EXHIBIT 13
Management's Discussion and Analysis
Dollars in millions, except per share data
Unless otherwise indicated, 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, 2001
and 2000, unless otherwise indicated, are to fiscal 2002, fiscal 2001
and fiscal 2000, 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. This
discussion should be read in conjunction with our Consolidated
Financial Statements and related notes. Certain amounts and
percentages do not recalculate due to rounding.
Results of Operations: Company-Wide
Modifications to Our Reporting Segments
During the fourth quarter of 2002 we modified our reporting segments to
reflect our new internal management organization. We have restated
operating segment results of operations for prior periods to conform to
our new operating segments.
North America Books and Home Entertainment
- Publishes and markets, primarily through direct marketing,
Books and Home Entertainment products (Select Editions; series
and general books; and music, video, Young Families, and
Children's Publishing products) in the United States and
Canada;
- Includes Reader's Digest Magazine Limited (Canada), which
publishes and markets, primarily through direct marketing,
Reader's Digest magazine in Canada;
- Sells Reader's Digest magazine and other publishers' magazines
and products through youth fundraising campaigns of Quality
Service Programs Inc. in Canada;
- Sells books and gift items, including Reader's Digest Books and
Home Entertainment products, by display marketing products
on-site through independent sales representatives, at schools
and businesses through Books Are Fun, Ltd. in the United States;
- Includes the operations of our financial services alliances in
the United States and Canada; and
- Includes the operations of Gifts.com, Inc. (including Good
Catalog Company), which will cease operations in fiscal 2003.
U.S. Magazines
- Publishes and markets, primarily through direct marketing,
Reader's Digest magazine and several special interest magazines
in the United States;
- Publishes and markets, primarily through direct marketing,
several magazines and books as well as operating complementary
businesses of Reiman Media Group, Inc., which we acquired on
May 20, 2002; and
- Sells its magazines and other publishers' magazines and
products through youth fundraising campaigns of QSP, Inc. in
the United States.
International Businesses
- Operates outside of the United States and Canada;
- Publishes and markets, primarily through direct marketing,
Books and Home Entertainment products (described above),
Reader's Digest magazine in numerous editions and languages,
and several special interest magazines; and
- Includes the operations of our financial services alliances and
other new business development initiatives, including the
introduction of display marketing and youth-fundraising
marketing, in some of our international markets.
Other Operating Items and Foreign Currency Translation
Management's Discussion and Analysis has been written excluding the
effect of foreign currency translation and other operating items.
Other operating items consist of restructuring and asset impairment
charges associated with restructuring plans, and were $(27) in 2002,
$(18) in 2001, and $(3) in 2000 (see Note 3, Other Operating Items,
Net, in our Notes to Consolidated Financial Statements).
In certain instances circumstances arose that resulted in decisions to
retain employees previously identified for termination, and in certain
other instances the cost associated with actions identified was settled
for less than originally anticipated. In these instances, the
associated charges were reversed.
Other operating items, net of $(27) in 2002 comprised: Charges of
$(13) related to our U.S. Books and Home Entertainment business;
charges of $(6) related to our closure of Gifts.com, Inc.; and $(17) of
other charges. Offsetting these charges were accrual reversals of $9
related to reserves established in 2001 and previous years. In
connection with these initiatives, we eliminated 289 positions, of
which 62% were separated during the fourth quarter of 2002.
Approximately 16% of the positions identified were located outside the
United States.
U.S. Books and Home Entertainment
In response to reduced volume in our U.S. Books and Home
Entertainment business, we announced new initiatives to reduce
the cost base of this business unit. Charges of $(3) for
severance costs, $(3) for contract terminations, and $(7) for
asset impairments and other items were the result of:
- Eliminating an unprofitable catalog business.
- Exiting the video business, except for certain single sales
videos.
- Reducing certain continuity series and general books.
- Consolidating two business units, Health and Home.
- Reducing mail quantities by approximately 40%.
- Reducing editorial, promotion, distribution and overhead costs.
Gifts.com, Inc.
In April 2002 we announced our intention to divest Gifts.com,
Inc. Subsequent to this determination, we decided to close the
business. Accordingly, our $(6) charge comprises: $(1) for
severance costs, $(1) for contract terminations and $(4) for
net asset write-downs, including goodwill.
Other Charges
Other charges of $(17) comprised: $(11) for severance costs,
$(4) for contract terminations, and $(2) for asset write-downs
and other charges. These charges were taken in connection with
a plan to streamline various U.S. and international businesses
and reduce global staffing levels.
Other operating items, net of $(18) in 2001 comprised: Net charges of
$(31) primarily related to severance costs associated with
cost-reduction and re-engineering activities; impairment losses of $(7)
relating primarily to our investment in Walking magazine; and,
offsetting these charges,
adjustments of $10 related to accrual balances originally recorded in
years prior to 2001 and adjustments to accrual balances of $10 as a
result of a favorable state tax settlement.
Other operating items, net of $(3) in 2000 comprised: Asset
impairments of $(3) primarily related to property, plant and equipment
in the United Kingdom; charges of $(10) for severance costs; and,
offsetting these charges, adjustments to accrual balances of $10 from
charges recorded in prior years.
Summary of Operating Segment Results
Years ended June 30,
2002 2001 2000
Revenues
North America Books and Home Entertainment $ 670 $ 757 $ 747
U.S. Magazines 627 652 582
International Businesses 1,072 1,109 1,156
------- ------- -------
Total revenues $ 2,369 $ 2,518 $ 2,485
======= ======= =======
Operating profit (loss)
North America Books and Home Entertainment $ 14 $ 56 $ 51
U.S. Magazines 81 77 90
International Businesses 90 114 116
------- ------- -------
Segment operating profit 185 247 257
Other operating items, net (27) (18) (3)
------- ------- -------
Total operating profit $ 158 $ 229 $ 254
======= ======= =======
Revenues and Operating Profit
2002 v. 2001
Revenues decreased 6% to $2,369 in 2002, compared with $2,518 in
2001. Excluding the adverse effect of foreign currency translation,
revenues decreased 5%. The decrease in revenues was attributable to
lower revenues in North America Books and Home Entertainment and (to
a lesser extent) in U.S. Magazines and in International Businesses.
Primary factors contributing to the decline were lower revenues for:
- General books, music and video products, and Select Editions in
our North America Books and Home Entertainment segment.
Lower revenues resulted principally from our significant
reduction of mail quantities in anticipation of lower
response rates as a result of promotion changes required by
our March 2001 attorneys general sweepstakes agreement and
continued softness in the U.S. economy. Moreover, due to
the aftermath of the September 11th terrorist attack and
subsequent anthrax scare, response rates were lower than
expected.
- Reader's Digest magazine subscriptions, which were adversely
affected by the aftermath of the September 11th terrorist
attack and the subsequent anthrax scare, as well as by an
increased number of new subscribers at lower introductory
rates. In addition, revenues were lower due to the absence
of revenues from Walking magazine. (In 2002 we recognized
revenues of $3 as the September/October issue was our last
issue, whereas 2001 included a full year of revenues, $13,
from the magazine.)
- International Businesses due to weakness in some markets,
including Germany and the United Kingdom for music products
and Select Editions. The decline in revenues was
principally driven by reductions in mail quantities to
eliminate marginally unprofitable mailings and by lower
response rates to mailings. Revenues also declined in
Australia, Mexico and Argentina. In Australia, the decline
was driven by planned reductions in mail quantities that
resulted in lower unit sales. In Mexico, revenues were down
principally due to lower sales of music products in direct
mail and kiosks. Our revenues in Argentina were down
principally due to weak economic conditions.
These declines in revenues were partially offset by:
- A 13% increase in revenues at Books Are Fun from growth in the
number of events held and in the average sales per event.
- Inclusion of revenues amounting to $31 related to Reiman from
the date of acquisition, May 20, 2002.
- Revenue growth in Eastern European countries (excluding Poland)
of 26% as a result of higher promotion efforts.
- An increase in revenues attributable to our financial services
alliances.
Segment operating profit decreased 25% to $185 in 2002, compared
with $247 in 2001. Excluding the effect of foreign currency
translation, segment operating profit decreased 26%. The decline in
profit was attributable to declines in North America Books and Home
Entertainment and International Businesses, partially offset by
improved performance in U.S. Magazines. Primary factors
contributing to the decline included:
- Lower operating profit in North America Books and Home
Entertainment, due to lower revenues principally in Select
Editions and general books, and investments in new marketing
channels, including third-party mailing lists. This decline
was partially offset by increased operating profit from
Books Are Fun due to revenue growth and from financial
services alliances.
- Lower profits in some markets, including the United Kingdom,
Australia, Poland and Mexico. The decrease is attributable
to lower revenues, the initial costs of investments in new
marketing channels, and in some markets, weak economic
conditions.
These declines were partially offset by:
- Increased profit in U.S. Magazines driven by lower promotion
costs and the timing of promotion costs at Reader's Digest
magazine and by reduced losses from Walking magazine, which
was sold in 2002.
- The absence in 2002 of nondeductible goodwill amortization
primarily related to Books Are Fun as a result of our
adoption of the Financial Accounting Standards Board (FASB)
Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets."
Product, distribution and editorial expenses decreased 2% to $948 in
2002, compared with $971 in 2001. This decline was principally a
result of lower unit volumes for most product lines in U.S. Books
and Home Entertainment, especially music and video products. In
addition, the elimination of Walking and New Choices magazines
contributed to the decrease in product costs. These declines were
partially offset by increased costs from higher sales volume at
Books Are Fun and from the acquisition of Reiman.
Promotion, marketing and administrative expenses decreased 5% to
$1,237 in 2002, compared with $1,300 in 2001. For North America
Books and Home Entertainment and for U.S. Magazines, the decline in
expenses was principally attributable to the strategic reductions in
mail quantities to eliminate marginally unprofitable mailings, the
elimination of Walking and New Choices magazines, lower operating
costs at Gifts.com, Inc., and the cessation of the amortization of
goodwill as required after the adoption of SFAS No. 142. The
decline in expenses for International Businesses was principally due
to the favorable cost impact of lower volumes in some markets and to
actions taken in 2001 that streamlined and consolidated
administrative functions worldwide. These declines were partially
offset by higher variable compensation plan expenses and lower net
pension income in 2002 compared with 2001.
During 2002 our results benefited from net pension income of $35,
compared with $42 in 2001. Net pension income arises because we are
in a net pension asset position with respect to our pension
obligation and our estimate of the long-term rate of return on our
assets exceeds the service and interest cost on our obligation. In
accordance with SFAS No. 87, "Employers' Accounting for Pensions,"
we recognize the difference between the actual and estimated returns
on plan assets over a five-year period. During 2001 our expected
return on assets exceeded our actual return. Accordingly, our net
pension income for 2002 was lower than the net pension income
recognized in 2001.
Pension income and other items, including postretirement medical
payments, executive compensation, and corporate administrative
costs, are allocated to our operating segments in accordance with
the methodology described in Note 14, Segments, in our Notes to
Consolidated Financial Statements. Such amounts appear in
promotion, marketing and administrative expenses on our income
statement.
2001 v. 2000
Revenues increased 1% to $2,518 in 2001, compared with $2,485 in 2000.
Excluding the adverse effect of foreign currency translation, revenues
increased 6%. The increase in revenues was principally attributable
to:
- Sales increase of 58% for QSP products, primarily from the
integration of the products and former sales force of World's
Finest Chocolate, Inc.
- Revenue growth in our International Businesses as a result of
increased membership in certain series products as well as
higher sales of general books, music and video products.
Revenues grew primarily in Eastern Europe and other developing
markets because of higher response rates to increased promotion
and more effective promotion techniques.
- Inclusion of a full year of revenues from Books Are Fun, which
was acquired during the second quarter of 2000, as well as
incremental revenue growth at Books Are Fun that resulted in
22% higher revenues in 2001 compared with the prior year.
Revenue growth was partially offset by:
- Lower sales primarily for video products and general books in
the United States due to reduced mailings and lower response
rates.
- A decline in circulation revenues for Reader's Digest magazine
primarily driven by lower renewals at higher subscription rates
and the addition of new subscribers at lower introductory rates.
- Lower advertising revenues for the special interest magazines
in the United States resulting from industry-wide softness,
particularly in the automotive, do-it-yourself and health
categories.
- Lower sales from a reduction in catalog activity, which was
intended to improve profitability at Gifts.com, Inc.'s Good
Catalog Company division.
Segment operating profit decreased 4% to $247 in 2001, compared with
$257 in 2000. However, excluding the adverse effect of foreign
currency translation, profit increased 4% principally from:
- Profit growth for International Businesses attributed to higher
sales of virtually all Books and Home Entertainment products
sold in these markets.
- Lower employee-related costs for all operating segments as a
result of reductions in variable compensation plans.
- Lower losses as a result of reduced marketing and development
costs associated with gifts.com, compared with higher costs
associated with the launch of the Web site in the earlier year.
Offsetting these profit improvements were declines in the United States
due to changes in sweepstakes promotions, softness in the U.S. economy
and the direct-mail industry that resulted in lower response rates to
certain products, and lower magazine advertising volume. These factors
were evident in certain segment and product line results, specifically
in:
- North America Books and Home Entertainment, where sales were
lower for video products, general books and illustrated
series products as a result of lower response rates.
- U.S. Magazines, where profits were lower for Reader's Digest
magazine as a result of increased testing of new
subscription sources and additional costs associated with a
major fulfillment-outsourcing project; and for the special
interest magazines due to industry-wide softness in several
advertising categories.
Product, distribution and editorial expenses increased 7% in 2001 to
$971, compared with $907 in 2000. These costs increased principally
due to additional volume for U.S. Magazines from the integration of
the products and former sales force of World's Finest Chocolate and
for North America Books and Home Entertainment from the inclusion of
a full year of results for Books Are Fun. In addition, costs
(excluding the effect of foreign currency translation) were higher
for International Businesses as a result of incremental volume
growth in many markets.
Promotion, marketing and administrative expenses decreased 2% in
2001 to $1,300, compared with $1,320 in 2000. However, excluding
the effect of foreign currency translation, these costs increased
2%. The increase in promotion, marketing and administrative
expenses was due to the volume increases described above for U.S.
Magazines, North America Books and Home Entertainment, and
International Businesses. Offsetting a portion of the increases
were lower expenses for North America Books and Home Entertainment
primarily from reduced marketing and development costs associated
with Gifts.com, Inc.
Other (Expense) Income, Net
2002 v. 2001
Other (expense) income, net for 2002 was $(17), compared with $(41) in
2001. Excluding equity in losses (including goodwill amortization)
associated with our investment in BrandDirect Marketing, Inc., other
(expense) income, net was $(16) in 2001. The primary factors affecting
comparability are:
- In 2002 we had a write-off of $(3) related to our remaining
investment in Schoolpop, Inc., compared with write-offs of
$(21) in 2001.
- A loss on foreign exchange of $(4) in 2002 compared with a gain
on foreign exchange of $1 in 2001.
- Lower interest income of $5 in 2002, compared with $8 in 2001,
due to lower interest rates.
- Lower gains on the sales of certain assets, other businesses
and contract terminations of $7 in 2002, compared with $13
in 2001, primarily attributable to a contract termination
payment recognized in 2001 of $4.
- Expenses associated with our proposed recapitalization of $(3)
(see Note 15, Subsequent Events, in our Notes to
Consolidated Financial Statements).
