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 March 31, 2002
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.Employer
incorporation or organization) Identification No.)
Pleasantville, New York 10570-7000
(Address of principal executive offices) (Zip Code)
(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 April 30, 2002, the following shares of the registrant's
common stock were outstanding:
Class A Nonvoting Common Stock, $0.01 par value:87,228,489 shares
Class B Voting Common Stock, $0.01 par value:12,432,164 shares
Page 1 of 25 pages.
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
Index to Form 10-Q
(unaudited)
March 31, 2002
Page No.
Part I - Financial Information:
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Financial Statements:
Consolidated Condensed Statements of Income
for the three-month and nine-month periods ended March 31, 2002
and 2001 3
Consolidated Condensed Balance Sheets
as of March 31, 2002 and June 30, 2001 4
Consolidated Condensed Statements of Cash Flows
for the nine-month periods ended March 31, 2002 and 2001 5
Notes to Consolidated Condensed Financial Statements 6
Management's Discussion and Analysis
of Financial Condition and Results of Operations 14
Part II - Other Information 24
The Reader's Digest Association, Inc. And Subsidiaries
Consolidated Condensed Statements of Income
Three-month and nine-month periods ended March 31, 2002 and 2001
(In millions, except per share data)
(unaudited)
Three-month period ended Nine-month period ended
March 31, March 31,
2002 2001 2002 2001
(Note 1) (Note 1)
Revenues $ 541.8 $ 597.9 $ 1,823.3 $ 1,973.7
Product, distribution and
editorial expenses (226.3) (236.5) (725.6) (751.2)
Promotion, marketing and
administrative expenses (293.8) (321.1) (946.6) (981.7)
Other operating items and
impairment losses -- -- -- 8.2
-------- -------- ---------- ----------
Operating profit 21.7 40.3 151.1 249.0
Other income (expense), net 2.2 2.6 (5.7) (4.6)
-------- -------- ---------- ----------
Income before provision for
income taxes 23.9 42.9 145.4 244.4
Provision for income taxes (7.5) (15.0) (51.2) (90.4)
-------- -------- ---------- ----------
Net income $ 16.4 $ 27.9 $ 94.2 $ 154.0
======== ======== ========== ==========
Basic earnings per share:
Weighted average common
shares outstanding 99.6 102.7 100.5 102.8
======== ======== ========== ==========
Basic earnings per share $ 0.16 $ 0.27 $ 0.93 $ 1.49
======== ======== ========== ==========
Diluted earnings per share:
Adjusted weighted average
common shares outstanding 99.7 103.6 100.8 103.9
======== ======== ========== ==========
Diluted earnings per share $ 0.16 $ 0.27 $ 0.92 $ 1.47
======== ======== ========== ==========
Dividends per common share $ 0.05 $ 0.05 $ 0.15 $ 0.15
======== ======== ========== ==========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
As of March 31, 2002 and June 30, 2001
(In millions)
(unaudited)
March 31, June 30,
2002 2001
Restated
Assets (Note 7)
Cash and cash equivalents $ 40.9 $ 35.4
Accounts receivable, net 308.1 274.8
Inventories, net 153.6 167.4
Prepaid and deferred promotion costs 87.6 106.7
Prepaid expenses and other current assets 190.7 192.1
--------- ---------
Total current assets 780.9 776.4
Property, plant and equipment, net 158.9 160.2
Goodwill and other intangible assets, net 402.8 409.8
Other noncurrent assets 360.2 334.5
--------- ---------
Total assets $ 1,702.8 $ 1,680.9
========= =========
Liabilities and stockholders' equity
Loans and notes payable $ 154.1 $ 160.3
Accounts payable 83.9 86.4
Accrued expenses 260.3 251.1
Income taxes payable 56.1 41.2
Unearned revenue 306.3 291.6
Other current liabilities 3.4 28.9
--------- ---------
Total current liabilities 864.1 859.5
Other noncurrent liabilities 351.5 361.6
--------- ---------
Total liabilities 1,215.6 1,221.1
Capital stock 25.1 29.6
Paid-in capital 225.3 226.1
Retained earnings 1,270.4 1,191.3
Accumulated other comprehensive (loss)income (80.1) (84.6)
Treasury stock, at cost (953.5) (902.6)
--------- ---------
Total stockholders' equity 487.2 459.8
--------- ---------
Total liabilities and stockholders' equity $ 1,702.8 $ 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
Nine-month periods ended March 31, 2002 and 2001
(In millions)
(unaudited)
Nine-month period ended
March 31,
2002 2001
Cash flows from operating activities
Net income $ 94.2 $ 154.0
Depreciation, amortization and asset
impairments 24.3 41.8
Net (gain) loss on the sales of businesses,
certain assets, investments and contract
terminations (5.6) (7.3)
Equity in losses of an affiliate -- 12.2
Other, net of the effects of acquisitions
and dispositions (18.7) (169.0)
------- --------
Net change in cash due to operating activities 94.2 31.7
------- --------
Cash flows from investing activities
Proceeds from maturities and sales of
short-term investments and marketable
securities 6.4 11.3
Purchases of investments and marketable
securities (1.0) (0.8)
Proceeds from other long-term investments,
net and sale of a business 2.2 1.3
Proceeds from sales of property, plant and
equipment 1.9 1.3
Investment in and advances to an affiliate -- (23.0)
Capital expenditures (18.3) (31.3)
------- --------
Net change in cash due to investing activities (8.8) (41.2)
------- --------
Cash flows from financing activities
Short-term borrowings, net (9.6) 58.2
Dividends paid (16.1) (16.4)
Common stock repurchased (64.1) (34.1)
Proceeds from employee stock purchase plan
and exercise of stock options 5.8 16.3
Other, net 2.2 2.0
------- --------
Net change in cash due to financing activities (81.8) 26.0
------- --------
Effect of exchange rate changes on cash 1.9 (12.3)
------- --------
Net change in cash and cash equivalents 5.5 4.2
Cash and cash equivalents at beginning of period 35.4 49.7
------- --------
Cash and cash equivalents at end of period $ 40.9 $ 53.9
======= ========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Notes to Consolidated Condensed Financial Statements
(Dollars in millions, except per share data)
(unaudited)
Unless indicated otherwise, references in Notes to Consolidated
Condensed Financial Statements to "we", "us" and "our" are to The
Reader's Digest Association, Inc. and Subsidiaries. All references to
2002 and 2001, unless specifically identified, are to fiscal 2002 and
fiscal 2001, respectively.
