QRT.L Regulatory News (QRT)

8 Mar 2007 07:02

Quarto Group Inc08 March 2007 Thursday March 8, 2007 THE QUARTO GROUP, INC - PRELIMINARY ANNOUNCEMENT Quarto (QRT.L), the fully listed independent book producer and publisher basedin London, announces underlying annual results very much in line withexpectations, although the Publishing segment was weaker, and the Co-Editionsegment was stronger, than the Board had forecast. FINANCIAL HIGHLIGHTS Year to December 31 2006 2005 Increase Revenue (£m) 93.6 95.0 -1%Adjusted EBITDA (£m) 18.0 17.5 +3%Operating profit: adjusted (£m) 9.6 8.9 +7% reported (£m) 6.9 6.8 +2%Pre-tax profit: adjusted (£m) 7.3 6.7 +9% reported (£m) 4.64 4.57 +2%Diluted earnings per share: adjusted (p) 22.5 21.3 +6% reported (p) 13.9 13.5 +3%Dividends per share (p) 6.75 6.5 +4%Net debt (£m) 31.0 35.1 -12% Adjusted excludes amortization of non-current intangibles and non-recurring items • The revenue decline was predominantly the result of a £3.2m fall inUS sales and the elimination of some marginal business elsewhere. COMMERCIAL HIGHLIGHTS • The International Co-Edition Book Publishing segment increased itsadjusted operating profit by 16% to £5.3m (2005: £4.5m) on revenue up 4% to£38.4m (2005: £37.1m), an adjusted operating margin of 13.7% (2005: 12.3%).Co-edition performed better than expected, in what remained, with fewexceptions, tougher and more challenging conditions in most of its majorgeographical markets. In response to these, almost all its units lifted theirgames, by reducing, or eliminating, marginal activities and turning away frommarginal opportunities. • The Publishing segment had a tough year. It operates entirely inEnglish-language markets, and suffered, along with the general malaise,particularly in the United States. Adjusted operating profit, at £5.2m (2005:£5.3m), was 1% down on revenues that declined by 5% to £55.2m (2005: £57.9m),representing an adjusted operating margin of 9.5% (2005: 9.2%). The revenuedecline is accounted for mostly by the running-down of Quarto's UK-basedmagazine business, and by the sharp fall in revenues at Book Sales, Quarto's USpromotional publishing subsidiary. • The unexpected and unwelcome Chapter 11 bankruptcy filing of AdvancedMarketing Services (AMS), the principal conduit to the US warehouse clubs, onthe last business day of 2006, generated a £1.2m exceptional write-off, Quartobeing its 19th largest creditor, but doesn't usher in a winter of discontent. • In 2006, Quarto spent a great deal of time trying to execute itsgrowth strategy that focuses on making acquisitions. There were severalimportant opportunities in 2006, with the focus increasingly on overseasbusinesses with revenues in excess of $30m, but, in spite of management's bestefforts, Quarto failed to conclude a deal. Laurence Orbach, Chairman and CEO, stated, 'During 2006, we corrected theshort-comings of some of our units, and eliminated some unsuccessfulinitiatives, emerging with a better trading result. In 2007, we expect to manageour way through whatever is thrown at us and, in a recitation echoing governmenthealth warnings, anticipate that, in the absence of major currency movements,Stock Exchange crashes, wars, and various other acts of Man, we shall againimprove on our performance.' Notes for Editors: Quarto is an international book producer and publisher with two principalstrands of activity: it publishes, under imprints owned by the Group, books andart prints in the US, the UK, and Australia; and it creates books that arelicensed to other publishers for publication under their own imprints in manylanguages around the world. Enquiries: The Quarto Group, Inc. Laurence Orbach (Chairman & CEO) 020-7700 9003Mick Mousley (Finance Director) 020-7700 9004 Bankside Consultants Limited Charles Ponsonby 020-7367 8851 CHAIRMAN'S LETTER Dear Shareholder: Quarto traded strongly in 2006. Our performance, as the 2006 results demonstrate, benefited from the increase in the sales, and percentage of sales, of our'long tail' of backlist titles which, thanks in part to the Internet, growslonger, and continues to endorse our robust business models. All of this tookplace against a background of demanding business conditions. All in all, 2006produced more surprises than expected: the continued strength of sterling (or,more accurately, that sterling did not reflect the softer UK economy by driftingdownwards with the US dollar); Quarto's failure to close any of the substantialcorporate transactions on which we had been devoting considerable seniorexecutive resources; the first signs, in many years, of an end to the almostnon-inflationary environment that had lately become the norm; thenot-so-unexpected maturing of Internet use, and its ubiquity as a new medium. The fly in the ointment was the wholly unexpected and unwelcome Chapter 11bankruptcy protection filing of Advanced Marketing Services (AMS), the principalconduit to the US warehouse clubs, on the last business day of 2006. If we areliving through revolutionary times in media development, and the glory days ofbook publishing are gone for ever, Quarto, and the book publishing industry as awhole, is adapting remarkably well to the challenges (albeit, not without pain). Following many years of good service from KPMG, the Board decided that it wastime to appoint a new firm of auditors. RSM Robson Rhodes have brought to theaudit of our 2006 financial results a new perspective on our processes,procedures, and policies, which is what the audit committee wanted from a newauditor. The first of these to be adopted is an important accounting policychange, which brings us into compliance with International Accounting Standards,and with common practice in our industry. I also commend the new format of thestatement of cash flows which, for a lay person, is much simpler to follow. Under our prior policy, at the time of first printing, we expensed the pre-pressdevelopment costs of creating a new title. The rationale was that this was veryprudent, and reflected the then irreversible commitment to invest in thecreation of the title. What it failed to do was to match the flow of revenuewhich, in our case, follows over a period of several years. After extensiveconsultation with, and testing of our data by, our auditors, we have adopted anew policy of capitalizing our development costs and writing them off over athree-year period following the first delivery of a