REYNOLDS & REYNOLDS CO - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED JUNE 30, 2003

COMMISSION FILE NO. 1-10147

THE REYNOLDS AND REYNOLDS COMPANY

OHIO 31-0421120
(State of incorporation) (IRS Employer Identification No.)

ONE REYNOLDS WAY
KETTERING, OHIO 45430
(Address of principal executive offices)

(937) 485-2000
(Telephone No.)

115 SOUTH LUDLOW STREET
DAYTON, OHIO 45402
(Former address of principal executive offices)

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 checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No
---- -----

On June 30, 2003, 67,249,866 Class A common shares and 16,000,000 Class B common
shares were outstanding.

THE REYNOLDS AND REYNOLDS COMPANY
TABLE OF CONTENTS

PAGE
NUMBER
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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Statements of Consolidated Income
For the Three and Nine Months Ended June 30, 2003 and 2002 3

Condensed Consolidated Balance Sheets
As of June 30, 2003 and September 30, 2002 4

Condensed Statements of Consolidated Cash Flows
For the Nine Months Ended June 30, 2003 and 2002 5

Notes to Condensed Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
For the Three and Nine Months Ended June 30, 2003 and 2002 11

Item 3. Quantitative and Qualitative Disclosures About Market Risk
(See the caption entitled "Market Risks" included in the Management's
Discussion and Analysis of Financial Condition and Results of Operations) 17

Item 4. Controls and Procedures 18

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K 19

SIGNATURES 20

2

THE REYNOLDS AND REYNOLDS COMPANY
STATEMENTS OF CONSOLIDATED INCOME
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2003 AND 2002
(In thousands except per share data)

Three Months Nine Months
----------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- --------

Net Sales and Revenues
Services $157,708 $153,807 $465,519 $452,661
Products 83,823 86,065 258,704 251,397
Financial services 8,874 10,696 27,929 31,621
-------- -------- -------- --------
Total net sales and revenues 250,405 250,568 752,152 735,679
-------- -------- -------- --------
Cost of Sales
Services 58,036 52,767 174,523 156,723
Products 50,181 46,833 149,257 140,393
Financial services 2,119 2,760 6,914 8,051
-------- -------- -------- --------
Total cost of sales 110,336 102,360 330,694 305,167
-------- -------- -------- --------
Gross Profit 140,069 148,208 421,458 430,512
Selling, General and Administrative Expenses 91,647 99,200 280,755 301,446
-------- -------- -------- --------
Operating Income 48,422 49,008 140,703 129,066
-------- -------- -------- --------
Other Charges (Income)
Interest expense 1,155 1,137 3,855 2,698
Interest income (944) (862) (2,277) (2,975)
Equity in net losses (income) of affiliated companies (668) (514) (1,752) 13,731
Other (489) 171 (2,690) 107
-------- -------- -------- --------
Total other charges (income) (946) (68) (2,864) 13,561
-------- -------- -------- --------
Income Before Income Taxes 49,368 49,076 143,567 115,505
Provision for Income Taxes 21,119 18,843 57,543 30,805
-------- -------- -------- --------
Income Before Cumulative Effect of Accounting Change 28,249 30,233 86,024 84,700
Cumulative Effect of Accounting Change 0 0 0 (36,563)
-------- -------- -------- --------
Net Income $ 28,249 $ 30,233 $ 86,024 $ 48,137
======== ======== ======== ========
Basic Earnings Per Common Share
Income Before Cumulative Effect of Accounting Change $ 0.41 $ 0.43 $ 1.26 $ 1.19
Cumulative Effect of Accounting Change $ 0.00 $ 0.00 $ 0.00 $ (0.52)
Net Income $ 0.41 $ 0.43 $ 1.26 $ 0.68
Average Number of Common Shares Outstanding 68,220 71,000 68,504 70,903
Diluted Earnings Per Common Share
Income Before Cumulative Effect of Accounting Change $ 0.40 $ 0.41 $ 1.22 $ 1.15
Cumulative Effect of Accounting Change $ 0.00 $ 0.00 $ 0.00 $ (0.50)
Net Income $ 0.40 $ 0.41 $ 1.22 $ 0.65
Average Number of Common Shares Outstanding 70,823 74,191 70,652 73,805
Cash Dividends Declared Per Common Share $ 0.11 $ 0.11 $ 0.33 $ 0.33

See Notes to Condensed Consolidated Financial Statements.