(1) Basis of Presentation and Use of Estimates
The accompanying consolidated condensed financial statements include
the accounts of The Reader's Digest Association, Inc. and its U.S. and
international subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. These statements
and accompanying notes have not been audited but, in the opinion of
management, have been prepared in conformity with accounting principles
generally accepted in the United States applying certain assumptions
and estimates, including all adjustments considered necessary to
present such information fairly. Although these estimates are based on
management's knowledge of current events and actions that we may
undertake in the future, actual results may ultimately differ from
those estimates.
We report on a fiscal year beginning July 1. The three-month periods
ended March 31, 2002 and 2001 are the third 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 $5.4 and
$18.8 for the three-month and nine-month periods, respectively,
ended March 31, 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 $4.4 and $27.8 for the
three-month and nine-month periods, respectively, ended March 31,
2001, were originally recorded in product, distribution and
editorial expenses and have been reclassified to revenues.
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.
Effective July 1, 2001, we elected early adoption of SFAS No. 142,
Goodwill and Other Intangible Assets (Note 9). Under SFAS No. 142
goodwill is no longer amortized, but reviewed for impairment at least
annually. Accordingly, no goodwill amortization was recognized in
2002. We have completed our transitional goodwill impairment
assessment and concluded that there was no impairment of goodwill as of
July 1, 2001 (the date of adoption) or in 2002.
(2) Acquisitions
On March 21, 2002, we entered into a definitive agreement to acquire
substantially all of the assets and assume specified liabilities of
Reiman Holding Company, LLC and subsidiaries (Reiman) for $760.0 in
cash, subject to adjustment. Reiman publishes cooking, gardening,
country lifestyle and nostalgia magazines and books in the United
States and Canada. The acquisition is expected to be financed entirely
through debt. The acquisition is subject to customary closing
conditions, including finalizing financing arrangements. We expect to
close the acquisition in the fourth quarter of 2002.
(3) Basic and Diluted Earnings Per Share
Basic earnings per share is computed by dividing net income less
preferred stock dividend requirements by the weighted average number of
common shares outstanding during the period. The preferred stock
dividend requirements were $0.3 for each of the three-month periods
ended March 31, 2002 and 2001 and $1.0 for each of the nine-month
periods ended March 31, 2002 and 2001.
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 stock options and vesting of certain
restricted stock. For the three-month period ended March 31, 2002, the
assumed exercise, conversion and vesting totaled 0.1 million shares;
for the comparable period ended March 31, 2001, there were 0.9 million
shares. For the nine-month period ended March 31, 2002 the assumed
exercise, conversion and vesting was 0.3 million shares, for the
nine-month period ended March 31, 2001, there were 1.1 million shares.
(4)Revenues and Operating Profit (Loss) by Operating Segments
Reportable segments are based on our method of internal reporting. The
accounting policies of our segments are the same as those described in
Note 1 to our consolidated financial statements included in our 2001
Annual Report to Stockholders. In addition, we allocate all corporate
administrative costs to operating segments.
Three-month period ended Nine-month period ended
March 31, March 31,
2002 2001 2002 2001
Revenues
North America Books and
Home Entertainment $ 146.8 $ 171.4 $ 491.4 $ 578.6
International Businesses 242.2 264.3 787.6 822.8
U.S. Magazines 131.6 149.3 489.4 531.4
New Business Development 21.2 12.9 54.9 40.9
-------- -------- --------- ---------
Total revenues $ 541.8 $ 597.9 $ 1,823.3 $ 1,973.7
======== ======== ========= =========
Operating profit (loss)
North America Books and
Home Entertainment $ 0.8 $ 12.7 $ 13.1 $ 74.2
International Businesses 12.1 22.4 63.1 97.4
U.S. Magazines 5.5 11.0 76.1 84.1
New Business Development 3.3 (5.8) (1.2) (14.9)
-------- -------- --------- ---------
Segment operating profit 21.7 40.3 151.1 240.8
Other operating items -- -- -- 8.2
-------- -------- --------- ---------
Total operating profit $ 21.7 $ 40.3 $ 151.1 $ 249.0
======== ======== ========= =========
(5) Comprehensive Income (Loss)
Accumulated other comprehensive (loss) income as reported in the
Consolidated Condensed Balance Sheets as of March 31, 2002 and June 30,
2001, primarily represents unrealized gains/losses on certain
investments and foreign currency translation adjustments. The
components of comprehensive income, net of related tax, for the
three-month and nine-month periods ended March 31, 2002 and 2001 were
as follows:
Three-month period ended Nine-month period ended
March 31, March 31,
2002 2001 2002 2001
Net income $ 16.4 $ 27.9 $ 94.2 $ 154.0
Change in:
Foreign currency translation
adjustments (1.4) (15.0) 1.8 (17.6)
Net unrealized gains
(losses) on certain
investments (1) 3.3 (6.6) 3.5 (104.0)
Net unrealized (losses)
gains on certain derivative
transactions (2) (0.3) 0.5 (0.8) 0.7
------- ------- ------- --------
Total comprehensive income $ 18.0 $ 6.8 $ 98.7 $ 33.1
======= ======= ======= ========
(1)Net unrealized gains (losses) on certain investments, net of related tax,
principally represents our investment in the voting common shares of
LookSmart, Ltd. For the three- and nine- month periods ended March
31, 2002, these amounts are net of deferred tax liabilities of
$(1.8) and $(1.9), respectively. For the three- and nine- month
periods ended March 31, 2001, these amounts are net of deferred tax
assets of $3.6 and $56.1, respectively.
(2)Net unrealized (losses) gains on certain derivative transactions, net of
related tax, principally represents (losses) gains on derivative
instruments used to hedge our exposure to foreign currency risk
associated with forecasted royalty payments (see Note 10). For the
three- and nine- month periods ended March 31, 2002, these amounts
are net of deferred tax assets of $0.2 and $0.5, respectively. For
the three- and nine- month periods ended March 31, 2001, these
amounts are net of deferred tax liabilities of $(0.3) and $(0.4),
respectively.
