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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 April 29, 2005 was 50,536,211.

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PART I-FINANCIAL INFORMATION

Item 1. Financial Statements.

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

See Notes to Unaudited Consolidated Financial Statements

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DELUXE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(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
(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 March 31, 2005 and the consolidated statements of income and cash flows for the quarters ended March 31, 2005 and 2004 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, 2004.

Note 2: 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 reported 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 stock options granted prior to January 1, 2004. 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.

Note 3: New accounting pronouncements

        In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. This FSP allows additional time for companies to determine how the new law affects a company’s accounting for deferred tax liabilities on unremitted foreign earnings. The new law provides for a special one-time deduction of 85% of certain foreign earnings that are repatriated and which meet certain requirements. We are currently evaluating whether any of the earnings of our Canadian operations will be repatriated in accordance with the terms of this law. Any repatriation of these earnings must occur in 2005. The maximum amount of earnings that could be repatriated is approximately $34 million, which would result in tax expense of approximately $3.5 million. We expect our evaluation to be completed in the second quarter of 2005.

        In December 2004, the FASB issued a revision to SFAS No. 123, Accounting for Stock-Based Compensation. The new statement is referred to as SFAS No. 123(R) and is entitled Share-Based Payment. The new statement requires companies to recognize expense for stock-based compensation in the statement of income and is effective for us on January 1, 2006. We do not expect the provisions of SFAS No. 123(R) to result in a significant change in the compensation expense we currently recognize in our statements of income under SFAS No. 123.

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Note 4: Supplementary balance sheet information

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

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

        We maintain a VEBA trust to fund employee and retiree medical costs, as well as severance benefits. We typically make the majority of our contributions to this trust in the first quarter of the year. During the quarter ended March 31, 2005, we contributed $34.0 million to the trust.

        Assets held for sale – Assets held for sale include four Financial Services check printing facilities and one Small Business Services printing facility which we closed during 2004, as well as one Small Business Services facility which was closed prior to our acquisition of New England Business Service, Inc. (NEBS) in June 2004.

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        Intangibles – Intangibles were comprised of the following (in thousands):

        Total amortization of intangibles for continuing operations was $23.5 million for the quarter ended March 31, 2005 and $9.6 million for the quarter ended March 31, 2004. Based on the intangibles in service as of March 31, 2005, estimated amortization expense is as follows (in thousands):

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

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        Changes in contract acquisition costs during the first quarter of 2005 were as follows (in thousands):

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

Note 5: Earnings per share

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

        During the quarter ended March 31, 2005, options to purchase 2.3 million common shares were outstanding but were not included in the computation of diluted earnings per share. During the quarter ended March 31, 2004, 2.4 million options were excluded from the calculation. These options were excluded from the calculation of diluted earnings per share because their effect would have been antidilutive.

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Note 6: Acquisition of New England Business Service, Inc.

        On June 25, 2004, we acquired all of the outstanding common stock of NEBS for $44 per share and agreed to redeem all outstanding NEBS stock options for $44 per option share less the option exercise price. The total purchase price, including direct costs of the acquisition, was $639.8 million. To finance the acquisition, we utilized a bridge financing agreement, as well as commercial paper. This debt was re-financed in the fourth quarter of 2004 when we issued $600.0 million of long-term debt. Further details concerning this long-term debt can be found in Note 9.

        NEBS is a leading supplier of products and services to small businesses. Its offerings include checks, forms, packaging supplies, embossed foil anniversary seals, promotional products and other printed material which are marketed through direct response marketing, financial institution referrals, independent distributors, sales representatives and the internet. NEBS results of operations are included in our consolidated results of operations from the acquisition date. Our balance sheet as of December 31, 2004 reflects the final allocation of the purchase price to the assets acquired and liabilities assumed. Details concerning the assets acquired and liabilities assumed are presented in the Notes to Consolidated Financial Statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2004. NEBS results of operations are included in our Small Business Services segment, except for those portions which are reported as discontinued operations (see Note 7).

        The following pro forma financial information illustrates our estimated results of operations for the first quarter of 2004 as if the acquisition of NEBS had occurred on January 1, 2004 (in thousands, except per share amounts):

Note 7: Discontinued operations

        During the fourth quarter of 2004, we disposed of substantially all of the operations of NEBS European businesses. Not included in this sale was a building located in the United Kingdom. This building is currently for sale and is expected to be sold during 2005.

