Business Project

Financial Statements &

Ratio Analysis:
Analyzing
“Washington Post Co.”

Submitted by
- Group 8 -

November 18, 2010

Abbreviations

The following abbreviations have been used in the report:

The Washington Post Co. at a glance
The Washington Post Co. (WPO:NYSE) - in the following referred to as “WP” - is a diversified
media and education company. Its main businesses include newspaper, magazine, TV
broadcasting, Cable television systems and education services. The company is headquartered in
Washington DC and employs 21,500 people. The company had revenues of $4,569.7 million in
2009, an increase of 2.4% over 2008. The operating profit of the company was $194 million in
2009, an increase of 11.4% over 2008. Its net profit was $92.8 million in 2009, an increase of
41.2% over 2008. The company's key products include the newspapers under the brand name
‘The Washington Post’, education services under the brand name ‘Kaplan' and international
magazine under the brand ‘Newsweek´. The company in its education business competes directly
with the Apollo Group and Kapella Group among others and in the media business they face
strong competition from NY Times and Newscorp.

Analysis of the financial statements

Balance sheet analysis - The main accounts

In our review of WP’s balance sheet we were able to reveal the following main accounts:
Cash, Cash Equivalents & Short-Term Investments: This account made up for over 16% of WP
total assets in FY09. At $ 862m, it is the maximum cash WP has held on its balance sheet in the
last 5 years. This huge change in cash is mainly due to WP decision to treat its investment in
Berkshire Hathaway as current assets in 2008, before this company treated this investment as
long term investment (see Other Investments) and hence was excluded from current assets. In
2007 company completed acquisitions totaling $ 296.3m whereas it only spent $ 26.1m in 2009
on acquisitions. As company forecasts strong growth in its education business and has been
growing this business through acquisitions in the past, a high cash reserve reflects on company´s
intent to acquire new businesses in the coming years.
Investment in affiliates: The Company values these investments according to equity method and
considers whether the fair values of any of its investments have declined below their book value
whenever adverse events indicate that the book value may not give a clear picture of these
investments. On November 13, 2006, the Company sold its 49% interest in BrassRing and
recorded a $ 43.2m pre-tax gain, other than that during 2009 and 2008, the Company recorded $
29.0m and $ 6.8m of impairment charges at the Company’s affiliates, respectively. The 2009
charges primarily relate to an impairment charge recorded on the Company’s interest in Bowater
Mersey Paper Company as a result of the challenging economic environment for newsprint
producers.
Net Receivables: WP’s net receivables accounted for in between 8% and 9% throughout the five
analyzed years. Net receivables for WP consist of trade accounts receivable reduced by estimated
returns, doubtful accounts and allowances. Furthermore it includes other accounts receivables.
The figure for net receivables in 2009 is low compared to previous years (-10.16% YoY) as
receivables were adjusted by $ 106.8m in order to account for allowances for uncollectible
amounts. Receivables turnover thus diminished slightly, but stayed quite stable from FY05 to
FY09 (see p.XX).
Net Plant, Property & Equipment: As to non-current assets, a proportion of 24% refers to its
property, plant and equipment (“PPE”). This account is composed of gross PPE reduced by
accumulated depreciation. Machinery, equipment and fixtures account for 76% of gross PPE
which seems logical as WP must hold for instance special printing machines to print its daily
newspapers. The company states that it holds items under operational lease as well as under
capital lease agreements. As the printing machines are very special items, lessors might not want
to hold the risk of these assets and thus WP in our opinion holds a majority of these under capital
lease agreements. As operational leases are not accounted for as assets the true extent to which
WP uses assets might be biased. The company only states that under its current agreements it
will have to pay approximately $ 841.6m until 2015.
Intangibles: Intangibles make up around 40% of total assets. This item primarily includes
