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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 March 31, 2004 Commission File No. 333-96119
WRC MEDIA INC. WEEKLY READER CORPORATION
(Exact name of Registrant as specified in its charter) (Exact name of Registrant as specified in its charter)
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)
7372
13-4066535
(I.R.S. Employer Identification Number)
WRC MEDIA INC. WEEKLY READER CORPORATION COMPASSLEARNING, INC.
512 7th AVENUE, 22nd FLOOR 512 7th AVENUE, 22nd FLOOR 512 7th AVENUE, 22nd FLOOR
NEW YORK, NY 10018 NEW YORK, NY 10018 NEW YORK, NY 10018
(212) 768-1150 (212) 768-1150 (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.
|_| Yes |X| No
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act.
|_| Yes |X| 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
- -------------------------------------------------------------------------------
2
PART 1.
ITEM 1. FINANCIAL STATEMENTS
3
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, March 31,
2003* 2004**
----------- ---------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,432 $ 6,372
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,519 and $2,391, respectively) 30,027 25,758
Inventories, net 16,652 15,213
Prepaid expenses 3,367 3,165
Other current assets 1,889 1,564
--------- ---------
Total current assets 53,367 52,072
Property and equipment, net 5,526 4,824
Capitalized software, net 7,293 7,414
Goodwill 143,149 143,149
Deferred financing costs, net 4,939 8,856
Other intangible assets, net 92,610 89,479
Other assets 30,448 32,649
--------- ---------
Total assets $ 337,332 $ 338,443
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 16,963 $ 13,960
Accrued payroll, commissions and benefits 9,356 7,773
Current portion of deferred revenue 35,900 27,559
Other accrued liabilities 17,166 20,345
Current portion of long-term debt 8,477 -
--------- ---------
Total current liabilities 87,862 69,637
Deferred revenue, net of current portion 959 990
Deferred tax liability 12,700 13,200
15% Series B mandatorily redeemable preferred stock,
including accrued dividends and accretion of warrant value
(5,701,360 shares outstanding)
(Liquidation preference of $142,866) - 135,169
Long-term debt 262,925 292,844
--------- ---------
Total liabilities 364,446 511,840
--------- ---------
Commitments and contingencies
15% Series B mandatorily redeemable preferred stock,
including accrued dividends and accretion of warrant value
(5,508,000 shares outstanding) 129,767 -
Warrants on common stock of subsidiaries 11,751 11,751
--------- ---------
Common stock subject to redemption 940 940
--------- ---------
Stockholders' deficit:
Common stock, ($.01 par value, 20,000,000 shares authorized;
7,008,406 shares outstanding in 2003 and 2004) 70 70
18% convertible preferred stock, ($.01 par value, 750,000 shares
authorized, 547,980 and 572,639 outstanding, respectively) 21,919 22,905
Additional paid-in capital 131,753 131,753
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (321,415) (338,917)
--------- ---------
Total stockholders' deficit (169,572) (186,088)
--------- ---------
Total liabilities and stockholders' deficit $ 337,332 $ 338,443
========= =========
* Condensed from audited financial statements.
** Unaudited.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(Amounts in thousands)
2003 2004
------------ --------
(As Restated
See Note 16)
Revenue, net $ 47,220 $ 42,760
Cost of goods sold 13,273 12,920
-------- --------
Gross profit 33,947 29,840
-------- --------
Costs and expenses:
Sales and marketing 11,481 11,555
Research and development 711 747
Distribution, circulation and fulfillment 3,510 3,552
Editorial 2,579 2,873
General and administrative 5,642 7,121
Restructuring costs and other non-recurring expenses 480 65
Depreciation 616 425
Amortization of intangible assets 4,691 4,530
-------- --------
Total operating costs and expenses 29,710 30,868
-------- --------
Income (loss) from operations 4,237 (1,028)
Interest expense, including amortization
of deferred financing costs (7,082) (14,423)
Other income (expense), net (231) (250)
-------- --------
Loss before income tax provision (3,076) (15,701)
Income tax provision 588 577
-------- --------
Net loss $ (3,664) $(16,278)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- ----------
(As Restated
See Note 16)
Cash flows from operating activities:
Net loss $ (3,664) $ (16,278)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 500 500
Depreciation and amortization 6,030 5,468
Accretion of manditorily redeemable preferred stock dividends - 5,164
Accretion of debt discount 107 120
Amortization of deferred financing costs 305 2,222
Changes in operating assets and liabilities:
Accounts receivable 5,371 4,269
Inventories 945 1,439
Prepaid expenses and other current assets (1,177) 527
Other non-current assets (4,638) (3,601)
Accounts payable (5,481) (3,002)
Deferred revenue (8,491) (8,310)
Accrued liabilities 2,492 1,595
--------- ---------
Net cash used in operating activities (7,701) (9,887)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (112) (144)
Capitalized software (898) (634)
Landlord reimbursement for leasehold improvements - 421
Proceeds from the disposition of property and equipment 4 -
--------- ---------
Net cash used in investing activities (1,006) (357)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 7,000 18,000
Repayments of borrowings under revolving line of credit (2,000) (23,000)
Repayment of senior bank debt (1,834) (118,678)
Deferred financing fees - (6,138)
Proceeds from issuance of long-term debt - 145,000
Purchase of common stock subject to redemption (25) -
--------- ---------
Net cash provided by financing activities 3,141 15,184
--------- ---------
(Decrease) increase in cash and cash equivalents (5,566) 4,940
Cash and cash equivalents, beginning of period 9,095 1,432
--------- ---------
Cash and cash equivalents, end of period $ 3,529 $ 6,372
========= =========
The accompanying notes are anp integral part of these condensed
consolidated financial statements.
6
WRC MEDIA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share and per share amounts)
1. DESCRIPTION OF BUSINESS
The accompanying condensed consolidated financial statements include the
accounts of WRC Media Inc. ("WRC Media") and its subsidiaries - Weekly Reader
Corporation ("Weekly Reader"), CompassLearning, Inc. ("CompassLearning") and
ChildU, Inc. ("ChildU"). WRC Media was incorporated on May 14, 1999. The term
"Company" refers to WRC Media and its subsidiaries.
The Company is in the business of developing, publishing and marketing print and
electronic supplemental education materials. Certain of the Company's products
have been sold in the education marketplace for as long as 100 years. The
Company's customers are primarily within the United States.
2. BASIS OF PRESENTATION
Under the terms of the indenture relating to the Company's 12 3/4% Senior
Subordinated Notes due 2009 (the "Notes"), the Company is required to furnish
"all quarterly and annual financial information that would be required to be
contained in a filing with the Securities and Exchange Commission (the `SEC') on
Forms 10-Q and 10-K if the Company were required to file such forms, including a
`Management's Discussion and Analysis of Financial Condition and Results of
Operations' and, with respect to the annual information only, a report thereon
by the Company's certified independent accountants. . ." in each case within the
time periods specified in the SEC's rules and regulations.
The Company has restated its previously issued financial statements as of and
for the year ended December 31, 2001. Because the originally issued 2001
financial statements were audited by Arthur Andersen LLP, an audit firm that has
ceased operations, the restated financial statements for 2001 are unaudited at
this time pending a reaudit which is not yet complete. The Company believes that
upon furnishing its audited 2003 financial statements to the noteholders and
filing such statements with the SEC on its Form 8-K dated March 31, 2004, it was
in compliance with the indenture's information requirements. There is no
assurance, however, that the trustee or noteholders will not claim that the
Company is in breach of the indenture's information requirements, or that after
any such claim is made and the applicable cure period has expired, the trustee
or the noteholders will not send a notice to accelerate repayment of the Notes.
