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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

Commission file number:   1-7945

DELUXE CORPORATION
(Exact name of registrant as specified in its charter)

(651) 483-7111
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ü    No    

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).   Yes  ü    No    

The number of shares outstanding of registrant’s common stock, par value $1.00 per share, at July 26, 2004 was 50,030,272.

PART I–FINANCIAL INFORMATION

Item 1.   Financial Statements.

DELUXE CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share par value)
(Unaudited)

See Notes to Unaudited Consolidated Financial Statements

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DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
(Unaudited)

See Notes to Unaudited Consolidated Financial Statements

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DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

See Notes to Unaudited Consolidated Financial Statements

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DELUXE CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1:   Consolidated financial statements

        The consolidated balance sheet as of June 30, 2004, the consolidated statements of income for the quarters and six months ended June 30, 2004 and 2003 and the consolidated statements of cash flows for the six months ended June 30, 2004 and 2003 are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements are included. Adjustments consist only of normal recurring items, except for any discussed in the notes below. Interim results are not necessarily indicative of results for a full year. The consolidated financial statements and notes are presented in accordance with instructions for Form 10-Q, and do not contain certain information included in our consolidated annual financial statements and notes. The consolidated financial statements and notes appearing in this report should be read in conjunction with the consolidated audited financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2003.

Note 2:   Acquisition of New England Business Service, Inc. and related financing

        On June 25, 2004, we acquired New England Business Service, Inc. (NEBS) for an estimated total purchase price of $642.6 million. Further detail regarding the accounting for this acquisition can be found in Note 3, Acquisition of New England Business Service, Inc. To finance this acquisition, we utilized $475.0 million of an $800.0 million committed line of credit, as well as commercial paper. The amount drawn on the $800.0 million committed line of credit related to a bridge financing agreement put in place to complete the acquisition (see Note 10). This $800.0 million line of credit expires in May 2005. Accordingly, as of June 30, 2004, we had short-term debt of $916.1 million and a working capital deficit of $987.4 million.

        It is our intention to refinance a portion of our short-term debt during the last half of 2004 with long-term debt. We currently have a shelf registration in place for the issuance of up to $500.0 million of long-term debt securities. As of June 30, 2004, $425.0 million remained available for issuance under this shelf registration. Debt issuance activities are subject to market and interest rate conditions. As such, we can provide no assurance as to the timing and/or amount of debt that we may issue or whether the terms of the debt will be favorable to us.

Note 3:   Acquisition of New England Business Service, Inc.

        On June 25, 2004, we acquired via a tender offer approximately 98% of the outstanding common stock of NEBS for $44 per share. Immediately following the close of the tender offer, we completed a merger under which NEBS became a wholly-owned subsidiary and we became obligated to acquire the untendered shares at a price of $44 per share. We also agreed to redeem all outstanding NEBS stock options for $44 per option less the option exercise price. As of June 30, 2004, payments for the untendered shares, the redemption of stock options and a portion of the direct costs of the acquisition had not been made and were included in accrued liabilities in our consolidated balance sheet. We anticipate

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that these payments will be substantially completed during the third quarter of 2004. The estimated total purchase price for the acquisition was comprised of the following (dollars in thousands):

        As of June 30, 2004, we had $23.8 million of restricted cash. Upon the acquisition of NEBS, we were required to place on deposit the funds required to pay the shareholders who did not tender their shares of NEBS common stock under the tender offer. These shareholders must present their stock certificates in order to receive their portion of the funds. The funds must remain on deposit for a period of nine months, after which time the funds will be returned to us, and thereafter, any remaining unclaimed funds will be remitted to the appropriate governmental authority under applicable escheat laws. In July 2004, we completed the cash payments to redeem the outstanding NEBS stock options.

        NEBS is a leading provider of products and services to small businesses. Its offerings include checks, forms, packaging supplies, embossed foil anniversary seals and other printed material which are marketed through direct sales, telesales, a direct sales force, dealers, dedicated distributors and the Internet. NEBS also designs, embroiders and sells specialty apparel products through distributors and independent sales representatives. We believe NEBS is a strategic fit, as we both serve small business customers, and the acquisition expands our product offerings, customer base and non-check revenue.

        NEBS operating results are included in our consolidated results of operations from the date of acquisition. Our consolidated balance sheet as of June 30, 2004 reflects the allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. This allocation is preliminary, pending detailed analysis and outside appraisals of the fair values of the assets acquired and liabilities assumed, as well as completion of management’s integration plans. Once the analyses and the asset appraisals have been completed, the allocation of the purchase price will be finalized. We have announced our intention to utilize a shared services environment approach for both manufacturing and certain selling, general and administrative (SG&A) functions. This approach will most likely result in the exit of certain activities. However, to ensure that we continue to meet client expectations, significant analysis is required before such plans can be finalized. To the extent the activities to be discontinued are NEBS activities, we would adjust the preliminary purchase price allocation to reflect additional restructuring liabilities. If the discontinued activities are Deluxe activities, any restructuring accruals would be reflected in our consolidated statements of income. The preliminary allocation of the purchase price does reflect $11.1 million of restructuring accruals for those NEBS activities which we have already decided to exit. These accruals are discussed in Note 9, Restructuring charges.

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        The preliminary purchase price allocation resulted in goodwill of $515.9 million. We believe that the NEBS acquisition resulted in the recognition of goodwill primarily because of its industry position, the potential to introduce products across multiple channels and the ability to realize cost synergies. The following illustrates our preliminary allocation of the purchase price to the assets acquired and liabilities assumed (dollars in thousands):

        The intangibles acquired primarily relate to trade names and customer lists which will be amortized on the straight-line basis over periods averaging approximately five years. For the quarter ended June 30, 2004, we recorded amortization of intangibles acquired from NEBS of $0.3 million, which related to the post-acquisition activity for the last five days of the quarter. The amount assigned to intangible assets acquired, as well as the related amortization periods, may change once our detailed analysis and outside asset appraisals are completed.

        The following unaudited, pro forma financial information illustrates our estimated results of operations as if the acquisition of NEBS had occurred as of the beginning of each period presented (dollars in thousands):

        The pro forma results of operations for the quarter and six months ended June 30, 2003, include goodwill and asset impairment charges of $13.2 million related to NEBS PremiumWear apparel business. The pro forma operating results are presented for comparative purposes only. They do not represent the results which would have been reported had the acquisition occurred on the dates assumed and are not necessarily indicative of future operating results.

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Note 4:   Employee stock-based compensation

        On January 1, 2004, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation.   We are reporting this change in accounting principle using the modified prospective method of adoption described in SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. Beginning in 2004, our results of operations reflect compensation expense for all employee stock-based compensation, including the unvested portion of previous stock options granted. This is the same amount of compensation expense which would have been recognized had the fair value recognition provisions of SFAS No. 123 been applied from its original effective date. Prior to 2004, we accounted for our employee stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under this method of accounting, no compensation expense was recognized for stock options or for our employee stock purchase plan. In accordance with the modified prospective method of transition, results for 2003 have not been restated to reflect this change in accounting principle.