Goodwill (more than 75% of Intangibles, 30% of WP’s total assets) and of other intangible
assets, e.g. non-compete agreements, student & customer relationships, etc. US GAAP does not
allow for including self-created Goodwill, that is why the high proportion of goodwill comes
from the purchase price allocations of WP’s acquired businesses. WP has been growing rapidly in
its education business driven from acquisitions. WP records goodwill as excess of purchase price
over the fair value of identified net assets of businesses acquired. It also annually reviews its
intangibles and goodwill for possible impairment using impairment tests and discounted cash
flows to estimate fair value. The company has identified 18 reporting units for goodwill and the
results of these tests as of January 3, 2010 showed that WP had to adjust Goodwill by $ 142.1m.
Most of all, these charges affected the intangibles of the Newspaper Publishing ($ 65.77m) and
the Other Businesses division ($ 60.79m). $ 15.53m of impairment losses related to Kaplan
Venture a division of WP’s Education division (adjustments at Kaplan EduNeering and Kaplan
Compliance Solutions reporting units).
Other Current Liabilities: This account on the liabilities side includes both deferred revenues
(70%) and accrued liabilities (30%), accounting for 11.6% of total assets in FY09. Deferred
revenues mainly consist of advance fees received from customers for various services that lead to
advances revenue recognition (e.g. education/tutoring fees, cable subscription fees, etc.).
Deferred revenues only account for the services that will be recognized in revenues within 1 year.
The item has experienced strong increases in FY05 and FY06 (over 20% yoy) and has been
increasing over 9% yoy for the last 3 years.
Long Term Debt: The absolute amount of WP’s long-term debt that it uses to finance its
operations stayed stable at around $ 400m throughout the last five years, averaging 7.5% of total
assets. Interestingly, whenever WP needed more financing than these $ 400m it used bank loans
due in one year (for instance in FY08 this account amounted to $ 154m). We imagine this
strategy to be part of WP’s management of its capital structure.
Deferred Taxes: Deferred Income Taxes accounted for a big proportion of WP’s total liabilities
& assets from FY05 to FY09. At the end of 2009 this account was 8.15% of total liabilities &
equity. WP traditionally had a relatively high amount of deferred taxes (also compared with for
example NYT). According to management comments and thorough analysis of this account we
came to the conclusion that the deferred taxes originated from many one-time charges. In the
letter to shareholders, the CEO of WP describes that these charges had for many years substantial
effect on the company’s Net Income. These included for instance accelerated depreciation of
fixed assets, impairments to goodwill (see above), lease terminations, severance payments to
employees, etc. All of these in our eyes contributed to high deferred taxes recognized in WP’s
balance sheet.
Other Liabilities: The composition of the Other Liabilities account is as follows: accrued
compensation (50%), postretirement benefits other than pensions (17.5%) and other (32.5%).
This account resulted in $ 419m in FY09, accounting for 8% of total liabilities & equity. The
accrued compensation includes in our perception obligations that arise from different pension
plans. These are very much affected by assumptions that determine discount rates and
compensation rates which are to be considered carefully when analyzing WP.
Common Equity: Equity plays an important role in WP’s capital structure (over 50% of total
assets throughout the last five years, 57% in FY09). As already mentioned above, a vast
proportion of WP’s total assets consist of intangible assets and therefore cannot be used as
collateral for debt financing. In addition, a substantial part of WP’s value consists of its capability
to strengthen its own created brand as well as its online platforms and to attain human capital.
Such value drivers cannot be capitalized and therefore, WP relies very much on shareholders that
trust in these “assets”. A significant stake of WP shares is held by Berkshire Hathaway, Warren
Buffett’s investment company.
The company does not have any off-balance sheet arrangements. According to its AR09, all
transactions with related parties are conducted through the ordinary course of business.

