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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
---------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
Commission file number 001-15395
Martha Stewart Living Omnimedia, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-2187059
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
11 West 42nd Street, New York, NY 10036
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (212) 827-8000
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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding as of August 5, 2004
Class A, $0.01 par value 20,366,853
Class B, $0.01 par value 29,422,860
----------
Total 49,789,713
==========
Martha Stewart Living Omnimedia, Inc.
Index to Form 10-Q
Page
----
Part I. Financial information
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 4. Controls and Procedures 24
Part II. Other Information
Item 1. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
2
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MARTHA STEWART LIVING OMINIMEDIA, INC.
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)
June 30, December 31,
2004 2003
---------- ------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 119,462 $ 165,566
Short-term investments 38,891 3,100
Accounts receivable, net 17,736 39,758
Inventories, net 9,234 7,485
Deferred television production costs 1,448 3,465
Income taxes receivable 5,771 5,658
Deferred income taxes 1,833 5,024
Other current assets 6,046 4,422
---------- ----------
TOTAL CURRENT ASSETS 200,421 234,478
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, net 19,870 22,673
INTANGIBLE ASSETS, net 44,257 44,257
DEFERRED INCOME TAXES 3,224 3,224
OTHER NONCURRENT ASSETS 4,440 4,470
---------- ----------
TOTAL ASSETS $ 272,212 $ 309,102
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 24,663 $ 26,628
Accrued payroll and related costs 12,245 10,360
Income taxes payable 692 167
Current portion of deferred subscription income 23,532 23,833
---------- ----------
TOTAL CURRENT LIABILITIES 61,132 60,988
---------- ----------
DEFERRED SUBSCRIPTION INCOME 7,028 7,133
OTHER NONCURRENT LIABILITIES 4,211 4,316
---------- ----------
TOTAL LIABILITIES 72,371 72,437
---------- ----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Class A common stock, $.01 par value, 350,000 shares authorized; 20,328 and
19,628 shares outstanding in 2004 and
2003, respectively 203 196
Class B common stock, $.01 par value, 150,000 shares
authorized; 29,423 and 30,059 outstanding in 2004 and 2003,
respectively 294 301
Capital in excess of par value 186,207 183,744
Unamortized restricted stock (44) (307)
Retained earnings 13,956 53,506
---------- ----------
200,616 237,440
Less: Class A treasury stock - 59 shares at cost (775) (775)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 199,841 236,665
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 272,212 $ 309,102
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
Martha Stewart Living Omnimedia, Inc.
Condensed Consolidated Income Statements
(unaudited, in thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
---------- ---------- ---------- ----------
2004 2003 2004 2003
---------- ---------- ---------- ----------
REVENUES
Publishing $ 23,722 $ 39,617 $ 47,632 $ 73,678
Television 3,056 6,588 7,233 13,203
Merchandising 10,903 11,763 21,692 22,091
Internet/Direct Commerce 6,365 7,814 11,978 14,833
---------- ---------- ---------- ----------
TOTAL REVENUES 44,046 65,782 88,535 123,805
---------- ---------- ---------- ----------
OPERATING COSTS AND EXPENSES
Production, distribution and editorial 30,411 35,448 59,352 71,049
Selling and promotion 14,393 13,699 28,612 26,495
General and administrative 15,877 12,934 31,393 27,836
Amortization of non-cash stock
compensation 1,026 144 2,480 267
Depreciation and amortization 1,635 2,054 3,309 4,195
---------- ---------- ---------- ----------
TOTAL OPERATING COSTS AND EXPENSES 63,342 64,279 125,146 129,842
---------- ---------- ---------- ----------
OPERATING INCOME (LOSS) (19,296) 1,503 (36,611) (6,037)
Interest income, net 319 395 681 797
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES (18,977) 1,898 (35,930) (5,240)
Income tax benefit (provision) (189) (665) (3,332) 2,184
---------- ---------- ---------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE LOSS FROM DISCONTINUED OPERATIONS (19,166) 1,233 (39,262) (3,056)
Loss from discontinued operations, net of tax
benefit (127) (302) (288) (523)
---------- ---------- ---------- ----------
NET INCOME (LOSS) $ (19,293) $ 931 $ (39,550) $ (3,579)
========== ========== ========== ==========
INCOME (LOSS) PER SHARE - BASIC AND DILUTED
Income (loss) from continuing operations $ (0.39) $ 0.02 $ (0.79) $ (0.06)
Loss from discontinued operations (0.00) (0.01) (0.01) (0.01)
---------- ---------- ---------- ----------
Net income (loss) $ (0.39) $ 0.02 $ (0.80) $ (0.07)
========== ========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 49,572 49,488 49,518 49,560
Diluted 49,572 49,627 49,518 49,560
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
Martha Stewart Living Omnimedia, Inc.
Consolidated Statement of Shareholders' Equity
For the Six Months Ended June 30, 2004
(unaudited, in thousands)
Class A Class B Class A
common stock common stock Capital in Unamortized Treasury Stock
-------------- -------------- excess of Restricted Retained --------------
Shares Amount Shares Amount par value Stock Earnings Shares Amount Total
------ ------ ------ ------ ---------- ----------- -------- ------ ------ --------
Balance at January 1, 2004 19,628 $ 196 30,059 $ 301 $ 183,744 $ (307) $ 53,506 (59) $ (775) $236,665
Net loss - - - - - - (39,550) - - (39,550)
Conversion of shares 486 5 (486) (5) - - - - - -
Issuance of shares for stock
option exercises 214 2 - - 291 - - - - 293
Shares returned on net
treasury basis - - (150) (2) 2 - - - - -
Amortization of restricted
stock - - - - 2,170 263 - - - 2,433
------ ------ ------ ------ ---------- ------ -------- --- ------ --------
Balance at June 30, 2004 20,328 $ 203 29,423 $ 294 $ 186,207 $ (44) $ 13,956 (59) $ (775) $199,841
====== ====== ====== ====== ========== ====== ======== === ====== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
Martha Stewart Living Omnimedia, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands)
Six Months Ended
June 30,
2004 2003
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (39,550) $ (3,579)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 3,309 4,195
Amortization of restricted stock 2,480 267
Deferred income tax expense 3,191 -
Changes in operating assets and liabilities 20,470 (6,807)
---------- ----------
NET CASH USED IN OPERATING ACTIVITIES (10,100) (5,924)
---------- ----------
CASH FLOWS USED IN INVESTING ACTIVITIES
Capital expenditures (506) (637)
Purchases of short-term investments (35,791) -
Sales of short-term investments - 300
---------- ----------
NET CASH USED IN INVESTING ACTIVITIES (36,297) (337)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds received from stock option exercises 293 84
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 293 84
---------- ----------
NET DECREASE IN CASH (46,104) (6,177)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 165,566 131,664
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 119,462 $ 125,487
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
Martha Stewart Living Omnimedia, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data)
1. Accounting policies
a. General
Martha Stewart Living Omnimedia, Inc., together with its subsidiaries, is herein
referred to as the "Company."
The information included in the foregoing interim condensed consolidated
financial statements is unaudited. In the opinion of management, all adjustments
which are of a normal recurring nature and necessary for a fair presentation of
the results of operations for the interim periods presented have been reflected
herein. The results of operations for interim periods are not necessarily
indicative of the results to be expected for the entire year. These condensed
consolidated financial statements are unaudited and should be read in
conjunction with the audited financial statements included in the Company's
Annual Report on Form 10-K filed with the Securities and Exchange Commission
with respect to its fiscal year ended December 31, 2003.
b. Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. Management does not expect
such differences to have a material effect on the Company's consolidated
financial statements.
c. Income taxes
The Company follows Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." Under the asset and liability method of SFAS 109,
deferred assets and liabilities are recognized for the future costs and benefits
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. The Company
periodically reviews the requirements for a valuation allowance and makes
adjustments to such allowances when changes in circumstances result in changes
in management's judgment about the future realization of deferred tax assets.