        During the second quarter of 2004, we implemented changes to our long-term compensation strategy. Rather than using stock options as the exclusive form of long-term incentive, we now utilize a combination of stock options, performance shares and restricted stock. All such awards are granted under our shareholder-approved stock incentive plan. The level of shares earned under the performance share component is contingent upon the attainment of specific performance targets over a three-year period. The fair value of the performance shares granted is equal to the market price of our stock at the date of grant. Compensation expense is recorded over the three-year performance period based on our estimate of the number of shares which will be earned by the award recipients. Expense for the performance share component of our long-term incentive plan was $0.6 million for the quarter and six months ended June 30, 2004. In addition, during the second quarter of 2004, we issued 40,404 restricted shares to employees. The fair value of these awards is equal to the market price of our stock at the date of grant. Compensation expense is recorded over the three year vesting period. Expense for these awards was $0.1 million for the quarter and six months ended June 30, 2004. Expense for previously issued restricted shares and restricted stock units was $0.7 million for the quarter ended June 30, 2004 and $1.4 million for the six months ended June 30, 2004.

        Total stock-based compensation expense was $3.1 million for the second quarter of 2004. This expense is reflected as cost of goods sold of $0.3 million and SG&A expense of $2.8 million in our consolidated statement of income for the quarter ended June 30, 2004. For the first six months of 2004, total stock-based compensation expense was $5.8 million, with $0.5 million reflected in cost of goods sold and $5.3 million reflected in SG&A expense in our consolidated statement of income for the six months ended June 30, 2004.

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        The following table illustrates the effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested awards in each period (dollars in thousands, except per share amounts):

Note 5:   Changes in accounting estimates

        During the first quarter of 2004, we revised the estimated useful lives for certain of our software and production assets, as we anticipate that the assets will be replaced or retired sooner than originally anticipated. The weighted-average useful life for these assets was shortened from 8.0 years to 6.8 years. This change in accounting estimate is expected to result in increased depreciation and amortization expense of $8.5 million in 2004. In the second quarter of 2004, $2.7 million of this additional expense was recorded, and during the six months ended June 30, 2004, $3.4 million of this additional expense was recorded.

Note 6: New accounting pronouncement

        In May 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003. This FSP outlines the appropriate accounting treatment for the effects of the new Medicare law, including the required financial statement disclosures, and supersedes the previous guidance issued by the FASB in January 2004. The new Medicare law introduces a prescription drug benefit under Medicare, as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the Medicare plan. Our retiree medical plans do provide prescription drug coverage which is at least actuarially equivalent to the Medicare plan. Effective April 1, 2004, we have elected to adopt the accounting treatment required by FSP No. FAS 106-2 utilizing the retroactive application method. As a result, our post-retirement benefit expense for the second quarter of 2004 reflects the impact of the new Medicare law. This impact is discussed in Note 12, Post-retirement benefits.

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Note 7:   Supplementary balance sheet information

        Inventories and supplies – Inventories and supplies were comprised of the following (dollars in thousands):

        Other current assets — Other current assets were comprised of the following (dollars in thousands):

        Assets held for sale — Assets held for sale relate to three of our Financial Services check printing facilities which were closed in the first half of 2004, as well as one NEBS facility which was closed prior to our acquisition of NEBS (see Note 3). We are actively seeking buyers for these properties and expect to dispose of them within one year from the date they were closed. Based on preliminary market research and appraisal information, we believe the fair values of the assets less costs to sell exceed the carrying values of the assets. As such, no impairment loss has been recognized for these assets. Assets held for sale were comprised of the following (dollars in thousands):

        We are currently in the process of closing one additional check printing facility located in Anniston, Alabama (see Note 9). We anticipate that this facility will be closed during the fourth quarter of 2004. This facility is leased, and thus will not be reported as an asset held for sale.

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        Other non-current assets – Other non-current assets were comprised of the following (dollars in thousands):

        Changes in contract acquisition costs during the first six months of 2004 were as follows (dollars in thousands):

        Accrued liabilities — Accrued liabilities were comprised of the following (dollars in thousands):

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Note 8: Earnings per share

        The following table reflects the calculation of basic and diluted earnings per share (dollars and shares in thousands, except per share amounts):

        During the quarter ended June 30, 2004, options to purchase 1.3 million common shares were outstanding but were not included in the computation of diluted earnings per share. During the six months ended June 30, 2004, a weighted-average of 1.8 million options were excluded from the calculation. During the quarter and six months ended June 30, 2003, 1.2 million outstanding options were excluded from the computation. These options were excluded from the calculation of diluted earnings per share because their effect would have been antidilutive.

Note 9:   Restructuring charges

        During the second quarter of 2004, we recorded restructuring charges of $1.4 million for severance related to the planned closing of our Direct Checks check printing facility located in Anniston, Alabama, as well as various reductions within our Financial Services segment and our corporate support group. The expertise we have developed in logistics, productivity and inventory management, as well as the decline in check usage due to the use of alternative payment methods, allows us to reduce the number of production facilities while still meeting client requirements. Additionally, cost management is one of our strategic objectives, and we are continually seeking ways to lower our cost structure. We anticipate that the Anniston facility will be closed during the fourth quarter of 2004. We estimate that 175 employees will receive $1.1 million of severance benefits in the fourth quarter of 2004, utilizing cash from operations. These severance benefits are being accrued over the last three quarters of 2004, as they are payable under a one-time severance benefit plan. The reductions within Financial Services and our corporate support group are payable under our ongoing severance benefit plan and impact 29 employees. We expect these reductions to be substantially completed by the end of the year. Also during the second quarter of 2004, we reversed $0.2 million of previously recorded restructuring accruals due to fewer employees receiving severance benefits than originally estimated. These restructuring charges and reversals are reflected as cost of goods sold of $0.1 million and SG&A expense of $1.1 million in our consolidated statement of income for the quarter ended June 30, 2004.

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        During the first quarter of 2004, we recorded restructuring charges of $1.4 million for severance related to employee reductions within various functional areas, primarily within our Direct Checks segment. These reductions were a result of our ongoing cost management efforts. The restructuring charges included estimated severance payments for 105 employees, which are payable under our ongoing severance benefit plan. The majority of these reductions were completed in the first quarter of 2004. The related severance payments are expected to be substantially completed by the third quarter of 2004, utilizing cash from operations. Also during the first quarter of 2004, we reversed $0.9 million of previously recorded restructuring accruals due to fewer employees receiving severance benefits than originally estimated. These restructuring charges and reversals, along with those recorded during the second quarter of 2004, are reflected as cost of goods sold of $0.1 million and SG&A expense of $1.6 million in our consolidated statement of income for the six months ended June 30, 2004.

        During the second quarter of 2003, we recorded restructuring charges of $1.3 million for employee severance related to the closing of our Financial Services check printing facility located in Indianapolis, Indiana. This facility was closed during the first quarter of 2004. The restructuring charges reflected severance payments for 136 employees, which are payable under our ongoing severance benefit plan. We anticipate that these payments will be completed in the third quarter of 2004, utilizing cash from operations. The restructuring charges are reflected in cost of goods sold in our consolidated statements of income for the quarter and six months ended June 30, 2003.

