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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002 Commission File No.
WRC MEDIA INC. WEEKLY READER CORPORATION
(Exact name of Registrant as specified in its charter) (Exact of Registrant as specified in itscharter)
DELAWARE DELAWARE
(State or other jurisdiction of incorporation or (State or other jurisdiction of incorporation or
organization) organization)
2731 2721
(Primary Standard Industrial Classification Number) (Primary Standard Industrial Classification Number)
13-4066536 13-3603780
(I.R.S. Employer Identification Number) (I.R.S. Employer Identification Number)
COMPASSLEARNING, INC.
(Exact name of Registrant as specified in its charter)
2731
DELAWARE
(State or other jurisdiction of incorporation or
organization)
7372
(Primary Standard Industrial Classification Number)
13-4066535
(I.R.S. Employer Identification Number)
WRC MEDIA INC. WEEKLY READER CORPORATION
512 7th AVENUE, 23RD FLOOR 512 7th AVENUE, 23RD FLOOR
NEW YORK, NY 10018 NEW YORK, NY 10018
(212) 768-1150 (212) 768-1150
COMPASSLEARNING, INC.
512 7th AVENUE, 23RD FLOOR
NEW YORK, NY 10018
(212) 768-1150
(Address, including zip code, and telephone number, including area
code, of each Registrant's principal executive offices)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12-months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
X Yes |_| No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
- ------------------------------------------------------------------------------------------------------------
TITLE OF CLASS | NAME OF EACH EXCHANGE ON WHICH REGISTERED
- ------------------------------------------------------------------------------------------------------------
12 3/4% Senior Subordinated Notes due 2009 | OVER-THE-COUNTER MARKET
- ------------------------------------------------------------------------------------------------------------
PART 1.
ITEM 1. FINANCIAL STATEMENTS
2
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
December 31, September 30,
2001 2002
------------------ -------------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 8,919 $ 9,117
Accounts receivable, net 43,658 53,069
Inventories, net 15,026 16,335
Prepaid expenses 3,468 3,779
Other current assets 13,891 9,068
------------------ -------------------
Total current assets 84,962 91,368
Property and equipment, net 9,215 7,291
Purchased software, net 2,851 4,907
Goodwill, net 234,982 168,021
Deferred financing costs, net 6,645 6,470
Identified intangible assets, net 119,492 103,620
Other assets and investments 20,715 28,099
------------------ -------------------
Total Assets $ 478,862 $ 409,776
================== ===================
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 18,180 $ 18,812
Accrued payroll, commissions and benefits 11,305 8,686
Current portion of deferred revenue 39,070 51,385
Other accrued liabilities 33,996 27,146
Current portion of long-term debt 6,171 7,333
------------------ -------------------
Total current liabilities 108,722 113,362
Deferred revenue, net of current portion 2,040 1,136
Deferred tax liability - 6,500
Due to related party 2,160 2,160
Long-term debt 273,544 278,335
------------------ -------------------
Total liabilities 386,466 401,493
------------------ -------------------
Commitments and contingencies
15% Series B preferred stock subject to redemption,
including accrued dividends and accretion of warrant value
(Liquidation preference of $75,000 plus accrued dividends) 92,760 105,436
------------------ -------------------
Warrants on preferred stock 11,751 11,751
------------------ -------------------
Common stock subject to redemption 1,180 965
------------------ -------------------
Stockholders' deficiency:
Common stock, ($.01 par value, 20,000,000 shares authorized;
and 7,022,385 shares outstanding) 70 70
Preferred stock, ($.01 par value, 750,000 shares authorized,
385,325 and 420,800 outstanding, respectively) 15,413 17,589
Additional paid-in capital 132,562 132,464
Accumulated comprehensive income (316) (316)
Accumulated deficit (161,024) (259,676)
------------------ -------------------
Total stockholders' deficiency (13,295) (109,869)
------------------ -------------------
Total liabilities and stockholders' deficiency $ 478,862 $ 409,776
================== ===================
The accompanying notes to the condensed consolidated financial statements are
an integral part of these condensed consolidated financial statements.
3
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30
(Unaudited)
(Dollars in thousands)
2001 2002
----------------- -----------------
Sales, net $ 60,237 $ 56,456
Cost of goods sold 16,554 15,375
----------------- -----------------
Gross profit 43,683 41,081
----------------- -----------------
Costs and expenses:
Sales and marketing 14,356 11,135
Research and development 1,353 280
Distribution, circulation and fulfillment 3,677 3,497
Editorial 2,295 2,606
General and administrative 6,519 5,945
Depreciation 813 693
----------------- -----------------
29,013 24,156
----------------- -----------------
Income before amortization of goodwill and intangible assets 14,670 16,925
Amortization of goodwill and intangible assets 17,178 4,495
----------------- -----------------
Income (loss) from operations (2,508) 12,430
Interest expense, including amortization
of deferred financing costs (8,243) (7,576)
Loss on investments (282) (963)
Other, net (162) 1,171
----------------- -----------------
Income (loss) before income tax provision (11,195) 5,062
Income tax provision 223 501
----------------- -----------------
Net income (loss) $ (11,418) $ 4,561
================= =================
The accompanying notes to the condensed consolidated financial statements are
an integral part of these condensed consolidated financial statements.
4
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Dollars in thousands)
2001 2002
------------------ -----------------
Sales, net $ 161,131 $ 147,182
Cost of goods sold 45,327 41,530
------------------ -----------------
Gross profit 115,804 105,652
------------------ -----------------
Costs and expenses:
Sales and marketing 39,483 36,077
Research and development 3,803 1,236
Distribution, circulation and fulfillment 9,417 9,494
Editorial 7,901 7,476
General and administrative 19,767 16,439
Depreciation 2,419 2,284
------------------ -----------------
82,790 73,006
------------------ -----------------
Income before amortization of goodwill and intangible assets 33,014 32,646
Amortization of goodwill and intangible assets 51,261 14,149
------------------ -----------------
Income (loss) from operations (18,247) 18,497
Interest expense, including amortization
of deferred financing costs (25,530) (22,380)
Loss on investments (411) (2,100)
Other, net (504) 889
------------------ -----------------
Loss before income tax provision (44,692) (5,094)
Income tax provision 503 6,684
------------------ -----------------
Net loss before cumulative effect of change
in accounting principle (45,195) (11,778)
Cumulative effect of change in accounting principle - (72,022)
------------------ -----------------
Net loss $ (45,195) $ (83,800)
================== =================
The accompanying notes to the condensed consolidated financial statements are
an integral part of these condensed consolidated financial statements.
