FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number: 1-10434
THE READER'S DIGEST ASSOCIATION, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-1726769
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Pleasantville, New York 10570-7000
(Address of principal executive offices) (Zip Code)
(914) 238-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of January 31, 2006, 96,967,741 shares of the registrant's common stock
were outstanding.
Page 1 of 30 pages.
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
Index to Form 10-Q
December 31, 2005
Page No.
Part I - Financial Information:
Item 1. Financial Statements
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Financial Statements (unaudited):
Consolidated Condensed Statements of Operations
for the three-month and six-month periods ended December 31,
2005 and 2004 3
Consolidated Condensed Balance Sheets
as of December 31, 2005 and June 30, 2005 4
Consolidated Condensed Statements of Cash Flows
for the six-month periods ended December 31, 2005 and 2004 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 4. Controls and Procedures 27
Part II - Other Information:
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits 29
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Statements of Operations
Three-month and six-month periods ended December 31, 2005 and 2004
(In millions, except per share data)
(unaudited)
Three-month period ended Six-month period ended
December 31, December 31,
2005 2004 2005 2004
Revenues $ 765.2 $ 798.0 $ 1,281.6 $ 1,288.0
Product, distribution and editorial expenses (301.3) (308.5) (522.4) (511.5)
Promotion, marketing and administrative
expenses (353.1) (401.3) (657.8) (724.3)
Other operating items 0.8 7.2 3.4 7.3
Goodwill charge (187.8) -- (187.8) --
--------- --------- ----------- -----------
Operating (loss) profit (76.2) 95.4 (83.0) 59.5
Other expense, net (10.4) (10.8) (19.6) (21.8)
--------- --------- ----------- -----------
(Loss) income before provision for
income taxes (86.6) 84.6 (102.6) 37.7
Provision for income taxes (35.8) (26.8) (28.0) (10.2)
--------- --------- ----------- -----------
Net (loss) income $ (122.4) $ 57.8 $ (130.6) $ 27.5
========= ========= =========== ===========
Basic (loss) earnings per share:
Weighted average common shares
outstanding 96.6 97.4 97.0 97.4
Basic (loss) earnings per share $ (1.27) $ 0.59 $ (1.35) $ 0.28
========= ========= =========== ===========
Diluted (loss) earnings per share:
Adjusted weighted average common
shares outstanding 96.6 99.9 97.0 99.9
Diluted (loss) earnings per share $ (1.27) $ 0.58 $ (1.35) $ 0.27
========= ========= =========== ===========
Dividends per common share $ 0.10 $ 0.05 $ 0.20 $ 0.10
========= ========= =========== ===========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
As of December 31, 2005 and June 30, 2005
(In millions)
December 31, June 30,
2005 2005
(unaudited)
Assets
Cash and cash equivalents $ 68.8 $ 37.7
Accounts receivable, net 340.4 233.9
Inventories 200.5 162.4
Prepaid and deferred promotion costs 43.2 53.8
Prepaid expenses and other current assets 167.5 144.9
---------- ----------
Total current assets 820.4 632.7
Property, plant and equipment, net 117.5 119.3
Goodwill 693.4 880.9
Other intangible assets, net 130.3 137.8
Prepaid pension assets 316.8 307.9
Other noncurrent assets 94.7 102.0
---------- ----------
Total assets $ 2,173.1 $ 2,180.6
========== ==========
Liabilities and stockholders' equity
Accounts payable 145.9 109.8
Loans and notes payable 0.4 --
Accrued expenses 273.1 267.4
Income taxes payable 25.9 34.5
Unearned revenue 435.4 395.5
Other current liabilities 14.6 12.4
---------- ----------
Total current liabilities 895.3 819.6
Long-term debt 625.0 559.2
Unearned revenue 142.3 133.0
Accrued pension 119.3 121.5
Postretirement and postemployment benefits other than pensions 95.7 96.7
Other noncurrent liabilities 107.9 84.4
---------- ----------
Total liabilities 1,985.5 1,814.4
Capital stock 30.4 21.2
Paid-in capital 200.6 206.8
Retained earnings 1,070.7 1,221.6
Accumulated other comprehensive loss (80.8) (84.1)
Treasury stock, at cost (1,033.3) (999.3)
---------- ----------
Total stockholders' equity 187.6 366.2
---------- ----------
Total liabilities and stockholders' equity $ 2,173.1 $ 2,180.6
========== ==========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows
Six-month periods ended December 31, 2005 and 2004
(In millions)
(unaudited)
Six-month period ended
December 31,
2005 2004
Cash flows from operating activities
Net (loss) income $ (130.6) $ 27.5
Depreciation and amortization 18.7 30.4
Goodwill charge 187.8 --
Amortization of debt issue costs 0.7 2.0
Stock-based compensation 7.1 5.5
Net gain on sales of long-term assets (3.4) (7.2)
Changes in operating assets and liabilities, net of
effects of dispositions
Accounts receivable, net (107.4) (97.6)
Inventories (38.5) (17.8)
Prepaid and deferred promotion costs 10.2 45.5
Other assets (26.6) 3.9
Unearned revenues 49.7 39.6
Deferred taxes 16.8 10.4
Accounts payable and accrued expenses 45.6 44.5
Other, liabilities 0.7 (5.5)
-------- --------
Net change in cash due to operating activities 30.8 81.2
-------- --------
Cash flows from investing activities
Proceeds from other long-term investments and sales of businesses 0.2 4.2
Proceeds from sales of property, plant and equipment 3.7 58.4
Purchases of intangible assets (0.5) --
Capital expenditures (10.8) (7.6)
-------- --------
Net change in cash due to investing activities (7.4) 55.0
-------- --------
Cash flows from financing activities
Proceeds (repayments) from borrowings, net 66.2 (44.6)
Repayments of term loan -- (80.9)
Dividends paid (20.1) (10.4)
Cash paid for financing fees -- (0.5)
Treasury stock repurchases (35.6) --
Proceeds from employee stock purchase plan and exercise of stock
options 1.5 1.4
Other, net (3.8) (1.9)
-------- --------
Net change in cash due to financing activities 8.2 (136.9)
-------- --------
Effect of exchange rate changes on cash (0.5) 6.8
-------- --------
Net change in cash and cash equivalents 31.1 6.1
Cash and cash equivalents at beginning of period 37.7 50.3
-------- --------
Cash and cash equivalents at end of period $ 68.8 $ 56.4
======== ========
See accompanying Notes to Consolidated Condensed Financial Statements.
The Reader's Digest Association, Inc. and Subsidiaries
Notes to Consolidated Condensed Financial Statements
(In millions, except per share data)
(unaudited)
Unless indicated otherwise, references in Notes to Consolidated Condensed
Financial Statements to "we," "us" and "our" are to The Reader's Digest
Association, Inc. and subsidiaries. All references to 2006 and 2005, unless
otherwise indicated, are to fiscal 2006 and fiscal 2005, respectively. Our
fiscal year is the period from July 1 through June 30.
(1) Basis of Presentation and Use of Estimates
The accompanying consolidated condensed financial statements include the
accounts of The Reader's Digest Association, Inc. and its majority-owned
subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation. These statements and accompanying notes
have not been audited but, in the opinion of management, have been prepared
in conformity with U.S. generally accepted accounting principles, applying
certain assumptions and estimates, including all adjustments considered
necessary to present such information fairly. Included in the adjustments
for the three- and six-month periods ended December 31, 2005 is a goodwill
charge related to Books Are Fun. See Note 8 for further information. All
other adjustments are of a normal recurring nature. Although these estimates
are based on management's knowledge of current events and actions that we may
undertake in the future, actual results may ultimately differ from those
estimates. The accompanying consolidated condensed financial statements
should be read in conjunction with the audited consolidated financial
statements included in our 2005 Annual Report to Stockholders.
We report on a fiscal year beginning July 1. The three-month periods ended
December 31, 2005 and 2004 are the second fiscal quarters of 2006 and 2005,
respectively. Operating results for any interim period are not necessarily
indicative of the results for an entire year due to the seasonality of our
business.
In some instances, certain prior period amounts have been reclassified to
conform to the current year presentation.
Recent Accounting Standards
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004),
"Share-Based Payment" (SFAS No. 123R). This statement supersedes SFAS No.
123, "Accounting for Stock-Based Compensation" and SFAS No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB
Statement No. 123," and Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees." The statement is effective for
interim or annual periods beginning after June 15, 2005. Accordingly,
effective July 1, 2005, we adopted the fair-value recognition provisions of
SFAS No. 123R. See Note 3, Stock-Based Compensation, for further information
on the adoption of SFAS No. 123R.
