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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 (State or other jurisdiction of
or organization) 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, September 30,
2003 2004
------------------ -------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,432 $ 8,207
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,519 and $2,601, respectively) 30,027 52,928
Inventories 16,652 15,959
Prepaid expenses 3,367 2,264
Other current assets (including restricted assets of $1,006
and $802, respectively) 1,889 1,757
------------ ------------
Total current assets 53,367 81,115
Property and equipment, net 5,792 5,138
Capitalized software, net 7,293 8,560
Goodwill 241,324 241,324
Other intangible assets, net 76,860 69,229
Deferred financing costs, net 5,675 9,008
Other assets 29,896 33,091
------------ ------------
Total assets $ 420,207 $ 447,465
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 16,963 $ 18,079
Accrued payroll, commissions and benefits 9,356 10,425
Current portion of deferred revenue 35,900 47,580
Other accrued liabilities 17,166 22,357
Current portion of long-term debt 8,477 --
------------ ------------
Total current liabilities 87,862 98,441
Deferred revenue, net of current portion 959 1,144
Deferred tax liabilities 10,800 12,975
15% senior preferred stock, including accrued dividends and
accretion of warrant value (6,192,960 shares outstanding),
(Liquidation preference of $154,824) -- 147,606
Long-term debt 262,925 293,103
------------ ------------
Total liabilities 362,546 553,269
------------ ------------
Commitments and contingencies
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,508,080 shares outstanding) 130,701 --
Warrants on common stock of subsidiaries 11,751 11,751
Common stock subject to redemption 940 950
------------ ------------
Stockholders' deficit:
Common stock, ($.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 625,336 shares outstanding, respectively) 21,919 25,013
Additional paid-in capital 131,753 131,753
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (237,574) (273,442)
------------ ------------
Total stockholders' deficit (85,731) (118,505)
------------ ------------
Total liabilities and stockholders' deficit $ 420,207 $ 447,465
============ ============
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 SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2003 2004
----------------- -----------------
(As Restated
See Note 17)
Revenue, net $ 55,389 $ 61,012
Cost of goods sold 14,804 16,075
------------ ------------
Gross profit 40,585 44,937
------------ ------------
Costs and expenses:
Sales and marketing 11,749 14,423
Research and development 634 97
Distribution, circulation and fulfillment 3,697 3,565
Editorial 2,266 2,926
General and administrative 5,777 7,598
Restructuring costs and other non-recurring expenses (576) 338
Depreciation 549 479
Amortization of intangible assets 4,473 4,033
------------ ------------
Total operating costs and expenses 28,569 33,459
------------ ------------
Income from operations 12,016 11,478
Interest expense, including amortization
of deferred financing costs (7,460) (13,718)
Other expense, net (250) (247)
------------ ------------
Income (loss) before income tax provision 4,306 (2,487)
Income tax provision 764 776
------------ ------------
Net income (loss) $ 3,542 $ (3,263)
============ ============
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 NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2003 2004
----------------- -----------------
(As Restated
See Note 17)
Revenue, net $ 146,568 $ 149,621
Cost of goods sold 41,161 42,910
--------------- ---------------
Gross profit 105,407 106,711
--------------- ---------------
Costs and expenses:
Sales and marketing 33,531 37,148
Research and development 1,558 1,828
Distribution, circulation and fulfillment 10,112 9,886
Editorial 7,410 8,273
General and administrative 16,790 22,047
Restructuring costs and other non-recurring expenses 905 1,035
Depreciation 1,769 1,405
Amortization of intangible assets 13,164 12,328
--------------- ---------------
Total operating costs and expenses 85,239 93,950
--------------- ---------------
Income from operations 20,168 12,761
Interest expense, including amortization
of deferred financing costs (21,828) (41,628)
Other expense, net (1,169) (771)
--------------- ---------------
Loss before income tax provision (2,829) (29,638)
Income tax provision 2,256 2,418
--------------- ---------------
Net loss $ (5,085) $ (32,056)
=============== ===============
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 NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2003 2004
----------------- -----------------
(As Restated
See Note 17)
Cash flows from operating activities:
Net loss $ (5,085) $ (32,056)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 2,175 2,175
