Consolidation–The consolidated financial statements include the accounts of the Company and all wholly owned subsidiaries. All significant intercompany accounts, transactions and profits have been eliminated.

In 1998, the dispositions of PaperDirect, Inc., and the Social Expressions unit of Current, Inc. (see Note 6), included the sale of LIFO inventories.

The Company evaluates the recoverability of long-lived assets held for disposal by comparing the asset’s carrying amount with its fair value less costs to sell. Should the fair value less costs to sell be less than the carrying value of the long-lived asset, an impairment loss would be recognized. The impairment loss would be calculated as the amount by which the carrying value of the asset exceeds the fair value of the asset less costs to sell. In keeping with this policy, the Company recorded a charge of $99 million in 1997 and $111.9 million in 1996 to write down businesses held for disposal within its Deluxe Direct and Deluxe Electronic Payment Systems segments (see Note 4).

In April 1998, AcSEC issued SOP 98-5, "Reporting the Costs of Start-up Activities," which provides guidance on the appropriate accounting for start-up activities. This statement is effective for the Company on January 1, 1999. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which provides guidance on accounting for derivatives and hedge transactions. This statement is effective for the Company on January 1, 2000. The Company anticipates that the effect of these pronouncements will not have a material impact on reported operating results.

The following table reflects the calculation of basic and diluted earnings per share.

In January 1998, the Company awarded options to substantially all employees (excluding foreign employees and employees of businesses held for sale), allowing them, subject to certain conditions, to purchase 100 shares of common stock at an exercise price of $33 per share. Options for the purchase of 1.7 million shares of common stock were issued under this program. Had these options been issued in previous years, the dilutive impact of options presented above for 1997 and 1996 may have differed.

In the first quarter of 1996, the Company announced a plan to close 21 of its financial institution check printing plants over a two-year period. The plant closings were made possible by advancements in the Company’s telecommunications, order processing and printing technologies. Also, during the first quarter of 1996, the Company announced a plan to move the operating and administrative facilities of one of its direct mail businesses from New Jersey to Colorado. In conjunction with these plans, the Company recorded a pretax restructuring charge of $45.4 million in 1996. The charge consisted of estimated costs for asset dispositions ($9 million) and employee severance ($36.4 million). The severance portion of this charge assumed the termination of approximately 1,300 employees in production, customer service and front-end processing functions. This charge is reflected in cost of sales ($35.2 million) and selling, general and administrative (SG&A) expense ($10.2 million) in the 1996 consolidated statement of income.

During the third quarter of 1997, the Company recorded pretax restructuring charges of $24.5 million. The charges included additional costs for closing the 21 plants discussed above and costs associated with the continued consolidation of the Company’s core businesses. The additional charge for plant closing costs represented amounts that could not be recorded in 1996 because they did not meet the requirements for accrual in that year. Termination of additional employees was expected to result from process improvements in the post-press phase of check production, implementation of a new order processing and customer service system and reductions in support functions at corporate operations and other businesses. The restructuring charges consisted of employee severance costs of $21.6 million and $2.9 million for expected losses on the disposition of assets. The severance portion of this charge assumed the termination of approximately 2,800 employees. Expenses of $7.7 million were included in cost of sales, $13.9 million in SG&A expense and $2.9 million in other expense in the 1997 consolidated statement of income. As of December 31, 1998, the production functions at all 21 plants were closed. The front-end operations of three of the plants remain open and are expected to close in 1999. Implementation of the new order processing and customer service system and improvements to the post-press production process are expected to be substantially completed in 1999. Through December 31, 1998, termination benefits of approximately $42.5 million have been paid to approximately 2,950 employees under the plans included in the 1996 and 1997 charges.