new title. According totheir annual reports, Reed, Pearson, and Haynes all capitalize their developmentcosts and, in their cases, use a five-year period for amortization. Our newpolicy has the virtue, aside from complying with accounting standards, ofallowing easier comparison with the performance of companies in our sector, andof recognizing value for the intangible assets that we are creating. Consideringthat we had been applying the prior policy consistently for many years, theimpact on the income statement is minor, which is only to be expected; but thebalance sheet emerges stronger. This is definitely a positive move as the bulkof our revenue comes from titles that, previously, have had no value attached tothem on the balance sheet. Even the balance sheet, though, fails to do justiceto this value as, being struck on one day in the year, it shows that our netassets, and many of the assets are dollar-denominated, didn't grow,year-on-year, which is unflattering, since those that were translated intosterling went in at $1.96 to the pound at December 31, 2006, against $1.72 atDecember 31, 2005, for a dollar decline of 14%. The accounting policy change has necessitated a restating of the prior yearresults and, in these remarks, my comments relate to our results followingimplementation of the policy change. Commentary on Financial Results I am pleased to report that for the year ended December 31, 2006, our auditedrevenues were £93.6 million (2005: £95.0 million), a decline of 1.5%,predominantly the result of a fall of £3.2 million in US sales, and theelimination of some marginal business, offset by increases in other geographicalmarkets. Operating profit, before amortization of intangibles and exceptional,non-recurring items, rose by 8% to £9.6 million (2005: £8.9 million), profitbefore tax, on the same basis, at £7.3 million (2005: £6.7 million) was up by9%, and underlying diluted earnings per share were 22.5p (2005: 21.3p), for anincrease of 6%. Earnings before interest, taxes, interest, depreciation, andamortization (EBITDA) were £18.0 million (2005: £17.5 million). Net debt wasdown to £31.0 million (2005: £35.1 million). Earnings are solidly ahead of lastyear and prospects are good so, in spite of the AMS bankruptcy charge, yourboard is recommending a final dividend of 3.75p (2005: 3.6p), making a totaldividend for the year of 6.75p (2005: 6.5p). The final dividend is payable on 7June 2007 to shareholders on the register on 4 May 2007. The exceptional,non-recurring charge for the AMS debt was £1.2 million, and basic earnings pershare were 14.3p (2005: 13.8p). A reconciliation of the above figures is givenin Note 6 to the financial information. The bankruptcy filing of AMS hit us hard, and has had a similar impact onnumerous other book publishers. Primarily, AMS is a distributor of books intothe warehouse clubs, such as Costco, Sam's, and BJ's, and it sourced its books,as a wholesaler, from almost every publisher in the United States. Its APG unitalso publishes titles, for which the principal outlets are the warehouse clubs,with a minority of its sales going through the more traditional book sales'channels. The bulk of our losses arose on titles licensed to the publishingunit. At this stage, it hasn't been possible to establish whether there islikely to be any dividend to unsecured creditors, even though resolution of thebankruptcy is at a fairly advanced stage. For this reason, and in the light ofwhat we know at this stage, we have provided for all of the debt. AMS's bankruptcy is one of the largest ever for the book publishing industry. Inthe tabulation of the 40 largest creditors, whose combined claims wereapproximately $225 million, we only ranked as the 19th largest, which gives someidea of the scale of other losses. What was most remarkable about the filing wasthat, although the regulatory and legal issues that AMS had with the relevantauthorities - and which had led to successful criminal prosecutions of threeindividuals in its advertising department - were widely known, they wereconsidered to be no more than a blot on its reputation and, given that AMS wasreliable in paying its bills, we were given no hint of financial strain. Our results were very much in line with expectations, although the publishingsegment was weaker, and the co-edition segment stronger, than we had forecast.The publishing segment's major markets are in the principal English-languagecountries, and results in the United States were below our forecast. Incontrast, there was a significant improvement in the co-edition segment'sresults and this reflects, in part, the wider geographical spread of thesegment's markets. As I've noted above, the co-edition segment performed better than we expected,in what remained, with few exceptions, tougher and more challenging conditionsin most of our major geographical markets. In response to these, almost all ourunits lifted their games, spurred by the greater focus and direction they havebeen given by senior management, and by reducing, or eliminating, marginalactivities and turning away from marginal opportunities. For much of the yearMick Mousley, Chief Financial Officer, and I were devoting enormous amounts ofour time to abortive corporate transactions, and to putting in place longer-termfinancing. We're much encouraged that our reduced involvement in operationsallowed other talented individuals within Quarto to display their abilities. Interest costs were virtually flat, in spite of higher interest rates. Thehedge, that we have in place on a substantial part of our borrowings, increasedcash generation, and lower debt all helped to improve the picture. As witheverything else in this financial commentary, I need to remind readers thatQuarto's principal operating currency is the US dollar, and that most debt isdollar denominated. We continue to review whether it would be more helpful toshareholders and investors for us to report our results in dollars, rather thanin sterling. Corporate developments We spent a great deal of time trying to execute our growth strategy that focuseson making acquisitions. There were several important opportunities in 2006 but,in spite of our best efforts, we failed to conclude a deal. Much of our focus, in this area, has shifted to more substantial stand-alonebusinesses, typically with revenues in excess of $30 million. It's difficult toknow whether this level of