-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UQoaYlTeBTK9X1sqlkTYe7WvSz8EFitlF8d9LYuLHpPxKp6pqi6FcVUnj7KcUHZp 9hbXVOebme52O7WxnUaiTg== 0000950123-04-009450.txt : 20040809 0000950123-04-009450.hdr.sgml : 20040809 20040809154203 ACCESSION NUMBER: 0000950123-04-009450 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MARTHA STEWART LIVING OMNIMEDIA INC CENTRAL INDEX KEY: 0001091801 STANDARD INDUSTRIAL CLASSIFICATION: PERIODICALS: PUBLISHING OR PUBLISHING AND PRINTING [2721] IRS NUMBER: 522187059 STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15395 FILM NUMBER: 04961251 BUSINESS ADDRESS: STREET 1: 20 WEST 43RD STREET CITY: NEW YORK STATE: NY ZIP: 10036 BUSINESS PHONE: 2128278000 MAIL ADDRESS: STREET 1: 20 WEST 43RD STREET CITY: NEW YORK STATE: NY ZIP: 10036 10-Q 1 y99950e10vq.txt MARTHA STEWART LIVING OMNIMEDIA, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 --------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 Commission file number 001-15395 Martha Stewart Living Omnimedia, Inc. (Exact Name of Registrant as Specified in Its Charter) Delaware 52-2187059 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 11 West 42nd Street, New York, NY 10036 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (212) 827-8000 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 check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class Outstanding as of August 5, 2004 Class A, $0.01 par value 20,366,853 Class B, $0.01 par value 29,422,860 ---------- Total 49,789,713 ==========
Martha Stewart Living Omnimedia, Inc. Index to Form 10-Q
Page ---- Part I. Financial information Item 1. Financial Statements 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 4. Controls and Procedures 24 Part II. Other Information Item 1. Legal Proceedings 24 Item 4. Submission of Matters to a Vote of Security Holders 26 Item 6. Exhibits and Reports on Form 8-K 27 Signatures 28
2 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MARTHA STEWART LIVING OMINIMEDIA, INC. Condensed Consolidated Balance Sheets (in thousands, except per share amounts)
June 30, December 31, 2004 2003 ---------- ------------ (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 119,462 $ 165,566 Short-term investments 38,891 3,100 Accounts receivable, net 17,736 39,758 Inventories, net 9,234 7,485 Deferred television production costs 1,448 3,465 Income taxes receivable 5,771 5,658 Deferred income taxes 1,833 5,024 Other current assets 6,046 4,422 ---------- ---------- TOTAL CURRENT ASSETS 200,421 234,478 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT, net 19,870 22,673 INTANGIBLE ASSETS, net 44,257 44,257 DEFERRED INCOME TAXES 3,224 3,224 OTHER NONCURRENT ASSETS 4,440 4,470 ---------- ---------- TOTAL ASSETS $ 272,212 $ 309,102 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and accrued liabilities $ 24,663 $ 26,628 Accrued payroll and related costs 12,245 10,360 Income taxes payable 692 167 Current portion of deferred subscription income 23,532 23,833 ---------- ---------- TOTAL CURRENT LIABILITIES 61,132 60,988 ---------- ---------- DEFERRED SUBSCRIPTION INCOME 7,028 7,133 OTHER NONCURRENT LIABILITIES 4,211 4,316 ---------- ---------- TOTAL LIABILITIES 72,371 72,437 ---------- ---------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Class A common stock, $.01 par value, 350,000 shares authorized; 20,328 and 19,628 shares outstanding in 2004 and 2003, respectively 203 196 Class B common stock, $.01 par value, 150,000 shares authorized; 29,423 and 30,059 outstanding in 2004 and 2003, respectively 294 301 Capital in excess of par value 186,207 183,744 Unamortized restricted stock (44) (307) Retained earnings 13,956 53,506 ---------- ---------- 200,616 237,440 Less: Class A treasury stock - 59 shares at cost (775) (775) ---------- ---------- TOTAL SHAREHOLDERS' EQUITY 199,841 236,665 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 272,212 $ 309,102 ========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 Martha Stewart Living Omnimedia, Inc. Condensed Consolidated Income Statements (unaudited, in thousands, except per share amounts)
Three Months Ended Six Months Ended June 30, June 30, ---------- ---------- ---------- ---------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- REVENUES Publishing $ 23,722 $ 39,617 $ 47,632 $ 73,678 Television 3,056 6,588 7,233 13,203 Merchandising 10,903 11,763 21,692 22,091 Internet/Direct Commerce 6,365 7,814 11,978 14,833 ---------- ---------- ---------- ---------- TOTAL REVENUES 44,046 65,782 88,535 123,805 ---------- ---------- ---------- ---------- OPERATING COSTS AND EXPENSES Production, distribution and editorial 30,411 35,448 59,352 71,049 Selling and promotion 14,393 13,699 28,612 26,495 General and administrative 15,877 12,934 31,393 27,836 Amortization of non-cash stock compensation 1,026 144 2,480 267 Depreciation and amortization 1,635 2,054 3,309 4,195 ---------- ---------- ---------- ---------- TOTAL OPERATING COSTS AND EXPENSES 63,342 64,279 125,146 129,842 ---------- ---------- ---------- ---------- OPERATING INCOME (LOSS) (19,296) 1,503 (36,611) (6,037) Interest income, net 319 395 681 797 ---------- ---------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAXES (18,977) 1,898 (35,930) (5,240) Income tax benefit (provision) (189) (665) (3,332) 2,184 ---------- ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE LOSS FROM DISCONTINUED OPERATIONS (19,166) 1,233 (39,262) (3,056) Loss from discontinued operations, net of tax benefit (127) (302) (288) (523) ---------- ---------- ---------- ---------- NET INCOME (LOSS) $ (19,293) $ 931 $ (39,550) $ (3,579) ========== ========== ========== ========== INCOME (LOSS) PER SHARE - BASIC AND DILUTED Income (loss) from continuing operations $ (0.39) $ 0.02 $ (0.79) $ (0.06) Loss from discontinued operations (0.00) (0.01) (0.01) (0.01) ---------- ---------- ---------- ---------- Net income (loss) $ (0.39) $ 0.02 $ (0.80) $ (0.07) ========== ========== ========== ========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING Basic 49,572 49,488 49,518 49,560 Diluted 49,572 49,627 49,518 49,560
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 Martha Stewart Living Omnimedia, Inc. Consolidated Statement of Shareholders' Equity For the Six Months Ended June 30, 2004 (unaudited, in thousands)
Class A Class B Class A common stock common stock Capital in Unamortized Treasury Stock -------------- -------------- excess of Restricted Retained -------------- Shares Amount Shares Amount par value Stock Earnings Shares Amount Total ------ ------ ------ ------ ---------- ----------- -------- ------ ------ -------- Balance at January 1, 2004 19,628 $ 196 30,059 $ 301 $ 183,744 $ (307) $ 53,506 (59) $ (775) $236,665 Net loss - - - - - - (39,550) - - (39,550) Conversion of shares 486 5 (486) (5) - - - - - - Issuance of shares for stock option exercises 214 2 - - 291 - - - - 293 Shares returned on net treasury basis - - (150) (2) 2 - - - - - Amortization of restricted stock - - - - 2,170 263 - - - 2,433 ------ ------ ------ ------ ---------- ------ -------- --- ------ -------- Balance at June 30, 2004 20,328 $ 203 29,423 $ 294 $ 186,207 $ (44) $ 13,956 (59) $ (775) $199,841 ====== ====== ====== ====== ========== ====== ======== === ====== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 Martha Stewart Living Omnimedia, Inc. Condensed Consolidated Statements of Cash Flows (unaudited, in thousands)
Six Months Ended June 30, 2004 2003 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (39,550) $ (3,579) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 3,309 4,195 Amortization of restricted stock 2,480 267 Deferred income tax expense 3,191 - Changes in operating assets and liabilities 20,470 (6,807) ---------- ---------- NET CASH USED IN OPERATING ACTIVITIES (10,100) (5,924) ---------- ---------- CASH FLOWS USED IN INVESTING ACTIVITIES Capital expenditures (506) (637) Purchases of short-term investments (35,791) - Sales of short-term investments - 300 ---------- ---------- NET CASH USED IN INVESTING ACTIVITIES (36,297) (337) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds received from stock option exercises 293 84 ---------- ---------- NET CASH PROVIDED BY FINANCING ACTIVITIES 293 84 ---------- ---------- NET DECREASE IN CASH (46,104) (6,177) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 165,566 131,664 ---------- ---------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 119,462 $ 125,487 ========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 6 Martha Stewart Living Omnimedia, Inc. Notes to Condensed Consolidated Financial Statements (unaudited, in thousands, except per share data) 1. Accounting policies a. General Martha Stewart Living Omnimedia, Inc., together with its subsidiaries, is herein referred to as the "Company." The information included in the foregoing interim condensed consolidated financial statements is unaudited. In the opinion of management, all adjustments which are of a normal recurring nature and necessary for a fair presentation of the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year. These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited financial statements included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission with respect to its fiscal year ended December 31, 2003. b. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Management does not expect such differences to have a material effect on the Company's consolidated financial statements. c. Income taxes The Company follows Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under the asset and liability method of SFAS 109, deferred assets and liabilities are recognized for the future costs and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company periodically reviews the requirements for a valuation allowance and makes adjustments to such allowances when changes in circumstances result in changes in management's judgment about the future realization of deferred tax assets. The Company has used carryback income to realize net deferred tax assets. Since the amounts and extent of the Company's future earnings are not determinable with a sufficient degree of probability to recognize the deferred tax assets in accordance with the requirements of SFAS 109, the Company has established a valuation allowance of $16,453 in the first six months of 2004. The Company intends to maintain a valuation allowance until evidence would support the conclusion that it is more likely than not that the deferred tax asset could be realized. The Company has reached final settlement with the Internal Revenue Service ("IRS") related to the 1999 audit of the Company's consolidated federal income tax return. Resolution of the examination did not have a material effect on our consolidated financial position, results of operations, or liquidity. d. Reclassifications Certain prior year financial information has been reclassified to conform with fiscal 2004 financial statement presentation. 7 e. Stock Compensation As permitted by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock Based Compensation," the Company has elected to continue accounting for employee stock compensation under the APB 25 rules, but disclose pro forma results using SFAS No. 123's alternative accounting treatment, which calculates the total compensation expense to be recognized as the fair value of the award at the date of grant. The fair values of options granted were estimated on the grant date using the Black-Scholes option pricing model, using the following assumptions for the three month periods ended June 30,:
2004 2003 ------- -------- risk-free interest rates 2.73% 2.64% dividend yields zero zero expected volatility 150% 139% expected option life 3 years 6 years average fair market value per option granted $ 7.26 $ 9.16
Under SFAS No. 123, compensation cost is recognized in the amount of the estimated fair value of the options over the relevant vesting periods. The pro forma effects on net loss for the three and six month periods ended June 30, 2004 and 2003 were as follows:
Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Net income (loss), as reported $(19,293) $ 931 $(39,550) $ (3,579) -------- -------- -------- -------- Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 457 3,955 477 7,906 -------- -------- -------- -------- Pro forma net loss $(19,750) $ (3,024) $(40,027) $(11,485) ======== ======== ======== ======== Income (loss) per share: Basic and diluted - as reported $ (0.39) $ 0.02 $ (0.80) $ (0.07) Basic and diluted - pro forma $ (0.40) $ ( 0.06) $ (0.81) $ (0.23)
8 2. Inventories The components of inventories are as follows:
June 30, December 31, 2004 2003 ---------- ------------ Paper $ 5,935 $ 4,610 Product merchandise 5,134 4,801 ---------- ------------ 11,069 9,411 Less: reserve for obsolete and excess inventory 1,835 1,926 ---------- ------------ $ 9,234 $ 7,485 ========== ============
3. Earnings (loss) per share Earnings (loss) per share is computed in accordance with SFAS No. 128, "Earnings Per Share". Basic earnings (loss) per share is calculated by dividing net earnings (loss) by the weighted-average number of common shares outstanding during each period. Diluted earnings (loss) per share includes the determinants of basic earnings (loss) per share and, in addition, gives effect to potentially dilutive common shares. For the three and six month periods ended June 30, 2004 and 2003, the following options were excluded from the calculation of earnings (loss) per share as their inclusion would be antidilutive:
Three Months Ended Six Months Ended June 30, June 30, --------------------- ------------------- 2004 2003 2004 2003 --------- --------- ------- --------- Options excluded 1,068,236 3,804,902 794,698 4,209,056 --------- --------- ------- ---------
4. Industry segments The Company is a leading creator of original "how to" content and related products for homemakers and other consumers. The Company's business segments are Publishing, Television, Merchandising and Internet/Direct Commerce. The Publishing segment primarily consists of the Company's magazine operations, and also those related to its book operations. The Television segment consists of the Company's television production operations that produce television programming that airs in syndication in the United States and on cable in the United States. The Merchandising segment consists of the Company's operations related to the design of merchandise and related promotional and packaging materials that are distributed by its retail and manufacturing partners in exchange for royalty income. The Internet/Direct Commerce segment comprises the Company's operations relating to its catalog, Martha Stewart: The Catalog For Living, its direct-to-consumer floral business and the website marthastewart.com. The Company believes operating income before depreciation and amortization, including the amortization of non-cash stock compensation, ("OIDA") is an appropriate measure when evaluating the operating performance of its business segments and the Company on a consolidated basis. OIDA is used externally by the Company's investors, analysts, and industry peers. OIDA is among the primary metrics used by management for planning and forecasting of future periods, and is considered an important indicator of the operational strength of the Company's businesses. The Company believes the presentation of this measure is relevant and useful for investors because it allows investors to view performance in a manner similar to the method used by the Company's management and makes it easier to compare the Company's results with other companies that have different capital structures or tax rates. The Company believes OIDA should be considered in addition to, not as a substitute for, operating income (loss), net income (loss), cash flows, and other measures of financial performance prepared in accordance with generally accepted accounting principles ("GAAP"). As OIDA is not a measure of performance calculated in accordance with GAAP, this measure may not be comparable to similarly titled measures employed by other companies. 9 Revenues for each segment are presented in the condensed consolidated statements of income. Income (loss) from operations for each segment were as follows:
Three Months Ended Six Months Ended June 30, June 30, (unaudited) (unaudited) -------- -------- -------- -------- 2004 2003 2004 2003 -------- -------- -------- -------- OPERATING INCOME (LOSS) Publishing $ (5,321) $ 9,335 $ (9,946) $ 14,306 Television (3,531) 2 (5,478) 229 Merchandising 5,314 7,808 11,803 14,842 Internet/Direct Commerce (2,426) (4,552) (5,105) (12,804) -------- -------- -------- -------- Operating Income (Loss) before Corporate Overhead (5,964) 12,593 (8,726) 16,573 Corporate Overhead (13,332) (11,090) (27,885) (22,610) -------- -------- -------- -------- TOTAL OPERATING INCOME (LOSS) (19,296) 1,503 (36,611) (6,037) -------- -------- -------- -------- DEPRECIATION AND AMORTIZATION Publishing 61 41 123 82 Television 59 385 116 779 Merchandising 190 168 380 337 Internet/Direct Commerce 249 244 492 491 Corporate Overhead 1,076 1,216 2,198 2,506 -------- -------- -------- -------- TOTAL DEPRECIATION AND AMORTIZATION 1,635 2,054 3,309 4,195 -------- -------- -------- -------- AMORTIZATION OF NON-CASH STOCK COMPENSATION EXPENSE (BENEFIT) Publishing 51 51 102 102 Television - - - - Merchandising 12 12 25 25 Internet/Direct Commerce - - - (22) Corporate Overhead 963 81 2,353 162 -------- -------- -------- -------- TOTAL AMORTIZATION OF NON-CASH STOCK COMPENSATION EXPENSE 1,026 144 2,480 267 -------- -------- -------- -------- OPERATING INCOME (LOSS) BEFORE DEPRECIATION AND AMORTIZATION AND AMORTIZATION OF NON-CASH STOCK COMPENSATION Publishing (5,209) 9,427 (9,721) 14,490 Television (3,472) 387 (5,362) 1,008 Merchandising 5,516 7,988 12,208 15,204 Internet/Direct Commerce (2,177) (4,308) (4,613) (12,335) -------- -------- -------- -------- Operating Income (Loss) before Depreciation and Amortization and Amortization of Non-Cash Stock Compensation and before Corporate Overhead (5,342) 13,494 (7,488) 18,367 Corporate Overhead (11,293) (9,793) (23,334) (19,942) -------- -------- -------- -------- TOTAL OPERATING INCOME (LOSS) BEFORE DEPRECIATION AND AMORTIZATION AND AMORTIZATION OF NON-CASH STOCK COMPENSATION $(16,635) $ 3,701 $(30,822) $ (1,575) ======== ======== ======== ========
10 5. Discontinued Operations In June 2002, the Company decided to exit The Wedding List, a wedding registry and gift business that was reported within the Internet/Direct Commerce business segment. Operating results for The Wedding List were as follows:
Three Months Ended Six Months Ended June 30, (unaudited) June 30, (unaudited) -------- -------- -------- -------- 2004 2003 2004 2003 -------- -------- -------- -------- Revenues $ - $ - $ - $ 580 -------- -------- -------- -------- Loss from operations, including restructuring and shutdown costs (127) (464) (288) (804) -------- -------- -------- -------- Income tax benefit - 162 - 281 -------- -------- -------- -------- Loss from discontinued operations, net of tax benefit in 2003 $ (127) $ (302) $ (288) $ (523) ======== ======== ======== ========
6. Supplemental cash flow information:
Three Months Ended Six Months Ended June 30, June 30, -------- -------- -------- -------- 2004 2003 2004 2003 -------- -------- -------- -------- Cash paid for interest - $ 40 - $ 15 Cash paid for income taxes $ 3 $ 3,597 $ 14 $ 1,529
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this report, the terms "we," "us," "our" and "MSO" refer to Martha Stewart Living Omnimedia, Inc., and its subsidiaries. EXECUTIVE SUMMARY TRENDS, RISKS AND UNCERTAINTIES Since June 2002, public disclosure of various governmental investigations into Martha Stewart's sale of non-Company stock and of the criminal and civil charges against Ms. Stewart arising out of the investigations has generated a great deal of negative publicity surrounding Ms. Stewart. Because our principal brand labels are closely associated with Ms. Stewart, we have seen , since June 2002, substantial negative impacts on our business as a result of the uncertainty surrounding the resolution of these legal proceedings and associated negative publicity. Although difficult to quantify with any precision, we believe that the uncertainty and publicity surrounding these matters contributed substantially to the adverse trends our business has experienced since June 2002. On June 4, 2003, a federal grand jury in the United States District Court for the Southern District of New York indicted Ms. Stewart, then the Company's Chairman and Chief Executive Officer, on charges of obstruction of an agency proceeding, making false statements to federal investigators, conspiracy, and securities fraud. That same day, the Securities and Exchange Commission ("SEC") filed a civil complaint against Ms. Stewart, in the United States District Court for the Southern District of New York, alleging violations of federal securities law. On July 10, 2003, the SEC action was stayed until further order of the court. Following the indictment, Ms. Stewart resigned her positions as Chairman and Chief Executive Officer, but retained her roles as a director and the Company's Chief Creative Officer. 