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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 MARCH 31, 2004
COMMISSION FILE NO. 1-10147
THE REYNOLDS AND REYNOLDS COMPANY
OHIO 31-0421120
(State of incorporation) (IRS Employer Identification No.)
ONE REYNOLDS WAY
DAYTON, OHIO 45430
(Address of principal executive offices)
(937) 485-2000
(Telephone No.)
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 March 31, 2004, 64,806,893 Class A common shares and 14,000,000 Class B
common shares were outstanding.
THE REYNOLDS AND REYNOLDS COMPANY
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Consolidated Income (unaudited)
For the Three and Six Months Ended March 31, 2004 and 2003 3
Condensed Consolidated Balance Sheets (unaudited)
As of March 31, 2004 and September 30, 2003 4
Condensed Statements of Consolidated Cash Flows (unaudited)
For the Six Months Ended March 31, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
For the Three and Six Months Ended March 31, 2004 and 2003 13
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) 19
Item 4. Controls and Procedures 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
2
THE REYNOLDS AND REYNOLDS COMPANY
STATEMENTS OF CONSOLIDATED INCOME (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2004 AND 2003
(In thousands except per share data)
Three Months Six Months
2004 2003 2004 2003
-------- -------- -------- --------
Net Sales and Revenues
Software $135,963 $135,282 $278,469 $271,601
Services 60,920 66,223 118,729 126,284
Documents 44,258 44,179 83,946 84,807
Financial services 8,351 9,415 16,751 19,055
-------- -------- -------- --------
Total net sales and revenues 249,492 255,099 497,895 501,747
-------- -------- -------- --------
Cost of Sales
Software 42,003 46,417 87,014 90,010
Services 43,788 45,480 86,868 90,212
Documents 20,881 20,241 40,689 38,176
Financial services 1,863 2,261 3,780 4,795
-------- -------- -------- --------
Total cost of sales 108,535 114,399 218,351 223,193
-------- -------- -------- --------
Gross Profit 140,957 140,700 279,544 278,554
Selling, General and Administrative Expenses 98,233 97,919 200,861 193,916
-------- -------- -------- --------
Operating Income 42,724 42,781 78,683 84,638
-------- -------- -------- --------
Other Charges (Income)
Interest expense 1,230 1,179 2,570 2,700
Interest income (403) (462) (1,060) (1,333)
Other (1,204) (2,289) (2,152) (3,285)
-------- -------- -------- --------
Total other charges (income) (377) (1,572) (642) (1,918)
-------- -------- -------- --------
Income Before Income Taxes 43,101 44,353 79,325 86,556
Provision for Income Taxes 16,744 17,363 29,146 33,993
-------- -------- -------- --------
Net Income $ 26,357 $ 26,990 $ 50,179 $ 52,563
======== ======== ======== ========
Basic Earnings Per Common Share
Net income $ 0.40 $ 0.40 $ 0.75 $ 0.77
Average number of common shares outstanding 66,604 68,094 66,925 68,647
Diluted Earnings Per Common Share
Net income $ 0.38 $ 0.39 $ 0.73 $ 0.75
Average number of common shares outstanding 68,642 69,923 69,045 70,448
Cash Dividends Declared Per Common Share $ 0.11 $ 0.11 $ 0.22 $ 0.22
See Notes to Condensed Consolidated Financial Statements.
3
THE REYNOLDS AND REYNOLDS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2004 AND SEPTEMBER 30, 2003
(In thousands)
Unaudited
3/31/04 9/30/03
---------- ----------
AUTOMOTIVE SOLUTIONS ASSETS
Current Assets
Cash and equivalents $ 123,785 $ 105,829
Trade accounts receivable 108,836 118,694
Other accounts receivables 10,159 21,063
Inventories 14,100 12,432
Prepaid expenses and other assets 40,189 31,673
---------- ----------
Total current assets 297,069 289,691
Property, Plant and Equipment, less accumulated depreciation of
$129,690 at 3/31/04 and $156,674 at 9/30/03 180,540 184,691
Goodwill 47,660 41,728
Software Licensed to Customers 94,628 94,472
Acquired Intangible Assets 36,698 37,731
Other Assets 103,259 98,029
---------- ----------
Total Automotive Solutions Assets 759,854 746,342
---------- ----------
FINANCIAL SERVICES ASSETS
Cash 567 722
Finance Receivables 371,249 394,292
Other Assets 441 480
---------- ----------
Total Financial Services Assets 372,257 395,494
---------- ----------
TOTAL ASSETS $1,132,111 $1,141,836
========== ==========
AUTOMOTIVE SOLUTIONS LIABILITIES
Current Liabilities
Accounts payable $ 42,543 $ 45,917
Accrued liabilities 47,420 53,236
Deferred revenues 30,674 33,704
Income taxes 30,393 10,926
---------- ----------
Total current liabilities 151,030 143,783
Long-Term Debt 106,335 106,912
Other Liabilities 124,907 118,452
---------- ----------
Total Automotive Solutions Liabilities 382,272 369,147
---------- ----------
FINANCIAL SERVICES LIABILITIES
Notes Payable 193,176 198,768
Other Liabilities 102,739 99,010
---------- ----------
Total Financial Services Liabilities 295,915 297,778
---------- ----------
SHAREHOLDERS' EQUITY
Capital Stock 322,353 299,779
Accumulated Other Comprehensive Losses (30,786) (32,446)
Retained Earnings 162,357 207,578
---------- ----------
Total Shareholders' Equity 453,924 474,911
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,132,111 $1,141,836
========== ==========
See Notes to Condensed Consolidated Financial Statements.