5
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(dollars in thousands)
2001 2002
----------------- ------------------
Cash flows from operating activities:
Net loss $ (45,195) $ (83,800)
Adjustments to reconcile net loss to net cash
used in operating activities:
Cumulative effect of accounting change - 72,022
Deferred income taxes - 6,500
Depreciation and amortization 53,680 16,537
Loss on investments 411 2,100
Unrealized gain from hedging transactions - (1,619)
Loss on disposition of property and equipment 3 43
Interest expense-accretion of discounts 254 291
Amortization of deferred financing fees 760 859
Changes in assets and liabilities:
(Increase) in accounts receivable (16,620) (9,411)
(Increase) in inventories (1,129) (1,309)
Decrease in prepaid expenses and other current assets 1,646 4,512
Increase in other noncurrent assets (7,882) (10,333)
Increase in accounts payable 194 632
Increase in deferred revenue 14,633 11,936
(Decrease) in accrued liabilities (4,687) (9,475)
----------------- ------------------
Net cash used in operating activities (3,932) (515)
----------------- ------------------
Cash flows from investing activities:
Purchase of acquired business (18,286) -
Capital expenditures (2,880) (976)
Software development costs - (3,554)
Proceeds from disposition of property & equipment - 578
Investments (2,698) -
----------------- ------------------
Net cash used in investing activities (23,864) (3,952)
----------------- ------------------
Cash flows from financing activities:
Net proceeds from revolving line of credit 7,000 10,000
Repayment of senior bank debt (3,141) (4,337)
Increase in deferred financing fees - (685)
Proceeds from term loans 10,000 -
Proceeds from issuance of preferred stock 13,750 -
Proceeds from issuance of common stock 6,500 150
Purchase of common stock subject to redemption (10) (463)
----------------- ------------------
Net cash provided by financing activities 34,099 4,665
----------------- ------------------
Increase in cash and cash equivalents 6,303 198
Cash and cash equivalents, beginning of period 2,968 8,919
----------------- ------------------
Cash and cash equivalents, end of period $ 9,271 $ 9,117
================= ==================
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 19,408 $ 16,128
================= ==================
Cash paid during the period for income taxes $ 344 $ 229
================= ==================
Preferred stock dividends accrued $ 11,337 $ 14,153
================= ==================
Accretion of preferred stock $ 688 $ 698
================= ==================
The accompanying notes to the condensed consolidated financial statements are
an integral part of these condensed consolidated financial statements.
6
WRC MEDIA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share amounts)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
The accompanying condensed consolidated financial statements include the
accounts of WRC Media Inc. ("WRC Media") and its subsidiaries - Weekly Reader
Corporation, CompassLearning, Inc. and ChildU, Inc. The term "Company" refers to
WRC Media and its subsidiaries. Separate financial statements for
CompassLearning, Inc. are not presented and it is not filing a separate report
under the Securities Exchange Act of 1934 because the Company's management has
determined that the information contained in such documents would not be
material to investors.
WRC Media was incorporated on May 14, 1999. On July 14, 1999, WRC acquired
CompassLearning in a business combination accounted for as a purchase.
On November 17, 1999, WRC Media completed the recapitalization and purchase of
Weekly Reader and its subsidiaries. As a result of these transactions, WRC Media
owns 94.9% and PRIMEDIA Inc. owns 5.1% of the common stock of the Weekly Reader
Corporation.
On May 9, 2001, WRC Media entered into an Agreement and Plan of Merger with
ChildU, Inc. ("ChildU"). Pursuant to the agreement, each issued share of
ChildU's common and preferred stock not directly or indirectly owned by ChildU
was converted into a contingent right to receive a number of shares of WRC Media
Inc. common stock. Following the merger, WRC Media agreed to provide funding to
ChildU for up to $5,871,907 of ChildU's existing or committed obligations and
liabilities. Concurrent with the merger, WRC Media and all holders of ChildU's
Group One Notes entered into an exchange agreement pursuant to which WRC Media
exchanged 162,500 shares of WRC Media common stock for all the outstanding Group
One Notes. The Company issued $13.75 million of 18% Junior Participating
Cumulative Convertible Preferred Stock, the proceeds of which will fund the
operating losses of ChildU and WRC Media's investment in ThinkBox(TM) (see
below). ChildU was incorporated on June 1, 1999 and is a leading provider of
Internet-based educational services to both individual and institutional
consumers.
On May 18, 2001 WRC Media made a strategic investment in ThinkBox Inc., a
leading creator of Internet-delivered education programs for the school and home
markets. Key elements of the broad partnership include an investment by WRC
Media in ThinkBox(TM), WRC Media's acquisition of distribution rights for
ThinkBox(TM) programs to schools, and the licensing to ThinkBox(TM) of the
Weekly Reader(R) brand names and content for use in its programs. This
investment is accounted for under the equity method of accounting. For the
nine-months ended September 30, 2002, WRC Media has recorded a $2.1 million loss
on this investment. The investment of ThinkBox is currently valued at $1.0
million and is included in Other assets and investments on the balance sheet at
September 30, 2002.
The separate financial statements of the Subsidiary Guarantors have not been
included because (i) the Subsidiary Guarantors constitute all of WRC Media's
direct and indirect subsidiaries, (ii) the Subsidiary Guarantors have fully and
unconditionally guaranteed the Company's obligations on a joint and several
basis; (iii) WRC Media has limited operations and its ability to service its
debt is dependent on the operations of its subsidiaries.
All significant intercompany balances and transactions have been eliminated in
the accompanying condensed consolidated financial statements.
The accompanying condensed consolidated financial statements have been prepared
without audit. In the opinion of management, all adjustments, consisting of only
normal recurring adjustments necessary to present fairly the financial position,
the results of operations and cash flows for the periods presented, have been
made.
7
The accompanying condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Accordingly, certain information and note disclosures normally included
in financial statements prepared in conformity with generally accepted
accounting principles have been condensed or omitted. Certain reclassifications
have been made to the prior year amounts in order to conform to the current
year's presentation.
These condensed consolidated financial statements should be read in conjunction
with the Company's annual financial statements and related notes for the year
ended December 31, 2001. The operating results for the nine-month periods ended
September 30, 2001 and 2002 are not necessarily indicative of the results that
may be expected for a full year.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued two new
statements, SFAS No.141, "Business Combinations," and SFAS No.142, "Goodwill and
Other Intangible Assets". SFAS No. 141 requires that the purchase method be used
for all business combinations initiated after June 30, 2001 and prohibits the
use of the pooling of interest method. The adoption of SFAS No. 141 did not have
a material effect on the Company's results of operations or financial position.
SFAS No. 142 specifies the financial accounting and reporting for acquired
goodwill and other intangible assets. Goodwill and intangible assets that have
indefinite useful lives will not be amortized but rather be tested at least
annually for impairment. SFAS No. 142 requires that the useful lives of
intangible assets acquired on or before June 30, 2001 be reassessed and the
remaining amortization periods adjusted accordingly. Previously recognized
intangible assets deemed to have indefinite lives should be tested for
impairment as well. Goodwill recognized on or before June 30, 2001 has been
assigned to various reporting units and has been tested for impairment during
the six months ending June 30, 2002, the period in which SFAS No. 142 is
initially applied in its entirety. On January 1, 2002, the Company adopted SFAS
No. 142 for its goodwill and identifiable intangible assets. Upon adoption, the
Company ceased the amortization of goodwill and other indefinite lived
intangible assets, which consist of trademarks. As required by this statement,
the Company reviewed its indefinite lived intangibles (trademarks) for
impairment as of January 1, 2002. The effect on the results of operations for
the comparative period ended September 30, 2001 had the Company adopted this
accounting change on January 1, 2001 would have resulted in reducing the
Company's amortization expense and pre-tax losses approximately $8,180 for the
nine-months ended September 30, 2001.
The Company performed the transitional impairment tests on its goodwill and
indefinite lived intangibles in the second quarter ended June 30, 2002. The
previous method for determining impairment prescribed by SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to
be Disposed Of," utilized an undiscounted cash flow approach for the impairment
assessment, while SFAS No. 142 utilizes a fair value approach. The Company has
five reporting units with goodwill. Goodwill was tested for impairment at the
reporting unit level. As a result, the Company recorded a transitional goodwill
and indefinite lived intangible asset impairment charge of $72,022 at American
Guidance Service, Inc. a subsidiary of Weekly Reader Corporation. This charge is
reported as a cumulative effect of accounting change, as of January 1, 2002, in
the Condensed Consolidated Statements of Operations. The Company is required to
perform impairment tests on an annual basis, or between yearly tests under
certain circumstances for goodwill and indefinite lived intangibles. There can
be no assurance that future impairment tests will not result in a charge to
earnings.
