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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 June 30, 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 organization) (State or other jurisdiction of incorporation or 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.
|X| Yes |_| 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 FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
3
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, June 30,
2003 2004
--------- ----------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,432 $ 5,080
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,519 and $2,583, respectively) 30,027 38,854
Inventories 16,652 14,894
Prepaid expenses 3,367 3,174
Other current assets (including restricted assets of $1,006
and $842, respectively) 1,889 1,317
--------- ---------
Total current assets 53,367 63,319
Property and equipment, net 5,792 4,996
Capitalized software, net 7,293 7,333
Goodwill 241,324 241,324
Other intangible assets, net 76,860 71,539
Deferred financing costs, net 5,675 9,559
Other assets 29,896 32,843
--------- ---------
Total assets $ 420,207 $ 430,913
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 16,963 $ 14,430
Accrued payroll, commissions and benefits 9,356 8,800
Current portion of deferred revenue 35,900 35,930
Other accrued liabilities 17,166 17,857
Current portion of long-term debt 8,477 -
--------- ---------
Total current liabilities 87,862 77,017
Deferred revenue, net of current portion 959 1,203
Deferred tax liabilities 10,800 12,250
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,966,119 shares outstanding), (Liquidation preference of $149,228) - 141,771
Long-term debt 262,925 300,973
--------- ---------
Total liabilities 362,546 533,214
--------- ---------
Commitments and contingencies
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,508,080 shares outstanding) 130,701 -
Warrants on common stock of subsidiaries 11,751 11,751
Common stock subject to redemption 940 950
--------- ---------
Stockholders' deficit:
Common stock, ($.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 23,936
Additional paid-in capital 131,753 131,753
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (237,574) (268,862)
--------- ---------
Total stockholders' deficit (85,731) (115,002)
--------- ---------
Total liabilities and stockholders' deficit $ 420,207 $ 430,913
========= =========
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 JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- --------
(As Restated
See Note 17)
Revenue, net $ 44,141 $ 45,849
Cost of goods sold 13,084 13,915
-------- --------
Gross profit 31,057 31,934
-------- --------
Costs and expenses:
Sales and marketing 10,301 11,170
Research and development 213 984
Distribution, circulation and fulfillment 2,905 2,769
Editorial 2,565 2,474
General and administrative 5,370 7,328
Restructuring costs and other non-recurring expenses 1,001 632
Depreciation 599 495
Amortization of intangible assets 4,374 4,076
-------- --------
Total operating costs and expenses 27,328 29,928
-------- --------
Income from operations 3,729 2,006
Interest expense, including amortization
of deferred financing costs (7,236) (13,408)
Other expense, net (688) (274)
-------- --------
Loss before income tax provision (4,195) (11,676)
Income tax provision 679 840
-------- --------
Net loss $ (4,874) $(12,516)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------ --------
(As Restated
See Note 17)
Revenue, net $ 91,179 $ 88,609
Cost of goods sold 26,357 26,835
-------- --------
Gross profit 64,822 61,774
-------- --------
Costs and expenses:
Sales and marketing 21,782 22,725
Research and development 924 1,731
Distribution, circulation and fulfillment 6,415 6,321
Editorial 5,144 5,347
General and administrative 11,013 14,449
Restructuring costs and other non-recurring expenses 1,481 697
Depreciation 1,220 926
Amortization of intangible assets 8,691 8,295
-------- --------
Total operating costs and expenses 56,670 60,491
-------- --------
Income from operations 8,152 1,283
Interest expense, including amortization
of deferred financing costs (14,368) (27,910)
Other expense, net (919) (524)
-------- --------
Loss before income tax provision (7,135) (27,151)
Income tax provision 1,492 1,642
-------- --------
Net loss $ (8,627) $(28,793)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- ----------
(As Restated
See Note 17)
Cash flows from operating activities:
Net loss $ (8,627) $ (28,793)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 1,450 1,450
Depreciation and amortization 11,432 10,406
Management fees forgiven by principal shareholder 300 -
(Loss) gain on disposition of property and equipment (1) 1
Accrual of manditorily redeemable preferred stock dividends - 10,593
Amortization of debt discount 218 249
Amortization of deferred financing costs 725 2,783
Changes in operating assets and liabilities:
Accounts receivable (900) (8,827)
Inventories 744 1,758
Prepaid expenses and other current assets (308) 763
Other noncurrent assets (8,153) (5,925)
Accounts payable (7,575) (2,534)
Deferred revenue (1,451) 273
Accrued liabilities (1,806) 144
--------- ---------
Net cash used in operating activities (13,952) (17,659)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (610) (553)
Capitalized software (2,066) (1,225)
Landlord reimbursement for leasehold improvements - 421
Proceeds from the disposition of property and equipment 4 -
--------- ---------
Net cash used in investing activities (2,672) (1,357)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 27,000 31,000
Repayments of revolving line of credit (3,000) (28,000)
Repayment of senior bank debt (3,945) (118,678)
Deferred financing fees (20) (6,668)
Proceeds from issuance of long-term debt - 145,000
Purchase and issuance of common stock subject to redemption (25) 10
--------- ---------
Net cash provided by financing activities 20,010 22,664
--------- ---------
Increase in cash and cash equivalents 3,386 3,648
Cash and cash equivalents, beginning of period 9,095 1,432
--------- ---------
Cash and cash equivalents, end of period $ 12,481 $ 5,080
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
7
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
The accompanying condensed consolidated financial statements of the Company as
of June 30, 2004 and for the three- and six-month periods ended June 30, 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 the Company's annual financial statements and related notes thereto as
reported in the Company's Annual Report on Form 10-K dated June 15, 2004. The
operating results for the three- and six-month periods ended June 30, 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.
