UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
For the Quarterly Period Ended September 26, 2004
or
Commission File Number 1-6714
THE WASHINGTON POST COMPANY
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(202) 334-6000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x. No ¨.
Indicate by check mark whether the registrant is an accelerated filer as defined by Rule 12b-2 of the Exchange Act.
Yes x. No ¨.
Shares outstanding at October 28, 2004:
Class A Common Stock
Class B Common Stock
Index to Form 10-Q
PART I.
FINANCIAL INFORMATION
Item 1.
Financial Statements
a.
Condensed Consolidated Statements of Income (Unaudited) for the Thirteen and Thirty-Nine Weeks Ended September 26, 2004 and September 28, 2003
b.
Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the Thirteen and Thirty-Nine Weeks Ended September 26, 2004 and September 28, 2003
c.
Condensed Consolidated Balance Sheets at September 26, 2004 (Unaudited) and December 28, 2003
d.
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Thirty-Nine Weeks Ended September 26, 2004 and September 28, 2003
e.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Results of Operations and Financial Condition
Item 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Item 6.
Exhibits and Reports on Form 8-K
Signatures
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PART I. FINANCIAL INFORMATION
The Washington Post Company
Condensed Consolidated Statements of Income (Unaudited)
Operating revenues
Advertising
Circulation and subscriber
Education
Other
Operating costs and expenses
Operating
Selling, general and administrative
Depreciation of property, plant and equipment
Amortization of intangible assets
Income from operations
Other income (expense)
Equity in earnings (losses) of affiliates
Interest income
Interest expense
Other, net
Income before income taxes
Provision for income taxes
Net Income
Redeemable preferred stock dividends
Net income available for common shares
Basic earnings per share
Diluted earnings per share
Dividends declared per common share
Basic average number of common shares outstanding
Diluted average number of common shares outstanding
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Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Net income
Other comprehensive income (loss)
Foreign currency translation adjustment
Less: reclassification adjustment on sale of affiliate investment
Change in unrealized gain on available-for-sale securities
Less: reclassification adjustment for realized losses included in net income
Income tax expense related to other comprehensive income
Comprehensive income
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Condensed Consolidated Balance Sheets
December 28,
2003
Assets
Current assets
Cash and cash equivalents
Investments in marketable equity securities
Accounts receivable, net
Inventories
Income taxes receivable
Other current assets
Property, plant and equipment
Buildings
Machinery, equipment and fixtures
Leasehold improvements
Less accumulated depreciation
Land
Construction in progress
Investments in affiliates
Goodwill, net
Indefinite-lived intangible assets, net
Amortized intangible assets, net
Prepaid pension cost
Deferred charges and other assets
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable and accrued liabilities
Deferred revenue
Dividends declared
Federal and state income taxes payable
Short-term borrowings
Postretirement benefits other than pensions
Other liabilities
Deferred income taxes
Long-term debt
Redeemable preferred stock
Preferred stock
Common shareholders’ equity
Common stock
Capital in excess of par value
Retained earnings
Accumulated other comprehensive incomeCumulative foreign currency translation adjustment
Unrealized gain on available-for-sale securities
Cost of Class B common stock held in treasury
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Condensed Consolidated Statements of Cash Flows (Unaudited)
September 28,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of goodwill and other intangibles
Net pension benefit
Early retirement program expense
Gain from sale of affiliate
Cost method and other investment write-downs
Equity in losses of affiliates, net of distributions
Provision for deferred income taxes
Change in assets and liabilities:
Increase in accounts receivable, net
Increase in inventories
Increase in accounts payable and accrued liabilities
Increase in deferred revenue
Increase (decrease) in income taxes payable
(Increase) decrease in other assets and other liabilities, net
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of property, plant and equipment
Investments in certain businesses
Proceeds from the sale of business
Other investments
Net cash used in investing activities
Cash flows from financing activities:
Net repayment of commercial paper
Principal payments on debt
Dividends paid
Proceeds from exercise of stock options
Net cash used in financing activities
Effect of currency exchange rate change
Net (decrease) increase in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
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Results of operations, when examined on a quarterly basis, reflect the seasonality of advertising that affects the newspaper, magazine and broadcasting operations. Advertising revenues in the second and fourth quarters are typically higher than first and third quarter revenues. All adjustments reflected in the interim financial statements are of a normal recurring nature.
The Company generally reports on a 13 week fiscal quarter ending on the Sunday nearest the calendar quarter-end. With the exception of the newspaper publishing operations, subsidiaries of the Company report on a calendar-quarter basis.
