FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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: 1-10434
THE READER'S DIGEST ASSOCIATION, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-1726769
(State or other jurisdiction of (I.R.S.
incorporation or organization) Employer
Identification
No.)
Pleasantville, New York 10570-7000
(Address of principal executive (Zip Code)
offices)
(914) 238-1000
(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 [X] No [ ]
As of October 31, 2001, the following shares of the registrant's common stock
were outstanding:
Class A Nonvoting Common Stock, $0.01 par value: 87,589,233 shares
Class B Voting Common Stock, $0.01 par value: 12,432,164 shares
Page 1 of 21 pages.
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
Index to Form 10-Q
September 30, 2001
Part I - Financial Information Page No.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Financial Statements (unaudited):
Consolidated Condensed Statements of Income
for the three-month periods ended September 30, 2001 and 2000 3
Consolidated Condensed Balance Sheets
as of September 30, 2001 and June 30, 2001 4
Consolidated Condensed Statements of Cash Flows for the three-month
periods ended September 30, 2001 and 2000 5
Notes to Consolidated Condensed Financial Statements 6
Management's Discussion and Analysis
of Financial Condition and Results of Operations 13
Part II - Other Information 19
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Statements of Income
Three-month periods ended September 30, 2001 and 2000
(In millions, except per share data)
(unaudited)
Three-month periods ended
September 30,
2001 2000
RESTATED
(Note 7)
Revenues $ 497.5 $ 551.5
Product, distribution and editorial expenses (207.5) (208.8)
Promotion, marketing and administrative expenses (287.2) (298.4)
--------- ---------
Operating profit 2.8 44.3
Other expense, net (4.5) (3.6)
--------- ---------
(Loss) Income before provision for income taxes (1.7) 40.7
Provision for income taxes 0.6 (18.4)
--------- ---------
Net (loss) income $ (1.1) $ 22.3
========= =========
Basic earnings per share:
Weighted average common shares outstanding 101.9 102.9
Basic earnings per share $ (0.01) $ 0.21
========= =========
Diluted earnings per share:
Adjusted weighted average common shares outstanding 101.9 104.2
Diluted earnings per share $ (0.01) $ 0.21
========= =========
Dividends per common share $ 0.05 $ 0.05
========= =========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
As of September 30, 2001 and June 30, 2001
(In millions)
(unaudited)
September 30, June 30,
2001 2001
Assets RESTATED
(Note 6)
Cash and cash equivalents $ 52.2 $ 35.4
Accounts receivable, net 322.4 274.8
Inventories, net 200.2 167.4
Prepaid and deferred promotion costs 112.8 106.7
Prepaid expenses and other current assets 209.7 192.1
---------- ----------
Total current assets 897.3 776.4
Property, plant and equipment, net 161.8 160.2
Goodwill and other intangible assets, net 406.5 409.8
Other noncurrent assets 340.0 334.5
---------- ----------
Total assets $ 1,805.6 $ 1,680.9
========== ==========
Liabilities and stockholders' equity
Loans and notes payable $ 303.5 $ 160.3
Accounts payable 87.9 86.4
Accrued expenses 289.5 251.1
Income taxes payable 46.2 41.2
Unearned revenue 303.4 291.6
Other current liabilities 8.3 28.9
---------- ----------
Total current liabilities 1,038.8 859.5
Other noncurrent liabilities 351.6 361.6
---------- ----------
Total liabilities 1,390.4 1,221.1
Capital stock 23.8 29.6
Paid-in capital 225.9 226.1
Retained earnings 1,184.2 1,191.3
Accumulated other comprehensive loss (86.3) (84.6)
Treasury stock, at cost (932.4) (902.6)
---------- ----------
Total stockholders' equity 415.2 459.8
---------- ----------
Total liabilities and stockholders' equity $ 1,805.6 $ 1,680.9
========== ==========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows
Three-month periods ended September 30, 2001 and 2000
(In millions)
(unaudited)
Three-month periods ended
September 30,
2001 2000
Cash flows from operating activities RESTATED
(Note 7)
Net (loss) income $ (1.1) $ 22.3
Equity in losses of BrandDirect Marketing, Inc. -- 7.7
Depreciation and amortization 8.2 11.5
Net gain on the sales of a business, certain assets
and certain investments (0.7) (3.9)
Changes in assets and liabilities, net (96.8) (156.0)
-------- --------
Net change in cash due to operating activities (90.4) (118.4)
-------- --------
Cash flows from investing activities
Proceeds from maturities and sales of marketable
securities and short-term investments 0.1 6.6
Purchases of marketable securities and investments (0.1) (0.5)
Proceeds from other long-term investments 2.2 2.3
Proceeds from sales of property, plant and equipment 0.1 0.3
Investments in and advances to BrandDirect Marketing, Inc. -- (20.0)
Capital expenditures (6.2) (10.6)
-------- --------
Net change in cash due to investing activities (3.9) (21.9)
-------- --------
Cash flows from financing activities
Short-term borrowings, net 143.5 160.5
Dividends paid (5.5) (5.5)
Common stock repurchased (28.7) (3.6)
Proceeds from employee stock purchase plan
and exercise of stock options 0.5 1.8
Other, net 0.4 (3.5)
-------- --------
Net change in cash due to financing activities 110.2 149.7
-------- --------
Effect of exchange rate changes on cash 0.9 (7.4)
-------- --------
Net change in cash and cash equivalents 16.8 2.0
Cash and cash equivalents at beginning of period 35.4 49.7
-------- --------
Cash and cash equivalents at end of period $ 52.2 $ 51.7
======== ========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Notes to Consolidated Condensed Financial Statements
(In millions, except per share data)
(unaudited)
Unless indicated otherwise, references in Notes to Consolidated Condensed
Financial Statements to "we," "our" and "us" are to The Reader's Digest
Association, Inc. and its subsidiaries. All references to 2002 and 2001,
unless otherwise indicated, are to fiscal 2002 and fiscal 2001, respectively.