December 31, Impairment September 30,
(in thousands) 2001 Adjustment 2002
- -------------------------------- --------------------------------------------
Goodwill $ 234,982 $ (66,961) $ 168,021
Long Lived Assets - Trademarks 47,211 (5,061) 42,150
--------- --------- ---------
$ 282,193 $ (72,022) $ 210,171
========= ========= =========
8
The Company also recorded non-cash deferred income tax expense of approximately
$5,000 on January 1, 2002 and $1,500 during the nine-months ended September 30,
2002, related to the adoption of SFAS 142. The non-cash charge of $5,000 on
January 1, 2002 was recorded to increase the valuation allowance related to the
deferred tax asset associated with the Company's net operating losses.
Historically, the Company did not need a valuation allowance for the portion of
their net operating loss equal to the excess of tax over book amortization on
tax-deductible goodwill and trademarks since the liability was expected to
reverse during the carryforward period of the net operating losses. As a result
of the adoption of SFAS 142, the timing of the reversal of this liability is
indefinite and can no longer be offset by the Company's net operating loss
carryforwards. While book amortization of tax-deductible goodwill and trademarks
ceased on January 1, 2002, the Company continues to amortize these assets for
tax purposes. As a result, the Company will have deferred tax liabilities that
will arise each quarter as the taxable temporary differences related to the
amortization of these assets will not reverse prior to the expiration period of
the Company's deductible temporary differences unless the related assets are
sold or an impairment of the assets is recorded. Accordingly, the Company also
recorded an additional $1,500 to increase the valuation allowance for the
nine-months ended September 30, 2002. The Company expects that it will record an
additional $500 to increase the valuation allowance during the remaining
three-months of 2002.
The following information represents pro forma net loss assuming the adoption of
SFAS 142 on January 1, 2001:
For the Three Months Ended For the Nine Months Ended
---------------------------------- -----------------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2001 2002 2001 2002
- ---------------------------------------------------------------------------------------- -----------------------------------
Reported Net Income (loss) $(11,418) $ 4,561 $(45,195) $(83,800)
Addback:
Goodwill Amortization 2,433 -- 7,197 --
Amortization of Trademarks 328 -- 983 --
Cumulative effect of a change in
accounting principle -- -- -- 72,022
Deferred provision for income taxes -- 500 -- 6,500
-------- -------- -------- --------
$ (8,657) $ 5,061 $(37,015) $ (5,278)
======== ======== ======== ========
The Company adopted the provisions of SFAS No. 133 ("SFAS 133"), Accounting for
Derivative Instruments and Hedging Activities, as amended by Statements of
Financial Accounting Standards No. 137, Accounting for Derivative Instruments
and Hedging Activities--Deferral of the Effective Date of FASB Statement No.
133, and No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities, and as interpreted by the FASB and the Derivatives
Implementation Group through "Statement 133 Implementation Issues," as of
January 1, 2001. The Company believes that it has properly identified all
derivative instruments and any embedded derivative instruments that require
bifurcation. The Company's hedging activities, if any, are in accordance with
its documented and approved hedging and risk management policies. Specifically,
we have appropriately designated all hedging instruments as either fair value or
cash flow hedges, or hedges of a net investment in a foreign operation. We
believe the timing, nature, and amounts of all forecasted transactions are
probable of occurring. The fair values of all derivatives, embedded derivatives
that have been bifurcated, and hedged items have been determined based on
prevailing market prices or by using financial models that we believe are the
appropriate models for valuing such instruments and that incorporate market data
and other assumptions that we have determined to be reasonable and appropriate
at September 30, 2002. WRC Media Corporation has $152 million of callable senior
subordinated notes outstanding. These notes pay a fixed coupon of 12.75% and
mature on 11/15/09. The prolonged Fed easing campaign of 2001-2002 has brought
short-term rates down to 40-year lows, greatly increasing the opportunity cost
of the notes. In order to immediately reduce funding costs, WRC Media moved down
the yield curve by swapping a portion of the fixed rate 12.75% Notes to floating
rate. In addition, WRC also guaranteed positive carry for the one-year period
May 15, 2002 through May 15, 2003 of the transaction by locking in the LIBOR
forwards below the fixed rate of the swap. The swap transaction does not qualify
for hedge accounting treatment and as such, the Company marks-to-market the swap
contract at the end of each quarter. For the nine-months ended September 30,
2002, WRC has recorded an unrealized gain of $1.6 million related to its
interest rate swap, which is being marked to market under SFAS 133. This gain is
reflected in Other, net in the consolidated statement of operations.
9
Debt
As of September 30, 2002, there were $10 million in outstanding advances under
the Company's $30 million revolving credit facility, which bear interest
approximating 5.3% at September 30, 2002. In addition, there is an annually
renewable stand-by letter of credit in the amount of $2 million in connection
with a real estate lease entered into by the Company. While this letter of
credit is in effect, the Company's available borrowing under the revolving
credit facility is reduced by $2 million.
Inventories
Inventories are comprised of the following:
December 31, September 30,
2001 2002
------------ -------------
Finished goods $ 17,588 $ 18,555
Raw materials 211 751
Less - allowance for obsolescence (2,773) (2,971)
---------- -----------
$ 15,026 $ 16,335
========== ==========
Intangibles
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill and indefinite lived intangible assets as
of December 31, 2001 and September 30, 2002 are as follows:
--------------------------------------------------- ---------------------------------------------------
December 31, 2001 September 30, 2002
--------------------------------------------------- ---------------------------------------------------
Accumulated Accumulated
Gross Amortization Net Gross Amortization Net
--------------- ----------------- -------------- --------------- ----------------- --------------
Customer Lists $ 62,911 $ (15,210) $ 47,701 $ 62,911 $ (19,895) $ 43,016
Copyrights 21,053 (4,537) 16,516 21,053 (7,239) 13,814
Product Titles 13,475 (8,192) 5,283 13,475 (9,843) 3,632
Trade name 3,520 (2,169) 1,351 3,520 (2,829) 691
Workforce in place 2,980 (2,449) 531 2,980 (2,980) -
Non-compete agreements 77,334 (77,334) - 77,334 (77,334) -
Databases 560 (471) 89 560 (530) 30
Other 1,199 (389) 810 677 (390) 287
--------------- ----------------- -------------- --------------- ----------------- --------------
Total: $ 183,032 $ (110,751) $ 72,281 $ 182,510 $ (121,040) $ 61,470
=============== ================= ============== =============== ================= ==============
For intangible assets other than goodwill not subject to amortization, the total
carrying amount is $42,150 at September 30, 2002.