Certain amounts in previously issued financial statements have been reclassified to conform with the 2004 presentation.
Note 1: Acquisitions and Dispositions.
In the third quarter of 2004, Kaplan acquired three businesses in their professional division totaling $3.9 million.
In the second quarter of 2004, Kaplan acquired two businesses in their higher education and professional divisions totaling $4.5 million, financed through cash and debt, with $0.3 million remaining to be paid. In addition, the cable division completed two small transactions for $1.8 million. In May 2004, the Company acquired El Tiempo Latino, a leading Spanish-language weekly newspaper in the greater Washington area.
In the first quarter of 2004, Kaplan acquired three businesses in their higher education and test preparation divisions, totaling $49.8 million, financed through cash and debt. Most of the purchase price has been allocated to goodwill on a preliminary basis.
In the third quarter of 2003, Kaplan acquired five additional businesses in its higher education and professional divisions for a total of $38.2 million, financed through cash and debt. In addition, the cable division acquired two additional systems for $1.2 million.
In the second quarter of 2003, Kaplan acquired two businesses in its higher education and professional divisions for a total of $17.5 million. In addition, the cable division acquired a system in North Dakota for $1.5 million.
In March 2003, Kaplan completed its acquisition of the stock of Financial Training Company (FTC), for £55.3 million ($87.4 million). Headquartered in London, FTC provides test preparation services for accountants and financial services professionals, with training centers in the United Kingdom and Asia.
On January 1, 2003, the Company sold its 50 percent interest in the International Herald Tribune for $65 million and the Company recorded an after-tax non-operating gain of $32.3 million in the first quarter of 2003.
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Note 2: Investments.
Investments in marketable equity securities at September 26, 2004 and December 28, 2003 consist of the following (in thousands):
September 26,
2004
Total cost
Gross unrealized gains
Total fair value
The Company made $46.9 million in investments in marketable equity securities during the third quarter of 2004. There were no sales of marketable equity securities in the first nine months of 2004 or 2003.
At September 26, 2004 and December 28, 2003, the carrying value of the Company’s cost method investments was $4.6 million and $9.6 million, respectively. In June 2004, one of the Company’s cost method investments went public and is now reported as a marketable equity security, recorded at fair value in the consolidated balance sheet, with the change in fair value during the period excluded from earnings and recorded net of tax as a separate component of comprehensive income. The Company recorded charges of $0 and $0.7 million during the third quarter and first nine months of 2004, respectively, to write-down certain of its investments to estimated fair value; for the same periods of 2003, the Company recorded charges of $0 and $1.1 million, respectively.
Note 3: Borrowings.
Long-term debt consists of the following (in millions):
Commercial paper borrowings
5.5 percent unsecured notes due February 15, 2009
4.0 percent notes due 2004-2006 (£8.3 million and £16.7 million at September 26, 2004 and December 28, 2003, respectively)
Other indebtedness
Total
Less current portion
Total long-term debt
The Company’s commercial paper borrowings at September 26, 2004 were at an average interest rate of 1.8% and mature through October 2004; the Company’s commercial paper borrowings at December 28, 2003 were at an average interest rate of 1.1% and matured through February 2004. During 2003, the notes of £16.7 million were issued to current FTC employees who were former FTC shareholders in connection with the acquisition. The noteholders, at their discretion, had the option of electing to receive 25% of their outstanding balance in January 2004. In August 2004, 50% of the original outstanding balance (less the amount paid in January 2004) was due for payment. As a result, payments of $6.2 million and $8.8 million were made in January 2004 and August 2004, respectively. The remaining balance outstanding is due for repayment in August 2006. The Company’s other indebtedness at September 26, 2004 and December 28, 2003 is at interest rates of 6% to 7% and matures from 2004 to 2009.
During the third quarter of 2004 and 2003, the Company had average borrowings outstanding of approximately $490.1 million and $595.5 million, respectively, at average annual interest rates of approximately 5.0 percent and 4.3 percent,
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respectively. During the third quarter of 2004 and 2003, the Company incurred net interest expense on borrowings of $6.5 million and $6.8 million, respectively.
During the first nine months of 2004 and 2003, the Company had average borrowings outstanding of approximately $532.9 million and $610.1 million, respectively, at average annual interest rates of approximately 4.7 percent and 4.2 percent, respectively. During the first nine months of 2004 and 2003, the Company incurred net interest expense on borrowings of $19.4 million and $20.2 million, respectively.
Note 4: Business Segments.
The following table summarizes financial information related to each of the Company’s business segments. The 2004 and 2003 asset information is as of September 26, 2004 and December 28, 2003, respectively.
