FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number: 1-10434
THE READER'S DIGEST ASSOCIATION, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-1726769
(State or other jurisdiction of (I.R.S.
incorporation or organization) Employer
Identification
No.)
Pleasantville, New York 10570-7000
(Address of principal executive (Zip Code)
offices)
(914) 238-1000
(Registrant's telephone number, including area code)
______________________________________________
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 [ ]
As of October 30, 1998, the following shares of the
registrant's common stock were outstanding:
Class A Nonvoting Common Stock, $0.01 par value: 85,450,747 shares
Class B Voting Common Stock, $0.01 par value: 21,716,057 shares
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
Index to Form 10-Q
September 30, 1998
Part I - Financial Information Page No.
The Reader's Digest Association, Inc. and Subsidiaries
Financial Statements (unaudited):
Consolidated Condensed Statements of Income
for the three-month periods ended September 30, 1998 and 1997 3
Consolidated Condensed Balance Sheets
as of September 30, 1998 and June 30, 1998 4
Consolidated Condensed Statements of Cash Flows
for the three-month periods ended September 30, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 6
Management's Discussion and Analysis
of Financial Condition and Results of Operations 9
Part II - Other Information 16
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
Three-month periods ended September 30, 1998 and 1997
(In millions, except per share data)
(unaudited)
Three-month period ended
September 30,
1998 1997
Revenues $ 575.0 $ 561.4
Product, distribution and editorial expenses 212.5 203.5
Promotion, marketing and administrative expenses 345.9 371.4
Other operating items --- 70.0
Operating profit (loss) 16.6 (83.5)
Other (expense) income, net (12.6) 6.2
Income (loss) before provision (benefit) for
income taxes 4.0 (77.3)
Provision (benefit) for income taxes 1.5 (20.9)
Income (loss) before cumulative effect of change
in accounting principles 2.5 (56.4)
Cumulative effect of change in accounting principles
for pension assets(net of tax provision of $15.2) 25.3 ---
Net income (loss) $ 27.8 $ (56.4)
Basic and diluted earnings (loss) per share:
Before cumulative effect of change in accounting
principles $ 0.02 $ (0.53)
Cumulative effect of change in accounting
principles 0.24 ---
Basic and diluted earnings (loss) per share $ 0.26 $ (0.53)
Average common shares outstanding 107.2 106.3
Dividends per common share $ 0.225 $ 0.225
See accompanying notes to consolidated condensed financial statements.
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
As of September 30, 1998 and June 30, 1998
(In millions)
(unaudited)
September 30, June 30,
1998 1998
Assets
Cash and cash equivalents $ 96.3 $ 122.8
Receivables, net 478.2 376.4
Inventories 164.1 162.2
Prepaid expenses and other current assets 316.3 311.2
Total current assets 1,054.9 972.6
Property, plant and equipment, net 286.3 285.4
Other noncurrent assets 314.3 306.0
Total assets $ 1,655.5 $ 1,564.0
Liabilities and stockholders' equity
Accounts payable $ 162.3 $ 172.1
Accrued expenses 375.5 377.4
Income taxes payable 8.9 21.0
Unearned revenue 384.1 355.4
Other current liabilities 115.9 90.0
Total current liabilities 1,046.7 1,015.9
Other noncurrent liabilities 338.9 289.5
Total liabilities 1,385.6 1,305.4
Capital stock 19.5 16.6
Paid-in capital 144.5 144.8
Retained earnings 848.4 845.0
Accumulated other comprehensive loss (44.7) (49.8)
Treasury stock, at cost (697.8) (698.0)
Total stockholders' equity 269.9 258.6
Total liabilities and stockholders' equity $ 1,655.5 $ 1,564.0
See accompanying notes to consolidated condensed financial statements.
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
Three-month periods ended September 30, 1998 and 1997
(In millions)
(unaudited)
Three-month period ended
September 30,
1998 1997
Cash flows from operating activities
Net income (loss) $ 27.8 $ (56.4)
Depreciation and amortization 10.5 11.2
Other, net (90.2) (43.3)
Net change in cash due to operating activities (51.9) (88.5)
Cash flows from investing activities
Proceeds from maturities and sales of short-term
investments and marketable securities 0.5 9.8
Proceeds from other long-term investments, net 0.8 46.1
Advance on sale of assets 50.0 ---
Other, net (5.6) (0.9)
Net change in cash due to investing activities 45.7 55.0
Cash flows from financing activities
Short-term borrowings, net 2.6 43.2
Dividends paid (24.4) (24.2)
Other, net 2.7 (0.2)
Net change in cash due to financing activities (19.1) 18.8
Effect of exchange rate changes on cash (1.2) (0.3)
Net change in cash and cash equivalents (26.5) (15.0)
Cash and cash equivalents at beginning of period 122.8 69.1
Cash and cash equivalents at end of period $ 96.3 $ 54.1
See accompanying notes to consolidated condensed financial statements.
