Ed Merritt - Vice President of Investor Relations and Treasurer Lee J. Schram - Chief Executive Officer and Director Terry D. Peterson - Chief Financial Officer and Senior Vice President.

Randy L. Hugen - Feltl and Company, Inc., Research Division Tim Klasell - Northland Capital Markets, Research Division Charles Strauzer - CJS Securities, Inc..

Good day, ladies and gentlemen, and welcome to Quarter 2 2014 Deluxe Corporation Earnings Conference Call. My name is Annette, and I will be your coordinator for today. [Operator Instructions] Please be advised, this conference is being recorded for replay purposes.

I will now turn the conference over to Ed Merritt, Treasurer and Vice President of Investor Relations. Please proceed, sir..

Thank you, Annette, and welcome, everyone, to Deluxe Corporation's Second Quarter 2014 Earnings Call. I'm Ed Merritt, Deluxe's Treasurer and Vice President of Investor Relations. Joining me on today's call are Lee Schram, our Chief Executive Officer; and Terry Peterson, our Chief Financial Officer.

At the conclusion of today's prepared remarks, Lee, Terry and I will take questions from analysts.

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 in the company's Form 10-K for the year ended December 31, 2013.

The financial and statistical information that will be reviewed during this call is addressed in greater detail in today's press release, which was furnished to the SEC on Form 8-K by the company this morning. The press release is also posted on our Investor Relations website at deluxe.com/investor.

Any references to 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, Ed, and good morning, everyone. Deluxe delivered another very strong quarter, and we are well positioned as we enter the second half of the year to grow revenue for the year 3% to 4% despite a continued sluggish economic environment.

We reported revenue and adjusted earnings per share in the second quarter above the upper end of our outlook. Revenue grew over 6% compared with the prior year quarter. Small Business Services revenue grew almost 9%. Financial Services revenue grew over 6%.

Checks and forms performed well, and marketing solutions and other services revenues grew 20% over the prior year, and represented over 23% of total second quarter revenue. Adjusted diluted earnings per share grew over 5% from the prior year.

We generated solid operating cash flow, and we were not drawn on our credit facility during the quarter, increasing our balance sheet cash position $26 million from last December.

We announced the quarterly dividend increase of 20% in April and also repurchased $20 million in shares in the quarter, bringing our year-to-date repurchase total to $52 million. We continued our brand awareness campaign to help better position our products and services offerings and drive future revenue growth.

We also advanced process improvements and slightly exceeded on our cost reduction expectations for the quarter. In a few minutes, I will discuss more details around our recent progress and next steps. But first, Terry will cover our financial performance..

Small Business Services revenue is expected to increase 7% to 8%, as volume declines in core business products are expected to be offset by benefits from our e-commerce investments, price increases, growth in our distributor, dealer and major accounts channels, and double-digit growth in marketing solutions and other services offerings.

We expect Financial Services revenue to be flat to up 1%, driven by recurring check order declines of approximately 6%, and some pricing pressure, which we expect will be at least offset by continued growth from noncheck revenue streams, including Destination Rewards, higher revenue per order, full year of HSBC, and a quarter from a new account win; a direct checks revenue decline of approximately 9%, which is slightly better than our previous outlook driven by check order volume declines, a continued sluggish economy, full year cost and expense reductions of approximately $55 million, net of investments; increases in medical expenses, material cost and delivery rates; continued investments in revenue growth opportunities, including brand awareness, marketing solutions and other services offers and enhanced Internet capabilities; lower interest expense in the fourth quarter; and an effective tax rate of approximately 34%.

We expect to continue generating strong operating cash flows for the full year 2014 outlook to range from $270 million to $280 million. Versus last year, this outlook reflects stronger earnings and lower medical and incentive compensation payments, offset by higher tax payments.

We continue to expect full year contract acquisition payments to be approximately $15 million. 2014 capital expenditures are expected to be approximately $40 million, slightly higher than 2013, as we continue to grow Deluxe.

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 $66 million, including approximately $20 million of acquisition-related amortization.

For the third quarter of 2014, we expect revenue to range from $406 million to $414 million. Adjusted diluted earnings per share is expected to range from $0.97 to $1.02.

In comparison to the second quarter, adjusted EPS is expected to be slightly lower at the midpoint of the range in the third quarter, primarily due to expected lower Financial Services and Direct Checks' higher-margin revenue, and the resulting flow-through to operating income and higher brand awareness spend. 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 business transformation. Additionally, we expect to continue paying a quarterly dividend. Year-to-date, we have repurchased almost $52 million of common stock, compared to $32 million in the first half of 2013.