8
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% Senior 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% Senior Preferred Stock ("15% Senior
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 15% Senior Preferred as of January 1, 2004 as book value
approximated fair value at January 1, 2004. For the three- and six-month periods
ended June 30, 2004 the Company recognized $5,394 and $10,593, respectively, of
accrued dividends on 15% Senior Preferred as interest expense.
On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits, an amendment of
FASB Statements No. 87, 88 and 106." It requires additional disclosures to those
in the original Statement 132 about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension plans and other defined benefit
post-retirement plans. The majority of the provisions of this statement apply to
financial statements issued for fiscal years ending after December 15, 2003. The
Company has adopted such disclosure provisions (See Note 15).
On March 17, 2004, the Emerging Issues Task Force of the FASB reached a
consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments." ("Issue 03-1") Issue 03-1 provides
guidance for determining when an investment is other-than-temporarily impaired
specifically, whether an investor has the ability and intent to hold an
investment until recovery. In addition, Issue 03-1 contains disclosure
requirements about impairments that have not been recognized as other than
temporary for investments. Issue 03-1 also requires the investor to disclose
investments with unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance for evaluating whether an
investment is other-than-temporarily impaired shall be applied in
other-than-temporary impairment evaluations made in reporting periods beginning
after June 15, 2004. The disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003, for investments
accounted for under Statements 115 and 124. For all other investments within the
scope of this Issue, the disclosures are effective in annual financial
statements for fiscal years ending after June 15, 2004. The additional
disclosures for cost method investments are effective for fiscal years ending
after June 15, 2004. The adoption of this consensus is not expected to have any
impact on the Company's consolidated results of operations or financial
position.
4. SEGMENT INFORMATION
The Company has four reporting segments: Weekly Reader, World Almanac, American
Guidance Service ("AGS"), and CompassLearning and ChildU ("Compass/ChildU").
This classification reflects the nature of the Company's organizational
structure by which the chief operating decision-maker reviews and assesses the
operating performance of the reporting segment and allocates corporate
resources.
o Weekly Reader is a publisher of classroom periodicals, grade-specific
workbooks and custom publisher of instructional materials paid for by
various sponsors.
o World Almanac publishes print reference materials sold into the trade
channel; publishes nonfiction and fiction children's books under three
imprints for K-12 students; publishes print and electronic reference
materials sold into the library channel; and distributes third-party
books targeted for K-12 students through its catalogs.
o AGS is a publisher of testing and assessment products and supplemental
instructional materials. AGS products are sold into the school
channel. Testing and assessment products are primarily for K-12
students and supplemental instructional materials are primarily for
low-performing students in middle and secondary schools.
o Compass/ChildU produce research-based technology learning solutions,
including web-based e-learning solutions that bring into being
educational assessment, curriculum and management tools for grades
Pre-K through 12, all of which are aligned to local, state and
national standards.
Information regarding the operations of the Company's reporting segments is set
forth below. Parent Company expenses and assets not allocated are included in
Corporate. WRC Media evaluates segment performance based on several factors, of
which the primary financial measure is operating income (loss).
9
Weekly World Compass /
Reader Almanac AGS ChildU Corporate Eliminations Total
------ ------- --- ------ --------- ------------ -----
Three months ended June 30, 2004
- --------------------------------
Revenue, net $ 4,138 $ 10,506 $ 17,867 $ 13,338 $ - $ - $ 45,849
Income (loss) from operations (2,073) 969 5,816 (1,735) (971) - 2,006
Depreciation and amortization 119 530 1,809 1,843 942 - 5,243
Restructuring costs and other non-recurring items - - - 603 29 - 632
Assets 55,620 99,146 192,861 52,501 280,348 (249,563) 430,913
Capital expenditures 126 25 122 717 10 1,000
Three months ended June 30, 2003
- --------------------------------
Revenue, net 5,588 10,666 13,457 14,430 - - 44,141
Income (loss) from operations (1,094) 877 4,094 688 (836) - 3,729
Depreciation and amortization 179 543 1,856 2,249 942 - 5,769
Restructuring costs and other non-recurring items - 21 - 875 105 1,001
Assets 57,133 91,726 174,009 58,697 275,177 (215,568) 441,174
Capital expenditures 37 30 7 1,592 - 1,666
Weekly World Compass /
Reader Almanac AGS ChildU Corporate Eliminations Total
------ ------- --- ------ --------- ------------ -----
Six-months ended June 30, 2004
- ------------------------------
Revenue, net $ 14,252 $ 22,387 $ 30,300 $ 21,670 $ - $ - $ 88,609
Income (loss) from operations (172) 2,339 7,354 (6,325) (1,913) - 1,283
Depreciation and amortization 250 1,016 3,795 3,462 1,883 - 10,406
Restructuring costs and other non-recurring items - - - 667 30 - 697
Capital expenditures 160 45 182 1,376 15 1,778
Six-months ended June 30, 2003
- ------------------------------
Revenue, net 16,085 23,259 25,186 26,649 - - 91,179
Income (loss) from operations 1,595 3,173 5,975 (459) (2,130) - 8,154
Depreciation and amortization 364 1,099 3,648 4,437 1,884 - 11,432
Restructuring costs and other non-recurring items - 21 - 875 585 1,481
Capital expenditures 104 54 23 2,493 2 2,676
5. RESTRUCTURING COSTS AND OTHER NON-RECURRING EXPENSES
During the six-months ended June 30, 2004, the Company reviewed its
restructuring reserve established in 2002 and increased the reserve $697 for
lease terminations primarily resulting from the updating of the sublease
assumptions used in determining the fair value of the remaining lease
obligations associated with facilities vacated during 2002.
