Deluxe Corp (DLX) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Deluxe Corporation's third-quarter earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Ed Merritt, Interim Chief Financial Officer, Treasurer and Vice President of Investor Relations. Sir, you may begin.

Thank you, Chelsea, and welcome, everyone, to Deluxe Corporation's third-quarter 2016 earnings call. I'm Ed Merritt, Interim Chief Financial Officer, Treasurer and Vice President of Investor Relations. Also joining me on today's call is Lee Schram, our Chief Executive Officer. At the conclusion of today's prepared remarks, Lee and I will take some questions.

I would like to remind you that comments made today regarding financial estimates, projections, and Management's intentions and expectations regarding the Company's future performance are forward-looking in nature, as defined in the Private Securities Litigation Reform Act of 1995. As such, these comments are subject to risks and uncertainties which could cause actual results to differ materially from those projected. Additional information about various factors that could cause actual results to differ from those projected are contained in the press release that we issued this morning, as well as in the Company's form 10-K for the year ended December 31, 2015.

The financial and statistical information that will be reviewed during this call is addressed in more detail in today's press release, which is posted on our investor relations website at Deluxe.com/investor. This information was also furnished to the SEC on form 8-K, filed by the Company this morning. Any references to non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release or as part of our remarks during this call.

Now I will turn call over to Lee.

Thank you, Ed, and good morning, everyone. Deluxe delivered a solid quarter and we are well-positioned to grow revenue 5% for the year despite a continued sluggish economic environment. We reported revenue in the middle of our outlook range and adjusted earnings per share at the top end of our outlook range. Revenue grew better than 4% over the prior-year quarter, driven by financial services growth of 11% and small business services growth of 3%.

Marketing solutions and other services revenues grew 16% over the prior-year and represented about 33% of total third-quarter revenue. Adjusted diluted earnings per share grew more than 5% over the prior-year quarter. We generated strong operating cash flow of $208 million for the first three quarters, and we were drawn $418 million on our credit facility at the end of the quarter.

We repurchased $15 million in common shares in quarter. We continued our brand awareness campaign to help better our position our products services offerings and drive future revenue growth. We also advanced processed improvements and slightly exceeded our cost reduction commitment for the quarter.

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

Thanks, Lee. Earlier today we reported diluted earnings per share for the third quarter of $1.19 compared to $1.13 last year. Both year's results included $0.03 per share for restructuring charges and transaction costs. Excluding these restructuring charges and transaction costs, adjusted diluted EPS of $1.22 was at the higher end of our previous outlook and increased 5.2% above the $1.16 reported in the third quarter of 2015. The increase was driven primarily by stronger earnings performance and lower average shares outstanding.

Revenue for the quarter came in at $459 million and grew 4.3% over last year. The growth rate, excluding Datamyx, FISC, InkHead and Payce Payroll acquisitions was about 1%. Small businesses service revenue of $299 million grew 3.4% versus last year, primarily due to growth in marketing solutions and other services.

We saw some revenue short falls compared to our expectations in Safeguard distributor and major accounts in the quarter and continue to be impacted by the sluggish economy. In small business services, we delivered growth in marketing solutions and other services and from a channel perspective, we grew our online, major accounts, and dealer channels.

Financial services revenue was $123 million in the quarter and grew 10.9% above last year. Excluding revenue from acquisitions, financial services would have grown 1% in the quarter. Higher marketing solutions and other services revenue, driven by Datamyx, Wausau, and Deluxe Rewards and price increases more than offset the impact of lower check orders.

In the direct check segment, revenue was $37 million, or down 7.3% from last year. From a product and services revenue perspective, check revenue was $215 million, representing 47% of total revenue. Marketing solutions and other services was $154 million, or about 33% of total revenue and forms and accessories was $90 million, or about 20% of total revenue.

Gross margin for the quarter was 63.8% of revenue and was the same rate as 2015. Higher delivery and material costs were offset by the benefits of previous price increases and improvements in manufacturing productivity.

SG&A expense increase 4.6% in the quarter and as a percent of revenue ended at 43.2% compared to 43.1% last year. Benefits from our continuing cost reduction initiatives and all three segments were more than offset by increased SG&A associated with recent acquisitions.

Excluding restructuring and transaction-related charges in both 2016 and 2015, adjusted operating margin for the quarter was 20.7%, down from 20.8% last year. Financial services delivered an operating margin better than expectations, Direct Checks margins were in line with our expectations, and small business services margins were slightly below our expectations. Small business services adjusted operating margin was 17.6%, down 0.8 of a point from 2015, driven by acquisitions and higher brand awareness spend, but was partially offset by price increases, cost reductions, and lower incentive compensation expense.

