10-Q 1 l95350ae10vq.txt REYNOLDS & REYNOLDS 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2002 COMMISSION FILE NO. 1-10147 THE REYNOLDS AND REYNOLDS COMPANY OHIO 31-0421120 (State of incorporation) (IRS Employer Identification No.) 115 SOUTH LUDLOW STREET DAYTON, OHIO 45402 (Address of principal executive offices) (937) 485-2000 (Telephone No.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- On August 8, 2002, 69,450,221 Class A common shares and 16,000,000 Class B common shares were outstanding. THE REYNOLDS AND REYNOLDS COMPANY TABLE OF CONTENTS
PAGE NUMBER PART I. FINANCIAL INFORMATION Item 1. Financial Statements Statements of Consolidated Income For the Three and Nine Months Ended June 30, 2002 and 2001 3 Condensed Consolidated Balance Sheets As of June 30, 2002 and September 30, 2001 4 Condensed Statements of Consolidated Cash Flows For the Nine Months Ended June 30, 2002 and 2001 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations For the Three and Nine Months Ended June 30, 2002 and 2001 12 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 18 SIGNATURES 19
2 THE REYNOLDS AND REYNOLDS COMPANY STATEMENTS OF CONSOLIDATED INCOME FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2002 AND 2001 (In thousands except per share data)
Three Months Nine Months 2002 2001 2002 2001 ---------- ----------- ---------- ---------- Net Sales and Revenues Services $153,807 $152,079 $452,661 $452,461 Products 86,065 87,720 251,397 268,477 Financial services 10,696 10,651 31,621 31,340 ---------- ----------- ---------- ---------- Total net sales and revenues 250,568 250,450 735,679 752,278 ---------- ----------- ---------- ---------- Cost of Sales Services 52,767 55,504 156,723 168,008 Products 46,833 50,271 140,393 153,735 Financial services 2,760 3,224 8,051 10,481 ---------- ----------- ---------- ---------- Total cost of sales 102,360 108,999 305,167 332,224 ---------- ----------- ---------- ---------- Gross Profit 148,208 141,451 430,512 420,054 Selling, General and Administrative Expenses 99,200 95,158 301,446 295,622 ---------- ----------- ---------- ---------- Operating Income 49,008 46,293 129,066 124,432 ---------- ----------- ---------- ---------- Other Charges (Income) Interest expense 1,137 1,390 2,698 4,401 Interest income (862) (1,594) (2,975) (6,640) Equity in net losses (income) of affiliated companies (514) 5,091 13,731 8,630 Other 171 169 107 (464) ---------- ----------- ---------- ---------- Total other charges (income) (68) 5,056 13,561 5,927 ---------- ----------- ---------- ---------- Income Before Income Taxes 49,076 41,237 115,505 118,505 Provision for Income Taxes 18,843 16,518 30,805 47,708 ---------- ----------- ---------- ---------- Income from Continuing Operations 30,233 24,719 84,700 70,797 Income from Discontinued Operations 0 0 0 1,623 ---------- ----------- ---------- ---------- Income Before Cumulative Effect of Accounting Change 30,233 24,719 84,700 72,420 Cumulative Effect of Accounting Change 0 0 (36,563) 0 ---------- ----------- ---------- ---------- Net Income $30,233 $24,719 $48,137 $72,420 ========== =========== ========== ========== Basic Earnings Per Common Share Income from Continuing Operations $0.43 $0.34 $1.19 $0.97 Income from Discontinued Operations $0.00 $0.00 $0.00 $0.02 Income Before Cumulative Effect of Accounting Change $0.43 $0.34 $1.19 $0.99 Cumulative Effect of Accounting Change $0.00 $0.00 ($0.52) $0.00 Net Income $0.43 $0.34 $0.68 $0.99 Average Number of Common Shares Outstanding 71,000 73,237 70,903 73,361 Diluted Earnings Per Common Share Income from Continuing Operations $0.41 $0.33 $1.15 $0.94 Income from Discontinued Operations $0.00 $0.00 $0.00 $0.02 Income Before Cumulative Effect of Accounting Change $0.41 $0.33 $1.15 $0.97 Cumulative Effect of Accounting Change $0.00 $0.00 ($0.50) $0.00 Net Income $0.41 $0.33 $0.65 $0.97 Average Number of Common Shares Outstanding 74,191 75,033 73,805 74,966 Cash Dividends Declared Per Common Share $0.11 $0.11 $0.33 $0.33
See Notes to Condensed Consolidated Financial Statements. 3 THE REYNOLDS AND REYNOLDS COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2002 AND SEPTEMBER 30, 2001 (In thousands)
6/30/02 9/30/01 ----------- ---------- AUTOMOTIVE SOLUTIONS ASSETS Current Assets Cash and equivalents $148,966 $110,511 Accounts receivable 130,460 124,954 Inventories 13,214 10,846 Other current assets 28,700 39,902 ----------- ---------- Total current assets 321,340 286,213 Property, Plant and Equipment, less accumulated depreciation of $156,841 at 6/30/02 and $179,062 at 9/30/01 161,963 159,051 Goodwill 28,256 34,663 Software Licensed to Customers 75,373 59,690 Other Intangible Assets 46,428 107,262 Other Assets 75,293 73,137 ----------- ---------- Total Automotive Solutions Assets 708,653 720,016 ----------- ---------- FINANCIAL SERVICES ASSETS Finance Receivables 401,855 421,370 Cash and Other Assets 1,156 964 ----------- ---------- Total Financial Services Assets 403,011 422,334 ----------- ---------- TOTAL ASSETS $1,111,664 $1,142,350 =========== ========== AUTOMOTIVE SOLUTIONS LIABILITIES Current Liabilities Current portion of long-term debt $6,061 $6,061 Accounts payable 43,805 44,638 Accrued liabilities 68,301 78,801 Deferred revenues 22,567 18,362 ----------- ---------- Total current liabilities 140,734 147,862 Long-Term Debt 106,878 105,805 Other Liabilities 88,410 104,000 ----------- ---------- Total Automotive Solutions Liabilities 336,022 357,667 ----------- ---------- FINANCIAL SERVICES LIABILITIES Notes Payable 206,347 203,512 Other Liabilities 105,037 104,388 ----------- ---------- Total Financial Services Liabilities 311,384 307,900 ----------- ---------- SHAREHOLDERS' EQUITY Capital Stock 217,516 167,981 Other Comprehensive Income (Loss) (8,565) (9,547) Retained Earnings 255,307 318,349 ----------- ---------- Total Shareholders' Equity 464,258 476,783 ----------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,111,664 $1,142,350 =========== ==========
See Notes to Condensed Consolidated Financial Statements. 4 THE REYNOLDS AND REYNOLDS COMPANY CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS FOR THE NINE MONTHS ENDED JUNE 30, 2002 AND 2001 (In thousands)
