UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2003.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-11427
NEW ENGLAND BUSINESS SERVICE, INC.
----------------------------------
(Exact name of the registrant as specified in its charter)
Delaware 04-2942374
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 Main Street
Groton, Massachusetts, 01471
----------------------------
(Address of principal executive offices)
(Zip Code)
(978) 448-6111
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 and 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 X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
The number of common shares of the Registrant outstanding on November 12, 2003
was 13,220,338.
PART I - FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
- ----------------------------
NEW ENGLAND BUSINESS SERVICE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
Sept. 27, June 28,
2003 2003
-------- --------
ASSETS
Current Assets
Cash and cash equivalents $ 3,226 $ 4,743
Accounts receivable, net 71,850 71,049
Inventories, net 45,420 39,792
Direct mail advertising materials, net
and prepaid expenses 24,817 18,710
Deferred income tax benefit 13,922 14,041
-------- --------
Total current assets 159,235 148,335
Property and Equipment 79,108 80,110
Property Held for Sale - 328
Deferred Income Tax Benefit 20,728 20,728
Goodwill, net 92,208 88,001
Other Intangible Assets, net 73,753 76,292
Other Assets 5,576 4,672
-------- --------
TOTAL ASSETS $430,608 $418,466
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 22,966 $ 22,937
Accrued expenses 68,019 65,192
Obligations under capital lease-current portion 643 764
-------- --------
Total current liabilities 91,628 88,893
Long-Term Debt 162,379 157,025
Deferred Income Taxes 21,377 21,377
STOCKHOLDERS' EQUITY
Common stock 15,944 15,889
Additional paid-in capital 61,093 59,111
Unamortized value of restricted stock awards (2,270) (487)
Accumulated other comprehensive loss (2,420) (2,626)
Retained earnings 138,828 135,634
-------- --------
Total 211,175 207,521
Less Treasury stock, at cost (55,951) (56,350)
-------- --------
Stockholders' Equity 155,224 151,171
-------- --------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $430,608 $418,466
======== ========
See Notes to Condensed Consolidated Financial Statements
NEW ENGLAND BUSINESS SERVICE, INC.
STATEMENTS OF CONSOLIDATED INCOME
(In thousands, except per share data)
Three Months Ended
Sept. 27, Sept. 28,
2003 2002
-------- --------
NET SALES $167,288 $128,851
COST OF SALES 69,142 54,279
-------- --------
GROSS PROFIT 98,146 74,572
OPERATING EXPENSES:
Selling and advertising 61,894 43,999
General and administrative 24,108 19,317
Exit costs 791 -
-------- --------
Total operating expenses 86,793 63,316
-------- --------
INCOME FROM OPERATIONS 11,353 11,256
OTHER (EXPENSE)/INCOME:
Interest income 83 32
Interest expense (1,750) (3,077)
Loss on settlement of interest rate swaps - (3,211)
Gain on sale of long-term investment - 6,322
-------- --------
Total other(expense)/income (1,667) 66
-------- --------
INCOME BEFORE INCOME TAXES 9,686 11,322
PROVISION FOR INCOME TAXES 3,874 4,348
-------- --------
NET INCOME $ 5,812 $ 6,974
======== ========
PER SHARE AMOUNTS:
Basic Earnings Per Share $ .44 $ .54
======== ========
Diluted Earnings Per Share $ .43 $ .52
======== ========
Dividends Paid $ .20 $ .20
======== ========
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 13,062 13,025
Plus incremental shares from assumed
conversion of stock options and
contingently returnable shares 561 360
-------- --------
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 13,623 13,385
======== ========
See Notes to Condensed Consolidated Financial Statements
NEW ENGLAND BUSINESS SERVICE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Three Months Ended
Sept. 27, Sept. 28,
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 5,812 $ 6,974
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 5,885 5,017
Amortization 2,563 1,784
Exit costs 791 -
Loss/(gain) on disposal of equipment 11 (2)
Gain on sale of long-term investment - (6,322)
Provision for losses on accounts receivable 1,148 1,507
Deferred grants - (2)
Employee benefit charges 448 214
Changes in assets and liabilities:
Accounts receivable (1,925) (1,186)
Inventories and advertising material (10,327) (6,427)
Prepaid expenses and other assets (1,554) (555)
Accounts payable 26 (11)
Income taxes payable (1,501) 2,100
Other accrued expenses 1,343 (2,039)
-------- --------
Net cash provided by operating activities 2,720 1,052
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (4,943) (4,124)
Purchase of long-term investment - (5,421)
Proceeds from sale of long-term investment - 42,264
Proceeds from sale of building 370 -
Proceeds from sale of equipment - 11
Acquisition of business (2,129) -
-------- --------
Net cash (used)/provided by
investing activities (6,702) 32,730
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt (14,967) (52,734)
Proceeds from borrowings - net of issuance costs 20,177 22,498
Proceeds from issuance of common stock 2,480 6
Acquisition of treasury stock (2,608) -
Dividends paid (2,618) (2,609)
-------- --------
Net cash provided/(used) by
financing activities 2,464 (32,839)
EFFECT OF EXCHANGE RATE CHANGES ON CASH 1 (271)
-------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS (1,517) 672
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,743 6,112
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,226 $ 6,784
======== ========
See Notes to Condensed Consolidated Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
1. Basis of Presentation/Accounting Policies
- --------------------------------------------
The condensed consolidated financial statements contained in this report are
unaudited, but reflect all adjustments, consisting only of normal recurring
adjustments, which are, in the opinion of management, necessary for a fair
presentation of the results of the interim periods reflected. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been omitted pursuant to applicable rules and
regulations of the Securities and Exchange Commission. The condensed
consolidated financial statements included herein should be read in
conjunction with the consolidated financial statements and notes thereto, and
the Independent Auditors' Report in the Company's Annual Report on Form 10-K
for the fiscal year ended June 28, 2003. Reference is made to the accounting
policies of the Company described in the notes to the consolidated financial
statements in the Company's Annual Report on Form 10-K for the fiscal year
ended June 28, 2003. The Company has consistently followed those policies in
preparing this report. The results from operations for the interim periods
reported herein are not necessarily indicative of results to be expected for
the full year.
2. Acquisitions
- -----------------
In March 2003, the Company acquired certain assets of the payroll division of Parkwood Computer
Services, Inc. ("NEBS Payroll Service Limited") for approximately $1,200. The Company acquired NEBS
Payroll Service Limited to provide economical full-service payroll services to Canadian small businesses.
The acquisition was accounted for using the purchase method of accounting. Accordingly, NEBS Payroll
Service Limited's results from operations are included in the accompanying financial statements from the
date of acquisition. The purchase price, including acquisition costs, was allocated to the net tangible
assets acquired based on the fair value of such assets. The excess cost over fair value of the net
tangible assets acquired was $477, of which $44 and $39 were allocated to customer lists and tradenames,
respectively, and the balance of $394 to goodwill.
In June 2003, the Company acquired all the outstanding shares of Safeguard Business Systems, Inc.