11 On March 5, 2004, Martha Stewart was found guilty of conspiracy, obstruction of an agency proceeding, and making false statements to federal investigators concerning her personal sale of non-Company stock. On March 15, 2004, Ms. Stewart resigned her positions as a director and Chief Creative Officer of the Company, and assumed the position of Founding Editorial Director, a non-officer position. On July 16, 2004, Ms. Stewart was sentenced to five months in prison and two years of supervised release, which includes five months of home confinement to be served immediately upon release from prison. The sentence is stayed pending appeal. The Company continues to evaluate the responses of customers, advertisers, and business partners to the outcome of Ms. Stewart's legal matters, in order to assess the potential impact upon the Company's operating assets and make appropriate decisions with respect to the Company's business operations and strategy. In light of the results of this assessment, the Company has already implemented a number of business initiatives and may consider a broad range of additional business initiatives and strategic alternatives. These may include, without limitation, repositioning certain brands, changes in core content areas, new business initiatives, development of new expert personalities, changes in relationships with strategic partners, disposition of certain products, assets and businesses, and cost reduction initiatives as well as other business efficiencies. Although we are unable to predict the full effect of the outcome of Ms. Stewart's trial and related sentencing on our business, we continue to experience declines in advertising revenues since the trial outcome, principally in our publishing segment. We may experience further material adverse impacts as a result of the trial outcome, including, without limitation, additional revenue declines, additional litigation, additional expenses relating to corporate communications and corporate professional fees and loss of key personnel. For the six month period ended June 30, 2004, we suffered a net loss of $39.6 million compared to a net loss of $3.6 million in the period of the prior year. We may sustain substantial operating losses in future periods and our cash position may be materially adversely affected. Since March 5, 2004, the availability of the Martha Stewart Living television program has declined to approximately 50% of U.S. television households from previous levels of approximately 90% primarily due to the loss of coverage from the CBS owned and operated stations. This reduction in household coverage has resulted in lower license fees and advertising revenues. In light of this and other developments, we will not produce Season 12, the 2004-2005 broadcast season. However, we intend to provide content for the remainder of the current season which concludes in mid September. Additionally, certain contracts relating to our cable television shows expired on December 31, 2003 and were not renewed and we were informed in May 2004 that the Food Network intends to terminate our agreement beginning in October 2004. We have recently signed an agreement with The Style Network to air Martha Stewart Living nationally on cable television. However, we believe that the combined impact of lower license fees, reduction in household coverage of our flagship syndicated television program, and contract expirations will result in continued losses in the Television segment in 2004. On April 22, 2004, we reached an agreement with Kmart to amend the terms of our contract and executed certain releases with respect to a legal action Kmart filed against the Company on February 11, 2004. We believe that this agreement better aligns the two companies' mutual business interests. In connection with the amendment and releases, on April 23, 2004, Kmart voluntarily dismissed its complaint with prejudice, terminating the litigation. The amendment, among other things, extends the Kmart contract for an additional two years and expands the scope of the contract to cover several new product categories. At the same time, the amendment eliminates, with respect to 2003 and subsequent years, provisions of the contract providing for payment of guaranteed minimum royalties by individual product category and reduces the amount Kmart is obligated under the contract to spend with MSO on advertising in MSO media properties. The amendment also reduces the aggregate minimum royalty payments. The aggregate minimum royalty payment for the period February 1, 2004 to January 31, 2005 was reduced to $49.0 million from $53.4 million previously. In accordance with the amended Kmart contract, $3.8 million of the January 31, 2005 minimum royalty payment, but not more than $10.0 in the aggregate over the term of the agreement, will be deferred and subject to recoupment in the periods ending January 31, 2009 and January 31, 2010. We continue to expect that the minimum guaranteed royalty payments will exceed actual royalties earned from retail sales through January 31, 2008. For the contract years ending January 31, 2009 and 2010 (the extension years), the minimum guarantees will be substantially lower than in prior years. 12 In August 2004, we decided to discontinue the Catalog for Living and its online product offerings, which is included in the Internet/ Direct Commerce segment, by year-end 2004. This will result in lower revenues in this segment beginning in 2005 and we expect that it will lead to a reduced operating loss in the segment. As a result, we may take charges related to inventory disposition and/or severance payments in the third and fourth quarters. We do not expect the total amount of the charges to exceed $1 million in the second half of the year. RESULTS OF OPERATIONS COMPARISON OF THREE MONTHS ENDED JUNE 30, 2004 TO THREE MONTHS ENDED JUNE 30, 2003 PUBLISHING SEGMENT
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ ------------ PUBLISHING REVENUE Advertising $ 8,419 $ 23,892 $ (15,473) Circulation 14,922 14,853 69 Other 381 872 (491) ------------ ------------ ------------ TOTAL PUBLISHING SEGMENT REVENUE 23,722 39,617 (15,895) ------------ ------------ ------------ PUBLISHING OPERATING COSTS AND EXPENSES Production, distribution and editorial 15,402 17,857 2,455 Selling and promotion 13,043 11,473 (1,570) General and administrative 487 861 374 Amortization of non-cash compensation expense 50 50 - Depreciation and amortization 61 41 (20) ------------ ------------ ------------ TOTAL PUBLISHING OPERATING COSTS AND EXPENSES 29,043 30,282 1,239 ------------ ------------ ------------ OPERATING INCOME (LOSS) $ (5,321) $ 9,335 $ (14,656) ============ ============ ============
Publishing revenues decreased $15.9 million, or 40.1%, to $23.7 million for the three months ended June 30, 2004, from $39.6 million for the three months ended June 30, 2003. This decrease was primarily due to a decrease in advertising revenues of $15.5 million. The decrease in advertising revenue resulted primarily from fewer advertising pages in Martha Stewart Living, as well as a reduction in the advertising page rate, due in part to the rate base (the number of copies per issue we guarantee to advertisers) reduction which became effective commensurate with the January 2004 issue. The decrease in advertising revenue in Martha Stewart Living magazine was $10.4 million. The decrease in advertising revenue was also attributable to lower advertising revenue in Everyday Food magazine of $2.7 million, as the prior year's period included advertising revenues from a sponsorship arrangement, as well as lower revenue from our Special Interest Publications (SIP). Circulation revenue was unchanged in the quarter, as lower revenue from Martha Stewart Living was offset by higher circulation revenues from Everyday Food and Martha Stewart Weddings due primarily to publishing more issues in the current period compared to the same period one year ago. Magazine Publication Schedule
Second Quarter 2004 Second Quarter 2003 ------------------- ------------------- Martha Stewart Living Three Issues Three Issues Martha Stewart Weddings Three Issues Two Issues Everyday Food Three Issues Two Issues Special Interest Publications One Issue Two Issues
13 Production, distribution and editorial expenses decreased $2.5 million primarily reflecting lower paper, printing and distribution costs of Martha Stewart Living magazine, due primarily to a lower number of pages printed per issue and lower circulation, partially offset by the additional costs associated with the publication of an additional issue of Everyday Food as well as an additional issue of Martha Stewart Weddings in the quarter. Selling and promotion expenses increased $1.6 million primarily due to higher circulation acquisition costs relating to Everyday Food and one of our Special Interest Publications, partially offset by lower spending related to Martha Stewart Living magazine. TELEVISION SEGMENT
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ ------------ TELEVISION REVENUE Syndication $ 2,244 $ 4,558 $ (2,314) Licensing and other 812 2,030 (1,218) ------------ ------------ ------------ TOTAL TELEVISION SEGMENT REVENUE 3,056 6,588 (3,532) ------------ ------------ ------------ TELEVISION OPERATING COSTS AND EXPENSES Production, distribution and editorial 5,275 4,564 (711) Selling and promotion 329 773 444 General and administrative 924 864 (60) Depreciation and amortization 59 385 326 ------------ ------------ ------------ TOTAL TELEVISION OPERATING COSTS AND EXPENSES 6,587 6,586 (1) ------------ ------------ ------------ OPERATING INCOME (LOSS) (3,531) 2 (3,533) ------------ ------------ ------------
Television revenues decreased $3.5 million primarily due to lower revenue from our syndicated daily program. The decrease in revenue from our syndicated daily program was due primarily to lower license fees and lower advertising revenue. The segment was also impacted by the expiration of certain cable and international licensing contracts effective December 31, 2003. Revenue in the quarter benefited from the launch of our programming on The Style Network, as well as revenue from our Petkeeping program. Both products did not exist in the prior year period. Production, distribution and editorial expenses increased $0.7 million in the period due to a $1.5 million write-down of deferred production costs resulting from the early termination of a cable television licensing agreement, as well as the cost of employee severance payments of $0.5 million, partially offset by lower distribution and in-period production costs due to the winding down of production for the syndicated program, Martha Stewart Living. Selling and promotion expenses decreased $0.4 million due to lower marketing efforts for the nationally syndicated daily show. Depreciation and amortization decreased $0.3 million primarily due to a reduction in the net carrying value of certain assets in our Connecticut television studio in the fourth quarter of 2003. 14 MERCHANDISING SEGMENT
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ ------------ MERCHANDISING REVENUE Kmart earned royalty $ 9,378 $ 9,965 (587) Other 1,525 1,798 (273) ------------ ------------ ------------ TOTAL MERCHANDISING SEGMENT REVENUE 10,903 11,763 (860) ------------ ------------ ------------ MERCHANDISING OPERATING COSTS AND EXPENSES Production, distribution and editorial 2,547 2,639 92 Selling and promotion 463 150 (313) General and administrative 2,376 985 (1,391) Amortization of non-cash compensation expense 13 13 - Depreciation and amortization 190 168 (22) ------------ ------------ ------------ TOTAL MERCHANDISING OPERATING COSTS AND EXPENSES 5,589 3,955 (1,634) ------------ ------------ ------------ OPERATING INCOME 5,314 7,808 (2,494) ------------ ------------ ------------
Merchandising revenues decreased $0.9 million, or 7.3%, to $10.9 million for the quarter ended June 30, 2004, from $11.8 million for the quarter ended June 30, 2003, primarily due to lower sales of our Martha Stewart Everyday product at Kmart due to lower same-store-sales, as well as Kmart store closings that took place in the early part of 2003. The revenue decline was partially offset by an increase in the royalty rate on a year-over-year basis. The royalty rate under our agreement with Kmart increased 5% on February 1, 2004. Royalty revenue from Kmart was recorded based on actual sales in the current and prior year periods. We expect the minimum guarantees will exceed actual royalties earned from retail sales for the foreseeable future primarily due to store closings. Other revenue declined modestly due to a decline in creative service revenue and royalty revenue from our Japanese retail partner, partially offset by revenue from the launch of our program at Sears Canada and higher royalty revenue from the sale of Martha Stewart Signature products. Our program at Sears Canada launched in the second half of 2003. The following table sets forth the minimum guarantees as contained in our contract with Kmart Corporation.
