THE WASHINGTON POST COMPANY NEWSPAPER/ONLINE PUBLISHING TELEVISION BROADCASTING MAGAZINE PUBLISHING CABLE TELEVISION EDUCATION 2005 Annual Report CONTENTS Financial Highlights, 1 Letter to Shareholders, 2 Corporate Directory, 12 Form 10-K FINANCIAL HIGHLIGHTS (in thousands, except per share amounts) 2005 2004 % Change Operating revenue $ 3,553,887 $ 3,300,104 + 8% Income from operations $ 514,914 $ 563,006 – 9% Net income $ 314,344 $ 332,732 – 6% Diluted earnings per common share $ 32.59 $ 34.59 – 6% Dividends per common share $ 7.40 $ 7.00 + 6% Common shareholders’ equity per share $ 274.79 $ 251.11 + 9% Diluted average number of common shares outstanding 9,616 9,592 – OPERATING REVENUE INCOME FROM OPERATIONS NET INCOME ($ in millions) ($ in millions) ($ in millions) 05 3,554 05 515 05 314 04 3,300 04 563 04 333 03 2,839 03 364 03 241 02 2,584 02 378 02 204 01 2,411 01 220 01 230 DILUTED EARNINGS RETURN ON AVERAGE COMMON PER COMMON SHARE SHAREHOLDERS’ EQUITY ($) 05 32.59 05 12.4% 04 34.59 04 14.9% 03 25.12 03 12.3% 02 21.34 02 11.6% 01 24.06 01 14.4% 2005 ANNUAL REPORT 1 TO OUR SHAREHOLDERS 2005 was a somewhat disappointing year. Our newspaper, TV and magazine businesses turned in poor- er results than their managers expected when the year began. Cable ONE was having a spectacular year until Hurricane Katrina devastated our Mississippi Gulf Coast systems. Kaplan’s brick-and-mortar college business missed its goals badly, disappointing Jonathan Grayer and me. These are the facts, and I’ll set them out for you in detail. You need to know them. You also need to know this: all of us at The Washington Post Company feel we have a chance to be a sig- nificantly more valuable business a few years from now. That’s a chance, not a certainty (certainty departed the media business some time ago). A letter from Donald E. Graham For our company to achieve this in full, four Let us try to unscramble a complicated 2005: principal things have to happen: Kaplan became our most profitable business for the first time. Writing that sentence still feels some- 1. Kaplan has to realize its potential. As much what amazing: ten years ago, Kaplan had rev- progress as our education company has made enues of $89 million and lost money. It was so in ten years, we still have a chance to be sub- small we recorded its results in the “other” seg- stantially bigger and better. ment. Last year, Kaplan’s revenues were 40% of 2. The Post and washingtonpost.com together The Post Company’s. The education company have to equal or surpass the reach and com- employs 8,980 people, 55% of the company’s petitive strength The Post has traditionally had total full-time employees. in the Washington area (and Newsweek needs rapid growth from its web affiliate). Kaplan is thriving. And it’s thriving because of outstanding management, starting with CEO 3. Post–Newsweek Stations must keep the quali- Jonathan Grayer and extending deep into many ties that make it such a strong company in businesses. The record at Kaplan since Jonathan the face of the blizzard of upcoming changes took over in 1994 is more than extraordinary. In in broadcasting. the years to come, Kaplan will become a bigger and bigger part of our total business. This will 4. Cable ONE has to continue to maneuver its change our company. way past satellite, telephone and other com- petitors and build on its unique strength in the That said, Jonathan and I would both tell you markets it serves. that 2005 was not, across the board, a good year. Kaplan Test Prep and Admissions, Kaplan That’s a lot to do. To abbreviate: Kaplan’s International and our online Kaplan University growth has been extraordinary and has to go on turned in great results. But a big miss at our brick- for us to succeed. But the media businesses and-mortar campuses brought Kaplan’s results in accounted for 76% of our operating income in at a disappointing level. 2005; their continued success is as important to our future as the growth we hope for and expect Why do I write this when our bottom line shows from Kaplan. Kaplan earning $158 million, against $121 mil- M M M lion in 2004? This probably is a good time to spell 2005 ANNUAL REPORT 3 out something important to you: Kaplan’s bottom- So despite this, how did Kaplan’s bottom line show line 2005 results look better than the underlying 30% growth, from $121 million to $158 million? business reality. The reverse is likely to be true in 2006 — the real performance of our business will The answer lies mostly in the fluctuations of the be better than the apparent bottom-line results. charges we record under our stock compensation plan for Kaplan management. About 