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Third Quarter Period
(in thousands)
Income (loss) from operations
Equity in earnings of affiliates
Interest expense, net
Depreciation expense
Amortization expense
Net pension credit (expense)
Identifiable assets
Total assets
Equity in losses of affiliates
10
Nine Month Period
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Newspaper publishing includes the publication of newspapers in the Washington, D.C. area and Everett, Washington; newsprint warehousing and recycling facilities; and the Company’s electronic media publishing business (primarily washingtonpost.com).
The magazine publishing division consists of the publication of a weekly news magazine, Newsweek, which has one domestic and three international editions, the publication of Arthur Frommer’s Budget Travel, and the publication of business periodicals for the computer services industry and the Washington-area technology community.
Television broadcasting operations are conducted through six VHF, television stations serving the Detroit, Houston, Miami, San Antonio, Orlando and Jacksonville television markets. All stations are network-affiliated (except for WJXT in Jacksonville) with revenues derived primarily from sales of advertising time.
Cable television operations consist of cable systems offering basic cable, digital cable, pay television, cable modem and other services to subscribers in midwestern, western, and southern states. The principal source of revenue is monthly subscription fees charged for services.
Education products and services are provided through the Company’s wholly-owned subsidiary Kaplan, Inc. Kaplan’s businesses include supplemental education services, which is made up of Kaplan Test Prep and Admissions, providing test preparation services for college and graduate school entrance exams; Kaplan Professional, providing education and career services to business people and other professionals; and Score!, offering multi-media learning and private tutoring to children and educational resources to parents. Kaplan’s businesses also include higher education services, which includes all of Kaplan’s post-secondary education businesses, including fixed facility colleges which offer Bachelor’s degrees, Associate’s degrees and diploma programs primarily in the fields of healthcare, business and information technology; and online post-secondary and career programs (various distance-learning businesses, including kaplancollege.com).
Corporate office includes the expenses of the Company’s corporate office.
Note 5: Goodwill and Other Intangible Assets.
The Company’s intangible assets with an indefinite life are principally from franchise agreements at its cable division, as the Company expects its cable franchise agreements to provide the Company with substantial benefit for a period that extends beyond the foreseeable horizon, and the Company’s cable division historically has obtained renewals and extensions of such agreements for nominal costs and without any material modifications to the agreements. Amortized intangible assets are primarily non-compete agreements, with amortization periods up to five years.
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The Company’s goodwill and other intangible assets as of September 26, 2004 and December 28, 2003 were as follows (in thousands):
Goodwill
Indefinite-lived intangible assets
Amortized intangible assets
Activity related to the Company’s goodwill and other intangible assets during the nine months ended September 26, 2004 was as follows (in thousands):
Beginning of year
Acquisitions
Foreign currency exchange rate changes
Balance at September 26, 2004
Indefinite-Lived Intangible Assets, net
Amortization
Activity related to the Company’s goodwill and other intangible assets during the nine-months ended September 28, 2003 was as follows (in thousands):
Disposition
Balance at September 28, 2003
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Note 6: Change in Accounting Method – Stock Options.
Effective the first day of the Company’s 2002 fiscal year, the Company adopted the fair-value-based method of accounting for Company stock options as outlined in Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). This change in accounting method was applied prospectively to all awards granted from the beginning of the Company’s fiscal year 2002 and thereafter. Stock options awarded prior to fiscal 2002 are accounted for under the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The following table presents what the Company’s results would have been had the fair values of options granted after 1995, but prior to 2002, been recognized as compensation expense in the third quarter and first nine-months of 2004 and 2003 (in thousands, except per share amounts).
September
26, 2004
28, 2003
Net income available for common shares, as reported
Add: Company stock option compensation expense included in net income, net of related tax effects
Deduct: Total Company stock option compensation expense determined under the fair value based method for all awards, net of related tax effects
Pro forma net income available for common shares
Basic earnings per share, as reported
Pro forma basic earnings per share
Diluted earnings per share, as reported
Pro forma diluted earnings per share
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Note 7: Antidilutive Securities.
There were no antidilutive stock options outstanding during the third quarter and first nine months of 2004. The third quarter and first nine months of 2003 diluted earnings per share amounts exclude the effects of 12,000 and 11,500 stock options outstanding, respectively, as their inclusion would be antidilutive.
Note 8: Kaplan Stock Option Plan.
