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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2004
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 001-15395
MARTHA STEWART LIVING OMNIMEDIA, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-2187059
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
11 WEST 42ND STREET, NEW YORK, NEW YORK 10036
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 827-8000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Class A Common Stock, Par Value
$0.01 Per Share NYSE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, computed by reference to the number of shares outstanding on
March 7, 2005, but using the price at which the stock was last sold on June 30,
2004, was $195,691,338.*
* Excludes 644,473 shares of our Class A Common Stock, and 29,122,860
shares of our Class B Common Stock, held by directors, officers and our founder,
as of March 1, 2005. Exclusion of shares held by any person should not be
construed to indicate that such person possesses the power, direct or indirect,
to direct or cause the direction of the management or policies of the Company,
or that such person is controlled by or under common control with the Company.
NUMBER OF SHARES OUTSTANDING AS OF MARCH 7, 2005:
22,387,955 SHARES OF CLASS A COMMON STOCK
29,122,860 SHARES OF CLASS B COMMON STOCK
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of Martha Stewart Living Omnimedia, Inc.'s Proxy Statement for Its
Annual Meeting of Stockholders Presently Scheduled for May 10, 2005
Are Incorporated
by Reference into Part III of this Report.
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TABLE OF CONTENTS
Item 1. Business........................................................................ 3
Item 2. Properties...................................................................... 9
Item 3. Legal Proceedings............................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders............................. 11
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........... 11
Item 6. Selected Financial Data......................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................... 12
Item 7A. Quantitative and Qualitative Disclosure About Market Risk....................... 12
Item 8. Financial Statements and Supplementary Data..................................... 12
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................... 12
Item 9A. Controls and Procedures......................................................... 12
Item 9B. Other Information............................................................... 14
Item 10. Directors and Executive Officers of the Registrant.............................. 14
Item 11. Executive Compensation.......................................................... 14
Item 12. Security Ownership of Certain Beneficial Owners and Management.................. 14
Item 13. Certain Relationships and Related Transactions.................................. 14
Item 14. Principal Accountant Fees and Services.......................................... 14
Item 15. Exhibits and Financial Statement Schedules...................................... 15
Signatures................................................................................. 18
Index to Consolidated Financial Statements, Financial Statement Schedules and Other
Financial Information.................................................................... F-1
Selected Financial Data.................................................................... F-2
Management's Discussion and Analysis of Financial Conditions and
Results of Operations.................................................................... F-4
Report of Independent Registered Public Accounting Firm.................................... F-18
Consolidated Statements of Operations for years ended December 31, 2004, 2003
and 2002................................................................................. F-19
Consolidated Balance Sheets at December 31, 2004 and 2003.................................. F-20
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2004, 2003 and 2002......................................................... F-21
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003 and 2002...................................................................... F-22
Notes to Consolidated Financial Statements................................................. F-23
Financial Statement Schedule: II -- Valuation and Qualifying
Accounts for years ended December 31, 2004, 2003 and 2002................................ F-40
Exhibit Index.............................................................................. II-1
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In this Annual Report on Form 10-K, the terms "we," "us," "our," "MSO" and
the "Company" refer to Martha Stewart Living Omnimedia, Inc. and, unless the
context requires otherwise, Martha Stewart Living Omnimedia LLC ("MSLO LLC"),
the legal entity that, prior to October 22, 1999, operated many of the
businesses we now operate, and their respective subsidiaries.
Forward-Looking Statements
We have included in this Annual 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: adverse reactions to publicity relating to Martha Stewart
by consumers, advertisers and business partners; an adverse resolution to the
pending SEC enforcement proceeding 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 loss of the services of Ms. Stewart; a loss of the
services of other key personnel; 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 at 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 the sections, "Business -- Recent Developments" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
PART I
ITEM 1. BUSINESS
OVERVIEW
We are an integrated content and commerce company that creates "how-to"
content and domestic merchandise for homemakers and other consumers. Our
products are generally sold under various brand labels, including the well-known
"Martha Stewart" brand name, which we leverage across a broad range of media and
retail outlets. We primarily focus on the domestic arts, providing consumers
with the how-to ideas, information, merchandise and other resources they need to
raise the quality of living in and around their homes. The content and
merchandise we create generally span eight core areas:
- Home: decorating, collecting, and renovating.
- Cooking & Entertaining: recipes, techniques, and indoor and outdoor
entertaining.
- Gardening: planting, landscape design, and outdoor living.
- Crafts: how-to projects and similar family activities and an
appreciation of the natural world.
- Holidays: celebrating special days and special occasions.
- Keeping: homekeeping, organizing, petkeeping, clotheskeeping,
restoring, and other types of domestic maintenance.
- Weddings: all aspects of planning and celebrating a wedding.
- Baby & Kids: cooking, decorating, crafts, and other projects and
celebrations surrounding infants and children.
Our company comprises four business segments -- Publishing, Television,
Merchandising and Internet/Direct Commerce -- through which content and
merchandise relating to our eight core content areas are created and distributed
to consumers. As of March 7, 2005, we had approximately 480 employees. Our
revenues from foreign sources were $7.1 million, $8.7 million and $11.8 million
in 2004, 2003 and 2002, respectively. Substantially all of our assets are
located within the United States.
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HISTORY
Martha Stewart published her first book, Entertaining, in 1982. Over the
next eight years she became a well-known authority on the domestic arts,
authoring eight more books relating to a variety of our core content areas. In
1991, Time Publishing Ventures, Inc. ("TPV"), a subsidiary of Time Inc.,
launched Martha Stewart Living magazine with Ms. Stewart serving as its
editor-in-chief. In 1993, TPV began producing a Martha Stewart Living weekly
television program hosted by Ms. Stewart. In 1995, TPV launched a mail-order
catalog, Martha by Mail, which made available products featured in, or developed
in connection with, the magazine and television program. In late 1996 and early
1997 a series of transactions occurred resulting in MSLO LLC operating all
Martha Stewart-related businesses. Ms. Stewart was the majority owner of MSLO
LLC and TPV retained a small equity interest in the business. Additionally,
affiliates of TPV entered into various agreements with MSLO LLC pursuant to
which such affiliates would provide newsstand distribution services for our
magazines, provide fulfillment services for our magazines and direct commerce
business, publish certain books containing content originally featured in our
magazines, and provide various corporate services to us.
On October 22, 1999, MSLO LLC merged into MSO, then a wholly-owned
subsidiary of MSLO LLC. Immediately following the merger, we consummated an
initial public offering of 8,280,000 shares of our Class A Common Stock at an
offering price of $18 per share, receiving aggregate proceeds, net of
underwriting discounts, commissions and expenses, of $132.3 million.
On March 31, 2000, we purchased 1,366,000 shares of our Class A Common
Stock from TPV (approximately 52% of TPV's total equity interest in us), for
$23.79 per share, or an aggregate of $32.5 million. As part of this transaction,
TPV agreed to extend certain of the agreements we had with TPV's affiliates
described above, to continue, subject to certain limited exceptions, to hold
shares of our Class A Common Stock until 2003, and to allow us to place
advertisements in Time Inc. magazines and websites through 2004 at discounted
rates, subject to annual limitations.
RECENT DEVELOPMENTS
Since June 2002, public disclosure of various governmental investigations
into Martha Stewart's sale of non-Company stock and of the criminal and civil
proceedings against Ms. Stewart arising out of the investigations has generated
a great deal of negative publicity surrounding Ms. Stewart. Because our
principal brand and several brand labels are closely associated with the name
Martha Stewart, we have experienced substantial negative impacts on our business
as a result of the resolution of certain of these legal proceedings and
resulting 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. These adverse trends included substantial declines in
advertising in our magazines, cancellation of the Company's daily syndicated
television program and declines in cable television revenues and reduced
opportunities for new merchandising initiatives.
In August 2004, we decided to discontinue the Catalog for Living and its
online product offerings, which are included in the Internet/Direct Commerce
segment. The operations of the Catalog for Living and the online component of
this business were not profitable. In the future, the Internet/ Direct Commerce
segment will principally consist of our online flowers program,
marthasflowers.com, as well as the online content portion of our business.
Although we cannot provide any assurances regarding future trends, based
on our current view of the market, we are cautiously optimistic about the
Company's prospects in 2005, including prospects for an increase in advertising
pages and revenue in certain of the Company's magazines, as well as potential
benefits from the launch of a new syndicated television program in the Fall of
2005, which is being distributed by NBC Universal Domestic Television
Distribution.
Additionally, as part of an agreement with Mark Burnett, a well regarded
producer of prime-time programming, the Company will participate in the
production of a primetime network television series titled, The Apprentice:
Martha Stewart. This new program will feature Martha Stewart as the host and
will be broadcast by NBC in primetime. While MSO will not have a direct
financial interest in the program, MSO expects to benefit from promotion of the
Company's brands, products and its business. We expect that this program will
expose the brand to a wider audience of viewers, consumers and business
partners.
4
BUSINESS SEGMENTS
Our four business segments are described below. Additional financial
information relating to these segments may be found in Note 16 to our
Consolidated Financial Statements on page F-38 of this Report.
PUBLISHING
Our Publishing segment currently consists of our operations relating to
magazines, books, radio and newspapers. In 2004, revenues from magazine
advertising and circulation represented approximately 35% and 63% of the
segment's revenues, respectively.
MAGAZINES
Martha Stewart Living. Martha Stewart Living, our flagship magazine, is
the foundation of our publishing business. It was launched in 1991 as a
quarterly publication with a circulation of 250,000. In 2001, we increased the
frequency from eleven to twelve times per year. Starting with the January 2004
issue, we guaranteed our advertisers a minimum circulation of 1.8 million,
compared to 2.3 million for 2003. This adjustment allowed us to focus on our
core demographics. Advertising pages, as reported to Publisher's Information
Bureau, were 659 pages in 2004, 1,234 pages in 2003 and 1,887 in 2002.
Martha Stewart Living appeals primarily to the college-educated woman
between the ages of 25 and 54 who owns her principal residence. Martha Stewart
Living seeks to offer reference-quality and original how-to information from our
core content areas for the homemaker and other consumers in a unique upscale
editorial and aesthetic environment. Martha Stewart Living has won numerous
prestigious industry awards. Revenues generated by Martha Stewart Living
magazine constitute the substantial majority of our magazine revenues.
Everyday Food. We launched Everyday Food in September of 2003 after
publishing four test issues earlier in the year. Everyday Food, a digest sized
magazine, was created for the supermarket shopper and the everyday cook,
featuring quick, easy recipes. The magazine targets women ages 25 to 49, and is
intended to broaden our consumer audience while developing a new brand.
Effective January 1st 2005, we guaranteed advertisers a circulation of 800,000
per issue, up from 750,000 per issue for the five issues published in the second
half of 2004 and up from 500,000 per issue for the five issues published in the
first half of 2004.
Martha Stewart Weddings. We launched Martha Stewart Weddings in 1994 as an
annual publication, and extended it to a semi-annual publication in 1997. In
1999, Martha Stewart Weddings became a quarterly publication. Martha Stewart
Weddings targets the upscale bride and serves as an important vehicle for
introducing young women to our brands. Martha Stewart Weddings is sold primarily
through newsstand distribution and had an average circulation of 249,000 per
issue in the second half of 2004.
Special Interest Publications. We also publish certain special interest
magazine editions, beginning with one in 1998, growing to eight publications in
2004. Our Special Interest Publications provide in-depth advice and ideas around
a particular topic contained in one or more of our core content areas, allowing
us to draw upon our distribution network and brand name to further promote our
expertise in our core content areas. Additionally, we use this format to explore
additional content areas, potential new standalone titles and branding
variations. Our Special Interest Publications can either be sponsored by a
single advertiser or multiple advertisers, or contain no advertising, and,
depending on the issue, may be sold at newsstands, distributed to subscribers
with issues of Martha Stewart Living, or sold as part of an annual subscription.
Body & Soul. In August 2004, the Company acquired certain assets and
liabilities of Body & Soul magazine and Dr. Andrew Weil's Self Healing
newsletter, which are publications featuring "natural living" content. The
primary purpose of the acquisition was to enter a new market and to launch
"natural living" as a new lifestyle category and brand for the Company. The
newsletter generates substantially all of its revenue from subscriptions, while
the magazine generates both advertising and circulation revenue. Body & Soul had
a guaranteed circulation of 230,000 per issue as of December 31, 2004.
Magazine Production, Distribution and Fulfillment. We print most of our
domestic magazines under agreements with R. R. Donnelly. We currently purchase
paper through an agreement with Time Inc. Paper for use in
5
our domestic magazines is widely available. We use no other significant raw
materials in our businesses. Newsstand distribution of the magazines is
conducted by an affiliate of Time Inc. under an agreement that expires with the
December 2007 issue of Martha Stewart Living, but which we currently have the
right to cancel. Our subscription fulfillment services are provided by another
affiliate of Time Inc. under an agreement that expires in December 2005, and is
renewable for an additional three-year period at our option.
BOOKS
We create two different types of books: Martha Stewart Living books and
Martha Stewart-authored books. Our current book library comprises 49 titles. Of
these books, 35 are Martha Stewart Living books, and 14 are Martha
Stewart-authored books. We own the copyrights to all these books.
Martha Stewart Living Books. Historically, these books consist of a
mixture of content previously published in our magazines and original material.
In 2004 we created three Martha Stewart Living books; however, we currently do
not plan on publishing any books under this series in 2005.
Martha Stewart-Authored Books. Under an agreement with Clarkson N. Potter,
we have created 14 completely original Martha Stewart-authored books, and are
obligated to deliver one more book. These books are generally sold by Clarkson
N. Potter through retail distribution channels.
NEWSPAPER COLUMN
Our syndicated newspaper columns appear weekly in approximately 100
newspapers in North America. In general, the columns provide informative how-to
content in response to particular questions posed by our consumers. The
newspaper columns are syndicated by The New York Times Syndication Sales
Corporation. Our distribution partner pays us a percentage of the revenues
generated by these properties. While the revenue contributed by the business is
small, our columns provide low-cost brand promotion outside our core audience.
COMPETITION
Publishing is a highly competitive business. Our magazines, books and
related publishing products compete with other mass media and many other types
of leisure-time activities. Overall competitive factors in this segment include
price as well as editorial and aesthetic quality. Competition for advertising
dollars in magazine operations is primarily based on advertising rates as well
as editorial and aesthetic quality, the desirability of the magazine's
demographic, reader response to advertisers' products and services and
effectiveness of the advertising sales staff. Martha Stewart Living competes for
readers and advertising dollars with women's service, decorating, cooking and
lifestyle magazines. Everyday Food competes for readers and advertising dollars
with women's service and cooking magazines. Martha Stewart Weddings competes for
readers and advertising dollars primarily in the wedding service magazine
category. Our Special Interest Publications can compete with a variety of
magazines depending on the focus of the particular issue. Body & Soul competes
for readers and advertising dollars primarily with women's lifestyle and natural
living magazines.
SEASONALITY
Our Publishing segment can experience fluctuations in quarterly
performance due principally to publication schedule variations from year to year
and other seasonality factors. Martha Stewart Weddings was published five times
in 2004, including one special issue: three issues in the second quarter and two
issues in the fourth quarter. Additionally, the publication schedule for our
Special Interest Publications can vary and lead to quarterly fluctuations in the
segment's results.
TELEVISION
Our Television business segment consists of our operations relating to the
production of new television programming and to the domestic and international
distribution of that programming in existing and repurposed formats through a
variety of distribution channels, including syndication and cable broadcast. We
own the copyrights in the television programming we produce.