Although we plan to spend more on share repurchases than we did last year, the pace for the balance of the year is expected to be less than the first half level. In the foreseeable future, we plan to allocate more funding to common stock repurchases than we have in prior years.

We also plan to accumulate cash in advance of our October 2014 senior note maturity. We plan to retire these notes as they come due using cash-on-hand and a draw on our $350 million credit facility. We may also, from time to time, consider retiring outstanding debt through open market purchases, privately negotiated transactions or other means.

We believe our increasing cash flow, strong balance sheet, and flexible capital structure position us well to continue advancing our transformation. I will conclude my overall comments with an update on our cost and expense reduction initiatives.

Overall, we had a solid performance in the second quarter, as we slightly exceeded our expected cost and expense reductions, as far as our $55 million commitment, net of investments in 2014.

Approximately 60% of the $55 million in expected reductions will come from sales and marketing; another 30% from fulfillments; and the remaining 10% coming from our Shared Services organizations.

Our focus in sales and marketing for the remainder of 2014 will be on sales channel optimization, platform and tool consolidation, and leveraging order streaming and marketing efficiencies. We also continue to improve the mix of paper catalog and online search engine marketing.

In fulfillment, we expect to continue our lean, direct and indirect spend reductions, further consolidate our manufacturing technology platforms, drive delivery technology and process efficiencies, reduce spoilage, further enhance our strategic supplier sourcing arrangements, and continue with other supply chain improvements and efficiencies.

Finally, for Shared Services infrastructure, we expect to continue to reduce expenses, primarily in IT, but we also have opportunities in finance and real estate. Now, I'll turn the call back to Lee..

An alert monitoring capability that helps financial institutions target consumers when they are actively shopping for a loan.

In SwitchAgent, we worked closely with our financial institutions and have implemented product enhancements for pilot offers that started in the second quarter that further our vision, the most simple and efficient account switching and anchoring experience for financial institution customers.

Banker's Dashboard also continued to perform well in the second quarter, including our introduction of our tablet offer. Destination Rewards had another solid quarter. We received commitments from 2 large financial institutions that they will commence rewards and loyalty program rollouts starting in the fourth quarter.

Positively, we also received a commitment from Verizon, that they will be moving from a successful pilot to a full implementation starting this quarter.

Finally, we received a commitment from one of the largest insurance companies that they will be implementing in about 50% of the United States, a new rewards and loyalty program starting in the fourth quarter.

As you can see, strong momentum continues to build, and we expect strong double-digit growth in these marketing solutions and other services, and Financial Services in 2014. In Direct Checks, revenue was higher than our expectations, driven by higher initial orders and reorders.

We continue to look for opportunities to provide accessories and other check-related products and services to our consumers. We continue to 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 enhancement synergies through our call center scripting and upsell capabilities, as well as synergistic cost and expense reductions. Our direct checks expectations for the year are slightly better.

Previously we guided to a decline of 10%, but we now believe that the decline will be closer to 9%, driven by continued declines, consumer usage and a sluggish economy. We expect to reduce our manufacturing cost and SG&A in this segment, and continue to deliver operating margins of about 30% while generating strong operating cash flow.

As we exit the second quarter on the heels of a very strong quarterly performance in a continued sluggish economy, we have made tremendous progress in transforming Deluxe. And we have identified many opportunities ahead of us in 2014. We believe we are well positioned in 2014 to deliver our fifth consecutive year of revenue growth.

The breadth of offers and financial discipline has enabled us to position ourselves for sustainable revenue growth, while continuing to improve profitability and operating cash flow. 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 know it is critical for us to be able to grow revenue again in 2014, and improve the mix of our marketing services solutions and other services revenue, and we are well positioned to make this happen.

We have developed a strong platform for long-term growth with the objective of transforming Deluxe to more of a growth services provider than primarily a check printer, thereby changing our product mix and resulting stock price multiple. Now on that, we're going to open the phone lines up to take questions..

[Operator Instructions] The first question comes from the line of Randy Hugen of Feitl..

It looks like it might be growing faster than maybe you expected.

Could you give us an information on the overall growth rate there? And then also, is that growth being driven by those large clients that you mentioned, or are there many other small clients that are also adopting that offering?.

Randy, I missed the beginning of the -- you weren't coming through at the beginning of the question.