The estimated amortization expense for each of the five succeeding fiscal years
is as follows:
For the year ended December 31,
- ----------------------------------------------
2002 ............................. $ 20,186
2003 ............................. $ 14,965
2004 ............................. $ 11,294
2005 ............................. $ 8,895
2006 ............................. $ 6,413
10
Notes Offering and Guarantor and Non-Guarantor Financial Information
In connection with the recapitalization and purchase of Weekly Reader during
November 1999, the Company, Weekly Reader and Compass as co-issuers completed an
offering of $152.0 million 12 3/4% Senior Subordinated Notes due 2009 (the "Old
Notes"). In June 2000, the Old Notes were exchanged in full for $152.0 million
of new 12 3/4% Senior Subordinated Notes due 2009 (the "Notes"), which have
terms that are substantially identical to the Old Notes except that the Notes
were registered with the SEC. Interest on the Notes is payable semi-annually, on
May 15 and November 15 of each year. The Notes are jointly, severally, fully and
unconditionally guaranteed by certain subsidiaries of the Company, including
CompassLearning, Inc., a 100% wholly owned subsidiary and Weekly Reader
Corporation, a non-wholly owned subsidiary of the Company (collectively, the
"Subsidiary Guarantors").
The following tables present condensed consolidating financial information for
the three-months and nine-months ended September, 30, 2001 and 2002 for: (1) the
Company on a standalone basis, (2) Weekly Reader Corporation, a non-wholly owned
subsidiary, (3) CompassLearning, Inc., a wholly owned subsidiary on a standalone
basis, (4) the non-guarantor subsidiary of the Company (ChildU, Inc.), and (5)
the Company on a consolidated basis.
Separate financial statements for CompassLearning, Inc. are not presented and it
is not filing a separate report under the Securities Exchange Act of 1934
because the Company's management has determined that the information contained
in such documents would not be material to investors.
Subsidiary Guarantors
------------------------------------------------
Weekly Reader CompassLearning
WRC Media Inc. Corporation Inc.
--------------------- --------------------- --------------------------
(In thousands)
Balance Sheet as of September 30, 2002
Current assets $ 9,832 $ 136,270 $ 23,346
Property and equipment, net -- 6,228 816
Goodwill and other intangible assets, net 173,353 55,052 31,969
Other assets 106,622 43,863 2,803
--------- --------- ---------
Total assets $ 289,807 $ 241,413 $ 58,934
========= ========= =========
Current liabilities: $ 83,915 $ 72,932 $ 24,810
Long-term debt, less current portion 147,168 109,467 21,700
Other liabilities 11,751 6,500 3,296
Warrants on preferred stock -- 9,133 2,618
Common stock subject to redemption 965 -- --
Redeemable preferred stock, plus accrued dividends 105,436 75,000 --
Stockholders equity (deficit): (59,428) (151,025) 6,510
Interdivisional equity -- 119,406 --
--------- --------- ---------
Total liabilities and stockholders equity (deficit) $ 289,807 $ 241,413 $ 58,934
========= ========= =========
Subsidiary Guarantors
------------------------------------------------
Weekly Reader CompassLearning
Statement of operations for three months WRC Media Inc. Corporation Inc.
ended September 30, 2002 --------------------- --------------------- --------------------------
(In thousands)
Revenue $ -- $ 44,672 $ 10,502
Operating expenses 1,045 30,298 11,277
Interest expense, net 5,205 7,325 1
Other (income) expense 1,219 (1,423) (4)
Provision for income taxes -- 501 --
Cumulative effect of accounting change -- -- --
--------- --------- ---------
Net income (loss) $ (7,469) $ 7,971 $ (772)
========= ========= =========
Subsidiary Guarantors
------------------------------------------------
Weekly Reader CompassLearning
Statement of operations for nine months WRC Media Inc. Corporation Inc.
ended September 30, 2002 --------------------- --------------------- --------------------------
(In thousands)
Revenue $ -- $ 109,404 $ 35,767
Operating expenses 3,133 84,883 37,166
Interest expense, net 15,550 21,646 10
Other (income) expense 2,860 (1,651) 2
Provision for income taxes 30 6,618 36
Cumulative effect of accounting change -- 72,022 --
--------- --------- ---------
Net income (loss) $ (21,573) $ (74,114) $ (1,447)
========= ========= =========
Cash flow for nine months
ended September 30, 2002
Cash flow provided by (used in) operations $ (14,402) $ (3,975) $ 5,014
Cash flow provided by (used in) investing activities -- (121) (2,502)
Cash flow provided by (used in) financing activities 13,557 5,628 (2,901)
Cash at beginning of period 2,643 5,691 394
--------- --------- ---------
Cash at end of period $ 1,798 $ 7,223 $ 5
========= ========= =========
Subsidiary Guarantors
Non-Guarantor WRC Media Inc.
Subsidiaries Elimination Consolidated
-------------------- ----------------- ---------------------
Balance Sheet as of September 30, 2002
Current assets $ 1,848 $ (79,928) $ 91,368
Property and equipment, net 247 0 7,291
Goodwill and other intangible assets, net 16,174 0 276,548
Other assets -- (118,719) 34,569
--------- --------- ---------
Total assets $ 18,269 $(198,647) $ 409,776
========= ========= =========
Current liabilities: $ 11,624 $ (79,919) $ 113,362
Long-term debt, less current portion -- 278,335
Other liabilities -- 21,547
Warrants on preferred stock -- (11,751) --
Common stock subject to redemption -- -- 965
Redeemable preferred stock, plus accrued dividends -- (75,000) 105,436
Stockholders equity (deficit): 6,645 87,429 (109,869)
Interdivisional equity (119,406) --
--------- --------- ---------
Total liabilities and stockholders equity (deficit) $ 18,269 $(198,647) $ 409,776
========= ========= =========
Non-Guarantor WRC Media Inc.
Statement of operations for three months Subsidiaries Elimination Consolidated
ended September 30, 2002 -------------------- ----------------- ---------------------
Revenue $ 1,282 $ -- $ 56,456
Operating expenses 1,406 -- 44,026
Interest expense, net (1) (4,954) 7,576
Other (income) expense -- -- (208)
Provision for income taxes -- -- 501
Cumulative effect of accounting change -- -- --
--------- --------- ---------
Net income (loss) $ (123) $ 4,954 $ 4,561
========= ========= =========
Non-Guarantor WRC Media Inc.
Statement of operations for nine months Subsidiaries Elimination Consolidated
ended September 30, 2002 -------------------- ----------------- ---------------------
Revenue $ 2,011 $ -- $ 147,182
Operating expenses 3,503 -- 128,685
Interest expense, net -- (14,826) 22,380
Other (income) expense -- -- 1,211
Provision for income taxes -- -- 6,684
Cumulative effect of accounting change -- -- 72,022
--------- --------- ---------
Net income (loss) $ (1,492) $ 14,826 $ (83,800)
========= ========= =========
Cash flow for nine months
ended September 30, 2002
Cash flow provided by (used in) operations $ (1,684) $ 14,532 $ (515)
Cash flow provided by (used in) investing activities (1,329) -- (3,952)
Cash flow provided by (used in) financing activities 2,913 (14,532) 4,665
Cash at beginning of period 191 -- 8,919
--------- --------- ---------
Cash at end of period $ 91 $ -- $ 9,117
========= ========= =========
11
Subsidiary Guarantors
------------------------------------------------
Weekly Reader CompassLearning
Statement of operations for three months WRC Media Inc. Corporation Inc.
ended September 30, 2001 -------------------- --------------------- --------------------------
(In thousands)
Revenue $ -- $ 45,676 $ 14,218
Operating expenses 11,630 34,231 15,648
Interest expense, net 5,045 8,136 --
Other (income) expense 481 (26) (11)
Provision for income taxes 8 215 --
--------- --------- ---------
Net income (loss) $ (17,164) $ 3,120 $ (1,419)
========= ========= =========
Statement of operations for nine months
ended September 30, 2001
Revenue $ -- $ 111,967 $ 48,747
Operating expenses 34,707 92,399 50,285
Interest expense, net 15,474 24,853 (7)
Other (income) expense 1,071 (145) (11)
Provision for income taxes 177 324 2
--------- --------- ---------
Net income (loss) $ (51,429) $ (5,464) $ (1,522)
========= ========= =========
Cash flow for nine months
ended September 30, 2001
Cash flow provided by (used in) operations $ (13,528) $ (7,313) $ 5,056
Cash flow provided by (used in) investing activities (14,063) (9,818) (102)
Cash flow provided by (used in) financing activities 31,838 19,028 (4,944)
Cash at beginning of period -- 2,914 54
--------- --------- ---------
Cash at end of period $ 4,247 $ 4,811 $ 64
========= ========= =========
Non-Guarantor WRC Media Inc.
