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 30, 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 0-1349
Enesco Group, Inc.
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(Exact name of registrant as specified in its charter)
Illinois 04-1864170
- ------------------------------------ ----------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 Windsor Drive, Itasca, Illinois 60143
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(Address of principal executive offices) (Zip Code)
630-875-5300
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(Registrant's telephone number, including area code)
N/A
(Former name, address and fiscal year, if changed since last report)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [x] No [ ]
September 30,
2003 2002
---- ----
Shares Outstanding:
Common Stock with 14,074,126 13,888,905
Associated Rights
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENESCO GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------------ -------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,277 $ 17,418
Accounts receivable, net 78,296 54,347
Inventories 55,993 48,334
Prepaid expenses 2,996 2,491
Deferred income taxes and taxes receivable 6,004 7,586
------------------ -------------------
Total current assets 148,566 130,176
------------------ -------------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 82,571 72,920
Less - accumulated depreciation (55,081) (46,691)
------------------ -------------------
Property, plant and equipment, net 27,490 26,229
------------------ -------------------
OTHER ASSETS:
Goodwill 2,890 -
Other 1,355 1,171
Deferred income taxes 22,509 22,209
------------------ -------------------
Total other assets 26,754 23,380
------------------ -------------------
TOTAL ASSETS $ 202,810 $ 179,785
================== ===================
The accompanying notes are an integral part of these condensed financial
statements.
2
ENESCO GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------------ ------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes and loans payable $ 13,471 $ -
Accounts payable 22,800 18,395
Federal, state and foreign income taxes 13,384 15,416
Accrued expenses:
Payroll and commissions 3,646 4,412
Royalties 7,146 7,911
Post-retirement benefits 1,754 2,320
Other 6,524 5,623
------------------ ------------------
Total current liabilities 68,725 54,077
------------------ ------------------
LONG-TERM LIABILITIES:
Notes payable 61 -
Deferred income taxes 678 703
Post-retirement benefits 2,867 3,092
------------------ ------------------
Total long-term liabilities 3,606 3,795
------------------ ------------------
Minority interest 114 -
SHAREHOLDERS' EQUITY:
Common stock 3,154 3,154
Capital in excess of par value 46,409 47,148
Retained earnings 334,348 330,368
Accumulated other comprehensive income (loss) 641 (2,712)
------------------ ------------------
384,552 377,958
Less - shares held in treasury, at cost (254,187) (256,045)
------------------ ------------------
Total shareholders' equity 130,365 121,913
------------------ ------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 202,810 $ 179,785
================== ==================
The accompanying notes are an integral part of these condensed financial
statements.
3
ENESCO GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2003 2002
-------------- -------------
Net revenues $ 71,766 $ 69,043
Cost of sales 40,628 40,412
-------------- -------------
Gross profit 31,138 28,631
Selling, distribution, general and administrative expenses 24,009 21,896
-------------- -------------
Operating profit 7,129 6,735
Interest expense (97) (203)
Interest income 66 65
Other income (expense), net (339) (362)
-------------- -------------
Income before income taxes 6,759 6,235
Income tax expense 2,162 1,834
-------------- -------------
Net income 4,597 4,401
Retained earnings, beginning of period $ 329,751 $ 310,085
-------------- -------------
Retained earnings, end of period $ 334,348 $ 314,486
-------------- -------------
Earnings per common share:
Basic $ 0.33 $ 0.32
-------------- -------------
Diluted $ 0.32 $ 0.31
-------------- -------------
The accompanying notes are an integral part of these condensed
financial statements.
4
ENESCO GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2003 2002
-------------- -------------
Net revenues $ 178,789 $ 190,409
Cost of sales 101,532 111,109
-------------- -------------
Gross profit 77,257 79,300
Selling, distribution, general and administrative expenses 70,620 71,102
-------------- -------------
Operating profit 6,637 8,198
Interest expense (641) (505)
Interest income 472 214
Other income (expense), net (974) (1,110)
-------------- -------------
Income before income taxes 5,494 6,797
Income tax expense 1,514 2,006
-------------- -------------
Income before cumulative effect
of a change in accounting principle 3,980 4,791
Cumulative effect of a change in
accounting principle, net of income taxes - (29,031)
-------------- -------------
Net income (loss) 3,980 (24,240)
Retained earnings, beginning of period 330,368 338,726
-------------- -------------
Retained earnings, end of period $ 334,348 $ 314,486
============== =============
Earnings (loss) per common share:
Income before cumulative effect
of a change in accounting principle
Basic $ 0.28 $ 0.35
============== =============
Diluted $ 0.28 $ 0.34
============== =============
Cumulative effect of a change in accounting
principle, net of income taxes $ - $ (2.10)
============== =============
Net income (loss) - basic and diluted $ 0.28 $ (1.75)
============== =============
The accompanying notes are an integral part of these condensed
financial statements.