Our fiscal year represents the period from July 1 through June 30.
(1) Basis of Presentation and Use of Estimates
The accompanying consolidated financial statements include the accounts of
The Reader's Digest Association, Inc. and its subsidiaries. The preparation
of these 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,
the disclosure of contingent assets and liabilities, and the reported amounts
of operating revenues and expenses. These estimates are based on management's
knowledge of current events and actions that we may undertake in the future,
yet actual results may ultimately differ from those estimates.
We report on a fiscal year beginning July 1. The three-month periods ended
September 30, 2001 and 2000 are the first fiscal quarters of 2002 and 2001,
respectively. Operating results for any interim period are not necessarily
indicative of the results for an entire year due to the seasonality of our
business.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
No. 101). The principal changes we recorded as a result of SAB No. 101 relate
to gross versus net presentation of revenue as prescribed by the Emerging
Issues Task Force Abstract No. 99-19, Reporting Revenue Gross as a Principal
versus Net as an Agent (EITF 99-19). We adopted EITF 99-19 concurrently with
SAB No. 101 in the fourth quarter of 2001, and accordingly, certain prior
year amounts have been reclassified to conform to our current year
presentation:
- Magazine advertising agency commission costs have been reclassified to
present advertising revenues net of these costs in accordance with SAB No.
101. These costs, totaling $6.5 for the first quarter of 2001, were
originally recorded in promotion, marketing and administrative expenses
and have been reclassified to revenues.
- Magazine and music product remittances to publishers have been
reclassified to present revenues net of these costs in accordance with SAB
No. 101. These costs, totaling $1.7 for the first quarter of 2001, were
originally recorded in product, distribution and editorial expenses and
have been reclassified to revenues.
Other expense, net and net income have been restated in 2001 to reflect
equity in losses (including goodwill amortization associated with our
investment) of BrandDirect Marketing, Inc. (Note 7). This restatement was the
result of changing the method of accounting for this investment from the cost
to the equity method.
New Accounting Standards
On July 1, 2001, we adopted Statement of Financial Accounting Standards
(SFAS) No. 141, Business Combinations. As a result, the purchase method of
accounting will be used for all business combinations initiated after June
30, 2001. We have not had any business combinations subsequent to the
adoption of this statement.
Effective July 1, 2001, we elected early adoption of SFAS No. 142,
Goodwill and Other Intangible Assets (Note 8). Under SFAS No. 142
goodwill is no longer amortized, but reviewed for impairment at
least annually. Accordingly, no goodwill amortization was
recognized during the first quarter of 2002. We expect to complete
our transitional goodwill impairment assessment by the end of the
second quarter. Any impairment will be treated as a change in
accounting principle in accordance with SFAS No. 142.
(2) Basic and Diluted Earnings Per Share
Basic earnings per share is computed by dividing net income less preferred
stock dividend requirements ($0.3 for each of the three-month periods ended
September 30, 2001 and 2000) by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed in the
same manner except that the weighted average number of common shares
outstanding assumes the exercise and conversion of certain dilutive stock
options and vesting of restricted stock (0.4 million shares were antidilutive
as of September 30, 2001 and 1.3 million shares were dilutive as of September
30, 2000).
For the three-month periods ended September 30, 2001 and 2000, basic and
diluted earnings per share were $(0.01) and $0.21, respectively.
(3) Revenues and Operating Profit by Reporting Segments
Reportable segments were modified during the fourth quarter of 2001 to
reflect our new internal management organization. The accounting policies of
our segments are the same as those described in Note 1 to the consolidated
financial statements included in our 2001 Annual Report to Stockholders. In
addition, we allocate all corporate administrative costs to reporting
segments.
Three-month periods ended
September 30,
2001 2000
Revenues:
North America Books and Home Entertainment $ 133.7 $ 161.6
U.S. Magazines 114.5 117.4
International Businesses 238.2 263.8
New Business Development 11.1 8.7
-------- --------
Total revenues $ 497.5 $ 551.5
======== ========
Operating Profit (Loss):
North America Books and Home Entertainment $ (9.8) $ 23.8
U.S. Magazines 1.1 (2.3)
International Businesses 13.7 29.4
New Business Development (2.2) (6.6)
-------- --------
Total operating profit $ 2.8 $ 44.3
======== ========
(4) Comprehensive Loss
Accumulated other comprehensive loss as reported in the balance sheet as of
September 30, 2001 and September 30, 2000, primarily represents unrealized
losses on certain investments and foreign currency translation adjustments.