4
THE REYNOLDS AND REYNOLDS COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED MARCH 31, 2004 AND 2003
(In thousands)
2004 2003
--------- ---------
AUTOMOTIVE SOLUTIONS
Cash Flows Provided By Operating Activities $ 109,852 $ 60,929
--------- ---------
Cash Flows Provided By (Used For) Investing Activities
Business combinations (11,645) (11,714)
Capital expenditures (21,788) (14,166)
Net proceeds from asset sales 10,318 157
Capitalization of software licensed to customers 0 (10,359)
Repayments from financial services 8,991 1,910
--------- ---------
Net cash flows used for investing activities (14,124) (34,172)
--------- ---------
Cash Flows Provided By (Used For) Financing Activities
Principal payments on debt (5,275) (6,061)
Cash dividends paid (7,371) (7,548)
Capital stock issued 27,689 10,251
Capital stock repurchased (94,010) (57,796)
--------- ---------
Net cash flows used for financing activities (78,967) (61,154)
--------- ---------
Effect of Exchange Rate Changes on Cash 1,195 1,490
--------- ---------
Increase (Decrease) in Cash and Equivalents 17,956 (32,907)
Cash and Equivalents, Beginning of Period 105,829 155,295
--------- ---------
Cash and Equivalents, End of Period $ 123,785 $ 122,388
========= =========
FINANCIAL SERVICES
Cash Flows Provided By Operating Activities $ 11,876 $ 9,702
--------- ---------
Cash Flows Provided By (Used For) Investing Activities
Finance receivables originated (75,566) (76,100)
Collections on finance receivables 78,118 85,090
--------- ---------
Net cash flows provided by investing activities 2,552 8,990
--------- ---------
Cash Flows Provided By (Used For) Financing Activities
Additional borrowings 12,339 0
Principal payments on debt (17,931) (16,012)
Repayments to automotive solutions (8,991) (1,910)
--------- ---------
Net cash flows used for financing activities (14,583) (17,922)
--------- ---------
Increase (Decrease) in Cash and Equivalents (155) 770
Cash and Equivalents, Beginning of Period 722 635
--------- ---------
Cash and Equivalents, End of Period $ 567 $ 1,405
========= =========
See Notes to Condensed Consolidated Financial Statements.
5
THE REYNOLDS AND REYNOLDS COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands except per share data)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The balance sheet as of September 30, 2003 is condensed financial information
taken from the annual audited financial statements, as restated. The interim
financial statements are unaudited. In the opinion of management, the
accompanying interim financial statements contain all significant adjustments
necessary to present fairly the company's financial position, results of
operations and cash flows for the periods presented. These interim financial
statements should be read in conjunction with the audited financial statements
included in the company's 2003 Annual Report on Form 10-K.
(2) INVENTORIES
3/31/04 9/30/03
------- -------
Finished products $13,514 $11,921
Work in process 412 295
Raw materials 174 216
------- -------
Total inventories $14,100 $12,432
======= =======
(3) REORGANIZATION COSTS
On October 2, 2003, the company announced the consolidation of its automotive
Documents printing plant, located in Grand Prairie, Texas, into the company's
Celina, Ohio manufacturing facility. All employees located in Texas were offered
the opportunity to accept a position in the Ohio facility. Those not accepting
positions in Ohio were offered severance and outplacement services. Grand
Prairie document production ceased in December 2003 and 72 positions were
eliminated. During the first six months of fiscal year 2004, the company also
reorganized the Documents sales force, eliminating 37 positions, and eliminated
121 additional positions in Software Solutions development, Services and
administration.
The company had previously estimated that total costs for severance,
outplacement, relocation and other plant consolidation efforts would be about
$8,000 in fiscal year 2004. Through March 31, 2004 the company has incurred
expense of $7,513 before taxes or $.07 per share after taxes and eliminated 230
positions.
6
The following table summarizes reorganization costs recognized and payments made
by the company through March 31, 2004.
Software
Solutions Services Documents Total
--------- -------- --------- --------
Cost of Sales
Employee termination benefits $ 43 $ 13 $ 710 $ 766
Other direct expenses 594 594
--------- -------- --------- --------
Total cost of sales 43 13 1,304 1,360
--------- -------- --------- --------
SG&A Expenses
Employee termination benefits 1,432 974 1,072 3,478
Lease obligations 378 244 9 631
Other direct expenses 185 127 465 777
--------- -------- --------- --------
Total SG&A expenses 1,995 1,345 1,546 4,886
--------- -------- --------- --------
Expenses 10/1/03 - 12/31/03 2,038 1,358 2,850 6,246
Payments 10/1/03 - 12/31/03 (845) (1,123) (1,532) (3,500)
--------- -------- --------- --------
Liability 12/31/03 1,193 235 1,318 2,746
--------- -------- --------- --------
Cost of Sales
Employee termination benefits 3 2 126 131
Other direct expenses 192 192
--------- -------- --------- --------
Total cost of sales 3 2 318 323
--------- -------- --------- --------
SG&A Expenses
Employee termination benefits 530 285 60 875
Other direct expenses 0 0 69 69
--------- -------- --------- --------
Total SG&A expenses 530 285 129 944
--------- -------- --------- --------
Expenses 1/1/04 - 3/31/04 533 287 447 1,267
Payments 1/1/04 - 3/31/04 (641) (269) (1,096) (2,006)
--------- -------- --------- --------
Liability 3/31/04 $ 1,085 $ 253 $ 669 $ 2,007
========= ======== ========= ========
(4) BUSINESS COMBINATIONS
In October 2003, the company purchased the outstanding shares of Incadea GmbH, a
provider of global automotive retailing software solutions. Privately-held
Incadea, based in Raubling, Germany, had annual revenues of about $6,000. The
purchase price of $6,181 was paid with cash from existing balances. During the
first quarter of fiscal year 2004, the company also repaid $5,046 of debt
assumed in the purchase of Incadea GmbH. The results of Incadea's operations
have been included in the company's financial statements since the acquisition.
At March 31, 2004, the company has recorded goodwill of $5,868 based on the
allocation of the purchase price. An independent appraisal firm was used to
determine the fair values of intangible assets.
In October 2003, the company purchased the net assets of Third Coast Media, a
provider of Web and customer relationship management software to automotive
retailers. Third Coast Media, headquartered in Richardson, Texas, had annual
revenues of about $5,000. The purchase price of $5,464 was paid with cash from
existing balances. Under terms of the purchase agreement, the company may be
required to make additional payments over the next three years of up to $2,300,
contingent on the achievement of certain operating results of the business
purchased. The results of Third Coast Media's operations have been included in
the company's financial statements since the acquisition. The company recorded
tax deductible goodwill of $2,420 based on a preliminary allocation of the
purchase price. During the quarter ended March 31, 2004, the valuation of the
net assets was completed by an independent appraisal firm and the company
adjusted the purchase price allocation to decrease capitalized software by $78,
reduce non-compete agreement intangible assets by $151 and increase tax
deductible goodwill by $229.