Depreciation and amortization 16,929 15,598
Management fees forgiven by principal shareholder 300 --
(Gain) loss on disposition of property and equipment (1) 14
Impairment of pre-publication costs -- 76
Accrual of manditorily redeemable preferred stock dividends -- 16,188
Amortization of debt discount 333 379
Amortization of deferred financing costs 1,081 3,295
Changes in operating assets and liabilities:
Accounts receivable (12,885) (22,901)
Inventories (1,325) 693
Prepaid expenses and other current assets (60) 1,235
Other noncurrent assets (10,503) (7,971)
Accounts payable (2,926) 1,116
Deferred revenue 10,563 11,865
Accrued liabilities 1,018 6,262
------------ ------------
Net cash used in operating activities (386) (4,032)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (1,045) (1,186)
Capitalized software (3,087) (3,132)
Landlord reimbursement for leasehold improvements -- 421
Proceeds from the disposition of property and equipment 4 --
------------ ------------
Net cash used in investing activities (4,128) (3,897)
------------ ------------
Cash flows from financing activities:
Proceeds from revolving line of credit 27,000 35,000
Repayments of revolving line of credit (21,000) (40,000)
Repayment of senior bank debt (5,773) (118,678)
Deferred financing fees (20) (6,628)
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 182 14,704
------------ ------------
(Decrease) increase in cash and cash equivalents (4,332) 6,775
Cash and cash equivalents, beginning of period 9,095 1,432
------------ ------------
Cash and cash equivalents, end of period $ 4,763 $ 8,207
============ ============
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 September 30, 2004 and for the three- and nine-month periods ended
September 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
(except as described in Note 17) 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 nine-month periods ended September 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 nine-month
periods ended September 30, 2004 the Company recognized $5,596 and $16,188,
respectively, of accrued dividends on the 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 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. In September 2004, the FASB delayed the
effective date of the measurement and recognition guidance of Issue 03-1 until
the FASB issues FASB Staff Position 03-1a. 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, excluding World Almanac
and American Guidance Services, 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 a 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.
9
o Compass/ChildU produces research-based technology learning solutions,
including web-based e-learning solutions that provide 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. WRC Media Inc. related expenses and assets that are not allocable
to the other operating segments are included in Corporate. WRC Media evaluates
segment performance based on several factors, of which the primary financial
measure is operating income (loss).
Weekly World Compass /
Reader Almanac AGS ChildU
-------- --------- -------- -----------
Three-months ended September 30, 2004
Revenue, net $ 13,376 $ 9,313 $ 24,897 $ 13,426
Income (loss) from operations 2,442 75 10,031 (17)
Depreciation and amortization 102 562 1,735 1,173
Restructuring costs and other non-recurring expenses - - - 385
Assets 65,951 100,873 205,674 57,197
Capital expenditures 19 561 27 1,923
Three-months ended September 30, 2003
Revenue, net 12,194 11,432 20,644 11,119
Income (loss) from operations 2,467 1,764 8,790 (925)
Depreciation and amortization 177 576 2,109 1,221
Restructuring costs and other non-recurring expenses - - - 71
Assets 68,283 96,727 184,131 55,264
Capital expenditures 115 38 152 1,149
Weekly World Compass /
Reader Almanac AGS ChildU
-------- --------- -------- -----------
Nine-months ended September 30, 2004
Revenue, net $ 27,628 $ 31,700 $ 55,197 $ 35,096
Income (loss) from operations 2,270 2,414 17,385 (6,342)
Depreciation and amortization 352 1,578 5,530 3,450
Restructuring costs and other non-recurring expenses - - - 1,052
Capital expenditures 179 606 209 3,299
Nine-months ended September 30, 2003
Revenue, net 28,279 34,691 45,830 37,768
Income (loss) from operations 4,062 4,937 14,765 (1,385)
Depreciation and amortization 541 1,675 5,757 4,137
Restructuring costs and other non-recurring expenses - 21 - 946
Capital expenditures 219 92 175 3,642
Corporate Eliminations Total
---------- -------------- ---------
Three-months ended September 30, 2004
Revenue, net $ - $ - $ 61,012
Income (loss) from operations (1,053) - 11,478
Depreciation and amortization 940 - 4,512
Restructuring costs and other non-recurring expenses (47) - 338
Assets 268,799 (251,029) 447,465
Capital expenditures 10 - 2,540
Three-months ended September 30, 2003
Revenue, net - - 55,389
Income (loss) from operations (80) - 12,016