Could you just repeat it?.

Sure, sure.

Destination Rewards, is that growing faster than what you expected? How fast is it growing? And then also, could you give us some information on the type of clients that are driving that? Is that the large client that you mentioned in the script or are there other smaller clients that are all contributing to that growth?.

Yes, right now, we clearly expected a ramp as we bought the company in December last year. So -- and we expected some of the pilots that they introduced, Randy, to become rollouts. So think of that as that was our ambition when we bought it and kind of what we planned for as the year unfolded. So we expected to see a ramp.

I think the thing that's really interesting for us right now though is that we are starting to see some success and larger financial institutions that are committing to either pilots or rollouts at this point in time, and we're just getting started there. We've put a good program in place. We have a lot of interest in the rewards and loyalty space.

And then, Destination Rewards always had customers in other non-financial Services markets, and we're just trying to opportunistically take advantage of that. I made a comment today about an opportunity we had of one of the largest insurance companies, and that's starting in the fourth quarter as well.

So we think we're at the early stages of momentum here. But we had a ramp planned as we went -- as we bought the company. And clearly, we expect that ramp to happen in the second half of the year. And also extend into the 2015 from a ramp standpoint as well. So we're really excited about this, and we think there's a lot of potential.

And we think it's a unique program, with the 0 liability program and something that's not out there in the market place today. So clearly, we are enthused with it..

All right. And then, you've mentioned that you're seeing strong growth in email marketing. Gmail made some changes in their services a few months ago that seems to be impacting how frequently a customer has been using [ph] some promotional marketing email.

Have you got any impact on that, on the rate in the past quarter?.

No. The way to think about it is the opportunity for us here is with the new freemium offer that we've got out from our acquisition of VerticalResponse. We're early stages with the new footprint in the market.

But I look at this and I see the results and week to week, Randy, we're seeing more and more sign-ups, first of all, and we see more and more conversions from the premium offer to actually paying customers. So at this point in time, we're seeing a ramp there, and we expect that ramp to continue..

The next line of questions comes from the line of Tim Klasell of Northland Securities..

Just to circle back on the Destination Rewards. I noticed that the MSO revenues weren't -- the guidance there wasn't raised, but the other revenues were.

Are some of the big, new customers that you mentioned in the script, does this take a while for them to ramp up? How should we think about that, going forward?.

Tim, it does. We left the range that we had of $400 million to $410 million, we raised the top end of the revenue, about $500 million, it came from non-NOS. But it does take a while to ramp. What happens is we -- sometimes a new bank or a Verizon, the example we gave, or the large insurance company, will start a pilot and then they'll roll out.

And even when they do a full rollout, it can take time for a consumer to sign up for the various programs. So even though we're excited about it, what we have to be mindful of is what that ramp is actually going to look like. So we're just obviously trying -- we're learning.

It's still a very new acquisition for us, but I don't want to signal that we feel all negative on it. It's just that the look -- the ramp curve is not something that we're used to at this point in time. And honestly, for DR, they are learning in some of these new markets, especially in the financial institution space as well..

Okay, good. And then are you adding 50,000 or plan to add 50,000 new hosting customers, hosting sites.

What's driving that? Is that new customers or is that existing customers expanding their usage?.

No. These would be -- these are all new customers. So we either get them through accounts that we take over and migrate in, or we get them through accounts that we win and then they are basically on organic build. So they never had a telco or media small business offer, Tim, is the way to think about it.

So what happens is that we basically add small business customers through what we call an organic program. It's coming from both..

Okay, good. And then final question, you're adding new Web-to-print capabilities to bring down your cost, it sounds like.

Exactly what are you doing there? And is the primary competitor there, Vistaprint?.

They're the largest player in the market, as you know. But there's a lot of other competitors in the market, and we are really excited about this. Let me tell you what we try to do here, expand on that, a little more color on what I mentioned in the script.

If you think about what we did for the common order fulfillment system, basically putting software and mechanical work technology behind how we ship in effect a box of checks or now a flat package of checks. We've done the same thing, and we've been working on this for a while now. But we created the same thing.

So think of it as an ability to produce business cards and postcards at -- and I call it in a frictionless way where no human intervention. And I wish I could show you the video. We didn't put one out onto the release today, but I've seen it and it's getting ready, as I mentioned, to go into production this quarter.

And we think it's going to allow us to get more -- get things through our systems and our process better and to your point, give us a cost reduction play as well.