2001 v. 2000
Other (expense) income, net for 2001 was $(41), compared with $(19) in
2000. The principal items affecting the comparability of other
(expense) income, net were:
- Reduced equity in losses (including amortization of goodwill
associated with our investment) of BrandDirect Marketing of
$5. These losses included a write-down of $(13), which
reduced the carrying value of our investment to zero. In
2000, these losses amounted to $(29).
- A write-down of our investment in Schoolpop of $(7) and a
write-off of our investment in e-finet.com of $(3) in the
fourth quarter of 2001.
- Recognition of an other-than-temporary decline in the market
value of our investment in WebMD Corporation amounting to
$(10) in the fourth quarter of 2001.
- Higher interest expense, net in 2001 of $(18) resulting from
higher debt levels.
- Income in 2001 of $8 from the sale of certain investments and
proceeds of $4 from the termination of an agreement. In
2000, other (expense) income, net included a gain of $7 from
the sale of American Health magazine.
Income Taxes
2002 v. 2001
The effective tax rate for 2002 was 35.1%, compared with a rate of
29.7% for 2001. The increase was primarily attributable to a change in
the valuation allowance in the fourth quarter of 2001 on capital losses
relating to BrandDirect Marketing. Excluding this, our effective tax
rate was 33.5% in 2001. The higher effective rate in 2002 was
attributable to the write-down of certain investments in 2001, which
did not occur to the same extent in 2002, as described above, partially
offset by the absence in 2002 of nondeductible goodwill amortization
primarily related to Books Are Fun as a result of our adoption of SFAS
No. 142.
2001 v. 2000
The effective tax rate for 2001 was 29.7%, compared with a rate of
38.3% for 2000. The decrease was primarily because of a change in the
valuation allowance in the fourth quarter of 2001 on capital losses
relating to BrandDirect Marketing. Excluding this and other items
affecting the comparability of reported results, our effective tax rate
was 33.5% in 2001 and 34.5% in 2000.
Net Income
2002 v. 2001
As a result of the items discussed above, net income in 2002 was $91
or $0.89 per share on a diluted-earnings basis ($0.90 per share for
basic earnings per share). In 2001, net income was $132 or $1.26
per share on a diluted-earnings basis ($1.27 per share for basic
earnings per share).
2001 v. 2000
As a result of the items discussed above, net income in 2001 was
$132 or $1.26 per share on a diluted-earnings basis ($1.27 per share
for basic earnings per share). In 2000, net income was $145 or
$1.34 per share on a diluted-earnings basis ($1.35 per share for
basic earnings per share).
Results of Operations: Operating Segments
North America Books and Home Entertainment
2002 v. 2001
Revenues for North America Books and Home Entertainment decreased 11%
to $670 in 2002, compared with $757 in 2001. The decline in revenues
was driven by lower sales for most products in U.S. Books and Home
Entertainment, especially music and video products and general books,
partially offset by an increase in revenues at Books Are Fun and from
our financial services alliances. In anticipation of lower response
rates as a result of promotion changes required by the attorneys
general sweepstakes agreement and of softness in the U.S. economy, we
reduced our mail quantities by approximately 32% in 2002. Moreover,
due to the aftermath of the September 11th terrorist attack and
subsequent anthrax scare, response rates were lower than expected.
These declines in revenues were partially offset by a 13% increase in
revenues at Books Are Fun due to strong growth in school and corporate
events, sales per event, and the successful introduction of art and
jewelry events. In addition, revenues from our financial services
alliances doubled when compared with 2001. This was due to a contract
termination payment of $5 from a former insurance marketing alliance
partner and the introduction of a new investment products marketing
alliance in the United States.
Operating profit for this segment decreased 74% to $14 in 2002,
compared with $56 in 2001. The decline in profit was primarily
attributable to the revenue changes described above and investments in
new marketing channels, including telemarketing and third party mailing
lists. These declines were partially offset by significant cost
reduction initiatives in our U.S. Books and Home Entertainment
business, profit growth at Books Are Fun, due in part to the absence of
goodwill amortization in accordance with SFAS No. 142, and lower
operating costs for the Gifts.com, Inc. Web site.
2001 v. 2000
Revenues for North America Books and Home Entertainment increased 1% in
2001 to $757, compared with $747 in 2000. Revenues for Books Are Fun
increased 22% in 2001 compared with the prior year, principally the
result of the inclusion of a full year of operations and incremental
revenue growth. Revenues increased in our Canadian operations for
Books and Home Entertainment and QSP products. In addition, revenues
grew for Young Families products as a result of increased promotional
activity to attract new customers. Such growth was partially offset by
lower sales primarily in the United States during the second half of
2001 due to:
- The elimination of mailings for video products during the
fourth quarter of 2001 as well as a shift in mailings during
the second quarter of 2001 from video to music products.
- Lower response rates for general books primarily from a product
with stronger appeal in fiscal 2000, How to Do Just About
Anything on a Computer, which outperformed sales of titles
in 2001.
- Reduced mailings and lower response rates during the third
quarter of 2001 for series products (Select Editions and
reading and illustrated series).
- Adjustments to our sweepstakes promotions in 2001 as a result
of an agreement with the attorneys general.
Operating profit for North America Books and Home Entertainment
increased 9% in 2001 to $56, compared with $51 in 2000. Profit was
higher principally because of planned reductions in marketing and
development costs related to our gifts.com Web site, improved results
from financial services alliances, and higher profits for Young
Families and music single-sales products that resulted from increased
promotions.
Partially offsetting these profit improvements were:
- Lower revenues for video products and general books as
described above.
- Lower response rates for an illustrated series product compared
with the prior year.
- Inclusion of a full year of operations for Books Are Fun in
2001 compared with only three quarters of operations for
2000. Accordingly, results for 2000 exclude Books Are Fun's
typical first quarter seasonal loss.
U.S. Magazines
2002 v. 2001
Revenues for U.S. Magazines decreased 4% to $627 in 2002, compared with
$652 in 2001. The decline was principally due to factors described
below, partially offset by the addition of $31 in revenue from the
acquisition of Reiman in the fourth quarter of 2002. The declines were
principally attributable to:
- A 10% decline in revenues for Reader's Digest magazine. Lower
circulation revenues resulted principally from the aftermath
of the September 11th terrorist attack and subsequent
anthrax scare as well as an increased number of new
subscribers at lower introductory rates. Advertising
revenues declined due to continued softness in the U.S.
advertising market.
- Lower revenues of 57% from the sale of Walking magazine in the
first quarter of 2002 and the closure of New Choices
magazine.
- A 3% decline in revenues at QSP in part due to the displacement
or cancellation of events after the September 11th terrorist
attack in the second quarter of 2002, QSP's peak seasonal
marketing period.
Operating profit for this segment increased 5% to $81 in 2002, compared
with $77 in 2001. This increase was principally driven by lower
promotion and fulfillment costs for Reader's Digest magazine, the sale
of an unprofitable magazine, Walking, and profit of $1 contributed by
Reiman.
2001 v. 2000
Revenues for U.S. Magazines increased 12% in 2001 to $652, compared
with $582 in 2000. Revenues for QSP products increased 53% in 2001
compared with the prior year primarily due to higher sales of food and
gift items. During 2001, QSP benefited from the integration of the
products and sales force of World's Finest Chocolate, which took place
during the fourth quarter of 2000. Also, advertising revenues for
Reader's Digest magazine were higher during the period compared with
the prior year. These improvements in revenues were slightly offset by:
- A decline in circulation revenues for Reader's Digest magazine
primarily driven by lower renewals at higher subscription
rates and the addition of new subscribers at lower
introductory rates.
- Lower advertising revenues for the special interest magazines
from industry-wide softness, particularly in the automotive,
do-it-yourself and health categories.
- The absence of revenues following the sale of American Health
magazine, which ended publication in the second quarter of
2000.
Operating profit for U.S. Magazines decreased 14% in 2001 to $77,
compared with $90 in 2000, with the majority of the operating profit
continuing to be provided by QSP. Operating profit decreased for
Reader's Digest magazine due to increased testing of new subscription
sources, higher costs associated with a major fulfillment outsourcing
project and lower profits for the special interest magazines due to
industry-wide softness in certain advertising sectors particular to
these magazines. Partially offsetting the decline in operating profit
were additional sales of QSP products and higher advertising sales of
Reader's Digest magazine.
International Businesses
2002 v. 2001
Revenues for International Businesses decreased 3% to $1,072 in 2002,
compared with $1,109 in 2001. Excluding the adverse impact of foreign
currency translation, revenues decreased 2%. Declines were principally
attributable to weaker performance in certain markets, including
Australia, Germany, Argentina, the United Kingdom and Poland. During
the third quarter of 2002, we experienced slightly lower response rates
in countries that converted to the euro (promotional efforts may differ
significantly depending on the market). We evaluate promotional
investments on a market-by-market basis taking into consideration
various factors, including the local economic environment. Specific
details of revenue declines include:
- An 18% decline in revenues across a majority of the products in
Australia due to a 25% reduction in mail quantities as part
of a plan to lower mailing intensity and due to lower
response rates, compared with 2001. In addition, during
late 2001 and early 2002 we restructured the management team
to focus on revitalizing the business.
- A revenue decline of 6% in Germany as a result of reduced mail
quantities for music products and lower response rates to
mailings for Select Editions products. Mail quantities were
reduced to eliminate marginally unprofitable mailings. These
declines were partially offset by the results of mailings
for new products promoted in the second half of 2002.
- A 45% decline in revenues in Argentina attributable to
strategic reductions in mail quantities in response to the
poor economic conditions in the country.
- A revenue decline of 4% in the United Kingdom primarily due to
lower response rates for general books mailings and the
timing of Select Editions promotions. These reductions were
partially offset by higher revenues for some products from
the use of new marketing channels. In addition, response
rates were lower for Reader's Digest magazine promotional
mailings; however, this decline was partially offset by
increased subscription renewals.
- A 13% decline in revenues in Poland for most products due to
lower mail quantities and response rates compared with
2001. The decline was partially offset by the introduction
of new products and the use of new marketing channels.
The revenue declines above were partially offset by strong performances
in Russia and most developing markets, including Hungary, Asia, the
Czech Republic and Slovakia. Principal offsetting factors were:
- Higher revenues of 27% across all products in Russia
principally due to increased mail quantities, increased
response rates to mailings and new music product
introductions in 2002.
- Higher revenues of 26% in the Eastern European countries
(excluding Poland) principally due to increased mail
quantities and mailings for general books and new music
product introductions in 2002.
- Increased revenues in Asia principally due to increased mail
quantities and response rates to mailings for general books,
partially offset by lower mail quantities for music products
and Reader's Digest magazine.
Operating profit for this segment decreased 22% to $90 in 2002,
compared with $114 in 2001. Excluding the impact of foreign currency
translation, segment operating profit decreased 25%. The decrease is
primarily attributable to the revenue changes described above as well
as increased promotion costs in the United Kingdom. In addition,
investments in new marketing channels, including telemarketing, and new
product introductions in the United Kingdom, Australia and Mexico
contributed to the decline. These declines were partially offset by
the effects of cost-reduction initiatives in most European markets.
2001 v. 2000
Revenues for International Businesses decreased 4% in 2001 to $1,109,
compared with $1,156 in 2000. However, excluding the adverse effect of
foreign currency translation, revenues increased 4%. Revenues were
higher for virtually all Books and Home Entertainment products, with
nearly half of our markets recording double-digit growth for the
year. Revenues increased principally because of:
- Growth for series products (Select Editions and reading and
illustrated series) in Germany and Eastern Europe. Sales of
these products were higher as a result of increased
promotional efforts and increased membership.
- Higher revenues for general books in Russia, Asia, Mexico and
the Czech Republic. These increases were due to improved
response rates that resulted from more effective promotion
techniques and more popular products.
- Increased promotions and higher response rates for music and
video products, primarily in Mexico, Asia and Switzerland.
Offsetting a portion of the revenue increase (excluding the adverse
effect of foreign currency translation) was:
- Modestly lower revenues across all product lines resulting from
the sale of our Italian operations in the fourth quarter of
2000.
- Reduced mailing activity of music and series products in the
United Kingdom.
- Reduced revenues for Reader's Digest magazine sold in our
international markets. Revenues declined due to weaker
advertising sales in many countries and strategic reductions
in the circulation rate base in the United Kingdom.
Operating profit for International Businesses decreased 2% in 2001 to
$114, compared with $116 in 2000. However, excluding the adverse
effect of foreign currency translation, operating profit increased
14%. Profits were higher in almost all markets. Profit growth was
primarily from increased sales of Books and Home Entertainment products
as described above. Also, in Asia and Mexico profits were higher as a
result of higher subscription sales of Reader's Digest magazine. In
addition, profits increased in many markets from the execution of
global contracts to facilitate magazine fulfillment resulting in lower
paper and printing costs for Reader's Digest magazines.
Profit growth (excluding the adverse effect of foreign currency
translation) was partially offset by incremental spending on
initiatives to acquire new customers in Brazil, the sale of our Italian
operations and higher promotion costs in Australia from a shift in the
timing of mailings.
Critical Accounting Policies
Our significant accounting policies are more fully described in Note 1,
Organization and Summary of Significant Accounting Policies, in our
Notes to Consolidated Financial Statements. The accounting policies
described below are those that we believe are critical to an
understanding of our financial statements and require a significant
level of management judgment. These judgments entail estimates and
assumptions that are essential to determining the recorded amounts and
their impact on our operating results. Due to the uncertainty inherent
in these estimates and assumptions, actual results may differ.
Estimates of Returns and Bad Debt
Our ability to accurately estimate returns and bad debt is critical in
determining the amount of revenue to recognize and promotion and agent
costs to defer. These estimates are also important to an accurate
presentation of revenue on our income statement. We estimate returns
for all products as well as cancellations of magazine subscriptions
based on historical data, method of promotion and results of market
testing for the products. Reserve levels are adjusted as actual return
data is received. Generally, on a consolidated basis, our estimates of
returns have not differed significantly from actual results.
Estimates of bad debts are prepared using historical data based on the
type of product and promotion and the source of customer. We review
our bad debt reserves periodically to ensure they are appropriately
stated. If actual results differ from our estimates, the reserve is
adjusted as actual bad debt data is received. Generally, on a
consolidated basis, our estimates of bad debts have not differed
significantly from actual results.
Inventory Valuation
We periodically assess our inventory for obsolescence and to ensure it
is recorded at the lower of cost or market value. In estimating the
necessary inventory reserve, we forecast demand for products on hand
and assess market conditions, including potential usage in future
promotions. Adjustments to inventory reserves are recorded in product,
distribution and editorial expenses on our income statement.
Deferred Promotion Costs and Related Amortization
Deferral of promotion costs is only allowed if certain criteria are
met, including whether the future revenues expected to be generated by
a promotional campaign are greater than the costs deferred. Estimates
of revenues to be generated, and returns, are made using historical
data based on the type of product, method of promotion and customer
targeted. As actual revenues for a specific promotional campaign are
received, the campaign is re-assessed. To the extent the costs of the
campaign exceed revenues generated, the difference is expensed
immediately.
Pension Assumptions
The calculation of pension income (expense) is based on various
actuarial assumptions. The expected return on assets, a significant
factor in determining pension expense, requires significant judgment.
We review this assumption annually, together with actuarial
consultants, to determine a reasonable rate.
Restructuring Charges
We establish reserves for severance costs, contract terminations and
asset impairments as a result of plans we undertake to streamline our
organization and reposition certain businesses. Estimates of costs to
be incurred to complete these actions, such as future lease payments,
sublease income, the fair value of assets, and contract termination
settlements, are based on assumptions at the time the actions are
initiated. To the extent actual costs differ from those estimates,
reserve levels may need to be adjusted. In addition, plans for certain
severance actions may be revised due to changes in business conditions
that we did not foresee at the time such plans were approved.
