ITEM 1. BUSINESS
The Reynolds and Reynolds Company, founded in 1866 and an Ohio corporation since 1889 (the "company"), operates principally in three business segments: the Automotive Group, the Information Solutions Group and Financial Services.
AUTOMOTIVE GROUP
During the late 1920s, the company created a niche in the automotive market by manufacturing and selling standardized business forms for automobile dealerships across the United States. Then, in the mid-1960s the company leveraged its strong relationships with automobile dealers and manufacturers, and its knowledge of the automotive industry by applying that knowledge to develop automated accounting solutions for automobile dealerships. Over the next three decades, the company moved from those early simple batch systems to its current extensive portfolio of retail management solutions for automotive retailers and manufacturers. Today, the Group provides a complete range of automotive retailing solutions including systems and support, consulting and professional services, e-business, customer relationship management networking-software and data communications systems; a complete line of paper-based and electronic business forms and integrated document management systems. The company also owns an equity interest in Kalamazoo Computer Group plc, a Great Britain based leading supplier of information management systems to the automotive retail market in Europe.
INFORMATION SOLUTIONS GROUP
Although the company served the business forms needs of the general business market ever since its founding in 1866, it did not seriously expand its coverage of that market until the acquisition of The Arnold Corporation in 1986. Since that time, the company has further expanded its position through internal growth and acquisitions, most notably the acquisitions of Duplex Products Inc. (1996), Vanier Graphics (1996) and Crain-Drummond (1997). While printed business forms remain a significant source of revenue, this business today sells a balanced mix of traditional forms and digital solutions for medium to large-sized organizations. Key to the Group's offerings is the Internet-based Reynolds Advantage solution which will allow customers to process document requisitions, electronic forms distribution, customized reporting and billing using their Web browsers. It will also include hot links to Reynolds' supplier partners' home pages so customers can shop multiple supply catalogs without leaving their offices. The Group is increasingly expanding its customer relationship management (CRM) services to include strategic direct marketing campaign development and implementation. The Group is also leveraging its e-business skills to create e-CRM solutions. The Group operates 22 manufacturing and 32 distribution facilities across North America.
FINANCIAL SERVICES
Through its wholly-owned subsidiary, Reyna Capital Corporation, the company provides financing services to automotive retailers across North America who wish to invest in the acquisition of one of the Automotive Group's retail management systems. Reyna's portfolio also includes a number of finance receivables for computer systems previously offered by the discontinued Healthcare Systems segment.
FINANCIAL INFORMATION ABOUT SEGMENTS AND FOREIGN AND DOMESTIC OPERATIONS
See Note 13 to the Consolidated Financial Statements on page 50 for financial and descriptive information about the business segments described above, including information about foreign and domestic operations and export sales.
NEW PRODUCTS
New products and services introduced by the company's Automotive Group include: eService Reminders, a Web-enabled service marketing process which will allow automotive retailers to perform service marketing through direct, online interaction with their customers; and Managed Connections, a family of networking services.
New products and services introduced by the company's Information Solutions Group include: Reynolds' E-Merge(R) interViewer which enables end-users to quickly view, annotate and print electronic documents through their preferred Web browser; a major enhancement to the Group's electronic printing and mailing services that provides high-speed automated verification and quality inspection for critical mailings like checks and statements; an enhanced eDocument Repository service, a complete outsourcing solution that provides companies the flexibility to digitally distribute and archive business critical documents via a Web browser using the Internet, intranet or an extranet environment; and the formation of a new electronic Customer Relationship Management group to deliver technology- and Internet-enabled customer marketing solutions.
RAW MATERIALS
Computer hardware and peripherals are essential to the company's Automotive Group. It purchases these products from a variety of suppliers. The hardware platform for the ERA system is supplied by Silicon Graphics, Inc. If this source of supply were to be interrupted, some delay would occur in converting to a new platform. The company historically has not experienced difficulties in obtaining hardware and peripherals, nor does it reasonably foresee difficulty in obtaining them in the future on competitive terms and conditions.
An adequate supply of paper products is essential to the manufacture of the company's business forms product line. The company obtains those products from major suppliers and historically has not experienced difficulties in obtaining them, nor does it reasonably foresee difficulty in obtaining them in the future on competitive terms and conditions. Through its supply management initiative, the company from time to time has realized substantial savings by consolidating its purchases of goods and services with a single supplier. While there is some risk in being dependent on a single supplier, the company believes if one of those single sources of supply were to be interrupted for whatever reason, the goods and services would be available from an alternate source of supply on competitive terms and conditions.
PATENTS, TRADEMARKS AND RELATED RIGHTS
Except as described below, the company does not have any patents, trademarks, licenses, franchises or concessions which are material to an understanding of its business.
The company's trademark REYNOLDS & REYNOLDS(R) is associated with many goods and services provided by the company. In the automotive systems market, the company has a number of direct and indirect distribution and licensing arrangements with equipment vendors and software providers relating to certain components of the company's products, including the principal operating systems. Such arrangements are in the aggregate, but not individually (except for the operating systems), material to the company's business.
COMPETITION
The company's Automotive Group is North America's leading provider of retail management solutions to automotive retailers. The Group's main competitor is Automatic Data Processing, Inc., whose assets and financial resources substantially exceed those of the company. Together, the two vendors provide a significant share of the information management systems for automotive retailers in the United States and Canada. The company's automotive forms business has a leading market share position but experiences energetic competition from local printing brokers and regional printers across the United States and Canada.
The company's Information Solutions Group is one of four large North American business forms and document management services providers, some of whom have assets and resources greater than those of the company. Even when combined, those four companies have less than a majority share of the document services business in the general business market, which is also served by a large number of local and regional brokers and printers.
The company believes it competes in both business segments by providing high value-added products, services and solutions that satisfy market needs and use current technology to provide additional value and to improve price and performance. By specializing in a particular niche market, the Automotive Group has emphasized reliable and responsive service, broad industry knowledge and long-term relationships to meet customer needs more effectively.
While no single customer accounts for five percent or more of the revenues of any of the three business segments, the company does have several significant customers whose loss, in the aggregate, could be material to the Information Solutions Group. The company believes that the likelihood of losing all such customers is remote.
BACKLOG
AUTOMOTIVE GROUP: The backlog represents computer systems or upgrades which have not been shipped to customers (includes deferred revenues and software license fees). At December 1, 1999, the dollar value of the backlog, is estimated to be $41,772 compared with $44,537 last year.
INFORMATION SOLUTIONS GROUP: The company manufactures several thousand different types of standard and custom business forms. At December 1, 1999, the dollar value of the printing backlog (includes deferred revenues) is $54,238 compared with $42,818 last year.
The company expects the backlogs of the Automotive Group and the Information Solutions Group to be shipped and/or recognized as revenue during the coming fiscal year.
RESEARCH AND DEVELOPMENT
During fiscal 1999 the company continued its research and development to deliver new and enhanced solutions for customers in the automotive and general business markets. Expenditures for those activities were approximately $54,960 in 1999, $46,588 in 1998 and $43,052 in 1997.
ENVIRONMENTAL PROTECTION
The company believes that it is in substantial compliance with all applicable federal, state and local statutes concerning environmental protection. The company has not experienced any material costs in this regard. The U.S. Environmental Protection Agency has designated the company as one of a number of potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act at one environmental remediation site. (See Note 14 to the Consolidated Financial Statements, page 52.)
EMPLOYEES
On September 30, 1999, the company and its subsidiaries employed 9,083 persons.
ITEM 2.