1/31/02 1/31/03 1/31/04 1/31/05 1/31/06 1/31/07 1/31/08 1/31/09 1/31/10 ------- ------- ------- ------- ------- ------- ------- --------- --------- Minimum Royalty Amounts $15.3 $40.4 $47.5 $49.0 $54.0 $59.0 $65.0 See below See below
For the year ending January 31, 2009 the minimum royalty amount is the greater of $20 million or 50% of the earned royalty for the year ending January 31, 2008. For the year ending January 31, 2010 the minimum royalty amount is the greater of $15 million or 50% of the earned royalty for the year ending January 31, 2009. Furthermore, $3.8 million of the January 31, 2005 and January 31, 2006 minimum royalty payments and $2.5 million of the January 31, 2007 and January 31, 2008 minimum royalty payments, but not more than $10.0 in the aggregate over the term of the agreement, will be deferred and subject to recoupment in the periods ending January 31, 2009 and January 31, 2010. We continue to expect that the minimum guaranteed royalty payments will exceed actual royalties earned from retail sales through January 31, 2008. Selling and promotion expenses increased $0.3 million in the period due to higher marketing related to our Martha Stewart Signature program. General and administrative expense increased $1.4 million primarily due to professional fees incurred in the quarter associated with amending the Kmart contract. 15 INTERNET/DIRECT COMMERCE SEGMENT
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ ------------ INTERNET/DIRECT COMMERCE REVENUE Product $ 6,254 $ 7,363 (1,109) Other 111 451 (340) ------------ ------------ ------------ TOTAL INTERNET/DIRECT COMMERCE SEGMENT REVENUE 6,365 7,814 (1,449) ------------ ------------ ------------ INTERNET/DIRECT COMMERCE OPERATING COSTS AND EXPENSES Production, distribution and editorial 7,095 10,289 3,194 Selling and promotion 532 655 123 General and administrative 915 1,178 263 Amortization of non-cash compensation expense - - - Depreciation and amortization 249 244 (5) ------------ ------------ ------------ TOTAL INTERNET/DIRECT COMMERCE OPERATING COSTS AND EXPENSES 8,791 12,366 3,575 ------------ ------------ ------------ OPERATING INCOME (LOSS) (2,426) (4,552) 2,126 ------------ ------------ ------------
Internet/Direct Commerce revenues decreased $1.4 million, or 18.5%, to $6.4 million for the three months ended June 30, 2004, from $7.8 million for the three months ended June 30, 2003, due to lower commerce sales related to our catalog offerings, partially offset by higher revenue from our direct-to-consumer floral business. The lower commerce sales are primarily due to planned lower catalog circulation. The decline in commerce revenue was largely attributable to our lower catalog circulation. The decline in other revenue was principally due to lower advertising revenue. Production, distribution and editorial costs decreased $3.2 million reflecting lower catalog production and distribution costs of $1.5 million due to reduced catalog circulation and lower product and fulfillment costs of $1.4 million primarily due to the lower revenue. General and administrative expenses decreased $0.3 million due primarily to lower employee related expenses. CORPORATE
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ -------- CORPORATE OPERATING COSTS AND EXPENSES Production, distribution and editorial 92 99 7 Selling and promotion 26 648 622 General and administrative 11,175 9,046 (2,129) Amortization of non-cash compensation expense 963 81 (882) Depreciation and amortization 1,076 1,216 140 ------------ ------------ -------- TOTAL CORPORATE OPERATING COSTS AND EXPENSES 13,332 11,090 (2,242) ------------ ------------ -------- OPERATING LOSS (13,332) (11,090) (2,242) ------------ ------------ --------
Selling and promotion expenses decreased $0.6 million, as the prior year quarter included media spending associated with a corporate advertising program. General and administrative expenses increased $2.1 16 million principally resulting from higher employee-related costs, including costs relating to the November 2003 stock option exchange offers of $0.4 million, additional retention programs of $0.8 million as well as higher professional fees. OTHER ITEMS Income tax expense. Income tax expense for the quarter ended June 30, 2004 was $0.2 million, compared to an income tax expense of $0.7 million for the quarter ended June 30, 2003. The current period provision includes a valuation allowance of $9.3 million taken against certain deferred tax assets since the amounts and extent of the Company's future earnings are not determinable with a sufficient degree of probability. Loss from discontinued operations. Loss from discontinued operations was $0.1 million for the quarter ended June 30, 2004 compared to $0.3 million for the quarter ended June 30, 2003. Discontinued operations represent the operations of the Wedding List, which the Company decided to discontinue in 2002. The current year expenses are primarily facility related. Net Income (Loss). Net loss was $(19.3) million for the quarter ended June 30, 2004, compared to net income of $0.9 million for the quarter ended June 30, 2003, as a result of the above mentioned factors. COMPARISON OF SIX MONTHS ENDED JUNE 30, 2004 TO SIX MONTHS ENDED JUNE 30, 2003 PUBLISHING SEGMENT
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ ------------ PUBLISHING REVENUE Advertising $ 16,554 $ 43,477 $ (26,923) Circulation 30,355 28,718 1,637 Other 723 1,483 (760) ------------ ------------ ------------ TOTAL PUBLISHING SEGMENT REVENUE 47,632 73,678 (26,046) ------------ ------------ ------------ PUBLISHING OPERATING COSTS AND EXPENSES Production, distribution and editorial 30,418 34,666 4,248 Selling and promotion 26,108 23,054 (3,054) General and administrative 829 1,470 641 Amortization of non-cash compensation expense 100 100 - Depreciation and amortization 123 82 (41) ------------ ------------ ------------ TOTAL PUBLISHING OPERATING COSTS AND EXPENSES 57,578 59,372 1,794 ------------ ------------ ------------ OPERATING INCOME (LOSS) $ (9,946) $ 14,306 $ (24,252) ------------ ------------ ------------
Publishing revenues decreased $26.0 million, or 35.4%, to $47.6 million for the six months ended June 30, 2004, from $73.7 million for the six months ended June 30, 2003. This decrease was primarily due to a decrease in advertising revenues of $26.9 million. The decrease in advertising revenue resulted primarily from fewer advertising pages in Martha Stewart Living, as well as a reduction in the advertising page rate, due in part to the rate base (the number of copies per issue we guarantee to advertisers) reduction which became effective commensurate with the January 2004 issue. The decrease in advertising revenue in Martha Stewart Living magazine was $18.9 million for the six months ended June 30, 2004. The reduction in advertising revenue was also attributable to lower advertising revenue in Everyday Food magazine of $5.3 million, as the prior year's period included advertising revenues from a sponsorship arrangement. Circulation revenue increased $1.6 million in the period primarily due to the increase in circulation and frequency of Everyday Food, as well as an additional issue of Martha Stewart Weddings published in the period, partially offset by lower circulation revenue from Martha Stewart Living magazine, due primarily to lower subscription copies sold in the period. 17 Magazine Publication Schedule
First Half 2004 First Half 2003 --------------- --------------- Martha Stewart Living Six Issues Six Issues Martha Stewart Weddings Three Issues Two Issues Everyday Food Six Issues Four Issues Special Interest Publications Four Issues Four Issues
Production, distribution, and editorial costs decreased $4.2 million primarily reflecting lower paper, printing and distribution costs of Martha Stewart Living magazine, due mainly to a lower number of pages printed per issue and lower copies printed, partially offset by the additional costs associated with the publication of two additional issues of Everyday Food. Selling and promotion expenses increased increased $3.1 million resulting primarily from higher circulation acquisition costs relating to Everyday Food and one of our Special Interest Publication's, partially offset by lower spending related to Martha Stewart Living magazine. TELEVISION SEGMENT
2004 2003 (unaudited) (unaudited) Variance ------------ ------------ --------- TELEVISION REVENUE Syndication $ 5,733 $ 9,232 $ (3,499) Licensing and other 1,500 3,971 (2,471) ------------ ------------ --------- TOTAL TELEVISION SEGMENT REVENUE 7,233 13,203 (5,970) ------------ ------------ --------- TELEVISION OPERATING COSTS AND EXPENSES Production, distribution and editorial 9,878 9,080 (798) Selling and promotion 898 1,409 511 General and administrative 1,819 1,706 (113) Amortization of non-cash compensation expense - - - Depreciation and amortization 116 779 663 ------------ ------------ --------- TOTAL TELEVISION OPERATING COSTS AND EXPENSES 12,711 12,974 263 ------------ ------------ --------- OPERATING INCOME (LOSS) (5,478) 229 (5,707) ------------ ------------ ---------
Television revenues decreased $6.0 million, or 45.2%, to $7.2 million for the six months ended June 30, 2004, from $13.2 million for the six months ended June 30, 2003. The decrease is primarily attributable to lower revenue from our syndicated daily program of $4.1 million due primarily to lower license fees and lower advertising revenue. The decrease was partially offset by revenue from the launch of our programming on The Style Network and Petkeeping. The segment was also impacted by the expiration of certain cable and international licensing contracts effective December 31, 2003, included in licensing above. Production, distribution and editorial expenses increased $0.8 million in the period due to higher non-cash production amortization recognized in the period, principally due to a $1.5 million write-down of deferred production costs resulting from the early termination of a cable television licensing agreement and the cost of employee severance payments of $0.5 million, partially offset by lower distribution and in-period production costs due to the winding down of production for the syndicated national show, Martha Stewart Living. Selling and promotion expenses decreased $0.5 million due to lower marketing efforts for the nationally syndicated daily show. Depreciation and amortization decreased $0.7 million primarily due to a reduction in the net carrying value of certain assets in our Connecticut television studio in the fourth quarter of 2003. The decrease in depreciation will continue through the remainder of the year. 18 MERCHANDISING SEGMENT