Through September 2004 the operations of the television segment
principally consisted of the Martha Stewart Living show, a syndicated how-to
program hosted by Martha Stewart consisting of several segments, each of which
generally showcases one or several of our eight core content areas. King World
Productions, Inc. syndicated the
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program domestically. Under the arrangement with King World, we were compensated
partially in cash through license fees and partially in airtime. We then sold
that airtime to advertisers, subject to a distribution fee payable to King
World. In September of 2004, we discontinued airing of the program. In the Fall
of 2005 we expect to produce and air a new nationally syndicated daily program
featuring Martha Stewart. This new show is being distributed by NBC Universal
Domestic Television Distribution.
Our television operations also include a cable television distribution
agreement with The Style Network, which airs repurposed programming from the
Martha Stewart Living program and a weekly syndicated program - Petkeeping with
Marc Morrone, a nationally syndicated half-hour program. This program focuses on
providing practical how-to information about the care of all types of pets. The
program is syndicated by Tribune Entertainment. Beginning in January 2005 we
launched Everyday Food as a weekly show airing on PBS stations nationwide. The
television program offers quick, easy and practical solutions for preparing
everyday meals.
In 2004 this business segment also included revenue from an agreement with
The Food Network which was terminated in the third quarter of 2004.
COMPETITION
Series television is a highly competitive business. Our television
programs compete directly for viewers, distribution and/or advertising dollars
with other how-to television programs, as well as with general programming on
other television stations. Overall competitive factors in this segment include
programming content, quality and distribution and demographics of the
programming. Similar to publishing, competition for advertising dollars is
primarily based on advertising rates, the demographics of the audience, viewer
response to advertisers' products and services and effectiveness of the
advertising sales staff.
MERCHANDISING
Our Merchandising segment consists of our operations relating to the
design of merchandise and related packaging, promotional and advertising
materials, and the licensing of various trademarks owned by us, in connection
with retail programs conducted through third-party retailers and manufacturers.
MARTHA STEWART EVERYDAY
Martha Stewart Everyday is the brand under which our merchandise is sold
in the mass-market and national chain channels of distribution. Currently, the
label is associated with products that generally fall into the following
categories: Home (which includes sheets, towels, pillows, bath accessories,
window treatments and kitchen textiles), Garden (which includes outdoor
furniture and accessories, garden tools, planting pots, bulbs and seeds),
Kitchen (which includes cookware, bakeware, utensils, dinnerware, flatware, and
beverageware), Keeping (which includes organizational products relating to the
pantry, closet and laundry), Decorating (which includes mirrors, picture frames,
candles and lamps), Holiday (which includes artificial Christmas trees,
decorating products and ornaments) and Colors (which consists of a line of
interior paints available in 256 colors).
In the United States and Canada, these products, other than the paint
products, are sold pursuant to exclusive agreements with retailers. Pursuant to
these agreements, we are primarily responsible for the design of all merchandise
and related packaging, signage and advertising and promotional materials, while
our retail partners source the products through a large manufacturer base and
are responsible for the promotion of the product. In the United States we have
an exclusive license agreement with Kmart Corporation. In Canada, we have an
exclusive license agreement with Sears Canada, which launched the Martha Stewart
Everyday brand label in September 2003. Paint products are manufactured pursuant
to an agreement with The Sherwin-Williams Company and are then distributed by
Sherwin-Williams to retailers, including Kmart and Sears in the United States.
We own the Martha Stewart Everyday trademark and generally retain all
intellectual property rights related to the designs of the merchandise,
packaging, signage and collateral materials developed for the various programs.
We are also generally assured sufficient in-store presence and volume to
establish and protect our brands through guaranteed minimum royalties and
through dedicated store-within-a-store selling formats.
The company has license agreements for the use of the Martha Stewart
Everyday brand as follows:
License Partner Basis For Royalties Expiration Date
Kmart Corporation Retail sales of certain MSE products January 2010
Sears Canada Inc. Retail sales of certain MSE products August 2008
The Sherwin-Williams Company Wholesale sale of MSE products December 2005
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MARTHA STEWART SIGNATURE
Martha Stewart Signature is the brand label under which our products are
offered in the specialty channel of distribution. Through licensing agreements
we have developed a national network of retailers offering coordinated
categories of home decorating products. We own the trademark Martha Stewart
Signature and generally retain all intellectual property rights related to the
designs of the merchandise, packaging, signage and collateral materials
developed for the various programs.
Paint. Through an agreement with The Sherwin-Williams Company, which
expires in December 2005, our Martha Stewart Signature Color Palette, consisting
of 416 colors, is available at Sherwin-Williams stores nationwide. Consumers are
able to have any of the colors mixed in a wide variety of Sherwin-Williams
paints. We receive royalties on the sale of all paints mixed in a Martha Stewart
Signature color.
Furniture. Beginning in March 2003, furniture products for the living
room, bedroom, and dining room became available at furniture stores and
department stores nationwide. Through an agreement with Bernhardt Furniture
Company, Inc., these products are designed by us and the Bernhardt design staff
and manufactured and distributed by Bernhardt. Our agreement provides for
royalty payments to us on sales of our products by Bernhardt and expires in
early 2008.
Flooring. The Company's agreement with Shaw Industries, Inc. to sell a
line of floor covering products was terminated in late 2004.
COMPETITION
The retail merchandising business is highly competitive. The principal
competition for our Martha Stewart Everyday lines is the competitors of the
retail stores in which these products are sold, including Wal-Mart and Target as
well as other products in the respective product categories. Competitive factors
include numbers and locations of stores, brand awareness and price. The
principal competition for our Martha Stewart Signature products comes from other
products in the respective product categories available at the participating
stores, including branded and non-branded merchandise.
SEASONALITY
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 recognize a substantial portion of the revenue
resulting from the difference between the minimum royalty amount under the Kmart
contract and royalties paid on actual sales in the fourth quarter of each year,
when the amount can be determined.
INTERNET/DIRECT COMMERCE
Our Internet/Direct Commerce segment consists of our operations relating
to our content and commerce businesses. In August 2004, we decided to
discontinue the Catalog for Living and its online product offerings, which
historically was included in the Internet/Direct Commerce segment. The last
catalog offering our products was mailed in the fourth quarter of 2004, with the
remaining inventory expected to be sold in the early part of 2005. Once we have
completely ceased operation of the catalog and related online product sales, the
segment's operations will primarily consist of our online flowers program,
marthasflowers.com, as well as the content portion of our online business.
MARTHA'S FLOWERS
Launched in 1999, marthasflowers.com provides fresh floral products
shipped directly from farms to consumers. This business model enables customers
to ship floral gifts overnight, delivering Martha Stewart inspired designs with
superior freshness. Product categories include grower's bunches, mixed bouquets,
blooming plants, fresh wreaths and garlands. Marthasflowers.com is marketed
primarily through MSO media assets.
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CONTENT
The content portion of our website offers information related to all of
our publications, as well as television program guides and various other
features. We sell advertising on our website individually and as part of
multi-media packages. One of our principal strategies is to use the content
portions of our website to attract visitors and communicate in a low-cost manner
with our core audiences. The website is also an important source of generating
new magazine subscribers at low incremental costs. We believe the content
portion of our website is popular with our consumers and is an important
ingredient in sustaining brand loyalty and cross-promoting our various
activities.
Substantially all of this segment's 2004 revenues were from the sale of
merchandise. In 2005, we expect the substantial portion of the revenue of the
Internet/ Direct Commerce segment will be generated from our flowers business
and to a lesser extent from advertising sales.
COMPETITION
The online flower and content businesses are highly competitive.
Competition in our flower business includes other online sellers of farm direct
flowers. The content business competes for advertising revenue on the basis of
our content and the frequency and quality of our online traffic.
SEASONALITY
In the future, Internet/Direct Commerce segment revenues will likely be
tied to certain key holidays throughout the year, as the floral business is
holiday driven.
INTELLECTUAL PROPERTY
We use multiple trademarks to distinguish our brands, including Martha
Stewart Living, Martha Stewart Everyday, Martha Stewart Signature, Everyday
Food, Martha Stewart Weddings, marthastewart.com, marthasflowers and Body &
Soul. These and numerous other trademarks are the subject of registrations and
pending applications, both domestically and internationally, filed by us for use
with a variety of products and other content, and we continue to expand our
worldwide usage and registration of related trademarks. We file copyrights
regarding our proprietary designs and editorial content on a regular basis. We
regard our rights in and to our trademarks and materials as valuable assets in
the marketing of our products and vigorously seek to protect them against
infringement and denigration by third parties. We own and license the rights to
many of these marks pursuant to an agreement between us and Ms. Stewart, which
is described under Item 13 of this Report.
AVAILABLE INFORMATION
Our website can be found on the Internet at www.marthastewart.com. The
website, in addition to the offerings described under Internet/Direct Commerce,
contains information about us and our operations. Our proxy statements, Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form
8-K, as well as certain of our other filings with the Securities and Exchange
Commission, can be viewed and downloaded free of charge as soon as reasonably
practicable after they have been filed with the SEC by accessing
marthastewart.com and clicking on Investor Relations and SEC Filings.
ITEM 2. PROPERTIES
Information concerning the location, use and approximate square footage of
our principal facilities, all of which are leased, is set forth below:
APPROXIMATE AREA
LOCATION USE IN SQUARE FEET
-------- --- --------------
11 West 42nd Street, Principal executive and 73,383
New York, New York administrative offices; publishing
offices; and sales offices
9
19 Newtown Turnpike, Executive and administrative 30,523
Westport, Connecticut offices for Television, including
the television studio and
production facilities; and sales
offices for Television
601 West 26th Street, Product design facilities, 149,421
New York, New York photography studio, test kitchens,
and prop storage
The leases for these offices and facilities expire between June 2006 and
June 2012, and some of these leases are subject to our renewal. We anticipate
that we will be able to extend these leases on terms satisfactory to us or, if
necessary, locate substitute facilities on acceptable terms.
We also lease the right to use various properties owned by Martha Stewart
for our editorial, creative and product development processes. These living
laboratories allow us to experiment with new designs and new products, such as
garden layouts, and help generate ideas for new content available to all of our
media outlets. The terms of this location rental agreement are described in Item
13 of this Report.
We believe that our existing facilities are well maintained and in good
operating condition.
ITEM 3. 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, and certain other officers and directors
of the Company as defendants: 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 New York. 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.
10
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.
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. By order dated
August 4, 2004, the Company's motion to dismiss the Sargent complaint was
granted in its entirety, and as to the issue of plaintiffs' failure to make
pre-suit demand, with prejudice. The Sargent plaintiffs' time to appeal that
dismissal has expired. 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. By
stipulation and order entered September 24, 2004, the parties to the Shareholder
Derivative Litigation agreed to the dismissal of that action on the same terms
as ordered by the Sargent Court in dismissing the Sargent Action.
While still in its early stages, we believe the Company has substantial defenses
to the remaining Consolidated Class Action Complaint. The Company is unable to
predict the outcome of that action or reasonably estimate a range of possible
loss at this time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the fourth
quarter of our fiscal year ending December 31, 2004.
PART II
ITEM 5. MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
SECURITIES MATTERS
Our Class A Common Stock is listed and traded on The New York Stock
Exchange. Our Class B Common Stock is not listed or traded on any exchange, but
is convertible into Class A Common Stock at the option of its owner on a
share-for-share basis.
Q1 2003 Q2 2003 Q3 2003 Q4 2003 Q1 2004 Q2 2004 Q3 2004 Q4 2004
------- ------- ------- ------- ------- ------- ------- -------
High Sales Price $ 10.48 $ 12.65 $ 9.49 $ 11.30 $ 17.00 $ 11.25 $ 19.60 $ 33.50
Low Sales Price $ 7.10 $ 7.79 $ 7.56 $ 8.78 $ 9.22 $ 8.25 $ 8.01 $ 15.35
As of March 7, 2005, there were 7,184 record holders of our Class A Common
Stock and one record holder of our Class B Common Stock. We believe that there
is a significantly larger number of beneficial owners of our Class A Common
Stock.
We have not paid any dividends on our common stock and we have no
intention to pay any dividends in the foreseeable future.
11
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth on page F-2 of this
Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this Item is set forth on pages F-4 through
F-17 of this Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth on pages F-19 through
F-41 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial and Administrative
Officer, we evaluated the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this report. Based upon that
evaluation, our Chief Executive Officer and Chief Financial and Administrative
Officer concluded that our disclosure controls and procedures were effective to
provide reasonable assurance that we record, process, summarize and report the
information we must disclose in reports that we file or submit under the
Securities Exchange Act of 1934, as amended, within the time periods specified
in the SEC's rules and forms.
Evaluation of Changes in Internal Control over Financial Reporting
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial and Administrative
Officer, we have determined that, during the fourth quarter of fiscal 2004,
there were no changes in our internal control over financial reporting that have
affected, or are reasonably likely to affect, materially our internal control
over financial reporting.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. Under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial and Administrative Officer, we assessed the effectiveness of our
internal control over financial reporting as of the end of the period covered by
this report based on the framework in "Internal Control -- Integrated Framework"
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on that assessment, our Chief Executive Officer and Chief Financial and
Administrative Officer concluded that our internal control over financial
reporting was effective to provide reasonable assurance regarding the
reliability of our financial reporting and the preparation of our financial
statements for external purposes in accordance with United States generally
accepted accounting principles.
Our independent registered public accounting firm, Ernst & Young LLP, has
issued an attestation report on our management's assessment of our internal
control over financial reporting. The attestation report is included herein.
12
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
To The Board of Directors and Shareholders of
Martha Stewart Living Omnimedia, Inc.
We have audited management's assessment, included in Management's Report on
Internal Control Over Financial Reporting, that Martha Stewart Living Omnimedia,
Inc. maintained effective internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). Martha Stewart Living Omnimedia, Inc.'s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Martha Stewart Living Omnimedia,
Inc. maintained effective internal control over financial reporting as of
December 31, 2004, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, Martha Stewart Living Omnimedia, Inc.
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the related consolidated balance
sheets of Martha Stewart Living Omnimedia, Inc. as of December 31, 2004 and
2003, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 2004 and our report dated March 15, 2005 expressed an unqualified opinion
thereon.
Ernst & Young LLP
New York, New York
March 15, 2005
13
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth in our Proxy Statement
for our annual meeting of stockholders scheduled to be held on May 10, 2005 (our
"Proxy Statement") under the captions "ELECTION OF DIRECTORS -- Information
Concerning Nominees," "INFORMATION CONCERNING EXECUTIVE OFFICERS," and "SECTION
16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" and is hereby incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in our Proxy Statement
under the captions "COMPENSATION OF OUTSIDE DIRECTORS," "EXECUTIVE
COMPENSATION," "EMPLOYMENT AND SEVERANCE ARRANGEMENTS," "EQUITY COMPENSATION
PLANS," AND "COMPENSATION AND CORPORATE GOVERNANCE COMMITTEE REPORT ON EXECUTIVE
COMPENSATION" and is hereby incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in our Proxy Statement
under the caption "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT" and is hereby incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth in our Proxy Statement
under the caption "CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS" and is
hereby incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is set forth in our Proxy Statement
under the caption "PRINCIPAL ACCOUNTANT FEES AND SERVICES" and is hereby
incorporated herein by reference.
14
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) and (2) Financial Statements and Schedules: See page F-1 of this Report.
(3) Exhibits:
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -------------
3.1 -- Martha Stewart Living Omnimedia, Inc.'s Certificate of Incorporation
(incorporated by reference to our Registration Statement on Form S-1, File
Number 333-84001 (the "Registration Statement")).
3.2 -- Martha Stewart Living Omnimedia, Inc.'s By-Laws (incorporated by reference to the
Registration Statement).
10.1 -- Form of Stockholders' Agreement (incorporated by reference to the Registration
Statement).