THE READER'S DIGEST ASSOCIATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In millions, except per share data)
(unaudited)
(1) Basis of Presentation
The company reports on a fiscal year beginning July 1. The three-
month periods ended September 30, 1998 and 1997 are the first
fiscal quarters of fiscal year 1999 and fiscal year 1998,
respectively.
The accompanying consolidated condensed financial statements have
not been audited, but in the opinion of management, have been
prepared in conformity with generally accepted accounting
principles applying certain judgments and estimates which include
all adjustments (consisting only of normal recurring adjustments)
considered necessary to present fairly such information.
Operating results for any interim period are not necessarily
indicative of the results for an entire year due to the
seasonality of the company's business.
(2) Basic and Diluted Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net
income (loss), less preferred stock dividend requirements of $0.3
in each of the three-month periods ended September 30, 1998 and
1997 by the weighted average number of common shares outstanding
during the period. Diluted earnings (loss) per share is computed
by dividing net income (loss), less preferred stock dividend
requirements, by the weighted average number of common shares
outstanding during the period, assuming exercise and conversion
of stock options. A weighted average number of common shares of
107.4 and 106.3 for the three-month periods ended September 30,
1998 and 1997, respectively was used for the computation of
diluted earnings (loss) per share.
(3) Inventories
September 30, June 30,
1998 1998
Raw materials $ 17.5 $ 21.8
Work-in-progress 20.1 24.7
Finished goods 126.5 115.7
$ 164.1 $ 162.2
(4) Revenues by Business Segments and Geographic Areas
Three-month period ended
September 30,
1998 1997
BUSINESS SEGMENTS
Reader's Digest Magazine $ 167.6 $ 172.1
Books and Home Entertainment Products 372.3 352.0
Special Interest Magazines 22.9 21.3
Other Businesses 12.2 16.0
Total revenues $ 575.0 $ 561.4
GEOGRAPHIC AREAS
United States $ 256.5 $ 248.5
Europe 222.0 217.7
Pacific and Other Markets 96.5 95.2
Total revenues $ 575.0 $ 561.4
(5) Comprehensive Income (Loss)
Effective July 1, 1998, the company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." The company has determined that at June 30, 1999, it
will display comprehensive income (loss) in the Consolidated
Statement of Changes in Stockholders' Equity. Accumulated other
comprehensive loss as reported in the Consolidated Condensed
Balance Sheets as of September 30, 1998 and June 30, 1998,
represents foreign currency translation adjustments. The
components of comprehensive income (loss), net of related tax,
for the three-month periods ended September 30, 1998 and 1997
were as follows:
Three-month period ended
September 30,
1998 1997
Net income (loss) $ 27.8 $(56.4)
Change in:
Foreign currency translation adjustment 5.1 (6.5)
Net unrealized gains on certain investments --- 0.2
$ 32.9 $(62.7)
(6) Other Operating Items
In connection with the new long-term strategy announced in
September 1998, the company expects to record additional charges
to other operating items in the second quarter of fiscal 1999 in
a range of $30.0 to $50.0 for the discontinuation of
unproductive businesses, cost reductions and re-engineering as
components of the plan are finalized.
As described in Note TWO to the company's consolidated financial
statements included in its 1998 Annual Report to Stockholders,
the company recorded charges of $70.0 in the first quarter of
1998 relating to the discontinuation of certain businesses and
the realignment of business processes and operations, charges of
$35.0 in the fourth quarter of 1997 relating primarily to the
realignment of the organization and operations, and charges of
$204.0 in the third quarter of 1996 relating to the streamlining
of the company's organizational structure and the strategic
repositioning of certain businesses. The current activity, as
well as reserve balances remaining at September 30, 1998, were:
Balance at Current Balance
June 30, 1998 Activity Remaining
Employee retirement & severance
benefits $ 59.6 $ (4.5) $ 55.1
Other items 24.2 (6.3) 17.9
Business repositioning 3.9 --- 3.9
Total $ 87.7 $ (10.8) $ 76.9
(7) Debt
As described in Note NINE to the company's consolidated financial
statements included in its 1998 Annual Report to Stockholders,
the company is a party to a Competitive Advance and Revolving
Credit Facility Agreement (the credit agreement) of up to $300.0.
Under the credit agreement, the company must comply with certain
financial covenants, including a minimum level of consolidated
tangible net worth. At September 30, 1998, no borrowings were
outstanding under the credit agreement. In addition, various
international subsidiaries of the company have available lines of
credit totaling $70.9. At September 30, 1998, loans in the
amount of $10.2 were outstanding under international lines of
credit at a weighted average interest rate of 7.8%.
