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Deluxe Corporation (NYSE:DLX)

Q2 2012 Earnings Call

July 26, 2012, 11:00 a.m. ET

Executives

Jeff Johnson – Treasurer and VP of IR

Lee J. Schram – CEO

Terry D. Peterson – CFO

Analysts

Charles Strauzer – CJS Securities

John Kraft – D. A. Davidson & Co.

James Clement – Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2012 Deluxe Corporation earnings conference call. My name is Tiffany, and I’ll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question and answer session towards the end of the conference. (Operator Instructions).

As a reminder, this call is being recorded for repay purposes.

I would now like to turn the call over to Jeff Johnson, Treasurer and Vice President of Investor Relations. Please proceed.

Jeff Johnson

Thank you, Tiffany. Welcome to Deluxe Corporation’s 2012 second quarter earnings call. I am 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 actual 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, 2011.

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 at deluxe.com, and was furnished to the FCC on the Form 8-K filed this morning. In particular, any non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release. Now, I’ll turn the call over to Lee.

Lee Schram

Thank you Jeff and good morning everyone. We had another outstanding quarter following an outstanding first quarter performance. We are well positioned as we enter the second half of the year, to grow revenue for the year in the mid-single digits, despite the continued sluggish economic environment.

We reported second quarter revenue and adjusted earnings per share well above our outlook. Revenue grew 7% over the prior year, driven by Small Business Services revenue growth of 15%, of which 5% came from the PsPrint and OrangeSoda acquisitions.

This quarterly growth rate matched the first quarter of 2012 for the strongest we have reported since we acquired NEBS in 2004.

Checks and Forms both performed better than our expectations, and Marketing Solutions and Other Service’s revenue grew 30% over the prior year.

Adjust diluted EPS grew 13% over a strong prior year. We also generated solid operating cash flow, we’ve not drawn on our credit facility during the quarter, and we increased our cash position $16 million from last December.

Encouragingly, we continued to see more stabilizations than expected in secular check decline rates with financial institution consumer declines less than 5% in the quarter, which is the second quarter in a row we have seen significantly lower decline rates.

We enhanced our marketing solutions and Other Services offers and capabilities with the acquisition of OrangeSoda. We also invested more in brand awareness to help better position our marketing solutions and Other Services offering, and drive future revenue growth.

Further, we 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.

Terry Peterson

Thanks, Lee. Earlier today, we reported diluted earnings per share for the second quarter of $0.82, which included restructuring and transaction related cost of $0.03 per share. Excluding these costs, adjusted EPS of $0.85 was well above the upper end of our outlook, and 13% higher than the $0.75 reported in the second quarter of 2011.

Strong revenues and favorable product mix drove better than expected EPS performance, and more than offset an increase in variable compensation expense. The restructuring charges are primarily for employee severance and infrastructure consolidations, while the transaction cost related to the OrangeSoda acquisition.

Revenue for the quarter came in at $371 million, which was well above the range of our outlook, and up 7% from 2011. All three of our business segments performed well. Small Business Services revenue of $233 million, included $10.5 million from the PsPrint and OrangeSoda acquisitions, and grew 15% versus last year on a reported basis.

While we continued to operate in a weak economic environment, we delivered growth in marketing solutions and Other Services, our Safeguard distributor, dealer and major accounts channels, and in checks and forms.

Financial Services revenue of $86 million declined only 1% versus the second quarter of last year, and reflected a lower-than-expected secular check decline rate of less than 5%. The impact of lower check orders was mostly offset by higher revenue per order, higher non-check services revenue, and the addition of Citizens Financial Group. Direct Checks revenue of $52 million was down 7.4% on a year-over-year basis.

Gross margin for the quarter was 65.6% of revenue, up 0.5 percentage points from 2011. Benefits from price increases, improvements in manufacturing productivity, delivery initiatives, and product mix were partly offset by increased delivery rates, material costs, and performance base compensation expense.