The Company has used carryback income to realize net deferred tax assets. Since
the amounts and extent of the Company's future earnings are not determinable
with a sufficient degree of probability to recognize the deferred tax assets in
accordance with the requirements of SFAS 109, the Company has established a
valuation allowance of $16,453 in the first six months of 2004. The Company
intends to maintain a valuation allowance until evidence would support the
conclusion that it is more likely than not that the deferred tax asset could be
realized. The Company has reached final settlement with the Internal Revenue
Service ("IRS") related to the 1999 audit of the Company's consolidated federal
income tax return. Resolution of the examination did not have a material effect
on our consolidated financial position, results of operations, or liquidity.
d. Reclassifications
Certain prior year financial information has been reclassified to conform with
fiscal 2004 financial statement presentation.
7
e. Stock Compensation
As permitted by Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock Based Compensation," the Company has elected to continue
accounting for employee stock compensation under the APB 25 rules, but disclose
pro forma results using SFAS No. 123's alternative accounting treatment, which
calculates the total compensation expense to be recognized as the fair value of
the award at the date of grant. The fair values of options granted were
estimated on the grant date using the Black-Scholes option pricing model, using
the following assumptions for the three month periods ended June 30,:
2004 2003
------- --------
risk-free interest rates 2.73% 2.64%
dividend yields zero zero
expected volatility 150% 139%
expected option life 3 years 6 years
average fair market value per option granted $ 7.26 $ 9.16
Under SFAS No. 123, compensation cost is recognized in the amount of the
estimated fair value of the options over the relevant vesting periods. The pro
forma effects on net loss for the three and six month periods ended June 30,
2004 and 2003 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income (loss), as reported $(19,293) $ 931 $(39,550) $ (3,579)
-------- -------- -------- --------
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects 457 3,955 477 7,906
-------- -------- -------- --------
Pro forma net loss $(19,750) $ (3,024) $(40,027) $(11,485)
======== ======== ======== ========
Income (loss) per share:
Basic and diluted - as reported $ (0.39) $ 0.02 $ (0.80) $ (0.07)
Basic and diluted - pro forma $ (0.40) $ ( 0.06) $ (0.81) $ (0.23)
8
2. Inventories
The components of inventories are as follows:
June 30, December 31,
2004 2003
---------- ------------
Paper $ 5,935 $ 4,610
Product merchandise 5,134 4,801
---------- ------------
11,069 9,411
Less: reserve for obsolete and
excess inventory 1,835 1,926
---------- ------------
$ 9,234 $ 7,485
========== ============
3. Earnings (loss) per share
Earnings (loss) per share is computed in accordance with SFAS No. 128, "Earnings
Per Share". Basic earnings (loss) per share is calculated by dividing net
earnings (loss) by the weighted-average number of common shares outstanding
during each period. Diluted earnings (loss) per share includes the determinants
of basic earnings (loss) per share and, in addition, gives effect to potentially
dilutive common shares. For the three and six month periods ended June 30, 2004
and 2003, the following options were excluded from the calculation of earnings
(loss) per share as their inclusion would be antidilutive:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- -------------------
2004 2003 2004 2003
--------- --------- ------- ---------
Options excluded 1,068,236 3,804,902 794,698 4,209,056
--------- --------- ------- ---------
4. Industry segments
The Company is a leading creator of original "how to" content and related
products for homemakers and other consumers. The Company's business segments are
Publishing, Television, Merchandising and Internet/Direct Commerce. The
Publishing segment primarily consists of the Company's magazine operations, and
also those related to its book operations. The Television segment consists of
the Company's television production operations that produce television
programming that airs in syndication in the United States and on cable in the
United States. The Merchandising segment consists of the Company's operations
related to the design of merchandise and related promotional and packaging
materials that are distributed by its retail and manufacturing partners in
exchange for royalty income. The Internet/Direct Commerce segment comprises the
Company's operations relating to its catalog, Martha Stewart: The Catalog For
Living, its direct-to-consumer floral business and the website
marthastewart.com.
The Company believes operating income before depreciation and amortization,
including the amortization of non-cash stock compensation, ("OIDA") is an
appropriate measure when evaluating the operating performance of its business
segments and the Company on a consolidated basis. OIDA is used externally by the
Company's investors, analysts, and industry peers. OIDA is among the primary
metrics used by management for planning and forecasting of future periods, and
is considered an important indicator of the operational strength of the
Company's businesses. The Company believes the presentation of this measure is
relevant and useful for investors because it allows investors to view
performance in a manner similar to the method used by the Company's management
and makes it easier to compare the Company's results with other companies that
have different capital structures or tax rates. The Company believes OIDA should
be considered in addition to, not as a substitute for, operating income (loss),
net income (loss), cash flows, and other measures of financial performance
prepared in accordance with generally accepted accounting principles ("GAAP").
As OIDA is not a measure of performance calculated in accordance with GAAP, this
measure may not be comparable to similarly titled measures employed by other
companies.
9
Revenues for each segment are presented in the condensed consolidated statements
of income. Income (loss) from operations for each segment were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
(unaudited) (unaudited)
-------- -------- -------- --------
2004 2003 2004 2003
-------- -------- -------- --------
OPERATING INCOME (LOSS)
Publishing $ (5,321) $ 9,335 $ (9,946) $ 14,306
Television (3,531) 2 (5,478) 229
Merchandising 5,314 7,808 11,803 14,842
Internet/Direct Commerce (2,426) (4,552) (5,105) (12,804)
-------- -------- -------- --------
Operating Income (Loss) before Corporate Overhead (5,964) 12,593 (8,726) 16,573
Corporate Overhead (13,332) (11,090) (27,885) (22,610)
-------- -------- -------- --------
TOTAL OPERATING INCOME (LOSS) (19,296) 1,503 (36,611) (6,037)
-------- -------- -------- --------
DEPRECIATION AND AMORTIZATION
Publishing 61 41 123 82
Television 59 385 116 779
Merchandising 190 168 380 337
Internet/Direct Commerce 249 244 492 491
Corporate Overhead 1,076 1,216 2,198 2,506
-------- -------- -------- --------
TOTAL DEPRECIATION AND AMORTIZATION 1,635 2,054 3,309 4,195
-------- -------- -------- --------
AMORTIZATION OF NON-CASH STOCK COMPENSATION EXPENSE (BENEFIT)
Publishing 51 51 102 102
Television - - - -
Merchandising 12 12 25 25
Internet/Direct Commerce - - - (22)
Corporate Overhead 963 81 2,353 162
-------- -------- -------- --------
TOTAL AMORTIZATION OF NON-CASH STOCK COMPENSATION
EXPENSE 1,026 144 2,480 267
-------- -------- -------- --------
OPERATING INCOME (LOSS) BEFORE DEPRECIATION AND AMORTIZATION
AND AMORTIZATION OF NON-CASH STOCK COMPENSATION
Publishing (5,209) 9,427 (9,721) 14,490
Television (3,472) 387 (5,362) 1,008
Merchandising 5,516 7,988 12,208 15,204
Internet/Direct Commerce (2,177) (4,308) (4,613) (12,335)
-------- -------- -------- --------
Operating Income (Loss) before Depreciation and
Amortization and Amortization of Non-Cash Stock
Compensation and before Corporate Overhead (5,342) 13,494 (7,488) 18,367
Corporate Overhead (11,293) (9,793) (23,334) (19,942)
-------- -------- -------- --------
TOTAL OPERATING INCOME (LOSS) BEFORE DEPRECIATION AND
AMORTIZATION AND AMORTIZATION OF NON-CASH STOCK
COMPENSATION $(16,635) $ 3,701 $(30,822) $ (1,575)
======== ======== ======== ========
10
5. Discontinued Operations
In June 2002, the Company decided to exit The Wedding List, a wedding registry
and gift business that was reported within the Internet/Direct Commerce business
segment.