Depreciation and amortization 939 - 5,022
Restructuring costs and other non-recurring expenses (647) - (576)
Assets 252,796 (211,987) 445,214
Capital expenditures 2 - 1,456
Corporate Eliminations Total
---------- -------------- ---------
Nine-months ended September 30, 2004
Revenue, net $ - $ - $ 149,621
Income (loss) from operations (2,966) - 12,761
Depreciation and amortization 2,823 - 13,733
Restructuring costs and other non-recurring expenses (17) - 1,035
Capital expenditures 25 - 4,318
Nine-months ended September 30, 2003
Revenue, net - - 146,568
Income (loss) from operations (2,211) - 20,168
Depreciation and amortization 2,823 - 14,933
Restructuring costs and other non-recurring expenses (62) - 905
Capital expenditures 4 - 4,132
5. RESTRUCTURING COSTS AND OTHER NON-RECURRING EXPENSES
During the nine-months ended September 30, 2004, the Company reviewed its
restructuring reserve established in 2002 and increased the reserve $1,035 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 September 30, 2004
------------------ ------------- ------------ ------------------
Severance and other benefits $ 32 $ - $ (32) $ -
Lease terminations 3,243 1,035 (1,163) 3,115
--------- --------- ---------- ----------
Total $ 3,275 $ 1,035 $ (1,195) $ 3,115
========= ========= ========== ==========
The restructuring reserve totaled approximately $3,115 at September 30, 2004 and
is expected to be paid as follows: remaining three months of 2004 - $376, 2005
and beyond - $2,739. These charges are included in other accrued liabilities on
the condensed consolidated balance sheets.
10
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.
The following table details the effect on net loss if compensation expense for
stock-based compensation arrangements with employees had been recorded based on
the fair value method under SFAS 123, as amended.
Three-Months Ended Nine-Months Ended
September 30, September 30,
2003 2004 2003 2004
---------------------------- ------------------------------
Net income (loss), as reported $ 3,542 $ (3,263) $ (5,085) $ (32,056)
Deduct: Total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of related tax
effects (34) (1) (125) (9)
----------- -------- ----------- -------------
Pro forma Net income (loss) $ 3,508 $ (3,264) $ (5,210) $ (32,065)
=========== ======== =========== =============
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
nine-month periods ended September 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
11
o annually, 50% of the Company's excess cash flow (as defined) from the
prior year.
The Second-Lien Facility provides for certain restrictions, including
restrictions on asset sales, dividend payments, additional indebtedness and
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 Company. 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.
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 2.25% or the alternate base rate as defined in the First-Lien
Facility plus 1.25%.
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 $1,914. These costs are included in interest expense, including
amortization of deferred financing costs, on the condensed consolidated
statements of operations for the nine-months ended September 30, 2004.
In connection with the refinancing, the Company incurred costs and expenses,
primarily investment banking and legal fees, of approximately $6,600. These
amounts have been recorded as deferred financing fees at September 30, 2004 and
are being amortized over the term of the Second Lien Facility using the
effective interest method.
At September 30, 2004, there were no outstanding advances under the Company's
$30,000 revolving credit facility. 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. The Company's
available borrowing under the revolving credit facility is reduced by any
outstanding letters of credit. At September 30, 2004, the Company had, net of
the $2,050 in outstanding letters of credit, $27,950 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. No amount is in the condensed consolidated balance
sheet at December 31, 2003 and September 30, 2004 as the fair value of the
interest rate cap at those dates is de-minimis. At November 15, 2004, more than
50% of the aggregate principal amount of Total Debt, as defined, is subject to a
fixed interest rate. Therefore the interest rate cap will not be renewed.
12
9. INVENTORIES
Inventories as of December 31, 2003 and September 30, 2004 are as follows:
December 31, September 30,
2003 2004
------------ -----------
Finished goods $ 16,533 $ 15,021
Raw materials 119 938
------------ -----------
$ 16,652 $ 15,959
============ ===========
10. GOODWILL AND TRADEMARKS
At December 31, 2003 and September 30, 2004, goodwill and indefinite lived
intangible assets are as follows:
December 31, September 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 nine-months ended September 30, 2004.