(8) Change in Accounting for Pension Assets
Effective July 1, 1998, the company changed the method for
calculating the market-related value of pension plan assets used
in determining the return-on-asset component of annual pension
expense and the cumulative net unrecognized gain or loss subject
to amortization. The company believes that the new method is
more widely used in practice and preferable because it results in
pension plan asset values that more closely approximate fair
value, while still mitigating the effect of annual market value
fluctuations. In addition, the new method facilitates the global
management of the company's pension plans as it results in a
consistent methodology for all plans for this calculation. This
change resulted in a noncash benefit in fiscal 1999 of $40.5
($25.3 after tax, or $0.24 per share) representing the cumulative
effect of the change related to years prior to fiscal 1999 and
$4.8 in lower pension expense ($3.0 after tax, or $0.03 per
share) related to the three-month period ended September 30, 1998
as compared to the previous accounting method. Had this change
been applied retroactively, pension expense would have been
reduced by $3.9 ($2.5 after tax, or $0.02 per share) in the three-
month period ended September 30, 1997.
(9) Sale Leaseback Transaction
In the first quarter of fiscal 1999 the company announced its
intention to enter into a sale leaseback agreement for its
principal operating office in the United Kingdom. The company
anticipates that this transaction will be finalized in the second
quarter of fiscal 1999.
The Reader's Digest Association, Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations
(Dollars in millions, except per share data)
Results of Operations
Three-Month Period Ended September 30, 1998 Compared With Three-
Month Period Ended September 30, 1997
Management's discussion and analysis, as it pertains to
geographic and business segment information, has been written
excluding the effect of the 1998 first quarter other operating
items of $70.0 in order to analyze the results on a comparable
basis.
Revenues/Operating Profit (Loss)
Worldwide revenues for the first quarter of 1999 increased to
$575.0, or by 2%, compared with $561.4 in the first quarter of
1998. Excluding the adverse effect of changes in foreign
currency exchange rates, revenues increased 4%. This improvement
was primarily attributable to higher unit sales and sales of a
higher-priced product mix within Books and Home Entertainment
Products. The increase in unit sales was predominantly a result
of the timing of mail dates and number of promotional mailings
during the quarter, as well as improved customer response to
promotional mailings in most international markets. The higher
customer response rates resulted primarily from a return to
traditional promotional formats and the elimination of the least
profitable names from promotional mailings. Higher revenues in
most major developed markets and growth in Eastern Europe and
Latin America were moderately offset by declines in other
developed European markets.
The company reported worldwide operating profit of $16.6 in the
first quarter of 1999, compared with an operating loss of $83.5
in the first quarter of 1998, before excluding the first quarter
1998 other operating items of $70.0. These operating results
reflect higher revenues, the benefits of cost-containment
initiatives in developed markets resulting from actions taken in
prior years, lower proportionate promotional spending as a result
of lower mail quantities and higher customer response rates, and
the termination of strategic alliances as well as the elimination
of spending on certain unprofitable growth initiatives, slightly
offset by losses at the company's operations in Russia stemming
primarily from the economic turmoil in Russia that resulted in
the devaluation of the ruble.
Other (Expense) Income, Net
Other (expense) income, net decreased in the first quarter of
1999 to expense of $12.6, compared with income of $6.2 in the
prior year. This decrease was primarily because of foreign
exchange translation losses of $7.8 resulting from the
devaluation of the Russian ruble and, to a lesser extent, losses
on foreign exchange transactions and hedging activity. In
addition, other income in the first quarter of 1998 included
gains from sales of certain investments.
Income Taxes
For the first quarter of 1999, the effective tax rate was 37.5%.
For the first quarter of 1998, the reported tax rate was 27.1%.
Excluding the effect of other operating items, the overall
effective tax rate was 37.5% for the first quarter of 1998.
Change in Accounting Principles
In the first quarter of fiscal 1999, the company adopted a
preferred method for calculating the market-related value of
pension plan assets used in determining the return-on-asset
component of annual pension expense and the cumulative net
unrecognized gain or loss subject to amortization. The
cumulative effect of adopting this change, for years prior to
fiscal 1999, was a benefit of $40.5 ($25.3 after tax, or $0.24
per share). In addition, this change reduced pension expense for
the first quarter of 1999 by $4.8 ($3.0 after tax, or $0.03 per
share).
Basic and Diluted Earnings (Loss) per Share
The company reported net income of $27.8, or $0.26 per share, in
the first quarter of 1999, compared with a net loss of $56.4, or
$0.53 per share, in the first quarter of 1998. Excluding the
cumulative effect of change in accounting principles for pension
assets in 1999 and other operating items in 1998, basic and
diluted earnings per share was $0.02 in the first quarter of
1999, compared with a loss of $0.05 per share in the first
quarter of 1998.
The company's operations in Russia were significantly affected by
the general economic turmoil and resulting devaluation of the
ruble in the first quarter of 1999. In response to the Russian
economic situation, the company took actions to scale back its
operations in Russia. The company's operations in Russia
generated a net loss of $16.4, or $0.15 per share in the first
quarter of 1999, primarily as a result of the economic turmoil.
Geographic Areas
United States
Revenues in the United States increased from $248.5 in 1998 to
$256.5, or by 3%, in 1999. This increase was primarily
attributable to higher unit sales and sales of a higher-priced
product mix within Books and Home Entertainment Products and
increased advertising revenues for Reader's Digest Magazine.