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 June 30, 2004
----------------- ------------ ------------ -------------
Severance and other benefits $ 32 $ - $ (32) $ -
Lease terminations 3,243 697 (807) 3,133
------ ------ ------ ------
Total $3,275 $ 697 $ (839) $3,133
====== ====== ====== ======
The restructuring reserve totaling approximately $3,133 at June 30, 2004, is
expected to be paid as follows: remaining nine months of 2004 - $796, 2005 and
beyond - $2,337. These charges are included in other accrued liabilities on the
condensed consolidated balance sheets.
6. 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.
10
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.
Three-Months Ended June 30, Six-Months Ended June 30,
2003 2004 2003 2004
-------- -------- -------- --------
Net loss, as reported $ (4,874) $(12,516) $ (8,627) $(28,793)
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all
awards, net of related tax effects (46) (4) (91) (8)
-------- -------- -------- --------
Pro forma net loss $ (4,920) $(12,520) $ (8,718) $(28,801)
======== ======== ======== ========
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- and
six-month periods ended June 30, 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.
7. 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 the Parent 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.
11
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 2.0% or the alternate base rate as
defined in the First-Lien Facility plus 1.0%.
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 six-months ended June 30, 2004.
In connection with the refinancing the Company incurred costs and expenses,
primarily investment banking and legal fees, of approximately $6,668. These
amounts have been recorded as deferred financing fees at June 30, 2004 and are
being amortized over the term of the Second Lien Facility using the effective
interest method.
At June 30, 2004, there were $8,000 in outstanding advances under the Company's
$30,000 revolving credit facility, which bears interest at approximately 3.5%
for Eurodollar rate advances and 5.0% for base rate advances as of June 30,
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. At June 30, 2004, the Company had $19,950 of available credit under
the revolving credit facility.
8. 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 June 30,
2004 is de-minimis.
9. INVENTORIES
Inventories as of December 31, 2003 and June 30, 2004 are as follows:
December 31, June 30,
2003 2004
-------- ---------
Finished goods $ 16,533 $ 14,803
Raw materials 119 91
-------- ---------
$ 16,652 $ 14,894
======== =========
12
10. GOODWILL AND TRADEMARKS
At December 31, 2003 and June 30, 2004, goodwill and indefinite lived intangible
assets are as follows:
December 31, June 30,
2003 2004
----------- ----------
Goodwill $ 241,324 $ 241,324
Long Lived Assets - Trademarks and
copyrights 23,772 23,772
----------- ----------
$ 265,096 $ 265,096
=========== ==========
There were no changes in goodwill and indefinite lived intangible assets during
the three- and six-months ended June 30, 2004.
The Company recorded non-cash deferred income tax expense of $725 and $1,450 for
the three- and six-month periods ended June 30, 2003 and 2004, respectively, 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 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 $1,450 to increase deferred tax
liabilities during the remaining six-months of 2004.
11. 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 June 30, 2004
-------------------------------------- -------------------------------------
Accumulated Accumulated
Useful Lives Gross Amortization Net Gross Amortization Net
------------ ---------- -------------- --------- ---------- -------------- ---------
Customer Lists 6-15 yrs $ 48,600 $ (24,948) $ 23,652 $ 48,600 $ (27,865) $ 20,735
Copyrights 10-20 yrs 30,800 (6,462) 24,338 30,800 (7,248) 23,552
Software 3-5 yrs 14,789 (10,027) 4,762 14,789 (11,577) 3,212
Trademark 4-10 yrs 200 (82) 118 200 (92) 108
Distributor relationships 6 yrs 700 (482) 218 700 (540) 160
-------- ---------- -------- --------- ---------- ---------
Total: $ 95,089 $ (42,001) $ 53,088 $ 95,089 $ (47,322) $ 47,767
======== ========== ======== ========= ========== =========
Included in other intangible assets, are trademarks and copyrights not subject
to amortization, for which the total carrying amount was $23,772 at December 31,
2003 and June 30, 2004.
Amortization of intangibles for the three-months ended June 30, 2003 and 2004
was $3,081 and $2,501, respectively. Amortization of intangibles for the
six-months ended June 30, 2003 and 2004 was $6,195 and $5,321, respectively.
Amortization of intangibles is included in amortization of intangible 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 six months of 2004............................. $ 4,610
2005..................................................... 9,197
2006..................................................... 6,843
2007..................................................... 4,600
2008..................................................... 3,461
2009..................................................... 3,253
Thereafter............................................... 15,803
13
12. 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 Securities and Exchange Commission ("SEC") is conducting a preliminary
inquiry concerning the Company and has requested that the Company voluntarily
provide the SEC with various documents and information, and that certain
officers and employees of the Company voluntarily give testimony or be
interviewed. The Company is cooperating fully with the SEC inquiry, and has
continued to provide all documents, information and testimony requested by the
SEC, and has arranged all interviews requested by the SEC with Company
employees. The Company cannot predict the final outcome of this inquiry at this
time.