The components of comprehensive loss, net of related tax, for the three-month
periods ended September 30, 2001 and 2000 were as follows:
Three-month periods ended
September 30,
2001 2000
Restated
(Note 7)
Net income $ (1.1) $ 22.3
Change in:
Foreign currency translation adjustments 2.5 (11.3)
Net unrealized losses on certain investments, net
of deferred taxes of $1.9 and $23.7, respectively (3.6) (44.1)
Net unrealized (losses) gains on certain derivative
transactions, net of deferred taxes of $0.3 and $(0.6) (0.6) 1.0
------ -------
Total comprehensive loss $ (2.8) $ (32.1)
====== =======
Net unrealized losses on certain investments, net of related tax, principally
represent our investment in the voting common shares of LookSmart, Ltd.
(5) Other Operating Items
Other operating items represent charges related primarily to the streamlining
of our organizational structure and the strategic repositioning of certain
businesses. There were no charges recorded during the three-month periods
ended September 30, 2001 and 2000. The components of other operating items
are described in further detail below:
- Severance Costs - For each reporting period, we identify the employees who
are to be separated from our operations as a result of actions taken to
streamline our organizational structure. This separation is accomplished
through a combination of voluntary and involuntary severance programs. Of
the 380 employees identified at June 30, 2001 to be separated during 2002,
approximately 30% of the total employees identified were severed in the
first quarter of 2002, with the majority in the United States.
- Contract Terminations - These charges represent anticipated costs to
terminate contractual obligations in connection with streamlining
activities.
- Impairment Losses - As a result of restructuring activities, we may incur
charges related to the carrying value of certain assets.
At September 30, 2001, we had accruals for other operating items of $30.6,
primarily for severance costs. At June 30, 2001, these accruals totaled
$33.3. During the three-month period ended September 30, 2001, we made
payments of $2.7 related to primarily to severance costs.
(6) Inventories
September 30, June 30,
2001 2001
RESTATED
Raw materials $ 13.2 $ 12.0
Work-in-progress 19.1 19.2
Finished goods 167.9 148.1
------- -------
Total inventories $ 200.2 $ 167.4
======= =======
During the first quarter of 2002, we changed our method of accounting for
inventories in the United States, except for Books Are Fun, Ltd., from the
last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method.
Books Are Fun was already recording their inventory according to the FIFO
method. We believe that the new method of accounting for inventories is
preferable because it provides consistency in accounting for inventories that
are being managed globally as a result of our worldwide system implementation
project and because it better measures the current value of such inventories
and provides a more accurate reflection of our financial position.
The consolidated balance sheet as of June 30, 2001 has been restated to
reflect this change in accordance with the requirements of APB Opinion No.
20, Accounting Changes. The restatement did not have a material impact on
consolidated net income or the related earnings per share amounts in any
prior period. The restatement had no cash flow impact. To account for the
change, we increased retained earnings, net of a deferred tax liability, by
$3.6 and increased inventory by $5.8 on July 1, 2000.
(7) Investments
Available-for-Sale Marketable Securities
Marketable securities included in other noncurrent assets on the balance
sheet primarily represents the fair market value (based on quoted market
prices) of our investments in LookSmart, Ltd. and WebMD Corporation. These
securities are accounted for and classified as available-for-sale securities.
As of September 30, 2001, the market value of those shares totaled $3.0 for
LookSmart ($7.4 as of June 30, 2001) and $1.8 for WebMD ($3.0 as of June 30,
2001).
Investments, Equity Method
During the second quarter of 2001, we changed our method of accounting for
our investment in BrandDirect Marketing, Inc. from the cost method to the
equity method of accounting. Due to additional funding in the form of an
advance and other changes in circumstances, we obtained the ability to
exercise significant influence as defined in APB Opinion No.18, The Equity
Method of Accounting for Investments in Common Stock. Accordingly, other
expense, net and net income for the three-month period ended September 30,
2000 have been restated in accordance with APB Opinion No. 18, to reflect the
equity in losses of this investment of $7.7 (including goodwill
amortization). As of June 30, 2001, we had written-off our investment in
BrandDirect Marketing to zero.
Licensing Agreement
In May 2000, we entered into a long-term licensing agreement with World's
Finest Chocolate, Inc. The cost of entering into the agreement was assigned
to distribution rights, included in intangible assets on the balance sheet.
These rights are being amortized using the straight-line method over the
initial period of the agreement (10 years). Under the terms of the agreement,
QSP, Inc. has a long-term commitment to purchase World's Finest Chocolate
products and the exclusive right to sell those products for fundraising
purposes. Our purchase commitment is based on annual minimum tonnage amounts.
(8) Goodwill and Intangible Assets, Net
On July 1, 2001, we elected early adoption of SFAS No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. In
accordance with SFAS No. 141, the purchase method of accounting is to be used
for all business combinations initiated after June 30, 2001. We have not had
any business combinations subsequent to our adoption of the standard. SFAS
No. 142 requires that goodwill amortization is no longer to be recorded and
that the carrying amount of goodwill be evaluated at least annually for
recoverability. Accordingly, we have not recorded any goodwill amortization
during the first quarter of 2002. Furthermore, we will test our goodwill for
any transitional impairment during the second quarter of 2002 and, if
necessary, adjust the carrying value of our goodwill.
The changes in the carrying amount of goodwill for the three-month period
ended September 30, 2001 are as follows:
North America
Books and
Home U.S. New Business
Entertainment Magazines Development Total
Balance as of June 30, 2001 $ 323.6 $ 30.0 $ 11.6 $ 365.2
Identified intangible assets (1.3) -- (0.9) (2.2)
------- ------ ------ -------
Balance as of September 30, 2001 $ 322.3 $ 30.0 $ 10.7 $ 363.0
======= ====== ====== =======
Included in our balance sheet as of September 30, 2001 are the following
categories of acquired intangible assets.