        Also during the fourth quarter of 2004, we announced the planned sale of NEBS’ apparel business known as PremiumWear. We anticipate that this sale will be completed in 2005.

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        The results of operations of these businesses are reflected as discontinued operations in our consolidated financial statements. The major classes of assets and liabilities of discontinued operations were as follows (in thousands):

        Revenue and loss from discontinued operations for the first quarter of 2005 was as follows (in thousands):

Note 8: Restructuring accruals

        Restructuring accruals of $12.4 million as of March 31, 2005 and $16.9 million as of December 31, 2004 are reflected in accrued liabilities and other non-current liabilities in the consolidated balance sheets. Our restructuring accruals consist primarily of employee severance benefits and mainly relate to NEBS activities we are exiting as we combine the two companies. Further information regarding our restructuring accruals can be found under the caption “Note 6: Restructuring accruals” in the Notes to Consolidated Financial Statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2004.

        Changes in the restructuring accruals during the first quarter of 2005 were as follows (dollars in thousands):

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        On a cumulative basis through March 31, 2005, the status of our restructuring accruals was as follows (dollars in thousands):

Note 9: Debt

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

        In October 2004, we issued $325.0 million of 3.5% senior, unsecured notes maturing on October 1, 2007 and $275.0 million of 5.125% senior, unsecured notes maturing on October 1, 2014. The notes were issued via a private placement under Rule 144A of the Securities Act of 1933. These notes were subsequently registered with the Securities and Exchange Commission (SEC) via a registration statement which became effective on November 23, 2004. Interest payments are due each April and October. Principal redemptions on the three-year notes may not be made prior to their stated maturity. Principal redemptions on the ten-year notes may be made at our election prior to their stated maturity. The notes include covenants that place restrictions on the issuance of additional debt that would be senior to the notes and the execution of certain sale-leaseback agreements. The notes were issued at a discount from par value. The resulting discount of $0.8 million is being amortized ratably as an increase to interest expense over the terms of the notes. Proceeds from the offering, net of offering costs, were $595.5 million. These proceeds were used to pay off commercial paper borrowings used for the acquisition of NEBS (see Note 6). The fair market value of these notes was $576.0 million as of March 31, 2005, based on quoted market prices.

        In December 2002, we issued $300.0 million of 5.0% senior, unsecured notes maturing on December 15, 2012. These notes were issued under our shelf registration statement covering up to $300.0 million in medium-term notes, which became effective on October 27, 1995, thereby exhausting that registration statement. Interest payments are due each June and December. Principal redemptions may be made at our election prior to their stated maturity. The notes include covenants that place restrictions on the issuance of additional debt that would be senior to the notes and the execution of certain sale-leaseback agreements. The notes were issued at a discount from par value. The resulting discount of $1.9 million is being amortized ratably as an increase to interest expense over the ten-year term of the notes. Proceeds from the offering, net of offering costs, were $295.7 million. These proceeds were used for general corporate purposes, including funding share repurchases, capital asset purchases and working capital. The fair value of these notes was $292.4 million as of March 31, 2005, based on quoted market prices.

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        In September 2003, we issued $50.0 million of 2.75% senior, unsecured notes maturing on September 15, 2006. The notes were issued under a shelf registration statement which became effective on July 8, 2003 and allows for the issuance of debt securities, from time to time, up to an aggregate of $500.0 million. Interest payments are due each March and September. Principal redemptions may be made at our election prior to their stated maturity. The notes include covenants that place restrictions on the issuance of additional debt that would be senior to the notes and the execution of certain sale-leaseback agreements. Proceeds from the offering, net of offering costs, were $49.8 million. These proceeds were used for general corporate purposes, including funding share repurchases, capital asset purchases and working capital. The fair value of these notes was $48.7 million as of March 31, 2005, based on quoted market prices.

        In November 2003, we issued $25.0 million of variable rate, senior, unsecured notes maturing on November 4, 2005. The notes were issued under the July 8, 2003 shelf registration statement. Interest payments are due each February, May, August and November at an annual interest rate equal to the 3-month London InterBank Offered Rate (LIBOR) plus .05%. This interest rate is reset on a quarterly basis. Principal redemptions may be made at our election prior to their stated maturity. The notes include covenants that place restrictions on the issuance of additional debt that would be senior to the notes and the execution of certain sale-leaseback agreements. Proceeds from the offering were $25.0 million. These proceeds were used for general corporate purposes, including funding share repurchases, capital asset purchases and working capital. The fair value of these notes was estimated to be $24.9 million as of March 31, 2005, based on a broker quote.