SG&A expense increased $10.3 million in the quarter, and was 45.2% of revenue, compared to 45.5% of revenue in the same period last year. Increased SG&A associated with commissions on increased revenue, acquisitions, and higher performance-based compensation expense, and investments in revenue-generating initiatives was partially offset by benefits from continuing our cost reduction initiatives, and lower amortization related to previous acquisitions.

Excluding restructuring and transaction-related cost, operating margins for the quarter of 20.5% was up from the 19.9% generated in 2011 and was above our expectations with favorability coming from strong revenue performance including favorable product mix, which more than offset higher performance-based compensation expense.

All three segments delivered strong operating margins.

Excluding restructuring and transaction costs, Small Business Services’ operating margin of 16.9% was down 1 percentage point from last year due to expenses associated with the PsPrint and OrangeSoda acquisitions, increased commissions and investments in revenue-generating initiatives, which was only partially offset by continued progress with cost reduction initiatives.

Financial Services operating margin of 23.7% was up 5.7 points from 2011 due to higher revenue from price increases as well as continue progress with cost reductions.

Direct Checks’ operating margin of 30.8% increase 0.7 points from 2011 as we continued to realized planned synergies from integrating Custom Direct, and lower acquisition-related amortization.

Turning to the balance sheet and cash flow statement, year-to-date we increased our cash and cash equivalence balance by $16 million, despite having paid cash for the OrangeSoda acquisition and repurchasing $12 million of our common stock to offset expected dilution from employee plans.

Total debt at the end of the quarter was $742 million, the same as at the end of 2011. Cash provided by operating activities for the first half of the year, exceeded our expectations at $99.9 million, driven by stronger operating performance. Compared to last year, cash benefits from stronger operating performance and the discontinuation of our defined contribution pension plan, were more than offset by higher income tax payments, a planned contribution to our Vivat Trust, for future medical cost in first quarter, and higher contract acquisition and interest payments.

Capital expenditures for the first six months were $17 million, and depreciation and amortization expense was $33 million.

On May 31, we purchased OrangeSoda for approximately $27 million using cash on hand. The acquisition is expected to generate revenue of approximately $15 million during 2012, and be a penny dilutive to EPS in the third quarter, as well as the full 2012 year, after absorbing acquisition related amortization expense and transaction cost.

Given our strong performance in the second quarter and the addition of OrangeSoda, we are raising our consolidated revenue outlook for the year to a range of 1.49 to $1.51 billion. We’re not expecting much improvement in economic conditions for the balance of the year.

Positively, excluding marketing solutions and Other Services in our outlook range, the underlying core business is actually growing from 2011. Adjusted diluted earnings per share is also expected to increase to a range of $3.30 to $3.45 excluding $0.10 related to restructuring and transaction related cost.

There are several key factors that contribute to our full-year outlook versus 2011, including small business services revenue is expected to increase in the low double-digits as declines in core business products are expected to be offset by price increases and growth in our e-commerce, distributor, dealer and major accounts channel, plus double-digit growth in marketing solutions and Other Services offering, which now include the OrangeSoda acquisition.

We expect financial services revenue to decline in the low single digit range, driven by secular check order declines, which we expect to be approximately 5 to 6% for the remainder of the year, partially offset by higher revenue per order, the Citizens Financial Group migration, and continued growth from non-check revenue streams.

Direct Checks revenue declined in the mid to high single digits, driven by check volume reduction in a sluggish economy. Additional cost and expense reduction, increases in material and delivery rates, increases in performance base incentive compensation, continued investments in revenue growth opportunities, including brand awareness, direct response campaigns, marketing solutions and Other Service offers, and enhanced internet capabilities, and an effective tax rate of approximately 33%.

We are tightening our operating cash flow outlook to a range between 235 and $245 million in 2012, reflecting stronger earnings, offset by higher income tax payments, and a first quarter contribution to our Vivat Trust.

We expect contract acquisition payments to be approximately $20 million for the year, which is higher than previously guided, as we continue to aggressively renew contracts into 2013.

2012 capital expenditures are expected to be approximately $35 million, roughly the same as 2011. We plan to continue to invest in key revenue growth initiatives and make other investments in order fulfillments and IT infrastructure.

Depreciation and amortization expense is expected to be $65 million, including $15 million of acquisition related amortization.

