Deluxe Corporation - 10-Q quarterly report FY

 

(Mark One)

(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.

þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ                     Accelerated filer o                     Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes þ No

The number of shares outstanding of registrant’s common stock, par value $1.00 per share, at July 25, 2007 was 52,181,462.

 

 

(in thousands, except share par value)
(Unaudited)

See Condensed Notes to Unaudited Consolidated Financial Statements

(in thousands, except per share amounts)
(Unaudited)

See Condensed Notes to Unaudited Consolidated Financial Statements

(in thousands)
(Unaudited)

See Condensed Notes to Unaudited Consolidated Financial Statements

     The consolidated balance sheet as of June 30, 2007, the consolidated statements of operations for the quarters and six months ended June 30, 2007 and 2006 and the consolidated statements of cash flows for the six months ended June 30, 2007 and 2006 are unaudited. The consolidated balance sheet as of December 31, 2006 was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles (GAAP) in the United States of America. In the opinion of management, all adjustments necessary for a fair statement 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, 2006 (the 2006 Form 10-K).

     We have reclassified certain amounts presented in the consolidated balance sheets and the consolidated statements of cash flows as of and for the six months ended June 30, 2007 to conform to the current period presentation. These reclassifications did not effect our previously reported financial position, results of operations or cash flows.

     On January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes. The new standard defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authorities based solely on the technical merits of the position. If the recognition threshold is met, the tax benefit is measured and recognized as the largest amount of tax benefit that in our judgment is greater than 50% likely to be realized. The adoption of FIN No. 48 on January 1, 2007 impacted our consolidated balance sheet as follows:

     The total amount of unrecognized tax benefits as of January 1, 2007 was $16.2 million, excluding accrued interest and penalties. Of this amount, $9.3 million would affect our effective tax rate if recognized. Interest and penalties recorded for uncertain tax positions were included in our provision for income taxes in the consolidated statements of operations prior to the adoption of FIN No. 48, and we continue this classification subsequent to the adoption of FIN No. 48. As of January 1, 2007, $4.7 million of accrued interest and penalties was accrued, excluding the tax benefits of deductible interest. The years 2003 through 2006 remain subject to examination by the Internal Revenue Service (IRS). The years 2002 through 2006 remain subject to examination by major state and city tax jurisdictions. In the event that we have determined not to file tax returns with a particular state or city, all years remain subject to examination by the tax jurisdiction.

     During the six months ended June 30, 2007, we settled a city jurisdictional matter for $1.0 million and reduced our reserve for contingent tax liabilities. There were no other significant changes to our unrecognized tax benefits during this period. Within the next 12 months, it is reasonably possible that our unrecognized tax benefits will decrease in the range of $1.6 million to $3.4 million as we settle certain federal and state tax matters. We are not able to predict what, if any, impact these settlements may have on our effective tax rate.

     On January 1, 2007, we adopted the measurement date provisions of Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 requires companies to measure the funded status of a plan as of the date of its year-end balance sheet. We historically used a September 30 measurement date. To transition to a December 31 measurement date, we completed plan measurements for our postretirement benefit and pension plans as of December 31, 2006. In accordance with SFAS No. 158, postretirement benefit expense for the period from October 1, 2006 through December 31, 2006, as calculated based on the September 30, 2006 measurement date, was recorded as an increase to accumulated deficit of $0.7 million, net of tax, as of January 1, 2007. Additionally, we adjusted our postretirement assets and liabilities to reflect the funded status of the plans, as calculated based on the December 31, 2006 measurement date. This adjustment, along with the postretirement benefit expense for the period from October 1, 2006 through December 31, 2006, resulted in an increase in other comprehensive loss of $0.1 million, net of tax, as of January 1, 2007. Postretirement benefit expense reflected in our consolidated statements of operations for the quarter and six months ended June 30, 2007 is based on the December 31, 2006 measurement date. Further information regarding the expense included in our consolidated statements of operations can be found in Note 9: Pension and other postretirement benefits.