        As a result of the NEBS acquisition on June 25, 2004 (see Note 3), we assumed restructuring accruals of $1.3 million related to NEBS facility closings which were completed prior to the acquisition. Employee severance payments related to these facility closings are expected to be substantially completed by the end of 2004, utilizing cash from operations. Additionally, as a result of the acquisition, we recorded restructuring accruals of $11.1 million related to activities of NEBS which will be exited as we combine the two companies and execute a shared services model for both manufacturing and certain SG&A functions. These accruals include severance payments for 115 employees in information services, finance and human resources. This amount also includes payments due to certain NEBS executives under change of control provisions included in their employment agreements, as we eliminate redundancies between the two companies. The related payments are expected to be substantially completed by the end of 2004, utilizing cash from operations. As these accruals were included in the liabilities recorded upon acquisition, they are not reflected in our consolidated statements of income.

        Restructuring accruals for employee severance costs of $17.2 million as of June 30, 2004 and $10.7 million as of December 31, 2003 are reflected in accrued liabilities in the consolidated balance sheets. Our restructuring accruals as of December 31, 2003, related to the closing of three Financial Services check printing facilities and other employee reductions within Financial Services and our corporate support group. All three of the check printing facilities were closed in the first half of 2004. The other employee reductions were substantially completed during the first quarter of 2004.

        Changes in the restructuring accruals during the first six months of 2004 were as follows (dollars in thousands):

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On a cumulative basis through June 30, 2004, the status of our restructuring accruals was as follows (dollars in thousands):

        In addition to severance costs, we are also incurring costs related to the closing of our Financial Services and Direct Checks check printing facilities such as equipment moves, training and travel. These costs are expensed as incurred, primarily as cost of goods sold, and are expected to total approximately $2 million. Of this amount, $0.9 million was expensed in the first six months of 2004 and $0.3 million was expensed in 2003. The remainder of these expenses will be recognized in the last half of 2004 as we complete the closure of the Direct Checks facility.

Note 10: Debt

        Total debt outstanding was comprised of the following (dollars in thousands):

        Our short-term debt consisted of amounts drawn on a committed line of credit, as well as commercial paper outstanding under a $500.0 million commercial paper program. The amount of our commercial paper program was increased from $350.0 million to $500.0 million during the second quarter of 2004. The amount drawn on the committed line of credit related to a bridge financing agreement put in place to complete the acquisition of NEBS (see Note 3). This $800.0 million line of credit expires in May 2005 and carries a commitment fee of ten basis points (.10%). It also supported up to $150.0 million of our commercial paper program as of June 30, 2004. The daily average amount outstanding under this line of credit during the first six months of 2004 was $5.2 million at a weighted-average interest rate of 4.00%. As of June 30, 2004, $475.0 million was outstanding at a weighted-average interest rate of 4.00%. The daily average amount of commercial paper outstanding during the first six months of 2004 was $193.5 million at a weighted-average interest rate of 1.10%. As of June 30, 2004, $441.1 million was outstanding at a weighted-average interest rate of 1.40%. The daily average amount of commercial paper outstanding during

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2003 was $149.4 million at a weighted-average interest rate of 1.15%. As of December 31, 2003, $213.3 million was outstanding at a weighted-average interest rate of 1.11%.

        In addition to the $800.0 million bridge line of credit, we also have committed lines of credit which primarily support our commercial paper program. As of June 30, 2003, we had a 364-day line of credit for $175.0 million which was scheduled to expire on August 11, 2004 and carried a commitment fee of ten basis points (.10%). In July 2004, we canceled this credit facility and we entered into two new credit facility agreements. One of the new facilities is a 364-day line of credit for $100.0 million which expires in July 2005 and carries a commitment fee of ten basis points (.10%). The other new line of credit is for $225.0 million. This line of credit expires in July 2009 and carries a commitment fee of 12.5 basis points (.125%). We also have a $175.0 million line of credit which expires in August 2007 and carries a commitment fee of 12.5 basis points (.125%). The credit agreements governing the lines of credit contain customary covenants regarding the ratio of earnings before interest and taxes (EBIT) to interest expense and levels of subsidiary indebtedness. No amounts were drawn on these lines of credit during the first six months of 2004 or during 2003, and no amounts were outstanding under these lines of credit as of June 30, 2004. To the extent not needed to support outstanding commercial paper or letters of credit, we may borrow funds under our lines of credit. As of June 30, 2004, $230.6 million was available under our lines of credit for borrowing or for support of additional commercial paper. As a result of the new credit facilities established in July, we also reduced the amount available under our bridge financing agreement to $650.0 million.

        We also have an uncommitted bank line of credit for $50.0 million available at variable interest rates. No amounts were drawn on this line of credit during the first six months of 2004 or during 2003, and no amounts were outstanding under this line of credit as of June 30, 2004.

        In December 2002, we issued $300.0 million of senior, unsecured notes which mature in December 2012 and have a coupon rate of 5.0%. The notes include covenants that place restrictions on the issuance of debt that would be senior to the notes and the execution of certain sale-leaseback arrangements. The fair value of these notes was estimated to be $290.0 million as of June 30, 2004, based on quoted market rates.

        On April 30, 2003, we filed a Form S-3 shelf registration statement with the Securities and Exchange Commission. This shelf registration allows for the issuance of debt securities, from time to time, up to an aggregate of $500.0 million. The shelf registration statement became effective on July 8, 2003. In September 2003, we established a $250.0 million medium-term note program under this shelf registration and issued $50.0 million of medium-term notes. These notes mature in September 2006 and have a coupon rate of 2.75%. The fair value of these notes was estimated to be $49.6 million as of June 30, 2004, based on quoted market rates. In November 2003, we issued $25.0 million of medium-term notes which mature in November 2005 and have an interest rate equal to the 3-month London InterBank Offered Rate (LIBOR) plus .05%. This interest rate is reset on a quarterly basis. The fair value of these notes was estimated to be $24.9 million as of June 30, 2004, based on a broker quote.

Note 11:   Derivative financial instruments

        In June 2004, we entered into $350.0 million of forward starting interest rate swaps to hedge, or lock-in, the interest rate on anticipated long-term debt we plan to issue during the last half of 2004. Gains and losses on these instruments, to the extent that the hedge relationship is effective, are reflected in accumulated other comprehensive loss in our consolidated balance sheets. Any ineffectiveness on these instruments is immediately recognized in interest expense. As of June 30, 2004, the hedges were effective, and unrealized pre-tax losses of $3.1 million were reflected in accumulated other comprehensive loss in our consolidated balance sheet. These agreements will be terminated upon the issuance of the anticipated debt. Once the agreements are terminated, any realized gain or loss will be reclassified ratably to our statements of income as a component of interest expense over the term of the debt.

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Note 12:   Post-retirement benefits

        We have historically provided certain health care benefits for a large number of retired employees. As discussed in Note 6, our retiree medical plan provides prescription drug coverage which is at least actuarially equivalent to the Medicare law enacted in December 2003. Our post-retirement benefit expense for the second quarter of 2004 reflects the impact of the new Medicare law, utilizing the retroactive application method outlined in FSP No. FAS 106-2. In accordance with this accounting guidance, we completed a re-measurement of our plan assets and liabilities as of December 31, 2003. The federal subsidy provided for under the new Medicare law resulted in a $9.5 million reduction in our accumulated post-retirement benefit obligation as of December 31, 2003 and resulted in a $0.3 million reduction in our post-retirement benefit expense for the quarter ended June 30, 2004.