September 30, 2001
Gross Net
Goodwill (Excess of cost over fair value of net assets of businesses acquired:
North America Books and Home $ 354.7 $ 322.3
Entertainment
U.S. Magazines 39.7 30.0
New Business Development 12.4 10.7
------- -------
Total goodwill $ 406.8 $ 363.0
======= =======
Intangible Assets (finite lives):
Licensing agreement $ 43.1 $ 37.2
Customer lists 23.3 5.1
Trademarks and noncompete agreements 3.0 1.2
------- -------
Total intangible assets (finite lives) $ 69.4 $ 43.5
======= =======
Amortization related to intangible assets (finite lives) amounted to $1.7 for
the three-month period ended September 30, 2001 ($1.4 for the three-month
period ended September 30, 2000). In accordance with SFAS No. 142, we
reassessed the useful lives of all other intangible assets. There were no
changes to such lives and there are no expected residual values associated
with these intangible assets. Our licensing agreement intangible asset is
being amortized over 10 years while customer lists are being amortized over
principally over five years. Estimated fiscal year amortization expense is as
follows: 2002 - $7.0; 2003 - $5.8; 2004 - $4.7; 2005 - $4.5 and 2006 - $4.5.
The following table reconciles the prior period's reported net income to its
respective pro forma balance adjusted to exclude goodwill amortization, which
is no longer recorded under SFAS No. 142.
For the three-month period ended September 30, 2000
Earnings Per Share
Amount Basic Diluted
Net income $ 22.3 $0.21 $0.21
Add back goodwill amortization 5.1 0.05 0.05
------ ----- -----
Adjusted net income $ 27.4 $0.26 $0.26
====== ===== =====
(9) Derivative Instruments
Risk Management and Objectives
In the normal course of business, we are exposed to market risk from the
effect of foreign exchange rate fluctuations on the U.S. dollar value of our
foreign subsidiaries' results of operations and financial condition. A
significant portion of our risk is associated with foreign exchange rate
fluctuations of the euro and the British pound. We purchase foreign currency
option and forward contracts to minimize the effect of fluctuating foreign
currencies on our subsidiaries' earnings and specifically identifiable
anticipated transactions. In addition, we enter into forward contracts to
minimize the effect of fluctuating foreign currency exchange rates on certain
foreign currency denominated assets and liabilities. Generally, we purchase
foreign currency option and forward contracts over periods ranging up to 12
months. As a matter of policy, we do not speculate in financial markets and,
therefore, we do not hold financial instruments for trading purposes. We
continually monitor foreign currency risk and the use of derivative
instruments.
Strategies and Description of Derivative Instruments
The following is a brief description of our derivative transactions.
- We enter into option contracts to hedge against the foreign
currency risk associated with intercompany royalty fees paid to us by our
foreign subsidiaries. The contract amounts of these options are based on
forecasted future revenues earned by our subsidiaries. These contracts are
designated as and qualify for cash flow hedge accounting.
- Similarly, option contracts are used to economically hedge against foreign
currency risk associated with operating cash flows of our foreign
subsidiaries. The contract amounts of these options are based on
forecasted cash flows from operating profit recognized by our
subsidiaries. These contracts do not qualify for hedge accounting
treatment.
- We utilize foreign currency forward contracts to economically hedge
against foreign currency risk associated with anticipated or forecasted
transactions, as well as foreign currency denominated loans due to and
from our foreign subsidiaries. These transactions do not qualify for hedge
accounting treatment.
Quantitative Disclosures of Derivative Instruments
Cash Flow Hedges - For the three-month period ended September 30, 2001,
changes in the spot value of the foreign currencies associated with option
contracts designated and qualifying as cash flow hedges of forecasted
intercompany royalty payments amounted to a loss of $(0.6), net of deferred
taxes of $0.3 (gain of $1.0, net of deferred taxes of $0.6, for the
three-month period ended September 30, 2000). These changes are reported in
accumulated other comprehensive loss included in stockholders' equity on the
balance sheet. The gains and losses are deferred until the underlying
transaction is recognized in earnings.
The ineffective portion of the change in market value of these option
contracts, specifically the time-value component of $(0.1), was recognized as
a loss in other expense, net on the income statement for the three-month
period ended September 30, 2001 (loss of $(0.7) for the three-month period
ended September 30, 2000). The fair value of the option contracts at
September 30, 2001, of $0.7 ($1.8 as of June 30, 2001) is included in prepaid
expenses and other current assets on the balance sheet.
We anticipate that the net gains in accumulated other comprehensive loss
relating to foreign currency option contracts existing at September 30, 2001
will be recognized as gain (loss) on foreign exchange during the 12-month
period ended September 30, 2002. As of September 30, 2001, the approximate
length of time over which we will hedge our exposure to the variability in
future cash flows associated with foreign currency royalty fees is 12 months.
There were no cash flow hedges discontinued during the three-month periods
ended September 30, 2001 or 2000.