(2) Basic and Diluted (Loss) Earnings Per Share
Basic (loss) earnings per share is computed by dividing net (loss) income
less preferred stock dividend requirements by the weighted average number of
common shares outstanding during the period. The preferred stock dividend
requirements were $0.3 for the three-month periods ended December 31, 2005
and 2004, and $0.7 for the six-month periods ended December 31, 2005 and
2004.
Diluted (loss) earnings per share is computed in the same manner except that
the weighted average number of common shares outstanding assumes the exercise
and conversion of certain stock options and vesting of certain restricted
stock. For the three- and six-month periods ended December 31, 2005, 15.0
million stock options and restricted stock outstanding were excluded from the
diluted loss per share calculations since the effect of including these
options and restricted stock would have been anti-dilutive. Accordingly, our
diluted loss per share for the three- and six-month periods ended December
31, 2005 is calculated using the basic weighted average number of common
shares outstanding.
For the three- and six-month periods ended December 31, 2004, the assumed
exercise and conversion of stock options and vesting of restricted stock was
2.5 million shares. In addition, stock options to purchase approximately
12.2 million shares of Common Stock that were outstanding during the three-
and six-month periods ended December 31, 2004, respectively, were not
included in the computation of diluted earnings per share since the effect of
including these options would have been anti-dilutive.
(3) Stock-Based Compensation
As of July 1, 2005, we maintain certain stock-based compensation plans that
are described in Note 9 to the Consolidated Financial Statements included in
our 2005 Annual Report to Stockholders. In addition to these plans, the
Compensation and Nominating Committee of the Board of Directors (the
Committee) approved the 2005 Key Employee Long-Term Incentive Plan (the 2005
Plan) in August 2005. Under the 2005 Plan, the Committee may grant stock
options, stock appreciation rights, restricted stock, restricted stock units,
deferred stock, performance units, performance shares and other stock-based
awards to eligible employees. The Committee may grant up to a maximum of
2,900,000 underlying shares of Common Stock under the 2005 Plan. In addition,
661,440 underlying shares available for grant under the 2002 Key Employee
Long-Term Incentive Plan became available for issuance under the 2005 Plan.
Prior to July 1, 2005, we accounted for these plans under SFAS No. 123. As
permitted under this standard, compensation cost was recognized using the
intrinsic value method described in APB No. 25. Effective July 1, 2005, we
adopted the fair-value recognition provisions of SFAS No. 123R and Securities
and Exchange Commission Staff Accounting Bulletin No. 107 using the modified
prospective transition method; therefore, prior periods have not been
restated. Compensation cost recognized in the three- and six-month periods
ended December 31, 2005 includes compensation cost for all share-based payments
granted prior to, but not yet vested as of July 1, 2005, based on the grant
date fair value estimated in accordance with the original provisions of SFAS
No. 123, and compensation cost for all share-based payments granted
subsequent to July 1, 2005, based on the grant date fair value estimated in
accordance with the provisions of SFAS No. 123R.
Stock Options
Stock options are granted with exercise prices not less than the fair market
value of our Common Stock at the time of the grant, and 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. Option awards usually provide
for accelerated vesting upon retirement, death or disability. During the
three-month periods ended December 31, 2005 and 2004, we granted an
insignificant number of options. During the six-month periods ended December
31, 2005 and 2004 we granted 1.2 million and 1.9 million options,
respectively.
No stock-based compensation cost related to stock options was recognized in
the statements of operations for the years ended June 30, 2005 and 2004, as
all options granted in these periods had an exercise price equal to the
market price at the date of grant. As a result of adopting SFAS No. 123R,
our loss before taxes and net loss for the three-month period ended December
31, 2005 are $1.7 and $1.1 higher, respectively, than if we had continued to
account for stock-based compensation under APB No. 25. For the six-month
period ended December 31, 2005, our loss before taxes and net loss are $3.3
and $2.1 higher, respectively. This resulted in an increase in our reported
basic and diluted loss per share of $0.01 and $0.02 for the three- and
six-month periods ended December 31, 2005, respectively. Compensation
expense is recognized in the promotion, marketing and administrative expenses
line item of our statements of operations on a ratable basis over the vesting
periods. There were no capitalized stock-based compensation costs at
December 31, 2005 and 2004. As of December 31, 2005, there was $9.3 of total
unrecognized compensation cost related to nonvested stock options to be
recognized over a weighted-average period of 1.2 years.
The intrinsic values of options exercised during the six-month periods ended
December 31, 2005 and 2004 were not significant. The total cash received
from the exercise of stock options was $0.5 and $0.2 for the six-month
periods ended December 31, 2005 and 2004, respectively, and is classified as
financing cash flows. Shares are issued from treasury stock upon exercise of
the options. Prior to the adoption of SFAS No. 123R, we presented all tax
benefits of deductions resulting from the exercise of stock options as
operating cash flows in the statements of cash flows. SFAS No. 123R requires
that cash flows from tax benefits attributable to tax deductions in excess of
the compensation cost recognized for those options (excess tax benefits) be
classified as financing cash flows. We did not have any significant excess
tax benefits for the six-month period ended December 31, 2005.
The fair values of the options granted during the six-month periods ended
December 30, 2005 and 2004 were estimated on the dates of their grants using
the Black-Scholes option-pricing model on the basis of the following weighted
average assumptions:
December 31, December 31,
2005 2004
Risk-free interest rate 4.2% 3.4%
Expected life 6.25 years 4.1 years
Expected volatility 31.8% 32.9%
Expected dividend yield 2.6% 1.2%
Weighted-average fair value of
options granted $4.39 $4.43
The risk-free interest rate for the periods within the expected life of the
option is based on the U.S. Treasury yield curve in effect at the time of
grant. In fiscal 2005, the expected life was based on historical exercises
and terminations. Due to the insignificant number of stock option exercises
during the past three fiscal years, in 2006 we have estimated the expected
life of options granted to be the midpoint between the average vesting term
and the contractual term. The expected volatility for the periods with the
expected life of the option is determined using historical volatilities based
on historical closing stock prices. The expected dividend yield is based on
our annual dividend in relation to our historical average stock price. The
increase in the dividend yield is attributed to the increased quarterly
dividend beginning February 15, 2005.
Changes in outstanding options are as follows:
Weighted
Weighted Average
Average Remaining Aggregate
Options Exercise Contractual Intrinsic
(000's) Price Term (yrs.) Value
Outstanding at June 30, 2005 12,757 $ 23.76
Granted 1,186 $ 15.13
Exercised (37) $ 14.47
Canceled (590) $ 29.81
Options outstanding at December 31, 2005 13,316 $ 22.75 5.4 $ 2.7
Options vested or expected to vest at
December 31, 2005 12,763 $ 23.08 5.3 $ 2.4
Options exercisable at December 31, 2005 9,768 $ 25.52 4.3 $ 1.3
Options available for grant at December 31, 2005 3,590
The table below presents the pro forma effect on net income and basic and
diluted earnings per share if we had applied the fair value recognition
provision to options granted under our stock option plans for the three- and
six-month periods ended December 31, 2004. For purposes of this pro forma
disclosure, the value of the options is estimated using the Black-Scholes
option-pricing model and amortized to expense over the options' vesting
periods.
Three-month Six-month
period ended period ended
December 31, December 31,
2004 2004
Net income, as reported $ 57.8 $ 27.5
======= =======
Less: stock-based compensation expense determined
using the fair-value based method, net of tax 1.6 3.6
------- -------
Net income, pro forma $ 56.2 $ 23.9
======= =======
Basic earnings per share, as reported $0.59 $0.28
======= =======
Basic earnings per share, pro forma $0.57 $0.24
======= =======
Diluted earnings per share, as reported $0.58 $0.27
======= =======
Diluted earnings per share, pro forma $0.56 $0.23
======= =======
Included in our net income and earnings per share, as reported, was
restricted and deferred stock expense of $1.6 and $3.6, net of tax, for the
three- and six-month periods ended December 31, 2004, respectively.
Restricted Stock and Deferred Stock
Restricted Stock - Restricted stock are shares of Common Stock that are
subject to restrictions on transfer and risk of forfeiture until the
fulfillment of specified conditions. In 2005, the market value of restricted
stock awards on the date of grant was recorded as a reduction of capital
stock. In connection with the adoption of SFAS No. 123R in 2006, we
reclassified the unamortized restricted stock to paid-in capital. Restricted
stock is expensed ratably over the term of the restriction period, ranging
from two to four years. Restricted stock expense for the three-month periods
ended December 31, 2005 and 2004, amounted to $1.5 and $2.0, respectively,
before taxes of $0.6 and $0.6, respectively. Restricted stock expense for
the six-month periods ended December 31, 2005 and 2004, amounted to $3.1 and
$4.8, respectively, before taxes of $1.2 and $1.6, respectively.