Statement of operations for three months Subsidiaries Elimination Consolidated
ended September 30, 2001 -------------------- ----------------- ---------------------
Revenue $ 343 $ -- $ 60,237
Operating expenses 1,236 -- 62,745
Interest expense, net (1) (4,937) 8,243
Other (income) expense -- -- 444
Provision for income taxes -- -- 223
--------- --------- ---------
Net income (loss) $ (892) $ 4,937 $ (11,418)
========= ========= =========
Statement of operations for nine months
ended September 30, 2001
Revenue $ 417 $ -- $ 161,131
Operating expenses 1,987 -- 179,378
Interest expense, net (1) (14,789) 25,530
Other (income) expense -- -- 915
Provision for income taxes -- -- 503
--------- --------- ---------
Net income (loss) $ (1,569) $ 14,789 $ (45,195)
========= ========= =========
Cash flow for nine months
ended September 30, 2001
Cash flow provided by (used in) operations $ (2,010) $ 13,863 $ (3,932)
Cash flow provided by (used in) investing activities 119 -- (23,864)
Cash flow provided by (used in) financing activities 2,040 (13,863) 34,099
Cash at beginning of period -- -- 2,968
--------- --------- ---------
Cash at end of period $ 149 $ -- $ 9,271
========= ========= =========
Litigation
The Company is a party to litigation arising in the normal course of business.
Management regularly analyzes current information and, as necessary, provides
accruals for probable liabilities on the eventual disposition of these matters.
Management believes that the effect on its results of operations and financial
position, if any, for the disposition of these matters, will not be material.
12
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
December 31, September 30,
2001 2002
--------------------- ------------------------
(Unaudited)
ASSETS
Current Assets:
Cash $ 5,691 $ 7,223
Accounts receivable, net 24,818 41,900
Inventories, net 13,718 14,875
Due from related party, net 2,858 7,934
Prepaid expenses 2,702 2,980
Other current assets 13,891 9,068
--------- ---------
Total current assets 63,678 83,980
Property and equipment, net 7,541 6,228
Goodwill, net 101,978 35,018
Deferred financing costs, net 873 737
Identified intangible assets, net 29,109 20,034
Other assets 17,651 26,950
--------- ---------
Total Assets $ 220,830 $ 172,947
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 15,855 $ 17,220
Deferred revenue 18,398 32,881
Accrued expenses and other 26,664 19,550
Current portion of long-term debt 6,171 7,333
--------- ---------
Total current liabilities 67,088 76,984
Deferred tax liability -- 6,500
Long-term debt 273,544 278,335
--------- ---------
Total liabilities 340,632 361,819
--------- ---------
Commitments and contingencies
Redeemable preferred stock, plus accrued dividends (Liquidation 102,573 114,550
preference of $75,000 plus accrued dividends)
Stockholders' deficiency:
Common stock, ($.01 par value, 20,000,000 shares authorized;
2,830,000 shares issued & outstanding) 28 28
Additional paid-in capital 9,133 9,133
Due from parent (67,738) (62,693)
Accumulated comprehensive income (316) (316)
Accumulated deficit (163,482) (249,574)
--------- ---------
Total stockholders' deficiency (222,375) (303,422)
--------- ---------
Total liabilities and stockholders' deficiency $ 220,830 $ 172,947
========= =========
The accompanying notes to the condensed consolidated financial
statements are an integral part of these condensed consolidated
financial statements.
13
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Dollars in thousands)
2001 2002
------------------ -----------------
Sales, net $ 45,676 $ 44,672
Cost of goods sold 11,471 10,461
-------- --------
Gross profit 34,205 34,211
-------- --------
Costs and expenses:
Marketing and selling 8,767 6,853
Distribution, circulation and fulfillment 3,677 3,497
Editorial 2,295 2,606
General and administrative 4,511 4,339
Depreciation 495 462
-------- --------
19,745 17,757
-------- --------
Income before amortization of goodwill and intangible assets 14,460 16,454
Amortization of goodwill and intangible assets 3,015 2,080
-------- --------
Income from operations 11,445 14,374
Other income (expense):
Interest expense, including amortization
of deferred financing costs (8,136) (7,325)
Other, net 26 1,423
-------- --------
Income before income tax provision 3,335 8,472
Income tax provision 215 501
-------- --------
Net income $ 3,120 $ 7,971
======== ========
The accompanying notes to the condensed consolidated financial
statements are an integral part of these condensed consolidated
financial statements.
14
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Dollars in thousands)
2001 2002
----------------- -----------------
Sales, net $ 111,967 $ 109,404
Cost of goods sold 29,517 27,492
--------- ---------
Gross profit 82,450 81,912
--------- ---------
Costs and expenses:
Marketing and selling 21,188 20,364
Distribution, circulation and fulfillment 9,417 9,494
Editorial 7,901 7,476
General and administrative 14,006 12,181
Depreciation 1,501 1,396
--------- ---------
54,013 50,911
--------- ---------
Income before amortization of goodwill and intangible assets 28,437 31,001
Amortization of goodwill and intangible assets 8,869 6,480
--------- ---------
Income from operations 19,568 24,521
Other income (expense):
Interest expense, including amortization
of deferred financing costs (24,853) (21,646)
Other, net 145 1,651
--------- ---------
Income (loss) before income tax provision (5,140) 4,526
Income tax provision 324 6,618
--------- ---------
Net loss before cumulative effect of change
in accounting principle (5,464) (2,092)
Cumulative effect of change in accounting principle -- (72,022)
--------- ---------
Net loss $ (5,464) $ (74,114)
========= =========
The accompanying notes to the condensed consolidated financial
statements are an integral part of these condensed consolidated
financial statements.