The Company maintains a stock option plan at its Kaplan subsidiary that provides for the issuance of Kaplan stock options to certain members of Kaplan’s management. The fair value of Kaplan’s common stock is determined by the Company’s compensation committee of the Board of Directors. In September 2003, the committee set the fair value price of Kaplan common stock at $1,625 per share, which is determined after deducting intercompany debt from Kaplan’s enterprise value. Also in September 2003, the Company announced an offer totaling $138 million for approximately 55% of the stock options outstanding at Kaplan. The Company’s offer included a 10% premium over the current valuation price of Kaplan common stock of $1,625 per share; by the end of October 2003, 100% of the eligible stock options were tendered. The Company paid out $118.7 million in the fourth quarter of 2003 and the remainder of the payouts, related to 14,463 tendered stock options, will be made at the time of their scheduled vesting from 2004 to 2007 if the option holder is still employed at Kaplan. Additionally, stock compensation expense will be recorded on these remaining exercised options over the remaining vesting periods of 2004 to 2007. A small number of key Kaplan executives continue to hold the remaining 68,000 outstanding Kaplan stock options, with roughly half of these options expiring in 2007 and half expiring in 2011. The remaining 68,000 of outstanding Kaplan stock options represent 4.8% of Kaplan’s common stock at September 30, 2004.
The Company recorded expense of $5.1 million and $74.6 million for the third quarter of 2004 and 2003, respectively, and $22.9 million and $104.6 million for the first nine months of 2004 and 2003, respectively, related to this plan.
Note 9: Pension and Postretirement Plans.
The total (income) cost arising from the Company’s defined benefit pension plans for the third quarter and nine months ended September 26, 2004 and September 28, 2003 consists of the following components (in thousands):
Service cost
Interest cost
Expected return on assets
Amortization of transition asset
Amortization of prior service cost
Recognized actuarial gain
Net periodic benefit
Total benefit
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The total (income) cost arising from the Company’s postretirement plans for the third quarter and nine months ended September 26, 2004 and September 28, 2003, consists of the following components (in thousands):
The expected rate of return on plan assets is 7.5% in 2004.
In December of 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act) was enacted. The Act introduced a prescription drug benefit under Medicare, as well as a federal subsidy to sponsors of retiree health benefit plans that provide a benefit that meets certain criteria. The Company’s other postretirement plans covering retirees currently provide certain prescription benefits to eligible participants. In accordance with FASB Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003,” the Company has concluded that the Act is not significant to the Company’s other postretirement plans; therefore, the effects of the Act shall be incorporated in the December 31, 2004 measurement of plan obligations.
Note 10: Recent Accounting Pronouncements.
In January 2003, the Financial Accounting Standards Board (the FASB) released Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 requires primary beneficiaries of Variable Interest Entities (VIEs) to consolidate those entities. In December 2003, the FASB published a revision of FIN 46 (FIN 46R) to clarify some of the provisions of FIN 46 and to defer the effective date of implementation for certain entities. Under the guidance of FIN 46R, entities that did not have interests in structures that are commonly referred to as SPEs are required to apply the provisions of the interpretation in financial statements for periods ending after March 14, 2004. Based on the provisions of FIN 46 and FIN 46R, the Company does not have any unconsolidated interests that are now required to be consolidated, and therefore, FIN 46 and FIN 46R did not have any impact on the Company in 2003 or 2004.
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This analysis should be read in conjunction with the consolidated financial statements and the notes thereto.
Revenues and expenses in the first and third quarters are customarily lower than those in the second and fourth quarters because of significant seasonal fluctuations in advertising volume.
Results of Operations
Net income for the third quarter of 2004 was $82.5 million ($8.57 per share), up from net income of $19.9 million ($2.06 per share) for the third quarter of last year.
In the third quarter of 2003, there was a partial buyout of the Kaplan stock compensation plan and total Kaplan stock compensation expense was $74.6 million. This year’s quarter three stock compensation expense was $5.1 million.
Revenue for the third quarter of 2004 was $820.0 million, up 16% from $706.1 million in 2003. The increase in revenue is due to strong revenue growth at all of the Company’s divisions, particularly the education and television broadcasting divisions.
Operating income was up for the third quarter of 2004 to $140.3 million, from $40.1 million in 2003. The increase is attributable to improved operating results at each of the Company’s divisions, as well as the decline in the charge for stock compensation expense at the Kaplan education division noted above.
For the first nine months of 2004, net income totaled $226.8 million ($23.54 per share), compared with net income of $153.6 million ($15.97 per share) for the same period of 2003. Results for the first nine months of 2004 included $22.9 million in stock compensation expense at the education division, versus $104.6 million for the first nine months of 2003.