        Our post-retirement benefit expense for the quarters and six months ended June 30, 2004 and 2003 consisted of the following components (dollars in thousands):

        We have invested assets in a trust established under section 401(h) of the Internal Revenue Code to partially fund our post-retirement benefit obligation. We are not contractually obligated to make contributions to this trust, and we do not anticipate making any such contributions during 2004. However, we do anticipate that we will pay benefits of $9.6 million during 2004 utilizing the assets of our VEBA trust which are available to fund employee and retiree medical and severance benefits.

        As discussed in Note 3, we acquired NEBS on June 25, 2004. NEBS sponsors a plan which provides post-retirement health and dental care benefits for officers and health and insurance benefits for certain employees of two NEBS subsidiaries, Safeguard Business Systems, Inc. and PremiumWear, Inc. As of the date of acquisition, the plan’s accumulated post-retirement benefit obligation was estimated to be $3 million. This plan is not funded. NEBS also has a supplemental executive retirement plan (SERP). As of the date of our acquisition of NEBS, the SERP’s projected benefit obligation was estimated to be $7 million. We are currently in the process of completing full valuations of these liabilities. Once these valuations are complete, we will fully fund the SERP obligation.

Note 13:   eFunds indemnification

        In connection with the spin-off of our former eFunds segment on December 29, 2000, we agreed to indemnify eFunds for future losses arising from any litigation based on the conduct of eFunds’ electronic benefits transfer and medical eligibility verification business prior to eFunds’ initial public offering in June 2000, and for certain future losses on identified loss contracts in excess of eFunds’ accrual for contract losses as of April 30, 2000. The maximum contractual amount of litigation and contract losses for which we would indemnify eFunds is $14.6 million. This agreement remains in effect until one year after the termination of the identified loss contracts or until all disputes have been settled. All identified loss contracts are scheduled to expire by 2006. Through June 30, 2004, no amounts have been paid or claimed under this

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indemnification agreement. This obligation is not reflected in the consolidated balance sheets, as it is not probable that any payment will occur.

Note 14:   Shareholders’ deficit

        Shareholders’ deficit decreased from $298.1 million as of December 31, 2003 to $251.4 million as of June 30, 2004. We are in a deficit position primarily due to our share repurchase programs. Share repurchases are reflected as reductions of shareholders’ equity in the consolidated balance sheets. Under the laws of Minnesota, our state of incorporation, shares which we repurchase are considered to be authorized and unissued shares. Thus, share repurchases are not presented as a separate treasury stock caption in our consolidated balance sheets, but are recorded as direct reductions of additional paid-in capital and retained earnings.

        In January 2001, our board of directors approved a plan to purchase up to 14 million shares of our common stock. These repurchases were completed in June 2002 at a cost of $463.8 million. In August 2002, our board of directors approved the repurchase of an additional 12 million shares. These repurchases were completed in September 2003 at a cost of $503.2 million. In August 2003, the board authorized the repurchase of up to 10 million additional shares of our common stock. Through June 30, 2004, 2.1 million of these additional shares had been repurchased at a cost of $85.0 million.

        Changes in shareholders’ deficit during the first six months of 2004 were as follows (dollars and shares in thousands):

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Note 15:   Business segment information

        For most of the second quarter of 2004 we operated three business segments: Financial Services, Direct Checks and Business Services. Financial Services sells checks, related products and check merchandising services to financial institutions. Direct Checks sells checks and related products directly to consumers through direct mail and the Internet. Business Services sells checks, forms and related products to small businesses and home offices through financial institution referrals, business alliances and via direct mail and the Internet. All three of these segments operate only in the United States. On June 25, 2004, we acquired NEBS (see Note 3). We have not yet completed our evaluation as to how NEBS various lines of business will be incorporated into our reportable business segments. Until this evaluation is completed, we will manage and monitor NEBS as a separate segment. NEBS operates primarily in the United States, but also has operations in Canada, the United Kingdom and France.

        The accounting policies of the segments are the same as those described in the summary of significant accounting policies as presented in the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003. Corporate expenses are allocated to three of our segments based on segment revenues. No corporate expenses are allocated to NEBS, as their operations have not yet been integrated into our corporate functions. The corporate allocation includes expenses for various support activities such as executive management, human resources and finance and includes depreciation and amortization expense related to corporate assets. The corresponding corporate asset balances are not allocated to the segments. Corporate assets consist primarily of cash, deferred tax assets, investments and internal-use software related to corporate activities.

        We are an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and the sharing of assets. Therefore, we do not represent that these segments, if operated independently, would report the operating income and other financial information shown.

        The following is our segment information as of and for the quarters ended June 30, 2004 and 2003 (dollars in thousands):

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        The following is our segment information as of and for the six months ended June 30, 2004 and 2003 (dollars in thousands):

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Company Profile

        We are the largest provider of checks in the United States, both in terms of revenue and number of checks produced. We design, manufacture and distribute a comprehensive line of printed checks. In addition to checks, we also offer other personalized printed items (e.g., business forms, business cards, stationery, greeting cards, labels, and shipping and packaging supplies), promotional products and merchandising materials, fraud prevention services and customer retention programs. On June 25, 2004, we acquired New England Business Service, Inc. (NEBS). NEBS is a leading provider of products and services to small businesses. We believe NEBS is a strategic fit, as we both serve small business customers, and the acquisition expands our product offerings, customer base and non-check revenue.

        Until the acquisition of NEBS, we operated three business segments: Financial Services, Direct Checks and Business Services. Financial Services sells checks, related products and check merchandising services to more than 8,000 financial institution clients nationwide, including banks, credit unions and financial services companies. Direct Checks is the nation’s leading direct-to-consumer check supplier, selling under the Checks Unlimited® and Designer® Checks brands. Through these two brands, Direct Checks sells personal and business checks, as well as related products, using direct response marketing and the Internet. Business Services sells checks, forms and related products to small businesses and home offices through financial institution referrals, business alliances and via direct mail and the Internet. All three of these segments operate only in the United States. We have not yet completed our evaluation as to how NEBS various lines of business will be incorporated into our reportable business segments. Until this evaluation is completed, we will manage and monitor NEBS as a separate segment. NEBS operates primarily in the United States, but also has operations in Canada, the United Kingdom and France.

        The biggest challenge we face is that our two largest product groups, checks and business forms, are not growth products. The check printing portion of the payments industry is mature. According to our estimates, the total number of personal, business and government checks written in the United States has been in decline since the mid-1990s as a result of alternative payment methods, such as debit cards, smart cards, electronic and other bill paying services and Internet-based payment services. However, a 2002 Federal Reserve study reported that the check is still Americans’ preferred method of non-cash payment,

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accounting for approximately 60% of all non-cash payments. Another planned Federal Reserve update this year is expected to provide more insight into check volumes and the trend of total checks written. The business forms product has also reached maturity. Continual technological improvements have provided small business customers with alternative means to enact and record business transactions. For example, the price and performance capabilities of personal computers and related printers now provide a cost effective means to print low quality versions of business forms on plain paper. Additionally, electronic transaction systems and off-the-shelf business software applications have been designed to automate several of the functions performed by business forms products.