10.2 -- 1999 Stock Incentive Plan (incorporated by reference to the Registration
Statement).+
10.2.1 -- Amendment Number 1 to 1999 Stock Incentive Plan, dated as of March 9, 2000
(incorporated by reference to our Annual Report on Form 10-K for the year ended
December 31, 1999, File Number 001-15395 (the "1999 10-K")).+
10.2.2 -- Amendment Number 2 to 1999 Stock Incentive Plan, dated as of May 11, 2000
(incorporated by reference to our Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, File Number 001-15395 (the "June 2000 10-Q")).+
10.3 -- 1999 Non-Employee Director Stock and Option Compensation Plan (incorporated by
reference to the Registration Statement).+
10.4 -- Martha Stewart Living Omnimedia LLC Nonqualified Class A LLC Unit/Stock Option
Plan (incorporated by reference to the Registration Statement).+
10.5 -- Form of Employment Agreement, dated as of October 22, 1999, by and between Martha
Stewart Living Omnimedia, Inc. and Martha Stewart (incorporated by reference to
the Registration Statement).+
10.6 -- Form of Intellectual Property License and Preservation Agreement, dated as of
October 22, 1999, by and between Martha Stewart Living Omnimedia, Inc. and Martha
Stewart (incorporated by reference to the Registration Statement).
10.7 -- Form of Location Rental Agreement, dated as of October 22, 1999, by and between
Martha Stewart Living Omnimedia, Inc. and Martha Stewart (incorporated by
reference to the Registration Statement).
10.7.1 -- Amendment, dated as of January 1, 2003, to Location Rental Agreement, dated as of
October 22, 1999, by and between Martha Stewart Living Omnimedia, Inc. and Martha
Stewart (incorporated by reference to the 2002 10-K).
10.8 -- Lease, dated as of September 24, 1992, between Tishman Speyer Silverstein
Partnership and Time Publishing Ventures, Inc., as amended by First Amendment of
Lease dated as of September 24, 1994 between 11 West 42 Limited Partnership and
Time Publishing Ventures, Inc. (incorporated by reference to the Registration
Statement).
10.9 -- Lease, dated as of March 31, 1998, between 11 West 42 Limited Partnership and
Martha Stewart Living Omnimedia LLC (incorporated by reference to the Registration
Statement).
10.10 -- Lease, dated August 20, 1999, between 601 West Associates LLC and Martha
Stewart Living Omnimedia LLC (incorporated by reference to the Registration
Statement).
15
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -------------
10.10.1 -- First Lease Modification Agreement, dated December 24, 1999, between 601 West
Associates LLC and Martha Stewart Living Omnimedia, Inc. (incorporated by
reference to the 1999 10-K).
10.11 -- Lease, dated as of October 1, 2000, between Newtown Group Properties Limited
Partnership and Martha Stewart Living Omnimedia, Inc. (incorporated by reference
to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, File
Number 001-15395 (the "June 2001 10-Q")).
10.12 -- License Agreement, dated June 21, 2001 by and between Kmart Corporation and MSO IP
Holdings, Inc. (incorporated by reference to the June 2001 10-Q).
10.14.1 -- Split-Dollar Life Insurance Agreement, dated February 28, 2001, by and among
Martha Stewart Living Omnimedia, Inc., Martha Stewart and The Martha Stewart
Family Limited Partnership (incorporated by reference to our Annual Report on Form
10-K for the year ended December 31, 2000, File Number 001-15395 (the "2000
10-K")).+
10.14.2 -- Amendment, dated January 28, 2002, to Split-Dollar Life Insurance Agreement, dated
February 28, 2001, by and between Martha Stewart Living Omnimedia, Inc., Martha
Stewart and The Martha Stewart Family Limited Partnership (incorporated by
reference to our Annual Report on Form 10-K for the year ended December 31, 2001,
File Number 001-15395 (the "2001 10-K")).+
10.14.3 -- Amendment, dated as of January 1, 2003, to Split-Dollar Life Insurance Agreement,
dated February 28, 2001, as amended, by and among Martha Stewart Living Omnimedia,
Inc., Martha Stewart and The Martha Stewart Family Limited Partnership
(incorporated by reference to the 2002 10-K).
10.15 -- Investment Agreement, dated as of January 8, 2002, by and among Martha Stewart
Living Omnimedia, Inc., The Martha Stewart Family Limited Partnership, L.P.,
ValueAct Capital Partners, L.P., ValueAct Capital Partners II, L.P. and
ValueAct Capital International, Ltd (incorporated by reference to the 2001
10-K).
10.16 -- Martha Stewart Living Omnimedia, Inc. 2002 Executive Severance Pay Plan
(incorporated by reference to our Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002, File Number 001-15395).+
10.17 -- Martha Stewart Living Omnimedia, Inc. 2002 Performance-Based Executive Bonus Plan
(incorporated by reference to the 2002 10-K). +
10.18 -- Martha Stewart Living Omnimedia, Inc. 2003 Key Executive Bonus Plan (incorporated
by reference to the 2003 10-K).+
10.20 -- Amendment, dated as of March 15, 2004 to the Employment Agreement, dated October
22, 1999, as amended, by and between the Company and Martha Stewart (incorporated
by reference to the March 2004 10-Q). +
10.21 -- Amendment, dated as of March 15, 2004 to the Location Rental Agreement, dated
October 22, 1999, as amended, by and between the Company and Martha Stewart
(incorporated by reference to the March 2004 10-Q). +
10.22 -- 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 (incorporated by
reference to our quarterly report on Form 10-Q for the quarter ended June 30,
2004).
10.23 -- Employment Agreement dated as of September 17, 2004, between Martha Stewart Living
Omnimedia, Inc. and Martha Stewart (incorporated by reference to our Current
Report on Form 8-K filed on September 23, 2004). +
10.24 -- Location Rental Agreement dated as of September 17, 2004, between Martha Stewart
Living Omnimedia, Inc. and Martha Stewart (incorporated by reference to our
Current Report on Form 8-K filed on September 23, 2004). +
10.25 -- Letter Agreement dated September 17, 2004 between Martha Stewrt Living Omnimedia,
Inc. and Martha Stewart (incorporated by reference to our Current Report on Form
8-K filed on September 23, 2004). +
10.26 -- Employment Agreement dated as of November 11, 2004, between Martha Stewart Living
Omnimedia, Inc. and Susan Lyne (incorporated by reference to our Current Report on
Form 8-K filed on November 16, 2004). +
10.27 -- Restricted Stock Agreement dated as of November 11, 2004, between
Martha Stewart Living Omnimedia, Inc. and Susan Lyne (incorporated by reference
to our Current Report on Form 8-K filed on November 16, 2004). +
10.28 -- Stock Option Agreement dated as of November 11, 2004, between Martha Stewart
Living Omnimedia, Inc. and Susan Lyne (incorporated by reference to our Current
Report on Form 8-K filed on November 16, 2004). +
16
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -------------
21 -- List of Subsidiaries.
31.1 -- Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 -- Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 -- Certification of Chief Executive Officer and Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Disclosures Required by Section 303A.12 of the NYSE Listed Company Manual.
Section 303A.12 of the NYSE Listed Company Manual requires the Chief Executive
Officer of each listed company to certify to the NYSE each year that he or she
is not aware of any violation by the listed company of any of the NYSE corporate
governance listing standards. The Chief Executive Officer of MSO submitted the
required certification without qualification to the NYSE as of September, 2004.
In addition, the certifications of the Chief Executive Officer and the Chief
Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002 (the
"SOX 302 Certifications") with respect to MSO's disclosures in its Annual Report
on Form 10-K for the year ended December 31, 2003 were filed as Exhibits 31.1
and 31.2 to such Annual Report on Form 10-K. The SOX 302 Certifications with
respect to MSO's disclosures in its Form 10-K for the year ended December 31,
2004 are being filed as Exhibits 31.1 and 31.2 to this Annual Report on Form
10-K.
+ Indicates management contracts and compensatory plans.
17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ Susan Lyne
--------------------------
Name: Susan Lyne
Title: President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
SIGNATURE TITLE
--------- -----
/s/ Susan Lyne President, Chief Executive Officer and
- -------------------------------- Director (Principal Executive Officer)
Susan Lyne
/s/ James Follo Chief Financial and Administrative Officer
- -------------------------------- (Principal Financial and Accounting Officer)
James Follo
/s/ Rick Boyko Director
- --------------------------------
Rick Boyko
/s/ Michael Goldstein Director
- --------------------------------
Michael Goldstein
/s/ Charles Koppelman Vice Chairman of the Board
- --------------------------------
Charles Koppelman
/s/ Wenda Harris Millard Director
- --------------------------------
Wenda Harris Millard
/s/ Thomas C. Siekman Chairman of the Board
- --------------------------------
Thomas C. Siekman
/s/ Bradley E. Singer Director
- --------------------------------
Bradley E. Singer
/s/ Jeffrey W. Ubben Director
- --------------------------------
Jeffrey W. Ubben
Each of the above signatures is affixed as of March 15, 2005.
18
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS,
FINANCIAL
STATEMENT SCHEDULES AND OTHER FINANCIAL
INFORMATION
Selected Financial Data F-2
Management's Discussion and Analysis of Financial Condition and
Results of Operations F-4
Consolidated Financial Statements:
Report of Independent Registered Public Accounting Firm F-18
Consolidated Statements of Operations for each of the three years in the period ended
December 31, 2004, 2003 and 2002 F-19
Consolidated Balance Sheets at December 31, 2004 and 2003 F-20
Consolidated Statements of Shareholders' Equity for each of the three years in the
period ended December 31, 2004, 2003, and 2002 F-21
Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 2004, 2003, and 2002 F-22
Notes to Consolidated Financial Statements F-23
Financial Statement Schedule:
II- Valuation and Qualifying Accounts for each of the three years ended December 31,
2004, 2003, and 2002 F-40
All other schedules are omitted because they are not applicable or the required
information is shown in the Consolidated Financial Statements or Notes thereto.
F-1
SELECTED FINANCIAL DATA
FIVE YEARS ENDED DECEMBER 31,
(IN THOUSANDS EXCEPT PER SHARE DATA)
2004 2003 2002 2001 2000
--------- ----------- ---------- ---------- ---------
INCOME STATEMENT DATA
REVENUES
Publishing $ 96,035 $ 135,936 $ 182,600 $ 177,422 $ 175,774
Television 10,505 25,704 26,680 29,522 32,464
Merchandising 53,386 53,395 48,896 35,572 24,345
Internet/Direct Commerce 27,512 30,813 36,873 46,094 49,739
--------- ----------- ---------- ---------- ---------
Total revenues 187,438 245,848 295,049 288,610 282,322
--------- ----------- ---------- ---------- ---------
Operating income (loss) (60,004) (6,405) 19,993 37,064 31,707
--------- ----------- ---------- ---------- ---------
Income (loss) from continuing operations (59,073) (1,923) 13,314 23,615 21,278
--------- ----------- ---------- ---------- ---------
Loss from discontinued operations (526) (848) (2,909) (1,709) -
--------- ----------- ---------- ---------- ---------
Cumulative effect of accounting change - - (3,137) - -
--------- ----------- ---------- ---------- ---------
Net income (loss) $ (59,599) $ (2,771) $ 7,268 $ 21,906 $ 21,278
--------- ----------- ---------- ---------- ---------
PER SHARE DATA
Earnings per share:
Basic-Income (loss) from continuing operations $ (1.19) $ (0.04) $ 0.27 $ 0.49 $ 0.44
Basic-Loss from discontinued operations (0.01) (0.02) (0.06) (0.04) -
Basic-Cumulative effect of accounting change - - (0.06) - -
--------- ----------- ---------- ---------- ---------
Basic-Net Income (loss) $ (1.20) $ (0.06) $ 0.15 $ 0.45 $ 0.44
========= =========== ========== ========== =========
Diluted-Income (loss) from continuing operations $ (1.19) $ (0.04) 0.27 0.48 $ 0.43
Diluted-Loss from discontinued operations (0.01) (0.02) (0.06) (0.03) -
Diluted-Cumulative effect of accounting change - - (0.06) - -
--------- ----------- ---------- ---------- ---------
Diluted-Net income (loss) $ (1.20) $ (0.06) $ 0.15 $ 0.45 $ 0.43
========= =========== ========== ========== =========
Weighted average common shares outstanding
Basic 49,712 49,389 49,250 48,639 48,678
Diluted 49,712 49,389 49,343 49,039 49,623
FINANCIAL POSITION
Cash and cash equivalents $ 104,647 $ 165,566 $ 158,840 $ 87,968 $ 98,113
Short-term investments 35,309 3,100 20,110 53,194 29,312
Total assets 264,678 309,102 324,542 311,621 297,414
Shareholders' equity 187,628 236,665 236,635 222,192 196,116
OTHER FINANCIAL DATA
Cash flow provided by (used in) operating activities $ (22,226) $ (9,634) $ 38,042 $ 19,389 $ 39,538
Cash flow provided by (used in) investing activities (39,756) 15,956 28,777 (31,941) 10,922
Cash flow provided by (used in) financing activities 1,063 404 4,053 2,407 (28,794)
F-2
NOTES TO SELECTED FINANCIAL DATA
GENERAL
Prior years are reclassified to conform with the current-year
presentation.
EARNINGS FROM CONTINUING OPERATIONS
FISCAL 2004 results include royalty revenue of $1.6 million related to the
dissolution of a merchandising licensing agreement. The results also
include a non-cash equity compensation charge of $3.9 resulting from the
modification of the terms of certain previously granted employee stock
options.
FISCAL 2003 nonrecurring items primarily represented a $1.7 million
reduction in the net carrying value of certain assets located in our
Connecticut television studio.
FISCAL 2002 nonrecurring items primarily represented a $7.7 million
restructuring charge resulting from the write down of inventory of $1.6
and website development costs of $6.1 million in the Internet/Direct
Commerce segment as well as a $1.2 million pension plan termination.
FISCAL 2001 has been restated to reflect the results of the Wedding List
as a discontinued operation.
F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONS AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2004, TO YEAR ENDED DECEMBER 31, 2003
EXECUTIVE SUMMARY
Since June 2002, public disclosure of various governmental investigations
into Martha Stewart's sale of non-Company stock and of the criminal and
civil proceedings against Ms. Stewart arising out of the investigations
has generated a great deal of negative publicity surrounding Ms. Stewart.
Because our principal brand and several brand labels are closely
associated with the name Martha Stewart, we have experienced substantial
negative impacts on our business as a result of the resolution of these
legal proceedings and resulting 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.
Although we cannot provide any assurances regarding future trends, based
on our current view of the market, we are cautiously optimistic about the
Company's prospects in 2005, including prospects for an increase in
advertising pages and revenue in certain of the Company's magazines, as
well as potential benefits from the launch of a new syndicated television
program in the Fall of 2005, which is being distributed by NBC Universal
Domestic Television Distribution. Additionally, as part of an agreement
discussed below, the Company will participate in the production of a
primetime network television series titled, The Apprentice: Martha
Stewart. This new program will feature Martha Stewart as the host and will
be broadcast by NBC. While MSO will not have a direct financial interest
in the prime-time program, MSO expects to benefit from promotion of the
Company's brands, products and its business. We expect that this program
will expose the brand to a wider audience of viewers, consumers and
business partners.
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. A new Chairman and CEO assumed those positions.
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. Ms. Stewart later
assumed the role of Founder. 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. Ms. Stewart has completed her prison term.
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. 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
F-4
years ending January 31, 2009 and 2010 (the extension years), the minimum
guarantees will be substantially lower than in prior years. The specific
computation is discussed in the paragraph below.
1/31/02 1/31/03 1/31/04 1/31/05 1/31/06 1/31/07 1/31/08
------- ------- ------- ------- ------- ------- -------
Minimum Royalty Amounts $ 15.3 $ 40.4 $ 47.5 $ 49.0 $ 54.0 $ 59.0 $ 65.0
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.