Financial services adjusted operating margin was 23.7% and increased 1.8 points from 2015. The increase was driven by the continued benefits of cost reductions, price increases and lower incentive compensation, partially offset by the secular decline in check usage. Direct Checks adjusted operating margin of 35.1% decreased slightly from last year, driven by lower order volume and unfavorable mix, only partially offset by cost reductions.

Now turning to the balance sheet and cash flow statement, total debt at the end of the quarter was $618 million, down $11 million from the beginning of the year. Cash provided by operating activities for the first three quarters of the year was $208.1 million, a decline of $11 million compared to the prior year, driven primarily by higher income tax payments, higher contract acquisition payments, an incentive payment related to a previous acquisition and partially offset by stronger earnings and lower interest payment. Capital expenditures for the first three quarters of the year were $32.2 million and depreciation and amortization expense was $67.7 million.

We are adjusting our previous consolidated revenue outlook for the full year and now expect it to range from $1.85 billion to $1.86 billion. We are strengthening our expectations for adjusted diluted earnings per share to a range of $4.95 to $5. There are several key factors that contribute to our revised full-year outlook, including small business services revenue is expected to increase 4% to 5% as volume declines in core business products and the negative impact of foreign exchange rates are expected to be offset by growth in our online, dealer, and major accounts channels, price increases, double-digit growth in marketing solutions and other services offerings, and continued small tuck-in acquisitions.

We expect financial services revenue to increase 9% to 10%, as recurring check orders unit declines of 4% and some pricing pressure are expected to be more than offset by continued growth from marketing solutions and other services revenue, including Datamyx, Wausau, and Deluxe Rewards and some small tuck-in acquisitions, a Direct Checks revenue decline of 8%, driven by lower check order volumes stemming from the secular decline in check usage, a continued sluggish economy, full-year cost expense reductions of approximately $50 million net of investments, increases in medical expenses, material costs and delivery rates, continued investments in revenue growth opportunities, including brand awareness, marketing solutions, and other service offers, and enhanced Internet capabilities. We expect an effective tax rate of approximately 33%.

We expect to continue generating strong operating cash flow, ranging from $315 million to $320 million in 2016, reflecting stronger earnings and lower interest payments, partially offset by higher tax, contract acquisition, and employee medical payments. We now expect full-year contract acquisition payments to be approximately $25 million. 2016 capital expenditures are expected to be $43 million or the same as 2015 as we continue to invest in revenue growth initiatives and make other investments in our order fulfillment and IT infrastructure. Depreciation and amortization expense is expected to be $95 million, including approximately $49 million of acquisition-related amortization.

For the fourth quarter of 2016, we expect revenues to range from $481 million to $491 million. Adjusted diluted earnings per share is expected from $1.34 to $1.39. In comparison to our previous outlook for the fourth quarter, we expect revenue to be lower in small business services, primarily due to the continued softness compared to our previous expectations in Safeguard distributor and major accounts channels.

The softness continues to be primarily in forms and marketing product solutions, which includes holiday cards, as we have seen, some of our larger accounts reduce their spending plans and expected rollouts have been delayed in addition, and expected tuck-in acquisition did not close.

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 transformation. Additionally, we expect to continue paying a quarterly dividend and periodically repurchase common stock. To the extent we generate excess cash, we plan to reduce the amount of outstanding against our credit facility.

On October 13, we announced the redemption of our $200 million 2020 senior notes, which will be redeemed on November 15, 2016. We expect to record a charge in the fourth quarter related to the extinguishment of debt of approximately $8 million, or about $0.11 per share. We believe our increasing cash flow, strong balance sheet and flexible capital structure position us well to continue advancing our transformation into 2017.

I will conclude my comments with an update our cost and expense reduction initiatives. Overall we had a solid third quarter and as Lee mentioned, we delivered slightly better on our expected cost and expense reductions towards the $50 million annual commitment, net of investments. Approximately 55% of the $50 million is expected to come from sales and marketing, 30% from fulfillment, and the remaining 15% is expected to come from our shared services organizations.

Our focus in sales and marketing for 2016 continues to be on sales channel optimization, platform and tool consolidation, and leveraging sales and marketing efficiencies through integration from recent acquisitions. In fulfillment, we expect to continue our lean spend reductions, further consolidator manufacturing technology platforms, drive delivery technology and process efficiencies, reduce spoilage, and continuous supply chain improvements and efficiencies. Finally, for shared services infrastructure, we expect to continue to reduce expenses, primarily in IT, but we also see opportunities in finance and real estate.

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

Thank you, Ed. I will continue my comments with an update on MOS revenue, highlight progress in each of our three segments using our eight strategic initiatives for a perspective on how we progressed in the third quarter, and then provide some context looking forward to 2017.