If the reaudit of the Company's 2001 financial statements is completed and a
report thereon issued by its independent auditors as required by the indenture
prior to any claim of breach being made, the potential for such a claim would be
eliminated. If a breach of the information requirements of the indenture were to
be claimed and the trustee or holders of at least 25% of the aggregate principal
amount of the Notes were to provide written notice of such breach, the Company
would vigorously defend against any such claim. Even if the claim of breach were
to prevail, the Company would have 60 days from the date of written notice of
such claim of breach to cure the breach and avoid an event of default under the
indenture. If the reaudit of the Company's 2001 financial statements is
completed and a report thereon issued by its independent auditors as required by
the indenture prior to the end of the 60 day cure period, the right to
accelerate the Notes or indebtedness under the credit facility as a result of
the alleged breach of the indenture's information requirements would be
eliminated. The Company has engaged its independent auditors to perform a
reaudit of the 2001 financial statements and expects to be able to provide its
auditors with the information necessary for them to complete their audit prior
to the end of the cure period, if any claim of breach of the indenture's
information requirements is made.
While the Company is diligently working to provide such information, there is no
assurance that the Company will be able to provide the information necessary to
complete the reaudit or that the reaudit of the 2001 financial statements will
be completed and a report thereon issued by the Company's certified independent
accountants as required by the indenture. If the trustee or holders representing
at least 25% of the aggregate principal amount of the Notes claim that the
Company will be in breach of the indenture, the Company is not successful in
defending against such claim of breach and such breach is not cured within the
cure period, there would be an event of default under the indenture, and the
trustee or holders of at least 25% of the aggregate principal amount of the
Notes would have the right to accelerate payment of the Notes, and the holders
of indebtedness under the Company's credit facility also would have the right to
accelerate payment thereunder. If any such acceleration occurred, the Company
would not be able to repay the amounts due and such acceleration would have a
material adverse effect on the Company's consolidated financial condition and
liquidity. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
7
The accompanying condensed consolidated financial statements of the Company as
of March 31, 2004 and for the three-month periods ended March 31, 2003 and 2004
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP") for interim financial information and
the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. 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.
These condensed consolidated financial statements should be read in conjunction
with the Company's annual financial statements and related notes thereto as
reported in the Company's Form 8-K dated March 31, 2004. The operating results
for the three-month periods ended March 31, 2003 and 2004 are not necessarily
indicative of the results that may be expected for a full year.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variables Interest Entities ("FIN 46").
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements" to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. In
December 2003, the FASB issued FIN No. 46 (Revised) ("FIN 46R") to address
certain FIN 46 implementation issues. This interpretation requires that the
assets, liabilities, and results of activities of a Variable Interest Entity
("VIE") be consolidated into the financial statements of the enterprise that is
the primary beneficiary of the VIE. FIN 46R also requires additional disclosures
by primary beneficiaries and other significant variable interest holders. This
interpretation is effective no later than the end of the first interim or
reporting period ending after March 15, 2004, except for those VIE's that are
considered to be special purpose entities, for which the effective date is no
later than the end of the first interim or annual reporting period ending after
December 15, 2003. The adoption of FIN 46R effective March 31, 2004, did not
have any effect on the Company's consolidated financial position or results of
operations.
In April 2003, the FASB issued Statements of Financial Accounting Standards
("SFAS") No. 149 "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS 149"), which amends and clarifies accounting for
derivative instruments, and for hedging activities under SFAS 133. Specifically,
SFAS 149 requires that contracts with comparable characteristics be accounted
for similarly. Additionally, SFAS 149 clarifies the circumstances in which a
contract with an initial net investment meets the characteristics of a
derivative and when a derivative contains a financing component that requires
special reporting in the statement of cash flows. This Statement is generally
effective for contracts entered into or modified after June 30, 2003 and its
adoption did not have any effect on the Company's consolidated financial
position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement was effective for the
Company beginning January 1, 2004. For financial instruments created before the
issuance date of this statement and still existing at the beginning of the
interim period of adoption, transition shall be achieved by reporting the
cumulative effect of a change in an accounting principle by initially measuring
the financial instruments at fair value or other measurement attribute required
by this statement. The adoption of this statement required the Company to
reclassify its 15% Series B Redeemable Preferred Stock from the mezzanine
section of the balance sheet to long-term liabilities at March 31, 2004.
Effective January 1, 2004 dividend payments for the 15% Series B Redeemable
Preferred Stock ("Series B Preferred") are recorded as interest expense in the
consolidated statement of operations. The adoption of this statement did not
result in any adjustment to the book value of its Series B Preferred as of
January 1, 2004 as book value approximated fair value at January 1, 2004. For
the three-months ended March 31, 2004 the Company recognized $5,164 of accrued
dividends on Series B Preferred as interest expense. Interest expense for the
three-months ended March 31, 2004 also includes amortization of deferred
financing costs related to the Series B Preferred in the amount of $30.
8
4. RESTRUCTURING COSTS AND OTHER NON-RECURRING EXPENSES
During the three-months ended March 31, 2004, the Company reviewed its
restructuring reserve established in 2002 and increased the reserve $65 for
lease terminations resulting from the updating of the assumptions used in
determining the fair value of the remaining lease obligations associated with
facilities vacated during 2002.
The restructuring reserve totaling approximately $2,893 at March 31, 2004, is
expected to be paid as follows: remaining nine months of 2004 - $727, 2005 and
beyond - $2,166. These charges are included in other accrued liabilities on the
condensed consolidated balance sheets.
Components of the Company's restructuring plan initiated in the fourth quarter
of 2002 are shown in the following table.
Balance at Additional Balance at
December 31, 2003 Charges Amounts Paid March 31, 2004
----------------- ----------- ----------- --------------
Severance and other benefits $ 32 $ - $ (32) $ -
Lease terminations 3,243 65 (415) 2,893
------ ------ ------ ------
Total $3,275 $ 65 $ (447) $2,893
====== ====== ====== ======
5. STOCK-BASED COMPENSATION
Stock based compensation arrangements with employees are accounted for using the
intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). The Company applies SFAS No. 123, "Accounting for Stock-Based
Compensation and Related Interpretations" ("SFAS 123") for stock-based
compensation arrangements with non-employees. The Company applies the additional
disclosure requirements of SFAS 123, as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure," for employee stock
arrangements.
The following table details the effect on net loss had compensation expense for
stock-based compensation arrangements with employees been recorded based on the
fair value method under SFAS 123, as amended for the three-month periods ended
March 31, 2003 and 2004.
Three-Months Ended March 31,
2003 2004
-------- ---------
Net loss, as reported $ (3,664) $ (16,278)
Deduct: Total stock-based employee compensation
expense determined under the fair value based method
for all awards, net of related tax effects (46) (4)
-------- ---------
Pro forma net loss $ (3,710) $ (16,282)
======== =========
9
The Company has outstanding stock options issued to certain of its executives
that are required to be accounted for as variable options. During the
three-month periods ended March 31, 2003 and 2004 no compensation expense was
recognized for these options as the fair market value of the Company's common
stock, as estimated by the Company's Board of Directors, was less than the
exercise price of these options.
6. DEBT
On March 29, 2004, the Company refinanced all of its term loans under its Senior
Bank Credit Facilities (the "First-Lien Facility") with a $145,000 senior,
second-priority lien secured financing that was provided to the Company pursuant
to a term loan facility (the "Second-Lien Facility"). The proceeds of the
Second-Lien Facility were used (i) to refinance in full all term loans
outstanding under the First-Lien Facility, (ii) to pay fees and expenses related
to the Second-Lien Facility and all transactions contemplated in connection
therewith and (iii) for general corporate purposes of the Company.
All payment obligations under the Second-Lien Facility are secured by a
second-priority lien on the collateral securing the First-Lien Facility;
provided that all obligations under the Second-Lien Facility will rank equally
in right of payment with all payment obligations under the First-Lien Facility
and will not otherwise be subordinated in any respect to the First-Lien
Facility. The final maturity of the Second-Lien Facility is March 29, 2009. At
the Company's option, the loans will bear interest at either the Administrative
Agent's (i) alternate base rate ("base rate loans") or (ii) reserve-adjusted
LIBO rate ("LIBO rate loans") plus, in each case, the "Applicable Margin" (as
defined). "Applicable Margin" means, with respect to (i) Base Rate Loans, a rate
of 4.00% per annum and (ii) LIBO Rate Loans, a rate of 5.00% per annum.