During the third quarter of 1998, the Company recorded pretax restructuring charges of $39.5 million. The charges included costs associated with reducing SG&A expense, discontinuing production of the Deluxe Direct Response segment’s direct mail products, and closing four additional financial institution check printing plants. The Company anticipates eliminating 800 SG&A positions within sales and marketing, finance and accounting, human resources, and information services. Discontinuing production of direct mail products will result in the elimination of approximately 60 positions. The Company also plans to close four additional financial institution check printing plants in 1999 and early 2000, affecting approximately 870 employees. The restructuring charges consisted of employee severance costs of $31.2 million and $8.3 million for expected losses on the disposition of assets. Expenses of $10.9 million were included in cost of sales, $21.1 million in SG&A expense and $7.5 million in other expense in the 1998 consolidated statement of income. Through December 31, 1998, termination benefits of approximately $1 million have been paid to approximately 100 employees under the 1998 plans.

The Company’s consolidated balance sheets reflect restructuring accruals of $45.7 million and $39.5 million as of December 31, 1998 and 1997, respectively, for employee severance costs, and $6.8 million and $3.7 million as of December 31, 1998 and 1997, respectively, for estimated losses on asset dispositions. The majority of the severance costs are expected to be paid in 1999 and early 2000 with cash generated from the Company’s operations.

In 1996, the Company announced plans to divest three businesses in the Deluxe Direct segment-Nelco, Inc., PaperDirect, Inc., and the Social Expressions unit of Current, Inc. In 1997, the Company determined that it would dispose of the international operations of the Deluxe Electronic Payment Systems segment, and in 1998 the Company determined that it would dispose of the businesses in the Deluxe Direct Response segment. The Company does not depreciate or amortize any of the long-term assets of businesses while they are held for disposal.

Based on fair market value estimates, the Company recorded charges of $99 million in 1997 and $111.9 million in 1996 to write down the carrying amounts of businesses held for sale to their estimated fair values less costs to sell. These charges are included in the 1997 consolidated statement of income in goodwill impairment charge ($82.9 million) and SG&A expense ($16.1 million), and in the 1996 consolidated statement of income in goodwill impairment charge. The disposal of the businesses in the Deluxe Direct and Deluxe Direct Response segments was completed in 1998. In January 1999, the Company determined that the international operations of the Deluxe Electronic Payment Systems segment maintained a continuing strategic importance within the segment and is no longer held for sale. This will not have a material impact on the results of operation or the financial position of the Company. At December 31, 1997, the aggregate remaining carrying amount of businesses held for sale on that date was $83 million. Together, all of the aforementioned businesses recorded sales of $270.4 million, $270.1 million and $292 million and contributed a net loss of $2.6 million, $13.2 million and $19.2 million in 1998, 1997 and 1996, respectively, excluding the impairment charges in 1997 and 1996.

During the third quarter of 1998, the Company recorded a charge of $36.4 million to reserve for expected future losses on existing long-term contracts and relationships of the Deluxe Government Services segment. This charge is reflected in cost of sales in the 1998 consolidated statement of income. This segment provides electronic benefits transfer services to state governments. Due to a continuing strong economy, record low unemployment and welfare reform, the actual transaction volumes and expected future revenues of this business are well below original expectations. Additionally, actual and expected future telecommunications, installation, help desk and other costs are significantly higher than originally anticipated, resulting in expected future losses on the existing electronic benefits transfer contracts and relationships of this business.

1998 divestitures–During 1998, the Company sold substantially all of the assets of PaperDirect (UK) Limited, ESP Employment Screening Partners, Inc., Social Expressions, and the businesses within the Deluxe Direct Response segment. The Company also sold all of the outstanding stock of PaperDirect, Inc. The aggregate net sales price for these businesses was $113.7 million, consisting of cash proceeds of $87.9 million and notes receivable of $25.8 million. The Company realized a loss of $10.5 million on the combined sale of PaperDirect and Social Expressions. The individual gains and losses recognized on the sales of the other businesses did not have a material impact on the results of the Company. The consolidated financial statements of the Company include the results of these businesses through their individual sale dates.

The following summarized, unaudited pro forma results of operations for the years ended December 31, 1998 and 1997, assume the divestitures occurred as of the beginning of the respective periods. No assumptions were made in the pro forma information concerning the use of the cash received in consideration for the sales of the businesses.