15% Senior Preferred Stock due 2011
In 1999, the Company issued 3,000,000 shares of 15% Senior Preferred Stock due
in 2011 with a liquidation preference of $25.00 per share. The 15% Senior
Preferred Stock shall accrue dividends at a rate of 15% per annum, subject to
adjustment if the Company fails to redeem all outstanding shares of such 15%
Senior Preferred Stock in connection with a mandatory redemption or change of
control. Such accrued dividends reflect penalty dividends of 0.5% for periods
prior to November 17, 2001. While the Company believes that no penalty dividend
is due for subsequent periods, the preferred shareholders may disagree with that
conclusion.
13. 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 $152,000 of 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. 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").
The following tables present condensed consolidating financial information for
WRC Media and the subsidiary guarantors as of and for the three- and six-month
periods ended June 30, 2003 and 2004 for: (1) WRC Media, (2) Weekly Reader, a
majority-owned subsidiary, (3) CompassLearning, a wholly-owned subsidiary, (4)
ChildU a wholly-owned subsidiary, and (5) the Company on a consolidated basis.
SUBSIDIARY GUARANTORS
-----------------------------------
COMPASS
WEEKLY READER LEARNING WRC MEDIA INC.
WRC MEDIA INC. CORPORATION INC. CHILDU ELIMINATIONS CONSOLIDATED
-------------- ----------- --------- --------- ------------ ------------
(IN THOUSANDS)
Balance Sheet as of June 30, 2004
Assets:
Current assets $ 1,761 $ 84,995 $ 15,648 $ 2,563 $ (41,648) $ 63,319
Property and equipment, net - 4,280 584 132 - 4,996
Goodwill and other intangible assets, net 154,572 132,235 22,844 3,212 - 312,863
Other assets 109,484 32,658 5,100 2,418 (99,925) 49,735
--------- --------- --------- --------- --------- ---------
Total assets $ 265,817 $ 254,168 $ 44,176 $ 8,325 $(141,573) $ 430,913
========= ========= ========= ========= ========= =========
Liabilities and stockholders' deficit:
Current liabilities $ 114,022 $ 49,725 $ 48,649 $ 7,404 $(142,783) $ 77,017
Redeemable preferred stock, plus accrued dividends 141,771 149,228 - - (149,228) 141,771
Long-term debt 147,973 300,973 - - (147,973) 300,973
Other liabilities 7,100 5,150 1,203 - - 13,453
Warrants on common stock of subsidiaries 11,751 - - - - 11,751
Common stock subject to redemption 950 - - - - 950
Stockholders' deficit (157,750) (250,908) (5,676) 921 298,411 (115,002)
--------- --------- --------- --------- --------- ---------
Total liabilities and stockholders' deficit $ 265,817 $ 254,168 $ 44,176 $ 8,325 $(141,573) $ 430,913
========= ========= ========= ========= ========= =========
14
SUBSIDIARY GUARANTORS
-----------------------------------
COMPASS
WEEKLY READER LEARNING WRC MEDIA INC.
WRC MEDIA INC. CORPORATION INC. CHILDU ELIMINATIONS CONSOLIDATED
-------------- ----------- --------- --------- ------------ ------------
(IN THOUSANDS)
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED JUNE 30, 2004
Revenue, net $ - $ 32,511 $ 8,271 $ 5,067 $ - $ 45,849
Operating costs and expenses 930 27,839 11,726 3,348 - 43,843
Interest expense, net 10,885 12,890 - - (10,367) 13,408
Other (income) expense 274 199 1 - (200) 274
Provision for income taxes 616 198 26 - - 840
-------- -------- -------- -------- -------- --------
Net income (loss) $(12,705) $ (8,615) $ (3,482) $ 1,719 $ 10,567 $(12,516)
======== ======== ======== ======== ======== ========
STATEMENTS OF OPERATIONS FOR THE SIX MONTHS
ENDED JUNE 30, 2004
Revenue, net $ - $ 66,939 $ 14,940 $ 6,730 $ - $ 88,609
Operating costs and expenses 1,859 57,472 21,927 6,068 - 87,326
Interest expense, net 22,803 25,638 - - (20,531) 27,910
Other (income) expense 527 396 1 - (400) 524
Provision for income taxes 1,225 356 61 - - 1,642
-------- -------- -------- -------- -------- --------
Net income (loss) $(26,414) $(16,923) $ (7,049) $ 662 $ 20,931 $(28,793)
======== ======== ======== ======== ======== ========
CASH FLOW FOR THE SIX MONTHS
ENDED JUNE 30, 2004
Cash flow provided by (used in) operations $ (9,865) $ (9,835) $ (9,831) $ 2,182 $ 9,690 $(17,659)
Cash flow used in investing activities - (402) (668) (287) - (1,357)
Cash flow provided by (used in) financing activities 9,850 13,933 10,499 (1,928) (9,690) 22,664
Cash and cash equivalents at beginning of period 100 1,267 4 61 - 1,432
-------- -------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 85 $ 4,963 $ 4 $ 28 $ - $ 5,080
======== ======== ======== ======== ======== ========
SUBSIDIARY GUARANTORS
----------------------------------
COMPASS
WEEKLY READER LEARNING WRC MEDIA INC.