Deferred Stock - Deferred stock are rights to receive shares of Common Stock
upon the fulfillment of specified conditions. We offer deferred stock
outside the United States. Deferred stock is similar to restricted stock in
all respects, except that deferred stock is issued to the employee at the
completion of the vesting period. We recognized expense of $0.4, before
taxes of $0.2, during both three-month periods ended December 31, 2005 and
2004, respectively, related to these awards. We recognized expense of $0.7,
before taxes of $0.3, during both six-month periods ended December 31, 2005
and 2004 related to those awards.
A summary of the status of our nonvested shares for both restricted and
deferred stock as of December 31, 2005 and changes during the six months
ended December 31, 2005, is as follows:
Weighted
Average
Shares Grant Date
Nonvested Shares (000's) Fair Value
Nonvested at June 30, 2005 2,416 $15.01
Granted 138 $15.09
Vested(1) (782) $15.62
Forfeitures (56) $14.77
----- ------
Nonvested at December 31, 2005 1,716 $14.75
===== ======
(1) The shares vested during the six months ended December 31, 2005
include 234 shares of our Common Stock surrendered by employees in order
to fulfill their tax withholding obligations.
The fair value of nonvested shares is determined based on the average of the
high and low stock price of our Common Stock on the grant date. The
weighted-average grant date fair values of nonvested shares granted during
the six-month periods ended December 31, 2005 and 2004 were $15.09 and
$15.74, respectively. As of December 31, 2005, there was $8.4 of total
unrecognized compensation cost related to nonvested restricted and deferred
stock arrangements to be recognized over a weighted-average period of 1.6
years.
(4) Revenues and Operating Profit by Reportable Segment
Reportable segments are based on our method of internal reporting. We
present our segment revenues as if the transactions were with third parties.
Revenues and expenses attributable to intercompany transactions are
eliminated (under the intercompany eliminations caption below) to reconcile
our reportable segment amounts to consolidated amounts, as reported in our
statements of operations.
The accounting policies of our segments are the same as those described in
Note 1 to the Consolidated Financial Statements included in our 2005 Annual
Report to Stockholders.
Three-month period ended Six-month period ended
December 31, December 31,
2005 2004 2005 2004
Revenues
Reader's Digest North America $ 247.0 $ 251.8 $ 474.7 $ 478.0
Reader's Digest International 300.8 306.2 535.8 521.0
Consumer Business Services 228.7 250.3 288.5 305.3
Intercompany eliminations (11.3) (10.3) (17.4) (16.3)
-------- -------- ---------- ----------
Total revenues $ 765.2 $ 798.0 $ 1,281.6 $ 1,288.0
======== ======== ========== ==========
Operating (loss) profit
Reader's Digest North America $ 28.1 $ 25.2 $ 44.1 $ 41.1
Reader's Digest International 38.7 41.2 40.1 41.9
Consumer Business Services 54.3 61.2 36.3 42.7
Corporate Unallocated(1) (10.3) (13.3) (19.1) (21.9)
Other operating items(2) 0.8 7.2 3.4 7.3
Magazine deferred promotion
amortization(3) -- (26.1) -- (51.6)
Goodwill charge(4) (187.8) -- (187.8) --
-------- -------- ---------- ----------
Operating (loss) profit $ (76.2) $ 95.4 $ (83.0) $ 59.5
======== ======== ========== ==========
Intercompany eliminations
Reader's Digest North America $ (2.2) $ (1.0) $ (6.4) $ (5.7)
Reader's Digest International (1.7) (1.0) (3.2) (2.0)
Consumer Business Services (7.4) (8.3) (7.8) (8.6)
-------- -------- ---------- ----------
Total intercompany eliminations $ (11.3) $ (10.3) $ (17.4) $ (16.3)
======== ======== ========== ==========
(1)Corporate Unallocated includes expenses for the cost of governance and
centrally managed expenses, as well as the accounting for U.S. pension
plans, postretirement healthcare costs, and stock and
executive compensation programs that are not allocated to the
reportable segments. Governance and centrally managed
expenses include costs for departments such as corporate
finance, general corporate management, investor relations,
legal, public relations and treasury and for related
information technology and facility costs incurred by these
departments.
(2)Other operating items include gains on sales of certain non-strategic
assets and, therefore, are not included in segment results reviewed
by our chief operating decision maker. See Note 6 for further
information. In previous periods, such amounts were included in
other expense, net, and have been reclassified to other operating
items to conform to the current period presentation.
(3)In connection with our change to expensing magazine deferred promotion
costs when the promotion is mailed to prospective customers, our
reportable segment operating profit in 2005 includes such
expenses as incurred. Amortization of previously deferred
promotion costs is not included in segment results reviewed
by our chief operating decision maker. For the three-month
period ended December 31, 2005, magazine deferred promotion
amortization relates: 89% to Reader's Digest North America
and 11% to Reader's Digest International. For the six-month
period ended December 31, 2005, magazine deferred promotion
amortization relates: 87% to Reader's Digest North America
and 13% to Reader's Digest International.
(4)The goodwill charge related to Books Are Fun, part of the Consumer
Business Services reportable segment, is a non-cash item and,
therefore, is not included in segment results reviewed by our
chief operating decision maker. See Note 8, Goodwill and
Other Intangible Assets, Net, for further information.
(5) Comprehensive (Loss) Income
Accumulated other comprehensive (loss) income, as reported in the balance
sheets, primarily represents foreign currency translation adjustments. The
components of comprehensive (loss) income, net of related tax, for the three-
and six-month periods ended December 31, 2005 and 2004 were as follows:
Three-month period ended Six-month period ended
December 31, December 31,
2005 2004 2005 2004
Net (loss) income $ (122.4) $ 57.8 $(130.6) $ 27.5
Change in:
Foreign currency translation adjustments -- 10.6 3.3 15.3
Net unrealized gains on certain derivative
transactions -- 0.1 -- 0.1
-------- ------- ------- ------
Total comprehensive (loss) income $ (122.4) $ 68.5 $(127.3) $ 42.9
======== ======= ======= ======
(6) Other Operating Items and Restructuring Charges
Included in other operating items in the accompanying statements of operations
for the six-month periods ended December 31, 2005 and 2004 are gains from the
sales of certain non-strategic assets totaling $3.4 and $7.3, respectively.
Gains on the sales of certain assets in 2006 included $2.5 from the sale of
our building in Mexico in the first quarter of 2006, and $0.5 from the sale
of certain fine art in the second quarter of 2006. Gains on the sales of
certain assets in the second quarter of 2005 included $1.7 from the sale of our
building in Australia, $3.0 from the sale of Moneywise magazine in the
United Kingdom and Crafting Traditions magazine in the United States, $1.2
from the sales of certain fine art and $1.4 from the sale of other
non-strategic assets.
For the three- and six-month periods ended December 31, 2005 and 2004, we did
not recognize any restructuring charges. The components of restructuring
charges previously recognized and currently included in accrued expenses on the
accompanying balance sheets, are described in further detail below:
- - Severance Costs - These accruals represent the cost to separate
employees from our operations as a result of actions taken to streamline
the organizational structure. This separation is accomplished through a
combination of voluntary and involuntary severance programs. Accordingly,
the positions to be separated were identified when the charge was
recorded.
- - Contract Terminations - These accruals represent costs incurred to
terminate contractual obligations in connection with streamlining
activities.
The table below reflects changes for the six-month period ended December 31,
2005 to accruals recorded in previous periods. The majority of the accruals
remaining relate to severance and guaranteed minimum payments for products
that have been discontinued. Most of the spending to date relates to
severance costs. Of the approximately 880 positions identified to be
separated under the charges recorded in fiscal 2003, 2004 and 2005,
approximately 95% have been separated as of December 31, 2005.