Operating results for The Wedding List were as follows:
Three Months Ended Six Months Ended
June 30, (unaudited) June 30, (unaudited)
-------- -------- -------- --------
2004 2003 2004 2003
-------- -------- -------- --------
Revenues $ - $ - $ - $ 580
-------- -------- -------- --------
Loss from operations, including
restructuring and shutdown costs (127) (464) (288) (804)
-------- -------- -------- --------
Income tax benefit - 162 - 281
-------- -------- -------- --------
Loss from discontinued operations, net
of tax benefit in 2003 $ (127) $ (302) $ (288) $ (523)
======== ======== ======== ========
6. Supplemental cash flow information:
Three Months Ended Six Months Ended
June 30, June 30,
-------- -------- -------- --------
2004 2003 2004 2003
-------- -------- -------- --------
Cash paid for interest - $ 40 - $ 15
Cash paid for income taxes $ 3 $ 3,597 $ 14 $ 1,529
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In this report, the terms "we," "us," "our" and "MSO" refer to Martha Stewart
Living Omnimedia, Inc., and its subsidiaries.
EXECUTIVE SUMMARY
TRENDS, RISKS AND UNCERTAINTIES
Since June 2002, public disclosure of various governmental investigations into
Martha Stewart's sale of non-Company stock and of the criminal and civil charges
against Ms. Stewart arising out of the investigations has generated a great deal
of negative publicity surrounding Ms. Stewart. Because our principal brand
labels are closely associated with Ms. Stewart, we have seen , since June 2002,
substantial negative impacts on our business as a result of the uncertainty
surrounding the resolution of these legal proceedings and associated negative
publicity. Although difficult to quantify with any precision, we believe that
the uncertainty and publicity surrounding these matters contributed
substantially to the adverse trends our business has experienced since June
2002.
On June 4, 2003, a federal grand jury in the United States District Court for
the Southern District of New York indicted Ms. Stewart, then the Company's
Chairman and Chief Executive Officer, on charges of obstruction of an agency
proceeding, making false statements to federal investigators, conspiracy, and
securities fraud. That same day, the Securities and Exchange Commission ("SEC")
filed a civil complaint against Ms. Stewart, in the United States District Court
for the Southern District of New York, alleging violations of federal securities
law. On July 10, 2003, the SEC action was stayed until further order of the
court. Following the indictment, Ms. Stewart resigned her positions as Chairman
and Chief Executive Officer, but retained her roles as a director and the
Company's Chief Creative Officer.
11
On March 5, 2004, Martha Stewart was found guilty of conspiracy, obstruction of
an agency proceeding, and making false statements to federal investigators
concerning her personal sale of non-Company stock. On March 15, 2004, Ms.
Stewart resigned her positions as a director and Chief Creative Officer of the
Company, and assumed the position of Founding Editorial Director, a non-officer
position. On July 16, 2004, Ms. Stewart was sentenced to five months in prison
and two years of supervised release, which includes five months of home
confinement to be served immediately upon release from prison. The sentence is
stayed pending appeal.
The Company continues to evaluate the responses of customers, advertisers, and
business partners to the outcome of Ms. Stewart's legal matters, in order to
assess the potential impact upon the Company's operating assets and make
appropriate decisions with respect to the Company's business operations and
strategy. In light of the results of this assessment, the Company has already
implemented a number of business initiatives and may consider a broad range of
additional business initiatives and strategic alternatives. These may include,
without limitation, repositioning certain brands, changes in core content areas,
new business initiatives, development of new expert personalities, changes in
relationships with strategic partners, disposition of certain products, assets
and businesses, and cost reduction initiatives as well as other business
efficiencies.
Although we are unable to predict the full effect of the outcome of Ms.
Stewart's trial and related sentencing on our business, we continue to
experience declines in advertising revenues since the trial outcome, principally
in our publishing segment. We may experience further material adverse impacts as
a result of the trial outcome, including, without limitation, additional revenue
declines, additional litigation, additional expenses relating to corporate
communications and corporate professional fees and loss of key personnel. For
the six month period ended June 30, 2004, we suffered a net loss of $39.6
million compared to a net loss of $3.6 million in the period of the prior year.
We may sustain substantial operating losses in future periods and our cash
position may be materially adversely affected.
Since March 5, 2004, the availability of the Martha Stewart Living television
program has declined to approximately 50% of U.S. television households from
previous levels of approximately 90% primarily due to the loss of coverage from
the CBS owned and operated stations. This reduction in household coverage has
resulted in lower license fees and advertising revenues. In light of this and
other developments, we will not produce Season 12, the 2004-2005 broadcast
season. However, we intend to provide content for the remainder of the current
season which concludes in mid September. Additionally, certain contracts
relating to our cable television shows expired on December 31, 2003 and were not
renewed and we were informed in May 2004 that the Food Network intends to
terminate our agreement beginning in October 2004. We have recently signed an
agreement with The Style Network to air Martha Stewart Living nationally on
cable television. However, we believe that the combined impact of lower license
fees, reduction in household coverage of our flagship syndicated television
program, and contract expirations will result in continued losses in the
Television segment in 2004.
On April 22, 2004, we reached an agreement with Kmart to amend the terms of our
contract and executed certain releases with respect to a legal action Kmart
filed against the Company on February 11, 2004. We believe that this agreement
better aligns the two companies' mutual business interests. In connection with
the amendment and releases, on April 23, 2004, Kmart voluntarily dismissed its
complaint with prejudice, terminating the litigation. The amendment, among other
things, extends the Kmart contract for an additional two years and expands the
scope of the contract to cover several new product categories. At the same time,
the amendment eliminates, with respect to 2003 and subsequent years, provisions
of the contract providing for payment of guaranteed minimum royalties by
individual product category and reduces the amount Kmart is obligated under the
contract to spend with MSO on advertising in MSO media properties. The amendment
also reduces the aggregate minimum royalty payments. The aggregate minimum
royalty payment for the period February 1, 2004 to January 31, 2005 was reduced
to $49.0 million from $53.4 million previously. In accordance with the amended
Kmart contract, $3.8 million of the January 31, 2005 minimum royalty payment,
but not more than $10.0 in the aggregate over the term of the agreement, will be
deferred and subject to recoupment in the periods ending January 31, 2009 and
January 31, 2010. We continue to expect that the minimum guaranteed royalty
payments will exceed actual royalties earned from retail sales through January
31, 2008. For the contract years ending January 31, 2009 and 2010 (the extension
years), the minimum guarantees will be substantially lower than in prior years.
12
In August 2004, we decided to discontinue the Catalog for Living and its online
product offerings, which is included in the Internet/ Direct Commerce segment,
by year-end 2004. This will result in lower revenues in this segment beginning
in 2005 and we expect that it will lead to a reduced operating loss in the
segment. As a result, we may take charges related to inventory disposition
and/or severance payments in the third and fourth quarters. We do not expect the
total amount of the charges to exceed $1 million in the second half of the year.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED JUNE 30, 2004 TO THREE MONTHS ENDED JUNE 30,
2003
PUBLISHING SEGMENT
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ ------------
PUBLISHING REVENUE
Advertising $ 8,419 $ 23,892 $ (15,473)
Circulation 14,922 14,853 69
Other 381 872 (491)
------------ ------------ ------------
TOTAL PUBLISHING SEGMENT REVENUE 23,722 39,617 (15,895)
------------ ------------ ------------
PUBLISHING OPERATING COSTS AND EXPENSES
Production, distribution and editorial 15,402 17,857 2,455
Selling and promotion 13,043 11,473 (1,570)
General and administrative 487 861 374
Amortization of non-cash compensation expense 50 50 -
Depreciation and amortization 61 41 (20)
------------ ------------ ------------
TOTAL PUBLISHING OPERATING COSTS AND EXPENSES 29,043 30,282 1,239
------------ ------------ ------------
OPERATING INCOME (LOSS) $ (5,321) $ 9,335 $ (14,656)
============ ============ ============
Publishing revenues decreased $15.9 million, or 40.1%, to $23.7 million for the
three months ended June 30, 2004, from $39.6 million for the three months ended
June 30, 2003. This decrease was primarily due to a decrease in advertising
revenues of $15.5 million. The decrease in advertising revenue resulted
primarily from fewer advertising pages in Martha Stewart Living, as well as a
reduction in the advertising page rate, due in part to the rate base (the number
of copies per issue we guarantee to advertisers) reduction which became
effective commensurate with the January 2004 issue. The decrease in advertising
revenue in Martha Stewart Living magazine was $10.4 million. The decrease in
advertising revenue was also attributable to lower advertising revenue in
Everyday Food magazine of $2.7 million, as the prior year's period included
advertising revenues from a sponsorship arrangement, as well as lower revenue
from our Special Interest Publications (SIP). Circulation revenue was unchanged
in the quarter, as lower revenue from Martha Stewart Living was offset by higher
circulation revenues from Everyday Food and Martha Stewart Weddings due
primarily to publishing more issues in the current period compared to the same
period one year ago.