7
(5) GOODWILL AND ACQUIRED INTANGIBLE ASSETS
GOODWILL
Software
Solutions Services Documents Totals
--------- -------- --------- --------
Balances as of September 30, 2003 $ 22,217 $ 16,634 $ 2,877 $ 41,728
Business Combinations 8,517 8,517
Adjustment (2,585) (2,585)
--------- -------- --------- --------
Balances as of March 31, 2004 $ 30,734 $ 14,049 $ 2,877 $ 47,660
========= ======== ========= ========
During the quarter ended March 31, 2004, the company adjusted tax benefits for a
prior business combination and recorded a deferred tax asset of $2,585 and
decreased goodwill by $2,585.
ACQUIRED INTANGIBLE ASSETS
Gross Accumulated Useful Life
Amount Amortization (years)
------ ------------ -----------
AS OF MARCH 31, 2004
Amortized intangible assets
Contractual customer relationship $33,100 $ 6,482 20
Trademarks 6,259 1,185 6-20
Other 7,619 2,613 2-15
------- -------
Total $46,978 $10,280
======= =======
AS OF SEPTEMBER 30, 2003
Amortized intangible assets
Contractual customer relationship $33,100 $ 5,655 20
Customer contract 17,700 16,493 3.67
Trademarks 5,900 1,008 20
Other 6,449 2,262 3-10
------- -------
Total $63,149 $25,418
------- -------
Aggregate amortization expense was $2,551 for the six months ended March 31,
2004. Estimated amortization expense for the years ended September 30, is $3,939
in 2004, $2,703 in 2005, $2,478 in 2006, $2,478 in 2007 and $2,478 in 2008.
(6) FINANCING ARRANGEMENTS
AUTOMOTIVE SOLUTIONS
As of March 31, 2004, 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 $6,468 at March 31, 2004 and $7,069 at September 30,
2003 and was included in Automotive Solutions' other assets on the condensed
consolidated balance sheet. The adjustments to record the net change in the fair
values 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 22, 2004, 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 with
interest payable on a variable rate basis. This loan funding agreement is
renewable annually through January 23, 2006. As of March 31, 2004, Reyna
Funding, L.L.C. had outstanding borrowings of $100,000 under this arrangement.
8
As of March 31, 2004, 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 $9,125. These
interest rate swap agreements were designated as cash flow hedges. The fair
value of the company's cash flow derivative instruments was a liability of
$1,621 at March 31, 2004, and $2,422 at September 30, 2003, 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 2004, the company expects the amounts to
be reclassified from other comprehensive income into earnings to be immaterial
to the financial statements.
REVOLVING CREDIT AGREEMENT
On April 8, 2004, the company obtained a new $200,000 revolving credit agreement
and terminated the old agreement. The new revolving credit agreement has a five
year term. Automotive Solutions and Financial Services share this revolving
credit agreement.
(7) COMPREHENSIVE INCOME
THREE MONTHS SIX MONTHS
2004 2003 2004 2003
------- ------- ------- -------
Net income $26,357 $26,990 $50,179 $52,563
Foreign currency translation adjustment (929) 1,375 1,195 1,490
Net unrealized gains (losses) on derivative contracts (13) 195 465 361
------- ------- ------- -------
Comprehensive income $25,415 $28,560 $51,839 $54,414
======= ======= ======= =======
9
(8) CASH FLOW STATEMENTS
Reconciliation of net income to net cash provided by operating activities.
SIX MONTHS
2004 2003
-------- --------
AUTOMOTIVE SOLUTIONS
Net Income $ 44,211 $ 45,902
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities
Depreciation and amortization 23,685 16,813
Stock-based compensation expense 5,551 7,919
Deferred income taxes (4,955) 764
Deferred income taxes transferred to Financial Services 348 2,516
Losses on sales of assets 684 804
Changes in operating assets and liabilities
Accounts receivable 40,878 9,330
Inventories (1,668) (2,549)
Prepaid expenses and other current assets (3,968) (1,486)
Other assets 3,283 (1,515)
Accounts payable (5,311) (4,378)
Accrued liabilities 3,893 (7,441)
Other liabilities 3,221 (5,750)
-------- --------
Net Cash Provided by Operating Activities $109,852 $ 60,929
======== ========
FINANCIAL SERVICES
Net Income $ 5,968 $ 6,661
Stock-based Compensation Expense 52 94
Deferred Income Taxes 698 1,856
Deferred Income Taxes Transferred from Automotive Solutions (348) (2,516)
Changes in Receivables, Other Assets and Other Liabilities 5,506 3,607
-------- --------
Net Cash Provided by Operating Activities $ 11,876 $ 9,702
======== ========
10
(9) BUSINESS SEGMENTS
During the first quarter of fiscal year 2004, the company changed its reporting
segments to reflect the revised organizational structure of the company. In
executing this realignment, the company changed its method of allocating certain
revenues and expenses. Prior year financial results were restated, to the extent
possible, to reflect financial results consistent with the current year.
The Software Solutions segment provides computer solutions including computer
hardware, integrated software packages, software enhancements and related
support.
The Services segment includes installation and maintenance of computer hardware,
software training and consulting services.
The Documents segment manufactures and distributes printed business forms
primarily to automotive retailers.
The Financial Services segment provides financing, principally for sales of the
company's computer solutions and services, through the company's wholly-owned
affiliates, Reyna Capital Corporation, Reyna Funding, L.L.C. and a similar
operation in Canada.
THREE MONTHS SIX MONTHS
2004 2003 2004 2003
-------- -------- -------- --------
NET SALES AND REVENUES
Software Solutions $135,963 $135,282 $ 278,469 $ 271,601
Services 60,920 66,223 118,729 126,284
Documents 44,258 44,179 83,946 84,807
Financial Services 8,351 9,415 16,751 19,055
-------- -------- ---------- ----------
Total Net Sales and Revenues $249,492 $255,099 $ 497,895 $ 501,747
======== ======== ========== ==========
OPERATING INCOME (LOSS)
Software Solutions $ 35,572 $ 31,830 $ 74,441 $ 67,460
Services (5,202) (1,230) (16,263) (7,741)
Documents 7,400 7,057 10,666 13,936
Financial Services 4,954 5,124 9,839 10,983
-------- -------- ---------- ----------
Total Operating Income $ 42,724 $ 42,781 $ 78,683 $ 84,638
======== ======== ========== ==========
3/31/04 9/30/03
---------- ----------
ASSETS
Automotive Solutions $ 759,854 $ 746,342
Financial Services 372,257 395,494
---------- ----------
Total Assets $1,132,111 $1,141,836
========== ==========
(10) CONTINGENCIES
In 2000, the company was named one of many defendants in a cost recovery lawsuit
filed by a Potentially Responsible Party (PRP) coalition in the United States
District Court for the Southern District of Ohio regarding an environmental
remediation site in Dayton, Ohio. The court has ordered the parties to
participate in non-binding mediation. The company believes that the reasonably
foreseeable resolution of this matter will not have a material adverse effect on
the 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 March 31, 2004, this contingent liability totaled $1,344. The
majority of these leases expire in 2004. Also in connection with the sale of
these operations to The Carlyle Group, the company remained contingently liable
for a portion of long-term debt, which is collateralized by a Relizon
11
facility in Canada and matures in 2007. In connection with this contingent
liability, the company secured a standby letter of credit which expires in 2007.