Here's an update on our four sub-categories revenues framework for marketing solutions and other services. We ended the third quarter slightly below our expectations in revenue, with mix lower in small business marketing solutions.

First, small business marketing is expected to represent approximately 39% in 2016, with expected growth of approximately 17% to 18%. Key 2016 growth initiatives include profitably scaling integrated marketing, on-demand solution offers, with the largest opportunity in major account verticals, including retail, healthcare, financial services, hospitality, service franchises, automotive, real estate, and telcos. We also see strong growth opportunities and promotional products and holiday cards and specifically in distributor, dealer and major account channels.

The second category, Web services, which includes logo and web design, web hosting, SEM, SCO, email marketing, social and payroll services, is expected to represent approximately 19% in 2016, with expected growth rates in the mid-single digits. Key 2016 growth initiatives include scaling, Web services offers through our Deluxe marketing suite across all customers and channels, delivering partnerships and acquisitive opportunities that both, quote-unquote, double down on existing capabilities and address gaps within our portfolio.

The third category, fraud, security, risk management and operational services, are expected to represent approximately 13% in 2016, with expected low-single-digit declines. Key focus areas for growth in this category in addition to our standard fraud and security offerings include performance management by adding Banker's Dashboard customers, as well as strategic sourcing new financial institution wins. In addition we continue to see growth from scaling e-checks, including scaling in many areas where we do not sell paper checks today.

Finally, other financial institution services are expected to represent approximately 29% in 2016, with expected double-digit growth rates. Key growth initiatives here include scaling Wausau, Deluxe Rewards, and Datamyx.

We expect marketing solutions and other services revenue to be between $620 million and $625 million in 2016, up from $532 million in 2015, with growth about 16% to 17%. If achieved, this performance would translate to a total revenue mix of around 34% of revenue and up from almost 30% in 2015 and 26% and 22% the previous two years. We continue to target increasing marketing solutions and other services as a percent of total Company revenue to approximately 40% by 2018, with checks expected to represent approximately 40% of revenue and forms and accessories expected to represent approximately 20% of revenue.

Now shifting to our segments, in small business services, we have five strategic focus areas for 2016. Before I review these, including accomplishments in the third quarter and opportunities through the balance of the year, here is a brief small business market and optimism index perspective.

As expected, we did not see any notable improvements, as the economic climate for small businesses remains sluggish. Optimism indices basically were flat throughout the quarter, ending slightly down at 94.1, but remain well below the 40-year average of 98. Small businesses generally remain in maintenance mode, experiencing a little growth, although the outlook for business conditions six months out dramatically improved.

In summary, small business optimism was flat in the third quarter, but hopefully the expected improvement in the outlook for business conditions is an encouraging sign for small businesses as we head into the fourth quarter. The good news is that increasing sales continues to be very high on the list of a small business owners pain points, and our portfolio is robust, with many offers to help them here. As the economy recovers with the transformative changes we are making to deliver more services offerings that help small businesses get and keep customers, Deluxe is better positioned as an indispensable partner for growth.

Now to our focus, which I will review from largest to smallest by revenue. First, operate your business products, including checks, forms, and accessories. Our primary focus is on driving customer acquisition and retention and improving distributor channel processes and profitability. We ended the third quarter above our expectations for checks and forms, but below our expectations on accessories revenue. We made progress in improving distributor channel processes and profitability, but we have more work to do here in the balance of the year.

Second, market your business products, which include small business marketing solutions. Our focus areas here is our profitably scaling integrated marketing on-demand solution offers with the largest opportunity in major account verticals, including retail, healthcare, financial services, hospitality, service franchises, automotive, real estate, and telcos.

Third-quarter revenue was lower than expected at the high end of our previous outlook, as Ed mentioned earlier, driven by shortfalls in Safeguard distributor and major accounts. bIn Q3, we also completed the acquisition of a InkHead, a storefront marketing solutions online e-commerce adds specialty, promotional, and apparel provider. We plan on leveraging their e-commerce and product configuration technology into our shop Deluxe, retail packaging, and web-to-print offers, as well as into the distributor network and Deluxe marketing suite.

Third, market your business services, including Web services offers and where our focus areas are improving operating income by optimizing product portfolio, channels and operations, delivering partnerships and acquisitive opportunities that both, quote-unquote, double down on existing capabilities and address gaps within our portfolio, and providing our integrated Deluxe marketing suite across all customers and channels. We also saw a continued strong cross-sell ramp in logo customers who became web design customers as well, with all marketing services offers now being fulfilled through our Deluxe marketing suite.