For the third quarter of 2012, we expect revenue to range from 366 to $375 million. Adjusted diluted earnings per share is expected to range from $0.76 to $0.81. In comparison to the second quarter, third quarter revenue at the upper end of the range is expected to be higher, despite one less business day, which represents approximately $6 million in revenue.

In addition, the ongoing secular decline in checks and forms is expected to be more than offset by OrangeSoda revenue and a ramp in Marketing Solutions and Other Services revenue, primarily driven by new customer migration rollouts in wholesale web services.

Adjusted EPS in the third quarter is expected to be lower than the second quarter due to additional investments, including $0.01 of dilution from OrangeSoda acquisition, and the previously communicated increase in expected brand awareness spending.

Shifting to our capital structure, we expect to maintain our balanced approach of investing organically, and through small to medium size acquisitions in order to drive our growth transformation. We also expect to maintain our current dividend level and repurchase shares to offset dilution from employee plan as we did in the second quarter. 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.

As you saw in the first half of the year, it is possible we may accumulate larger investments on our balance sheet in 2012, in anticipation of paying off the $85 million of notes maturing in December.

We believe our strong cash flow, strength in balance sheet, and flexible capital structure position well to continue advancing our transformation.

I will conclude my comments with an update on our cost and expense reduction initiatives. Overall, we had another solid quarter as we delivered on our expected cost and expense reductions, towards our $50 million commitments, net of investments in 2012.

Our focus in sales and marketing for 2012 continues to be improving sales and marketing back and operations through process centralization, simplification, platform and tool consolidation and leveraging e-commerce capability.

We consolidated our Little Rock and Joplin call centers for customer direct, into our Colorado Springs Direct Checks call center in early July. We will also continue to improve the mix of paper catalog, and online search engine marketing expenditures.

In fulfillments, we expect to continue our lean, product standardization, [inaudible] reduction, and direct and indirect span 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 are also working to close our Joplin printing facility for Custom Direct, and consolidate the work into another Deluxe printing facility by early 2013.

Finally, for the shared services infrastructure, we expect to continue to reduce cost in IT and other areas, as more opportunities exist to improve efficiencies.

Now, I’ll turn the call back to Lee.

Lee Schram

Thank you, Terry. I will continue my comments with an update on our key revenue growth area, Marketing Solutions and Other Services, including perspectives on our recent OrangeSoda acquisition and insights on the next steps for improving our brand awareness. I will then highlight progress in each of our three segments, including a perspective on what we hope to accomplish during the balance of 2012.

We have segment growth opportunities in Marketing Solutions and Other Services, including for small businesses, [inaudible] design, web services, social media, web-to-print, search engine marketing and optimization, payroll and fraud and security services. And for financial institutions, customer acquisition, risk management, and profitability offers.

We will continue to access potential small to medium size acquisition that complement our large customer bases with a focus on Marketing Solutions and Other Services.

Here is an update on the four sub-categories framework we introduced on our first quarter call for Marketing Solutions and Other Services. First, small business marketing is expected to represent approximately 41% of total Marketing Solutions and Other Services revenue, with expected organic growth rates this year in the high teens, although expected actual growth rates will be higher this year, closer to the upper 30s, given the PsPrint acquisition in July of 2011.

Key growth initiatives include scaling web-to-print by cross-selling to our customer base, and adding new customers through major account, distributors and partners. Second, web services, which includes logo and web design, web hosting, SEM, SEO, e-mail marketing, social, and payroll services, is expected to represent approximately 30% of total Marketing Solutions and Other Services revenue, with expected growth rates this year in the 40%, driven by the OrangeSoda acquisition.

Key growth initiatives include adding wholesale [inaudible] and major accounts, cross-selling to our retail base through bundled present packages, and adding new customers. This category also is our focus area for tuck in acquisition, with OrangeSoda being a good example.

OrangeSoda provides internet marketing services for small and mid-size businesses, including online and mobile ads, social media marketing, SEO, SEM, pay-per-click, reporting and analytics, including call and conversion tracking. They directly support over 5,000 high [inaudible], as well as 20 channel partners, with strong scalable product offerings and processes, a low turn rate, and a seasoned management team.