3

THE REYNOLDS AND REYNOLDS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2003 AND SEPTEMBER 30, 2002
(In thousands)

6/30/03 9/30/02
------------ ------------

AUTOMOTIVE SOLUTIONS ASSETS
Current Assets
Cash and equivalents $115,550 $155,295
Accounts receivable 108,933 117,471
Inventories 15,372 13,067
Other current assets 31,863 31,970
---------- ----------
Total current assets 271,718 317,803
Property, Plant and Equipment, less accumulated depreciation of
$166,568 at 6/30/03 and $159,558 at 9/30/02 163,021 161,073
Goodwill 40,649 28,999
Software Licensed to Customers 95,386 81,557
Acquired Intangible Assets 39,558 44,366
Other Assets 94,191 95,762
---------- ----------
Total Automotive Solutions Assets 704,523 729,560
---------- ----------
FINANCIAL SERVICES ASSETS
Cash 1,870 635
Finance Receivables 396,980 406,160
Other Assets 564 810
---------- ----------
Total Financial Services Assets 399,414 407,605
---------- ----------
TOTAL ASSETS $1,103,937 $1,137,165
========== ==========

AUTOMOTIVE SOLUTIONS LIABILITIES
Current Liabilities
Current portion of long-term debt $0 $6,061
Notes payable 560 0
Accounts payable 37,600 45,144
Accrued liabilities 60,915 81,860
Deferred revenues 30,422 24,404
---------- ----------
Total current liabilities 129,497 157,469
Long-Term Debt 108,281 107,408
Other Liabilities 94,531 96,488
---------- ----------
Total Automotive Solutions Liabilities 332,309 361,365
---------- ----------
FINANCIAL SERVICES LIABILITIES
Notes Payable 192,348 217,252
Other Liabilities 101,222 103,522
---------- ----------
Total Financial Services Liabilities 293,570 320,774
---------- ----------
SHAREHOLDERS' EQUITY
Capital Stock 248,104 217,018
Other Comprehensive Losses (10,121) (14,234)
Retained Earnings 240,075 252,242
---------- ----------
Total Shareholders' Equity 478,058 455,026
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,103,937 $1,137,165
========== ==========

See Notes to Condensed Consolidated Financial Statements.

4

THE REYNOLDS AND REYNOLDS COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
(In thousands)

See Notes to Condensed Consolidated Financial Statements.

5

THE REYNOLDS AND REYNOLDS COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The balance sheet as of September 30, 2002 is condensed financial information
taken from the annual audited financial statements. The interim financial
statements are unaudited. In the opinion of management, the accompanying interim
financial statements contain all significant adjustments (which consist only of
normal recurring adjustments) necessary to present fairly the company's
financial position, results of operations and cash flows for the periods
presented.

(2) INVENTORIES

(3) BUSINESS COMBINATIONS

In November 2002, the company purchased all outstanding shares of Networkcar,
Inc., the provider of a telematics device which monitors a car's diagnostic
information, locates stolen cars through a satellite-based Global Positioning
System and performs remote emissions testing. The company purchased Networkcar
to enable the rollout to North American automotive retailers as a component of
the company's integrated suite of customer relationship management solutions.
The purchase price of $11,714 was paid with cash from existing balances. The
results of Networkcar's operations have been included in the company's financial
statements since the November 29, 2002, purchase date. As of March 31, 2003, the
company had recorded goodwill of $12,550 based on the preliminary allocation of
the purchase price. The company engaged an independent appraisal firm to
determine fair values of intangible assets, such as patents. During the third
quarter of fiscal year 2003, a preliminary valuation of the net assets was
completed by the independent appraisal firm and the company adjusted its
purchase price allocation to increase fixed assets by $600, increase intangible
assets for patents by $2,800, reduce non-compete agreements by $400 and reduce
goodwill by $3,000. Because the company purchased stock, goodwill would be tax
deductible only if the company disposes of the stock of Networkcar.

In August 2002, the company purchased BoatVentures.com Corporation, a provider
of Web-based applications and education processes to boat, power sports and
recreational vehicle retailers and manufacturers. The company preliminarily
allocated the purchase price to the net assets at that time. During fiscal year
2003, the valuation of the net assets was completed by an independent appraisal
firm and the company adjusted the purchase price allocation to increase computer
equipment by $200, increase capitalized software by $100, reduce non-compete
agreement intangible assets by $2,400 and increase goodwill by $2,100.

(4) GOODWILL AND INTANGIBLE ASSETS

In 2002, the company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that goodwill no longer be amortized, but instead tested for impairment
at least annually. During fiscal year 2002, the company completed the initial
goodwill impairment test and recorded impairment losses of $36,563 ($60,938 net
of income tax benefits of $24,375). These impairment losses were recorded
effective October 1, 2001, as the cumulative effect of accounting change in the
statements of consolidated income.

GOODWILL

6

ACQUIRED INTANGIBLE ASSETS

Aggregate amortization expense was $1,822 and $5,406 for the three and nine
months ended June 30, 2003, respectively. Estimated amortization expense for the
years ended September 30, is $7,100 in 2003, $3,567 in 2004, $2,300 in 2005,
$2,300 in 2006 and $2,300 in 2007.