5
ENESCO GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(Unaudited)
(In thousands)
2003 2002
---------------- ----------------
OPERATING ACTIVITIES:
Net income (loss) $ 3,980 $ (24,240)
Cumulative effect of a change in accounting
principle, net of income taxes - 29,031
Adjustments to reconcile net loss to net
cash used by operating activities (23,436) (15,263)
---------------- ----------------
Net cash used by operating activities (19,456) (10,472)
---------------- ----------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (3,843) (2,349)
Acquisition of Bilston & Battersea (3,732) -
Proceeds from sales of property, plant and equipment 38 109
---------------- ----------------
Net cash used by investing activities (7,537) (2,240)
---------------- ----------------
FINANCING ACTIVITIES:
Net isssuance of notes and loans payable 13,287 6,882
Proceeds from the issuance of common stock 1,119 727
---------------- ----------------
Net cash provided by financing activities 14,406 7,609
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents 446 344
---------------- ----------------
Decrease in cash and cash equivalents (12,141) (4,759)
Cash and cash equivalents, beginning of period 17,418 7,932
---------------- ----------------
Cash and cash equivalents, end of period $ 5,277 $ 3,173
================ ================
The accompanying notes are an integral part of these condensed financial
statements.
6
ENESCO GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
A global leader in the gift, collectibles and home decor industry for 45 years,
Enesco Group, Inc. (the "Company" or "Enesco") offers such notable product lines
as Cherished Teddies, Disney, Mary Engelbreit, Border Fine Arts, Lilliput Lane,
Heartwood Creek by Jim Shore and NICI, among others. The Company's award winning
Precious Moments figurine collection is one of the top collectible lines
throughout the world. Enesco distributes product worldwide and has wholly owned
subsidiaries located in Hong Kong, Canada, France and the U.K.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying financial data as of September 30, 2003 and for the three and
nine months ended September 30, 2003 and September 30, 2002 has been prepared by
Enesco, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission ("SEC"). Certain information and disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations. These Consolidated
Condensed Financial Statements should be read in conjunction with the
Consolidated Financial Statements and the notes thereto included in Enesco's
Annual Report on Form 10-K for the year ended December 31, 2002.
In the opinion of management, these Consolidated Condensed Financial Statements
have been prepared in conformity with accounting principles generally accepted
in the United States of America applicable to interim period financial
statements and reflect all adjustments necessary for a fair presentation of
Enesco's financial position as of September 30, 2003, results of operations for
the three and nine months ended September 30, 2003 and September 30, 2002, and
cash flows for the nine months ended September 30, 2003 and September 30, 2002.
The results of operations for interim periods are not necessarily indicative of
the operating results for full fiscal years or any future period. The
information in this report reflects all normal recurring adjustments and
disclosures that are, in our opinion, necessary to fairly present the results of
operations and financial condition for the interim periods.
7
REVENUE RECOGNITION
Enesco recognizes revenue when title passes to its customers, which generally
occurs when merchandise is turned over to the shipper. A provision for
anticipated merchandise returns and allowances is recorded based upon historical
experience when a sale is recorded. Amounts billed to customers for shipping and
handling are included in revenue. License and royalty fees received by Enesco
are recognized as revenue when earned.
COMPUTATION OF EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed using the weighted-average
number of common shares outstanding during the period. Diluted earnings per
share is computed using the weighted-average number of common shares and
potential dilutive common shares outstanding during the period. Diluted loss per
share is computed using the weighted-average number of common shares and
excludes dilutive potential common shares outstanding, as their effect is
antidilutive. Potential dilutive common share equivalents consist of stock
options and warrants calculated using the treasury stock method.
PAYMENTS FOR INTEREST AND INCOME TAXES
Enesco made cash payments for interest and income taxes as follows (in
thousands):
Nine Months Ended
September 30,
-----------------
2003 2002
--------- ------
Interest $ 294 $ 515
Income taxes $ 1,989 $ 896
ACCOUNTING FOR STOCK BASED COMPENSATION
At September 30, 2003, the Company has six stock-based employee compensation
plans. The Company accounts for those plans under the recognition and
measurement provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and
8
related interpretations. No stock-based employee compensation cost is reflected
in net income, as all options granted under those plans had exercise prices
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
as if the Company had applied the fair value recognition provisions of Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
--------------- ------------- ------------- ----------
Net income (loss) as reported $ 4,597 $ 4,401 $ 3,980 $ (24,240)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (342) (301) (1,028) (905)
--------------- ------------ ------------- ---------
Pro forma net income (loss) $ 4,255 $ 4,100 $ 2,952 $ (25,145)
--------------- ------------ ------------- ---------
Earnings (loss) per share:
Basic - as reported $ 0.33 $ 0.32 $ 0.28 $ (1.75)
--------------- ------------ ------------- ---------
Diluted - as reported $ 0.32 $ 0.31 $ 0.28 $ (1.75)
--------------- ------------ ------------- ---------
Basic - pro forma $ 0.30 $ 0.30 $ 0.21 $ (1.82)
--------------- ------------ ------------- ---------
Diluted - pro forma $ 0.29 $ 0.29 $ 0.21 $ (1.82)
--------------- ------------ ------------- ---------
MINORITY INTEREST
Bilston & Battersea Enamels plc (Bilston & Battersea), our newly acquired
subsidiary as of April 8, 2003, owns 75% of two different companies, Fine
Ceramics Transfers Limited and Carolyn Sheffield Designs Limited. The minority
interest reflected on Enesco's Condensed Consolidated Balance Sheet represents
the remaining 25% that Enesco does not own of the above companies.