The Company recorded non-cash deferred income tax expense of $725 and $2,175
each of for the three- and nine-month periods ended September 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 $725 to increase deferred
tax liabilities during the remaining three-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 assets
are as follows:
---------------------------------------------------
December 31, 2003
---------------------------------------------------
Accumulated
Useful Lives Gross Amortization Net
------------ --------------- -------------- --------------
Customer Lists 6-15 yrs $ 48,600 $ (24,948) $ 23,652
Copyrights 10-20 yrs 30,800 (6,462) 24,338
Software 3-5 yrs 14,789 (10,027) 4,762
Trademark 4-10 yrs 200 (82) 118
Distributor relationships 6 yrs 700 (482) 218
--------------- -------------- --------------
Total: $ 95,089 $ (42,001) $ 53,088
=============== ============== ==============
--------------------------------------------------
September 30, 2004
--------------------------------------------------
Accumulated
Useful Lives Gross Amortization Net
------------ -------------- -------------- --------------
Customer Lists 6-15 yrs $ 48,600 $ (29,327) $ 19,273
Copyrights 10-20 yrs 30,800 (7,641) 23,159
Software 3-5 yrs 14,789 (11,999) 2,790
Trademark 4-10 yrs 200 (97) 103
Distributor relationships 6 yrs 700 (568) 132
-------------- -------------- --------------
Total: $ 95,089 $ (49,632) $ 45,457
============== ============== ==============
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 September 30, 2004 (See note 10).
13
Amortization of intangibles for the three-months ended September 30, 2003 and
2004 was $2,829 and $2,310, respectively. Amortization of intangibles for the
nine-months ended September 30, 2003 and 2004 was $9,024 and $7,631,
respectively. Amortization of intangibles is included in amortization of
intangible assets on the condensed consolidated statements of operations. The
estimated amortization expense for intangible assets subject to amortization for
the next five years is as follows:
Remaining three months of 2004........................... $ 2,300
2005..................................................... 9,197
2006..................................................... 6,843
2007..................................................... 4,600
2008 .................................................... 3,461
2009 .................................................... 3,253
Thereafter............................................... 15,803
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 in
November 1999, the Company, Weekly Reader and CompassLearning as co-issuers,
completed an offering of $152,000 12 3/4% Senior Subordinated Notes due 2009
(the "Old Notes"). In September 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 nine-month
periods ended September 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.
14
Subsidiary Guarantors
--------------------------------------------------------
Compass
Weekly Reader Learning
WRC Media Inc. Corporation Inc.
------------------ ---------------- ------------
(In thousands)
Balance Sheet as of September 30, 2004
Assets:
Current assets $ 1,676 $ 99,054 $ 20,544
Property and equipment, net - 4,520 496
Goodwill and other intangible assets, net 153,643 131,926 22,194
Other assets 108,933 32,906 6,045
------------ ------------ ------------
Total assets $ 264,252 $ 268,406 $ 49,279
============ ============ ============
Liabilities and stockholders' deficit:
Current liabilities $ 119,013 $ 62,434 $ 57,317
Redeemable preferred stock, plus accrued dividends 147,606 154,824 -
Long-term debt 148,103 293,103 -
Other liabilities 7,650 5,325 1,144
Warrants on common stock of subsidiaries 11,751 - -
Common stock subject to redemption 950 - -
Stockholders' deficit (170,821) (247,280) (9,182)
------------ ------------ ------------
Total liabilities and stockholders' deficit $ 264,252 $ 268,406 $ 49,279
============ ============ ============
Subsidiary Guarantors
--------------------------------------------------------
Compass
Weekly Reader Learning
WRC Media Inc. Corporation Inc.
------------------ ---------------- ------------
(In thousands)
Statements of operations for the three months
ended September 30, 2004
Revenue, net $ - $ 47,586 $ 6,588
Operating costs and expenses 929 35,162 10,069
Interest expense, net 11,082 13,207 -
Other (income) expense 237 195 13
Provision for income taxes 583 181 12
------------ ------------ ------------
Net income (loss) $ (12,831) $ (1,159) $ (3,506)
============ ============ ============
Statements of operations for the nine months
ended September 30, 2004
Revenue, net $ - $ 114,525 $ 21,528
Operating costs and expenses 2,788 92,634 31,996
Interest expense, net 33,885 38,845 -
Other (income) expense 764 591 14
Provision for income taxes 1,808 537 73
------------ ------------ ------------
Net income (loss) $ (39,245) $ (18,082) $ (10,555)
============ ============ ============
Cash flow for the nine months
ended September 30, 2004
Cash flow provided by (used in) operations $ (11,024) $ (4,799) $ (10,199)
Cash flow used in investing activities - (1,019) (2,074)
Cash flow provided by (used in) financing activities 10,924 12,714 12,273
Cash and cash equivalents at beginning of period 100 1,267 4
------------ ------------ ------------
Cash and cash equivalents at end of period $ - $ 8,163 $ 4
============ ============ ============
Subsidiary Guarantors
------------------------------------------------------
Compass
Weekly Reader Learning
WRC Media Inc. Corporation Inc.