WRC MEDIA INC. CORPORATION INC. CHILDU ELIMINATIONS CONSOLIDATED
-------------- ----------- --------- --------- ------------ ------------
(IN THOUSANDS)
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED JUNE 30, 2003
Revenue, net $ - $ 29,711 $ 12,497 $ 1,933 $ - $ 44,141
Operating costs and expenses 929 25,740 12,260 1,483 - 40,412
Interest expense, net 5,281 6,911 - - (4,956) 7,236
Other (income) expense 474 114 - - 100 688
Provision for income taxes 592 64 23 - - 679
-------- -------- -------- -------- -------- --------
Net loss $ (7,276) $ (3,118) $ 214 $ 450 $ 4,856 $ (4,874)
======== ======== ======== ======== ======== ========
STATEMENTS OF OPERATIONS FOR THE SIX MONTHS
ENDED JUNE 30, 2003
Revenue, net $ - $ 64,530 $ 23,743 $ 2,906 $ - $ 91,179
Operating costs and expenses 2,338 53,579 24,266 2,844 - 83,027
Interest expense, net 10,543 13,733 - - (9,908) 14,368
Other (income) expense 711 308 - - (100) 919
Provision for income taxes 1,200 254 38 - - 1,492
-------- -------- -------- -------- -------- --------
Net income (loss) $(14,792) $ (3,344) $ (561) $ 62 $ 10,008 $ (8,627)
======== ======== ======== ======== ======== ========
CASH FLOW FOR THE SIX MONTHS
ENDED JUNE 30, 2003
Cash flow provided by (used in) operations $(11,756) $(15,082) $ 803 $ 1,293 $ 10,790 $(13,952)
Cash flow used in investing activities - (179) (1,546) (947) - (2,672)
Cash flow provided by (used in) financing activities 10,807 19,483 743 (233) (10,790) 20,010
Cash and cash equivalents at beginning of period 1,154 7,819 4 118 - 9,095
-------- -------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 205 $ 12,041 $ 4 $ 231 $ - $ 12,481
======== ======== ======== ======== ======== ========
14. RELATED PARTY TRANSACTIONS
Management Agreements
In connection with the acquisition of Weekly Reader 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, which are 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 each of the three- and six-month periods ended June 30,
2003 and 2004, the Company recognized general and administrative expense of $238
and $476, respectively, for management fees. In June 2003, the shareholder
waived the payment of $300 in management fees for 2003. The waived amount has
been recorded as a capital contribution. At June 30, 2004, other accrued
liabilities include approximately $1,126 of accrued management fees.
15. PENSION BENEFITS
The following table provides components of net periodic benefit cost for the
Company's defined benefit pension plan for the three- and six-months ended June
30, 2003 and 2004:
15
Three-months ended June 30,
---------------------------
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
===== =====
Six-months ended June 30,
-------------------------
2003 2004
---- ----
Service cost $ 458 $ 450
Interest Cost 442 476
Expected return on plan assets (338) (484)
Amortization of net loss 148 84
----- -----
Net periodic benefit cost $ 710 $ 526
===== =====
16. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Six-Months Ended June 30,
-------------------------
2003 2004
---- ----
Cash paid during the period for interest $13,558 $13,234
Cash paid during the period for income taxes $ 169 $ 228
Non-cash financing activities:
Preferred stock dividends accrued $10,833 12,610(1)
Accretion of preferred stock $ 471 $ 478
(1) During the six-months ended June 30, 2004, $10,593 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.
17. RESTATEMENT
In connection with the audit of the Company's 2003 consolidated financial
statements (the "Initial Restatement") and the reaudit of its 2001 consolidated
financial statements (the "Further Restatement), the Company has restated its
previously audited consolidated balance sheets as of December 31, 2001, 2002 and
2003 and the related statements of operations, stockholders' deficit and cash
flows for the years ended December 31, 2001, 2002 and 2003.
In connection with the Initial Restatement, management had restated its
financial statements for the three- and six-months ended June 30, 2003 because
it had incorrectly accounted for (i) the revenue recognition of a software and
services sale in December 2002; (ii) the purchase price related to the ChildU
acquisition in 2001 (iii) revenue recognition for distributor sales; (iv) rent
expense; (v) other items including an adjustment relating the amortization
period for certain capitalized prepublication costs .
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and six-months ended June
30, 2003 in connection with the Initial Restatement.
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 $249 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 six-months ended June 30, 2003 was to decrease net loss by
approximately $920.
16
o ChildU Goodwill Reduction. The Company's subsidiary, ChildU, 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 $837,
respectively in the three- and six-months ended June 30, 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 by $89 and $258 respectively
for the three- and six-months ended June 30, 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 $194 and $352, respectively for the
three- and six-months ended June 30, 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 and $210
respectively for the three- and six-months ended June 30, 2003 and it
reclassified $462 and $927, respectively of software development
amortization from amortization of intangibles to cost of goods sold in
the condensed consolidated statement of operations for the three- and
six-months ended June 30, 2003. An adjustment was also made related to
the waiver, by the Company's principal shareholder, of certain
management fees owed to it. The adjustment increased operating
expenses and additional paid in capital by $300 in the three and
six-months ended June 30, 2003.
