CSS INDUSTRIES INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

For the Quarter Ended		Commission file number 1-2661
June 30, 2004

CSS INDUSTRIES, INC.

(Exact name of registrant as specified in its Charter)

Delaware		13-1920657

(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification number)

1845 Walnut Street, Philadelphia, PA		19103

(Address of principal executive offices)		(Zip Code)

(215) 569-9900

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes No

As of July 29, 2004, there were 11,958,643 shares of common stock outstanding which excludes shares which may still be issued upon exercise of stock options.

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CSS INDUSTRIES, INC. AND SUBSIDIARIES

INDEX

PART I – FINANCIAL INFORMATION

	PAGE NO.

Item 1. Financial Statements

Consolidated Statements of Operations and Comprehensive Loss – Three months ended June 30, 2004 and 2003	3

Condensed Consolidated Balance Sheets – June 30, 2004 and March 31, 2004	4

Consolidated Statements of Cash Flows – Three months ended June 30, 2004 and 2003	5

Notes to Consolidated Financial Statements	6-13

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	14-15

Item 3. Quantitive and Qualitative Disclosures About Market Risk	16

Item 4. Controls and Procedures	16

PART II – OTHER INFORMATION

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	17

Item 6. Exhibits and Reports on Form 8-K	17-18

Signatures	19

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CSS INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)

(In thousands, except
per share data)

	Three Months Ended June 30,

		2004			2003

SALES	$	49,555		$	58,290

COSTS AND EXPENSES
Cost of sales		36,061			43,161
Selling, general and administrative expenses		20,175			21,078
Interest expense, net		417			705
Rental and other income, net		(235	)		(304	)

		56,418			64,640

LOSS BEFORE INCOME TAXES		(6,863	)		(6,350	)

INCOME TAX BENEFIT		(2,456	)		(2,311	)

NET LOSS	$	(4,407	)	$	(4,039	)

BASIC AND DILUTED NET LOSS PER COMMON SHARE	$	(.37	)	$	(.35	)

WEIGHTED AVERAGE BASIC AND DILUTED SHARES OUTSTANDING		11,894			11,632

CASH DIVIDENDS PER SHARE OF COMMON STOCK	$	.10		$	.067


COMPREHENSIVE LOSS

Net loss	$	(4,407	)	$	(4,039	)
Change in fair value of interest rate swap agreements, net		—			(1	)
Foreign currency translation adjustment		2			—

Comprehensive loss	$	(4,405	)	$	(4,040	)

See notes to consolidated financial statements.

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CSS INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

	June 30, 2004		March 31, 2004

	(Unaudited)
ASSETS

CURRENT ASSETS
Cash and cash equivalents	$	41,718	$	93,191
Accounts receivable, net		37,617		40,460
Inventories		146,271		94,459
Deferred income taxes		7,681		7,937
Other current assets		14,784		12,987

Total current assets		248,071		249,034

PROPERTY, PLANT AND EQUIPMENT, NET		79,696		81,193

OTHER ASSETS
Intangible assets, net		35,582		35,619
Other		4,797		4,551

Total other assets		40,379		40,170

Total assets	$	368,146	$	370,397

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES
Accrued customer programs	$	10,988	$	12,385
Other current liabilities		52,604		48,836

Total current liabilities		63,592		61,221

LONG-TERM DEBT, NET OF CURRENT PORTION		50,139		50,251

LONG-TERM OBLIGATIONS		3,631		3,631

DEFERRED INCOME TAXES		6,138		6,142

STOCKHOLDERS’ EQUITY		244,646		249,152

Total liabilities and stockholders’ equity	$	368,146	$	370,397

See notes to consolidated financial statements.