     On January 1, 2007, we adopted SFAS No. 157, Fair Value Measurements. This new standard addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. For recognition purposes, on a recurring basis we are required to measure at fair value our marketable securities, which are classified as available-for-sale, and a long-term mutual fund investment accounted for under the fair value option of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The long-term mutual fund investment had an aggregate fair value of $3.1 million as of June 30, 2007 and $3.3 million as of December 31, 2006 and is included in long-term investments on our consolidated balance sheets. The fair value of these investments is determined using quoted prices in active markets. Changes in the fair value of these investments have historically been insignificant. For disclosure purposes, we are required to measure the fair value of outstanding debt on a recurring basis. The fair value of our outstanding debt is determined using quoted prices in active markets.

     On a nonrecurring basis, we are required to use fair value measures when measuring plan assets of our postretirement benefit and pension plans and when analyzing asset impairment. As we elected to adopt the measurement date provisions of SFAS No. 158 as of January 1, 2007, we were required to determine the fair value of our postretirement benefit and pension plan assets as of December 31, 2006. The fair value of our postretirement medical plan assets was $94.4 million and the fair value of our pension plan assets was $6.0 million as of December 31, 2006. These assets are valued in highly liquid markets. During the third quarter of each year, we evaluate goodwill and indefinite-lived intangibles for impairment using the income approach. The income approach is a valuation technique under which estimated future cash flows are discounted to their present value to calculate fair value. When analyzing our indefinite-lived intangibles for impairment, we use a relief from royalty method which calculates the cost savings associated with owning rather than licensing the trade name, applying an assumed royalty rate within our discounted cash flow calculation.

     On January 1, 2007, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This new standard permits companies to choose to measure many financial instruments and certain other items at fair value that were not previously required to be measured at fair value. We have elected the fair value option for a mutual fund investment previously classified as available-for-sale. This investment was carried at fair value on our consolidated balance sheets. However, under the fair value option, unrealized gains and losses now will be reflected in our consolidated statements of operations, as opposed to being recorded in accumulated other comprehensive loss on the consolidated balance sheets. This investment corresponds to our liability under an officers’ deferred compensation plan. This deferred compensation plan is not available to new participants and is fully funded by the mutual fund investment. The liability under the plan equals the fair value of the mutual fund investment, so changes in the value of both the plan asset and the liability are now netted in the consolidated statements of operations. This mutual fund investment had a fair value of $3.1 million as of June 30, 2007 and $3.3 million as of December 31, 2006, and is included in long-term investments on our consolidated balance sheets. The long-term investments caption on our consolidated balance sheet also includes life insurance policies which are recorded at their cash surrender values. The fair value of the mutual fund investment is determined using quoted prices in active markets. Changes in the fair value of this investment have historically been insignificant and were insignificant during the six months ended June 30, 2007. As required by SFAS No. 159, the cumulative unrealized gain related to this mutual fund investment of $0.2 million, net of tax, as of January 1, 2007, was reclassified from accumulated other comprehensive loss to accumulated deficit as of January 1, 2007. The unrealized pre-tax gain on this investment as of January 1, 2007 was $0.4 million.

     Marketable securities – Marketable securities were comprised of the following as of June 30, 2007:

     These investments are accounted for as available-for-sale securities and are carried at fair value on the consolidated balance sheet. They are reported as current assets as they represent the investment of cash available for current operations. Auction rate securities have long-term underlying maturities, but have interest rates that are reset every 90 days or less, at which time the securities can typically be sold. The fair values of the auction rate securities, based on quoted market prices, were equal to the cost of these investments due to the frequency of the interest reset dates. As of June 30, 2007, the average auction rate securities portfolio duration was less than 40 days, and the securities had contractual maturities of 17 to 35 years. The mutual fund investments are comprised of variable rate demand notes, municipal bonds and notes, and commercial paper. The cost of these investments also equaled fair value due to the short-term duration of the underlying investments. Proceeds from sales of available-for-sale marketable securities were $103.0 million for the six months ended June 30, 2007. There were no gains or losses realized on these sales.