(5) FINANCING ARRANGEMENTS

AUTOMOTIVE SOLUTIONS

As of June 30, 2003, the company had outstanding interest rate swap agreements
with notional amounts of $100,000. These interest rate swap agreements were
designated as fair value hedges. The fair value of the company's fair value
derivative instruments was $8,450 at June 30, 2003 and $7,614 at September 30,
2002 and was included in Automotive Solutions' other assets on the condensed
consolidated balance sheet. The adjustments to record the net change in the fair
value of fair value hedges and related debt during the periods presented were
recorded in income. All existing fair value hedges were 100% effective. As a
result, there was no current impact to earnings because of hedge
ineffectiveness.

FINANCIAL SERVICES

On January 24, 2003, Reyna Funding, L.L.C., a consolidated affiliate of the
company, renewed a loan funding agreement, whereby Reyna Funding, L.L.C. may
borrow up to $100,000 using finance receivables purchased from Reyna Capital
Corporation, also a consolidated affiliate of the company, as security for the
loan. The securitization allows borrowings, up to the $100,000 limit, through
January 23, 2004. This loan funding agreement is renewable annually through
January 23, 2006. Any borrowings will be repaid as collections on finance
receivables balances are received. As of June 30, 2003, Reyna Funding, L.L.C.
had outstanding borrowings of $100,000 under this arrangement.

As of June 30, 2003, Reyna Funding, L.L.C. had outstanding interest rate swap
agreements with notional amounts of $100,000 and Reyna Capital Corporation had
outstanding interest rate swap agreements with notional amounts of $20,000.
These interest rate swap agreements were designated as cash flow hedges. The
fair value of the company's cash flow derivative instruments was a $3,286
liability at June 30, 2003, and a $4,035 liability at September 30, 2002, and
was included in Financial Services' other liabilities on the condensed
consolidated balance sheets. The adjustments to record the net change in the
fair value of cash flow hedges during the periods presented were recorded, net
of income taxes, in other comprehensive income. Fluctuations in the fair value
of the derivative instruments are generally offset by changes in the value of
cash flows of the underlying exposure being hedged because of the high degree of
effectiveness of these cash flow hedges. In fiscal year 2003, the company
expects the amounts to be reclassified from other comprehensive income into
earnings to be immaterial to the financial statements.

7

(6) COMPREHENSIVE INCOME

(7) STOCK OPTIONS

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." This Statement amends the disclosure
requirements of Statement 123, "Accounting for Stock-Based Compensation," to
require disclosure in interim financial statements about the method of
accounting for stock-based compensation and the effect of the method used on
reported results. This statement was effective for interim financial statements
beginning after December 15, 2002.

The company accounts for employee stock options under APB Opinion No. 25,
"Accounting for Stock Issued to Employees". The company follows the disclosure
requirements of SFAS No. 123, as amended by SFAS No. 148, which requires the
valuation of stock options using option valuation models and the disclosure of
the pro forma effect on earnings. The company valued its stock options using the
Black-Scholes option valuation model which was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of
subjective assumptions, such as expected stock price volatility, which can
materially affect the fair value estimate. Because the company's stock options
have characteristics significantly different from traded options, the fair value
determined may not reflect the actual value of the company's stock options.

8

(8) CASH FLOW STATEMENTS

Reconciliation of net income to net cash provided by operating activities.

(9) BUSINESS SEGMENTS

Reclassifications were made to the prior year's segment information to conform
to the presentation used in fiscal year 2003. The results of operations for a
consulting business unit were transferred from the Software Solutions segment to
the Transformation Solutions segment. This presentation reflects the current
organizational structure of the company.

9

(10) CONTINGENCIES

The U.S. Environmental Protection Agency (EPA) had designated the company as one
of a number of potentially responsible parties (PRP) under the Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA) at an
environmental remediation site. The EPA contended that any company linked to a
CERCLA site is potentially liable for all response costs under the legal
doctrine of joint and several liability. This environmental remediation site
involved a municipal waste disposal facility owned and operated by four
municipalities. The company joined a PRP coalition and shared remedial
investigation and feasibility study costs with other PRPs. On May 7, 2003, a
consent decree was entered in the United States District Court for the District
of Connecticut (U.S. v. Regional Refuse Disposal District, et al) pursuant to
which the company paid $244 on May 14, 2003. The company believes that any
further involvement in the remediation will be minimal and will not have a
material adverse effect on the financial statements.

In 2000, the company was named a defendant in a cost recovery lawsuit filed by
PRP coalition in the United States District Court for Southern District of Ohio
regarding an environmental remediation site in Dayton, Ohio. The court has
ordered the parties to participate in non-bonding mediation. The company
believes that the reasonably foreseeable resolution of this matter will not have
a material adverse effect on the financial statements.

In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This Interpretation requires the company
to disclose contingent obligations under certain guarantees in both interim and
annual financial statements. In fiscal year 2000, the company sold the net
assets of its Information Solutions segment to The Carlyle Group. The Carlyle
Group renamed the business Relizon Corporation. The company became secondarily
liable under new real estate leases after being released as primary obligor for
facilities leased and paid by Relizon. As of June 30, 2003, this contingent
liability totaled $3,408. The majority of these leases expire during 2003 and
2004. Also in connection with the sale of these operations to The Carlyle Group,
the company secured a standby letter of credit which expires in 2007. The
company is contingently liable for a portion of long-term debt secured by a
Relizon facility in Canada. As of June 30, 2003, the unamortized balance on this
letter of credit was $1,605.