Results for the first nine months of 2003 included an after-tax non-operating gain from the sale of the Company’s 50 percent interest in the International Herald Tribune (after-tax impact of $32.3 million, or $3.38 per share) and an early retirement program charge at The Washington Post newspaper (after-tax impact of $1.3 million, or $0.14 per share).
Revenue for the first nine months of 2004 was $2,397.4 million, up 17% over revenue of $2,053.5 million for the first nine months of 2003. The increase in revenue is due mostly to significant revenue growth at the Company’s education and television broadcasting divisions, along with strong revenue growth at the Company’s other divisions. Operating income increased to $391.2 million, from $226.1 million in 2003. Consistent with the Company’s third quarter results, the Company’s year-to-date results benefited from the decline in Kaplan stock compensation expense as discussed above. Also consistent with the Company’s results for the third quarter of 2004, the Company’s year-to-date results benefited from improved operating results at each of its operating divisions, particularly at the education and television broadcasting divisions.
Excluding charges related to early retirement programs, the Company’s operating income for the third quarter and first nine months of 2004 includes $10.9 million and $31.0 million of net pension credits, respectively, compared to $14.1 million and $41.0 million for the same periods of 2003. At December 28, 2003, the Company reduced its assumption on the discount rate from 6.75% to 6.25%. Overall, the
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pension credit for 2004 is expected to be down by approximately $13 million compared to 2003, excluding charges related to early retirement programs.
Newspaper Publishing Division. Newspaper publishing division revenue totaled $224.9 million for the third quarter of 2004, an increase of 6% from $211.4 million in the third quarter of 2003; division revenue increased 6% to $677.7 million for the first nine months of 2004, from $638.6 million for the first nine months of 2003. Division operating income for the third quarter increased 23% to $30.0 million, from $24.3 million in the third quarter of 2003; operating income increased 21% to $99.6 million for the first nine months of 2004, compared to $82.7 million for the first nine months of 2003. Third quarter operating results in 2004 reflect higher print and online advertising revenue, payroll savings from early retirement programs implemented at The Post in 2003, an 11% increase in newsprint expense at The Post, and a $2.1 million reduction in the net pension credit. The increase in operating income for the first nine months of 2004 is due to increased advertising revenue, cost control initiatives employed throughout the division, and a $2.2 million pre-tax early retirement program charge at The Washington Post newspaper in the second quarter of 2003, offset by an 8% increase in newsprint expense at The Post and an $8.5 million reduction in the net pension credit, excluding charges related to early retirement programs.
Print advertising revenue at The Washington Post newspaper in the third quarter increased 4% to $140.9 million, from $135.7 million in 2003, and increased 4% to $433.1 million for the first nine months of 2004, from $416.4 million for the first nine months of 2003. The increase in print advertising revenue for the third quarter of 2004 is primarily due to increases in classified recruitment and several special sections. Classified recruitment advertising revenue was up 23% to $20.1 million in the third quarter of 2004, a $3.7 million increase compared to the third quarter of 2003. The increase in print advertising revenue for the first nine months of 2004 is primarily due to increases in classified recruitment, general and preprints. Classified recruitment advertising revenue was up 21% to $58.7 million, a $10.2 million increase compared to the first nine months of 2003.
For the first nine months of 2004, Post daily and Sunday circulation declined 3.3% and 2.3%, respectively, compared to the same period of the prior year. For the nine months ended September 26, 2004, average daily circulation at The Post totaled 709,500 and average Sunday circulation totaled 1,014,000.
Revenue generated by the Company’s online publishing activities, primarily washingtonpost.com, increased 33% to $15.9 million for the third quarter of 2004, from $12.0 million in the third quarter of 2003; online revenues increased 37% to $44.7 million for the first nine months of 2004, from $32.6 million in the first nine months of 2003. Local and national online advertising revenues grew 55% and 59% for the third quarter and first nine months of 2004, respectively. Online classified advertising revenue on washingtonpost.com increased 27% in the third quarter of 2004 and 36% for the first nine months of 2004.
Television Broadcasting Division. Revenue for the television broadcasting division increased 22% in the third quarter of 2004 to $91.4 million, from $74.6 million in 2003, due primarily to $9.6 million in political advertising and $8.0 million in incremental summer Olympics-related advertising at the Company’s NBC affiliates. Offsetting these increases, the Company’s advertising revenues at its three television stations in Florida were adversely affected as a result of three hurricanes that hit Florida in the third quarter of 2004. For the first nine months of 2004, revenue increased 14% to $257.9 million, from $227.2 million in 2003. 2004 results include $16.8 million in political advertising and $8.0 million in incremental Olympics-advertising, while 2003 results were negatively impacted by several days of commercial-free coverage in connection with the Iraq war in March 2003.