     Inventories and supplies – Inventories and supplies were comprised of the following:

     Intangibles – Intangibles were comprised of the following:

     Total amortization of intangibles was $11.7 million for the quarter ended June 30, 2007 and $16.2 million for the quarter ended June 30, 2006. Amortization of intangibles was $23.6 million for the six months ended June 30, 2007 and $32.9 million for the six months ended June 30, 2006. Based on the intangibles in service as of June 30, 2007, estimated future amortization expense is as follows:

     Goodwill – Changes in goodwill during the six months ended June 30, 2007 were as follows:

     Other non-current assets – Other non-current assets were comprised of the following:

     Changes in contract acquisition costs during the first six months of 2007 and 2006 were as follows:

     Accrued liabilities – Accrued liabilities were comprised of the following:

     Supplemental cash flow disclosure – As of June 30, 2007, we had accounts payable of $4.1 million related to capital asset purchases. These amounts were reflected in property, plant and equipment and intangibles in our consolidated balance sheet as of June 30, 2007, as we did receive the assets as of that date. The payment of these liabilities will be included in purchases of capital assets on the consolidated statements of cash flows when these liabilities are paid.

     The following table reflects the calculation of basic and diluted earnings (loss) per share from continuing operations. During each period, certain options as noted below, were excluded from the calculation of diluted earnings (loss) per share because their effect would have been antidilutive.

     Earnings (loss) per share amounts for continuing operations, discontinued operations and net income (loss), as presented on the consolidated statements of operations, are calculated individually and may not sum due to rounding differences.

     In February 2007, we acquired all of the common stock of All Trade Computer Forms, Inc. (All Trade) for cash of $2.3 million, net of cash acquired. All Trade is a custom form printer based in Canada and is included in our Small Business Services segment. All Trade’s operating results are included in our consolidated results of operations from the acquisition date. The allocation of the purchase price to the assets acquired and liabilities assumed resulted in goodwill of $0.7 million. We believe this acquisition resulted in goodwill due to All Trade’s expertise in custom printing which we expect will help us expand our core printing capabilities and product offerings for small businesses.

     In January 2007, we completed the sale of the assets of our Small Business Services industrial packaging product line for $19.2 million, realizing a pre-tax gain of $3.8 million. This sale had an insignificant impact on diluted earnings per share because the effective tax rate specifically attributable to the gain was higher since the goodwill written-off is not deductible for tax purposes. This product line generated approximately $51 million of revenue in 2006. The disposition of this product line did not qualify to be reported as discontinued operations in our consolidated financial statements.

In December 2004, we sold our European operations, with the exception of one facility which was sold in the second quarter of 2006. Net income from discontinued operations for the quarter and six months ended June 30, 2006 consisted primarily of the net gain on disposal of the facility.

     During the second quarter of 2006, we determined that a software project intended to replace major portions of our existing order capture, billing and pricing systems would not meet our future business requirements in a cost-effective manner. Therefore, we made the decision to abandon the project. Accordingly, during the second quarter of 2006, we wrote down the carrying value of the related internal-use software to zero. This resulted in a non-cash asset impairment loss of $44.7 million. Of this amount, $26.4 million was allocated to the Financial Services segment and $18.3 million was allocated to the Small Business Services segment.