Initial year Balance at Balance at
of charge June 30, 2005 Spending December 31, 2005
Fiscal 2002 & prior $ 1.7 $ 0.1 $ 1.6
Fiscal 2003 1.8 0.6 1.2
Fiscal 2004 3.7 1.6 2.1
Fiscal 2005 2.9 1.4 1.5
-------- ------ ------
Total $ 10.1 $ 3.7 $ 6.4
======== ====== ======
(7) Inventories
December 31, June 30, December 31,
2005 2005 2004
Raw materials $ 13.7 $ 11.5 $ 11.4
Work-in-progress 3.3 5.6 3.2
Finished goods 183.5 145.3 160.6
------ ------ ------
Total inventories $200.5 $162.4 $175.2
====== ====== ======
(8) Goodwill and Other Intangible Assets, Net
Changes in the carrying amount of goodwill by segment for the six-month
period ended December 31, 2005, are as follows:
Consumer
Reader's Digest Business
North America Services Total
Balance as of June 30, 2005 $ 687.5 $ 193.4 $ 880.9
Impact of foreign currency translation on
goodwill balances outside the United States -- 0.3 0.3
Goodwill charge -- (187.8) (187.8)
-------- -------- --------
Balance as of December 31, 2005 $ 687.5 $ 5.9 $ 693.4
======== ======== ========
At least annually (in the third quarter), we review the carrying amount of
goodwill and other intangibles with indefinite lives in our reporting units
for recoverability. Reiman and Books Are Fun are our primary reporting units
in Reader's Digest North America and Consumer Business Services,
respectively. In interim periods, we continually monitor changes in our
businesses for indicators of impairment. Due to a shortfall in Books Are
Fun's operating performance relative to our expectations during our peak
selling season, we were required to review goodwill balances related to this
business in the second quarter. The decline in performance was attributed to
competitive pressure on margin and turnover of independent sales
representatives. Based on our assessment, Books Are Fun recorded a charge of
$187.8 in the second quarter of 2006 to write off its remaining goodwill.
The fair value of Books Are Fun was determined by a third-party appraiser
using a combination of discounted future net cash flows and an assessment of
comparable companies in the marketplace. There were no indicators of
impairment in the remaining reporting units and we will perform the annual
recoverability test for these units during the third quarter.
The following categories of acquired intangible assets are included in other
intangible assets, net, on the balance sheets, as of December 31, 2005 and
June 30, 2005:
December 31, 2005 June 30, 2005
Gross Net Gross Net
Intangible assets with indefinite lives:
Trade names $ 89.7 $ 89.7 $ 89.7 $ 89.7
Intangible assets with finite lives:
Licensing agreements 58.1 29.5 57.3 31.9
Customer lists 138.3 11.1 137.8 16.2
Other trade names and
noncompete agreements 1.9 -- 3.0 --
-------- -------- -------- --------
Total intangible assets $ 288.0 $ 130.3 $ 287.8 $ 137.8
======== ======== ======== ========
Amortization related to intangible assets with finite lives amounted to $4.2
and $8.4 for the three- and six-month periods ended December 31, 2005,
respectively. For the three- and six-month periods ended December 31, 2004
amortization amounted to $9.9 and $19.7, respectively. Our World's Finest
Chocolate licensing agreement (discussed below) is principally amortized over
the initial 10-year contract term, with a portion being amortized over the
remaining 15-year term of our amended agreement. Customer lists are being
amortized principally between three and six years. Estimated annual
amortization expense for intangible assets with finite lives by fiscal year
is as follows: 2006 - $16.2; 2007 - $10.9; 2008 - $6.1; 2009 - $5.8 and 2010
- - $5.8.
Licensing Agreement
In May 2000, QSP, Inc. entered into a long-term licensing agreement with
World's Finest Chocolate, Inc. In September 2002, this agreement was amended
to extend the term of the original agreement by 10 years, reduce the annual
minimum tonnage purchase requirements, favorably adjust pricing and permit
QSP to sell World's Finest Chocolate products through marketing channels
other than fundraising, under specified circumstances. The cost associated
with the agreement was assigned to licensing agreements and is included in
other intangible assets, net on the balance sheets. Amounts paid in
connection with this agreement have been assigned to various amortization
periods through 2020 (the remaining period of the amended agreement). This
asset will be substantially amortized by 2010.
The approximate annual minimum purchase amounts under the amended agreement
by calendar year are: 2005 - $58.8; 2006 - $60.8; 2007 - $62.6; 2008 - $64.5;
2009 - $66.4; and approximately $79.7 per year from 2010 through 2020. These
amounts are estimates based on defined minimum tonnage requirements, as
stipulated in the amended agreement, and nominal price increases.
(9) Debt
As described in Note 11 to the Consolidated Financial Statements included in
our 2005 Annual Report to Stockholders, our borrowings include proceeds under
our $400.0 Five-Year Revolving Credit Agreement (2005 Credit Agreement) and
$300.0 in 6 1/2% senior unsecured notes due in 2011. The interest rate on the
2005 Credit Agreement at December 31, 2005 is at LIBOR plus 125 basis points
and is subject to change based on our leverage ratio (as defined in the 2005
Credit Agreement). The 2005 Credit Agreement contains financial covenants
that require us to maintain minimum interest coverage and maximum leverage
ratios, and it is secured by the stock of a substantial portion of our
subsidiaries.
As of December 31, 2005, we had $325.0 of outstanding borrowings under the
2005 Credit Agreement and $300.0 outstanding under the senior unsecured
notes. Interest expense for the three- and six-month periods ended December
31, 2005 was $11.8 and $22.6, respectively ($12.3 and $23.8 for the three-
and six-month periods ended December 31, 2004, respectively). Interest
income on cash balances was $1.6 and $3.3 for the three- and six-month
periods ended December 31, 2005, respectively ($1.9 and $2.7 for the three-
and six-month periods ended December 31, 2004, respectively). The weighted
average interest rate on our borrowings for the six-month periods ended
December 31, 2005 and 2004 was 5.7% and 4.9%, respectively.
(10) Pension Information
We sponsor various pension plans, including those for certain U.S. employees,
certain international employees and supplemental plans for executives. The
largest plan, which covers substantially all employees in the United States,
is a cash balance plan.
The table below details the components of our net periodic pension (benefit)
cost for the three- and six-month periods ended December 31, 2005 and 2004
for our material plans.
Three-month period ended Six-month period ended
December 31, December 31,
2005 2004 2005 2004
Service cost $ 4.1 $ 4.8 $ 8.2 $ 9.5
Interest cost 11.1 11.2 22.2 22.2
Expected return on plan assets (17.2) (18.1) (34.5) (36.0)
Amortization (0.3) (0.3) (0.6) (0.6)
Recognized actuarial gain 1.7 0.8 3.5 1.6
------ ------ ------ ------
Net periodic pension (benefit) $ (0.6) $ (1.6) $ (1.2) $ (3.3)
====== ====== ====== ======
For the three- and six-month periods ended December 31, 2005, approximately
$1.5 and $3.6, respectively, was contributed to our international pension
plans. Because the Retirement Plan in the United States is over-funded, we
did not make any contributions during the six-month period ended December 31,
2005. The U.S. supplemental retirement plans are not qualified under the
Internal Revenue Code because they are available only to certain executives.
We pay the benefits under these unfunded plans as the obligations are
incurred ($1.4 and $3.4 during the three- and six-month periods ended
December 31, 2005).
We also sponsor certain postretirement benefit plans in the United States and
Canada. The table below details the components of our net periodic
postretirement (benefit) cost for the three- and six-month periods ended
December 31, 2005 and 2004.
Three-month period ended Six-month period ended
December 31, December 31,
2005 2004 2005 2004
Service cost $ 0.2 $ 0.3 $ 0.4 $ 0.6
Interest cost 1.0 1.2 2.1 2.5
Amortization (0.7) (0.5) (1.4) (0.9)
------ ------ ------ ------
Net periodic postretirement cost $ 0.5 $ 1.0 $ 1.1 $ 2.2
====== ====== ====== ======
(11) Share Repurchase Authorization
In April 2005, we announced a $100.0 share repurchase authorization. In the
six-month period ended December 31, 2005, we repurchased approximately 2.3
million shares for $35.8. As of December 31, 2005, we have repurchased
approximately 2.7 million shares for $42.8.
(12) Income Taxes
Although we recognized a loss for the six-month period ended December 31,
2005, we recorded a tax expense because of the non-deductible write-down of
goodwill at Books Are Fun. The $28.0 of tax expense recorded included a net
discrete tax benefit of $2.9, principally from the settlement of a tax audit
in a foreign country.
The Reader's Digest Association, Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations
(Dollars in millions, except per share data)
(unaudited)
Unless indicated otherwise, references in Management's Discussion and
Analysis to "we," "us" and "our" are to The Reader's Digest Association, Inc.
and subsidiaries. All references to 2006 and 2005, unless otherwise
indicated, are to fiscal 2006 and fiscal 2005, respectively. Our fiscal year
is the period from July 1 through June 30.
The following discussion and analysis provides information that we believe is
relevant to an assessment and understanding of our consolidated results of
operations and financial condition and has been written excluding the effect
of foreign currency translation, except as specifically noted otherwise.
This discussion should be read in conjunction with the Consolidated Condensed
Financial Statements and related notes. Certain amounts and percentages do
not recalculate due to rounding. Operating results for any interim period
are not necessarily indicative of the results for an entire year due to the
seasonality of our business.