2002 2001 ---------- --------- AUTOMOTIVE SOLUTIONS Cash Flows Provided By Operating Activities $115,444 $91,573 ---------- --------- Cash Flows Provided By (Used For) Investing Activities Business combinations (11,684) Capital expenditures (30,503) (39,540) Net proceeds from asset sales 9,183 2,697 Capitalization of software licensed to customers (15,831) (12,453) Repayments from (advances to) financial services 31,116 (977) ---------- --------- Net cash flows used for investing activities (6,035) (61,957) ---------- --------- Cash Flows Provided By (Used For) Financing Activities Principal payments on debt (346) (2,165) Cash dividends paid (23,404) (24,110) Capital stock issued 48,158 29,281 Capital stock repurchased (96,343) (82,533) ---------- --------- Net cash flows used for financing activities (71,935) (79,527) ---------- --------- Effect of Exchange Rate Changes on Cash 981 (656) ---------- --------- Net Cash Used for Discontinued Operations (35,083) ---------- --------- Increase (Decrease) in Cash and Equivalents 38,455 (85,650) Cash and Equivalents, Beginning of Period 110,511 205,455 ---------- --------- Cash and Equivalents, End of Period $148,966 $119,805 ========== ========= FINANCIAL SERVICES Cash Flows Provided By Operating Activities $18,163 $14,860 ---------- --------- Cash Flows Provided By (Used For) Investing Activities Finance receivables originated (124,185) (134,330) Collections on finance receivables 134,131 124,556 ---------- --------- Net cash flows provided by (used for) investing activities 9,946 (9,774) ---------- --------- Cash Flows Provided By (Used For) Financing Activities Additional borrowings 80,000 70,383 Principal payments on debt (77,165) (76,413) Advances from (repayments to) automotive solutions (31,116) 977 ---------- --------- Net cash flows used for financing activities (28,281) (5,053) ---------- --------- Increase (Decrease) in Cash and Equivalents (172) 33 Cash and Equivalents, Beginning of Period 441 456 ---------- --------- Cash and Equivalents, End of Period $269 $489 ========== =========
See Notes to Condensed Consolidated Financial Statements. 5 THE REYNOLDS AND REYNOLDS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands except per share data) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The balance sheet as of September 30, 2001 is condensed financial information taken from the annual audited financial statements. The interim financial statements are unaudited. In the opinion of management, the accompanying interim financial statements contain all significant adjustments (which consist only of normal recurring adjustments, except the cumulative effect of accounting change discussed in Note 6) necessary to present fairly the company's financial position, results of operations and cash flows for the periods presented. (2) INVENTORIES 6/30/02 9/30/01 ------------- ------------- Finished products $12,877 $10,271 Work in process 332 398 Raw materials 5 177 ------------- ------------- Total inventories $13,214 $10,846 ============= ============= (3) EQUITY INVESTMENT During March 2002, the company sold its shares of Kalamazoo Computer Group plc of the United Kingdom for cash of $1,636 and recorded a net gain of $103. The company recorded a loss of $12,274, included with equity in net losses of affiliated companies on the statement of consolidated income and income tax benefits of $12,377 related to the sale of these shares, included in the provision for income taxes on the statement of consolidated income. (4) FINANCING ARRANGEMENTS In the ordinary course of business, the company, or its affiliate Reyna Funding, L.L.C., borrows cash to fund investments in finance receivables from the sale of the company's products. The company attempts to limit its interest rate exposure between the interest earned on fixed rate finance receivables and the interest paid on variable rate financing agreements through the use of interest rate management agreements. Interest rate swaps provide for interest to be received on notional amounts at variable rates and provide for interest to be paid on the same notional amounts at fixed rates. Fixed interest rates do not change over the life of the agreements. Variable interest rates are reset at least every 90 days based on LIBOR and are settled with counterparties at that time. These derivative instruments meet the criteria for cash flow hedge accounting. On January 24, 2002, Reyna Funding, L.L.C., an affiliate of the company, entered into a loan funding agreement, whereby Reyna Funding, L.L.C. may borrow up to $100,000 using finance receivables purchased from Reyna Capital Corporation, also an affiliate of the company, as security for the loan. The securitization allows additional borrowings, up to the $100,000 limit, through January 23, 2003. This loan funding agreement is renewable annually through January 23, 2006. Any borrowings will be repaid as collections on finance receivables balances are received. During the second quarter of fiscal year 2002, Reyna Funding, L.L.C. borrowed $80,000 under this agreement. Proceeds received by Reyna Capital Corporation from Reyna Funding L.L.C. were used to retire other debt. During the second quarter of fiscal year 2002, Reyna Funding, L.L.C. entered into $80,000 of interest rate swap agreements in connection with obtaining this variable rate debt. These interest rate swap agreements meet the criteria for cash flow hedge accounting. The fair value of the company's cash flow derivative instruments was a $2,700 liability at June 30, 2002 and a $2,724 liability at September 30, 2001 and was included in Financial Services' other liabilities on the condensed consolidated balance sheets. The adjustments to record the net change in the fair value of cash flow hedges during the periods presented was recorded, net of income taxes, in other comprehensive income. Fluctuations in the fair value of the derivative instruments are generally offset by changes in the value or cash flows of the underlying exposure being hedged because