Balance sheet analysis - The financing mixture

WP´s balance sheet shows healthy current assets to liability ratio. Over the last five years WP
current assets balance has been more than its current liabilities. The accounts payable and
accounts receivables have been in the same ratio in respect to the total assets and accounts
receivables have always been more than the accounts payable. More than half of current
liabilities for WP come from deferred revenues, which are fees paid by consumers for services to
be delivered within one year. In all WP is equipped and financially strong to cover its current
liabilities and this strength mainly comes from their cash holdings that they have been building
up throughout the last few years.
As to the WP’s long-term financing we already described how WP manages its capital structure.
The company’s PPE and equipment is enough to serve as collateral for WP’s long-term debt that
amounted to $ 429.1m in 2009. However, we point out that some parts of WP’s PPE are under
financial leasing agreements making the use of this part of PPE as collateral more difficult. The
major financing source for WP is its shareholder’s equity. Due to the importance of its self-
created and acquired intangibles, WP depends on shareholders who believe in the company’s
strength to create long-term value with those assets. Income Statement Analysis
Income statement analysis - Recognition principles
In FY09 WP reported revenue of USD 4.5 billion, an YoY increase of 2%. The revenue in the
last 5 years has increased by 28.5%, which is mainly due to growth in revenues from its
education business. WP income from operations is up 11% in 2009 to 193 million. WP derives its
revenues from various divisions such as Kaplan (education), Cable One (telephone, cable TV and
internet services), newspaper, magazine and local TV broadcasting.  In 2009, WP derived 58%,
16% and 25% of its revenues from Kaplan, Cable One and another three divisions respectively.
WP recognizes revenues when persuasive evidence of contract/arrangements exists, when the
fees are fixed, when the product or service has been delivered and when collectability of
payments is assured. For Kaplan, tuition revenues are realized rateably over the period of
instruction/classes delivered to students. Online access revenue is recognized rateably over the
period of access and other revenues are realized when these services are provided. For Cable
One, revenues are recognized monthly as services are delivered and advertising revenues are
recognized when commercials are aired. For newspaper, magazine and television broadcasting,
media advertising revenues are recognized when the underlying advertisement is published.
Revenues from newspaper and magazine subscription and retail sales are recognized upon the
later of delivery date with adequate provision made for sales returns. As a whole, WP uses fair
recognition principles. The ones for its educational division, however, are rather subjective and
might imply possibilities for manipulations.
Impairment of goodwill and other long lived assets is one account that is consistently included in
WP´s Income Statements. The reason is that WP reviews their goodwill and intangibles annually
for any impairment. Though, annual impairment may be looked at as a good management
practice as it provides with fair value of goodwill, this account can also be used by the WP´s
managers to overstate or understate revenues as the results of impairment tests are not usually
published and these tests rely on several assumptions that the management makes.

Income statement analysis - Margins overview

The income statement analysis unveils that both sales and cost of goods sold have been
increasing over the years. While the increase in costs has been moderate, sales have increased
from $ 3,554m in FY05 to $4,570m in FY09. Thus, gross margin has increased from 46.9% to
56.17% by the year 2009. The main driver of sales increase is the performance of the educational
division. Sales revenue increase of Kaplan accounted for 15%. Compared to New York Times,
gross margins reported by WP are slightly lower. However, while those numbers for NYT have
been rather constant over the last five years, gross margins have been steadily increasing for WP.
If this trend continues, we can expect Washington Post to show better results in the upcoming
years.
WP has a positive profit margin which has declined substantially over the last two years from a
level of 8.8% in FY05 to 2% in FY09. This decline is due to an increase in SG&As which
accounted for 26.21% of sales in FY05 compared to 44.31% in FY09. This increase in SG&As
expenses is mainly because of higher marketing and advertising costs for Kaplan Higher
Education business and also because in 2007, the company made some changes to certain
departments and cost centers at most of its divisions, resulting in a net increase to selling, general
and administrative expenses and net decrease to operating expenses. From 2007 – 2009, WP´s
revenues have increased by $600,000 but its operating expenses has only increased by $120,000,
as most of the growth in costs is included in SG&As. In addition, the income statement of the
company includes non-operating expenses for the last two years referred to as one-time charges
which decrease the profit margin further. Despite high and stable gross margins, the industry
competitor NYT reports profit margins varying between -17% and 8% for the last years. This
indicates that WP has a much more stable and consistent performance compared to the industry in
which it operates. In general high product margins are not common since the industry is rather
competitive and even though there are some entry barriers, there is a possibility of new entrants
in the industry.

Analysis of different ratios

Reformulation of the balance sheet and comparison of ratios

We reformulated the balance sheet in order to use the Advanced DuPont model to get a more
detailed view on the profitability of WP. Ratios are very useful to understand the performance of
the company and compare it with a competitor or with the whole industry. In our case, we have
chosen New York Times (“NYT”) as our main competitor. Also, we found The Standard &
Poor’s Publishing Index which is comprised of Gannett Co., Inc., The McGraw-Hill Companies
and The Meredith Corporation apart from The New York Times Company and The Washington
Post Company. We will use some of these companies to further compare in case we believe the
NYT not to be adequate. Additionally, due to the importance of Kaplan in our company, we will
also compare WP to American Public Education and Apollo Group Inc.