2004 2003 (unaudited) (unaudited) Variance ----------- ----------- -------- MERCHANDISING REVENUE Kmart earned royalty $ 15,864 $ 18,542 (2,678) Kmart minimum true-up 2,412 - 2,412 Other 3,416 3,549 (133) ----------- ----------- -------- TOTAL MERCHANDISING SEGMENT REVENUE 21,692 22,091 (399) ----------- ----------- -------- MERCHANDISING OPERATING COSTS AND EXPENSES Production, distribution and editorial 5,164 4,709 (455) Selling and promotion 570 186 (384) General and administrative 3,750 1,992 (1,758) Amortization of non-cash compensation expense 25 25 - Depreciation and amortization 380 337 (43) ----------- ----------- -------- TOTAL MERCHANDISING OPERATING COSTS AND EXPENSES 9,889 7,249 (2,640) ----------- ----------- -------- OPERATING INCOME 11,803 14,842 (3,039) ----------- ----------- --------
Merchandising revenues decreased $0.4 million, or 1.8%, to $21.7 million for the six months ended June 30, 2004, from $22.1 million for the six months ended June 30, 2003, primarily due to lower product sales at Kmart as a result of lower same - store-sales as well as Kmart store closings that took place in the early part of 2003. The revenue decline was partially offset by recognizing as revenue the pro-rata portion of the contractual minimum royalty amount due from Kmart for the 12 month period ended January 31, 2004, relating to January 2004 as well as an increase in the royalty rate on a year-over-year basis. The royalty rate under our agreement with Kmart increased 5% on February 1, 2004. We expect the minimum guarantees will exceed actual royalties earned from retail sales for the foreseeable future primarily due to store closings. Other revenue declined modestly due to a decline in creative service revenue, partially offset by revenue from the launch of our program at Sears Canada and higher royalty revenue from our Martha Stewart Signature products. Our program at Sears Canada launched in the second half of 2003. Production, distribution and editorial expense increased $0.5 million due to higher compensation related expenses. Selling and promotion expenses increased $0.4 million in the period due to higher marketing related to our Martha Stewart Signature program. General and administrative expense increased $1.8 million primarily due to professional fees incurred in the quarter associated with amending the Kmart contract. 19 INTERNET/DIRECT COMMERCE SEGMENT
2004 2003 (unaudited) (unaudited) Variance ----------- ----------- -------- INTERNET/DIRECT COMMERCE REVENUE Product sale $ 11,726 $ 14,080 (2,354) Other 252 753 (501) ----------- ----------- -------- TOTAL INTERNET/DIRECT COMMERCE SEGMENT REVENUE 11,978 14,833 (2,855) ----------- ----------- -------- INTERNET/DIRECT COMMERCE OPERATING COSTS AND EXPENSES Production, distribution and editorial 13,707 22,395 8,688 Selling and promotion 991 1,168 177 General and administrative 1,893 3,605 1,712 Amortization of non-cash compensation expense - (22) (22) Depreciation and amortization 492 491 (1) ----------- ----------- -------- TOTAL INTERNET/DIRECT COMMERCE OPERATING COSTS AND EXPENSES 17,083 27,637 10,554 ----------- ----------- -------- OPERATING INCOME (LOSS) (5,105) (12,804) 7,699 ----------- ----------- --------
Internet/Direct Commerce revenues decreased $2.9 million, or 19.2%, to $12.0 million for the six months ended June 30, 2004, from $14.8 million for the six months ended June 30, 2003. The decrease was primarily due to lower commerce sales related to our catalog offerings, partially offset by increased revenue from our direct-to-consumer floral business. The decline in commerce sale was largely attributable to our planned lower catalog circulation. The decline in other revenue was principally due to lower advertising revenue. Production, distribution and editorial costs decreased $8.7 million, due to lower catalog production and distribution costs of $3.9 million due to reduced catalog circulation. Lower costs were also due in part to lower product sales, an improved product gross margin and improved fulfillment efficiencies, which collectively contributed to $3.5 million of lower costs in the period. The segment continued to benefit from the restructuring initiated in the first half of 2003, which reduced headcount and lowered technology costs. General and administrative expenses decreased $1.7 million due primarily to lower employee related expenses and lower professional fees. CORPORATE
2004 2003 (unaudited) (unaudited) Variance ----------- ----------- -------- CORPORATE OPERATING COSTS AND EXPENSES Production, distribution and editorial 185 199 14 Selling and promotion 51 678 627 General and administrative 23,096 19,063 (4,033) Amortization of non-cash compensation expense 2,355 164 (2,191) Depreciation and amortization 2,198 2,506 308 ----------- ----------- -------- TOTAL CORPORATE OPERATING COSTS AND EXPENSES 27,885 22,610 (5,275) ----------- ----------- -------- OPERATING LOSS (27,885) (22,610) (5,275) ----------- ----------- --------
20 Selling and promotion expenses decreased $0.6 million, as the prior year quarter included media spending associated with a corporate advertising program. General and administrative expenses increased $4.0 million principally resulting from higher employee-related costs, including costs relating to the November 2003 stock option exchange offers of $0.8 million and additional retention programs of $1.7 million as well as higher corporate communications and consulting fees. OTHER ITEMS Income tax benefit (expense). Income tax expense for the six months ended June 30, 2004 was $3.3 million, compared to an income tax benefit of $2.2 million for the six months ended June 30, 2003. The current period provision includes a valuation allowance of $16.5 million taken against certain deferred tax assets since the amounts and extent of the Company's future earnings are not determinable with a sufficient degree of probability. Loss from discontinued operations. Loss from discontinued operations was $0.3 million for the six months ended June 30, 2004 compared to $0.5 million for the six months ended June 30, 2003. Discontinued operations represent the operations of the Wedding List, which the Company decided to discontinue in 2002. The current year expenses are primarily facility related. Net Loss. Net loss was $(39.5) million for the six months ended June 30, 2004, compared to a net loss $(3.6) million for the six months ended June 30, 2003, as a result of the above mentioned factors. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $119.5 million and $165.6 million and short-term investments were $38.9 million and $3.1 million at June 30, 2004 and December 31, 2003, respectively. Cash flows used in operating activities were $10.1 million during the six months ended June 30, 2004, compared to cash used in operating activities of $5.9 million during the six months ended June 30, 2003. Cash flows used in operating activities during the six months ended June 30, 2004 were primarily due to a net loss for the period of $39.6 million, partially offset by changes in operating assets and liabilities of $20.5 million, depreciation and amortization of $3.3 million, an increase in the deferred income tax expense of $3.2 million, as well as the amortization of equity based compensation expense of $2.5 million. The changes in operating assets and liabilities include a decrease in accounts receivable due principally to the collection of a royalty receivable due from Kmart related to our minimum royalty payment, partially offset by a decrease in certain accounts payable. Cash flows used in operating activities during the six months ended June 30, 2003 were primarily due to a net loss for the period of $3.6 million and changes in operating assets and liabilities of $6.8 million, partially offset by depreciation and amortization of $4.2 million. Cash used by changes in operating assets and liabilities during the period is primarily a result of decreases in accounts payable and accrued liabilities and accrued payroll and related costs, partially offset by decreased accounts receivable. Cash flows used in investing activities were $36.3 million and $0.3 million during the six months ended June 30, 2004 and 2003, respectively. Cash flows used in investing activities in 2004 resulted from the purchase of short-term investments of $35.8 million and capital expenditures $0.5 million. Cash flows used in investing activities in 2003 resulted from capital expenditures of $0.6 million partially offset by the sale of short-term investments of $0.3 million. We expect capital expenditures in 2004 to be less than $1.5 million. Cash flows provided by financing activities for the six month periods ended June 30, 2004 and 2003 were $0.3 and $0.1 million, respectively, representing proceeds received from the exercise of employee stock options. We have a line of credit with Bank of America in the amount of $5 million, which is generally used to secure outstanding letters of credit. As of June 30, 2004, we had no outstanding borrowings under this facility. 21 We believe that our available cash balances and short-term investments together with any funds available under existing credit facilities will be sufficient to meet our operating and recurring cash needs for foreseeable periods. We have not paid dividends on our common stock and have no intention to pay any dividends in the foreseeable future. SEASONALITY AND QUARTERLY FLUCTUATIONS Several of our businesses can experience fluctuations in quarterly performance. For example, in our Publishing segment, the publication schedule of Special Interest Publications can vary from quarter to quarter. Internet/Direct Commerce revenues have tended to be higher in the fourth quarter due to increased catalog circulation and consumer spending during that period. Revenues from the Merchandising segment can vary significantly from quarter to quarter due to new product launches and the seasonality of certain product lines. In addition, we expect to recognize the pro-rata portion of the difference between the minimum royalty amount under the Kmart contract and royalties paid on actual sales in the fourth quarter of 2004 and first quarter of 2005, net of amounts required to be deferred, when the amount can be determined. CRITICAL ACCOUNTING POLICIES AND ESTIMATES General Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, long-lived assets and accrued losses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that, of our significant accounting policies, the following may involve the highest degree of judgment and complexity. Revenue Recognition Revenues are recognized when realized or realizable and earned. Revenues and associated accounts receivable are recorded net of provisions for estimated future returns, doubtful accounts and other allowances. Newsstand revenues in our Publishing segment and product sales in our Internet/Direct Commerce segment are recognized based upon assumptions with respect to future returns. The Company bases its estimates on historical experience and current market conditions. Reserves are adjusted regularly based upon actual results. We maintain allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Receivables for royalties in our merchandising business are accrued on a monthly basis and payment is generally made by our strategic partners on a quarterly basis. For the six month period ended June 30, 2004, the Company has recognized royalty revenues earned under our agreement with Kmart based upon actual royalties earned, not contractual minimum amounts. Contractual minimum amounts under the agreement with Kmart are computed on January 31st annually and are payable shortly thereafter. We expect to recognize the difference between the minimum royalty amount and royalties paid on actual sales in the fourth quarter of 2004 and first quarter of 2005, net of amounts required to be deferred, when the amount can be determined. 