------------------ ---------------- ------------
Statements of operations for the three months
ended September 30, 2003 (In thousands)
Revenue, net $ - $ 44,270 $ 9,684
Operating costs and expenses 929 30,400 10,746
Interest expense, net 5,271 7,148 1
Other (income) expense 256 194 -
Provision for income taxes 580 183 1
------------ ------------ ------------
Net income (loss) $ (7,036) $ 6,345 $ (1,064)
============ ============ ============
Statements of operations for the nine months
ended September 30, 2003
Revenue, net $ - $ 108,800 $ 33,427
Operating costs and expenses 3,267 83,979 35,012
Interest expense, net 15,814 20,881 1
Other (income) expense 967 502 -
Provision for income taxes 1,780 437 39
------------ ------------ ------------
Net income (loss) $ (21,828) $ 3,001 $ (1,625)
============ ============ ============
Cash flow for the nine months
ended September 30, 2003
Cash flow provided by (used in) operations $ (11,506) $ (11,628) $ 5,143
Cash flow used in investing activities - (486) (2,299)
Cash flow provided by (used in) financing activities 10,494 8,847 (2,844)
Cash and cash equivalents at beginning of period 1,154 7,819 4
------------ ------------ ------------
Cash and cash equivalents at end of period $ 142 $ 4,552 $ 4
============ ============ ============
Subsidiary Guarantors
--------------------------------------------------------
WRC
Media Inc.
ChildU Eliminations Consolidated
------------ --------------- ------------------
Balance Sheet as of September 30, 2004
Assets:
Current assets $ 6,356 $ (46,515) $ 81,115
Property and equipment, net 122 - 5,138
Goodwill and other intangible assets, net 2,790 - 310,553
Other assets 2,700 (99,925) 50,659
------------ ------------ ------------
Total assets $ 11,968 $ (146,440) $ 447,465
============ ============ ============
Liabilities and stockholders' deficit:
Current liabilities $ 7,585 $ (147,908) $ 98,441
Redeemable preferred stock, plus accrued dividends - (154,824) 147,606
Long-term debt - (148,103) 293,103
Other liabilities - - 14,119
Warrants on common stock of subsidiaries - - 11,751
Common stock subject to redemption - - 950
Stockholders' deficit 4,383 304,395 (118,505)
------------ ------------ ------------
Total liabilities and stockholders' deficit $ 11,968 $ (146,440) $ 447,465
============ ============ ============
------------------------------------
WRC
Media Inc.
ChildU Eliminations Consolidated
Statements of operations for the three months ------------ --------------- ------------------
ended September 30, 2004
Revenue, net $ 6,838 $ - $ 61,012
Operating costs and expenses 3,374 - 49,534
Interest expense, net - (10,571) 13,718
Other (income) expense 2 (200) 247
Provision for income taxes - - 776
------------ ------------ ------------
Net income (loss) $ 3,462 $ 10,771 $ (3,263)
============ ============ ============
Statements of operations for the nine months
ended September 30, 2004
Revenue, net $ 13,568 $ - $ 149,621
Operating costs and expenses 9,442 - 136,860
Interest expense, net - (31,102) 41,628
Other (income) expense 2 (600) 771
Provision for income taxes - - 2,418
------------ ------------ ------------
Net income (loss) $ 4,124 $ 31,702 $ (32,056)
============ ============ ============
Cash flow for the nine months
ended September 30, 2004
Cash flow provided by (used in) operations $ 6,480 $ 15,510 $ (4,032)
Cash flow used in investing activities (804) - (3,897)
Cash flow provided by (used in) financing activities (5,697) (15,510) 14,704
Cash and cash equivalents at beginning of period 61 - 1,432
------------ ------------ ------------
Cash and cash equivalents at end of period $ 40 $ - $ 8,207
============ ============ ============
--------------------------------------
WRC
Media Inc.