Magazine Publication Schedule
Second Quarter 2004 Second Quarter 2003
------------------- -------------------
Martha Stewart Living Three Issues Three Issues
Martha Stewart Weddings Three Issues Two Issues
Everyday Food Three Issues Two Issues
Special Interest Publications One Issue Two Issues
13
Production, distribution and editorial expenses decreased $2.5 million primarily
reflecting lower paper, printing and distribution costs of Martha Stewart Living
magazine, due primarily to a lower number of pages printed per issue and lower
circulation, partially offset by the additional costs associated with the
publication of an additional issue of Everyday Food as well as an additional
issue of Martha Stewart Weddings in the quarter. Selling and promotion expenses
increased $1.6 million primarily due to higher circulation acquisition costs
relating to Everyday Food and one of our Special Interest Publications,
partially offset by lower spending related to Martha Stewart Living magazine.
TELEVISION SEGMENT
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ ------------
TELEVISION REVENUE
Syndication $ 2,244 $ 4,558 $ (2,314)
Licensing and other 812 2,030 (1,218)
------------ ------------ ------------
TOTAL TELEVISION SEGMENT REVENUE 3,056 6,588 (3,532)
------------ ------------ ------------
TELEVISION OPERATING COSTS AND EXPENSES
Production, distribution and editorial 5,275 4,564 (711)
Selling and promotion 329 773 444
General and administrative 924 864 (60)
Depreciation and amortization 59 385 326
------------ ------------ ------------
TOTAL TELEVISION OPERATING COSTS AND EXPENSES 6,587 6,586 (1)
------------ ------------ ------------
OPERATING INCOME (LOSS) (3,531) 2 (3,533)
------------ ------------ ------------
Television revenues decreased $3.5 million primarily due to lower revenue from
our syndicated daily program. The decrease in revenue from our syndicated daily
program was due primarily to lower license fees and lower advertising revenue.
The segment was also impacted by the expiration of certain cable and
international licensing contracts effective December 31, 2003. Revenue in the
quarter benefited from the launch of our programming on The Style Network, as
well as revenue from our Petkeeping program. Both products did not exist in the
prior year period.
Production, distribution and editorial expenses increased $0.7 million in the
period due to a $1.5 million write-down of deferred production costs resulting
from the early termination of a cable television licensing agreement, as well as
the cost of employee severance payments of $0.5 million, partially offset by
lower distribution and in-period production costs due to the winding down of
production for the syndicated program, Martha Stewart Living. Selling and
promotion expenses decreased $0.4 million due to lower marketing efforts for the
nationally syndicated daily show. Depreciation and amortization decreased $0.3
million primarily due to a reduction in the net carrying value of certain assets
in our Connecticut television studio in the fourth quarter of 2003.
14
MERCHANDISING SEGMENT
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ ------------
MERCHANDISING REVENUE
Kmart earned royalty $ 9,378 $ 9,965 (587)
Other 1,525 1,798 (273)
------------ ------------ ------------
TOTAL MERCHANDISING SEGMENT REVENUE 10,903 11,763 (860)
------------ ------------ ------------
MERCHANDISING OPERATING COSTS AND EXPENSES
Production, distribution and editorial 2,547 2,639 92
Selling and promotion 463 150 (313)
General and administrative 2,376 985 (1,391)
Amortization of non-cash compensation expense 13 13 -
Depreciation and amortization 190 168 (22)
------------ ------------ ------------
TOTAL MERCHANDISING OPERATING COSTS AND EXPENSES 5,589 3,955 (1,634)
------------ ------------ ------------
OPERATING INCOME 5,314 7,808 (2,494)
------------ ------------ ------------
Merchandising revenues decreased $0.9 million, or 7.3%, to $10.9 million for the
quarter ended June 30, 2004, from $11.8 million for the quarter ended June 30,
2003, primarily due to lower sales of our Martha Stewart Everyday product at
Kmart due to lower same-store-sales, as well as Kmart store closings that took
place in the early part of 2003. The revenue decline was partially offset by an
increase in the royalty rate on a year-over-year basis. The royalty rate under
our agreement with Kmart increased 5% on February 1, 2004. Royalty revenue from
Kmart was recorded based on actual sales in the current and prior year periods.
We expect the minimum guarantees will exceed actual royalties earned from retail
sales for the foreseeable future primarily due to store closings. Other revenue
declined modestly due to a decline in creative service revenue and royalty
revenue from our Japanese retail partner, partially offset by revenue from the
launch of our program at Sears Canada and higher royalty revenue from the sale
of Martha Stewart Signature products. Our program at Sears Canada launched in
the second half of 2003.
The following table sets forth the minimum guarantees as contained in our
contract with Kmart Corporation.
1/31/02 1/31/03 1/31/04 1/31/05 1/31/06 1/31/07 1/31/08 1/31/09 1/31/10
------- ------- ------- ------- ------- ------- ------- --------- ---------
Minimum Royalty Amounts $15.3 $40.4 $47.5 $49.0 $54.0 $59.0 $65.0 See below See below
For the year ending January 31, 2009 the minimum royalty amount is the greater
of $20 million or 50% of the earned royalty for the year ending January 31,
2008. For the year ending January 31, 2010 the minimum royalty amount is the
greater of $15 million or 50% of the earned royalty for the year ending January
31, 2009. Furthermore, $3.8 million of the January 31, 2005 and January 31, 2006
minimum royalty payments and $2.5 million of the January 31, 2007 and January
31, 2008 minimum royalty payments, but not more than $10.0 in the aggregate over
the term of the agreement, will be deferred and subject to recoupment in the
periods ending January 31, 2009 and January 31, 2010. We continue to expect that
the minimum guaranteed royalty payments will exceed actual royalties earned from
retail sales through January 31, 2008.
Selling and promotion expenses increased $0.3 million in the period due to
higher marketing related to our Martha Stewart Signature program. General and
administrative expense increased $1.4 million primarily due to professional fees
incurred in the quarter associated with amending the Kmart contract.
15
INTERNET/DIRECT COMMERCE SEGMENT
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ ------------
INTERNET/DIRECT COMMERCE REVENUE
Product $ 6,254 $ 7,363 (1,109)
Other 111 451 (340)
------------ ------------ ------------
TOTAL INTERNET/DIRECT COMMERCE SEGMENT REVENUE 6,365 7,814 (1,449)
------------ ------------ ------------
INTERNET/DIRECT COMMERCE OPERATING COSTS AND
EXPENSES
Production, distribution and editorial 7,095 10,289 3,194
Selling and promotion 532 655 123
General and administrative 915 1,178 263
Amortization of non-cash compensation expense - - -
Depreciation and amortization 249 244 (5)
------------ ------------ ------------
TOTAL INTERNET/DIRECT COMMERCE OPERATING COSTS AND
EXPENSES 8,791 12,366 3,575
------------ ------------ ------------
OPERATING INCOME (LOSS) (2,426) (4,552) 2,126
------------ ------------ ------------
Internet/Direct Commerce revenues decreased $1.4 million, or 18.5%, to $6.4
million for the three months ended June 30, 2004, from $7.8 million for the
three months ended June 30, 2003, due to lower commerce sales related to our
catalog offerings, partially offset by higher revenue from our
direct-to-consumer floral business. The lower commerce sales are primarily due
to planned lower catalog circulation. The decline in commerce revenue was
largely attributable to our lower catalog circulation. The decline in other
revenue was principally due to lower advertising revenue.