(6) Other Operating Items
In the nine-month period ended March 31, 2001, we recorded other
operating income of $8.2 comprised of: (i) adjustments to remaining
accrual balances from restructuring charges originally recorded in
prior periods, that resulted in a benefit of $11.3; (ii) additional
restructuring charges of $1.1 primarily related to costs associated
with the discontinuation of certain unproductive businesses; and (iii)
an impairment loss of $2.0 relating to Walking magazine.
Other operating items represents restructuring charges related
primarily to the streamlining of our organizational structure and the
strategic repositioning of certain businesses, such as:
- - Severance Costs - These charges represent the cost to separate
employees from our operations as a result of actions taken to
streamline the organizational structure. This separation is
accomplished through a combination of voluntary and involuntary
severance programs. The positions to be separated were identified
when the charge was recorded.
- - 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
incurred charges related to the carrying value of certain long-lived
assets, leasehold improvements, computer hardware and software and,
to a lesser extent, property, plant and equipment no longer used in
our operations.
At March 31, 2002, we had accruals for other operating items of $21.9,
primarily for severance costs. At June 30, 2001, these accruals
totaled $33.3. For the nine-month period ended March 31, 2002, we made
payments totaling $11.4, primarily related to severance costs.
(7) Inventories
March 31, June 30,
2002 2001
Restated
(Note 1)
Raw materials $ 12.2 $ 12.0
Work-in-progress 7.8 19.2
Finished goods 133.6 136.2
----- -----
Total inventories $ 153.6 $ 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 globally, supports our recent
transition to a global system, and provides a more accurate reporting
of the current value of the inventory.
The Consolidated Condensed 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.
(8) Investments
Available for Sale Marketable Securities
Marketable securities included in other noncurrent assets on the
Consolidated Condensed Balance Sheets 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 March 31,
2002, the market value of the remaining shares totaled $12.6 for
LookSmart and $2.5 for WebMD. As of June 30, 2001, the market value of
the remaining shares was $7.4 for LookSmart and $3.0 for WebMD.
During the three- and nine-month periods ended March 31, 2002,
respectively, we sold 1.7 million and 3.2 million shares of LookSmart,
and recorded a pre-tax gain of $3.0 and $4.6 in other income (expense),
net on the Consolidated Condensed Statement of Income. During the
three- and nine-month periods ended March 31, 2001, respectively, we
sold 0.3 million and 1.3 million shares of LookSmart, and recorded
pre-tax gains of $0.9 and $6.2 in other income (expense), net on the
Consolidated Condensed Statements of Income.
Investments, Equity Method
Long-term equity investments included in other noncurrent assets on the
Consolidated Condensed Balance Sheets represent our investment in
BrandDirect Marketing, Inc. Due to additional funding in the form of
an advance, and other circumstances, we have the ability to exercise
significant influence as defined in APB Opinion No.18, The Equity
Method of Accounting for Investments in Common Stock. In accordance
with APB Opinion No. 18, equity in losses of this investment (including
goodwill amortization) were included in other income (expense), net on
the Consolidated Condensed Statements of Income. For the nine-month
period ended March 31, 2001 we recorded equity in losses of our
investee of $12.2. As of June 30, 2001, we had written down our
investment in BrandDirect Marketing, Inc. 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 licensing agreements, included in goodwill and other
intangible assets on the Consolidated Condensed Balance Sheets. 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. (a wholly owned subsidiary) has a long-term
commitment to purchase World's Finest Chocolate, Inc. products and the
exclusive right to sell those products for fundraising purposes. Our
purchase commitment is based on annual minimum tonnage amounts.
(9) 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. SFAS No. 142 requires that amortization of goodwill cease and
that the carrying amount of goodwill be evaluated, at least annually,
for recoverability. Accordingly, we have not recorded any goodwill
amortization in 2002. Furthermore, we have tested our goodwill for any
transitional impairment and have concluded that there was no impairment
as of July 1, 2001 (the date of adoption) or in 2002.
The changes in the carrying amount of goodwill for the nine-month
period ended March 31, 2002 are as follows:
North
America
Books and
Home New Business
Entertainment U.S.Magazines Development Total
Balance as of June 30, 2001 $ 323.6 $ 30.0 $ 11.6 $ 365.2
Reclassification of identified
intangible assets on July 1, 2002 (1.3) -- (0.9) (2.2)
------- ------ ------ -------
Balance as of March 31, 2002 $ 322.3 $ 30.0 $ 10.7 $ 363.0
======= ====== ====== =======
Included in our Consolidated Condensed Balance Sheets as of March 31,
2002 and June 30, 2001 are the following categories of acquired
intangible assets:
March 31, 2002 June 30, 2001
Gross Net Gross Net
Intangible Assets (finite lives):
Licensing agreement $ 43.5 $ 35.6 $ 43.1 $ 38.3
Customer lists 23.3 3.8 22.7 5.7
Trademarks and noncompete agreements 3.0 0.4 1.1 0.6
------ ------ ------ ------
Total intangible assets (finite lives) $ 69.8 $ 39.8 $ 66.9 $ 44.6
====== ====== ====== ======
Amortization related to intangible assets (finite lives) amounted to
$1.9 and $5.5 for the three and nine-month periods ended March 31,
2002, respectively ($1.5 and $4.3 for the three and nine-month periods
ended March 31, 2001, respectively). In accordance with SFAS No. 142,
we reassessed the useful lives of all other intangible assets in the
first quarter of 2002. 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 from the initial contract date, while customer lists are
being amortized principally over five years. Estimated fiscal year
amortization expense is as follows: 2002 - $7.4; 2003 - $6.0; 2004 -
$5.3; 2005 - $4.7 and 2006 - $4.7.
The following table reconciles the prior period's reported net income
to its respective unaudited pro forma amounts adjusted to exclude
goodwill amortization, which is no longer recorded under SFAS No. 142.
For the three-month period ended March 31, 2001
Earnings Per Share
Amount Basic Diluted
Net income $ 27.9 $ 0.27 $ 0.27
Add back goodwill amortization 5.2 0.05 0.05
------ ------ ------
Adjusted net income $ 33.1 $ 0.32 $ 0.32
====== ====== ======
For the nine-month period ended March 31, 2001
Earnings Per Share
Amount Basic Diluted
Net income $ 154.0 $ 1.49 $ 1.47
Add back goodwill amortization 15.7 0.15 0.15
------ ------ ------
Adjusted net income $ 169.7 $ 1.64 $ 1.62
====== ====== ======
(10) 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 British pound.