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CSS INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

(In thousands)

	Three Months Ended June 30,

		2004			2003

Cash flows from operating activities:
Net loss	$	(4,407	)	$	(4,039	)

Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		3,447			3,407
Provision for doubtful accounts		114			33
Deferred tax provision		252			265
Loss on sale of assets		6			—
Compensation expense related to stock options		165			—
Changes in assets and liabilities:
Decrease in accounts receivable		2,729			1,810
Increase in inventory		(51,812	)		(56,385	)
Increase in other assets		(2,076	)		(523	)
Decrease in accrued customer programs		(1,397	)		(371	)
Increase in other current liabilities		6,542			13,118
Decrease in accrued taxes		(2,774	)		(2,714	)

Total adjustments		(44,804	)		(41,360	)

Net cash (used for) operating activities		(49,211	)		(45,399	)

Cash flows from investing activities:
Purchase of property, plant and equipment		(1,889	)		(2,261	)
Proceed from sale of assets		2			156

Net cash (used for) investing activities		(1,887	)		(2,105	)

Cash flows from financing activities:
Payments on long-term obligations		(111	)		(172	)
Dividends paid		(1,190	)		(778	)
Purchase of treasury stock		(2,466	)		—
Proceeds from exercise of stock options		3,390			1,899

Net cash (used for) provided by financing activities		(377	)		949

Effect of exchange rate changes on cash		2			—

Net (decrease) in cash and temporary investments		(51,473	)		(46,555	)

Cash and cash equivalents at beginning of period		93,191			51,981

Cash and cash equivalents at end of period	$	41,718		$	5,426

See notes to consolidated financial statements.

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CSS INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2004
(Unaudited)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation –

CSS Industries, Inc. (collectively with its subsidiaries, “CSS” or “the Company”) has prepared the consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission. The Company has condensed or omitted certain information and footnote disclosures normally included on consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States pursuant to such rules and regulations. In the opinion of management, the statements included all adjustments (which include normal recurring adjustments) required for a fair presentation of financial position, results of operations and cash flows for the interim periods presented. These financial statements should be read in conjunction with the financial statements and notes thereto included in the latest Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results for the full year.

Principles of Consolidation –

The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.

Nature of Business –

CSS is a consumer products company primarily engaged in the design, manufacture and sale to mass market retailers of seasonal, social expression products, including gift wrap, gift bags, boxed greeting cards, gift tags, tissue paper, paper and vinyl decorations, classroom exchange Valentines, decorative ribbons and bows, Halloween masks, costumes, make-ups and novelties, Easter egg dyes and novelties and educational products. The seasonal nature of CSS’ business results in low sales and operating losses in the first and fourth quarters and high shipment levels and operating profits in the second and third quarters of the Company’s fiscal year which ends March 31, thereby causing significant fluctuations in the quarterly results of operations of the Company.

Reclassification –

Certain prior period amounts have been reclassified to conform with the current period presentation.

Stock Split –

On May 27, 2003 the Board of Directors authorized a three-for-two split of the Company’s common stock, effected by a distribution on July 10, 2003 of one share for each two shares held of record at the close of business on June 30, 2003. All earnings per share and common stock information is presented as if the stock split occurred prior to the earliest year included in these financial statements.

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Foreign Currency Translation and Transactions –

Translation adjustments are charged or credited to a separate component of stockholders’ equity. Gains and losses on foreign currency transactions are not material and are included in rental and other income, net in the consolidated statements of operations.

Use of Estimates –

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Judgments and assessments of uncertainties are required in applying the Company’s accounting policies in many areas. Such estimates pertain to the valuation of inventory and accounts receivable, the assessment of goodwill, income tax accounting and resolution of litigation. Actual results could differ from those estimates.

Inventories –

The Company records inventory at the date of taking title which generally occurs upon receipt or prior to receipt of in-transit inventory of overseas product. The Company adjusts unsaleable and slow-moving inventory to its net realizable value. Substantially all of the Company’s inventories are stated at the lower of first-in, first-out (FIFO) cost or market. The remaining portion of the inventory is valued at the lower of last-in, first-out (LIFO) cost or market. Inventories consisted of the following (in thousands):

	June 30,	March 31,
	2004	2004

Raw material	27,9002	17,878
Work-in-process	25,934	27,363
Finished goods	93,335	49,218

	$146,271	$94,459

Revenue Recognition –

The Company recognizes revenue from product sales when the goods are shipped and title and risk of loss pass to the customer. Provisions for allowances and rebates to customers, returns and other adjustments are provided in the same period that the related sales are recorded.