     Restructuring accruals of $2.9 million as of June 30, 2007 and $11.2 million as of December 31, 2006 are reflected in accrued liabilities and other non-current liabilities in the consolidated balance sheets. The accruals consist of employee severance benefits and payments due under operating lease obligations for facilities that we have vacated. During the six months ended June 30, 2007, we recorded restructuring accruals of $1.5 million related to employee reductions resulting from our cost savings initiatives. The restructuring accruals included severance benefits for 56 employees. Also during the first six months of 2007, we reversed $1.8 million of previously recorded restructuring accruals due to fewer employees receiving severance benefits than originally estimated and the re-negotiation of operating lease obligations. These restructuring charges, net of reversals, did not have a significant impact on any individual caption within our consolidated statement of operations for the six months ended June 30, 2007.

     The remaining severance accruals relate to employee reductions resulting from our cost savings initiatives. Severance payments related to the 2006 restructuring accruals are expected to be fully paid by the end of 2007 utilizing cash from operations. Severance payments for the 2007 restructuring accruals are expected to be paid by early 2008. The remaining payments due under the operating lease obligations will be paid through early 2009, utilizing cash from operations. 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 the 2006 Form 10-K.

     As of June 30, 2007, our restructuring accruals were as follows:

     We have historically provided certain health care benefits for a large number of retired employees. In addition to our postretirement medical plan, we also have supplemental executive retirement plans (SERPs) in the United States and Canada and a pension plan which covers certain Canadian employees. As discussed in Note 2, on January 1, 2007, we adopted the measurement date provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. As such, pension and postretirement benefit expense reflected in our consolidated statements of operations for the quarter and six months ended June 30, 2007 is based on a December 31, 2006 measurement date. Further information regarding our postretirement benefit plans can be found under the caption “Note 12: Pension and other postretirement benefits” in the Notes to Consolidated Financial Statements appearing in the 2006 Form 10-K.

     Pension and postretirement benefit expense for the quarters ended June 30, 2007 and 2006 consisted of the following components:

     Pension and postretirement benefit expense for the six months ended June 30, 2007 and 2006 consisted of the following components:

     Our effective tax rate for the six months ended June 30, 2007 was 36.2%, compared to our 2006 annual effective tax rate of 29.5%. Our 2006 effective tax rate included net favorable adjustments which lowered our effective tax rate 2.8 percentage points, including the true-up of certain deferred income tax balances, as discussed under the caption “Note 9: Provision for income taxes” of the Notes to Consolidated Financial Statements included in the 2006 Form 10-K. Our provision for income taxes for the six months ended June 30, 2007 included net discrete expense items of $1.5 million related to the non-deductible write-off of goodwill resulting from the sale of our industrial packaging product line, partially offset by other factors, primarily the impact of the final settlement of a contingent tax item. The impact of these discrete items on our effective tax rate was an increase of 1.3 percentage points.

     Total debt outstanding was comprised of the following:

     Our senior, unsecured notes include covenants that place restrictions on the issuance of additional debt, the execution of certain sale-leaseback agreements and limitations on certain liens. Discounts from par value are being amortized ratably as increases to interest expense over the term of the related debt.

     In May 2007, we issued $200.0 million of 7.375% senior, unsecured notes maturing on June 1, 2015. 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 June 29, 2007. Interest payments are due each June and December. The notes place a limitation on restricted payments, including dividends and share repurchases. This limitation does not apply if the notes are upgraded to an investment-grade credit rating. Principal redemptions may be made at our election at any time on or after June 1, 2011 at redemption prices ranging from 100% to 103.688% of the principal amount. We may also redeem up to 35% of the notes at a price equal to 107.375% of the principal amount plus accrued and unpaid interest using the proceeds of certain equity offerings completed before June 1, 2010. In addition, at any time prior to June 1, 2011, we may redeem some or all of the notes at a price equal to 100% of the principal

amount plus accrued and unpaid interest and a make-whole premium. If we sell certain of our assets or experience specific types of changes in control, we must offer to purchase the notes at 101% of the principal amount. Proceeds from the offering, net of offering costs were $196.5 million. These proceeds were used to repay amounts drawn on our credit facility and to invest in marketable securities. We plan to use proceeds from liquidating the marketable securities, together with an advance on our credit facilities, to repay the 3.5% unsecured notes due October 1, 2007. The fair market value of these notes was $201.0 million as of June 30, 2007, based on quoted market prices.