        Because our products are mature, we have been encountering significant pricing pressure when negotiating contracts with our financial institution clients. Our relationships with specific financial institutions are usually formalized through supply contracts. This pricing pressure has resulted in reduced profit margins, and we expect this trend to continue.

        Our Direct Checks segment and our newly acquired NEBS business have been impacted by reduced consumer response rates to direct mail advertisements. We believe that the decline in consumer response rates is attributable to the decline in check usage, the gradual obsolescence of our standardized forms products and an overall increase in direct mail solicitations received by our target customers. Because each advertisement is resulting in fewer new customers, the cost to acquire each new customer has increased. We have also been impacted by a lengthening of the check reorder cycle due to the decline in check usage and the multi-box promotional strategies which are standard practice for direct mail sellers of checks.

        To offset all of these challenges, we have focused on increasing revenue per unit by improving our selling techniques and introducing new product offerings. We have also taken steps to lower our cost structure.

        In Financial Services, we have implemented the DeluxeSelect^SM program. This program allows us to interact directly with the customers of financial institutions and to leverage our extensive market research and knowledge of consumer behaviors and preferences. As of June 30, 2004, over 4,500 financial institutions had enrolled in DeluxeSelect. Our Financial Services segment intends to target financial institution clients that understand the value we provide. We provide high quality products, superior service, enhanced customer satisfaction and the check program management skills which lead to improved revenue and profitability for financial institutions. We will not focus on financial institutions for which the only goal is low price. In Direct Checks, we have encouraged consumers to place their orders by phone, where our sales associates have the opportunity to interact with the consumer. During the first half of 2004, 27% of first-time customers placed their orders via the telephone, as compared to 16% in the first half of 2003. In Business Services, we have partnered with our financial institution clients to increase the use of our financial institution referral program. Under this program, our financial institution clients refer their small business customers to us at the time of new account opening. This allows us direct interaction with the small business customer. Additionally, Business Services has established business alliances under which consumers interact directly with us when ordering checks and related products. We have also provided extensive training to our Business Services sales associates to transition that organization from a service to a selling environment. All of these efforts have led to increased sales of premium-priced licensed and specialty check designs and additional value-added products and services such as fraud prevention and express delivery. Additionally, through the NEBS acquisition, we will have the ability to introduce products across channels, thereby enhancing our product and service offerings to small businesses. To combat the reduced consumer response rates to direct mail advertisements within the Direct Checks and NEBS businesses, we continually analyze our marketing approach to ensure we utilize the most effective media sources.

        We continue to be cost conscious so that we are able to compete as the decline in check usage and pricing pressure continue. We have closed three check printing facilities this year and will close one additional facility in the fourth quarter of 2004. We have also implemented other employee reductions in recent quarters. The application of lean principles in our manufacturing area has resulted in increased efficiencies, and we intend to apply these principles throughout the rest of the company. We continue to closely manage spending and seek additional cost saving opportunities wherever possible. Additionally,

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in integrating NEBS businesses, we plan to realize cost synergies exceeding $25 million annually beginning in 2005. We expect to realize these synergies through eliminating redundancies, leveraging our shared services environment and enhancing productivity by implementing lean principles and sharing best practices.

        Recent economic indicators have been somewhat promising. Consumer spending began improving in the second half of 2003 and continued to improve in the first half of 2004. Additionally, the employment growth that occurred in the first quarter of this year continued into the second quarter. There is a correlation between employment and the rate at which consumers open checking accounts. Thus, the employment rate is a key factor for the check printing portion of the payments industry. Our Business Services and NEBS segments are also impacted by small business confidence. Statistics indicate that 2004 will be a strong year for small businesses. The National Federation of Independent Business (NFIB) reported that 29% of small business owners expect the economy to be better in six months. Additionally, small business sales levels, employment and capital spending are all trending upwards. We will continue to monitor the impact these economic conditions are having on our business.

        Even with the challenges we face with our mature products, checks and business forms printing continues to be a profitable business for us. We generated operating cash flows of $123.5 million during the first half of 2004 and $181.5 million during full year 2003. We believe our stable cash flows and our focus on cost management will allow us to maintain our leadership position in the check printing portion of the payments industry. We were able to complete the NEBS acquisition during the second quarter of 2004 utilizing our debt capacity. We have also utilized debt proceeds to repurchase our common shares. During the first half of 2004, we repurchased 0.6 million shares; and during 2003, we repurchased a total of 12.2 million shares. We have also continued to pay dividends at an annual rate of $1.48 per share, resulting in a dividend yield of 3.4% based on our June 30, 2004 closing stock price. We believe we have sufficient financial resources to pursue additional acquisitions which leverage our core competencies and are accretive to earnings and cash flow, to strengthen our leading position in the markets in which we compete and to expand into closely related or adjacent products and services.

Acquisition of New England Business Service, Inc.

        As discussed earlier under Company Profile, on June 25, 2004, we acquired via a tender offer approximately 98% of the outstanding common stock of NEBS for $44 per share. Immediately following the close of the tender offer, we completed a merger under which NEBS became a wholly-owned subsidiary and we became obligated to acquire the untendered shares at a price of $44 per share. We also agreed to redeem all outstanding NEBS stock options for $44 per option less the option exercise price. As of June 30, 2004, payments for the untendered shares, the redemption of stock options and a portion of the direct costs of the acquisition had not been made and were included in accrued liabilities in our consolidated balance sheet. We anticipate that these payments will be substantially completed during the third quarter of 2004. The estimated total purchase price for the acquisition was comprised of the following (dollars in thousands):

        As of June 30, 2004, we had $23.8 million of restricted cash. Upon the acquisition of NEBS, we were required to place on deposit the funds required to pay the shareholders who did not tender their shares of NEBS common stock under the tender offer. These shareholders must present their stock

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certificates in order to receive their portion of the funds. The funds must remain on deposit for a period of nine months, after which time the funds will be returned to us, and thereafter, any remaining unclaimed funds will be remitted to the appropriate governmental authority under applicable escheat laws. In July 2004, we completed the cash payments to redeem the outstanding NEBS stock options.

        NEBS operating results are included in our consolidated results of operations from the date of acquisition. Our consolidated balance sheet as of June 30, 2004 reflects the allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. This allocation is preliminary, pending detailed analysis and outside appraisals of the fair values of the assets acquired and liabilities assumed, as well as completion of management’s integration plans. Once the analyses and the asset appraisals have been completed, the allocation of the purchase price will be finalized. We have announced our intention to utilize a shared services environment approach for both manufacturing and certain selling, general and administrative (SG&A) functions. This approach will most likely result in the exit of certain activities. However, to ensure that we continue to meet client expectations, significant analysis is required before such plans can be finalized. To the extent the activities to be discontinued are NEBS activities, we would adjust the preliminary purchase price allocation to reflect additional restructuring liabilities. If the discontinued activities are Deluxe activities, any restructuring accruals would be reflected in our consolidated statements of income. The preliminary allocation of the purchase price does reflect $11.1 million of restructuring accruals for those NEBS activities which we have already decided to exit. These accruals are discussed in Other Matters.