ITEM 2. PROPERTIES
As of September 30, 1999, the company operated 16 forms manufacturing plants in the United States and 6 in Canada encompassing approximately 2.1 million square feet. Of those, approximately 1.3 million square feet are owned outright by the company. The remaining .8 million square feet are leased. Corporate headquarters and the respective division headquarters are located in Dayton, Ohio in several buildings owned by the company which contain more than .7 million square feet. In addition, the company leases approximately 179 sales offices and 32 warehouses throughout the country.
Most printing and other equipment used in the manufacture of business forms is owned by the company and its subsidiaries.
In early 1999 the company completed the first phase of a new Dayton facility (240,000 square feet which is included in the .7 million square feet noted in the first paragraph) for its operating divisions. The new campus provides an environment that fosters high-level creative thinking and enhances the company's ability to attract and retain a very high quality workforce. In the fall of 1999, the company broke ground on phase two (352,000 square feet) of the new facility. See Note 16 to the Consolidated Financial Statements on page 52.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Relevant information appears in Note 14 to the Consolidated Financial Statements on page 52.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
PART II
(Dollars in thousands except per share data)
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The company's Class A Common Shares are listed on the New York Stock Exchange. There is no principal market for the Class B Common Shares. The company also has an authorized class of 60 million preferred shares with no par value. As of the filing of this report, the company currently has no agreements or commitments with respect to the sale or issuance of the preferred shares except as described in Note 8 to the Consolidated Financial Statements, page 43.
Information on market prices and dividends is set forth below:
CLASS A COMMON SHARES SALE PRICES
1999 1998 ----- ---- Fiscal Quarter High Low High Low -------------- ---- --- ---- --- First $22.94 $16.50 $21.00 $17.00 Second $23.25 $17.75 $22.25 $17.69 Third $23.44 $18.31 $23.88 $16.88 Fourth $25.13 $20.38 $18.50 $12.63
CASH DIVIDENDS PAID
Class A Common Class B Common -------------- -------------- Months 1999 1998 1999 1998 ------ ----- ----- ----- ---- January $.10 $.09 $.005 $.0045 April $.10 $.09 $.005 $.0045 June $.10 $.09 $.005 $.0045 September $.10 $.09 $.005 $.0045
As of December 1, 1999, there were approximately 3,874 holders of record of Class A Common Shares and one holder of record of Class B Common Shares.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In thousands except per share data)
SIGNIFICANT EVENTS
ACCOUNTING CHANGE
In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, "Software Revenue Recognition," which superseded SOP 91-1, "Software Revenue Recognition." SOP 97-2 provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The company adopted this pronouncement effective October 1, 1998. The adoption of this pronouncement reduced the Automotive Group's computer systems products revenues $17,936, gross profit $11,205, operating income $10,624 and net income $6,204 or $.08 per diluted share during the six months ended March 31, 1999. The company completed the transition period for the adoption of SOP 97-2 as of March 31, 1999, and there was no impact on fiscal year 1999's third or fourth quarter operating results.
DISCONTINUED OPERATIONS
In September 1998, the company's board of directors approved a plan to discontinue operations of the company's Healthcare Systems segment. This business segment provided computer systems products and services to hospital-based and office-based physicians. Net sales and revenues were $48,226 in 1998 and $40,346 in 1997. Operating losses were $16,700 in 1998 and $32,055 in 1997. Operating losses in 1997 included restructuring and special charges of $13,075. The operating results of the Healthcare Systems segment have been presented as discontinued operations in the statements of consolidated income.
On October 23, 1998, the company sold essentially all net assets of Healthcare Systems to InfoCure Corporation for about $50,000. The proceeds consisted of about $40,000 in cash with the balance in subordinated notes. The company recorded a gain on the sale of $5,785 or $.07 per diluted share in the first quarter of fiscal year 1999. This gain was presented as discontinued operations in the statements of consolidated income. See Note 2 to the Consolidated Financial Statements for more information on discontinued operations.
SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement requires that a public enterprise report financial and descriptive information about its reportable operating segments. Generally, financial information is required to be reported on the same basis used internally for evaluating segment performance and deciding how to allocate resources to segments. In 1998, the company determined that its reportable operating segments under the new pronouncement were Automotive, Information Solutions (previously Business Systems), Healthcare Systems and Financial Services. Automotive, Information Solutions and Healthcare Systems operate as independent groups with separate management, operations and sales personnel, different customers and their own unique products and services. Financial Services will continue to be reported as a separate segment because, as a financing operation, it has a much different financial profile than other groups. See Note 13 to the Consolidated Financial Statements for more information on business segments.
RESTRUCTURING AND SPECIAL CHARGES
During fiscal year 1997, the company recorded pretax charges of $49,241 consisting of a $25,339 restructuring charge ($1,427 included in discontinued Healthcare Systems operations) and $23,902 of other special charges ($11,648 included in discontinued Healthcare Systems operations). After income taxes, the restructuring and special charges reduced net income by $34,078 or $.41 per share. The income tax benefit on the combined charges represented a 30.8% effective income tax rate because not all of the charges were tax deductible. See Note 3 to the Consolidated Financial Statements for more information on restructuring and special charges.
BUSINESS COMBINATIONS
In fiscal year 1997, the Information Solutions Group purchased two sizable business forms and document management services companies. On July 2, 1997, the company purchased the outstanding shares of Canadian-based Crain-Drummond Inc. from UARCO, a subsidiary of Settsu Corporation of Osaka, Japan. Effective December 31, 1996, the company purchased substantially all net assets of Vanier Graphics Corporation from American Business Products. Crain-Drummond and Vanier Graphics provide document outsourcing, document management and work optimization services to customers in Canada and the United States, respectively. The combined annual revenues of these two businesses were about $261,000 in fiscal year 1996. The company retained about $190,000 of these sales. See Note 4 to the Consolidated Financial Statements for additional disclosures about the company's business combinations.
RESULTS OF OPERATIONS
CONSOLIDATED SUMMARY
Consolidated net sales and revenues were a new record for the company in 1999 and grew for the ninth consecutive year. Excluding the previously mentioned accounting change, consolidated net sales and revenues increased 6% in 1999 with Automotive revenues growing 9% and Information Solutions sales rising 3%. All growth was internally generated as no business combinations occurred in 1999 or 1998. About $110,000 of 1998 sales growth resulted from the full year effect of 1997 business combinations. Excluding the effect of business combinations, consolidated net sales and revenues increased 2% in 1998 as Automotive's 9% revenue growth was partially offset by Information Solutions' lower sales.
Consolidated gross profit represented 46.2% of Information Systems revenues (excluding Financial Services) in 1999, compared to 44.9% in 1998 and 45.4% in 1997. Both Automotive and Information Solutions improved their gross profit margins in 1999. In 1998, gross profit margins declined primarily as a result of the full year effect of 1997 business combinations. The acquired businesses had lower gross profit margins than the company's existing Information Solutions Group. Automotive gross profit margins were essentially flat in 1998 as compared to 1997 (excluding restructuring and special charges).
As a percentage of revenues, consolidated operating income was 13.1% in 1999 (13.7% excluding the accounting change) compared to 13.7% in 1998 and 11.8% in 1997 (14.2% excluding 1997 restructuring and special charges). Excluding the accounting change, operating margins remained consistent in 1999 as the company increased investment in new businesses, product development and internal systems. Information Solutions operating margins improved from 5.9% in 1998 to 7.2% in 1999 because of the improvement in gross profit margins. Automotive operating margins declined slightly from 21.7% in 1998 to 21.2% (excluding the accounting change) in 1999 because of higher investment in development of new products and services. The company also invested in an
enterprise resource planning (ERP) system and incurred about $.05 cents per share of ERP related expenses during 1999. The company has refocused its ERP efforts and now estimates that about $.01 cent per share will be incurred during each quarter of fiscal year 2000 to complete the initial phase of this implementation. The 1998 decline in operating profit percentages (excluding 1997 restructuring and special charges) resulted primarily from including the lower operating margins of the 1997 business combinations.