Within Books and Home Entertainment Products, higher revenues
from unit sales of general books and, to a lesser extent,
Condensed Books, were moderately offset by declines in sales of
music products. General books revenues increased primarily
because of the number of promotional mailings in the first
quarter of 1999 which resulted in an additional promotional
mailing as compared to a year ago and, to a lesser extent, higher
customer response to promotional mailings. Revenues for
Condensed Books improved principally because of the timing of
shipments compared with the prior year. The decrease in music
products was caused by lower customer response to mailings, as
well as lower mail quantities within the mailings. Higher
average prices in Books and Home Entertainment Products were the
result of an increase in the price of Condensed Books and a
higher-priced mix of products offered in 1999. Advertising
revenues for Reader's Digest Magazine increased because of a
higher number of advertising pages sold, moderately offset by a
lower average rate per page. Operating results improved
significantly in 1999, compared with 1998, resulting from the
improved revenues, a reduction in employee benefit costs as a
result of the change in accounting for pension assets and the
termination of strategic alliances as well as the elimination of
spending on certain unprofitable growth initiatives.
Europe
Revenues in Europe increased from $217.7 in 1998 to $222.0, or by
2%, in 1999. Excluding the positive effect of changes in foreign
currency exchange rates, revenues were at the same level as a
year ago. Higher revenues in major developed markets and growth
in Eastern Europe were offset by declines in other developed
markets. Higher Books and Home Entertainment revenues were
offset by lower circulation revenues for Reader's Digest Magazine
in major developed markets and lower activity in the merchandise
catalog business. Within Books and Home Entertainment Products,
increased general books revenues resulting from higher units sold
at a higher average price and increased unit sales of music
products, were moderately offset by lower unit sales of video
products. Improved customer response rates to promotional
mailings in major developed markets principally resulting from a
return to traditional promotional formats and the elimination of
the least profitable names from promotional mailings contributed
to higher general books and music products revenues. General
books revenues also benefited from a significantly higher-priced
mix of products offered in the first quarter of 1999 and growth
in Eastern Europe. Sales of video products were negatively
affected by the timing of mail dates and number of promotional
mailings during the quarter, which resulted in fewer mailings as
compared to a year ago. Operating profit improved significantly
in 1999, compared with 1998, as a result of higher revenues,
lower proportionate promotional spending as a result of lower
mail quantities and higher customer response rates, and the
benefits of cost-containment initiatives in most developed
markets resulting from actions taken in prior years, moderately
offset by losses at the company's operations in Russia stemming
primarily from the economic turmoil in Russia that resulted in
the devaluation of the ruble.
Pacific and Other Markets
Revenues in Pacific and Other Markets increased from $95.2 in
1998 to $96.5, or by 1%, in 1999. Excluding the adverse effect
of changes in foreign currency exchange rates, revenues increased
16%. Revenues increased primarily within Books and Home
Entertainment Products, because of higher unit sales in all
product lines, most notably music and video products and
Condensed Books and, to a lesser extent, sales of a higher-priced
product mix within general books. Higher unit sales were
attributable to growth in music and video product sales in Latin
America, particularly in Brazil, as well as the launch of
Condensed Books in this region. Revenues also increased in
Australia because of the timing of mail dates and shipments as
well as the number of promotional mailings during the quarter
compared with the prior year, and improved customer response to
promotional mailings. Operating results improved in 1999,
compared with 1998, primarily because of higher revenues, lower
proportionate promotional spending as a result of higher customer
response rates and the benefits of cost-containment initiatives
in developed markets resulting from actions taken in prior years.
Corporate Expense
Corporate Expense in the first quarter of 1999 decreased to $8.4,
compared with $10.9 in 1998, primarily as a result of lower
consulting and recruiting costs, moderately offset by certain
employee benefit costs.
Business Segments
Reader's Digest Magazine
Revenues for Reader's Digest Magazine decreased from $172.1 in
1998 to $167.6, or by 3%, in 1999. Excluding the adverse effect
of changes in foreign currency exchange rates, revenues decreased
1%. The decrease in revenues was primarily attributable to lower
circulation revenues moderately offset by a higher number of
advertising pages sold at a lower average rate per page in the
first quarter of 1999. Lower circulation revenues were
principally caused by lower circulation levels in the United
States and circulation declines in several major markets,
particularly Germany and the United Kingdom. The effect of a
significantly higher number of ad pages sold in the United States
and, to a lesser extent, in Germany, was moderately offset by a
lower negotiated average rate per page in these markets.
Operating profit for Reader's Digest Magazine improved in the
first quarter of 1999 compared with the same period a year ago.
The increase primarily reflects a reduction in employee benefit
costs as a result of the change in accounting for pension assets.