ChildU Eliminations Consolidated
------------ --------------- ------------------
Statements of operations for the three months
ended September 30, 2003
Revenue, net $ 1,435 $ - $ 55,389
Operating costs and expenses 1,298 - 43,373
Interest expense, net - (4,960) 7,460
Other (income) expense - (200) 250
Provision for income taxes - - 764
------------ ------------ ------------
Net income (loss) $ 137 $ 5,160 $ 3,542
============ ============ ============
Statements of operations for the nine months
ended September 30, 2003
Revenue, net $ 4,341 $ - $ 146,568
Operating costs and expenses 4,142 - 126,400
Interest expense, net - (14,868) 21,828
Other (income) expense - (300) 1,169
Provision for income taxes - - 2,256
------------ ------------ ------------
Net income (loss) $ 199 $ 15,168 $ (5,085)
============ ============ ============
Cash flow for the nine months
ended September 30, 2003
Cash flow provided by (used in) operations $ 2,272 $ 15,333 $ (386)
Cash flow used in investing activities (1,343) - (4,128)
Cash flow provided by (used in) financing activities (982) (15,333) 182
Cash and cash equivalents at beginning of period 118 - 9,095
------------ ------------ ------------
Cash and cash equivalents at end of period $ 65 $ - $ 4,763
============ ============ ============
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.
15
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 nine-month periods ended September
30, 2003 and 2004, the Company recognized general and administrative expense of
$238 and $713, 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 September 30, 2004, other accrued
liabilities include approximately $713 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 nine-month periods
ended September 30, 2003 and 2004:
Three-Months Ended September 30, Nine-Months Ended September 30,
--------------------------------- -------------------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Service cost $ 229 $ 225 $ 687 $ 675
Interest cost 221 238 663 714
Expected return on plan
assets (169) (242) (507) (726)
Amortization of net loss 74 42 222 126
---------- ---------- ---------- ----------
Net periodic benefit cost $ 355 $ 263 $ 1,065 $ 789
========== ========== ========== ==========
16. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Nine-Months Ended September 30,
--------------------------------------------------------
2003 2004
------------ ------------
Cash paid during the period for interest $ 16,222 $ 15,809
Cash paid during the period for income taxes $ 208 $ 280
Non-cash financing activities:
Preferred stock dividends accrued $ 13,972 $ 16,188(1)
Accretion of preferred stock $ 708 $ 718
(1) During the nine-month period ended September 30, 2004, $16,188 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 nine-months ended September 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; and (v) other items including an adjustment relating to the
amortization period for certain capitalized pre-publication costs.
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and nine-months ended September
30, 2003 in connection with the Initial Restatement.
16
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 nine-months ended September 30, 2003 was to decrease net loss
by approximately $920.
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 $1,255, respectively
in the three- and nine-months ended September 30, 2003.
Following the determination to restate the Company's financial statements for
matters described above, the Company also determined that it would correct the
financial statement 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 $61 and $319 respectively
for the three- and nine-months ended September 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 $546, respectively for the three- and nine-months
ended September 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 $93 and $303 respectively for the
three- and nine-months ended September 30, 2003 and it reclassified $67
and $994, 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 nine-months
ended September 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 for the nine-months ended September
30, 2003.
17
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 decided to correct. In addition, the Company corrected certain errors in
its disclosures regarding stock options granted to its employees.