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Operating income for the third quarter and first nine months of 2004 increased 36% and 22%, respectively, to $43.4 million and $118.3 million, respectively, from $31.9 million and $97.2 million for the third quarter and first nine months of 2003, respectively. The operating income increases are primarily related to the revenue growth discussed above, offset by approximately $0.9 million in expenses incurred in connection with the Florida hurricanes.
Magazine Publishing Division. Revenue for the magazine publishing division totaled $85.2 million for the third quarter of 2004, a 7% increase from $80.0 million for the third quarter of 2003; division revenue totaled $260.8 million for the first nine months of 2004, a 5% increase from $249.4 million for the first nine months of 2003. The revenue increase in the third quarter is due primarily to a 13% rise in advertising revenue, largely driven by increased ad pages at both the domestic and international editions of Newsweek, and one additional issue of the international division, offset by a 1% decrease in circulation revenue. The increase in revenues for the first nine months of 2004 is primarily due to an 11% increase in advertising revenue, largely from increased ad pages at the domestic and international editions of Newsweek, as well as lower travel-related advertising revenues at the Pacific edition of Newsweek in 2003 due to the SARS outbreak, offset by a 4% decrease in circulation revenue.
Operating income totaled $11.4 million for the third quarter of 2004, an 11% increase from $10.3 million in the third quarter of 2003. The increase in operating income is primarily due to the increase in Newsweek advertising revenue and a reduction in subscription acquisition, advertising and circulation expenses at the international editions of Newsweek, offset by increases in subscription acquisition, editorial and general operating expenses at the domestic edition of Newsweek. Operating income totaled $35.9 million for the first nine months of 2004, up 52% from $23.6 million for the first nine months of 2003. The year-to-date improvement in operating results is primarily attributable to increased advertising revenue, continued cost controls at Newsweek’s international editions, and improved results at the Company’s trade magazines.
Cable Television Division. Cable division revenue of $124.9 million for the third quarter of 2004 represents an 8% increase over 2003 third quarter revenue of $115.3 million; for the first nine months of 2004, revenue increased 9% to $372.3 million, from $340.3 million in 2003. The 2004 revenue increase is due to continued growth in the division’s cable modem and digital service revenues and a $2 monthly rate increase for basic cable service, effective March 1, 2004, at most of the cable division’s systems.
Cable division operating income for the third quarter of 2004 increased 9% to $24.5 million, from $22.5 million for the third quarter of 2003; for the first nine months of 2004, operating income increased 12% to $72.4 million, from $64.5 million for the first nine months of 2003. These increases in operating income are due mostly to the division’s significant revenue growth, offset by higher depreciation and programming expenses, along with increases in internet and employee benefit costs.
The increase in depreciation expense is due to significant capital spending in recent years that has enabled the cable division to offer digital and broadband cable services to its subscribers. At September 30, 2004, the cable division had approximately 220,500 digital cable subscribers, down slightly from 222,900 at December 31, 2003, but up from 212,700 at the end of September 2003. This represents a 31% penetration of the subscriber base. At September 30, 2004, the cable division had 165,600 CableONE.net service subscribers, compared to 121,700 at the end of September 2003. Both digital and cable modem services are now offered in virtually all of the cable division’s markets.
At September 30, 2004, the cable division had 712,800 basic subscribers, compared to 716,700 at the end of September 2003. The decrease is due to small losses associated with the basic rate increase discussed above.
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At September 30, 2004, Revenue Generating Units (RGUs), as defined by the NCTA Standard Reporting Categories, totaled 1,098,900, compared to 1,051,100 as of September 30, 2003. The increase is due to an increase in the number of digital cable and high speed data customers. RGUs include about 7,000 subscribers who receive free basic cable service, primarily local governments, schools and other organizations as required by the various franchise agreements.
Below are details of Cable division capital expenditures for the nine months of 2004 and 2003, as defined by the NCTA Standard Reporting Categories (in millions):
Customer Premise Equipment
Commercial
Scaleable Infrastructure
Line Extensions
Upgrade/Rebuild
Support Capital
Education Division. Education division revenue totaled $293.6 million for the third quarter of 2004, a 31% increase over revenue of $224.7 million for the same period of 2003. Excluding revenue from acquired businesses, primarily in the higher education division and the professional training schools that are part of supplemental education, education division revenue increased 24% for the third quarter of 2004. Kaplan reported operating income for the third quarter of 2004 of $38.0 million, compared to an operating loss for the third quarter of 2003 of $43.1 million; a significant portion of the improvement is due to a $69.5 million decrease in Kaplan stock compensation expense as discussed previously.
