READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
Semiannual Report
June 30, 1998
Trustees
Donald J. Puglisi, Managing Trustee
William R. Latham III
James B. O'Neill
Administrator, Custodian, Transfer Agent
and Paying Agent
The Bank of New York
101 Barclay Street
New York, New York 10286
<PAGE>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
Summary Information
- --------------------------------------------------------------------------------
Each of the Trust Automatic Common Exchange Securities ("TRACES") issued by the
Reader's Digest Automatic Common Exchange Security Trust represents the right to
receive an annual distribution of $1.9336, and will be exchanged on February 15,
2001 (the "Exchange Date") for between 0.8696 and 1.0 shares of the Class A
Nonvoting Common Stock, par value $0.01 per share (the "Class A Stock"), of The
Reader's Digest Association, Inc. (the "Company"). The TRACES are designed to
provide investors with a higher yield than the dividend yield paid on the Class
A Stock, while also providing the opportunity for investors to share in the
appreciation, if any, of the Class A Stock above a threshold appreciation price.
The TRACES are not subject to early redemption.
The Trust was established to purchase and hold a portfolio of stripped U.S.
Treasury securities maturing on a quarterly basis through February 15, 2001, and
one or more forward purchase contracts with certain shareholders of the Company
(the "Sellers"). The trustees of the Trust do not have the power to vary the
investments held by the Trust. The Trust's investment objective is to provide
each holder of TRACES with a quarterly distribution of $0.4834 per TRACES,
payable quarterly on each February 15, May 15, August 15 and November 15,
through the Exchange Date, and, on the Exchange Date, a number of shares of
Class A Stock per TRACES at the Exchange Rate (determined as described below).
If the Average Market Price (as defined below) on the Exchange Date is equal to
or greater than $26.9531 per share, the Exchange Rate is equal to 0.8696 of a
share of Class A Stock per TRACES; if the Average Market Price is less than
$26.9531 per share but is equal to or greater than $23.4375 per share, the
Exchange Rate is equal to a number (or fractional number) of shares of Class A
Stock per TRACES having a value (determined at the Average Market Price) equal
to $23.4375; and if the Average Market Price is less than $23.4375 per share,
the Exchange Rate is equal to one share of Class A Stock per TRACES. The
Exchange Rate is subject in each case to adjustment in certain events. The
"Average Market Price" means the average of the daily closing sale price (or, if
no closing sale price is reported, the last reported sale price) of the Class A
Stock as reported by the New York Stock Exchange Consolidated Tape for the 20
trading days immediately prior to, but not including, the Exchange Date. Holders
of TRACES will receive cash in lieu of any fractional share of Class A Stock to
which their aggregate holdings of TRACES otherwise would entitle them.
<PAGE>
READER'S DIGEST AUTOMATIC COMMON
EXCHANGE SECURITY TRUST
FINANCIAL REPORT
JUNE 30, 1998
(Unaudited)
<PAGE>
CONTENTS
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FINANCIAL STATEMENTS
Statement of net assets 1
Schedule of investments 2
Statement of operations 3
Statement of changes in net assets 4
Notes to financial statements 5-7
Financial highlights 8
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<TABLE>
<CAPTION>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
STATEMENT OF NET ASSETS
June 30, 1998
(Unaudited)
- -----------------------------------------------------------------------------------------------------
<S> <C>
ASSETS
Investments, at value (amortized cost $264,742,278) (Notes 2, 4, and 8) $ 305,278,126
Cash 794
---------------
Total Assets $ 305,278,920
===============
Net Assets $ 305,278,920
===============
COMPOSITION OF NET ASSETS
$1.9336 Trust Automatic Common Exchange Securities ("TRACES"), no par value;
11,854,496 shares issued and outstanding (Note 9) $ 263,577,711
Unrealized appreciation of investments 40,535,848
Undistributed net investment income 1,165,361
---------------
Net Assets $ 305,278,920
===============
Net Asset Value per TRACES $ 25.75
===============
</TABLE>
See Notes to Financial Statements.