     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 SEC via a registration statement which became effective on November 23, 2004. Interest payments are due each April and October. Principal redemptions of the $275.0 million notes may be made at our election prior to their stated maturity. 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 in 2004. The fair market value of these notes was $555.5 million as of June 30, 2007, 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, thereby exhausting that registration statement. Interest payments are due each June and December. Principal redemptions may be made at our election prior to the stated maturity. 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 $266.3 million as of June 30, 2007, based on quoted market prices.

     As of June 30, 2007, we had a $500.0 million commercial paper program in place. Given our current credit ratings, the commercial paper market is not available to us. We also have committed lines of credit which are available for borrowing and to support our commercial paper program. The credit agreements governing the lines of credit contain customary covenants requiring a ratio of earnings before interest and taxes to interest expense of 3.0 times, as well as limits on the levels of subsidiary indebtedness. No commercial paper was outstanding during the six months ended June 30, 2007. The daily average amount outstanding under our lines of credit during the six months ended June 30, 2007 was $50.0 million at a weighted-average interest rate of 5.78%. As of June 30, 2007, no amounts were outstanding under our lines of credit. During 2006, the daily average amount outstanding under our commercial paper program and our lines of credit was $162.5 million at a weighted-average interest rate of 5.34%. As of December 31, 2006, no commercial paper was outstanding and $112.7 million was outstanding under our lines of credit at a weighted-average interest rate of 6.01%. As of June 30, 2007, amounts were available under our committed lines of credit for borrowing or for support of commercial paper, as follows:

     Absent certain defined events of default under our debt instruments, and as long as our ratio of earnings before interest, taxes, depreciation and amortization to interest expense is in excess of 2 to 1, our debt covenants do not restrict our ability to pay cash dividends at our current rate.

     We are in a shareholders’ deficit position due partially to the adoption on December 31, 2006 of the recognition provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. Adoption of SFAS No. 158 increased shareholders’ deficit $33.4 million as of December 31, 2006. Additionally, shareholders’ equity had been reduced due to the required accounting treatment for share repurchases, completed primarily in 2002 and 2003. 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 common shares, additional paid-in capital and retained earnings. We have not repurchased any shares since the second quarter of 2004. We have an outstanding authorization from our board of directors to purchase up to 10 million shares of our common stock. This authorization has no expiration date, and 7.9 million shares remain available for purchase under this authorization.

     Changes in shareholders’ deficit during the six months ended June 30, 2007 were as follows:

     Accumulated other comprehensive loss was comprised of the following:

     We operate three business segments: Small Business Services, Financial Services and Direct Checks. Small Business Services sells business checks, forms and related printed products to small businesses and home offices through financial institution referrals, direct response marketing, sales representatives, independent distributors and the internet. Financial Services sells personal and business checks, check-related products and services, and customer loyalty solutions to financial institutions. Direct Checks sells personal and business checks and related products and services directly to consumers through direct response marketing 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 the 2006 Form 10-K. We allocate corporate costs to our business segments, including costs of our executive management, human resources, supply chain, finance, information technology and legal functions. Generally, where costs incurred are directly attributable to a business segment, primarily within the areas of information technology, supply chain and finance, those costs are reported in that segment’s results. Due to our shared services approach to many of our functions, certain costs are not directly attributable to a business segment. These costs are allocated to our business segments based on segment revenue.

     Effective January 1, 2007, we reclassified as corporate assets the property, plant and equipment, internal-use software, inventories and supplies related to our corporate shared services functions of manufacturing, information technology and real estate. These assets had previously been managed as business segment assets and were reported within our business segments. As we realigned our organization and continued the implementation of a shared services approach for most functions, these assets are now managed as corporate assets which we do not allocate to our business segments. Other corporate assets consist primarily of long-term investments and deferred income taxes. Asset and capital expenditure information for prior periods has been recast to reflect this change. Amortization and depreciation expense related to corporate assets is allocated to our business segments based on segment revenue.