Other Derivatives - For the three-month period ended September 30, 2001,
changes in the spot value of the foreign currencies and contract settlements
associated with option and forward contracts amounted to a loss of $(3.0)
(gain of $9.8 for the three-month period ended September 30, 2000). These
changes are reported in gain (loss) on foreign exchange included in other
expense, net on the income statement. This effect would generally be offset
by the translation of the assets, liabilities and future operating cash flows
being hedged. The fair value of the option and forward contracts as of
September 30, 2001, of $3.5 ($6.6 as of June 30, 2001) is included in prepaid
expenses and other current assets on the balance sheet.
(10) Debt
As described in Note 10 to the consolidated financial statements included in
our 2001 Annual Report to Stockholders, on July 27, 2001, we replaced a 1996
credit agreement with a Five-Year Revolving Credit and Competitive Advance
Facility Agreement (Five-Year Facility) that expires on July 27, 2006, and a
364-Day Revolving Credit and Competitive Advance Facility Agreement (364-Day
Facility) that expires on July 26, 2002 (the Credit Agreements). Together,
these Credit Agreements allow for up to $385.0 in principal amount of
borrowings ($192.5 for each agreement). At September 30, 2001, short-term
borrowings aggregated $303.2 ($192.5 on the Five-Year Facility and $110.7 on
the 364-Day Facility). These amounts are included in loans and notes payable
on the balance sheet.
(11) Share Repurchase Authorization
In January 2000, we announced authorization to repurchase up to 5.0 million
shares of our outstanding Class A nonvoting common stock. As of June 30,
2001, we had completed all purchases (amounting to $167.6) against the
January 2000 Repurchase Authorization. In May 2001, we announced
authorization to repurchase up to a total of $250.0 in shares of our
outstanding Class A nonvoting common stock, which superseded a
5.0-million-share repurchase authorization announced in October 2000. During
the three-month period ended September 30, 2001, we purchased approximately
2.1 million shares totaling $36.7 under the May 2001 Repurchase Authorization
($28.7 of this amount settled in cash). During the three-month period ended
September 30, 2000, we had purchased approximately 0.2 million shares
totaling $6.7 under the January 2000 Repurchase Authorization ($3.6 of this
amount settled in cash).
The Reader's Digest Association, Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations
(Dollars in millions, except per share data)
Unless indicated otherwise, references in Management's Discussion and
Analysis to "we," "our" and "us" are to The Reader's Digest Association, Inc.
and its subsidiaries. All references to 2002 and 2001, unless otherwise
indicated, are to fiscal 2002 and fiscal 2001, respectively. Our fiscal year
represents the period from July 1 through June 30.
The following discussion and analysis provides information that we believe is
relevant to an assessment and understanding of our consolidated results of
operations and financial condition and has been written excluding the effect
of fluctuations in foreign currency exchange rates and other operating items.
This discussion should be read in conjunction with the Consolidated Condensed
Financial Statements and related notes. Certain amounts and percentages do
not recalculate due to rounding.
Three-Month Period Ended September 30, 2001, Compared With
Three-Month Period Ended September 30, 2000
Results of Operations: Company-Wide
Revenues
Revenues for the first quarter of 2002 decreased 10% to $498, compared with
$552 in the first quarter of 2001. Excluding the adverse effect of foreign
currency translation, revenues decreased 8%. The decrease in revenues was
primarily attributable to lower sales of our North America Books and Home
Entertainment and International Businesses segments.
Revenues were significantly lower in the U.S. market of North America Books
and Home Entertainment, which represented $31 of the total $28 decline in
revenues for this segment. Slightly offsetting the decline in the U.S. were
higher revenues in Canada for Books and Home Entertainment and QSP products.
Revenues in the U.S. were lower principally for single sales products,
including general books, trade, music and video products. North America Books
and Home Entertainment significantly reduced mail quantities in the United
States, in response to promotional changes required by the 2001 attorneys
general sweepstakes agreement and overall softening of the U.S. economy, and
experienced lower response rates to certain products.
Revenues were lower for International Businesses primarily for Books and Home
Entertainment products. Revenue reductions were significant in the following
countries: Germany, Australia, Brazil, the Nordic region, Argentina and
Poland. Planned shifts in the timing of series shipments, lower mail
quantities and poor economic conditions in Brazil and Argentina contributed
to the declines. Partially offsetting these declines were higher revenues in
certain Eastern European countries, the United Kingdom and France as a result
of increased mail quantities and higher response rates.
Operating Profit
Operating profit for the first quarter of 2002 decreased significantly to $3,
compared with $44 in the first quarter of 2001. The decline in operating
profit resulted from the revenue declines described above for North America
Books and Home Entertainment and International Businesses. Partially
offsetting these declines were reduced losses for New Business Development
and U.S. Magazines. Lower operating expenses for Gifts.com, Inc. and
increased sales from our marketing alliances contributed to higher profits
for New Business Development. U.S. Magazines realized higher profits
primarily from lower promotion costs and re-engineering cost savings related
to subscription fulfillment.
We estimate that the aftermath of the September 11, 2001 terrorist attacks
cost us in excess of $10 in revenues and $5 in profits in the first quarter
of 2002. These events adversely affected U.S. magazine subscription and
advertising sales as well as response rates for U.S. Books and Home
Entertainment promotional mailings, and caused the cancellation or
postponement of a modest number of seasonal school events at QSP and
corporate events at Books Are Fun.