("SBS"). The purchase price totaled approximately $73,587 (net of cash and restricted cash acquired) for
the shares. The purchase price is also subject to a post-closing working capital adjustment. The Company
also incurred fees of approximately $1,332 in connection with the acquisition which are included in the
purchase price above. The Company acquired SBS in order to expand its customer base in the small business
market. The SBS distributor channel and product set are highly complementary to the Company's business
model. The acquisition was accounted for using the purchase method of accounting. Accordingly, SBS's
results from operations are included in the accompanying financial statements from the date of
acquisition. The purchase price, including acquisition costs, was allocated to the net tangible assets
acquired based on the fair value of such assets and liabilities. The excess cost over fair value of the
net tangible assets acquired was $67,627, of which $34,560 was allocated to long-term contracts and the
balance of $33,067 to goodwill. These allocations are still subject to final fixed and intangible asset
valuations. The long-term contracts are being amortized over their estimated respective useful lives
estimated at 10 years.
The cost to acquire NEBS Payroll Service Limited and SBS has been allocated to the assets acquired and
liabilities assumed according to estimated fair values. The following table summarizes the estimated fair
values of the assets acquired and liabilities assumed for NEBS Payroll Service Limited and SBS at the
date of their acquisition:
NEBS Payroll
Service Limited SBS Total
------------------ -------- --------
Current assets $ - $25,633 $25,633
Deferred tax asset - 1,533 1,533
Property and equipment 723 8,789 9,512
Intangible assets 83 34,560 34,643
Goodwill 394 33,067 33,461
Current liabilities - (29,995) (29,995)
-------- -------- --------
Total purchase price $ 1,200 $73,587 $74,787
======== ======== ========
The following unaudited pro forma financial information reflects the consolidated results from
operations of the Company for the fiscal quarter ended September 28, 2002 as though the acquisitions
described above had occurred on the first day of the respective fiscal quarter. The pro forma operating
results are presented for comparative purposes only and do not purport to present the Company's actual
operating results had the acquisitions been consummated on June 29, 2002 or results which may occur in
the future:
Three Months Ended
Sept. 28,
2002
-------
Net sales $167,711
Net income 7,429
Net income per diluted share 0.56
3. Restructuring
- -----------------
During fiscal year 2001, the Company undertook two distinct restructuring actions. The first
resulted in a net restructuring charge of $4,523 in fiscal years 2002 and 2001 to provide for costs
primarily associated with the Company's decision to more closely align its direct marketing and direct
sales activities. As part of the restructuring program, the McBee US headquarters was relocated from
Parsippany, New Jersey to the existing RapidForms facility in Thorofare, New Jersey. In addition, the
McBee manufacturing plant in Damascus, Virginia was closed and a portion of leased warehousing space
occupied by Chiswick in Sudbury, Massachusetts was vacated. In Canada, the McBee sales and marketing
organizations were combined with the NEBS direct marketing organization and are operating under the NEBS
name. The second restructuring resulted in a net charge of $3,322 in fiscal years 2002 and 2001 to
provide for costs associated with the Company's decision to eliminate excess capacity by closing a
manufacturing facility in Ogden, Utah and a leased distribution facility in Sudbury, Massachusetts, along
with other actions to reduce the workforce in various locations. Approximately 315 employees were
affected by these restructuring actions either through elimination of their positions or relocation.
During fiscal year 2003, the Company implemented a workforce reduction in specific areas of the
business, affecting approximately 44 employees. This action primarily included the closure of a sales
office in Canada, as well as targeted reductions of staff in the Company's direct marketing operation in
Groton as well as in Chiswick and PremiumWear. In addition, as part of the purchase accounting for the
SBS acquisition and included in the allocation of the acquisition costs, a liability of $3,300 was
recorded to cover the anticipated costs (primarily termination benefits) related to a plan to close
redundant SBS manufacturing and warehouse facilities and to reduce manufacturing and administrative
personnel.
During fiscal year 2004, the Company announced its plans to close a manufacturing plant in
Peterborough, New Hampshire after an extensive review of the Company's manufacturing capacity following
the SBS acquisition. The manufacturing activities will be absorbed into other existing facilities during
the current fiscal year with operations in Peterborough, New Hampshire expected to cease by June 26,
2004.
Pursuant to these plans, the following charges and payments have been accrued and recorded:
Balance Charge/ Balance
June 28, (credit) for Payments for Sept. 27,
2003 the period the period 2003
------------- ------------- ------------- ---------
2001 Restructuring
- --------------------
Facility closure costs $ 511 $ - $ (458) $ 53
Employee termination 62 - (22) 40
benefit costs
2003 Restructuring
- --------------------
Facility closure costs 548 (14) (38) 496
Employee termination
benefit costs 3,606 222 (1,118) 2,710
2004 Restructuring
- --------------------
Employee termination
benefit costs - 507 - 507
------- -------- -------- ---------
Total $4,727 $ 715 ($1,636) $3,806
======= ======== ======== =========
The activities related to all restructuring actions identified above are anticipated to be completed
by the Company during fiscal year 2004, however payments for employee termination benefits and idle
facilities maintenance will extend beyond that time period.
Additional information related to exit costs expected to be incurred and expensed during the period
is as follows:
Exit Cumulative
Exit costs incurred exit costs
costs expected for the period ended incurred as of
to be incurred Sept. 27, 2003 Sept. 27, 2003
------------- ------------ -----------
2001 Restructuring
- --------------------
Facility closure costs $ 3,240 $ - $ 3,240
Employee termination
benefit costs $ 4,486 - 4,486
2003 Restructuring
- --------------------
Facility closure costs 248 (14) 248
Employee termination
benefit costs 1,077 222 1,077
2004 Restructuring
- --------------------
Employee termination
benefit costs 1,700 545 545
Facility closure costs 1,300 8 8
Other associated costs 1,200 30 30
--------- ----------- -----------
Total $13,251 $ 791 $ 9,634
========= =========== ===========
4. Inventories, net
- -------------------
Inventories are carried at the lower of first-in, first-out cost or market.
Inventories at September 27, 2003 and June 28, 2003 consisted of:
Sept.27, June 28,
2003 2003
------- -------
Raw Material $ 4,640 $ 4,594
Work in Process 18 -
Finished Goods 40,762 35,198
------ -------
Total $45,420 $39,792
======= =======
5. Long-Term Investment
- -----------------------
In March 2000, the Company invested $12,869 in the common stock of
Advantage Payroll Services, Inc. In August 2001 and July 2002, the Company
invested an additional $17,652 and $5,421, respectively, in the common stock
of Advantage Payroll Services, Inc. for a total investment of $35,942. In
September 2002, Advantage merged with Paychex, Inc. The Company received a
total of $47,366 in proceeds from the merger and recognized a gain of $11,424
in the year ended June 28, 2003.
The Company used the proceeds from the sale of the Advantage investment
to pay down floating rate debt and to terminate three interest rate swap
agreements with a notional amount of $75,000 with two commercial banks during
fiscal year 2003. These interest rate swaps were no longer needed to hedge the
reduced level of the Company's floating rate debt. The Company was required
to make termination payments equivalent to the fair value of the swaps
totaling $3,277. This amount, which was reclassified from other comprehensive
income to other expense, represents a loss on settlement of interest rate
swaps to terminate the agreements.
6. Goodwill and Other Intangible Assets
- ------------------------------------------
The Company completed the annual intangible asset impairment test as of
April 26, 2003 using a discounted cash flows analysis and recognized an
impairment charge to write-off goodwill and long-term contracts in the amounts
of $9,624 and $3,625, respectively, relating to its Premiumwear business
within its Apparel business segment. The impairment loss is recognized in the
consolidated statements of income for the fiscal year ended June 28, 2003
under "Operating Expenses".