Historically, we purchased 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 entered into forward contracts to
minimize the effect of fluctuating foreign currency exchange rates on
certain foreign currency denominated assets and liabilities.
Generally, we purchased 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.
As of March 31, 2002, all of our forward contracts have expired. Our
currently outstanding option contracts will expire before June 30,
2002. We have performed a detailed cost benefit analysis of hedging
our non-U.S. profits and have decided to discontinue this practice
prospectively. We will continue to hedge known significant
transactional exposures.
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 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 March 31, 2002,
changes in the spot value of the foreign currencies associated with
option contracts designated and qualifying as cash flow hedges of
forecasted royalty payments amounted to a loss of $0.3, net of deferred
taxes of $0.2 (loss of $0.8, net of deferred taxes of $0.5, for the
nine-month period ended March 31, 2002). For the three- and nine-month
periods ended March 31, 2001, such changes amounted to a gain of $0.5
(net of deferred taxes of $0.3) and a gain of $0.7 (net of deferred
taxes of $0.4), respectively. These changes are reported in
accumulated other comprehensive (loss) income included in stockholders'
equity on the Consolidated Condensed Balance Sheets. 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 income (expense), net on the Consolidated
Condensed Statements of Income for the three-month period ended March
31, 2002 (loss of $0.4 for the nine-month period ended March 31,
2002). For the three- and nine-month periods ended March 31, 2001,
such amounts were recognized as a loss of $0.4 and $1.0, respectively.
The fair value of the option contracts at March 31, 2002 of $0.1 ($1.8
at June 30, 2001) is included in prepaid expenses and other current
assets on the Consolidated Condensed Balance Sheets.
We anticipate that the net gains (losses) in accumulated other
comprehensive (loss) income relating to foreign currency option
contracts existing at March 31, 2002 will be recognized as a gain
(loss) on foreign exchange during the three-month period ended June 30,
2002. As of March 31, 2002, 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 one month. There were
no cash flow hedges discontinued during the nine-month period ended
March 31, 2002.
Other Derivatives - For the three-month period ended March 31, 2002,
changes in the spot value of the foreign currencies and contract
settlements associated with option and forward contracts amounted to a
loss of $0.1 (loss of $4.6 for the nine-month period ended March 31,
2002). For the three- and nine-month periods ended March 31, 2001,
such changes amounted to a gain of $7.0 and a gain of $4.8,
respectively. These changes are reported in gain (loss) on foreign
exchange included in other income (expense), net on the Consolidated
Condensed Statements of Income. 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 March 31, 2002 of $0.2 ($6.6 as of June 30, 2001) is included in
prepaid expenses and other current assets on the Consolidated Condensed
Balance Sheets.
(11) Debt
As described in Note 10 to the consolidated financial statements
included in our 2002 Annual Report to Stockholders, on July 27, 2002,
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 March 31, 2002, short-term borrowings
aggregated $154.1 ($100.1 on the Five-Year Facility and $54.0 on the
364-Day Facility). These amounts are included in loans and notes
payable on the Consolidated Condensed Balance Sheets. Also, in the
second quarter of 2002, we filed a shelf registration statement with
the Securities and Exchange Commission allowing us to issue up to
$500.0 of public debt securities. As of March 31, 2002, there were no
securities issued under this registration statement.
(12) Share Repurchase Authorization
As of March 31, 2002, under various share repurchase authorizations
(announced during fiscal 2000, 2001 and 2002), we have repurchased 8.6
million shares of our Class A nonvoting common stock for approximately
$231.7. During the nine-month period ended March 31, 2002, we
purchased approximately 3.6 million shares totaling $64.1. No shares
were repurchased during the three months ended March 31, 2002. During
the three- and nine- month periods ended March 31, 2001, we purchased
approximately 0.7 million shares totaling $22.5, and 1.0 million shares
for $34.1, respectively.
(13) Subsequent Events
On April 12, 2002, we entered into an agreement with the DeWitt
Wallace-Reader's Digest Fund, Inc. and the Lila Wallace Reader's Digest
Fund, Inc. (the Funds) providing for a series of actions that will
result in all shares of our Class B Voting Common Stock and Class A
Nonvoting Common Stock being recapitalized into a single class of
common stock with one vote per share. These actions include: (1) our
repurchase of approximately 3.6 million shares of Class B stock from
the Funds for approximately $100.0 in cash; (2) the conversion, in a
merger into a wholly-owned subsidiary, of each remaining Class B share
into 1.24 shares of common stock and the conversion of each Class A
share into one share of common stock; and (3) the amendment of our
charter to, among other things, reflect the reclassification of the
stock and to divide our board of directors into three classes. Under
specified circumstances, we may effect the recapitalization through a
charter amendment, rather than a merger. The merger and the charter
amendment are subject to stockholder approval. The Funds have agreed
to vote in favor of those transactions. The transactions are subject
to customary closing conditions, including financing arrangements. We
expect to fund the stock repurchase transaction entirely with debt.
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)
(unaudited)
Unless otherwise indicated, reference 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 foreign currency translation. 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.
To analyze results on a comparable basis, Management's Discussion and
Analysis of operating profit has been written excluding the net effect
of other operating items, income of $8.2, in the second quarter of
fiscal 2001. Other operating items consisted of the following:
- - Adjustments to remaining accrual balances from restructuring
charges originally recorded in prior periods, that resulted in a
benefit of $11.3.
- - Additional restructuring charges of $1.1 primarily related to
costs associated with the discontinuation of certain unproductive
businesses.
- - An impairment loss of $2.0 relating to goodwill associated with
Walking magazine.
Three-Month Period Ended March 31, 2002, Compared With Three-Month
Period Ended March 31, 2001
Results of Operations: Company-Wide
Revenues and Operating Profit
Revenues for the third quarter of 2002 declined 9% to $542, compared
with $598 in the third quarter of 2001. Excluding the adverse impact
of changes in foreign currency exchange rates, revenues declined 7%.