of the high degree of effectiveness of these cash flow hedges During February 2002, the company entered into $100,000 of interest rate swaps to reduce the effective interest expense on outstanding long-term debt. In this transaction the company effectively converted 7% fixed rate debt into variable rate debt. These interest rate swap agreements with total notional amounts of $100,000 are designated as fair value hedges. As of June 30, 2002, the fair value of these derivative instruments was an asset of $1,382 and was included in 6 Automotive Solutions' other liabilities on the condensed consolidated balance sheet. The adjustments to record the net change in the fair value of fair value hedges and related debt during the periods presented were recorded in income. All existing fair value hedges were 100% effective. As a result, there was no current impact to earnings because of hedge ineffectiveness. (5) COMPREHENSIVE INCOME
THREE MONTHS NINE MONTHS 2002 2001 2002 2001 -------------- -------------- -------------- -------------- Net income $30,233 $24,719 $48,137 $72,420 Foreign currency translation adjustment 1,214 944 981 (656) Cumulative effect of accounting change 15 Net unrealized gains (losses) on derivative contracts (924) 75 1 (1,052) -------------- -------------- -------------- -------------- Comprehensive income $30,523 $25,738 $49,119 $70,727 ============== ============== ============== ==============
(6) ACCOUNTING CHANGE In June 2001, the FASB voted in favor of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill no longer be amortized, but instead tested for impairment at least annually. The statement also requires recognized intangible assets with finite useful lives to be amortized over their useful lives and reviewed for impairment in accordance with SFAS Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The company elected to adopt the provisions of SFAS No 142 effective October 1, 2001. Accordingly, goodwill has not been amortized in the financial statements for the periods ended June 30, 2002. This statement also required certain intangible assets that did not meet the criteria for recognition apart from goodwill, to be subsumed into goodwill. During the quarter ended December 31, 2001, the company subsumed into goodwill $54,531 of intangible assets representing assembled workforce and a noncontractual customer relationship, that did not meet the separability criteria under SFAS No. 141, "Business Combinations." SFAS No 142 also requires that goodwill be tested for impairment, initially as of October 1, 2001, and thereafter at least annually. During the second quarter of fiscal year 2002, the company completed the goodwill impairment test and recorded impairment losses of $36,563 ($60,938 net of income tax benefits of $24,375). These impairment losses were recorded effective October 1, 2001, as the cumulative effect of the accounting change on the consolidated statement of income. The company divided its four reporting segments into eight reporting units for purposes of applying the provisions of this pronouncement. For each reporting unit a fair value was determined based primarily on the present value of discounted future cash flows. Other methods were considered to validate this valuation method. Where initial impairment was indicated, the company hired an outside appraisal firm to determine the fair value and allocate this fair value among assets and liabilities. Based on this analysis two reporting units within the Transformation Solutions reporting segment incurred impairment losses. The customer relationship management consulting business, acquired in fiscal year 2000 as part of the HAC Group business combination, recorded an impairment loss of $33,515 ($55,858 net of income tax benefits of $22,343). The company also recorded an impairment loss of $3,048 ($5,080 net of income tax benefits of $2,032) related to its Campaign Management Services reporting unit. These impairment losses occurred because of discounting future cash flows to determine the fair value of the reporting units. Under previous accounting standards, future cash flows were not discounted in determining if impairment existed. 7 ACQUIRED INTANGIBLE ASSETS
Gross Accumulated Useful Life Amount Amortization (years) ---------------- ---------------- ---------------- AS OF JUNE 30, 2002 Amortized intangible assets Contractual customer relationship $33,100 $3,586 20 Customer contract 17,700 10,459 3.67 Trademarks 5,900 639 20 Other 3,005 2,751 3-7 ---------------- ---------------- Subtotal 59,705 17,435 Software licensed to customers 4,579 4,298 5-7 ---------------- ---------------- Total $64,284 $21,733 ================ ================ AS OF SEPTEMBER 30, 2001 Amortized intangible assets Intangible assets subsumed into goodwill 10/1/01 $56,948 $2,417 10-20 Contractual customer relationship 33,100 2,344 20 Customer contract 17,700 6,839 3.67 Trademarks 5,900 418 20 Other 2,987 2,602 3-7 ---------------- ---------------- Subtotal 116,635 14,620 Software licensed to customers 14,621 14,279 5-7 ---------------- ---------------- Total $131,256 $28,899 ================ ================
Aggregate amortization expense was $1,760 and $5,279 for the three and nine months ended June 30, 2002, respectively. Estimated amortization expense for the years ended September 30, is $7,038 in 2002, $7,038 in 2003, $3,269 in 2004, $2,032 in 2005 and $1,964 in 2006. GOODWILL
Software Transform. Solutions Solutions Documents Totals ------------- ------------- ------------- ------------- Balances as of September 30, 2001 $10,412 $21,374 $2,877 $34,663 Intangible assets subsumed Noncontractual customer relationship 47,376 47,376 Assembled workforce 7,155 7,155 Cumulative Effect of Accounting Change (60,938) (60,938) ------------- ------------- ------------- ------------- Balances as of June 30, 2002 $10,412 $14,967 $2,877 $28,256 ============= ============= ============= =============
8 PRO FORMA INCOME FROM CONTINUING OPERATIONS The table below presents the pro forma effect on net income and earnings per share from the adoption of SFAS Statement No. 142.
