Back to GetFilings.com
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, 2005
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, 2005, 63,332,414 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, 2005 and 2004 3
Condensed Consolidated Balance Sheets
As of March 31, 2005 (unaudited) and September 30, 2004 4
Statements of Consolidated Cash Flows (unaudited)
For the Six Months Ended March 31, 2005 and 2004 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, 2005 and 2004 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
(See the caption entitled "Market Risks" included in the Management's
Discussion and Analysis of Financial Condition and Results of Operations)
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 22
Item 6. Exhibits 22
SIGNATURES 23
2
THE REYNOLDS AND REYNOLDS COMPANY
STATEMENTS OF CONSOLIDATED INCOME (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2005 AND 2004
(In thousands except per share data)
Three Months Six Months
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net Sales and Revenues
Products $ 174,262 $ 174,595 $ 339,459 $ 351,274
Services 69,651 66,546 136,927 129,870
Financial services 6,702 8,351 13,551 16,751
--------- --------- --------- ---------
Total net sales and revenues 250,615 249,492 489,937 497,895
--------- --------- --------- ---------
Cost of Sales
Products 65,142 60,487 125,891 123,211
Services 44,158 46,185 91,399 91,360
Financial services 1,878 1,863 3,629 3,780
--------- --------- --------- ---------
Total cost of sales 111,178 108,535 220,919 218,351
--------- --------- --------- ---------
Gross Profit 139,437 140,957 269,018 279,544
Selling, General and Administrative Expenses 102,285 98,233 196,262 200,861
--------- --------- --------- ---------
Operating Income 37,152 42,724 72,756 78,683
--------- --------- --------- ---------
Other Charges (Income)
Interest expense 1,631 1,230 3,076 2,570
Interest income (780) (403) (1,364) (1,060)
Other - net (530) (1,204) (2,485) (2,152)
--------- --------- --------- ---------
Total other charges (income) 321 (377) (773) (642)
--------- --------- --------- ---------
Income Before Income Taxes 36,831 43,101 73,529 79,325
Income Taxes 14,261 16,744 29,605 29,146
--------- --------- --------- ---------
Net Income $ 22,570 $ 26,357 $ 43,924 $ 50,179
========= ========= ========= =========
Basic Earnings Per Common Share
Net income $ 0.35 $ 0.40 $ 0.69 $ 0.75
Average number of common shares outstanding 63,838 66,604 64,105 66,925
Diluted Earnings Per Common Share
Net income $ 0.34 $ 0.38 $ 0.67 $ 0.73
Average number of common shares outstanding 65,646 68,642 65,509 69,045
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 (UNAUDITED)
AS OF MARCH 31, 2005 AND SEPTEMBER 30, 2004
(In thousands)
3/31/05 9/30/04
------------ ------------
AUTOMOTIVE SOLUTIONS ASSETS
Current Assets
Cash and equivalents $ 153,081 $ 79,772
Marketable securities 37,020
Trade accounts receivable 98,181 102,293
Other accounts receivables 2,779 3,637
Inventories 10,346 12,843
Prepaid and other assets 39,817 39,689
----------- -----------
Total current assets 304,204 275,254
Property, Plant and Equipment, less accumulated depreciation of
$142,166 at 3/31/05 and $135,956 at 9/30/04 175,070 178,447
Goodwill 49,078 48,366
Software Licensed to Customers 76,147 83,757
Acquired Intangible Assets 34,039 35,315
Other Assets 87,384 86,916
----------- -----------
Total Automotive Solutions Assets 725,922 708,055
----------- -----------
FINANCIAL SERVICES ASSETS
Cash 705 901
Finance Receivables 341,652 351,649
Other Assets 1,394 262
----------- -----------
Total Financial Services Assets 343,751 352,812
----------- -----------
TOTAL ASSETS $ 1,069,673 $ 1,060,867
=========== ===========
AUTOMOTIVE SOLUTIONS LIABILITIES
Current Liabilities
Accounts payable $ 40,606 $ 41,313
Accrued liabilities 52,699 55,323
Deferred revenues 30,677 27,871
Income taxes 28,386 14,838
----------- -----------
Total current liabilities 152,368 139,345
Long-Term Debt 100,975 103,512
Other Liabilities 84,227 81,983
----------- -----------
Total Automotive Solutions Liabilities 337,570 324,840
----------- -----------
FINANCIAL SERVICES LIABILITIES
Notes Payable 198,134 192,131
Other Liabilities 68,544 74,079
----------- -----------
Total Financial Services Liabilities 266,678 266,210
----------- -----------
SHAREHOLDERS' EQUITY
Capital Stock 369,969 346,352
Accumulated Other Comprehensive Losses (11,864) (13,739)
Retained Earnings 107,320 137,204
----------- -----------
Total Shareholders' Equity 465,425 469,817
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,069,673 $ 1,060,867
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
4
THE REYNOLDS AND REYNOLDS COMPANY
STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2004
(In thousands)
2005 2004
---------- ----------
Cash Flows Provided by (Used for) Operating Activities:
Net Income $ 43,924 $ 50,179
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 25,352 23,685
Provision for doubtful accounts 3,880 4,429
Stock-based compensation 5,525 5,603
Deferred income taxes (14,697) (3,609)
Net (gains) losses from sales of assets (173) 684
Changes in operating assets and liabilities:
Accounts receivable 3,115 19,354
Finance receivables originated (45,491) (65,005)
Collections on finance receivables 63,526 91,093
Inventories 2,497 (1,668)
Prepaid expenses (382) (3,967)
Other assets (1,937) 3,323
Accounts payable (707) (5,311)
Accrued liabilities 6,807 2,272
Other liabilities 9,296 7,689
--------- ---------
Net cash provided by operating activities 100,535 128,751
--------- ---------
Cash Flows Provided by (Used for) Investing Activities:
Business Combinations (500) (11,645)
Capital expenditures (13,793) (21,788)
Net proceeds from sales of assets 1,912 10,318
Marketable securities purchased (35,000) (27,100)
Marketable securities sold 72,020 7,180
Finance receivables originated (13,725) (10,285)
Collections on finance receivables 3,663 5,815
--------- ---------
Net cash provided by (used for) investing activities 14,577 (47,505)
--------- ---------
Cash Flows Provided by (Used for) Financing Activities:
Additional borrowings 27,000 12,339
Principal payments on debt (20,997) (23,206)
Cash dividends paid (7,109) (7,371)
Capital stock issued 32,804 27,689
Capital stock repurchased (74,736) (94,010)
--------- ---------
Net cash used for financing activities (43,038) (84,559)
--------- ---------
Effect of Exchange Rate Changes on Cash 1,039 1,195
--------- ---------
Increase (Decrease) in Cash and Equivalents 73,113 (2,118)
Cash and Equivalents - Beginning of Period 80,673 77,450
--------- ---------
Cash and Equivalents - End of Period $ 153,786 $ 75,332
========= =========
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, 2004 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 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 2004
Annual Report on Form 10-K.