Interest expense was $13,201 in 1999, $15,196 in 1998 and $10,443 in 1997. In 1998, the company borrowed to finance the July 1997 purchase of Crain-Drummond. Interest income was $6,971 in 1999, $2,505 in 1998 and $2,306 in 1997. The increase in 1999 resulted from higher cash balances from strong operating cash flows and the sale of the Healthcare Systems segment. Other income increased in 1999, compared to 1998 and 1997, primarily because of gains on the sales of several smaller product lines in 1999. Other income also included the company's share of losses from its equity interest in Kalamazoo Computer Group plc. See Note 1 to the Consolidated Financial Statements for additional disclosures about the company's investment in Kalamazoo.
The effective income tax rate was 41.3% in 1999, compared to 39.6% in 1998 and 45.5% in 1997. Excluding the following items, the comparable tax rates were 43.0% in 1998 and 42.9% in 1997. The 1999 tax rate was lower than the comparable 1998 and 1997 tax rates because of lower state income tax rates. The 1998 tax rate reflected a $4,910 gain from the favorable resolution of several tax audits. The 1997 tax rate included the effect of nondeductible restructuring and special charges.
In 1999, net income and earnings per common share (diluted) set new records for the company as net income exceeded $122,000. The effect of the accounting change was essentially offset by the gain on the sale of the Healthcare Systems segment. Also contributing to earnings per share were fewer average shares outstanding, primarily as a result of the company's share repurchase program. In fiscal year 1999, return on average shareholders' equity also reached a new high of 28.3%, compared to 26.8% in 1998 and 24.2% in 1997 (excluding the effect of restructuring and special charges).
AUTOMOTIVE
In 1999 and 1998, Automotive revenues increased because of strong growth of computer services and systems revenues, which more than offset a slight decline in automotive business forms sales. Computer services revenues increased 17% in 1999 and 15% in 1998 primarily because of the increased number of software applications
supported. Computer systems products sales increased 5% (excluding the accounting change) in 1999 and 9% in 1998 primarily because of higher sales of ERA2 retail management systems. In 1998, increased sales of electronic parts catalogs also contributed to the sales growth. In 1998, a portion of the higher sales volume resulted from customers replacing systems that were not year 2000 qualified. Automotive business forms sales declined slightly each year because of lower volume, primarily caused by the shift to laser printing. The company includes its laser printing equipment, software and support revenues in computer systems products and services, respectively, and related forms and supplies sales in business forms products. In 1999 and 1998, laser revenues, while still relatively small, continued to grow rapidly. Management expects the shift from printed forms to laser printing to continue.
Gross profit margins increased in 1999 because of the growth in higher margin recurring service revenues. Gross profit percentages were essentially flat in fiscal year 1998 compared to 1997 (excluding 1997 special charges).
Operating margins remained strong, exceeding 21% for each of the three years (excluding the 1999 accounting change and the 1997 restructuring and special charges). In 1999, operating margins declined slightly because of increased investments in new businesses and product development.
INFORMATION SOLUTIONS
In fiscal year 1999, Information Solutions sales increased 3% with volume and price each contributing about half of the increase. In fiscal year 1998, Information Solutions revenues rose because of the full year effect of 1997 business combinations that contributed about $110,000 of the sales increase. Excluding the effect of the business combinations, sales declined about 5% in 1998 because of reduced volume and lower sales prices. Sales prices were lowered in 1998 to reflect declining paper costs.
In 1999, Information Solutions gross profit margin increased over last year because of higher sales and the full year benefit of the 1997 restructuring, which included closing four manufacturing plants. These benefits overcame the initial negative margin impact of several large new accounts. Information Solutions gross profit percentage declined in 1998 primarily because of including lower gross profit margins of businesses acquired (Crain-Drummond and Vanier Graphics). In 1998, paper costs declined during the year. Gross profit margins were relatively unaffected by the decline in paper costs because the company lowered sales prices a comparable amount.
Operating income grew 25% in 1999 and operating margins were the highest since 1996. During the last six months of fiscal year 1999, operating margins neared 8%, compared to 5% in the last six months of fiscal year 1998. Operating margins declined in fiscal year 1998 primarily because businesses acquired in 1997 had lower operating margins than existing businesses. SG&A expenses were relatively constant, as a percentage of revenues, during the last three years.
FINANCIAL SERVICES
Average finance receivables grew 8% in 1999 and 14% in 1998 as a result of computer systems sales growth. Financial Services revenues grew each of the last two years because of the increased receivables balances. The average interest rate earned on the portfolio of finance receivables was relatively stable over the last three years.
Financial Services' interest rate spread remained strong at 3.7% in 1999, compared to 3.2% in 1998 and 3.5% in 1997. The 1999 increase in interest rate spread occurred primarily because of lower borrowing rates on debt. The 1998 decline in the interest rate spread resulted from slightly higher borrowing rates. Bad debt expenses were $2,550 in 1999, $2,395 in 1998 and $1,600 in 1997.
LIQUIDITY AND CAPITAL RESOURCES
INFORMATION SYSTEMS CASH FLOWS (EXCLUDING FINANCIAL SERVICES)
Information Systems continued to provide strong cash flows from operating activities in fiscal year 1999. Net cash provided by operating activities was $145,088 in 1999 compared to $146,248 in 1998. Fiscal year 1999's operating cash flow resulted primarily from net income adjusted for non-cash charges, such as depreciation and amortization. This strong cash flow funded the company's investments for normal operations including capital expenditures of $54,386. Fiscal year 2000 capital expenditures in the ordinary course of business are anticipated to be about $65,000 to $70,000. The anticipated increase in fiscal year 2000 capital expenditures is principally because of the construction of a new office building near Dayton, Ohio. During fiscal year 1999, the company also capitalized $16,038 of software licensed to customers, consisting of about $2,500 of purchased software with the balance representing capitalization of payroll costs for employees and independent contractors. In October 1998, the company received about $40,000 of proceeds from the sale of the Healthcare Systems segment. See the shareholders' equity caption of this analysis regarding the payment of dividends and share repurchases.
FINANCIAL SERVICES CASH FLOWS
Financial Services operating cash flow, collections on finance receivables and additional borrowings were invested in new finance receivables for the company's computer systems and used to make scheduled debt repayments.
CAPITALIZATION
The company's ratio of total debt (total Information Systems debt) to capitalization (total Information Systems debt plus shareholders' equity) was 26.8% at September 30, 1999 and 29.4% at September 30, 1998. Remaining credit available under a revolving credit agreement was $103,740 at September 30, 1999. In addition to this committed credit agreement, the company also has a variety of other short-term credit lines available. Management estimates that cash flow from operations and cash available from existing credit agreements will be sufficient to fund fiscal year 2000 normal operations, including the acquisition of Sterling Direct Inc. See Note 16 to the Consolidated Financial Statements for additional disclosures regarding this business combination.
The company has consistently produced strong operating cash flows sufficient to fund normal operations. These cash flows resulted primarily from income, of which the Automotive Group generates nearly 80% of the total.
Automotive's strong 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. In fiscal year 1997, the company filed a shelf registration statement with the Securities and Exchange Commission whereby the company can issue up to $300,000 of notes. Through September 30, 1999, the company has issued $170,000 of notes under this arrangement. 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 fiscal year 2000. See Note 7 to the Consolidated Financial Statements for additional disclosures regarding the company's debt instruments.
SHAREHOLDERS' EQUITY
The company lists its Class A common shares on the New York Stock Exchange. There is no principal market for Class B common shares. The company also has an authorized class of 60 million preferred shares with no par value. As of November 16, 1999, none of these preferred shares were outstanding and there were no agreements or commitments with respect to the sale or issuance of these shares, except for those described in Note 8 to the Consolidated Financial Statements.