1
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<TABLE>
<CAPTION>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
SCHEDULE OF INVESTMENTS
June 30, 1998
(Unaudited)
Par Maturity Market Amortized
Securities Description Value Date Value Cost
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
UNITED STATES GOVERNMENT
SECURITIES:
United States Treasury Strips $ 5,731,000 08/15/98 $ 5,694,837 $ 5,692,343
United States Treasury Strips 5,731,000 11/15/98 5,620,621 5,617,666
United States Treasury Strips 5,731,000 02/15/99 5,542,966 5,540,616
United States Treasury Strips 5,731,000 05/15/99 5,467,718 5,468,252
United States Treasury Strips 5,731,000 08/15/99 5,392,756 5,395,265
United States Treasury Strips 5,731,000 11/15/99 5,320,832 5,324,374
United States Treasury Strips 5,731,000 02/15/00 5,247,132 5,251,416
United States Treasury Strips 5,731,000 05/15/00 5,179,793 5,184,937
United States Treasury Strips 5,731,000 08/15/00 5,107,639 5,111,982
United States Treasury Strips 5,731,000 11/15/00 5,039,440 5,045,871
United States Treasury Strips 5,731,000 02/15/01 4,972,330 4,976,491
-------------- -------------- --------------
$ 63,041,000 58,586,064 58,609,213
=================
FORWARD PURCHASE CONTRACTS:
Reader's Digest Association, Inc. Class A
Nonvoting Common Stock
Forward Purchase Agreements 02/15/01 246,692,062 206,133,065
-------------- -------------
Total $ 305,278,126 $ 264,742,278
=============== =============
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
<TABLE>
<CAPTION>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
STATEMENT OF OPERATIONS
For the period from February 13, 1998 (commencement of operations) to June 30, 1998
(Unaudited)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
INTEREST INCOME $ 1,241,668
EXPENSES:
Administrative fees and expenses $ 12,557
Legal fees 1,883
Accounting fees 13,630
Insurance expense 11,653
Trustees' fees (Note 5) 4,520
Other expenses 377
------------
Total fees and expenses 44,620
EXPENSE REIMBURSEMENT (Note 7) (44,620)
------------
Total expenses - net ---
---------------
Net Investment Income 1,241,668
Unrealized appreciation
of investments 40,535,848
---------------
Net increase in net assets resulting from operations $ 41,777,516
===============
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
<TABLE>
<CAPTION>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
STATEMENT OF CHANGES IN NET ASSETS
For the period from February 13, 1998 (commencement of operations) to June 30, 1998
(Unaudited)
- --------------------------------------------------------------------------------------------------
<S> <C>
OPERATIONS
Net investment income $ 1,241,668
Unrealized appreciation of investments 40,535,848
------------------
Net increase in net assets
from operations 41,777,516
------------------
DISTRIBUTIONS
Net investment income (76,307)
Return of capital (5,780,999)
------------------
Net decrease in net assets from distributions (5,857,306)
------------------
INCREASE IN NET ASSETS FROM CAPITAL
SHARES TRANSACTION (Note 9)
Gross proceeds from the sale of 11,854,492 TRACES 277,839,656
Less:
Selling commissions (8,334,896)
Offering costs (146,150)
------------------
Net increase in net assets from capital
shares transactions 269,358,610
------------------
Total increase in net assets for
the period 305,278,820
Net assets, beginning of period 100
------------------
Net assets, end of period $ 305,278,920
==================
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION
Reader's Digest Automatic Common Exchange Security Trust (the "Trust") was
established on June 2, 1997 and is registered as a non-diversified, closed-end
management investment company under the Investment Company Act of 1940 (the
"Act"). In February 1998, the Trust sold $1.9336 Trust Automatic Common Exchange
Securities ("TRACES") to the public pursuant to a Registration Statement on Form
N-2 under the Securities Act of 1933 and the Act. The Trust used the proceeds to
purchase a portfolio comprised of stripped U.S. Treasury securities and forward
purchase contracts for shares of Class A Nonvoting Common Stock of The Reader's
Digest Association, Inc. (the "Company"), from one or more existing shareholders
of the Company (the "Sellers"). Each TRACES represents between 0.8696 and 1
share of Reader's Digest Common Stock. The stock is deliverable pursuant to the
contracts on February 15, 2001 and the Trust will thereafter terminate.