As of March 31, 2004, the unamortized balance on this letter of credit was
$1,626.
(11) POSTRETIREMENT BENEFITS
In December 2003, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other
Postretirement Benefits an amendment of FASB Statements No. 87, 88, and 106."
This statement revises employers' disclosures about pension plans and other
postretirement plans. The provisions of this statement are effective for the
first interim period beginning after December 15, 2003.
THREE MONTHS SIX MONTHS
2004 2003 2004 2003
------- ------- ------- -------
PENSION BENEFITS
Service cost $ 2,822 $ 2,136 $ 5,642 $ 4,273
Interest cost 4,217 4,260 8,431 8,519
Estimated return on plan assets (3,184) (3,118) (6,367) (6,236)
Amortization of unrecognized transitional asset 64 35 129 70
Amortization of prior service cost 195 150 391 299
Recognized net actuarial losses 984 323 1,970 647
Plan administration 220 440
Settlements 40 40
------- ------- ------- -------
Net periodic pension cost $ 5,098 $ 4,046 $10,196 $ 8,052
======= ======= ======= =======
POSTRETIREMENT MEDICAL AND LIFE INSURANCE BENEFITS
Service cost $ 166 $ 120 $ 332 $ 240
Interest cost 924 1,073 1,848 2,146
Amortization of prior service cost (185) (185) (371) (371)
Recognized net actuarial losses 280 272 560 544
------- ------- ------- -------
Net periodic postretirement medical and life insurance cost $ 1,185 $ 1,280 $ 2,369 $ 2,559
======= ======= ======= =======
During the six months ended March 31, 2004, the company made voluntary
contributions of $4,600 to its defined benefit pension plans. The company
anticipates contributions of $9,600 to its pension plans in fiscal 2004 for a
total of $14,200. In fiscal year 2004, the company changed from the explicit
method of reporting plan administration costs to the more common, implicit
method of recording the costs by reducing the expected return on plan assets by
the expected costs.
(12) ACCOUNTING CHANGE
Effective October 1, 2003, the company elected to adopt the provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation" and began recognizing stock
option expense in the Statements of Consolidated Income. Under the fair value
recognition provisions of SFAS No. 123, stock-based compensation cost is
measured at the grant date based on the value of the award and is recognized as
expense over the vesting period. SFAS No. 148, "Accounting for Stock-Based
Compensation - - Transition and Disclosure" provides three alternative methods
for reporting this change in accounting principle. The company elected the
retroactive restatement method which required that all periods presented be
restated to reflect stock-based compensation cost under the fair value based
accounting method of SFAS No. 123 for all awards granted, modified or settled in
fiscal years beginning after December 15, 1994. Accordingly, prior year
financial statements have been restated to reflect the adoption of SFAS No. 123.
For the six months ended March 31, 2003, income before income taxes was reduced
by $7,644, the provision for income taxes was decreased by $2,433 and net income
was reduced by $5,211 (or $.07 per share). As of September 30, 2003, deferred
income tax assets were increased by $17,781, capital stock was increased by
$38,538 and retained earnings were reduced by $20,757.
(13) ACCOUNTING STANDARDS
In January 2004, the Financial Accounting Standards Board (FASB) staff issued
FASB Staff Position SFAS 106-1, "Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization Act of 2003."
This statement permits a sponsor of a postretirement health care plan that
provides a prescription drug benefit to make a
12
one-time election to defer recognizing the effects of the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 (the "Act") until authoritative
guidance on accounting for the federal subsidy is issued or until certain other
events occur. The company has not determined whether it would need to amend its
postretirement benefit plan in order to benefit from the new legislation. The
company has elected to defer recognizing the effects of the Act until
authoritative accounting guidance is issued. Accordingly, the consolidated
financial statements do not reflect the effect of the Act, if any. Authoritative
guidance, when issued, could require the company to change previously reported
information.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2004 AND 2003
(In thousands except employee and per share data)
SIGNIFICANT EVENTS
ACCOUNTING CHANGE
Effective October 1, 2003, the company elected to adopt the provisions of
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation" and began recognizing stock option expense in the
Statements of Consolidated Income. Under the fair value recognition provisions
of SFAS No. 123, stock-based compensation cost is measured at the grant date
based on the value of the award and is recognized as expense over the vesting
period. SFAS No. 148, "Accounting for Stock-Based Compensation - - Transition
and Disclosure" provides three alternative methods for reporting this change in
accounting principle. The company elected the retroactive restatement method
which required that all periods presented be restated to reflect stock-based
compensation cost under the fair value based accounting method of SFAS No. 123
for all awards granted, modified or settled in fiscal years beginning after
December 15, 1994. Accordingly, prior year financial statements have been
restated to reflect the adoption of SFAS No. 123. See Note 12 to the Condensed
Consolidated Financial Statements for additional disclosures about this
accounting change.
SEGMENT REPORTING
During the first quarter of fiscal year 2004, the company changed its reporting
segments to reflect the revised organizational structure of the company. In
executing this realignment, the company changed its method of allocating certain
revenues and expenses. Prior year financial results were restated to the extent
possible to reflect financial results consistent with the current year. See Note
9 to the Condensed Consolidated Financial Statements for additional disclosures
regarding business segments.
REORGANIZATION COSTS
On October 2, 2003, the company announced the consolidation of its automotive
Documents printing plant, located in Grand Prairie, Texas, into the company's
Celina, Ohio manufacturing facility. All employees located in Texas were offered
the opportunity to accept a position in the Ohio facility. Those not accepting
positions in Ohio were offered severance and outplacement services. Grand
Prairie document production operations ceased in December 2003 and 72 positions
were eliminated. During the first quarter of fiscal year 2004, the company also
reorganized the Documents sales force, eliminating 37 positions, and eliminated
109 additional positions in Software Solutions development, Services and
administration. During the second quarter of fiscal year 2004, an additional 12
positions were eliminated, primarily in Services.