2. RECLASSIFICATIONS
During the quarter ended March 31, 2005, the company changed its presentation of
cash flows to present a Statement of Consolidated Cash Flows. The company
previously had presented separate statements of cash flows for Automotive
Solutions and Financial Services. The prior year's statement of cash flows has
been revised to conform to the new presentation.
In 2005, the company changed its classification of auction rate securities from
cash and equivalents to marketable securities, according to Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The effect of this revision was to reduce cash and
equivalents and increase marketable securities by $37,020 as of September 30,
2004. The company purchased marketable securities of $35,000 in 2005 and $27,100
in 2004 and sold marketable securities of $72,020 in 2005 and $7,180 in 2004.
Purchases and sales of marketable securities were considered investing
activities for purposes of reporting cash flows.
In February 2005, the Securities and Exchange Commission (SEC) published a
letter related to the Statement of Cash Flows. This letter clarified that cash
flows for finance receivables related to sales of the company's products and
services should be considered operating activities in the statement of cash
flows. The company historically reported cash flows from finance receivables as
investing activities in the statement of cash flows. Additionally, cash flows
from intercompany receivables, which were included in trade receivables, were
historically included in operating activities, even though no cash was received
by the company on a consolidated basis when the sale was made to the customer.
The company revised its Statements of Consolidated Cash Flows to comply with the
new SEC guidance to reflect the fact that no cash is received upon the initial
sale and to properly classify cash receipts from the sales of products and
services as operating activities. Cash flows for finance receivables
representing financing of customers' purchases from other vendors will continue
to be considered investing activities in the Statements of Consolidated Cash
Flows. This reclassification did not change total cash flow.
The following table summarizes the previously discussed revisions to cash flows
from operating activities, investing activities and financing activities for the
six months ended March 31, 2004.
Operating Investing Financing
Activities Activities Activities
---------- ---------- ----------
Previously reported cash flows
Automotive solutions $ 109,852 ($ 14,124) ($ 78,967)
Financial services 11,876 2,552 (14,583)
--------- --------- ---------
Totals 121,728 (11,572) (93,550)
Finance receivables originated (65,281) 65,281 0
Finance receivables collected 90,408 (90,408) 0
Prepaid expenses and other assets 1 0 0
Marketable securities purchased 0 (27,100) 0
Marketable securities sold 0 7,180 0
Intercompany receivables (18,105) 18,105 0
Intercompany payments 0 (8,991) 8,991
--------- --------- ---------
Revised cash flows $ 128,751 ($ 47,505) ($ 84,559)
========= ========= =========
6
3. INVENTORIES
3/31/05 9/30/04
------- -------
Finished products $ 9,891 $12,420
Work in process 333 314
Raw materials 122 109
------- -------
Total inventories $10,346 $12,843
======= =======
4. BUSINESS COMBINATIONS
On October 1, 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.
In 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, 2005,
the company has recorded goodwill of $6,382 based on the allocation of the
purchase price. An independent appraisal firm was used to assist the company in
determining the fair values of intangible assets.
On October 1, 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. During December 2004, the company paid an additional $500
purchase price based on achievement of specified operating results. Under terms
of the purchase agreement, the company may be required to make additional
payments of up to $1,300 through 2006, 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. At March 31, 2005, the company has recorded tax deductible goodwill
of $3,649 based on the allocation of the purchase price. An independent
appraisal firm was used to assist the company in determining the fair values of
intangible assets.
5. GOODWILL AND ACQUIRED INTANGIBLE ASSETS
GOODWILL
Software
Solutions Documents Totals
--------- --------- --------
Balances as of September 30, 2004 $45,489 $2,877 $48,366
Business Combinations 500 500
Divestiture (46) (46)
Translation 258 258
------- ------ -------
Balances as of March 31, 2005 $46,201 $2,877 $49,078
======= ====== =======
ACQUIRED INTANGIBLE ASSETS
Weighted
Gross Accumulated Average
Amount Amortization Life (years)
------- ------------ ------------
AS OF MARCH 31, 2005
Amortized intangible assets
Contractual customer relationship $33,100 $ 8,137 20
Trademarks 6,278 1,545 19
Other 6,055 1,712 10
------- -------
Total $45,433 $11,394 18
======= =======
AS OF SEPTEMBER 30, 2004
Amortized intangible assets
Contractual customer relationship $33,100 $ 7,310 20
Trademarks 6,263 1,364 19
Other 7,006 2,380 10
------- -------
Total $46,369 $11,054 18
======= =======
7
Aggregate amortization expense was $1,314 for the six months ended March 31,
2005. Estimated amortization expense for the years ended September 30, is $2,627
in 2005, $2,627 in 2006, $2,477 in 2007, $2,477 in 2008 and $2,477 in 2009.
6. FINANCING ARRANGEMENTS
AUTOMOTIVE SOLUTIONS
During February 2002, the company entered into $100,000 of interest rate swap
agreements that effectively converted 7% fixed rate debt into variable rate
debt. These interest rate swap agreements were designated as fair value hedges.
The fair value of these derivative instruments was an asset of $1,058 at March
31, 2005, and $3,621 at September 30, 2004, and was included in Automotive
Solutions' other assets on the condensed consolidated balance sheets. 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 interest expense. 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 May 19, 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
$150,000 using finance receivables purchased from Reyna Capital Corporation,
also a consolidated affiliate of the company, as security for the loan. Interest
is payable on a variable rate basis. This loan funding agreement is renewable
through January 23, 2006. As of March 31, 2005, Reyna Funding, L.L.C. had
outstanding borrowings of $127,000 under this arrangement.