We expect to leverage our retail and wholesale customer basis by significantly expanding our existing SEM and SEO capabilities. We also have added a scalable front and to back end delivery production system, able to support volume expansion, while adding campaign, building, production and analytics capabilities.

Third, fraud, security and risk management service are expected to represent approximately 24% of total Marketing Solutions and Other Services revenue in 2012, with expected growth rates this year in the low double-digits.

Key growth initiatives include scaling our Program Services for both national and community banks, and fraud and security offers for small businesses and direct to our consumers. As an example, we initiated two large FI Provent rollouts in the second quarter that will ramp through the balance of the year. It also includes adding Bankers Dashboard customer, as well as adding features for [inaudible] Bankers Dashboard base.

Finally, other financial institution services are expected to represent approximately 5% of total Marketing Solutions and Other Services revenue, with expected growth rates this year in the 30% range, a very high percent driven by a small starting revenue base.

Key growth initiatives here include adding new Cornerstone, SwitchAgent, and Gift and Reward Card financial institutions.

We expect Marketing Solutions and Other Services revenues to be approximately 280 to $290 million in 2012, up from $223 million in 2011, with organic growth in the mid-teens. If achieved, this performance would translate to a total revenue mix of around 19% of revenue, towards our goal of achieving a 25% mix over the strategic period. And up from 16% in 2011 and 12% to 13% the previous few years.

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 continue to refine our branding strategy and expect to increase spending more from the second quarter to the third and fourth quarter. Our brand awareness improvement includes differentiating our offers for small businesses around a brand platform with a key message that Deluxe is a small businesses genuine, passionate partner that gives them everything they need, so they can focus on what they love. Think of it as helping small businesses pursue their unique passion, while Deluxe assist them in this pursuit.

We will highlight more specific here on our third quarter earnings call, after the creative and key messaging platform is introduced into the marketplace.

Now shifting to our segments. In Small Business Services we had strong performance, despite a continued sluggish economic environment. Revenue grew 15%, 5% of which came from the PsPrint and OrangeSoda acquisitions and matched the first quarter for the strongest rate we reported since acquiring NEBS in 2004.

Checks and forms performed better than our expectations. 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 balance, integrate content, and online and print base [inaudible]. Average order value and conversion rates remained strong. Our Safeguard distributor, dealer, and major accounts channels grew revenue over the prior year. We also saw strong growth in logo, web, SEM, SEO, and payroll services.

We ended the quarter with approximately 500,000 web hosting customers. We continue to closely monitor the small business market. Optimism industries declined as we exited the second quarter and remained at historically low levels.

Small business spending is more for maintenance than expansion, and the outlook for improvements in sales and business conditions dropped to the lowest level of the year in June. Small businesses continue to spend cautiously, scrutinize purchases, and experience tight cash flow.

In summary, current optimism industries have been turning downward, and the outlook is not conducive for new spending or hiring.

The good news is that increasing sales continues to be a small business owners number one pain point, and our portfolio is significantly more robust now with many offers to help them here. As the economy recovers, the transformative changes we are making to deliver more services offerings that help small businesses get and keep customers. Deluxe is better position as that indispensable partner for growth.

Our focus for 2012 and core small business checks and forms is on acquiring new customers, increasing our share or wallet through our enhanced shop Deluxe e-commerce site, growing distributor and dealer partners, adding new and cross-selling more in major accounts, 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 Marketing Solutions and Other Services we expect to continue to gain new customers through our Telco, focused wholesale web services model, and customers and our retail model by selling bundled web presence packages, and other marketing services, payroll services and logo customers [inaudible]

… of 7 to 8%, driven by strength in both the national and community segments. In addition, we benefited from processing checks for Citizens Financial Group in the current year quarter. We had strong overall new acquisition rates and our retention rates remain strong on yields pending in the current quarter in excess of 90%.