On December 31, 1998 and 1997, marketable securities available for sale consisted of the following:

Proceeds from sales of marketable securities available for sale were $19.2 million and $6.3 million in 1998 and 1996, respectively. The Company realized a net gain of $70,000 and a net loss of $36,000 on the sales of marketable securities in 1998 and 1996, respectively. There were no sales of marketable securities in 1997.

The components of the provision for income taxes are as follows:

Tax effected temporary differences which give rise to a significant portion of deferred tax assets and liabilities at December 31, 1998 and 1997, are as follows:

The valuation allowance at December 31, 1998 and 1997 relates to the uncertainty of realizing foreign and state deferred tax assets.

Stock purchase plan–The Company has an employee stock purchase plan that enables eligible employees to purchase the Company’s common stock at 75% of its fair market value on the first business day following each three-month purchase period. Compensation expense recognized for the difference between the employees’ purchase price and the fair value of the stock was $5.9 million, $6.7 million and $7.5 million in 1998, 1997 and 1996, respectively. Under the plan, 698,830, 840,143 and 907,424 shares were issued at prices ranging from $24.38 to $26.16, $22.88 to $24.75 and $22.41 to $28.04 in 1998, 1997 and 1996, respectively.

In 1998, the Company adopted the DeluxeSHARES program. Under this program, options were awarded to substantially all employees (excluding foreign employees and employees of businesses held for sale), allowing them, subject to certain conditions, to purchase 100 shares of common stock at an exercise price of $33 per share. The options become exercisable when the value of the Company’s common stock reaches $49.50 per share or January 30, 2001, whichever occurs first. Options for the purchase of 1.7 million shares of common stock were issued under this program.

All options allow for the purchase of shares of common stock at prices equal to their market value at the date of grant. Information regarding the options issued under the current plan, which was adopted in 1994, the remaining options outstanding under the former plan adopted in 1984, and the DeluxeSHARES plan, is as follows:

Pro forma information regarding net income and income per share has been determined as if the Company had accounted for its employee stock-based compensation under the fair value method of SFAS No. 123. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model. The following weighted-average assumptions were used in valuing options issued in 1998: risk-free interest rate of 5.94%, dividend yield of 4.52% and expected volatility of 21.75%. The following weighted-average assumptions were used in valuing options issued in 1997 and 1996: risk-free interest rate of about 6%, dividend yield of approximately 4% and expected volatility of 23%. The weighted-average expected option life was 5.90 years, 7.17 years and 6.90 years for 1998, 1997 and 1996, respectively. The weighted-average fair value of options granted in 1998, 1997 and 1996 was $5.99, $7.49 and $6.86 per share, respectively. For purposes of pro forma disclosures, the estimated fair value of the options was recognized as expense over the options’ vesting periods. The Company’s pro forma net income and income per share were as follows:

Contributions to the defined contribution pension plan equaled 4% of eligible compensation in 1998 and 6% of eligible compensation in 1997 and 1996. Related expense for these years was $13.7 million, $18.6 million and $19.9 million, respectively. Contributions to the profit sharing plans vary based on the Company’s performance. Expense for these plans was $27.5 million, $25.6 million and $44.5 million in 1998, 1997 and 1996, respectively. The 401(k) plan was established on January 1, 1997. Company contributions to this plan were $7.8 million and $7 million in 1998 and 1997, respectively.

The Company provides certain health care benefits for a large number of its retired employees. Employees included in the plan may become eligible for such benefits if they attain the appropriate years of service and age while working for the Company. Certain retirees’ medical insurance premiums are based on the amounts paid by active employees. Effective January 1, 1998, active employees’ premiums were reduced, thus reducing the medical premiums required to be paid by these retirees. Additionally, for retirees who participate in the active employees’ indemnity plans, their copayment amount was increased 5%. In 1997, the plan was also amended to provide employees who are involuntarily terminated and who are qualified retirees at the time of termination with a bridge for retiree medical benefits if they are terminated prior to age 53.