In August 2004, we decided to discontinue the Catalog for Living and its
online product offerings, which are included in the Internet/ Direct
Commerce segment. The operations of the Catalog for Living and the online
component of this business were not profitable. In the future, the
Internet/ Direct Commerce segment will principally consist of our online
flowers program, marthasflowers.com, as well as the online content portion
of our business.
The operations of our television segment were significantly reduced in
2004. Pending the launch of our new syndicated television program, the
segment primarily consists of a cable television distribution agreement
with The Style Network, a weekly syndicated program - Petkeeping with Marc
Morrone and effective January 2005 a weekly show airing on PBS stations
nationwide - Everyday Food. Previously, the segment included our
nationally syndicated daily show, Martha Stewart Living, as well as
several other cable television shows.
In September 2004, we entered into agreements (referred to above) with
Mark Burnett, a well regarded producer of prime-time programming, and an
affiliated entity under which Mr. Burnett will advise and consult with the
company regarding various television matters, including developing
opportunities to evolve the future Martha Stewart Living daily syndicated
television show and relating to the development and production of a
primetime network television series to feature Martha Stewart. In
connection with the consulting agreement with Mr. Burnett, MSO issued to
Mr. Burnett a warrant to purchase up to 2.5 million shares of MSO's Class
A Common Stock at the market price on the date of signing or $12.59 per
share. The warrant will vest and become exercisable in several tranches,
subject to the achievement of various milestones achieved with respect to
various television programs. We currently expect to begin to recognize as
an expense, a portion of the 2.5 million shares in mid 2005, when certain
milestones are achieved.
F-5
COMPARISON FOR THE YEAR ENDED DECEMBER 31, 2004 TO YEAR ENDED DECEMBER 31,
2003.
PUBLISHING SEGMENT
2004 2003 Variance
---------- --------- ----------
PUBLISHING REVENUE
Advertising $ 34,084 $ 75,735 $ (41,651)
Circulation 60,086 58,634 1,452
Other 1,865 1,567 298
---------- --------- ----------
TOTAL PUBLISHING SEGMENT REVENUE 96,035 135,936 (39,901)
---------- --------- ----------
PUBLISHING OPERATING COSTS AND EXPENSES
Production, distribution and editorial 62,546 68,585 6,039
Selling and promotion 55,321 45,299 (10,022)
General and administrative 2,164 2,088 (76)
Amortization of non-cash equity compensation 143 202 59
Depreciation and amortization 472 165 (307)
---------- --------- ----------
TOTAL PUBLISHING SEGMENT OPERATING COSTS AND EXPENSES 120,646 116,339 (4,307)
---------- --------- ----------
PUBLISHING SEGMENT OPERATING INCOME (LOSS) $ (24,611) $ 19,597 $ (44,208)
---------- --------- ----------
Publishing revenues decreased $39.9 million, or 29.4%, to $96.0 million
for the year ended December 31, 2004, from $135.9 million for the year
ended December 31, 2003. This decrease was primarily due to a decrease in
advertising revenues of $41.7 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
$34.9 million. The reduction in advertising revenue was also attributable
to lower advertising revenue in Everyday Food magazine of $4.7 million, as
the prior year period included advertising revenues from a sponsorship
arrangement and lower revenue in Martha Stewart Weddings. Circulation
revenue increased $1.5 million in the period primarily due to the increase
in circulation and frequency of Everyday Food which increased $5.2
million, as well as from the acquisition of Body & Soul magazine and The
Dr. Weil Self Healing newsletter which collectively contributed $1.4
million towards the increase. The increases in circulation revenue were
partially offset by lower circulation revenue from Martha Stewart Living
magazine of $7.0 million, due primarily to lower subscription copies sold.
Magazine Publication Schedule
Year ended December 31,:
2004 2003
------------- -------------
Martha Stewart Living Twelve Issues Twelve Issues
Martha Stewart Weddings Five Issues Four Issues
Everyday Food Ten Issues Eight Issues
Special Interest Publications Eight Issues Seven Issues
Body & Soul (a) Four Issues n/a
(a) Acquired in August 2004 and therefore was not included in prior
periods.
F-6
Production, distribution and editorial expenses decreased $6.0 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 additional magazines
referred to above. Selling and promotion expenses increased $10.0 million
resulting primarily from higher subscription acquisition costs relating to
Everyday Food, one of our Special Interest Publications, and the recent
acquisition, partially offset by lower spending related to Martha Stewart
Living magazine.
TELEVISION SEGMENT
2004 2003 Variance
--------- --------- ---------
TELEVISION REVENUE
Syndication $ 7,546 $ 18,103 $ (10,557)
Licensing and other 2,959 7,601 (4,642)
--------- --------- ---------
TOTAL TELEVISION SEGMENT REVENUE 10,505 25,704 (15,199)
--------- --------- ---------
TELEVISION OPERATING COSTS AND EXPENSES
Production, distribution and editorial 14,371 18,985 4,614
Selling and promotion 1,267 2,845 1,578
General and administrative 3,349 3,516 167
Amortization of non-cash equity compensation - - -
Depreciation and amortization 230 2,974 2,744
--------- --------- ---------
TOTAL TELEVISION SEGMENT OPERATING COSTS AND EXPENSES 19,217 28,320 9,103
--------- --------- ---------
TELEVISION SEGMENT OPERATING (LOSS) $ (8,712) $ (2,616) $ (6,096)
--------- --------- ---------
Television revenues decreased $15.2 million, or 59.1%, to $10.5 million
for the year ended December 31, 2004, from $25.7 million for the year
ended December 31, 2003. The decrease was primarily due to lower revenue
from our syndicated daily program which ceased airing in mid September
2004. We expect the ending of the program to negatively impact revenue in
the first nine months of 2005 until the Company's new program launches in
September 2005. However, given the early stages of the new program, it is
difficult to determine with any certainty the potential operating results.
The segment was also impacted by the expiration of certain cable and
international licensing contracts effective December 31, 2003. Future
quarters will be adversely impacted by the third quarter 2004 termination
of our contract with the Food Network. Licensing revenue benefited from
the June 2004 launch of our programming on The Style Network.
Production, distribution and editorial expenses decreased $4.6 million in
the period due to lower production costs as a result of the winding down
of production for the syndicated daily program as well as a lower
distribution fees associated with the lower license fee revenue from the
Martha Stewart Living show. The decrease was partially offset by higher
non-cash production amortization recognized in the period, including a
$1.5 million write-down of deferred production costs resulting from the
early termination of a cable television licensing agreement. Selling and
promotion expenses decreased $1.6 million due to lower marketing efforts
for the nationally syndicated daily show. Depreciation and amortization
decreased $2.7 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.
F-7
MERCHANDISING SEGMENT
2004 2003 Variance
---------- ---------- ---------
MERCHANDISING REVENUE
Kmart earned royalty $ 32,434 $ 35,579 $ (3,145)
Kmart minimum true-up 13,074 10,208 2,866
Other 7,878 7,608 270
---------- ---------- ---------
TOTAL MERCHANDISING SEGMENT REVENUE 53,386 53,395 (9)
---------- ---------- ---------
MERCHANDISING OPERATING COSTS AND EXPENSES
Production, distribution and editorial 9,005 10,307 1,302
Selling and promotion 926 598 (328)
General and administrative 6,340 4,051 (2,289)
Amortization of non-cash equity
compensation (72) 51 123
Depreciation and amortization 760 671 (89)
---------- ---------- ---------
TOTAL MERCHANDISING SEGMENT OPERATING COSTS
AND EXPENSES 16,959 15,678 (1,281)
---------- ---------- ---------
MERCHANDISING SEGMENT OPERATING INCOME $ 36,427 $ 37,717 $ (1,290)
---------- ---------- ---------
Merchandising revenues of $53.4 million for the year ended December 31,
2004, were essentially flat with prior year revenue of $53.4 million.
Royalty revenue based on product sales at Kmart declined $3.1 million as a
result of lower same-store-sales as well as store closings that took place
in the early part of 2003, partially offset by a higher royalty rate. The
royalty rate under our agreement with Kmart increased 5% on February 1,
2004. Listed separately above, is the revenue related to the contractual
minimum amounts. In accordance with our Kmart contract, we have recognized
as revenue the pro-rata portion of the contractual minimum royalty amount
due from Kmart, net of amounts subject to recoupment, for the 12 month
periods ended January 31, 2005 and January 31, 2004. We expect the minimum
guarantees will exceed actual royalties earned from retail sales through
January 31, 2008 due to store closings and negative trends in same-store
sales. For the contract years ending January 31, 2009 and 2010, the
minimum guarantees will be substantially lower than in prior years. Other
revenue increased modestly due in part to the launch of our program at
Sears Canada and higher royalty revenue from our Martha Stewart Signature
products, partially offset by a decline in revenue from our Japanese
retail partner, as well as a decline in creative service revenue. Our
program at Sears Canada launched in the second half of 2003.
Production, distribution and editorial expense decreased $1.3 million due
to lower compensation related expenses. Selling and promotion expenses
increased $0.3 million in the period due to higher marketing expenses
related to our Martha Stewart Signature program. General and
administrative expense increased $2.3 million primarily due to higher
legal fees.
F-8
INTERNET/DIRECT COMMERCE SEGMENT
2004 2003 Variance
--------- --------- --------
INTERNET/DIRECT COMMERCE REVENUE
Product sale $ 26,820 $ 29,041 $ (2,221)
Other 692 1,772 (1,080)
--------- --------- --------
TOTAL INTERNET/DIRECT COMMERCE SEGMENT REVENUE 27,512 30,813 (3,301)
--------- --------- --------
INTERNET/DIRECT COMMERCE OPERATING COSTS AND
EXPENSES
Production, distribution and editorial 29,912 37,995 8,083
Selling and promotion 1,735 2,141 406
General and administrative 3,739 5,751 2,012
Amortization of non-cash equity compensation - (21) (21)
Depreciation and amortization 987 960 (27)
--------- --------- --------
TOTAL INTERNET/DIRECT COMMERCE OPERATING COSTS AND
EXPENSES 36,373 46,826 10,453
--------- --------- --------
INTERNET/DIRECT COMMERCE SEGMENT OPERATING (LOSS) $ (8,861) $ (16,013) $ 7,152
--------- --------- --------
Internet/Direct Commerce revenues decreased $3.3 million, or 10.7%, to
$27.5 million for the year ended December 31, 2004, from $30.8 million for
the year ended December 31, 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 sales was largely attributable to our planned lower catalog
circulation. The decline in other revenue was principally due to lower
advertising revenue. Based on our August 2004 decision to discontinue the
Catalog for Living and its online product offerings, we expect to see a
reduction in revenue, operating costs and a reduced operating loss in this
segment in 2005.
Production, distribution and editorial costs decreased $8.1 million due to
lower catalog production and distribution costs of $4.0 million due to
reduced catalog circulation. Lower costs were also due in part to lower
product sales, which resulted in lower cost of goods sold as well as lower
fulfillment expenses, which collectively contributed to $1.8 million of
lower costs in the period. The segment also benefited from lower staffing
levels. Selling and promotion expenses benefited from lower media buying
in the current period. General and administrative expenses decreased $2.0
million due primarily to lower employee related expenses and lower
professional fees.
CORPORATE
2004 2003 Variance
-------- -------- --------
CORPORATE OPERATING COSTS AND EXPENSES
Production, distribution and editorial $ 370 $ 395 $ 25
Selling and promotion 102 738 636
General and administrative 40,124 37,764 (2,360)
Amortization of non-cash equity compensation 9,428 1,294 (8,134)
Depreciation and amortization 4,223 4,899 676
-------- -------- --------
TOTAL CORPORATE OPERATING COSTS AND EXPENSES 54,247 45,090 (9,157)
-------- -------- --------
CORPORATE OPERATING LOSS $(54,247) $(45,090) $ (9,157)
-------- -------- --------
F-9
Corporate operating costs and expenses increased $9.2 million, or 20.3%,
to $54.2 million for the year ended December 31, 2004, from $45.1 million
for the year ended December 31, 2003. 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 $2.4 million principally resulting from
higher employee-related costs, including retention programs of $3.5
million, as well as higher corporate communications and consulting fees,
partially offset by lower insurance and location fees. The increase in the
amortization of non-cash compensation expense is principally related to
the cost associated with extending the exercise period of certain stock
options relating to our former Chief Executive Officer and the
amortization of the value of restricted stock units granted in connection
with a November 2003 stock option exchange program.
INTEREST INCOME, NET Interest income, net, was $1.8 million for the year
ended December 31, 2004, compared with $1.4 million for the year ended
December 31, 2003. The increase was attributable to higher interest rates.
INCOME TAX BENEFIT (PROVISION) Income tax provision for the year ended
December 31, 2004 was $0.9 million, compared to an income tax benefit of
$3.0 million for the year ended December 31, 2003. The current period
results exclude any potential tax benefits generated from current period
losses due to the establishment of a valuation reserve taken against any
such benefits.
LOSS FROM DISCONTINUED OPERATIONS Loss from discontinued operations was
$0.5 million for the year ended December 31, 2004, compared to $0.8
million from the same operations for the year ended December 31, 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 $(59.6) million for the year ended December 31,
2004, compared to a net loss of $(2.8) million for the year ended December
31, 2003, as a result of the above mentioned factors.
F-10
RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2003, TO YEAR ENDED DECEMBER 31, 2002
EXECUTIVE SUMMARY
Total Company revenues for the year ended December 31, 2003 were $245.8
million compared to $295.0 million in the prior year period. Operating
income (loss) for the year ended December 31, 2003 was a loss of $(6.4),
compared to operating profit of $20.0 million in the year ago period. The
prior year results include a restructuring charge of $7.7 million related
to the restructuring of the Company's Internet Direct Commerce segment.
Publishing revenue declined $46.7 million, or 25.6% in 2003, due
principally to a decline in advertising and circulation revenue in Martha
Stewart Living magazine primarily resulting from the negative impact of
various governmental investigations into Martha Stewart, the Company's
Founder. The decline in revenue was partially offset by revenue from
Everyday Food, a new publication launched in the third quarter of 2003.
The revenue reduction in Martha Stewart Living magazine, and to a lesser
extent, the Company's focus on maintaining product quality and brand
vitality, were the primary drivers behind the company's overall reduction
in profitability. Operating profit in this business segment declined from
$62.5 million in 2002 to $19.6 million in 2003. The decline in operating
profit was mitigated, in part, by the successful restructuring of the
Internet/Direct Commerce segment, initiated in the early part of 2003 as
well as the results in the Merchandising segment. The restructuring of the
Internet/Direct Commerce segment led to a smaller, more productive
merchandising assortment, reduced staffing levels, lower catalog
circulation, and generally lower fixed costs. This restructuring led to a
decline in revenue and a reduced operating loss. The operating loss in
this segment improved from a loss of $37.2 million in 2002 to a loss of
$16.0 million in 2003. The prior year amount includes a restructuring
charge of $7.7 million. Excluding the charge in 2002, the operating loss
of the Internet/Direct Commerce segment would have been $29.6 million. The
improvement in the operating profit of the Merchandising segment from
$33.0 million in 2002 to $37.7 million in 2003 was largely due to our
contractual relationship with Kmart which resulted in higher royalty
revenue due to the company receiving payments based on the contractual
minimum amounts. This business segment operates with a high degree of
operating leverage, and therefore, the additional revenue generated from
the contractual minimums directly improves operating profit.
The Company continues to maintain its favorable liquidity position with
cash and short-term investments totaling $168.7 million. The Company
continues to be debt free.