3. COMPREHENSIVE INCOME (LOSS):
Other comprehensive income (loss) consists only of cumulative foreign currency
translation adjustments. Comprehensive income (loss) for the three and nine
months ended September 30, 2003 and 2002 was as follows (in thousands):
9
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2003 2002 2003 2002
--------- -------- --------- ---------
Net income (loss) $ 4,597 $ 4,401 $ 3,980 $(24,240)
Other comprehensive income:
Cumulative translation adjustments (no tax effects) 135 (76) 3,353 2,099
--------- ------- --------- --------
Comprehensive income (loss) $ 4,732 $ 4,325 $ 7,333 $(22,141)
========= ======= ========= ========
4. GEOGRAPHIC OPERATING SEGMENTS:
Enesco operates in the giftware and collectible wholesale industry,
predominantly in two major geographic classifications (United States and
International). Prior year segment data has been reclassified based on current
year segment information. The following table summarizes operations by
geographic classification for the three and nine months ended September 30, 2003
and 2002 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- --------------------------------
2003 2002 2003 2002
------------- ---------- --------------- ------------
NET SALES
United States $ 48,220 $ 49,356 $ 118,387 $ 135,376
United States inter-company (145) (251) (606) (879)
International 23,868 20,127 61,640 56,505
International inter-company (177) (189) (632) (593)
------------- ---------- --------------- ------------
Total consolidated $ 71,766 $ 69,043 $ 178,789 $ 190,409
============= ========== =============== ============
OPERATING PROFIT
United States $ 4,316 $ 4,481 $ 806 $ 2,877
International 2,813 2,254 5,831 5,321
------------- ---------- --------------- ------------
Total consolidated $ 7,129 $ 6,735 $ 6,637 $ 8,198
------------- ---------- --------------- ------------
Transfers between geographic operating segments are made at the market value of
the merchandise transferred. No single customer accounted for 10% or more of
consolidated net sales. Export sales to foreign unaffiliated customers represent
less than 10% of consolidated net sales.
10
There were no material changes in assets from the amounts disclosed in Enesco's
December 31, 2002 Annual Report.
5. OTHER INCOME (EXPENSE), NET:
Other income (expense), net for the three and nine months ended September 30,
2003 and 2002 consisted of the following (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Foreign currency gain (loss) $ (1) $ - $ (1) $ 11
Loss on sale of fixed assets (3) (4) (8) (7)
Bank charges and other (335) (358) (965) (1,114)
--------- --------- --------- ---------
$ (339) $ (362) $ (974) $ (1,110)
========= ========= ========= =========
6. INCOME (LOSS) PER COMMON SHARE (BASIS OF CALCULATIONS):
The number of shares used in the income (loss) per common share computation for
the three and nine months ended September 30, 2003 and 2002 were as follows (in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Basic
Average common shares outstanding 14,065 13,879 14,000 13,839
Diluted
Stock options and warrants 396 367 344 -
--------- --------- --------- ---------
Average shares diluted 14,461 14,246 14,344 13,839
========= ========= ========= =========
The average number of diluted shares outstanding for the nine months ended
September 30, 2002 excludes common stock equivalents relating to options and
warrants because the impact on the reported net loss was antidilutive. Had
Enesco reported a profit for the nine months ended September 30, 2002, the
number of average shares diluted would have increased by 256 thousand.
Additionally, options to purchase 1.0 million and 1.5 million shares were
outstanding during 2003 and 2002, respectively, but were not included in the
computation of diluted income (loss) per share
11
because the options' exercise price was greater than the average market price of
the common shares.
7. FINANCIAL INSTRUMENTS:
Enesco operates globally with various manufacturing and distribution facilities
and product sourcing locations around the world. Enesco may reduce its exposure
to fluctuations in interest rates and foreign exchange rates by creating
offsetting positions through derivative financial instruments. Enesco currently
does not use derivative financial instruments for trading or speculative
purposes. Enesco regularly monitors foreign currency exposures and ensures hedge
contract amounts do not exceed the amounts of the underlying exposures.
