10-Q 1 form10qq2_02.txt NEW ENGLAND BUSINESS SERVICE, INC. 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended December 29, 2001. 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 --- --- The number of common shares of the Registrant outstanding on January 30, 2002 was 12,802,506. PART I - FINANCIAL INFORMATION ------------------------------ Item 1. Financial Statements ---------------------------- NEW ENGLAND BUSINESS SERVICE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements NEW ENGLAND BUSINESS SERVICE, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)

See Notes to Unaudited Condensed Consolidated Financial Statements NEW ENGLAND BUSINESS SERVICE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 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 30, 2001. 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 30, 2001. 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. Acquisition ---------------- In July 2000, the Company acquired all the outstanding shares of PremiumWear, Inc. The purchase price was $13.50 per share in cash and totaled approximately $38,976,000 (net of cash acquired) for the shares plus debt assumed of $3,856,000. The Company incurred fees of approximately $602,000 in connection with the acquisition. The acquisition was accounted for using the purchase method of accounting. 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 $16,013,000, of which $5,300,000 and $583,000 were allocated to long-term contracts and non-compete agreements, respectively, and the balance of $10,130,000 to goodwill. The long-term contracts and non-compete agreements are being amortized over their respective useful lives. The amortization of goodwill was impacted by the Company's adoption of Statement of Financial Accounting Standard No. 142 as discussed in note 6. 3. Restructuring and Impairment of Assets ---------------------------------------- During fiscal year 2001, the Company undertook two distinct restructuring actions. The first resulted in a restructuring charge of $3,500,000 to provide for costs primarily associated with the Company's decision to more closely align certain 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 NEBS Direct Marketing and are operating under the NEBS name. Approximately 140 employees were affected by the restructuring either through elimination of their positions or relocation. Pursuant to this plan, the following charges and payments have been recorded:

4. Inventories -------------- Inventories are carried at the lower of first-in, first-out cost or market. Inventories at December 29, 2001 and June 30, 2001 consisted of:

5. Long-Term Investment ----------------------- In August 2001, the Company invested $17,652,000 in the common stock of Advantage Payroll Services, Inc. This investment is in addition to the Company's holdings at June 30, 2001 and in aggregate represents a voting interest of 17.7%. The securities are not considered to be marketable equity securities under Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities", because the company is currently privately held and, hence, the securities are restricted and have no readily determinable market value. This investment has been carried at cost and will periodically be evaluated to determine whether a decline in fair value below the original cost basis has occurred and is other than temporary. The investment has been classified as a long-term asset on the condensed consolidated balance sheet because of its non-marketable nature. 6. Adoption of Statement of Financial Accounting Standards No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets ----------------------------------------------------------------------------- In the first quarter of fiscal 2002, the Company adopted SFAS 141, "Business Combinations" and SFAS 142,"Goodwill and Other Intangible Assets". SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations and modifies the application of the purchase accounting method. SFAS No. 142 eliminates the current requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life and addresses the impairment testing and recognition for goodwill and intangible assets. As of July 1, 2001, the Company had identified those intangible assets that remain separable under the provisions of SFAS 141 and those that are to be included in goodwill. In applying SFAS 142, the Company completed the transitional intangible asset impairment test by determining the carrying amount of its various reporting units and comparing that with their fair value, determined by using a multiple of earnings before interest, taxes, depreciation and amortization. As a result, the Company recognized an impairment charge to write off goodwill in the amount of $2,792,000 (net of tax) relating to its European business within its International business segment. The impairment loss is recognized in the condensed consolidated statements of income under the caption "Effect of a Change in Accounting Principle". Had the provisions of SFAS 141 and 142 been applied for the three and six months ended December 23, 2000, the Company's net income and net income per share would have been as follows:

Intangible assets consist of the following:

Changes in the carrying amount of goodwill (net) for the six months ended December 29, 2001, are by segment as follows: June 30, Dec. 29, 2001 Adjustments 2001 -------- ------------ ---------- Direct Marketing-US $24,137,000 $0 $24,137,000 Direct Sales-US 5,119,000 2,382,000 7,501,000 Apparel 9,624,000 0 9,624,000 Packaging and Display Products 23,246,000 0 23,246,000 International 6,148,000 (2,945,000) 3,203,000 ----------- ------------ ----------- Total $68,274,000 $ (563,000) $67,711,000 =========== ============ =========== Adjustments include the reclassification of $2,382,000 related to an assembled workforce intangible asset in the Direct Sales-US segment, an asset impairment write-off in the International Segment of $2,792,000 discussed above and the effect of the change in foreign currency translation rates of $153,000 in the International segment. Amortization of intangible assets for the three and six months ended December 29, 2001 was $2,269,000 and $4,516,000, respectively. Estimated amortization of intangible assets for fiscal years 2002, 2003, 2004, 2005 and 2006 is $8,526,000, $7,052,000, $5,352,000, $757,000 and $757,000, respectively.

7. Comprehensive Income -------------------------- Other Comprehensive Income consists of foreign currency translation adjustments, unrealized gains and losses on investments and changes in the fair market value of cash flow hedges. Comprehensive income for the six months ending December 23, 2000 also includes the impact of the Company's adoption of SFAS No. 133 which resulted in an initial credit of $391,000 (net of tax) to Accumulated Other Comprehensive Loss. The Company's comprehensive income is set forth below:
Three Months Ended Six Months Ended Dec. 29, Dec. 23, Dec. 29, Dec. 23, 2001 2000 2001 2000 ----------- --------- ---------- --------- Net Income $ 9,349,000 $ 8,802,000 $11,203,000 $11,626,000 Changes in: Unrealized gains/(losses) on investments held in supplemental executive retirement plan, net of tax (4,000) 14,000 (45,000) 14,000 Foreign currency translation adjustments, net (80,000) (122,000) (638,000) (331,000) Unrealized gains/(losses) on derivatives held for hedging purposes, net of tax 624,000 (1,367,000) (1,433,000) (2,054,000) ---------- ---------- ---------- ---------- Other comprehensive income/(loss) 540,000 (1,475,000) (2,116,000) (2,371,000) before cumulative effect adjustment Cumulative effect adjustment recorded upon the adoption of SFAS No. 133 - - - 391,000 ---------- ---------- ---------- ---------- Comprehensive Income $ 9,889,000 $ 7,327,000 $ 9,087,000 $ 9,646,000 =========== =========== ========== ==========

Packaging and Direct Direct Display Marketing-US Sales-US Apparel Products International Total ----------- ----------- ----------- ----------- ------------- ------ Three months ended Dec. 29, 2001 Net sales $84,419,000 $27,172,000 $13,145,000 $22,010,000 $10,786,000 $157,532,000 Profit from operations 20,078,000 2,752,000 (367,000) 650,000 1,323,000 24,436,000 Less adjustments listed above 9,258,000 Income before income taxes $ 15,178,000

Three months ended Dec. 23, 2000 Net sales $90,846,000 $26,411,000 $13,490,000 $24,583,000 $11,145,000 $166,475,000 Profit from operations 20,974,000 1,992,000 807,000 1,367,000 830,000 25,970,000 Less adjustments listed above 11,541,000 Income before income taxes $ 14,429,000

Six months ended Dec. 29, 2001 Net sales $151,208,000 $52,892,000 $24,991,000 $41,535,000 $20,421,000 $291,047,000 Profit from operations 34,269,000 4,164,000 (356,000) 1,024,000 2,000,000 41,101,000 Less adjustments listed above 18,381,000 Income before income taxes $ 22,720,000