The fair value of the company's cash flow derivative instruments was a $1,146
asset at March 31, 2005 and a $128 liability at September 30, 2004 and was
included in Financial Services' other assets and other liabilities,
respectively, 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 was 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 or cash flows of the underlying exposure being
hedged because of the high degree of effectiveness of these cash flow hedges. In
fiscal year 2005, the company expects the amounts to be reclassified out of
other comprehensive income into earnings to be immaterial to the financial
statements.
REVOLVING CREDIT AGREEMENT
The company has a $200,000 revolving credit agreement. The revolving credit
agreement has a five year term expiring on April 8, 2009. Automotive Solutions
and Financial Services share this revolving credit agreement. As of March 31,
2005, the balance outstanding on this facility was $50,000.
7. COMPREHENSIVE INCOME
THREE MONTHS SIX MONTHS
2005 2004 2005 2004
--------- --------- -------- --------
Net income $ 22,570 $ 26,357 $ 43,924 $ 50,179
Foreign currency translation adjustment (374) (929) 1,039 1,195
Net unrealized gains on derivative contracts (1) 477 (13) 836 465
-------- -------- -------- --------
Comprehensive income $ 22,673 $ 25,415 $ 45,799 $ 51,839
======== ======== ======== ========
(1) Net of income tax provision of $316 and income tax benefit of $24 for the
three months ended March 31, 2005 and 2004, respectively and income tax
provisions of $555 and $310 for the six months ended March 31, 2005 and 2004,
respectively.
8. BUSINESS SEGMENTS
Effective October 1, 2004, the company changed its segment reporting for
consistency with the current organizational structure and how management views
the company's financial results. In fiscal year 2005, the company is reporting
financial information for three reporting segments: Software Solutions,
Documents and Financial Services. Software Solutions will be comprised of the
former Software Solutions segment and the former Services segment. Management
reviews the financial results of Software Solutions, Documents and Financial
Services to measure performance and allocate resources. This reporting will
provide a better economic picture of the company's solutions by combining the
operating results of products and related services that are sold together. For
example, software licenses and related software training will be included in a
single segment. In fiscal year 2004, these items were separated, with software
licenses reported in the Software Solutions segment and the related software
training reported in the Services segment. There were no changes in
8
the reporting of the Documents and Financial Services segments. Prior year
financial results were restated to report financial results on a consistent
basis with the current year.
The Software Solutions segment provides computer solutions including computer
hardware, integrated software packages, software enhancements and related
support. This segment also includes the 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
2005 2004 2005 2004
-------- -------- ---------- ----------
NET SALES AND REVENUES
Software Solutions
Products
Hardware $ 15,245 $ 12,251 $ 29,514 $ 27,705
Software 116,860 118,086 230,182 239,623
Services 69,651 66,546 136,927 129,870
-------- -------- ---------- ---------
Total Software Solutions 201,756 196,883 396,623 397,198
Documents 42,157 44,258 79,763 83,946
Financial Services 6,702 8,351 13,551 16,751
-------- -------- ---------- ---------
Total Net Sales and Revenues $250,615 $249,492 $ 489,937 $ 497,895
======== ======== ========== ==========
OPERATING INCOME (LOSS)
Software Solutions $ 25,932 $ 30,370 $ 50,865 $ 58,178
Documents 8,215 7,400 15,677 10,666
Financial Services 3,005 4,954 6,214 9,839
-------- -------- ---------- ----------
Total Operating Income $ 37,152 $ 42,724 $ 72,756 $ 78,683
======== ======== ========== ==========
3/31/2005 9/30/04
---------- ----------
ASSETS
Automotive Solutions $ 725,922 $ 708,055
Financial Services 343,751 352,812
---------- ----------
Total Assets $1,069,673 $1,060,867
========== ==========
9. CONTINGENCIES
In 2000, the company was named one of many defendants in a cost recovery lawsuit
filed by a potential responsible party (PRP) coalition in the United States
District Court for Southern District of Ohio regarding an environmental
remediation site in Dayton, Ohio. The court had ordered the parties to
participate in non-binding mediation; however, the mediation did not result in
resolution of the matter. The company continues to negotiate with the PRP
coalition and the company believes that this matter can still be resolved by
settlement. The company believes that the reasonably foreseeable resolution of
this matter will not have a material adverse effect on the financial statements.
In 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. This
contingent liability, which matures in January 2006, was $712 as of March 31,
2005. 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 facility in Canada and matures in 2007. As of
March 31, 2005, the unamortized balance on this letter of credit was $1,526.
9
Subsequent to the company's announcement on June 24, 2004, regarding third
quarter earnings, two shareholder class action complaints and two shareholder
derivative claims, subsequently consolidated, were filed in the United States
District Court for the Southern District of Ohio. A third shareholder derivative
claim was filed in the Court of Common Pleas in Montgomery County, Ohio. The
class action complaints allege that the company, a current officer and a former
officer violated provisions of the Securities Exchange Act of 1934. On October
19, 2004, the plaintiffs in one of the shareholder class actions voluntarily
moved to dismiss the action, without prejudice. On January 26, 2005, the second
shareholder class action was voluntarily dismissed, without prejudice. The
shareholder derivative claims were filed against the company, as nominal
defendant, members of the Board of Directors and certain executive officers and
allege breach of fiduciary duty, and other violations of law. On April 18, 2005,
the plaintiffs in the federal consolidated derivative claims voluntarily moved
to dismiss the action, without prejudice. Only the shareholder derivative claim
in the Court of Common Pleas in Montgomery County, Ohio remains. The company
denies that these allegations have any merit and is vigorously defending against
this remaining action.
The company is also subject to other claims and lawsuits that arise in the
ordinary course of business. The company believes that the reasonably
foreseeable resolution of these matters will not have a material adverse effect
on the financial statements.