        The preliminary purchase price allocation resulted in goodwill of $515.9 million. We believe that the NEBS acquisition resulted in the recognition of goodwill primarily because of its industry position, the potential to introduce products across multiple channels and the ability to realize cost synergies. The following illustrates our preliminary allocation of the purchase price to the assets acquired and liabilities assumed (dollars in thousands):

        The intangibles acquired primarily relate to trade names and customer lists which will be amortized on the straight-line basis over periods averaging approximately five years. For the quarter ended June 30, 2004, we recorded amortization of intangibles acquired from NEBS of $0.3 million, which related to the post-acquisition activity for the last five days of the quarter. The amount assigned to

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intangible assets acquired, as well as the related amortization periods, may change once our detailed analysis and outside asset appraisals are completed.

        The following unaudited, pro forma financial information illustrates our estimated results of operations as if the acquisition of NEBS had occurred as of the beginning of each period presented (dollars in thousands):

        The pro forma results of operations for the quarter and six months ended June 30, 2003, include goodwill and asset impairment charges of $13.2 million related to NEBS PremiumWear apparel business. The pro forma operating results are presented for comparative purposes only. They do not represent the results which would have been reported had the acquisition occurred on the dates assumed and are not necessarily indicative of future operating results.

        To finance this acquisition, we utilized $475.0 million of an $800.0 million committed line of credit, as well as commercial paper. The amount drawn on the $800.0 million committed line of credit related to a bridge financing agreement put in place to complete the acquisition. This $800.0 million line of credit expires in May 2005. Accordingly, as of June 30, 2004, we had short-term debt of $916.1 million and a working capital deficit of $987.4 million.

        It is our intention to refinance a portion of our short-term debt during the last half of 2004 with long-term debt. We currently have a shelf registration in place for the issuance of up to $500.0 million of long-term debt securities. As of June 30, 2004, $425.0 million remained available for issuance under this shelf registration. Debt issuance activities are subject to market and interest rate conditions. As such, we can provide no assurance as to the timing and/or amount of debt that we may issue or whether the terms of the debt will be favorable to us.

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Results of Operations – Quarter Ended June 30, 2004 Compared to the Quarter Ended June 30, 2003

        The following table presents, for the periods indicated, the relative composition of selected statement of income data (dollars in thousands):

        See note 15 of the Notes to Unaudited Consolidated Financial Statements included in Item 1 of this report for discussion of the accounting policies of our reportable business segments.

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        Revenue — Revenue was flat at $309.4 million for the second quarter of 2004 compared to $309.6 million for the second quarter of 2003. The NEBS acquisition contributed revenue of $7.7 million for the second quarter of 2004 for the five days subsequent to the acquisition. Unit volume for our other businesses was down 6.1% as compared to 2003. Revenue was impacted by the overall decline in the number of checks being written due to the increasing use of alternative payment methods. Our Direct Checks segment was also impacted by lower direct mail consumer response rates, longer reorder cycles due to promotional strategies for multi-box orders and lower customer retention. These decreases in unit volume were partially offset by increased financial institution referrals within our Business Services segment. Revenue per unit was up 3.8% as compared to 2003 due to continued strength in selling premium-priced licensed and specialty check designs and additional value-added products and services such as express delivery and fraud prevention, as well as price increases in our Direct Checks and Business Services segments. Partially offsetting these increases was continuing competitive pricing pressure within our Financial Services segment.

        Gross profit — Gross profit increased $3.7 million, or 1.8%, to $206.5 million for the second quarter of 2004 from $202.8 million for the second quarter of 2003. Gross margin increased to 66.8% for the second quarter of 2004 from 65.5% for the second quarter of 2003. The increase in revenue per unit due to continued strength in selling premium-priced licensed and specialty check designs and additional value-added products and services, as well as continued productivity improvements and on-going cost management efforts was partially offset by the continued pricing pressure facing our Financial Services segment.

        Selling, general and administrative (SG&A) expense — SG&A expense increased $1.5 million, or 1.2%, to $126.6 million for the second quarter of 2004 from $125.1 million for the second quarter of 2003. The increase was due to NEBS SG&A expense for the five days subsequent to the acquisition and a $2.5 million increase in stock-based compensation expense. In January 2004 we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Further information concerning this change in accounting principle can be found under Other Matters. Partially offsetting these increases were cost management efforts, including savings realized from the employee reductions announced during the last three quarters, and lower discretionary spending. As a percentage of revenue, SG&A expense increased to 40.9% for the second quarter of 2004 from 40.4% for the second quarter of 2003.

        Net income — Net income increased $1.1 million, or 2.4%, to $46.0 million for the second quarter of 2004 from $44.9 million for the second quarter of 2003. The increase was primarily due to the manufacturing productivity improvements and cost management efforts discussed earlier.

        Diluted earnings per share — Diluted earnings per share increased $0.11, or 13.8%, to $0.91 for the second quarter of 2004 from $0.80 for the second quarter of 2003. In addition to higher net income, the increase was due to the net decrease in average shares outstanding resulting from our share repurchase programs. In August 2002, our board of directors authorized the repurchase of 12 million shares of our common stock and in August 2003, the board authorized the repurchase of up to 10 million additional shares. As of June 30, 2004, 14.1 million shares had been repurchased under these authorizations. The change in average shares outstanding resulting from share repurchases, partially offset by the impact of shares issued under employee stock purchase and stock incentive plans, resulted in a $0.09 increase in earnings per share for the second quarter of 2004 as compared to 2003.

        During 2003, we accounted for our employee-stock based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, our 2003 results of operations do not include compensation expense for stock options or for our employee stock purchase plan. Had this expense been included in our results, diluted earnings per share would have been $0.02 lower for the second quarter of 2003. On January 1, 2004, we adopted the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation. As a result, our 2004 results include compensation expense for all employee stock-based compensation. Further information concerning this change in accounting principle can be found under Other Matters.

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Results of Operations – Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003

        The following table presents, for the periods indicated, the relative composition of selected statement of income data (dollars in thousands):

        See note 15 of the Notes to Unaudited Consolidated Financial Statements included in Item 1 of this report for discussion of the accounting policies of our reportable business segments.

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        Revenue — Revenue decreased $8.6 million, or 1.4%, to $618.2 million for the first six months of 2004 from $626.8 million for the first six months of 2003. The NEBS acquisition contributed revenue of $7.7 million for the second quarter of 2004 for the five days subsequent to the acquisition. Unit volume for our other businesses was down 4.0% as compared to 2003 due to an overall decline in the number of checks being written due to the increasing use of alternative payment methods. Our Direct Checks segment was also impacted by lower direct mail consumer response rates, longer reorder cycles due to promotional strategies for multi-box orders and lower customer retention. These decreases in unit volume were partially offset by increased financial institution referrals for our Business Services segments. Partially offsetting the unit decline was a 1.4% increase in revenue per unit as compared to 2003 due to continued strength in selling premium-priced licensed and specialty check designs and additional value-added products and services such as express delivery and fraud prevention, as well as price increases in our Direct Checks and Business Services segments. These increases were partially offset by increased competitive pricing pressure within our Financial Services segment.