Enesco's current hedging activity is limited to foreign currency purchases and
intercompany foreign currency transactions. The purpose of Enesco's foreign
currency hedging activities is to protect Enesco from the risk that eventual
settlement of foreign currency transactions will be affected adversely by
changes in exchange rates. Enesco hedges these exposures by entering into
various short-term foreign exchange forward contracts. Derivative instruments
are carried at fair value in the Condensed Consolidated Balance Sheets as a
component of current assets or current liabilities. Changes in the fair value of
foreign exchange forward contracts that meet the applicable hedging criteria are
recorded as a component of other comprehensive income and reclassified into
earnings in the same period during which the hedged transaction affects
earnings. Changes in the fair value of foreign exchange forward contracts that
do not meet the applicable hedging criteria are recorded currently in income as
cost of sales or foreign exchange gain or loss, as applicable. Hedging
activities did not have a material impact on results of operations or financial
condition during the three and nine months ended September 30, 2003.
To manage foreign currency risk, as of September 30, 2003, Enesco had entered
into forward exchange agreements with a notional value of $6.3 million that will
mature within 48 days. These contracts include sales of British pounds sterling
and purchases of U.S. dollars at an average exchange rate of 1.66, a sale of
U.S. dollars and the purchase of British pounds sterling at an average exchange
rate of 1.66 and sales of Euros and purchases of U.S. dollars at an average
exchange rate of 1.13. The fair value of these contracts is not significant. As
of September 30, 2003, Enesco had $13.5 million of interest bearing debt
outstanding, of which $12.1 million was revolving credit facility debt with an
interest rate of 2.13%. $1.3 million was international subsidiary debt at an
interest rate of 2.72%, and the remaining $110 thousand was notes payable,
related to the purchase of machinery and vehicles by Bilston & Battersea, with
interest rates ranging
12
from 8.3% to 10.6% and maturities ranging from October 2003 through May 2005.
The fair value approximates the carrying value of these debt instruments. Enesco
currently has not hedged the interest rate risk on any of its outstanding
borrowings.
8. ACQUISITION
On April 8, 2003, the Company acquired Bilston & Battersea, which is based in
Bilston, West Midlands, England, through its European subsidiary, Enesco
Holdings Limited. Bilston & Battersea manufactures and distributes giftware,
home accessories and related products, including the high quality,
hand-decorated enamels and sculptured boxes sold under the Halcyon Days Enamels
and Halcyon Days Bonbonnieres brands. Bilston & Battersea generated sales of
approximately $10 million worldwide in 2002 and expects similar sales for 2003.
Enesco paid approximately $4.4 million in cash ($3.7 million net of acquired
cash) to acquire the company, which resulted in Enesco recording $2.9 million of
goodwill related to the purchase. As of September 30, 2003, Enesco has purchased
100% of the outstanding shares of Bilston & Battersea and has included Bilston &
Battersea's results of operations in its condensed consolidated financial
statements as of April 8, 2003.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ENESCO GROUP, INC.
NINE MONTHS ENDED SEPTEMBER 30, 2003
Certain statements contained in this Quarterly Report on Form 10-Q, including,
without limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," "projections," "projects," and words of similar meaning,
constitute "forward-looking statements" within the meaning of Federal securities
laws. These forward-looking statements are based in part on Enesco's reasonable
expectations and are subject to a number of factors and risks, many of which are
beyond Enesco's control. Our actual results could differ materially from those
anticipated in these forward-looking statements for many reasons, including the
risks faced by us described below under the heading "Risk Factors" and elsewhere
in this Quarterly Report, and in other documents we file with the Securities and
Exchange Commission. In light of these uncertainties and risks, there can be no
assurance that the forward-looking statements in this Form 10-Q will occur or
continue in the future. Except for required filings under the Securities
Exchange Act of 1934, Enesco undertakes no obligation to release publicly any
revisions to these forward-looking statements that may reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make judgments, assumptions and estimates that affect the
amounts reported in the Consolidated Condensed Financial Statements and
accompanying notes. If applicable, estimates are used for, but not limited to,
the accounting for allowances for doubtful accounts and sales returns, inventory
valuation, goodwill impairment, contingencies, restructuring costs and other
special charges and taxes. Actual results could differ from these estimates. The
following critical accounting policies are impacted significantly by judgments,
assumptions and estimates used in the preparation of the Consolidated Condensed
Financial Statements.
14
The allowance for doubtful accounts is based on our assessments of the
collectibility of specific customer accounts and the aging of accounts
receivable. If there is a deterioration of a major customer's credit worthiness
or actual defaults are significantly different than our historical experience,
estimates of the recoverability of amounts due could be affected. An allowance
for sales returns is established based on historical trends in product returns.
If future returns do not reflect historical trends, net revenues could be
affected.
Inventory purchases and commitments are based on future demand forecasts. If
there is a sudden or significant decrease in demand for our products or there is
a higher incidence of inventory obsolescence because of rapidly changing
customer requirements, we may be required to decrease the carrying value of
inventory and gross profit could be affected.