In August 1997, the company entered into an agreement with a trust for the
construction and lease of an office building near Dayton, Ohio. The trust was
formed by a consortium of institutional investors who purchased equity interest
in the trust and provided loans to the trust for the construction of the

10

building. This building was completed in 1999 at a cost of $28,800. This lease
was accounted for as an operating lease for financial reporting purposes.
Accordingly, neither the asset nor the related liability is reported on the
company's balance sheets. The company guaranteed 80% of the trust's debt related
to the construction of the building. The original five-year term was extended
two years through August 2004. At the end of the lease term, the company had the
option to purchase the building for $28,800 or sell the building on behalf of
the lessor. If the building was sold and the proceeds from the sale were
insufficient to repay investors, the company might have been required to make a
payment to the lessor of up to 80% of the building's cost. On July 1, 2003, the
company purchased the office building for cash of $28,800 and terminated the
lease agreement.

(11) ACCOUNTING STANDARDS

In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities." This interpretation requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among the
parties involved. This interpretation applies immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. It applies to the first
fiscal year or interim period beginning after June 15, 2003, to variable
interest entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003. On July 1, 2003, the company purchased an
office building, leased from a nonconsolidated trust discussed in Note 10 to the
Consolidated Financial Statements, for cash of $28,800 and terminated the lease
agreement. The company has no other variable interest entities.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
requires that certain financial instruments be classified as either a liability
or an asset, instead of equity, on the balance sheet. The provisions of this
statement are effective for the first interim period beginning after June 15,
2003. The adoption of this pronouncement will not have a material impact on the
company's financial statements.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2003 AND 2002
(In thousands except per share data)

2002 SPECIAL ITEMS

During the second quarter of fiscal year 2002, the company recorded several
items that when combined added $742 or $.01 per share to earnings. The company
settled a state income tax audit that covered fiscal years 1992 through 1998.
Based on the settlement, the company reduced interest and income tax accruals
for fiscal years 1999 through 2001. The company also filed amended returns in a
number of states to correct the apportionment and allocation of taxable income
among the states. The combination of audit settlements, accrual adjustments and
amended returns added $5,890 or $.08 per share of earnings in the second quarter
of fiscal year 2002. The income tax adjustments were recorded as follows: $2,310
in selling, general and administrative (SG&A) expenses, primarily for
professional fees associated with obtaining the income tax benefits, $1,709 for
the reversal of previously recorded interest expense, $819 of interest income on
tax refunds, $200 of other charges and $5,872 of income tax benefits. During the
second quarter of fiscal year 2002, the company also recorded $8,552 of expenses
($5,251 or $.07 per share after income taxes) for the following items: employee
termination benefits of $4,492 for 114 employees, communications software
distributed to customers of $2,500 and real estate costs of $1,560. These items
were recorded as follows: $2,000 in cost of sales, $6,552 in SG&A expenses and
related income tax benefits of $3,301. During March 2002, the company also sold
its shares of Kalamazoo Computer Group plc of the United Kingdom for cash of
$1,636 and recorded a net gain of $103. The company recorded a loss of $12,274,
included with equity in net losses of affiliated companies on the statement of
consolidated income and income tax benefits of $12,377 related to the sale of
these shares, included with the provision for income taxes on the statement of
consolidated income.

11

RESULTS OF OPERATIONS
CONSOLIDATED SUMMARY

Consolidated revenues were essentially flat in the third quarter and up 2%
year-to-date. For both the third quarter and nine months, consolidated revenues
reflected growth in Software Solutions segment revenues, the company's largest
segment, and revenue declines in the three smaller segments. Gross profit and
gross margins declined from last year for both the quarter and nine months
reflecting lower Transformation Solutions revenues and Documents sales. Gross
margin was also negatively affected by a shift in the Software Solutions sales
mix, with lower margin systems sales growing faster than higher margin recurring
service revenues. Gross margin also reflected a change in the allocation of
certain expenses previously reported as SG&A expenses to cost of sales. This
improved allocation of expenses was made possible by a new general ledger
system, however, it was not practicable to restate the prior year. Third quarter
and year-to-date SG&A expenses declined from last year, both in total dollars
and as a percentage of revenues. SG&A expenses declined because of lower selling
expenses and the change in cost allocation methodology. Last year's SG&A
expenses for the nine month period also included special items previously
discussed. Research and development (R&D) expenses were approximately $17,000 in
the quarter and $53,000 year-to-date, compared to $18,000 and $50,000 last year,
respectively. Operating income also included combined losses for Reydiance(TM)
(acquired as BoatVentures.com in August 2002), Networkcar (acquired in November
2002) and Dealerpoint (software license acquired in January 2003) of $3,100 for
the quarter and $8,300 year-to-date.

