10-Q 1 l06914ae10vq.txt REYNOLDS & REYNOLDS 10-Q 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