Enesco has established accruals for taxes payable and tax assessments. The
accruals are included in current income taxes payable since it is uncertain as
to when assessments may be made and paid. Enesco has filed and continues to file
tax returns with a number of taxing authorities worldwide. While Enesco believes
such filings have been and are in compliance with applicable laws, regulations
and interpretations, positions taken are subject to challenge by the taxing
authorities often for an extended number of years after the filing dates. To the
extent accruals differ from assessments, or when the open tax years are closed,
the accruals are adjusted through the provision for income taxes. The majority
of open tax years become closed for assessments at the end of December for the
particular open year.
ACQUISITION OF BILSTON & BATTERSEA
On April 8, 2003, the Company acquired Bilston & Battersea Enamels plc (Bilston
& Battersea), which is based in Bilston, West Midlands, England, through its
European subsidiary, Enesco Holdings Limited. Bilston & Battersea manufactures
and distributes giftware, home accessories and related products, including the
high quality, hand-decorated enamels and sculptured boxes sold under the Halcyon
Days Enamels and Halcyon Days Bonbonnieres brands. Bilston & Battersea generated
sales of approximately $10 million worldwide in 2002 and expects similar sales
for 2003. Enesco paid approximately $4.4 million in cash ($3.7 million net of
acquired cash) to acquire the company, which resulted in Enesco recording $2.9
million of goodwill related to the purchase.
NET REVENUE AND GROSS PROFIT
Net sales of $71.8 million in the third quarter of 2003 increased by 4.1%, or
$2.8 million, from $69.0 million in the third quarter of 2002. Net sales of
$178.8 million in the first nine months of
15
2003 decreased by 6.1%, or $11.6 million, from $190.4 million in the first nine
months of 2002. The increase in net sales for the third quarter of 2003 compared
to 2002 was due to the addition of Bilston & Battersea in 2003, favorable impact
of foreign currency translation rates and the success of new product lines such
as Heartwood Creek and Foundations, partially offset by lower mass market
promotional sales. The decrease in net sales for the first nine months of 2003
compared to the same period last year was primarily the result of decreased U.S.
sales of the Precious Moments and Cherished Teddies product lines, as well as
lower mass market promotional sales offset partially by the acquisition of
Bilston & Battersea, favorable foreign currency translation rates and the
success of new product lines such as Heartwood Creek and Foundations. Enesco's
Precious Moments lines represented approximately 32% of year-to-date sales
through September 30, 2003 compared to 37% for the same period of 2002. The
Cherished Teddies lines represented approximately 8% of year-to-date sales
through September 30, 2003 compared to 11% for the same period of 2002.
Net new orders of $190.0 million through September 30, 2003 were down 4.2%
compared to the same period in 2002. Net open orders (backlog) of $29.5 million
at September 30, 2003 were down approximately $6 million, or 16.8%, from the
same point in time last year. Backlog consists of orders received and approved
by Enesco, subject to cancellation for various reasons, including credit
considerations, product availability and customer requests. We believe the
decrease in backlog is mainly due to lower sales in the United States due to
general economic conditions and continued consolidation in the card and gift
channel.
Gross profit for the third quarter of 2003 of $31.1 million was 43.3% of net
sales as compared to the third quarter of 2002 gross profit of $28.6 million,
which was 41.4% of net sales. Gross profit for the first nine months of 2003 was
$77.3 million or 43.2% of net sales, as compared to gross profit for the first
nine months of 2002 of $79.3 million, or 41.6% of net sales. The increase in
gross profit for the third quarter of 2003 as compared to 2002 was due to the
acquisition of Bilston & Battersea, favorable foreign currency translation rates
and favorable changes in product and sales channel mix, which also resulted in
higher gross profit margins. The decrease in gross profit for the first nine
months of 2003 as compared to 2002 was primarily due to the lower U.S. sales
volume offset partially by the addition of Bilston & Battersea and higher gross
profit margins in 2003 due to the factors noted above. Gross profit can be
affected in the future by changes in vendor pricing, obsolescence charges,
changes in shipment volume, price competition and changes in distribution
channel, geographic or product mix.
16
SELLING, DISTRIBUTION, AND GENERAL AND ADMINISTRATIVE EXPENSES
Selling, distribution and general and administrative expenses (operating
expenses) for the third quarter of 2003 were $24.0 million, or 33.4% of sales,
as compared to third quarter of 2002 operating expenses of $21.9 million, or
31.7% of sales. Operating expenses year to date through September 30, 2003 were
$70.6 million, or 39.5% of sales as compared to 2002 operating expenses of $71.1
million, or 37.3% of sales. The increase in operating expenses in the third
quarter of 2003 as compared to 2002 is largely due to the inclusion of Bilston &
Battersea expenses in 2003 and the impact of foreign currency translation rate
changes. Operating expenses for the first nine months of 2003 decreased $0.5
million as compared to 2002 due to the continuing impact of numerous cost
control measures offset partially by the addition of Bilston & Battersea.