Goodwill and Intangible Assets
As discussed more fully in Note 6, Goodwill and Other Intangible
Assets, Net in our Notes to Consolidated Financial Statements, on July
1, 2001, we elected early adoption of SFAS No. 142. Under this
statement, goodwill and intangibles with indefinite lives must be
assessed annually for impairment. These assessments, which require a
great deal of judgment, involve management's estimates of future cash
flows, market trends and other factors. If goodwill is determined to
be impaired, a loss is recorded in accordance with the statement.
Intangible assets with finite lives must be assessed for impairment
whenever changes in circumstances indicate that the assets may be
impaired. Similar to goodwill, the assessment for impairment requires
estimates of future cash flows related to the intangible asset. To the
extent the carrying value of the asset exceeds its future cash flows,
an impairment loss is recorded based on the fair value of the asset.
Liquidity and Capital Resources
(forward-looking information)
The consolidated statement of cash flows for the year ended June 30,
2002, is summarized below:
Cash and cash equivalents at June 30, 2001 $ 35
Net change in cash due to:
Operating activities 133
Investing activities (773)
Financing activities 716
Effect of exchange rate changes on cash and cash equivalents (3)
-----
Net change in cash and cash equivalents 73
-----
Cash and cash equivalents at June 30, 2002 $ 108
=====
Cash and cash equivalents increased to $108 as of June 30, 2002,
compared with $35 as of June 30, 2001. The positive cash flow from
operating activities was principally attributable to an $80 improvement
in working capital in 2002, compared with a $132 reduction in working
capital in 2001. Primary factors contributing to improved working
capital include:
- Reductions in inventory in our QSP and North America Books and
Home Entertainment businesses due to the timing of purchases
and better inventory management practices, respectively.
- Reduced levels of incentive compensation paid in 2002 for 2001.
- Decreased promotion expenses.
- Increased focus on working capital management.
Other changes in cash were principally driven by the $950 borrowed to
complete the Reiman acquisition and to pay expenses relating to the
proposed recapitalization (see Note 15, Subsequent Events, in our Notes
to Consolidated Financial Statements). In connection with the proposed
recapitalization that was scheduled to occur after June 30, 2002, the
$100 borrowed in order to repurchase shares from the DeWitt
Wallace-Reader's Digest Fund, Inc. and the Lila Wallace Reader's Digest
Fund, Inc. (the Funds) was included in cash and cash equivalents on our
balance sheet. In addition to the acquisition of Reiman, uses of cash
during 2002 included net repayments on our revolving credit facilities
of $160, the repurchase of approximately 3.6 million shares of our
stock for $64 and $21 of dividends paid.
As described in Note 11, Debt, in our Notes to Consolidated Financial
Statements, on May 20, 2002, we:
- Borrowed $950 under a new Term Loan Agreement with a syndicate
of banks and other financial institutions;
- Amended and restated our Five-Year Revolving Credit and
Competitive Advance Facility Agreement (which allows for
$193 of principal borrowings) to conform it to the Term Loan
Agreement (the Term Loan Agreement and the Five-Year
Revolving Credit and Competitive Advance Facility Agreement
are collectively referred to as the 2002 Credit Agreements);
and
- Terminated our 364-Day Revolving Credit and Competitive Advance
Facility Agreement.
The proceeds of $950 were partially used to complete the Reiman
acquisition, pay related financing and transaction costs, and
refinance previously existing obligations; part will be used to
finance the proposed recapitalization. Borrowings under the Five-Year
Revolving Credit and Competitive Advance Facility Agreement may be
used for general corporate purposes, including acquisitions, share
repurchases and commercial paper backup. Borrowings under the 2002
Credit Agreements are secured by substantially all of our assets and
are subject to various covenants, including limitations on additional
debt for money borrowed and related guarantees, acquisitions, share
repurchases, liens, and minimum interest coverage and maximum leverage
ratios. As of June 30, 2002, we were in compliance with these
covenants.
In the event the recapitalization transactions are completed by
December 31, 2002, the $100 of principal borrowed under the Term Loan
Agreement would be used to finance these transactions. As a result,
$100 included in loans and notes payable on the balance sheet would be
reclassified to long-term debt.
The Term Loan Agreement requires quarterly principal repayments,
beginning with the first quarter of fiscal 2003, with the final payment
due in 2008. Aggregate mandatory principal payments are $132 in fiscal
2003, $32 in fiscal 2004, $57 in fiscal 2005, $82 in each of fiscal
2006 and fiscal 2007, and $565 in fiscal 2008. The Term Loan Agreement
requires us to use our excess cash flow to prepay the principal amount
of borrowings.
The interest rate under the Term Loan Agreement is required to be reset
from time to time for periods of up to six months. The interest rate
is either LIBOR plus a spread based on our credit rating at the time
the rate is established, or the Alternate Base Rate, as defined in the
Term Loan Agreement. If our current credit rating were to decrease one
increment, our interest rate would increase 43 basis points. If our
credit rating were to improve one increment, our interest rate would
decrease 13 basis points. Due to the increased level of borrowings
outstanding, our interest expense will be significantly higher in
fiscal 2003 than in 2002.
Under the 2002 Credit Agreements, we are required to hedge at least
one-third of borrowings outstanding under the Term Loan Agreement. In
July 2002, we entered into agreements to cap at 6% the interest rate on
$400 of the LIBOR component of our borrowings under the Term Loan
Agreement for a period of three years.
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 June 2002, we had purchased approximately 3.6
million shares for approximately $64 under the May 2001 authorization.
We do not expect to repurchase additional shares during any period when
repurchases are prohibited under the 2002 Credit Agreements.
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 June 30, 2002, no securities had
been issued under the registration statement.
At June 30, 2002, some of our international subsidiaries had available
lines of credit totaling $12. There were no borrowings outstanding
under these facilities at June 30, 2002.
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 and the
implementation of our strategic initiatives.
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.
On January 1, 2001, Greece established a fixed conversion rate between
its sovereign currency and the euro. Beginning January 1, 2002,
euro-denominated bills and coins were introduced in those 12 countries
and by July 1, 2002, legacy currencies were no longer legal tender.
The transition to the euro has not significantly affected our marketing
strategy or our consolidated business operations. The estimated costs
to convert all affected systems to the euro did not have a material
adverse effect on our results of operations, financial position or cash
flow.
Contractual Obligations and Commitments
For information regarding debt and other obligations, including lease
commitments and contingencies, see Note 11, Debt; Note 13, Commitments
and Contingencies; and Note 15, Subsequent Events, in our Notes to
Consolidated Financial Statements. In addition, in the normal course
of business, we enter into long-term arrangements with suppliers for
raw materials and merchandise and with other parties whose recordings
or works we use in our products. These arrangements may contain
minimum purchase requirements. We enter into these agreements to
facilitate an adequate supply of materials and to enable us to develop
better products for sale to our customers.
Currency Risk Management
(forward-looking information)
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. In 2002 we 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.
Additional information concerning derivative financial instruments is
available in Note 7, Financial Instruments, in our Notes to
Consolidated Financial Statements.
Fiscal 2003 Outlook
(forward-looking information)
For 2003, we see stronger earnings per share performance, from $1.20 to
$1.30, up from the $1.12 in 2002, as adjusted to exclude non-recurring
items: other operating items, net of $(0.17), expenses associated with
our proposed recapitalization of $(0.04) and our investment write-off
of $(0.02). In the first quarter of 2003, we expect earnings per share
to be in the range of $0.00 to $0.05 per share, slightly higher than
last year. We expect to achieve operating profit growth in 2003
through: reduced losses at U.S. Books and Home Entertainment; growth at
Books Are Fun and QSP; a full year of contribution from Reiman; and
flat results for our International Businesses segment. We expect this
growth will be partially offset principally by: a modest decline at
U.S. Reader's Digest magazine; a $12 lower pension income (primarily
attributable to a reduction in our return on assets assumption from
9.75% in 2002 to 9.25% in 2003); and higher variable compensation plan
expenses.
In July of fiscal 2003 we will reduce the circulation rate base for the
U.S. edition of Reader's Digest magazine from 12.5 million copies to
12.0 million copies. This reduction is somewhat less than the number
of subscriptions we lost in the second quarter of 2002 partially
because of the diminished effectiveness of promotional mailings as a
result of the September 11th terrorist attack and the subsequent
anthrax scare. It is our intention to reduce the circulation rate base
in January of fiscal 2003 to 11.0 million copies. We believe that
these reductions will enable the magazine to reduce new subscriber
acquisition costs and improve profitability.
The United States Postal Service increased its postal rates 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 fiscal 2003. This estimate does not include any impact as a
result of the Reiman acquisition.
Recent Accounting Standards
The FASB has issued SFAS No. 143, "Accounting for Asset
Retirement Obligations"; SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets"; SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections"; and SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal
Activities."
SFAS No. 143 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
is required to be accreted each year based on a present value
interest rate. This statement is effective for us on July 1,
2002 (fiscal 2003).
SFAS No. 144 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; it also resolves 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. This statement is
effective for us on July 1, 2002 (fiscal 2003).
Adoption of these statements is not expected to have a material
impact on our operating results.
SFAS No. 145 changes the income statement classification of debt
extinguishments, amends the existing literature regarding the
accounting for modifications of leases that result in the same
economic transaction as a sale-leaseback and makes technical
corrections to other existing pronouncements. This statement is
effective July 1, 2002 (fiscal 2003).
SFAS No. 146 supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs To Exit an Activity (Including Certain
Costs Associated with a Restructuring)," and requires that a
liability for a cost associated with an exit or disposal activity
be recognized when the liability is incurred, as opposed to when
management is committed to an exit plan. Such liabilities should
be recorded based on their fair value, as defined. This
statement is effective for exit or disposal activities initiated
after December 31, 2002 (the second half of fiscal 2003).
We are currently evaluating the impact of adopting these
statements.
Cautionary Statement
(forward-looking information)
This report contains or incorporates by reference "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. 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 and acquire 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 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 successfully integrate newly acquired and newly
formed businesses (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 achieve financial savings related to
restructuring programs;
- our ability to contain and reduce costs, especially through
global efficiencies;
- the cost and effectiveness of our re-engineering of business
processes and operations;
- the accuracy of our 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 our management's assessment of the future
effective tax rate and the effects of initiatives to reduce
the rate;
- the adequacy of our financial resources;
- the effects of the terms of, and increased leverage resulting
from additional borrowings under, our credit facilities;
- the effects of interest rate fluctuations;
- the effects of ratings downgrades resulting from our increased
leverage;
- the effects of unforeseen economic and political changes in the
markets where we compete;
- the effects of weather in limiting access to consumers;
- the economic effects of terrorist activity and subsequent
related events, especially those limiting access to
consumers and otherwise affecting the direct marketing
industry; and
- the effects and pace of our stock repurchase program.
We do not undertake to update any forward-looking statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Statements of Income
Years ended June 30,
In millions, except per share data 2002 2001 2000
Revenues $ 2,368.6 $ 2,518.2 $ 2,484.5
Product, distribution and editorial expenses (947.7) (971.2) (907.1)
Promotion, marketing and administrative expenses (1,236.5) (1,299.6) (1,320.2)
Other operating items, net (26.7) (18.4) (3.4)
----------- ----------- -----------
Operating profit 157.7 229.0 253.8
Other (expense) income, net (17.1) (41.2) (19.1)
----------- ----------- -----------
Income before provision for income taxes 140.6 187.8 234.7
Provision for income taxes (49.4) (55.7) (90.0)
----------- ----------- -----------
Net income $ 91.2 $ 132.1 $ 144.7
=========== =========== ===========
Basic and diluted earnings per share
Basic earnings per share
Weighted average common shares outstanding 100.2 102.7 106.0
----------- ----------- -----------
Basic earnings per share $0.90 $1.27 $1.35
=========== =========== ===========
Diluted earnings per share
Adjusted weighted average common shares outstanding 100.6 103.7 107.0
----------- ----------- -----------
Diluted earnings per share $0.89 $1.26 $1.34
=========== =========== ===========
See accompanying Notes to Consolidated Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Balance Sheets
At June 30,
In millions 2002 2001
Restated
Assets
Current assets
Cash and cash equivalents $ 107.6 $ 35.4
Accounts receivable, net 306.0 274.8
Inventories 156.0 167.4
Prepaid and deferred promotion costs 140.9 106.7
Prepaid expenses and other current assets 153.2 192.1
---------- ----------
Total current assets 863.7 776.4
Property, plant and equipment, net 168.1 160.2
Goodwill and other intangible assets, net 1,244.6 409.8
Other noncurrent assets 426.3 334.5
---------- ----------
Total assets $ 2,702.7 $ 1,680.9
========== ==========
Liabilities and stockholders' equity
Current liabilities
Loans and notes payable $ 132.7 $ 160.3
Accounts payable 102.8 86.4
Accrued expenses 283.2 251.1
Income taxes payable 28.4 41.2
Unearned revenues 426.9 291.6
Other current liabilities 6.8 28.9
---------- ----------
Total current liabilities 980.8 859.5
Postretirement and postemployment benefits other than pensions 128.1 138.7
Unearned revenues 134.8 54.1
Long-term debt 818.0 9.8
Other noncurrent liabilities 169.1 159.0
---------- ----------
Total liabilities 2,230.8 1,221.1
---------- ----------
Commitments and Contingencies (Notes 11 and 13)
Stockholders' equity
Capital stock 25.5 29.6
Paid-in capital 224.6 226.1
Retained earnings 1,261.2 1,191.3
Accumulated other comprehensive (loss) income (89.7) (84.6)
Treasury stock, at cost (949.7) (902.6)
---------- ----------
Total stockholders' equity 471.9 459.8
---------- ----------
Total liabilities and stockholders' equity $ 2,702.7 $ 1,680.9
========== ==========
See accompanying Notes to Consolidated Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended June 30,
In millions 2002 2001 2000
Cash flows from operating activities
Net income $ 91.2 $ 132.1 $ 144.7
Equity in losses of BrandDirect Marketing -- 24.9 29.1
Investment impairments 2.5 21.3 4.0
Asset impairments 11.7 6.6 3.7
Depreciation and amortization 35.9 56.8 47.5
Minority interest -- -- (2.6)
Net (gain) loss on the sales of certain assets, other
businesses and contract terminations (6.9) (13.3) (5.7)
Changes in current assets and liabilities, net of effects of
acquisitions and dispositions
Accounts receivable, net 7.4 (27.4) 20.9
Inventories, net 21.8 (45.5) 35.2
Unearned revenues (10.1) 9.1 (27.2)
Accounts payable and accrued expenses 24.7 (109.4) (55.8)
Other, net 35.7 40.9 (21.3)
Changes in noncurrent assets and liabilities, net of effects
of acquisitions and dispositions (81.4) (79.4) 2.4
-------- -------- --------
Net change in cash due to operating activities 132.5 16.7 174.9
-------- -------- --------
Cash flows from investing activities
Proceeds from maturities and sales of marketable securities,
short-term investments and contract terminations 11.6 12.4 23.2
Proceeds from sales of businesses and other long-term investments, net 2.2 1.3 13.8
Proceeds from sales of property, plant and equipment 2.4 1.4 2.8
Investments in and advances to BrandDirect Marketing -- (24.0) (30.0)