Three-Month Period Ended December 31, 2005, Compared With Three-Month Period
Ended December 31, 2004
Results of Operations: Company-Wide
Overview
The second quarter of the fiscal year is the peak selling season for most of
our businesses. During the second quarter of 2006, revenues and profits
declined at Consumer Business Services, and to a lesser extent, at Reader's
Digest International. Profits at Reader's Digest North America improved.
Lower overall profits were principally driven by the goodwill charge and
lower results at Books Are Fun, investments in new products and increased
customer acquisition mailings. Just as we are reaping the benefits of
previous investments, we believe current initiatives will drive future
growth. Also, during the quarter we accelerated our share repurchase program.
Revenues
Revenues for the second quarter of 2006 decreased 4% to $765, compared with
$798 for the second quarter of 2005. Excluding the effect of foreign
currency translation, revenues declined 3%. Lower revenues were driven by
Consumer Business Services, and to a much lesser extent, Reader's Digest
North America. Revenues for Reader's Digest International increased.
In Consumer Business Services, revenues for Books Are Fun and QSP were
lower. Competitive pressures resulted in fewer events and lower average
sales per event in certain markets at Books Are Fun, while lower magazine and
food volumes drove the decline in revenues at QSP.
The decrease in revenues for Reader's Digest North America was driven by
lower sales of books and home entertainment products, especially single sales
products in Canada and certain established book annual products. Also,
revenues were adversely affected by the effects of Hurricanes Katrina and
Rita. These decreases were partially offset by circulation growth for newer
titles and improved advertising revenues for Reader's Digest magazine.
Increased mail quantities and response rates to promotional mailings in
certain markets drove the improvement in revenues for Reader's Digest
International. This segment also benefited from growth in new markets,
including Romania and Ukraine. Lower revenues in certain established markets
partially offset this improvement.
Operating (Loss) Profit
The operating loss for the second quarter of 2006 was $(76), compared with a
profit of $95 for the second quarter of 2005. Excluding the effect of
foreign currency translation, the loss would have been $(74). The
comparability of results was affected by two significant items, the
write-down of Books Are Fun goodwill of $(188) in the second quarter of 2006,
and the absence of $(26) of expense related to the amortization of previously
deferred magazine promotion costs in the second quarter of 2005 (this change
is more fully explained in our 2005 Annual Report to Stockholders). In
addition, lower profits at Consumer Business Services and lower gains on
non-strategic asset sales in 2006 were partially offset by lower Corporate
Unallocated expenses and improved results for Reader's Digest North America.
Profits for Reader's Digest International were slightly lower.
Profits at Consumer Business Services were adversely affected by competitive
pressures on margin and higher freight and fuel costs, due in part to the
after-effects of Hurricanes Katrina and Rita. Offsetting a portion of this
decline were lower promotion and overhead costs for QSP.
Profits for Reader's Digest International were slightly lower as investments
in new products and customer acquisition mailings were partially offset by
growth from geographic expansion.
Improved profits for Reader's Digest North America were driven by lower
amortization of intangible assets established when we acquired Reiman,
because the assets reached the end of their useful lives. In addition,
increased advertising for Reader's Digest magazine was offset by investments
in new magazine titles and other products and by the effects of Hurricanes
Katrina and Rita.
Corporate Unallocated expenses in the second quarter of 2006 were $10,
compared with $13 in the second quarter of 2005. The decrease in these costs
was driven by the reversal of $4 from a litigation-related accrual recorded
in previous periods that is no longer necessary and by lower facilities costs
due to the sale and partial leaseback of our Westchester, New York
headquarters facility. These decreases in cost were partially offset by
stock option expense (see Recent Accounting Standards, below, for additional
information) and lower net pension income.
Other Operating Items
Other operating items were lower because 2005 included gains of $7 from the
sale of non-strategic assets, including the sale of certain magazines
and buildings, while 2006 included gains of $1 from the sale of non-strategic
assets.
Goodwill Charge
The third quarter of the fiscal year is our designated annual period to
assess the recoverability of goodwill and our indefinite lived intangible
assets. However, due to a shortfall in Books Are Fun's operating performance
relative to our expectations during our peak selling season, we were required
to review goodwill balances related to this business in the second quarter.
Based on our assessment, Books Are Fun recorded a charge of $(188) in the
second quarter of 2006 to write off its remaining goodwill. The fair value
of Books Are Fun was determined by a third-party appraiser using a
combination of discounted future net cash flows and an assessment of
comparable companies in the marketplace.
Other Expense, Net
Other expense, net decreased to $(10) in the second quarter of 2006,
compared with $(11) in the second quarter of 2005. Other expense, net is
principally composed of interest expense and interest income.
Income Taxes
Because our loss for the second quarter of 2006 was driven by the
non-deductible write-down of goodwill at Books Are Fun, we recorded an income
tax expense of $(36). Tax expense for the second quarter of 2005 of $(27),
included certain discrete tax benefits related to the reversal of tax
reserves resulting from various settlements of U.S. federal and state tax
audits, partially offset by a reduction in the value of certain deferred tax
assets.
Net (Loss) Income and (Loss) Earnings Per Share
As a result of the activities described above, for the second quarter of 2006
we incurred a net loss of $(122) or $(1.27) for both basic and diluted loss
per share, compared with net income of $58, or $0.58 per share for diluted
earnings per share ($0.59 for basic earnings per share) for the second
quarter of 2005. For the second quarter of 2006, the effect of potentially
dilutive shares was not considered in the calculation of loss per share
because such shares would have been anti-dilutive.
Results of Operations: Reportable Segments
Three-month periods ended
December 31,
2005 2004
Revenues
Reader's Digest North America $ 247 $ 252
Reader's Digest International 301 306
Consumer Business Services 228 250
Intercompany eliminations (11) (10)
----- -----
Total revenues $ 765 $ 798
===== =====
Operating (loss) profit
Reader's Digest North America $ 28 $ 25
Reader's Digest International 39 41
Consumer Business Services 54 61
Corporate Unallocated(1) (10) (13)
Other operating tiems(2) 1 7
Magazine deferred promotion amortization(3) -- (26)
Goodwill charge(4) (188) --
----- -----
Operating (loss) profit $ (76) $ 95
===== =====
Intercompany eliminations
Reader's Digest North America $ (2) $ (1)
Reader's Digest International (2) (1)
Consumer Business Services (7) (8)
----- -----
Total intercompany eliminations $ (11) $ (10)
===== =====
(1) Corporate Unallocated includes expenses for the cost of governance and
centrally managed expenses, as well as the accounting for U.S. pension
plans, postretirement healthcare costs, and stock and executive
compensation programs that are not allocated to the reportable
segments. Governance and centrally managed expenses include
costs for departments such as corporate finance, general
corporate management, investor relations, legal, public
relations and treasury and for related information technology
and facility costs incurred by these departments.
(2) Other operating items include gains on sales of certain non-strategic
assets and, therefore, are not included in segment results reviewed
by our chief operating decision maker. See Note 6 in our Notes to
Consolidated Condensed Financial Statements for further information.
In previous periods, such amounts were included in other expense, net,
and have been reclassified to other operating items to conform to the
current period presentation.
(3) In connection with our change to expensing magazine deferred promotion
costs when the promotion is mailed to prospective customers,
our reportable segment operating profit in 2005 includes such
expenses as incurred. Amortization of previously deferred
promotion costs is not included in segment results reviewed by
our chief operating decision maker. Magazine deferred
promotion amortization relates: 89% to Reader's Digest North
America and 11% to Reader's Digest International.
(4) The goodwill charge related to Books Are Fun, part of the Consumer
Business Services reportable segment, is a non-cash item and,
therefore, is not included in segment results reviewed by our
chief operating decision maker. See Note 8, Goodwill and Other
Intangible Assets, Net, in our Notes to Consolidated Condensed
Financial Statements for further information.
Reader's Digest North America
Revenues for Reader's Digest North America for the second quarter of 2006
decreased 2% to $247, compared with $252 for the second quarter of 2005. The
decline in revenues was principally driven by lower sales of books and home
entertainment products and by the adverse effects of Hurricanes Katrina and
Rita on promotional mailings and delivery of products. These declines were
partially offset by the addition of revenues from newer magazines.
Lower revenues were driven by weaker performance of certain established book
annual products at Reiman, and lower response rates to promotional mailings
in Canada. Additionally, revenues for U.S. Books and Home Entertainment
declined because of reduced telemarketing activity in Reader's Digest Young
Families and weaker performance of Entertainment products. These declines
were partially offset by improved performance at Trade Publishing due to a
shift in the timing of customer orders.
Magazine revenues improved because of circulation growth for newer magazines,
including Every Day with Rachael Ray (launched in the second quarter of
2006), Cooking for 2 (launched in the third quarter of 2005) and Our Canada.