5% of Here is the usual table of Kaplan’s 2005 results: Kaplan’s stock is under option under this plan; the company is valued annually by the compensation (in thousands) 2005 2004 2003 committee of our board, advised by an outside Revenue Supplemental education $ 690,815 $ 575,014 $ 469,757 firm. The committee’s task is to value Kaplan as if Higher education 721,579 559,877 368,320 it were a public company. Two key elements the $1,412,394 $1,134,891 $ 838,077 committee takes into account are Kaplan’s present Operating Income (loss) and expected profits and the stock market valua- Supplemental education $ 117,075 $ 100,795 $ 87,044 Higher education 82,660 93,402 58,428 tions of publicly traded education companies. Kaplan corporate overhead (33,305) (31,533) (36,782) Other* $ (8,595) $ (41,209) $ (120,399) $ 157,835 $ 121,455 $ (11,709) Since those valuations were mostly lower in 2005 and since Kaplan’s profits fell short of * Other includes charges for Kaplan stock-based incentive compensation and amortization of certain intangibles. expectations, the value attributed to Kaplan’s stock options actually fell (for the first time). You can see that supplemental education (test prep, professional training and Score!) had a We account annually for changes in the value of good year. Test prep results in particular, under the stock options in Kaplan’s compensation plan. John Polstein’s management, were outstanding. You should note that it’s a different kind of charge than public companies typically record for stock But despite rapid growth in international educa- option expense, even now that they are treating tion under William Macpherson and in online under options as an expense. In essence, we annually Andy Rosen, our brick-and-mortar campus results calculate the full value of all the options out- fell so sharply that the whole higher education seg- standing and show the year-over-year change as ment was down for the first time since we bought a charge to earnings. Valuation methods typically Quest Education Corp. in 2000. (International used by public companies yield smaller charges. results are dispersed in both Kaplan segments.) In 2004 we recorded a $33 million charge for stock compensation. 4 THE WASHINGTON POST COMPANY In 2005 there was a charge of only $3 million. What led to the poor performance in our cam- Thus $30 million of the apparent $36 million pus business in 2005? increase in Kaplan operating income came from the fluctuation in the stock comp plan. We had had five great years in a row, and new campuses and programs had contributed mighti- In 2006 the reverse is likely to happen — I ly. As 2005 dawned, we were ready with a blizzard expect Kaplan’s profits to grow and trigger a nor- of new initiatives — all of which cost some money. mal stock comp charge. The stock comp charges We expected this to be repaid by new enrollments. are real — they represent obligations we expect Kaplan became our most profitable business for the first time.… Last year, Kaplan’s revenues were 40% of The Post Company’s. eventually to pay out to Kaplan managers who But campuses of our sort are famously some- participate in the plan. Kaplan management has what countercyclical. Among other things, they made substantial amounts; the stock plan to date help students (adults mostly) get a good first job. As has paid out $170 million and has accumulated unemployment lessens and jobs become easier to $64 million in future obligations. If Kaplan be- find, students need our campuses less. (Many of our comes much more profitable in the future, these programs help job-holders qualify for better paying charges could go much higher. jobs, which helps in all economic environments.) These payments do not seem unreasonable to Another factor affecting campus enrollment was me; the division lost $42 million five years ago, in plain sight: the booming growth in online high- and as noted, made $158 million in 2005. This is er education, competing with campuses like ours partly a result of being a good business, but large- for students. ly the result of managerial skill, particularly Jonathan Grayer’s. Kaplan management has been Affected by these two factors, campus enrollments and will be well paid. In return, they have devel- fell far short of our hopes. We did not cut back soon oped our largest and fastest-growing business. enough. The resultant fall in profits was greater than at most public secondary-education companies. M M M 2005 ANNUAL REPORT 5 In response, we have consolidated manage- When any of our businesses makes an impor- ment of our online and campus businesses under tant misstep, we’ll tell you about it.