OPERATING PROFIT (LOSS)
In the third quarter of 2003, Enesco generated operating profit of $7.1 million
compared to $6.7 million in 2002. The $400 thousand increase was the result of
gross margin improvements in 2003 offset partially by an increase in operating
expenses. Enesco generated an operating profit of $6.6 million for the first
nine months of 2003, compared with a profit of $8.2 million in the first nine
months of 2002. This year-to-date decrease of $1.6 million is the result of
lower gross profit due to lower sales volumes, partially offset by a decrease in
operating expenses of $0.5 million.
INTEREST AND OTHER INCOME (EXPENSE), NET
Interest expense of $97 thousand for the third quarter of 2003 was $106 thousand
less than the third quarter of 2002 primarily due to lower interest rates and
lower borrowings. Interest income in the third quarter of 2003 remained
virtually unchanged as compared to the third quarter of 2002. Other expense,
net, for the third quarter of 2003 is $339 thousand compared to $362 thousand in
2002. The decrease is due to lower bank and credit card processing costs.
Interest expense of $641 thousand for the first nine months of 2003 was $136
thousand more than the first nine months of 2002 primarily due to interest
related to an Illinois income tax audit settlement offset partially by lower
bank related interest expenses. Interest income of $472 thousand for the first
nine months of 2003 was $258 thousand more than the first nine months of 2002.
The increase in interest income in 2003 is due to interest income on an Illinois
tax refund as well as increased interest income due to higher invested cash
balances. Other expense, net, of $974 thousand for the first nine months of 2003
is lower than other expense, net in the first nine months of 2002 by $136
thousand due to lower bank and credit card processing fees.
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PROVISION FOR INCOME TAXES
The effective tax rate was 32.0% for the third quarter of 2003 and 27.5% for the
first nine months of 2003. The comparable tax rates were 29.4% and 29.5% for
third quarter and the first nine months of 2002, respectively, reflecting the
geographical mix of earnings. The effective tax rate differs from the U.S.
statutory rate primarily due to the varying tax rates of foreign jurisdictions.
Our future effective tax rates could be affected if the mix of earnings varies
in countries that have higher or lower statutory rates or if tax laws and
regulations change.
INTERNATIONAL ECONOMIES AND CURRENCIES
We conduct business globally. Accordingly, our future results could be
materially affected by a variety of uncontrollable and changing factors
including, among others, foreign currency exchange/translation rates;
regulatory, political, or economic conditions in a specific country or region;
trade protection measures and other regulatory requirements; and the effects of
terrorist activity, armed conflict, epidemics and natural disasters. Any or all
of these factors could have a material impact on our future results.
As a global concern, we face exposure to movements in foreign currency
exchange/translation rates. These exposures may change over time and could have
a material impact on our financial results and cash flows. Historically, our
primary exposures have related to non-dollar-denominated transactions in Canada
and Europe, as well as dollar-denominated inventory purchases by our
international operating units.
At the present time, we hedge only those currency exposures associated with
certain assets and liabilities denominated in foreign currencies and
periodically will hedge anticipated foreign currency cash flows. The hedging
activity undertaken by Enesco is intended to offset the impact of currency
fluctuations on certain foreign currency transactions. See Note 7, "Financial
Instruments", to the Consolidated Condensed Financial Statements for additional
information.
LIQUIDITY AND CAPITAL RESOURCES
Enesco has historically satisfied working capital requirements with internally
generated funds and short-term loans. Cash balances and working capital
requirements fluctuate due to operating results, shipping cycles, accounts
receivable collections, inventory management and timing of payments, among other
factors. Working capital requirements fluctuate during the year and are
generally greatest early in the fourth quarter and lowest early in the first
quarter. For additional
18
discussion, see the Risk Factors section below. Cash and cash equivalents were
$5.3 million on September 30, 2003.
Operating cash flows are a function of net income (loss) plus non-cash expenses
such as depreciation, and our ability to manage working capital. Cash used by
operating activities in the first nine months of 2003 was $19.5 million. The
major uses of funds from operating activities include increased accounts
receivables, increased inventory, and decreased accrued expenses. These uses of
cash were partially offset by operating cash provided by reductions in current
tax assets, increased accounts payable and depreciation expense.
Enesco has filed and continues to file tax returns with a number of taxing
authorities worldwide. While we believe such filings have been and are in
compliance with applicable laws, regulations and interpretations, positions
taken are subject to challenge by the taxing authorities often for an extended
number of years after the filing dates. Enesco has established accruals for tax
assessments. These accruals are included in current income taxes payable since
it is uncertain as to when assessments may be made and paid. Based upon Enesco's
current liquid asset position and credit facilities, Enesco believes it has
adequate resources to fund any such assessments. To the extent accruals differ
from actual assessments or when the open tax years are closed, the accruals will
be adjusted through the provision for income taxes. The majority of the open tax
years become closed at the end of December for the particular open year.