Purchases of investments and marketable securities (1.3) -- (24.2)
Payments for business acquisitions, net of cash acquired (763.2) (2.3) (436.9)
Capital expenditures (24.6) (43.5) (34.3)
Other, net -- -- (0.1)
-------- -------- --------
Net change in cash due to investing activities (772.9) (54.7) (485.7)
-------- -------- --------
Cash flows from financing activities
Short-term borrowings, net (160.4) 72.3 86.5
Proceeds from other borrowings 950.0 0.8 7.8
Proceeds from employee stock purchase plan and exercise of stock options 8.6 19.8 13.4
Dividends paid (21.3) (21.9) (22.6)
Common stock repurchased (64.1) (34.1) (133.5)
Other, net 2.7 (0.9) 6.7
-------- -------- --------
Net change in cash due to financing activities 715.5 36.0 (41.7)
-------- -------- --------
Effect of exchange rate fluctuations on cash (2.9) (12.3) (11.2)
-------- -------- --------
Net change in cash and cash equivalents 72.2 (14.3) (363.7)
-------- -------- --------
Cash and cash equivalents at beginning of year 35.4 49.7 413.4
-------- -------- --------
Cash and cash equivalents at end of year $ 107.6 $ 35.4 $ 49.7
======== ======== ========
Supplemental information
Cash paid for interest $ 9.3 $ 14.8 $ 3.0
Cash paid for income taxes $ 13.8 $ 58.7 $ 57.9
See accompanying Notes to Consolidated Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Capital Stock Accumulated
Unamortized Other Treasury
Preferred Common Restricted Paid-in Retained Comprehensive Stock, at
In millions Stock Stock Stock Capital Earnings (Loss) Income Cost Total
Balance at June 30, 1999, as previously reported $ 28.8 $ 1.4 $ (5.4) $ 146.2 $ 955.4 $ (56.6) $(688.3) $ 381.5
Change in accounting principle (see Note 1) 3.6 3.6
Balance at June 30, 1999, as restated 28.8 1.4 (5.4) 146.2 959.0 (56.6) (688.3) 385.1
------ ----- ------ ------- --------- ------- ------- -------
Comprehensive income
Net income 144.7 144.7
Other comprehensive income:
Translation loss (16.4) (16.4)
Net unrealized gain on investments, net of
deferred taxes of $56.0 104.0 104.0
-------
Total comprehensive income 232.3
=======
Stock issued under various plans 4.1 1.9 11.5 17.5
Exchange of common stock 75.0 (75.0) --
Common stock repurchased (133.5) (133.5)
Common stock dividends (21.3) (21.3)
Preferred stock dividends (1.3) (1.3)
------ ----- ------ ------- --------- ------- ------- -------
Balance at June 30, 2000, as restated 28.8 1.4 (1.3) 223.1 1,081.1 31.0 (885.3) 478.8
------ ----- ------ ------- --------- ------- ------- -------
Comprehensive income
Net income 132.1 132.1
Other comprehensive income:
Translation loss (15.6) (15.6)
Net unrealized loss on investments, net of
deferred taxes of $53.4 (99.1) (99.1)
Net unrealized gain on derivatives, net of
deferred taxes of $0.5 0.8 0.8
Minimum pension liability, net of deferred
taxes of $0.9. (1.7) (1.7)
-------
Total comprehensive income 16.5
=======
Stock issued under various plans 0.7 3.0 16.8 20.5
Common stock repurchased (34.1) (34.1)
Common stock dividends (20.6) (20.6)
Preferred stock dividends (1.3) (1.3)
------ ----- ------ ------- --------- ------- ------- -------
Balance at June 30, 2001, as restated 28.8 1.4 (0.6) 226.1 1,191.3 (84.6) (902.6) 459.8
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity, continued
Capital Stock Accumulated
Unamortized Other Treasury
Preferred Common Restricted Paid-in Retained Comprehensive Stock, at
In millions Stock Stock Stock Capital Earnings (Loss) Income Cost Total
Comprehensive income
Net income 91.2 91.2
Other comprehensive income:
Translation gain 13.0 13.0
Net unrealized loss on investments, net of (1.1) (1.1)
deferred taxes of $0.6
Net realized gain on derivatives, net of
deferred taxes of $0.5 (0.8) (0.8)
Minimum pension liability, net of
deferred taxes of $6.8 (16.2) (16.2)
-------
Total comprehensive income 86.1
=======
Stock issued under various plans (4.1) (1.5) 17.0 11.4
Common stock repurchased (64.1) (64.1)
Common stock dividends (20.0) (20.0)
Preferred stock dividends (1.3) (1.3)
------ ----- ------ ------- --------- ------- ------- -------
Balance at June 30, 2002 $ 28.8 $ 1.4 $ (4.7) $ 224.6 $ 1,261.2 $ (89.7) $ (949.7) $ 471.9
====== ===== ====== ======= ========= ======= ======== =======
See accompanying Notes to Consolidated Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Dollars in millions, except per share data
Unless otherwise indicated, references in Notes to Consolidated
Financial Statements to "we," "our" and "us" are to The Reader's Digest
Association, Inc. and its subsidiaries. All references to 2002, 2001
and 2000, unless otherwise indicated, are to fiscal 2002, fiscal 2001
and fiscal 2000, respectively. Our fiscal year represents the period
from July 1 through June 30.
Note 1 Organization and Summary of Significant Accounting Policies
Nature of Our Business
We are a diversified media company that produces books, magazines and
other products worldwide. We sell our products primarily through
direct marketing channels. Our best known trademark is our flagship
magazine, Reader's Digest. We conduct business through three segments:
North America Books and Home Entertainment, U.S. Magazines and
International Businesses. For further commentary regarding these
segments, see Management's Discussion and Analysis and Note 14,
Segments.
Basis of Presentation and Use of Estimates
The accompanying consolidated financial statements include the accounts
of The Reader's Digest Association, Inc. and its majority-owned
subsidiaries. These financial statements are prepared in conformity
with accounting principles generally accepted in the United States,
which require management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial
statements, and the reported amounts of operating revenues and expenses
during the reporting period. These estimates are based on management's
knowledge of current events and actions that we may undertake in the
future, however actual results may ultimately differ from those
estimates. The primary estimates underlying our consolidated financial
statements include allowances for returns, doubtful accounts, valuation
of inventories, valuation of direct response advertising and subscriber
acquisition costs, deferred tax assets, deferred promotion costs, and
pension, postemployment and postretirement benefits.
Concentrations of Credit Risk
Financial instruments that potentially expose the Company to
concentrations of credit risk, as defined by the Financial Accounting
Standards Board's (FASB) Statement of Financial Accounting Standards
(SFAS) No. 105, "Disclosure of Information about Financial Instruments
with Off-Balance Sheet Risk and Financial Instruments with
Concentrations of Credit Risk," consist primarily of trade accounts
receivable. However, we believe our concentrations of credit risk with
respect to trade receivables are limited due to our large number of
customers and their dispersion across many different geographic and
economic environments.
Cash and Cash Equivalents
We consider all highly liquid investments with original maturities of
three months or less at the date of purchase to be cash equivalents.
The carrying amount approximates fair value based upon the short-term
maturity of these investments.
Inventories
Inventories consist primarily of finished goods and raw materials,
including paper, and are stated at the lower of cost or market value.
During the first quarter of 2002, we changed our method of accounting
for the cost of 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. In our non-U.S. markets, the
cost of inventory is primarily determined on the FIFO basis. We
believe that the new method of accounting for inventories in the United
States is preferable because it provides consistency in accounting for
inventories globally, supports our recent transition to a global
financial system and provides for more accurate reporting of the
current value of the inventory. The impact of changing from LIFO to
FIFO did not have a material impact on the results of operations for
2001 and 2000. In accordance with Accounting Principles Board (APB)
Opinion No. 20, "Accounting Changes," the change was recorded by
increasing inventory by $5.8 and retained earnings by $3.6, net of
deferred taxes of $2.2, at the beginning of the period presented.
Property, Plant and Equipment, Net
Assets that comprise property, plant and equipment, net are stated at
cost. Depreciation expense is generally calculated on a straight-line
basis over the estimated useful lives of the assets: 10 - 40 years for
buildings and 3 - 10 years for equipment, furniture and fixtures.
Leasehold improvements are amortized using the straight-line basis over
the term of the lease or the useful life of the improvement, whichever
is shorter.
During 2000, we modified the useful lives assigned to certain assets to
gain global consistency of useful lives, the effect of which was not
significant.
Goodwill and Other Intangible Assets, Net
Goodwill and other intangible assets, net is composed of the excess of
costs over the fair value of net assets of acquired businesses
(goodwill), licensing agreements, customer lists, tradenames and other
intangible assets.
In accordance with the adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets," on July 1, 2001, we ceased amortization of goodwill
and intangible assets with indefinite lives. Acquired intangibles with
finite lives are amortized, on a straight-line basis, over their
estimated useful lives, which range from 3 to 10 years. Prior to the
adoption of SFAS No. 142, goodwill was amortized, on a straight-line
basis, over varying periods not in excess of 40 years.
SFAS No. 142 requires that the carrying amount of goodwill and
intangibles with indefinite lives be evaluated, at least annually, for
recoverability. This assessment involves comparing the fair value of
the reporting unit or asset, as applicable, to its carrying value.
Recognition of the impairment, if any, is determined in accordance with
the statement. We review our intangible assets with finite lives for
impairment whenever events or changes in circumstances indicate that
the carrying amount of that asset may not be recoverable. We measure
recoverability by comparing the asset's carrying amount to the
undiscounted future net cash flows expected to be generated by the
asset. If we determine that the asset is impaired, the impairment
recognized is the amount by which the carrying amount of the asset
exceeds the fair value of the asset. See Note 6, Goodwill and Other
Intangible Assets, Net, for additional information on our adoption of
SFAS No. 142.
Investments
Equity Method Investments
The equity method is used to account for investments in entities that
are not majority-owned by us and that we do not control but over which
we have the ability to exercise significant influence. Generally,
under the equity method, original investments in these affiliates are
recorded at cost and are subsequently adjusted by our share of equity
in earnings or losses after the date of acquisition (including
amortization of goodwill prior to July 1, 2001). Equity in earnings or
losses of each affiliate is recorded according to our level of
ownership until our investment has been fully depleted. If our
investment has been fully depleted, we recognize the full amount of the
losses generated by the affiliate only when we are the primary funding
source. These investments are recorded in other noncurrent assets on
the balance sheet.
Cost Method Investments
The cost method is used to account for investments in entities that are
not majority-owned and that we do not control or have the ability to
significantly influence. Investments of this type are recorded at
cost, less valuation allowances, and are included in other noncurrent
assets on the balance sheet.
Marketable Securities
We classify investments in equity securities in one of three
categories: trading, held-to-maturity and available-for-sale. Trading
securities are those acquired for the purpose of short-term investing
of funds. Held-to-maturity securities are those acquired for the
purpose of holding the security until maturity. Available-for-sale
securities are recorded at fair value in other noncurrent assets on the
balance sheet. Unrealized gains and losses on available-for-sale
securities, net of tax, are recorded in other comprehensive income in
stockholders' equity on the balance sheet. Realized gains and losses,
and declines in carrying value deemed to be other than temporary, are
recorded in other (expense) income, net on the income statement.
Impairment of Long-Lived Assets
We review long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of such an asset may
not be recoverable. We measure the recoverability of an asset that is
to be held and used by comparing its carrying amount to the
undiscounted future net cash flows expected to be generated by the
asset. If we determine that the asset is impaired, the impairment
recognized is the amount by which the carrying amount of the asset
exceeds the fair value of the asset. We report assets to be disposed
of at the lower of the carrying amount or fair value less costs to sell.
Debt Issue Costs
Debt issuance costs consist of fees and expenses incurred in connection
with our borrowings. These fees are being amortized over the terms of
the related debt agreements, ranging from four to six years.
Stock-Based Compensation
We account for stock-based compensation under SFAS No. 123, "Accounting
for Stock-Based Compensation." As permitted by this standard,
compensation cost is recognized for stock-based compensation using the
intrinsic value method under APB Opinion No. 25, "Accounting for Stock
Issued to Employees." Under this method, compensation cost is the
excess, if any, of the quoted market price of the stock at the grant
date over the amount an employee must pay to acquire the stock. Our
policy is to grant stock options at fair market value at the date of
grant. Pro forma information regarding the net income and earnings per
share under the alternate fair value method are disclosed in Note 9,
Employee Compensation Plans.
Financial Instruments
We record all derivative instruments on our balance sheet at fair
value. Derivatives that are not classified as hedges are adjusted to
fair value through earnings. Changes in fair value of the derivatives
that we have designated and that qualify as effective hedges are
recorded in either other comprehensive income or earnings, as
appropriate. The ineffective portion of our derivatives that are
classified as hedges is immediately recognized in earnings.
Revenues
Sales of products by North America Books and Home Entertainment and by
U.S. Magazines are recorded as revenues when title passes, at the time
of shipment, net of provisions for estimated returns and bad debts.
Sales of our magazine subscriptions, less estimated cancellations, are
deferred and recognized proportionately as revenues over the
subscription period. Sales of magazine advertising, net of discounts
and advertising agency commissions, are recorded as revenues at the
time the advertisements are published. Sales of subscriptions to
magazines published by other companies and music by QSP, Inc. are
recorded as revenues at the time orders are submitted to the publisher,
net of bad debts and remittances to magazine and music publishers.
Promotion Costs
Costs of direct response advertising are accounted for under the
American Institute of Certified Public Accountants Statement of
Position (SOP) 93-7, "Reporting on Advertising Costs." Under SOP 93-7,
costs associated with direct response advertising that can be directly
linked to eliciting sales and result in probable future benefits are
capitalized on a cost-pool-by-cost-pool basis and amortized over the
expected future revenue stream. Direct response advertising consists
primarily of promotion costs incurred in connection with the sale of
magazine subscriptions, books and other products. Promotion costs of
$(666.3), $(719.1) and $(725.7) were incurred for 2002, 2001 and 2000,
respectively. Prepaid promotion costs included in prepaid expenses and
other current assets on the balance sheet were $140.9 and $106.7 as of
June 30, 2002 and 2001, respectively. Amounts included in other
noncurrent assets on the balance sheet were $21.8 as of June 30, 2002.
Commissions paid to agents for new magazine subscribers are included in
promotion, marketing and administrative expenses in the income
statement. These costs are deferred and amortized over the related
subscription term, typically one to three years. Amounts deferred and
included in prepaid expenses and other current assets on the balance
sheet were $42.3 and $35.6 as of June 30, 2002 and 2001, respectively.
Amounts included in other noncurrent assets on the balance sheet were
$34.5 and $33.9 as of June 30, 2002 and 2001, respectively.
Income Taxes
Income taxes are accounted for under the provisions of SFAS No. 109,
"Accounting for Income Taxes." In accordance with SFAS No. 109,
deferred income taxes, net of valuation allowances, reflect the future
tax consequences of differences between the financial statement and tax
bases of assets and liabilities. These deferred taxes are calculated
by applying currently enacted tax laws.
Basic and Diluted Earnings Per Share
Basic earnings per share is computed by dividing net income less
preferred stock dividend requirements ($1.3 for each of 2002, 2001 and
2000) by the weighted average number of common shares outstanding
during the year. 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 (0.4 million shares for
2002, and 1.0 million shares for both 2001 and 2000).
Options to purchase approximately 10.3 million shares of Class A
nonvoting common stock were outstanding during 2002, but were not
included in the computation of diluted earnings per share (5.5 million
in 2001 and 3.8 million in 2000). The exercise prices of these options
were greater than the average market price of the Class A nonvoting
common stock during the period.