Production, distribution and editorial costs decreased $3.2 million reflecting
lower catalog production and distribution costs of $1.5 million due to reduced
catalog circulation and lower product and fulfillment costs of $1.4 million
primarily due to the lower revenue. General and administrative expenses
decreased $0.3 million due primarily to lower employee related expenses.
CORPORATE
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ --------
CORPORATE OPERATING COSTS AND EXPENSES
Production, distribution and editorial 92 99 7
Selling and promotion 26 648 622
General and administrative 11,175 9,046 (2,129)
Amortization of non-cash compensation expense 963 81 (882)
Depreciation and amortization 1,076 1,216 140
------------ ------------ --------
TOTAL CORPORATE OPERATING COSTS AND EXPENSES 13,332 11,090 (2,242)
------------ ------------ --------
OPERATING LOSS (13,332) (11,090) (2,242)
------------ ------------ --------
Selling and promotion expenses decreased $0.6 million, as the prior year quarter
included media spending associated with a corporate advertising program. General
and administrative expenses increased $2.1
16
million principally resulting from higher employee-related costs, including
costs relating to the November 2003 stock option exchange offers of $0.4
million, additional retention programs of $0.8 million as well as higher
professional fees.
OTHER ITEMS
Income tax expense. Income tax expense for the quarter ended June 30, 2004 was
$0.2 million, compared to an income tax expense of $0.7 million for the quarter
ended June 30, 2003. The current period provision includes a valuation allowance
of $9.3 million taken against certain deferred tax assets since the amounts and
extent of the Company's future earnings are not determinable with a sufficient
degree of probability.
Loss from discontinued operations. Loss from discontinued operations was $0.1
million for the quarter ended June 30, 2004 compared to $0.3 million for the
quarter ended June 30, 2003. Discontinued operations represent the operations of
the Wedding List, which the Company decided to discontinue in 2002. The current
year expenses are primarily facility related.
Net Income (Loss). Net loss was $(19.3) million for the quarter ended June 30,
2004, compared to net income of $0.9 million for the quarter ended June 30,
2003, as a result of the above mentioned factors.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2004 TO SIX MONTHS ENDED JUNE 30, 2003
PUBLISHING SEGMENT
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ ------------
PUBLISHING REVENUE
Advertising $ 16,554 $ 43,477 $ (26,923)
Circulation 30,355 28,718 1,637
Other 723 1,483 (760)
------------ ------------ ------------
TOTAL PUBLISHING SEGMENT REVENUE 47,632 73,678 (26,046)
------------ ------------ ------------
PUBLISHING OPERATING COSTS AND EXPENSES
Production, distribution and editorial 30,418 34,666 4,248
Selling and promotion 26,108 23,054 (3,054)
General and administrative 829 1,470 641
Amortization of non-cash compensation expense 100 100 -
Depreciation and amortization 123 82 (41)
------------ ------------ ------------
TOTAL PUBLISHING OPERATING COSTS AND EXPENSES 57,578 59,372 1,794
------------ ------------ ------------
OPERATING INCOME (LOSS) $ (9,946) $ 14,306 $ (24,252)
------------ ------------ ------------
Publishing revenues decreased $26.0 million, or 35.4%, to $47.6 million for the
six months ended June 30, 2004, from $73.7 million for the six months ended June
30, 2003. This decrease was primarily due to a decrease in advertising revenues
of $26.9 million. The decrease in advertising revenue resulted primarily from
fewer advertising pages in Martha Stewart Living, as well as a reduction in the
advertising page rate, due in part to the rate base (the number of copies per
issue we guarantee to advertisers) reduction which became effective commensurate
with the January 2004 issue. The decrease in advertising revenue in Martha
Stewart Living magazine was $18.9 million for the six months ended June 30,
2004. The reduction in advertising revenue was also attributable to lower
advertising revenue in Everyday Food magazine of $5.3 million, as the prior
year's period included advertising revenues from a sponsorship arrangement.
Circulation revenue increased $1.6 million in the period primarily due to the
increase in circulation and frequency of Everyday Food, as well as an additional
issue of Martha Stewart Weddings published in the period, partially offset by
lower circulation revenue from Martha Stewart Living magazine, due primarily to
lower subscription copies sold in the period.
17
Magazine Publication Schedule
First Half 2004 First Half 2003
--------------- ---------------
Martha Stewart Living Six Issues Six Issues
Martha Stewart Weddings Three Issues Two Issues
Everyday Food Six Issues Four Issues
Special Interest Publications Four Issues Four Issues
Production, distribution, and editorial costs decreased $4.2 million primarily
reflecting lower paper, printing and distribution costs of Martha Stewart Living
magazine, due mainly to a lower number of pages printed per issue and lower
copies printed, partially offset by the additional costs associated with the
publication of two additional issues of Everyday Food. Selling and promotion
expenses increased increased $3.1 million resulting primarily from higher
circulation acquisition costs relating to Everyday Food and one of our Special
Interest Publication's, partially offset by lower spending related to Martha
Stewart Living magazine.
TELEVISION SEGMENT
2004 2003
(unaudited) (unaudited) Variance
------------ ------------ ---------
TELEVISION REVENUE
Syndication $ 5,733 $ 9,232 $ (3,499)
Licensing and other 1,500 3,971 (2,471)
------------ ------------ ---------
TOTAL TELEVISION SEGMENT REVENUE 7,233 13,203 (5,970)
------------ ------------ ---------
TELEVISION OPERATING COSTS AND EXPENSES
Production, distribution and editorial 9,878 9,080 (798)
Selling and promotion 898 1,409 511
General and administrative 1,819 1,706 (113)
Amortization of non-cash compensation expense - - -
Depreciation and amortization 116 779 663
------------ ------------ ---------
TOTAL TELEVISION OPERATING COSTS AND EXPENSES 12,711 12,974 263
------------ ------------ ---------
OPERATING INCOME (LOSS) (5,478) 229 (5,707)
------------ ------------ ---------
Television revenues decreased $6.0 million, or 45.2%, to $7.2 million for the
six months ended June 30, 2004, from $13.2 million for the six months ended June
30, 2003. The decrease is primarily attributable to lower revenue from our
syndicated daily program of $4.1 million due primarily to lower license fees and
lower advertising revenue. The decrease was partially offset by revenue from the
launch of our programming on The Style Network and Petkeeping. The segment was
also impacted by the expiration of certain cable and international licensing
contracts effective December 31, 2003, included in licensing above.
Production, distribution and editorial expenses increased $0.8 million in the
period due to higher non-cash production amortization recognized in the period,
principally due to a $1.5 million write-down of deferred production costs
resulting from the early termination of a cable television licensing agreement
and the cost of employee severance payments of $0.5 million, partially offset by
lower distribution and in-period production costs due to the winding down of
production for the syndicated national show, Martha Stewart Living. Selling and
promotion expenses decreased $0.5 million due to lower marketing efforts for the
nationally syndicated daily show. Depreciation and amortization decreased $0.7
million primarily due to a reduction in the net carrying value of certain assets
in our Connecticut television studio in the fourth quarter of 2003. The decrease
in depreciation will continue through the remainder of the year.