In connection with the re-audit of the Company's 2001 consolidated financial
statements, management determined that it had incorrectly accounted for the
following items, which comprise the Further Restatement: (i) intangible assets
acquired in 1999 in connection with the Company's acquisition of Weekly Reader;
(ii) acquisition reserves for acquisitions in 1999; (iii) its adoption of SFAS
142 and the preparation of its transitional impairment analysis; (iv) deferred
tax liabilities recognized upon the adoption of SFAS 142; (v) 15% Senior
Preferred Stock dividends; and (vi) a number of other items which had been
previously identified and collectively determined to be immaterial but which the
Company has now decided to correct. In addition, the Company corrected certain
errors in its disclosures regarding stock options granted to its employees.
17
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and six-months ended June 30,
2003 in connection with the Further Restatement.
o WRC Media Goodwill and Intangible Assets. In connection with the
reaudit of the Company's 2001 consolidated financial statements, the
Company reconsidered the assumptions used to determine the estimated
fair value and economic lives of the intangible assets acquired in
connection with the 1999 acquisition and recapitalization of Weekly
Reader by WRC Media (the "1999 Intangible Assets"). The Company has
determined that the original basis for estimating the fair value and
economic lives of the intangible assets was a valuation report that
the former owners of Weekly Reader had provided to WRC Media at the
time of the 1999 acquisition. Accordingly, in 2004, the Company
engaged a valuation consulting firm to assist management in assessing
the fair values and economic lives of the 1999 Intangible Assets as of
the acquisition date. As a result, certain estimated fair values and
economic lives of the 1999 Intangible Assets have been revised.
Accordingly, the Company has restated its financial statements to
correctly state the estimated fair value and economic lives of the
1999 Intangible Assets acquired as of November 17, 1999. This had the
effect of increasing goodwill by $36,238 and decreasing other
intangibles in the aggregate by the same amount. Other intangible
assets include Copyrights, Customer lists and Trademarks. Copyrights
increased by $4,733 and their estimated useful life was amended from
10 years to approximately 20 years, Customer lists decreased by
$13,680 and their estimated useful life decreased from 10 years to
approximately 8.5 years and Trademarks decreased by $27,291 and their
estimated useful life decreased from 40 years to approximately 39
years. In addition, the Company has restated its financial statements
to correct amortization expense for other intangible assets, which had
the effect of reducing amortization expense of intangible assets for
the three- and six-months ended June 30, 2003 by $376 and $750,
respectively.
o CompassLearning/Weekly Reader Additional Goodwill Reduction. As
discussed above the Company recorded certain reserves for a planned
restructuring in connection with the acquisitions of CompassLearning
and Weekly Reader. In connection with the reaudit of its 2001
consolidated financial statements the Company determined that it had
incorrectly recorded reserves of $3,106 related to estimated
liabilities it believed it had assumed at the date of such
acquisitions. The Company concluded that the acquisition reserves
associated with these liabilities should have been reversed in 1999.
The estimated liabilities associated with the excess reserves included
$1,522 of debt issuance costs, $1,157 of severance and consulting
fees, primarily attributable to employees or consultants hired
subsequent to the acquisition date, $362 of leasehold improvements for
space to be occupied by employees of World Almanac Group and other
administrative costs of $65. The Company determined that goodwill and
the related acquisition reserves should be reduced by $3,106. The
Company has restated its financial statements to correct for these
errors. The net effect of such adjustments was to increase net loss
for the three- and six-months ended June 30, 2003 by $54 and $110,
respectively.
o Goodwill and Long-lived Intangible Asset Impairment. On January 1,
2002, the Company adopted SFAS 142 for its goodwill and intangible
assets. Upon adoption, the Company ceased amortization of goodwill and
other indefinite lived intangible assets, which primarily consist of
trademarks. As required by SFAS 142, the Company reviewed its
indefinite lived intangibles (goodwill and trademarks) for impairment
as of January 1, 2002. The Company has four 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. ("AGS") a subsidiary of Weekly Reader.
This charge was reported as a cumulative effect of accounting change,
as of January 1, 2002, in the consolidated statements of operations.
In connection with the reconsideration of the assumptions used to
determine the estimated fair value and economic lives of the 1999
Intangible Assets discussed above, the Company updated its
transitional impairment analysis and determined that it had
incorrectly calculated the fair value of its reporting units.
Accordingly, the impairment charge of $72,022 at AGS was incorrect and
not required. The Company's measurement of fair value was based on an
evaluation of future discounted cash flows. This evaluation utilized
the best information available in the circumstances, including
reasonable and supportable assumptions and projections. The discounted
cash flow evaluation considered several earnings scenarios and the
likelihood of possible outcomes. Collectively, this evaluation was
management's best estimate of projected future cash flows. The
Company's discounted cash flow evaluation used a range of discount
rates that corresponds to the Company's weighted-average cost of
capital. This discount rate range assumed was consistent with that
used for investment decisions and takes into account the specific and
detailed operating plans and strategies of the WRC Media's reporting
units. Certain other key assumptions utilized, including changes in
revenue, operating expenses, working capital requirements and capital
expenditures including pre-publication costs, are based on reasonable
estimates related to the Company's strategic initiatives and current
market conditions. Such assumptions also are consistent with those
utilized in the Company's annual planning process. The Company has
restated its December 31, 2002 and 2003 balance sheets to correct for
this error. The net effect of such adjustment was to increase goodwill
and decrease accumulated deficit by $72,022 as of December 31, 2002
and 2003.