Intangible assets consist of the following:
June 28, Sept. 27,
2003 2003
---------- ---------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------------- ------------ -------------- ------------
Intangible assets with
defined lives:
Customer lists $46,367 $42,336 $46,373 $43,785
Debt issue costs 3,517 1,840 3,542 1,987
Long-term contracts 36,238 1,285 36,231 2,161
Bank referral agreements 7,400 1,881 7,400 1,972
Intangible assets with
indefinite lives:
Tradenames 32,839 2,727 32,839 2,727
-------- -------- -------- --------
Total intangible assets $126,361 $50,069 $126,385 $52,632
======== ======== ======== ========
Changes in the carrying amount of goodwill (net) for the three months ended
September 27, 2003, by segment, are as follows:
Direct and Packaging
Direct Distributor and Display
Marketing-US Sales Apparel Products International Total
----------- ----------- ----------- ----------- ------------- ------
Balance
June 28, 2003 $24,237 $36,361 $ - $23,246 $ 4,157 $88,001
Goodwill acquired-
SBS - 4,207 - - - 4,207
-------- -------- -------- -------- -------- --------
Balance
Sept. 27, 2003 $24,237 $40,568 $ - $23,246 $ 4,157 $92,208
======== ======== ======== ======== ======== ========
Amortization of intangible assets with defined lives for the three months ended September 27, 2003
was $2,563. Estimated amortization of intangible assets for fiscal years 2004, 2005, 2006, 2007 and
2008, without consideration of any other increases or decreases in the balance of the assets, is
$8,450, $4,484, $4,296, $3,932 and $3,932, respectively.
7. Stock Options
- ------------------
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require,
companies to record compensation cost for stock-based employee compensation plans at fair value. The
Company has chosen to continue to account for stock-based compensation using the intrinsic-value
method prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. Accordingly, compensation costs of stock-based employee
compensation is measured as the excess, if any, of the fair value of the stock at the date of the
grant over the option exercise price and is charged to operations over the vesting period.
If the fair-value-based accounting method was utilized for stock-based compensation, the Company's
pro forma net earnings would have been as follows:
Three Months Ended
Sept. 27, Sept. 28,
2003 2002
-------- -------
Net income:
As reported $ 5,812 $ 6,974
Deduct total stock-based compensation
expense determined under the
intrinsic-value method for all awards,
net of related tax effects - -
Deduct total stock-based compensation
expense determined under the fair-value
method for all awards, net of related
tax effects (75) (232)
------- --------
Pro forma $ 5,737 $ 6,742
======== ========
Net income per basic share:
As reported $ 0.44 $ 0.54
Pro forma 0.44 0.52
Net income per diluted share:
As reported $ 0.43 $ 0.52
Pro forma 0.42 0.50
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model. The weighted-average grant date
fair value of options granted during the three months ended September 27, 2003
and September 28, 2002, respectively, were $8.52 and $6.48. It should be noted that
the Black-Scholes option pricing model used in the calculation was designed to value
readily tradable stock options with relatively short lives. The options granted to employees
are not tradable and have contractual lives of up to ten years. Management believes that the
assumptions used and the model applied to value the awards yield a reasonable estimate of the fair
value of the grants made under the circumstances.
8. Other Comprehensive Income
- -----------------------------
Other Comprehensive Income consists of foreign currency translation
adjustments, pension adjustments, unrealized gains and losses on investments
and changes in the fair market value of cash flow hedges. The Company's
comprehensive income is set forth below:
Three Months Ended
Sept. 27, Sept. 28,
2003 2002
-------- -------
Net Income $ 5,812 $ 6,974
Changes in:
Unrealized gains
on investments,
net of tax 63 159
Foreign currency
translation adjustments, net 27 (766)
Unrealized gains on derivatives
held for hedging purposes, net of tax 116 2,076
-------- -------
Comprehensive income $ 6,018 $ 8,443
======== =======
The Company's accumulated other comprehensive loss is set forth below:
Balance Balance
Sept. 27, June 28,
2003 2003
--------- ----------
Unrealized gains/(losses)
on investments,
net of tax $ 48 $ (15)
Foreign currency
translation adjustments, net (1,046) (1,073)
Pension adjustments, net of tax (1,055) (1,055)
Unrealized losses on derivatives
held for hedging purposes, net of tax (367) (483)
-------- -------
Total $(2,420) $(2,626)
======== =======
9. Financial Information by Business Segment
- --------------------------------------------
The Company has identified five reportable segments. The first segment is
"Direct Marketing-US" and represents those business operations that sell
principally printed products such as checks and business forms to small
businesses through direct marketing in the United States. The second segment,
"Direct and Distributor Sales", also sells primarily checks and business forms
to small businesses; however, they sell through a direct sales force to the
customer and through local, dedicated, independent distributors in the United
States and Canada. The third segment, "Apparel", utilizes independent sales
representatives to market its specialty apparel products and to solicit orders
from customers in the promotional products/advertising specialty industry.
"Packaging and Display Products", the fourth segment, primarily resells
packaging and shipping supplies and retail signage marketed through a
combination of direct marketing and direct selling efforts. The fifth segment,
"International", sells principally printed products such as checks and
business forms to small businesses in Europe and Canada through direct
marketing, independent distributors or by directly selling to the customer.
The Company evaluates segment performance and allocates resources based on
a profit from operations measure. This measure is similar to income from
operations as reported on the statements of consolidated income in that it
excludes interest and other income and expense. This measure, however, also
excludes certain items that are reported within income from operations. These
include management incentive compensation, amortization, integration charges,
restructuring charges, impairment charges and corporate expenses. The
individuals performing the function of chief operating decision-maker by
overseeing the performance of all the segments, in assessing segment results,
do not consider these items.
In order to reconcile the segment numbers to the Company's income before
income taxes, adjustments representing the items listed above totaling $11,063
and $6,162 for the three months ended September 27, 2003 and September 28,
2002, respectively, need to be made to the reported segment results.
Net sales and profit from operations for each of the Company's business segments are set forth below:
Direct and Packaging
Direct Distributor and Display
Marketing-US Sales Apparel Products International Total
----------- ----------- ----------- ----------- ------------- ------
Three months ended
Sept. 27, 2003
Net sales $61,613 $66,587 $ 9,396 $19,618 $10,074 $167,288
Profit (loss)
from
operations 14,680 5,794 (398) 625 48 20,749
Less
adjustments
listed above 11,063
Income before
income taxes $ 9,686
Three months ended
Sept. 28, 2002
Net sales $63,886 $26,546 $ 9,758 $19,629 $ 9,032 $128,851
Profit (loss)
from
operations 14,967 2,356 (708) 419 450 17,484
Less
adjustments
listed above 6,162
Income before
income taxes $ 11,322
10. New Accounting Pronouncements
- -------------------------------
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS 149 amended certain
provisions of SFAS 133 for decisions made by the Board as part of the
Derivatives Implementation Group (DIG) process. This statement is effective
for contracts entered into or modified after June 30, 2003. The adoption of
SFAS No. 149 did not have a material impact on the Company's consolidated
financial position or results of operations.