Year-to-date, other income and expenses improved from last year primarily
because last year included the previously mentioned pretax losses on the sale of
Kalamazoo Computer Group shares. Also, in the second quarter of 2003, the
company sold its investment in Credit Online and recorded a pretax gain of
$1,369. The effective income tax rate was 42.8% for the quarter compared to
38.4% last year. The 2003 tax rate reflected $3,400 of higher state income tax
expense ($2,210 net of federal income tax benefits) related to Ohio tax
legislation enacted in late June 2003. This tax law resulted in increased
taxable income apportioned to the state of Ohio and did not reduce taxable
income apportioned to other states. Excluding this tax law change, the third
quarter tax rate was 38.3%. Year-to-date the effective income tax rate was 40.1%
(38.5% excluding the tax law change), compared to 26.7% last year. Last year
included many special items previously discussed. Excluding the 2002 special
items, last year's tax rate for nine months was 38.4%.

SOFTWARE SOLUTIONS

12

Software Solutions revenues grew over last year for both the third quarter and
nine months as both computer systems products sales and computer service
revenues increased over last year. For the third quarter computer systems
products sales increased as more Electronic Document Management systems and
personal computers were sold. Year-to-date, computer systems products sales grew
primarily as a result of higher sales of ERA(R) retail management systems and
personal computers. Computer services revenues, comprised predominately of
recurring software support and equipment maintenance revenues, grew for both the
three and nine months because of the increased number of ERA retail management
software applications supported, growth in Network Services revenues and the
addition of Internet Lead Management (formerly Dealerpoint) sales which resulted
from a license agreement between the company and Microsoft Corporation. The
backlog of new orders for computer systems products and deferred revenues
(orders shipped, but not yet recognized in revenues) was approximately $54,000
at June 30, 2003, compared to $60,000 at September 30, 2002. Gross profit
increased over last year for the quarter and year-to-date because of the sales
increase. Gross margins, however, declined from last year, primarily because of
the strong growth in product sales, which have lower margins than service
revenues, and the allocation of certain expenses previously reported as SG&A
expenses to cost of sales. The new allocation methodology reduced gross margin
by about one percentage point in both the third quarter and nine months. This
improved allocation of expenses was made possible by a new general ledger
system. It was not practicable, however, to restate the prior year. Gross
margins also reflected the ramp up of costs to support Internet Lead Management.
SG&A expenses declined from last year, as a percentage of revenues, for the
quarter primarily because of lower selling expenses and the change in cost
allocation methodology. Year-to-date, SG&A expenses declined from last year, as
a percentage of revenues, primarily because of lower selling expenses, the
change in cost allocation methodology and last year's special items previously
discussed. Operating margins exceeded last year for both the three and nine
month periods, primarily because of the sales growth.

TRANSFORMATION SOLUTIONS

Transformation Solutions revenues were less than last year for both the three
and nine months as growth of credit applications revenues was more than offset
by declines in Reynolds Consulting Services, Campaign Management Services, and
Automark(R) Web Services revenues. Reynolds Consulting Services revenues
reflected a decline in the number of consulting days delivered and Campaign
Management Services lower revenues resulted from a decrease in the number of
service reminders mailed. Automark Web Services revenues declined as the company
began recording revenues over the contract service period instead of upon
delivery of the software license. Automark Web Services historically included a
mixture of one-time and recurring revenues based on contract terms which have
allowed customers the option to host their Web sites. As part of the Reynolds
Generation Series(TM), the company has launched additional hosted services and
will release more in the future. As many of these hosted services integrate into
the Web services offerings, the company is transitioning Automark Web Services
to the company's standard contract terms, which do not contain the hosting
option. Automark Web Services also delivered fewer web sites than last year's
very strong third quarter. Gross profit and gross profit margins declined from
last year for both the three and nine months because of the decline in revenues
which resulted in lower utilization of consultants and lower fixed cost coverage
for Campaign Management Services and Automark Web Services. Third quarter and
year-to-date operating losses reflect the revenue driven decline in gross profit
and the purchases of Networkcar in November 2002 and BoatVentures.com in August
2002. These businesses lost a combined $1,900 in the third quarter and $6,100
year-to-date. See Note 3 to the Consolidated Financial Statements for additional
disclosures regarding these business combinations.

13

DOCUMENTS

Documents sales decreased for both the three and nine months ended June 30,
2003, as a result of the continued decline in the number of business forms sold.
In the third quarter, revenues declined 3%, compared to a 7% decline for the
first six months of the fiscal year. Laser and continuous forms revenues
increased for both the three and nine months; however, this increase was more
than offset by lower volume in other product lines. Gross profit and gross
profit margins were less than last year for both the third quarter and
year-to-date primarily because of the sales decline, which reduced fixed cost
coverage and contributed to manufacturing inefficiencies. Gross profit was also
negatively impacted by the change in allocation methodology, which shifted
certain expenses from SG&A expenses to cost of sales. It was not practicable to
restate last year. SG&A expenses declined from last year for both periods,
reflecting both lower sales and the cost allocation change. Operating margins
were the same as last year in the third quarter as revenues shrank at a slower
rate than earlier in the year. Year-to-date operating margins declined because
of lower revenues and the effect on gross profit margins.