In order to increase the efficiency of its promotional spending,
the company announced on October 1, 1998 that it will reduce the
rate base for Reader's Digest Magazine in the United States from
15 million copies per issue to 13.3 million for the January -
June 1999 issues, then level off at 12.5 million copies with the
July 1999 issue.
Books and Home Entertainment Products
Revenues for Books and Home Entertainment Products increased from
$352.0 in 1998 to $372.3, or by 6%, in 1999. Excluding the
adverse effect of changes in foreign currency exchange rates,
revenues increased 8%, principally attributable to the company's
Pacific and Other Markets and, to a lesser extent, United States
operations. Revenues increased in general books and, to a lesser
extent, Condensed Books, as a result of higher unit sales and
sales of a higher-priced product mix. The increase in general
books was caused by the number of promotional mailings in the
first quarter of 1999 which resulted in an additional promotional
mailing as compared to a year ago in the United States, higher
customer response to promotional mailings in major developed
markets, growth in Eastern Europe and a significantly higher-
priced mix of products offered in the first quarter of 1999.
Higher customer response rates to promotional mailings resulted
primarily from a return to traditional promotional formats and
the elimination of the least profitable names from promotional
mailings. Condensed Books revenues improved principally because
of the timing of shipments compared with the prior year, improved
customer response to promotional mailings in certain markets, and
the launch of Condensed Books in Latin America. Higher average
prices for Condensed Books were the result of price increases in
the United States and certain International markets. Operating
profit for Books and Home Entertainment Products increased
significantly in 1999, compared with 1998. These operating
results were affected by higher revenues, lower proportionate
promotional spending as a result of lower mail quantities and
higher customer response rates, the elimination of spending on
certain unprofitable growth initiatives and the benefits of cost-
containment initiatives in most developed markets resulting from
actions taken in prior years.
Special Interest Magazines
Revenues for Special Interest Magazines increased from $21.3 in
1998 to $22.9, or by 8%, in 1999. This increase was primarily
attributable to higher circulation and advertising revenues,
resulting from subscription price increases, higher subscription
levels and a higher average rate per advertising page sold in
1999, principally as a result of rate base increases for several
magazines. Operating results improved in 1999 compared with 1998
primarily as a result of the higher circulation and advertising
revenues.
Forward-Looking Information
Strategic Initiatives
The company is undertaking a three-phase strategy to build on its
fundamental strengths and create growth opportunities over the
next three years.
In July 1998, the company announced as the first step in this
strategy a global reorganization that included the organization
of operations into four business groups, the restructuring of
editorial organizations, the establishment of new reporting
relationships and the reassignment of certain executives. The
second phase of the strategy, announced in September 1998,
targeted the restructuring of costs and the conversion of
underproductive assets to cash. The main components of the
second phase of the strategy were the elimination or
rationalization of unproductive businesses, activity-based cost
reductions and re-engineering, and leveraging the asset base of
the company.
The global reorganization announced in July is substantially
complete. The second phase of the strategy is currently
underway, and the elimination or rationalization of unproductive
businesses is still on track to be completed within the next 18
months. The company expects to record charges to other operating
items in a range of $30.0 to $50.0 in the second quarter of
fiscal 1999 related to cost reduction and re-engineering actions
as components of the plan are finalized. Actions to leverage the
asset base of the company are in process and the sale of key
works from the art collection and the sale of the company's U.K.
Canary Wharf office facility are expected to be completed by the
end of the second quarter of 1999. In addition, on October 9,
1998 the company announced a reduction in its quarterly dividend
for the second quarter of 1999 from $0.225 per share to $0.05 per
share.
The third phase of the strategy is expected to be announced in
January 1999 and will focus on plans to expand the business.
This will include investing in internal opportunities, as well as
targeting acquisitions that leverage the company's core
strengths, expanding geographically, introducing new products and
engaging in at least one completely new business.
Fiscal 1999 Results
The first quarter of fiscal 1999 was significantly affected by
the economic turmoil in Russia that resulted in the devaluation
of the ruble. The company has taken actions to scale back
operations in Russia in response to the economic turmoil. The
company's actions are expected to mitigate future losses from the
company's operations in Russia. Further losses are anticipated
for the company's operations in Russia, although not at the
levels that were recognized in the first quarter.
In addition, results for the first quarter of fiscal 1999 were
positively affected by the timing of mail dates and number of
promotional mailings during the quarter as compared to a year
ago, as well as improved customer response to those mailings. On
balance, the remainder of fiscal 1999 is expected to reflect an
offset to a portion of this timing, as well as some weakness in
series product lines in certain markets resulting from
disappointing introductory mailings in the first quarter. The
remainder of the year is expected to continue to benefit from the
improved customer response rates and the reduction in employee
benefit costs as a result of the change in accounting for pension
assets. However, the company continues to see significant
volatility in the level of customer response rates in individual
mailings. As such, the company is cautious regarding the
continuing effect of improved customer response rates on its
outlook for results for fiscal 1999. Notwithstanding the events
in Russia, results for fiscal 1999 are expected to show a modest
improvement over fiscal 1998 including the benefit for the change
in accounting for pension assets and before the effects of the
execution of the second phase of the strategy and other operating
items; however, as the strategy is executed worldwide, results
are expected to show additional improvement in 1999 and more
significant benefits are anticipated over the next two to three
years.