10. POSTRETIREMENT BENEFITS
THREE MONTHS SIX MONTHS
2005 2004 2005 2004
--------- --------- --------- ---------
PENSION BENEFITS
Service cost $ 2,904 $ 2,822 $ 5,805 $ 5,642
Interest cost 4,580 4,217 9,148 8,431
Estimated return on plan assets (3,895) (3,184) (7,549) (6,367)
Amortization of unrecognized transitional asset 0 64 0 129
Amortization of prior service cost 192 195 383 391
Recognized net actuarial losses 895 984 1,792 1,970
Termination Benefits 472 0 472 0
Settlements 0 0 935 0
-------- -------- -------- --------
Net periodic pension cost $ 5,148 $ 5,098 $ 10,986 $ 10,196
======== ======== ======== ========
POSTRETIREMENT MEDICAL AND LIFE INSURANCE BENEFITS
Service cost $ 112 $ 166 $ 224 $ 166
Interest cost 865 924 1,730 924
Amortization of prior service cost (353) (186) (706) (186)
Recognized net actuarial losses 248 280 496 280
-------- -------- -------- --------
Net periodic postretirement medical and life insurance cost $ 872 $ 1,184 $ 1,744 $ 1,184
======== ======== ======== ========
As of March 31, 2005, the company has made $5,637 of contributions to the
pension plan. The company anticipates contributing an additional $663 to fund
its pension plan in fiscal 2005 for a total of $6,300.
11. ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 123 (revised 2004), "Share-Based
Payment." In March 2005, the Securities Exchange Commission issued Staff
Accounting Bulletin 107, "Share-Based Payment," to assist companies in the
adoption of SFAS No. 123 (revised). SFAS 123 requires that the cost resulting
from all share-based payment transactions are recognized in the financial
statements. That cost will be measured based on the fair value of the equity or
liability instruments issued. 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 fair value of the
award and is recognized as expense over the vesting period. On April 14, 2005,
the Securities Exchange Commission announced the adoption of a rule that defers
the required effective date of SFAS 123(revised). It will now become effective
for fiscal years
10
beginning after June 15, 2005, effective for the company October 1, 2005. The
company is currently evaluating this pronouncement and does not anticipate a
material impact on the company's results of operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2005 AND 2004
(In thousands except employee and per share data)
COMPANY OVERVIEW
INTRODUCTION
The company provides integrated computer systems products and related services,
documents and financial services primarily to automobile dealers. Computer
systems products include integrated software packages, software enhancements and
computer hardware. Computer services include installation and maintenance of
computer hardware, software training and professional services. Typically
hardware, hardware installation and software training revenues (i.e. one-time
revenues) are billed upon shipment and recognized over the implementation
period. Depending on their nature, software license fees may be billed upon
shipment (typically when a perpetual software license is sold) or billed monthly
over the term of the software license agreement. 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" and related pronouncements. Service revenues are recorded ratably
over the contract period or as services are performed. Software term licenses
and hardware maintenance revenues (i.e. recurring revenues) are invoiced monthly
and recognized ratably over the term of the contract as the software is used or
as services are provided. Professional services may be purchased separately or
bundled with the initial sale of software. Professional services revenues are
recognized as services are provided. Documents revenues are recorded when title
passes upon shipment to customers. The company also offers financial services
through Reyna Capital Corporation, Reyna Funding L.L.C. and a similar operation
in Canada. Financial services revenues consist primarily of interest earned on
financing the company's computer systems sales and are recognized over the lives
of financing contracts, generally five years, using the interest method.
Although the company's primary customers are automobile dealers in the United
States and Canada, the company's financial performance is not necessarily
correlated with the number of new vehicles sold by these retailers. Automobile
dealers have other profit centers such as used vehicles, service and parts which
provide a more consistent revenue stream and a greater proportion of a typical
automobile dealer's income than provided by new vehicle sales. This allows
automobile dealers to invest in products and services that improve customer
satisfaction and increase productivity.
The company earns most of its income from recurring software and hardware
maintenance revenues which comprise about 60% of the company's revenues. When
documents and financial services revenues are included, about 80% of the
company's revenues are recurring in nature. Additionally, much of professional
services revenues tend to be recurring in nature as programs are continued each
year. This provides a measure of stability and limits the effect of economic
downturns on the company's financial performance.
KEY ISSUES
On January 17, 2005, Finbarr J. O'Neill joined the company as President and
Chief Executive Officer. Mr. O'Neill had previously been President and Chief
Executive Officer of Mitsubishi Motors North America and prior thereto held the
same position at Hyundai Motor America. Mr. O'Neill also joined the company's
board of directors. Philip A. Odeen, who had served as Chairman and Acting Chief
Executive Officer since July 2004, remained the company's Chairman.
As a provider of software and related services, the company must continually
develop new software offerings and upgrade existing solutions to meet customer
requirements and increase revenues. The company has invested in research and
development during recent years to develop new software solutions. As a result,
the company currently has several software solutions which are relatively new
and in the early stages of their lifecycle. In August 2003, the company launched
Reynolds Generations Series(R) (RGS) Suite, the company's next generation dealer
management system. The company has significantly slowed the rate of RGS Suite
installations scheduled in 2005 to review and focus on necessary software
enhancements and improvements, system usability and implementation improvements.
The company has also taken a series of actions to improve product development
and ensure the readiness of software solutions. The company has consolidated
profit and loss responsibility for all software solutions and related services
under one management, devoted additional senior management resources to focus on
product development and created a Solutions Readiness Council to improve
solution readiness standards and processes.
11
Over the past year, three of the largest automobile dealership groups selected a
single vendor to provide dealer management software (DMS) solutions for all
their dealerships. One dealership group selected the company to be its exclusive
provider of both DMS and Web solutions. The other two dealership groups chose a
competitive DMS solution for their dealerships. In each case, the company
remains the exclusive provider of the dealerships' Web solutions and continues
to provide substantial document solutions to these other groups. The company
believes that it is too early to conclude that there is a trend towards single
sourcing as certain other large automobile dealership groups have indicated a
preference for two or more vendors or have a decentralized operating model which
permits more local autonomy in DMS decision making. In any event, if the company
is not able to continue to replace the net reduction in DMS-related revenue from
these three decisions with revenues from other solutions or net gains from
subsequent decisions in favor of the company by other large dealership groups,
the company's future revenues may be adversely impacted, albeit over time as the
transition to a single source typically takes two to three years.
RESULTS OF OPERATIONS
The following summaries of segment reporting, reorganization costs and special
items and business combinations have been provided to facilitate an
understanding of management's discussion and analysis. Additional disclosures
for these items have been provided in the Notes to the Condensed Consolidated
Financial Statements.