For the first nine months of 2004, education division revenue totaled $828.6 million, a 39% increase over revenue of $598.0 million for the same period of 2003. Excluding revenue from acquired businesses, primarily in the higher education division and the professional training schools that are part of supplemental education, education division revenue increased 25% for the first nine months of 2004. Kaplan reported operating income of $88.1 million for the first nine months of 2004, compared to an operating loss of $23.6 million for the first nine months of 2003; a significant portion of the improvement is due to an $81.7 million decrease in Kaplan stock compensation expense as discussed previously.
A summary of operating results for the third quarter and the first nine months of 2004 compared to 2003 is as follows:
Revenue
Supplemental education
Higher education
Operating income (loss)
Kaplan corporate overhead
Other*
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Supplemental education includes Kaplan’s test preparation, professional training and Score! businesses. Part of the increase in supplemental education revenue and operating income for the first nine months of 2004 is from Financial Training Company (FTC), which was acquired in March 2003. Headquartered in London, FTC provides test preparation services for accountants and financial services professionals, with training centers in the United Kingdom and Asia. The improvement in supplemental education results for 2004 is also due to strong enrollment growth at Kaplan’s traditional test preparation business (particularly the SAT/PSAT and MCAT) and the professional real estate courses. Score! also contributed to the improved revenue and operating results due to higher rates and 11 new centers compared to 2003.
Higher education includes all of Kaplan’s post-secondary education businesses, including fixed-facility colleges as well as online post-secondary and career programs (various distance-learning businesses). Higher education results are showing significant growth, due to student enrollment increases and several acquisitions.
Corporate overhead represents unallocated expenses of Kaplan, Inc.’s corporate office.
Other expense is comprised of accrued charges for stock-based incentive compensation arising from a stock option plan established for certain members of Kaplan’s management and amortization of certain intangibles. Under the stock-based incentive plan, the amount of compensation expense varies directly with the estimated fair value of Kaplan’s common stock and the number of options outstanding. For the third quarter of 2004 and 2003, the Company recorded expense of $5.1 million and $74.6 million, respectively, and $22.9 million and $104.6 million for the first nine months of 2004 and 2003, respectively, related to this plan. The stock compensation expense for the first nine months of 2003 includes the impact of the third quarter 2003 buyout offer for approximately 55% of the stock options outstanding at Kaplan. The stock compensation expense in 2004 is based on the remaining Kaplan stock options held by a small number of Kaplan executives after the 2003 buyout.
Corporate Office. The corporate office operating expenses increased in the third quarter of 2004 to $7.0 million, from $5.8 million in the third quarter of 2003; for the first nine months of 2004, expenses increased to $23.1 million, from $18.2 million for the first nine months of 2003. The increase in expenses is associated with several company-wide technology projects and compliance costs in connection with Section 404 of the Sarbanes-Oxley Act of 2002.
Equity in Losses of Affiliates. The Company’s equity in earnings of affiliates for the third quarter of 2004 was $0.5 million, compared to losses of $1.1 million for the third quarter of 2003. For the first nine months of 2004, the Company’s equity in losses of affiliates totaled $1.5 million, compared to losses of $9.3 million for the same period of 2003. The Company’s affiliate investments consist of a 49 percent interest in BrassRing LLC and a 49 percent interest in Bowater Mersey Paper Company Limited. The reduction in affiliate losses for 2004 is attributable to improved operating results at both BrassRing and Bowater.
Other Non-Operating Income. The Company recorded other non-operating income, net, of $0.9 million for the third quarter of 2004, compared to $1.6 million of other non-operating income, net, in the third quarter of 2003. The Company recorded other non-operating income, net, of $1.5 million for the first nine months of 2004, compared to other non-operating income, net, of $52.0 million for the same period of the prior year. The 2003 non-operating income, net, is comprised mostly of a $49.8 million pre-tax gain from the sale of the Company’s 50 percent interest in the International Herald Tribune.
A summary of non-operating income (expense) for the thirty-nine weeks ended September 26, 2004 and September 28, 2003, follows (in millions):
Gain on sale of interest in IHT
Impairment write-downs on cost method and other investments
Foreign currency gains, net
Net Interest Expense. The Company incurred net interest expense of $6.5 million and $19.4 million for the third quarter and first nine months of 2004, respectively, compared to $6.8 million and $20.2 million for the same periods of 2003. At September 26, 2004, the Company had $499.2 million in borrowings outstanding at an average interest rate of 5.0%.