revenues inevitably invites more interest, leading tobids that we simply will not match, or whether part of the reason we came awayempty-handed is because we are, culturally, organizationally, and at boardlevel, a little too conscious of the downside when assessing the calculus ofreward and potential risk. I've noted before that most of our targets, at this level, will be basedoverseas. It's possible that this "foreignness" counts against us, and that ourdue diligence focus tends to be more on operations and market strength than, asin the case of many domestic bidders, on synergies and financial engineering. Inany event, your board has concluded that, disappointing as the outcomes were,the efforts were tremendously worthwhile, not only in giving us more experienceat this level, but also in affirming that the growth strategy should still bepursued. Another component in our strategy has been to put in place both medium- andlonger-term financing, so that we can follow through swiftly on potentialacquisitions. Our $90 million syndicated 5-year revolving credit facility isscheduled for renewal in July 2007, and in November we concluded a privateplacement of 8-year $50 million note to an investor group led by PrudentialInsurance Company of America, achieving our objective of longer-term funding. Aswe noted at the time, this was important in three principal respects: (i)affirming support for our current business and strategy, (ii) demonstratingconfidence in the abilities of management to execute its plans for the business,and (iii) reducing significantly any need to turn to the equity market to fundpotential acquisitions. We have largely exited from the magazine business, as discussed below, and oursole totally new venture in 2006 was to establish JR Books, a new venture withwell-known and respected publishing veteran Jeremy Robson, whose brief is tobring his own broad and eclectic interests (which range from poets and writerssuch as Ted Hughes and Sylvia Plath to entertainment celebrities Joan Collins,Michael Winner, and Maureen Lippman). Jeremy's first list, as JR Books, will belaunched in the second half of 2007. Prospects I approach the writing of this section of my letter with dread. Of course,having long been in book publishing, we have better knowledge of theopportunities and obstacles than the average financial analyst. We setexpectations with our unit presidents and managers in this context. Only 18% ofour sales are in sterling, so the exchange rate with our principal operatingcurrency, the US dollar, is an important underlying assumption in our budgetsand forecasts. Last year, in drawing up our budgets, we used the then prevailingrate of $1.72 to the pound sterling. In the event, the average for the year was$1.84, a difference of 7%. Our budgets for 2007 have assumed a value forsterling of $1.96. The budget exercise is valuable as a stimulus for sustained reflection andanalysis of the business. It has always seemed to me both futile and faintlyabsurd to measure performance against our informed "guesstimates". At Quarto, weconcentrate on what we can control in all circumstances, and at all times, morethan we agonize over variances from budget. If budgets are drawn up in difficulttimes, they will probably reflect low expectations; in times of over-exuberancethey may well become over-confident. The only certainty is that they will bewrong and, in evaluating the performance of our senior people, we prefer a morenuanced approach that acknowledges the dynamic context in which we operate, andoffers a more balanced assessment. We don't appoint people to senior positionsbased upon their skills as prophets, so it seems more sensible to hold them toaccount for how they have performed "in the circumstances". During 2006 we corrected the shortcomings of some of our units, and eliminatedsome unsuccessful initiatives, emerging with a better trading result. In 2007 weexpect to manage our way through whatever is thrown at us and, in a recitationechoing government health warnings, anticipate that, in the absence of majorcurrency movements, stock exchange crashes, wars, and various other acts of Man,we shall again improve our performance. The probable demise of AMS in itshistoric form will cause a hiatus for us, and for some of our licenseepublishers and, as this is written, it's impossible to guess how long this maycontinue, and whether AMS's unique position will be taken up by another player. In summary, we shall continue to focus, laser-like, on our existing businesses,and shall redouble our efforts to make worthwhile, affordable, and above all,sensible acquisitions that will add to our earnings per share. Your board,recognizing that Quarto operates in a very mature industry, still expects growthto come mainly from acquisitions. The renegotiation of our revolving creditfacility coincides with the ending of our current interest rate hedge, which hasserved us well. We can expect higher interest costs as a result, although weshall continue to hedge our interest rate, and will continue to be vigilant inallocating capital around the group. I'll close as I began, with the comment that, self-evidently, the bankruptcy ofAMS took the gloss off what was a year of substantial underlying positivedevelopment. Your board and I are pleased that we dealt with some of our legacybusiness issues during the year, that we are successfully bringing on board anew, young generation of publishers, and that enthusiasm still drives our staffto come to work every day. We are, indeed, fortunate to work in such anenvironment. Sincerely, Laurence F Orbach Chairman and Chief Executive Officer London, March 8, 2006 REVIEW OF OPERATIONS Our International Co-Edition Book Publishing segment, under the very abledirection of Piers Spence, put in a strong performance across the board,increasing its operating profit, before amortization of non-current intangiblesand exceptional, non-recurring items, by 16% to £5.3 million (2005: £4.5million), or almost 14% of its revenues of £38.4 million (2005: £37.1 million). During 2006 our investment in adult and children's reference publishing atMarshall Editions began to bear fruit, and the imprint delivered a sequence ofsolidly successful publishing projects. These included To the Ends of the Earth,Whale Watcher, and The Atlas of Bird Migration, as well as another four titlesin the bestselling People who Made History