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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, 2003 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.
ITEM 1. FINANCIAL STATEMENTS
3
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
December 31, September 30,
2002 2003
------------ -------------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 9,095 $ 4,763
Accounts receivable (net of allowance for
doubtful accounts of $1,717 and $1,956) 38,373 49,377
Inventories, net 15,287 16,745
Prepaid expenses 3,200 3,179
Other current assets 1,797 1,678
--------- ---------
Total current assets 67,752 75,742
Property and equipment, net 6,299 5,500
Purchased software, net 4,970 6,061
Goodwill 163,349 163,271
Deferred financing costs, net 6,165 5,389
Other intangible assets, net 100,499 91,370
Other assets and investments 25,218 31,883
--------- ---------
Total assets $ 374,252 $ 379,216
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 20,869 $ 17,900
Accrued payroll, commissions and benefits 8,693 8,594
Deferred revenue 39,840 50,445
Other accrued liabilities 23,285 24,660
Current portion of long-term debt 7,721 8,863
--------- ---------
Total current liabilities 100,408 110,462
Deferred revenue, net of current portion 1,167 704
Deferred tax liabilities 10,700 12,200
Due to related party 2,160 2,160
Long-term debt 266,219 265,636
--------- ---------
Total liabilities 380,654 391,162
--------- ---------
Commitments and contingencies
15% Series B redeemable preferred stock,
including accrued dividends and accretion of
warrant value (3,000,000 shares outstanding)
(Liquidation preference of $132,486) 109,966 124,551
--------- ---------
Warrants on preferred stock 11,751 11,751
--------- ---------
Common stock subject to redemption 965 940
--------- ---------
Stockholders' deficit:
Common stock, ($.01 par value,
20,000,000 shares authorized
and 7,009,750 shares outstanding) 70 70
18% convertible preferred stock, ($.01 par
value, 750,000 shares authorized
524,375 outstanding) 18,381 20,975
Additional paid-in capital 132,464 132,464
Accumulated comprehensive loss (3,357) (3,357)
Accumulated deficit (276,642) (299,340)
--------- ---------
Total stockholders' deficit (129,084) (149,188)
--------- ---------
Total liabilities and stockholders' deficit $ 374,252 $ 379,216
========= =========
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)
2002 2003
-------- -------
Revenue, net $ 56,242 $ 55,322
Cost of goods sold 15,161 14,714
-------- --------
Gross profit 41,081 40,608
-------- --------
Costs and expenses:
Sales and marketing 11,135 11,749
Research and development 280 634
Distribution, circulation and fulfillment 3,497 3,697
Editorial 2,606 2,266
General and administrative 5,945 6,113
Restructuring costs - (576)
Depreciation 693 543
Amortization of intangible assets 4,495 4,401
-------- --------
Total operating costs and expenses 28,651 28,827
-------- --------
Income from operations 12,430 11,781
Interest expense, including amortization
of deferred financing costs (7,576) (7,413)
Loss on investment (963) -
Other income/(expense), net 1,171 (250)
-------- --------
Income before income tax provision 5,062 4,118
Income tax provision 501 539
-------- --------
Net income $ 4,561 $ 3,579
======== ========
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)
2002 2003
--------- ---------
Revenue, net $ 146,839 $ 145,792
Cost of goods sold 41,187 39,990
--------- ---------
Gross profit 105,652 105,802
--------- ---------
Costs and expenses:
Sales and marketing 36,077 33,281
Research and development 1,236 1,558
Distribution, circulation and fulfillment 9,494 10,112
Editorial 7,476 7,410
General and administrative 16,439 18,447
Restructuring costs and other non-recurring expenses - 905
Depreciation 2,284 1,750
Amortization of intangible assets 14,149 13,725
--------- ---------
Total operating costs and expenses 87,155 87,188
--------- ---------
Income from operations 18,497 18,614
Interest expense, including amortization
of deferred financing costs (22,380) (21,683)
Loss on investment (2,100) -
Other income/(expense), net 889 (869)
--------- ---------
Loss before income tax provision (5,094) (3,938)
Income tax provision 10,384 1,581
--------- ---------
Loss before cumulative effect of change
in accounting principle (15,478) (5,519)
Cumulative effect of change in accounting principle (72,022) -