In May 2003, SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity," was issued. This
statement establishes standards concerning the classification and measurement
of certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003 and is otherwise primarily effective for the
Company on July 1, 2003. The adoption of SFAS No. 150 did not have a material
impact on the Company's consolidated financial position or results of
operations.
11. Contingencies
- -----------------
On June 30, 2000, a complaint entitled "Perry Ellis International, Inc.
v. PremiumWear Inc.", was filed. The Company was subsequently named a co-
defendant. The amended complaint relates to a Right of First Refusal
Agreement dated as of May 22, 1996 (the "RFR Agreement") between the
plaintiff and PremiumWear, Inc., and to the Company's acquisition of all the
outstanding shares of PremiumWear in July 2000. In the amended complaint, the
plaintiff alleges breach of the RFR Agreement and breach of an implied
covenant of good faith and fair dealing against PremiumWear as a result of
PremiumWear's alleged failure to notify the plaintiff of certain discussions
between PremiumWear and the Company preceding the Company's agreement to
purchase all of the outstanding shares of PremiumWear. The amended complaint
also alleges that the Company tortiously interfered with the plaintiff's
rights under the RFR Agreement by allegedly inducing PremiumWear to breach
its obligations to the plaintiff under the RFR Agreement. The plaintiff is
seeking damages in an unspecified amount, attorneys' fees, interest and
costs. The Company believes the allegations in the amended complaint are
without merit and intends to defend the lawsuit vigorously.
On July 24, 2002, a class action lawsuit entitled "OLDAPG, Inc. v. New
England Business Service, Inc." was filed in the Court of Common Pleas of the
Ninth Judicial Circuit in and for Charleston County, South Carolina. The
named plaintiff in the lawsuit seeks to represent a class consisting of all
persons who allegedly received facsimiles containing unsolicited advertising
from the Company in violation of the Telephone Consumer Protection Act of
1991 (the "TCPA"). The litigation has been settled by agreement between the
parties on terms which the Company believes will not be material to its
financial condition and results of operations. The settlement agreement has
received preliminary approval of the court, with final approval of the
settlement set for hearing on December 2, 2003.
The Company is also involved in a number of other legal matters related to
the business and in the opinion of management the outcome of these matters
will not have a material effect on the Company's consolidated financial
position or results of operations.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- -------------------------------------------------------------------
Overview
- --------
New England Business Service, Inc. (the "Company") was founded in 1952,
incorporated in Massachusetts in 1955 and reincorporated in Delaware in 1986.
The Company designs, produces and distributes business forms, checks,
envelopes, labels, greeting cards, signs, stationery and related printed
products, and distributes packaging, shipping and warehouse supplies,
software, work and promotional apparel, advertising specialties and other
business products through direct mail, direct sales, telesales, dealers,
dedicated distributors and the Internet to small businesses throughout the
United States, Canada, the United Kingdom and France. The Company also
markets and sells payroll services provided by a payroll services company on
a private label basis in the United States and in Canada through its wholly-
owned subsidiary. The Company also designs, embroiders and sells specialty
apparel products through distributors and independent sales representatives
to the promotional products/advertising specialty industry, primarily in the
United States.
The Company has identified five reportable segments. The first segment is
"Direct Marketing-US" and represents those business operations that sell
principally printed products such as checks and business forms to small
businesses through direct marketing in the United States. The second segment,
"Direct and Distributor Sales", also sells primarily checks and business
forms to small businesses; however, they sell through a direct sales force to
the customer and through local, dedicated and independent distributors in the
United States and Canada. The third segment, "Apparel", utilizes independent
sales representatives to market its specialty apparel products and to solicit
orders from customers in the promotional products/advertising specialty
industry. "Packaging and Display Products", the fourth segment, primarily
resells packaging and shipping supplies and retail signage marketed through a
combination of direct marketing and direct selling efforts. The fifth
segment, "International", sells principally printed products such as checks
and business forms to small businesses in Europe and Canada through direct
marketing, independent distributors or by directly selling to the customer.
Any sentence followed by an asterisk (*) in this section constitutes a
forward-looking statement which reflects the Company's current expectations.
There can be no assurance the Company's actual performance will not differ
materially from those projected in such forward-looking statements due to the
important factors described in the section to this Management's Discussion
and Analysis of Financial Condition and Results of Operations titled "Certain
Factors That May Affect Future Results."
Results of Operations
- ---------------------
Net sales increased $38.4 million or 29.8% to $167.3 million in the first
quarter of fiscal year 2004 from $128.9 million in last year's first quarter.
The increase in sales was primarily the result of the acquisition of
Safeguard Business Systems, Inc.(SBS), which was acquired June 2, 2003. SBS
contributed $39.1 million in net sales to the quarter's performance in the
Direct and Distributor Sales segment. Excluding the effect of the
acquisition, net sales decreased $.7 million or .5%. The sales change
included decreases of approximately $2.3 million in the Direct Marketing-US
segment and $.4 million in the Apparel segment and are primarily attributable
to declines in standardized forms sales due to product obsolescence and, with
respect to the Apparel segment, a channel shift away from wholesalers and
reduced discretionary business spending by corporate customers. These
decreases were offset by an increase of $40.0 million in sales of the
Company's Direct and Distributor Sales segment which is benefiting from the
SBS acquisition and expanded bank relationships and the implementation of
direct marketing strategies at McBee Business Systems, Inc. Net sales in the
International segment increased $1.0 million primarily as a result of foreign
currencies strengthening against the U.S. dollar. The Packaging and Display
segment remained relatively unchanged.
For the first quarter of fiscal year 2004, cost of sales improved to
41.3% of sales from 42.1% in last year's comparable period. This is the
result of favorable product and channel mix and strong manufacturing
performance. The Company also benefited from improvements in material costs
as a result of favorable vendor negotiations. The inclusion of SBS in the
quarter lowered cost of sales as a percent of sales by .4% points. Cost of
sales as a percent of sales is expected to increase slightly for the
remainder of the fiscal year.*
Selling and advertising expense increased to 37.0% of sales in the first
quarter of fiscal year 2004 as compared to 34.1% of sales in last year's
comparable quarter as a result of the addition of SBS, which, consistent with
the other businesses in the Direct and Distributor Sales segment, has a
higher selling and advertising expense as a percentage of sales than in the
Company's other segments. Excluding SBS, selling and advertising expense was
34.7% of sales due to similar channel mix changes related to the Direct and
Distributor Sales segment. Selling and advertising expense as a percentage of
sales is expected to decrease slightly for the remainder of the fiscal year.*
General and administrative expense decreased to 14.4% of sales in the
first quarter of fiscal year 2004 from 15.0% of sales in last year's
comparable quarter. Excluding SBS, general and administrative expense was
15.9% of sales. The increase is due to higher management incentive and
deferred compensation expenses. General and administrative expense as a
percent of sales is expected to increase slightly for the remainder of the
fiscal year.*
During fiscal year 2001, the Company undertook two distinct restructuring actions. The first
resulted in a net restructuring charge of $4,523 in fiscal years 2002 and 2001 to provide for
costs primarily associated with the Company's decision to more closely align its direct marketing
and direct sales activities. As part of the restructuring program, the McBee US headquarters was
relocated from Parsippany, New Jersey to the existing RapidForms facility in Thorofare, New
Jersey. In addition, the McBee manufacturing plant in Damascus, Virginia was closed and a portion
of leased warehousing space occupied by Chiswick in Sudbury, Massachusetts was vacated. In Canada,
the McBee sales and marketing organizations were combined with the NEBS direct marketing
organization and are operating under the NEBS name. The second restructuring resulted in a net
charge of $3,322 in fiscal years 2002 and 2001 to provide for costs associated with the Company's
decision to eliminate excess capacity by closing a manufacturing facility in Ogden, Utah and a
leased distribution facility in Sudbury, Massachusetts, along with other actions to reduce the
workforce in various locations. Approximately 315 employees were affected by these restructuring
actions either through elimination of their positions or relocation.