FINANCIAL SERVICES

Financial Services revenues decreased from last year for both the three and nine
months because of lower interest rates and a decline in receivable balances from
a year ago. Gross profit decreased from last year's third quarter and nine
months because of the revenue decline, but gross profit margins increased as
interest rate spreads were strong. Interest rate spreads were 5.2% for both the
third quarter and nine months, compared to 4.8% and 4.9% for the third quarter
and nine months last year. These interest rate spreads represent relatively high
levels for this segment as reduced interest rates decreased borrowing costs.
SG&A expenses were down slightly for the quarter and declined from last year
through nine months because of lower bad debt expenses. Bad debt expenses were
$1,150 in the third quarter of 2003, the same as last year, and $2,565
year-to-date, compared to $3,750 last year. Reduced bad debt expenses reflect
lower write-offs and a decline in past due accounts. Overall, operating margins
remained strong for this segment.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOWS

The company's balance of cash and equivalents was $115,550 as of June 30, 2003.
Cash flows from operating activities were $92,629 for the nine months ended June
30, 2003, and resulted primarily from net income adjusted for non cash
depreciation and amortization expenses. Cash flows used for investing activities
included the company's purchase of Networkcar for $11,714, capital expenditures
of $20,681 for normal operations and the capitalization of $14,685 of software
licensed to customers. As of June 30, 2003, the balance of software licensed to
customers was $95,386. Most of the capitalized software development costs relate
to Reynolds Generations Series solutions. In the fourth quarter of fiscal year
2003, the company will begin amortizing these costs. Fiscal year 2003 capital
expenditures and capitalized software in the ordinary course of business are
anticipated to be about $45,000 excluding real estate transactions. On July 1,
2003, the company purchased an office building for $28,800 of cash and
terminated a lease agreement. See related disclosure in Notes 10 and 11 to the
Consolidated Financial Statements.

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Financial services operating cash flows and collections on finance receivables
were invested in new finance receivables for the company's automotive systems
and used to make scheduled debt repayments.

CAPITALIZATION

The company's ratio of total debt (total automotive solutions debt) to
capitalization (total automotive solutions debt plus shareholders' equity) was
18.5% as of June 30, 2003 and 20.0% as of September 30, 2002. During the first
nine months of fiscal year 2003, the company repaid $6,061 of long-term debt.
Remaining credit available under committed revolving credit agreements was
$100,000 at June 30, 2003. In addition to committed credit agreements, the
company also has a variety of other short-term credit lines available. The
company anticipates that cash balances, cash flow from operations and cash
available from committed credit agreements will be sufficient to fund normal
operations over the next year. Cash balances are placed in short-term
investments until such time as needed.

In August 1997, the company entered into an agreement with a trust for the
construction and lease of an office building near Dayton, Ohio. The trust was
formed by a consortium of institutional investors who purchased equity interests
in the trust and provided loans to the trust for the construction of the
building. This building was completed in 1999 at a cost of $28,800. This lease
was accounted for as an operating lease for financial reporting purposes.
Accordingly, neither the asset nor the related liability is reported on the
company's balance sheets. The company guaranteed 80% of the trust's debt related
to the construction of the building. The company made quarterly lease payments
based on the outstanding lease balance of $28,800. The original five-year term
was extended two years through August 2004. At the end of the lease term, the
company had the option to purchase the building for $28,800 or sell the building
on behalf of the lessor. If the building was sold and the proceeds from the sale
were insufficient to repay the investors, the company might have been required
to make a payment to the lessor of up to 80% of the building's cost. On July 1,
2003, the company purchased the aforementioned office building from the trust
for cash of $28,800 and terminated the lease agreement.

On January 24, 2003, Reyna Funding, L.L.C., a consolidated affiliate of the
company, renewed a loan funding agreement, whereby Reyna Funding, L.L.C.
borrowed $100,000 secured by finance receivables purchased from Reyna Capital
Corporation, also an affiliate of the company. The securitization allows
borrowings, up to the $100,000 limit, through January 23, 2004. This loan
funding agreement is renewable annually through January 23, 2006. Any borrowings
will be repaid as collections on finance receivables balances are received. The
outstanding borrowings under this arrangement were included with Financial
Services' notes payable on the Consolidated Balance Sheet.

The company has consistently produced strong operating cash flows sufficient to
fund normal operations. Strong operating cash flows are the result of stable
operating margins and a high percentage of recurring service revenues, which
require relatively low capital investment. Debt instruments have been used
primarily to fund business combinations and Financial Services receivables. As
of June 30, 2003, the company can issue an additional $130,000 of notes under a
shelf registration statement on file with the Securities and Exchange
Commission. Management believes that its strong balance sheet and cash flows
should help maintain an investment grade credit rating that should provide
access to capital sufficient to meet the company's cash requirements beyond the
next year.