--------- ---------
Net loss $ (87,500) $ (5,519)
========= =========
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)
2002 2003
-------- --------
Cash flows from operating activities:
Net loss $(87,500) $ (5,519)
Adjustments to reconcile net loss to net cash
used in operating activities:
Cumulative effect of change in accounting principle 72,022 -
Deferred income tax provision 10,200 1,500
Depreciation and amortization 16,537 16,478
Loss on investments 2,100 -
Gain from hedging transactions (1,619) -
Gain (loss) on disposition of property and equipment 43 (1)
Interest expense-accretion of debt discount 291 333
Amortization of deferred financing costs 859 936
Changes in operating assets and liabilities:
Increase in accounts receivable (9,411) (11,004)
Increase in inventories (1,309) (1,458)
Decrease in prepaid expenses and other current assets 4,512 140
Increase in other noncurrent assets (10,333) (10,503)
Increase (decrease) in accounts payable 632 (2,969)
Increase in deferred revenue 11,936 10,377
Increase (decrease) in accrued liabilities (9,475) 1,353
-------- --------
Net cash used in operating activities (515) (337)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (976) (954)
Capitalized software development costs (3,554) (3,087)
Proceeds from disposition of property & equipment 578 4
-------- --------
Net cash used in investing activities (3,952) (4,037)
-------- --------
Cash flows from financing activities:
Proceeds from revolving line of credit 29,000 27,000
Repayments of revolving line of credit (19,000) (21,000)
Retirement of senior bank debt (4,337) (5,773)
Deferred financing fees (685) (160)
Proceeds from issuance of common stock 150 -
Purchase of common stock subject to redemption (463) (25)
-------- --------
Net cash provided by financing activities 4,665 42
-------- --------
Increase (decrease) in cash and cash equivalents 198 (4,332)
Cash and cash equivalents, beginning of period 8,919 9,095
-------- --------
Cash and cash equivalents, end of period $ 9,117 $ 4,763
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 16,128 $ 16,222
======== ========
Cash paid during the period for income taxes $ 229 $ 208
======== ========
Non-cash financing activities:
Preferred stock dividends accrued $ 14,153 $ 16,471
======== ========
Accretion of preferred stock $ 698 $ 708
======== ========
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 AND BASIS OF PRESENTATION
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. All material intercompany
accounts and transactions have been eliminated in consolidation.
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.
On July 14, 1999, WRC Media acquired CompassLearning in a business combination
accounted for as a purchase.
On November 17, 1999, WRC Media completed the recapitalization and purchase of
Weekly Reader and its subsidiaries. As a result of these transactions, WRC Media
owns 94.9% and PRIMEDIA Inc. owns 5.1% of the common stock of Weekly Reader.
On May 9, 2001, WRC Media entered into an Agreement and Plan of Merger with
ChildU. Contemporaneously, the Company issued $13.75 million of 18% Junior
Participating Cumulative Convertible Preferred Stock. The proceeds funded the
operating losses of ChildU and WRC Media's investment in ThinkBox, Inc.,
described below.
Concurrent with the ChildU acquisition, on May 9, 2001, a subsidiary of the
Company acquired the assets of Lindy Enterprises, Inc. ("Lindy").
On May 18, 2001, WRC Media made a strategic investment in ThinkBox Inc., a
creator of Internet-delivered education programs for the school and home
markets. This investment is accounted for under the equity method of accounting.
The Company recorded equity losses equal to the carrying value of its
investment of ThinkBox during the year ended December 31, 2002.
The accompanying condensed consolidated financial statements of the Company as
of September 30, 2003 and for the three and nine month periods ended September
30, 2003 and 2002 have been prepared in accordance with generally accepted
accounting principles for interim financial information and the instructions for
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments, consisting of only normal recurring adjustments necessary to
present fairly the financial position, the results of operations and cash flows
for the periods presented, have been made.