The Second-Lien Facility is subject to mandatory prepayment with:
o the proceeds of the incurrence of certain indebtedness
o the proceeds of certain asset sales or other dispositions
o a change in control
o annually, 50% of the Company's excess cash flow (as defined) from the
prior year.
The Second-Lien Facility provide for certain restrictions, including
restrictions on asset sales, dividend payments, additional indebtedness payments
for restricted investments. In addition, the Second-Lien Facility provides for
the maintenance of a financial covenant, a maximum ratio (the "Senior Leverage
Ratio") of Senior Secured Debt to trailing four quarter EBITDA (as defined
therein) not to exceed 4.25:1.00 for any fiscal quarter, except the fiscal
quarter ended June 30, 2005 for which the Senior Leverage Ratio shall not exceed
4.50:1.00, in each case to be tested on the last day of each fiscal quarter and
computed for WRC Media (as defined within the agreement) and its consolidated
subsidiaries. In connection with entering into the Second-Lien Facility, the
Company entered into an amendment and restatement of its First-Lien Facility,
which now consists solely of a $30,000 revolving credit facility.
The First-Lien Facility, as amended and restated, has a maturity of December 29,
2008, and has one financial covenant, a Senior Leverage Ratio of senior secured
debt to trailing four quarter EBITDA (as defined therein) not to exceed
4.00:1.00 for any fiscal quarter, except the fiscal quarter ended June 30, 2005
for which the Senior Leverage Ratio may not exceed 4.25:1.00, in each case to be
tested on the last day of the fiscal quarter and computed for the Company and
its consolidated subsidiaries. Interest on revolving loan borrowings under the
First-Lien Facility bear interest at a rate per annum equal to the LIBO rate as
defined in the First-Lien Facility plus 3.5% or the alternate base rate as
defined in the First-Lien Facility plus 2.5%.
As a result of the refinancing of the Company wrote-off the remaining balances
of deferred financing costs associated with the First Lien Facility of
approximately $1,914. These costs are included in interest expense, including
amortization of deferred financing costs, on the condensed consolidated
statement of operations for the three-months ended March 31, 2004.
10
In connection with the refinancing the Company incurred costs and expenses,
primarily investment banking and legal fees, of approximately $6,138. These
amounts have been recorded as deferred financing fees at March 31, 2004 and will
be amortized over the term of the Second Lien Facility using the effective
interest method.
At March 31, 2004, there were no outstanding advances under the Company's
$30,000 revolving credit facility, which bears interest at approximately 4.6%
for Eurodollar rate advances and 6.4% for base rate advances as of March 31,
2004. The Company has stand-by letters of credit, renewable annually, in the
amount of $2,050 of which $2,000 serves as security for a real estate lease
entered into by the Company and $50 serves as security for certain surety bonds
issued on behalf of the Company. While these letters of credit are in effect,
the Company's available borrowing under the revolving credit facility is reduced
by $2,050.
7. FINANCIAL INSTRUMENTS
Pursuant to the terms of the First and Second-Lien Credit Agreements, the
Company is required to enter into or maintain interest rate protection
agreements (interest rate swaps, caps, collars or similar agreements) in a
notional amount that, when taken together with the aggregate principal amount of
Total Debt, as defined subject to a fixed interest rate, is at least equal to at
least 50% of the aggregate principal amount of all Total Debt. On November 15,
2003, the Company entered into a one year interest rate cap agreement with a
notional principal of $61,000, which caps the LIBOR based rate, as defined, on
those loans at 2.5%. The interest rate protection agreement did not qualify for
hedge accounting treatment and as such the Company marks to market the contract
at the end of each period. The fair value of the interest rate cap at March 31,
2004 is de-minimus.
8. INVENTORIES
Inventories as of December 31, 2003 and March 31, 2004 are as follows:
December 31, March 31,
2003 2004
----------- -----------
Finished goods $ 19,932 $ 18,739
Raw materials 119 101
Less - impaired, excess and obsolete inventory (3,399) (3,627)
----------- -----------
Inventory, net $ 16,652 $ 15,213
=========== ===========
9. GOODWILL AND TRADEMARKS
At December 31, 2003 and March 31, 2004, goodwill and indefinite lived
intangibles are as follows:
December 31, March 31,
2003 2004
----------- ----------
Goodwill $ 143,149 $ 143,149
Long Lived Assets - Trademarks 42,150 42,150
----------- ----------
$ 185,299 $ 185,299
=========== ==========
There were no changes in goodwill during the three-months ended March 31, 2004.
The Company recorded non-cash deferred income tax expense of $500 during the
three-months ended March 31, 2003 and 2004, for taxable temporary differences
that will not reverse prior to expiration of the Company's net operating loss
carryforward periods. Book amortization of tax-deductible goodwill and
trademarks ceased on January 1, 2002 upon the Company's adoption of SFAS
No. 142, however 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. The Company expects that it
will record an additional $1,500 to increase the valuation allowance during the
remaining nine months of 2004.
11
10. OTHER INTANGIBLE ASSETS
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill and indefinite lived intangible are as
follows:
December 31, 2003 March 31, 2004
-------------------------------- -------------------------------
Accumulated Accumulated
Useful Lives Gross Amortization Net Gross Amortization Net
------------ ---------- --------- -------- --------- ------------ ---------
Customer Lists 7-9 yrs $ 62,911 $ (27,770) $ 35,141 $ 62,911 $ (29,535) $ 33,376
Copyrights 8 yrs 21,053 (11,742) 9,311 21,053 (12,107) 8,946
Product Titles 7 yrs 13,475 (11,760) 1,715 13,475 (12,099) 1,376
Software 5 yrs 8,369 (4,320) 4,049 8,369 (4,738) 3,631
Trade name 5 yrs 3,520 (3,276) 244 3,520 (3,520) -
---------- --------- -------- --------- ---------- --------
Total: $ 109,328 $ (58,868) $ 50,460 $ 109,328 $ (61,999) $ 47,329
---------- --------- -------- --------- ---------- ---------
Included in other intangible assets, are trademarks not subject to amortization,
for which the total carrying amount was $42,150 at December 31, 2003 and March
31, 2004.
Amortization of intangibles for the three-months ended March 31, 2003 and 2004
was $3,488 and $3,131, respectively and is included in amortization of
intangibles assets on the condensed consolidated statement of operations. The
estimated amortization expense for intangible assets subject to amortization for
the next five years is as follows:
Remaining nine months of 2004 ......................... $ 7,830
Year ended 2005 ......................... $ 9,459
Year ended 2006 ......................... $ 6,671
Year ended 2007 ......................... $ 4,439
Year ended 2008 ......................... $ 4,420
Year ended 2009 ......................... $ 4,178
Thereafter ......................... $ 10,332
11. COMMITMENTS AND CONTINGENCIES
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.
The SEC is conducting a preliminary inquiry concerning the Company. The SEC has
requested that the Company voluntarily provide the SEC with various documents
and information, and that certain officers of the Company voluntarily give
testimony. The Company is cooperating fully with the SEC inquiry, and has
provided all documents, information and testimony requested by the SEC. The
Company cannot predict the final outcome of this inquiry at this time.
12. 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 CompassLearning 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 the same as Old Notes except that the
Notes were registered with the Securities and Exchange Commission. 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, a wholly-owned
subsidiary and Weekly Reader, a majority (94.9%) owned subsidiary of the Company
(collectively, the "Subsidiary Guarantors").
12
The following tables present condensed consolidating financial information for
WRC Media and the subsidiary guarantors as of and for the three-month periods
ended March 31, 2003 and 2004 for: (1) WRC Media, (2) Weekly Reader, a
non-wholly-owned guarantor subsidiary, (3) CompassLearning, Inc., a wholly-owned
guarantor subsidiary, (4) ChildU, Inc. a wholly-owned subsidiary, guarantor
subsidiary and (5) the Company on a consolidated basis.