SHAREHOLDERS' EQUITY

The company lists its Class A common shares on the New York Stock Exchange.
There is no principal market for the Class B common shares. The company also has
an authorized class of 60,000 preferred shares with no par value. As of June 30,
2003, no preferred shares were outstanding and there were no agreements or
commitments with respect to the sale or issuance of these shares, except for
preferred share purchase rights described in the company's annual report on Form
10-K for the fiscal year ended September 30, 2002.

Dividends are typically declared each November, February, May and August and
paid in January, April, June and September. Dividends per Class A common share
must be twenty times the dividends per Class B common share and all dividend
payments must be simultaneous. The company has paid dividends every year since
the company's initial public offering in 1961.

During the three months ended June 30, 2003, the company repurchased 989 Class A
common shares for $28,215 ($28.53 per share). Year-to-date, the company
repurchased 3,270 Class A common shares for $86,013 ($26.31 per share). As of
June 30, 2003, the company could repurchase an additional 1,634 Class A common
shares under existing board of directors' authorizations. On August 12, 2003,
the board of directors authorized an additional 8,000 Class A common shares for
repurchase.

15

APPLICATION OF CRITICAL ACCOUNTING POLICIES

The company's consolidated financial statements and notes to consolidated
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America. Preparing financial
statements and applying accounting policies require management to make
judgments, estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. Critical accounting policies for the company
include revenue recognition, accounting for software licensed to customers,
accounting for long-lived assets and accounting for income taxes.

REVENUE RECOGNITION

Sales of computer hardware and business forms products are recorded when title
passes upon shipment to customers. Revenues from software license fees are
accounted for in accordance with American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) 97-2, "Software Revenue
Recognition." The company recognizes revenue when (i) persuasive evidence of an
arrangement exists; (ii) delivery has occurred or services have been rendered;
(iii) the sales price is fixed or determinable; and (iv) collectibility is
reasonably assured. Service revenues, which include computer hardware
maintenance, software support, training, consulting and Web hosting are recorded
ratably over the contract period or as services are performed. The application
of SOP 97-2 requires judgment, including whether a software arrangement includes
multiple elements, and if so, whether vendor-specific objective evidence of fair
value exists for those elements. Software revenues which do not meet the
criteria set forth in Emerging Issues Task Force (EITF) Issue No. 00-3,
"Application of AICPA SOP 97-2 to Arrangements That Include the Right to Use
Software Stored on Another Entity's Hardware," are recorded ratably over the
contract period as services are provided.

SOFTWARE LICENSED TO CUSTOMERS

The company capitalizes certain costs of developing its software products in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed." SFAS No. 86 specifies that costs
incurred in creating a computer software product should be charged to expense
when incurred, as research and development, until technological feasibility has
been established for the product. Technological feasibility is established
either by creating a detail program design or a tested working model. Judgment
is required in determining when technological feasibility of a product is
established. The company follows a standard process for developing software
products. This process has five phases; selection, definition, development,
delivery and general customer acceptability (GCA). When using proven technology,
management believes that technological feasibility is established upon the
completion of the definition phase (i.e. detail program design). When using
newer technology, management believes that technological feasibility is
established upon completion of the delivery phase (tested working model). Once
technological feasibility has been established, software development costs are
capitalized until the product is available for general release to customers
(GCA). Software development costs consist primarily of payroll and benefits for
both employees and outside contractors. Upon general release of a software
product, amortization is determined based on the larger of the amounts computed
using (a) the ratio that current gross revenues for each product bears to the
total of current and anticipated future gross revenues for that product or (b)
the straight-line method over the remaining estimated economic life of the
product, ranging from three to seven years.

LONG-LIVED ASSETS

The company has completed numerous business combinations over the years. These
business combinations result in the acquisition of intangible assets and the
recognition of goodwill on the company's consolidated balance sheet. The company
accounts for these assets under the provisions of SFAS No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No.
142 requires that goodwill not be amortized, but instead tested for impairment
at least annually. The statement also requires recognized intangible assets with
finite useful lives to be amortized over their useful lives. Long-lived assets,
goodwill and intangible assets are reviewed for impairment annually or whenever
events or circumstances indicate that the carrying amount of an asset may not be
recoverable from future cash flows. Future cash flows are forecasted based on
management's estimates of future events and could be materially different from
actual cash flows. If the carrying value of an asset is considered impaired, an
impairment charge is recorded for the amount by which the carrying value of the
asset exceeds its fair value.

INCOME TAXES

The company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." The objectives of accounting for income taxes are
to recognize the amount of taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in the company's financial statements or tax returns.
Judgment is required in assessing the future tax consequences of events that
have been recognized in the company's financial statements or tax returns.
Fluctuations in the actual outcome of these future tax consequences could
materially impact the company's financial position or its results of operations.