        As of March 31, 2005, we had a $500.0 million commercial paper program in place. The daily average amount of commercial paper outstanding during the first quarter of 2005 was $233.8 million at a weighted-average interest rate of 2.62%. As of March 31, 2005, $258.8 million was outstanding at a weighted-average interest rate of 2.85%. The daily average amount of commercial paper outstanding during 2004 was $344.7 million at a weighted-average interest rate of 1.59%. As of December 31, 2004, $264.0 million was outstanding at a weighted-average interest rate of 2.45%.

        We also have committed lines of credit which primarily support our commercial paper program. 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 quarter of 2005 or during 2004, and no amounts were outstanding under these lines of credit as of March 31, 2005. To the extent not needed to support outstanding commercial paper or letters of credit, we may borrow funds under our committed lines of credit. As of March 31, 2005, $237.2 million was available under our committed lines of credit for borrowing or for support of additional commercial paper, as follows (in thousands):

        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 quarter of 2005 or during 2004, and no amounts were outstanding under this line of credit as of March 31, 2005.

        Absent certain defined events of default under our committed credit facilities, there are no significant contractual restrictions on our ability to pay cash dividends.

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Note 10: Pension and post-retirement benefits

        We have historically provided certain health care benefits for a large number of retired employees. In addition to our post-retirement benefit plans, we have a supplemental executive retirement plan (SERP) for certain NEBS employees and a pension plan which covers certain Canadian employees.

        Our pension and post-retirement benefit expense for the quarters ended March 31, 2005 and 2004 consisted of the following components (in thousands):

        On January 21, 2005, final regulations implementing the Medicare Prescription Drug Improvement and Modernization Act of 2003 were issued. We do not believe that these regulations will have a significant impact on the accumulated post-retirement benefit obligation or the periodic benefit expense related to our post-retirement benefit plans.

Note 11: Shareholders’ deficit

        We are in a shareholders’ deficit position primarily as a result of our share repurchase programs and their required accounting treatment. 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 March 31, 2005, 2.1 million of these additional shares had been repurchased at a cost of $85.0 million. There have been no share repurchases under this authorization since the second quarter of 2004.

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        Changes in shareholders’ deficit during the quarter ended March 31, 2005 were as follows (in thousands):

        Accumulated other comprehensive loss was comprised of the following (in thousands):

Note 12: Business segment information

        We operate three business segments: Small Business Services, Financial Services and Direct Checks. Our Small Business Services segment consists of the acquired NEBS business (see Note 6), as well as our former Business Services segment. This segment sell checks, forms and related products to small businesses and home offices through direct response marketing, financial institution referrals, sales representatives, independent distributors and the internet. Financial Services sells checks and related products and services to financial institutions. Direct Checks sells checks and related products directly to consumers through direct mail and the internet. All three segments operate primarily in the United States. Small Business Services also has operations in Canada.

        The accounting policies of the segments are the same as those described in the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. Corporate expenses are allocated to the segments based on segment revenues. No corporate expenses have been allocated to the NEBS portion of our Small Business Services segment as NEBS operations have not yet been fully 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.

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        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 March 31, 2005 and 2004 (in thousands):

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

        We provide a wide range of customized products and services: personalized printed items (checks, forms, business cards, stationery, greeting cards, labels and shipping and packaging supplies), promotional products and merchandising materials, fraud prevention services and customer retention programs. Through our various brands and businesses, our product offerings help financial institutions and small businesses better manage, promote, and grow their businesses. We also sell personalized checks and accessories directly to consumers. We are the largest provider of checks in the United States, both in terms of revenue and number of checks produced.

        On June 25, 2004, we acquired New England Business Service, Inc. (NEBS). NEBS is a leading provider of products and services to small businesses. Accordingly, our consolidated results of operations include the results of NEBS from the acquisition date.

EXECUTIVE SUMMARY

First Quarter 2005 Consolidated Results of Operations

• Revenue was $437.2 million, up $128.5 million from the first quarter of 2004. NEBS contributed revenue of $160.5 million.
• Excluding NEBS, units⁽¹⁾ were down 17.3%, primarily due to the loss of a large financial institution client in late 2004. Revenue per unit increased 8.4% compared to the first quarter of 2004.
• Gross margin was 65.2%, down slightly compared to 65.4% in the first quarter of 2004. NEBS results decreased our gross margin by 3.5 percentage points, offsetting the savings from increased revenue per unit, manufacturing efficiencies and cost synergies resulting from the NEBS acquisition. NEBS has historically had lower gross margins than our other businesses because of its non-check product mix.