Subsidiary Guarantors
----------------------------------------
Weekly Compass-
Reader Learning WRC Media Inc.
WRC Media Inc. Corporation Inc. ChildU Eliminations Consolidated
-------------- ----------- --------- --------- ------------ --------------
(In thousands)
Balance Sheet as of March 31, 2004
Assets:
Current assets $ 1,761 $ 73,782 $ 14,533 $ 9,196 $ (47,200) $ 52,072
Property and equipment, net - 4,131 555 138 - 4,824
Goodwill and other intangible assets, net 157,127 48,376 23,494 3,631 - 232,628
Other assets 108,781 32,464 5,136 2,463 (99,925) 48,919
--------- --------- --------- --------- --------- ---------
Total assets $ 267,669 $ 158,753 $ 43,718 $ 15,428 $(147,125) $ 338,443
========= ========= ========= ========= ========= =========
Liabilities and stockholders' deficit:
Current liabilities $ 109,838 $ 37,195 $ 44,369 $ 16,226 $(137,991) $ 69,637
Redeemable preferred stock, plus accrued
dividends 135,169 142,866 - - (142,866) 135,169
Long-term debt, less current portion 147,844 292,844 - - (147,844) 292,844
Other liabilities 10,400 2,800 990 - - 14,190
Warrants on common stock of subsidiaries 11,751 - - - - 11,751
Common stock subject to redemption 940 - - - - 940
Stockholders' deficit: (148,273) (316,952) (1,641) (798) 281,576 (186,088)
--------- --------- --------- --------- --------- ---------
Total liabilities and stockholders' deficit $ 267,669 $ 158,753 $ 43,718 $ 15,428 $(147,125) $ 338,443
========= ========= ========= ========= ========= =========
Subsidiary Guarantors
----------------------------------------
Weekly Compass-
Reader Learning WRC Media Inc.
WRC Media Inc. Corporation Inc. ChildU Eliminations Consolidated
-------------- ----------- --------- --------- ------------ --------------
(In thousands)
Statements of operations for the three months
ended March 31, 2004
Revenue, net $ - $ 34,428 $ 6,669 $ 1,663 $ - $ 42,760
Operating costs and expenses 1,044 29,822 10,202 2,720 - 43,788
Interest expense, net 11,839 12,713 - - (10,129) 14,423
Other (income) expense 253 (3) - - - 250
Provision for income taxes 399 143 35 - - 577
-------- -------- -------- -------- -------- --------
Net loss $(13,535) $ (8,247) $ (3,568) $ (1,057) $ 10,129 $(16,278)
======== ======== ======== ======== ======== ========
Cash flow for the three months
ended March 31, 2004
Cash flow provided by (used in) operations $ 22 $(10,400) $ (3,926) $ (428) $ 4,845 $ (9,887)
Cash flow used in investing activities - (119) (120) (118) - (357)
Cash flow provided by (used in) financing activities (37) 15,468 4,046 552 (4,845) 15,184
Cash and cash equivalents at beginning of period 100 1,267 4 61 - 1,432
-------- -------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 85 $ 6,216 $ 4 $ 67 $ - $ 6,372
======== ======== ======== ======== ======== ========
Subsidiary Guarantors
----------------------------------------
Weekly Compass-
Reader Learning Non-guarantor WRC Media Inc.
WRC Media Inc. Corporation Inc. Subsidiary Eliminations Consolidated
-------------- ----------- --------- --------- ------------ --------------
(In thousands)
Statements of operations for the three months
ended March 31, 2003
Revenue, net $ - $ 35,001 $ 11,246 $ 973 $ - $ 47,220
Operating costs and expenses 1,524 28,092 12,006 1,361 - 42,983
Interest expense, net 5,212 6,822 - - (4,952) 7,082
Other (income) expense 237 (6) - - - 231
Provision for income taxes 398 175 15 - - 588
-------- -------- -------- -------- -------- --------
Net loss $ (7,371) $ (82) $ (775) $ (388) $ 4,952 $ (3,664)
======== ======== ======== ======== ======== ========
Cash flow for the three months
ended March 31, 2003
Cash flow provided by (used in) operations $ (537) $(12,739) $ 709 $ 23 $ 4,843 $ (7,701)
Cash flow used in investing activities - (105) (515) (386) - (1,006)
Cash flow provided by (used in) financing activities 318 7,493 (194) 367 (4,843) 3,141
Cash and cash equivalents at beginning of period 1,154 7,819 4 118 - 9,095
-------- -------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 935 $ 2,468 $ 4 $ 122 $ - $ 3,529
======== ======== ======== ======== ======== ========
13
13. RELATED PARTY TRANSACTIONS
Management Agreements
In connection with the recapitalization of Weekly Reader and acquisition and
CompassLearning, the Company entered into management agreements with its
principal shareholder. In accordance with the management agreements, the
shareholder provides to Weekly Reader and CompassLearning management consulting
and advisory services. As a result, Weekly Reader and CompassLearning are
obligated to pay to the shareholder annual aggregate management fees for
services to both Weekly Reader and CompassLearning totaling $950 payable
quarterly.
In addition, the Company will reimburse the principal shareholder for reasonable
out-of-pocket costs and expenses incurred in connection with the performance of
its services. During the three-month periods ended March 31, 2003 and 2004, the
Company recognized general and administrative expense of $238 for management
fees. At March 31, 2004, other accrued liabilities includes approximately $888
of accrued management fees.
14. PENSION BENEFITS
The following table provides components of net periodic benefit cost for the
Company's defined benefit pension plan for the three-months ended March 31, 2003
and 2004:
Pension Benefits
----------------
2003 2004
----- -----
Service cost $ 229 $ 225
Interest Cost 221 238
Expected return on plan assets (169) (242)
Amortization of net loss 74 42
----- -----
Net periodic benefit cost $ 355 $ 263
===== =====
15. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Three-Months Ended March 31,
----------------------------
2003 2004
------ --------
Cash paid during the period for interest $2,053 $2,676
Cash paid during the period for income taxes $ 88 $ 114
Non-cash financing activities:
Preferred stock dividends accrued $5,284 $6,150 (1)
Accretion of preferred stock $ 235 $ 238
(1) During the quarter ended March 31, 2004, $5,164 of such preferred stock
dividends have been recorded as interest expense in the statement of
operations, resulting from the Company's adoption of SFAS 150 effective
January 1, 2004.
16. RESTATEMENT
In connection with the audit of the Company's 2003 consolidated financial
statements, management has restated its financial statements for the years ended
December 31, 2002 and 2001 because it had incorrectly accounted for certain
transactions.
14
As a result, the Company has restated its condensed consolidated financial
statements for the three-months ended March 31, 2003. After giving effect to the
restatement described below, the Company believes it was in compliance with the
financial covenants in its credit facility for the reporting period ended March
31, 2003.
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for three-months ended March 31, 2003.
o Software and Services Sale. In December 2002, the Company recorded a
$1,860 receivable of revenue from the sale of educational software and
services to a school district. Of this amount, $1,169 was recognized
as revenue during the fiscal quarter ended December 31, 2002, and $691
was recorded as a deferred revenue liability as of December 31, 2002.