Stock-Based Compensation –

The Company applies Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock options plans. Accordingly, compensation expense is generally not recognized for its stock-based compensation plans. Had compensation expense for the Company’s stock option plans been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company’s net loss and loss per share would have been increased as follows:

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		Three Months Ended June 30,
		Three Months Ended June 30,

(in thousands, except per share data)		2004			2003

Net loss, as reported	$	(4,407	)	$	(4,039	)
Add: Total stock-based employee compensation expense included in the determination of net loss, as reported		165			—
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(755	)		(627	)

Pro forma net loss	$	(4,997	)	$	(4,666	)


Loss per share:
Basic and diluted – as reported	$	(.37	)	$	(.35	)
Basic and diluted – pro forma	$	(.42	)	$	(.40	)

Net Income Per Common Share –

The following table sets forth the computation of basic loss per common share and diluted loss per common share for the three months ended June 30, 2004 and 2003 (in thousands, except per share data):


		Three Months Ended June 30,

		2004			2003

Numerator:
Net loss	$	(4,407	)	$	(4,039	)


Denominator:
Weighted average shares outstanding for basic loss per common share		11,894			11,632
Effect of dilutive stock options		—			—

Adjusted weighted average shares outstanding for diluted loss per common share		11,894			11,632


Basic and diluted loss per common share	$	(.37	)	$	(.35	)

Statements of Cash Flows –

For purposes of the consolidated statements of cash flows, the Company considers all holdings of highly liquid debt instruments with a purchased maturity of less than three months to be cash equivalents.

(2) DERIVATIVE FINANCIAL INSTRUMENTS:

The Company enters into foreign currency forward contracts in order to reduce the impact of certain foreign currency fluctuations. Firmly committed transactions and the related receivables and payables may be hedged with foreign currency forward contracts. Gains and losses arising from foreign currency forward contracts are recognized in income or expense as offsets of gains and losses resulting from the underlying hedged transactions. As of June 30, 2004, the notional amount of open foreign currency forward contracts was $2,225,000 and the related gain was $30,000.

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In 2001, the Company entered into interest rate swap agreements, with maturities through January 2004, to manage its exposure to interest rate movements by effectively converting a portion of its anticipated working capital debt from variable to fixed rates. These agreements involved the Company receiving variable rate payments in exchange for fixed rate payments without the effect of leverage and without the exchange of the underlying face amount. Variable rate payments were based on one month U.S. dollar LIBOR. There were no interest rate swap contracts outstanding during the quarter ended June 30, 2004. During the quarter ended June 30, 2003, interest rate differentials paid under these agreements were recognized as adjustments to interest expense and amounted to $11,000.


(3)	BUSINESS ACQUISITIONS AND DIVESTITURES:

Crystal Creative Products, Inc.

On October 18, 2002, a subsidiary of the Company acquired all of the capital stock of Crystal Creative Products, Inc. (“Crystal”) for $22,891,000, including transaction costs, and assumed and repaid $18,828,000 of outstanding debt (primarily seasonal working capital debt). During fiscal 2004, the Company received cash of approximately $2,155,000 in satisfaction of a post closing adjustment to the purchase price. Crystal, headquartered in Middletown, Ohio, is a leading designer, manufacturer and distributor of consumer convenience gift wrap products and competed in the seasonal end of the gift bag and tissue markets with the Company’s existing product lines. Its product lines include gift tissue, gift bags, and related packaging products for the consumer market, as well as specialty tissues for in-store packaging of retailers and for industrial applications. A portion of the purchase price is being held in escrow for certain indemnification obligations. The acquisition was accounted for as a purchase and the excess of cost over the fair market value of the net tangible assets acquired of $9,877,000 was recorded as intangible assets in the accompanying consolidated balance sheets. Of the $9,877,000 of acquired intangible assets, $4,290,000 was assigned to tradenames that are not subject to amortization, $5,287,000 was assigned to goodwill and $300,000 was assigned to a covenant not to compete which has a useful life of five years.