Impact of the Year 2000 Issue
The year 2000 issue is the result of computer programs which were
written using only two digits, rather than four, to represent a
year. Date-sensitive software or hardware may not be able to
distinguish between 1900 and 2000 and programs that perform
arithmetic operations, comparisons or sorting of date fields may
begin yielding incorrect results. This could potentially cause a
system failure or miscalculations that could disrupt operations.
The Company's State of Readiness. The company has developed a
remediation plan for its year 2000 issue that involves three
overlapping phases:
1)Inventory - This phase includes the creation of an inventory
of three functional areas:
a)Applications and information technology (IT) equipment -
These include all mainframe, network and desktop hardware
and software, including custom and packaged applications,
and IT embedded systems.
b)Non-information technology (non-IT) embedded systems -
These include non-IT equipment and machinery. Non-IT
embedded systems, such as security, fire prevention and
climate control systems typically include embedded
technology, such as microcontrollers.
c)Vendor relationships - These include significant third
party vendors and suppliers of goods and services, as well
as vendor and supplier interfaces.
The United States and developed international markets have
substantially completed the inventory phase and plan to be
fully completed by December 1998.
2) Analysis - This phase includes the evaluation of the
inventoried items for year 2000 compliance, the determination
of the remediation method and resources required and the
development of an implementation plan. A significant portion
of the analysis phase is complete in the United States and
developed international markets. The United States and major
developed international markets expect to complete the
analysis phase for non-IT embedded systems by December 1998.
All other components of the analysis phase for the United
States and developed international markets are expected to be
completed by March 1999.
3) Implementation - This phase includes executing the
implementation plan for all applicable hardware and software,
interfaces and systems. This involves testing the changes,
beginning to utilize the changed procedures in actual
operations, testing in a year 2000-simulated environment and
vendor interface testing. Subsequent to implementation, the
company will conduct live testing on January 1 and 2, 2000,
before business commences on January 3, 2000. The
implementation phase, including testing for certain critical
applications, has commenced in the United States and major
developed international markets, and is expected to be
completed by June 1999 for applications and IT equipment and
non-IT embedded systems. All other components of the
implementation phase for the United States and developed
international markets are expected to be completed by
September 1999.
The company's operations in developing international markets,
including operations in Latin America, Eastern Europe and the Far
East, are in the preliminary stages of assessing exposure with
respect to their local year 2000 issues.
The company's remediation plan for its year 2000 issue is an
ongoing process and the estimated completion dates above are
subject to change.
The Risk of the Company's Year 2000 Issue. Overall, at this time
the company believes that its systems will be year 2000 compliant
in a timely manner for several reasons. Several significant
marketing and fulfillment systems are already compliant. In
addition, the company extensively utilizes certain shared
applications that should be remediated once and then deployed to
all appropriate markets. Also, comprehensive testing of all
critical systems is planned to be conducted in a simulated year
2000 environment. Additionally, critical fulfillment systems in
the United States and several developed international markets use
a one-digit field to denote the year, therefore the date fields
for these systems are updated every 10 years and the year 2000 is
not an issue requiring separate attention.
The company believes that the risk of developing international
markets' not being year 2000 compliant on a timely basis is low
primarily because the majority of their custom applications are
shared systems that were developed in the United States and
Canada and are currently year 2000 compliant, or are expected to
be by December 31, 1998. In addition, since most of the
equipment in these locations is relatively new there is less
likelihood that the equipment is not currently year 2000
compliant.
The company believes that the area of greatest risk to the
company surrounding the year 2000 issue relates to significant
suppliers' failing to remediate their year 2000 issues in a
timely manner. The company has relationships with certain
significant suppliers in most of the locations in which it
operates. These relationships may be material to some local
operations and, in the aggregate, may be material to the company.
The company relies on suppliers to deliver a broad range of goods
and services worldwide, including book and magazine printing
services, supplies of promotional materials and paper, warehouse
facilities, lettershops which assemble promotional mailings,
customer service facilities, postal delivery services, banking
services, telecommunications and electricity. The company is
conducting formal communications with its significant suppliers
in all locations to determine the extent to which it may be
affected by those third parties' plans to remediate their own
year 2000 issue in a timely manner. The level of preparedness of
significant suppliers can vary greatly from country to country.
If a number of significant suppliers are not year 2000 compliant,
this could have a material adverse effect on the company's
results of operations, financial position or cash flow.