series of historical biographies forchildren, licensed in the US to National Geographic. There were a number oftangible advances in the business: Marshall significantly expanded its customerbase during the year and is now no longer over-reliant on a handful ofpublishing partners. Foreign language sales reached a five-year high, and newand profitable relationships were struck with several prestigious Europeanpublishers. And the editorial and design team was restructured and revitalized,the better to face the demands of tomorrow. The combined effect of theseinitiatives was to see sales increase by 28% and profits significantly ahead: afine achievement by any standards. It has taken longer than we thought, butMarshall seems to have finally rediscovered its identity as a force to bereckoned with in international reference publishing. A stellar performance in 2005 left Quarto Books with a tough act to follow,especially in the light of increased competition in its key arts, crafts, andhobbies categories as new entrants were attracted on to the bandwagon. Despitethis, the unit succeeded in growing new title sales by 5% in a mature market,principally through relentless focus on its core audience. Over the year, Quartoshowed readers how to improve their skills at knitting, crochet, scrapbooking,calligraphy, jewellery-making and a wide range of other craft and hobbyactivities-Build Your Own Electric Guitar was perhaps one of the morechallenging of these. In the general reference field 100 Characters fromClassical Mythology and The Bridge Player's Bible were well received, while Howto Raise and Keep a Dragon proved to be one of the hits of the Christmas season,with many booksellers filing it in the "Pets" category! Foreign language saleskept pace with the previous year's record result, and the unit once againcontributed generously to group profits. This time last year Quantum, our specialist backlist imprint, found itself onthe horns of a dilemma. Its value proposition, long the principal driver ofgrowth and profitability, was no longer appealing in a market full of cheapercompetitors, and it was clear that new thinking, and some means to differentiateitself from the mass, was required. The unit responded decisively by acquiringthe Cartographica map database in early 2006, and this looks increasingly like ashrewd move: the initial investment has already been repaid from profits on thefirst four Cartographica titles published-and early indications are that all ofthese will reprint this year-while another four books will be launched inmid-2007. Although original publishing represents a significant departure forQuantum, as a pragmatic response to a fall-off in its traditional markets it hasbeen particularly effective: sales and profits are comfortably ahead of budget,and access to quality product has allowed Isabel Leao, Quantum's publisher,to strengthen her editorial and sales teams to meet future challenges. QED, Quarto's educational publishing unit, creates books principally for theschool and library market, a sector that still enjoys some protection, and onewhere margins can be healthy if you can find a way through the sometimesconvoluted supply channels. QED is still a young business, and to a certainextent is still determining the most suitable route to market in a number of itssales territories: although sales increased by 27%, there were setbacks in anumber of export distribution channels that prevented the business fromachieving its full potential in 2006. These deficiencies are being addressed oneby one, principally by the appointment of new distributors, and improvement isexpected in the current year. On the positive side, foreign-language co-editionsales were ahead of forecast, and the unit continued to deepen its alreadyexcellent relationship with book clubs, school book clubs, anddirect-to-consumer businesses, achieving double-digit increases in sales tothese markets. In a sign of the business's growing maturity, significantinternal promotions were made in the product creation team, and these arealready feeding through to a stronger publishing program for the year ahead. RotoVision, our graphic design and photography specialist, had its best year forsome time, with sales and profits ahead of expectations. The result appears tovalidate the decision taken last year to move the business to a co-editionbasis, and it has certainly sharpened the focus of our publishingdecision-making. Foreign-language co-edition sales grew by over 40%, and whilesome of this is accounted for by one-off backlist sales into previouslyunexploited territories, a three-point increase in margin gives an indication ofwhat might be achievable here in future with discipline and consistentapplication. Even in the UK book trade, traditionally the bugbear of a businesslike RotoVision, things turned out better than expected: sales were ahead by 13%and returns were very significantly down on the previous year. Like manyspecialist publishers, RotoVision is learning to love the online booksellers, asAmazon creeps steadily up its list of top customers. Not everything went toplan, however: one of our three initial US business partners failed to deliversales that met our expectations, and we terminated the relationship at year-end.Sales to Japan, traditionally a very strong market for RotoVision, were theweakest for years. And the move from a distribution to a co-edition model in theUSA may saddle us with a higher than anticipated number of overstocks. Againstthis, there is a palpable sense that RotoVision is emerging into the light andready to start on the next phase of growth. The challenge for the business nowis to quantify how far, how fast, and in what direction. Q+, our books-plus unit incorporating Quarto Children's Books and Design Eye,began the year with a clear brief for change: our strategic review of thebusiness had shown that we needed to reinvent our approach to children's books,and turn our backs on the gimmick-driven model that makes much of what passesfor books-plus barely distinguishable from a cheap toy. Instead, new publisherSue Grabham began to articulate her vision of a line of children's books thatwere not just innovative, engaging, and fun, but that had at their centre a coreof curricular relevance that would stimulate young minds, while at the same timemaking parents feel good about the purchase. The global success of first