The company paid cash dividends of $31,316 in 1999, $28,604 in 1998 and $26,056 in 1997. Dividends per Class A common share were $.40 in 1999, $.36 in 1998 and $.32 in 1997. 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. In November 1999, the board of directors raised the quarterly dividend 10% to $.11 per Class A common share. The company has increased cash dividends fourteen times in the ten years since 1989 and paid dividends each year since the company's initial public offering in 1961.
The company has conducted an active share repurchase program during recent years to provide additional returns to shareholders. The company repurchased $55,679 of Class A common shares in 1999, $35,583 in 1998 and $46,799 in 1997. Average prices paid per share were $20.69 in 1999, $19.77 in 1998 and $19.75 in 1997. As of September 30, 1999, the company could repurchase an additional 2,679 Class A common shares under existing board of directors' authorizations.
YEAR 2000
STATE OF READINESS
The company has assessed potential year 2000 effects on its internal computer systems, computer systems provided to customers and other non-information technology systems. The assessment included not only the company's systems, but also systems of outside parties such as key suppliers and business partners. Detailed plans were prepared to address year 2000 issues. These plans covered software applications, operating systems, hardware and embedded technology in other equipment. The plans called for a determination of whether affected systems should be modified, replaced or retired. Management reviews progress against these plans with the audit committee of the board of directors at its regularly scheduled meetings.
As of November 16, 1999, about 95% of the company's systems were year 2000 qualified. The few remaining systems include non-mission critical internal systems that are scheduled to be year 2000 qualified by December 31, 1999. In July 1998, the company released a year 2000 qualified version of its ERA2 retail management system for automobile dealers. In December 1998, the company completed the conversion of customers to the new ERA2 software release. The company decided late in 1997 to retire several older product lines by December 1998 rather than make these systems year 2000 qualified. Early in fiscal year 1998 the company communicated this decision to affected customers and presented them with various product alternatives. The company reinforced this communication on a number of occasions. The company discontinued support of non-year 2000 qualified systems on January 1, 1999.
The company has contacted significant suppliers, customers and critical business partners to determine the extent to which the company may be vulnerable in the event those parties fail to properly remediate their own year 2000
issues. About 70% of our business partners responded and indicated that their systems will be year 2000 qualified. The company has performed testing where applicable to determine that the third party systems are year 2000 qualified and function properly with the company's systems. As of November 16, 1999, the company has not experienced material adverse results from third party systems. While the company has taken significant actions to help ensure that these systems will be able to process and store dates into the next century, no amount of testing or contractual assurances will guarantee that errors or systems failures will not occur.
COSTS
The company's year 2000 efforts have been undertaken largely with existing personnel. In some instances, consultants have been engaged to perform specific services. During fiscal year 1999, year 2000 compliance costs were about $7,000 bringing the total amount spent on year 2000 compliance efforts to $14,000. The company estimates that the total costs (including costs already incurred) to make all systems year 2000 qualified will be about $15,000. However, there can be no assurance that the company will not incur unanticipated costs, which could have a material adverse effect on the company's financial statements.
RISKS
Management believes that the reasonably likely worst case scenario, with respect to year 2000 issues, is the failure of a supplier (including energy or communications suppliers) to be year 2000 qualified. Such a failure could temporarily interrupt the supply of needed products or services to the company or its customers, which could affect the company's ability to deliver products and services and have a material adverse effect on the company's financial statements.
CONTINGENCY PLANS
In addition to the year 2000 remediation efforts, the company has also focused on year 2000 contingency planning. Through a customer-oriented risk assessment process, the company identified areas where contingency strategies needed to be developed. Detailed contingency plans have been developed for all identified areas and testing of these plans will continue through the remainder of calendar year 1999.
MARKET RISKS
INTEREST RATES
The Information Systems 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.
The Financial Services segment of the business obtains borrowings to fund the investment in finance receivables. These fixed rate receivables have repayment terms of four to eight years, with five years being the most common term. 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.
Because fixed rate finance receivables are primarily funded with fixed rate debt 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. See Note 7 to the Consolidated Financial Statements for additional disclosures regarding the company's debt instruments and interest rate management agreements.
FOREIGN CURRENCY EXCHANGE RATES
The company has foreign-based operations in Canada, which accounted for 11% of net sales and revenues in 1999. 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 September 30, 1999, the company had no foreign currency exchange contracts outstanding. Based on the company's overall foreign currency exchange rate exposure at September 30, 1999, management believes that a 10% change in currency rates would not have a material effect on the company's financial statements.
COMMODITIES
The company is exposed to changes in the cost of paper, a key raw material in the production of business forms. The company has attempted to limit this exposure by consolidating its purchases among a few suppliers and negotiating longer-term contracts that limit the amount and frequency of price increases and generally delay the effective date of the increase. When paper costs increase, the company typically has been able to increase the sales prices of its business forms products and maintain its profit margins. Conversely, when paper costs decline, the company generally lowers its sales prices to meet competitive pressures. Historically, the company has not used financial instruments to manage its exposure to changes to the cost of paper. Because the company has historically been able to raise sales prices to offset higher paper costs, management believes that a 10% change in paper costs would not have a material effect on the company's financial statements.
ENVIRONMENTAL MATTERS
See Note 14 to the Consolidated Financial Statements for a discussion of the company's environmental contingencies.
ACCOUNTING STANDARDS
See Note 15 to the Consolidated Financial Statements for a discussion of the effect of accounting standards that the company has not yet adopted.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risks" section in Management Discussion and Analysis (Part II, ITEM 7 of this report on pages 14 and 15).
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial information required by Item 8 is contained in Item 14 of Part IV (pages 17-23) of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The name, age background information and business experience for each of the company's directors and nominees are incorporated herein by reference to the section of the company's Proxy Statement for its 2000 Annual Meeting of Shareholders captioned "ELECTION OF DIRECTORS."
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the company are elected by the Board of Directors at its meeting immediately following the Annual Meeting of Shareholders to serve generally for a term of one year. The executive officers of the company, as of December 1, 1999, are:
A description of prior positions held by executive officers of the company within the past 5 years, to the extent applicable, is as follows:
Mr. Holmes has been Chairman of the Board and Chief Executive Office since May 1999; prior thereto, Chairman of the Board, President and Chief Executive Officer.
Mr. Waterhouse has been President and Chief Operating Officer since May 1999; prior thereto, General Manager of E-Business Services for IBM Corporation from July 1998 to May 1999; General Manager of Marketing & Business Development for IBM Global Services from 1996 to July 1998; and Director of Strategy for IBM from 1994-1995.
Mr. Nevin has been President, Automotive Group (formerly known as Automotive Division) since January 1997; prior thereto was President, Business Systems Division.
Mr. Hedeen has been President, Information Solutions Group (formerly known as Business Systems Division) since January 1997; prior thereto was Senior Vice President and General Manager, Forms and Systems Group.
All other executive officers of the company have held their positions for at least 5 years.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information on compensation of the company's executive officers and directors is incorporated herein by reference to the section of the company's Proxy Statement for its 2000 Annual Meeting of Shareholders captioned "EXECUTIVE COMPENSATION."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The number of Common Shares of the company beneficially owned by each five percent shareholder, director or current nominee for director, officer and by all directors and officers as a group as of December 1, 1999 is incorporated herein by reference to the section of the company's Proxy Statement for its 1999 Annual Meeting of Shareholders captioned "VOTING SECURITIES OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning transactions with management, certain business relationships and indebtedness of management is incorporated herein by reference to the section of the company's Proxy Statement for its 1999 Annual Meeting of Shareholders captioned "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
PART IV (Dollars in thousands)
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS
The following consolidated financial statements of the company are set forth on pages 30 through 53.