Revenues declined due to weak performance in the North America Books
and Home Entertainment, U.S. Magazines, and International Businesses
segments.
The 14% decline in revenues for North America Books and Home
Entertainment was driven by lower sales in U.S. Books and Home
Entertainment, partially offset by a 25% increase in revenues at Books
Are Fun and a 6% increase in revenues in Canada. Overall, revenues
declined due to planned significant reductions in mail quantities and
lower response rates because of changes we made to sweepstakes
promotions to comply with our 2001 agreement with 32 state attorneys
general and the District of Columbia, continued softness in the U.S.
economy, and to reduce promotion costs.
Revenues for U.S. Magazines decreased 12% due primarily to lower
circulation revenues, lower volumes at QSP, Inc., and the absence of
revenues from Walking magazine, which was discontinued in June 2001.
Additionally, during the third quarter of 2002, we announced our
intention to cease publication of New Choices magazine.
International Businesses also experienced softness this quarter,
declining 8%. This decline was primarily attributable to lower sales
of music products and Select Editions in certain countries.
Operating profit declined 46% in the third quarter of 2002 to $22, compared with
$40 in the third quarter of 2001. This was a result of lower sales volumes in
North America Books and Home Entertainment and our International Businesses and
lower circulation revenues in U.S. Magazines. These decreases were partially
offset by lower promotion costs in U.S. Magazines and the benefits of cost
reduction initiatives.
Other Income (Expense), Net
Other income (expense), net decreased to $2 in the third quarter of
2002, compared with $3 in the prior year period. The primary changes
were:
- Lower interest income recognized of $(2).
- Increased income recognized from sales of certain marketable
securities of $3.
- A lower net foreign exchange gain from our hedging program of $1,
compared with a net gain in the prior period of $3.
Income Taxes
The effective tax rate for the third quarter of 2002 was 31.5%,
compared with a rate of 35.0% for the third quarter of 2001. The lower
effective tax rate for the current period was primarily attributable to
the absence of nondeductible goodwill amortization primarily related to
Books Are Fun, Ltd. in response to our adoption of Statement of
Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets, and the effects of tax planning strategies.
Net Income and Earnings Per Share
For the third quarter of 2002, net income was $16, or $0.16 per share
for both basic and diluted earnings per share. In the prior year
period, net income was $28 or $0.27 per share for both basic and
diluted earnings per share.
Effective July 1, 2001, we elected early adoption of SFAS No. 142.
Accordingly, no goodwill amortization was recognized during the third
quarter of 2002. Net income in the third quarter of 2001 included
goodwill amortization of $5, or $0.05 per share on a diluted-earnings
basis, primarily related to Books Are Fun, Ltd., which is included in
the North America Books and Home Entertainment operating segment.
Results of Operations: Operating Segments
North America Books and Home Entertainment
Revenues for North America Books and Home Entertainment decreased 14%
in the third quarter of 2002 to $147, compared with $171 in the third
quarter of 2001. The decrease was primarily attributable to lower
sales across all products due to planned reductions in mail quantities
and lower shipments, partially offset by higher revenues at Books Are
Fun. In anticipation of lower response rates due to promotion changes
required by the attorneys general sweepstakes agreement and continued
softness in the U.S. economy, we significantly reduced our mail
quantities in the third quarter of 2002, which resulted in mail
quantities that were substantially lower than the prior year period.
In addition, lower than expected response rates to our mailings, due in
part to direct mail disruptions in the aftermath of the September 11th
terrorist attacks and postal system anthrax scares, resulted in lower
sales volume compared with the prior year period.
This decrease in revenues was partially offset by a 25% increase in
revenues at Books Are Fun. This growth was driven by a 28% increase in
school event sales and a 22% increase in corporate event sales, and
more effective product selection.
Operating profit for the third quarter of 2002 decreased significantly
to $1, compared with $13 in the third quarter 2001. The decrease was
primarily a result of lower sales volume described above and investment
in new marketing channels, including telemarketing and direct-response
television. Lower profits attributable to these factors were partially
offset by higher profits at Books Are Fun from increased sales volume
and by lower costs from reengineering activities at U.S. Books and Home
Entertainment.
International Businesses
Revenues for International Businesses decreased 8% to $242 for the
third quarter of 2002, compared with $264 for the prior year period.
Excluding the adverse effect of changes in foreign currency exchange
rates, revenues decreased 4%. The decline was primarily driven by
reduced mail quantities, to eliminate marginally profitable mailings,
and lower response rates for some products, due to unfavorable economic
conditions in many countries. Specifically, the declines were
attributable principally to:
- Reduced mail quantities and lower response rates for certain
products, including Select Editions, music products, and general
books, in Germany, Australia, Poland and France.
- A planned shift of several mailings to the fourth quarter in
Poland and the Benelux region.
- Lower magazine circulation due to decreased mail quantities in
France.
- Planned reductions in mail quantities in Argentina due to poor
economic conditions in that country.
These decreases were partially offset by increased revenues in Brazil,
Russia, and Hungary. These increases were primarily attributable to:
- Higher response rates to mailings for general books due to more
appealing product offerings, and higher average prices for Select
Editions in Brazil.
- Increased mail quantities to new customers and improved response
rates to mailings for general books in Russia and Hungary.
Operating profit decreased 46% to $12 in the third quarter of 2002,
compared with $22 in the third quarter of 2001. The profit decline was
primarily due to the revenue changes described above and investments in
new marketing channels, including telemarketing, and new products,
partially offset by increased profits from our international
magazines.
U.S. Magazines
Revenues for U.S. Magazines decreased 12% to $132 in the third quarter
of 2002, compared with $149 in the third quarter of 2001. The decline
in revenues was attributable to both magazines and QSP, Inc. The
decline in magazine revenues was primarily a result of lower
subscription revenues for Reader's Digest magazine due to lower renewal
and donor subscriptions resulting principally from the aftermath of the
September 11th terrorist attacks and subsequent anthrax scare,
partially offset by the addition of new subscriptions at lower
introductory rates. Also contributing to the decline was the absence
of revenues in 2002 from Walking magazine, which was discontinued in
June 2001. These declines were partially offset by increased newsstand
sales. Advertising revenues were flat when compared with the prior
year period.