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and nine-months ended September
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 nine-months ended September 30, 2003 by $374 and $1,124,
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
nine-months ended September 30, 2003 by $53 and $163, 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 nine-months ended September 30, 2003 increased by $225, from $539
to $764 and by $675, from $1,581 to $2,256, 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 $33 and $94 during the three- and nine-months ended
September 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 September 30, 2003
-------------------------------------------------
As Previously
Reported in
November 14, 2003 Restatement
Form 10-Q Adjustments As Restated
------------------- -------------- -------------
Revenue, net $ 55,322 $ 67 $ 55,389
Cost of goods sold 14,714 90 14,804
------------- ---------- -------------
Gross profit 40,608 (23) 40,585
------------- ---------- -------------
Costs and expenses:
Sales and marketing 11,749 11,749
Research and development 634 634
Distribution, circulation and fulfillment 3,697 3,697
Editorial 2,266 2,266
General and administrative 6,113 (336) 5,777
Restructuring costs and other non-recurring (576) (576)
expenses
Depreciation 543 6 549
Amortization of intangible assets 4,401 72 4,473
------------- ---------- -------------
Total operating costs and expenses 28,827 (258) 28,569
------------- ---------- -------------
Income from operations 11,781 235 12,016
Interest expense, including amortization
of deferred financing costs (7,413) (47) (7,460)
Other expense, net (250) (250)
------------- ---------- -------------
Income before income tax provision 4,118 188 4,306
Income tax provision 539 225 764
------------- ---------- -------------
Net income $ 3,579 $ (37) $ 3,542
============= ========== =============
20
Nine Months Ended September 30, 2003
----------------------------------------------------
As Previously
Reported in
November 14, 2003 Restatement
Form 10-Q Adjustments As Restated
----------------- ------------ -----------
Revenue, net $ 145,792 $ 776 $ 146,568
Cost of goods sold 39,990 1,171 41,161
--------- --------- ---------
Gross profit 105,802 (395) 105,407
--------- --------- ---------
Costs and expenses:
Sales and marketing 33,281 250 33,531
Research and development 1,558 1,558
Distribution, circulation and fulfillment 10,112 10,112
Editorial 7,410 7,410
General and administrative 18,447 (1,657) 16,790
Restructuring costs and other non-recurring 905 905
expenses
Depreciation 1,750 19 1,769
Amortization of intangible assets 13,725 (561) 13,164
--------- --------- ---------
Total operating costs and expenses 87,188 (1,949) 85,239
--------- --------- ---------
Income from operations 18,614 1,554 20,168
Interest expense, including amortization
of deferred financing costs (21,683) (145) (21,828)
Other expense, net (869) (300) (1,169)
--------- --------- ---------
Loss before income tax provision (3,938) 1,109 (2,829)
Income tax provision 1,581 675 2,256
--------- --------- ---------
Net loss $ (5,519) $ 434 $ (5,085)
========= ========= =========
21
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, September 30,
2003 2004
---------------------- --------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,267 $ 8,163
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,179 and $2,465, respectively) 20,880 40,063
Inventories 15,890 15,587
Due from related party 11,502 31,870
Prepaid expenses 2,882 1,614
Other current assets (including restricted assets of $1,006
and $802, respectively) 1,889 1,757
------------ ------------
Total current assets 54,310 99,054
Property and equipment, net 4,665 4,520
Goodwill 101,978 101,978
Other intangible assets, net 31,580 29,948
Deferred financing costs, net 512 -
Other assets 29,711 32,906
------------ ------------
Total assets $ 222,756 $ 268,406
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 15,446 $ 16,663
Deferred revenue 17,565 29,040
Accrued expenses and other current liabilities 15,865 16,731
Current portion of long-term debt 8,477 -
------------ ------------
Total current liabilities 57,353 62,434
Deferred tax liability 4,800 5,325
15% senior preferred stock, including accrued dividends and
accretion of warrant value (6,192,960 shares outstanding),
(Liquidation preference of $154,824) - 154,824
Long-term debt 262,925 293,103
------------ ------------
Total liabilities 325,078 515,686
------------ ------------
Commitments and contingencies
15% senior preferred stock, including accrued
dividends and accretion of warrant value
(5,508,000 shares outstanding) 138,636 -
Stockholders' deficit:
Common stock, ($.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) (44,704)
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (191,756) (209,838)
------------ ------------
Total stockholders' deficit (240,958) (247,280)
------------ ------------
Total liabilities and stockholders' deficit $ 222,756 $ 268,406
============ ============
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 SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2003 2004
----------------- -----------------
(As Restated
See Note 15)
Revenue, net $ 44,270 $ 47,586
Cost of goods sold 10,351 10,819
------------ ------------
Gross profit 33,919 36,767
------------ ------------
Costs and expenses:
Sales and marketing 7,199 9,543
Distribution, circulation and fulfillment 3,697 3,565
Editorial 2,266 2,926
General and administrative 4,662 5,946
Restructuring costs (647) (47)
Depreciation 426 378
Amortization of intangible assets