Positively, we now have all our large contracts extended through the end of 2012 except one, which is being worked, and we have confidence we will also extend. We also continued to work a number of competitive RFPs, none of which are included in our outlook for 2012. We also simplified our processes and took complexity out of the business while reducing our cost and expense structure.

We are planning for check units to be in a decline range of around 5 to 6% for the balance of the year. We also expect retention rates in excess of 90% on yields pending this year, and with about 70% of our 2012 community bank contract renewals already completed, at the halfway point in the year, we are well ahead of last year’s pace.

We made progress again in the quarter in advancing non-check Marketing Solutions and Other Services opportunities. Revenue grew over last year in these non-check services, which include customer acquisition, risk management and other profitability offers.

In customer acquisition and specifically our cornerstone direct marketing analytics offer, we saw continued growth and new financial institutions that will roll-out in 2012.

In addition to a number of community banks that have started to roll out the [inaudible] offer. We have commitments in the second half of the year for branch pilots from four large financial institutions, including one where we do not produce checks for them.

Although still early in the roll-out of our offer, we continue to be excited about SwitchAgent opportunity. A recent [inaudible] strategy and research report indicated about 11% of respondents indicated they were very likely, or likely, to switch financial institutions in the next 12 months. And the survey also indicated that these respondents have average deposits 30% higher than customers who have no intention of leaving.

Bankers Dashboard also continued to perform in the second quarter, as we had the highest number of new quarterly financial institution wins since closing the acquisition. As you can see, although not as fast as we had hoped in some areas, momentum continues to build, and we expect strong double-digit growth in these Marketing Solutions and Other Services in 2012.

In direct checks, revenue was in line with our expectations driven by strong revenue per order and strong custom direct accessory revenue. We continue to look for opportunities to provide accessories and other check related products and services to our consumers. Although we have made significant progress with the custom direct integration, we are still working on a number of initiatives to create a integrated best-in-class direct consumer check experience.

One key initiative is the integration of our Little Rock and Joplin custom direct call centers into our Colorado Direct Checks call center, which was just completed in early July. We continued to see a ramp in revenue enhancement synergies through our call center scripting and upscale capabilities, as well as synergistic cost and expense reductions.

For 2012, we expect Direct Checks revenue to decline in the mid to high single digits, driven by continued declines in consumer usage in a weak economy. We expect to reduce our manufacturing cost and SG&A in this segment, and drive our operating margins into the 30% range while generating strong operating cash flow.

As we exit the second quarter on the heels of a exceptionally strong quarterly performance in a continued sluggish economy, we have made tremendous progress in transforming Deluxe, but we still have many opportunities ahead of us in 2012.

Our outstanding first half performance positions us well to grow revenue in 2012 for our third consecutive year. We are conserveably not expecting the economic climate to improve throughout the balance of the year. If the economy improves, we should have upside in revenue.

Positively, excluding Marketing Solutions and Other Services in our outlook range, our underlying core business is stabilizing, actually glowing from 2011. Marketing Solutions and Other Services are expected to grow 26 to 30% this year. At the same time, we will not take our eyes off cost reductions, process improvement, and accelerating brand awareness, and we expect to continue to generate strong cash flows and provide a very attractive dividend.

Now, Tiffany, I’ll let you open the line for questions.

Question-and-Answer Session

Operator

Okay, (Operator instructions). And it looks like your first question will be coming from Charles Strauzer from CJS Securities.

Charles Strauzer – CJS Securities

Thanks, good morning.

Lee Schram

Hi, John.

Charles Strauzer – CJS Securities

Just if you can delve into the check decline rates being better a little bit more, get a little more color there. Just as you talk to the banks and stuff, what do you think is kind of driving those – that a couple of quarters now that it has been a few base points that you’ve expected. What do you think the drivers are behind that?