18
MERCHANDISING SEGMENT
2004 2003
(unaudited) (unaudited) Variance
----------- ----------- --------
MERCHANDISING REVENUE
Kmart earned royalty $ 15,864 $ 18,542 (2,678)
Kmart minimum true-up 2,412 - 2,412
Other 3,416 3,549 (133)
----------- ----------- --------
TOTAL MERCHANDISING SEGMENT REVENUE 21,692 22,091 (399)
----------- ----------- --------
MERCHANDISING OPERATING COSTS AND EXPENSES
Production, distribution and editorial 5,164 4,709 (455)
Selling and promotion 570 186 (384)
General and administrative 3,750 1,992 (1,758)
Amortization of non-cash compensation
expense 25 25 -
Depreciation and amortization 380 337 (43)
----------- ----------- --------
TOTAL MERCHANDISING OPERATING COSTS AND EXPENSES 9,889 7,249 (2,640)
----------- ----------- --------
OPERATING INCOME 11,803 14,842 (3,039)
----------- ----------- --------
Merchandising revenues decreased $0.4 million, or 1.8%, to $21.7 million for the
six months ended June 30, 2004, from $22.1 million for the six months ended June
30, 2003, primarily due to lower product sales at Kmart as a result of lower
same - store-sales as well as Kmart store closings that took place in the early
part of 2003. The revenue decline was partially offset by recognizing as revenue
the pro-rata portion of the contractual minimum royalty amount due from Kmart
for the 12 month period ended January 31, 2004, relating to January 2004 as well
as an increase in the royalty rate on a year-over-year basis. The royalty rate
under our agreement with Kmart increased 5% on February 1, 2004. We expect the
minimum guarantees will exceed actual royalties earned from retail sales for the
foreseeable future primarily due to store closings. Other revenue declined
modestly due to a decline in creative service revenue, partially offset by
revenue from the launch of our program at Sears Canada and higher royalty
revenue from our Martha Stewart Signature products. Our program at Sears Canada
launched in the second half of 2003.
Production, distribution and editorial expense increased $0.5 million due to
higher compensation related expenses. Selling and promotion expenses increased
$0.4 million in the period due to higher marketing related to our Martha Stewart
Signature program. General and administrative expense increased $1.8 million
primarily due to professional fees incurred in the quarter associated with
amending the Kmart contract.
19
INTERNET/DIRECT COMMERCE SEGMENT
2004 2003
(unaudited) (unaudited) Variance
----------- ----------- --------
INTERNET/DIRECT COMMERCE REVENUE
Product sale $ 11,726 $ 14,080 (2,354)
Other 252 753 (501)
----------- ----------- --------
TOTAL INTERNET/DIRECT COMMERCE SEGMENT REVENUE 11,978 14,833 (2,855)
----------- ----------- --------
INTERNET/DIRECT COMMERCE OPERATING COSTS AND EXPENSES
Production, distribution and editorial 13,707 22,395 8,688
Selling and promotion 991 1,168 177
General and administrative 1,893 3,605 1,712
Amortization of non-cash compensation expense - (22) (22)
Depreciation and amortization 492 491 (1)
----------- ----------- --------
TOTAL INTERNET/DIRECT COMMERCE OPERATING COSTS AND EXPENSES 17,083 27,637 10,554
----------- ----------- --------
OPERATING INCOME (LOSS) (5,105) (12,804) 7,699
----------- ----------- --------
Internet/Direct Commerce revenues decreased $2.9 million, or 19.2%, to $12.0
million for the six months ended June 30, 2004, from $14.8 million for the six
months ended June 30, 2003. The decrease was primarily due to lower commerce
sales related to our catalog offerings, partially offset by increased revenue
from our direct-to-consumer floral business. The decline in commerce sale was
largely attributable to our planned lower catalog circulation. The decline in
other revenue was principally due to lower advertising revenue.
Production, distribution and editorial costs decreased $8.7 million, due to
lower catalog production and distribution costs of $3.9 million due to reduced
catalog circulation. Lower costs were also due in part to lower product sales,
an improved product gross margin and improved fulfillment efficiencies, which
collectively contributed to $3.5 million of lower costs in the period. The
segment continued to benefit from the restructuring initiated in the first half
of 2003, which reduced headcount and lowered technology costs. General and
administrative expenses decreased $1.7 million due primarily to lower employee
related expenses and lower professional fees.
CORPORATE
2004 2003
(unaudited) (unaudited) Variance
----------- ----------- --------
CORPORATE OPERATING COSTS AND EXPENSES
Production, distribution and editorial 185 199 14
Selling and promotion 51 678 627
General and administrative 23,096 19,063 (4,033)
Amortization of non-cash compensation expense 2,355 164 (2,191)
Depreciation and amortization 2,198 2,506 308
----------- ----------- --------
TOTAL CORPORATE OPERATING COSTS AND EXPENSES 27,885 22,610 (5,275)
----------- ----------- --------
OPERATING LOSS (27,885) (22,610) (5,275)
----------- ----------- --------
20
Selling and promotion expenses decreased $0.6 million, as the prior year quarter
included media spending associated with a corporate advertising program. General
and administrative expenses increased $4.0 million principally resulting from
higher employee-related costs, including costs relating to the November 2003
stock option exchange offers of $0.8 million and additional retention programs
of $1.7 million as well as higher corporate communications and consulting fees.
OTHER ITEMS
Income tax benefit (expense). Income tax expense for the six months ended June
30, 2004 was $3.3 million, compared to an income tax benefit of $2.2 million for
the six months ended June 30, 2003. The current period provision includes a
valuation allowance of $16.5 million taken against certain deferred tax assets
since the amounts and extent of the Company's future earnings are not
determinable with a sufficient degree of probability.
Loss from discontinued operations. Loss from discontinued operations was $0.3
million for the six months ended June 30, 2004 compared to $0.5 million for the
six months ended June 30, 2003. Discontinued operations represent the operations
of the Wedding List, which the Company decided to discontinue in 2002. The
current year expenses are primarily facility related.
Net Loss. Net loss was $(39.5) million for the six months ended June 30, 2004,
compared to a net loss $(3.6) million for the six months ended June 30, 2003, as
a result of the above mentioned factors.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $119.5 million and $165.6 million and short-term
investments were $38.9 million and $3.1 million at June 30, 2004 and December
31, 2003, respectively.
Cash flows used in operating activities were $10.1 million during the six months
ended June 30, 2004, compared to cash used in operating activities of $5.9
million during the six months ended June 30, 2003. Cash flows used in operating
activities during the six months ended June 30, 2004 were primarily due to a net
loss for the period of $39.6 million, partially offset by changes in operating
assets and liabilities of $20.5 million, depreciation and amortization of $3.3
million, an increase in the deferred income tax expense of $3.2 million, as well
as the amortization of equity based compensation expense of $2.5 million. The
changes in operating assets and liabilities include a decrease in accounts
receivable due principally to the collection of a royalty receivable due from
Kmart related to our minimum royalty payment, partially offset by a decrease in
certain accounts payable. Cash flows used in operating activities during the six
months ended June 30, 2003 were primarily due to a net loss for the period of
$3.6 million and changes in operating assets and liabilities of $6.8 million,
partially offset by depreciation and amortization of $4.2 million. Cash used by
changes in operating assets and liabilities during the period is primarily a
result of decreases in accounts payable and accrued liabilities and accrued
payroll and related costs, partially offset by decreased accounts receivable.
Cash flows used in investing activities were $36.3 million and $0.3 million
during the six months ended June 30, 2004 and 2003, respectively. Cash flows
used in investing activities in 2004 resulted from the purchase of short-term
investments of $35.8 million and capital expenditures $0.5 million. Cash flows
used in investing activities in 2003 resulted from capital expenditures of $0.6
million partially offset by the sale of short-term investments of $0.3 million.
We expect capital expenditures in 2004 to be less than $1.5 million.
Cash flows provided by financing activities for the six month periods ended June
30, 2004 and 2003 were $0.3 and $0.1 million, respectively, representing
proceeds received from the exercise of employee stock options.
We have a line of credit with Bank of America in the amount of $5 million, which
is generally used to secure outstanding letters of credit. As of June 30, 2004,
we had no outstanding borrowings under this facility.
21
We believe that our available cash balances and short-term investments together
with any funds available under existing credit facilities will be sufficient to
meet our operating and recurring cash needs for foreseeable periods. We have not
paid dividends on our common stock and have no intention to pay any dividends in
the foreseeable future.