Other Expense, Net
Other expense, net increased 26% to $5 in the first quarter of 2002, compared
with $4 in the first quarter of 2001. The increase was primarily the result
of:
- A net foreign exchange loss from our hedging program of $1, compared with
a net gain in the prior period of $3.
- Equity in losses (including goodwill amortization) of BrandDirect
Marketing, Inc. of $8 in the prior period. No such losses were recorded in
the current period as a result of a write-down of the investment to zero
as of June 30, 2001.
- Income in the prior period of $4 from the sale of certain
investments.
Income Taxes
The effective tax rate for the first quarter of 2002 was 36.0%, compared with
a rate of 45.1% for the first quarter of 2001. Excluding equity in losses
(including goodwill amortization) of BrandDirect Marketing, Inc. and
nondeductible goodwill amortization, the effective tax rate for the first
quarter of 2001 was 34.4%.
Net Income and Earnings Per Share
For the first quarter of 2002, the net loss was $(1), or $(0.01) for both
basic and diluted earnings per share, compared with net income of $22, or
$0.21 per share in the prior year period.
Effective July 1, 2001, we elected early adoption of Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets.
Accordingly, no goodwill amortization was recognized during the first quarter
of 2002. Net income in the first quarter of 2001 included goodwill
amortization of $5, or $0.05 per share, primarily related to Books Are Fun,
Ltd. included in our North America Books and Home Entertainment segment.
Results of Operations: Operating Segments
North America Books and Home Entertainment
Revenues for North America Books and Home Entertainment decreased 17% in the
first quarter of 2002 to $134, compared with $162 in the first quarter of
2001. Lower revenues in the U.S. contributed to $31 of the decline while
revenues in Canada increased $3. The decrease in the U.S. was primarily
driven by the effects of the 2001 attorneys general sweepstakes agreement and
overall softening of the U.S. economy. These events resulted in a decision to
reduce mail quantities and in a decline in response rates of primarily
general books, Select Editions, video and music single-sales products. In the
U.S., mailings were reduced, compared with the prior period, in anticipation
of lower responses to promotions because of changes to promotional material
to comply with the 2001 attorneys general sweepstakes agreement and because
of weakness in the U.S. economy. In addition, revenues for trade products
were lower as a result of promotion in the prior year period of a significant
product that was not promoted in the current period.
Operating profit for North America Books and Home Entertainment decreased
significantly in the first quarter of 2002 to a loss of $(10), compared with
a profit of $24 in the first quarter of 2001. Virtually all of the change in
operating profit was in the U.S. market and was attributed to the revenue
declines described above as well as investment in outside lists, primarily
used for Select Editions promotions.
U.S. Magazines
Revenues for U.S. Magazines decreased 2% in the first quarter of 2002 to
$115, compared with $117 in the first quarter of 2001. The reduction in
revenues was driven by:
- Lower circulation revenues for Reader's Digest magazine primarily from
lower renewals partially offset by new subscribers at lower introductory
rates.
- Lower advertising revenues for Reader's Digest magazine from fewer
advertising pages sold as a result of softness in the industry, partially
offset by a higher average rate per page.
Offsetting a portion of these declines were increases in revenues for food
and gift items sold by QSP, Inc. as a result of continued sales growth from
the sales force and products of the World's Finest Chocolate, Inc.
Operating profit for U.S. Magazines increased in the first quarter of 2002 to
a profit of $1, compared with a loss of $2 in the first quarter of 2001. The
increase was primarily the result of lower promotion costs and cost-reduction
initiatives of Reader's Digest and Special Interest magazines. These cost
savings offset the declines in profits from lower circulation and advertising
revenues described above. Profits for QSP were lower due to a change in
product mix and an investment in the sales force (i.e., an increase in the
number of sales representatives and area managers).
International Businesses
Revenues for International Businesses decreased 10% in the first quarter of
2002 to $238, compared with $264 in the first quarter of 2001. Excluding the
adverse effect of changes in foreign currency exchange rates, revenues
decreased 7%. Revenues were lower for International Businesses primarily due
to:
- Planned shifts in the timing of series shipments in several markets,
including Germany, Poland and the Nordic region, which resulted in higher
revenues in the first quarter of 2001.
- Reduced mailings for music, general books and, to a lesser extent, video
products primarily in Germany, Poland, Australia and Brazil.
- Weak economic conditions in Argentina and Brazil, which resulted in lower
response rates to products.
Offsetting a portion of these declines in revenues were higher revenues in
certain markets, including certain Eastern European countries, the United
Kingdom and France. The following highlights the more prevalent drivers:
- In certain Eastern European countries (specifically Russia, the Czech
Republic and Hungary), revenues were higher from increased mail
quantities. In Russia, mail quantities were increased for Select Editions
and video products. In the Czech Republic and Hungary, mail quantities
were higher for general books and Select Editions, and music series
products, which were introduced in these countries.
- In the United Kingdom, sales were higher as a result of increased
telemarketing activity and affinity mailings (i.e., specific mailings
targeted to a group of customers).
- Revenues were higher in France as a result of higher responses to music
products and reading and illustrated series products.
Operating profit for International Businesses decreased 53% in the first
quarter of 2002 to $14, compared with a $29 in the first quarter of 2001. The
net reduction in revenue described above contributed significantly to the
reduction in profit. For the most part, profits were lower as a result of
reduced activity for Books and Home Entertainment products. Profits for
Reader's Digest magazine from both circulation and advertising revenues were
relatively consistent with the prior year period.