The following table summarizes the change in benefit obligation and plan assets during 1998 and 1997 (dollars in thousands):

In measuring the accumulated postretirement benefit obligation as of December 31, 1998, the Company’s health care inflation rate for 1999 was assumed to be 7%. Inflation rates are assumed to trend downward gradually over the next two years to 5% for the years 2000 and beyond. A one percentage point increase in the health care inflation rate for each year would increase the accumulated postretirement benefit obligation by approximately $11.9 million, and the service and interest cost components of the net postretirement benefit cost by approximately $1 million. A one percentage point decrease in the health care inflation rate for each year would decrease the accumulated postretirement benefit obligation by approximately $10.4 million, and the service and interest cost components of the net postretirement benefit cost by approximately $.9 million. The discount rate used in determining the accumulated postretirement benefit obligation as of December 31, 1998 and 1997, was 6.75% and 7.25%, respectively. The expected long-term rate of return on plan assets used to determine the net periodic postretirement benefit cost was 9.5% in 1998, 1997 and 1996.

Long-term debt was as follows at December 31:

Other long-term debt consists principally of capital leases on equipment. The capital lease obligations bear interest rates of 3.7% to 16.2% and are due through the year 2011. Carrying value materially approximates fair value for these obligations.

Maturities of long-term debt for the five years ending December 31, 2003, are $7.3 million, $2.9 million, $101.8 million, $1.0 million and $.1 million, and $.6 million thereafter.

The Company has uncommitted bank lines of credit for $145 million available at variable interest rates. No amounts were drawn on these lines during 1998. The average amount drawn on these lines during 1997 was $3.1 million at a weighted-average interest rate of 6.47%. There was no outstanding balance at December 31, 1998 and 1997 on these lines of credit. The Company also has in place a $150 million committed line of credit available for borrowing and as support for commercial paper. As of December 31, 1998 and 1997, the Company had no commercial paper outstanding and no indebtedness outstanding under its committed line of credit. Additionally, the Company has a shelf registration in place for the issuance of up to $300 million in medium-term notes. Such notes could be used for general corporate purposes, including working capital, capital expenditures, possible acquisitions and repayment or repurchase of outstanding indebtedness and other securities of the Company. As of December 31, 1998 and 1997, no such notes were issued or outstanding.

Minimum future rental payments for leased facilities and equipment for the five years ending December 31, 2003, are $31.6 million, $22.7 million, $10.5 million, $5.7 million and $2.7 million, and $4.5 million thereafter. Rental expense was $45.4 million, $40.9 million and $40.4 million, for 1998, 1997 and 1996, respectively.

Absent certain defined events of default under the Company’s $150 million committed credit facility or the indenture related to its outstanding 8.55% unsecured and unsubordinated notes due February 15, 2001, there are no significant contractual restrictions on the ability of the Company to pay cash dividends.

On February 5, 1988, the Company declared a distribution to shareholders of record on February 22, 1988, of one common stock purchase right for each outstanding share of common stock. These rights were governed by the terms and conditions of a rights agreement entered into by the Company as of February 12, 1988. That agreement was amended and restated as of January 31, 1997 (Restated Agreement).

Pursuant to the Restated Agreement, upon the occurrence of certain events, each right will entitle the holder to purchase one share of common stock at an exercise price of $150. In certain circumstances described in the Restated Agreement, if (i) any person becomes the beneficial owner of 15% or more of the Company’s common stock, (ii) the Company is acquired in a merger or other business combination or (iii) upon the occurrence of other events, each right will entitle its holder to purchase a number of shares of common stock of the Company, or the acquirer or the surviving entity if the Company is not the surviving corporation in such a transaction. The number of shares purchasable will be equal to the exercise price of the right divided by 50% of the then-current market price of one share of common stock of the Company, or other surviving entity (i.e., at a 50% discount), subject to adjustments provided in the Restated Agreement. The rights expire January 31, 2007, and may be redeemed by the Company at a price of $.01 per right at any time prior to the occurrence of the circumstances described above.