So really, a wonderful team of people that I have here in our Shoreview headquarters location or near the location have worked on this capability, and kudos to them for what we believe is going to be something exciting for the Web-to-print space..

[Operator Instructions] The next line of question comes from the line of Charlie Strauzer of CJS Securities..

A couple of questions. Why don't we just kind of go on the gross profit line, if we could. I know it was a little bit lower year-over-year for the reason you mentioned.

But as we look at to the second half of the year, Terry, can you give us a sense of the assumptions we should be using for gross profit versus maybe SG&A as a percent of revenue?.

Yes, in comparison to second quarter of last year, we're down about 1 point, and there was really a couple of things happening there, Charlie. There was a bit of an unfavorable mix coming through there, causing the margin to come down just a little bit. Also too, we have been seeing higher material and delivery rates coming through.

And that's been a pretty consistent trend for the past couple of years, so that coming through is also impacting the margins there a little bit. And both of those factors, we would -- we did expect and would continue to expect those going forward, as we look ahead..

Is that mostly -- when you said delivery, is that mostly from the postal increase [ph] that just went through?.

Postal, we use the United States Postal Service. We also use UPS for a significant portion of our delivery in certain parts of the business. So it's a collective increase, across the whole platform..

And as we look out longer term, in terms of the operating income growth versus revenue growth, obviously it's kind of trailing right now.

But do you think as you implement some of these additional clauses [ph] and stuff that you can see that trend more in line longer term?.

We -- what we've really stated right now is that we as a team are really committed to delivering growth in our earnings and that's through profitable revenue growth. But really, from a margin rate perspective, because we're still investing in the business, we really expect that the margin rate is going to be fairly flat over the foreseeable future.

So again, our commitment is really on growing the earnings dollars, not so much the margin rate, as we go ahead. And then really get back to the level of investments that are offsetting some of the cost reductions that we continue to generate. But that's probably the best way to think about it for the foreseeable future..

And Charlie, I would like to add though that we still do expect to be able to, out into the kind of the strategic horizon, be able to grow our earnings per share at a faster rate than revenue because of the way we continue to manage the company, the transformation between our tax rates and our debt level. So you need to think about all that.

But we don't want to underinvest now as we're starting to get some real nice scale, and we're just going to be -- we're going to stay after our cost reductions and keep the formula going here. And that's hopefully what we've been talking about, and we've been guiding in terms of people that are interested in the stock..

That's very helpful. And if I can circle back for a second on the PsPrint side.

You mentioned, Lee, in terms of finding other products to offer your direct check customers, is there a plan to maybe integrate some of the PsPRint type of offerings into that type of strategy?.

Yes, I'll talk a little bit more as we get into the third quarter about where we're going with this, what I mentioned this integrated technology customer experience. I prefer to not make a lot more comments on that. I know there's a lot of my competitors are out there and wondering what we're talking about here.

But the best I can tell you right now is think of it as a way for a customer to come in and get with -- intuitively and simply, add our services and add our print offers in a just lot easier way than the way we do it today from all of these acquisitions that we've done over time.

It's got really cool technology that my team is working on, and we're excited about it.

I think it's a little early to spend a lot more color on it, but as we get into the balance of the year, similar to what I did today on e-checks, and we'll be talking a little bit more about Destination Rewards, I'll try to get some more color on that as well, Charlie..

Thank you for your questions. I would thank you for all your questions, ladies and gentlemen. That now concludes the question-and-answer session. I would now like to turn the conference over to Lee Schram for closing remarks. Thank you..

We believe we delivered a very strong second quarter; second, marketing solutions and other services revenue grew 20%, and our mix improved towards our goal of 25% for this year and 40% in 2018; we had a solid first half of the year, which we believe propels us towards revenue growth again in 2014 for our fifth consecutive year.

We're not going to roll up our sleeves, we're going to get back to work and I look forward to providing another positive progress report on our next call. I'm going to turn it over to Ed for some announcements on where we're going to be out in the street in the quarter and some other housekeeping..

Thanks, Lee. Before we conclude today's call, I'd like to mention that the Deluxe management will be presenting in a few upcoming conferences in the second -- in the third quarter where you can hear more about our transformation. On August 5, we will be in New York City at the Needham Interconnect Conference.

On August 6, we will be at an investment conference in Minneapolis. And on September 16, we'll be in New York at the Credit Suisse Small Cap Conference. Thank you for joining us, and this concludes the Deluxe second quarter 2014 earnings call..

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