Statements of Consolidated Income - For The Years Ended September 30, 1999, 1998 and 1997
Consolidated Balance Sheets - September 30, 1999 and 1998
Statements of Consolidated Shareholders' Equity and Comprehensive Income - For The Years Ended September 30, 1999, 1998 and 1997
Statements of Consolidated Cash Flows - For the Years Ended September 30, 1999, 1998 and 1997
Notes to Consolidated Financial Statements (Including Supplementary Data)
(a) (2) FINANCIAL STATEMENT SCHEDULES FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED SEPTEMBER 30, 1999 ARE ATTACHED HERETO:
Schedule II Valuation Accounts Page 54
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
(a) (3) EXHIBITS
* Management contracts or compensatory plans or arrangements required to be filed as an exhibit to this form pursuant to Item 14(c) of this report.
(B) REPORTS ON FORM 8-K.
During the quarter ended September 30, 1999, no reports on Form 8-K were filed by registrant.
(C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K.
Please refer to Part IV, ITEM 14. (a) (3) beginning on page 17.
(d) CONSOLIDATED FINANCIAL STATEMENTS
Individual financial statements and schedules of the company's consolidated subsidiaries are omitted from this Annual Report on Form 10-K because consolidated financial statements and schedules are submitted and because the registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements are wholly owned.
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The Company will provide a copy of its 1999 Annual Report to Shareholders upon written request to:
ADAM M. LUTYNSKI, GENERAL COUNSEL & SECRETARY THE REYNOLDS AND REYNOLDS COMPANY P. O. BOX 2608 DAYTON, OHIO 45401
Or by calling: 1-888-4REYREY (473-9739)
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SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) 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
By /S/ ADAM M. LUTYNSKI ---------------------------------------
ADAM M. LUTYNSKI General Counsel and Secretary
Date: December 28, 1999
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
Date: December 28, 1999 By /S/ DAVID R. HOLMES ---------------------------------------
DAVID R. HOLMES Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
Date: December 28, 1999 By /S/ DALE L. MEDFORD ---------------------------------------
DALE L. MEDFORD Corporate Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) and Director
Date: December 28, 1999 By /S/ JAMES L. ARTHUR ---------------------------------------
JAMES L. ARTHUR, Director
Date: December 28, 1999 By /S/ DR. DAVID E. FRY ---------------------------------------
DR. DAVID E. FRY, Director
Date: December 28, 1999 By /S/ RICHARD H. GRANT, JR. ---------------------------------------
RICHARD H. GRANT, JR. Chairman of the Steering Committee and Director
Date: December 28, 1999 By /S/ RICHARD H. GRANT, III ---------------------------------------
RICHARD H. GRANT, III, Director
Date: December 28, 1999 By /S/ CLEVE L. KILLINGSWORTH, JR. ---------------------------------------
CLEVE L. KILLINGSWORTH, JR. Director
Date: December 28, 1999 By /S/ ALLAN Z. LOREN ---------------------------------------
ALLAN Z. LOREN, Director
Date: December 28, 1999 By /S/ PHILIP A. ODEEN ---------------------------------------
PHILIP A. ODEEN, Director
Date: December 28, 1999 By /S/ DONALD K. PETERSON ---------------------------------------
DONALD K. PETERSON, Director
Date: December 28, 1999 By /S/ GAYLE B. PRICE, JR. ---------------------------------------
GAYLE B. PRICE, JR., Director
ANNUAL REPORT ON FORM 10-K ITEM 14(a)(1) and (2); 14(c) and (d) Financial Statements, Schedules and Exhibits Year Ended September 30, 1999 The Reynolds and Reynolds Company Dayton, Ohio
MANAGEMENT'S STATEMENT OF RESPONSIBILITY
November 16, 1999
To Our Shareholders:
The management of The Reynolds and Reynolds Company is responsible for accurately and objectively preparing the company's consolidated financial statements. These statements are prepared in accordance with generally accepted accounting principles and include amounts based on management's best estimates and judgments. Management believes that the financial information in this annual report is free from material misstatement.
The company's management maintains an environment of multilevel controls. The Company Business Principles, for example, is distributed to all employees and communicates high standards of integrity that are expected in the company's day-to-day business activities. The Company Business Principles addresses a broad range of issues including potential conflicts of interest, business relationships, accurate and timely reporting of financial information, confidentiality of proprietary information, insider trading and social responsibility.
The company also maintains and monitors a system of internal controls designed to provide reasonable assurances regarding the safeguarding of company assets and the integrity and reliability of financial records. These internal controls include the appropriate segregation of duties and the application of formal policies and procedures. Furthermore, an internal audit department, which has access to all financial and other corporate records, regularly performs tests to evaluate the system of internal controls to ensure the system is adequate and operating effectively. At the date of these financial statements, management believes the company has an effective internal control system.
The company's independent auditors, Deloitte & Touche LLP, perform an independent audit of the company's consolidated financial statements. They have access to minutes of board meetings, all financial information and other corporate records. Their audit is conducted in accordance with generally accepted auditing standards and includes consideration of the system of internal controls. Their report is included in this annual report on page 28.
Another level of control resides with the audit committee of the company's board of directors. The committee, comprised of six directors who are not members of management, oversees the company's financial reporting process. They recommend to the board, subject to shareholder approval, the selection of the company's independent auditors. They discuss the overall audit scope and the specific audit plans with the independent auditors and the internal auditors. This committee also meets regularly (separately and jointly) with the independent auditors, the internal auditors and management to discuss the results of those audits, the evaluation of internal controls, the quality of financial reporting and specific accounting and reporting issues.
David R. Holmes Dale L. Medford Chairman and Corporate Vice President, Finance Chief Executive Officer and Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
The Shareholders of The Reynolds and Reynolds Company:
We have audited the accompanying consolidated balance sheets of The Reynolds and Reynolds Company and its subsidiaries as of September 30, 1999 and 1998 and the related statements of consolidated income, shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended September 30, 1999. Our audits also included the financial statement schedule included at item 14(a)(2). These financial statements and financial statement schedule are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Reynolds and Reynolds Company and its subsidiaries at September 30, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 1 to the Consolidated Financial Statements, the company changed its method of accounting for software revenue recognition effective October 1, 1998.
DELOITTE & TOUCHE LLP Dayton, Ohio November 16, 1999
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in The Reynolds and Reynolds Company (1) Registration Statement No. 33-56045 on Form S-8, (2) Post-Effective Amendment No. 1 to Registration Statement No. 333-12681 on Form S-8, (3) Registration Statement No. 333-16583 on Form S-3, (4) Registration Statement No. 333-18585 on Form S-3, (5) Registration Statement No. 333-41983 on Form S-3, (6) Registration Statement No. 333-41985 on Form S-3, (7) Post-Effective Amendment No. 1 to Registration Statement No. 33-51895 on Form S-3, (8) Pre-Effective Amendment No. 1 to Registration Statement No. 33-58877 on Form S-3, (9) Pre-Effective Amendment No. 1 to Registration Statement No. 33-61725 on Form S-3, (10) Registration Statement No. 33-59615 on Form S-3, (11) Registration Statement No. 33-59617 on Form S-3, (12) Registration Statement No. 333-12967 on Form S-3, (13) Registration Statement No. 333-72639 on Form S-3, (14) Registration Statement No. 333-85177 on Form S-8, (15) Registration Statement No. 333-85179 on Form S-8, and (16) Registration Statement No. 333-85551 on Form S-8, of our report dated November 16, 1999, appearing in this Annual Report on Form 10-K of The Reynolds and Reynolds Company for the year ended September 30, 1999, and to the reference to us under the heading "Experts" in the respective Prospectuses, which is part of each of the above Registration Statements.