15
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(dollars in thousands)
2001 2002
---------------------- ---------------------
Cash flows from operating activities:
Net loss $ (5,464) $(74,114)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of accounting change -- 72,022
Deferred income taxes -- 6,500
Depreciation and amortization 10,370 7,876
Unrealized gain from hedging transactions -- (1,619)
Amortization of deferred financing fees 75 135
Loss on disposition of property and equipment 3 43
Interest expense-accretion of discounts and stock 254 291
Changes in operating assets and liabilities:
(Increase) in accounts receivable (15,052) (17,082)
Decrease in inventories (437) (1,157)
(Increase) in prepaid expenses and other assets (5,394) (5,604)
(Decrease) in accounts payable 420 1,365
Increase in deferred revenue 11,236 14,483
(Decrease) in accrued expenses and other liabilities (3,324) (7,114)
-------- --------
Net cash used in operating activities (7,313) (3,975)
-------- --------
Cash flows used in investing activities:
Payments for businesses acquired (7,043) --
Capital expenditures (2,775) (699)
Proceeds from disposition of property and equipment -- 578
-------- --------
Net cash used in investing activities (9,818) (121)
-------- --------
Cash flows from financing activities:
Net proceeds from revolving line of credit 7,000 10,000
Repayment of senior bank debt (3,141) (4,337)
Proceeds from term loans 10,000 --
Decrease in due from parent, net 6,302 (285)
Increase in due from related party (1,133) 250
-------- --------
Net cash provided by financing activities 19,028 5,628
-------- --------
Increase in cash and cash equivalents 1,897 1,532
Cash, beginning of period 2,914 5,691
-------- --------
Cash, end of period $ 4,811 $ 7,223
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 19,408 $ 16,128
======== ========
Cash paid during the period for income taxes $ 142 $ 163
======== ========
Preferred stock dividends accrued $ 10,337 $ 11,977
======== ========
The accompanying notes to the condensed consolidated financial
statements are an integral part of these condensed consolidated
financial statements.
16
WEEKLY READER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share amounts)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Weekly Reader Corporation ("WRC"), PRIMEDIA Reference, Inc. ("PRI") and American
Guidance Services, Inc. ("American Guidance") were wholly owned subsidiaries of
PRIMEDIA Inc. ("PRIMEDIA"). On August 13, 1999, PRIMEDIA entered into a
Redemption, Stock Purchase and Recapitalization Agreement (as amended as of
October 6, 1999, the "Recapitalization Agreement") with WRC Media Inc. ("WRC
Media"). The terms of the Recapitalization Agreement required that all of the
outstanding capital stock of PRI and American Guidance be contributed to WRC
prior to WRC Media's purchase of a majority interest in WRC for a purchase price
of $395,000. The presentation of these financial statements reflects the capital
contribution made by PRIMEDIA to WRC of all the PRI and American Guidance shares
at their historical carrying values. In addition, on October 5, 1999, the
authorized capital of WRC was amended to consist of 20,000,000 shares of common
stock, par value $.01/share, and WRC declared a 10,000-for-one stock split
effective on October 5, 1999. On November 17, 1999 WRC Media completed its
recapitalization of WRC. The consolidated financial statements include the
accounts of WRC and its subsidiary, Lifetime Learning System, Inc. ("Lifetime
Learning"), PRI and its subsidiaries, Funk & Wagnalls Yearbook Corporation and
Gareth Stevens, Inc. ("Gareth Stevens"), and American Guidance and its
subsidiary, AGS International Sales, Inc. (collectively referred to as "Weekly
Reader"). As a result of the recapitalization, WRC Media owns 94.9% and PRIMEDIA
5.1% of the common stock of Weekly Reader. On November 17, 1999 PRI legally
changed its name to World Almanac Education Group ("WAE"). On May 9, 2001
American Guidance acquired through a subsidiary all of the operating assets of
Lindy Enterprises, Inc. ("Lindy") for approximately $7,500. The transaction was
accounted for as an asset purchase. Lindy develops curriculum-based skills
assessment and test preparation products that correlate to national and state
curriculum. The acquisition, if it had occurred on January 1 of the year prior
to acquisition, would not have had a material impact on the results of
operations.
All significant intercompany balances and transactions have been eliminated in
the accompanying condensed consolidated financial statements.
The accompanying condensed consolidated financial statements have been prepared
without audit. In the opinion of management, all adjustments, consisting of only
normal recurring adjustments necessary to present fairly the financial position,
the results of operations and cash flows for the periods presented, have been
made.
The accompanying condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the SEC. Accordingly, certain
information and note disclosures normally included in financial statements
prepared in conformity with generally accepted accounting principles have been
condensed or omitted. Certain reclassifications have been made to the prior year
amounts in order to conform to the current year's presentation.
These condensed consolidated financial statements should be read in conjunction
with Weekly Reader Corporation and Subsidiaries annual financial statements and
related notes for the year ended December 31, 2001.
The operating results for the nine-month periods ended September 30, 2001 and
2002 are not necessarily indicative of the results that may be expected for a
full year.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued two new
statements, SFAS No.141, "Business Combinations," and SFAS No.142, "Goodwill and
Other Intangible Assets". SFAS No. 141 requires that the purchase method be used
for all business combinations initiated after June 30, 2001 and prohibits the
use of the pooling of interest method. The adoption of SFAS No. 141 did not have
a material effect on WRC's results of operations or financial position. SFAS No.
142 specifies the financial accounting and reporting for acquired goodwill and
other intangible assets. Goodwill and intangible assets that have indefinite
useful lives will not be amortized but rather be tested at least annually for
impairment. SFAS No. 142 requires that the useful lives of intangible assets
acquired on or before June 30, 2001 be reassessed and the remaining amortization
periods adjusted accordingly. Previously recognized intangible assets deemed to
have indefinite lives should be tested for impairment as well. Goodwill
recognized on or before June 30, 2001 has been assigned to various reporting
units and has been tested for impairment during the six-months ending June 30,
2002, the period in which SFAS No. 142 is initially applied in its entirety. On
January 1, 2002, WRC adopted SFAS No. 142 for its goodwill and identifiable
intangible assets. Upon adoption, WRC ceased the amortization of goodwill and
other indefinite lived intangible assets, which consist of trademarks. As
required by this statement, WRC reviewed its indefinite lived intangibles
(trademarks) for impairment as of January 1, 2002. The effect on the results of
operations for the comparative period ended September 30, 2001 had WRC adopted
this accounting change on January 1, 2001 would have resulted in reducing WRC's
amortization expense and pre-tax losses approximately $2,523 for the nine-months
ended September 30, 2001.
17
WRC performed the transitional impairment tests on its goodwill and
indefinite-lived intangibles in the second quarter ended June 30, 2002. The
previous method for determining impairment prescribed by SFAS 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," utilized an undiscounted cash flow approach for the impairment assessment,
while SFAS No. 142 utilizes a fair value approach. WRC has three reporting units
with goodwill. Goodwill was tested for impairment at the reporting unit level.
As a result, WRC recorded a transitional goodwill and indefinite lived
intangible asset impairment charge of $72,022 at its subsidiary, American
Guidance Service, Inc. This charge is reported as cumulative effect of
accounting change, as of January 1, 2002, in the Condensed Consolidated
Statement of Operations. WRC is required to perform impairment tests on an
annual basis, or between yearly tests under certain circumstances for goodwill
and indefinite lived intangibles. There can be no assurance that future
impairment tests will not result in a charge to earnings.
December 31, Impairment September 30,
(in thousands) 2001 Adjustment 2002
- -------------------------------- ---------------------------------------------
Goodwill $ 101,979 $ (66,961) $ 35,018
Long Lived Assets - Trademarks 15,017 (5,061) 9,956
--------- --------- ---------
$ 116,996 $ (72,022) $ 44,974
========= ========= =========
WRC also recorded non-cash deferred income tax expense of approximately $5,000
on January 1, 2002 and $1,500 during the nine-months ended September 30, 2002,
related to the adoption of SFAS 142. The non-cash charge of $5,000 on January 1,
2002 was recorded to increase the valuation allowance related to the deferred
tax asset associated with WRC's net operating losses. Historically, WRC did not
need a valuation allowance for the portion of their net operating loss equal to
the excess of tax over book amortization on tax-deductible goodwill and
trademarks since the liability was expected to reverse during the carryforward
period of the net operating losses. As a result of the adoption of SFAS 142, the
timing of the reversal of this liability is indefinite and can no longer be
offset by WRC's net operating loss carryforwards. While book amortization of
tax-deductible goodwill and trademarks ceased on January 1, 2002, WRC will
continue to amortize these assets for tax purposes. As a result, WRC will have
deferred tax liabilities that will arise each quarter because the taxable
temporary differences related to the amortization of these assets will not
reverse prior to the expiration period of WRC's deductible temporary differences
unless the related assets are sold or an impairment of the assets is recorded.