MyDad's Toolbox and then Tutankhamen's Tomb, both of which have had multiplereprints and are available in a dozen foreign-language editions, speaks to thesuccess of the initiative. Aside from the product offering, better disciplineand more farsighted planning ensured that in the wake of increased sales cameimproved margins, higher revenue per title, fewer production errors, and muchimproved customer satisfaction. Indeed, such was the effect of these changesthat as we approached the end of the fourth quarter Q+ was heading for its bestresult in five years. Unfortunately all this was undone by AMS's Chapter 11filing: they were a significant customer of Q+, and, despite some very nimblefootwork, we were unable to protect ourselves entirely from the fallout.Frustrating as this is-and it seems particularly unfair on the Q+ team whoworked so hard to get a result, only to have it snatched from their grasp at thelast possible moment-much of the groundwork has been done to ensure that 2007delivers on the promise of a creditable business turnaround. QU:ID, one of our two Brighton-based operating units, creates quirky, oftenhumorous titles aimed at the impulse-buy and gift market. Such products aresubject to a fairly modest price ceiling, and this has previously acted as adrag on growth, which is a major source of frustration in a business that isstill in its infancy. During the year QU:ID introduced a number oflarger-format, higher-priced titles in categories with more enduring referencevalue, and this has had the twin benefits of increasing revenue per title, andraising the percentage of titles that go on to reprint. It also realigned itspublishing decision-making with the standard Quarto co-edition model (from whichit had too frequently tended to depart), to ensure that future co-editionopportunities are maximized. Despite these important structural changes, salesremained flat and profit fell marginally, due to the failure of a significanttitle to meet its year-end delivery date. Responsibility for QU:ID'sforeign-language sales has now been assigned to the very experiencedLondon-based sales team. Nigel Browning, QU:ID's publisher, is confident thatthis, together with the changes noted above, should bring worthwhile advancesduring 2007. The folks at Global Publishing in Sydney like to deliver at least one monumentalnew book each year. In 2006 they surpassed themselves with Biblica, the mostambitious, beautiful, and comprehensive atlas of the Bible lands ever produced.Published in two face sizes, large (10 x 13 in), and enormous (12 x 16 in), andweighing in at over 15 pounds, it arrived fully loaded with every possibleenhancement, including fifth-colour gold, printed endpapers, two place-markerribbons, and a slipcase with embossed titles and spot varnish. Publication waswidely celebrated; sales on the first printing totalled $1.5 million, andBiblica quickly climbed into Costco's top-five bestseller list by value, for theChristmas 2006 gift season. But it was here that the seeds of disaster layconcealed: the primary distributor in the US was AMS. On 29 December 2006, AMSfiled for Chapter 11, owing Global more than $1.3m. The small team at Globalhave responded to this devastating blow in the best way possible, and set theirfaces to the wind. At time of writing, Global's order book stands at double thelevel of this time last year, with a three-point margin improvement. There ismuch to do, but the path to recovery is clearly signposted. IQON is a small, but perfectly formed, co-edition imprint that turns outsumptuously illustrated reference books in the field of high arts and culture.Understanding Architecture, launched at the beginning of 2006, went on to selljust short of 100,000 copies in 19 languages over six printings. UnderstandingReligion will top the list for 2007; sales and pre-orders to date exceed 50,000copies. Quintet had an interesting 2006. Since the launch of our bestselling 1001 . . .series in 2003, the unit had increasingly developed a split personality, inwhich the half that was responsible for international mega-sellers such as 1001Movies You Must See Before You Die, 1001 Albums You Must Hear Before You Die, etal. had completely overshadowed the original Leisure and Lifestyle imprint, andwas starving it of resources and attention. Accordingly, in the third quarter of2006, we took the decision to bring this tendency to its logical conclusion, andthe conjoined lists were surgically separated into Quintet and a new imprint,Quintessence. New publishers were appointed for both units-crucially, these wereinternal promotions from a talented second line of management, thereby releasinghuge reserves of productivity and goodwill in house. Quintessence has since continued it stellar trajectory: multiple English andforeign language reprintings of 1001 Movies, 1001 Books, and 1001 Albumsproduced like-for-like sales growth of 25% and, unusually for a Quarto Groupimprint, engendered huge public awareness through a wall-to-wall brandingexercise at HMV stores in the UK, which is now being rolled out to publishingpartners overseas. Its immediate future looks very exciting, with four 1001 . .. titles planned for each of 2007 and 2008, together with two titles per year ofa spin-off series. The medium term challenge for the unit is to come up with asecond act that stands comparison to the first. Quintet proper, in the meantime, has bought itself some time to regroup andre-establish its raison d'etre. Early signs are promising: major customers havewelcomed the clarity brought about by the separation of the two units, and thekey series, especially 500 Cookies, 500 Cupcakes, etc., are finding anenthusiastic response in the market. In one of those rare instances where thesum of the parts is greater than the whole, the combined revenues and profits ofQuintet and Quintessence in 2006 were very significantly ahead of the previousyear's results for the parent imprint, and both units seem poised for anexciting future. Both of our publishing services businesses prospered, with Regent, inparticular, producing a hugely impressive performance in an extremelycompetitive market, replacing a large, but only marginally profitable, customerwith a string of new publishing clients. George Tai, and his team, did a finejob. The Publishing segment had a tough year. It operates entirely inEnglish-language markets, and suffered, along with the