Fourth, operate your business services, which includes primarily fraud and security, e-checks, and payroll services, and where our focus is on scaling e-checks, accessing adjacent offer extensions like checks and e-checks for e-deposit, variable check printing, and remotely created checks, and payroll time and attendance tracking as well as continuing to evaluate potential partnership and acquisition operating services opportunities. We continue to positively progress e-checks in Q3, with opportunities with financial institutions, medical and insurance payment processors, accounting services and software providers and other document, management and payment solution companies.

In late Q3, we also completed the acquisition of Payce Payroll, a US-based payroll services provider. This acquisition marks our entry into the US payroll services market, adding to our payroll services business in Canada and allowing us in the future to create a North American customer-centric payroll capability. Market growth in the US is expected to be 4% and 36% of Deluxe customers outsource payroll today, so we have a wonderful addressable market opportunity. In addition, payroll services provide us with a compelling recurring revenue business model, with high operating leverage and unlike many payroll service providers, Payce Payroll is workflow and invoicing software enabled.

The fifth SBS focus area is continuing to improve brand awareness. In 2016, we have been telling more stories and packaging great advice for small business cut owners.

We completed the previously announced revitalization of Wabash, Indiana's, Main Street businesses, which is being showcased in a new eight-part web series on Smallbusinessrevolution.org. In every episode, experts from Deluxe and Robert Herjavec from Shark Tank help one small business conquer common-place marketing challenges by providing services such as logo design, building their website, or email marketing, as well as offering business advice. We have already been receiving acclaim from the media and small business owners from across the country, and so we are building on this successful momentum and asked the public for nominations for another small town to revitalize in 2017.

Deluxe will also continue to work with Roger Herjavec's investments he makes through Shark Tank. The marketing help and expertise Deluxe provides these entrepreneurs will be featured as case studies and videos on the Deluxe blog.

We also further enhanced our partnership with CNBC as we served as an integrated marketing partner for our new series called Cleveland Hustles, produced by Lebron James, where his team invested in and mentored small businesses through the help of partners like Deluxe. We believe these efforts to provide real help to support small businesses through these various marketing makeovers, resources, and advice are a genuine relationship-building approach to improving our brand awareness within the small business community.

Now shifting into financial services, we have three strategic focus areas for 2016. First, retail banking, which includes checks, marketing services and rewards and loyalty.

For checks, our focus is on improving retention rates and gaining share. In the third quarter we saw the rate of decline of checks perform better than expected at less than 4%, driven by stronger performance in the mid- to lower-tiered financial institutions. We now expect the unit decline rate to be about 4% for the year compared to our previous outlook decline of 4% to 5% for the year.

We had strong overall new acquisition rates and our retention rates were very strong on deals pending in the current quarter. We simplified our processes and took complexity out of the business while reducing our cost and expense structure. We have now extended all our large contracts through at least year end 2016. Compared to the end of the third quarter last year to this year, we have about 25% fewer bank contracts left to renew, and we have more competitive opportunities coming up.

For marketing services, our focus is on leveraging Datamyx data and analytics, together with marketing services campaign execution to accelerate outsourced campaign targeting and multi channel execution. Datamyx revenue was on our previous expectations in the third quarter and we remain very excited about the data and analytics space and continued prospects to grow revenue with our diverse approach to vertical markets, including mortgage lending, automotive finance, home equity, student loans, card, banking, and insurance. For rewards and loyalty our focus is on profitably growing Deluxe Rewards revenue, which continue to perform well in the third quarter.

The second financial services strategic focus area is commercial banking and includes treasury management, with our focus on profitably growing Wausau revenue and assessing and executing tuck-in acquisitions, along with assessing other adjacent opportunities in commercial banking. In the third quarter revenue was up a strong 6% organically and slightly exceeded our expectations. Yesterday we closed the acquisition of Data Support Systems, or DSS, a small tuck-in acquisition of image-based software for payment related back-office case management.

DSS's solutions are complementary to Wausau and include exception processing, disputes resolution, and collections for check and electronic payment types, also referred to in the industry as day two solutions. Wausau is primarily involved in day one processing, but both businesses have the same customer decision maker, which creates dual cross-sell opportunities, and this, too, is a SaaS version built on the same technology as Wausau. Our Wausau Advisory Council of financial institution customers highly recommended DSS, so we are excited to add DSS to our treasury management solutions.

The third FS strategic focus area is performance management and includes scaling Banker's Dashboard and strategic sourcing. Performance management revenue was slightly below our expectations for the quarter, driven by shortfalls in strategic sourcing.