18
o Deferred Tax Liabilities. The Company recognized non-cash deferred
income tax expense and a deferred tax liability on January 1, 2002 in
connection with its adoption of SFAS 142. The deferred tax liability
relates to the excess of tax over book amortization of tax-deductible
goodwill and trademarks since the timing of the reversal of this
liability is indefinite, unless the related assets are sold or an
impairment of the assets is recorded, and can no longer be offset by
the Company's net operating loss carryforwards, which expire within a
statutory period. During 2003, the Company recorded additional
deferred tax expense. The non-cash income tax expense recorded during
the three- and six-months ended June 30, 2003 increased by $225, from
$454 to $679 and by $450, from $1,042 to $1,492, respectively. These
restatements are principally due to the reversal of the impairment
charges and the revision of estimated fair value and economic lives of
the 1999 Intangible Assets discussed above.
o 15% Senior Preferred Stock due 2011. In 1999, the Company issued
3,000,000 shares of 15% Senior Preferred Stock due in 2011. The 15%
Senior Preferred Stock accrued dividends at a rate of 15% per annum.
The Certificate of Designation provides that the 15% Senior Preferred
Stock was subject to a default or penalty dividend of 0.5% in the
event of certain registration defaults. A penalty dividend was
applicable from mid-August of 2000 through November 17, 2001. While
the Company believes that no penalty dividend is due for subsequent
periods, the preferred shareholders may disagree with that conclusion.
The Company had not previously recorded this penalty dividend. The
recording of the penalty dividends (and required compounding in
subsequent periods) resulted in the Company increasing accrued
dividends on 15% Senior Preferred Stock by $31 and $61 during the
three- and six-months ended June 30, 2003, respectively.
o Segment Information. The Company previously disclosed one reportable
segment. The Company now discloses four reportable segments.
o Other. In connection with the re-audit of the Company's 2001 financial
statements, the Company has made a number of other corrections to the
financial statements, which collectively were immaterial.
Summarized below are the significant effects of the Initial Restatement and the
Further Restatement.
19
Three Months Ended June 30, 2003
---------------------------------------------------
As Previously
Reported in
August 13, 2003 Restatement
Form 10-Q Adjustment As Restated
------------- ----------- -----------
Revenue, net $ 43,493 $ 648 $ 44,141
Cost of goods sold 12,542 542 13,084
-------- -------- --------
Gross profit 30,951 106 31,057
-------- -------- --------
Costs and expenses:
Sales and marketing 10,051 250 10,301
Research and development 213 213
Distribution, circulation and fulfillment 2,905 2,905
Editorial 2,565 2,565
General and administrative 5,614 (244) 5,370
Restructuring costs and other non-recurring expenses 1,001 1,001
Depreciation 591 8 599
Amortization of intangible assets 4,691 (317) 4,374
-------- -------- --------
Total operating costs and expenses 27,631 (303) 27,328
-------- -------- --------
Income from operations 3,320 409 3,729
Interest expense, including amortization
of deferred financing costs (7,188) (48) (7,236)
Other expense, net (388) (300) (688)
-------- -------- --------
Loss before income tax provision (4,256) 61 (4,195)
Income tax provision 454 225 679
-------- -------- --------
Net loss $ (4,710) $ (164) $ (4,874)
======== ======== ========
20
Six Months Ended June 30, 2003
----------------------------------------------------
As Previously
Reported in
August 13, 2003 Restatement
Form 10-Q Adjustment As Restated
------------- ------------ -----------
Revenue, net $ 90,470 $ 709 $ 91,179
Cost of goods sold 25,276 1,081 26,357
-------- -------- --------
Gross profit 65,194 (372) 64,822
-------- -------- --------
Costs and expenses:
Sales and marketing 21,532 250 21,782
Research and development 924 924
Distribution, circulation and fulfillment 6,415 6,415
Editorial 5,144 5,144
General and administrative 12,334 (1,321) 11,013
Restructuring costs and other non-recurring expenses 1,481 1,481
Depreciation 1,207 13 1,220
Amortization of intangible assets 9,324 (633) 8,691
-------- -------- --------
Total operating costs and expenses 58,361 (1,691) 56,670
-------- -------- --------
Income from operations 6,833 1,319 8,152
Interest expense, including amortization
of deferred financing costs (14,270) (98) (14,368)
Other expense, net (619) (300) (919)
-------- -------- --------
Loss before income tax provision (8,056) 921 (7,135)
Income tax provision 1,042 450 1,492
-------- -------- --------
Net loss $ (9,098) $ 471 $ (8,627)
======== ======== ========
21
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, June 30,
2003 2004
------------ ---------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,267 $ 4,963
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,179 and $2,367, respectively.) 20,880 28,162
Inventories 15,890 14,232
Due from related party 11,502 33,864
Prepaid expenses 2,882 2,457
Other current assets (including restricted assets of $1,006
and $842, respectively) 1,889 1,317
--------- ---------
Total current assets 54,310 84,995
Property and equipment, net 4,665 4,280
Goodwill 101,978 101,978
Other intangible assets, net 31,580 30,257
Deferred financing costs, net 512 -
Other assets 29,711 32,658
--------- ---------
Total assets $ 222,756 $ 254,168
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 15,446 $ 12,917
Deferred revenue 17,565 21,044
Accrued expenses and other current liabilities 15,865 15,764
Current portion of long-term debt 8,477 -
--------- ---------
Total current liabilities 57,353 49,725
Deferred tax liability 4,800 5,150
