduced in the second quarter of 2010 have now been deployed to just about all of our financial institutions. At the same time in the first quarter and then continuing in the second quarter, we invested and will invest organically in both the customer acquisition and regulatory compliance areas for expected second half of the year revenue generating opportunities.

We made progress again in the quarter in advancing non-check revenue growth services opportunities. Revenue grew over last year in these non-check services, which include customer acquisition, regulatory compliance, rewards checking, and other profitability offers. We saw continued growth from our Cornerstone acquisition. We also introduced late in the first quarter a new regulatory compliance offer, which is a comprehensive web-based service to help our financial institution clients manage through the challenging demands of the regulatory environment.

Also early in the second quarter, we completed a small tuck-in acquisition of Banker's Dashboard. This brings us a software-as-a-service financial management tool that provides community banks with instant, daily on-demand access to data to help improve their performance and their profitability. We also believe it will help community banks with managing the increasing regulatory climate. We expect this acquisition will help us scale regulatory and profitability services offers more quickly and robustly for our financial institutions. As you can see, momentum continues to build in these non-check revenue initiatives.

In Direct Checks, revenue was slightly higher than our expectations, driven by accelerated reorder rates and strong Custom Direct upsell revenue. We continue to look for opportunities to provide accessories and other check-related products and services to consumers. We also continue to be very pleased with the integration of Custom Direct as we leverage the best of both Direct Checks and Custom Direct into a best-in-class, direct-to-consumer check experience. We continued to see a ramp in revenue enhancement synergies through our call center scripting and upsell capabilities. In addition, cost reduction activities continue with savings occurring in material, procurement, delivery, media and marketing expense leverage and other SG&A. We expect continued revenue enhancements and cost reductions over the balance of 2011.

For 2011, we expect revenue growth in the mid single digits range, driven by the Custom Direct acquisition and accelerated reorder rates, partially offset by declines in consumer check usage and spending in a continued weak economy. We expect to reduce our manufacturing costs and SG&A in this segment and maintain our operating margins in the high 20's percent range, including acquisition amortization, while generating strong cash flow.

As we exit the first quarter on the heels of a very strong quarterly performance in a continued sluggish economy, we have made good progress again in transforming Deluxe, but we still have a lot of work and opportunities ahead of us in the balance of 2011. We are only expecting the economic climate to improve slightly in the second half of the year, at the high end of our outlook range.

As I indicated earlier, our primary focus is on revenue growth and we are investing in our future with better product and services offers in all three customer segments and an improved brand awareness campaign. We are playing offense, making positive strategic moves to reposition the Company for sustainable longer-term revenue growth.

If the economy improves, we should have upside in Small Business Services revenue as we know it is important for us to continue to demonstrate growth in this segment. At the same time, we will not take our eyes off of cost reductions and process improvements and we expect to generate -- to continue to generate strong cash flows and provide a very attractive dividend.

And now Mary, we will open the line and Terry, Jeff and I will address questions.

(Operator Instructions) Charles Strauzer, CJS Securities

Hi, good morning.

Hi, Charlie.

Hi, Charlie.

Two quick things. One is if you could expand a little bit more on your discussion about the Financial Services segment. It was flat from Q4 and you're down a pretty decent percentage year over year. Can you give a little more color into kind of what the machinations are in that segment right now?

I think it's actually pretty simple here. If you think about the quarter, we performed in the unit check decline of about -- in that 7% to 8% range. We had the price increase that we talked about in the January call starting to come into play and we improved our performance in the non-check area. And so the real number is really down in the less than 6% range. Then we again had the hurdle that we discussed last year and just reminded everybody on the call of the 2009 contract settlement that hit in the first quarter last year. So, I think it's pretty set, pretty straight forward and really came in pretty much exactly in line of what we expected.

Okay, great. Then maybe Terry if you can just give me this if you have it, the full-year assumption for D&A, just so we can kind of get our models right on that, cause it seems to be a little bit higher in Q1 than it had been in our models here.