For 2016 we expect marketing solutions and other services revenue within financial services to be approximately 43% of their total revenue, with the following at the midpoint of the FS revenue range, marketing services, including Datamyx, $52 million; rewards and loyalty, $33 million; fraud and security, $24 million; treasury management, $93 million; and performance management, including Banker's Dashboard and strategic sourcing, $15 million. We continue to expect Datamyx revenue to be approximately $38 billion in 2016, with strong double-digit EBITDA margins and we expect Datamyx to be about neutral from an EPS perspective.

In Direct Checks, revenue was about on our expectations. We continue to look for opportunities to provide accessories and other check-related products and services to our consumers, as well as work on a number of initiatives to create an integrated best-in-class direct-to-consumer check experience. We continue to see a ramp in revenue enhancements synergies through our call center scripting and upsell capabilities, as well as synergistic costs and expense reductions.

For 2016, we expect Direct Checks revenue to decline about 8%, driven by continued declines in consumer usage and a sluggish economy. We anticipate that marketing solutions and other services revenue, which is primarily fraud and security officers for this segment, to be about 10% of Direct Checks revenue. We expect to reduce our manufacturing costs and SG&A in this segment and continue to deliver operating margins in the low- to mid-30% range while generating strong operating cash flow.

As we exit the third quarter on the heels of a strong -- or solid performance in a continued sluggish economy, we have made tremendous progress in transforming Deluxe, but we still have many opportunities ahead of us. Looking ahead to the fourth quarter and into 2017, we believe our portfolio is even better positioned to deliver continued, sustainable revenue growth as our technologies and sales channels are stronger, our digital technology services offers more mature, our infrastructure better, and our management talent is deeper and aligned to grow revenue. We have developed a strong platform for long-term growth, with the objective of transforming Deluxe to more of a growth services provider from primarily a check printer, thereby changing our product mix and resulting stock price multiple.

In 2017, we are planning for what we expect to be an eighth consecutive year of revenue growth of approximately 2% to 4% compared to 2016. This is expected to produce adjusted diluted earnings per share growth ranging from approximately 3% to 6% with the assumption that we will invest more in brand awareness, benefit from a reduction in interest expense, and have a slightly higher tax rate than 2016. We also expect operating cash flow growth for a ninth consecutive year.

To give some more color on our revenue thinking, we are planning on consumer checks through financial institutions to decline approximately 5% to 6% on secular basis. On top of this, we have extended all large financial institution contracts through at least 2017, with the exception of one that we are working to extend, and we have about 10% fewer bank contracts up for renewal in 2017 compared to 2016, and we have more competitive opportunities coming due. In business products, we expect to expand existing organic initiatives in shop Deluxe, our Canadian business, and grow our dealer and major accounts businesses.

In marketing solutions and other services, we expect revenue growth roughly in the 12% to 15% range. 2016 results include approximately $16 million of revenue from several cPanel Web services, InkHead, Payce and DSS acquisitions. Excluding these, we expect approximately 6% to 7% growth on the 2016 base. Then, annualized revenue from these 2016 acquisitions of $37 million to $42 million.

Finally we expect to continue additional tuck-in acquisitions in line with 2016 revenue levels. This would imply a targeted marketing solutions and other services revenue to total revenue mix of approximately 37% for the year. We are excited with the progress here and with a more cooperative economy and even more additional tuck-in acquisitions as catalysts, we could potentially grow marketing solutions and other services even faster toward our goal of 40% of revenue mix by 2018.

We also expect our costs and expense reduction initiatives to continue in 2017. Please note very importantly that 2017 has one less business day, or approximately 0.4 points of revenue growth, than 2016, with the first quarter having one more business day and the third quarter and fourth quarters having one less business day. Also, as a reminder, the first quarter is traditionally the Direct Checks' strongest revenue quarter of the year. It is also extremely important for us to see how the fourth quarter progresses and to closely monitor the marketplace and the economy over the next three months before providing more specific outlook details for 2017.

Before I open it up for questions, here is an update on filling the CFO position. I have selected Russell Reynolds to work with me on the search. I am looking for a strategic and operational CFO, or one that can really partner with me in continuing our positive transformation. I am prepared to be patient to get the right leader, as these types of CFOs are taking longer right now in the market to fill.

Now Chelsea, Ed and I will take questions.

(Operator Instructions)

Jamie Clement, Macquarie Securities.

Thanks a lot for taking my questions in advance.

You are welcome.

First question maybe for Ed, if I may. The comments for next year surrounding Datamyx, is the difference between reconciling the double-digit EBITDA margin comment with the EPS neutrality, is that just deal-related amortization?

Yes. That's this year, too, Jamie, 2016.

Right. That I already got. I was just, into next year with the growth of it, that was a little confusing to me.