The Company's Contingency Plans. The company is developing its
country-by-country contingency plans and expects to have them
completed by June 1999. To mitigate the effects of the company's
or significant suppliers' potential failure to remediate the year
2000 issue in a timely manner, the company would take appropriate
actions. Such actions may include having arrangements for
alternate suppliers, re-running processes if errors occur, using
manual intervention to ensure the continuation of operations
where necessary, and scheduling activity in December 1999 that
would normally occur at the beginning of January 2000. If it
becomes necessary for the company to take these corrective
actions, it is uncertain, until the contingency plans are
finalized, whether this would result in significant delays in
business operations or have a material adverse effect on the
company's results of operations, financial position or cash flow.
Costs to Address the Company's Year 2000 Issue. The total cost
of the company's remediation plan is estimated at approximately
$13.0 to $18.0 and is being funded through operating cash flows.
To manage the cash flow effects of these incremental costs, the
company has deferred certain IT development costs and system
enhancements. Of the total cost, approximately $2.0 is
attributable to new hardware and software that will be
capitalized. The remainder will be expensed as incurred. To
date, approximately $6.0 of the total cost of the remediation
plan has been spent, the majority of which was expensed.
Impact of the Euro Conversion
On January 1, 1999, 11 of the 15 member countries of the European
Union are scheduled to establish fixed conversion rates between
their existing sovereign currencies ("legacy currencies") and a
single currency called the euro. The legacy currencies are
scheduled to remain legal tender as denominations of the euro
during the transition period from January 1, 1999 to January 1,
2002. Beginning January 1, 2002, euro-denominated bills and
coins will be introduced and by July 1, 2002, legacy currencies
will no longer be legal tender.
The company has initiated an internal analysis regarding the
business and systems issues related to the euro conversion and is
in the process of developing a strategic plan to ensure that all
necessary modifications are made on a timely basis. As the first
step, to accommodate the introduction of the euro on January 1,
1999, the company's operations in markets that are adopting the
euro plan to be able to accept payments and pay suppliers in
euros at that time, as well as have the ability to indicate the
euro equivalent of pricing on invoices. During the transition
period, the company will be monitoring customer and competitor
reaction to the euro and will update the strategic plan as
needed.
The company believes that the conversion to the euro will not
have a significant impact on the marketing strategy for the
company's European operations. The euro is not expected to have
a significant competitive impact, including the resulting need to
synchronize prices between markets, primarily because, for the
most part, the editorial content of the company's publishing
products varies, the products are published in local languages
and they are sold principally through direct mail rather than
retail channels. These factors result in products that tend to
be unique to each market that do not easily lend themselves to
price comparisons across borders. The estimated costs to convert
all affected systems to the euro will not be finalized until the
company has completed a strategic plan; therefore it is uncertain
whether the costs of conversion will have a material adverse
effect on the company's results of operations, financial position
or cash flow.
*****
The statements contained in this report, if not historical, are
forward-looking statements, which involve risks and uncertainties
that could cause actual results to differ materially from the
financial results described in the forward-looking statements.
These risks and uncertainties include: the effect of potentially
more restrictive privacy and other governmental regulation
relating to the company's marketing methods; the effect of
modified and varied promotions; the ability to identify customer
trends; the ability to continue to create a broadly appealing mix
of new products; the ability to attract and retain new and
younger magazine subscribers and product customers in view of the
maturing of an important portion of the U.S. customer base; the
ability to attract and retain subscribers and customers in an
economically efficient manner; the effect of selective
adjustments in pricing; the ability to expand and more
effectively utilize the company's customer database; the ability
to expand into new international markets and to introduce new
product lines into new and existing markets; the ability to
expand into new channels of distribution; the ability to
negotiate and implement productive strategic alliances and joint
ventures; the ability to contain and reduce costs, especially
through global efficiencies; the cost and effectiveness of the re-
engineering of business processes and operations; the accuracy of
management's assessment of the current status of the company's
business; the evolution of the company's organizational and
structural capabilities; the ability of the company to respond to
competitive pressures within and outside the direct marketing
industry; the effect of worldwide paper and postage costs; the
effect of postal disruptions on deliveries; the effect of foreign
currency fluctuations; the effect of the year 2000 issue; the
effect of the transition to the euro; and general economic
conditions, particularly those in Russia.
Liquidity and Capital Resources
Cash and cash equivalents, short-term investments and marketable
securities decreased $26.8 to $99.3 at September 30, 1998
compared with June 30, 1998. The decrease was primarily a result
of operating cash flow requirements and dividend payments, which
were offset to a large extent by an advance on the sale of
certain assets.
In the first quarter of 1999, the company paid a $0.225 per share
dividend on its common stock, the same as a year ago. On October
9, 1998, the company announced a reduction in its quarterly
dividend for the second quarter of 1999 to $0.05 per share. At
the current rate, the annualized dividend is $0.375 per share in
1999 compared with $0.90 in 1998.
The company did not repurchase any shares of Class A nonvoting
common stock in the first quarter of 1999.
The company is a party to a Competitive Advance and Revolving
Credit Facility Agreement amended as of June 2, 1998, with a
syndicate of domestic and foreign banks (the credit agreement).