Accrued sales commissions of $342 also were recorded. In the first
quarter of 2003, this $1,169 of revenue previously recognized in
December 2002 was offset by recording a bad debt reserve of $920
and by retaining an excess of $250 in the Company's allowance for
doubtful accounts, which excess amount would have otherwise been
reversed. The Company has concluded that the sale did not meet the
criteria under GAAP for revenue recognition for the year ended
December 31, 2002, and that it incorrectly recorded the related bad
debt reserve and retained the excess allowance for doubtful accounts
in 2003. The Company has corrected these errors by reversing these
transactions. The net effect for the three-months ended March 31, 2003
was to decrease net loss by approximately $920. In addition, total
assets increased by approximately $920 as of March 31, 2003.
o ChildU Goodwill Reduction. The Company's subsidiary, ChildU, Inc., was
acquired in 2001. In connection with such acquisition, the Company
issued shares of its common stock to the holders of notes issued by
ChildU. The Company has determined that the value assigned to these
shares when the Company recorded the purchase price for this
acquisition in its historical financial statements for 2001 exceeded
the fair market value of these shares. Accordingly, the Company has
restated its financial statements to record correctly the fair market
value of these shares, which had the effect of reducing the purchase
price for ChildU, goodwill and additional paid-in capital, by
approximately $3,419 as of December 31, 2001. In addition, the Company
allocated the entire purchase price to goodwill, and had assigned that
goodwill an estimated life of 40 years. The asset acquired was
software technology and not goodwill. The Company has restated its
financial statements to record the software technology and to amortize
such acquired technology over its estimated useful life of five years,
which had the effect of increasing net loss by $418, and increasing
intangibles amortization expense by $418 in the three-months ended
March 31, 2003.
Following the determination to restate the Company's financial statements for
matters described above, the Company also determined that it would correct for
certain errors made in the application of GAAP that had not previously been
corrected because in each such case it believed that the amount of any such
error was not material to its condensed consolidated financial statements. These
matters are described below.
o Distributor Sales. Historically the Company recognized revenue under a
distribution contract between its subsidiary, World Almanac Education
Group, and a distributor at the time that the Company shipped its
products to the distributor rather than at the time those products
were resold by the distributor. The Company also recorded distribution
fees under this contract as operating costs and expenses, based on its
understanding of the distribution contract. The Company has determined
to recognize revenue only at the time the distributor ships these
products to its customer. The Company has restated its financial
statements which decreased its net loss and increased net assets by
$169 for the three-months ended March 31, 2003.
o Rent. The Company has two leases that have "free rent" incentives at
the commencement of the leases and also contain rent escalation
clauses (which clauses provide for rent increases over time) for which
it was required under GAAP to record the average rent expense ratably
over the lease term. In its historical 2001 financial statements,
however, the Company recorded the rent expense from these leases as it
was paid. In its historical 2002 financial statements, the Company
began correctly recording the average rent expense for these leases,
but it calculated the average rent using the remainder of the lease
term instead of the entire lease term. The Company has restated its
financial statements to correct these errors, which had the net effect
of decreasing its net loss by $158 and decreasing liabilities by $158
for the three-months ended March 31, 2003.
15
o Other. The Company also made an adjustment relating to the
amortization period for certain capitalized pre-publication costs
which had the effect of increasing net loss by $105 for the
three-months ended March 31, 2003 and it reclassified $465 of software
development amortization from amortization of intangibles to cost of
goods sold in the condensed consolidated statement of operations for
the three-months ended March 31, 2003.
Summarized below are the significant effects of the restatement of the Company's
condensed consolidated statement of operations for the three-months ended March
31, 2003.
March 31, 2003
---------------------------------------------------------
As Previously
Reported As Restated
-------------------------- --------------------------
Statement of Operations, for the three-months ended
Revenue, net $ 46,977 $ 47,220
Gross profit 34,243 33,947
Operating costs and expenses 30,730 29,710
Income from operations 3,513 4,237
Net loss $ (4,388) $ (3,664)
16
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, March 31,
2003* 2004**
------------ ---------
ASSETS
Current Assets:
Cash $ 1,267 $ 6,216
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,179 and $2,205, respectively.) 20,880 19,387
Inventories, net 15,890 14,476
Due from related party 11,502 29,892
Prepaid expenses 2,882 2,600
Other current assets 1,889 1,211
--------- ---------
Total current assets 54,310 73,782
Property and equipment, net 4,399 4,131
Goodwill 35,018 35,018
Deferred financing costs, net 512 -
Other intangible assets, net 14,377 13,358
Other assets 30,263 32,464
--------- ---------
Total assets $ 138,879 $ 158,753
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 15,446 $ 12,372
Deferred revenue 17,565 12,307
Accrued expenses and other current liabilities 15,365 12,516
Current portion of long-term debt 8,477 -
--------- ---------
Total current liabilities 56,853 37,195
Deferred tax liability 2,640 2,800
15% Series B mandatorily redeemable preferred stock,
including accrued dividends and accretion of warrant value
(5,701,360 shares outstanding)
(Liquidation preference of $142,866) - 142,866
Long-term debt 262,925 292,844
--------- ---------
Total liabilities 322,418 475,705
--------- ---------
Commitments and contingencies
15% Series B mandatorily redeemable preferred stock,
including accrued dividends and accretion of warrant value
(5,508,000 shares outstanding) 137,702 -
Stockholders' deficit:
Common stock, ($.01 par value, 20,000,000 shares authorized;
2,830,000 shares outstanding in 2003 and 2004) 28 28
Additional paid-in capital 9,133 9,133
Due from parent (59,028) (46,492)
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (269,475) (277,722)
--------- ---------
Total stockholders' deficit (321,241) (316,952)
--------- ---------
Total liabilities and stockholders' deficit $ 138,879 $ 158,753
========= =========
* Condensed from audited financial statements.
** Unaudited.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
17
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- --------
(As Restated
See Note 14)
Revenue, net $ 35,001 $ 34,428
Cost of goods sold 8,439 8,501
-------- --------
Gross profit 26,562 25,927
-------- --------
Costs and expenses:
Sales and marketing 6,327 7,025
Distribution, circulation and fulfillment 3,510 3,552
Editorial 2,579 2,873
General and administrative 4,439 5,065
Restructuring costs - 1
Depreciation 439 387
Amortization of intangible assets 2,359 2,418
-------- --------
Total operating costs and expenses 19,653 21,321
-------- --------
Income from operations 6,909 4,606
Other income (expense) :
Interest expense, including amortization
of deferred financing costs (6,822) (12,713)
Other income (expense), net 6 3
-------- --------
Income (loss) before income tax provision 93 (8,104)
Income tax provision 175 143
-------- --------
Net loss $ (82) $ (8,247)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
18
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- ---------
(As Restated
See Note 14)
Cash flows from operating activities:
Net loss $ (82) $ (8,247)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 160 160
Depreciation and amortization 2,798 2,805
Accretion of manditorily redeemable preferred stock dividends - 5,164
Accretion of debt discount 107 120
Amortization of deferred financing costs 45 512
Changes in operating assets and liabilities:
Accounts receivable 2,262 1,493
Inventories 994 1,414
Prepaid expenses and other current assets (853) 960
Other non-current assets (4,638) (3,601)
Accounts payable (5,160) (3,074)
Deferred revenue (6,513) (5,258)
Accrued liabilities (1,859) (2,848)
--------- ---------
Net cash used in operating activities (12,739) (10,400)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (109) (119)
Proceeds from the disposition of property and equipment 4 -
--------- ---------
Net cash used in investing activities (105) (119)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 7,000 18,000
Repayments of borrowings under revolving line of credit (2,000) (23,000)
Repayment of senior bank debt (1,834) (118,678)
Proceeds from issuance of long term debt - 145,000
Decrease in due from parent, net 5,865 12,536
Increase in due from related party (1,538) (18,390)
--------- ---------
Net cash provided by financing activities 7,493 15,468
--------- ---------
(Decrease) increase in cash and cash equivalents (5,351) 4,949
Cash and cash equivalents, beginning of period 7,819 1,267
--------- ---------
Cash and cash equivalents, end of period $ 2,468 $ 6,216
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
19
WEEKLY READER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share and per share amounts)
1. DESCRIPTION OF BUSINESS
The condensed consolidated financial statements of Weekly Reader Corporation
("WRC") include the accounts of WRC and its subsidiary, Lifetime Learning
System, Inc. ("Lifetime Learning"), World Almanac Education Group ("WAE") and
its subsidiaries, Funk & Wagnalls Yearbook Corporation and Gareth Stevens, Inc.