/s/ DELOITTE & TOUCHE LLP - --------------------------
Dayton, Ohio December 28, 1999
STATEMENTS OF CONSOLIDATED INCOME (In thousands except per share data)
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS (In thousands)
See Notes to Consolidated Financial Statements.
STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (In thousands except per share data)
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of the parent company and its domestic and foreign subsidiaries and present details of revenues, expenses, assets, liabilities and cash flows for both Information Systems and Financial Services. Information Systems is comprised of the company's Automotive and Information Solutions Groups. Financial Services is comprised of Reyna Capital Corporation, the company's wholly owned financial services subsidiary and a similar operation in Canada. In accordance with industry practice, the assets and liabilities of Information Systems are classified as current or noncurrent and those of Financial Services are unclassified. Intercompany balances and transactions between the consolidated companies are eliminated.
USE OF ESTIMATES
The consolidated financial statements are prepared in conformity with generally accepted accounting principles and include amounts based on management's best estimates and judgments. The use of estimates and judgments may affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
CASH AND EQUIVALENTS
For purposes of reporting cash flows, cash and equivalents includes cash on hand, cash deposits and investments with maturities of three months or less at the time of purchase. The carrying amount of these short-term investments approximates fair value.
CONCENTRATIONS OF CREDIT RISK
The company is a leading provider of information management systems to automotive retailers. A significant portion of finance receivables and accounts receivable are from automotive retailers.
ALLOWANCE FOR LOSSES
An allowance for losses on finance receivables is established based on historical loss experience, portfolio profile, industry averages and current economic conditions. Finance receivables are charged to the allowance for losses when an account is deemed to be uncollectible, taking into consideration the financial condition of the customer and the value of the collateral. Recoveries of finance receivables, previously charged off as uncollectible, are credited to the allowance for losses.
INVENTORIES
Inventories are stated at the lower of cost or market. Costs of Information Solutions and Automotive business forms inventories are determined by the last-in, first-out (LIFO) method. At September 30, 1999 and 1998, LIFO inventories were $67,301 and $56,913, respectively. These inventories determined by the first-in, first-out (FIFO) method would increase by $5,161 in 1999 and $5,068 in 1998. For other inventories, cost is determined by specific identification or the FIFO method. Market is based on net realizable value.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation and amortization are provided over the estimated useful service lives of the assets or asset groups, principally on the straight-line method for financial reporting purposes. Estimated asset lives are:
Years - --------------------------------------------------------------------------------
Land improvements 10 Buildings and improvements 3--33 Computer equipment 3-- 5 Machinery and equipment 3--18 Furniture and other 3--15
INTANGIBLE ASSETS
The excess of cost over net assets of companies acquired is recorded as goodwill and amortized on a straight-line basis over five to forty years. Amortization expense was $9,826 in 1999, $15,258 in 1998 and $15,066 in 1997. Amortization expense in 1997 included $3,560 from restructuring and special charges. At September 30, 1999 and 1998, accumulated amortization was $65,005 and $62,626, respectively.
The company capitalizes certain costs of developing its software products. Upon completion of a software product, amortization is determined based on the larger of the amounts computed using (a) the ratio that current gross revenues for each product bears to the total of current and anticipated future gross revenues for that product or (b) the straight-line method over the remaining estimated economic life of the product, ranging from five to seven years. Amortization expense for software licensed to customers was $1,642 in 1999, $5,872 in 1998 and $9,188 in 1997. Amortization expense in 1997 included $3,920 from restructuring and special charges. At September 30, 1999 and 1998, accumulated amortization was $46,572 and $58,025, respectively.
Other intangible assets are amortized over periods ranging from three to fifteen years. Amortization expense was $866 in 1999, $2,492 in 1998 and $2,885 in 1997. At September 30, 1999 and 1998, accumulated amortization was $9,697 and $15,728, respectively.
The carrying values of goodwill and other intangible assets are reviewed if the facts and circumstances indicate potential impairment of their carrying value. Any impairment in the carrying value of such intangibles is recorded when identified in accordance with Accounting Principles Board (APB) Opinion No. 17, "Intangible Assets" and Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of."
EQUITY INVESTMENT
In September 1997, the company purchased 16,500 shares of Kalamazoo Computer Group plc of the United Kingdom for about $36,000. This investment represents about 26% of Kalamazoo's outstanding shares and is accounted for under the equity method. Accordingly, the investment in Kalamazoo's common stock is included in the balance sheet as other assets and the company's share of Kalamazoo's net losses is included in the consolidated income statement as other charges. The company recorded its share of Kalamazoo's net losses of $3,043 in 1999, $3,225 in 1998 and $3,850 in 1997. At September 30, 1999, the market value of the company's share of Kalamazoo's stock was about $20,500.
REVENUE RECOGNITION ACCOUNTING CHANGE
In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, "Software Revenue Recognition," which superseded SOP 91-1, "Software Revenue Recognition." SOP 97-2 provides guidance on applying generally accepted accounting principles recognizing revenue on software transactions. The company adopted this pronouncement effective October 1, 1998. The adoption of this pronouncement reduced the Automotive Group computer systems products revenues $17,936, gross profit $11,205,
operating income $10,624 and net income $6,204 or $.08 per diluted share during the six months ended March 31, 1999. The company completed the transition period for the adoption of SOP 97-2 as of March 31, 1999, and there was no impact on third or fourth quarter's operating results.
INFORMATION SYSTEMS
Sales of computer hardware and business forms products are generally recorded upon shipment to customers. Under certain forms management contractual arrangements, custom forms are stored for future delivery to customers, and are recognized as revenue when title passes and the customer has been invoiced. Revenues from software license fees are recorded over the installation period. Service revenues, which include computer hardware maintenance, software support, training and forms management services, are recorded ratably over the contract period or as services are performed. Forms management services represent fees for inventory management and warehousing services. Forms management services may be included in product sales or separately billed to customers.
FINANCIAL SERVICES
Financial Services revenues consist primarily of interest earned on financing the company's computer systems product sales. Revenues are recognized over the lives of financing contracts, generally four to eight years, using the interest method.
LEASE OBLIGATIONS
The company leases premises and equipment under various capital and operating lease agreements. Certain of these leases contain renewal and purchase options and residual value guarantees. As of September 30, 1999, future minimum lease payments relating to operating lease agreements were $109,191 with annual payments of $35,347 in 2000, $23,874 in 2001, $17,439 in 2002, $9,160 in 2003 and $5,818 in 2004. Rental expenses were $37,804 in 1999, $37,210 in 1998 and $36,018 in 1997. Under the provisions of purchase accounting, the carrying value of assets under capital lease is not significant. The obligation associated with the capital lease is discussed in Note 7 to the Consolidated Financial Statements.
RESEARCH AND DEVELOPMENT COSTS
The company expenses research and development costs as incurred. These costs were $54,960 in 1999, $46,588 in 1998 and $43,052 in 1997. Included in 1997 were $14,850 of purchased in-process research and development costs. In-process research and development acquired in business combinations represented software development costs for which technological feasibility was not established and for which there was no alternative future use.
INCOME TAXES
The parent company and its domestic subsidiaries file a consolidated U.S. federal income tax return. Deferred income taxes are provided for temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. Temporary differences result principally from Financial Services product financing activities, postretirement benefits and different depreciation methods. No deferred income tax liabilities are recorded on undistributed earnings of the foreign subsidiary because, for the most part, those earnings are permanently reinvested. Undistributed earnings of the foreign subsidiary at September 30, 1999, were $24,702. The calculation of the unrecognized deferred income tax liability on these earnings is not practicable.