The credit agreement, which expires in November 2001, permits
competitive advance and revolving credit borrowings of up to
$300.0 by the company and its designated subsidiaries. Interest
rates can be based on several pricing options that can vary based
upon operating results of the company. The proceeds of the
borrowings may be used for general corporate purposes, including
acquisitions, share repurchases and commercial paper backup. The
credit agreement contains certain restrictions on incurrence of
debt, liens and guarantees of indebtedness. The company must
also comply with certain financial covenants, including a minimum
level of consolidated tangible net worth. At September 30, 1998,
there were no borrowings outstanding under the credit agreement.
In addition, various international subsidiaries of the company
have available lines of credit totaling $70.9. At September 30,
1998, loans in the amount of $10.2 were outstanding under
international lines of credit at a weighted average interest rate
of 7.8%.
The company believes that its liquidity, capital resources, cash
flow and borrowing capacity are sufficient to fund normal capital
expenditures, working capital requirements, the payment of
dividends and implementation of the company's strategic
initiatives.
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
18 Letter from KPMG Peat Marwick LLP dated as of November 13, 1998
re change in accounting principles for pension assets.
27 Financial Data Schedule
(b) Reports on Form 8-K
During the three-months ended September 30, 1998, the
company filed the following reports on Form 8-K:
Form 8-K dated July 27, 1998 which included a copy of a
press release relating to senior management changes.
Form 8-K dated August 19, 1998 which included a copy of a
press release relating to the election of a director to the
company's Board of Directors.
Form 8-K dated September 16, 1998 which included a copy of a
press release relating to the company's strategic
initiatives.
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 Reader's Digest Association, Inc.
(Registrant)
Date: November 13, 1998 By: GEORGE S. SCIMONE
George S. Scimone
Senior Vice President and
Chief Financial Officer
(and authorized signatory)
EXHIBIT INDEX
Exhibit Page
18 Letter from KPMG Peat Marwick LLP dated as of November 13,
1998 re change in accounting principles for pension assets.
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information extracted from the
Registrant's Consolidated Condensed Statement of Income and Consolidated
Condensed Balance Sheet for the three-month period ended September 30, 1998,
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-Mos
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> SEP-30-1998
<CASH> 96,300
<SECURITIES> 1,900
<RECEIVABLES> 665,200
<ALLOWANCES> 187,000
<INVENTORY> 164,100
<CURRENT-ASSETS> 1,054,900
<PP&E> 632,600
<DEPRECIATION> 346,300
<TOTAL-ASSETS> 1,655,500
<CURRENT-LIABILITIES> 1,046,700
<BONDS> 0
<COMMON> (9,300)
0
28,800
<OTHER-SE> 250,400
<TOTAL-LIABILITY-AND-EQUITY> 1,655,500
<SALES> 575,000
<TOTAL-REVENUES> 575,000
<CGS> 558,400
<TOTAL-COSTS> 558,400
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,200
<INCOME-PRETAX> 4,000
<INCOME-TAX> 1,500
<INCOME-CONTINUING> 2,500
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 25,300
<NET-INCOME> 27,800
<EPS-PRIMARY> 0.26
<EPS-DILUTED> 0.26
</TABLE>
Mr. George Scimone
Senior Vice President and
Chief Financial Officer
The Reader's Digest Association, Inc.
Pleasantville, New York 10570-7000
Dear Mr. Scimone,
We have been furnished with a copy of Form 10-Q of The Reader's
Digest Association, Inc. and Subsidiaries (the "Company") as of
and for the three month periods ended September 30, 1998 and
1997, and have read the Company's statements contained in Note 8
to the Consolidated Condensed Financial Statements included
therein. As stated in Note 8, the Company changed its method for
calculating the market-related value of pension plan assets used
in determining the return-on-asset component of annual pension
expense and the cumulative net unrecognized gain or loss subject
to amortization, and asserts that the new method is preferable in
the circumstances because it results in pension plan asset values
that more closely approximate fair value, while still mitigating
the effect of annual market value fluctuations. In accordance
with your request, we have reviewed and discussed with Company
officials the circumstances, business judgment and planning upon
which the decision to make this change in the method of
accounting was based.
We have not audited any financial statements of the Company as of
any date for any period subsequent to June 30, 1998 nor have we
audited the information set forth in the aforementioned Note 8 to
the Consolidated Condensed Financial Statements; accordingly, we
do not express an opinion concerning the factual information
contained therein.
With regard to the aforementioned accounting change,
authoritative criteria have not been established for evaluating
the preferability of one acceptable method of accounting over
another acceptable method. However, for the purposes of the
Company's compliance with the requirements of the Securities and
Exchange Commission, we are furnishing this letter.
Based on our review and discussion, with reliance on management's
business judgment and planning, we concur that the newly adopted
method of accounting is preferable in the Company's
circumstances.
Very truly yours,
/S/KPMG PEAT MARWICK LLP
KPMG Peat Marwick LLP
New York, New York
November 13, 1998