Accordingly, WRC also recorded an additional $1,500 to increase the valuation
allowance for the nine-months ended September 30, 2002. WRC expects that it will
record an additional $500 to increase the valuation allowance during the
remaining three-months of 2002.
18
The following information represents pro forma net loss assuming the adoption of
SFAS 142 on January 1, 2001:
For the Three Months Ended For the Nine Months Ended
---------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2001 2002 2001 2002
- ---------------------------------------------------------------------------------------------- ---------------------------------
Reported Net Income (loss) $ 3,120 $ 7,971 $ (5,464) $(74,114)
Addback:
Goodwill Amortization 726 -- 2,178 --
Amortization of Trademarks 115 -- 345 --
Cumulative effect of a change in accounting principle -- -- -- 72,022
Deferred provision for income taxes -- 500 -- 6,500
-------- -------- -------- --------
$ 3,961 $ 8,471 $ (2,941) $ 4,408
======== ======== ======== ========
WRC adopted the provisions of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended by Statements of Financial
Accounting Standards No. 137, Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133, and No.
138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities, and as interpreted by the FASB and the Derivatives Implementation
Group through "Statement 133 Implementation Issues," as of January 1, 2001. WRC
believes that it has properly identified all derivative instruments and any
embedded derivative instruments that require bifurcation. WRC's hedging
activities, if any, are in accordance with its documented and approved hedging
and risk management policies. Specifically, we have appropriately designated all
hedging instruments as either fair value or cash flow hedges, or hedges of a net
investment in a foreign operation. We believe the timing, nature, and amounts of
all forecasted transactions are probable of occurring. The fair values of all
derivatives, embedded derivatives that have been bifurcated, and hedged items
have been determined based on prevailing market prices or by using financial
models that we believe are the appropriate models for valuing such instruments
and that incorporate market data and other assumptions that we have determined
to be reasonable and appropriate at September 30, 2002. WRC Media Corporation
has $152 million of callable senior subordinated notes outstanding. These notes
pay a fixed coupon of 12.75% and mature on 11/15/09. The prolonged Fed easing
campaign of 2001-2002 has brought short-term rates down to 40-year lows, greatly
increasing the opportunity cost of the notes. In order to immediately reduce
funding costs, WRC Media moved down the yield curve by swapping a portion of the
fixed rate 12.75% Notes to floating rate. In addition, WRC also guaranteed
positive carry for the one-year period May 15, 2002 through May 15, 2003 of the
transaction by locking in the LIBOR forwards below the fixed rate of the swap.
The swap transaction does not qualify for hedge accounting treatment and as
such, the Company marks-to-market the swap contract at the end of each quarter.
For the nine-months ended September 30, 2002, WRC has recorded an unrealized
gain of $1.6 million related to its interest rate swap, which is being marked to
market under SFAS 133. This gain is reflected in Other, net in the consolidated
statement of operations.
Debt
As of September 30, 2002, there were $10 million in outstanding advances under
WRC's $30 million revolving credit facility, which bear interest approximating
5.3% at September 30, 2002. In addition, there is an annually renewable stand-by
letter of credit in the amount of $2 million in connection with a real estate
lease entered into by the Company. While this letter of credit is in effect,
WRC's available borrowing under the revolving credit facility is reduced by $2
million.
Inventories
Inventories are comprised of the following:
December 31, September 30,
2001 2002
------------ -------------
Finished goods $ 16,377 $ 17,164
Raw materials 114 682
Less - allowance for obsolescence (2,773) (2,971)
----------- -----------
$ 13,718 $ 14,875
=========== ===========
19
Intangibles
The gross carrying amount and accumulated amortization of the WRC's intangible
assets other than goodwill and indefinite-lived intangible assets as of
September 30, 2002 and December 31, 2001 are as follows:
---------------------------------------------------- ----------------------------------------------------
December 31, 2001 September 30, 2002
---------------------------------------------------- ----------------------------------------------------
Accumulated Accumulated
Gross Amortization Net Gross Amortization Net
-------------- ------------------ -------------- --------------- ----------------- --------------
Customer Lists $ 36,748 $(33,070) $ 3,678 $ 36,748 $(33,769) $ 2,979
Copyrights 17,520 (12,527) 4,993 17,520 (14,132) 3,388
Product Titles 22,400 (17,117) 5,283 22,400 (18,768) 3,632
Non-compete agreements 17,098 (17,098) -- 17,098 (17,098) --
Databases 5,812 (5,723) 89 5,812 (5,782) 30
Other 264 (215) 49 264 (215) 49
-------- -------- -------- -------- -------- --------
Total: $ 99,842 $(85,750) $ 14,092 $ 99,842 $(89,764) $ 10,078
======== ======== ======== ======== ======== ========
For intangible assets other than goodwill not subject to amortization, the total
carrying amount is $9,956 at September 30, 2002.
The estimated amortization expense for each of the five succeeding fiscal years
is as follows:
For the year ended December 31,
- -----------------------------------------------
2002 ............................. $ 11,998
2003 ............................. $ 7,717
2004 ............................. $ 4,517
2005 ............................. $ 2,188
2006 ............................. $ 845
Litigation
The Company is a party to litigation arising in the normal course of business.
Management regularly analyzes current information and, as necessary, provides
accruals for probable liabilities on the eventual disposition of these matters.
Management believes that the effect on its results of operations and financial
position, if any, for the disposition of these matters, will not be material.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the financial
condition as of September 30, 2002 of WRC Media Inc. ("WRC Media") and its
subsidiaries and their results of operations for the three-month and nine-month
periods ended September 30, 2001 and 2002. You should read the following
discussion in conjunction with the financial statements of WRC Media and Weekly
Reader Corporation ("Weekly Reader") attached to this discussion and analysis.
Unless the context otherwise requires, references to "Weekly Reader" herein are
to Weekly Reader and its subsidiaries, including American Guidance Service, Inc.
("AGS" or "American Guidance") and World Almanac Education Group, Inc. ("World
Almanac"). Unless the context otherwise requires, the terms "we," "our," and
"us" refer to WRC Media and its subsidiaries after giving effect to the
transactions related to the acquisition of CompassLearning, Inc.
("CompassLearning") and recapitalization of Weekly Reader effectuated on July
14, 1999 and November 17, 1999, respectively (the "Acquisition and
Recapitalization"). This discussion and analysis contains forward-looking
statements. Although we believe that our plans, intentions and expectations
reflected in or suggested by these forward-looking statements are reasonable, we
cannot assure you that these plans, intentions or expectations will be achieved.
These forward-looking statements are subject to risks, uncertainties and
assumptions about us.