Pursuant to the Administration Agreement between the Trust and The Bank of New
York (the "Administrator"), the Trustees have delegated to the Administrator the
administrative duties with respect to the Trust.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting policies followed by
the Trust, which are in conformity with generally accepted accounting
principles.
Valuation of Investments
------------------------
The U.S. Treasury Strips are valued at the mean of the bid and ask price at
the close of the period. Amortized cost is calculated using the effective
interest method. The forward purchase contracts are valued at the bid price
received by the Trust at the end of each period from an independent
broker-dealer firm unaffiliated with the Trust who is in the business of
making bids on financial instruments similar to the contracts and with
terms comparable thereto, or if such bid quotation is not available, as
determined in good faith by the Trustees.
Investment Transactions
-----------------------
Securities transactions are accounted for as of the date the securities
are purchased and sold (trade date). Interest income is recorded as earned
and consists of accrual of discount. Realized gains and losses are
accounted for on the specific identification method.
Use of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
5
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READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 3. DISTRIBUTIONS
TRACES holders are entitled to receive distributions from the maturity of U.S.
Treasury Strips of $1.9336 per annum or $.4834 per quarter (except for the first
distribution on May 15, 1998 which was $.4941).
NOTE 4. PURCHASES AND SALES ON INVESTMENT
Purchases and maturities of U.S. Treasury Strips for the period ended June 30,
1998 totaled $63,225,545 and $5,858,000, respectively. There were no sales of
such investments during the period. Purchase of the forward purchase contracts
during the period totaled $206,133,065.
NOTE 5. TRUSTEES FEES
Each of the three Trustees was paid a one-time, up front fee of $10,800 for his
services during the life of the Trust. In addition, the Managing Trustee was
paid an additional one-time, up front fee of $3,600 for serving in such
capacity. The total fees paid to the Trustees ($36,000) are being expensed over
the life of the Trust. As of June 30, 1998, the Trust had expensed $4,520 of
such fees.
NOTE 6. INCOME TAXES
The Trust is not an association taxable as a corporation for Federal income tax
purposes; accordingly, no provision is required for such taxes.
As of June 30, 1998, net unrealized appreciation of investments, based on
amortized cost for Federal income tax purposes, aggregated $40,535,848, which
consists of gross unrealized appreciation and depreciation of $40,566,796 and
$30,948, respectively. The amortized cost of investment securities for Federal
income tax purposes was $264,742,278 at June 30, 1998.
NOTE 7. EXPENSES
The estimated expenses to be incurred by the Trust in connection with its
ongoing operations is $118,000, annually. Cash received by the Administrator
from Goldman Sachs & Co. for the payment of administrative and related operating
expenses of the Trust, in the amount of $355,346, has not been included in the
Trust's financial statements since the amount does not represent Trust property.
At June 30, 1998, $225,346 had been paid by the Administrator for current and
prepaid administrative and related operating expenses. All administrative and
related operating expenses incurred by the Trust are reflected in the Trust's
financial statements net of amounts reimbursed. Expenses incurred in excess of
this amount will be paid by Goldman Sachs & Co.
6
<PAGE>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 8. FORWARD PURCHASE CONTRACT
On February 13, 1998, the Trust entered into forward purchase contracts with
certain existing shareholders of the Company (the "Sellers") and paid to the
Sellers $206,279,215 in connection therewith. Pursuant to such contracts, the
Sellers are obligated to deliver to the Trust a specified number of shares of
Reader's Digest Class A Nonvoting Common Stock on February 15, 2001 (the
"Exchange Date") so as to permit the holders of the TRACES to exchange on the
Exchange Date each of their TRACES for between 0.8696 and 1 shares. See the
Trust's original prospectus dated February 10, 1998 for the formula upon which
such exchange will be determined.