SEGMENT REPORTING
Effective October 1, 2004, the company changed its segment reporting for
consistency with the current organizational structure and how management views
the company's financial results. In fiscal year 2005, the company is reporting
financial information for three reporting segments: Software Solutions,
Documents and Financial Services. Software Solutions will be comprised of the
former Software Solutions segment and the former Services segment. Management
reviews the financial results of Software Solutions, Documents and Financial
Services to measure performance and allocate resources. This reporting will
provide a better economic picture of the company's solutions by combining the
operating results of products and related services that are sold together. For
example, software licenses and related software training will be included in a
single segment. In fiscal year 2004, these items were separated, with software
licenses reported in the Software Solutions segment and the related software
training reported in the Services segment. There were no changes in the
reporting of the Documents and Financial Services segments. Prior year segment
financial information was restated to report financial results on a consistent
basis with the current year. See Note 8 to the Condensed Consolidated Financial
Statements for more information on segment reporting.
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 a
position in Ohio were offered severance and outplacement services. Grand Prairie
document production operations ceased in December 2003 and 72 positions were
eliminated. The company added about 65 positions at the Celina, Ohio
manufacturing facility as production was transferred from Grand Prairie. During
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 incurred expenses of $1,267 before taxes or $.01 per share after
taxes during the quarter ended March 31, 2004 and $7,513 before taxes or $.07
per share after taxes for the six months ended March 31, 2004, for severance,
outplacement, relocation and other plant consolidation efforts. For the twelve
months ended September 30, 2004, the company incurred expenses of $7,054 before
taxes or $.06 per share after taxes for severance, outplacement, relocation and
other plant consolidation efforts and eliminated 230 positions. The company did
not incur any expenses related to this reorganization in 2005 and does not
anticipate incurring additional expenses related to these efforts in 2005.
BUSINESS COMBINATIONS
In October 2003, the company purchased the outstanding shares of Incadea GmbH, a
provider of global automotive retailing software solutions. At the time of the
acquisition, privately-held Incadea, based in Raubling, Germany, had annualized
revenues of about $6,000.
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. At the time of the acquisition, Third Coast Media, headquartered in
Richardson, Texas, had annualized revenues of about $5,000.
See Note 4 to the Condensed Consolidated Financial Statements for more
information on business combinations.
12
CONSOLIDATED SUMMARY
Three Months Six Months
-------------------------------------------- --------------------------------------------
2005 2004 Change % Change 2005 2004 Change % Change
--------- --------- ---------- -------- --------- --------- --------- --------
Net sales and revenues $250,615 $249,492 $ 1,123 0% $489,937 $497,895 ($ 7,958) -2%
Gross profit $139,437 $140,957 ($ 1,520) -1% $269,018 $279,544 ($10,526) -4%
% of revenues 55.6% 56.5% 54.9% 56.1%
SG&A expenses $102,285 $ 98,233 $ 4,052 4% $196,262 $200,861 ($ 4,599) -2%
% of revenues 40.8% 39.4% 40.0% 40.3%
Operating income $ 37,152 $ 42,724 ($ 5,572) -13% $ 72,756 $ 78,683 ($ 5,927) -8%
% of revenues 14.8% 17.1% 14.9% 15.8%
Net income $ 22,570 $ 26,357 ($ 3,787) -14% $ 43,924 $ 50,179 ($ 6,255) -12%
Basic earnings per share $ 0.35 $ 0.40 ($ 0.05) -13% $ 0.69 $ 0.75 ($ 0.06) -8%
Diluted earnings per share $ 0.34 $ 0.38 ($ 0.04) -11% $ 0.67 $ 0.73 ($ 0.06) -8%
Consolidated net sales and revenues increased slightly during the three months
ended March 31, 2005, the first quarterly increase in five quarters. Second
quarter revenues increased 2% in Software Solutions and declined in Documents
and Financial Services. Software Solutions revenues increased primarily because
of an 8% increase in one-time revenues resulting from greater professional
services (consulting) sales. Through six months, consolidated net sales and
revenues declined 2% with revenues declining in all three segments. The backlog
of new orders for Software Solutions computer systems products and services and
deferred revenues (orders shipped, but not yet recognized in revenues) was
approximately $45,000 at March 31, 2005, compared to $44,000 as of September 30,
2004. Last year the order backlog was reduced to $45,000 at March 31, 2004 from
$65,000 at September 30, 2003. Documents sales reflected the exit from low
margin products during the second half of last year. Financial Services revenues
reflect both lower average interest rates and lower average finance receivable
balances. See also the Key Issues caption of this analysis for additional
information which could impact future revenues.
Gross profit declined from last year for both the second quarter and six months.
The second quarter gross profit was negatively impacted by consolidation costs
related to a software service center and lower recurring revenue margins.
Year-to-date, gross profit declined because of lower revenues, the software
service center consolidation costs and $2,345 of costs to write off software
assets that will not be recovered by estimated future cash flows. Documents
gross margins increased as compared to a year ago because of the productivity
gains resulting from last year's plant consolidation and the elimination of last
year's plant consolidation costs.
Selling General & Administrative (SG&A) expenses increased over last year for
the quarter primarily as a result of $3,810 of retirement and other employee
separation costs, primarily related to the senior leadership team. In the third
quarter of 2005, the company anticipates incurring about $3,000 of employment,
retirement and other employee separation costs as new employees are hired and
existing employees provide services through retirement. Year-to-date, SG&A
expenses declined from last year because of lower costs as a result of last
year's sales reorganization and plant consolidation, as well as the elimination
of last year's consolidation costs of $5,830 and lower amortization expenses.
Research and development expenses were approximately $22,000 for the second
quarter and $44,000 for the six months compared to $23,000 and $44,000 for the
same periods, respectively, a year ago. No software development costs were
capitalized in either year. See the Software Solutions caption of this analysis
for additional information regarding R&D expenses and software capitalization.
Operating margins declined to 14.8% in the second quarter of fiscal year 2005,
compared to 17.1% last year as a result of the 2005 retirement and other
employee separation costs. Year-to-date, operating margins declined to 14.9%
from 15.8% last year, primarily as a result of lower revenues which reduced
operating income. Other income reflected $1,044 of increased exchange losses
over last year in the second quarter resulting from movements in foreign
currency.