22 Inventory Inventory, consisting of paper and product merchandise, is stated at the lower of cost or market. The Company has recorded a reserve for excess and obsolete product inventory, reducing inventory from cost to estimated market value, based upon historical experience and current market conditions. The reserve is evaluated regularly based upon actual results and adjusted accordingly. Television Production Costs Television production costs are capitalized and amortized based upon estimates of future revenues to be received for the applicable television product. The Company bases its estimates on existing contracts for programs, historical advertising rates and ratings as well as market conditions. Estimated future revenues are adjusted regularly based upon actual results and changes in market and other conditions. Long-Lived Assets We review the carrying values of our long-lived assets whenever events or changes in circumstances indicate that such carrying values may not be recoverable. Unforeseen events and changes in circumstances and market conditions and material differences in the value of long-lived assets due to changes in estimates of future cash flows could negatively affect the fair value of our assets and result in an impairment charge. Intangible assets Commencing January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets, effective July 1, 2002. SFAS No. 142 requires that goodwill and intangible assets with indefinite lives no longer be amortized to earnings and be tested for impairment at least annually. The impairment tests are based upon a fair-value approach as described in SFAS No. 142. Tests for impairment or recoverability require significant management judgment, and future events affecting cash flows and market conditions could result in impairment losses. Forward-looking Statements We have included in this Quarterly Report certain "forward-looking statements," as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts but instead represent only our current beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside of our control. These statements can be identified by terminology such as "may," "will," "should," "could", "expects," "intends," "plans," "anticipates," "believes," "estimates," "potential" or "continue" or the negative of these terms or other comparable terminology. The Company's actual results may differ materially from those projected in these statements, and factors that could cause such differences include further adverse reaction to the prolonged and continued negative publicity relating to Martha Stewart by consumers, advertisers and business partners; further adverse reaction by the Company's consumers, advertisers and business partners to the outcome of Ms. Stewart's legal proceeding arising from a sale of non-Company stock by Ms. Stewart; a loss of the services of Ms. Stewart; a loss of the services of other key personnel; an adverse resolution to the SEC enforcement proceeding currently underway against Ms. Stewart arising from her personal sale of non-Company stock; adverse resolution of some or all of the Company's ongoing litigation; downturns in national and/or local economies; shifts in our business strategies; a softening of the domestic advertising market; changes in consumer reading, purchasing and/or television viewing patterns; unanticipated increases in paper, postage or printing costs; operational or financial problems any of our contractual business partners; the receptivity of consumers to our new product introductions; and changes in government regulations affecting the Company's industries. Certain of these and other factors are discussed in more detail in other parts of this report, especially in this section, "Management's Discussion and Analysis of Financial Condition and Results of Operations." 23 ITEM 4. CONTROLS AND PROCEDURES An evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14 (c) under the Securities Exchange Act of 1934) as of June 30, 2004. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. No significant changes were made in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On February 3, 2003, the Company was named as a defendant in a Consolidated and Amended Class Action Complaint (the "Consolidated Class Action Complaint"), filed in the United States District Court for the Southern District of New York, by plaintiffs purporting to represent a class of persons who purchased common stock in the Company between January 8, 2002 and October 2, 2002. In re Martha Stewart Living Omnimedia, Inc. Securities Litigation, 02-CV-6273 (JES). The Consolidated Class Action Complaint also names Martha Stewart and seven of the Company's other present or former officers (Gregory R. Blatt, Sharon L. Patrick, and five other Company officers (collectively, the "Individual Defendants")) as defendants. The action consolidates seven class actions previously filed in the Southern District of New York: Semon v. Martha Stewart Living Omnimedia, Inc. (filed August 6, 2002), Rosen v. Martha Stewart Living Omnimedia, Inc. (filed August 21, 2002), MacKinnon v. Martha Stewart Living Omnimedia, Inc. (filed August 30, 2002), Crnkovich v. Martha Stewart Living Omnimedia, Inc. (filed September 4, 2002), Rahilly v. Martha Stewart Living Omnimedia, Inc. (filed September 6, 2002), Steele v. Martha Stewart Living Omnimedia, Inc. (filed September 13, 2002), and Hackbarth v Martha Stewart Living Omnimedia, Inc. (filed September 18, 2002). The claims in the Consolidated Class Action Complaint arise out of Ms. Stewart's sale of 3,928 shares of ImClone Systems stock on December 27, 2001. The plaintiffs assert violations of Sections 10(b) (and rules promulgated thereunder), 20(a) and 20A of the Securities Exchange Act of 1934. The plaintiffs allege that MSO, Ms. Stewart and the Individual Defendants made statements about Ms. Stewart's sale that were materially false and misleading. The plaintiffs allege that, as a result of these false and misleading statements, the market price of the Company's stock was inflated during the putative class periods and dropped after the alleged falsity of the statements became public. The plaintiffs further allege that the Individual Defendants traded MSO stock while in possession of material non-public information. The Consolidated Class Action Complaint seeks certification as a class action, damages, attorneys' fees and costs, and further relief as determined by the court. On May 19, 2003, the Company's motion to dismiss the Consolidated Class Action Complaint was denied, and discovery in that action is ongoing. By stipulation of the parties, and an order of the court entered November 10, 2003, all claims asserted in the Consolidated Class Action Complaint pursuant to Section 20A (Insider Trading) of the Securities Exchange Act against the Individual Defendants, and all remaining claims against the Individual Defendants, other than Mr. Blatt and Ms. Patrick, have been dismissed without prejudice. The Company has also been named as a nominal defendant in four derivative actions, all of which name Ms. Stewart as a defendant: In re Martha Stewart Living Omnimedia, Inc. Shareholder Derivative Litigation (the "Shareholder Derivative Litigation"), filed on December 19, 2002 in New York State Supreme Court; Beam v. Stewart, initially filed on August 15, 2002 and amended on September 6, 2002, in Delaware Chancery Court; Richards v. Stewart, filed on November 1, 2002 in Connecticut Superior Court; and Sargent v. Martinez, filed on September 29, 2003 in the U.S. District Court for the Southern District of 24 New York. Company directors Arthur Martinez, Sharon Patrick, Jeffrey Ubben and former directors John Doerr, Darla Moore and Naomi Seligman, are also named as defendants in Beam. Mr. Martinez, Ms. Patrick, Mr. Ubben, Mr. Doerr, Ms. Moore, Ms. Seligman, five of the Company's present or former officers (Mr. Blatt, Ms. Cardinale, Ms. Roach, Ms. Sobel, and Ms. Towey), and Kleiner Perkins Caufield & Byers are also named as defendants in Richards. Mr. Martinez, Ms. Patrick, Mr. Ubben, Ms. Moore and Ms. Seligman are also named as defendants in Sargent. In re Martha Stewart Living Omnimedia, Inc. Shareholder Derivative Litigation consolidates three previous derivative complaints filed in New York State Supreme Court and Delaware Chancery Court: Beck v. Stewart, filed on August 13, 2002 in New York State Supreme Court, Kramer v. Stewart, filed on August 20, 2002 in New York State Supreme Court, and Alexis v. Stewart, filed on October 3, 2002 in Delaware Chancery Court. Sargent consolidates two derivative complaints previously filed in the U.S. District Court for the Southern District Court of New York: Acosta v. Stewart, filed on October 10, 2002, and Sargent v. Martinez, filed on May 30, 2003. All four derivative actions allege that Ms. Stewart breached her fiduciary duties to the Company by engaging in insider trading in ImClone stock and making false and misleading statements about such trading. The plaintiffs allege that these actions have diminished Ms. Stewart's reputation and injured the Company through lost revenues, loss of reputation and good will, decreased stock price, and increased costs. The plaintiff in Beam further alleges that (i) Ms. Stewart's actions have jeopardized the Company's intellectual property; (ii) the directors breached their fiduciary duties by failing to monitor Ms. Stewart's affairs to ensure she did not harm the Company; (iii) Ms. Stewart and