During fiscal year 2003, the Company implemented a workforce reduction in specific areas of
the business, affecting approximately 44 employees. This action primarily included the closure of
a sales office in Canada, as well as targeted reductions of staff in the Company's direct
marketing operation in Groton as well as in Chiswick and PremiumWear. In addition, as part of the
purchase accounting for the SBS acquisition and included in the allocation of the acquisition
costs, a liability of $3,300 was recorded to cover the anticipated costs (primarily termination
benefits) related to a plan to close redundant SBS manufacturing and warehouse facilities and to
reduce manufacturing and administrative personnel.
During fiscal year 2004, the Company announced its plans to close a manufacturing plant in
Peterborough, New Hampshire after an extensive review of the Company's manufacturing capacity
following the SBS acquisition. The manufacturing activities will be absorbed into other existing
facilities during the current fiscal year with operations in Peterborough, New Hampshire expected
to cease by June 26, 2004.
Pursuant to these plans, the following charges and payments have been accrued and recorded:
Balance Charge/ Balance
June 28, (credit) for Payments for Sept. 27,
2003 the period the period 2003
------------- ------------- ------------- ---------
2001 Restructuring
- --------------------
Facility closure costs $ 511 $ - $ (458) $ 53
Employee termination 62 - (22) 40
benefit costs
2003 Restructuring
- --------------------
Facility closure costs 548 (14) (38) 496
Employee termination
benefit costs 3,606 222 (1,118) 2,710
2004 Restructuring
- --------------------
Employee termination
benefit costs - 507 - 507
------- -------- -------- ---------
Total $4,727 $ 715 ($1,636) $3,806
======= ======== ======== =========
The activities related to all restructuring actions identified above are anticipated to be
completed by the Company during fiscal year 2004, however payments for employee termination
benefits and idle facilities maintenance will extend beyond that time period.
Additional information related to exit costs expected to be incurred and expensed during the
period is as follows:
Exit Cumulative
Exit costs incurred exit costs
costs expected for the period ended incurred as of
to be incurred Sept. 27, 2003 Sept. 27, 2003
------------- ------------ -----------
2001 Restructuring
- --------------------
Facility closure costs $ 3,240 $ - $ 3,240
Employee termination
benefit costs $ 4,486 - 4,486
2003 Restructuring
- --------------------
Facility closure costs 248 (14) 248
Employee termination
benefit costs 1,077 222 1,077
2004 Restructuring
- --------------------
Employee termination
benefit costs 1,700 545 545
Facility closure costs 1,300 8 8
Other associated costs 1,200 30 30
--------- ----------- -----------
Total $13,251 $ 791 $ 9,634
========= =========== ===========
Interest expense was 1.0% of sales in the first quarter of fiscal year
2004 as compared to 2.4% of sales in the prior year's comparable period. The
decrease is the result of lower effective interest rates on the Company's
debt as compared to the same period last year.
The provision for income taxes as a percentage of pretax income was 40.0%
for the first quarter as compared to 38.4% in the prior year's comparable
period. The change is the result of an increase in the state tax provision
due to recently enacted tax legislation and changes in the mix of anticipated
earnings between different subsidiaries. The provision for income taxes as a
percentage of pretax income is expected to remain consistent with the first
three months of fiscal year 2004 for the remainder of the current year.*
Critical Accounting Policies
- ----------------------------
The Company's discussion and analysis of its financial condition and
results of operations are based upon the consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets and liabilities, the disclosure of contingent liabilities
and the reported amounts of revenues and expenses. On an on-going basis, the
Company evaluates its estimates and judgments, including those related to
revenue recognition, bad debts, inventories, intangible assets, and incomes
taxes. Estimates and judgments are based on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances. Actual results may differ materially from these estimates
under different assumptions or conditions. The Company believes the following
accounting policies are the most critical due to their affect on the
Company's more significant estimates and judgments used in preparation of its
consolidated financial statements.
Revenue is recognized on product sales at the point in time when
persuasive evidence of an arrangement exists, the price is fixed and final,
delivery has occurred and there is reasonable assurance of collection of the
sales proceeds. The Company generally obtains purchase authorizations from
its customers for a specified amount of product at a specified price and
considers delivery to have occurred at the point of shipment. While the
Company does provide its customers with a right of return, revenue is not
deferred. Rather, a reserve for sales returns is provided based on
significant historical experience.
Asset valuation includes assessing the recorded value of certain assets,
including accounts receivable, inventories, property, plant and equipment,
investments, capitalized software, goodwill, deferred mail costs and
intangible and other assets. Asset valuation is governed by various
accounting principles, including Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", SFAS No. 141, "Business Combinations", SFAS No. 142 "Goodwill and
Other Intangible Assets" and Accounting Research Bulletin No. 43, among
others. Management uses a variety of factors to assess valuation depending on
the asset. For example, accounts receivable are evaluated based upon an aging
schedule. The recoverability of inventories is based upon the types and
levels of inventory held. Property, plant and equipment, capitalized software
and intangible and other assets are evaluated utilizing various factors,
including the expected period the asset will be utilized, forecasted cash
flows, the cost of capital and customer demand. Investments are evaluated for
impairment based upon market conditions and the viability of the investment.
Deferred mail is capitalized and amortized over its expected period of future
benefit in accordance with AICPA Statement of Position 93-7. Changes in any
of these factors could impact the value of the asset resulting in an
impairment charge.
As part of the process of preparing our consolidated financial statements, we
are required to estimate our income taxes in each jurisdiction in which we
operate that imposes a tax on income. This process involves estimating our
actual current tax exposure together with assessing temporary differences
resulting from different treatment of items for tax and accounting purposes.
These differences result in deferred tax assets and liabilities, which are
included in our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income, and to the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we establish a valuation
allowance, we must include an expense within the tax provision in the
consolidated statements of income. In the event that actual results differ
from these estimates, our provision for income taxes could be materially
impacted.
New Accounting Pronouncements
- -----------------------------
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS 149 amended certain
provisions of SFAS 133 for decisions made by the Board as part of the
Derivatives Implementation Group (DIG) process. This statement is effective
for contracts entered into or modified after June 30, 2003. The adoption of
SFAS No. 149 did not have a material impact on the Company's consolidated
financial position or results of operations.
In May 2003, SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity," was issued. This
statement establishes standards concerning the classification and measurement
of certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003 and is otherwise primarily effective for the
Company on July 1, 2003. The adoption of SFAS No. 150 did not have a material
impact on the Company's consolidated financial position or results of
operations.
Liquidity and Capital Resources
- -------------------------------
Cash provided by operating activities for the three months ended September
27, 2003 was $2.7 million and represented an increase of $1.6 million from
the $1.1 million provided in the comparable period last year. This increase
in cash provided by operating activities was due to increases in
depreciation, amortization and exit accruals from year to year, as well as
the gain on the sale of a long-term investment in the prior year which is
removed from cash provided by operations in the statements of cash flows
offset by the impact of an increase in inventory due to select products being
inventoried in the Apparel segment versus outsourced.