The company had previously estimated that costs for severance, outplacement,
relocation and other plant consolidation efforts would total about $8,000 or
$.07 per share after taxes in fiscal year 2004. During the second quarter of
fiscal year 2004, the company incurred pretax expense of $1,267 or $.01 per
share after taxes and during the first six months of fiscal year 2004, the
company incurred pretax expense of $7,513 or $.07 per share after taxes. See
Note 3 to the Condensed Consolidated Financial Statements for additional
disclosure about these reorganization costs.
BUSINESS COMBINATIONS
In October 2003, the company purchased the outstanding shares of Incadea GmbH, a
provider of global automotive retailing software solutions. Privately-held
Incadea, based in Raubling, Germany, had annual revenues of about $6,000. The
purchase price of $6,181 was paid with cash from existing balances. During the
first quarter of fiscal year 2004, the company also repaid $5,046 of debt
assumed in the purchase of Incadea GmbH.
In October 2003, the company purchased the net assets of Third Coast Media, a
provider of Web and customer relationship management software to automotive
retailers. Third Coast Media, headquartered in Richardson, Texas, had annual
revenues of about $5,000. The purchase price of $5,464 was paid with cash from
existing balances. Under terms of the purchase
13
agreement, the company may be required to make additional payments over the next
three years of up to $2,300, contingent on the achievement of certain operating
results of the business purchased. See Note 4 to the Condensed Consolidated
Financial Statements for more information on business combinations.
RESULTS OF OPERATIONS
CONSOLIDATED SUMMARY
Three Months Six Months
------------------------------------------ ------------------------------------------
2004 2003 Change % Change 2004 2003 Change % Change
---- ---- ------ -------- ----- ----- ------ --------
Net sales and revenues $249,492 $255,099 ($ 5,607) -2% $497,895 $501,747 ($ 3,852) -1%
Gross profit $140,957 $140,700 $ 257 0% $279,544 $278,554 $ 990 0%
% of revenues 56.5% 55.2% 56.1% 55.5%
SG&A expenses $ 98,233 $ 97,919 $ 314 0% $200,861 $193,916 $ 6,945 4%
% of revenues 39.4% 38.4% 40.3% 38.6%
Operating income $ 42,724 $ 42,781 ($ 57) 0% $ 78,683 $ 84,638 ($ 5,955) -7%
% of revenues 17.1% 16.8% 15.8% 16.9%
Net income $ 26,357 $ 26,990 ($ 633) -2% $ 50,179 $ 52,563 ($ 2,384) -5%
Basic earnings per share $ 0.40 $ 0.40 $ 0.00 0% $ 0.75 $ 0.77 ($ 0.02) -3%
Diluted earnings per share $ 0.38 $ 0.39 ($ 0.01) -3% $ 0.73 $ 0.75 ($ 0.02) -3%
Consolidated net sales and revenues declined slightly in both the second quarter
and first six months of fiscal year 2004. In the second quarter, slight growth
in Software Solutions and Documents revenues was offset by declines in revenues
from Services and Financial Services. Year-to-date growth in Software Solutions
revenues was offset by revenue declines in the other three segments. The backlog
of new orders for Software Solutions and Services computer systems products and
deferred revenues (orders shipped, but not yet recognized in revenues) was
approximately $45,000 at March 31, 2004, compared to $47,000 at December 31,
2003 and $65,000 at September 30, 2003. Gross profit increased slightly for both
the quarter and six months as higher Software Solutions recurring revenues
overcame higher software amortization expenses for Reynolds Generations Series
Suite, Documents plant consolidation expenses and declines in the other three
segments. SG&A expenses exceeded last year primarily because of reorganization
and plant consolidation expenses of $944 in the second quarter and $5,830
through six months. Excluding these reorganization and plant consolidation
expenses, SG&A expenses were $97,290 or 39.0% of revenues in the second quarter
and $195,031 or 39.2% of revenues for six months. SG&A expenses reflect higher
research and development expenses as no software development costs were
capitalized during the first half of fiscal year 2004. Research and development
costs were approximately $23,000 in the second quarter of fiscal year 2004 and
$44,000 through six months, versus $18,000 and $36,000 last year, respectively.
Excluding reorganization and plant consolidation costs of $1,267 in the quarter
and $7,513 for six months, operating income was $43,991 or 17.6% of revenues in
the second quarter and $86,196 or 17.3% year-to-date.
Other income declined from last year for both the second quarter and six months
because last year's second quarter included a $1,369 gain on the company's sale
of its investment in Credit Online. The effective income tax rate was 36.7% in
fiscal year 2004, compared to 39.3% last year. In first quarter of fiscal year
2004, the tax rate reflected a $1,859 reduction of income taxes, primarily
related to Ohio income tax legislation enacted during the quarter ended December
31, 2003. Excluding the $1,859 of tax benefits, the tax rate would have been
39.1%.
14
SOFTWARE SOLUTIONS
Three Months Six Months
----------------------------------------- -----------------------------------------
2004 2003 Change % Change 2004 2003 Change % Change
-------- -------- ------ -------- -------- -------- ------ --------
Net sales and revenues $135,963 $135,282 $ 681 1% $278,469 $271,601 $6,868 3%
Gross profit $ 93,960 $ 88,865 $5,095 6% $191,455 $181,591 $9,864 5%
% of revenues 69.1% 65.7% 68.8% 66.9%
SG&A expenses $ 58,388 $ 57,035 $1,353 2% $117,014 $114,131 $2,883 3%
% of revenues 42.9% 42.2% 42.1% 42.1%
Operating income $ 35,572 $ 31,830 $3,742 12% $ 74,441 $ 67,460 $6,981 10%
% of revenues 26.2% 23.5% 26.7% 24.8%
During the first quarter of fiscal year 2004, the company changed its reporting
segments to reflect the revised organizational structure of the company. In
executing this realignment, the company changed its method of allocating certain
revenues and expenses. See Note 9 to the Condensed Consolidated Financial
Statements for additional disclosures about segment reporting. Second quarter
revenues increased slightly over last year as recurring software revenues
increased 10% while one-time hardware and software sales declined 24%.