the other directors breached their fiduciary duties by failing to address the impropriety of the Company's payment of split-dollar insurance premiums; and (iv) Ms. Stewart and Mr. Doerr usurped corporate opportunities by selling personally owned Company stock to an investment firm without first presenting the Company with the opportunity to sell its stock to the firm. The plaintiffs in the Shareholder Derivative Litigation also allege that Ms. Stewart breached the terms of her employment agreement with the Company. The plaintiff in Richards further alleges (i) intentional breach of fiduciary duty by, among other things, acting in reckless disregard of, and failing to prevent, Ms. Stewart's insider trading in ImClone stock, violating federal securities laws by selling Company stock while in possession of material, non-public information, misuse of corporate information, and gross mismanagement of the Company; (ii) negligent breach of fiduciary duty; (iii) abuse of control; (iv) constructive fraud; (v) gross mismanagement; and (vi) waste. The plaintiffs in Sargent further allege that the directors breached their fiduciary duties by (i) failing to take appropriate action to address Ms. Stewart's wrongdoing; (ii) granting Ms. Stewart a bonus for 2002; and (iii) endorsing an amendment to the Company's agreement with Ms. Stewart for the rental of certain properties. The derivative actions seek damages in favor of the Company, attorneys' fees and costs, and further relief as determined by the court. Certain of the complaints also seek declaratory relief. The plaintiffs in the Shareholder Derivative Litigation and Sargent further seek the creation of a committee or other administrative mechanism to address the alleged "corporate governance" issues raised in the complaints and to protect the Company's "cornerstone assets." The plaintiff in Richards further seeks injunctive relief in the form of attachment or other restriction of the proceeds of defendants' trading activities or other assets. On April, 17, 2003, the Company's motion to dismiss the Shareholder Derivative Litigation was granted to the extent that the action has been stayed pending plaintiffs' submission of a demand to initiate litigation on the Company's Board or a determination by the Federal District Court in the Acosta action (now the consolidated Sargent action) that such a demand is excused. On September 30, 2003, the Company's motion to dismiss the Beam complaint was granted in its entirety. The plaintiffs in Beam appealed the dismissal of the complaint to the Delaware Supreme Court. On March 31, 2004, the Delaware Supreme Court, sitting en banc, unanimously affirmed the dismissal of the Beam complaint. The Sargent action had previously been stayed by order of the court pending resolution of the Beam appeal by the Delaware Supreme Court. On April 22, 2004, the court lifted that stay and ordered the plaintiffs to respond to MSO's and the MSO directors' previously filed motions to dismiss. In their opposition brief and at oral argument, the plaintiffs did not oppose the dismissal of the Sargent action, arguing only that such dismissal should be without prejudice; MSO and the other defendants seek a with prejudice dismissal. Oral argument was held July 23, 2004 and the court has not yet announced a decision. The Richards action had been stayed by agreement of the parties pending resolution of the Beam appeal by the Delaware Supreme Court. By motion filed June 4, 2004, the plaintiff in the Richards action voluntarily sought an order dismissing the Richards action with prejudice, and that dismissal with prejudice was ordered by the court on June 9, 2004. 25 The Company is unable to predict the outcome of these actions or reasonably estimate a range of possible loss at this time. While still in their early stages, we believe the Company has substantial defenses to the Consolidated Class Action Complaint and the derivative actions. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) We held our 2004 Annual Meeting of Stockholders on June 21, 2004. (b) The following matters were acted upon at the meeting by holders of Class A Common Stock and Class B Common Stock voting as one class for the election of directors to hold office until our next annual meeting and to approve an amendment to MSO's Amended and Restated 1999 Stock Incentive Plan (the "Plan"). The amendment to the Plan permitted employees to exchange options held by them for restricted stock units. The vote on these matters was as follows: BOARD OF DIRECTORS ELECTION RESULTS
BROKER VOTES FOR VOTES WITHHELD NON-VOTES ----------- ------------- --------- Rick Boyko 304,002,248 47,091 0 Michael Goldstein 304,001,528 47,811 0 Susan Lyne 304,001,775 47,564 0 Arthur C. Martinez 303,972,116 77,223 0 Wenda Harris Millard 304,002,918 46,421 0 Sharon L. Patrick 304,005,656 43,683 0 Thomas C. Siekman 303,972,247 77,092 0 Bradley E. Singer 303,986,118 63,221 0 Jeffrey W. Ubben 303,977,662 71,677 0
AMENDMENT TO MSO'S AMENDED AND RESTATED 1999 STOCK INCENTIVE PLAN RESULTS
VOTES FOR VOTES AGAINST VOTES ABSTAIN ----------- --------------- -------------- Amendment to MSO's Amended and Restated 1999 Stock Incentive Plan 303,736,239 299,944 13,156
26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed as part of this report:
Exhibit Number Exhibit Title - ---------- ----------------------------------------------------- 10.1 Amendment, dated as of April 22, 2004, to the License Agreement, by and between MSO IP Holdings, Inc. and Kmart Corporation, dated June 21, 2001 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
(b) Reports on Form 8-K On May 7, 2004, the Company filed a Current Report on Form 8-K reporting its earnings for its fiscal first quarter ended March 31, 2004. On May 11, 2004, the Company filed a Current Report on Form 8-K providing a transcript of its fiscal first quarter earnings conference call held on May 7, 2004. 27 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. MARTHA STEWART LIVING OMNIMEDIA, INC. Date: August 9, 2004 /s/ James Follo ----------------------- Name: James Follo Title: Executive Vice President, Chief Financial and Administrative Officer 28 EX-10.1 2 y99950exv10w1.txt AMENDMENT TO THE LICENSE AGREEMENT EXHIBIT 10.1 AMENDMENT TO THE LICENSE AGREEMENT BY AND BETWEEN MSO IP HOLDINGS AND KMART CORPORATION NOTE: CERTAIN MATERIAL HAS BEEN OMITTED FROM THIS AGREEMENT PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT UNDER RULE 24B-2. THE LOCATIONS OF THESE OMISSIONS ARE INDICATED THROUGHOUT THE AGREEMENT BY THE FOLLOWING MARKINGS: [***]. AMENDMENT Reference is made to the license agreement (the "Agreement") dated as of June 21, 2001 by and between MSO IP Holdings, Inc., a California corporation ("MSO"), and Kmart Corporation, a Michigan corporation. Whereas, the parties have now agreed to extend the Term of the Agreement and to modify certain terms and conditions contained therein; for good and valuable consideration the sufficiency of which is hereby acknowledged by the parties hereto, the parties hereby agree to amend the Agreement as follows (this document shall be referred to hereafter as the "Amendment"): 1. Unless otherwise defined in this Amendment, all defined terms used herein shall have the same meaning as in the Agreement. 2. In Paragraph I of the Agreement, the following language shall be added in Line 12 after the words "its Kmart stores.": [***] 3. The following new Paragraph I(1) shall be added to the Agreement: [***] 4. In Line 18 of Paragraph II(3) the following shall be inserted: "The parties hereby agree to add the following Additional Products to this Agreement on a non-exclusive basis: rugs, ready-to-assemble furniture and bath fixtures, as more specifically set forth in Schedule I(e) attached hereto. Notwithstanding the other terms and conditions of this Paragraph II(3), solely with regard to these particular categories of Additional Products there shall be no separate additional Minimum Royalty Amounts payable and royalties earned (at the rate specified in Schedule IV) from Sales of such Additional Products in Schedule I(e) shall count toward meeting or exceeding the Minimum Royalty Amounts in the particular year of sale. It is understood that Sales of any other products in the same product categories as those set forth on Schedule I(e) that the parties mutually agree to include under this Agreement shall be automatically added to Schedule I(e) and all royalties so earned in connection with such products shall also count toward meeting or exceeding the Minimum Royalty Amounts as described above." 5. "Ready-to-assemble furniture" and "Area rugs" shall be deleted from Schedule II(3) of the Agreement. 6. The following language shall be added in the last line of Paragraph II(3) after the words "cameras or jewelry": [***] 7. Schedule IV to the Agreement shall be deleted in its entirety and the new Schedule IV attached to this Amendment shall be inserted in its place. 8. The following subparagraph 9 shall be added to Paragraph VI: "(9) Kmart shall have the right, but not the obligation, to hire a brand manager to work with MSO in connection with the development, creation, production and advertising of the Licensed Products, and in the event Kmart does hire a brand manager, then MSO shall cooperate and work with such person." 