        Gross profit — Gross profit decreased $1.7 million, or 0.4%, to $408.5 million for the first six months of 2004 from $410.2 million for the first six months of 2003. Gross margin increased to 66.1% for the first six months of 2004 from 65.5% for the first six months of 2003. The increase in revenue per unit due to continued strength in selling premium-priced licensed and specialty check designs and additional value-added products and services, as well as continued productivity improvements and on-going cost management efforts was partially offset by the continued pricing pressure facing our Financial Services segment.

        Selling, general and administrative (SG&A) expense — SG&A expense decreased $1.2 million, or 0.5%, to $246.7 million for the first six months of 2004 from $247.9 million for the first six months of 2003. The decrease was primarily due to cost management efforts, including savings realized from the employee reductions announced during the last three quarters, and lower discretionary spending. These decreases were partially offset by a $7.9 million increase in Direct Checks advertising expense due to new product launches, higher cost per customer acquisition and the timing of promotional spending. Additionally, stock-based compensation expense increased $4.6 million and our results included NEBS SG&A expense for the five days subsequent to the acquisition. In January 2004, we adopted the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Further information concerning this change in accounting principle can be found under Other Matters. As a percentage of revenue, SG&A expense increased to 40.0% for the first six months of 2004 from 39.6% for the first six months of 2003.

        Interest expense — Interest expense increased $1.1 million to $10.4 million for the first six months of 2004 from $9.3 million for the first six months of 2003 due to an increase in debt levels as we continued to repurchase shares throughout 2003 and the first half of 2004, partially offset by lower interest rates. During the first six months of 2004, we had weighted-average debt outstanding of $585.4 million at a weighted-average interest rate of 3.62%. During the first six months of 2003, we had weighted-average debt outstanding of $394.4 million at a weighted-average interest rate of 4.11%.

        Net income — Net income decreased $1.2 million, or 1.3%, to $93.7 million for the first six months of 2004 from $94.9 million for the first six months of 2003. The decrease was primarily due to lower revenue, partially offset by the decrease in SG&A expense and the manufacturing productivity improvements discussed earlier.

        Diluted earnings per share — Despite the decrease in net income, diluted earnings per share increased $0.22, or 13.4%, to $1.86 for the first six months of 2004 from $1.64 for the first six months of 2003. The increase was due to the net decrease in average shares outstanding resulting from our share repurchase programs. In August 2002, our board of directors authorized the repurchase of 12 million shares of our common stock and in August 2003, the board authorized the repurchase of up to 10 million additional shares. As of June 30, 2004, 14.1 million shares had been repurchased under these authorizations. The change in average shares outstanding resulting from share repurchases, partially offset by the impact of shares issued under employee stock purchase and stock incentive plans, resulted in a $0.24 increase in earnings per share for the first six months of 2004 as compared to 2003.

        During 2003, we accounted for our employee-stock based compensation in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, our 2003 results of operations do not include compensation expense for stock options or for our employee stock purchase plan. Had this

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expense been included in our results, diluted earnings per share would have been $0.03 lower for the first six months of 2003. On January 1, 2004, we adopted the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation. As a result, our 2004 results include compensation expense for all employee stock-based compensation. Further information concerning this change in accounting principle can be found under Other Matters.

Segment Disclosures

        Additional information regarding our business segments appears in note 15 of the Notes to Unaudited Consolidated Financial Statements included in Item 1 of this report.

        Financial Services — Financial Services sells checks, related products and check merchandising services to financial institutions. Additionally, we offer enhanced services to our financial institution clients, such as customized reporting, file management, expedited account conversion support and fraud prevention. The following table shows the results of this segment for the quarters and six months ended June 30, 2004 and 2003 (dollars in thousands):

        Financial Services revenue decreased $6.4 million, or 3.7%, to $167.1 million for the second quarter of 2004 from $173.5 million for the second quarter of 2003. The decrease was primarily due to competitive pricing pressure and an overall decline in the number of checks being written due to the increasing use of alternative payment methods. These revenue decreases were partially offset by increased sales of premium-priced licensed and specialty check designs and additional value-added services.

        Operating income increased $2.8 million, or 7.9%, to $38.5 million for the second quarter of 2004 from $35.7 million for the second quarter of 2003. This increase was the result of cost management efforts, lower discretionary spending and productivity improvements, partially offset by the revenue decline.

        Financial Services revenue decreased $16.9 million, or 4.8%, to $333.9 million for the first six months of 2004 from $350.8 million for the first six months of 2003. The decrease was primarily due to competitive pricing pressure and an overall decline in the number of checks being written due to the increasing use of alternative payment methods. These revenue decreases were partially offset by increased sales of premium-priced licensed and specialty check designs and additional value-added services, as well as the timing of client gains and losses.

        Operating income increased $4.2 million, or 5.8%, to $77.2 million for the first six months of 2004 from $73.0 million for the first six months of 2003. As for the quarter, this increase was the result of cost management efforts, lower discretionary spending and productivity improvements, partially offset by the revenue decline.

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        Direct Checks — Direct Checks sells checks and related products directly to consumers through direct mail and the Internet. We use a variety of direct marketing techniques to acquire new customers in the direct-to-consumer channel, including freestanding inserts in newspapers, in-package advertising, statement stuffers and co-op advertising. We also use e-commerce strategies to direct traffic to our websites. Direct Checks sells under the Checks Unlimited and Designer Checks brand names. The following table shows the results of this segment for the quarters and six months ended June 30, 2004 and 2003 (dollars in thousands):

        Direct Checks revenue decreased $4.8 million, or 6.3%, to $71.0 million for the second quarter of 2004 from $75.8 million for the second quarter of 2003. Unit volume decreased from 2003 due to an overall decline in the number of checks being written resulting from the increasing use of alternative payment methods, lower consumer response rates to direct mail advertisements, longer reorder cycles due to our promotional strategies for multi-box orders and lower customer retention. Partially offsetting the volume decline was an increase in revenue per unit due to price increases, the improved effectiveness of our selling techniques and continued strength in selling premium-priced licensed and specialty check designs and additional value-added products and services.

        Operating income decreased $2.5 million, or 10.8%, to $20.9 million for the second quarter of 2004 from $23.4 million for the second quarter of 2003. This decrease was primarily due to the revenue decline, partially offset by productivity improvements.

        Direct Checks revenue decreased $8.4 million, or 5.4%, to $148.1 million for the first six months of 2004 from $156.5 million for the first six months of 2003. Unit volume decreased from 2003 due to an overall decline in the number of checks being written resulting from the increasing use of alternative payment methods, lower consumer response rates to direct mail advertisements, longer reorder cycles due to our promotional strategies for multi-box orders and lower customer retention. Partially offsetting the volume decline was an increase in revenue per unit due to price increases, the improved effectiveness of our selling techniques and continued strength in selling premium-priced licensed and specialty check designs and additional value-added products and services.

        Operating income decreased $12.3 million, or 22.5%, to $42.4 million for the first six months of 2004 from $54.7 million for the first six months of 2003. This decrease was primarily due to a $7.9 million increase in advertising expense due to new product launches, higher cost per customer acquisition and the timing of promotional spending. Additionally, the revenue decline and severance charges contributed to the decrease. Further information concerning the severance charges can be found under Other Matters.