EARNINGS PER COMMON SHARE
Basic earnings per common share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted EPS is computed by dividing net income by the weighted average number of common shares and common share equivalents outstanding during each year. The weighted average number of common shares outstanding assumed that Class B common shares were converted into Class A common shares. The company's common share equivalents represent the effect of employee stock options.
2. DISCONTINUED OPERATIONS
On October 23, 1998, the company sold essentially all net assets of its Healthcare Systems segment to InfoCure Corporation for about $50,000. The proceeds consisted of about $40,000 of cash with the balance in subordinated notes. The company recorded a gain on the sale of $5,785 (net of income taxes of $2,064) or $.07 per diluted share in the first quarter of fiscal year 1999. About $1,200 of Healthcare Systems operating losses, net of income taxes of about $800, from October 1, 1998 through October 23, 1998, were included in the determination of the gain on the sale of the Healthcare Systems segment. As discontinued operations, the operating results of Healthcare Systems were segregated from continuing operations and reported as a separate line on the consolidated statement of income. Revenues reclassified to discontinued operations were $48,226 in 1998 and $40,346 in 1997. Net assets of about $27,000 at September 30, 1998 were included in the company's consolidated balance sheet.
3. RESTRUCTURING AND SPECIAL CHARGES
During fiscal year 1997 the company recorded a pretax charge of $49,241 consisting of a $25,339 restructuring charge and $23,902 of other special charges. Restructuring charges included $1,427 related to discontinued operations. Special charges increased cost of sales $4,061, selling general and administrative expenses $4,343, other charges $3,850 and loss on discontinued operations $11,648 before income taxes. The restructuring charge consisted primarily of employee termination benefits related to closing a number of manufacturing and distribution facilities. At September 30, 1998, these facilities had been closed and involuntary termination benefits, which approximated amounts accrued, were paid. Voluntary termination benefits are discussed in Note 11 to the Consolidated Financial Statements. Special charges consisted primarily of in-process research and development expenses from three 1997 computer services business combinations and represented software development costs for which technological feasibility was not established and for which there was no alternative future use. The balance of restructuring and special charges represented the write-off of intangible assets associated with discontinued products in the automotive business and the write-off of impaired software licensed to customers and internal software which the company will no longer use. After income taxes, the combined charges reduced net income by $34,078 or $.41 per diluted earnings per common share. The income tax benefit on the combined charges represented a 30.8% effective income tax rate because not all of the charges were tax deductible.
4. BUSINESS COMBINATIONS
The company purchased four businesses in fiscal year 1997 with annual sales of $271,000. All businesses were purchased with a combination of cash and stock as reported in the table titled Components of Purchase Prices. The issuance of capital stock was considered a noncash transaction for accounting purposes and was not included in the statements of cash flows. All business combinations were accounted for as purchases and the accounts of the acquired businesses were included in the company's financial statements since the dates of acquisition. In connection with these business combinations, the company recorded goodwill of $10,609 in 1997. This goodwill is being amortized on a straight-line basis over fifteen years. Under the terms of some of the purchase agreements, the company may be required to make additional payments, contingent on the sales and profitability of the business purchased. These payments, if made, will either be expensed in the period incurred or charged to goodwill. Contingent payments increased goodwill by $2,048 in 1999, $2,071 in 1998 and $3,728 in 1997. Contingent payments may be made through 2006.
COMPONENTS OF PURCHASE PRICES
1999 1998 1997 - -------------------------------------------------------------------------------- Cash (net of cash and equivalents acquired) $ 565 $142,022 Contingent payments Cash 638 3,325 Capital stock issued (1999 - 88 SHARES; 1998 - 105 shares; 1997 - 44 shares) $1,871 1,933 1,171 ------ ------ --------
Totals $1,871 $3,136 $146,518 ====== ====== ========
5. INCOME TAXES
PROVISION FOR INCOME TAXES
RECONCILIATION OF INCOME TAX RATES
INFORMATION SYSTEMS DEFERRED INCOME TAX ASSETS (LIABILITIES)
The carryforward of net operating losses expires primarily in 2006.
6. FINANCIAL SERVICES
INCOME STATEMENTS
FINANCE RECEIVABLES
As of September 30, 1999, product financing receivables due for each of the next five years were $163,921 in 2000, $128,607 in 2001, $95,491 in 2002, $61,410 in 2003 and $24,695 in 2004.
ALLOWANCE FOR LOSSES
7. FINANCING ARRANGEMENTS
INFORMATION SYSTEMS
Loan agreements limit consolidated indebtedness and require a minimum consolidated net worth. The fair values of Information Systems financing arrangements were $161,942 at September 30, 1999 and $169,562 at September 30, 1998. At September 30, 1999, debt maturities were $6,087 in 2000, $52,435 in 2001, $6,189 in 2002 and $5,714 in 2003. Interest paid was $13,250 in 1999, $11,698 in 1998 and $7,620 in 1997.
FINANCIAL SERVICES
In the ordinary course of business, the company 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. Ceiling agreements limit the maximum interest rates the company pays on variable rate financing agreements. Fixed interest rates do not change over the life of the agreements. Variable interest rates are reset at least every ninety days and are based on LIBOR or commercial paper indices and are settled with counterparties at that time. Net interest expense or income on these contracts is reflected in interest expense. The company is exposed to credit related losses in the event of nonperformance by counterparties to the interest rate management agreements. The company attempts to minimize this credit risk by entering into agreements only with counterparties that have a Standard & Poor's rating of "A" or higher. The company also diversifies its interest rate management agreements among several financial institutions. Interest rate management agreements are accounted for using settlement accounting.
Loan agreements limit consolidated indebtedness and require a minimum consolidated net worth. The fair value of Financial Services debt was $218,246 and $211,563 at September 30, 1999 and 1998, respectively. At September 30, 1999, maturities of notes were $65,383 in 2000, $68,655 in 2001, $75,760 in 2002, $7,625 in 2003 and $2,000 in 2004. Interest paid was $13,262 in 1999, $12,814 in 1998 and $11,178 in 1997.
At September 30, 1999, notional amount maturities of swap agreements were $19,057 in 2000, $17,716 in 2001, $14,500 in 2002, $7,625 in 2003 and $2,000 in 2004. The fair values of interest rate swap agreements were $(277) and $415 at September 30, 1999 and 1998, respectively. The fair values of interest rate ceiling agreements were $0 at September 30, 1998. The premiums paid for interest rate ceiling agreements are amortized to interest expense on a straight-line basis over the life of the agreement. Unamortized premium costs were $7 at September 30, 1998.
REVOLVING CREDIT AGREEMENTS
Information Systems and Financial Services share variable rate revolving credit agreements which total $150,000 and require commitment fees on unused credit. At September 30, 1999, available balances under these agreements were $103,740.
FAIR VALUES
Fair values of financial instruments are estimated based on quoted market prices for debt and interest rate management agreements with the same remaining maturities. The fair value of interest rate swap agreements represents the cost if existing agreements had been settled at September 30.
8. CAPITAL STOCK
Dividends on Class A common shares must be twenty times the dividends on Class B common shares and must be paid simultaneously. Each share of Class A common and Class B common is entitled to one vote. The Class B common shareholder may convert twenty Class B common shares to one share of Class A common. The company has reserved sufficient authorized Class A common shares for Class B conversions and stock option plans.
Each outstanding Class A common share has one preferred share purchase right. Each outstanding Class B common share has one-twentieth of a right. Rights become exercisable if a person or group acquires or seeks to acquire, through a tender or exchange offer, 20% or more of the company's Class A common shares. In that event, all holders of Class A common shares and Class B common shares, other than the acquirer, could exercise their rights and purchase preferred shares at a substantial discount. At the date of these financial statements, except for the preferred share purchase rights, the company had no agreements or commitments with respect to the sale or issuance of the preferred shares.