Working capital at September 27, 2003 totaled $67.6 million, including
$3.2 million of cash and short-term investments. At June 28, 2003, working
capital was $59.4 million, including cash and short term investments of $4.7
million. The increase in working capital is primarily the result of higher
mail and product inventory due to the anticipated sales of seasonal products
in the Company's second quarter. In addition, selected products in the
Apparel segment began to be inventoried versus outsourced.
Capital expenditures for the three months ended September 27, 2003 were
$4.9 million as compared to $4.1 million during last year's comparable
period. Capital expenditures in the first three months of fiscal year 2004
included improvements to enhance information systems' infrastructure and
manufacturing capability which includes the integration of SBS. The Company
anticipates that total capital outlays will approximate $21.0 million in
fiscal year 2004, which will include additional planned improvements in our
information systems' capabilities and investments to enhance manufacturing
capability.*
In March 2000, the Company invested $12.9 million in the common stock of
Advantage Payroll Services, Inc. In August 2001 and July 2002, the Company
invested an additional $17.6 and $5.4 million, respectively, in the common
stock of Advantage Payroll Services, Inc. for a total investment of $35.9
million. In September 2002, Advantage merged with Paychex, Inc. The Company
received a total of $47.3 million in proceeds from the merger and recognized
a gain of $11.4 million in the year ended June 28, 2003.
The Company used the proceeds from the sale of the Advantage investment
to pay down floating rate debt and to terminate three interest rate swap
agreements with a notional amount of $75.0 million with two commercial banks.
These interest rate swaps were no longer needed to hedge the reduced level of
the Company's floating rate debt. The Company was required to make
termination payments equivalent to the fair value of the swaps totaling $3.3
million. This amount, which was reclassified from other comprehensive income
to other expense, represents a loss on settlement of interest rate swaps.
During the three months ended September 27, 2003 $2.6 million was spent to
repurchase 89 thousand shares of the Company's common stock. There were no
repurchases of the Company's common stock during the first quarter of fiscal
year 2003.
During the three months ended September 27, 2003 and September 28, 2002,
the company declared and paid dividends of $.20 per share in the amount of
$2.6 million in each of the aforementioned periods.
In addition to its present cash and short-term investment balances, the
Company has historically generated sufficient cash internally to fund its
needs for working capital, dividends and capital expenditures. The Company
has a committed, unsecured, revolving credit agreement for $200 million. The
credit agreement contains various restrictive covenants which, among other
things, require the Company to maintain certain minimum levels of
consolidated net worth and to comply with specific consolidated debt and
fixed charge ratios. The Company is in compliance with these covenants and at
September 27, 2003, the Company had $112.0 million outstanding under this
arrangement.
In November 2001, the Company entered into a $50 million Note Purchase
Agreement with The Prudential Insurance Company of America. Under this
agreement, the Company borrowed at the Eurodollar rate plus a spread for the
first year, after which the interest rate became fixed at 7.23%. This
agreement contains various restrictive covenants, which, among other things,
require the Company to maintain certain minimum levels of consolidated net
worth and to comply with specific consolidated debt and fixed charge ratios.
The Company is in compliance with these covenants and at September 27, 2003,
had $50 million outstanding under this arrangement.
In order to effectively fix the interest rate on a portion of the debt
outstanding under the revolving credit agreement, the Company as of September
27, 2003 had one interest rate swap agreement with one of the banks party to
the credit agreement. This swap agreement contains a notional principal
amount and other terms (including rate of interest paid and received and
maturity date) determined with respect to the Company's forecasts of future
cash flows and borrowing requirements. At September 27, 2003 the notional
principal amount outstanding under the interest rate swap agreement totaled
$20.0 million. During fiscal year 2003, the Company terminated three other
interest rate swaps at a pretax cost of $3.3 million. In the first quarter of
fiscal years 2004 and 2003, other than related to the interest rate swap
termination, there were no amounts transferred from other comprehensive
income to earnings related to the Company's swaps as the ineffective portion
of the swaps was insignificant.
The Company anticipates that its current cash on hand, cash flow from
operations and additional availability under the revolving credit agreement
will be sufficient to meet the Company's liquidity requirements for its
operations and capital expenditures during fiscal year 2004.* The
Company may pursue additional acquisitions from time to time, which would
likely be funded through the use of available cash, issuance of stock,
obtaining of additional credit, or any combination thereof.*
Certain Factors That May Affect Future Results
- --------------------------------------------------
References in this section to "we", "us" and "our" refer to New England
Business Service, Inc.
We may make forward-looking statements in this report and in other
documents filed with the SEC, in press releases, and in discussions with
analysts, investors and others. These statements include:
- - descriptions of our operational and strategic plans,
- - expectations about our future sales and profits,
- - views of conditions and trends in our markets, and
- - other statements that include words like "expects", "estimates",
"anticipates", "believes" and "intends", and which describe opinions
about future events.
You should not rely on these forward-looking statements as though they
were guarantees. These statements are based on our expectations at the time
the statements are made, and we are not required to revise or update these
statements based on future developments. Known and unknown risks may cause
our actual results, performance or achievements to be materially different
from those expressed or implied by these statements.
A majority of our sales and profits come from selling standardized
business forms, checks and related products by mail order, telesales and
direct and distributor sales to a target market consisting mainly of small
businesses. We believe that the critical success factors to compete in this
market include competitive pricing, breadth of product offering, product
quality and the ability to attract and retain a large number of individual
customers. These critical success factors are also applicable to the success
of our packaging, shipping and warehouse supplies markets as well. Known
material risks that may affect those critical success factors are described
below.
A majority of the sales in our apparel business come from selling knit and
woven sport shirts under labels licensed from third parties to the
promotional products/advertising specialty and golf industries. We believe
that the critical success factors to compete in this market include product
quality, timely and accurate fulfillment of customer orders and brand
awareness. Known material risks that may affect those success factors are
also described below.
Our printed product lines face increased competition from various sources,
such as office supply superstores. Increased competition may require us to
reduce prices or offer other incentives in order to attract new customers and
retain existing customers, which could reduce our profits.
Low-price, high-volume office supply chain stores offer standardized
business forms, checks and related products to small businesses. Because of
their size, these superstores have the buying power to offer many of these
products at competitive prices. These superstores also offer the convenience
of "one-stop shopping" for a broad array of office supplies that we do not
offer. In addition, national superstore competitors have greater financial
strength to reduce prices or increase promotional discounts in order to seek
or retain market share.
If these new competitors seek to gain or retain market share through price
reductions or increased discounting, we may be forced to reduce our prices or
match the discounts in order to stay competitive, which could reduce our
profits.
Technological improvements may reduce our competitive advantage over our
smaller competitors, which could reduce our profits.
Historically, our relatively greater financial strength and size have
enabled us to offer a broader array of products, particularly those having a
complex construction, at lower prices than the small local and regional
dealers, distributors and printers who constitute our primary competition.
Improvements in the cost and quality of printing technology are enabling
these smaller competitors to gain access to products of complex design and
functionality at competitive costs. Increased competition from local and
regional competitors could force us to reduce our prices in order to attract
and retain customers, which could reduce our profits.