QSP revenues declined in the third quarter, when compared with the
prior year period, primarily as a result of lower unit volume in food
and gift products due to the soft U.S. economy and the reduced level of
fundraising events by schools after the September 11th terrorist
attacks.
Operating profit declined 50% to $6 in the third quarter of 2002,
compared with $11 in the third quarter of 2001. The decrease in
operating profit is attributable principally to lower revenues,
partially offset by overhead cost reductions, lower promotion costs for
Reader's Digest and New Choices magazines, and changes in the sales mix
at QSP, Inc. to higher margin products.
During the quarter, we announced our intention to cease publication of
New Choices magazine.
New Business Development
Revenues for New Business Development increased 64% for the third
quarter of 2002 to $21, compared with $13 in the prior year period.
This increase was primarily driven by an increase in revenues from our
financial product alliances, including a contract termination payment
of $5 from a former insurance alliance partner, and growth in both
insurance and investment products in the U.S. and abroad.
Operating profit increased to $3 for the third quarter of 2002,
compared with a loss of $(6) in the prior year period, due to increased
revenues from our financial product marketing alliances and reduced
costs at Gifts.com pending planned divestiture of this business, which
was announced in April. We do not expect the sale of Gifts.com to have
a material impact on our operating results.
Nine-Month Period Ended March 31, 2002, Compared With Nine-Month Period
Ended March 31, 2001
Results of Operations: Company-Wide
Revenues and Operating Profit
Revenues for the nine-month period ended March 31, 2002 decreased 8% to
$1,823, compared with $1,974 in the prior year period. Excluding the
adverse impact of changes in foreign currency rates, revenues declined
6%. The decrease in revenues is primarily attributable to weaker
performance in the North America Books and Home Entertainment segment,
and to a lesser extent, in our U.S. Magazines and International
Businesses segments. Offsetting a portion of these declines were
higher revenues from growth in our New Business Development segment.
The 15% decline in revenues in North America Books and Home
Entertainment consisted of a 19% decline in revenues at U.S. Books and
Home Entertainment, partially offset by a 13% increase in revenues at
Books Are Fun and a 4% increase in Canada. The decline in U.S. Books
and Home Entertainment was attributable to significant reductions in
mail quantities in anticipation of lower response rates resulting from
changes we made to sweepstakes promotions to comply with our 2001
agreement with 32 state attorneys general and the District of Columbia,
continued softness in the U.S. economy, and to reduce promotion costs.
The September 11th terrorist attacks and subsequent postal system
anthrax scare, as well as our actions to scale back our music and video
businesses, further reduced this segment's results.
The 8% decline in U.S. Magazines was attributable to lower circulation
and advertising revenues as well as the absence of revenues from
Walking magazine, which was discontinued in June 2001. In addition,
revenues at QSP, Inc. declined 5% due to lower volumes, and the
cancellation or displacement of events during the second quarter of
2002, QSP, Inc.'s peak season, and the continued reduced level of
school fundraising events due to the aftermath of the September 11th
terrorist attacks and anthrax scare. Additionally, during the third
quarter of 2002, we announced our intention to cease publication of New
Choices magazine.
Revenues for our International Businesses segment declined 4% during
the period due to weaker performance of music and video products and
Select Editions. In addition, Reader's Digest magazine revenues in our
international markets declined 7% due to lower circulation.
Operating profit for the nine-month period ended March 31, 2002
decreased 37% to $151, compared with $241 in the prior year period.
This change is a direct result of the revenue declines described above
and continued investment in new marketing channels. Partially
offsetting the revenue declines were an increase in profits at Books
Are Fun and the New Business Development segment, and lower operating
costs.
Other Income (Expense), Net
Other income (expense), net increased to $(6) for the nine-month period
ended March 31, 2002, compared with $(5) in the prior year period.
Excluding equity in losses (including goodwill amortization) associated
with our investment in BrandDirect Marketing, Inc., other expense, net
was income of $8 for the nine months ended March 31, 2001. The primary
reasons for the change in expenses, excluding the losses in BrandDirect
Marketing, Inc., were:
- Lower interest income recognized of $(2).
- Lower income recognized from sales of certain marketable
securities of $(3).
- Lower interest expense recognized, as a result of lower interest
rates, of $2.
- A net foreign exchange loss from our hedging program of $(3),
compared with a net gain in the prior period of $4.
- Income recognized in the prior period for a contract termination
payment of $4.
Income Taxes
The effective tax rate for the nine months ended March 31, 2002 was
35.2%, compared with a rate of 37.0% for the prior year period. The
lower effective tax rate for the current period was primarily
attributable to the absence of nondeductible goodwill amortization
primarily related to Books Are Fun, Ltd. in response to our adoption of
SFAS No. 142, and the effects of tax planning strategies.
Net Income and Earnings Per Share
For the nine-month period ended March 31, 2002, net income was $94, or
$0.92 per share on a diluted-earnings basis ($0.93 per share for basic
earnings per share). In the prior year period, net income was $154, or
$1.47 per share on a diluted-earnings basis ($1.49 per share for basic
earnings per share).
Effective July 1, 2001, we elected early adoption of SFAS No. 142.
Accordingly, no goodwill amortization was recognized during nine months
ended March 31, 2002. Net income for the nine months ended March 31,
2001 included goodwill amortization of $16, or $0.15 per share on a
diluted-earnings basis, primarily related to Books Are Fun, Ltd., which
is included in North America Books and Home Entertainment.
Results of Operations: Operating Segments
North America Books and Home Entertainment
Revenues for North America Books and Home Entertainment for the
nine-month period ended March 31, 2002 decreased 15% to $491, compared
with $579 for the prior year period. This decline was primarily
attributable to lower sales across all products and was driven by the
effects of promotion changes required by the 2001 attorneys general
sweepstakes agreement and continued softness in the U.S. economy.
These two influences prompted us to reduce mail quantities. Due to the
aftermath of the September 11th terrorist attacks and subsequent
anthrax scare, revenues were lower than expected. The decrease in
revenues was partially offset by a 13% increase in revenues at Books
Are Fun, due to increased school and corporate events and more
effective product selection, and a 4% increase in revenues in Canada.