REVENUES Total revenues decreased $49.2 million, or 16.7%, to $245.8
million for the year ended December 31, 2003, from $295.0 million for the
year ended December 31, 2002. Publishing revenues decreased $46.7 million,
or 25.6%, to $135.9 million for the year ended December 31, 2003, from
$182.6 million for the year ended December 31, 2002. This decrease was
primarily due to a decrease in advertising revenues of $37.0 million, a
decrease in circulation revenues of $6.3 million and decreased revenues
from our book business of $3.3 million. The decrease in advertising
revenue resulted primarily from fewer advertising pages in Martha Stewart
Living, as well as lower advertising revenues from Special Interest
Publications, and lower advertising rates in Martha Stewart Living. These
declines were partially offset by advertising revenues related to a new
publication, Everyday Food. The decrease in circulation revenues primarily
resulted from lower newsstand and subscription revenues from Martha
Stewart Living magazine, due to lower newsstand units sold and lower
subscription pricing, partially offset by circulation revenues from
Everyday Food magazine. Television revenues decreased $1.0 million, or
3.7%, to $25.7 million for the year ended December 31, 2003, from $26.7
million for the year ended December 31, 2002. The decrease is primarily
attributable to lower revenue from our syndicated daily program of $1.6
million due to lower license fee revenue as a result of a more competitive
market environment, partially offset by higher advertising revenue, due in
part to an adjustment to the audience under delivery reserve of the
nationally syndicated daily show related to prior seasons. This reduction
was partially offset by higher cable revenues of $1.1 million under
existing licensing agreements. Merchandising revenues increased $4.5
million, or 9.2%, to $53.4 million for the year ended December 31, 2003,
from $48.9 million for the year ended December 31, 2002, primarily due to
the contractual minimum royalty amount due from Kmart. Revenues recorded
under the contractual guarantee were $10.2 higher than actual royalties
earned during the period. We expect the minimum guarantees will exceed
actual royalties earned from retail sales through the remainder of the
life of the agreement. Earned royalties declined on a year-over-year basis
principally due to store closings, as well as the elimination of live
plants in the Martha Stewart Everyday Garden Line at Kmart and lower same
store sales,
F-11
partially offset by an increase in royalty rate in the current period. The
royalty rate under our agreement with Kmart increased 9% on February 1,
2003 and 5% on February 1, 2004. Revenue from Kmart represented
approximately 86% of total segment revenue for the year ended December 31,
2003. Royalty revenues from sales of products at Zellers in Canada was
nominal in the current period due to the early 2003 expiration of our
licensing agreement. In September 2003, we began selling Martha Stewart
Everyday products in Canada through an agreement with Sears Canada.
Royalty revenue from the sales of Martha Stewart Signature products
increased $2.2 million for the period ended December 31, 2003. Kmart
emerged from bankruptcy on May 6th, 2003. While operating under Chapter 11
of the Federal Bankruptcy Code, Kmart closed 283 stores in 2002 and an
additional 316 stores in 2003. The contractual minimum amounts under our
agreement with Kmart are computed on January 31st annually each year and
paid shortly thereafter. As of December 31, 2003 we had an amount due from
Kmart in the amount of $18.5 million, $10.2 million of which relates to
the minimum guarantees. This receivable was paid in full subsequent to
year-end. Internet/Direct Commerce revenues decreased $6.1 million, or
16.4%, to $30.8 million for the year ended December 31, 2003, from $36.9
million for the year ended December 31, 2002 due to lower advertising
revenue and lower commerce sales. The lower commerce sales are due
generally to lower catalog circulation.
Magazine Publication Schedule
Year ended December 31,:
2003 2002
------------- -------------
Martha Stewart Living Twelve Issues Twelve Issues
Martha Stewart Weddings Four Issues Four Issues
Everyday Food Eight Issues None
Special Interest Publications Seven Issues Seven Issues
PRODUCTION, DISTRIBUTION AND EDITORIAL Production, distribution and
editorial expenses decreased $25.3 million, or 15.7%, to $136.3 million
for the year ended December 31 2003, from $161.6 million for the year
ended December 31, 2002. Internet/Direct Commerce costs decreased $16.8
million. Reduced costs in the segment reflect lower cost of goods sold of
$5.5 million due to the successful disposition of previously written down
obsolete and slow moving inventory, as well as the impact of lower overall
commerce revenue due principally to lower catalog circulation. The segment
also benefited from lower fulfillment costs of $4.2 million due to lower
commerce revenue explained above as well as improved operating and
distribution efficiencies, lower catalog production costs of $2.6 million
due to the lower circulation previously mentioned. The segment continued
benefit of the first quarter restructuring which reduced headcount and
lowered technology costs. Publishing segment costs decreased $10.0 million
primarily reflecting lower paper, printing and distribution costs of
Martha Stewart Living magazine, due mainly to lower number of pages
printed per issue, partially offset by the additional costs associated
with the publication of eight issues of Everyday Food. In addition, the
costs associated with our book business declined $1.1 million. Television
costs increased $1.6 million, or 9.0%, principally due to higher
production costs recognized in the period due to principally to higher
staffing costs and the prior year benefit of extending a cable television
programming agreement which resulted in the recognition of less production
costs in the period. Merchandising costs decreased $0.4 million or 4.7%
due to good cost control.
SELLING AND PROMOTION. Selling and promotion expenses increased $7.2
million, or 16.3%, to $51.6 million for the year ended December 31, 2003,
from $44.4 million for the year ended December 31, 2002. Publishing
segment costs increased $5.6 million, or 14.2%, resulting primarily from
circulation acquisition costs relating to Everyday Food, partially offset
by lower spending related to Martha Stewart Living magazine. Television
segment costs increased $1.0 million, resulting primarily from higher
marketing and promotion expenses related to the syndicated programs.
Corporate costs increased $0.7 million as a result of media spending
relating to a corporate promotion program.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
$3.7 million, or 7.4%, to $53.2 million for the year ended December 31,
2003, from $49.5 million for the year ended December 31, 2002. Corporate
costs increased $4.7 million, or 13.5%, principally resulting from higher
insurance costs of $2.2 million, and higher employee related costs,
including the November exchange offers.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$2.0 million, or 16.9%, to $9.7 million for the year ended December 31,
2003, from $11.6 million for the year ended December 31, 2002.
F-12
The decrease is primarily due to lower depreciation associated with the
Company's website, which was written down by $6.1 million in the fourth
quarter of 2002 in connection with a restructuring of the Internet/Direct
Commerce segment. In the fourth quarter of 2003 the Company reduced the
net carrying value of certain assets located in our Connecticut television
studio by $1.7 million. This amount was charged to depreciation and
partially offset the decrease referred to above.
INTEREST INCOME, NET Interest income, net, was $1.4 million for the year
ended December 31, 2003, compared with $2.1 million for the year ended
December 31, 2002. Higher average cash balances throughout the year were
more than offset by lower interest yields on cash and short-term
investments.
INCOME TAX BENEFIT (PROVISION) Income tax benefit for the year ended
December 31, 2003 was $3.0 million, representing a 61.3% effective income
tax rate, compared to an income tax provision of $8.8 million representing
an effective income tax rate of 39.8% for the year ended December 31,
2002. The effective income tax rate for the year ended December 31, 2003
reflects a federal tax rate of 35%, without giving benefit to state income
tax carry-backs, but allowing for the benefit of certain book-tax
differences. These book-tax differences adjust for such items as
non-taxable interest income, which in the current period is a
disproportionate share of current period income, therefore, skewing the
effective tax rate. The effective tax rate is further distorted by the
favorable resolution of an international withholding tax issue. State
income tax benefits available to the Company resulting from the carry-back
of losses to prior years is limited. Accordingly, the Company has not
recognized any state tax benefit for the year ended December 31, 2003.
LOSS FROM DISCONTINUED OPERATIONS Loss from discontinued operations was
$0.8 million for the year ended December 31, 2003, compared to $2.9
million from the same operations for the year ended December 31, 2002.
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 and include a lease impartment
charge which writes down the current value of the lease to its fair market
value.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE In 2002, as part of the
implementation of Statement of Financial Accounting Standards No. 142,
"Accounting for Goodwill and Other Intangible Assets", the Company
completed the initial impairment tests in the second quarter of 2002 which
resulted in a charge of approximately $5 million ($3.1 million after
taxes) to reduce the carrying value of its goodwill related to the
Internet/Direct Commerce segment attributable to its 2001 acquisition of
The Wedding List.
NET INCOME (LOSS) Net (loss) was $(2.8) million for the year ended
December 31, 2003, compared to a net income of $7.3 million for the year
ended December 31, 2002, as a result of the above mentioned factors.
F-13
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $104.6 million and $165.6 million and short-term
investments were $35.3 million and $3.1 million at December 31, 2004 and 2003,
respectively.
Cash flows provided by (used in) operating activities were $(22.2) million,
$(9.6) million and $38.0 million for the years ended December 31, 2004, 2003 and
2002, respectively. In 2004, cash flows used in operating activities were
primarily due to a net loss from operations of $59.6 million, partially offset
by depreciation of and amortization of $16.2 million, a decrease in deferred tax
assets and an increase in working capital. Cash provided by changes in operating
assets and liabilities in 2004 is primarily a result of decreased accounts
receivable and deferred television production costs, partially offset by higher
payables. In 2003, cash flows used in operating activities was primarily due to
an increase in working capital. Cash used by changes in operating assets and
liabilities in 2003 is primarily a result of decreased accounts payable and
accrued liabilities, deferred subscription income and an increase in accounts
receivable, partially offset by a decrease in inventory. Cash flows from
operating activities in 2002 resulted primarily from net income from continuing
operations before cumulative effect of accounting change of $13.3 million, in
addition to non-cash charges totaling $16.3 million primarily related to
depreciation and amortization of $11.6 million, and impairment related charges
of $6.1 million, as well as $8.4 million of cash provided by changes in
operating assets and liabilities. Cash provided by changes in operating assets
and liabilities is primarily a result of decreases in accounts receivable,
inventories, and an increase in accounts payable and accrued liabilities,
partially offset by a decrease in deferred subscription income.
Cash flows provided by (used in) investing activities were $(39.8) million,
$16.0 million and $28.8 million for the years ended December 31, 2004, 2003 and
2002, respectively. Cash flows used in investing activities in 2004 resulted
from the purchase of short-term investments of $40.9 million, the acquisition of
certain assets of Body & Soul magazine and the Dr. Weil Self Healing newsletter
of $6.6 million as well as capital expenditures $0.9 million, partially offset
by the sales of short-term investments of $8.7 million. Cash flows provided by
investing activities in 2003 resulted from the sale of short-term investments of
$17.0 million, partially offset by capital expenditures of $1.1 million. Cash
flows provided by investing activities in 2002 reflect the sale of short-term
investments of $57.3 million, partially offset by the purchase of short-term
investments of $24.2 million and capital expenditures of $4.3 million.
Cash flows provided by financing activities were $1.1 million, $0.4 million and
$4.1 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Cash flows provided from financing activities in 2004, 2003, and 2002 was
primarily due to proceeds received from exercise of stock options.
We have a line of credit with Bank of America in the amount of $5.0 million,
which is generally used to secure outstanding letters of credit. As of December
31, 2004, we had no outstanding borrowings under this facility.
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
The Company's commitments consist primarily of leases for office facilities
under operating lease agreements. Future minimum payments under these leases are
included in footnote 11 to the consolidated financial statements on page F-34.
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, although due to the
changes in the business we now expect revenue to be tied to certain key
holidays. 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 recognize a
F-14
substantial portion of the revenue resulting from the difference between the
minimum royalty amount under the Kmart contract and royalties paid on actual
sales in the fourth quarter of each year, 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 US generally accepted accounting principles. 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. Revenues for
royalties in our merchandising business are accrued on a monthly basis based on
sales volume data provided to us by our partners and payment is generally made
by our partners on a quarterly basis. In addition, we recognize a substantial
portion of the revenue resulting from the difference between the minimum royalty
amount under the Kmart contract and royalties paid on actual sales in the fourth
quarter of each year, when the amount can be determined. Certain other of our
other merchandising agreements also contain minimum guarantee provisions. These
minimum guarantees will be recorded when such amounts are both determinable and
deemed collectible.
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
F-15
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.
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
proceedings against Ms. Stewart arising out of the investigations has generated
a great deal of negative publicity surrounding Ms. Stewart. Because our
principal brand and several brand labels are closely associated with the name
Martha Stewart, we have experienced substantial negative impacts on our business
as a result of the resolution of these legal proceedings and resulting 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.
Although we cannot provide any assurances regarding future trends, based on our
current view of the market, we are cautiously optimistic about the Company's
prospects in 2005, including prospects for an increase in advertising pages and
revenue in certain of the Company's magazines, as well as the potential benefits
from the launch of a new syndicated television program in the Fall of 2005,
which is being distributed by NBC Universal Domestic Television Distribution.
Additionally, as part of an agreement discussed below, the Company will
participate in the production of a primetime network television series titled,
The Apprentice: Martha Stewart. This new program will feature Martha Stewart as
the host and will be broadcast by NBC. While MSO will not have a direct
financial interest in the prime-time program, MSO expects to benefit from
promotion of the Company's brands, products and its business. We expect that
this program will expose the brand to a wider audience of viewers, consumers and
business partners.
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. A new Chairman and CEO assumed those
positions.
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. Ms. Stewart later assumed the role of Founder, Chief Editorial and
Media Director. 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. Ms. Stewart has
completed her prison term.
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. 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. The specific computation is discussed
in the paragraph below.
1/31/02 1/31/03 1/31/04 1/31/05 1/31/06 1/31/07 1/31/08
------- ------- ------- ------- ------- ------- -------
Minimum Royalty Amounts $ 15.3 $ 40.4 $ 47.5 $ 49.0 $ 54.0 $ 59.0 $ 65.0
F-16
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.
In August 2004, we decided to discontinue the Catalog for Living and its online
product offerings, which are included in the Internet/ Direct Commerce segment.
The operations of the Catalog for Living and the online component of this
business were not profitable. In the future, the Internet/ Direct Commerce
segment will principally consist of our online flowers program,
marthasflowers.com, as well as the online content portion of our business.
The operations of our television segment were significantly reduced in 2004.
Pending the launch of our new syndicated television program the segment
primarily consists of a cable television distribution agreement with The Style
Network, a weekly syndicated program - Petkeeping with Marc Morrone and
effective January 2005 a weekly show airing on PBS stations nationwide -
Everyday Food. Previously, the segment included our nationally syndicated daily
show, Martha Stewart Living, as well as several other cable television shows.
In September 2004, we entered into agreements (referred to above) with Mark
Burnett, a well regarded producer of prime-time programming, and an affiliated
entity under which Mr. Burnett will advise and consult with the company
regarding various television matters, including developing opportunities to
evolve the future Martha Stewart Living daily syndicated television show and
relating to the development and production of a primetime network television
series to feature Martha Stewart. In connection with the consulting agreement
with Mr. Burnett, MSO issued to Mr. Burnett a warrant to purchase up to 2.5
million shares of MSO's Class A Common Stock at the market price on the date of
signing or $12.59 per share. The warrant will vest and become exercisable in
several tranches, subject to the achievement of various milestones achieved with
respect to various television programs. We currently expect to begin to
recognize as an expense, a portion of the 2.5 million shares in mid 2005, when
certain milestones are achieved.
F-17
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
To The Board of Directors and Shareholders of Martha Stewart Living Omnimedia,
Inc.
We have audited the accompanying consolidated balance sheets of Martha Stewart
Living Omnimedia, Inc. as of December 31, 2004 and 2003, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 2004. Our audits also
included the financial statement schedule listed in the Index at Item 15(a).
These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and the financial statement schedule based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Martha Stewart
Living Omnimedia, Inc. at December 31, 2004 and 2003, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As discussed in Note 2 to the consolidated financial statements, on January 1,
2002, Martha Stewart Living Omnimedia, Inc. adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, "Accounting for Goodwill and Other
Intangible Assets."
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Martha Stewart
Living Omnimedia Inc.'s internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control -- Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 15, 2005 expressed an unqualified opinion
thereon.