     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, 2007 and 2006:

     The following is our segment information as of and for the six months ended June 30, 2007 and 2006:

     Our business is organized into three segments: Small Business Services, Financial Services and Direct Checks. Our Small Business Services segment generated 57.5% of our consolidated revenue for the first six months of 2007. This segment sells business checks, forms and related printed products to more than six million small businesses and home offices through financial institution referrals, direct response marketing, sales representatives, independent distributors and the internet. Our Financial Services segment generated 28.8% of our consolidated revenue for the first six months of 2007. This segment sells personal and business checks, check-related products and services, and customer loyalty services to approximately 7,500 financial institution clients nationwide, including banks, credit unions and financial services companies. Our Direct Checks segment generated 13.7% of our consolidated revenue for the first six months of 2007. This segment is the nation’s leading direct-to-consumer check supplier, selling under the Checks Unlimited® and Designer® Checks brands. Through these two brands, we sell personal and business checks and related products and services directly to consumers using direct response marketing and the internet. We operate primarily in the United States. Small Business Services also has operations in Canada.

     Our net income for the first half of 2007 benefited from the following:

     These benefits were partially offset by higher performance-based employee compensation, lower revenue per order for our Financial Services segment and lower order volume for our Direct Checks segment. Our results for the first half of 2006 included a non-cash pre-tax asset impairment loss of $44.7 million and a $4.9 million pre-tax gain on the sale of a facility.

     In May 2007, we issued $200.0 million of 7.375% senior, unsecured notes maturing on June 1, 2015. Proceeds from the offering, net of offering costs, were $196.5 million. These proceeds were used to repay amounts drawn on our credit facility and to invest in marketable securities. We plan to use proceeds from liquidating the marketable securities, together with an advance on our credit facilities, to repay our 3.5% unsecured notes due October 1, 2007. Further information regarding the debt issued can be found under the caption “Note 11: Debt” of the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.

     Details concerning our strategies and business challenges were provided in the Management’s Discussion and Analysis of Financial Condition and Results of Operation section of our Annual Report on Form 10-K for the year ended December 31, 2006 (the 2006 Form 10-K). There were no significant changes to our strategies or business challenges during the first six months of 2007.

     As discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operation section of the 2006 Form
10-K, we are pursuing aggressive cost reduction and business simplification initiatives which we expect to collectively reduce our annual cost structure by at least $150 million, net of required investments, by the end of 2008. The baseline for these anticipated savings is the estimated cost structure for 2006 which was reflected in the earnings guidance reported in our press release on July 27, 2006 regarding second quarter 2006 results. Through June 2007, we estimate that we have realized approximately 40% cumulatively of our $150 million target. To date, most of our savings are from manufacturing, sales and marketing, and information technology. We are currently on track to achieve the upper end of our goal of realizing 50-55% of our $150 million target in 2007.

     We anticipate that consolidated revenue will be between $1.60 billion and $1.62 billion for 2007, as compared to $1.64 billion for 2006. As discussed in the 2006 Form 10-K, in January 2007, we completed the sale of our Small Business Services industrial packaging product line which generated approximately $51 million of revenue for 2006. Excluding the impact of the divestiture, we expect that low single digit revenue growth for Small Business Services will be mostly offset by continuing pricing pressure within Financial Services and volume pressure at Direct Checks. However, based on the strategies outlined in the 2006 Form 10-K, we anticipate that the revenue declines for our personal check businesses will decrease to single digit rates.