In addition, advertising pages for Reader's Digest magazine were higher.
These increases were partially offset by lower circulation revenues for
certain cooking titles at Reiman, and for Reader's Digest magazine, because
of a change in the mix of the renewal pool to newer subscribers and less
reliance on agents. Also, advertising revenues for certain special interest
magazines decreased during the quarter.
Operating profit for this segment for the second quarter of 2006 increased
12% to $28, compared with $25 for the second quarter of 2005. This increase
was principally driven by $6 of lower amortization of intangible assets
established when we acquired Reiman because the assets reached the end of
their useful lives. In addition, improved advertising for Reader's Digest
magazine was offset by the revenue changes described above and investments in
new magazine titles and in new products, including our Taste of Home
Entertaining business.
Reader's Digest International
Revenues for Reader's Digest International for the second quarter of 2006
decreased 2% to $301, compared with $306 for the second quarter of 2005.
Excluding the effect of foreign currency translation, revenues increased 2%.
Improved revenues were driven by increased mail quantities and higher
response rates to promotional mailings for single sales products in
Australia, Russia, Brazil and Germany. The improvement in response rates in
these markets was attributable to stronger products and promotions. Also,
revenues improved in new markets, including Romania and Ukraine, as we
increased the level of operations, and from customer acquisition mailing
activity, to increase the size of our active customer base, in certain
markets.
These increases were partially offset by lower revenues in the United
Kingdom, France and the Nordic region, due to lower response rates.
Operating profit for this segment for the second quarter of 2006 decreased 6%
to $39, compared with $41 for the second quarter of 2005. Excluding the
effect of foreign currency translation, profits were slightly lower.
Improved profits in Brazil, Romania and Ukraine were offset by a marginal
decrease in profits in other markets due to a shift in the mix of products
sold, to lower margin products, and to costs associated with customer
acquisition mailings and introducing new products.
Consumer Business Services
Revenues for Consumer Business Services for the second quarter of 2006
decreased 9% to $228, compared with $250 for the second quarter of 2005.
Lower revenues at Books Are Fun were driven by fewer events and lower average
sales per event in the corporate and school markets. Fewer events in the
corporate market were principally driven by turnover of independent sales
representatives in certain regions, while increased competition for events
and lower unit sales volumes drove the decline in average sales per event.
In order to mitigate the effect of turnover in our independent sales force,
we have implemented various retention programs and we continue to
aggressively recruit new representatives. Additionally, revenues were
adversely affected by a shift in the timing of events between the first and
second quarters of 2006. These decreases were moderately offset by improved
results for certain developing lines of business.
Lower revenues at QSP were principally driven by lower renewal rates of
magazine accounts in the United States. In addition, volumes for World's
Finest Chocolate products were 5% lower, in part because of the after-effects
of Hurricanes Katrina and Rita, and a labor action in a Canadian territory.
Operating profit for this segment for the second quarter of 2006 decreased
11% to $54, compared with $61 for the second quarter of 2005. The decline
was principally driven by the revenue changes described above and by higher
freight and fuel costs partly due to the after-effects of Hurricanes Katrina
and Rita. Also, Books Are Fun continued to experience competitive pressures
on profit margins. These declines were partially offset by improved profits
at QSP due to lower promotion and overhead costs.
Six-Month Period Ended December 31, 2005, Compared With Six-Month Period
Ended December 31, 2004
Results of Operations: Company-Wide
Overview
Because of the significance of revenue and operating profit generated in the
second quarter, the peak selling season for most of our businesses, the
primary drivers of performance for the six-month period are similar to those
for the second quarter. During the first half of 2006, in Consumer Business
Services, Books Are Fun continued to experience the effect of competitive
pressures, while profits at QSP improved. Lower overall profits were
principally driven by the goodwill charge related to Books Are Fun,
investments in new products at Reader's Digest North America and increased
customer acquisition mailings at Reader's Digest International. Also, during
the second quarter we accelerated our share repurchase program.
Revenues
Revenues for the six-month period ended December 31, 2005 were down slightly
when compared with the six-month period ended December 31, 2004. Lower
revenues for Consumer Business Services, and to a lesser extent, Reader's
Digest North America, were partially offset by higher revenues for Reader's
Digest International.
Lower revenues for Consumer Business Services were principally driven by
fewer events and lower average sales per event at Books Are Fun and by lower
magazine and food volumes at QSP. However, at QSP, increased gift revenue
and the acquisition of more new magazine accounts in the first half of 2006,
when compared with the first half of 2005, lessened the decline.
The decline in revenues for Reader's Digest North America was attributable to
weaker sales of established book annual products and lower promotional
activity for certain books and home entertainment products. Also, revenues
were adversely affected by the effects of Hurricanes Katrina and Rita. These
declines were partially offset by circulation growth for newer magazine
titles and improved advertising revenues for Reader's Digest magazine.
Revenues for Reader's Digest International improved because of increased
response rates to promotional mailings in certain markets. Growth in new
markets, including Romania and Ukraine, contributed to the improvement.
Operating (Loss) Profit
Operating loss for the six-month period ended December 31, 2005 was $(83),
compared with a profit of $59 for the six-month period ended December 31,
2004. The comparability of results was affected by two significant items: the
write-down of Books Are Fun goodwill of $(188) in the second quarter of 2006
and the absence of $(52) of expense related to the amortization of previously
deferred magazine promotion costs in the first half of 2005 (amortization of
previously deferred magazine promotion costs is more fully explained in our
2005 Annual Report to Stockholders). Also, lower profits for Consumer
Business Services and Reader's Digest International, and lower gains from
sales of non-strategic assets, were partially offset by lower Corporate
Unallocated expenses and improved profits for Reader's Digest North America.
Lower profits for Consumer Business Services were driven by competitive
pressures on profit margins at Books Are Fun and by higher freight and fuel
costs for this segment. These decreases were partially offset by lower
promotion and overhead costs at QSP because of cost-reduction measures.
The decline in profits for Reader's Digest International was driven by lower
promotional activity in certain markets and by investments in new customer
acquisition and new products.
These decreases were partially offset by increased profits at Reader's Digest
North America driven by lower amortization of intangible assets established
when we acquired Reiman, because the assets reached the end of their useful
lives. These increases were partially offset by investments in new products
and by the effects of Hurricanes Katrina and Rita.
Corporate Unallocated expenses for the six-month period ended December 31,
2005 were $18, compared with $22 for the six-month period ended December 31,
2004. The decrease in these costs was driven by the reversal of $4 from a
litigation-related accrual recorded in previous periods that is no longer
necessary. In addition, fewer grants of restricted shares, and lower
facilities costs due to the sale and partial leaseback of our Westchester,
New York headquarters facility further lowered costs. These cost reductions
were partially offset by stock option expense (see Recent Accounting
Standards, below, for additional information) and lower net pension income.
Other Operating Items
The decrease in other operating items was driven by gains of $7 from the sale
of non-strategic assets in 2005, including the sale of certain magazines and
buildings, compared with gains of $3 on the sale of our building in Mexico
in the first quarter of 2006.
Goodwill Charge
The third quarter of the fiscal year is our designated annual period to
assess the recoverability of goodwill and our indefinite lived intangible
assets. However, due to a shortfall in Books Are Fun's operating performance
relative to our expectations during our peak selling season, we were required
to review goodwill balances related to this business in the second quarter.
Based on our assessment, Books Are Fun recorded a charge of $(188) in the
second quarter of 2006 to write off its remaining goodwill. The fair value
of Books Are Fun was determined by a third-party appraiser using a
combination of discounted future net cash flows and an assessment of
comparable companies in the marketplace.
Other Expense, Net
Other expense, net decreased to $(20) for the six-month period ended
December 31, 2005, compared with $(22) for the six-month period ended
December 31, 2004. Other expense, net is principally composed of interest
expense and interest income. The decrease in expense was driven by lower
interest expense.
Income Taxes
Because our loss for the six-month period ended December 31, 2005 was driven
by the non-deductible write-down of goodwill at Books Are Fun, we recorded an
income tax expense of $(28). This tax expense included discrete tax benefits
recognized in the first half of 2006 due to the settlement of a tax audit in
a foreign country. Income tax expense of $(10) for the six-month period
ended December 31, 2004 included certain discrete tax benefits related to the
reversal of tax reserves resulting from various settlements of U.S. federal
and state tax audits, partially offset by a reduction in the value of certain
deferred tax assets.
Net (Loss) Income and (Loss) Earnings Per Share
For the six-month period ended December 31, 2005, our net loss was $(131), or
$(1.35) for both basic and diluted loss per share. In the prior year period,
net income was $27, or $0.27 per share for diluted earnings per share ($0.28
for basic earnings per share). For the six-month period ended December 31,
2005, the effect of potentially dilutive shares was not considered in the
calculation of diluted loss per share because such shares would have been
anti-dilutive.