Offering expenses related to the Trust of $146,150 were paid by the Sellers.
This amount has been recorded as a reduction in the cost of the forward
contracts.
The forward purchase contracts held by the Trust at June 30, 1998 are as
follows:
<TABLE>
<CAPTION>
Exchange Cost of Contract Unrealized
Date Contract Value Appreciation
---- -------- ----- ------------
<S> <C> <C> <C> <C>
Reader's Digest Association,
Inc. Class A Nonvoting
Common Stock Forward
Purchase Agreements 02/15/01 $ 206,133,065 $ 246,692,062 $ 40,558,997
================ =============== ===============
</TABLE>
The Sellers' obligations under the forward purchase contracts are collateralized
by shares of The Reader's Digest Association, Inc. Class A Nonvoting Common
Stock which are being held in the custody of the Trust's Custodian, The Bank of
New York. At June 30, 1998, the Custodian held 11,854,496 shares with an
aggregate value of $321,553,204.
NOTE 9. CAPITAL SHARE TRANSACTIONS
On December 18, 1997, one TRACES was sold to the underwriter of the Trust for
$100. As a result of a stock split effected immediately prior to the public
offering of the TRACES, this TRACES was converted into 4 TRACES. During the
offering period, the Trust sold 11,854,492 TRACES to the public and received net
proceeds of $269,358,610 ($277,839,656 less sales commissions of $8,334,896 and
offering costs of $146,150). As of June 30, 1998, there were 11,854,496 TRACES
issued and outstanding with an aggregate cost, net of return of capital,
offering costs and sales commissions, of $263,577,711.
7
<PAGE>
READER'S DIGEST AUTOMATIC COMMON EXCHANGE SECURITY TRUST
FINANCIAL HIGHLIGHTS
(Unaudited)
- --------------------------------------------------------------------------------
The Trust's financial highlights are presented below. The per share operating
performance data is designed to allow investors to trace the operating
performance, on a per share basis, from the Trust's beginning net asset value to
the ending net asset value so that they can understand what effect the
individual items have on their investment assuming it was held throughout the
period. Generally, the per share amounts are derived by converting the actual
dollar amounts incurred for each item as disclosed in the financial statements
to their equivalent per share amounts.
The total return based on market value measures the Trust's performance assuming
investors purchased shares at market value as of the beginning of the period,
reinvested dividends and other distributions at market value, and then sold
their shares at the market value per share on the last day of the period. The
total return computations do not reflect any sales charges investors may incur
in purchasing or selling shares of the Trust. The total return for a period of
less than one year is not annualized.
<TABLE>
<CAPTION>
February 13,
1998
(Commencement
of Operations) to
June 30,
1998
-------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE FOR A TRACES
OUTSTANDING THROUGHOUT THE PERIOD
Investment income $ 0.11
Expenses 0.00
-------------------
Investment income - net 0.11
Adjustments to capital (sales commissions and offering costs) (0.72)
Distribution from income (0.01)
Return of capital (0.49)
Unrealized gain on investments 3.42
-------------------
Net increase in net asset value 2.31
Beginning net asset value 23.44
-------------------
Ending net asset value $ 25.75
===================
Ending market value $ 25.75 *
===================
TOTAL INVESTMENT RETURN BASED ON MARKET VALUE 11.88 %
RATIOS/SUPPLEMENTAL DATA
Ratio of expenses to average net assets:
Before reimbursement (1) .04 %
After reimbursement (1) .00 %
Ratio of net investment income to average net assets:
Before reimbursement (1) 1.10 %
After reimbursement (1) 1.14 %
Net assets, end of period (in thousands) $ 305,279
</TABLE>
- ----------
(1) Annualized
* Closing price on the New York Stock Exchange at June 30, 1998.
8