     We expect that 2007 diluted earnings per share will be between $2.70 and $2.80, compared to $1.96 for 2006. We expect that operating income will increase from 2006 due to our cost reduction initiatives, partially offset by the impact of revenue declines in our personal check businesses, higher performance-based employee compensation and other cost increases. Also, our results for 2006 included a non-cash pre-tax asset impairment loss of $44.7 million. We estimate that our annual effective tax rate for 2007 will range from 34% to 35% for the balance of the year, bringing the full year rate to 35% to 36%, given our higher first quarter rate.

     We anticipate that operating cash flow will be between $235 million and $250 million in 2007, compared to $239 million in 2006. Anticipated higher earnings and working capital improvements will be mostly offset by the $34.6 million benefit realized in 2006 from a decision to lower the level at which we pre-fund our voluntary employee beneficiary association (VEBA) trust, which is used to pay medical and severance benefits. We do not expect the sale of our industrial packaging product line to have a significant impact on operating cash flow. We expect capital spending to be approximately $30 million in 2007, with investment focused on manufacturing productivity, business simplification and non-check revenue growth. We also plan to continue paying down debt as we work towards strengthening our credit ratios and enhancing our financial flexibility.

     Revenue for the second quarter of 2007 decreased $3.1 million, as compared to the second quarter of 2006, primarily due to the sale of our industrial packaging product line in January 2007 and a decline in volume for our Direct Checks segment. Lower volume for Direct Checks was due to the overall decline in check usage, as well as lower customer retention, lower direct mail consumer response rates and lower advertising expenditures in prior periods which are negatively impacting reorder volumes in the current period. Partially offsetting these decreases was the acquisition of the Johnson Group in the fourth quarter of 2006 and higher revenue per order for Direct Checks due to the introduction of new products and services, including the EZShield^TM product, a fraud protection service which provides reimbursement to consumers for forged signatures or endorsements and altered checks. Also, check sales in Canada increased due to a new check format required by the Canadian Payments Association, and Financial Services revenue per order improved due to a price increase implemented in the first quarter of 2007 and a one-time benefit of $1.6 million from the resolution of contract matters.

     The number of orders decreased for the second quarter of 2007, as compared to the second quarter of 2006, due to declines for our personal check businesses and the sale of Small Business Services’ industrial packaging product line. Revenue per order increased in all three of our business segments for the second quarter of 2007, as compared to the second quarter of 2006.

     The $10.7 million decrease in revenue for the first half of 2007, as compared to 2006, was primarily due to the sale of our industrial packaging product line in January 2007, lower revenue per order given lower pricing in our Financial Services segment and a decline in volume for our Direct Checks segment for the same reasons as discussed for the quarter. Partially offsetting these decreases was the acquisition of the Johnson Group in the fourth quarter of 2006, increased volume for Financial Services due to client gains and financial institution conversion activity and higher revenue per order for Direct Checks due to the introduction of new products and services, including the EZShield product discussed earlier. Additionally, we benefited from increased check sales in Canada due to a new check format required by the Canadian Payments Association and a favorable impact on revenue at Direct Checks of approximately $3 million due to weather-related production and shipping disruptions during the last week of December 2006, which caused revenue to be delayed into 2007.

     The number of orders increased for the first half of 2007, as compared to 2006, as the Financial Services volume increase of 2.8% exceeded the negative impacts of Direct Checks’ volume decline and the sale of Small Business Services’ industrial packaging product line. Revenue per order decreased for the first half of 2007, as compared to 2006, as lower prices in Financial Services more than offset the impact of increases in revenue per order for Direct Checks and Small Business Services.

     Gross margin increased for the second quarter of 2007, as compared to the second quarter of 2006, primarily due to manufacturing efficiencies and 2006 costs related to the closing of two Small Business Services manufacturing facilities in mid-2006, as well as lower material costs in 2007 related to a higher mix of check products in Small Business Services.

     Gross margin increased for the first half of 2007, as compared to the first half of 2006, for the same reasons as discussed for the quarter. Additionally, we benefited from increased Financial Services check volume for the first half of 2007. Partially offsetting these gross margin increases was the lower Financial Services revenue per order discussed earlier.