Results of Operations: Reportable Segments
Six-month periods ended
December 31,
2005 2004
Revenues
Reader's Digest North America $ 475 $ 478
Reader's Digest International 536 521
Consumer Business Services 288 305
Intercompany eliminations (17) (16)
------- -------
Total revenues $ 1,282 $ 1,288
======= =======
Operating (loss) profit
Reader's Digest North America $ 44 $ 41
Reader's Digest International 40 42
Consumer Business Services 36 43
Corporate Unallocated(1) (18) (22)
Other operating items(2) 3 7
Magazine deferred promotion amortization(3) -- (52)
Goodwill charge(4) (188) --
------- -------
Operating (loss) profit $ (83) $ 59
======= =======
Intercompany eliminations
Reader's Digest North America $ (6) $ (6)
Reader's Digest International (3) (2)
Consumer Business Services (8) (8)
------- -------
Total intercompany eliminations $ (17) $ (16)
======= =======
(1) Corporate Unallocated includes expenses for the cost of governance and
centrally managed expenses, as well as the accounting for U.S. pension
plans, postretirement healthcare costs, and stock and executive
compensation programs that are not allocated to the reportable
segments. Governance and centrally managed expenses include
costs for departments such as corporate finance, general
corporate management, investor relations, legal, public
relations and treasury and for related information technology
and facility costs incurred by these departments.
(2) Other operating items include gains on sales of certain non-strategic
assets, and, therefore, are not included in segment results reviewed
by our chief operating decision maker. See Note 6 in our Notes to
Consolidated Condensed Financial Statements for further information.
In previous periods, such amounts were included in other expense, net,
and have been reclassified to other operating items to conform to
the current period presentation.
(3) In connection with our change to expensing magazine deferred promotion
costs when the promotion is mailed to prospective customers, our
reportable segment operating profit in 2005 includes such
expenses as incurred. Amortization of previously deferred
promotion costs is not included in segment results reviewed by
our chief operating decision maker. Magazine deferred
promotion amortization relates: 87% to Reader's Digest North
America and 13% to Reader's Digest International.
(4) The goodwill charge related to Books Are Fun, part of the Consumer
Business Services reportable segment, is a non-cash item and, therefore,
is not included in segment results reviewed by our chief
operating decision maker. See Note 8, Goodwill and Other
Intangible Assets, Net, in our Notes to Consolidated Condensed
Financial Statements for further information.
Reader's Digest North America
Revenues for Reader's Digest North America for the six-month period ended
December 31, 2005 decreased 1% to $475, compared with $478 for the six-month
period ended December 31, 2004. Lower revenues were principally driven by
lower sales for books and home entertainment products and the absence of a
one-time contract termination payment from a former financial services
alliance partner. Also, the adverse effects of Hurricanes Katrina and Rita
on promotional mailings and delivery of products, contributed to the
decline. These declines were partially offset by circulation growth for
newer magazines.
Lower revenues for books and home entertainment products were driven by
weaker performance of established book annual products and lower promotional
activity for Reader's Digest Young Families and for Entertainment products.
A continued drop in series membership contributed to the decline. This
activity was partially offset by improved revenues for Trade Publishing, due
to strong product performance, and for certain single sales products because
of increased promotional activity.
Magazine revenues improved principally due to circulation growth for newer
magazines, including Every Day with Rachael Ray (launched in the second
quarter of 2006), Cooking for 2 (launched in the third quarter of 2005) and
Backyard Living. In addition, advertising pages for Reader's Digest magazine
increased and the performance of newsstand products at Reiman improved.
These increases were partially offset by lower circulation revenues for
certain cooking titles, and for Reader's Digest magazine due to a change in
the mix of the renewal pool to newer subscribers and less reliance on agents.
Operating profit for this segment for the six-month period ended December 31,
2005 increased 7% to $44, compared with $41 for the six-month period ended
December 31, 2004. Excluding the effect of foreign currency translation,
profits increased 6%. The increase was principally driven by $11 of lower
amortization of intangible assets established when we acquired Reiman because
the assets reached the end of their useful lives. Lower amortization was
partially offset by the revenue changes described above and investments in
new products, including our Taste of Home Entertaining business.
Reader's Digest International
Revenues for Reader's Digest International for the six-month period ended
December 31, 2005 increased 3% to $536, compared with $521 for the six-month
period ended December 31, 2004. Excluding the effect of foreign currency
translation, revenues increased 4%. The most significant increases in
revenue were in Russia, Australia, Brazil and Germany. Revenues in these
markets increased principally due to better response rates to promotional
mailings for single sales products. In addition, revenues in new markets,
including Romania and Ukraine, increased significantly as we continue to
expand those businesses.
These increases were partially offset by lower revenues in the United Kingdom
driven by lower response rates to promotional mailings, due to very strong
products and promotions in 2005 and to the absence of revenues from Moneywise
magazine (which was sold in the second quarter of 2005). Lower response
rates to promotional mailings in the Nordic region contributed to the
decline.
Operating profit for this segment for the six-month period ended December 31,
2005 decreased 4% to $40, compared with $42 for the six-month period ended
December 31, 2004. Excluding the effect of foreign currency translation,
profit decreased 1%. The decline in profits was principally driven by lower
activity in certain markets, investments in new products, and additional
customer acquisition mailings, to increase the size of our active customer
base.
Consumer Business Services
Revenues for Consumer Business Services for the six-month period ended
December 31, 2005 decreased 6% to $288, compared with $305 for the six-month
period ended December 31, 2004.
Revenues at Books Are Fun decreased principally because of fewer events in
the corporate fair and display markets, which was attributable to turnover of
independent sales representatives in certain regions. Also, lower average
sales per event in the corporate and school markets, due to increased
competition for events and lower unit sales volumes, contributed to the
decline. In order to mitigate the effect of turnover on our independent
sales force, we have implemented various retention programs and we continue
to aggressively recruit new representatives. These decreases were moderately
offset by improved results for developing lines of business.
Revenues at QSP declined principally due to lower volumes for magazines and
food products. Volume declines were driven by lower renewal rates of
magazine accounts, while lower food product sales (primarily World's Finest
Chocolate products) were partly attributed to the after-effects of Hurricanes
Katrina and Rita and a labor action in a Canadian territory. The impact of
these decreases was mitigated because the rate of same school decline
improved significantly when compared with the prior year period. Also, gift
revenue increased as a result of improvements made to promotions and the sale
of more expensive products.
Operating profit for this segment for the six-month period ended December 31,
2005 decreased 15% to $36, compared with $43 for the six-month period ended
December 31, 2004. The decrease in profits was driven by the effects of
competitive pressures on margin at Books Are Fun and by increased freight and
fuel costs in both businesses. These declines were partially offset by
improved profits at QSP due to lower promotion and overhead costs.
Liquidity and Capital Resources
Six-month
period ended
December 31, 2005
Cash and cash equivalents at June 30, 2005 $ 38
Net change in cash due to:
Operating activities 31
Investing activities (7)
Financing activities 8
Effect of exchange rate changes on cash and cash equivalents (1)
-----
Net change in cash and cash equivalents 31
Cash and cash equivalents at December 31, 2005 $ 69
=====
Cash and cash equivalents increased to $69 as of December 31, 2005, compared
with $38 as of June 30, 2005. The increase in cash was principally driven by
cash from operations and proceeds from borrowings of $66. During the
quarter, cash was used to fund seasonal working capital requirements, stock
repurchases and dividend payments.
Debt
As described in Note 11 to the Consolidated Financial Statements included in
our 2005 Annual Report to Stockholders, our borrowings include proceeds under
our $400 Five-Year Revolving Credit Agreement (2005 Credit Agreement) and
$300 in 6 1/2% senior unsecured notes. The interest rate on the 2005 Credit
Agreement at December 31, 2005 was LIBOR plus 125 basis points and is subject
to change based on our leverage ratio (as defined in the 2005 Credit
Agreement). The 2005 Credit Agreement contains financial covenants that
require us to maintain minimum interest coverage and maximum leverage ratios,
and it is secured by the stock of a substantial portion of our subsidiaries.
As of December 31, 2005, we had $325 of outstanding borrowings under the 2005
Credit Agreement and $300 outstanding under the senior unsecured notes.
Interest expense for the three- and six-month periods ended December 31, 2005
was $12 and $23, respectively ($12 and $24 for the three- and six-month
periods ended December 31, 2004, respectively). Interest income on cash
balances was $2 and $3 for the three- and six-month periods ended
December 31, 2005, respectively ($2 and $3 for the three- and six-month
periods ended December 31, 2004, respectively). The weighted average
interest rate on our borrowings for the six-month periods ended December 31,
2005 and 2004 was 5.7% and 4.9%, respectively.