Activity ratios
The asset turnover (sales/NOA) shows how efficient is the company. In FY09 WP’s asset
turnover has been 1.441, which is quite high compared to NYT(0.99). In order to explain the
difference, we will try to estimate industry’s trend. The industry’s trend from two of the biggest
publishing companies shows WP’s results are outstanding: McGraw Hill’s ratio has been 0.38 for
FY09 and Gannett Co.’s ratio 0.56 for FY08 (we have not been able to access FY09 data).
Therefore, the difference can be attributed to the fact that the publishing segment is no longer the
main driver of WP’s revenues.
In order to see if Kaplan plays an important role in the result, we have tried to disclose its ratio
for FY09. We know Kaplan’s revenues for FY09 ($2,636.6) and we have found its identifiable
assets in the annual report ($2,188.3). The main problem is that this figure includes financial
assets and we haven’t information about the proportions. We have decided to assume a
percentage of FA similar to Apollo Group Inc., a competitor in the education industry, as we
believe it will be closer than WP’s percentage. Apollo Group Inc.’s FA/TA is equal to 13.8%.
Using this proportion, we can find Kaplan’s ratio, which has been 1.36 for FY09. In addition, we
have computed the ratio for Apollo Group Inc. (1.41).
After this overview, we reach the conclusion that Kaplan affects widely WP’s asset turnover.
Washington Post’s Working Capital turnover is similar to NYT’s, both standing between 3 and 4.
It implies $1 invested in NWC generate between $3 and $4 of sales.
If we analyse Receivables turnover ratio (10.04 in FY09) and Payables turnover (5.46 in FY09),
we can conclude WP manages efficiently its operations. WP obtains financing from their
suppliers and receives more than 90% of the sales in cash. This proportion is lower in NYT
(85%).
We use the term Operational leverage to describe how a company obtains financing from
operating activities. WP’s OLLEV fluctuates between 0.3 and 0.4, with a low tendency to
increase. NYT’s OLLEV is less volatile and stays close to 0.2. These figures strengthen what we
have pointed above: WP is more efficient in managing payments.
Liquidity ratios
Liquidity is key in a company because problems with it may suppose bankruptcy. Our company
doesn’t have liquidity problems. Current liabilities are in average 70% of current assets.
Cash represents more than 60% of CA in FY09. High percentages have been a constant during
the past years. A possible explanation is that WP’s growing strategy is mainly based in
acquisitions. Moreover, FY09 has been the slowest year in a long time in the acquisition front,
what resulted in an increase of cash. NYT, on the other hand, has percentages of cash/current
assets lower than 10%. This huge difference can be also consequence of the proportion
cash/receivables between the two companies. While our main competitor‘s proportion has been
steady at 1/10 during the last 5 years, WP’ cash represented 3/5 of the receivables in FY05 and
has increased to 2/1 in FY09.
McGraw Hill doesn’t help us very much as its proportion was 4.5/10 in 2008 and 12.5/10 in
2009. As we did before, we need to compare our results with Gannett Co. as well. Using 2007
and 2008 data, we obtain a mean of 1/10.
Therefore, comparing our company to the industry, we can conclude WP’s huge amount of cash
is due its specific (growing) strategy.
Solvency ratio measure a company's ability to meet long-term obligations. It provides a
measurement of how likely a company will be to continue meeting its debt obligations. WP’s
solvency ratio has been 18.51% in FY09. As a general rule, a solvency ratio of greater than 20%
is considered financially healthy. However, as WP’s debt can be considered as low, shareholders
shouldn’t perceive it as a risk.
Profitability ratios
Profitability is the measure which best describes the health of a company, at the same time that
allows us make previsions for the future (forecast).
We use Return on Net Operating Assets (RNOA) and Return on Common Equity (ROCE).
RNOA has been decreasing from FY05, when it was 10.66%. Last year it was 4.15%. The
decrease has been steady. However, its composition has changed substantially. We can split
RNOA into asset turnover (widely discussed above) and margin. WP’s margin has decreased by
more than 2 thirds within the last 5 years. It has been the main driver for the decrease in RNOA,
what has received a strong impact from the economic crisis and the changing newspaper industry.
NYT’s situation is similar. Its RNOA has followed the same tendency (6.80% in FY05 and
2.35% last year). In this case it has been more volatile (11.73% in FY06). Both turnover and
margin have followed the same evolution, so NYT RNOA’s composition has not changed.
Hence, we can’t disclose which of the two effects has had a higher influence in the profitability.
What we can say is that WP has managed more efficiently its assets, as the turnover is higher.
Return on Common Equity has a positive correlation with RNOA. It is also affected by the Net
Borrowing Cost and the Financial Leverage. RO(C)E is the ratio which best describe a
company’s profitability. It adds the capital structure leverage ratio to the margin and the asset
turnover.
The tendency over the last 5 years has been negative. WP’s ROE has decreased by 10 points from
FY05. Last year, WP’s ROE has been 3,21%, while it was 13.49% in FY05.
In FY08 we find a 71.73% drop from 9.04% to 2.34%. The main reason is the increase of the
NBC, caused by the increase of financial expenses together with a decrease in financial
obligations, which jumped from -0.32% to 13.2%. RNOA fell in this period by one half.
The drop can be also a consequence of the global crisis scenario. In order to strengthen our
assumption we look at NYT’s ROE. NYT’s ROE’s evolution is very irregular. The main
difference we can see is the financial leverage. While WP finances an important part of its
operations with equity, NYT basically uses debt. .
WE ANALYSE THE AVERAGE PAID DAILY CIRCULATION IN THE FIRST INICIATIVE.
I HAD WRITTEN A PARAGRAPH BUT IT WAS TOO REPETITIVE. WE ALREADY
PROVIDE NUMBERS AND CHANGES THERE
Risk factors that have an impact on future profitability
We identified many risks that in our opinion could have major impacts on WP’s profitability. We
have classified these factors according to the business. We include some management initiatives
which can help to compensate these factors.
EDUCATION:
It is a main issue for Kaplan to maintain its eligibility to participate in Title IV Program. If
Kaplan fails to comply with Statutory and Regulatory Requirements, it may loose its access to
U.S. Federal Student Financial Aid Program under Title IV, which would imply a significant loss
of students. Other changes in U.S. Department of Education regulations could lead to new
operational risks and requirements. New resolutions on the tests required, licensing of
examinations can also negatively affect Kaplan’s demand. Therefore, is very important for the
company to be flexible and adaptable to future changes, in order to guarantee its future position.