general malaise,particularly in the United States. Operating profit, before amortization ofnon-current intangibles and exceptional, non-recurring costs, at £5.2 million(2005: £5.3 million) was slightly down, on revenues that declined by 5% to £55.2million (2005: £57.9 million). The revenue decline is accounted for mostly bythe running-down of our UK-based magazine business, and by the sharp fall inrevenues at Book Sales, in the United States. Encouragingly, under Bill McCreadie's watchful and careful direction, AurumPress and Apple were beacons of light. A strong frontlist at Aurum producedrecord revenue and profit numbers on the back of vigorous marketing efforts withmajor retailers. Increased print runs strengthened margins across the board, anda number of titles went into reprint. Apple thrived in its first full year ofdistribution by the Aurum sales team, and made a useful contribution to profit.The Jacqui Small lifestyle imprint also enjoyed increased sales in the UK, asthe launch of two new series contributed to an overall increase in publishingoutput. Given the backlist nature of the Jacqui Small list, this augurs well forthe near-term. Elsewhere in the UK we wound down our magazine publishingactivities. They were too small, traded in a very difficult marketplace, andabsorbed a disproportionate amount of management attention. Our remaining title,The World of Fine Wine, which has won substantial critical acclaim and garneredan international circulation of high-net-worth individuals, will become the coreof a co-edition book list focusing on wine and fine living. In the USA meanwhile, Book Sales had a torrid year. Sales were off by 23%, andoperating profit slumped by 57%. Things never really recovered from a rockystart to the year although, by the end, the situation was stabilized and showingsigns of improvement. There's nothing to suggest that there is anythingfundamentally flawed with Book Sales' business model; the explanation lies withcyclical issues and a number of one-off occurrences. Management is confidentthat a number of new products, including some chunkier pint-size versions oftitles previously published in large formats, launched during the year will,despite their modest beginnings, continue to sell steadily and profitably foryears to come. Walter Foster has been trying, for some years, to break out of its box. As theoldest-established publisher of how-to instruction books for aspiring artists,it has adapted well to the change in retailing from independent arts and craftsshops to the big box stores, such as Michaels, A C Moore, and Hobby Lobby. Ithas attempted to leverage these relationships to enter into categories otherthan fine art. On the whole, the experiments have not been successful; nor havethey been disastrous, and a great deal has been learned. With flat revenues andprofits, Walter Foster sailed through a stormy year, with the distribution intoits major arts and crafts markets in a state of disarray which, by year's end,had been resolved. Following the purchase of the leading US arts and craftsretailer, Michaels, by private equity interests, sales into the store improved.Management believes that, with private equity's greater focus on returns, WalterFoster will benefit from the chain's concentration on core competencies in itsapproximately 1,000 stores. During the course of the year, Walter Foster startedto migrate its sales force and fulfillment operation to our Quayside PublishingGroup. To judge by the initial results, which have been positive for WalterFoster's sales into the book trade, Quarto can definitely build upon theinfrastructure that we have put in place. Quayside, which includes the Rockport imprint, Fair Winds, and Quiver, all inthe Boston area, and CPi, in Minneapolis, is the core of Quarto's sales,marketing, and fulfillment infrastructure for North America. With minorexceptions, all of the imprints produce for identified special interestaudiences, and this is what we wish to extend with further acquisitions.Overall, under the able leadership of Ken Fund, operating profit improved byapproximately 7.5% but CPi, which publishes into the home improvement market,felt the draught from the downturn in the housing market, and the stumbles ofHome Depot, the sector's major retailer. Sales into Lowe's, the number twooperator in the sector, increased substantially, but this was in marked contrastto what happened at Home Depot where, although register sales increased, themanagement of the supply chain was affected by arbitrary inventory mandateshanded down from on high. The new CEO at Home Depot has vowed to overhaul thechain and, although the revenues from selling books are immaterial to HomeDepot, their management does know, from examining its point-of-sale data, thatbook buyers tend to spend significantly more in the store on other homeimprovement merchandise which is, of course, only what one would expect. What is of particular note is that Quayside's sales into Amazon were upsubstantially, to the extent that it is becoming our second-largest book traderetailer, after Barnes & Noble. This is an encouraging sign that Amazon'scustomers are using it to replace traditional mail order specialist catalogs andbook clubs. If the large bricks-and-mortar retailers ever scale back theirranges of special interest titles because the inventory doesn't turn fastenough, Amazon will capture an even bigger slice of the pie. In Australia and New Zealand, where our display marketing subsidiaries, Lifetimeand Premier, respectively, are the market leaders, we had another satisfactoryyear. Lifetime continues to improve its organization, and refine its businessmodel, which is based upon franchised agents operating on an exclusive basis indesignated territories. More resources were ploughed into the franchising side,in order to improve the return from the territories, and to enhance the value offranchises for our franchisees. In Australia, interest rate rises and a slowing housing market combined withincreased fuel prices, and this, in a country of long distances and accustomedto relatively inexpensive fuel, affected consumer sentiment. Similar factorswere at work in New Zealand, but these were compounded by Premier's inability tocontinue to grow in the cramped warehouse that it occupied. Although the move tolarger premises was uneventful, inevitably it had some impact on performance,which was slightly