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• Selling, general and administrative (SG&A) expense was 47.7% of revenue, compared to 38.9% in the first quarter of 2004. NEBS results increased our SG&A percentage by 5.3 percentage points. NEBS has historically had a higher SG&A percentage than our other businesses. The higher SG&A primarily results from NEBS’ greater reliance on direct mail and a direct sales force to acquire and retain customers. Additionally, NEBS results included $9.8 million of acquisition-related amortization expense for certain intangible assets and $3.1 million of integration costs. Further information concerning the NEBS intangible assets acquired can be found in the Notes to Consolidated Financial Statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2004.
• Operating income was $76.7 million, a decrease of $5.1 million from the first quarter of 2004. NEBS contributed operating income of $3.9 million. The decrease for our other businesses was due to the revenue decline, partially offset by productivity improvements and cost management efforts, as well as cost synergies resulting from the NEBS acquisition.
• Operating margin was 17.5% compared to 26.5% in the first quarter of 2004. NEBS results, including acquisition-related amortization expense, decreased our operating margin by 8.8 percentage points. NEBS has historically had lower operating margins than our other businesses. The impact of acquisition-related amortization expense and integration costs contributed 2.9 of the 8.8 percentage point decrease attributable to NEBS.
• Interest expense was $13.4 million, up $8.2 million from the first quarter of 2004 primarily due to the debt issued to finance the NEBS acquisition.
• Net income was $39.4 million, or $0.78 per diluted share, compared to $47.7 million, or $0.94 per diluted share in the first quarter of 2004.

        ⁽¹⁾  Units represent an equivalent quantity of checks sold calculated across all check-related product lines.

First Quarter Cash Flow/Financial Condition

• Cash provided by operating activities of continuing operations was $32.4 million, down $16.3 million from the first quarter of 2004. The decrease was due primarily to higher employee profit sharing and pension contributions related to our 2004 operating results, as well as higher contract acquisition payments related to financial institution contract executions. These decreases were partially offset by NEBS operating cash flows.
• Purchases of capital assets increased $8.1 million to $12.1 million, as compared to the first quarter of 2004. Capital purchases in 2005 primarily related to our planned installation of the SAP sales and distribution module in portions of our order processing and call center operations, as well as NEBS implementation of certain SAP finance and other modules in the second quarter of 2005.
• During the first quarter of 2004, we repurchased common shares for $18.0 million. We have not purchased common shares under our board-approved share repurchase plan since the second quarter of 2004, as we utilized our resources to complete the acquisition of NEBS.
• Total assets increased by $56.6 million from December 31, 2004, primarily due to a $53.1 million increase in contract acquisition costs related to financial institution contracts executed during the quarter.
• Shareholders’ deficit decreased by $28.9 million from December 31, 2004, primarily because we generated net income of $39.4 million and we issued shares under employee plans of $7.3 million. These decreases were partially offset by cash dividends of $20.3 million.

CONSOLIDATED OVERVIEW

        We operate three business segments: Small Business Services, Financial Services and Direct Checks. Our Small Business Services segment is comprised of the acquired NEBS business and our former Business Services segment. This segment sells checks, forms and related products to more than six million small businesses and home offices through direct response marketing, financial institution referrals, independent distributors, sales representatives and the internet. Financial Services sells personal and business checks and related products and services to approximately 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 and services, using direct response marketing and the internet. We are the largest provider of checks in the United States, both in terms of revenue and number of checks produced. All three of our segments operate primarily in the United States. Small Business Services also has operations in Canada.

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        One of our main focuses during the remainder of 2005 will be the continued integration of NEBS. Small Business Services provides one of the most comprehensive product and service offerings for small businesses. This provides the basis for us to increase sales to existing customers, as well as to pursue new customers. The NEBS acquisition also provides a positive impact on our product mix by increasing our non-check revenue. Based on the success of the integration thus far, we expect that we will realize both the cost synergies and growth we expected when we acquired NEBS. We anticipate that growth in our Small Business Services segment will offset the decline in our core check businesses as we move into 2006.