Just changing gears, Lee, as you talk about the Safeguard and major account channels as being potentially a little bit soft, is that -- do you think that is macro small-business related? I mean, you had comments on the small business economy and obviously it's certainly been a rough stretch and obviously I saw that data you were referring to about the sentiment six months out and that kind of thing, but what are you hearing from some of these customers?

What we've seen is we've seen two things. We've seen a slowdown in what they are doing and then we have seen a push out. To me when you see slowdowns and push outs, and they happen to be in what I call more of the discretionary accessories and kind of marketing-related areas, those are the natural things where we see a pullback I think more related to the economy. Unfortunately, these aren't significant changes, but they are changes enough to pull back on what we saw both in Q3 and then we just believe that -- we're not sure the momentum is going to be there in Q4, as well. That's where you see a little bit of the pullback right now.

Okay.

The other thing I will highlight is that we also had an acquisition that we were looking at in that space that was really in line to get done and then we just decided it did not make sense for us as we got further into it. It would have been more kind of in the forms and accessories space as well, and we just decided to step away from it.

Do you consider a business card like an accessory in that area? Not a business card, excuse me, a greeting card in that area, or is that a totally separate product line?

The holiday cards would be in our MOS space, and we see growth there. Don't get me -- we see still real positive growth. We just see a little bit of a pullback compared to what we (multiple speakers).

I think we've seen this every couple of years, it seems like. Changing gears a little bit, it seems like any company this earnings season that touches the kind of printed-product and office-supply market, there's been some strange kind of sentiment or perception of some softness and some folks have actually gone so far as to reference the aftermath of the FTC turning down Staples and Office Depot and concerns about what are these guys going to do now, that kind of thing. Any link of that whole world to your business here that you are aware of?

No.

I figured it was a stretch, but it seems like it has kind of been a little bit pervasive in this earnings season so far. Okay. I will let someone else get some questions. I'll get back in the queue. Thank you.

Joan Tong, the Sidoti & Company.

Lee and Ed, good morning. A couple of things here. Maybe just drill down again on the small business, just wanted to get a sense the operating environment, what you are seeing out there. Do you feel like the small business customer is kind of holding back and wait to see what is going to happen regarding the presidential election, and so maybe after that you probably see some sort of a rebound in demand?

Yes. I mean, I think you see that in the sentiment of optimism information that comes directly from small business. I think once the election is cleared, and I think that is why the optimism is higher six months out, I think everybody in the United States just wants to get through the election and figure out who is going to be the president and then go through whatever changes -- there's going to be a change, since Obama, obviously, is going out. I think there is that going on right now and I think there's just a little bit of hesitancy. You see it in any optimism information that's out on a small business right now.

Okay, thank you. Also for next year, you gave us some color in terms of how you think about next year, and I think, Lee, you mentioned marketing solutions grew 11% to 15%, but did you exclude some of those acquisitions? You talked about 6% to 7%, so high-single, mid- to high-single digit type of growth. I just want to make sure I get this right.

We try to be as clear as we can, here. We said 12% to 15% total, so if you think 16% to 17% this year in total, 12% to 15% and you did get it right, 6% to 7%. Think of it when you adjust the base. If you take the base $620 million to $625 million, you adjust for the 16% that we mentioned that's in there this year. Then you take that out, you gross 6% to 7% and then you add the $37 million to $42 million. That will be the amount of revenue from the deals that we've closed. You add something roughly in line with what we've done this year to that 16% number, your magic comes in at that 37% mix and that 12% to 15% and you can back in the 2% to 4% on the total Company growth.

Yes, we are really -- and by the way, we've have the courage to put the guidance out now no matter what we think is going to happen with small business and the economy because we believe in what we are doing and we believe that the products and services that we are adding to the portfolio are things that our customers, whether they be in the small business area or in the financial institution space, are spaces that -- and products and services that are really going to help them. We are very enthusiastic and we're very optimistic -- again, I say we have the courage to put these perspectives out there right now because we believe in what we are doing.

Right. I assume that low- to mid- to high-single-digit marketing services grows organically, you take into consideration some of the small business softness might linger a little bit, so (multiple speakers) macro adjusted.

We took that into consideration, absolutely, when we came up with that, yes.

Okay, got it. Another question regarding the thought process of paying down or redeeming the 6% $200 million note. Why you think it is good timing, why you didn't do it earlier? Also for next year guidance, 3% to 6% EPS growth, how much do you think that is contributed by lower interest expense from the redemption of the note?