SEASONALITY AND QUARTERLY FLUCTUATIONS
Several of our businesses can experience fluctuations in quarterly performance.
For example, in our Publishing segment, the publication schedule of Special
Interest Publications can vary from quarter to quarter. Internet/Direct Commerce
revenues have tended to be higher in the fourth quarter due to increased catalog
circulation and consumer spending during that period. Revenues from the
Merchandising segment can vary significantly from quarter to quarter due to new
product launches and the seasonality of certain product lines. In addition, we
expect to recognize the pro-rata portion of the difference between the minimum
royalty amount under the Kmart contract and royalties paid on actual sales in
the fourth quarter of 2004 and first quarter of 2005, net of amounts required to
be deferred, when the amount can be determined.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to bad debts, inventories, long-lived assets and accrued losses. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
We believe that, of our significant accounting policies, the following may
involve the highest degree of judgment and complexity.
Revenue Recognition
Revenues are recognized when realized or realizable and earned. Revenues and
associated accounts receivable are recorded net of provisions for estimated
future returns, doubtful accounts and other allowances. Newsstand revenues in
our Publishing segment and product sales in our Internet/Direct Commerce segment
are recognized based upon assumptions with respect to future returns. The
Company bases its estimates on historical experience and current market
conditions. Reserves are adjusted regularly based upon actual results. We
maintain allowance for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required. Receivables for
royalties in our merchandising business are accrued on a monthly basis and
payment is generally made by our strategic partners on a quarterly basis. For
the six month period ended June 30, 2004, the Company has recognized royalty
revenues earned under our agreement with Kmart based upon actual royalties
earned, not contractual minimum amounts. Contractual minimum amounts under the
agreement with Kmart are computed on January 31st annually and are payable
shortly thereafter. We expect to recognize the difference between the minimum
royalty amount and royalties paid on actual sales in the fourth quarter of 2004
and first quarter of 2005, net of amounts required to be deferred, when the
amount can be determined.
22
Inventory
Inventory, consisting of paper and product merchandise, is stated at the lower
of cost or market. The Company has recorded a reserve for excess and obsolete
product inventory, reducing inventory from cost to estimated market value, based
upon historical experience and current market conditions. The reserve is
evaluated regularly based upon actual results and adjusted accordingly.
Television Production Costs
Television production costs are capitalized and amortized based upon estimates
of future revenues to be received for the applicable television product. The
Company bases its estimates on existing contracts for programs, historical
advertising rates and ratings as well as market conditions. Estimated future
revenues are adjusted regularly based upon actual results and changes in market
and other conditions.
Long-Lived Assets
We review the carrying values of our long-lived assets whenever events or
changes in circumstances indicate that such carrying values may not be
recoverable. Unforeseen events and changes in circumstances and market
conditions and material differences in the value of long-lived assets due to
changes in estimates of future cash flows could negatively affect the fair value
of our assets and result in an impairment charge.
Intangible assets
Commencing January 1, 2002, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets,
effective July 1, 2002. SFAS No. 142 requires that goodwill and intangible
assets with indefinite lives no longer be amortized to earnings and be tested
for impairment at least annually. The impairment tests are based upon a
fair-value approach as described in SFAS No. 142. Tests for impairment or
recoverability require significant management judgment, and future events
affecting cash flows and market conditions could result in impairment losses.
Forward-looking Statements
We have included in this Quarterly Report certain "forward-looking statements,"
as that term is defined in the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are not historical facts but instead represent
only our current beliefs regarding future events, many of which, by their
nature, are inherently uncertain and outside of our control. These statements
can be identified by terminology such as "may," "will," "should," "could",
"expects," "intends," "plans," "anticipates," "believes," "estimates,"
"potential" or "continue" or the negative of these terms or other comparable
terminology. The Company's actual results may differ materially from those
projected in these statements, and factors that could cause such differences
include further adverse reaction to the prolonged and continued negative
publicity relating to Martha Stewart by consumers, advertisers and business
partners; further adverse reaction by the Company's consumers, advertisers and
business partners to the outcome of Ms. Stewart's legal proceeding arising from
a sale of non-Company stock by Ms. Stewart; a loss of the services of Ms.
Stewart; a loss of the services of other key personnel; an adverse resolution to
the SEC enforcement proceeding currently underway against Ms. Stewart arising
from her personal sale of non-Company stock; adverse resolution of some or all
of the Company's ongoing litigation; downturns in national and/or local
economies; shifts in our business strategies; a softening of the domestic
advertising market; changes in consumer reading, purchasing and/or television
viewing patterns; unanticipated increases in paper, postage or printing costs;
operational or financial problems any of our contractual business partners; the
receptivity of consumers to our new product introductions; and changes in
government regulations affecting the Company's industries. Certain of these and
other factors are discussed in more detail in other parts of this report,
especially in this section, "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
23
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-14 (c) under the Securities
Exchange Act of 1934) as of June 30, 2004. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the design and
operation of these disclosure controls and procedures were effective. No
significant changes were made in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation. In addition, no change in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of
1934) occurred during our most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 3, 2003, the Company was named as a defendant in a Consolidated and
Amended Class Action Complaint (the "Consolidated Class Action Complaint"),
filed in the United States District Court for the Southern District of New York,
by plaintiffs purporting to represent a class of persons who purchased common
stock in the Company between January 8, 2002 and October 2, 2002. In re Martha
Stewart Living Omnimedia, Inc. Securities Litigation, 02-CV-6273 (JES). The
Consolidated Class Action Complaint also names Martha Stewart and seven of the
Company's other present or former officers (Gregory R. Blatt, Sharon L. Patrick,
and five other Company officers (collectively, the "Individual Defendants")) as
defendants. The action consolidates seven class actions previously filed in the
Southern District of New York: Semon v. Martha Stewart Living Omnimedia, Inc.
(filed August 6, 2002), Rosen v. Martha Stewart Living Omnimedia, Inc. (filed
August 21, 2002), MacKinnon v. Martha Stewart Living Omnimedia, Inc. (filed
August 30, 2002), Crnkovich v. Martha Stewart Living Omnimedia, Inc. (filed
September 4, 2002), Rahilly v. Martha Stewart Living Omnimedia, Inc. (filed
September 6, 2002), Steele v. Martha Stewart Living Omnimedia, Inc. (filed
September 13, 2002), and Hackbarth v Martha Stewart Living Omnimedia, Inc.
(filed September 18, 2002). The claims in the Consolidated Class Action
Complaint arise out of Ms. Stewart's sale of 3,928 shares of ImClone Systems
stock on December 27, 2001. The plaintiffs assert violations of Sections 10(b)
(and rules promulgated thereunder), 20(a) and 20A of the Securities Exchange Act
of 1934. The plaintiffs allege that MSO, Ms. Stewart and the Individual
Defendants made statements about Ms. Stewart's sale that were materially false
and misleading. The plaintiffs allege that, as a result of these false and
misleading statements, the market price of the Company's stock was inflated
during the putative class periods and dropped after the alleged falsity of the
statements became public. The plaintiffs further allege that the Individual
Defendants traded MSO stock while in possession of material non-public
information. The Consolidated Class Action Complaint seeks certification as a
class action, damages, attorneys' fees and costs, and further relief as
determined by the court.
On May 19, 2003, the Company's motion to dismiss the Consolidated Class Action
Complaint was denied, and discovery in that action is ongoing. By stipulation of
the parties, and an order of the court entered November 10, 2003, all claims
asserted in the Consolidated Class Action Complaint pursuant to Section 20A
(Insider Trading) of the Securities Exchange Act against the Individual
Defendants, and all remaining claims against the Individual Defendants, other
than Mr. Blatt and Ms. Patrick, have been dismissed without prejudice.