During the third quarter of 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which requires the disclosure of financial and descriptive information about the reportable operating segments of the Company. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of this statement did not affect the Company’s results of operations or financial position.

The Company has organized its business units into six operating segments based on the nature of the products and services offered by each: Deluxe Paper Payment Systems, Deluxe Payment Protection Systems, Deluxe Electronic Payment Systems, Deluxe Direct Response, Deluxe Government Services and Deluxe Direct. Deluxe Paper Payment Systems provides check printing services to financial services companies and markets checks and business forms directly to households and small businesses. Deluxe Payment Protection Systems provides payment protection, collection and risk management services to financial institutions and retailers. Deluxe Electronic Payment Systems provides electronic funds transfer processing and software services to the financial and retail industries. Deluxe Direct Response, which was sold in 1998, provided direct marketing, customer database management and related services to the financial industry and other businesses. Deluxe Government Services provides electronic benefits transfer services to state governments. Deluxe Direct, which was sold in 1998, primarily sold greeting cards, stationery, and specialty paper products through direct mail. All segments operate primarily in the United States. Deluxe Electronic Payment Systems also has international operations. No single customer of the Company accounted for more than 10% of net sales in 1998, 1997 or 1996.

The accounting policies of the segments are the same as those described in Note 1. In evaluating segment performance, management focuses on income from operations. This measurement excludes special charges (e.g., restructuring charges, asset impairment charges, charges for legal proceedings, etc.), interest expense, investment income, income tax expense and other non-operating items, such as gains or losses from asset disposals. Corporate expenses are allocated to the segments as a fixed percentage of segment revenues. This allocation includes expenses for various support functions such as human resources, information services and finance and includes depreciation and amortization expense related to corporate assets. The corresponding corporate asset balances are not allocated to the segments. Most intersegment sales are based on current market pricing.

Revenues are attributed to geographic areas based on the location of the assets producing the revenues. The Company’s operations by geographic area are as follows:

During 1997, a judgment was entered against Deluxe Electronic Payment Systems, Inc. (DEPS), in the U.S. District Court for the Western District of Pennsylvania. The case was brought against DEPS by Mellon Bank in connection with a potential bid to provide electronic benefit transfer services for the Southern Alliance of States. In September 1997, the Company recorded a pretax charge of $40 million to reserve for this judgment and other related costs. This charge was reflected in other expense in the 1997 consolidated income statement. At December 31, 1997, the remaining liability for this obligation was $40 million and was classified as other long-term liabilities in the consolidated balance sheet.

In 1998, Mellon’s motion for prejudgment interest was denied by the district court and the Company reversed $4.2 million of the $40 million liability. This reversal is reflected in other income in the 1998 consolidated statement of income. In January 1999, the United States Court of Appeals for the Third Circuit affirmed the judgment of the district court. At December 31, 1998, the remaining liability of $34.4 million was classified as other accrued liabilities in the consolidated balance sheet.

In February 1999, the Company acquired all of the outstanding shares of eFunds Corporation for $13 million. eFunds provides electronic check conversion solutions for financial services companies and retailers. This acquisition was accounted for under the purchase method of accounting. Accordingly, the consolidated financial statements of the Company will include the results of this business subsequent to its acquisition date. The purchase price was allocated to the assets acquired and liabilities assumed based on their fair values on the date of purchase. The estimated total cost in excess of net assets acquired of $15.7 million will be reflected as goodwill and will be amortized over 10 years. The effect of this acquisition was not material to the operations or financial position of the Company.

In January 1999, the Company’s appeal of the judgment against its subsidiary, Deluxe Electronic Payment Systems, Inc., was denied by the Third Circuit Court of Appeals and the Company paid $32.2 million to Mellon Bank in February 1999. The Company is reviewing whether a further appeal is warranted (see Note 15).