Ernst & Young LLP
New York, New York
March 15, 2005
F-18
MARTHA STEWART LIVING OMNIMEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS EXCEPT PER SHARE DATA)
2004 2003 2002
--------- --------- ----------
REVENUES
Publishing $ 96,035 $ 135,936 $ 182,600
Television 10,505 25,704 26,680
Merchandising 53,386 53,395 48,896
Internet/Direct Commerce 27,512 30,813 36,873
--------- --------- ----------
TOTAL REVENUES 187,438 245,848 295,049
--------- --------- ----------
OPERATING COSTS AND EXPENSES
Production, distribution and editorial 116,204 136,267 161,602
Selling and promotion 59,351 51,621 44,381
General and administrative 55,716 53,170 49,489
Amortization of non-cash equity compensation 9,499 1,526 261
Depreciation and amortization 6,672 9,669 11,631
Restructuring charge - - 7,692
--------- --------- ----------
TOTAL OPERATING COSTS AND EXPENSES 247,442 252,253 275,056
--------- --------- ----------
OPERATING INCOME (LOSS) (60,004) (6,405) 19,993
Interest income, net 1,799 1,439 2,120
--------- --------- ----------
INCOME (LOSS) BEFORE INCOME TAXES (58,205) (4,966) 22,113
Income tax provision (benefit) 868 (3,043) 8,799
--------- --------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE AND LOSS FROM DISCONTINUED OPERATIONS (59,073) (1,923) 13,314
--------- --------- ----------
Loss from discontinued operations, net of tax benefit of
$589 in 2003 and $1,939 in 2002 (526) (848) (2,909)
--------- --------- ----------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF ACCOUNTING CHANGE (59,599) (2,771) 10,405
Cumulative effect of accounting change, net of tax benefit of $2,015 - - (3,137)
--------- --------- ----------
NET INCOME (LOSS) $ (59,599) $ (2,771) $ 7,268
EARNINGS (LOSS) PER SHARE ========= ========= ==========
Basic and diluted - Income (loss) from continuing operations $ (1.19) $ (0.04) $ 0.27
Basic and diluted - Loss from discontinued operations (0.01) (0.02) (0.06)
Basic and diluted - Cumulative effect of accounting change - - (0.06)
--------- --------- ----------
Basic and diluted - Net income (loss) $ (1.20) $ (0.06) $ 0.15
========= ========= ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 49,712 49,389 49,250
Diluted 49,712 49,389 49,343
The accompanying notes are an integral part of these consolidated financial
statements.
F-19
MARTHA STEWART LIVING OMNIMEDIA, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
(IN THOUSANDS EXCEPT PER SHARE DATA)
2004 2003
--------- ---------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 104,647 $ 165,566
Short-term investments 35,309 3,100
Accounts receivable, net 31,332 39,758
Inventories, net 5,229 7,485
Deferred television production costs - 3,465
Income taxes receivable 6,321 5,658
Deferred income taxes - 5,024
Other current assets 3,573 4,422
--------- ---------
TOTAL CURRENT ASSETS 186,411 234,478
--------- ---------
PROPERTY, PLANT AND EQUIPMENT, net 17,175 22,673
INTANGIBLE ASSETS, net 54,264 44,257
DEFERRED INCOME TAXES - 3,224
OTHER NONCURRENT ASSETS 6,828 4,470
--------- ---------
TOTAL ASSETS $ 264,678 $ 309,102
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 25,604 $ 26,628
Accrued payroll and related costs 9,407 10,360
Income taxes payable 412 167
Current portion of deferred subscription income 27,160 23,833
--------- ---------
TOTAL CURRENT LIABILITIES 62,583 60,988
--------- ---------
DEFERRED SUBSCRIPTION INCOME 7,668 7,133
DEFERRED ROYALTY REVENUE 3,438 -
OTHER NONCURRENT LIABILITIES 3,361 4,316
--------- ---------
TOTAL LIABILITIES 77,050 72,437
--------- ---------
COMMITMENTS AND CONTIGENCIES
SHAREHOLDERS' EQUITY
Class A common stock, $.01 par value, 350,000
shares authorized: 21,660 and 19,628 shares
issued in 2004 and 2003, respectively 217 196
Class B common stock, $.01 par value, 150,000
shares authorized; 29,123 and 30,059 shares
outstanding in 2004 and 2003, respectively 291 301
Capital in excess of par value 196,781 183,744
Unamortized restricted stock (2,793) (307)
Retained earnings (accumulated deficit) (6,093) 53,506
--------- ---------
188,403 237,440
Less Class A treasury stock - 59 shares at cost (775) (775)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 187,628 236,665
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 264,678 $ 309,102
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-20
MARTHA STEWART LIVING OMNIMEDIA, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS)
Class A
Class A Class B Retained Treasury
common stock common stock Capital in Unamortized Earnings Stock
--------------- ----------------- excess of Restricted (Accumulated --------------
Shares Amount Shares Amount par value Stock deficit) Shares Amount Total
------ ------ ------ ------ ---------- ----------- ------------ ------ ------ --------
Balance at
January 1, 2002 15,160 $ 152 33,619 $ 336 $ 173,470 - $ 49,009 (59) $ (775) $222,192
Net income - - - - - - 7,268 - - 7,268
Conversion of
shares 3,324 33 (3,324) (33) - - - - - -
Issuance of
shares in
conjunction
with stock
options exercises
and restricted
stock plans 858 9 - - 5,298 (1,254) - - - 4,053
Tax benefit
from the
exercise of
stock options - - - - 2,861 - - - - 2,861
Amortization of
non-cash equity
compensation - - - - - 261 - - - 261
------ ------ ------- ------- ---------- ----------- ----------- ------ ------ --------
Balance at
December 31, 2002 19,342 194 30,295 303 181,629 (993) 56,277 (59) (775) 236,635
Net loss - - - - - - (2,771) - - (2,771)
Issuance of
shares for
stock options 316 2 - - 402 - - - - 404
Shares returned
on net treasury
basis - - (236) (2) 2 - - - - -
Tax benefit from
the exercise of
stock options - - - - 871 - - - - 871
Return of
restricted stock (30) - - - (203) 203 - - - -
Amortization of
non-cash equity
compensation - - - - 1,043 483 - - - 1,526
------ ------ ------- ------- ---------- ----------- ------------ ------ ------ --------
Balance at
December 31, 2003 19,628 196 30,059 301 183,744 (307) 53,506 (59) (775) 236,665
Net loss - - - - - - (59,599) - - (59,599)
Conversion of
shares 786 8 (786) (8) - - - - - -
Shares returned
on net treasury
basis - - (150) (2) 2 - - - - -
Issuance of
shares in
conjunction
with stock
options exercises
and restricted
stock plans,
net of tax
withholdings 1,261 13 - - 4,774 (3,724) - - - 1,063
Return of
restricted stock (15) - - - (102) 102 - - - -
Amortization of
non-cash equity
compensation - - - - 8,363 1,136 - - - 9,499
------ ------ ------- ------- ---------- ----------- ------------ ------ ------ --------
Balance at
December 31, 2004 21,660 $ 217 29,123 $ 291 $ 196,781 $ (2,793) $ (6,093) (59) $ (775) $187,628
====== ====== ======= ======= ========== =========== ============= ====== ====== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-21
MARTHA STEWART LIVING OMNIMEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS)
2004 2003 2002
--------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (59,599) $ (2,771) $ 7,268
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Cumulative effect of accounting change - - 5,040
Non-cash loss from discontinued operations - 325 1,429
Restructuring charge - - 7,692
Depreciation and amortization 6,672 9,669 11,631
Deferred income tax (benefit) expense 3,851 (4,052) (4,788)
Tax benefit from stock option exercises - 871 2,861
Amortization of non-cash equity compensation 9,499 1,526 261
Changes in operating assets and liabilities,
net of acquisition
Accounts receivable, net 9,049 (1,962) 7,833
Inventories 2,256 1,169 2,693
Other current assets 1,135 334 (756)
Deferred television production costs 3,465 714 (552)
Other non current assets (2,328) 337 (341)
Accounts payable and accrued liabilities (4,812) (13,238) 2,560
Income taxes 3,979 (156) 323
Deferred subscription income 2,124 (1,681) (5,148)
Deferred royalty revenue 3,438 - -
Other non current liabilities (955) (719) 36
--------- -------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (22,226) (9,634) 38,042
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (947) (1,054) (4,307)
Purchases of short-term investments (40,909) - (24,216)
Sales of short-term investments 8,700 17,010 57,300
Acquisition of business, net of cash acquired (6,600) - -
--------- -------- --------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (39,756) 15,956 28,777
--------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of stock options 1,063 404 4,053
--------- -------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,063 404 4,053
--------- -------- --------
NET INCREASE (DECREASE) IN CASH (60,919) 6,726 70,872
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 165,566 158,840 87,968
--------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 104,647 $165,566 $158,840
========= ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS EXCEPT SHARE DATA)
1 THE COMPANY
Martha Stewart Living Omnimedia, Inc. (together with its wholly owned
subsidiaries, 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 and on cable. 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, which will be discontinued in early
2005, its direct-to-consumer floral business and the website marthastewart.com.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company's
wholly-owned subsidiaries. All significant intercompany transactions have been
eliminated.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash equivalents that mature within three
months of the date of purchase.
SHORT-TERM INVESTMENTS
Short-term investments include investments that have maturity dates in excess of
three months on the date of acquisition. Unrealized gains/losses were
insignificant.
REVENUE RECOGNITION
Magazine advertising revenues are recorded upon release of magazines for sale to
consumers and are stated net of agency commissions and cash and sales discounts.
Allowances for estimated bad debts are provided based upon historical
experience.
Deferred subscription income results from advance payments for subscriptions
received from subscribers and is amortized on a straight-line basis over the
life of the subscription as issues are delivered.
Newsstand revenues are recognized based on the on-sale dates of magazines and
are recorded based upon estimates of sales, net of product placement costs paid
to resellers. Estimated returns are recorded based upon historical experience.
Television advertising revenues are recognized when the related commercial is
aired and is recorded net of estimated reserves for television audience
underdelivery. Royalties are recorded as earned in accordance with the specific
terms of each agreement.
Product revenues are recognized upon shipment of goods to customers. Shipping
and handling expenses are included in cost of goods sold. Estimated returns are
recorded based on historical experience.
Revenues for royalties in our merchandising business are accrued on a monthly
basis based on sales volume data provided to us by our partners. In addition, we
recognize a substantial portion of the revenue resulting from the difference
between the minimum royalty amount under the Kmart contract and royalties paid
on actual sales in the fourth quarter of each year, when the amount can be
determined.
F-23
TELEVISION PRODUCTION COSTS
Television production costs are capitalized and amortized based on revenue
earned as a percentage of total projected revenue for the applicable television
product. If a total net loss is projected for a particular product, television
production costs are written down to net realizable value.
INTANGIBLE ASSETS
Commencing January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, "Accounting for Goodwill and Other Intangible
Assets." Under SFAS 142, goodwill is no longer subject to amortization over its
estimated useful life. Rather, goodwill is subject to annual assessment for
impairment by applying a fair-value based test.
The Company reviews goodwill for impairment annually, or more frequently if
events or changes in circumstances warrant. In 2004, the Company engaged an
external valuation services firm to report on the fair value of the Company's
goodwill. In 2003, the Company estimated future cash flows based upon individual
magazine historical results, current trends, and operating and cash flows to
assess the fair value. No impairment charges were recorded in 2004 and 2003. In
the second quarter of 2002, the Company completed its initial impairment test by
estimating future cash flows based upon individual magazine historical results,
the Wedding List gift registry operations historical results, current trends,
and operating and cash flow projections. In 2002 the impairment test resulted in
a charge of $5,040 ($3,137 net of income taxes) to reduce the carrying value of
its goodwill related to The Wedding List
The components of the remaining intangible assets as of December 31, 2004 are
set forth in the schedule below, and are reported entirely within the publishing
business segment. In August 2004, the Company acquired certain intangible assets
in connection with business acquisitions discussed in Note 12. The Company
finalized the purchase price allocation of the fair value of net assets acquired
based upon receipt of an asset appraisal.
The components of intangible assets are as follows:
Accumulated Publishing Accumulated
Publishing Amortization - Publishing Subscriber Amortization-Publishing
Goodwill Publishing Goodwill Trademarks Lists Subscriber Lists Total
---------- ------------------- ---------- ---------- ----------------------- --------
Balance January 1, 2004 $ 59,009 $ (14,752) $ - $ - $ - $ 44,257
Acquisitions of businesses 8,832 - 500 900 - 10,232
Amortization expense - - - - (225) (225)
--------- ------------------ ---------- ---------- ----------------------- --------
Balance December 31, 2004 $ 67,841 $ (14,752) $ 500 $ 900 $ (225) $ 54,264
========= ================== ========== ========== ======================= ========
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived tangible assets and intangible assets with finite
useful lives for impairment whenever events or changes in circumstances indicate
that their carrying values may not be recoverable. Using the Company's best
estimates based on reasonable assumptions and projections, it records an
impairment loss to write down the assets to their estimated fair values if
carrying values of such assets exceed their related undiscounted expected future
cash flows. The Company evaluates intangible assets with finite useful lives by
individual magazine title, which is the lowest level at which independent cash
flows can be identified. The Company evaluates corporate assets or other
long-lived assets that are not magazine specific at a consolidated entity or
segment reporting unit level, as appropriate.
F-24
The Company estimates fair values based on the future expected cash flows. The
Company estimates future cash flows based upon segment level historical results,
current trends, and operating and cash flow projections. The Company's estimates
are subject to uncertainty, and may be affected by a number of factors outside
its control, including general economic conditions, the competitive market, and
regulatory changes. If actual results differ from the Company's estimate of
future cash flows, it may record additional impairment charges in the future.
For the year ended December 31, 2004, no impairment charge was recorded. For the
year ended December 31, 2003 the Company accelerated depreciation and
amortization of certain long-lived assets of the Television segment by $1,727 to
reflect the current fair value of the assets. For the year ended December 31,
2002, the Company recorded an asset impairment charge of $6,087 related to the
Company's website.
INVENTORIES
Inventories consisting of paper and product merchandise are stated at the lower
of cost or market. Cost is determined using the first-in, first-out (FIFO)
method
ADVERTISING COSTS
Advertising costs, consisting primarily of direct-response advertising, are
expensed in the year incurred.
RECLASSIFICATION ADJUSTMENTS
Certain prior year financial information has been reclassified to conform with
fiscal 2004 financial statement presentation.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed using the weighted average number of
actual common shares outstanding during the period. Diluted earnings (loss) per
share reflect the potential dilution that would occur from the exercise of
common stock options outstanding and the vesting of restricted shares. For the
year ended December 31, 2002 the dilutive effect of stock options included in
the determination of diluted weighted average common shares outstanding was
approximately 93,000. For the years ended December 31, 2004, 2003, and 2002 the
antidilutive options excluded from this amount totaled 971,000, 1,197,000 and
4,409,000 with a weighted average exercise price of $13.55, $9.15, and $13.58
respectively.
Options granted under the Martha Stewart Living Omnimedia LLC Nonqualified Class
A LLC Unit/Stock Option Plan are not included as they are not dilutive (see Note
8).
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost and depreciated using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized using the straight-line method over the lease term
or, if shorter, the estimated useful lives of the related assets. The useful
lives are as follows:
Studios and studio equipment 3-10 years
Furniture, fixtures and equipment 3-5 years
Computer hardware and software 3-5 years
Leasehold improvements life of lease
USE OF ESTIMATES
The preparation of financial statements in conformity with US 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 position or results of operations.