Year-to-date revenues increased 3% over last year as recurring software revenues
increased 12% while one-time hardware and software sales declined 20%. Recurring
revenues for both the quarter and six months reflected the increased number of
ERA(R) dealer management software applications supported, growth in Reynolds Web
Solutions revenues (which is converting to a recurring revenue model), growth of
Contact Management revenues, and the October 2003 acquisitions of Third Coast
Media and Incadea GmbH. The year-to-date revenue growth also reflects the
January 2003 addition of Internet Lead Management (which resulted from a license
agreement between the company and Microsoft Corporation in January 2003). The
company implemented an annual price increase effective March 1, 2004 to offset
inflation. One-time hardware and software sales declined from last year for both
the quarter and six months primarily as a result of lower sales of ERA and
related peripherals and the transition of Reynolds Web Solutions to a recurring
revenue model (the first half of last year was still predominately a one-time
sales recognition model). Gross profit increased as a result of the strong
growth in higher margin recurring revenues. The margin impact of the growth of
recurring revenues more than offset increased software amortization expenses of
$3,274 in the second quarter and $6,547 year-to-date related to Reynolds
Generations Series Suite. SG&A expenses included $530 of reorganization costs in
the second quarter of fiscal year 2004 and $2,525 year-to-date. See Note 3 to
the Condensed Consolidated Financial Statements for a discussion of these
reorganization costs. Excluding these reorganization costs, SG&A expenses were
$57,858 or 42.6% of revenues in the second quarter and $114,489 or 41.1% of
revenues for six months. SG&A expenses reflect higher research and development
expenses as the company did not capitalize any software development costs during
the first half of fiscal year 2004. SG&A expenses benefited from lower selling
expenses, primarily the result of the change in allocation methodology among
reporting segments. Excluding the reorganization costs, fiscal year 2004
operating income was $36,105 or 26.6% of revenues in the second quarter and
$77,012 or 27.7% of revenues through six months.
SERVICES
Three Months Six Months
----------------------------------------- -------------------------------------------
2004 2003 Change % Change 2004 2003 Change % Change
-------- -------- -------- -------- --------- -------- -------- --------
Net sales and revenues $60,920 $66,223 ($5,303) -8% $118,729 $126,284 ($7,555) -6%
Gross profit $17,132 $20,743 ($3,611) -17% $ 31,861 $ 36,072 ($4,211) -12%
% of revenues 28.1% 31.3% 26.8% 28.6%
SG&A expenses $22,334 $21,973 $ 361 2% $ 48,124 $ 43,813 $4,311 10%
% of revenues 36.6% 33.2% 40.5% 34.7%
Operating income (loss) ($ 5,202) ($ 1,230) ($3,972) ($ 16,263) ($ 7,741) ($8,522)
% of revenues -8.5% -1.9% -13.7% -6.1%
During the first quarter of fiscal year 2004, the company changed its reporting
segments to reflect the revised organizational structure of the company. In
executing this realignment, the company changed its method of allocating certain
revenues and expenses. See Note 9 to the Condensed Consolidated Financial
Statements for additional disclosures about segment reporting. Services revenues
declined from last year for both the second quarter and six months primarily
because of lower Campaign Management Services revenues which resulted from the
loss of a customer in April 2003. Gross profit declined from last year for both
the quarter and six months because of the decline in revenues. SG&A expenses
included $285 of reorganization costs in the second quarter of fiscal year 2004
and $1,630 through six months. See Note 3 to the Condensed Consolidated
Financial
15
Statements for a discussion of these reorganization costs. Excluding the
reorganization costs, SG&A expenses were $22,049 or 36.2% of revenues for the
three months and $46,494 or 39.2% of revenues year-to-date. SG&A expenses
included higher selling expenses, primarily the result of the change in
allocation methodology among reporting segments. The increase in operating
losses was consistent with the decline in revenues. Excluding reorganization
costs, fiscal year 2004 operating losses were $4,915 in the second quarter and
$14,618 year-to-date.
DOCUMENTS
Three Months Six Months
--------------------------------------- ------------------------------------------
2004 2003 Change % Change 2004 2003 Change % Change
------- -------- ------ -------- -------- -------- ------ ----------
Net sales and revenues $44,258 $44,179 $ 79 0% $83,946 $84,807 ($ 861) -1%
Gross profit $23,377 $23,938 ($561) -2% $43,257 $46,631 ($3,374) -7%
% of revenues 52.8% 54.2% 51.5% 55.0%
SG&A expenses $15,977 $16,881 ($904) -5% $32,591 $32,695 ($ 104) 0%
% of revenues 36.1% 38.2% 38.8% 38.6%
Operating income $ 7,400 $ 7,057 $343 5% $10,666 $13,936 ($3,270) -23%
% of revenues 16.7% 16.0% 12.7% 16.4%
Documents sales increased slightly over last year for the quarter and decreased
slightly from last year through six months. The decrease in the volume of
business forms was essentially offset by higher net sales prices. The company
expects the volume of certain documents to continue to decline as advances in
technology continue. Revenues from many product lines increased over last year
in both the second quarter and six months; however these increases were
essentially offset by a decline in custom forms revenues. Cost of sales included
plant consolidation costs of $318 in the second quarter of fiscal year 2004 and
$1,622 year-to-date. These costs were incurred as the Grand Prairie, Texas,
printing plant was consolidated into the Celina, Ohio, manufacturing facility.
This consolidation was completed in the second quarter of fiscal year 2004.
Excluding these plant consolidation costs, gross profit was $23,695 or 53.5% of
revenues in the second quarter of fiscal year 2004 and $44,879 or 53.5% of
revenues through six months. In addition to the plant consolidation costs, gross
profit declined from last year, for both the quarter and six months, because of
a change in the mix of products sold. SG&A expenses included costs associated
with the plant consolidation and reorganizing the sales force of $129 in the
second quarter and $1,675 for six months. See Note 3 to the Condensed
Consolidated Financial Statements for a discussion of these reorganization
costs. Excluding these plant consolidation and sales reorganization costs, SG&A
expenses were $15,848 or 35.8% of revenues in the quarter and $30,916 or 36.8%
of revenues year-to-date. Excluding the plant consolidation and sales
reorganization costs, fiscal year 2004 operating income was $7,847 or 17.7% of
sales in the second quarter and $13,963 or 16.6% of sales through six months.