Yes, the full-year D&A was $72 million is what I said.

Yes, 'cause it was $20 million in Q1.

$72 million and $23 of acquisition-related to amortization. So the $23 million is included as part of the $72 million.

Charlie, I think you're reacting 'cause it was 20 in Q1. So obviously we expect it to improve over the balance of the year.

And what's driving that, Charlie, is, as we've stated on past calls too, CDI had some short lived intangible assets when we acquired that last April. That's set to roll off in second quarter.

Great, excellent. Thank you very much.

(Operator Instructions) John Kraft, D.A. Davidson

Good morning, guys.

Hey, John.

Congrats on that win of the -- that should hit in Q3. I guess along those lines, you addressed two of those, Lee, and you said there were some others. Can you quantify? I mean are there five more or just a couple more or what sort of a grouping are we looking at for RFPs outstanding?

Just would say again, there's a significant number of them. Part of it, if you will recall, there was a question on the last call that we had. And rather than giving a specific numbers, what can happen sometimes, John, is that things get pushed out into a new year or they can -- through another quarter before an RFP comes out or before somebody makes the decision. So the way I would just frame without giving a specific number, there's still many opportunities out there that we're working and pursuing.

Okay, that's fair. If we could talk a little bit about what allowed you to win that contract. I mean presumably there was some price in there, but was it the Business Advantage? Was it -- I mean what was it that really you could call out that was the difference and allowed you to win that contract?

John, I think what we're focused on when we're going out and -- with our customers right now is it's a -- we've invested in more what we call technology in the check space. So we're a believer in the flat check package for delivery. We believe it allows us to have a potentially lower rate that we can charge through the banks and they can charge on to their customers, because it's lower to ship that package than a parcel package. We also have invested in the latest digital technology and we have the online tools and dashboards for our clients as well.

Another thing that helped with this deal was they also like the reach of some of our other non-check initiatives. So, the client that we've won here, they actually like the customer acquisition initiatives that we have and are very interested in some of the offers that we have in that space. Again, while we haven't started with them yet, we do expect that they're going to move on some of those over the life of the contract. So, I think it's just a look at holistically what Deluxe has to offer. And John, as you know, of course you have to be competitive from a pricing standpoint. But I think it's all those other pieces is just a differentiated play.

Got you. Terry, I think I must have missed this. Can you clarify what your expectations are for taxes? I mean I think you had said it is expected to be lower going forward. But did you give a specific?

Yes, it's -- the full-year rate is expected to be about 33% in our adjusted EPS guidance.

33%, okay, you said 34% before, I think.

34% was what we had originally guided.

Great. Thanks, guys. See you in a couple weeks.

Hey, John.

Hey, John.

(Operator Instructions) Davis Hebert, Wells Fargo.

Morning. Quick, just a quick housekeeping question. What was your revolver balance at the end of Q1? And what is it post the acquisition?

The revolver balance at the end of first quarter was actually nothing. We had nothing drawn on that at the end of March. And we did -- it was a $35 million cash purchase for Banker's Dashboard. We indicated that we funded that partially with cash on hand and partially with the draw on the credit facility. We usually don't give out interim guide (inaudible) to what our borrowings are on that facility.

Okay, so the debt as it stands at 3/31 consists only of bonds, including the newly placed ones in March?

That is correct.

Okay, thank you.

Welcome.

Thank you. There are no other questions in queue. I would like to hand the call to Lee Schram.

Again, thank you everybody for your participation and for those that asked questions, appreciate that. Again, as I normally say, we're going to get back to work now and we look forward to providing a positive progress report on our next earnings call. And I'll turn it back to Jeff to wrap up.

Thank you, Lee. This is a reminder that a replay of this call will be available until May 12th by dialing 888-286-8010. When instructed, provide the access code 98653998. The accompanying slides are archived in the News and Investor Relations section of Deluxe's website at www.deluxe.com. Again, thank you for joining us. Have a good afternoon.

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a wonderful day.