Operating profit for the nine-month period ended March 31, 2002
decreased 82% to $13, compared with $74 for the prior year period. The
decline was primarily due to the revenue declines described above,
investments in new marketing channels, such as telemarketing and
outside mailing lists, partially offset by a 100% increase in profits
at Books Are Fun, from increased revenues, and the benefits of
reengineering activities.
International Businesses
Revenues from International Businesses for the nine-months ended March
31, 2002 decreased 4% to $788, compared with $823 in the prior year
period. Excluding the adverse effects of changes in foreign currency
exchange rates, revenues declined 2%. The decrease in revenues is
primarily attributable to reduced mail quantities to eliminate
marginally unprofitable mailings, and lower response rates for products
in some markets. Primary factors include:
- Reduced mail quantities and lower sales for music and video
products, and other products in Germany and Poland.
- Lower mail quantities and response rates for most all products in
Australia.
- Planned reductions in mail quantities and response rates in
Argentina due to poor economic conditions in that country.
Partially offsetting these declines are increased revenues in most
Eastern European countries, Russia, France, and Brazil from increased
mail quantities and orders for some products. Specific reasons
include:
- Increased orders for general books, new music product
introductions and higher priced products in Czech Republic and
Slovakia.
- Increased mail quantities to new customers and new music product
introductions in Hungary and Russia.
- Increased response rates to mailings for general books and music
series products, due to more appealing product offerings,
increased use of new channels, and better payment performance,
which partially offset the effects of the weak economy in Brazil.
Operating profit for the nine-month period ended March 31, 2002
decreased 35% to $63, compared with $97 in the prior year period. The
decline is principally due to the revenue changes described above,
investments in new channels, and increased promotion costs in the
United Kingdom. These declines were partially offset by improved
operating profit from our international magazines, primarily due to
lower promotion costs.
U.S. Magazines
Revenues for U.S. Magazines decreased 8% to $489 for the nine-month
period ended March 31, 2002, compared with $531 for the nine-month
period ended March 31, 2001. The decline in revenues was attributable
to a decrease in circulation revenues for Reader's Digest magazine and
some of our special interest magazines, due to lower renewal and donor
subscriptions due to the aftermath of the September 11th terrorist
attacks and subsequent anthrax scare, partially offset by the addition
of new subscriptions at lower introductory rates. Also contributing to
the decline were lower advertising revenues from softness in the U.S.
advertising market and the absence of revenue from Walking magazine,
which was discontinued in June 2001.
Contributing to the overall decline in this segment was a 5% decrease
in revenues at QSP, Inc. Many QSP, Inc. events were either displaced
or cancelled during the second quarter of 2002, QSP, Inc.'s peak
seasonal marketing period as a result of the September 11th terrorist
attacks. The reduced level of school fundraising events after the
September 11th terrorist attacks and continued softness in the U.S.
economy also contributed to the decrease in revenues.
Operating profit for the nine-month period ended March 31, 2002
decreased 10% to $76, compared with $84 in the prior year period. The
decrease was caused by the revenue declines described above and
incremental costs for Reader's Digest magazines associated with
additional customer mailings to replace mailings whose effectiveness
was diminished in the aftermath of the September 11th terrorist attacks
and anthrax scare. The declines were partially offset by overhead cost
reductions and lower promotion costs for Reader's Digest and New
Choices magazines, and changes in the sales mix at QSP, Inc. to higher
margin products. During the third quarter of 2002, we announced our
intention to cease publication of New Choices magazine.
New Business Development
Revenues from New Business Development increased 34% to $55 for the
nine-month period ended March 31, 2002, compared with $41 for the
nine-month period ended March 31, 2001. The growth in this segment was
driven by a contract termination payment of $5 from a former insurance
alliance partner, continued growth in revenues from our other financial
product marketing alliances globally, and catalog and Internet revenues
at Gifts.com.
Operating losses decreased 92% to $(1) for the nine-month period ended
March 31, 2002, compared with $(15) for the prior year period. This
improvement was attributable to revenue growth from our marketing
alliances, and lower operating costs at Gifts.com pending planned
divestiture of this business, which was announced in April. We do not
expect the sale of Gifts.com to have a material impact on our operating
results.
Forward-Looking Information
Fiscal 2002 Results
We anticipate earnings in the range of $0.18 to $0.23 per share for the
fourth quarter of 2002, excluding one-time charges. Much of the
investment made throughout fiscal 2002 will begin to drive year over
year growth in both revenues and operating profits in the fourth
quarter. They include the launch of new series products and Select
Editions in many of our developing markets, and the shift in series
activity in some of our developed markets. Profitability in the fourth
quarter should also benefit from cost cutting initiatives throughout
Europe, Latin America, and Australia.
In response to weaker performance of U.S. Books and Home Entertainment,
we announced, in April 2002, new initiatives to reduce costs at North
America Books and Home Entertainment, including:
- Elimination of an unprofitable catalog business.
- Exiting the video business, except children's videos.
- Reducing some continuity series and general books.
- Consolidation of two business units, Health and Home.
- Reducing mail quantities by approximately 40%.
- Reducing editorial, promotion, distribution, and overhead costs.
We also announced a reduction-in-force of approximately 100 jobs,
mostly related to U.S. Books and Home Entertainment. We expect that
losses will continue in U.S. Books and Home Entertainment in the fourth
quarter as we reposition this business and as the cost-reduction
measures begin to take effect.
While these initiatives should reduce costs, we will continue to
diversify into new channels, including direct-response television,
telemarketing, and marketing alliances. We will emphasize products
with growth potential, including Reader's Digest Young Families and
Select Editions. We will also develop products for sale directly
through Books Are Fun and leverage our relationship with Reiman
Publications LLC.
In addition, we intend to reduce the rate base for Reader's Digest
magazine from 12.5 million copies to 12 million copies. This reduction
is somewhat less than the number of subscriptions we lost in the second
quarter of 2002 due in part to the September 11th terrorist attacks and
anthrax scare. We anticipate that this reduction will enable the
magazine to reduce new subscriber acquisition costs and improve
profitability.
On March 21, 2002, we entered into a definitive agreement to acquire
substantially all of the assets and assume specified liabilities of
Reiman Holding Company, LLC and subsidiaries (Reiman) for $760 in cash,
subject to adjustment. Reiman publishes cooking, gardening, country
lifestyle and nostalgia magazines and books in the United States and
Canada. We expect to finance the acquisition entirely through debt.