Lee Schram

I think that the thing that happened this quarter we mentioned in the comments, Charlie, we actually saw – you know, in the first quarter if you remember we actually saw the community banks perform a little bit better than the nationals, all though they were both lower than our expectations. This quarter they were more in line with each other, so you think about that less than 5% that was pretty consistent with both of them. What we know in pockets, there are in the nationals, for example, we know that some of our customers are opening new branches, and because they are opening new branches we are seeing some actual growth in pockets that we haven’t seen historically. We also know that in the case of the community business, you know, community – you know, FI’s that we have seen kind of more consistency across the various, what we call, regions of the United States. So, some of those were areas, again, the southeast, the west, the northeast, that were probably most hardest hit by the, you know, the recession. So, we are seeing more consistency there, we are constantly talking to our banks about, you know, how and why we have seen the trends. We actually seem to have, you now, a lot, you know, inside ourselves on the trends that we are seeing, we are trying to work through those, but at this point, Charlie, we that is what we know, and that’s kind of the perspective that we have at this point – obviously very encouraging for us.

Terry Peterson

Yes, the other thing that I would add, Charlie, too, is the housing numbers have been better since the first half of the year, and that typically will drive us and check orders as well.

Charles Strauzer – CJS Securities

Excellent, and if we could shift it a little bit more of a longer term view, and Lee, we talk about from time to time is, you know, the ability to cross sell some of these new services across, you know, various platforms – you know, what do you kind of see in the new cross selling abilities? I know that it was kind of always been a work in progress, and you thought you weren’t there yet, but are you making progress on that front too?

Lee J. Schram

We are clearly making progress – I mean, on of the exciting things is that we introduced – I’ll give you an example, we introduced the orange soda blend product into our retail call centers actually this week, and we already have small business owners that are signed up for the blend offer. So, yes, we are working our tails off to try to get as many as these offers as we have that we have added to that marketing solutions and other services into our platform, and trying to get those out. I – what I would tell you, honestly, Charlie, is it is a work in progress. We have a lot of work to go here where we want to be, and you can look at that as a short coming, I look at it as a huge opportunity for the company. We are getting better, we are performing better, and we have an opportunity to do better on bringing these services that we have out to our, you know, small business customers. One of the things that think is going to help, and I really would like to just give a little color on the brand, like I see in script, but – and not really spend a lot more on that until it hits the market here in the third quarter, but we are really – our belief is that the better we can do with bring that brand in – improve brand perspective and putting that out in front of small businesses, we thing that is also going to help, you know, with how we cross sell and the, you know, our ability there. Obviously the proof will be as we, you know, as we look at this and measure it from there, but I like to think we are improving, and yet I would like to think we also got a lot of opportunity out here.

Charles Strauzer – CJS Securities

Great, thank you very much.

Lee J. Schram

You’re welcome, Charlie.

Operator

Okay, and it looks like your net question will be from John Kraft from D. A. Davidson.

John Kraft – D. A. Davidson & Co.

Hey guys, congrats on the progress, especially given the environment.

Lee Schram

Thank you, John.

John Kraft – D. A. Davidson & Co.

I wanted to just talk about a few of the cost side of the equation here, a few things. First of all, Terry, you said something about closing a custom direct printing facility. When did say that was going to happen?

Terry D. Peterson

We are targeting to have that completed sometime by early 2013.

John Kraft – D. A. Davidson & Co.

Okay, and then on the increased delivery expenses, can you remind me that percent of your FI’s are using the flat packaging?

Terry D. Peterson

Percent of our FI’s is 100.

John Kraft – D. A. Davidson & Co.

Oh, everybody – well, but it hasn’t been adopted across all of them, is that…

Terry D. Peterson

Yes, all of our FI’s are and have the flat packaging, and have for several years at this point. There are sometimes that we do send out – if a customer orders several boxes of checks we might put that in a box and send that out UPS, but after seeing them double, all of the FI’s have adopted the FI packaging.

John Kraft – D. A. Davidson & Co.

Interesting, okay, I didn’t realize that. And then on the small business side of things, you said that the impacting in the quarter there was some [inaudible] print acquisition expenses and some higher sales commissions. I guess, where do you see the margin on that segment trend ending in the near term, and give a longer term target?

Terry D. Peterson

You know, we’re still pretty consistent in terms of revenues and the margin, and margin potential in that business – you know, we still invest quite a bit into the s-small business segment, and we [inaudible] universal target, kind of that upper teens, that is kind of where we see that margin for, you know, not only, you know, the short term year, but I would say in the mid-term as well.