Foreign Currency Translation
The functional currency for most foreign operations is the local
currency. Revenues and expenses denominated in foreign currencies are
translated at average monthly exchange rates prevailing during the
year. The assets and liabilities of international subsidiaries are
translated into U.S. dollars at the rates of exchange in effect at the
balance sheet date. The resulting translation adjustment is reflected
as a separate component of stockholders' equity in accumulated other
comprehensive income.
The U.S. dollar is used as the functional currency for subsidiaries
operating in highly inflationary economies, for which both translation
adjustments and gains and losses on foreign currency transactions are
included in other (expense) income, net.
Reclassifications
Certain reclassifications have been made to amounts in prior periods to
conform to the current period presentation.
Recent Accounting Standards
The FASB has issued SFAS No. 143, "Accounting for Asset
Retirement Obligations"; SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets"; SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections"; and SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal
Activities."
SFAS No. 143 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
is required to be accreted each year based on a present value
interest rate. This statement is effective for us on July 1,
2002 (fiscal 2003).
SFAS No. 144 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 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; it
also resolves 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. This statement is
effective for us on July 1, 2002 (fiscal 2003).
Adoption of these statements is not expected to have a material
impact on our operating results.
SFAS No. 145 changes the income statement classification of debt
extinguishments, amends the existing literature regarding the
accounting for modifications of leases that result in the same
economic transaction as a sale-leaseback and makes technical
corrections to other existing pronouncements. This statement is
effective July 1, 2002 (fiscal 2003).
SFAS No. 146 supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs To Exit an Activity (Including Certain
Costs Associated with a Restructuring)," and requires that a
liability for a cost associated with an exit or disposal activity
be recognized when the liability is incurred, as opposed to when
management is committed to an exit plan. Such liabilities should
be recorded based on their fair value, as defined. This
statement is effective for exit or disposal activities initiated
after December 31, 2002 (the second half of fiscal 2003).
We are currently evaluating the impact of adopting these
statements.
Note 2 Acquisitions and Investments
Acquisitions
On July 1, 2001, we adopted SFAS No. 141, "Business Combinations,"
which requires the purchase method of accounting to be used for all
business combinations initiated after June 30, 2001.
On May 20, 2002, we purchased substantially all of the assets and
assumed certain liabilities of Reiman Holding Company, LLC and
subsidiaries (Reiman). Reiman publishes cooking, gardening, country
lifestyle and nostalgia magazines and books in the United States and
Canada. The total purchase price of $760.0, plus capitalized
acquisition costs of $8.2, was financed entirely through bank and
institutional borrowings. The acquisition was accounted for using the
purchase method of accounting and resulted in $651.7 of goodwill, which
is deductible for tax purposes. Reiman's results have been
consolidated since May 20, 2002.
The following table represents the fair values of assets acquired and
liabilities assumed at the date of acquisition:
Current assets $ 101.1
Property, plant and equipment 10.7
Identified intangible assets 206.8
Goodwill 651.7
Other noncurrent assets 21.6
-------
Total assets acquired 991.9
Current liabilities (154.2)
Long-term liabilities (69.5)
-------
Net assets acquired $ 768.2
=======
Identified intangible assets comprise tradenames and customer lists.
The tradenames, with a fair value of $89.7, are determined to have an
indefinite life. The subscriber lists, with a fair value of $117.1,
are amortized over their estimated useful lives, ranging from three to
six years. The weighted average useful life of the customer lists is
approximately 3.5 years.
The following table presents pro forma information as though the
acquisition took place at the beginning of the periods presented.
2002 2001
Pro forma information (unaudited):
Revenues $ 2,648.2 $ 2,824.4
Net income $ 92.3 $ 110.9
Earnings per share (unaudited):
Basic $ 0.91 $ 1.07
Diluted $ 0.90 $ 1.06
In October 1999, we purchased 100% of the outstanding common stock of
Books Are Fun, Ltd. Books Are Fun sells books and gift items by
display marketing those products on-site at schools and corporate
businesses. The total purchase price of $393.2 was financed through a
combination of internal funds and bank borrowings of $120.0, which were
repaid during the second quarter of 2000. The acquisition was
accounted for using the purchase method of accounting and generated
$346.0 in goodwill. The results of Books Are Fun have been
consolidated since October 1, 1999, and are included in our financial
results for 2002, 2001 and 2000.
The following table presents pro forma information as though the
acquisition took place at the beginning of the period presented.
2000
Pro forma information (unaudited):
Revenues $ 2,515.4
Net income $ 139.1
Earnings per share (unaudited):
Basic $ 1.30
Diluted $ 1.29
These unaudited pro forma results have been prepared for comparative
purposes only and include certain adjustments, such as additional
amortization expense for identified intangibles, increased interest
expense from the incurrence of debt and lower interest income from
reduced cash on hand. The results are not intended to be indicative of
the results of operations that actually would have resulted had the
acquisition occurred at the beginning of each period, or of future
results of operations of our consolidated entity.
Available-for-Sale Marketable Securities
Marketable securities included in other noncurrent assets on the
balance sheet primarily represent 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 June 30, 2002 and 2001, the
market value of our investment in LookSmart shares totaled $5.7 and
$7.4, respectively. As of June 30, 2002, we had sold all of our
remaining 0.4 million shares in WebMD, resulting in a loss of $(0.3).
The market value of our investment in WebMD shares was $3.0 as of June
30, 2001.
The net unrealized gain on these investments, net of deferred taxes, is
included in accumulated other comprehensive (loss) income in
stockholders' equity on the balance sheet and amounted to $3.7 and $4.9
as of June 30, 2002 and 2001, respectively. In addition, during 2001
we recorded an impairment of $(10.0) related to our investment in
WebMD. This impairment represented a charge to record what we believed
to be an other-than-temporary decline in the market value of our shares
of WebMD. This impairment represents a write-down from the original
acquisition price to the approximate market value as of June 30, 2001.
During 2002 and 2001 we sold approximately 4.2 million shares and 2.0
million shares, respectively, of LookSmart and recorded pre-tax gains
of $7.3 and $7.2, respectively, in other (expense) income, net on the
income statement.
Investments, Equity Method
Long-term equity investments included in other noncurrent assets on the
balance sheet 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
prior to July 1, 2001) was included in other (expense) income, net on
the income statement. As of June 30, 2001, we had written down our
investment in BrandDirect Marketing to zero.
Investments, at Cost
Investments carried at cost are included in other noncurrent assets on
the balance sheet. During June 2002, we recorded an impairment charge
on our investment in Schoolpop, Inc. of $(2.5) and sold a portion of
our investment in e-finet.com, which had been written down to zero in
2001.
As of June 30, 2001, our investments, at cost, totaled $2.5,
representing our investment in Schoolpop. This balance is net of
impairment charges in other (expense) income, net on the income
statement totaling $(10.4) (Schoolpop -- $(7.5) and e-finet.com --
$(2.9)) recorded in 2001.
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 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. See
Note 15, Subsequent Events, for recent developments with respect to
this agreement.
Note 3 Other Operating Items, Net
Charges included in other operating items, net primarily represent the
streamlining of our organizational structure and the strategic
repositioning of certain businesses. We recorded charges for other
operating items, net of $(26.7) in 2002, $(18.4) in 2001 and $(3.4) in
2000. The components of other operating items, net are described in
further detail below:
- Severance Costs - For each reporting period, we identified
employees who would be separated and associated costs as a
result of actions taken to streamline our organizational
structure through involuntary severance programs.
- Contract Terminations - These charges represent anticipated
costs to terminate contractual obligations in connection
with streamlining activities.
- Impairment Losses - In connection with our restructuring
activities, we incurred charges related to the carrying
value of intangible assets, certain leasehold improvements,
computer hardware and software and, to a lesser extent,
property, plant and equipment no longer used in our
operations.
In certain instances circumstances arose that resulted in decisions to
retain employees previously identified for termination, and in certain
other instances the costs associated with actions identified were
settled for less than originally anticipated. In these instances, the
associated charges were reversed.
During 2002, other operating items, net of $(26.7) comprised:
- Charges of $(35.6), including $(14.7) for severance costs,
$(8.0) for contract terminations, and $(12.9) for asset
impairments and other items. We expect all of the
restructuring actions related to these charges to be completed
during 2003. The loss of revenues and operating profit (loss)
from the activities that are being discontinued were not
significant to our consolidated revenues and operating profit.
- The $(14.7) of severance costs relate to the separation of 289
employees (approximately 62% were separated during the fourth
quarter of 2002, the remainder are expected to be separated in
fiscal 2003). Approximately 16% of the employees identified
are located outside the United States. A majority of the
employee separations included in the severance charge are
related to U.S. Books and Home Entertainment and administrative
functions that support this business, including information
technology personnel and Gifts.com, Inc.
- Adjustments of $6.9 related to accrual balances from charges
originally recorded in 2001 and prior periods.
- A reversal of $2.0 pertaining to a pending legal matter that
was originally recorded in prior years in other operating
items, net.
Specific actions during 2002 related to other operating items, net
include:
- Closing Gifts.com, Inc. (to be completed during the second
quarter of fiscal 2003). This action resulted in severance
costs of $(0.9), contract termination charges of $(0.5) and
$(4.2) for net asset write-downs, including goodwill.
- The scaleback of our U.S. Books and Home Entertainment
business. This action resulted in severance costs of $(2.9),
contract termination charges of $(3.3) and $(6.6) for net asset
write-downs, including goodwill.
- Streamlining various U.S. and international businesses and
reducing global staffing levels. This includes $(10.9) in
severance charges, $(4.2) in contract termination charges and
$(2.1) in write-downs of assets and other items.
During 2001, other operating items, net of $(18.4) comprised:
- Charges of $(31.8) primarily for severance costs associated
with restructuring North America Books and Home Entertainment,
streamlining European operations and reducing overall staff
levels. Approximately 85% of the 380 employees included in the
2001 charge were separated from our operations.
- Adjustments of $9.9 to accrual balances from charges originally
recorded in years prior to 2001 as a result of unexpected
delays in the outsourcing of certain activities.
- An additional adjustment as a result of a favorable tax
settlement of $14.5 of which $10.1 was originally recorded in
other operating items and $4.4 was originally recorded in
administrative expenses.
- Asset impairments of $(6.6) related primarily to goodwill
associated with our investment in Walking magazine. We sold
this magazine in the first quarter of 2002.
During 2000, other operating items, net of $(3.4) comprised:
- Charges of $(9.9) primarily for severance costs associated with
the outsourcing of customer service in certain countries,
centralization of certain accounting functions and
discontinuance of certain unproductive activities.
- Adjustments of $10.2 to accrual balances from charges
originally recorded in fiscal years 1999, 1998 and 1996.
- Asset impairments of $(3.7) related primarily to property,
plant and equipment in the United Kingdom.
At June 30, 2002, we had restructuring reserves for other operating
items, net of $31.3, primarily for severance costs and contract
terminations that will take place during fiscal 2003. This reserve is
included in accrued expenses on the balance sheet. At June 30, 2001,
restructuring reserves totaled $33.3, primarily for severance costs.
During 2002, we recorded additional restructuring reserves of $35.6,
which were partially offset by adjustments to these reserve balances of
$6.9. In addition, $30.7 was charged to this reserve primarily for
severance payments and for asset write-downs.
Note 4 Other (Expense) Income, Net
2002 2001 2000
Interest income $ 4.7 $ 8.4 $ 13.5
Interest expense (18.6) (18.3) (5.6)
Equity in losses of BrandDirect Marketing -- (24.9) (29.1)
Investment impairments (1) (2.5) (21.3) (4.0)
Net gain on the sales of certain
assets, other businesses and
contract terminations (2) 6.9 13.3 5.7
Net (loss) gain on foreign exchange (4.2) 1.4 3.7
Other (expense) income, net (3) (3.4) 0.2 (3.3)
------- ------- -------
Total other (expense) income, net $ (17.1) $ (41.2) $ (19.1)
======= ======= =======
(1) Investment impairments in 2002 represent $(2.5) for Schoolpop. In
2001, impairments included $(10.0) for WebMD, $(7.5), for
Schoolpop, $(2.9) for e-finet.com and $(0.9) for Sticky Networks,
Inc. In 2000, investment impairments included $(4.0) for
Hardware.com.
(2) Net gain on the sales of certain assets, other businesses and
contract terminations principally includes sales of our shares in
LookSmart of $7.3 and $7.2 in 2002 and 2001, respectively. Receipt
of a contract termination payment of $4.2 is also included in
2001. In 2000, this amount included a gain on the sale of American
Health magazine of $6.5.
(3) In 2002, other (expense) income, net principally comprises expenses
associated with our proposed recapitalization. See Note 15,
Subsequent Events.
Note 5 Supplemental Balance Sheet Information
The components of certain balance sheet accounts as of June 30 are as
follows:
Accounts Receivable, Net
2002 2001 2000
Gross accounts receivable, trade $ 472.2 $ 418.6 $ 399.4
Beginning reserve for returns and bad debts (143.8) (146.0) (153.8)
Additions to allowances (1) (500.7) (502.7) (465.8)
Actual returns and bad debts (2) 478.3 504.9 473.6
------- ------- -------
Ending reserve for returns and bad debts (166.2) (143.8) (146.0)
Accounts receivable, net $ 306.0 $ 274.8 $ 253.4
======= ======= =======
(1) Additions to allowances represent estimated reserves
established at the time of revenue recognition for returns and bad
debts in accordance with SFAS No. 48, "Revenue Recognition When
Right of Return Exists." Amounts are recorded as an offset to
revenues.
(2) Actual returns and bad debts include actual experience during
the period and the effects of foreign currency translation.
Inventories
2002 2001
Raw materials $ 14.7 $ 12.0
Work-in-progress 8.7 19.2
Finished goods 132.6 136.2
--------- ---------
Total inventories $ 156.0 $ 167.4
========= =========
Property, Plant and Equipment, Net
2002 2001
Land $ 11.4 $ 9.6
Buildings and building improvements 180.8 161.5
Furniture, fixtures and equipment 169.6 164.2
Leasehold improvements 13.6 15.1
--------- ---------
375.4 350.4
Accumulated depreciation and amortization (207.3) (190.2)
--------- ---------
Total property, plant and equipment, net $ 168.1 $ 160.2
========= =========
Accrued Expenses
2002 2001
Compensation and other employee benefits $ 69.4 $ 55.2
Royalties and copyrights payable 19.9 21.2
Taxes, other than income taxes 5.8 6.0
Other operating items, net 31.3 33.3
Other, principally operating expenses 156.8 135.4
--------- ---------
Total accrued expenses $ 283.2 $ 251.1
========= =========
Note 6 Goodwill and Other Intangible Assets, Net
On July 1, 2001, we adopted SFAS No. 142, which 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
identified our reporting units and tested our goodwill for any
transitional impairment and have concluded that there was no impairment
as of the date of adoption. We also tested for annual impairment as of
the end of our third quarter and concluded there was no impairment at
that time.