The acquisition is subject to customary closing conditions, including
finalizing financing arrangements. We expect to close the acquisition
in the fourth quarter of 2002.
On April 12, 2002, we entered into an agreement with the DeWitt
Wallace-Reader's Digest Fund, Inc. and the Lila Wallace Reader's Digest
Fund, Inc. (the Funds) providing for a series of actions that will
result in all shares of our Class B Voting Common Stock and Class A
Nonvoting Common Stock being recapitalized into a single class of
common stock with one vote per share. These actions include: (1) our
repurchase of approximately 3.6 million shares of Class B stock from
the Funds for approximately $100 in cash; (2) the conversion, in a
merger into a wholly-owned subsidiary, of each remaining Class B share
into 1.24 shares of common stock and the conversion of each Class A
share into one share of common stock; and (3) the amendment of our
charter to, among other things, reflect the reclassification of the
stock and to divide our board of directors into three classes. Under
specified circumstances, we may effect the recapitalization through a
charter amendment, rather than a merger. The merger and the charter
amendment are subject to stockholder approval. The Funds have agreed
to vote in favor of those transactions. The transactions are subject
to customary closing conditions, including financing arrangements. We
expect to fund the stock repurchase transaction entirely with debt.
In the third quarter of 2002, the Governors of the Postal Service
approved a postal rate increase effective June 30, 2002. We estimate
the rate increase will raise our postage costs in the United States by
approximately 9%, or approximately $10 million in 2003. This estimate
does not include any impact as a result of the pending Reiman
acquisition.
Liquidity and Capital Resources
Nine-month
period ended
March 31, 2002
Cash and cash equivalents at June 30, 2001 $ 35
Net change in cash due to:
Operating activities 94
Investing activities (9)
Financing activities (81)
Effect of exchange rate changes on cash and cash equivalents 2
----
Net change in cash and cash equivalents 6
Cash and cash equivalents at March 31, 2002 $ 41
====
Cash and cash equivalents increased to $41 at March 31, 2002, compared
with $35 at June 30, 2001. The increase is attributable to favorable
changes in working capital, partially offset by repayments of debt and
share repurchases.
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 contain covenants to maintain a minimum level of interest
coverage and a maximum level of leverage. At March 31, 2002, we had
borrowings of $154 outstanding under the Credit Agreements and were in
compliance with all covenants. The weighted average interest rate on
these borrowings for the nine months ended March 31, 2002 was 3.5%. It
is currently our intention to repay the outstanding amount by the end
of 2002.
In the second quarter of 2002, we filed a shelf registration statement
with the Securities and Exchange Commission allowing us to issue up to
$500 of public debt securities. As of March 31, 2002, there were no
securities outstanding under this registration statement.
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 March 31, 2002, we had purchased approximately 3.6
million shares for approximately $64 under the May 2001 repurchase
authorization.
We expect to finance the pending Reiman acquisition and the pending
repurchase of shares of Class B stock in connection with the proposed
recapitalization entirely through debt. We expect to close the
acquisition in the fourth quarter of 2002 and the recapitalization
transactions in the fourth quarter of 2002 or the first quarter of 2003.
We believe that our liquidity, capital resources, cash flows 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.
Historically, we purchased foreign currency option and forward
contracts to minimize the effect of fluctuating foreign currency
exchange rates on our earnings and specifically identifiable
anticipated transactions. We have performed a detailed cost benefit
analysis of hedging our non-U.S. profits and have decided to
discontinue this practice prospectively. We will continue to hedge
known significant transactional exposures.
At March 31, 2002, our primary foreign currency market exposures
included the euro and the British pound. We estimate that the results
of a uniform 10% weakening in the value of the U.S. dollar relative to
the currencies in which our option contracts are denominated, with all
other variables held constant, would cause the fair value to decrease
$(3). Similarly, the impact of a 10% strengthening in the value of the
U.S. dollar would not have a significant impact.
These estimates represent changes to the fair value of our option
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
contracts.
Recent Accounting Standards
In June 2001, the Financial Accounting Standards Board issued SFAS
No. 143, Accounting for Asset Retirement Obligations. This
statement requires the recording of an asset and a liability equal
to the present value of the estimated costs associated with the
retirement of long-lived assets where a legal or contractual
obligation exists. The asset is required to be depreciated over the
life of the related equipment or facility, and the liability
accreted each year based on a present value interest rate.
We are required to adopt SFAS No. 143 no later than July 1, 2002
(fiscal 2003). We do not expect adoption of this statement to have
a material impact on our operating results.
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
(including the Reiman acquisition), strategic alliances and joint
ventures;
- - our ability to integrate newly acquired and newly formed
businesses successfully (including the Reiman business);
- - the strength of relationships of newly acquired and newly formed
businesses (including the Reiman business) with their employees,
suppliers and customers;
- - the accuracy of the basis of forecasts relating to newly acquired
and newly formed businesses (including the Reiman business);
- - 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 increased leverage resulting from additional
borrowings of $950 million to finance the Reiman acquisition and the
repurchase of 3,636,363 shares of Class B Voting Common Stock from
the Funds;
- - 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.
(b) Reports on Form 8-K
During the three months ended March 31, 2002, we filed the
following report on Form 8-K:
- Current report on Form 8-K dated January 24, 2002 including a
press release relating to the second quarter fiscal 2002
earnings release and related remarks of the Chief Executive
Officer and the Chief Financial Officer.
- Current Report on Form 8-K dated March 22, 2002 including a press
release relating to the Company's agreement to acquire
substantially all of the assets of Reiman Holding Company,
LLC, and related remarks of the Chief Executive Officer, a
related presentation of the Chief Executive Officer and a
press release relating to recent stockholder matters.
- Current Report on Form 8-K dated March 25, 2002 including the
Asset Purchase Agreement, dated as of March 21, 2002, by and
among the Company, Reiman Holding Company, LLC, and the
equityholders of Reiman Holding Company, LLC set forth on
the signature pages thereto.
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: May 7, 2002 By: THOMAS D. BARRY
-------------------------
Thomas D. Barry
Vice President and Corporate Controller
(chief accounting officer and authorized
signatory)