FINANCIAL SERVICES
Three Months Six Months
--------------------------------------- ---------------------------------------
2004 2003 Change % Change 2004 2003 Change % Change
------- ------- -------- -------- -------- -------- ------ --------
Net sales and revenues $8,351 $9,415 ($1,064) -11% $16,751 $19,055 ($2,304) -12%
Gross profit $6,488 $7,154 ($ 666) -9% $12,971 $14,260 ($1,289) -9%
% of revenues 77.7% 76.0% 77.4% 74.8%
SG&A expenses $1,534 $2,030 ($ 496) -24% $ 3,132 $ 3,277 ($ 145) -4%
% of revenues 18.4% 21.6% 18.7% 17.2%
Operating income $4,954 $5,124 ($ 170) -3% $ 9,839 $10,983 ($1,144) -10%
% of revenues 59.3% 54.4% 58.7% 57.6%
Financial Services revenues declined from last year for both the three and six
month periods primarily because of lower average interest rates. Gross profit
declined from last year for the quarter and year-to-date because of the decline
in revenues. Interest rate spreads were 4.5% in the second quarter and 4.6%
year-to-date, compared to 5.3% and 5.2%, respectively, for the same periods a
year ago. SG&A expenses were less than last year in the second quarter as the
result of lower bad debt expenses. Bad debt expenses were $675 in the second
quarter compared to $1,100 last year. Year-to-date, bad debt expenses were
essentially flat with a year ago. Operating income was less than last year for
both the quarter and six months because of the decline in revenues.
16
LIQUIDITY AND CAPITAL RESOURCES
AUTOMOTIVE SOLUTIONS CASH FLOWS (EXCLUDING FINANCIAL SERVICES)
The company's balance of cash and equivalents was $123,785 at March 31, 2004.
Cash flows from operating activities were $109,852 during the six months ended
March 31, 2004 and resulted primarily from net income, adjusted for non cash
charges such as depreciation and amortization. Collections of both trade
accounts receivable and other accounts receivable also contributed significantly
to cash flow from operations. Cash flows from operating activities were
significantly higher than last year because last year was impacted by the timing
of various payroll and tax payments. Cash flows used for investing activities
included the company's purchases of Third Coast Media and Incadea GmbH for a
combined $11,645. An additional $5,046 of Incadea debt repayments is included in
financing activities. Cash flows used for investing activities also included
capital expenditures of $21,788, partially offset by proceeds from asset sales
of $10,318. Fiscal year 2004 capital expenditures (net of proceeds from asset
sales) in the ordinary course of business are anticipated to be about $40,000,
including about $20,000 for expansion of an existing office building. See the
Shareholders' Equity caption of this analysis regarding the payment of dividends
and share repurchases.
FINANCIAL SERVICES CASH FLOWS
Financial Services operating cash flows, collections on finance receivables and
additional borrowings were invested in new finance receivables primarily for the
company's computer systems used to make scheduled debt repayments and used to
make dividend payments to Automotive Solutions.
CAPITALIZATION
The company's ratio of total debt (total Automotive Solutions debt) to
capitalization (total Automotive Solutions debt plus shareholders' equity) was
19.0% as of March 31, 2004 and 18.4% as of September 30, 2003. During the first
quarter of fiscal year 2004, the company repaid $5,046 of debt assumed in the
purchase of Incadea GmbH. Remaining credit available under then committed
revolving credit agreements was $100,000 at March 31, 2004. In addition to this
committed credit agreement, the company also has a variety of other short-term
credit lines available. Management estimates that cash balances, cash flow from
operations and cash available from existing credit agreements will be sufficient
to fund normal operations over the next year. Cash balances are placed in
short-term investments until needed.
On January 22, 2004, 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, with
interest payable on a variable rate basis. This loan funding agreement is
renewable annually through January 23, 2006. The outstanding borrowings under
this arrangement were included with Financial Services notes payable on the
Condensed Consolidated Balance Sheets. As of March 31, 2004, the balance
outstanding on this facility was $100,000.
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 revenues, which require
relatively low capital investment. Debt instruments have been used primarily to
fund business combinations and Financial Services receivables. As of March 31,
2004, the company could 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. During
the quarter ended March 31, 2004, Moody's Investors Service lowered the
company's senior unsecured rating to Baa2 from Baa1. Standard and Poors
maintained a rating of BBB. The company does not expect this action to have a
material effect on the company's financial statements or its ability to access
capital markets. On April 8, 2004, the company obtained a new $200,000 revolving
credit agreement and terminated the old agreement. The new revolving credit
agreement has a five year term and less restrictive covenants than the prior
agreement. See Note 6 to the Condensed Consolidated Financial Statements for
additional disclosures regarding the company's debt instruments.
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 March
31, 2004, 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, 2003.
17
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 March 31, 2004, the company repurchased 2,107
Class A common shares for $58,001 ($27.53 per share). Year-to-date, the company
repurchased 3,392 Class A common shares for $94,009 ($27.72 per share). As of
March 31, 2004, the company could repurchase an additional 4,774 Class A common
shares under existing board of directors' authorizations.
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 requires 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, accounting for income taxes and accounting for
retirement benefits.
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 (as defined in Emerging Issues Task Force (EITF) Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables"), 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 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 (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 is 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
18
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.
POSTRETIREMENT BENEFITS
The company sponsors defined benefit pension plans for most employees. The
company also sponsors a defined benefit medical plan and a defined benefit life
insurance plan for certain employees. The company's postretirement plans are
described in the company's annual report on Form 10-K for the fiscal year ended
September 30, 2003. The company accounts for its postretirement benefit plans
according to SFAS No. 87, "Employers' Accounting for Pensions" and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions." These
statements require the use of actuarial models that allocate the cost of an
employee's benefits to individual periods of service. The accounting under SFAS
No. 87 and SFAS No. 106 therefore requires the company to recognize costs before
the payment of benefits. Certain assumptions must be made concerning future
events that will determine the amount and timing of the benefit payments. Such
assumptions include the discount rate, the expected long-term rate of return on
plan assets, the rate of future compensation increases and the healthcare cost
trend rate. In addition, the actuarial calculation includes subjective factors
such as withdrawal and mortality rates to estimate the projected benefit
obligation. The actuarial assumptions used may differ materially from actual
results due to changing market and economic conditions, higher or lower
withdrawal rates, or longer or shorter life spans of participants. These
differences may result in a significant impact on the amount of postretirement
benefit expense recorded in future periods. The company annually evaluates the
assumptions used to determine postretirement benefit expense for its qualified
and non-qualified defined benefit plans. The company adjusted assumptions used
to measure the amount of postretirement benefit expense, reducing the discount
rate from 7.25% in fiscal year 2003 to 6.0% in fiscal year 2004 and reducing the
expected long-term rate of return on plan assets from 9.0% in fiscal year 2003
to 8.25% in fiscal year 2004. The company is not required to make minimum
contributions to its postretirement plans in fiscal year 2004, although the
company may elect to make contributions. See the company's annual report on Form
10-K for the fiscal year ended September 30, 2003, for more detail disclosures
regarding postretirement benefits, including relevant assumptions used to
determine expense and future obligations. The company's net periodic pension
expense was $5,098 for the three months and $10,196 through the six months ended
March 31, 2004, compared to $4,046 and $8,052, respectively, a year ago. The
company's net periodic postretirement medical and life insurance expense was
$1,185 for the quarter ended March 31, 2004, and $2,369 fiscal year-to-date
versus $1,280 and $2,559, respectively, for the same periods last year.