THREE MONTHS NINE MONTHS 2002 2001 2002 2001 -------------- -------------- -------------- -------------- Income from continuing operations, as reported $30,233 $24,719 $84,700 $70,797 Goodwill amortization, net of taxes 2,130 6,211 Subsumed intangible assets amortization, net of taxes 655 1,964 -------------- -------------- -------------- -------------- Pro forma income from continuing operations $30,233 $27,504 $84,700 $78,972 ============== ============== ============== ============== Basic Earnings per Common Share Income from continuing operations, as reported $0.43 $0.34 $1.19 $0.97 Pro forma income from continuing operations $0.43 $0.38 $1.19 $1.08 Diluted Earnings per Common Share Income from continuing operations, as reported $0.41 $0.33 $1.15 $0.94 Pro forma income from continuing operations $0.41 $0.37 $1.15 $1.05
9 (7) CASH FLOW STATEMENTS Reconciliation of net income to net cash provided by operating activities.
NINE MONTHS 2002 2001 ---------------- --------------- AUTOMOTIVE SOLUTIONS Net Income $37,659 $61,901 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Cumulative effect of accounting change 36,563 Depreciation and amortization 22,723 36,729 Deferred income taxes 20,242 1,505 Deferred income taxes transferred to Financial Services (2,980) (3,263) Income from discontinued operations (1,623) Losses (gains) on sales of assets 1,050 (335) Changes in operating assets and liabilities Accounts receivable (356) 3,268 Inventories (2,368) 3,605 Prepaid expenses and other current assets 581 (9,329) Intangible and other assets 12,757 (1,230) Accounts payable (833) (4,140) Accrued liabilities 4,577 41 Other liabilities (14,171) 4,444 ---------------- --------------- Net Cash Provided by Operating Activities $115,444 $91,573 ================ =============== FINANCIAL SERVICES Net Income $10,478 $10,519 Deferred Income Taxes (9,524) (5,434) Deferred Income Taxes Transferred from Automotive Solutions 2,980 3,263 Changes in Receivables, Other Assets and Other Liabilities 14,229 6,512 ---------------- --------------- Net Cash Provided by Operating Activities $18,163 $14,860 ================ ===============
10 (8) BUSINESS SEGMENTS Reclassifications were made to the prior year's segment information to conform with the presentation used in fiscal year 2002. This presentation reflects the current organizational structure of the company.
THREE MONTHS NINE MONTHS 2002 2001 2002 2001 -------------- -------------- -------------- -------------- NET SALES AND REVENUES Software Solutions $158,943 $153,587 $463,704 $454,152 Transformation Solutions 36,261 39,745 104,278 125,993 Documents 44,668 46,467 136,076 140,793 Financial Services 10,696 10,651 31,621 31,340 -------------- -------------- -------------- -------------- Total Net Sales and Revenues $250,568 $250,450 $735,679 $752,278 ============== ============== ============== ============== OPERATING INCOME (LOSS) Software Solutions $34,499 $33,771 $90,240 $86,411 Transformation Solutions 233 (3,145) (5,284) (7,526) Documents 8,341 9,898 26,931 28,042 Financial Services 5,935 5,769 17,179 17,505 -------------- -------------- -------------- -------------- Total Operating Income $49,008 $46,293 $129,066 $124,432 ============== ============== ============== ==============
6/30/02 9/30/01 -------------- -------------- ASSETS Automotive Solutions $708,653 $720,016 Financial Services 403,011 422,334 -------------- -------------- Total Assets $1,111,664 $1,142,350 ============== ==============
(9) CONTINGENCIES The U.S. Environmental Protection Agency (EPA) has designated the company as one of a number of potentially responsible parties (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at an environmental remediation site. The EPA has contended that any company linked to a CERCLA site is potentially liable for all response costs under the legal doctrine of joint and several liability. This environmental remediation site involves a municipal waste disposal facility owned and operated by four municipalities. The company joined a PRP coalition and is sharing remedial investigation and feasibility study costs with other PRPs. During fiscal year 1996, an agreement was reached whereby the state of Connecticut contributed $8,000 towards remediation costs. Preliminary remediation continued during fiscal year 2001, utilizing Connecticut's contribution. The EPA issued a Record of Decision on September 28, 2001, which selects a remedy at the site involving "monitored natural attenuation." The EPA's estimated future remedial costs are approximately $2,000. The company was also named a defendant in a cost recovery lawsuit in Dayton, Ohio, regarding another environmental remediation site. Discovery in that lawsuit is in its early stages, too early to determine the company's liability exposure. The company believes that the reasonably foreseeable resolution of these two matters will not have a material adverse effect on the financial statements. (10) ACCOUNTING STANDARDS In August 2001, the FASB issued SFAS No. 144, "Accounting for the impairment or Disposal of Long-Lived Assets." This pronouncement establishes a single accounting model, based on framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. The provisions of this statement are effective for fiscal years beginning after December 15, 2001. Management does not believe the adoption of this pronouncement will have a material impact on the company's financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is required to be applied prospectively to exit or disposal activities initiated after December 31, 2002. Management is currently assessing the impact of this pronouncement and has not determined the impact on the company's financial statements. 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2002 AND 2001 (In thousands except per share data) Special items and the accounting change discussed in the following sections did not have an impact on the third quarter of fiscal year 2002, but are disclosed to aid in the understanding of financial results for the nine months ended June 30, 2002. SPECIAL ITEMS During the second quarter of fiscal year 2002, the company recorded several items that when combined added $742 or $.01 per share to earnings. The company settled a state income tax audit that covered fiscal years 1992 through 1998. Based on the settlement, the company reduced interest and income tax accruals for fiscal years 1999 through 2001. The company also filed amended returns in a number of states to correct the apportionment and allocation of taxable income among the states. The combination of audit settlements, accrual adjustments and amended returns added $5,890 or $.08 per share of earnings in the second quarter of fiscal year 2002. The income tax