Because our sales growth is dependent on our ability to continually
attract new customers in our target small business market, economic events
that adversely affect the small business economy may reduce our sales and
profits.
Average annual sales per customer of our core products have remained
relatively stable over time. As a result, we rely, in part, on continually
attracting new customers for these products. Our sales and profits have been
adversely affected by economic-related contractions in the small business
economy. We expect that our sales and profits will continue to be affected by
changes in the levels of small business formations and failures and from
other economic events that affect the small business economy generally.
Because our sales growth is dependent on our ability to continually
attract new customers in our target small business market, changes in the
direct marketing industry that reduce our competitive advantage in contacting
prospective customers may reduce our sales and profits.
Growth in the total number of our direct mail customers depends on
continued access to high-quality lists of newly formed small businesses. In
the past, our ability to compile proprietary prospect lists was a distinct
competitive advantage. However, the external list compilation industry has
become more sophisticated and comprehensive lists of new small business
formations are now commercially available to our competitors. In addition,
the Internet has the potential to eliminate our advantage of scale in direct
marketing by providing all competitors, regardless of current size, with
access to prospective customers.
We currently rely on the speed of our delivery of promotional materials to
prospective customers to gain advantage over competitors. We are also
expanding our Internet product offerings and capabilities and seeking to
increase our visibility on the Internet. Notwithstanding these efforts, a
deterioration in our competitive advantage in contacting prospective
customers could reduce our sales and profits.
In addition, the enactment of privacy laws could constrain our ability to
obtain prospect lists or to market to prospective customers via the telephone
or through the use of marketing-oriented faxes.
Declining response rates to the Company's catalogs and other direct mail
promotional materials could reduce our sales and profits.
Our direct mail-based businesses have experienced declines in the response
rates to our catalogs and other direct mail promotional materials from both
existing customers and prospects. We believe that these declines are
attributable to a number of factors, including current economic conditions,
the overall increase in direct mail solicitations received by our target
customers generally, and the gradual obsolescence of our standardized forms
products. To the extent that we cannot compensate for reduced response rates
through increases in average order value or improve response rates through
new product introductions and improved direct mail contact strategies, our
sales and profits may be adversely affected.
Increases in the cost of paper and in postal rates adversely impact our
costs, which we may be unable to offset by reducing costs in other areas or
by raising prices.
The cost of paper to produce our products, catalogs and advertising
materials makes up a significant portion of our total costs. Also, we rely on
the U.S. Postal Service to deliver most of our promotional materials. Prices
for the various types of paper that we use have been volatile, and we expect
them to continue to be so. Third class postal rates have generally increased
over the past ten years, at times significantly. We are not sure that we will
always be able to reduce costs in other areas or to increase prices for our
products sufficiently to offset increases in paper costs and postal rates. If
we are unable to offset these cost and expense increases, our profits will be
adversely affected.
Disruption in the services provided by certain of our critical vendors may
adversely affect our operating performance and profits.
We use a limited number of vendors to provide key services to our
business. Examples of this are as follows:
- - we use MCI and Qwest Communications International to provide a majority
of the toll-free telephone lines for our direct marketing business,
- - we use United Parcel Service to deliver most of the products that we
ship to customers in the United States,
- - we rely on the postal services of the countries in which we do business
to deliver our catalogs and other advertising material to customers.
In the past, we have been adversely affected by disruption of some of
these services due to labor actions, system failures, adverse weather
conditions, natural disasters or other uncontrollable events. If there are
future interruptions in service from one or more of these vendors, we believe
that there could be a significant disruption to our business due to our
inability to readily find alternative service providers at comparable rates.
Sales of our standardized forms, checks and related products face
technological obsolescence and changing customer preferences, which could
reduce our sales and profits.
Our standardized business forms, checks and related products provide our
customers with financial and business records to manage their businesses.
Continual technological improvements have provided our target customers in
several market segments 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-competitive means to print
low-quality versions of our business forms on plain paper. In addition,
electronic transaction systems and off-the-shelf business software
applications have been designed to automate several of the functions
performed by our business form and check products.
In response to the gradual obsolescence of our standardized forms
business, we continue to develop our capability to provide custom and full-
color products. However, we have less of a cost advantage with these products
than with standardized forms, due to improvements in the cost and quality of
printing technology available to our smaller local and regional competitors.
We are also seeking to introduce new products and services that are less
susceptible to technological obsolescence. We may develop new products
internally, procure them from third party vendors, or obtain them through the
acquisition of a new business. We generally realize lower gross margins on
outsourced products than on products that we manufacture ourselves. The risks
associated with the acquisition of new businesses are described below.
If new printing capabilities and new product introductions do not continue
to offset the obsolescence of our standardized business forms products, there
is a risk that the number of new customers we attract and existing customers
we retain may diminish, which could reduce our sales and profits. Decreases
in sales of our historically high margin standardized business forms and
check products due to obsolescence could also reduce our gross margins. This
reduction could in turn adversely impact our profits unless we are able to
offset the reduction through the introduction of new high margin products and
services or realize cost savings in other areas.
We source our apparel products from offshore third party manufacturers.
Difficulty in securing reliable sources for these products could adversely
affect our ability to maintain inventory levels that are adequate to satisfy
customer demand.
We purchase a majority of our apparel products from "full package"
manufacturers outside the United States. In most cases, these same
manufacturers supply other apparel companies, many of which are significantly
larger than our apparel business and are able, when necessary, to secure
preferential treatment from the manufacturers. The availability of product
from these manufacturers can also be adversely affected by social, political
and economic conditions in their respective regions. Any significant
disruption in our relationships with our current manufacturers could
adversely affect our apparel business to the extent we cannot readily find
alternative sources of supply at comparable levels of price and quality.
Inaccurate forecasting of the demand for specific apparel styles and sizes
could reduce our sales and profits.
We believe that success in our apparel business depends in part on our
ability to maintain in stock and immediately ship ordered products. Given the
relatively long lead time in procuring inventory, we must estimate demand for
specific styles and sizes well in advance of receiving firm orders from
customers in order to ensure the timely availability of these products.
Inaccurate forecasting of demand for specific styles and sizes can result in
either lost sales due to product unavailability, or reduced margins from
liquidating overstocked items.
Failure of our apparel licensors to adequately promote our licensed brands
and protect those brands from infringement could reduce our sales and
profits.
We believe that brand awareness is an important factor to the end-user of
our apparel products, and in that regard we market and sell a majority of our
apparel products under nationally-recognized brands licensed from third
parties. In each case, the licensor is primarily responsible for promoting
its brand and protecting its brand from infringement. The failure of one or
more of our licensors to adequately promote or defend their brands could
diminish the perceived value of those brands to our customers, which could
lead to reduced sales and profits.
Reductions in the number of apparel lines carried by wholesalers in the
promotional products/advertising specialty industry may adversely impact our
sales and profits.
Until recently, a significant portion of the sales in our apparel business
has been to a relatively small number of wholesalers serving the promotional
products/advertising specialty market. Sales to these wholesalers recently
have been decreasing, and have been partially offset by increases in direct
sales to our advertising specialty dealers and golf pro shops. We believe
that the wholesale apparel business serving this market is undergoing
fundamental change, with wholesalers increasingly carrying only private label
lines and branded lines on an exclusive basis. We believe that these changes,
together with current economic conditions, are likely to result in an
accelerated decrease in our sales to wholesalers. To the extent that
increases in our direct sales to advertising specialty dealers, together with
increases in our apparel sales to other markets, cannot keep pace with the
erosion in our sales to wholesalers, sales and profits could be adversely
impacted.