The effective income tax rate was 40.3% for the six months ended March 31, 2005,
compared to 36.7% for the comparable period last year. During the second quarter
of 2005, the company recorded a $1,067 tax benefit related to higher Ohio jobs
credits for 2002 - 2004. Last year 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. The current year effective income tax rate
also reflects the greater impact of international operations and estimated
reduced benefits from stock option exercises.
13
SOFTWARE SOLUTIONS
Three Months Six Months
-------------------------------------------- --------------------------------------------
2005 2004 Change % Change 2005 2004 Change % Change
--------- --------- --------- -------- --------- --------- --------- --------
Net sales and revenues
Recurring revenues $152,622 $151,341 $ 1,281 1% $302,064 $301,464 $ 600 0%
One-time sales $ 49,134 $ 45,542 $ 3,592 8% $ 94,559 $ 95,734 ($ 1,175) -1%
Total net sales and revenues $201,756 $196,883 $ 4,873 2% $396,623 $397,198 ($ 575) 0%
Gross profit
Recurring revenues $ 95,904 $ 97,486 ($ 1,582) -2% $187,764 $195,234 ($ 7,470) -4%
One-time sales $ 14,942 $ 13,606 $ 1,336 10% $ 25,507 $ 28,082 ($ 2,575) -9%
Total gross profit $110,846 $111,092 ($ 246) 0% $213,271 $223,316 ($10,045) -4%
Gross Margin
Recurring revenues 62.8% 64.4% 62.2% 64.8%
One-time sales 30.4% 29.9% 27.0% 29.3%
Total gross margin 54.9% 56.4% 53.8% 56.2%
SG&A expenses $ 84,914 $ 80,722 $ 4,192 5% $162,406 $165,138 ($ 2,732) -2%
% of revenues 42.0% 41.0% 41.0% 41.6%
Operating income $ 25,932 $ 30,370 ($ 4,438) -15% $ 50,865 $ 58,178 ($ 7,313) -13%
% of revenues 12.9% 15.4% 12.8% 14.6%
Net sales and revenues increased 2% during the quarter ended March 31, 2005,
with one-time sales growing 8% and recurring revenues increasing 1%.
Year-to-date, net sales and revenues declined slightly with recurring revenues
up slightly and one-time sales down 1% from last year. The effect of divested
businesses (Boatventures.com and Web classifieds) reduced revenues about $900 in
the quarter and $2,700 through six months. See also the Key Issues caption of
this analysis for additional information which could impact future revenues.
Recurring revenues consist primarily of monthly revenues from software licenses,
software enhancements, telephone support, hardware maintenance, credit services
and network services. Recurring revenues increased slightly for both the three
and six months ended March 31, 2005 as a result of revenue growth in credit
services, customer relationship management solutions and Web solutions, all as a
result of greater volume. This growth was partially offset by lower ERA(R)
dealer management system recurring revenues, a decline in network services
revenues and as a result of divested businesses. ERA recurring revenues declined
from last year for both the quarter and six months because of a slight decrease
in market share, but increased slightly over the first quarter of 2005 as
additional applications such as ERA XT advanced reporting were installed and an
annual price increase of about 3% became effective March 1, 2005. Network
services recurring revenues declined for both the quarter and six months because
the company ceased being a reseller of network circuits. Network services
profitability improved as a result of this action.
One-time sales include revenues from hardware, software license fees,
implementation services (installation and training) and professional services.
During the second quarter, one-time sales increased because of growth in
professional services as a result of delivering more consulting days. This
growth was partially offset by a decline in ERA dealer management system
revenues. Through six months, one-time sales declined 1% as growth in
professional services was more than offset by lower ERA revenues. The actual
number of ERA systems shipped increased year-to-year for both the quarter and
six months. ERA one-time sales declined, however, because average sales prices
declined, primarily as a result of greater sales of ERA ES, the company's lower
priced solution for smaller automobile dealers. The six month comparisons were
also affected by last year's reduction in the order backlog. Last year the order
backlog was reduced $20,000, primarily in the first quarter of 2004, as strong
shipments of ERA occurred early in the quarter and allowed revenue recognition
as implementations were completed. This year the order backlog increased
slightly to $45,000 as of March 31, 2005, compared to $44,000 as of September
30, 2004.
Overall gross profit declined slightly in the second quarter as one-time gross
profit increased, because of professional services sales growth, and recurring
gross profit declined. Recurring gross profit declined primarily as a result of
costs incurred in the consolidation of a service center. These consolidation
costs included both termination costs and costs to ramp up the new location to
provide continued customer support. These costs will continue at a reduced level
in the third quarter. The mix of recurring revenues also contributed to the
recurring gross profit decline as lower margin credit services revenues
increased and higher margin ERA recurring revenues declined. The growth in
one-time sales, which have a lower margin than recurring revenues, also caused
the overall gross margin to decline. Year-to-date gross margins declined as a
result of lower ERA one-time and recurring revenues. The one-time revenues
decline was partially offset by higher gross margins from professional services
as consultant utilization increased. Recurring gross margins were also
negatively
14
affected by costs incurred in the consolidation of a service center and $2,345
of costs to write-off software assets that would not be recovered by estimated
future cash flows.
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. Once technological feasibility is established,
software development costs are capitalized until the product is available for
general release to customers. Upon general release of a software product, the
capitalized software development costs are amortized to expense over the
estimated economic life of the product. The company did not capitalize any
software development costs during the six month periods ended March 31, 2005 and
2004. Software amortization expenses (included in cost of sales) related to RGS
Suite were $6,547 in the six months ended March 31, 2005, the same as a year
ago. As of March 31, 2005, the unamortized balance of software development costs
related to RGS Suite was $69,832. The company believes that the capitalized
costs will be recovered from cash flow from future product revenues.
SG&A expenses increased $4,192 over last year in the second quarter, primarily
as a result of retirement and other employee separation costs, primarily related
to the senior leadership team. . In the third quarter of 2005, the company
anticipates incurring about $3,000 of employment, retirement and other employee
separation costs as new employees are hired and existing employees provide
services through retirement. Year-to-date SG&A expenses declined $2,732 because
of a decline related to consolidation costs incurred last year, productivity
gains from the consolidation and reduced amortization expenses. These declines
were partially offset by the second quarter's retirement and other employee
separation costs. Operating income declined from last year in the second quarter
primarily because of the retirement and other employee separation costs and
costs incurred to consolidate a service center. Year-to-date operating income
declined primarily as a result of the decline in gross profit as compared to
last year.