The changes in the carrying amount of goodwill by segment for the
fiscal year ended June 30, 2002, are as follows:
North America
Books and
Home U.S. International
Entertainment Magazines Businesses Total
Balance as of June 30, 2001 $ 334.3 $ 30.0 $ 0.9 $ 365.2
Reclassification of identified intangible assets
on July 1, 2001 (1.3) -- (0.9) (2.2)
Closure of Gifts.com, Inc. (see Note 3) (10.7) -- -- (10.7)
Additions as a result of the Reiman acquisition
(see Note 2) -- 651.7 -- 651.7
---------- ---------- ---------- ----------
Balance as of June 30, 2002 $ 322.3 $ 681.7 $ -- $ 1,004.0
========== ========== ========== ==========
The following categories of acquired intangible assets are included in
goodwill and other intangible assets, net as of June 30, 2002 and 2001:
2002 2001
Gross Net Gross Net
Intangible assets with indefinite lives:
Tradenames $ 89.7 $ 89.7 $ -- $ --
Intangible assets with finite lives:
Licensing agreements 43.5 34.6 43.1 38.3
Customer lists 137.8 116.3 22.7 5.7
Other tradenames and noncompete agreements 3.0 -- 1.1 0.6
------- ------- ------ ------
Total intangible assets $ 274.0 $ 240.6 $ 66.9 $ 44.6
======= ======= ====== ======
Amortization related to intangible assets with finite lives amounted to
$11.1 and $5.2 for 2002 and 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. Licensing agreements are principally amortized over
10 years from the initial contract date, while customer lists are being
amortized principally between three and six years. Estimated fiscal
year amortization expense, for intangible assets with finite lives, is
as follows: fiscal 2003 - $38.9; fiscal 2004 - $38.6; fiscal 2005 -
$35.7, fiscal 2006 - $14.8 and fiscal 2007 - $9.4.
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 fiscal years ended June 30, 2001 and 2000.
Years Ended June 30,
2001 2000
Net income $ 132.1 $ 144.7
Add-back amortization related to the excess of cost over net
assets of acquired businesses, net of tax 19.7 14.9
Add-back goodwill amortization related to an equity
method investee, net of tax 5.4 3.8
--------- ---------
Adjusted net income $ 157.2 $ 163.4
========= =========
Basic earnings per share $ 1.27 $ 1.35
Add-back amortization related to the excess of cost over net
assets of acquired businesses, net of tax, per share 0.19 0.14
Add-back goodwill amortization related to an equity
method investee, net of tax, per share 0.05 0.04
--------- ---------
Adjusted basic earnings per share $ 1.51 $ 1.53
========= =========
Diluted earnings per share $ 1.26 $ 1.34
Add-back amortization related to the excess of cost over net
assets of acquired businesses, net of tax, per share 0.19 0.14
Add-back goodwill amortization related to an equity
method investee, net of tax, per share 0.05 0.04
--------- ---------
Adjusted diluted earnings per share $ 1.50 $ 1.52
========= =========
Note 7 Financial Instruments
The FASB issued SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" in June 1998, and SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities," an
amendment of SFAS No. 133, in June 2000. We adopted these statements
effective July 1, 2000. These statements standardized the accounting
for our derivative instruments, including certain derivative
instruments embedded in other contracts. The cumulative effect of the
change in accounting principle recorded on July 1, 2000 was not
material to our results of operations, financial position or cash
flows. These statements were not required to be retroactively applied
to prior periods.
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.
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 our use of derivative instruments.
As of June 30, 2002, all of our forward and option contracts have
expired. 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 previous derivative
transactions.
- We entered 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 were based on forecasted future revenues earned by our
subsidiaries. These contracts were designated as and qualified
for cash flow hedge accounting.
- Similarly, option contracts were used to economically hedge
against foreign currency risk associated with operating cash
flows of our foreign subsidiaries. The contract amounts of
these options were based on forecasted cash flows from
operating profit recognized by our subsidiaries. These
contracts did not qualify for hedge accounting treatment.
- We utilized 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 did not qualify for hedge accounting
treatment.
Quantitative Disclosures of Derivative Instruments
Cash Flow Hedges - For 2001, 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 gain
of $0.8 (net of deferred taxes of $0.5). These changes are reported in
accumulated other comprehensive (loss) income, which is included in
stockholders' equity on the balance sheet. The gains and losses were
deferred until the underlying transactions were recognized in earnings.
The ineffective portion of the change in market value of these option
contracts, specifically the time-value component of $(0.4) and $(1.7),
was recognized as a loss in other (expense) income, net on the income
statement for 2002 and 2001, respectively. The fair value of the
option contracts at June 30, 2001, of $1.8 is included in prepaid
expenses and other current assets on the balance sheet. There were no
cash flow hedges discontinued during the 12-month periods ended June
30, 2002 and 2001.
Other Derivatives - For 2002 and 2001, changes in the spot value of the
foreign currencies and contract settlements associated with option and
forward contracts amounted to a loss of $(4.6) and a gain of $5.9,
respectively. These changes are reported in gain (loss) on foreign
exchange, which is included in other (expense) income, 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
June 30, 2001, of $6.6 is included in prepaid expenses and other
current assets on the balance sheet.
Note 8 Pension Plans and Other Postretirement Benefits
Pension and Other Benefits
Assumptions used to determine pension costs and projected benefit
obligations are as follows:
U.S. Plans
2002 2001 2000
Discount rate 7.25% 7.25% 7.75%
Compensation increase rate 5.00% 5.00% 5.00%
Long-term rate of return on plan assets 9.75% 9.75% 9.50%
International Plans
2002 2001 2000
Discount rate 6-10% 5-16% 5-18%
Compensation increase rate 3-8% 2-14% 2-16%
Long-term rate of return on plan assets 6-11% 5-17% 5-19%
Components of net periodic pension (benefit) cost are as follows:
Pension Benefits
2002 2001 2000
Service cost $ 16.4 $ 15.4 $ 16.9
Interest cost 44.2 45.1 44.9
Expected return on plan assets (84.7) (83.4) (80.9)
Amortization (1.0) (4.6) (4.6)
Recognized actuarial gain (8.4) (14.2) (8.9)
Curtailments, settlements and other items (1.3) -- (0.2)
------- ------- -------
Net periodic pension (benefit) cost $ (34.8) $ (41.7) $ (32.8)
======= ======= =======
We provide medical and dental benefits to U.S. retired employees and
their dependents. Substantially all of our U.S. employees, excluding
Books Are Fun and Reiman employees, become eligible for these benefits
when they meet minimum age and service requirements. We have the right
to modify or terminate these unfunded benefits. Discount rates of
7.25% for 2002, 7.25% for 2001 and 7.75% for 2000 were used in
determining the accumulated postretirement benefits liability.
Components of postretirement benefit cost are as follows:
Other Benefits
2002 2001 2000
Service cost $ 0.9 $ 0.9 $ 0.9
Interest cost 4.1 4.1 4.1
Amortization (0.5) (0.6) (0.6)
Recognized actuarial gain (3.4) (4.0) (3.7)
Curtailments, settlements and other items (0.8) -- --
----- ----- -----
Postretirement benefit cost $ 0.3 $ 0.4 $ 0.7
===== ===== =====
A reconciliation of beginning and ending balances of benefit
obligations and fair value of plan assets, and the funded status of the
plans are as follows:
Pension Benefits Other Benefits
2002 2001 2002 2001
Change in benefit obligation:
Benefit obligation at beginning of year $ 672.0 $ 656.1 $ 59.5 $ 58.2
Service cost 16.4 15.4 0.9 0.8
Interest cost 44.2 45.1 4.1 4.1
Actuarial loss 19.8 17.2 13.0 1.6
Plan amendments 0.3 -- -- --
Exchange rate changes 13.8 (12.2) -- --
Settlements/curtailments (1.5) -- (0.4) --
Benefits paid (57.3) (50.8) (5.0) (5.2)
Other items 1.4 1.2 -- --
Benefit obligation at end of year 709.1 672.0 $ 72.1 59.5
Change in plan assets:
Fair value at beginning of year 846.4 985.3 -- --
Actual return on plan assets 31.6 (78.9) -- --
Employer contribution 12.0 11.0 (0.7) (0.4)
IRC section 401(h) transfer (5.7) (5.6) 5.7 5.6
Exchange rate changes 12.4 (13.5) -- --
Benefits paid (57.3) (50.8) (5.0) (5.2)
Other items (2.5) (1.1) -- --
Fair value at end of year 836.9 846.4 -- --
Funded status 127.8 174.3 (72.1) (59.5)
Unrecognized actuarial loss (gain) 46.1 (41.6) (30.0) (46.6)
Unrecognized transition (asset)obligation (2.2) (2.9) 0.6 0.7
Unrecognized prior service obligation benefit (4.3) (4.6) (3.1) (4.2)
Employer - fourth quarter contribution 1.2 1.3 -- --
-------- -------- -------- --------
Net amount recognized $ 168.6 $ 126.5 $ (104.6) $ (109.6)
======== ======== ======== ========
During 2002 and 2001, in accordance with Internal Revenue Code section
401(h), we transferred $5.7 and $5.6, respectively, of excess pension
assets to fund postretirement benefits.
Amounts recognized on the balance sheet are as follows:
Pension Benefits Other Benefits
2002 2001 2002 2001
Other noncurrent assets $ 255.6 $ 212.0 $ -- $ --
Noncurrent liabilities (112.4) (89.1) (104.6) (109.6)
Accumulated other comprehensive income 25.4 3.6 -- --
-------- -------- -------- --------
Net amount recognized $ 168.6 $ 126.5 $ (104.6) $ (109.6)
======== ======== ======== ========
Balances of plans with projected and accumulated benefit obligations in
excess of the fair value of plan assets are as follows:
Plans with Plans with
Projected Benefit Accumulated Benefit
Obligations in Excess Obligations in Excess
of Plan Assets of Plan Assets
2002 2001 2002 2001
Projected benefit obligation $ 265.4 $ 221.0 N/A N/A
Accumulated benefit obligation N/A N/A $ 228.5 $ 82.2
Fair value of plan assets $ 142.7 $ 124.9 $ 126.0 $ --
Health Care Inflation and Cost Trend Rates
The health care inflation assumption used to determine the
postretirement benefits liability was 6.5% for 2002 and 7.0% for 2001.
The assumption decreases gradually to 5.5% by fiscal 2004 and remains
at that level thereafter.
Assumed health care cost trend rates have a significant effect on the
amounts reported for postretirement benefits. A one-percentage-point
increase in assumed health care cost trend rates would increase the
total of the service and interest cost components by $0.4 and the
postretirement benefit obligation by $6.6. A one-percentage-point
decrease in assumed health care cost trend rates would decrease the
total of the service and interest cost components by $(0.4) and the
postretirement benefit obligation by $(5.7).
Note 9 Employee Compensation Plans
We maintain several employee compensation plans relating to stock or
stock-based awards, including stock options, restricted stock, stock
appreciation rights, phantom stock and phantom stock options.
We have adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," and, as permitted by that statement,
have continued to measure compensation cost using the intrinsic value
method under APB No. 25. Intrinsic value represents the excess of the
quoted market price of our stock at the grant date over the amount the
employee must pay for the stock. Since we grant stock options at fair
market value at the date of grant, no compensation expense is
recognized. Compensation expense is recognized with respect to
restricted stock, stock appreciation rights, phantom stock and phantom
stock options.
SFAS No. 123 requires disclosure of pro forma net income and earnings
per share as if the fair-value-based method had been applied in
measuring compensation cost for stock-based awards granted after 1995.
As required by SFAS No. 123, we have disclosed below the pro forma
impact of using the fair value method to calculate compensation expense
of stock options and stock purchase rights granted.
2002 2001 2000
Net income As reported $ 91.2 $ 132.1 $ 144.7
Pro forma $ 77.0 $ 118.1 $ 133.8
Earnings per share As reported - basic $0.90 $1.27 $1.35
Pro forma - basic $0.76 $1.14 $1.25
As reported - diluted $0.89 $1.26 $1.34
Pro forma - diluted $0.75 $1.13 $1.24
The weighted average fair values of options granted in 2002, 2001 and
2000 were $7.30, $14.90 and $11.30, respectively.
The fair values of the options granted were estimated on the date of
their grant using the Black-Scholes option-pricing model on the basis
of the following weighted average assumptions:
2002 2001 2000
Risk-free interest rate 4.3% 6.0% 6.0%
Expected life 4.1 years 4.2 years 4.1 years
Expected volatility 39.5% 38.6% 35.3%
Expected dividend yield 1.2% 0.9% 0.5%
The following table summarizes information about stock options
outstanding at June 30, 2002:
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Options Contractual Exercise Options Exercise
Prices (000's) Life (yrs.) Price (000's) Price
$16.55 - $18.97 1,388 6.42 $18.91 979 $18.97
$20.59 - $29.53 4,408 7.60 $22.86 1,993 $24.19
$30.00 - $39.75 1,710 7.20 $32.29 912 $32.09
$40.13 - $48.00 4,190 5.21 $42.78 2,737 $43.32
$50.94 - $53.56 34 3.02 $51.25 34 $51.25
------ ---- ------ ----- ------
11,730 6.53 $30.97 6,655 $32.51
====== ==== ====== ===== ======
Changes in outstanding options are as follows:
Weighted
Average
Options Exercise
(000's) Price
Outstanding at June 30, 1999 9,785 $32.61
Granted 2,055 $31.67
Exercised (410) $22.10
Canceled (1,443) $39.03
------ ------
Outstanding at June 30, 2000 9,987 $31.99
Granted 2,526 $40.72
Exercised (549) $22.77
Canceled (905) $38.86
------ ------
Outstanding at June 30, 2001 11,059 $33.95
Granted 2,577 $21.52
Exercised (230) $19.87
Canceled (1,676) $36.68
------ ------
Outstanding at June 30, 2002 11,730 $30.97
====== ======
Options exercisable at June 30, 2002 6,655 $32.51
====== ======
Options available for grant at June 30, 2002 4,512 N/A
====== ======
1989 and 1994 Key Employee Long Term Incentive Plans (the Plans)
The Plans provide that the Compensation and Nominating Committee of the
Board of Directors (the committee) may grant stock options, stock
appreciation rights, restricted stock, performance units, performance
shares and other stock-based awards to eligible employees. The
committee may grant awards up to a maximum of 17,300,000 underlying
shares of Class A nonvoting common stock (Class A) under the Plans.
Effective in November 1999, no further awards may be granted under the
1989 plan.
Under the Plans, stock options have been granted with exercise prices
not less than the fair market value of our Class A stock at the time of
the grant, with an exercise term (as determined by the committee) not
to exceed 10 years. The committee determines the vesting period for
our stock options. Generally, such stock options become exercisable
over four years.
Restricted Stock - Restricted stock is granted with no exercise price
required by the employee. Accordingly, the market value of restricted
stock awards at the date of grant is recorded as a reduction of capital
stock on the balance sheet and is amortized ratably over the term of
the restriction period, four years. Amortization expense of restricted
stock amounted to $(2.4), $(0.7) and $(4.1) for 2002, 2001 and 2000,
respectively. During 2002, we had granted 297,622 restricted stock
awards to employees (8,640 restricted stock awards were granted during
2001).
Performance Shares - The committee awards phantom performance shares
that give the recipients the right to receive cash equal to the value
of shares of Class A stock that is earned if specific performance goals
are achieved during a specific performance period. Compensation cost
related to performance shares is based on management's best estimate as
to whether or not the performance criteria will be satisfied and the
market price of our shares on the date of the financial statements.
This amount is recognized ratably over the vesting period. Adjustments
based on changes in our estimate of whether or not the performance
criteria will be satisfied and changes in the market value of our
shares are recorded in the period in which the change occurs. The
awards relate to the 1999-2000, 1999-2001, 2000-2002 and 2001-2003
fiscal-year performance periods. We have recorded $(1.4), $(1.4) and
$(9.6) as expense during 2002, 2001 and 2000, respectively, for these
awards. We anticipate distributing $1.1 to award recipients in August
2002 relating to the 2000-2002 performance period. During 2001, we
distributed $7.8 to award recipients relating to the 1999-2001
performance period. During 2000, we distributed $10.5 to award
recipients relating to the 1999-2000 performance period.