The note redemption was really driven on the call date, which is in November of this year. That's the first call date so that's the first opportunity that we really had an opportunity to take those out. The bottom line is it's an interest expense arbitrage, for lack of a better term. We have got notes that are costing us, on average, 5.2% right now. They are swapped, fixed to floating, so our cost today is 5.2%. When put those on the credit facility, we're paying around 2%. Do the math of saving 3.2% of interest expense on $200 million, it is a pretty substantial annually $6 million, $6.5 million savings number for is.

That is really the logic behind it. We continue to look at the capital structure and what is the makeup of debt, long-term, short-term credit facility and for right now this makes sense. It keeps our capital structure strategy in place to be flexible, and we're managing interest expense in light of this low interest expense environment and that's where the logic of it.

Okay. All right, thank you, guys.

(Operator Instructions)

Charlie Strauzer, CJS Securities.

Couple of questions for you guys. When I look at the declines in check rates at kind of 4% there, I know this is always kind of a really tough thing to pinpoint, but what are you hearing from your commercial bank customers in terms of what's driving the lower decline rates? Is there anything that they can pinpoint on that?

No. This is one of the hardest things to try to do is to predict this. What we do is we talk to our customers. We survey our consumers, and we pull every trend -- statistical trend model we can. When you add all those up, some of the things we are seeing, though, is the areas where consumers are writing checks, one of the surprising things that we found is that there is a little bit of an uptick in what we would call retail establishments. We do hear from consumers that the fraud and security issues around electronification, we received feedback that says, I, the consumer am concerned with that. To us, that drives the correlation to are they worried about [losing] electronic forms of payment.

Now, you notice that we also said 5% to 6% next year. The reason we did that is we don't believe this will be a sustainable trend, meaning the 4%. We think this will come back up to what we've seen more traditionally over the last three, four years, around that 5% to 6% when the effect of fraud and securities starts to wane a little bit more and the public becomes a little bit more used to that. That is our logic; that is our thought process. We try every way to talk to the FIs, to talk to our consumers, to look at trending, to look at what is happening, and that is how we combined -- get to the decline rates that we have.

That's fair. As a follow up, related to the -- similar to what you've seen in the e-book marketplace where you've seen -- saw rapid growth in e-book substitution for printed books, that's slowed down significantly over the last couple years as the adoption has kind of peaked. Does it feel like there has been more of a peak also too on the e-payment side that maybe the number of checks you write is just kind of a finite amount now versus in the past where you basically moved a lot of that online?

No. All I can give is just what I just gave you. I think that's the best input (technical difficulty) that I've got.

Understood. As we look into kind of the MOS business kind of being, you said, 37% of revenue by the end of 2017, really kind of getting you very close to that 40% number for 2018 and kind of the goalposts are moving closer obviously. You look at your balance sheet, under one and a half times debt to EBITDA, you have got the firepower to continue doing acquisitions, but are there thoughts of making a more sizable acquisition to kind of really rapidly transform going forward here or is it more kind of the singles and doubles versus the home-run swing?

We are enormous believers and we've used two very strategic outside marketing consultants to confirm our strategy that programmatic acquisitions provide the best long-term returns for shareholders. We've looked at all the statistical information that we've had these two outside groups put that in front of us, and we continue to believe that, that is the right approach for a company like Deluxe right now that is continuing to build richness in terms of both the financial services as well as the small business portfolio. Does that mean, Charlie, we won't look at something as it comes up? We always are looking. We will absolutely continue to consider things that make sense.

We think the great work that Ed and his team and our whole Company has done on our capital structure gives us that ability to do that if need be, so we are open to it, but at the same time, we fundamentally believe that the programmatic way that we are doing this has worked quite well and we believe can continue to work. We just announced on this call three deals again and we like every one of these deals. We think these strategically really fit the bill and are all going to help us. I think that's what you should think about going forward. Again, if we see something that makes sense, that's larger, we will absolutely go to the rigor and process that we do on the ones that we are working today to consider that.

Excellent. Thank you very much.

Josh Elving, Feltl and Company.

Most of my questions have been answered. I just had one kind of housekeeping question and that has to do with the tax rate. I know you provided an outlook for around 33% for the full year. I guess looking at the past couple years, the fourth quarter has been significantly lower than the balance of the previous three quarters. Do you expect anything along those lines here in this fourth quarter? Obviously you can have a range of 3% or 4% in the tax rate and still end up at around 33% for the year. Just want to get any color on that.

No. I would tell you that we expect it to be in line to get to that 33% for the year, which I think if you probably did the math, it might be somewhere in a little bit lower than it's wrung out for the whole year in the fourth quarter, Josh, but no, there is not anything major or anything extremely significant to call out there.

Okay. On the redemption of the $200 million, I know you just commented on it. Is that -- you're essentially refinancing that with that with a short-term credit facility. Does that get fixed at some point and does that change your potential rates once it does get fixed?