("Gareth Stevens"), and American Guidance Service, Inc. and its subsidiaries,
AGS International Sales, Inc. and Lindy Acquisition Co., LLC (all are
collectively referred to as "Weekly Reader" or the "Company"). At December 31,
2003 and March 31, 2004, WRC Media Inc. (the "Parent") owns 94.9% and PRIMEDIA,
Inc. owns 5.1% of the common stock of Weekly Reader. 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.
2. BASIS OF PRESENTATION
Under the terms of the indenture relating to the Company's 12 3/4% Senior
Subordinated Notes due 2009 (the "Notes"), the Company is required to furnish
"all quarterly and annual financial information that would be required to be
contained in a filing with the Securities and Exchange Commission (the `SEC') on
Forms 10-Q and 10-K if the Company were required to file such forms, including a
`Management's Discussion and Analysis of Financial Condition and Results of
Operations' and, with respect to the annual information only, a report thereon
by the Company's certified independent accountants. . ." in each case within the
time periods specified in the SEC's rules and regulations.
The Company has restated its previously issued financial statements as of and
for the year ended December 31, 2001. Because the originally issued 2001
financial statements were audited by Arthur Andersen LLP, an audit firm that has
ceased operations, the restated financial statements for 2001 are unaudited at
this time pending a reaudit which is not yet complete. The Company believes that
upon furnishing its audited 2003 financial statements to the noteholders and
filing such statements with the SEC on its Form 8-K dated March 31, 2004, it was
in compliance with the indenture's information requirements. There is no
assurance, however, that the trustee or noteholders will not claim that the
Company is in breach of the indenture's information requirements, or that after
any such claim is made and the applicable cure period has expired, the trustee
or the noteholders will not send a notice to accelerate repayment of the Notes.
If the reaudit of the Company's 2001 financial statements is completed and a
report thereon issued by its independent auditors as required by the indenture
prior to any claim of breach being made, the potential for such a claim would be
eliminated. If a breach of the information requirements of the indenture were to
be claimed and the trustee or holders of at least 25% of the aggregate principal
amount of the Notes were to provide written notice of such breach, the Company
would vigorously defend against any such claim. Even if the claim of breach were
to prevail, the Company would have 60 days from the date of written notice of
such claim of breach to cure the breach and avoid an event of default under the
indenture. If the reaudit of the Company's 2001 financial statements is
completed and a report thereon issued by its independent auditors as required by
the indenture prior to the end of the 60 day cure period, the right to
accelerate the Notes or indebtedness under the credit facility as a result of
the alleged breach of the indenture's information requirements would be
eliminated. The Company has engaged its independent auditors to perform a
reaudit of the 2001 financial statements and expects to be able to provide its
auditors with the information necessary for them to complete their audit prior
to the end of the cure period, if any claim of breach of the indenture's
information requirements is made.
20
While the Company is diligently working to provide such information, there is no
assurance that the Company will be able to provide the information necessary to
complete the reaudit or that the reaudit of the 2001 financial statements will
be completed and a report thereon issued by the Company's certified independent
accountants as required by the indenture. If the trustee or holders representing
at least 25% of the aggregate principal amount of the Notes claim that the
Company will be in breach of the indenture, the Company is not successful in
defending against such claim of breach and such breach is not cured within the
cure period, there would be an event of default under the indenture, and the
trustee or holders of at least 25% of the aggregate principal amount of the
Notes would have the right to accelerate payment of the Notes, and the holders
of indebtedness under the Company's credit facility also would have the right to
accelerate payment thereunder. If any such acceleration occurred, the Company
would not be able to repay the amounts due and such acceleration would have a
material adverse effect on the Company's consolidated financial condition and
liquidity. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
The accompanying condensed consolidated financial statements of the Company as
of March 31, 2004 and for the three-month periods ended March 31, 2003 and 2004
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP") for interim financial information and
the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP for
complete financial statements 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.
These condensed consolidated financial statements should be read in conjunction
with Weekly Reader Corporation and Subsidiaries annual financial statements and
related notes thereto for the year ended December 31, 2003 included in the
Company's Form 8-K dated March 31, 2004. The operating results for the
three-month periods ended March 31, 2003 and 2004 are not necessarily indicative
of the results that may be expected for a full year.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variables Interest Entities ("FIN 46").
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements" to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. In
December 2003, the FASB issued FIN No. 46 (Revised) ("FIN 46R") to address
certain FIN 46 implementation issues. This interpretation requires that the
assets, liabilities, and results of activities of a Variable Interest Entity
("VIE") be consolidated into the financial statements of the enterprise that is
the primary beneficiary of the VIE. FIN 46R also requires additional disclosures
by primary beneficiaries and other significant variable interest holders. This
interpretation is effective no later than the end of the first interim or
reporting period ending after March 15, 2004, except for those VIE's that are
considered to be special purpose entities, for which the effective date is no
later than the end of the first interim or annual reporting period ending after
December 15, 2003. The adoption of FIN 46R effective March 31, 2004 did not have
a significant impact on the Company's consolidated financial position or results
of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149 "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS 149"), which amends and clarifies accounting for
derivative instruments, and for hedging activities under SFAS 133. Specifically,
SFAS 149 requires that contracts with comparable characteristics be accounted
for similarly. Additionally, SFAS 149 clarifies the circumstances in which a
contract with an initial net investment meets the characteristics of a
derivative and when a derivative contains a financing component that requires
special reporting in the statement of cash flows. This statement is generally
effective for contracts entered into or modified after June 30, 2003 and did not
have a significant impact on the Company's consolidated financial position or
results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement was effective for the
Company beginning January 1, 2004. For financial instruments created before the
issuance date of this statement and still existing at the beginning of the
interim period of adoption, transition shall be achieved by reporting the
cumulative effect of a change in an accounting principle by initially measuring
the financial instruments at fair value or other measurement attribute required
by this statement. The adoption of this statement required the Company to
reclassify its 15% Series B Redeemable Preferred Stock from the mezzanine
section of the balance sheet to long-term liabilities at March 31, 2004.
Effective January 1, 2004 dividend payments for the 15% Series B Redeemable
Preferred Stock ("Series B Preferred") are recorded as interest expense in the
consolidated statement of operations. The adoption of this statement did not
result in any adjustment to the book value of its Series B Preferred as of
January 1, 2004 as book value approximated fair value at January 1, 2004. For
the three-months ended March 31, 2004 the Company recognized $5,164 of accrued
dividends on Series B Preferred as interest expense. Interest expense for the
three-months ended March 31, 2004 also includes amortization of deferred
financing costs related to the Series B Preferred in the amount of $30.
21
4. RESTRUCTURING AND OTHER NON-RECURRING EXPENSES
During the three-months ended March 31, 2004, the Company reviewed its
restructuring reserve established in 2002 and adjusted the reserve by $1 due to
updating the assumptions used in determining the fair value of the remaining
lease obligations associated with facilities vacated during 2002.
The restructuring reserve totaling approximately $976 at March 31, 2004 is
expected to be paid as follows: remaining nine months of 2004 - $152 and 2005
and beyond - $824 and is included in accrued expenses and other current
liabilities in the condensed consolidated balance sheets.
Components of the Company's restructuring plan initiated in the fourth quarter
of 2002 are shown in the following table:
Balance at
December 31, Additional Balance at
2003 Adjustments Amounts Paid March 31, 2004
------------ ----------- ------------ --------------
Severance and other benefits $ 20 $ - $ (20) $ -
Lease terminations 988 1 (13) 976
------------- ---------- ---------- -------------
Total $ 1,008 $ 1 $ (33) $ 976
============= ========== ========== =============
5. DEBT
On March 29, 2004, the Company refinanced all of its term loans under its Senior
Bank Credit Facilities (the "First-Lien Facility") with a $145,000 senior,
second-priority lien secured financing that was provided to the Company pursuant
to a term loan facility (the "Second-Lien Facility"). The proceeds of the
Second-Lien Facility were used (i) to refinance in full all term loans
outstanding under the First-Lien Facility, (ii) to pay fees and expenses related
to the Second-Lien Facility and all transactions contemplated in connection
therewith and (iii) for general corporate purposes of the Company.