Overall, profits were, most notably, lower in the following countries:
Australia, Germany, Nordic countries, Brazil and Argentina. Regions and
countries reporting profit growth were led by Eastern Europe, the United
Kingdom and France.
New Business Development
Revenues from New Business Development increased 27% to $11 in the first
quarter of 2002, compared with $9 in the first quarter of 2001. Revenues
increased from higher catalog and Internet revenues of Gifts.com, Inc., and
the global expansion of marketing alliances for financial services and
vitamin products.
Operating losses from New Business Development decreased by 66% to $(2) in
the first quarter of 2002, compared with operating losses of $(7) in the
first quarter of 2001. This decrease resulted from reduced operating costs of
Gifts.com, Inc. and higher profits from expansion of our marketing alliances
in financial services.
Forward-Looking Information
Fiscal 2002 Results
We anticipate some residual impact from the September 11, 2001 terrorist
attacks and the subsequent anthrax scare primarily in the second and third
quarters of our fiscal year. We estimate that earnings per share in the
second quarter will be in the range of $0.75 to $0.80, contingent upon the
economy and world events. The full year visibility is still uncertain, but we
are increasingly optimistic about the second half of 2002, and expect
year-over-year improvement in both revenues and operating profit.
Liquidity and Capital Resources
Three-month
period ended
September 30, 2001
Cash and cash equivalents at June 30, 2001 $ 35
Net change in cash due to:
Operating activities (90)
Investing activities (4)
Financing activities 110
Effect of exchange rate changes on cash and cash equivalents 1
-----
Net change in cash and cash equivalents 17
Cash and cash equivalents at September 30, 2001 $ 52
=====
Cash and cash equivalents increased 47% to $52 at September 30, 2001,
compared with $35 at June 30, 2001. Short-term borrowings increased by $143
to $303 as of September 30, 2001 to finance additional receivables, as well
as additional inventory of Books Are Fun during the three-month period.
As described in Note 10 to the consolidated financial statements included in
our 2001 Annual Report to Stockholders, on July 27, 2001, we replaced a 1996
credit agreement with a Five-Year Revolving Credit and Competitive Advance
Facility Agreement that expires on July 27, 2006, and a 364-Day Revolving
Credit and Competitive Advance Facility Agreement that expires on July 26,
2002 (the Credit Agreements). Together, these Credit Agreements allow for up
to $385 in principal amount of borrowings ($192.5 for each agreement). The
Credit Agreements contains covenants to maintain minimum level of interest
coverage and a maximum level of leverage. At September 30, 2001, we had
borrowings of $303 outstanding under the Credit Agreements and were in
compliance with all covenants. It is our intent to repay the outstanding
amount by the end of 2002.
In January 2000, we announced authorization to repurchase up to 5.0 million
shares of our outstanding Class A nonvoting common stock. As of June 30,
2001, we had completed all purchases (amounting to $168) against the January
2000 Repurchase Authorization. In May 2001, we announced authorization to
repurchase up to a total of $250 in shares of our outstanding Class A
nonvoting common stock, which superseded a 5.0-million-share repurchase
authorization announced in October 2000. As of September 30, 2001, we
purchased approximately 2.1 million shares totaling $37 under the May 2001
Repurchase Authorization ($29 of this amount settled in cash during the
three-month period ended September 30, 2001).
We believe that our liquidity, capital resources, cash flows, credit lines
and borrowing capacity are sufficient to fund normal capital expenditures,
working capital requirements, the payment of dividends, the execution of our
share repurchase program and the implementation of our strategic initiatives.
Currency Risk Management
In the normal course of business, we are exposed to the effects of foreign
exchange rate fluctuations on the U.S. dollar value of our foreign
subsidiaries' results of operations and financial condition. We purchase
foreign currency option and forward contracts to minimize the effect of
fluctuating foreign currency exchange rates on our earnings and specifically
identifiable anticipated transactions. In addition, we enter into forward
contracts to minimize the effect of fluctuating foreign currency exchange
rates on certain foreign currency denominated assets and liabilities.
At September 30, 2001, our primary foreign currency market exposures included
the euro and the British pound. We estimate that the results of a uniform 10%
weakening and 10% strengthening in the value of the U.S. dollar relative to
the currencies in which our option and forward contracts are denominated,
with all other variables held constant, would have the following effect:
Effect of a 10% Effect of a 10%
Weakening Strengthening
of the U.S. Dollar of the U.S. Dollar
Option Contracts $ (2.9) $ 9.1
Forward Contracts $ (4.2) $ 3.4
These estimates represent changes to the fair value of our option and forward
contracts on a stand-alone basis. Such changes would be substantially offset
by the related impact on the assets, liabilities and operating profits being
hedged. Also, this calculation assumes that each exchange rate would change
in the same direction relative to the U.S. dollar. Changes in exchange rates
not only affect the U.S. dollar value of the fair value of these derivatives,
but also affect the underlying foreign subsidiaries' income. Our sensitivity
analysis as described above does not consider potential changes in local
sales levels, or currency prices, or the mitigating effects of option or
forward contracts.
Impact of the Euro Conversion
On January 1, 1999, 11 of the 15 member countries of the European Union
established fixed conversion rates between their existing sovereign
currencies (legacy currencies) and a single currency called the euro. The
legacy currencies are scheduled to remain legal tender as denominations of
the euro during the transition period from January 1, 1999, to December 31,
2001. Beginning January 1, 2002, euro-denominated bills and coins will be
introduced and by July 1, 2002, legacy currencies will no longer be legal
tender.