Lee Schram

And John, it’s always going to be a little lumpy here, you know – I mean, when we, you know, obviously given the performance that we had, we had – we made some comments around arranging, or increasing our performance instead of compensation, and so, we have to put that in, and we allocate everything out, as you know, to our segments, we don’t keep anything at the corporate level. So, you are going to cease, but you are also going to see some spikes when you make decisions to spend a little bit more on the brand area, but I think Terry said it well, we expect, you know, high teens, and you know, the performance is exactly in line with where we expect this point at time – we are actually very pleased with the small business margins and where they are at and where they are going.

John Kraft – D. A. Davidson & Co.

Great, that’s helpful. That’s all that I got guys, thanks.

Lee Schram

You’re welcome, John.

Operator

(Operator Instructions). Okay, and it looks like your next question is from Jamie Clement with Sidoti and Company.

James Clement – Sidoti & Company, LLC

Good morning, gentlemen.

Lee Schram

Hi, Jamie.

James Clement – Sidoti & Company, LLC

I was wondering if you might give a little bit more clarity in terms of the allocations of CapEx and how that's changed over the last couple of years as you build your services offerings. Are those business, I mean obviously, it's different from the current manufacturing business, but how much capital are those businesses requiring as kind of a percentage of a total over the course of the year? I mean, do you have a rough number you could give us?

Lee J. Schram

Here's the way I would think about strategically how we position in capital. If you think about the marketing solutions and other services, where we're getting – I mentioned in the script, Jamie, that we're going to have some bigger rollouts in the second half of the year in the wholesale area. So that's an area we've had to put some more server capacity in, in order to really be able to ramp those rollouts. We look at those as a very positive use of capital.

We also have capital that we mentioned in the web to print area. If you think about getting to that what I call best in class opportunity there, we're setting dollars on that. We're setting dollars on e-commerce and capital. That, and those are, they were more on putting the flat packaging several years ago. They're now shifting more to I would call it more revenue generating opportunities.

James Clement – Sidoti & Company, LLC

That's what I was asking was more the shift. That's what I was curious about your capital spending has been, you know, it's been pretty stable.

Lee J. Schram

But I also would add that as we integrate and continue to get cost out and especially in the fulfillment area, there are some other capital plays that we have there. But that is clearly to a lesser degree than what we've historically done.

So much more of the capital is going towards revenue generating plays than not.

Terry, anything you want to add?

Terry D. Peterson

Yes, the other thing that I would add kind of related to this, but beyond a bit of capital is that when we invest in new products that are being developed organically that might require say technology investments, typically because we don’t know how successful they will be in the marketplace, we actually expense those. So there's kind of capital types of expenditures that are actually expense. So many of our initiatives don’t even show up in the capital buckets.

James Clement – Sidoti & Company, LLC

Understood, and last question is a follow-up on Charley's. The rate of check decline or check usage being sub 5%, was that excluding the citizens and that was excluding the price? That was just pure unit?

Lee Schram

That's user retail from my retail days at MCR. That is a same source sales approach. So that's the way to think about it and that's how we look at the business. So yes, it excludes. That's unit decline.

Terry Peterson

And volume only, no price consideration there.

Lee Schram

Right, and no citizens.

James Clement – Sidoti & Company, LLC

Okay, well done. Thank you very much.

Lee Schram

You're welcome.

Operator

Okay, and so there are no more questions. I'd now like to turn the call back over to Lee Schram for closing remarks.

Lee J. Schram

I just want to thank everybody for your participation, and thanks for the questions that we got today. And as I consistently kind of say each quarter, we're going to get back to work now and we look forward to providing a positive progress report on our next earning's call. And I'll turn it over to Jeff for the wrap up.

Jeff Johnson

Thank you, Lee. This is a reminder that a replay of this call will be available until August 2nd by dialing 888-286-8010. When instructed, provide the access code 59901479. The accompanying slides are archived in the news and investor relations section of Deluxe's website at Deluxe.com.

Again, thank you for joining us. Have a good afternoon.

Operator

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

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