Cash used by investing activities in the first nine months of 2003 was $7.5
million, primarily due to: the acquisition of Bilston & Battersea in April 2003
and purchases of computer hardware and software related to implementation of a
new domestic computer system planned to be completed by the end of 2003.
Cash provided by financing activities in the first nine months of 2003 was $14.4
million, attributable to borrowings of $13.3 million and issuance of additional
treasury stock shares.
In June 2003, Enesco entered into a new three year domestic $50.0 million
unsecured revolving credit facility. The credit agreement contains financial and
operating covenants including restrictions on incurring indebtedness and liens,
acquisitions, selling property, repurchasing the Company's shares and paying
dividends. In addition, Enesco is required to satisfy fixed charge coverage
ratio and leverage ratio tests at the end of the second, third and fourth
quarters and a minimum annual operating profit covenant. As of September 30,
2003, Enesco was in compliance
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with all covenants under the revolving credit agreement. Enesco is not aware of
any trends, events, demands, commitments or uncertainties that reasonably can be
expected to have a material adverse effect on liquidity and the ability to meet
anticipated requirements for working capital and capital expenditures. We
believe that our current cash and cash equivalents, cash generated from
operations, and available financing will satisfy our expected working capital
needs, capital expenditures and other liquidity requirements associated with our
existing operations. In addition, there are no transactions, arrangements or
other relationships with unconsolidated entities or other persons that are
reasonably likely to materially affect liquidity or requirements for capital
resources.
The principal sources of Enesco's liquidity are its available cash balances,
cash from operations and available financing. At September 30, 2003, Enesco had
formal and informal unused lines of credit of approximately $44.2 million. The
informal lines are bank lines that have no commitment fees. As of September 30,
2003, Enesco had $13.5 million of interest bearing debt outstanding.
Fluctuations in the value of the U.S. dollar versus international currencies
affect the U.S. dollar translation value of international currency denominated
balance sheet items. The changes in the balance sheet dollar values due to
international currency translation fluctuations are recorded as a component of
shareholders' equity.
RISK FACTORS
Set forth below and elsewhere in this Report and in other documents we file with
the SEC are risks and uncertainties that could cause actual results to differ
materially from the results contemplated by the forward-looking statements
contained in this Report.
The results of operations for any quarter or fiscal year are not necessarily
indicative of results to be expected in future periods. Our operating results
have been in the past, and will continue to be, subject to quarterly and annual
fluctuations as a result of a number of factors. These factors include:
- - Changes in economic conditions and specific market conditions
- - The ability to secure, maintain and renew popular licenses,
particularly our licenses for Precious Moments, Cherished Teddies and
Heartwood Creek
- - Fluctuations in demand for our products
- - Manufacturing lead times
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- - The effects of terrorist activity and armed conflict, that could cause
a disruption in global economic activity, changes in logistics and
security arrangements, particularly with respect to our reliance on
manufacturing facilities in China
- - The timing of orders, timing of shipments and our ability to meet
customer demands
- - Inventory levels and purchase commitments below or exceeding
requirements based upon future demand forecasts
- - Price and product competition in the giftware industry
- - The trend toward retail store consolidation in the card and gift
channel in the United States
- - Variations in sales channels, product costs or mix of products sold
- - The geographical mix of our revenue and the associated impact on gross
margin
- - Our ability to achieve targeted cost reductions particularly in the
United States' operations
- - Actual events, circumstances, outcomes and amounts differing from
judgments, assumptions and estimates used in determining the amounts of
certain assets (including the amounts of related allowances),
liabilities and other items reflected in our financial statements.
As a consequence, operating results for a particular future period are difficult
to predict. Any of the foregoing factors, or any other factors discussed
elsewhere herein, could have a material adverse effect on our business, results
of operations and financial condition.
Gross margin may be adversely affected in the future by increases in vendor
costs, excess inventory, obsolescence charges, changes in shipment volume, price
competition and changes in channels of distribution or in the mix of products
sold. Gross margin may also be impacted by the geographic mix of product sold.
Our ability to import products and satisfy customer orders on a timely basis is
affected by the availability of, and demand for, quality production capacity
abroad. We compete with other importers of giftware products for the foreign
manufacturing sources that can produce high-quality products at affordable
prices. While we believe that there are other manufacturing sources available
for our product lines, any loss, disruption or substantial reduction of sourcing
capability or shipping from one or more of our key manufacturing facilities
could have a significant short-term adverse effect on our operations. We are
subject to the following risks inherent in foreign manufacturing: fluctuations
in currency exchange rates; labor, economic and political instability; the
effects of terrorist activity, armed conflict and epidemics, causing disruption
in global economic activity and changes in logistics and security arrangements;
cost and capacity fluctuation and delays in transportation, dockage and
materials handling; restrictive actions by foreign governments;
21
nationalizations; the laws and policies of the United States affecting
importation of goods, including duties, quotas and taxes. Since the terrorist
attacks on September 11, 2001 and the outbreak of the SARS epidemic, the U.S.