PUBLISHING/BROADCASTING:

The publishing industry has been strongly affected by the recent Financial Market Crisis and
Economic Downturn. Not only newspapers’ demand has decreased but also many of its
advertisers reduced their advertising expenditures. This decrease on advertising investment has
also affected the Broadcasting industry. Possible solutions could be focus in online publicity and
create new possibilities for the advertisers. Nevertheless, changes in consumer preferences can
also affect WP’s revenues, as rates that the company can charge for advertising are directly
related to the number of readers and viewers. In addition, increased competition resulting from
new technologies creates a difficult scenario for WP’s publishing and broadcasting businesses.
Changes in the prices of raw materials, especially newsprint; or significant disruptions in its
supply are also potential risks when we look to the future. Morgan Stanley predicts that newsprint
prices will rise to €500 per ton in 2011, $674.05 using the current €/$ exchange rate (at 17 th
November) while average prices for FY09 have been around $520. In 2009, WP’s consumption
of newsprint was higher than 150.000 tons. Hence, the increase in WP’s COGS would be higher
than $23 million. Although it only represents a 1.15% increase in COGS, RNOA decreases from
4.15% to 3.29% and ROCE from 3.29% to 2.40%.
WP can anticipate this scenario and make use of derivatives to cover price volatility risk.

CABLE:
In case of any patent infringement claims, which has been a common issue in the industry in last
years, Cable One’s operating results may be adversely affected. Also restrictions on certain types
of advertising and limitations on pricing flexibility can affect Cable One’s revenues.