1989 Employee Stock Purchase Plan (the ESPP)
Under the ESPP, we are authorized to issue up to 2,650,000 Class A
shares (330,000 Class A shares per annum), principally to our full-time
employees in the United States, nearly all of whom are eligible to
participate. Under the terms of the ESPP, employees can choose every
six months to have up to 10% of their annual base earnings withheld to
purchase Class A shares. The purchase price of the shares is 85% of the
lower of the fair market values of the Class A stock on the first and
last days of the six-month purchase period. In 2002, 2001 and 2000
approximately 32%, 38% and 30% of eligible employees participated in
the ESPP, respectively.
In addition, several of our international subsidiaries have employee
stock purchase plans (international ESPP) under which we are authorized
to issue up to 400,000 Class A shares to our full-time employees. The
terms of the international ESPP in most locations are essentially the
same as the ESPP.
Under the ESPP and the international ESPP, employees purchased 216,121
shares in 2002, 176,592 shares in 2001 and 191,928 shares in 2000.
The calculation of the fair value of these shares using the
Black-Scholes option-pricing model assumes that options were issued to
employees on the first day of the purchase period. The weighted
average fair values of these assumed options granted in 2002, 2001 and
2000 were $6.50, $9.79 and $9.13, respectively.
These fair values were estimated using the following assumptions:
2002 2001 2000
Risk-free interest rate 2.8% 6.0% 5.4%
Expected life 0.5 years 0.5years 0.5 years
Expected volatility 35.5% 31.8% 40.7%
Expected dividend yield 1.2% 0.9% 0.5%
Other Compensation Plans
Employee Ownership Plan and 401(k) Partnership (the 401(k) plan) - The
401(k) plan consists of both a profit sharing plan and a savings plan
under section 401(k) of the Internal Revenue Code. The savings plan
component allows employees to make pre-tax contributions to specified
investment options. In 2000 our plan allowed for a discretionary
profit sharing contribution and a matching contribution. Effective
July 1, 2000, we ceased contributions to the profit sharing plan
component of the 401(k) plan for most of our employees. The matching
contributions vest 20% per annum over a five-year period. Our
contributions to the 401(k) plan, including matching contributions,
were $5.0, $10.8 and $5.6 for 2002, 2001 and 2000, respectively.
Note 10 Income Taxes
Income before provision for income taxes is as follows:
2002 2001 2000
United States $ 47.9 $ 70.4 $ 98.9
International 92.7 117.4 135.8
------- ------- -------
Income before income taxes $ 140.6 $ 187.8 $ 234.7
======= ======= =======
Components of the provision (benefit) for income taxes are as follows:
2002 2001 2000
Current
Federal $ (16.9) $ (4.4) $ 2.9
State and local (2.4) 3.9 4.5
International 35.1 51.3 50.2
------- ------ ------
Total current 15.8 50.8 57.6
------- ------ ------
Deferred
Federal 25.5 4.7 33.3
State and local 9.6 1.1 3.8
International (1.5) (0.9) (4.7)
------- ------ ------
Total deferred 33.6 4.9 32.4
------- ------ ------
Provision for income taxes $ 49.4 $ 55.7 $ 90.0
======= ====== ======
A reconciliation between the statutory U.S. federal income tax rate and
the effective income tax rate is as follows:
2002 2001 2000
U.S. statutory tax rate 35.0% 35.0% 35.0%
International operations (2.5) (1.8) (1.9)
State taxes, net 3.3 1.7 2.3
Tax benefit from disposition of assets -- (3.9) (3.8)
Nondeductible goodwill -- 3.2 1.9
Changes in valuation allowance -- (3.5) 4.3
Other operating items, net 0.3 (0.1) (0.4)
Other, net (1.0) (0.9) 0.9
---- ---- ----
Effective tax rate 35.1% 29.7% 38.3%
==== ==== ====
Components of deferred tax assets and liabilities are as follows:
2002 2001
Deferred compensation and other employee benefits $ 13.2 $ 24.1
Accounts receivable and other allowances 56.2 49.5
Net operating loss carryforwards 12.2 8.8
Other operating items, net 17.4 25.3
Foreign tax credit 43.8 18.2
Other, net 26.9 30.0
------ -------
Gross deferred tax assets 169.7 155.9
Valuation allowance (11.0) (9.7)
------ -------
Total net assets 158.7 146.2
------ -------
Deferred compensation and other employee benefits 6.7 7.2
Unrealized gain on investments 2.0 3.0
Deferred promotion 41.2 --
Other, net 11.6 10.6
------ -------
Total net liabilities 61.5 20.8
------ -------
Net deferred taxes $ 97.2 $ 125.4
====== =======
Balance sheet classifications of deferred tax assets and liabilities
are as follows:
2002 2001
Prepaid expenses and other current assets $ 29.5 $ 76.9
Other noncurrent assets 79.3 66.4
Other current liabilities (3.1) (8.0)
Other noncurrent liabilities (8.5) (9.9)
------ -------
Net deferred taxes $ 97.2 $ 125.4
====== =======
We have concluded that it is more likely than not that the results of
future operations will generate sufficient taxable income to realize
the net deferred tax assets.
Net operating loss carryforwards of $47.4 at June 30, 2002, the
majority of which may be carried forward indefinitely, are available to
reduce future tax obligations of certain foreign subsidiaries in a
number of jurisdictions. In addition, foreign tax credits amounting to
$43.8 are available as of June 30, 2002. These credit carryforwards
have various expiration dates through 2007.
Approximately $9.0 of deferred tax expense is included as a component
of stockholders' equity.
Deferred federal income taxes have not been provided on undistributed
earnings of foreign subsidiaries because we do not anticipate those
undistributed earnings will be remitted in the foreseeable future.
Determination of the deferred tax liability related to our investments
in foreign subsidiaries is not practicable.
Note 11 Debt
Credit Agreements
Prior to July 27, 2001, we were a party to a Competitive Advance and
Revolving Credit Facility Agreement, as amended (the 1996 Credit
Agreement), which provided for bank borrowings of up to $300.0. On
July 27, 2001, we entered into a Five-Year Revolving Credit and
Competitive Advance Facility Agreement and a 364-Day Revolving Credit
and Competitive Advance Facility Agreement (the 2001 Credit
Agreements), each of which allowed for up to $192.5 in aggregate
principal amount of bank borrowings.
Interest under the 2001 Credit Agreements was based on several pricing
options that varied based upon our credit rating. Borrowings from
these facilities were allowed to be used for general corporate
purposes, including acquisitions, share repurchases and commercial
paper backup. Non-financial covenants included restrictions on our
ability to incur additional debt for money borrowed, create liens and
guarantee indebtedness. The financial covenants included minimum
interest coverage and maximum leverage ratios.
On May 20, 2002, we entered into a $950.0 Term Loan Agreement with a
syndicate of banks and other financial institutions and we amended and
restated the Five-Year Revolving Credit and Competitive Advance
Facility Agreement to conform it to the Term Loan Agreement (the 2002
Credit Agreements); we also terminated the 364-Day Revolving Credit and
Competitive Advance Facility Agreement. Borrowings under the Five-Year
Revolving Credit and Competitive Advance Facility Agreement may be used
for general corporate purposes, including acquisitions, share
repurchases and commercial paper backup. Borrowings under the 2002
Credit Agreements bear interest at either LIBOR plus a spread based
upon our credit rating at the time the rate is established, or the
Alternate Base Rate, as defined in the Term Loan Agreement. The
interest rate is required to be reset from time to time for periods of
up to six months. Borrowings under the 2002 Credit Agreements are
secured by substantially all of our assets and are subject to various
covenants. Non-financial covenants include limitations on: additional
debt for money borrowed and related guarantees; acquisitions; mergers
and asset transfers; share repurchases; liens; and dividend payments.
Financial covenants include minimum interest and fixed charge coverage,
maximum leverage ratios and limitations on annual capital
expenditures. As of June 30, 2002, we were in compliance with these
covenants. In addition, subsequent to June 30, 2002, we are required
to enter into one or more interest rate protection agreements to fix or
limit the interest cost with respect to at least one third of the
outstanding borrowings under the Term Loan Agreement for a period of
not less than three years.
The Term Loan Agreement requires quarterly principal repayments,
beginning with the first quarter of fiscal 2003, with the final payment
due in fiscal 2008. Total payments required during that period are as
follows:
2003 $ 132.0
2004 32.0
2005 57.0
2006 82.0
2007 82.0
2008 565.0
-------
Total $ 950.0
=======
On May 20, 2002, we borrowed $950.0 under the Term Loan Agreement to
finance the Reiman acquisition purchase price and pay related financing
and transaction costs, to finance our proposed recapitalization (See
Note 15, Subsequent Events) and to refinance obligations under the 2001
Credit Agreements. In the event the recapitalization transactions are
completed by December 31, 2002, the $100.0 of principal borrowed under
the Term Loan Agreement would be used to finance these transactions.
As a result, $100.0 included in loans and notes payable on the balance
sheet would be reclassified to long-term debt.
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 June 30, 2002, no securities
had been issued under the registration statement.
At June 30, 2002, we had borrowings of $950.7 outstanding, of which
$132.7 is classified as short-term debt and included in loans and notes
payable on our balance sheet. The average interest rate on borrowings
was 3.8% for 2002. At June 30, 2001, we had short-term borrowings of
$160.3 outstanding. The weighted average interest rate in 2001 for
these borrowings was 6.4%. The carrying amount of the borrowings
approximated fair value at June 30, 2002 and 2001.
Lines of Credit
International lines of credit totaled $11.7 at June 30, 2002, and $34.3
at June 30, 2001, of which no amounts were outstanding at these
respective dates. These lines of credit expire at various dates
throughout 2003.
Note 12 Capital Stock
Capital stock and treasury stock consist of the following:
2002 2001
First preferred stock,
par value $1.00 per share;
authorized 40,000 shares;
issued and outstanding 29,720 shares $ 3.0 $ 3.0
Second preferred stock,
par value $1.00 per share;
authorized 120,000 shares;
issued and outstanding 103,720 shares 10.3 10.3
Third subordinated preferred stock,
par value $1.00 per share;
authorized 230,000 shares;
issued and outstanding 155,022 shares 15.5 15.5
Preference stock,
par value $0.01 per share;
authorized 25,000,000 shares;
issued and outstanding none -- --
-------- --------
Total preferred stock 28.8 28.8
-------- --------
Class A nonvoting common stock,
par value $0.01 per share;
authorized 200,000,000 shares;
issued 119,428,472 shares 1.2 1.2
Class B voting common stock,
par value $0.01 per share;
authorized 25,000,000 shares;
issued 21,716,057 shares 0.2 0.2
-------- --------
Total common stock 1.4 1.4
Unamortized restricted stock (4.7) (0.6)
-------- --------
Total capital stock $ 25.5 $ 29.6
======== ========
Common stock in treasury, at cost
Class A shares: 32,337,230 in 2002 and
29,211,011 in 2001 $ (709.8) $ (662.7)
Class B shares: 9,283,893 in 2002 and 2001 (239.9) (239.9)
-------- --------
Total common stock in treasury, at cost $ (949.7) $ (902.6)
======== ========
All shares of preferred stock have a preference in liquidation of
$100.00 per share. The difference between the aggregate par value and
liquidation preference has been appropriated from retained earnings and
is shown as part of the value of preferred stock. At our option and at
any time, all preferred stock is redeemable at $105.00 per share plus
accrued dividends. The terms of the first preferred stock and the
second preferred stock provide for annual cumulative dividends of $4.00
per share. The terms of the third subordinated preferred stock provide
for annual cumulative dividends of $5.00 per share.
Share Exchange
In September 1999, we executed a share exchange with the DeWitt
Wallace-Reader's Digest Fund and the Lila Wallace-Reader's Digest Fund
(the Funds). Under the terms of the exchange, the Funds exchanged
approximately 9.3 million shares of Class B voting common stock (Class
B) for approximately 8.0 million shares of Class A stock, at an
exchange ratio of 0.865 Class A shares for each Class B share. As a
result, we exchanged Class A treasury shares at a cost of $164.9 and a
market value of $239.9, for Class B shares, resulting in additional
paid-in capital of $75.0.
Share Repurchase Authorization
As of June 30, 2002, under various share repurchase authorizations
(announced during 2000, 2001 and 2002), we have repurchased 8.6 million
shares of our Class A nonvoting common stock for approximately $231.7
(3.6 million shares totaling $64.1 during 2002, 1.0 million shares
totaling $34.1 during 2001 and 4.0 million shares totaling $133.5
during 2000). As of June 30, 2002, we had $186.0 remaining under a
$250.0 share repurchase authorization announced in May 2001. We do not
expect to repurchase additional shares during any period when
repurchases are prohibited under the 2002 Credit Agreements (see Note
11, Debt).
Note 13 Commitments and Contingencies
General Litigation
We are a defendant in lawsuits and claims arising in the regular course
of business. Based on the opinions of management and counsel on such
matters, recoveries, if any, by plaintiffs and claimants (net of
reserves established) would not significantly affect our financial
position or our results of operations.
In March 2001, we announced a voluntary comprehensive agreement with
attorneys general for 32 states and the District of Columbia regarding
standards for direct mail sweepstakes promotions. In March 2002, we
signed a similar agreement with the attorney general of an additional
state. We are promoting consumer education and have adopted standards
for promotions in the United States similar to those agreed to by other
direct marketing and publishing companies. The agreements include
establishment of a consumer fund of approximately $6.4 to be used at
the discretion of the attorneys general for activities including
consumer education efforts. In addition, we will include with all
sweepstakes promotion mailings a fact sheet that explains in detail how
our sweepstakes work and have modified the language and packaging we
use for those mailings. We have paid the total amount due under the
agreements, all of which was accrued in prior periods.
In 1996, Northeast Sort & Fulfillment Corp. (NSF) filed suit against
Reader's Digest and a subsidiary for wrongful termination of NSF's
contract to provide mail processing services to us. In August 2001,
the Supreme Court of the State of New York, County of Westchester,
granted NSF's motion for summary judgment and ordered a trial on the
issue of damages for breach of contract, which is scheduled to begin in
September 2002. We have appealed the Court's decision and intend to
defend vigorously to reduce any damages that may be awarded. As of
June 30, 2002, we believe our reserves for this matter are adequate.
Supply and Service Agreements
We maintain several long-term agreements with vendors primarily for the
purchase of paper, printing and fulfillment services. These agreements
expire at various times through fiscal 2007.
In the normal course of business, we enter into long-term arrangements
with suppliers for raw materials and merchandise and with other parties
whose recordings or works we use in our products. These arrangements
may contain minimum purchase requirements. We enter into these
agreements to facilitate an adequate supply of materials and to enable
us to develop better products for sale to our customers.
Sale and Leaseback
During 1999, we sold and leased back a portion of our operating
facility in the United Kingdom. The gain is being amortized on a
straight-line basis over the term of the lease as a reduction in lease
expense.
Lease Obligations
We occupy certain facilities under lease arrangements and lease certain
equipment.