F-25
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 value of options granted were estimated
on the grant date using the Black-Scholes option pricing model, using the
following assumptions:
2004 2003 2002
--------- ------- -------
risk-free interest rates 3.47% 2.94% 4.11%
dividend yields Zero Zero Zero
expected volatility 154% 137% 134%
expected option life 4.3 years 6 years 6 years
Average fair market value per option granted $ 12.07 $ 8.51 $ 9.24
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 effect on net income (loss) for the years ended December 31, 2004, 2003
and 2002, were as follows:
2004 2003 2002
--------- --------- --------
Net income (loss), as reported $ (59,599) $ (2,771) $ 7,268
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects 1,987 7,658 9,762
--------- --------- --------
Pro forma net income (loss) $ (61,586) $ (10,429) $ (2,494)
========= ========= ========
Earnings (loss) per share:
Basic and diluted - as reported $ (1.20) $ (0.06) $ 0.15
Basic and diluted - pro forma $ (1.24) $ (0.21) $ (0.05)
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of
FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement
123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees,
and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the
approach in Statement 123(R) is similar to the approach described in Statement
123. However, Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an
alternative.
Statement 123(R) must be adopted no later than July 1, 2005. Early adoption will
be permitted in periods in which financial statements have not yet been issued.
We expect to adopt Statement 123(R) on July 1, 2005.
F-26
Statement 123(R) permits public companies to adopt its requirements using one of
two methods:
1. The "modified prospective" method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of Statement
123(R) for all share-based payments granted after the effective date and (b)
based on the requirements of Statement 123 for all awards granted to employees
prior to the effective date of Statement 123(R) that remain unvested on the
effective date.
2. The "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under Statement 123 for
purposes of pro forma disclosures either (a) all prior periods presented or (b)
prior interim periods of the year of adoption.
The company plans to adopt Statement 123(R) using the modified-prospective
method.
As permitted by Statement 123, the company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have a
significant impact on our result of operations, although it will have no impact
on our overall financial position. The impact of adoption of Statement 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had we adopted Statement 123(R) in
prior periods, the impact of that standard would have approximated the impact of
Statement 123 as described in the disclosure of pro forma net income and Note 2
to our consolidated financial statements. Statement 123(R) also requires the
benefits of tax deductions in excess of recognized compensation cost to be
reported as a financing cash flow, rather than as an operating cash flow as
required under current literature. This requirement will reduce net operating
cash flows and increase net financing cash flows in periods after adoption.
While the company cannot estimate what those amounts will be in the future
(because they depend on, among other things, when employees exercise stock
options), the amount of operating cash flows recognized in prior periods for
such excess tax deductions were $871 and $2,861 in 2003 and 2002, respectively.
3 ACCOUNTS RECEIVABLE, NET
The components of accounts receivable at December 31, 2004 and 2003 are as
follows:
2004 2003
--------- ---------
Advertising $ 7,354 $ 14,204
Licensing 24,187 21,670
Other 1,314 5,795
--------- ---------
32,855 41,669
Less: reserve for credits and uncollectible
accounts 1,523 1,911
--------- ---------
$ 31,332 $ 39,758
========= =========
As of December 31, 2004 and 2003, accounts receivable from Kmart were
approximately $22,119 and $18,500, respectively.
4 INVENTORIES
The components of inventories at December 31, 2004 and 2003 are as follows:
2004 2003
-------- --------
Paper $ 4,279 $ 4,610
Product merchandise 1,236 4,801
-------- --------
5,515 9,411
Less: reserve for obsolete and excess inventory 286 1,926
-------- --------
$ 5,229 $ 7,485
======== ========
F-27
5 PROPERTY, PLANT AND EQUIPMENT, NET
The components of property, plant and equipment at December 31, 2004 and 2003
are as follows:
2004 2003
--------- ---------
Studios and equipment $ 6,729 $ 6,729
Furniture, fixtures and equipment 10,548 10,402
Computer hardware and software 27,883 27,141
Leasehold improvements 20,449 20,390
--------- ---------
65,609 64,662
Less: accumulated depreciation and amortization 48,434 41,989
--------- ---------
$ 17,175 $ 22,673
========= =========
Depreciation and amortization expense was $6,447, $9,669 and $11,631, for the
years ended December 31, 2004, 2003 and 2002, respectively. Included in the
$41,989 of accumulated depreciation at December 31, 2003 is $1,727 of
depreciation expense recognized in the fourth quarter of 2003 to reduce the net
carrying value of certain assets located in our Connecticut television facility.
6 LINE OF CREDIT
The Company has an agreement with Bank of America, N.A. for a line of credit in
the amount of $5,000 with an interest rate equal to LIBOR plus 0.5% per annum
and an expiration date of June 30, 2005. As of December 31, 2004, the Company
did not have any amounts outstanding under this agreement.
7 STOCKHOLDERS' EQUITY
Common Stock
The Company has two classes of common stock outstanding. The Class B common
stock is identical in all respects to Class A common stock, except with respect
to voting and conversion rights. Each share of Class B common stock entitles its
holder to ten votes and is convertible on a one-for-one basis to Class A stock
at the option of the holder and automatically upon most transfers.
8 EMPLOYEE BENEFIT PLANS
Executive bonus plan
During 2003, the Company adopted the 2003 Key Executive Bonus Plan. Under the
plan, the Company has made periodic cash payments to certain executives who
remain employed by the Company. The plan expired on December 31, 2004 and the
remaining payments under the plan were paid shortly thereafter. The Company
recognized the expected total expense of the plan ratably over the term of the
plan.
The amount recognized as expense for the years ended December 31, 2004 and 2003
were $3,109 and $552 respectively.
Retirement plans
The Company established a 401(k) retirement plan effective July 1, 1997,
available to substantially all employees. An employee can contribute any
percentage of compensation to the plan, up to a maximum of 25% or the maximum
allowable contribution by the IRS ($13.0 in 2004, $12.0 in 2003 and $11.0 in
2002), whichever is less. The Company matches 50% of the first 6% of
compensation contributed. Employees vest ratably in employer matching
contributions over a period of four years of service. The employer matching
F-28
contributions totaled approximately $863, $908 and $956 for the years ended
December 31, 2004, 2003 and 2002, respectively.
In December 2002, the Company terminated its defined benefit pension plan and
distributed to all participants their accrued benefits at that time. The
termination of the pension plan resulted in a gain of approximately $1,221,
which is included as an offset to general and administrative expenses in the
statement of operations for the year ended December 31, 2002.
The Company does not sponsor any post retirement and/or post employment benefit
plan.
Stock Options
The Company established the Martha Stewart Living Omnimedia LLC Nonqualified
Class A LLC Unit/Stock Option Plan (the "1997 Option Plan") in November 1997.
The Company has an agreement with Martha Stewart whereby she will periodically
return to the Company shares of Class B common stock owned by her or her
affiliates in amounts corresponding on a net treasury basis to the number of
options exercised under the 1997 Option Plan during the relevant period.
Accordingly, options outstanding under this plan are not dilutive. In 2003,
236,000 shares were returned under the agreement. In January 2004, 150,000
shares were returned under the agreement, representing shares due the Company as
of December 31, 2003. All options granted under the 1997 Option Plan are fully
vested as of December 31, 2002. The status of this stock option plan is
summarized as follows:
Weighted
Number of average
Shares exercise price
---------- --------------
Outstanding as of January 1, 2002 1,375,938 $ 0.63
Exercised (429,262) 0.63
Cancelled (24,574) 0.60
---------- -------
Outstanding as of December 31, 2002 922,102 0.62
Exercised (295,160) 0.68
---------- -------
Outstanding as of December 31, 2003 626,942 0.60
Exercised (424,544) 0.60
---------- -------
Outstanding as of December 31, 2004 202,398 $ 0.60
========== =======
Options exercisable at:
December 31, 2002 922,102 $ 0.62
December 31, 2003 626,942 $ 0.60
December 31, 2004 202,398 $ 0.60
The Company has an additional stock option plan that provides for the granting
of stock options and issuance to employees and non-employee members of the
Company's Board of Directors. The options granted under these plans are to
purchase Class A Common stock at the fair market value at the date of the
F-29
grant. Employee stock options vest ratably on each of the first four
anniversaries of the grant date. Non-employee director options are subject to
various vesting schedules ranging from one to three years. The term of the
options granted under these plans is ten years. The status of these stock option
plans is summarized as follows:
Weighted
Number of average
shares exercise price
---------- --------------
Outstanding as of January 1, 2002 7,795,967 $ 17.87
Granted 1,521,000 10.07
Exercised (226,540) 17.33
Cancelled (714,247) 16.98
---------- --------
Outstanding as of December 31, 2002 8,376,180 16.55
Granted 57,500 9.73
Exercised (28,675) 6.78
Cancelled (6,216,733) 17.04
---------- --------
Outstanding as of December 31, 2003 2,188,272 14.97
Granted 595,000 15.48
Exercised (389,742) 10.39
Cancelled (631,275) 15.82
---------- --------
Outstanding as of December 31, 2004 1,762,255 $ 15.85
========== ========
Options exercisable at:
December 31, 2002 3,848,438 $ 18.15
December 31, 2003 1,389,910 $ 17.07
December 31, 2004 913,936 $ 17.37
The following table summarizes information about the stock options outstanding
under the Company's option plans as of December 31, 2004:
F-30
Options Outstanding
Weighted
Average
Remaining Weighted Weighted
Contractual Average Average
Range of Exercise Price Life in Number Exercise Number Exercise
Per Share Years Outstanding Price Exercisable Price
- ----------------------- ----------- ----------- -------- ----------- --------
$0.60 2.9 202,398 $ 0.60 202,398 $ 0.60
$6.78-$10.61 8.4 493,875 7.75 160,188 6.97
$14.25-$15.52 5.9 18,600 15.13 18,100 15.14
$15.57 6.3 20,625 15.57 15,469 15.57
$15.75-$17.90 7.1 156,700 15.96 80,900 16.01
$18.00 4.8 378,255 18.00 378,130 18.00
$18.10-$33.75 8.2 694,200 20.45 261,150 23.51
------- ---------- ------- --------- -------
$0.60-$33.75 6.9 1,964,653 $ 14.28 1,116,335 $ 14.33
------- ---------- ------- --------- -------
In the fourth quarter of 2004 the Company incurred a non-cash equity
compensation charge of $3,875 resulting from the modification of the terms of
certain previously granted employee stock options related to the retirement of
our previous Chief Executive Officer.
Stock compensation plans
In 2002, the Company issued 185,000 shares of restricted stock to certain
employees. The stock vested on the second anniversary date of the grant, August
2004. The aggregate market value of the restricted stock at the date of issuance
of $1,254 was recorded as unamortized restricted stock which is a separate
component of shareholders' equity and was amortized over the two year vesting
period, net of cancellations due to employee terminations prior to vesting.
Accordingly, the Company recognized amortization of non-cash equity compensation
of $205, $483, and $261 in the years ended December 31, 2004, 2003, and 2002,
respectively.
In November 2003, the Company completed two stock option exchange offers with
its employees.
One offer allowed certain employees to exchange 4,300,000 stock options for
994,000 restricted stock units. The units vest 50% on the first anniversary of
the grant and the remaining 50% on the second anniversary of the grant provided
that the employee is still employed by the Company. The aggregate value of the
restricted stock units of $10,800 on the date of issuance is being be amortized
as expense over the two year vesting period, net of cancellations due to
terminations prior to vesting. Accordingly, the Company recognized amortization
of non-cash equity compensation of $4,374, and $1,043 in the years ended
December 31, 2004 and 2003, respectively.
The second offer allowed certain employees to exchange 575,000 stock options for
an aggregate cash award of $1,100. The award vested on June 30, 2004. The
Company amortized as expense the total cash award paid over the eight month
vesting period, net of cancellations due to terminations prior to vesting.
Accordingly, the Company recognized compensation expense of $776 and $272 in the
years ended December 31, 2004 and 2003, respectively.
In November 2004, the Company issued 200,000 shares of restricted stock to its
President and Chief Executive Officer. 150,000 shares will vest ratably on the
first, second and third anniversaries of the grant date based upon continued
service vesting requirements. The remaining 50,000 shares vest either on the
completion of seven years of service or the maintenance of a specified market
price of the Company's stock for a specified period of time. The aggregate
market value of the restricted stock at the date of issuance of $3,724 was
recorded as unamortized restricted stock which is a separate component of
shareholders' equity. 150,000 shares will be amortized over the three year
vesting period beginning in November 2004.
F-31
Of the remaining 50,000 shares, 25,000 shares met the conditions of an
accelerated vest clause by December 31, 2004, and have accordingly been
amortized in full to expense in the fourth quarter of 2004. The remaining 25,000
shares met the conditions of another accelerated vest clause in January 2005,
and the Company has accordingly recognized the pro-rata portion of their related
amortization expense in December 2004. Accordingly $931 was recognized as
non-cash equity compensation expense in the year ended December 31, 2004.
9 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. SFAS
No. 109 places more emphasis on historical information, such as the Company's
cumulative operating results and its current year taxable loss than it places on
estimates of future taxable income. Therefore the Company has established a
valuation allowance of $31,953 for 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 provision (benefit) for income taxes consists of the following for the years
ended December 31, 2004, 2003, and 2002:
2004 2003 2002
--------- --------- ----------
CURRENT INCOME TAXES
Federal $ (1,755) $ - $ 10,297
State and local (1,401) 350 2,779
Foreign 173 70 511
--------- --------- ----------
TOTAL CURRENT INCOME TAX EXPENSE/(BENEFIT) $ (2,983) $ 420 $ 13,587
--------- --------- ----------
DEFERRED INCOME TAXES (BENEFIT)
Federal $ 3,754 $ (3,120) (3,591)
State and local 97 (343) (1,197)
--------- --------- ----------
TOTAL DEFERRED INCOME TAX EXPENSE (BENEFIT) 3,851 (3,463) (4,788)
--------- --------- ----------
INCOME TAX PROVISION (BENEFIT) FROM
CONTINUING OPERATIONS $ 868 $ (3,043) $ 8,799
========= ========= ==========
A reconciliation from the federal income tax provision (benefit) from continuing
operations at the statutory rate to the effective rate for the year ended
December 31, 2004, 2003, and 2002 is as follows:
2004 2003 2002
---------- --------- ---------
Computed tax at the federal statutory rate of 35% $ (20,556) $ (1,738) $ 7,740
State income taxes, net of federal benefit (848) 5 1,028
Non-deductible compensation 1,608 - -
Non-deductible expense 163 243 625
Foreign tax credit - (351) -
Non-taxable foreign income (152) (272) (218)
Non-taxable interest income (253) (493) (376)
Valuation allowance 28,286 - -
F-32
Benefit of net operating loss ("NOL") and tax credits
carried back (7,090) - -
Other (290) (437) -
------- ------- ------
Provision (benefit) for income taxes $ 868 $(3,043) $8,799
======= ======= ======
Effective tax rate 1.5% 61.3% 39.8%
======= ======= ======
Significant components of the Company's deferred tax assets and liabilities as
of December 31, 2004 and 2003 are as follows:
2004 2003
-------- -------
DEFERRED TAX ASSETS
Inventory obsolescence reserves $ 117 $ 790
Provision for doubtful accounts 852 856
Accrued rent 1,711 1,346
Reserve for newsstand returns 465 791
Reserve for catalog returns 104 105
Website impairment 98 2,496
Accrued compensation 3,465 1,263
Deferred royalty revenue 1,410 -
NOL/credit carryforwards 26,215 899
Other 346 319
-------- -------
TOTAL DEFERRED TAX ASSETS 34,783 8,865
DEFERRED TAX LIABILITIES
Depreciation and amortization (1,708) (617)
Prepaid expenses (1,119) -
Other (3) -
-------- -------
TOTAL DEFERRED TAX LIABILITIES (2,830) (617)
Valuation Allowance (31,953) -
-------- -------
NET DEFERRED TAX ASSET $ - $ 8,248
======== =======
The Company has federal and state and local NOL carryforwards of $25,169
(after-tax), which will expire from 2006 through the year 2024, with the
majority expiring in 2024. The Company has federal and state tax credit
carryforwards of $1,046, with $697, $176 and $173 expiring in 2005, 2009 and
2014, respectively. Approximately $6,697 of our NOL carryforward relates to tax
deductible stock-based compensation in excess of amounts recognized for
financial reporting purposes. To the extent that NOL carryforwards, if realized,
relate to stock-based compensation, the resulting tax benefits will be recorded
to stockholders' equity rather than to results of operations. The Company has
reached final settlement with the Internal Revenue Service related to a 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. The Company currently has
recorded an accrual of $607 for income tax liabilities related to ongoing
federal, state, and local audits. The Company's balance sheet reflects a
receivable in the amount of $6,321, which represents refundable federal and
state income taxes.