down on expectations. Premier does not operate on thefranchise model; instead, although the display marketing experience appears thesame to the consumer, the distributors are self-employed agents working for uson commission, as distinct from being franchise owners. We need to do more toimprove the performance of some of our distributors, particularly on the NorthIsland, where there is more competition than previously. Despite this, Premierremains an enviably successful business, and has, in Grant Letica, a veryeffective general manager, who will surely come to terms with the challenges. Art Publishing continued its gentle decline, still generating operating profitand cash, but we have largely preferred to stand on the sidelines as we observethe profound changes in public attitudes to purchasing reproduction art. Thesehave affected the industry enormously. Most of our competitors are trying newventures, in efforts to re-ignite consumer interest. For our part, until we feelthat we understand how consumer sentiment is likely to settle down, and for solong as we can still generate profit and cash from the business, we'll elect toremain observers rather than initiators. In the UK, our publishing and marketing support services business, now renamedthe Image Factory, is turning the corner. We've installed a secondstencil-making machine for our silk screen processes, and have brought in a verylarge format digital printing machine. The impact of this investment has been toimprove operational efficiency and better workflow, and allows us to tackle newmarkets. Point-of-sale marketing remains a growth area, and we intend to take agreater share of the market. CONSOLIDATED INCOME STATEMENT Year ended December 31, 2006 2006 2005 £000 Restated £000 Continuing operations Revenue 93,613 95,038Cost of sales (58,137) (60,303) Gross profit 35,476 34,735 Other operating income 281 227Distribution costs (4,375) (4,148)Administrative expenses before amortization of non-current intangibles and non-recurring items (21,825) (21,898) Amortization of non-current intangibles (1,387) (1,381) Non-recurring items Bad debt (1,238) -Aborted acquisition costs - (102)Restructuring costs - (644) Total administrative expenses (24,450) (24,025) Profit from operations before amortization of non-current intangibles and non-recurring items 9,557 8,916 Operating profit 6,932 6,789 Finance income 298 128Finance costs (2,593) (2,351) Profit before tax 4,637 4,566 Tax (1,202) (1,293) Profit for the year 3,435 3,273 Attributable to: Equity holders of the parent 2,800 2,615Minority interest 635 658 3,435 3,273 Earnings per share From continuing operations Basic 14.3p 13.8p Diluted 13.9p 13.5p CONSOLIDATED BALANCE SHEET Year ended December 31, 2006 2006 2005 £000 Restated £000 Non-current assets Goodwill 9,710 10,317Other intangible assets 2,987 4,842Property, plant and equipment 7,501 8,533Deferred tax assets 198 25 Total non-current assets 20,396 23,717 Current assets Intangible assets: 20,919 21,008Pre-publication costs Inventories 13,948 14,079Tax receivable 178 152Trade and other receivables 27,022 28,399Cash and cash equivalents 13,929 14,431 Total current assets 75,996 78,069 Total assets 96,392 101,786 Current liabilities Short term borrowings (17,800) (3,932)Trade and other payables (25,981) (27,032)Tax payable (1,437) (1,258) Total current liabilities (45,218) (32,222) Non-current liabilities Medium and long term borrowings (27,121) (45,599)Deferred tax liabilities (4,404) (4,104)Other payables (21) (114) Total non-current liabilities (31,546) (49,817) Total liabilities (76,764) (82,039) Net assets 19,628 19,747 Equity Share capital 1,162 1,162Paid in surplus 21,740 21,716Retained deficit and other (6,951) (6,816)reserves Equity attributable to equity 15,951 16,062holders of the parent Minority interest 3,677 3,685 Total equity 19,628 19,747 CONSOLIDATED CASH FLOW STATEMENT Year ended December 31, 2006 2006 2005 £000 Restated £000 Profit for the year 3,435 3,273Adjustments for: Net finance costs 2,295 2,223Depreciation of property, plant and equipment 959 1,067Tax expense 1,202 1,293Amortization of non-current intangible assets 1,387 1,381Amortization of pre-publication costs 7,461 7,562Movement in fair value of derivatives (254) -Equity settled share - based payment expense 7 9(Gain)/Loss on disposal of property, plant and equipment (87) 51 Operating cash flows before movements in working capital 16,405 16,859 (Increase)/decrease in inventories (1,307) 11(Increase) in receivables (672) (3,057)Decrease in payables (267) (232) Cash generated by operations 14,159 13,581 Income taxes paid (611) (1,428) Net cash from operating activities 13,548 12,153 Investing activities Interest received 298 119Proceeds on disposal of property, plant 933 237and equipment Investment in pre-publication costs (8,444) (7,574)Purchases of property, plant and equipment (864) (678)Acquisition of subsidiaries (89) (2,847) Net cash used in investing activities (8,166) (10,743) Financing activities Dividends paid (1,291) (1,197)Interest payments (2,797) (2,390)Proceeds on issue of share capital 56 18New bank loans raised 583 2,288Dividends paid to minority interest (244) (121) Net cash used in financing activities (3,693) (1,402) Net increase in cash and cash equivalents 1,689 8 Cash and cash equivalents at beginning of year 11,899 10,611 Foreign currency exchange differences on cash and cash equivalents (1,478) 1,280 Cash and cash equivalents at end of year 12,110 11,899 NOTES 1. Segmented analysis Business segments Co-edition Co-edition Publishing Publishing Publishing Publishing Total Total 2006 2005 2006 2005 2006 2005 £000 £000 £000 £000 £000 £000 Revenue Total sales 40,307 38,314 55,210 57,989 95,517 96,303Inter-segment revenue (1,900) (1,259) (4) (6) (1,904) (1,265) External sales 38,407 37,055 55,206 57,983 93,613 95,038 Segment result before amortization of non-current intangibles and non-recurring costs 5,277 4,549 5,245 5,318 10,522 9,867 Amortization of non-current intangibles (12) (12) (1,375) (1,369) (1,387) (1,381)Bad debts (1,085) - (153) - (1,238) -Restructuring costs - - - (644) - (644)Aborted acquisition costs - (102) - - - (102) Segment result 4,180 4,435 3,717 3,305 7,897 7,740 Unallocated corporate expenses (965) (951) Profit from operations 6,932 6,789Investment income 298 128Finance costs (2,593) (2,351) Profit before tax 4,637 4,566Tax (1,202) (1,293) Profit after tax 3,435 3,273 Geographical Segments Revenue Revenue 2006 2005 £000 £000 United Kingdom 16,668 15,848United States of America 43,070 46,305Australia and the Far East 18,384 18,344Europe 11,860 10,415Rest of the World 3,631 4,126 93,613 95,038 2. Earnings per share 2006 2005 £000 £000 Earnings for the purposes of basic earnings per share, being net profit attributable to equity holders of the parent 2,800 2,615 Effect of dilutive potential ordinary shares: Interest on loan notes (net of tax) 45 57Interest on convertible redeemable preference shares - 204 Earnings for the purposes of diluted earnings per share 2,845 2,876 Number Number Number of shares Weighted average number of ordinary shares for the purposes of basic earnings per share 19,563,900 18,893,419 Effect of dilutive potential ordinary shares: Share options 104,651 139,183Dilutive loan note 855,015 1,074,288Dilutive preference shares - 1,218,131 Weighted average number of ordinary shares for the purposes of diluted earnings per share 20,523,566 21,325,021 2006 2005 pence pence Basic 14.3p 13.8p Diluted 13.9p 13.5p Adjusted Earnings Earnings for the purposes of basic earnings per share, being net 2,800 2,615 profit attributable to equity holders of the parent Amortization of non-current intangibles (net of tax and minority interest) 962 925 Bad debt (net of tax and minority interest) 818 -Restructuring costs - 644Aborted acquisition costs - 102 Earnings for the purposes of adjusted earnings per share 4,580 4,286Effect of dilutive potential ordinary shares: Interest on loan notes (net of tax) 45 57Interest on convertible redeemable preference shares - 204 Earnings for the purposes of diluted earnings per share 4,625 4,547 2006 2005 pence pence Basic 23.4p 22.7p Diluted 22.5p 21.3p 3. Dividends 2006 2005 £000 £000 Amounts recognised as distributions to equity holders in the period: Interim dividend for the year ended December 31, 2006 of 3.0p (2005: 2.9p) per share. 587 567 Final dividend for the year ended December 31, 2005 of 3.6p (2004: 3.5p) per share. 704 630 1,291 1,197 Proposed final dividend for the year ended December 31, 2006 of 3.75p (2005: 3.6p) per share. 736 704 736 704 4. Consolidated statement of recognised income and expense 2006 2005 £000 Restated £000 Exchange differences on translation of foreign operations (1,222) 754 Net loss on hedge of net investment in foreign subsidiaries - (120) Change in the fair value of cash flow hedges - 329 Net (expense)/income recognised directly in equity (1,222) 963 Profit for the year 3,435 3,273 Total recognised income and expense for the year 2,213 4,236 Prior period adjustment 7,505 Total recognised income and expense since last annual report 9,718 Attributable to: Equity holders of the parent 1,578 3,578Minority interest 635 658 2,213 4,236 5. Prior period adjustment The period adjustment relates to non-compliance with IAS 38. The Group'spre-publication costs meet all the criteria set out in IAS 38 and thereforethese costs should have been capitalised as development expenditure. Thefinancial statements have been restated to correct this. The effect of therestatement on these financial statements is summarised below: 2006 2005 £000 £000 Decrease in cost of goods sold 305 141Increase in tax (115) (30) Increase in profit for the year 190 111 Increase in intangible assets 20,919 21,008Decrease in inventories (9,408) (9,442)Increase in trade and other payables (246) (239)Increase in deferred tax liabilities (3,417) (3,436) Increase in net assets 7,848 7,891 Increase in total equity 7,848 7,891 Decrease in minority interest share of profit for the year 10 7 Increase in minority interest at the year end 29 41 Increase in basic earnings per share 1.0p 0.6p Increase in diluted earnings per share 1.0p 0.6p The effect on opening reserves at January 1, 2005 of this prior periodadjustment is £7,505,000. The revised accounting policy is stated below, for information: Pre-publication costs represent direct costs incurred in the development of booktitles prior to their publication. These costs are carried forward in currentintangible assets where the book title will generate future economic benefitsand costs can be measured reliably. These costs are amortized upon publicationof the book title over estimated economic lives of 3 years or less, being anestimate of the expected operating cycle of a book title. The investment inpre-publication has been disclosed as part of the investing activities in thecash flow statement. 6. Reconciliation of figures included in the Chairman's Letter 2006 2005 £000 £000 Profit before tax, before amortization of 7,262 6,693non-current intangibles and non-recurring items Amortization of non-current intangibles (1,387) (1,381)Non-recurring items (1,238) (746) Profit before tax 4,637 4,566 EBITDA Profit before tax, before amortization of 7,262 6,693non-current intangibles and non-recurring items Net interest 2,295 2,223Depreciation 959 1,067Amortization of pre-publication costs 7,461 7,562 EBITDA, before non-recurring items 17,977 17,545 Net debt Medium and long term borrowings 27,121 45,599Short term borrowings 17,800 3,932Cash and cash equivalents (13,929) (14,431) 30,992 35,100 7. The financial information set out above does not constitute thecompany's statutory accounts for the years ended December 31, 2006 or 2005 butis derived from the 2006 accounts. Statutory accounts for 2005, have beendelivered to the Registrar of Companies, and those for 2006, will be deliveredin due course. The auditors have reported on those accounts; their reports were(i) unqualified, (ii) did not include references to any matters to which theauditors drew attention by way of emphasis without qualifying their reports and(iii) did not contain statements under section 237(2) or (3) of the CompaniesAct 1985. 8. The accounting policies adopted for use in the preparation of the 2006Preliminary Results and of the 2006 Annual Financial Statements were consistentwith those used in the preparation of the 2005 Annual Financial Statements,except for the treatment of pre-publication costs, as noted in note 5, above. 9. The Annual Report will be sent out to shareholders in due course.Additional copies can be obtained from the Finance Director, The Quarto Group,Inc., 226 City Road, London EC1V 2TT. Tel: 020 7700 9000 (email:mickm@quarto.com). 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