adjustments were recorded as follows: $2,310 in selling, general and administrative (SG&A) expenses, primarily for professional fees associated with obtaining the income tax benefits, $1,709 for the reversal of previously recorded interest expense, $819 of interest income on tax refunds, $200 of other charges and $5,872 of income tax benefits. During the second quarter of fiscal year 2002, the company also recorded $8,552 of expenses ($5,251 or $.07 per share after income taxes) for the following items: employee termination benefits of $4,492 for 114 employees, communications software distributed to customers of $2,500 and real estate costs of $1,560. These items were recorded as follows: $2,000 in cost of sales, $6,552 in SG&A expenses and related income tax benefits of $3,301. During March 2002, the company also sold its shares of Kalamazoo Computer Group plc of the United Kingdom for cash of $1,636 and recorded a net gain of $103. The company recorded a loss of $12,274, included with equity in net losses of affiliated companies on the statement of consolidated income and income tax benefits of $12,377 related to the sale of these shares, included in the provision for income taxes on the statement of consolidated income. ACCOUNTING CHANGE During the second quarter of fiscal year 2002 the company completed the adoption of SFAS No. 142 and recorded a cumulative effect of the accounting change of $36,563 ($60,938 net of income tax benefits of $24,375) effective October 1, 2001. The company restated its first quarter financial statements as prescribed by the pronouncement. See Note 6 to the Consolidated Financial Statements for additional discussion of this accounting change. RESULTS OF OPERATIONS CONSOLIDATED SUMMARY
Three Months Nine Months --------------------------------------------- --------------------------------------------- 2002 2001 Change % Change 2002 2001 Change % Change ----------- ----------- -------- ------------ ---------- ---------- ----------- ----------- Net sales and revenues $250,568 $250,450 $118 0% $735,679 $752,278 ($16,599) -2% Gross profit $148,208 $141,451 $6,757 5% $430,512 $420,054 $10,458 2% % of revenues 59.1% 56.5% 58.5% 55.8% SG&A expenses $99,200 $95,158 $4,042 4% $301,446 $295,622 $5,824 2% % of revenues 39.5% 38.0% 41.0% 39.3% Operating income $49,008 $46,293 $2,715 6% $129,066 $124,432 $4,634 4% % of revenues 19.6% 18.5% 17.5% 16.5% Income from Continuing Operations $30,233 $24,719 $5,514 22% $84,700 $70,797 $13,903 20% Basic earnings per share $0.43 $0.34 $0.09 26% $1.19 $0.97 $0.22 23% Diluted earnings per share $0.41 $0.33 $0.08 24% $1.15 $0.94 $0.21 22% EXCLUDING SPECIAL ITEMS Net sales and revenues $250,568 $250,450 $118 0% $735,679 $752,278 ($16,599) -2% Gross profit $148,208 $141,451 $6,757 5% $432,512 $420,054 $12,458 3% % of revenues 59.1% 56.5% 58.8% 55.8% SG&A expenses $99,200 $95,158 $4,042 4% $292,584 $295,622 ($3,038) -1% % of revenues 39.5% 38.0% 39.8% 39.3% Operating income $49,008 $46,293 $2,715 6% $139,928 $124,432 $15,496 12% % of revenues 19.6% 18.5% 19.0% 16.5% Income from Continuing Operations $30,233 $24,719 $5,514 22% $83,958 $70,797 $13,161 19% Basic earnings per share $0.43 $0.34 $0.09 26% $1.18 $0.97 $0.21 22% Diluted earnings per share $0.41 $0.33 $0.08 24% $1.14 $0.94 $0.20 21%
12 Consolidated revenues were slightly ahead of last year for the third quarter, but declined from last year for the nine month period, primarily because CarPoint revenues declined about $6,000 and $19,000 for the three and nine months, respectively. The CarPoint decline reflects a change in the CarPoint business model. Year-to-date revenues were also impacted by an $8,000 decrease in customer relationship management consulting revenues. Software Solutions' recurring computer services revenues grew 9% in both the quarter and nine months, as compared to last year, and offset a decline in Software Solutions' computer systems products sales. Excluding special items, consolidated gross profit and operating income increased for both the three and nine months ended June 30, 2002, primarily as a result of growth in Software Solutions' higher margin recurring revenues. Research and development (R&D) expenses were $18,000 in the quarter, compared to $15,000 last year and $50,000 for nine months, compared to $54,000 last year. Last year's SG&A expenses included goodwill amortization of $2,896 in the third quarter and $8,489 for nine months. In addition to the higher R&D expenses, third quarter SG&A expenses reflected the following increased expenses over last year: $1,400 of inventory obsolescence, $900 of bad debt expenses and higher depreciation. Excluding special items recorded in the second quarter, year-to-date SG&A expenses reflected the following items: $3,200 of higher bad debt expenses, $3,000 of severance and termination benefits primarily associated with a sales department reorganization in the first quarter of fiscal year 2002; a $1,200 increase in the cost of the annual worldwide sales and service conference and higher inventory obsolescence and depreciation expenses. Bad debt expenses increased for both the third quarter and nine months because of higher charge-offs. Other charges declined from last year in the third quarter and year-to-date (excluding special items) primarily because last year included losses from the company's equity investment in Kalamazoo Computer Group plc (sold March 2002) and the $3,200 write-off of the company's investment in Consumer Car Club Inc. Interest income also declined from last year primarily because last year's interest income reflected cash proceeds from the August 2000 sale of the Information Solutions Group as well as higher interest rates. During February 2002, the company entered into $100,000 of interest rate swaps to reduce the effective interest expense on outstanding long-term debt. In this transaction the company effectively converted 7% fixed rate debt into variable rate debt. Interest expense was $253 less than last year in the third quarter. Excluding special items, the effective income tax rate declined to 38.4% year-to-date, compared to 40.3% last year, because of higher R&D tax credits, lower goodwill amortization expense and lower state tax rates. SOFTWARE SOLUTIONS