DOCUMENTS
Three Months Six Months
---------------------------------------- ------------------------------------------
2005 2004 Change % Change 2005 2004 Change % Change
------- ------- --------- -------- -------- -------- --------- --------
Net sales and revenues $42,157 $44,258 ($ 2,101) -5% $79,763 $83,946 ($ 4,183) -5%
Gross profit $23,767 $23,377 $ 390 2% $45,825 $43,257 $ 2,568 6%
% of revenues 56.4% 52.8% 57.5% 51.5%
SG&A expenses $15,552 $15,977 ($ 425) -3% $30,148 $32,591 ($ 2,443) -7%
% of revenues 36.9% 36.1% 37.8% 38.8%
Operating income $ 8,215 $ 7,400 $ 815 11% $15,677 $10,666 $ 5,011 47%
% of revenues 19.5% 16.7% 19.7% 12.7%
Documents sales declined 5% from last year for both the second quarter and six
months because of a decrease in the volume of business forms. About half of the
sales decline resulted from the company's decision to stop selling low-margin
stock continuous and copy paper products in the second half of 2004. The company
expects the sales of certain documents to continue to decline as advances in
technology continue.
Gross profit increased over last year for both the quarter and six months
primarily because of productivity gains from last year's consolidation of the
Grand Prairie, Texas manufacturing facility into the Celina, Ohio facility. Last
year also included consolidation costs of $318 in the quarter and $1,622
year-to-date related to closing the Grand Prairie location as well as costs to
set up production capabilities in Celina. No such costs were incurred in 2005.
SG&A expenses declined in the second quarter primarily as a result of lower
selling expenses because of last year's sales reorganization. Through six
months, SG&A expenses declined $2,443 with $1,675 related to costs incurred in
last year's sales reorganization and plant consolidation. The remainder of the
year-to-date reduction in SG&A expenses related to lower ongoing selling costs
as a result of last year's actions. Operating income increased over last year
for both the three and six months because of productivity gains resulting from
last year's consolidation activities and because last year included the costs of
the consolidation. The company has also eliminated some lower margin products
which helped improve operating margin.
15
FINANCIAL SERVICES
Three Months Six Months
---------------------------------------- ------------------------------------------
2005 2004 Change % Change 2005 2004 Change % Change
------- ------- -------- -------- -------- -------- --------- --------
Net sales and revenues $6,702 $8,351 ($ 1,649) -20% $13,551 $16,751 ($ 3,200) -19%
Gross profit $4,824 $6,488 ($ 1,664) -26% $ 9,922 $12,971 ($ 3,049) -24%
% of revenues 72.0% 77.7% 73.2% 77.4%
SG&A expenses $1,819 $1,534 $ 285 19% $ 3,708 $ 3,132 $ 576 18%
% of revenues 27.2% 18.4% 27.3% 18.7%
Operating income $3,005 $4,954 ($ 1,949) -39% $ 6,214 $ 9,839 ($ 3,625) -37%
% of revenues 44.8% 59.3% 45.9% 58.7%
About 75% of the three and six month declines in Financial Services revenues
resulted almost equally from lower average interest rates and a decrease in
average finance receivable balances. Average finance receivable balances
declined as a result of lower ERA one-time sales in Software Solutions. The
remaining decline in revenues is related to a reduction in other income,
primarily related to lease buyouts.
Gross profit also declined because of the declines in revenues. Interest rate
spreads were 3.4% in the quarter and 3.7% through six months, compared to 4.5%
and 4.6% respectively last year. In fiscal year 2004, the tax treatment for the
majority of new financing agreements changed from true leases to installment
sales contracts. The impact of this change was to lower deferred income tax
benefits. Assuming no change in the finance receivable balance, additional debt
will be required in the future to finance the portfolio because of the reduced
tax benefits. Debt balances are actually lower than last year because of the
decline in finance receivable balances.
SG&A expenses increased over last year because of higher bad debt expenses. Bad
debt expenses were $975 in the quarter and $2,025 year-to-date compared to $675
and $1,425 respectively last year. Bad debt expenses increased because of higher
net write-offs and an increase in inactive accounts as compared to last year.
Operating income declined primarily as a result of the decline in revenues.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
During the quarter ended March 31, 2005, the company reclassified its Statements
of Consolidated Cash Flows as described in Note 2 to the Condensed Consolidated
Financial Statements. These reclassifications adjusted cash flows to reflect
investments in auction rate securities as marketable securities instead of cash.
Purchases and sales of marketable securities were considered investing
activities for purposes of reporting cash flows.
The company also adjusted its Statements of Consolidated Cash Flows to reflect
cash flows for finance receivables related to sales of the company's products
and services as operating activities in the Statements of Consolidated Cash
Flows. The company historically reported cash flows from finance receivables as
investing activities in the statement of cash flows. Additionally, cash flows
from intercompany receivables, which were included in trade receivables, were
historically included in operating activities, even though no cash was received
by the company on a consolidated basis when the sale was made to the customer.
The company revised its Statements of Consolidated Cash Flows to comply with the
new SEC guidance to reflect the fact that no cash is received upon the initial
sale and to properly classify cash receipts from the sales of products and
services as operating activities. Cash flows for finance receivables
representing financing of customers' purchases from other vendors will continue
to be considered investing activities in the Statements of Consolidated Cash
Flows. This reclassification did not change total cash flow.
The company's balance of cash and equivalents was $153,786 at March 31, 2005.
Cash flows from operating activities were $100,535 during the first six months
of 2005 and resulted primarily from net income, adjusted for non cash charges
such as depreciation and amortization, and a reduction in finance receivables
related to the sales of the company's products and services. Cash flows provided
by investing activities reflected the net sale of marketable securities of
$37,020, partially offset by net capital expenditures of $11,881 and growth in
finance receivables related to financing non-company equipment of $10,062.
Fiscal year 2005 capital expenditures (net of proceeds from asset sales) in the
ordinary course of business are anticipated to be about $20,000, including about
$10,000 for buildings. Cash flows used for investing activities also included an
additional payment related to the fiscal year 2004 purchase of Third Coast
Media. This payment had been contingent upon meeting certain operating criteria
established at the purchase date. See the Shareholders' Equity caption of this
analysis regarding the payment of dividends and share repurchases.