Six months ended Dec. 23, 2000 Net sales $160,028,000 $51,930,000 $29,756,000 $44,907,000 $20,972,000 $307,593,000 Profit from operations 35,522,000 4,156,000 2,122,000 2,106,000 1,265,000 45,171,000 Less adjustments listed above 26,112,000 Income before income taxes $ 19,059,000
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, personalized apparel and other business products through direct mail, direct sales, telesales, dealers and the Internet to small businesses throughout the United States, Canada, the United Kingdom and France. The Company also markets 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 is Direct Marketing-US and represents those business operations that sell primarily printed products such as checks and business forms to small businesses through direct marketing in the United States. The second segment, Direct Sales-US, also sells primarily checks and business forms to small businesses; however, they sell directly to the customer in the United States, and, to a lesser extent, through distributors. 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 primarily printed products such as checks and business forms to small businesses in Europe and Canada through direct marketing, 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 decreased $9.0 million or 5.4% to $157.5 million in the second quarter of fiscal year 2002 from $166.5 million in last year's second quarter. The sales decline is attributable to the economic slowdown in the U.S. The sales decrease was comprised of approximately a $6.4 million decrease in Direct Marketing-US and $2.6 million in the Packaging and Display segments. The impact of the decline in the Direct Marketing-US segment was most notable due to a slowdown in discretionary business spending by its customers. The decline in the Packaging and Display segment is due to lower volume from and higher discounting to industrial sales customers. In addition, a slight sales decrease of $.7 million was realized in the International and Apparel segments. These decreases were offset by a slight increase of $.7 million in sales of the Company's other segment, Direct Sales-US. Net sales decreased $16.6 million or 5.4% to $291.0 million for the first six months of fiscal year 2002 from $307.6 million in last year's comparable period. The sales decrease was comprised of an $8.8 million decrease in the Direct Marketing-US, a $4.8 million decrease in the Apparel, $3.4 million decrease in the Packaging and Display Products and $.6 million in the International segments. The impact of the decline in the Direct Marketing-US and Packaging and Display segments was due to similar reasons as outlined above regarding the second quarter results. The decrease in the Apparel segment was also due to a slowdown in discretionary business spending by its customers. These decreases were offset by a slight increase of $1.0 million in the sales of the Company's Direct Sales-US segment. For the second quarter of fiscal year 2002, cost of sales decreased to 42.9% of sales from 43.2% in last year's comparable period. For the first six months of fiscal year 2002, cost of sales decreased to 43.2% from 43.7% in last year's comparable period. The Company's cost management strategies in all segments, except the Apparel segment, offset the volume impact of the decrease in sales on cost of sales. The Apparel segment has a higher cost of sales as a percent of sales due to higher fixed costs and product mix. Excluding the Apparel segment, cost of sales approximated 39.5% and 39.9% for the second quarter and the first six months of fiscal year 2002, respectively, a slight decrease from the comparable periods last year. Cost of sales as a percent of sales is expected to increase slightly for the remainder of the fiscal year.* Selling and advertising expense remained relatively constant at 33.5% of sales in the second quarter of fiscal year 2002 as compared to 33.3% of sales in last year's comparable quarter. For the first six months of fiscal year 2002, selling and advertising expense increased to 34.1% from 33.5% of sales in last year's comparable period. The percentage increase was due to a decrease in the proportion of sales coming from the Apparel segment, which has a lower selling and advertising expense as a percentage of sales than the Company's other businesses. Also contributing to the percentage increase was an increase in the proportion of sales coming from the Direct Sales-US segment, which has a higher selling and advertising expense as a percentage of sales than in the Company's other businesses. Offsetting this mix change was the effect of the Company's adoption of SFAS 142, which decreased the amortization charge for the current period. Selling and advertising expense as a percentage of sales is expected to be slightly lower for the remainder of the fiscal year.* General and administrative expense decreased to 11.7% in the second quarter of fiscal year 2002 from 12.8% of sales in last year's comparable quarter. For the first six months of fiscal year 2002, general and administrative expense decreased to 12.6% from 13.4% in last year's comparable period. General and administrative expenses in the first six months of fiscal year 2001 included an asset impairment charge of $1.7 million, for the write-off of capitalized internal-use software related to an enterprise resource planning system the Company no longer plans to implement. General and administrative expense as a percent of sales is expected to be slightly higher for the remainder of the fiscal year.* During fiscal year 2001, the Company undertook two distinct restructuring actions. The first resulted in a restructuring charge of $3.5 million to provide for costs primarily associated with the Company's decision to more closely align certain 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 has been vacated. In Canada, the McBee sales and marketing organizations were combined with NEBS Direct Marketing and are operating under the NEBS name. Approximately 140 employees were affected by the restructuring either through elimination of their positions or relocation. The second restructuring during fiscal year 2001 resulted in the Company recording an additional restructuring charge of $3.6 million 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 175 employees were affected by the restructuring, either through elimination of their positions or relocation. Pursuant to these plans, the following charges and payments have been recorded:
Three Months Ended Dec. 29, 2001 Balance Charge Payments or Balance Type of Sept. 29, credit) for reductions for Dec. 29, Liability 2001 the period the period 2001 --------- --------- ----------- ------------ ------------ First Restructuring Employee termination benefit costs $ 538,000 $ 0 $ (251,000) $ 287,000 Facility closure costs $ 479,000 $ 0 $ (179,000) $ 300,000 Second Restructuring Employee termination benefit costs $1,614,000 $ 0 $ (396,000) $1,218,000 Facility closure costs $ 719,000 $ 0 $ (35,000) $ 684,000 Six Months Ended Dec. 29, 2001 Balance Charge Payments or Balance Type of June 30, (credit) for reductions for Dec. 29, Liability 2001 the period the period 2001 --------- --------- ----------- ------------ ------------ First Restructuring Employee termination benefit costs $ 857,000 $ 0 $ (570,000) $ 287,000 Facility closure costs $ 672,000 $ 0 $ (372,000) $ 300,000 Second Restructuring Employee termination benefit costs $2,391,000 $ 0 $(1,173,000) $1,218,000 Facility closure costs $ 745,000 $ 0 $ (61,000) $ 684,000 The activities related to all restructuring actions identified above are anticipated to be completed by the Company during fiscal year 2002 with the exception of lease payments which may extend beyond this time frame.
Interest expense increased to 2.2% of sales in the second quarter of fiscal year 2002 as compared to 2.0% of sales in last year's comparable quarter. In the first six months of fiscal 2002, interest expense increased to 2.3% from 2.1% of sales in the prior year's comparable period. The increase is the result of debt incurred during the first quarter for the Company's additional investment of $17.7 million in Advantage Payroll Services, Inc. which increased the Company's average debt outstanding from the same period last year. The provision for income taxes as a percentage of pre-tax income declined to 38.4% from 39.0% in the second quarter and first six months of fiscal years 2002 and 2001, respectively. In the first quarter of fiscal year 2002, the Company adopted Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets", (SFAS 141 and 142). SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations and modifies the application of the purchase accounting method. SFAS No. 142 eliminates the current requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life and addresses the impairment testing and recognition for goodwill and intangible assets. As of July 1, 2001, the Company had identified those intangible assets that remain separable under the provisions of SFAS 141 and those that are to be included in goodwill. In applying SFAS 142, the Company completed the transitional intangible asset impairment test. As a result, the Company recognized an impairment charge to write off goodwill in the amount of $2.8 million (net of tax) relating to its European business within its International business segment. In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supercedes SFAS No. 121 on the same topic and the accounting and certain reporting provisions of APB Opinion 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as defined in that Opinion). This Statement also amends ARB 51, "Consolidated Financial Statements," to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company will adopt this Statement in fiscal 2003. Management believes that the impact of this Statement on its consolidated financial statements will not be material. In addition to its present cash and short-term investment balances, the Company has consistently generated sufficient cash internally to fund its needs for working capital, dividends and capital expenditures. The Company has, over time, amended the terms of its committed, unsecured, revolving line of credit agreement in order to facilitate certain transactions. The total committed line currently stands at $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 specific consolidated debt, and fixed charge ratios. The Company is currently in compliance with these covenants. 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 will borrow at the Eurodollar rate plus a spread for one year, after which the interest rate will become fixed. This agreement contains various restrictive covenants, which, among other things, require the Company to maintain certain minimum levels of consolidated net worth and specific consolidated debt, and fixed charge ratios. The Company is currently in compliance with these covenants. At December 29, 2001, the Company had $176 million of outstanding debt under these debt arrangements. In order to effectively fix the interest rate on a portion of the debt outstanding under the revolving line of credit and senior note, the Company has entered into interest rate swap agreements with several of the banks party to the credit agreement. These swap agreements contain notional principal amounts and other terms determined with respect to the Company's forecast of future cash flows and borrowing requirements. At December 29, 2001, the notional principal amount outstanding of the interest rate swap agreements totaled $160 million. For the three and six month periods ending December 29, 2001, there were no amounts transferred from other comprehensive income to earnings related to the Company's swaps and the amount of the swaps ineffectiveness was insignificant. The Company anticipates that its current cash on hand, cash flow from operations and additional availability under the line of credit will be sufficient to meet the Company's liquidity requirements for its operations and capital expenditures during fiscal year 2002.