Three Months Nine Months --------------------------------------------- --------------------------------------------- 2002 2001 Change % Change 2002 2001 Change % Change ----------- ----------- -------- ------------ ----------- ---------- --------- ------------ Net sales and revenues $158,943 $153,587 $5,356 3% $463,704 $454,152 $9,552 2% Gross profit $100,272 $92,847 $7,425 8% $291,023 $271,193 $19,830 7% % of revenues 63.1% 60.5% 62.8% 59.7% SG&A expenses $65,773 $59,076 $6,697 11% $200,783 $184,782 $16,001 9% % of revenues 41.4% 38.5% 43.3% 40.7% Operating income $34,499 $33,771 $728 2% $90,240 $86,411 $3,829 4% % of revenues 21.7% 22.0% 19.5% 19.0% EXCLUDING SPECIAL ITEMS Net sales and revenues $158,943 $153,587 $5,356 3% $463,704 $454,152 $9,552 2% Gross profit $100,272 $92,847 $7,425 8% $293,023 $271,193 $21,830 8% % of revenues 63.1% 60.5% 63.2% 59.7% SG&A expenses $65,773 $59,076 $6,697 11% $194,101 $184,782 $9,319 5% % of revenues 41.4% 38.5% 41.9% 40.7% Operating income $34,499 $33,771 $728 2% $98,922 $86,411 $12,511 14% % of revenues 21.7% 22.0% 21.3% 19.0%
Software Solutions revenues increased over last year for both the third quarter and nine months of fiscal year 2002 as growth in computer services revenues offset declines in computer systems products sales. Recurring computer services revenues, comprised predominately of recurring software support and equipment maintenance revenues, grew 9% in both the third quarter and nine months, primarily because of the increased number of ERA retail management systems supported. The company also increased sales prices since last year to offset inflation. Sales of computer systems products declined from last year for the third quarter and nine months, primarily because of declines in the number of IntelliPath, DocVantage and electronic parts catalog systems sold. Year-to-date computer systems products sales also reflected a decline in the number of new ERA retail management systems and the cancellation of a software development contract last year. The backlog of new orders for computer systems products and deferred revenues (orders shipped, but not yet recognized in revenues) was $49,000 at June 30, 2002 compared to $40,000 at September 30, 2001. Gross profit margins and operating margins increased over last year 13 primarily as a result of the growth in higher margin computer services revenues. SG&A expenses, as a percentage of revenues, were consistent with prior quarters of fiscal year 2002. Last year's SG&A expenses included goodwill amortization of $1,074 in the third quarter and $2,803 for nine months. Operating margins remained strong, exceeding 21% for both the third quarter and nine months. Last year's operating income for nine months also included $4,228 of costs associated with a work stoppage on the previously mentioned software development contract. TRANSFORMATION SOLUTIONS
Three Months Nine Months --------------------------------------------- --------------------------------------------- 2002 2001 Change % Change 2002 2001 Change % Change ---------- ---------- ---------- ------------ ---------- ---------- ----------- ----------- Net sales and revenues $36,261 $39,745 ($3,484) -9% $104,278 $125,993 ($21,715) -17% Gross profit $14,844 $13,884 $960 7% $37,443 $46,150 ($8,707) -19% % of revenues 40.9% 34.9% 35.9% 36.6% SG&A expenses $14,611 $17,029 ($2,418) -14% $42,727 $53,676 ($10,949) -20% % of revenues 40.3% 42.8% 41.0% 42.6% Operating income (loss) $233 ($3,145) $3,378 ($5,284) ($7,526) $2,242 % of revenues 0.6% -7.9% -5.1% -6.0% EXCLUDING SPECIAL ITEMS Net sales and revenues $36,261 $39,745 ($3,484) -9% $104,278 $125,993 ($21,715) -17% Gross profit $14,844 $13,884 $960 7% $37,443 $46,150 ($8,707) -19% % of revenues 40.9% 34.9% 35.9% 36.6% SG&A expenses $14,611 $17,029 ($2,418) -14% $41,405 $53,676 ($12,271) -23% % of revenues 40.3% 42.8% 39.7% 42.6% Operating income (loss) $233 ($3,145) $3,378 ($3,962) ($7,526) $3,564 % of revenues 0.6% -7.9% -3.8% -6.0%
Transformation Solutions revenues reflected the continued decline in CarPoint revenues of $6,000 in the third quarter and $19,000 through nine months. CarPoint revenues declined because of a change in the CarPoint business model that occurred June 2001. The year-to-date decline was also impacted by a slowdown in customer relationship management consulting revenues that began in the third quarter of fiscal year 2001. Revenues for Automark Web Services grew about $3,000 or 130% in the third quarter and caused gross margins to increase over last year. SG&A expenses were less than last year for both the quarter and nine months. SG&A expenses reflect lower selling, marketing and R&D expenses. The elimination of goodwill amortization lowered SG&A expenses $1,502 in the third quarter and $4,727 year-to-date, as compared to last year. Third quarter's operating income represented the first profitable quarter since fiscal year 2000. DOCUMENTS
Three Months Nine Months --------------------------------------------- --------------------------------------------- 2002 2001 Change % Change 2002 2001 Change % Change ---------- ---------- ---------- ------------ ----------- ---------- --------- ------------ Net sales and revenues $44,668 $46,467 ($1,799) -4% $136,076 $140,793 ($4,717) -3% Gross profit $25,156 $27,293 ($2,137) -8% $78,476 $81,852 ($3,376) -4% % of revenues 56.3% 58.7% 57.7% 58.1% SG&A expenses $16,815 $17,395 ($580) -3% $51,545 $53,810 ($2,265) -4% % of revenues 37.6% 37.4% 37.9% 38.2% Operating income $8,341 $9,898 ($1,557) -16% $26,931 $28,042 ($1,111) -4% % of revenues 18.7% 21.3% 19.8% 19.9% EXCLUDING SPECIAL ITEMS Net sales and revenues $44,668 $46,467 ($1,799) -4% $136,076 $140,793 ($4,717) -3% Gross profit $25,156 $27,293 ($2,137) -8% $78,476 $81,852 ($3,376) -4% % of revenues 56.3% 58.7% 57.7% 58.1% SG&A expenses $16,815 $17,395 ($580) -3% $50,767 $53,810 ($3,043) -6% % of revenues 37.6% 37.4% 37.3% 38.2% Operating income $8,341 $9,898 ($1,557) -16% $27,709 $28,042 ($333) -1% % of revenues 18.7% 21.3% 20.4% 19.9%
Documents sales declined in both the third quarter and nine months as a result of the continued decline in the number of business forms sold. Gross profit margins were strong in fiscal year 2002, however, less than last year for both the quarter and nine months. Gross profit margins were less than last year in the third quarter of fiscal year 2002, primarily because of a higher mix of purchased products which have lower margins than standard forms. Operating income declined from last year reflecting both lower sales and gross margins. SG&A expenses were less than last year for both the quarter and nine months. The elimination of goodwill amortization lowered SG&A expenses $320 in the third quarter and $959 year-to-date, as compared to 14 last year. FINANCIAL SERVICES