Results of Operations for the Three-Months Ended September 30, 2002-- WRC Media
Inc. and Subsidiaries
The results of operations of WRC Media and its subsidiaries encompass the
operations of Weekly Reader and its subsidiaries, including AGS and World
Almanac, CompassLearning, and ChildU, Inc. ("ChildU"). The results of operations
of WRC Media and its subsidiaries should be read together with the separate
discussion of the results of operations of Weekly Reader.
In analyzing WRC Media's results for the three-months ended September 30, 2001
and 2002, respectively, the seasonal nature of WRC Media's business should be
considered. As a result of seasonality, approximately 20% of WRC Media's
publication and related service revenues usually occur in its first quarter, 20%
in its second quarter, and 60% in the third and fourth quarters combined.
However, unlike this revenue stream, many of WRC Media's expenses are incurred
evenly throughout the year.
WRC Media analyzes its revenues, expenses and operating results on a percentage
of sales basis. The following table sets forth, for the periods indicated,
consolidated statements of operations data for WRC Media and its subsidiaries,
expressed in millions of dollars and as a percentage of net sales.
21
Three Months Ended September 30
2001 2002
------------------------------- -------------------------------
Amount % of Net Sales Amount % of Net Sales
------------ ----------------- ----------- -----------------
(Dollars in millions)
Sales, net $ 60.2 100.0% $ 56.5 100.0%
Cost of goods sold 16.5 27.4% 15.4 27.3%
------- ------ ------- -----
Gross profit 43.7 72.6% 41.1 72.7%
Costs and expenses:
Sales and marketing 14.4 24.0% 11.1 19.6%
Research and development 1.3 2.2% 0.3 0.5%
Distribution, circulation and fulfillment 3.7 6.1% 3.5 6.2%
Editorial 2.3 3.8% 2.6 4.6%
General and administrative 6.5 10.8% 6.0 10.6%
Depreciation 0.8 1.3% 0.7 1.2%
------- ------ ------- -----
29.0 48.2% 24.2 42.7%
------- ------ ------- -----
Income before amortization of goodwill and intangible assets,
interest expense, income taxes and other, net 14.7 24.4% 16.9 30.0%
Amortization of goodwill and intangible assets 17.2 28.6% 4.5 8.0%
------- ------ ------- -----
Income(loss) from operations (2.5) (4.2%) 12.4 22.0%
Interest expense, including amortization
of deferred financing costs (8.2) (13.6%) (7.6) (13.5%)
Loss on investments (0.3) (0.5%) (0.9) (1.6%)
Other, net (0.2) (0.3%) 1.2 2.1%
------- ------ ------- -----
Income(loss) before income tax provision (11.2) (18.6%) 5.1 9.0%
Income tax provision 0.2 0.3% 0.5 0.9%
------- ------ ------- -----
Net income(loss) $ (11.4) (18.9%) $ 4.6 8.1%
======= ====== ======= =====
EBITDA(a) $ 16.1 26.7% $ 17.5 31.0%
======= ====== ======= =====
(a) EBITDA is defined as income (loss) before interest expense, income taxes,
depreciation and amortization not including WRC Media's unrestricted
subsidiaries. EBITDA data is included because we understand that this
information may be considered by investors as an additional basis on which to
evaluate WRC Media's ability to pay interest, repay debt and make capital
expenditures. Because all companies do not calculate EBITDA identically, the
presentation of EBITDA in this report is not necessarily comparable to similarly
titled measures of other companies. EBITDA does not represent and should not be
considered more meaningful than, or an alternative to, measures of operating
performance determined in accordance with generally accepted accounting
principles. Given the projected near-term financial performance of ChildU and
ThinkBox, WRC Media designated ChildU and ThinkBox "Unrestricted Subsidiaries"
under its Credit Agreement so as to: (i) exclude them from all the negative
covenants in the Credit Agreement including the financial covenants, and from
agreed upon affirmative covenants, representations and warranties and events of
default; and (ii) Permit additional investments in ChildU and ThinkBox by WRC
Media and its subsidiaries in excess of the acquisition funding requirements to
fund operations, if necessary. As a result of the above-mentioned designation,
ChildU and ThinkBox performance will not be included in any covenant
calculations. Accordingly, Consolidated EBITDA (before unrestricted
subsidiaries) is defined as WRC Media consolidated EBITDA excluding the $1.0
million EBITDA loss in 2002 and the $1.1 million EBITDA loss in 2001 contributed
by its unrestricted subsidiaries - ChildU and its investment in Thinkbox.
Three-Months Ended September 30, 2002 Compared to Three-Months Ended September
30, 2001
Sales, net. For the three-months ended September 30, 2002, net sales decreased
$3.7 million, or 6.1%, to $56.5 million from $60.2 million for the same period
in 2001. This decrease was primarily the result of a $3.7 million or 26.1%
decrease at WRC Media's CompassLearning operating unit.
At CompassLearning, net revenue decreased $3.7 million, or 26.1%, to $10.5
million for the three-months ended September 30, 2002 from $14.2 million for the
same period in 2001 primarily driven by lower software revenue. New software
sales for the third quarter of 2002 decreased by $3.0 million or 40.5% to $4.4
million from $7.4 million for the same period in 2001. CompassLearning has been
the most affected by the extremely difficult funding situation, as the primary
funding sources for schools to purchase its software is Title 1 funding. Net
sales at ChildU, WRC's unrestricted subsidiary (see footnote 1 below), increased
nearly $1.0 million or 333.3% to $1.3 million for the three-months ended
September 30, 2002 from $0.3 million for the same period in 2001 driven by sales
of its online curriculum products.
22
At AGS, sales increased $0.5 million, or 2.6%, to $19.8 million for the
three-months ended September 30, 2002 from $19.3 million for the same period in
2001, primarily due to higher sales of assessment products.
At Weekly Reader, not including AGS and World Almanac, net sales decreased $2.0
million, or 14.6%, to $11.7 million from $13.7 million for the same period in
2001. This was attributable to $2.0 million or 46.2% decrease in custom
publishing revenue from Weekly Reader's subsidiary Lifetime Learning Systems for
the three-months ended September 30, 2002. Lifetime Learning Systems has been
affected by the general decline in media advertising spending.
At World Almanac Education Group, third quarter sales increased by $0.4 million,
or 3.1% (Excluding Funk & Wagnalls, World Almanac's third quarter core revenue*
increased 5.1% compared to the same period in 2001), to $13.1 million for the
three-months ended September 30, 2002 from $12.7 million for the same period in
2001, primarily as a result of continued strength of World Almanac's Gareth
Stevens children's library books division. At Gareth Stevens, the third quarter
of 2002 revenue of $4.8 million was $1.1 million or 29.7% greater than the third
quarter of 2001 driven by strong sales in wholesale and press run channels
(mostly from new imprints -World Almanac Library and Weekly Reader Early
Learning Library) and strong special sales. This was partially offset by $0.5
million or 8.6% sales decrease at WAE Library Services division compared to the
same period in 2001 driven by the weak library market.
Gross profit. For the three-months ended September 30, 2002, gross profit
decreased by $2.6 million, or 5.9%, to $41.1 million from $43.7 million for the
same period in 2001. This decrease was primarily driven by a decrease in new
software revenue at CompassLearning described above. WRC Media's gross profit as
a percentage of sales slightly increased to 72.7% for the three-months ended
September 30, 2002 from 72.6% for the same period in 2001.
Costs and expenses. For the three-months ended September 30, 2002, costs and
expenses decreased by $4.8 million, or 16.6%, to $24.2 million from $29.0
million for the same period i