10 RELATED PARTY TRANSACTIONS
F-33
Martha Stewart has submitted a claim, pursuant to the Corporation's By-laws, for
approximately $3.7 million, for reimbursement of certain expenses relating to
her defense of the count of the federal criminal complaint against her alleging
she made false and misleading statements intended to influence the price of the
Corporation's stock. Ms. Stewart's defense of this count was successful and a
judgment of acquittal was entered in her favor. The Corporation and Ms. Stewart
submitted the question of whether or not she is entitled to indemnification to
an independent expert on Delaware law. On March 15, 2005 the independent expert
determined that Ms. Stewart is entitled to indemnification. The Corporation
believes that any amount to be reimbursed to Ms. Stewart will be reimbursable to
the Corporation under its Directors & Officers insurance policy and,
accordingly, does not believe that the payment will result in an expense to the
Corporation.
The Company has entered into a location rental agreement with Martha Stewart,
whereby the Company uses various properties owned by Martha Stewart. Under a
location rental agreement dated September 2004, the Company pays Ms. Stewart
$500 annually for use of her properties. Under a location rental agreement that
terminated in June 2004, the Company paid Ms. Stewart $2,500 annually for use of
her properties. Under a location rental agreement that terminated December 31,
2002 the Company paid Ms. Stewart $2,000 for use of her properties. The fees for
use of these properties under the location rental agreement amounted to $1,443,
$2,500 and $2,000 in 2004, 2003 and 2002, respectively.
During 2002 the Company paid $452 to a company owned by Martha Stewart for
various expenses incurred on the Company's behalf in connection with her
properties.
In 2001, the Company entered into a split dollar life insurance arrangement with
Martha Stewart and a partnership controlled by her (the "Partnership") pursuant
to which the Company agreed to pay a significant portion of the premiums on a
whole life insurance policy insuring Ms. Stewart and owned by and benefiting the
Partnership. The Company will be repaid the cumulative premium payments it has
made upon the earlier of Ms. Stewart's death or the voluntary termination of the
arrangement by Ms. Stewart out of the policies' existing surrender value at the
time of repayment. In 2002, the arrangement was amended such that the Company
would not be obligated to make further premium payments unless legislation
permits such payments. As of December 31, 2004, the aggregate amount paid by the
Company under this arrangement is $2,238.
11 COMMITMENTS AND CONTINGENCIES
The Company leases office facilities, filming locations, and equipment for terms
extending through 2016 under operating lease agreements. Total rent expense
charged to operations for all such leases was approximately $10,253, $11,082,
and $10,192 for the years ended December 31, 2004, 2003, and 2002, respectively.
The following is a schedule of future minimum payments under operating leases at
December 31, 2004, including amounts related to the discontinued operations of
the Wedding List business (see Note 13):
Operating
Leases
---------
2005 $ 9,532
2006 8,846
2007 7,938
2008 8,099
2009 8,200
Thereafter 7,419
---------
Total minimum lease payments $ 50,034
=========
F-34
The Company has outstanding letters of credit for $2,326 as security for certain
leases as of December 31, 2004.
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, and certain other officers and directors
of the Company as defendants: 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 New York. 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.
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. By order dated
August 4, 2004, the Company's motion to dismiss the Sargent complaint was
granted in its entirety, and as to the issue of plaintiffs' failure to make
pre-suit demand, with prejudice. The Sargent plaintiffs' time to
F-35
appeal that dismissal has expired. 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. By stipulation and order entered September 24, 2004, the parties to the
Shareholder Derivative Litigation agreed to the dismissal of that action on the
same terms as ordered by the Sargent Court in dismissing the Sargent Action.
While still in its early stages, we believe the Company has substantial defenses
to the remaining Consolidated Class Action Complaint. The Company is unable to
predict the outcome of that action or reasonably estimate a range of possible
loss at this time.
12 BUSINESS ACQUISITIONS
In August 2004, the Company acquired certain assets and liabilities of Body &
Soul magazine and Dr. Andrew Weil's Self Healing newsletter, which are
publications featuring "natural living" content. The primary purpose of the
acquisition was to enter a new market and to launch "natural living " as a new
"omni" lifestyle category and brand for the Company. Consistent with SFAS No.
141, "Business Combinations," the acquisitions were accounted for under purchase
accounting.
In connection with the acquisition of the net assets of Body & Soul magazine,
the Company recorded tangible assets of $612, an intangible trademark asset of
$300, and assumed liabilities of $2,669 based on the receipt of an asset
appraisal performed by an external valuation services firm. Goodwill of $6,613
was recognized as the excess of the purchase price over the fair market value of
assets acquired.
In connection with the acquisition of Dr. Andrew Weil's Self Healing newsletter
net assets, the Company recorded tangible assets of $428, an intangible
subscriber list asset of $900, an intangible trademark asset of $200 and
liabilities assumed of $1,902 based on the receipt of an asset appraisal
performed by an external valuation services firm. Goodwill of $2,219 was
recognized as the excess of the purchase price over the fair market value of
assets acquired.
The results of operations for each acquisition are included in the consolidated
statement of operations from the date of acquisition through December 31, 2004.
The intangible subscriber list is subject to an eighteen month amortization
period. For the twelve month period ended December 31, 2004 $225 was charged to
amortization expense and accumulated amortization.
13 DISCONTINUED OPERATIONS
In March 2001, the Company paid cash of approximately $3,900 and assumed certain
liabilities to acquire the assets of The Wedding List, a wedding registry and
gift business. The acquisition was accounted for using the purchase method of
accounting and, accordingly, the results of operations of the acquired business
were included in the Company's results of operations commencing upon the
acquisition date. The acquisition resulted in goodwill of approximately $5,300,
which was being amortized over twenty years. The Wedding List was reported as a
component of the Internet/Direct Commerce segment.
In June 2002, the Company decided to exit The Wedding List business. In 2002 the
loss from exiting these operations resulted in charges related to the write-down
of property and equipment and the accrual of future lease commitments, net of
anticipated sublease rental income of $4,979, of approximately $1,277. The
anticipated sublease income was determined by estimating future cash flows based
upon current market conditions. In 2003 a review of the accrual of future lease
commitments resulted in an additional charge of $325. These lease payments and
offsetting receipts are payable through December 2016.
These charges have been included with the losses from operations during 2003 and
2002 and are reflected as a loss from the discontinued operations in the income
statements.
F-36
Revenue and loss from the discontinued operations for the years ended December
31, 2004, 2003, and 2002 were as follows:
2004 2003 2002
----- ------- -------
Revenues $ - $ 616 $ 2,849
----- ------- -------
Loss from operations, including
accrued restructuring and shutdown
costs (526) (1,437) (4,848)
Income tax benefit - 589 1,939
----- ------- -------
Net loss from discontinued
operations $(526) $ (848) $(2,909)
===== ======= =======
The summarized balance sheet of the discontinued operations as of December 31,
2004 and 2003 were as follows:
Total assets $ 52 $ 195
Account payable and accrued expenses (1,027) (1,197)
--------- ----------
Net liabilities of discontinued
operations $ (975) $ (1,002)
========= ==========
14 RESTRUCTURING CHARGE
In 2002, the Company recorded a restructuring charge of $7,692, which includes
an asset impairment charge of $6,087 related to the Company's website, and a
$1,605 charge to increase the Company's inventory valuation allowances, which
includes a $300 accrual for losses on firm inventory purchase commitments. The
website was written down to the fair value of its hardware. These charges were
taken in contemplation of a restructuring plan which was implemented beginning
in the first quarter of 2003 to downsize the operations of the Internet/Direct
Commerce business segment in order to achieve improved operating results.
15 OTHER INFORMATION
The Company's financial instruments consist of cash and cash equivalents,
short-term investments, accounts receivable, accounts payable and accrued
expenses. The carrying amount of these accounts approximates fair value.
At December 31, 2004, the Company had $2,326 of cash on deposit collateralizing
letters of credits which are maintained as security for certain leases.
In consideration of the execution of a consulting agreement under which Mark
Burnett has agreed to act as an advisor and consultant to the Company with
respect to various television matters, in September 2004, the Company issued to
Mr. Burnett a warrant to purchase 2,500,000 shares of the Company's Class A
Common Stock at an exercise price of $12.59 per share. The warrant will vest and
become exercisable in several tranches, subject to the achievement of various
milestones achieved with respect to certain television programs. The warrant
will expire on March 17, 2012.
The Company's revenues from foreign sources were $7,118, $8,669 and $11,778 in
2004, 2003 and 2002, respectively.
During the year ended 2004, 2003, and 2002, the revenues from Kmart Corporation
were approximately 26%, 22%, and 17% respectively of the company's total
revenues.
Advertising expense, including subscription acquisition costs, was $25,932,
$21,059, and $14,701 for the years ended December 31, 2004, 2003, and 2002,
respectively.
Interest paid was $0, $16, and $180 for the years ended December 31, 2004, 2003,
and 2002, respectively.
F-37
Income taxes paid were $284, $1,529, and $4,665 for the years ended December 31,
2004, 2003, and 2002 respectively.
16 INDUSTRY SEGMENTS
The Company's industry segments are discussed in Note 1. Segment information for
the years ended December 31, 2004, 2003, and 2002 was as follows:
Internet/Direct
Publishing Television Merchandising Commerce Corporate Consolidated
---------- ---------- ------------- --------------- --------- ------------
2004
Revenues $ 96,035 $ 10,505 $ 53,386 $ 27,512 $ - $ 187,438
Operating income (loss) (24,611) (8,712) 36,427 (8,861) (54,247) (60,004)
Amortization of non-cash
equity compensation 143 - (72) - 9,428 9,499
Depreciation and amortization 472 230 760 987 4,223 6,672
Total assets 66,914 605 24,014 5,037 168,108 264,678
Capital expenditures 75 37 177 132 526 947
2003
Revenues $ 135,936 $ 25,704 $ 53,395 $ 30,813 $ - $ 245,848
Operating income (loss) 19,597 (2,616) 37,717 (16,013) (45,090) (6,405)
Amortization of non-cash
equity compensation 202 - 51 (21) 1,294 1,526
Depreciation and amortization 165 2,974 671 960 4,899 9,669
Total assets 62,587 7,775 22,547 9,815 206,378 309,102
Capital expenditures 184 31 26 146 667 1,054
2002
Revenues $ 182,600 $ 26,680 $ 48,896 $ 36,873 $ - $ 295,049
Operating income (loss) 62,517 2,589 32,972 (37,242) (40,843) 19,993
Amortization of non-cash
equity compensation 85 - 21 21 134 261
Depreciation and amortization 158 1,693 633 2,867 6,280 11,631
Total assets 69,597 13,630 8,871 13,695 218,749 324,542
Capital expenditures 174 488 - 2,359 1,286 4,307
F-38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS EXCEPT PER SHARE DATA)
17 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
YEAR ENDED DECEMBER 31, 2004 Quarter Quarter Quarter Quarter Total
- ---------------------------- --------- -------- --------- -------- --------
Revenues $ 44,489 $ 44,046 $ 38,691 $ 60,212 $187,438
Operating loss (16,538) (17,827) (16,154) (9,485) (60,004)
Loss from continuing operations (19,319) (17,697) (14,837) (7,220) (59,073)
Loss from discontinued operations (161) (127) (129) (109) (526)
--------- -------- --------- -------- --------
NET LOSS $ (19,480) $(17,824) $ (14,966) $ (7,329) $(59,599)
========= ======== ========= ======== ========
EARNINGS PER SHARE - BASIC AND DILUTED
Loss from continuing operations $ (0.39) $ (0.36) $ (0.30) $ (0.14) $ (1.19)
Loss from discontinued operations 0.00 0.00 0.00 0.00 (0.01)
--------- -------- --------- -------- --------
Net loss $ (0.39) $ (0.36) $ (0.30) $ (0.15) $ (1.20)
========= ======== ========= ======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic and diluted 49,464 49,572 49,698 50,119 49,712
First Second Third Fourth
YEAR ENDED DECEMBER 31, 2003 Quarter Quarter Quarter Quarter Total
- ---------------------------- --------- -------- --------- -------- --------
Revenues $ 58,022 $ 65,782 $ 51,180 $ 70,864 $245,848
Operating income (loss) (5,475) 3,086 (6,281) 2,265 (6,405)
Income (loss) from continuing operations (2,946) 2,262 (3,816) 2,577 (1,923)
Loss from discontinued operations (220) (302) (122) (204) (848)
--------- -------- --------- -------- --------
NET INCOME (LOSS) $ (3,164) $ 1,960 $ (3,938) $ 2,371 $ (2,771)
========= ======== ========= ======== ========
EARNINGS PER SHARE - BASIC AND DILUTED
Income (loss) from continuing operations $ (0.06) $ 0.05 $ (0.08) $ 0.05 $ (0.04)
Loss from discontinued operations 0.00 (0.01) (0.00) 0.00 (0.02)
--------- -------- --------- -------- --------
Net income (loss) $ (0.06) $ 0.04 $ (0.08) $ 0.05 $ (0.06)
========= ======== ========= ======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 49,450 49,488 49,537 49,451 49,389
Diluted 49,450 49,627 49,537 49,581 49,389
F-39
Fourth Quarter Items:
Earnings per share amounts for each quarter are required to be computed
independently and may not equal the amount computed for the total year.
In the fourth quarter of fiscal 2004 the Company recorded income tax benefits of
$1,658, including approximately $842 related to an investment tax credit refund
due, and the remaining amounts related to adjustments to previous tax estimates.
The Company also recorded a non-cash equity compensation charge of $3,875
resulting from the modification of the terms of certain previously granted
employee stock options related to the retirement of our Chief Executive Officer.
In addition, royalty revenue of $1,631 was recorded in connection with the
dissolution of a licensing agreement. The Company also reduced its discretionary
year end bonus accrual by $1,370 to properly reflect current staffing levels and
performance based evaluations.
In the fourth quarter of fiscal 2003, the Company recorded an acceleration
depreciation charge of $1,727 related to the write-down to fair value of certain
television studio assets.
MARTHA STEWART LIVING OMNIMEDIA, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS
BALANCE CHARGED TO
BEGINNING OF COSTS AND BALANCE,END
DESCRIPTION YEAR EXPENSES DEDUCTIONS OF YEAR
----------- ------------ ---------- ---------- -----------
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Year ended December 31,
2004 1,126 383 565 944
2003 2,454 (523) 805 1,126
2002 2,093 1,694 1,333 2,454
RESERVE FOR AUDIENCE UNDERDELIVERY:
Year ended December 31,
2004 529 (93) 110 326
2003 1,275 (577) 169 529
2002 1,973 869 1,567 1,275
RESERVE FOR OBSOLETE AND EXCESS INVENTORY:
Year ended December 31,
2004 1,926 (1,640) - 286
2003 5,094 1,291 4,459 1,926
2002 3,139 6,103 4,148 5,094
F-40
RESERVE FOR PRODUCT RETURNS:
Year ended December 31,
2004 256 2,334 2,337 253
2003 469 1,973 2,186 256
2002 434 3,436 3,401 469
F-41