Three Months Nine Months --------------------------------------------- --------------------------------------------- 2002 2001 Change % Change 2002 2001 Change % Change ---------- ---------- --------- ------------- ---------- ---------- --------- ------------- Net sales and revenues $10,696 $10,651 $45 0% $31,621 $31,340 $281 1% Gross profit $7,936 $7,427 $509 7% $23,570 $20,859 $2,711 13% % of revenues 74.2% 69.7% 74.5% 66.6% SG&A expenses $2,001 $1,658 $343 21% $6,391 $3,354 $3,037 91% % of revenues 18.7% 15.5% 20.2% 10.7% Operating income $5,935 $5,769 $166 3% $17,179 $17,505 ($326) -2% % of revenues 55.5% 54.2% 54.3% 55.9% EXCLUDING SPECIAL ITEMS Net sales and revenues $10,696 $10,651 $45 0% $31,621 $31,340 $281 1% Gross profit $7,936 $7,427 $509 7% $23,570 $20,859 $2,711 13% % of revenues 74.2% 69.7% 74.5% 66.6% SG&A expenses $2,001 $1,658 $343 21% $6,311 $3,354 $2,957 88% % of revenues 18.7% 15.5% 19.9% 10.7% Operating income $5,935 $5,769 $166 3% $17,259 $17,505 ($246) -1% % of revenues 55.5% 54.2% 54.6% 55.9%
Financial Services revenues grew only slightly over last year for both periods presented as a slight decline in average finance receivable balances was offset by a slight increase in average interest rates earned on finance receivables. Gross profit margins increased over last year as year-to-date interest rate spreads increased to 4.9% compared to 3.3% last year, as a result of lower borrowing costs. Borrowing costs declined because of greater use of lower rate floating rate debt. These interest rate spreads represent historically high margins for this segment. SG&A expenses increased over last year primarily because of higher bad debt expenses, which increased $150 over last year for the quarter and $2,350 year-to-date. Bad debt expenses reflected higher write-offs than a year ago. Overall, operating margins remained strong for both the third quarter and nine months. The company has entered into various interest rate management agreements to limit interest rate exposure on financial services variable rate debt. It is important to manage this interest rate exposure because the proceeds from these borrowings were invested in fixed rate finance receivables. The company believes that over time it has reduced interest expense by using interest rate management agreements and variable rate debt instead of directly obtaining fixed rate debt. During the quarter ended March 31, 2002, Reyna Funding, L.L.C., an affiliate of the company, entered into $80,000 of interest rate swaps in connection with obtaining $80,000 of variable rate debt. See Note 4 to the Consolidated Financial Statements for additional discussion of interest rate management agreements. LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS The company's cash position remained strong, with cash balances of $148,966 as of June 30, 2002. Cash flows from operating activities were $115,444 during the first nine months of the fiscal year and resulted primarily from net income, adjusted for non cash charges, primarily depreciation and amortization and the cumulative effect of the accounting change. Cash flows provided by investing activities included intercompany loan repayments and dividends from financial services and proceeds from the sale of internally used computer equipment as part of a computer services outsourcing arrangement. These operating and investing cash flows funded the company's investments for normal operations including capital expenditures of $30,503. Capital expenditures included about $15,000 for the construction of a new office building near Dayton, Ohio. During the first nine months of the fiscal year, the company also capitalized $15,831 of software licensed to customers. As of June 30, 2002, the balance of software licensed to customers was $75,373. Most of the capitalized software development costs related to Generations Series solutions scheduled for release in fiscal year 2003 when the company will begin amortizing these costs. Fiscal year 2002 capital expenditures and capitalized software in the ordinary course of business are anticipated to be about $50,000, net of proceeds from the sale of computer equipment, and include about $17,000 for the new office building and related contents. Fiscal year 2001 cash flows for discontinued operations represent primarily the payment of taxes associated with the August 2000 sale of the Information Solutions segment. Financial services operating cash flows, collections on finance receivables and additional borrowings were invested in new finance receivables for the company's automotive systems, used to make scheduled debt repayments and dividend payments to 15 automotive solutions. CAPITALIZATION The company's ratio of total debt (total automotive solutions debt) to capitalization (total automotive solutions debt plus shareholders' equity) was 19.6% as of June 30, 2002 and 19.0% as of September 30, 2001. Remaining credit available under committed revolving credit agreements was $100,000 at June 30, 2002. In addition to committed credit agreements, the company also has a variety of other short-term credit lines available. The company anticipates that cash balances, cash flow from operations and cash available from committed credit agreements will be sufficient to fund normal operations over the next year. Cash balances are placed in short-term investments until such time as needed. In August 1997, the company entered into an agreement with a trust for the construction and lease of an office building near Dayton, Ohio. The trust was formed by a consortium of institutional investors who purchased equity interests in the trust and provided loans to the trust for the construction of the building. This building was completed in 1999 at a cost of $28,800. This lease is accounted for as an operating lease for financial reporting purposes. Accordingly, neither the asset nor the related liability is reported on the company's balance sheets. The company has guaranteed 80% of the trust's debt related to the construction of the building. The company makes quarterly lease payments based on the outstanding lease balance of $28,800. The original five-year term was extended two years through August 2004. At the end of the lease term, the company may either purchase the building for $28,800 or sell the building on behalf of the lessor. If the building is sold and the proceeds from the sale are insufficient to repay the investors, the company may be required to make a payment to the lessor of up to 80% of the building's cost. Based on appraised values, management does not believe any additional payments will be required at the termination of the lease. On January 24, 2002, Reyna Funding, L.L.C., a consolidated affiliate of the company, entered into a loan funding agreement, whereby Reyna Funding, L.L.C. may borrow up to $100,000 using finance receivables purchased from Reyna Capital Corporation, also an affiliate of the company, as security for the loan. The securitization allows additional borrowings, up to the $100,000 limit, through January 23, 2003. This loan funding agreement is renewable annually through January 23, 2006. Any borrowings will be repaid as collections on finance receivables