        Business Services — Business Services sells checks, forms and related products to small businesses and home offices through financial institution referrals, business alliances and via direct mail and the Internet. Through our business referral program, our financial institution clients refer new small business customers by calling us directly at the time of new account opening. We also use a variety of direct marketing techniques to retain customers. The following table shows the results of this segment for the quarters and six months ended June 30, 2004 and 2003 (dollars in thousands):

        Business Services revenue increased $3.2 million, or 5.4%, to $63.5 million for the second quarter of 2004 from $60.3 million for the second quarter of 2003. The increase resulted primarily from higher unit

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volume. Financial institution referrals increased due to the timing of client gains and losses and due to our focus on increasing the visibility of this program with our financial institution clients. Partially offsetting this improvement was the overall decline in the number of checks being written due to the increasing use of alternative payment methods.

        Operating income increased $1.5 million, or 8.1%, to $20.2 million for the second quarter of 2004 from $18.7 million for the second quarter of 2003. The increase was due to the higher revenue and our ability to leverage fixed costs as revenues increase, as well as lower discretionary spending.

        Business Services revenue increased $9.1 million, or 7.6%, to $128.5 million for the first six months of 2004 from $119.4 million for the first six months of 2003. The increase resulted from increased financial institution referrals, as well as improved selling techniques and price increases. Partially offsetting these improvements was the overall decline in the number of checks being written due to the increasing use of alternative payment methods.

        Operating income increased $6.9 million, or 19.9%, to $41.8 million for the first six months of 2004 from $34.9 million for the first six months of 2003. The increase was due to the higher unit volume, lower discretionary spending and price increases.

        NEBS — NEBS is a leading provider of products and services to small businesses. Its offerings include checks, forms, packaging supplies, embossed foil anniversary seals and other printed material which are marketed through direct sales, telesales, a direct sales force, dealers, dedicated distributors and the Internet. NEBS also designs, embroiders and sells specialty apparel products through distributors and independent sales representatives. The following table shows the results of this segment for the quarters and six months ended June 30, 2004 and 2003 (dollars in thousands):

        As discussed earlier, we acquired NEBS on June 25, 2004. As such, NEBS results of operations are included in our operating results only for the last five days of June.

Liquidity, Capital Resources and Financial Condition

        As of June 30, 2004, we had cash and cash equivalents of $19.8 million. The following table shows our cash flow activity for the first six months of 2004 and 2003 and should be read in conjunction with the consolidated statements of cash flows (dollars in thousands):

        Net cash provided by operating activities increased $73.2 million to $123.5 million for the first six months of 2004 from $50.3 million for the first six months of 2003. The increase was due primarily to a $28.2 million decrease in contract acquisition payments to financial institution clients within the Financial

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Services segment, a $19.0 million decrease in payments made for profit sharing and pension contributions and the 2003 change in deferred advertising and accounts receivable.

        During the first six months of 2004, cash inflows generated from operations were utilized primarily to make income tax payments of $43.2 million, voluntary employee beneficiary association (VEBA) trust contributions of $35.9 million, employee profit sharing and pension contributions of $20.6 million, interest payments of $12.3 million and contract acquisition payments to financial institution clients of $7.7 million. Net proceeds from short-term debt of $702.9 million, cash provided by operating activities during the first six months of 2004 of $123.5 million, cash receipts of $11.1 million from shares issued under employee plans and cash on hand of $3.0 million at December 31, 2003, enabled us to make net payments related to the NEBS acquisition of $549.5 million, to make payments on long-term debt of $165.6 million, to pay dividends of $37.1 million, to spend $26.6 million on share repurchases, to fund $23.8 million of restricted cash to pay for NEBS shares not tendered and to purchase capital assets of $13.7 million. The payments on long-term debt primarily related to NEBS debt assumed at the time of acquisition.

        During the first six months of 2003, cash inflows generated from operations were utilized primarily to make employee profit sharing and pension contributions of $39.6 million, income tax payments of $36.2 million, contract acquisition payments to financial institution clients of $35.9 million and VEBA trust contributions of $32.0 million, as well as to fund changes in accounts receivable and deferred advertising costs. The net issuance of $215.2 million of commercial paper, cash on hand of $124.9 million as of December 31, 2002, net cash provided by operating activities during the first six months of 2003 of $50.3 million and cash receipts of $11.3 million from shares issued under employee plans enabled us to spend $337.2 million on share repurchases, to pay dividends of $42.1 million and to purchase capital assets of $10.3 million.

        During July 2004, we completed the payments to redeem the outstanding stock options of NEBS as discussed earlier under Acquisition of New England Business Service, Inc. We anticipate that the majority of the direct costs of the acquisition will also be paid in the third quarter of 2004. Additionally, we anticipate that our third quarter cash flow from operating activities will be negatively impacted by payments made to NEBS executives under change of control provisions included in their employment agreements, as well as the funding of NEBS supplemental executive retirement plan and NEBS fiscal year 2004 cash bonus payments.

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        We believe that important measures of our financial strength are the ratios of earnings before interest and taxes (EBIT⁽⁵⁾) to interest expense and free cash flow⁽⁶⁾ to total debt. We calculate free cash flow as cash provided by operating activities less purchases of capital assets and dividends paid to shareholders. EBIT to interest expense was 15.7 times on a four-quarter trailing basis through June 30, 2004 and 16.5 times for the year ended December 31, 2003. Our committed lines of credit contain covenants requiring a minimum EBIT to interest expense ratio on a four-quarter trailing basis of 3.0 times. The decrease in 2004 was primarily due to higher interest expense resulting from higher debt levels as we continued to repurchase shares. This ratio will continue to decrease due to the additional debt we issued to complete the acquisition of NEBS. Nonetheless, we believe the risk of violating our financial covenants is low as we expect solid profitability and cash flow to continue. The comparable ratio of net income to interest expense was 9.4 times on a four-quarter trailing basis through June 30, 2004 and 10.0 times for the year ended December 31, 2003. Free cash flow to total debt was 11.9% on a four-quarter trailing basis through June 30, 2004 and 13.3% for the year ended December 31, 2003. The decrease was primarily due to the higher debt level as of June 30, 2004, due to financing required for the NEBS acquisition. The comparable ratio of net cash provided by operating activities to total debt was 19.6% on a four-quarter trailing basis through June 30, 2004 and 30.5% for the year ended December 31, 2003.

        As of June 30, 2004, we had $1,297.9 million of debt outstanding. Of this amount, $916.1 million was short-term debt and the remainder was long-term debt. Our short-term debt consisted of amounts drawn on a committed line of credit, as well as commercial paper outstanding under a $500.0 million commercial paper program. The amount of our commercial paper program was increased from $350.0 million to $500.0 million during the second quarter of 2004. The amount drawn on the committed line of credit related to a bridge financing agreement put in place to complete the acquisition of NEBS. This $800.0 million line of credit expires in May 2005 and carries a commitment fee of ten basis points (.10%). It also supported up to $150.0 million of our commercial paper program as of June 30, 2004. The daily average amount outstanding