The Company has also been named as a nominal defendant in four derivative
actions, all of which name Ms. Stewart as a defendant: In re Martha Stewart
Living Omnimedia, Inc. Shareholder Derivative Litigation (the "Shareholder
Derivative Litigation"), filed on December 19, 2002 in New York State Supreme
Court; Beam v. Stewart, initially filed on August 15, 2002 and amended on
September 6, 2002, in Delaware Chancery Court; Richards v. Stewart, filed on
November 1, 2002 in Connecticut Superior Court; and Sargent v. Martinez, filed
on September 29, 2003 in the U.S. District Court for the Southern District of
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New York. Company directors Arthur Martinez, Sharon Patrick, Jeffrey Ubben and
former directors John Doerr, Darla Moore and Naomi Seligman, are also named as
defendants in Beam. Mr. Martinez, Ms. Patrick, Mr. Ubben, Mr. Doerr, Ms. Moore,
Ms. Seligman, five of the Company's present or former officers (Mr. Blatt, Ms.
Cardinale, Ms. Roach, Ms. Sobel, and Ms. Towey), and Kleiner Perkins Caufield &
Byers are also named as defendants in Richards. Mr. Martinez, Ms. Patrick, Mr.
Ubben, Ms. Moore and Ms. Seligman are also named as defendants in Sargent. In re
Martha Stewart Living Omnimedia, Inc. Shareholder Derivative Litigation
consolidates three previous derivative complaints filed in New York State
Supreme Court and Delaware Chancery Court: Beck v. Stewart, filed on August 13,
2002 in New York State Supreme Court, Kramer v. Stewart, filed on August 20,
2002 in New York State Supreme Court, and Alexis v. Stewart, filed on October 3,
2002 in Delaware Chancery Court. Sargent consolidates two derivative complaints
previously filed in the U.S. District Court for the Southern District Court of
New York: Acosta v. Stewart, filed on October 10, 2002, and Sargent v. Martinez,
filed on May 30, 2003.
All four derivative actions allege that Ms. Stewart breached her fiduciary
duties to the Company by engaging in insider trading in ImClone stock and making
false and misleading statements about such trading. The plaintiffs allege that
these actions have diminished Ms. Stewart's reputation and injured the Company
through lost revenues, loss of reputation and good will, decreased stock price,
and increased costs. The plaintiff in Beam further alleges that (i) Ms.
Stewart's actions have jeopardized the Company's intellectual property; (ii) the
directors breached their fiduciary duties by failing to monitor Ms. Stewart's
affairs to ensure she did not harm the Company; (iii) Ms. Stewart and the other
directors breached their fiduciary duties by failing to address the impropriety
of the Company's payment of split-dollar insurance premiums; and (iv) Ms.
Stewart and Mr. Doerr usurped corporate opportunities by selling personally
owned Company stock to an investment firm without first presenting the Company
with the opportunity to sell its stock to the firm. The plaintiffs in the
Shareholder Derivative Litigation also allege that Ms. Stewart breached the
terms of her employment agreement with the Company. The plaintiff in Richards
further alleges (i) intentional breach of fiduciary duty by, among other things,
acting in reckless disregard of, and failing to prevent, Ms. Stewart's insider
trading in ImClone stock, violating federal securities laws by selling Company
stock while in possession of material, non-public information, misuse of
corporate information, and gross mismanagement of the Company; (ii) negligent
breach of fiduciary duty; (iii) abuse of control; (iv) constructive fraud; (v)
gross mismanagement; and (vi) waste. The plaintiffs in Sargent further allege
that the directors breached their fiduciary duties by (i) failing to take
appropriate action to address Ms. Stewart's wrongdoing; (ii) granting Ms.
Stewart a bonus for 2002; and (iii) endorsing an amendment to the Company's
agreement with Ms. Stewart for the rental of certain properties.
The derivative actions seek damages in favor of the Company, attorneys' fees and
costs, and further relief as determined by the court. Certain of the complaints
also seek declaratory relief. The plaintiffs in the Shareholder Derivative
Litigation and Sargent further seek the creation of a committee or other
administrative mechanism to address the alleged "corporate governance" issues
raised in the complaints and to protect the Company's "cornerstone assets." The
plaintiff in Richards further seeks injunctive relief in the form of attachment
or other restriction of the proceeds of defendants' trading activities or other
assets.
On April, 17, 2003, the Company's motion to dismiss the Shareholder Derivative
Litigation was granted to the extent that the action has been stayed pending
plaintiffs' submission of a demand to initiate litigation on the Company's Board
or a determination by the Federal District Court in the Acosta action (now the
consolidated Sargent action) that such a demand is excused. On September 30,
2003, the Company's motion to dismiss the Beam complaint was granted in its
entirety. The plaintiffs in Beam appealed the dismissal of the complaint to the
Delaware Supreme Court. On March 31, 2004, the Delaware Supreme Court, sitting
en banc, unanimously affirmed the dismissal of the Beam complaint. The Sargent
action had previously been stayed by order of the court pending resolution of
the Beam appeal by the Delaware Supreme Court. On April 22, 2004, the court
lifted that stay and ordered the plaintiffs to respond to MSO's and the MSO
directors' previously filed motions to dismiss. In their opposition brief and at
oral argument, the plaintiffs did not oppose the dismissal of the Sargent
action, arguing only that such dismissal should be without prejudice; MSO and
the other defendants seek a with prejudice dismissal. Oral argument was held
July 23, 2004 and the court has not yet announced a decision. The Richards
action had been stayed by agreement of the parties pending resolution of the
Beam appeal by the Delaware Supreme Court. By motion filed June 4, 2004, the
plaintiff in the Richards action voluntarily sought an order dismissing the
Richards action with prejudice, and that dismissal with prejudice was ordered by
the court on June 9, 2004.
25
The Company is unable to predict the outcome of these actions or reasonably
estimate a range of possible loss at this time.
While still in their early stages, we believe the Company has substantial
defenses to the Consolidated Class Action Complaint and the derivative actions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) We held our 2004 Annual Meeting of Stockholders on June 21, 2004.
(b) The following matters were acted upon at the meeting by holders of Class A
Common Stock and Class B Common Stock voting as one class for the election of
directors to hold office until our next annual meeting and to approve an
amendment to MSO's Amended and Restated 1999 Stock Incentive Plan (the "Plan").
The amendment to the Plan permitted employees to exchange options held by them
for restricted stock units. The vote on these matters was as follows:
BOARD OF DIRECTORS ELECTION RESULTS
BROKER
VOTES FOR VOTES WITHHELD NON-VOTES
----------- ------------- ---------
Rick Boyko 304,002,248 47,091 0
Michael Goldstein 304,001,528 47,811 0
Susan Lyne 304,001,775 47,564 0
Arthur C. Martinez 303,972,116 77,223 0
Wenda Harris Millard 304,002,918 46,421 0
Sharon L. Patrick 304,005,656 43,683 0
Thomas C. Siekman 303,972,247 77,092 0
Bradley E. Singer 303,986,118 63,221 0
Jeffrey W. Ubben 303,977,662 71,677 0
AMENDMENT TO MSO'S AMENDED AND RESTATED 1999 STOCK INCENTIVE PLAN RESULTS
VOTES FOR VOTES AGAINST VOTES ABSTAIN
----------- --------------- --------------
Amendment to MSO's Amended and
Restated 1999 Stock Incentive
Plan 303,736,239 299,944 13,156
26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report:
Exhibit
Number Exhibit Title
- ---------- -----------------------------------------------------
10.1 Amendment, dated as of April 22, 2004, to the License
Agreement, by and between MSO IP Holdings, Inc. and
Kmart Corporation, dated June 21, 2001
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32 Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
(b) Reports on Form 8-K
On May 7, 2004, the Company filed a Current Report on Form 8-K reporting
its earnings for its fiscal first quarter ended March 31, 2004.
On May 11, 2004, the Company filed a Current Report on Form 8-K providing
a transcript of its fiscal first quarter earnings conference call held on
May 7, 2004.
27
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.
MARTHA STEWART LIVING OMNIMEDIA, INC.
Date: August 9, 2004
/s/ James Follo
-----------------------
Name: James Follo
Title: Executive Vice President,
Chief Financial and
Administrative Officer
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