     The decrease in SG&A expense for the second quarter and first half of 2007, as compared to the same periods in 2006, was primarily due to various cost reduction initiatives within our shared services organizations, lower amortization expense and project costs related to a software project we wrote-off in the second quarter of 2006 and investments made in 2006 related to implementing our Small Business Services strategy. Additionally, we benefited from lower marketing costs within Small Business Services as we increase our focus on gaining new customers through financial institution referrals. Partially offsetting these decreases were higher accruals for performance-based employee compensation for the second quarter and first half of 2007.

     During the second quarter of 2006, we determined that a software project intended to replace major portions of our existing order capture, billing and pricing systems would not meet our future business requirements in a cost-effective manner. Therefore, we made the decision to abandon the project. Accordingly, we wrote down the carrying value of the related internal-use software to zero. This resulted in a non-cash asset impairment loss of $44.7 million. Of this amount, $26.4 million was allocated to the Financial Services segment and $18.3 million was allocated to the Small Business Services segment.

     During the first quarter of 2007, we completed the sale of our Small Business Services industrial packaging product line for $19.2 million, realizing a pre-tax gain of $3.8 million. This sale had an insignificant impact on earnings per share because of an unfavorable effective tax rate specifically attributable to the gain. During the first quarter of 2006, we completed the sale of a Financial Services facility which was closed in 2004 for $6.0 million, realizing a pre-tax gain of $4.9 million.

     The decrease in interest expense for the second quarter and first half of 2007, as compared to 2006, was due to our lower average debt level in 2007, partially offset by slightly higher average interest rates.

     The decrease in our effective tax rate for the second quarter of 2007, as compared to the second quarter of 2006, was primarily due to the small pre-tax loss in 2006. Also, during the second quarter of 2007, we reduced our estimated annual effective tax rate as compared to the first quarter of 2007, mainly due to income from tax-exempt investments and discrete events recorded in the second quarter of 2007.

     The increase in our effective tax rate for the first half of 2007, as compared to 2006, was primarily due to the non-deductible write-off of goodwill related to the sale of our industrial packaging product line in 2007, partially offset by a higher estimated domestic production activities deduction, income from investments in tax-exempt securities beginning in the second quarter of 2007 and the impact of the final settlement of a contingent tax item.

     During 2006, we recorded restructuring accruals of $11.1 million for severance related to employee reductions within our shared services functions of sales, marketing, customer care, fulfillment, information technology, human resources and finance, as well as the closing of a Financial Services customer service call center located in Syracuse, New York. During the first six months of 2007, we recorded additional restructuring accruals of $1.5 million related to employees in these shared services functions. The Syracuse facility was closed in January 2007 and the other employee reductions are expected to be completed in 2007. These reductions were the result of the cost reduction initiatives discussed earlier under Executive Overview. Also during the first six months of 2007, we reversed $1.8 million of previously recorded restructuring accruals due to fewer employees receiving severance benefits than originally estimated and the re-negotiation of operating lease obligations. The restructuring accruals, net of reversals, included severance payments for 563 employees. Severance payments related to the 2006 restructuring accruals are expected to be fully paid by the end of 2007 utilizing cash from operations. Severance payments for the 2007 restructuring accruals are expected to be paid by early 2008. As a result of these initiatives, we expect to realize annual cost savings of approximately $3 million in cost of goods sold and $28 million in SG&A expense in 2007, in comparison to our 2006 results of operations. Reduced costs consist primarily of labor costs.

     Further information regarding our restructuring accruals can be found under the caption “Note 8: Restructuring accruals” of the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.

     Additional financial information regarding our business segments appears under the caption “Note 13: Business segment information” of the Condensed Notes to Unaudited Consolidated Financial Statements appearing in Item 1 of this report.