        Our business continues to generate strong cash flows. We generated operating cash flows of $32.4 million during the first quarter of 2005 and $307.6 million during full year 2004. We believe our strong cash flows and our focus on cost management and operational excellence will allow us to maintain our leadership position in the check printing portion of the payments industry and to expand our presence in the small business arena. As a result of our strong credit profile and access to the capital markets, we were able to complete the NEBS acquisition in 2004, by using a combination of short-term and long-term debt financing. We have also used our solid financial profile and related debt capacity to repurchase common shares over the past several years. During 2003 and 2004, we repurchased 12.9 million shares for a total of $533.8 million. During the first quarter of 2005, we also increased our quarterly dividend to $0.40 per share, up $0.03 per share from our previous dividend level. This resulted in a dividend yield of 4.0% based on our March 31, 2005 closing stock price. We were able to increase the quarterly dividend because of our strong operating cash flows and our expectations of these cash flows going forward. Specifically, as a result of the NEBS integration effort, we are able to confirm that: (1) synergies realized from the NEBS integration are exceeding our expectations, and (2) we expect year-over-year growth from our Small Business Services segment to offset declines in our core check businesses beginning in 2006. We believe we have sufficient financial resources to pursue additional acquisitions that 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.

        Major challenges in our business are as follows. Two of our largest product groups, checks and business forms, are mature products and their use has been declining in the marketplace. 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. Because check usage is declining, we have also been encountering significant pricing pressure when negotiating contracts with our financial institution clients. Our traditional financial institution relationships are typically formalized through supply contracts averaging three to five years in duration. As we compete with other check printing companies to retain and obtain business in the face of declining volume, the resulting pricing pressure has reduced our profit margins, and we expect this trend to continue.

        A 2004 Federal Reserve study reported that the check is still Americans’ largest single non-cash payment type, accounting for approximately 45% of all non-cash payments. This is, however, a decrease from the previous Federal Reserve Study published in 2002 which reported that checks comprised approximately 60% of all non-cash payments. The report does note that this measure excludes checks written which are converted into electronic transactions at the point of sale. The Federal Reserve Study also indicated that consumer checks are declining faster than business checks. This study was completed prior to the implementation of Check 21 legislation in October 2004, which affects how checks can be processed. The new law states that an electronic or paper reproduction of a check is the legal equivalent of the original check. This permits financial institutions to submit these “substitute” checks for processing and clearing. We believe this legislation supports the use of checks by creating a more efficient processing system which is less costly and will allow financial institutions to detect fraud earlier. It remains to be seen what, if any, impact this legislation will have on consumers’ use of checks.

        Business forms products have 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 lower quality versions of business forms. 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.

        Our Direct Checks segment and portions of our Small Business Services segment have been impacted by reduced customer response rates to direct mail advertisements. We believe that the decline in customer 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 these challenges, we have focused on driving revenue growth by introducing new product offerings and improving our selling techniques. Examples of these efforts are as follows:

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• In Small Business Services, we are developing ways to leverage the many small business products and sales channels we now possess as a result of the NEBS acquisition. We recently launched our new Deluxe Business Advantage^(SM) program. This program provides a fast and simple way for financial institutions to offer expanded personalized service to small business customers based on a number of service level options available. Our customer care center expertise has been combined with our sales force, which makes one-on-one contact with small businesses and financial institution branches. This better positions us to meet the needs of small business and financial institution customers. Our broader set of capabilities also differentiates us from our competitors.
• The DeluxeSelect^SM program in Financial Services 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 March 31, 2005, over 5,000 financial institutions had enrolled in DeluxeSelect. We provide high quality products, superior service, enhanced customer satisfaction and the check program management skills that lead to improved revenue and profitability for financial institutions.
• In Direct Checks, we have attempted to maximize revenue per order by encouraging consumers to place their orders by phone, where our sales associates have the opportunity to interact with the consumer. Typically, phone orders result in higher revenue per order than other order channels. During the first quarter of 2005, 32% of first-time customers placed their orders via the telephone, as compared to 27% in the first quarter of 2004.

        The revenue growth efforts we have initiated 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.

        During the first quarter, we acquired three new financial institution clients and renewed our relationship with another major financial institution. We expect that the new business will partially offset the impact of a large financial institution client we lost in late 2004. We expect to see the new business activity grow over the next 12 months, with the majority coming on board early in 2006.

        On the cost side of our business, we continue to focus on cost management and operational excellence. In 2004, we closed six printing facilities. We have also implemented other employee reductions over the past year and have announced our intention to close two additional printing facilities. 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. Additionally, in integrating NEBS, we plan to realize cost synergies of at least $25 million annually beginning this year. These synergies represent reduced costs in relation to NEBS historical results of operations. We expect to realize these synergies through eliminating redundancies, leveraging our shared services environment, realizing the benefits of our larger purchasing power and enhancing productivity by implementing lean principles and sharing best practices.