16
CAPITALIZATION
The company's ratio of total debt (total Automotive Solutions debt) to
capitalization (total Automotive Solutions debt plus shareholders' equity) was
17.8% at March 31, 2005 and 18.1% at September 30, 2004. Remaining credit
available under a committed revolving credit agreement was $150,000 at March 31,
2005. 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 May 19, 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
$150,000 using finance receivables purchased from Reyna Capital Corporation,
also a consolidated affiliate of the company, as security for the loan. Interest
is payable on a variable rate basis. This loan funding agreement is renewable
through January 23, 2006. The outstanding borrowings under this arrangement were
included with Financial Services notes payable on the Consolidated Balance
Sheets. As of March 31, 2005, the balance outstanding on this facility was
$127,000.
The company has consistently produced operating cash flows sufficient to fund
normal operations. These operating cash flows result from 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, 2005, 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 to provide access to capital sufficient to meet
the company's cash requirements beyond the next year.
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, 2005, 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 as described in the company's annual report on
form 10-K for the fiscal year ended September 30, 2004.
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 quarter ended March 31, 2005, the company repurchased 1,945 Class A
common shares for $53,993 (an average price of $27.76 per share). Year-to-date,
the company repurchased 2,800 Class A common shares for $74,736 (an average
price of $26.69 per share). As of March 31, 2005, the company could repurchase
an additional 4,645 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
17
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. 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.
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, 2004. 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
18
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, increasing the discount rate from 6.0% in fiscal
year 2004 to 6.25% in fiscal year 2005. The expected long-term rate of return on
plan assets was estimated at 8.25% for both 2004 and 2005. The company is not
required to make minimum contributions to its postretirement plans in 2005,
although the company may elect to make contributions. The company made
contributions to its pension plans of $5,320 in the three months and $5,637 in
the six months ended March 31, 2005. The company anticipates making additional
contributions of $663 during the remaining six months of fiscal year 2005. See
Note 10 to the Consolidated Financial Statements included in Form 10-K for the
fiscal year ended September 30, 2004, for more detailed disclosures regarding
postretirement benefits, including relevant assumptions used to determine
expense and future obligations. The company's net periodic pension expense was
$5,148 for the three months and $10,986 for the six months ended March 31, 2005,
and compared to $5,098 and $10,196, respectively, a year ago. The company's net
periodic postretirement medical and life insurance expense was $872 for the
three months and $1,744 for the six months ended March 31, 2005, compared to
$1,185 and $2,369, respectively, a year ago.
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
4.9% during the second quarter and 4.6% for the six months ended March 31, 2005.
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 six months ended March 31, 2005, Reyna Funding, L.L.C. entered into
$48,919 of interest rate swaps associated with new debt issues and to replace
maturing interest rate swaps.
As of March 31, 2005, a one percentage point increase in interest rates would
increase annual consolidated interest expense by $1,500 while a one percentage
point decline in interest rates would reduce annual consolidated interest
expense by $1,500. 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 9% of net sales and revenues during the six months ended March 31, 2005. 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. During the second quarter
of 2005, the company did sell foreign currency forward contracts to limit
foreign currency risk on intercompany balances. The foreign currency positions
were closed as of March 31, 2005, the company had no foreign currency exchange
contracts outstanding. Based on the company's overall foreign currency exchange
rate exposure at March 31, 2005, management believes that a 10% change in
currency rates would not have a material effect on the company's financial
statements.
CONTINGENCIES
See Note 9 to the Condensed Consolidated Financial Statements for a discussion
of the company's contingencies.
ACCOUNTING STANDARDS
See Note 11 to the Condensed Consolidated Financial Statements for a discussion
of the effect of accounting standards that the company has not yet adopted.
19
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 November 3, 2004, 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 fiscal
year ended September 30, 2005. This effort includes documentation and testing of
internal controls. During the course of these activities, the company has
identified opportunities to improve internal controls and is in the process of
implementing these improvements. The company also identified segregation of
duties concerns at its relatively small European operations. As a result of
these findings, the company is changing its internal controls to properly
segregate duties at its European operations.
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 9 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 (IN THOUSANDS EXCEPT PER SHARE DATA)
As of December 31, 2004, the company could repurchase an additional 1,590 Class
A common shares under an existing board of directors' authorization. On February
15, 2005, the company's board of directors authorized the repurchase of an
additional 5,000 Class A common shares. This authorization has no fixed
expiration date and was in addition to previously approved authorizations. As of
March 31, 2005, the company could repurchase an additional 4,645 Class A common
shares under this board of directors' authorization. No other authorizations for
share repurchase were outstanding as of March 31, 2005. During the three months
ended March 31, 2005, the company repurchased 1,945 Class A common shares for
$53,993 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 2005 75 $27.04 75 1,515
8/12/03 February 2005 740 $27.58 740 775
8/12/03 March 2005 775 $27.99 775 0
2/15/05 New Authorization 5,000
2/15/05 March 2005 355 $27.78 355 4,645
----- -----
Total Quarter 1,945 $27.76 1,945
===== =====
21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders on February 17, 2005, the shareholders of
the company voted on and approved the following issues:
Shares
Shares For Withheld
---------- ---------
Issue 1 Election of Directors
Three-year terms Expiring in 2008
Stephanie W. Bergeron 65,386,662 8,356,581
Dr. David E. Fry 71,315,991 2,427,252
Richard H. Grant, III 71,504,509 2,238,734
Ira D. Hall 65,389,800 8,353,443
Shares Shares Shares Broker
For Against Abstain Nonvote
---------- ---------- ------- ---------
Issue 2 Approval of Non-Employee Director Stock 60,039,236 7,539,438 906,879 5,257,690
Compensation Plan
Issue 3 Approval of Material Terms of a Performance- 70,196,046 2,639,008 908,189 0
based Compensation Plan
Issue 4 Appointment of Deloitte & Touche LLP as 61,929,704 11,773,026 40,513 0
Independent Registered Public Accounting Firm
ITEM 6. EXHIBITS
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.
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 9, 2005 /s/ FINBARR J. O'NEILL
-------------------------------------
Finbarr J. O'Neill
President and Chief Executive Officer
Date May 9, 2005 /s/ DALE L. MEDFORD
-------------------------------------
Dale L. Medford
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
23