Customs Service has enacted various security procedures affecting the
importation of goods. Such procedures could adversely affect the cost and timing
of our receipt of goods from our foreign manufacturers.
In 2002, approximately 74% of our products were manufactured in, and imported
from China. We anticipate that this percentage will remain the same or increase
in the foreseeable future. China has joined the World Trade Organization and has
been accorded permanent "Normal Trade Relations" status by the U.S. government.
Various commercial and legal practices widespread in China, including the
handling of intellectual properties and certain labor practices, as well as
certain political and military actions taken or suggested by China, are under
review by the U.S. government. China has been designated a Country of Particular
Concern ("CPC") pursuant to the International Religious Freedom Act of 1998
("IRFA"). The IRFA provides several specific retaliatory actions that could be
taken by the U.S. government, none of which we believe would have a material
impact on our business. The IRFA, however, also accords the President of the
United States of America broad discretion in fashioning other or additional
actions and, due to the breadth of the presidential powers under the IRFA, we
are unable to predict what, if any, action the President might take in the
future.
Accordingly, conducting business with vendors located in China is subject to
political uncertainties, the financial impact of which we are unable to
estimate. To the extent China may have its exports or transaction of business
with U.S. entities subject to political retaliation, the cost of Chinese imports
could increase significantly and/or the ability to import goods from China may
be materially impaired. In such an event, there could be an adverse effect on
our operations until alternative arrangements for the manufacture of our
products were made on economic, production and operational terms at least as
favorable as those currently in effect.
The principal competitive risks in the markets in which we presently compete and
may compete in the future are:
- - Performance
- - Price
- - Collectibility of our products
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- - Market presence
- - New product introductions
- - Product costs
- - Differentiation of new products from those of our competitors
- - Time to market on new products
LEGAL PROCEEDINGS
We are a party to certain lawsuits in the normal course of our business.
Litigation can be expensive, lengthy and disruptive to normal business
operations. While we can not predict the eventual outcome of the proceedings, we
do not believe that any of the current legal proceedings will have a material
adverse effect on the consolidated financial statements of Enesco.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Enesco operates globally with various manufacturing and distribution facilities
and product sourcing locations around the world. As such, Enesco is exposed to
foreign exchange risk since purchases and sales are made in foreign currencies.
In addition, Enesco is subject to interest rate risk on outstanding borrowings.
Enesco may reduce its exposure to fluctuations in interest rates and foreign
exchange rates by creating offsetting positions through the use of derivative
financial instruments. Enesco currently does not use derivative financial
instruments for trading or speculative purposes. Enesco regularly monitors its
foreign currency exposures and ensures that the hedge contract amounts do not
exceed the amounts of the underlying exposures. To manage foreign currency risk,
as of September 30, 2003, Enesco had entered into forward exchange agreements
with a notional value of $6.3 million that will mature within 48 days. These
contracts include sales of British pounds sterling and the purchase of U.S.
dollars at an average exchange rate of 1.66, a sale of U.S. dollars and the
purchase of British pounds sterling at an average exchange rate of 1.66 and
sales of Euros and purchases of U.S. dollars at an average exchange rate of
1.13. The fair value of these contracts is not significant. As of September 30,
2003, Enesco had $13.5 million of interest bearing debt outstanding.
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ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, Enesco carried out an
evaluation, under the supervision and with the participation of Enesco's
management, including Enesco's (i) Chief Executive Officer ("CEO") and (ii)
Chief Financial Officer and Treasurer ("CFO"), of the effectiveness of the
design and operation of Enesco's disclosure controls and procedures. Based on
that evaluation, Enesco's management, including the CEO and CFO, concluded that
Enesco's disclosure controls and procedures are operating effectively as
designed. There have been no significant changes in Enesco's internal controls
or in other factors that could significantly affect internal controls over
financial reporting. We are committed to a continuing process of identifying,
evaluating and implementing improvements to the effectiveness of our disclosure
and internal controls and procedures. Our management, including our CEO and CFO,
does not expect that our controls and procedures will prevent all errors. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
within Enesco have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of a simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls is also based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in any control system, misstatements due to error or
violations of law may occur and not be detected.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of President and CEO
31.2 Certification of CFO and Treasurer
32.1 Statement of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2 Statement of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
Form 8-K filed October 23, 2003 reporting Enesco's Third Quarter 2003
financial results.
All other items hereunder are omitted because either such item is inapplicable
or the response to it is negative.
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Signatures
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 thereunto duly authorized.
ENESCO GROUP, INC.
(Registrant)
Date: November 13, 2003 /s/ Daniel DalleMolle
----------------------------------------
Daniel DalleMolle
President and Chief Executive Officer
Date: November 13, 2003 /s/ Thomas F. Bradley
----------------------------------------
Thomas F. Bradley
Chief Financial Officer and Treasurer
27