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,966,119 shares outstanding)
(Liquidation preference of $149,228) - 149,228
Long-term debt 262,925 300,973
--------- ---------
Total liabilities 325,078 505,076
--------- ---------
Commitments and contingencies
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,508,000 shares outstanding) 138,636 -
Stockholders' deficit:
Common stock, ($.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 (56,464) (49,491)
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (191,756) (208,679)
--------- ---------
Total stockholders' deficit (240,958) (250,908)
--------- ---------
Total liabilities and stockholders' deficit $ 222,756 $ 254,168
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
22
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- --------
(As Restated
See Note 15)
Revenue, net $ 29,711 $ 32,511
Cost of goods sold 7,908 8,622
-------- --------
Gross profit 21,803 23,889
-------- --------
Costs and expenses:
Sales and marketing 5,605 6,246
Distribution, circulation and fulfillment 2,905 2,769
Editorial 2,565 2,474
General and administrative 4,040 5,230
Restructuring costs 126 29
Depreciation 434 393
Amortization of intangible assets 2,157 2,076
-------- --------
Total operating costs and expenses 17,832 19,217
-------- --------
Income from operations 3,971 4,672
Other expense:
Interest expense, including amortization
of deferred financing costs (6,911) (12,890)
Other expense, net (114) (199)
-------- --------
Loss before income tax provision (3,054) (8,417)
Income tax provision 64 198
-------- --------
Net loss $ (3,118) $ (8,615)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
23
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------ --------
(As Restated
See Note 15)
Revenue, net $ 64,530 $ 66,939
Cost of goods sold 16,347 17,123
-------- --------
Gross profit 48,183 49,816
-------- --------
Costs and expenses:
Sales and marketing 11,932 13,271
Distribution, circulation and fulfillment 6,415 6,321
Editorial 5,144 5,347
General and administrative 8,479 10,295
Restructuring costs 126 30
Depreciation 879 786
Amortization of intangible assets 4,257 4,299
-------- --------
Total operating costs and expenses 37,232 40,349
-------- --------
Income from operations 10,951 9,467
Other expense:
Interest expense, including amortization
of deferred financing costs (13,733) (25,638)
Other expense, net (308) (396)
-------- --------
Loss before income tax provision (3,090) (16,567)
Income tax provision 254 356
-------- --------
Net loss $ (3,344) $(16,923)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
24
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- ---------
(As Restated
See Note 15)
Cash flows from operating activities:
Net loss $ (3,344) $ (16,923)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 350 350
Depreciation and amortization 5,136 5,085
Accrual of manditorily redeemable preferred stock dividends - 10,593
Amortization of debt discount 218 249
Amortization of deferred financing costs 90 512
Changes in operating assets and liabilities:
Accounts receivable (2,854) (7,282)
Inventories 881 1,658
Prepaid expenses and other current assets (7) 995
Other non-current assets (8,153) (5,925)
Accounts payable (7,172) (2,530)
Deferred revenue 1,500 3,478
Accrued liabilities (1,727) (95)
--------- ---------
Net cash used in operating activities (15,082) (9,835)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (183) (402)
Proceeds from the disposition of property and equipment 4 -
--------- ---------
Net cash used in investing activities (179) (402)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 27,000 31,000
Repayments of borrowings under revolving line of credit (3,000) (28,000)
Repayment of senior bank debt (3,945) (118,678)
Proceeds from issuance of long term debt - 145,000
Due from parent, net 2,450 6,973
Due from related party (3,022) (22,362)
--------- ---------
Net cash provided by financing activities 19,483 13,933
--------- ---------
Increase in cash and cash equivalents 4,222 3,696
Cash and cash equivalents, beginning of period 7,819 1,267
--------- ---------
Cash and cash equivalents, end of period $ 12,041 $ 4,963
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
25
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 June 30, 2004, WRC Media Inc. (the "Parent") owns 94.9% and PRIMEDIA,
Inc. owns 5.1% of the common stock of Weekly Reader.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of the Company as
of June 30, 2004 and for the three and six-month periods ended June 30, 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 Annual Report on Form 10-K dated June 15, 2004. The operating results
for the three- and six-month periods ended June 30, 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 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.
26
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% Senior Preferred Stock ("15% Senior Preferred") 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% Senior 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 15% Senior Preferred as of January 1, 2004 as book value
approximated fair value at January 1, 2004. For the three- and six-month periods
ended June 30, 2004 the Company recognized $5,394 and $10,593, respectively, of
accrued dividends on 15% Senior Preferred as interest expense.
On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits, an amendment of
FASB Statements No. 87, 88 and 106". It requires additional disclosures to those
in the original Statement 132 about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension plans and other defined benefit
post-retirement plans. The majority of the provisions of this statement apply to
financial statements issued for fiscal years ending after December 15, 2003. The
Company has adopted such disclosure provisions (see Note 13).
On March 17