All payment obligations under the Second-Lien Facility are secured by a
second-priority lien on the collateral securing the First-Lien Facility;
provided that all obligations under the Second-Lien Facility will rank equally
in right of payment with all payment obligations under the First-Lien Facility
and will not otherwise be subordinated in any respect to the First-Lien
Facility. The final maturity of the Second-Lien Facility will be March 29, 2009.
At the Company's option, the loans will bear interest at either the
Administrative Agent's (i) alternate base rate ("base rate loans") or (ii)
reserve-adjusted LIBO rate ("LIBO rate loans") plus, in each case, the
"Applicable Margin" (as defined). "Applicable Margin" means, with respect to (i)
Base Rate Loans, a rate of 4.00% per annum and (ii) LIBO Rate Loans, a rate of
5.00% per annum.
22
The Second-Lien Facility is subject to mandatory prepayment with:
o the proceeds of the incurrence of certain indebtedness
o the proceeds of certain asset sales or other dispositions
o a change in control
o annually, 50% of the Company's excess cash flow (as defined) from the
prior year.
The Second-Lien Facility provide for certain restrictions, including
restrictions on asset sales, dividend payments, additional indebtedness payments
for restricted investments. In addition, the Second-Lien Facility provides for
the maintenance of a financial covenant, a maximum ratio (the "Senior Leverage
Ratio") of Senior Secured Debt to trailing four quarter EBITDA (as defined
therein) not to exceed 4.25:1.00 for any fiscal quarter, except the fiscal
quarter ended June 30, 2005 for which the Senior Leverage Ratio shall not exceed
4.50:1.00, in each case to be tested on the last day of each fiscal quarter and
computed for WRC Media (as defined within the agreement) and its consolidated
subsidiaries. In connection with entering into the Second-Lien Facility, the
Company entered into an amendment and restatement of its First-Lien Facility,
which now consists solely of a $30,000 revolving credit facility.
The First-Lien Facility, as amended and restated, has a maturity of December 29,
2008, and has one financial covenant, a Senior Leverage Ratio of senior secured
debt to trailing four quarter EBITDA (as defined therein) not to exceed
4.00:1.00 for any fiscal quarter, except the fiscal quarter ended June 30, 2005
for which the Senior Leverage Ratio may not exceed 4.25:1.00, in each case to be
tested on the last day of the fiscal quarter and computed for the Company and
its consolidated subsidiaries. Interest on revolving loan borrowings under the
First-Lien Facility bear interest at a rate per annum equal to the LIBO rate as
defined in the First-Lien Facility plus 3.5% or the alternate base rate as
defined in the First-Lien Facility plus 2.5%.
As a result of the refinancing, the Company wrote-off the remaining balances of
deferred financing costs associated with the First Lien Facility of
approximately $467. These costs are included in interest expense, including
amortization of deferred financing costs on the condensed consolidated statement
of operations for the three-months ended March 31, 2004.
In connection with the refinancing the Company incurred costs and expenses,
primarily investment banking and legal fees, of approximately $6,138. These
amounts have been recorded as deferred financing fees at March 31, 2004 and will
be amortized over the term of the Second Lien Facility using the effective
interest method.
At March 31, 2004, there were no outstanding advances under the Company's
$30,000 revolving credit facility, which bears interest at approximately 4.6%
for Eurodollar rate advances and 6.4% for base rate advances as of March 31,
2004. The Company has stand-by letters of credit, renewable annually, in the
amount of $2,050 of which $2,000 serves as security for a real estate lease
entered into by the Company and $50 serves as security for certain surety bonds
issued on behalf of the Company. While these letters of credit are in effect,
the Company's available borrowing under the revolving credit facility is reduced
by $2,050.
6. FINANCIAL INSTRUMENTS
Pursuant to the terms of the First and Second-Lien Credit Agreements, the
Company is required to enter into or maintain interest rate protection
agreements (interest rate swaps, caps, collars or similar agreements) in a
notional amount that, when taken together with the aggregate principal amount of
the Company's Total Debt subject to a fixed interest rate, is at least equal to
at least 50% of the aggregate principal amount of all Total Debt. On November
15, 2003, the Company entered into a one year interest rate cap agreement with a
notional principal of $61,000, which caps the LIBOR based rate, as defined, on
those loans at 2.5%. The interest rate protection agreement did not qualify for
hedge accounting treatment and as such the Company marks the contract to market
at the end of each period. The fair value of the interest rate cap at March 31,
2004 is de-minimus.
23
7. INVENTORIES
Inventories are comprised of the following:
December 31, March 31,
2003 2004
------------- ----------
Finished goods $ 19,090 $ 17,995
Raw materials 37 24
Less - impaired, excess and obsolete inventory (3,237) (3,543)
------------- ----------
Inventory, net $ 15,890 $ 14,476
============= ==========
8. GOODWILL AND TRADEMARKS
At December 31, 2003 and March 31, 2004, Goodwill and indefinite lived
intangibles are as follows:
December 31, March 31,
2003 2004
---- ----
Goodwill $ 35,018 $ 35,018
Long Lived Assets - Trademarks 9,955 9,955
----------- ----------
$ 44,973 $ 44,973
=========== ==========
There were no changes to goodwill and indefinite lived intangibles during the
three-months ended March 31, 2004.
WRC recorded non-cash deferred income tax expense of $160 during the
three-months ended March 31, 2003 and 2004, for taxable temporary differences
that will not reverse prior to expiration of the Company's net operating loss
carryforward periods. Book amortization of tax-deductible goodwill and
trademarks ceased on January 1, 2002 upon the Company's adoption of SFAS No.
142, however, 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. The Company expects that it will record an additional $480
to increase the valuation allowance during 2004.
9. OTHER INTANGIBLE ASSETS
The gross carrying amount and accumulated amortization of the WRC's intangible
assets other than goodwill and indefinite lived intangible assets are as
follows:
December 31, 2003 March 31, 2004
------------------------------------ ------------------------------------
Accumulated Accumulated
Useful Lives Gross Amortization Net Gross Amortization Net
------------ -------- ------------ -------- -------- ------------ --------
Customer Lists 7-9 yrs $ 36,748 $(34,755) $ 1,993 $ 36,748 $(34,900) $ 1,848
Copyrights 8 yrs 17,520 (16,806) 714 17,520 (17,341) 179
Product Titles 7 yrs 22,400 (20,685) 1,715 22,400 (21,024) 1,376
-------- -------- -------- -------- -------- --------
Total $ 76,668 $(72,246) $ 4,422 $ 76,668 $(73,265) $ 3,403
======== ======== ======== ======== ======== ========
For trademarks not subject to amortization, which is included in other
intangible assets, the total carrying amount was $9,955 as of December 31, 2003
and March 31, 2004.
Amortization of intangibles for the three-months ended March 31, 2003 and 2004
was $1,156 and $1,019, respectively, and is included in amortization of goodwill
and intangible assets on the condensed consolidated statement of operations. The
estimated amortization expense for intangible assets still subject to
amortization for the next five years is as follows:
24
Remaining nine months ended 2004 ....................... $ 1,493
Year ended 2005 ....................... $ 1,009
Year ended 2006 ....................... $ 398
Year ended 2007 ....................... $ 261
Year ended 2008 ....................... $ 242
10. COMMITMENTS AND CONTINGENCIES
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.
The SEC is conducting a preliminary inquiry concerning the Company. The SEC has
requested that the Company voluntarily provide the SEC with various documents
and information, and that certain officers of the Company voluntarily give
testimony. The Company is cooperating fully with the SEC inquiry, and has
provided all documents, information and testimony requested by the SEC. The
Company cannot predict the final outcome of this inquiry at this time.