The company repurchased Class A common shares for treasury at average prices of $20.69 in 1999, $19.77 in 1998 and $19.75 in 1997. The remaining balance of shares authorized for repurchase by the board of directors was 2,679 at September 30, 1999. Treasury shares at September 30 were 15,654 in 1999, 14,482 in 1998, and 13,327 in 1997.
9. EMPLOYEE STOCK OPTION PLANS
The company's stock option plans award incentive stock options and/or nonqualified stock options to purchase Class A common shares to substantially all employees. Stock options are generally granted at a price equal to fair market value on the date of grant. During the three years ended September 30, 1999, only one grant of stock options was made at a price below fair market value. That nonqualified option grant was for 200 Class A common shares at an option price of $.01 per share. The company recognized $1,001 of compensation expense in fiscal year 1999. At September 30, 1999, options to purchase 2,560 additional Class A common shares were available for future awards to certain key employees. Under a broad-based stock option plan, the board of directors may award options at its discretion.
The company accounts for employee stock options under APB Opinion No. 25, "Accounting for Stock Issued to Employees" and follows the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 requires the valuation of stock options using option valuation models and the disclosure of the pro forma effect on earnings. The company valued its stock options using the Black-Scholes option valuation model which was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of subjective assumptions, such as expected stock price volatility, which can materially affect the fair value estimate. Because the company's stock options have characteristics significantly different from traded options, the fair value determined may not reflect the actual value of the company's stock options. The weighted average fair value of the company's stock options granted at fair market value was $4.91 in 1999, $6.05 in 1998 and $7.49 in 1997. The fair value of the company's stock options granted below fair market value was $23.04 in 1999. Had compensation expense been recognized using these fair values, the company's net income and diluted earnings per common share would have decreased by $8,152 or $.10 per share in 1999, $5,885 or $.07 per share in 1998 and $3,645 or $.04 per share in 1997.
OPTION VALUATION ASSUMPTIONS
10. EARNINGS PER COMMON SHARE
Basic earnings per common share (EPS) is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Employee stock options to purchase 2,617, 2,956 and 1,234 of common stock were outstanding during 1999, 1998 and 1997, respectively, but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares and, therefore, the effect would be antidilutive.
COMPUTATION OF BASIC AND DILUTED EPS
11. POSTRETIREMENT BENEFITS
PENSION EXPENSE
The company sponsors contributory and noncontributory, defined benefit pension plans for most employees. Pension benefits are primarily based on years of service and compensation. The company's funding policy is to make annual contributions to the plans sufficient to meet or exceed the minimum statutory requirements. The company and its actuaries review the pension plans each year. The actuarial assumptions are intended to reflect expected experience over the life of the pension liability.
The company expensed special termination benefits of $1,971 in 1999 in connection with the sale of the Healthcare Systems segment and $8,430 in 1997 in connection with a voluntary early retirement program. These benefits will be in addition to the employee's regular plan benefits and will be paid directly from company assets rather than plan assets.
The company sponsors defined contribution savings plans covering most domestic employees. Generally, contributions are funded monthly and represent 40% of the first 3% of compensation contributed to the plan by participating employees. The company also funds a discretionary contribution. Contributions for this portion of the plan are funded annually based on the company's return on equity and contributions are the same for each eligible employee. Forfeitures of nonvested discretionary contributions are used to reduce contributions required by the company.
FUNDED STATUS OF DEFINED BENEFIT PENSION PLANS
At September 30, 1999 and 1998, about 44% and 47% of the plans' assets were invested in cash and equivalents, government bonds and investment grade corporate bonds. The balance of the plans' assets were invested in equities.
The company sponsors certain unfunded pension plans. These pension plans have accumulated benefit obligations exceeding plan assets. The projected benefit obligations were $53,387 and $49,511 at September 30, 1999 and 1998, respectively. The accumulated benefit obligations were $50,416 and $44,851 at September 30, 1999 and 1998, respectively.
POSTRETIREMENT MEDICAL AND LIFE INSURANCE EXPENSE
The company sponsors a defined benefit medical plan for employees who retired before October 1, 1993. Future retirees may purchase postretirement medical insurance from the company. Discounts from the market price of postretirement medical insurance will be provided to certain retirees based on age and length of remaining service as of October 1, 1993. These discounts are included in the determination of the accumulated benefit obligation. The company also sponsors a defined benefit life insurance plan for substantially all employees. The company funds medical and life insurance benefits on a pay-as-you-go basis.
POSTRETIREMENT MEDICAL AND LIFE INSURANCE OBLIGATION
The effect of a 1% increase in the assumed healthcare cost trend rate would have increased the service and interest cost components of 1999 postretirement medical insurance by $202 and the September 30, 1999 accumulated benefit obligation by $2,641. Similiary, a 1% decrease would have decreased the components by $161 and the September 30, 1999 accumulated benefit obligation by $2,538.
12. CASH FLOW STATEMENTS
13. SEGMENT REPORTING
GEOGRAPHIC AREAS
The company provides integrated computer systems products and services and manufactures and distributes printed business forms and systems throughout the United States and Canada.
BUSINESS SEGMENTS
The Automotive Group provides integrated computer systems products and services, along with printed business forms to the automotive market. The group's products include integrated software packages, computer hardware, related hardware and software installation and business forms. Services include customer training and consulting, hardware maintenance, software support and database management.
The Information Solutions Group manufactures and distributes printed business forms and systems, custom continuous and snap out forms, specialty printed products and provides forms management services to general business markets.
Financial Services provides financing for the company's computer systems products primarily to the automotive market.
Discontinued operations represents the company's Healthcare Systems segment that was sold in October 1998. See Note 2 to the Consolidated Financial Statements for additional information regarding this transaction.
14. CONTINGENCY
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 1994, the PRP coalition received an engineering evaluation/cost analysis of the presumed remedy for the site from its private contractor. However, because the EPA has not yet selected a remedy, potential remediation costs remain uncertain. Remediation costs for a typical CERCLA site on the National Priorities List average about $30,000. The engineering evaluation/cost analysis was consistent with this average. During fiscal year 1996, an agreement was reached whereby the state of Connecticut will contribute $8,000 towards remediation costs. Preliminary remediation continued during fiscal year 1999 utilizing Connecticut's contribution. The company believes that the reasonably foreseeable resolution will not have a material adverse effect on the financial statements.
15. ACCOUNTING STANDARDS
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 requires that certain costs associated with developing or obtaining internal use software should be capitalized. Capitalized costs are then amortized over their useful life. This statement is effective for fiscal years beginning after December 15, 1998. The company does not expect the adoption of this statement to have a material effect because the company was already capitalizing certain costs related to internal use software.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to measure those instruments at fair value. Gains or losses resulting from changes in fair values of derivatives are recorded either as a separate component of shareholders' equity or in the income statement depending upon whether the instruments meet the criteria for hedge accounting. This statement is effective for all fiscal quarters for fiscal years beginning after June 15, 2000 (fiscal year 2001 as to the company). The company has not yet determined the effect of this pronouncement.
16. SUBSEQUENT EVENTS
In August 1999, the board of directors approved the construction of a new office building near Dayton, Ohio. In October 1999, the company began site excavation. The building is expected to be completed in 2002 at an estimated cost of about $45,000.
On October 1, 1999, the company purchased substantially all net assets of Sterling Direct Inc. for $22,500 of cash. Sterling, a privately-owned provider of turnkey direct marketing services, has annual sales of about $28,000.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
(a) Includes adjustments from translation of foreign currency to United States dollars, the effects of acquisitions of business and transfers between reserves. (b) Includes adjustments for disposal of businesses.