16

MARKET RISKS

INTEREST RATES

The Automotive Solutions portion of the business borrows money, as needed,
primarily to fund business combinations. Generally the company borrows under
fixed rate agreements with terms of ten years or less. During fiscal year 2002,
the company entered into $100,000 of interest rate swaps to reduce the effective
interest expense on outstanding long-term debt. In this transaction the company
effectively converted 7% fixed rate debt into variable rate debt. The company
does not use financial instruments for trading purposes. See Note 5 to the
Consolidated Financial Statements for additional discussion of interest rate
management agreements.

The Financial Services segment of the business, including Reyna Funding L.L.C.,
an affiliate of the company, obtains borrowings to fund the investment in
finance receivables. These fixed rate receivables generally have repayment terms
of five years. The company funds finance receivables with debt that has
repayment terms consistent with the maturities of the finance receivables.
Generally the company attempts to lock in the interest spread on the fixed rate
finance receivables by borrowing under fixed rate agreements or using interest
rate management agreements to manage variable interest rate exposure. Management
believes that over time it has reduced interest expense by using interest rate
management agreements and variable rate debt instead of directly obtaining fixed
rate debt. During the nine months ended June 30, 2002, Reyna Funding, L.L.C., an
affiliate of the company, entered into interest rate swaps of $25,085 to replace
maturing interest rate swaps. The company does not use financial instruments for
trading purposes. See Note 5 to the Consolidated Financial Statements for
additional discussion of interest rate management agreements.

Because the company's borrowings are generally under fixed rate debt
arrangements or its equivalent (variable rate debt that has been fixed with
interest rate swaps), management believes that a one percentage point move in
interest rates would not have a material effect on the company's financial
statements.

FOREIGN CURRENCY EXCHANGE RATES

The company has foreign-based operations, located primarily in Canada, which
accounted for 7% of net sales and revenues for the nine months ended June 30,
2003. In the conduct of its foreign operations the company has intercompany
sales, charges and loans between the U.S. and its foreign subsidiaries and may
receive dividends denominated in different currencies. These transactions expose
the company to changes in foreign currency exchange rates. At June 30, 2003, the
company had no foreign currency exchange contracts outstanding. Based on the
company's overall foreign currency exchange rate exposure at June 30, 2003,
management believes that a 10% change in currency rates would not have a
material effect on the company's financial statements.

ENVIRONMENTAL MATTER

See Note 10 to the Consolidated Financial Statements for a discussion of the
company's environmental contingencies.

ACCOUNTING STANDARDS

See Note 11 to the Consolidated Financial Statements for a discussion of the
effect of accounting standards that the company has not yet adopted.

FACTORS THAT MAY AFFECT FUTURE RESULTS

Certain statements in this Management's Discussion and Analysis of the Financial
Condition and Results of Operations constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. The
forward-looking statements are based on current expectations, estimates,
forecasts and projections of future company or industry performance based on
management's judgment, beliefs, current trends and market conditions.
Forward-looking statements made by the company may be identified by the use of
words such as "expects," "anticipates," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions. Forward-looking statements are not
guarantees of future performance and involve certain risks, uncertainties and
assumptions, which are difficult to predict. Actual outcomes and results may
differ materially from what is expressed, forecasted or implied in any
forward-looking statement. The company undertakes no obligation to update any
forward-looking statements, whether as a result of new information, future
events or otherwise. See also the discussion of factors that may affect future
results contained in the company's Current Report on Form 8-K filed with the SEC
on August 11, 2000, which we incorporate herein by reference.

17

CONTROLS AND PROCEDURES

The company's management, including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of disclosure
controls and procedures as required by paragraph (b) of Exchange Act Rule 13a-15
as of the end of the period covered by this quarterly report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures are effective in ensuring that all
material information required to be filed in this quarterly report has been made
known to them in a timely fashion. There has been no change in the company's
internal control over financial reporting that occurred during the fiscal period
covered by this quarterly report that has materially affected, or is reasonably
likely to materially affect, the company's internal control over financial
reporting.

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PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

31 Certifications

32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

32.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

(b) Reports on Form 8-K On April 23,2003, the company filed a
report on Form 8-K that included the company's April 23, 2003,
press release announcing financial results for the quarter
ended March 31,2003.

On July 9, 2003, the company filed a report on Form 8-K that
included the company's July 8, 2003, press release announcing
that a retroactive Ohio tax law change would increase tax
expense and reduce earnings.

On July 23, 2003, the company filed a report on Form 8-K that
included the company's July 23, 2003, press release announcing
financial results for the quarter ended June 30, 2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

THE REYNOLDS AND REYNOLDS COMPANY

Date August 14, 2003 /s/ Lloyd G. Waterhouse
----------------- --------------------------------
Lloyd G. Waterhouse
Chief Executive Officer,
Chairman and President

Date August 14, 2003 /s/ Dale L. Medford
----------------- --------------------------------
Dale L. Medford
Executive Vice President
and Chief Financial Officer

20