11. RELATED PARTY TRANSACTIONS
In connection with its recapitalization, the Company entered into a management
agreement with WRC Media's principal shareholder. In accordance with the
management agreement, the shareholder provides Weekly Reader management
consulting and advisory services. As a result, the Company is obligated to pay
to the shareholder annual aggregate management fees for services totaling $800
payable quarterly.
In addition, the Company will reimburse the principal shareholder for reasonable
out-of-pocket costs and expenses incurred in connection with the performance of
its services. During the three-month periods ended March 31, 2003 and 2004, the
Company recognized general and administrative expense of $200 for management
fees.
12. PENSION BENEFITS
The following table provides components of net periodic benefit cost for the
Company's defined benefit pension plan for the three-months ended March 31, 2003
and 2004:
Pension Benefits
-----------------------------
2003 2004
------ ------
Service cost $ 229 $ 225
Interest Cost 221 238
Expected return on plan assets (169) (242)
Amortization of net loss 74 42
------ ------
Net periodic benefit cost $ 355 $ 263
====== ======
25
13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Three-Months Ended March 31,
---------------------------
2003 2004
---- ----
Cash paid during the period for interest $ 2,053 $ 2,676
Cash paid during the period for income taxes $ 15 $ 20
Non-cash financing activity:
Preferred stock dividends accrued $ 4,457 $ 5,164 (1)
(1) During the quarter ended March 31, 2004, $5,164 of such preferred stock
dividends have been recorded as interest expense in the statement of
operations, resulting from the Company's adoption of SFAS 150 effective
January 1, 2004.
14. RESTATEMENT
In connection with the audit of the Company's 2003 consolidated financial
statements, management has restated its financial statements for the years ended
December 31, 2002 and 2001 because it had incorrectly accounted for certain
tranactions.
As a result, the Company has restated the condensed consolidated financial
statements for the three-months ended March 31, 2003. After giving effect to the
restatement described below, the Company believes it was in compliance with the
financial covenants in its credit facility for the reporting period ended March
31, 2003.
Described below are the matters for which the Company has restated its condensed
consolidated statement of operations for the three-months ended March 31, 2003.
o Distributor Sales. Historically the Company recognized revenue under a
distribution contract between its subsidiary, World Almanac Education
Group, and a distributor at the time that the Company shipped its
products to the distributor rather than at the time those products
were resold by the distributor. The Company also recorded distribution
fees under this contract as operating costs and expenses, based on its
understanding of the distribution contract. The Company has determined
to recognize revenue only at the time the distributor ships these
products to its customer. The Company has restated its financial
statements which decreased its net loss and increased net assets by
$169 for the three-months ended March 31, 2003.
o Rent. The Company has two leases that have "free rent" incentives at
the commencement of the leases and also contain rent escalation
clauses (which clauses provide for rent increases over time) for which
it was required under GAAP to record the average rent expense ratably
over the lease term. In its historical 2001 financial statements,
however, the Company recorded the rent expense from these leases as it
was paid. In its historical 2002 financial statements, the Company
began correctly recording the average rent expense for these leases,
but it calculated the average rent using the remainder of the lease
term instead of the entire lease term. The Company restated its
financial statements to correct these errors. The Company has restated
its financial statements to correct these errors, with the net effect
being to decrease its net loss by $158 and decrease liabilities by
$158 for the three-months ended March 31, 2003.
o Other. The Company also made an adjustment relating to the
amortization period for certain capitalized pre-publication costs
which had the effect of increasing net loss by $105 for the
three-months ended March 31, 2003.
26
Summarized below are the significant effects of the restatement of the Company's
condensed consolidated statement of operations for the three-months ended March
31, 2003.
March 31, 2003
-------------------------------
As Previously
Reported As Restated
-------- -----------
Statement of Operations, for the three-months ended
Revenue, net $ 34,758 $ 35,001
Gross profit 26,393 26,562
Operating costs and expenses 19,706 19,653
Income from operations 6,687 6,909
Net loss $ (304) $ (82)
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Management's Discussion and Analysis of Financial Condition and Results of
Operation set forth in this Item 2 has been revised to reflect the restatement
of the Company's condensed consolidated financial statements as of and for the
three months ended March 31, 2003. For a discussion of the restatement
adjustments, see "Item 1. Condensed Consolidated Financial Statements -WRC Media
Inc. and Subsidiaries--Note 16. Restatement" and "Item 1. Condensed Consolidated
Financial Statements - Weekly Reader Corporation and Subsidiaries - Note 14.
Restatement."
The following discussion is intended to assist in understanding the financial
condition as of March 31, 2004 of WRC Media Inc. ("WRC Media") and its
subsidiaries, and Weekly Reader Corporation and its subsidiaries, and their
results of operations for the three-months ended March 31, 2003 and 2004. You
should read the following discussion in conjunction with the Condensed
Consolidated Financial Statements of WRC Media and its subsidiaries and Weekly
Reader Corporation and its subsidiaries ("Weekly Reader") attached to this
discussion and analysis. Unless the context otherwise requires, the terms "we,"
"our," and "us" refer to WRC Media and its subsidiaries and their predecessor
companies. This discussion and analysis contains forward-looking statements.
These forward-looking statements are subject to certain risks and uncertainties,
including the Company's ability to continue to produce successful supplemental
education material and software products; reductions in state and local funding
for educational spending materials resulting, among other things, from
increasing state budget deficits; uncertainty in the current operating
environment which makes it difficult to forecast future results; and other risks
and factors identified in this report and in the Company's Report on Form 8-K as
filed with the Securities and Exchange Commission (the "SEC") dated March 31,
2004. 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.
Consolidated Results of Operations For the Three-Months Ended March 31, 2004--
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 March 31, 2003 and
2004, 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.
28
WRC Media analyzes its revenues, expenses and operating results on a percentage
of net revenue 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 revenue.
Three months ended March 31,
2003 2004
-------------------------- -------------------------------
Amount % of Net Revenue Amount % of Net Revenue
------- ---------------- -------- ----------------
(Dollars in millions)
Revenue, net $ 47.2 100.0% $ 42.8 100.0%
Cost of goods sold 13.3 28.2% 13.0 30.4%
----- ----- ----- -----
Gross profit 33.9 71.8% 29.8 69.6%
Costs and expenses:
Sales and marketing 11.5 24.4% 11.6 27.1%
Research and development 0.7 1.5% 0.7 1.6%
Distribution, circulation and fulfillment 3.5 7.4% 3.5 8.2%
Editorial 2.6 5.5% 2.9 6.8%
General and administrative 5.6 11.9% 7.1 16.6%
Restructuring costs and other non-recurring expenses 0.5 1.1% 0.1 0.2%
Depreciation 0.6 1.3% 0.4 0.9%
Amortization of intangible assets 4.7 10.0% 4.5 10.5%
----- ----- ----- -----
Total costs and expenses 29.7 62.9% 30.8 72.0%
----- ----- ----- -----
Income (loss) from operations 4.2 8.9% (1.0) (2.4%)
----- ----- ----- -----
Interest expense, including amortization
of deferred financing costs (7.1) (15.0%) (14.4) (33.6%)
Other income (expense), net (0.2) (0.4%) (0.3) (0.7%)
----- ----- ----- -----
Loss before income tax provision (3.1) (6.5%) (15.7) (36.7%)
Income tax provision 0.6 1.3% 0.6 1.4%
----- ----- ----- -----
Net loss $ (3.7) (7.8%) $ (16.3) (38.1%)
===== ===== ===== =====
Adjusted EBITDA (a) $ 10.5 22.2% $ 4.3 10.0%
===== ===== ===== =====
(a) Adjusted EBITDA represents (loss) before interest expense, taxes,
depreciation, amortization and other (income) charges including
restructuring costs of $0.3 million and non-recurring costs of $0.2 million
for the three-months ended March 31, 2003 and restructuring