Yes. What we did, if you recall, earlier in -- actually, very late September, we put out an [ATA] that we expanded the credit facility from $525 million capacity to $725 million. Essentially we are doing a term loan A through the credit facility at a 2% interest rate. It is all floating right now. We continue to monitor the market and we'll make a decision, maybe, if that makes sense to lock it into a fixed rate. That is an option, but today we are basically all floating, which is consistent with what we have been. If you recall, the $200 million 2020 notes are also floating. There's no change there. We will continue to monitor that and if it makes sense we could lock something in at that point in time.

Okay. Good. That's it for me. Thank you, guys.

Thank you. Jamie Clement, Macquarie.

As we head to a new year here shortly, was just looking for an update on the Company's strategy with respect to e-checks. I don't think that's a product that's necessarily well understood by potential consumers, certainly not well understood by investors. Can give us an update on where that stands?

Yes. Look. Every day we get more evangelists in the small business owners on e-checks. Every day we are growing the amount of e-check business that we are getting from them. The problem at this point, Jamie, is it is not sizable enough yet. The things that we are working on was all that list of various different types of companies that I talked about in the prepared remarks. What we are focused on is things that -- think of them as the software and accounting services companies, the health and medical area, document management, and payment. We have a whole string of relationships that we are working and getting them over the hump, testing in with them.

A lot of them want to make a bigger leap forward, but they all want to go through kind of these testing processes right now. We are kind of working with them, integrating with them, making sure that things are working well with them. We remain bullish on this. We've also have looked at some new payment technologies and how they take off, and this is taking off very similar to other things that you've seen that now are becoming more commonplace into the marketplace. We are being cautious because we are not trying to -- we're not predicting in our guidance here a big run up right now in terms of that, but we remain very optimistic about what's happening here.

What I would also tell you is that it's very interesting to see some of the small business customers that are financial institution customers that are using e-check. Yes, it is the big names that we have, the Citis and the Chases of the world, but very interestingly, some of the large financial institutions that are not our paper check customers today are also showing up as a very high mix of our e-check customers.

What does that mean? That means somebody is sending them an e-check from a business and they are seeing it, obviously liking it, and then ordering it, because they are not able to get those through the other provider at this point. All those things give us cause for optimism, but I sure wish it would scale faster than it has at this point in time. I also feel like we're doing a lot of the right things to make a new e-check market here.

Is there a strategic reason why you wouldn't look to one of the big FIs as almost like a quasi partner/sponsor of the new technology, that kind of thing, in this endeavor? It sounds like the focus is on the ultimate user rather than kind of the FI side. Is there an opportunity with a big FI?

We are trying to do that. The interesting thing is with all the various payment vehicles that are out there today and all the traffic around the new payment rail and what might happen, they are having to go through and look at all those things and swallow and absorb those as they are looking at this, as well. (Multiple speakers) really what is going on right now.

At the end of the day it is a check, though, right? It is not that complicated.

I think the simple way to explain it is an e-mailable check. When you explain it to somebody like that, oh, it's not so complicated. It's not (multiple speakers) technology. It's just an e-mailable check.

All right. I guess people are worried about security and that kind of thing in this day and age and maybe that's why. Who the heck knows. Okay, guys. Thanks very much for your time. I appreciate it.

You are welcome.

Thank you. This concludes the question-and-answer session. I would now like to turn the call back over to Mr. Lee Schram, Chief Executive Officer, for any closing remarks.

I just have a couple of closing thoughts. I want to thank everybody for their participation, all the questions today. Really three things to summarize. First, we delivered a solid third quarter. We delivered revenue at the midpoint of our outlook and with both diluted EPS and adjusted diluted EPS scoring over 5%. Second, our marketing solutions and other services revenue grew 16% in the quarter with a mix of MOS growing on track to account for about 34% of revenue this year. We believe we are on track with the 37% I mentioned for next year to get to that 40% mix by the end of 2018.

Then finally, looking ahead into next year we believe we continue to be well-positioned to deliver another year of growth in revenue, earnings per share, and cash flow from operations. Now we're going to get back, roll up our sleeves, get to work, and we look forward to providing another positive progress report on our next call. I'm going to turn it over to Ed, then, for some final housekeeping.

Thanks, Lee. Before we conclude today's call, I'd just like to mention that Deluxe Management will be participating at the upcoming events in the fourth quarter where you can continue to hear more about our transformation. On November 14 we will be in New York at the Global Mizuho Securities Conference and on December 1 we will be in Scottsdale at the Credit Suisse 20th Annual Technology Conference. Thanks to all of you for joining us. That concludes the Deluxe third-quarter 2016 earnings call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.