In July 2003, the Company finalized a restructuring plan related to the Crystal acquisition, under which the Company restructured its business to integrate the acquired entity with its current businesses. In connection with this plan, the Company sold assets related to a non-core portion of the Crystal business for $3,525,000 in July 2003, and closed Crystal’s primary manufacturing facility in Maysville, Kentucky. A separate administration building in Middletown, Ohio also closed in March 2004. The Company recorded a restructuring reserve of $1,672,000 as part of purchase accounting, including severance related to approximately 150 employees. Payments of $217,000, mainly for severance, were made in the quarter ended June 30, 2004. During the first quarter of fiscal 2005, the subsidiary of the Company reopened the Maysville facility in response to the filing of an anti-dumping petition related to tissue products manufactured in China. Uncommitted restructuring accruals related to the closing of the Maysville facility were reversed against goodwill in the fourth quarter of fiscal 2004. Remaining payments related to contractual obligations and facility exit costs will be paid through the end of fiscal 2005. As of June 30, 2004, the remaining liability of $150,000 was classified as a current liability in the accompanying condensed consolidated balance sheet.

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Selected information relating to the Crystal restructuring reserve follows (in thousands):

					Contractual
					Obligations and
		Severance			Facility Exit Costs			Total

Restructuring reserve as of March 31, 2004	$	143		$	224		$	367
Cash paid – fiscal 2005		(143	)		(74	)		(217	)

Restructuring reserve as of June 30, 2004	$	—		$	150		$	150

C. M. Offray & Son, Inc.

On March 15, 2002, a subsidiary of the Company completed the acquisition of substantially all of the business and assets of the portion of C. M. Offray & Son, Inc. (“Offray”) which manufactures and sells decorative ribbon products, floral accessories and narrow fabrics for apparel, craft and packaging applications. Berwick acquired substantially all of the business and assets of Offray for $44,865,000 in cash, including transaction costs. A portion of the purchase price is being held in escrow to cover indemnification obligations. The acquisition was accounted for as a purchase and the cost approximated the fair market value of the net assets acquired. Therefore, no goodwill was recorded in this transaction.

In conjunction with the acquisition of Offray, the Company’s management approved a restructuring plan. As part of this plan, the Company accrued $2,385,000 for severance and costs related to the closure of certain facilities. As of June 30, 2004, the Company had closed Offray’s distribution facility in Quebec, Canada and its warehouse in Antietam, Maryland and has communicated termination of employment to approximately 125 employees. Payments, mainly for severance and facility exit costs, of $202,000 were made in the quarter ended June 30, 2004. As of June 30, 2004, the remaining liability of $200,000 was classified as a current liability in the accompanying condensed consolidated balance sheet and will be paid during fiscal 2005.

Selected information relating to the Offray restructuring reserve follows (in thousands):

					Contractual
					Obligations and
		Severance			Facility Exit Costs			Total

Restructuring reserve as of March 31, 2004	$	310		$	92		$	402
Cash paid – fiscal 2005		(110	)		(92	)		(202	)

Restructuring reserve as of June 30, 2004	$	200		$	—		$	200

(4)	BUSINESS RESTRUCTURING:

On May 5, 2004, a subsidiary of the Company announced a restructuring of its business and established a restructuring reserve related to its administrative office located in Minneapolis, Minnesota. This restructuring was established in order to gain efficiencies within the business unit. As part of this restructuring plan, the Company accrued $377,000 for termination costs and costs related to the restructuring of its administrative office located in Minneapolis, expected to occur in December 2004. As of June 30, 2004, the Company has communicated termination of employment to 33 employees. Payments, mainly for termination costs, of $12,000 were made in the quarter ended June 30, 2004. As of June 30, 2004, the remaining liability of $365,000 was classified as a current liability in the accompanying condensed consolidated balance sheet and will be paid during fiscal 2005. The portion of the termination costs to be paid, which is contingent upon the continuing service of the terminated employees through the date of closure of the office is being accrued in the period it is earned. The Company anticipates incurring a total of $1,508,000, including $479,000 for termination costs and $1,029,000 for contractual obligations and facility exit costs, with such additional amounts being expensed over the remainder of fiscal 2005.

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Selected information relating to the Minneapolis restructuring reserve follows (in thousands):

		Termination Costs			Contractual		Total
					Obligations and
					Facility Exit Costs

Initial accrual – May 2004	$	171		$	206	$	377
Cash paid – fiscal 2005		(12	)		—		(12	)
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