These condensed consolidated financial statements should be read in conjunction
with the Company's annual financial statements and related notes for the year
ended December 31, 2002 included in the Company's Annual Report on Form 10-K.
The operating results for the three-month and nine-month periods ended September
30, 2002 and 2003 are not necessarily indicative of the results that may be
expected for a full year. Certain reclassifications have been made in the prior
year's consolidated financial statements to conform with current year
presentation.
8
Based on the Company's current forecast, it expects that as of December 31,
2003, it will not be in compliance with certain of the financial covenants in
its credit agreement. Because these financial covenants become more stringent as
of March 31, 2004, the Company also does not currently expect to be in
compliance after December 31, 2003. If the Company is unable to comply with one
or more of its financial covenants, it will be in default under the credit
agreement. Among other consequences, the Company will be unable to borrow
additional amounts under its revolving credit facility unless it is able to
obtain a waiver from the lenders. For the January through June time period, the
Company usually experiences negative cash flow due to the seasonality of its
business. As a result of this business cycle, borrowings usually increase during
the period January through June. Accordingly, if the Company is unable to borrow
additional amounts under its revolving credit facility, based on its current
forecast and cash position, the Company believes it will have sufficient cash to
pay its current obligations during the first fiscal quarter of 2004. The Company
expects it will have shortfalls in liquidity starting at some point in the
second fiscal quarter of 2004.
The Company's potential alternatives for resolving the liquidity issues
described above include (1) amending certain financial covenants the credit
agreement, (2) refinancing certain components of its capital structure and (3)
raising additional debt or equity capital. The Company is evaluating these
alternatives, and no assurances can be given that it will be successful in
achieving any of these alternatives, on reasonable terms or at all. The Company
can also give no assurances as to when in 2003 or 2004 any such alternatives, if
successful, would be completed, or what their impact on the Company's costs of
financing would be.
As of September 30, 2003, $120,900 was outstanding under the Company's
term loan facilities and there was $6,000 of outstanding borrowings under
its revolving credit facility. Upon the occurrence of an event of default under
the Company's credit agreement, our lenders have no obligation to grant the
Company a waiver or extend additional loans under the revolving facility and
have the right to accelerate in full the repayment of all amounts outstanding
under the credit agreement, including all amounts outstanding under the term
loan facilities and revolving credit facility. If any such event of default
occurs under our credit agreement and the lenders take steps to accelerate the
amounts due, the Company would not be able to repay such amounts. The credit
agreement is secured by liens on substantially all of the Company's assets.
In the event that the lenders were to accelerate the Company's prepayment
obligations under the term loan facilities and the revolving facility, such
action would constitute an event of default under the Company's Notes. If such
an event of default occurs under the Notes, the holders of the Notes would have
the right to accelerate in full the repayment of all amounts outstanding
thereunder, and the Company would be unable to repay such amounts. As of
September 30, 2003, $152,000 in aggregate principal amount of the Notes was
outstanding.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
FIN 45 elaborates on the disclosures to be made by a guarantor in its interim
and annual financial statements about its obligations under certain guarantees
that it has issued. FIN 45 requires a guarantor to recognize, at the inception
of a guarantee, a liability for the fair value of the obligations undertaken in
issuing the guarantee. The disclosure provisions of FIN 45 were effective for
financial statements of periods ending after December 15, 2002. The Company
adopted the disclosure provisions of FIN 45 effective December 31, 2002. The
recognition provisions of FIN 45 regarding a guarantor's obligation must be
applied to guarantees issued after December 31, 2002. The adoption of the
recognition provisions of FIN 45, effective January 1, 2003, did not have a
significant effect on the Company's consolidated financial position or results
of operations.
In January 2003, the 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. The provisions of FIN 46 apply to all variable
interest entities created after January 31, 2003. FIN 46 is effective for
variable interest entities created before February 1, 2003 in the first
interim or annual period ending after December 15, 2003. The adoption of FIN 46
is not expected to have any significant impact on the Company's consolidated
financial position or results of operations.