Apart from the factors commented above, there are other risk factors associated with the market
and to WP as a whole business. Changes in equity prices and interest rates, as well as failure to
successfully assimilate acquired businesses, are the main ones.

Future trends and their effects on WP’S profitability Management decision affecting WP’s
profitability
We detected some management decisions which have affected and can also affect future WP’s
market position.
During the last 3 years, WP raised its daily and Sunday newsstand prices from $0.75 to $1.00 and
from $2.00 to $2.50. This increase represents 33% for the daily newspaper and 25%for the
Sunday publication.
From FY07 to FY09, average paid circulation fell by 6.4% daily (from 657,918 to 615,628) and
7.3% on Sunday (912,433 to 845,587). As the price sensitivity (elasticity) in the industry is high,
we doubt it has been an appropriate initiative. It is a risky decision, especially in a period when
newspapers’ average paid daily circulation is decreasing.
However, the effect of the crisis and free newspapers make it very difficult to disaggregate the
impact of this management decision. Anyway, we believe this decision have had a negative
impact on asset turnover (due to a decrease in sales without any substantial variation of NOA)
and an uncertain effect on margin. The overall effect on RNOA will probably be negative. ROE,
therefore, may also decrease. In addition, inventory can suffer the consequences of a lower
amount of sales (in unities).
If we assume that due to this decision daily sales decline by 3.475% (average daily decrease from
2007 to 2009) we find that sales would decrease by $10.5 million. This would result in a decrease
on both RNOA and ROCE. RNOA would drop from 4.15% to 3.76% and ROCE from 3.21% to
2.84%.
Regarding the industry, we have found out that NYT increased its prices a year before (FY07) as
well and did so to a higher extent than WP did. Last year, NYT suffered a drop of 7.1% on its
daily sales and 3.1% on Sunday publication. This numbers don’t strengthen our theory about the
drop on WP circulation due to the increasing prices decision. As the publishing industry is
expected to grow in FY10, it can be an opportunity to measure the results of the initiative in
terms of customer loyalty and relative growth.
WP’s growth strategy was based very much on acquisitions in the last few years, although a
decline can be observed in FY09. Apart from companies in the education industry, WP has
acquired some free newspapers and local publications. The main reason is the potential growth of
this type of newspapers. Also synergies opportunities and power can affect WP decisions.
The revenues from these free newspapers come almost entirely from advertising. Reports on the
industry show advertising revenues have been decreasing as they have increased in online
newspapers. Therefore, free newspapers’ acquisitions may not be an appropriate strategy to face
future scenarios.
Regarding the effect on RNOA, as it increases operating assets and we doubt about the increase
in sales (advertising contracts), we assume it will be negative. It can increase its market share in
the publishing industry but, as WP has disclosed, growth opportunities are more attractive in the
online industry and other businesses. It is very difficult to estimate detailed effects as synergies,
economies of scale, and other intangibles play an important role in acquisitions

Quality of financial information

Regarding information provided by WP in its annual report and its financial statements, we want
to comment some points. We have found difficult to obtain certain information. In addition, we
believe managers can have manipulated some accounts due to its accounting method.

Selling, general and administrative costs have been increasing every year and WP fails to disclose
concrete numbers regarding this expenses. Also there is an important lack of data for the different
businesses (especially Kaplan, but also Cable one, Newsweek etc.). WP provides us with
information about revenues but we have been unable to find specific numbers for costs.
In addition, WP mentions increasing costs in advertising, marketing and inventory for Kaplan
without providing any numbers. Last but not least, any kind of information about deferred
charges is provided in the annual statements.

Regarding possible manipulations, intangible assets are especially problematic. As WP’s growing
strategy is based in acquisitions, Goodwill accounts for 30% of total assets in WP’s BS. Goodwill
and intangible assets valuation is based on estimates, so it can easily be manipulated. Also Other
Liabilities account can suffer manipulations by modifying the fiscal period when deferred
revenues are recognized.
Sources:

http://www.iciforestal.com.uy/el-mundo/5674-morgan-stanley-predicts-higher-newsprint-prices-for-2011
Appendix