* However, the Company may pursue additional acquisitions from time to time which would likely be funded through the use of available cash, the issuance of stock, the 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 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. 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 industry. We believe that the critical success factors to compete in this market include product quality, timely 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 new 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 have entered our core business of selling 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 any of 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 long-term 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 mature 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 long-term 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 grown 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 telemarket to prospective customers. 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. In order to obtain favorable pricing, we have selected a limited number of vendors to provide key services to our business. Examples of this are as follows: - we use MCI WorldCom 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, - 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 and other natural disasters. 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 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 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 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 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 either from "full package" manufacturers in various foreign countries, or through 807 programs (assembly only) in Central America. 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 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 immediately ship ordered products, either directly or through our distributors. 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 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. 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 may adversely affect the benefits that we expect to obtain from any given acquisition. Any write-down of our investment in Advantage Payroll Services, Inc. required under generally accepted accounting principles could reduce our reported earnings. As of the date of this Quarterly Report on Form 10-Q, we have invested a total of $30.5 million for a minority investment in Advantage Payroll Services, Inc. (formerly known as Advantage Business Services Holdings, Inc.), a closely-held payroll processing company. This investment is currently reported on our balance sheet at our cost. If, as a result of Advantage's performance or other economic factors beyond our control, the value of this investment on our books exceeds the realizable value of the investment in the market, then we may be required under generally accepted accounting principles to write-down the reported value of the investment, which could reduce our reported earnings for the period in which the write- down 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 creates an exposure to changes in interest rates. The effect 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 30, 2001. The Company does not hold or issue financial instruments for trading, profit or speculative purposes. In order to effectively convert the interest rate of 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. 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 near term changes in foreign currency or interest rates will have a material impact on its future earnings, fair values or cash flows. PART II - OTHER INFORMATION --------------------------- 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. 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 ---------------------------------------------------------- a. The Annual Meeting of Stockholders was held on October 26, 2001. b. See Item 4c below c. The stockholders fixed the number of Directors to be elected at nine and elected the following Directors: For Authority Withheld --- ------------------ Robert J. Murray 11,764,724 10,585 William T. End 11,764,724 10,585 Neil S. Fox 11,764,724 10,585 Robert L. Gable 11,760,448 14,861 Thomas J. May 11,758,124 17,185 Herbert W. Moller 11,764,724 10,585 Joseph R. Ramrath 11,755,724 19,585 Brian E. Stern 11,763,724 11,585 M. Anne Szostak 11,755,800 19,509 The stockholders voted to ratify the selection of Deloitte & Touche LLP as independent auditors of the Company for the fiscal year ending June 29, 2002. For Against Abstain --- -------- -------- 11,739,067 23,837 12,405 Item 5. OTHER INFORMATION -------------------------- Not applicable Item 6. EXHIBITS AND REPORTS ON FORM 8-K ----------------------------------------- a. Exhibits Exhibit No. Description ---------- ----------- 10.1* First Amendment to the Supplemental Retirement Plan for Executives of New England Business Service, Inc., effective October 26, 2001. 10.2 First Amendment to the Second Amended and Restated Revolving Credit Agreement dated as of October 24, 2001, by and between the Company, Fleet National Bank, and certain other financial institutions. 10.3 Note Purchase Agreement dated as of November 9, 2001, by and between the Company and The Prudential Insurance Company of America. 15 Awareness Letter of Independent Accountants. 99 Independent Accountants' Review Report. * Identifies a management contract or compensatory plan or arrangement in which an executive officer or director of the Company participates. b. Reports on Form 8-K. None 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) January 30, 2002 /s/Daniel M. Junius ----------------- -------------------- Date Daniel M. Junius Senior Vice President-Chief Financial Officer (Principal Financial and Accounting Officer)