Recent Accounting Standards
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004),
"Share-Based Payment" (SFAS No. 123R). This statement supersedes SFAS No.
123, "Accounting for Stock-Based Compensation" and SFAS No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB
Statement No. 123," and Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees." The statement is effective for
interim or annual periods beginning after June 15, 2005.
Prior to July 1, 2005, we accounted for our stock compensation plans under
SFAS No. 123. As permitted under this standard, compensation cost was
recognized using the intrinsic value method described in APB No. 25.
Effective July 1, 2005, we adopted the fair-value recognition provisions of
SFAS No. 123R and Securities and Exchange Commission Staff Accounting
Bulletin No. 107 using the modified prospective transition method; therefore,
prior periods have not been restated. Compensation cost recognized in the
three- and six-month periods ended December 31, 2005 includes compensation
cost for all share-based payments granted prior to, but not yet vested as of,
July 1, 2005, based on the grant date fair value estimated in accordance with
the original provisions of SFAS No. 123, and compensation cost for all
share-based payments granted subsequent to July 1, 2005, based on the grant
date fair value estimated in accordance with the provisions of SFAS No.
123R. See Note 3, Stock-Based Compensation, in our Notes to Consolidated
Condensed Financial Statements for further information on our compensation
plans.
No stock-based compensation cost related to stock options was recognized in
the statements of operations for the years ended June 30, 2005 and 2004, as
all options granted in these periods had an exercise price equal to the
market price at the date of grant. As a result of adopting SFAS No. 123R,
our loss before taxes and net loss for the three-month period ended December
31, 2005 are $2 and $1 higher, respectively, than if we had continued to
account for stock-based compensation under APB No. 25. For the six-month
period ended December 31, 2005, our loss before taxes and net loss were $3
and $2 higher, respectively. This resulted in an increase in our reported
basic and diluted loss per share of $0.01 and $0.02 for the three- and
six-month periods ended December 31, 2005, respectively. As of December 31,
2005, there was $9 of total unrecognized compensation cost related to
nonvested stock options to be recognized over a weighted-average period of
1.2 years.
The fair values of the options granted during the six-month periods ended
December 31, 2005 and 2004 were estimated on the dates of their grants under
SFAS No. 123R using the Black-Scholes option-pricing model. The risk-free
interest rate for the periods within the expected life of the option is based
on the U.S. Treasury yield curve in effect at the time of grant. In fiscal
2005, the expected life was based on historical exercises and terminations.
Due to the insignificant number of stock option exercises during the past three
fiscal years, in 2006 we have estimated the expected life of options granted to
be the midpoint between the average vesting term and the contractual term. The
expected volatility for the periods with the expected life of the option is
determined using historical volatilities based on historical stock prices.
The expected dividend yield is based on our annual dividend in relation to
our historical average stock price. The increase in the dividend yield is
attributed to the increased quarterly dividend beginning February 1, 2005.
We also maintain restricted and deferred stock plans. Restricted and
deferred stock expense amounted to $2, before taxes of $1 for both
three-month periods ended December 31, 2005 and 2004. Restricted and
deferred stock expense amounted to $4 and $5, before taxes of $2 and $2 for
the six-month periods ended December 31, 2005 and 2004, respectively. As of
December 31, 2005, there was $8 of total unrecognized compensation cost
related to nonvested restricted and deferred compensation arrangements to be
recognized over a weighted-average period of 1.6 years.
Forward-Looking Information
Fiscal 2006 Results
At the beginning of 2006, we commenced a three-year plan targeting annual
revenue growth in the low- to mid-single digits and operating profit growth
in the high-single to low-double digits. For 2006, our guidance called for
revenues to grow in the low- to mid-single digits on a currency-neutral
basis, and operating profits to grow in the mid teens. We believe Reader's
Digest International will exceed our original profit growth targets
(originally targeted to grow in the mid-single digits and now expected to
grow by low teens), while Reader's Digest North America will grow operating
profit by double digits, and QSP will grow operating profit by high
double-digits. We expect profits at Books Are Fun will be lower when
compared with 2005. Accordingly, we expect 2006 full-year loss per share to
be between $(1.04) and $(0.94) per share, which includes $(1.94) per share
related to our goodwill charge at Books Are Fun. This estimate does not
include the effect of special items, including restructuring charges, that
cannot be forecasted at this time. Also, as we have shifted our focus from
stabilization to growth, our cash flows will be affected by the timing of
working capital and our investments in the business.
In addition, for the second half of 2006, we believe improved profits will be
strongly weighted toward the fourth quarter.
*****
This report contains "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,
strategic alliances and joint ventures;
- - our ability to successfully integrate newly acquired and newly formed
businesses;
- - the strength of relationships of newly acquired and newly formed
businesses with their employees, suppliers and customers;
- - the accuracy of the basis of forecasts relating to newly acquired and
newly formed businesses;
- - our ability to achieve financial savings related to restructuring
programs;
- - our ability to contain and reduce costs, especially through global
efficiencies;
- - the cost and effectiveness of our reengineering 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 and direct sales industries, including the Internet;
- - our ability to recruit, train and retain effective sales personnel;
- - 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 downgrades of our credit ratings;
- - the effects of economic and political changes in the markets where we
compete;
- - the effects of weather in limiting access to consumers; and
- - the economic effects of terrorist activity and related events,
especially those limiting access to consumers and otherwise affecting the
direct marketing and direct sales industries.
We do not undertake to update any forward-looking statements.
Item 4. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our principal executive
officer and principal financial officer, the effectiveness of our disclosure
controls and procedures (as defined in rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934) as of the end of the period covered by
this report. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this report.
There has been no change in our internal control over financial reporting
during the fiscal quarter covered by this report, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II. OTHER INFORMATION
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Total Number of (d) Maximum Number (or
(a) Total Shares (or Units) Approximate Dollar
Number of (b) Average Purchased as Part Value) of Shares (or
Shares (or Price Paid of Publicly Units) that May Yet Be
Units) per Share Announced Plans Purchased Under the
Purchased (or Unit) or Programs Plans or Programs(1)
Period
October 1 - 31, 2005 -- -- 130,000 82,170,952
November 1 - 30, 2005 -- -- 800,000 69,992,638
December 1 - 31, 2005 -- -- 823,000 57,161,638
---------
Total 1,753,000
(1) On April 28, 2005, our Board of Directors authorized our repurchase of
up to $100.0 million of our Common Stock over the succeeding two years.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 2005 Annual Meeting of Stockholders of The Reader's Digest
Association, Inc. held on November 18, 2005, the following matters were voted
on by stockholders.
Proposal 1: Election of Class 3 Directors to hold office until the 2008
Annual Meeting or until their successors are duly elected and qualified.
Each nominee was elected by the votes cast as follows:
For Withheld
Lee Caudill 88,984,784 2,417,974
Walter Isaacson 87,717,600 3,685,158
John T. Reid 88,973,692 2,429,066
Thomas O. Ryder 80,672,948 10,729,810
Proposal 2: To approve The Reader's Digest Association, Inc. 2005 Key
Employee Long-Term Incentive Plan.
Broker
For Against Abstain Non-Votes
51,331,545 26,193,477 4,881,138 8,996,598
Proposal 3: To approve the business criteria, maximum amount and eligible
employees for awards under The Reader's Digest Association, Inc. Senior
Management Incentive Plan.
Broker
For Against Abstain Non-Votes
83,716,700 2,747,591 4,938,467 0
Proposal 4: Ratification of the appointment of Ernst & Young, LLP as
independent auditors for fiscal 2006.
Broker
For Against Abstain Non-Votes
89,565,186 57,147 1,780,425 0
Item 6. EXHIBITS
(a) Exhibits
10.53 Salary compensation information included in Item 1.01 of our
Current Report on Form 8-K dated November 18, 2005 is incorporated
herein by reference.
31.1 Certification of Chief Executive Officer of The Reader's Digest
Association, Inc. pursuant to rule 13a-14(a)/15d-14(a) of the
Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer of The Reader's Digest
Association, Inc. pursuant to rule 13a-14(a)/15d-14(a) of the
Securities Exchange Act of 1934.
32 Certifications of Chief Executive Officer and Chief Financial
Officer of The Reader's Digest Association, Inc. pursuant to rule
13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Reader's Digest Association, Inc.
(Registrant)
Date: February 3, 2006 By: /s/ THOMAS D. BARRY
Thomas D. Barry
Vice President and
Corporate Controller
(chief accounting officer and
authorized signatory)