        Looking at economic indicators, a key measure for our Small Business Services segment is small business confidence. Key trends in this area were positive in the first quarter of 2005, although confidence levels in early second quarter are showing signs of some deterioration. The National Federation of Independent Business (NFIB) reported that small business sales levels, employment and capital spending are trending upwards, and the NFIB’s measure of small business optimism continued to be strong through the first quarter. Our Financial Services and Direct Checks segments are primarily impacted by consumer spending and employment levels. We estimate that consumer spending growth in the first quarter of 2005 was moderate, with a lower increase for the quarter than we saw in the fourth quarter of 2004. Employment growth was up slightly from 2004. In 2004, an average of 183,000 jobs were created per month, as reported by the U.S. Department of Labor, Bureau of Labor Statistics (BLS). During the first quarter of 2005, BLS reported average job growth per month of 190,000 jobs. 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 outlook was developed assuming that economic factors will have little impact on our business in 2005.

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CONSOLIDATED RESULTS OF OPERATIONS

        Income from continuing operations — The decrease in income from continuing operations in the first quarter of 2005, as compared to 2004, was primarily due to the loss of a large financial institution client in late 2004, the continuing decline in check usage and higher interest expense in 2005 due to financing associated with the NEBS acquisition. These decreases were partially offset by manufacturing productivity improvements, cost management efforts, including employee reductions during the past year, as well as NEBS results of operations.

        Loss from discontinued operations — Discontinued operations include the results of the apparel business acquired from NEBS, which we plan to sell during 2005.

Consolidated Revenue

        The acquisition of NEBS contributed revenue of $160.5 million in the first quarter of 2005. The $32.1 million decrease in revenue for our other businesses compared to 2004 was due to a 17.3% decrease in units due primarily to two factors: (1) the loss of a large financial institution client in late 2004 and (2) the overall decline in the number of checks being written as a result of 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 Small Business Services segment. Partially offsetting the volume decline was an 8.4% increase in revenue per unit as compared to 2004. The large financial institution client we lost in late 2004 received higher discount levels as a result of its order volume. Thus, without this client’s business, our revenue per unit measure improved. Additionally, we continued to benefit from increased sales of 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 Small Business Services segments.

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Consolidated Gross Margin

        Gross margin decreased slightly in the first quarter of 2005, as compared to 2004. NEBS historical gross margins have been seven to eight points lower than our other businesses because of its non-check product mix. This translated into a 3.5 percentage point decrease in our consolidated gross margin in the first quarter of 2005. Additionally, as discussed earlier, our unit volume decreased 17.3% as compared to 2004. Offsetting these decreases was the higher revenue per unit discussed earlier, continued productivity improvements, on-going cost management efforts, including the closing of six printing facilities in 2004, as well as cost synergies resulting from the NEBS acquisition.

Consolidated Selling, General & Administrative Expense

        The increase in SG&A expense in the first quarter of 2005, as compared to 2004, was primarily due to expenses of the acquired NEBS business, including $9.8 million of acquisition-related amortization expense for certain intangible assets and $3.1 million of integration expenses. Partially offsetting this increase was a $2.0 million decrease in Direct Checks advertising expense related to new product initiatives in 2004, as well as our cost management efforts, including savings realized from employee reductions.

        SG&A expense as a percentage of revenue increased in the first quarter of 2005, as compared to 2004, primarily as a result of NEBS results. NEBS has historically had a higher SG&A percentage than our other businesses. NEBS relies to a greater degree on direct mail and a direct sales force to acquire and retain customers and also had not utilized a shared services environment for SG&A functions. Additionally, as previously discussed, NEBS results included $9.8 million of acquisition-related amortization expense and $3.1 million of integration expenses. The increase in SG&A expense as a percentage of revenue for our other businesses was due to the decline in revenue being greater than the reduction in their SG&A expense.

Interest Expense

        The increase in interest expense in the first quarter of 2005, as compared to 2004, was due to our higher debt level resulting from the acquisition of NEBS, as well as higher interest rates. During the first quarter of 2005, we had weighted-average debt outstanding of $1,216.0 million at a weighted-average interest rate of 4.06%. During the first quarter of 2004, we had weighted-average debt outstanding of $574.5 million at a weighted-average interest rate of 3.43%.

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Provision for Income Taxes