Our growth strategy depends, in part, on the acquisition of complementary
businesses that address our target small business market.
The acquisition of complementary businesses that address our target small
business market has been important to our growth strategy. We intend to
continue this acquisition activity in the future. The success of this
activity depends on the following:
- - our ability to identify suitable businesses and to negotiate agreements
on acceptable terms,
- - our ability to obtain financing through additional borrowings, by
issuing additional shares of common stock, or through internally
generated cash flow, and
- - our ability to achieve anticipated savings and growth and avoid
disruption to our existing businesses.
In evaluating a potential acquisition, we conduct a business, financial
and legal review of the target. This review is intended to support our
assumptions with respect to the projected future performance of the target
and to identify the benefits and risks associated with those assumptions. We
cannot be certain that our review will identify all potential risks
associated with the purchase, integration or operation of acquired
businesses. Unanticipated risks and/or performance inconsistent with our pre-
acquisition expectations may adversely affect the benefits that we expect to
obtain from any given acquisition and could result in an impairment of
intangible assets, which would reduce our reported earnings for the period
the impairment occurs.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ------------------------------------------------------------------
The Company is exposed to a number of market risks, primarily the effects
of changes in foreign currency exchange rates and interest rates. Investments
in and loans and advances to foreign subsidiaries and branches, and their
resultant operations, denominated in foreign currencies, create exposures to
changes in exchange rates. The Company's utilization of its revolving line of
credit (which carries a variable interest rate) creates an exposure to
changes in interest rates. The effect, however, of changes in exchange rates
and interest rates on the Company's earnings generally has been small
relative to other factors that also affect earnings, such as business unit
sales and operating margins. For more information on these market risks and
financial exposures, see the Notes to Consolidated Financial Statements
included in the Annual Report on Form 10-K for the year ended June 28, 2003.
The Company does not hold or issue financial instruments for trading, profit
or speculative purposes.
In order to effectively convert the interest rate on a portion of the
Company's debt from a Eurodollar-based floating rate to a fixed rate, the
Company has entered into interest rate swap agreements with major commercial
banks. Although the Company is exposed to credit and market risk in the event
of future nonperformance by any of the banks, management has no reason to
believe that such an event will occur.
During fiscal year 2003 as part of paying down floating rate debt, the
Company terminated three interest rate swap agreements with a notional amount
of $75.0 million with two commercial banks. These interest rate swaps were no
longer needed to hedge the reduced level of the Company's floating rate debt.
The Company was required to make termination payments equivalent to the fair
value of the swaps totaling $3.3 million. This amount, which was
reclassified from other comprehensive income to other expense, represents a
loss on settlement of interest rate swaps to terminate the agreements.
Upon reviewing its derivatives and other foreign currency and interest
rate instruments, based on historical foreign currency rate movements and the
fair value of market-rate sensitive instruments at year-end, the Company does
not believe that changes in foreign currency or interest rates will have a
material impact on its near-term earnings, fair values or cash flows.
Item 4. Controls and Procedures
- --------------------------------
The Company carried out an evaluation, under the supervision and with the
participation of management, including its principal executive officer and
principal financial officer, of the effectiveness of the Company's disclosure
controls and procedures (as defined in Rule 13a-15(e) promulgated under the
Securities Exchange Act of 1934), as of the end of the Company's first fiscal
quarter. Based upon that evaluation, the principal executive officer and
principal financial officer concluded that the Company's disclosure controls
and procedures are effective.
There has been no change in the Company's internal control over financial
reporting that occurred during the Company's first fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
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Item 1. LEGAL PROCEEDINGS
- --------------------------
On June 30, 2000, a lawsuit entitled "Perry Ellis International, Inc. v.
PremiumWear, Inc.", was filed in the Circuit Court of the Eleventh Judicial
Circuit in and for Miami-Dade County, Florida. The case has been removed to
federal court and is currently pending in the United States District Court
for the Southern District of Florida. On April 11, 2001, the court granted
the plaintiff's motion to amend its complaint to add the Company as a co-
defendant. The amended complaint relates to a Right of First Refusal
Agreement dated as of May 22, 1996 (the "RFR Agreement") between the
plaintiff and PremiumWear, Inc., and to the Company's acquisition of all the
outstanding shares of PremiumWear in July 2000. In the amended complaint, the
plaintiff alleges breach of the RFR Agreement and breach of an implied
covenant of good faith and fair dealing against PremiumWear as a result of
PremiumWear's alleged failure to notify the plaintiff of certain discussions
between PremiumWear and the Company preceding the Company's agreement to
purchase all of the outstanding shares of PremiumWear. The amended complaint
also alleges that the Company tortiously interfered with the plaintiff's
rights under the RFR Agreement by allegedly inducing PremiumWear to breach
its obligations to the plaintiff under the RFR Agreement. The plaintiff is
seeking damages in an unspecified amount, attorneys' fees, interest and
costs. The Company believes the allegations in the amended complaint are
without merit and intends to defend the lawsuit vigorously.
On July 24, 2002, a class action lawsuit entitled "OLDAPG, Inc. v. New
England Business Service, Inc." was filed in the Court of Common Pleas of the
Ninth Judicial Circuit in and for Charleston County, South Carolina. The
named plaintiff in the lawsuit seeks to represent a class consisting of all
persons who allegedly received facsimiles containing unsolicited advertising
from the Company in violation of the Telephone Consumer Protection Act of
1991 (the "TCPA"). The litigation has been settled by agreement between the
parties on terms which the Company believes will not be material to its
financial condition and results of operations. The settlement agreement has
received preliminary approval of the court, with final approval of the
settlement set for hearing on December 2, 2003.
From time to time the Company is involved in other disputes and/or
litigation encountered in the ordinary course of its business. The Company
does not believe that the ultimate impact of the resolution of such other
outstanding matters will have a material effect on the Company's business,
operating results or financial condition.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------
Not applicable.
Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
- ----------------------------------------------------------
Not applicable.
Item 5. OTHER INFORMATION
- --------------------------
Not applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
a. Exhibits
Exhibit No. Description
---------- -----------
31.1 Certification pursuant to Rule 13a-14(a)/15d-14(a)
(Principal Executive Officer).
31.2 Certification pursuant to Rule 12a-14(a)/15(d)-14(a)
(Principal Financial Officer).
32 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 (Principal Executive Officer and
Principal Financial Officer).
b. Reports on Form 8-K.
On July 28, 2003, the Company filed a Current Report on Form 8-K
announcing earnings for the fiscal quarter ended June 28, 2003.
On August 15, 2003, the Company filed a Current Report on Form 8-K/A
amending a Current Report on Form 8-K filed June 2, 2003. This amendment was
filed to include financial statement information related to the acquisition
of Safeguard Business Systems, Inc.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
NEW ENGLAND BUSINESS SERVICE,INC.
---------------------------------
(Registrant)
November 12, 2003
- ---------------- /s/Daniel M. Junius
--------------------
Date Daniel M. Junius
Executive Vice President-Chief
Financial Officer
(Principal Financial Officer)