We performed an internal analysis regarding the business and systems issues
related to the euro conversion and developed a strategic plan to ensure that
all necessary modifications would be made on a timely basis. Our operations
in markets that have adopted the euro are able to accept payments and pay
suppliers in euros and are able to indicate the euro equivalent of pricing on
invoices. During the transition period, we are monitoring customer and
competitor reaction to the euro and updating the strategic plan as needed.
To date, the transition to the euro has not significantly affected our
marketing strategy. In addition, we believe that the conversion to the euro
will not have a significant impact on the marketing strategy of our European
operations in the future. We do not anticipate the need to synchronize prices
between markets in the future, primarily because the editorial content of our
products varies. In addition, products are published in local languages and
are sold primarily through direct mail rather than retail channels. These
factors result in products that tend to be unique to each market and do not
easily lend themselves to price comparisons across borders. The estimated
costs to convert all affected systems to the euro are not expected to have a
material adverse effect on our results of operations, financial position or
cash flow.
Recent Accounting Standards
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. This
statement supersedes both SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions for the disposal of a segment of a
business of Accounting Principles Board (APB) Opinion No. 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. SFAS No. 144 retains the fundamental provisions in SFAS No. 121
for recognizing and measuring impairment losses on long-lived assets held for
use and long-lived assets to be disposed of by sale, while also resolving
significant implementation issues associated with SFAS No. 121.
SFAS No. 144 also retains the basic provisions of APB Opinion
No. 30 on how to present discontinued operations in the income
statement but broadens that presentation to include a component
of an entity (rather than a segment of a business). Unlike SFAS
No. 121, an impairment assessment under SFAS No. 144 will never
result in a write-down of goodwill. Rather, goodwill is
evaluated for impairment under SFAS No. 142.
We are required to adopt SFAS No. 144 no later than July 1, 2002 (fiscal
2003). We are currently evaluating the impact of adoption of this statement.
*****
This report includes "forward-looking statements" within the meaning of the
U.S. federal securities laws. Forward-looking statements include any
statements that address future results or occurrences. These forward-looking
statements inherently involve risks and uncertainties that could cause actual
future results and occurrences to differ materially from the forward-looking
statements. Except as required by those laws, we have no obligation to update
publicly any forward-looking statements and we have no intention to update
them.
Some of these risks and uncertainties include factors relating to:
- the effects of potentially more restrictive privacy and other
governmental regulation relating to our marketing methods;
- the effects of modified and varied promotions;
- our ability to identify customer trends;
- our ability to continue to create a broadly appealing mix of new
products;
- our ability to attract and retain new and younger magazine
subscribers and product customers in view of the maturing of an
important portion of our U.S. customer base;
- our ability to attract and retain subscribers and customers in an
economically efficient manner;
- the effects of selective adjustments in pricing;
- our ability to expand and more effectively utilize our customer
database;
- our ability to expand into new international markets and to
introduce new product lines into new and existing markets;
- our ability to expand into new channels of distribution;
- our ability to negotiate and implement productive acquisitions,
strategic alliances and joint ventures;
- our ability to integrate newly acquired and newly formed
businesses successfully;
- the strength of relationships of newly acquired and newly formed
businesses with their employees, suppliers and customers;
- the accuracy of the basis of forecasts relating to newly acquired
and newly formed businesses;
- our ability to contain and reduce costs, especially through
global efficiencies;
- the cost and effectiveness of re-engineering of business
processes and operations;
- the accuracy of management's assessment of the current status of
our business;
- the evolution of our organizational and structural capabilities;
- our ability to respond to competitive pressures within and
outside the direct marketing industry, including the Internet;
- the effects of worldwide paper and postage costs;
- the effects of possible postal disruptions on deliveries of
promotions, products and payments;
- the effects of foreign currency fluctuations;
- the accuracy of management's assessment of the future effective
tax rate and the effect of initiatives to reduce the rate;
- the effects of the transition to the euro;
- the adequacy of our financial resources;
- the effects of unforeseen economic and political changes in the
markets where we compete;
- the economic effects of the September 11, 2001 terrorist attacks, the
anthrax scare and subsequent related events, especially those affecting
the direct marketing industry;
- the effects and pace of our stock repurchase program; and
- the effects of general economic conditions.
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
18 Preferability Letter regarding Change in Accounting
Principles for Inventory.
(b) Reports on Form 8-K
During the three-month period ended September 30, 2001, we filed the
following Current Reports on Form 8-K.
- Current Report on Form 8-K dated August 14, 2001 including a press
release and conference call transcript relating to the fourth quarter
fiscal 2001 earnings release.
- Current Report on Form 8-K dated August 20, 2001 including a press
release relating to Michael S. Geltzeiler's appointment as Senior Vice
President and Chief Financial Officer.
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.
The Reader's Digest
Association, Inc.
(Registrant)
Date: November 9, 2001 By: /s/ THOMAS D. BARRY
-------------------------
Thomas D. Barry
Vice President and Corporate Controller
(chief accounting officer and
authorized signatory)
EXHIBIT INDEX
Exhibit Page
18 Preferability Letter regarding Change in Accounting
Principles for Inventory.