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, which averaged
3.5% in both the second quarter and first six months of fiscal year 2004. These
interest rate swap agreements were designated as fair value hedges. The company
does not use financial instruments for trading purposes.
The Financial Services segment of the business, including Reyna Funding L.L.C.,
a consolidated 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. The company does not use financial instruments for trading purposes.
During the first six months of fiscal year 2004, Reyna Funding, L.L.C. entered
into $17,195 of interest rate swaps to replace maturing interest rate swaps.
Because fixed rate finance receivables are primarily funded with fixed rate debt
or its equivalent (variable rate debt that has
19
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. See Note 6 to the Condensed Consolidated Financial
Statements for additional disclosures regarding the company's debt instruments
and interest rate management agreements.
FOREIGN CURRENCY EXCHANGE RATES
The company has foreign-based operations, primarily in Canada, which accounted
for 8% of net sales and revenues in the first six months of fiscal year 2004. In
the conduct of its foreign operations, the company has intercompany sales,
expenses and loans between the U.S. and its foreign operations and may receive
dividends denominated in different currencies. These transactions expose the
company to changes in foreign currency exchange rates. At March 31, 2004, the
company had no foreign currency exchange contracts outstanding. Based on the
company's overall foreign currency exchange rate exposure at March 31, 2004,
management believes that a 10% change in currency rates would not have a
material effect on the company's financial statements.
ACCOUNTING STANDARDS
See Note 12 to the Condensed 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 is incorporated herein by reference.
CONTROLS AND PROCEDURES
The company is currently undergoing a comprehensive effort to document and test
its significant business and financial processes and procedures to ensure
compliance with Section 404 of the Sarbanes-Oxley Act of 2002 for the year ended
September 30, 2005. This effort includes documentation and testing of internal
controls. During the course of these activities, the company identified
significant deficiencies in cash management internal controls which could have,
in the aggregate, constituted a material weakness. As a result of these
findings, the company implemented controls to mitigate these significant
deficiencies for future periods. The company notified the audit committee of the
board of directors and its independent auditors regarding these deficiencies.
After consultations with its independent auditors, the company's internal audit
department conducted tests to determine, as a result of these deficiencies, if
there was a material misstatement of the interim financial statements as of
March 31, 2004. Based on the results of these tests and procedures the company
concluded that no material misstatement of the interim financial statements
existed as of March 31, 2004.
Based upon the foregoing, management, including the Chief Executive Officer and
Chief Financial Officer, concluded that disclosure controls and procedures,
after implementing the aforementioned actions, 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. Except as mentioned above, there have
been no changes in the company's internal controls 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 controls over financial reporting.
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information included in note 10 to the Condensed Consolidated Financial
Statements of this Quarterly Report on Form 10-Q is incorporated by reference.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On August 12, 2003, the company's board of directors authorized the repurchase
of 8,000 additional Class A common shares. This authorization has no fixed
expiration date and was in addition to previously approved authorizations. As of
March 31, 2004, the company could repurchase an additional 4,774 Class A common
shares under this board of directors' authorization. No other authorizations for
share repurchase were outstanding as of March 31, 2004. During the three months
ended March 31, 2004, the company repurchased $58,001 of Class A common shares
as follows.
Total Shares Maximum Number
Shares Average Purchased During of Shares Remaining
Program Purchased Price the Period as for Purchase as
Approval During Paid Part of a Publicly Part of a Publicly
Date Month Period (per Share) Announced Program Announced Program
- -------- ------------- ------- ----------- ----------------- ------------------
8/12/03 January 2004 265 $27.00 265 6,616
8/12/03 February 2004 943 $27.23 943 5,673
8/12/03 March 2004 899 $27.99 899 4,774
----------- ---------------
8/12/03 Total Quarter 2,107 $27.53 2,107
=========== ===============
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders on February 12, 2004, the shareholders of
the company voted on and approved the following issues.
Issue 1 Election of Directors
Shares
Shares For Withheld
---------- ---------
Three-year terms Expiring in 2007
Eustace W. Mita 72,843,271 2,748,413
Philip A. Odeen 71,923,812 3,668,322
Donald K. Peterson 73,860,348 1,731,786
For Against Abstain
---------- ---------- -------
Issue 2 Approve the 2004 REYShare Plus Plan 52,849,588 15,728,474 613,813
Issue 3 Approve the 2004 Executive Stock Incentive Plan 49,524,714 19,029,205 637,956
Issue 4 Appointment of Deloitte & Touche LLP as Independent Auditors
Shares For 68,676,713
Shares Against 6,608,269
Shares Abstain 307,152
21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Arrangement with Mr. Michael Berry, Senior Vice
President, Reynolds Services Group
31.1 Certification
31.2 Certification
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 January 7, 2004, the company filed a report on Form 8-K
that included the company's presentation materials to be used
at an investor conference on January 7, 2004, and an Investor
forum on January 8, 2004.
On January 21, 2004, the company filed a report on Form 8-K
that included the company's January 21, 2004, press release
announcing financial results for the quarter ended December
31, 2003.
On March 15, 2004, the company filed a report on Form 8-K that
included the company's March 12, 2004 press release responding
to Moody's debt rating action.
On April 21, 2004, the company filed a report on Form 8-K that
included the company's April 21, 2004, press release
announcing financial results for the quarter ended March 31,
2004.
On May 4, 2004, the company filed a report on Form 8-K that
included the company's May 4, 2004, press release announcing a
third quarter dividend and a change in its board of directors
and certain board committees.
22
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 May 14, 2004 /s/ Lloyd G. Waterhouse
---------------------------------
Lloyd G. Waterhouse
Chief Executive Officer,
Chairman and President
Date May 14, 2004 /s/ Dale L. Medford
---------------------------------
Dale L. Medford
Executive Vice President
and Chief Financial Officer
23