Rental expense and sublease income are as follows:
2002 2001 2000
Rental expense $ 18.9 $ 17.1 $ 20.6
Sublease income (4.9) (2.6) (1.6)
-------- ------- -------
Net rental expense $ 14.0 $ 14.5 $ 19.0
======== ======= =======
Future minimum rental commitments, net of sublease income, for
noncancelable operating leases for the next five fiscal years and
thereafter are as follows:
Minimum Minimum
Rental Sublease
Payments Income Net
2003 $ 17.0 $ (5.0) $ 12.0
2004 $ 14.1 $ (4.8) $ 9.3
2005 $ 12.6 $ (4.9) $ 7.7
2006 $ 10.7 $ (4.9) $ 5.8
2007 $ 10.2 $ (4.8) $ 5.4
Later years $ 64.2 $ (33.3) $ 30.9
Note 14 Segments
During the fourth quarter of 2002 we modified our reporting segments to
reflect our new internal management organization. We have restated
operating segment results of operations for prior periods to conform to
our new operating segments.
North America Books and Home Entertainment
- Publishes and markets, primarily through direct marketing,
Books and Home Entertainment products (Select Editions; series
and general books; and music, video, Young Families, and
Children's Publishing products) in the United States and
Canada;
- Includes Reader's Digest Magazine Limited (Canada), which
publishes and markets, primarily through direct marketing,
Reader's Digest magazine in Canada;
- Sells Reader's Digest magazine and other publishers' magazines
and products through youth fundraising campaigns of Quality
Service Programs Inc. in Canada;
- Sells books and gift items, including Reader's Digest Books and
Home Entertainment products, by display marketing products
on-site through independent sales representatives, at schools
and businesses through Books Are Fun in the United States;
- Includes the operations of our financial services alliances in
the United States and Canada; and
- Includes the operations of Gifts.com, Inc. (including Good
Catalog Company), which will cease operations in fiscal 2003.
U.S. Magazines
- Publishes and markets, primarily through direct marketing,
Reader's Digest magazine and several special interest magazines
in the United States;
- Publishes and markets, primarily through direct marketing
several magazines and books as well as operating complementary
businesses of Reiman Media Group, Inc., which we acquired on
May 20, 2002; and
- Sells its magazines and other publishers' magazines and
products through youth fundraising campaigns of QSP in the
United States.
International Businesses
- Operates outside of the United States and Canada;
- Publishes and markets, primarily through direct marketing,
Books and Home Entertainment products (described above),
Reader's Digest magazine in numerous editions and languages,
and several special interest magazines; and
- Includes the operations of our financial services alliances and
other new business development initiatives, including the
introduction of display marketing and youth-fundraising
marketing, in some of our international markets.
Reportable segments are based on our method of internal reporting and
each operating segment is a strategic business unit that is managed
separately. Prior period revenue and operating profit (loss)
information has been restated to present our three reportable
segments. Accounting policies of our segments are the same as those
described in Note 1, Organization and Summary of Significant Accounting
Policies. In addition, we allocate all corporate administrative costs
to operating segments on the basis of headcount and, where appropriate,
revenue and estimated usage.
We evaluate performance and allocate resources based on operating
income from continuing operations excluding other operating items.
Identifiable assets by segment are those assets that are used in the
operations of that business. Corporate assets consist primarily of
cash and cash equivalents, certain prepaid expenses, marketable
securities and certain other current assets. Sales are attributed to
countries based on selling location. Long-lived assets are principally
composed of property, plant and equipment, net; intangible assets, net;
and prepaid pension benefits.
Operating Segment Financial Information
Years ended June 30,
2002 2001 2000
Revenues
North America Books and Home Entertainment $ 670.3 $ 756.8 $ 746.9
U.S. Magazines 626.6 652.5 581.6
International Businesses 1,071.7 1,108.9 1,156.0
---------- ---------- ----------
Total revenues $ 2,368.6 $ 2,518.2 $ 2,484.5
========== ========== ==========
Operating profit (loss)
North America Books and Home Entertainment $ 14.3 $ 55.8 $ 51.0
U.S. Magazines 80.7 77.1 89.9
International Businesses 89.4 114.5 116.3
---------- ---------- ----------
Segment operating profit 184.4 247.4 257.2
Other operating items (26.7) (18.4) (3.4)
---------- ---------- ----------
Total operating profit $ 157.7 $ 229.0 $ 253.8
========== ========== ==========
Identifiable assets
North America Books and Home Entertainment $ 447.0 $ 628.2 $ 559.2
U.S. Magazines 1,395.8 190.0 146.4
International Businesses 561.5 480.0 541.6
Corporate 298.4 382.7 488.3
---------- ---------- ----------
Total identifiable assets $ 2,702.7 $ 1,680.9 $ 1,735.5
========== ========== ==========
Years ended June 30,
2002 2001 2000
Depreciation, amortization and asset impairments
North America Books and Home Entertainment $ 6.0 $ 22.8 $ 21.4
U.S. Magazines 9.2 17.6 13.2
International Businesses 10.9 10.8 15.8
Corporate 21.5 12.2 0.8
---------- ---------- ----------
Total depreciation, amortization and asset impairments $ 47.6 $ 63.4 $ 51.2
========== ========== ==========
Capital expenditures
North America Books and Home Entertainment $ 1.8 $ 2.9 $ 9.8
U.S. Magazines 3.6 4.8 9.9
International Businesses 6.5 9.4 10.3
Corporate 12.7 26.4 4.3
---------- ---------- ----------
Total capital expenditures $ 24.6 $ 43.5 $ 34.3
========== ========== ==========
Information about geographic areas is as follows:
Years ended June 30,
2002 2001 2000
Revenues
United States $ 1,176.7 $ 1,280.9 $ 1,229.1
International 1,196.3 1,240.7 1,261.0
Inter-area (4.4) (3.4) (5.6)
-------- -------- --------
Total revenues $ 2,368.6 $ 2,518.2 $ 2,484.5
======== ======== ========
Revenues inter-area
United States $ (2.8) $ (1.8) $ (1.9)
International (1.6) (1.6) (3.7)
-------- -------- --------
Total revenues inter-area $ (4.4) $ (3.4) $ (5.6)
======== ======== ========
Long-lived assets
United States $ 1,646.6 $ 688.4 $ 665.3
International 107.2 102.5 80.5
-------- -------- --------
Total long-lived assets $ 1,753.8 $ 790.9 $ 745.8
======== ======== ========
Note 15 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. providing for a series of actions that would 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 included: (1) our repurchase of
approximately 3.6 million shares of Class B stock from the Funds for
approximately $100.0 in cash; (2) the recapitalization of each
remaining Class B share into 1.24 shares of common stock and the
recapitalization 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, divide our board of directors into
three classes and eliminate the ability of our stockholders to act by
written consent without a meeting (the recapitalization transactions).
As previously announced, the recapitalization transactions are subject
to approval by our Class B shareholders. On a pro forma basis, if the
recapitalization had occurred on June 30, 2002, both our basic and
diluted earnings per share would have been $0.90, due to the change in
the number of shares and that would be outstanding.
After we announced the agreement relating to the recapitalization
transactions, several of our stockholders commenced litigation
alleging, among other things, that the recapitalization transactions
are unfair and seeking, among other forms of relief, a preliminary and
permanent injunction against the recapitalization transactions. On
August 14, 2002, pursuant to the order of the Delaware Supreme Court,
the Delaware Court of Chancery entered a preliminary injunction with
respect to the recapitalization transactions pending a trial on the
merits.
If the recapitalization transactions are completed, we will incur a
non-cash compensation charge to reflect the new measurement date for
our outstanding stock options and unvested restricted stock awards.
Total compensation expense related to this new measurement date is not
determinable at this time. It will be based on the difference between
the market price of our stock on the date the recapitalization
transactions are completed and the option exercise price for those
options where the market price exceeds the option exercise price.
Compensation expense related to vested stock option awards will be
charged against earnings in the period the recapitalization
transactions are completed. Compensation expense related to unvested
stock option awards and unvested restricted stock will be recognized
over the remaining vesting period. See Note 9, Employee Compensation
Plans, for further details on average vesting periods of awards.
In May 2000, QSP entered into a licensing agreement with World's Finest
Chocolate that provides for QSP's commitment to purchase annual minimum
amounts of World's Finest Chocolate products and the exclusive right to
sell those products for fundraising purposes through 2010. In
September 2002, QSP and World's Finest Chocolate entered into an
amendment to the licensing agreement. The amendment extends the term
of the initial agreement by ten years, reduces the annual minimum
purchase requirements, adjusts pricing favorably to QSP and permits QSP
to sell World's Finest Chocolate products through channels other than
fundraising under specified circumstances. In connection with these
changes, QSP will pay $7.5 to World's Finest Chocolate in the first
quarter of fiscal 2003 and $3.0 in the fourth quarter of fiscal 2003.
Independent Auditors' Report
The Stockholders and Board of Directors
The Reader's Digest Association, Inc.
We have audited the accompanying consolidated balance sheets of The
Reader's Digest Association, Inc. and subsidiaries as of June 30, 2002
and 2001, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the years in the
three-year period ended June 30, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The
Reader's Digest Association, Inc. and subsidiaries at June 30, 2002 and
2001, and the results of their operations and their cash flows for each
of the years in the three-year period ended June 30, 2002, in
conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 1, the Company changed its method of accounting
for the cost of certain inventories from the last-in, first-out (LIFO)
method to the first-in, first-out (FIFO) method. Also, as discussed in
Notes 1 and 2, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 141, "Business Combinations," and SFAS No. 142,
"Goodwill and Other Intangible Assets," in the year ended June 30,
2002.
/S/KPMG LLP
New York, New York
July 24, 2002, except for
Note 15 which is as of September 18, 2002
Report of Management
We are responsible for the preparation and integrity of the
consolidated financial statements appearing in our Annual Report. The
consolidated financial statements were prepared in accordance with
generally accepted accounting principles; certain estimates and
judgments were applied as required. Financial information in this
Annual Report is consistent with that in the financial statements.
We are responsible for maintaining a system of internal accounting
controls and procedures to provide reasonable assurance, at an
appropriate cost/benefit relationship, that assets are safeguarded and
that transactions are authorized, recorded and reported properly. The
system of internal safeguards is characterized by a control-oriented
environment that includes written policies and procedures, careful
selection and training of personnel, and audits by a professional staff
of internal auditors.
In accordance with the requirements of the recently signed
Sarbanes-Oxley Act of 2002, we have filed our written certification
with the Securities and Exchange Commission. The certification has
been filed as an exhibit to our Form-10-K for the fiscal year ended
June 30, 2002.
KPMG LLP, independent auditors, have audited and reported on our
consolidated financial statements. Their report is presented herein.
The Audit Committee of the Board, composed of non-management directors,
meets periodically with KPMG LLP, the company's internal auditors and
management representatives to review internal accounting control,
auditing and financial reporting matters. Both KPMG LLP and the
internal auditors have unrestricted access to the Audit Committee and
may meet with the committee with or without management present.
/s/THOMAS O. RYDER
Thomas O. Ryder
Chairman of the Board and
Chief Executive Officer
/S/MICHAEL S. GELTZEILER
Michael S. Geltzeiler
Senior Vice President and
Chief Financial Officer
Selected Financial Data
In millions, except per share data 2002(2) 2001(3) 2000(4) 1999(5) 1998(6)
Income Statement Data
Revenues $ 2,368.6 $ 2,518.2 $ 2,484.5 $ 2,458.5 $ 2,618.5
EBITDA as adjusted(1) $ 220.3 $ 304.2 $ 304.7 $ 210.7 $ 146.3
Operating profit $ 157.7 $ 229.0 $ 253.8 $ 129.1 $ 30.2
Net income $ 91.2 $ 132.1 $ 144.7 $ 151.9 $ 17.9
Basic and diluted earnings per share $ 0.90/$0.89 $1.27/$1.26 $ 1.35/$1.34 $ 1.40/$1.39 $0.16
Dividends per common share $0.20 $0.20 $0.20 $0.38 $0.90
Balance Sheet Data RESTATED RESTATED RESTATED RESTATED
Cash and cash equivalents, short-term investments
and marketable securities $ 114.7 $ 47.3 $ 227.6 $ 437.2 $ 126.1
Total assets $ 2,702.7 $ 1,680.9 $ 1,735.5 $ 1,622.3 $ 1,507.5
Stockholders' equity $ 471.9 $ 459.8 $ 478.8 $ 385.1 $ 262.2
Weighted-average common shares outstanding
(basic and diluted) 100.2/100.6 102.7/103.7 106.0/107.0 107.3/108.0 106.5
Book value per common share $4.71 $4.47 $4.51 $3.59 $2.46
(1) Earnings before interest, taxes, depreciation and
amortization (EBITDA), as adjusted, represents operating profit
excluding other operating items, depreciation and amortization.
(2) Results for 2002 include the net effect of fourth quarter
adjustments and charges (aggregate pre-tax charges of $(26.7)).
(3) Results for 2001 include the net effect of second quarter
adjustments and fourth quarter charges (aggregate pre-tax charges
of $(18.4)).
(4) Results for 2000 include the net effect of third quarter charges
and fourth quarter adjustments (aggregate pre-tax charges of
$(3.4)).
(5) Results for 1999 include the net effect of second and fourth
quarter charges (aggregate pre-tax charges of $(37.9)).
(6) Results for 1998 include the effect of first quarter charges
(aggregate pre-tax charges of $(70.0)).
RESTATED - Total assets, stockholders' equity and book value per
common share were restated in accordance with APB No. 20 to
reflect the change from LIFO to FIFO. See Note 1 of Notes to
Consolidated Financial Statements.
Selected Quarterly Financial Data and Dividend and Market Information (Unaudited)
In millions, except
per share data and Operating Net Income (Loss) Stock Price Range
shareholder Profit Dividends Per Share Per Share High - Low
information Revenues (Loss) Per Share(1) Amount Basic Diluted Class A Class B
2002
First Quarter $ 497.5 $ 2.8 $0.05 $ (1.1) $(0.01) $(0.01) $28.64 - $16.68 $26.40 - $16.40
Second Quarter 784.0 126.6 $0.05 78.8 0.78 0.78 $23.56 - $15.65 $22.65 - $15.70
Third Quarter 541.8 21.7 $0.05 16.4 0.16 0.16 $23.20 - $19.99 $23.80 - $19.80
Fourth Quarter(2) 545.3 6.6 $0.05 (2.9) (0.03) (0.03) $24.15 - $18.73 $29.40 - $22.90
$ 2,368.6 $ 157.7 $0.20 $ 91.2 $0.90 $0.89 $28.64 - $15.65 $29.40 - $15.70
2001
First Quarter $ 551.5 $ 44.3 $0.05 $ 22.3 $0.21 $0.21 $41.88 - $33.13 $38.00 - $29.63
Second Quarter(3) 824.3 164.4 0.05 103.8 1.01 0.99 $40.44 - $32.44 $35.88 - $28.75
Third Quarter 597.9 40.3 0.05 27.9 0.27 0.27 $40.50 - $26.25 $35.25 - $23.25
Fourth Quarter(3) 544.5 (20.0) 0.05 (21.9) (0.22) (0.22) $29.98 - $25.50 $27.10 - $23.00
$ 2,518.2 $ 229.0 $0.20 $ 132.1 $1.27 $1.26 $41.88 - $25.50 $38.00 - $23.00
As of June 30, 2002, our Class A stock and Class B stock were listed
on the New York Stock Exchange under the symbols RDA and RDB,
respectively. At that time there were approximately 1,804 holders
of record of our Class A stock and 173 holders of record of our
Class B stock.
(1) Cash dividends on common stock are declared and paid share and share
alike on Class A stock and Class B stock.
(2) Results for 2002 include the net effect of fourth quarter pre-tax
adjustments of $8.9 and pre-tax charges of $(35.6).
(3) Results for 2001 include the net effect of second quarter
pre-tax adjustments of $8.2 and fourth quarter pre-tax charges
of $(26.6).
The Reader's Digest Association, Inc. and Subsidiaries