Provision for Income Taxes. The effective tax rate for the third quarter and first nine months of 2004 was 39.0%, compared to 41.0% and 38.2%, respectively, for the same periods of 2003. The 2003 year-to-date effective tax rate benefited from the 35.1% effective tax rate applicable to the one-time gain arising from the sale of the Company’s interest in the International Herald Tribune.
Earnings Per Share. The calculation of diluted earnings per share for the third quarter and first nine months of 2004 was based on 9,598,000 and 9,591,000 weighted average shares outstanding, respectively, compared to 9,556,000 and 9,554,000, respectively, for the third quarter and first nine months of 2003. The Company made no significant repurchases of its stock during the first nine months of 2004.
Financial Condition: Capital Resources and Liquidity
Acquisitions and Dispositions. In the third quarter of 2004, Kaplan acquired three businesses in their professional division totaling $3.9 million.
In the second quarter of 2004, Kaplan acquired two businesses in their higher education and professional divisions, totaling $4.5 million, financed through cash and debt, with $0.3 million remaining to be paid. In addition, the cable division completed two small transactions for $1.8 million. In May 2004, the Company acquired El Tiempo Latino, a leading Spanish-language weekly newspaper in the greater Washington area.
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Capital expenditures. During the first nine months of 2004, the Company’s capital expenditures totaled $137.8 million. The Company estimates that its capital expenditures will be in the range of $190 million to $215 million in 2004.
Liquidity. Throughout the first nine months of 2004, the Company’s borrowings, net of repayments, decreased by $131.9 million, with the decrease primarily due to cash flows from operations.
At September 26, 2004, the Company had $499.2 million in total debt outstanding, which comprised $66.2 million of commercial paper borrowings, $398.8 million of 5.5 percent unsecured notes due February 15, 2009, and $34.2 million in other debt.
During the third quarter of 2004 and 2003, the Company had average borrowings outstanding of approximately $490.1 million and $595.5 million, respectively, at average annual interest rates of approximately 5.0 percent and 4.3 percent, respectively. During the third quarter of 2004 and 2003, the Company incurred net interest expense on borrowings of $6.5 million and $6.8 million, respectively.
At September 26, 2004 and December 28, 2003, the Company has a working capital deficit of $120.0 million and $216.0 million, respectively. The Company maintains working capital levels consistent with its underlying business requirements and consistently generates cash from operations in excess of required interest or principal payments. The Company has classified all of its commercial paper borrowing obligations as a current liability at September 26, 2004 and December 28, 2003 as the Company intends to pay down commercial paper borrowings from operating cash flow. However, the Company continues to maintain the ability to refinance such obligations on a long-term basis through new debt issuance and/or its revolving credit facility agreements.
The Company expects to fund its estimated capital needs primarily through internally generated funds and, to a lesser extent, commercial paper borrowings. In management’s opinion, the Company will have ample liquidity to meet its various cash needs throughout 2004.
As noted above, the Company’s borrowings have declined by $131.9 million, to $499.2 million, as compared to borrowings of $631.1 million at December 28, 2003. In the second quarter of 2004, the Company entered into a building lease and other commitments aggregating about $45.0 million from 2004 through 2014. There were no other significant changes to the Company’s contractual obligations or other commercial commitments from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 28, 2003.
Forward-Looking Statements
This report contains certain forward-looking statements that are based largely on the Company’s current expectations. Forward-looking statements are subject to various risks and uncertainties that could cause actual results or events to differ materially from those anticipated in such statements. For more information about these forward-looking statements and related risks, please refer to the section titled “Forward-Looking Statements” in Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2003.
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An evaluation was performed by the Company’s management, with the participation of the Company’s Chief Executive Officer (the Company’s principal executive officer) and the Company’s Vice President-Finance (the Company’s principal financial officer), of the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of September 26, 2004. Based on that evaluation, the Company’s Chief Executive Officer and Vice President-Finance have concluded that the Company’s disclosure controls and procedures, as designed and implemented, are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
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PART II. OTHER INFORMATION
ExhibitNumber
Description
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Current Report on Form 8-K dated July 30, 2004, reporting under Item 7 the Company’s second quarter earnings and including as an exhibit the Company’s press release dated July 30, 2004.
Current Report on Form 8-K dated September 9, 2004, reporting under Item 5 the Company’s announcement of the election of Melinda Gates to the Board of Directors.
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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.
(Registrant)
Date: October 29, 2004
Donald E. Graham,
Chairman & Chief Executive Officer
(Principal Executive Officer)
John B. Morse, Jr.,
Vice President-Finance
(Principal Financial Officer)
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