9. Paragraph V(2) of the Agreement shall be deleted in its entirety and the following shall be inserted in its place: "When Kmart delivers the Quarterly Reports to MSO, Kmart shall also pay to MSO the royalties due and owing for the corresponding quarter and, if applicable, any Aggregate Shortfall. These payments shall be made by wire transfer to a bank account designated by MSO unless it is not practicable for Kmart to utilize such method, in which event payment shall be made by check to MSO. Additionally, Schedule V(2) hereto sets forth certain guaranteed royalty amounts as of each January 31 of the Term commencing on January 31, 2002 ("Minimum Royalty Amounts") which may give rise to increases in royalty payments otherwise payable as set forth below. In the event that the amount of Kmart's total royalty payments on the Sale of Licensed Products ("Earned Royalties") for each twelve month period ending January 31 are less than the applicable Minimum Royalty Amount for the same period, Kmart shall pay the difference between such amount and the Minimum Royalty Amount (the "Aggregate Shortfall"). If Kmart has paid any Aggregate Shortfall to MSO at any time from February 1, 2004 through January 31 2008 pursuant to this Paragraph V(2) ("Aggregate Shortfall Payments"), then Kmart shall be entitled to recoup the amount of such Aggregate Shortfall Payments, up to the aggregate credit of ten million dollars ($10,000,000), as a credit against 25% of any royalties earned in excess of the Minimum Royalty Amounts set forth in Schedule V(2) for the period ending January 31, 2009 and/or the period ending January 31, 2010 subject to the following limitation: For the period from (i) February 1, 2004 through January 31, 2005, such credit shall not exceed three million and seven hundred and fifty thousand dollars ($3,750,000) for such period, (ii) February 1, 2005 through January 31, 2005, such credit shall not exceed three million and seven hundred and fifty thousand dollars ($3,750,000) for such period, (iii) February 1, 2006 through January 31, 2007, such credit shall not exceed two million and five hundred thousand dollars ($2,500,000) for such period, and (iv) February 1, 2007 through January 31, 2008, such credit shall not exceed two million five hundred thousand dollars ($2,500,000) for such period. For the purpose of clarity, the aggregate credit under (i) - (iv) above shall not exceed ten million dollars ($10,000,000). Notwithstanding anything contained in this Agreement, the parties acknowledge and agree that there shall be no Minimum Royalty Amounts by Product Category for 2003 or thereafter during the Term of this Agreement. Kmart represents and warrants that the Quarterly Reports delivered to MSO pursuant to the Agreement are true and accurate and that all amounts due MSO with respect thereof have been paid." 10. Schedule V(2) to the Agreement shall be deleted in its entirety and the new Schedule V(2) attached to this Amendment shall be inserted in its place. 11. Paragraph VII of the Agreement shall be deleted in its entirety and the following shall be inserted in its place: "VII. Term. This Agreement shall commence on August 1, 2001 and continue in full force and effect until January 31, 2010 (the "Term")." 12. Paragraph VIII(1) shall be deleted and the following language shall be inserted in its place: "VIII. Promotional and Marketing Services. (1) If and as may be requested by Kmart from time to time, MSO shall cause Stewart to render her services in a professional manner consistent with the intent of this Agreement and to use her reasonable good faith efforts to participate in the promotion and imaging of the Licensed Products including, without limitation, through television, radio and print advertising, in-store videos, appearances and other media presentations or programs and shall use reasonable and appropriate opportunities, in her reasonable discretion, to promote the Licensed Products and Kmart's sale thereof including, without limitation, interviews, editorials, press conferences, press releases and television appearances. In light of the considerable demands on Stewart's schedule, Kmart and MSO shall cooperate in good faith to schedule the dates, times, places and manner in which Stewart shall fulfill her obligations under this Section as far in advance, and in the most convenient manner, possible. Subject to the final sentence of this Section VIII(1), MSO shall cause Martha Stewart to be available to render services under this Section VIII(1) consistent with past practices under the Prior Agreements, but in no event for more than 25 days annually, inclusive of travel time. Kmart shall pay all costs and expenses in connection with such services including, without limitation, cost of first class air travel (or private plane) and lodging consistent with Kmart's past practices with Stewart under the Prior Agreements as of the date hereof. Any significant expenses anticipated by MSO in excess of those generally borne by Kmart pursuant to past practice under the Prior Agreements shall be first submitted to Kmart for approval. No failure by MSO to comply with the terms of this provision by reason of the death, disability, incapacity, or other circumstances beyond the reasonable control of Martha Stewart (including, without limitation, the prosecution and resolution of any civil or criminal claims involving Ms. Stewart) shall be considered a breach of this Agreement." 13. In Line 13 of Paragraph VIII(2) following the sentence ending "expenditures during 2001", the following shall be inserted: "Notwithstanding the foregoing, beginning on January 1, 2004 and continuing for the remainder of the Term the Annual MSE Ad Spend shall be equal to at least the lesser of: (i) [***] of Kmart Corporation's aggregate advertising expenditures during such year, and (ii) [***] of the prior year's Earned Royalty, but in no event shall such amount be less than [***] of Kmart Corporation's aggregate advertising expenditures during such year. [***] 14. In Line 14 of Paragraph VIII(2), the sentence beginning "Kmart and MSO agree" shall be deleted. 15. The period at the end of Paragraph VIII(2) shall be changed to a semi-colon and the following proviso shall be added: "provided that beginning on February 1, 2004 through the end of the Term this amount shall be fixed at [ * * * ] (net of all third party advertising commissions) per year, but in no event shall Kmart be obligated to make any advertising expenditures that represent more than [ * * * ] of aggregate annual advertising pages in any particular MSO publication and [ * * * ] of aggregate annual television advertising spots in any particular MSO produced or sponsored programming." 16. In Line 3 of Paragraph XIII, the following language shall be added after the phrase "reasonable commercial efforts": "to market, sell and promote Licensed Products in all Product Categories licensed hereunder and" 17. Schedule XIV and Paragraph XIV of the Agreement shall be deleted in their entirety and the following shall be inserted in place of Paragraph XIV: "MSO and Kmart shall meet to strategize for materially increasing Sales and profitability in all Product Categories specified in this Agreement. To that end, MSO and Kmart shall meet at least annually to so strategize and otherwise develop programs and plans to materially increase Sales and profitability." 18. The following language shall be added at the end of Paragraph XX: "MSO shall continue to dedicate senior level and design support personnel in connection with the Licensed Products, materially consistent with past practices (including, without limitation, with respect to the overall expertise of such personnel); provided, however, that the failure to dedicate any particular employee shall not be a breach of this Agreement." 19. In the event that either party, is required by applicable law, regulations or legal processes (including, without limitation, any disclosures of Information which are required to be made by applicable securities laws in connection with any financing activities of either party or standard disclosure requirements under the Securities and Exchange Act of 1934, as amended), then the party required to make such disclosure shall give prior notification to the other party and the parties shall agree upon any redactions to the Amendment to be filed or otherwise disclosed, and, at the other party's request, shall request that the relevant legal or regulatory authority, or major stock exchange, as applicable, treat as confidential any Information of either Party and/or any of the terms or conditions of this Amendment included in any such disclosure. Notwithstanding the foregoing, the final content of any such disclosure shall be determined by MSO as may be necessary to comply with its obligations under applicable laws and regulations. In addition, MSO and Kmart shall mutually agree upon the press release or other publicity materials issued with respect to the terms or conditions of this Amendment. 20. The parties have agreed to execute a release in a separate agreement concurrently with this Amendment. 21. Except as expressly set forth in this Amendment, the Agreement shall remain in full force and effect and shall not be deemed modified or changed in any other manner whatsoever. MSO IP HOLDINGS, INC. By: /s/ Sharon Patrick ------------------------ Name: Sharon Patrick Title: President and CEO KMART CORPORATION By: /s/ Julian C. Day ------------------------ Name: Julian C. Day Title: President and CEO Dated: as of April 22, 2004 SCHEDULE I(e) Rugs: Area Rugs Scatter Rugs Novelty Rugs Ready-To-Assemble Furniture: RTA Home Office Furniture RTA Entertainment Centers RTA Kitchen Furniture RTA Bedroom Furniture RTA Occasional Furniture Bath Fixtures: Bathroom Cabinets Bathroom Shelving Bathroom Mirrors Bathroom Storage Wall Mounted Towel Bars Wall Mounted Soap Holders Wall Mounted Toothbrush Holders Wall Mounted Cup Holders SCHEDULE IV Royalty Rates Time Period Royalty Rate as a Percentage of Sales 8/01 - 1/02 [ * * * ] 2/02 - 1/03 [ * * * ] 2/03 - 1/04 [ * * * ] 2/04 - 1/05 [ * * * ] 2/05 - 1/06 [ * * * ] 2/06 - 1/07 [ * * * ] 2/07 - 1/08 [ * * * ] 2/08 - 1/09 [ * * * ] 2/09 - 1/10 [ * * * ] SCHEDULE V(2) Minimum Royalty Amounts 1/31/02 $15.3 million 1/31/03 $40.4 million 1/31/04 $47.5 million 1/31/05 $49.0 million 1/31/06 $54.0 million 1/31/07 $59.0 million 1/31/08 $65.0 million 1/31/09 The greater of (i) $20 million or (ii) 50% of the Earned Royalty for the year ending 1/31/08. 1/31/10 The greater of (i) $15 million or (ii) 50% of the Earned Royalty for the year ending 1/31/09. EX-31.1 3 y99950exv31w1.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATION I, Sharon Patrick, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Martha Stewart Living Omnimedia, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [omitted pursuant to SEC Release No. 33-8238]; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ Sharon Patrick ----------------------------------- Sharon Patrick President & Chief Executive Officer EX-31.2 4 y99950exv31w2.txt CERTIFICATION EXHIBIT 31.2 CERTIFICATION I, James Follo, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Martha Stewart Living Omnimedia, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [omitted pursuant to SEC Release No. 33-8238]; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ James Follo ------------------------------ James Follo Chief Financial and Administrative Officer EX-32 5 y99950exv32.txt CERTIFICATION EXHIBIT 32 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Martha Stewart Living Omnimedia, Inc., a Delaware corporation (the "Company"), does hereby certify that: The Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 (the "Form 10-Q") of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 9, 2004 /s/ Sharon Patrick --------------------------- Sharon Patrick President & Chief Executive Officer Dated: August 9, 2004 /s/ James Follo --------------------------- James Follo Chief Financial and Administrative Officer -----END PRIVACY-ENHANCED MESSAGE-----