balances are received. During the second quarter of fiscal year 2002, Reyna Funding, L.L.C. borrowed $80,000 under this agreement. These borrowings were included with Financial Services' notes payable on the consolidated balance sheet. Proceeds received by Reyna Capital Corporation from Reyna Funding L.L.C. were used to retire other debt. The company has consistently produced strong operating cash flows sufficient to fund normal operations. Strong operating cash flows are the result of stable operating margins and a high percentage of recurring service revenues, which require relatively low capital investment. Debt instruments have been used primarily to fund business combinations and Financial Services receivables. As of June 30, 2002, the company can issue an additional $130,000 of notes under a shelf registration statement on file with the Securities and Exchange Commission. Management believes that its strong balance sheet and cash flows should help maintain an investment grade credit rating that should provide access to capital sufficient to meet the company's cash requirements beyond the next year. SHAREHOLDERS' EQUITY The company lists its Class A common shares on the New York Stock Exchange. There is no principal market for the Class B common shares. During the second quarter of fiscal year 2002, 4,000 Class B common shares were converted into 200 Class A common shares. The company also has an authorized class of 60,000 preferred shares with no par value. As of August 8, 2002, no preferred shares were outstanding and there were no agreements or commitments with respect to the sale or issuance of these shares, except for preferred share purchase rights described in the company's annual report on Form 10-K for the fiscal year ended September 30, 2001. Dividends are typically declared each November, February, May and August and paid in January, April, June and September. Dividends per Class A common share must be twenty times the dividends per Class B common share and all dividend payments must be simultaneous. The company has paid dividends every year since the company's initial public offering in 1961. During the nine months ended June 30, 2002, the company repurchased 3,600 Class A common shares for $96,343 ($26.76 per share). As of June 30, 2002, the company could repurchase an additional 1,100 Class A common shares under existing board of directors' authorizations. On August 6, 2002, the board of directors approved an increase of 5,000 shares to the company's share repurchase authorization. 16 MARKET RISKS INTEREST RATES The Automotive Solutions portion of the business borrows money, as needed, primarily to fund business combinations. Generally the company borrows under fixed rate agreements with terms of ten years or less. During February 2002, the company entered into $100,000 of interest rate swaps to reduce the effective interest expense on outstanding long-term debt. In this transaction the company effectively converted 7% fixed rate debt into variable rate debt. The Financial Services segment of the business, including Reyna Funding L.L.C., an affiliate of the company, obtains borrowings to fund the investment in finance receivables. These fixed rate receivables generally have repayment terms of five years. The company funds finance receivables with debt that has repayment terms consistent with the maturities of the finance receivables. Generally the company attempts to lock in the interest spread on the fixed rate finance receivables by borrowing under fixed rate agreements or using interest rate management agreements to manage variable interest rate exposure. The company does not use financial instruments for trading purposes. See Note 4 to the Consolidated Financial Statements for additional discussion of interest rate management agreements. Because the company's borrowings are generally under fixed rate debt arrangements or its equivalent (variable rate debt that has been fixed with interest rate swaps), management believes that a 100 basis point change in interest rates would not have a material effect on the company's financial statements. FOREIGN CURRENCY EXCHANGE RATES The company has foreign-based operations in Canada, which accounted for 6% of net sales and revenues for the nine months ended June 30, 2002. In the conduct of its foreign operations the company has intercompany sales, charges and loans between the U.S. and Canada and may receive dividends denominated in different currencies. These transactions expose the company to changes in foreign currency exchange rates. At June 30, 2002, the company had no foreign currency exchange contracts outstanding. Based on the company's overall foreign currency exchange rate exposure at June 30, 2002, management believes that a 10% change in currency rates would not have a material effect on the company's financial statements. ENVIRONMENTAL MATTER See Note 9 to the Consolidated Financial Statements for a discussion of the company's environmental contingencies. ACCOUNTING STANDARDS See Note 10 to the Consolidated Financial Statements for a discussion of the effect of accounting standards that the company has not yet adopted. FACTORS THAT MAY AFFECT FUTURE RESULTS Certain statements in this Management's Discussion and Analysis of the Financial Condition and Results of Operations constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are based on current expectations, estimates, forecasts and projections of future company or industry performance based on management's judgment, beliefs, current trends and market conditions. Forward-looking statements made by the company may be identified by the use of words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions. Forward-looking statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Actual outcomes and results may differ materially from what is expressed, forecasted or implied in any forward-looking statement. The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. See also the discussion of factors that may affect future results contained in the company's Current Report on Form 8-K filed with the SEC on August 11, 2000, which we incorporate herein by reference. 17 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K The company did not file any reports on Form 8-K during the quarter ended June 30, 2002. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE REYNOLDS AND REYNOLDS COMPANY Date August 12, 2002 /s/ Lloyd G. Waterhouse ----------------------- ------------------------------------ Lloyd G. Waterhouse Chairman, President and Chief Executive Officer Date August 12, 2002 /s/ Dale L. Medford ----------------------- ------------------------------------ Dale L. Medford Executive Vice President and Chief Financial Officer 19