In August 2001, the FASB issued Statement of Financial Accounting
Standards("SFAS") No. 143 "Accounting for Asset Retirement Obligations"("SFAS
143") which requires entities to record the fair value of a liability for an
asset retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing the
carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. The standard was effective for the
Company beginning January 1, 2003. The adoption of SFAS 143 did not have any
impact on the Company's consolidated financial position or results of
operations.
9
In April 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"), which amends and
clarifies accounting for derivative instruments, and for hedging activities
under SFAS 133. Specifically, SFAS 149 requires that contracts with comparable
characteristics be accounted for similarly. Additionally, SFAS 149 clarifies the
circumstances in which a contract with an initial net investment meets the
characteristics of a derivative and when a derivative contains a financing
component that requires special reporting in the statement of cash flows. This
Statement is generally effective for contracts entered into or modified after
June 30, 2003 and did not have a significant impact on the Company's
consolidated financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement will become effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
shall be effective for the Company at the beginning of the first interim period
beginning after December 15, 2003. 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 Company is evaluating the impact that the adoption of
this statement will have on the Company's consolidated financial position or
results of operations.
3. RESTRUCTURING COSTS AND OTHER NON-RECURRING EXPENSES
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred rather than the date an entity commits to an exit
plan. SFAS 146 also establishes that fair value is the objective for initial
measurement of the liability. The provisions of SFAS 146 are effective for exit
or disposal activities that are initiated after December 31, 2002 with earlier
adoption encouraged. The Company adopted SFAS 146 in December 2002.
During the nine-months ended September 30, 2003, the Company reviewed its
restructuring reserve established in 2002 and increased the reserve for
severance in the amount of $308 related to an executive severed in 2002 and $405
for lease terminations resulting from the updating of the assumptions used in
determining the fair value of the remaining lease obligations associated with
facilities vacated during 2002. The $405 restructuring costs increase related to
the vacated facilities includes $476 of interest accretion expense.
Of the restructuring reserve totaling approximately $6,252 at December 31, 2002,
approximately $3,145 was paid in the first nine months of 2003. The remaining
$3,820 is expected to be paid as follows: remaining three months of 2003 - $800,
2004 and beyond - $3,020. These charges are included in other accrued
liabilities on the condensed consolidated balance sheet.
10
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, 2002 Charges Amounts Paid September 30, 2003
------------------ ------- ------------ ------------------
Severance and other benefits $ 1,337 $ 308 $ (1,391) $ 254
Lease terminations 4,915 405 (1,754) 3,566
--------- --------- ---------- ----------
Total $ 6,252 $ 713 $ (3,145) $ 3,820
========= ========= ========== ==========
During the nine months ended September 30, 2003 the Company incurred $192 of due
diligence and other costs related to an acquisition that was not completed and
is not expected to be completed in the foreseeable future. These non-recurring
costs have been included in the statement of operations in Restructuring costs
and other non-recurring expenses.
4. 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 Statement of Financial Accounting Standards
("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.
At September 30, 2002 and 2003, the Company had one stock-based employee
compensation plan. No stock-based employee compensation costs is reflected in
net loss, as all options granted under the plan have an exercise price equal to
the market value of the underlying common stock on the date of grant.
The following tables detail the effect on net income (loss) had compensation
expense for the Stock Option Plan been recorded based on the fair value method
under SFAS 123, as amended for the three-month and nine-month ended September
30, 2002 and 2003, respectively.
Three-months ended September 30,
2002 2003
---- ----
Net income, as reported $ 4,561 $ 3,579
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (143) (118)
------------ -------------
Pro forma net income $ 4,418 $ 3,461
============ =============
Nine-months ended September 30,
2002 2003
---- ----
Net loss, as reported $ (87,500) $ (5,519)
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (407) (411)
------------ -------------
Pro forma net loss $ (87,907) $ (5,930)
============ =============
11
Options vest over several years and additional option grants are expected to be
made in future years, therefore, the pro forma impact on the results of
operations for the three-month and nine-months ended September 30, 2002 and
2003, respectively, is not necessarily representative of the pro forma effects
on the results of operations expected for future periods.
5. DEBT
At September 30, 2003, there were $6,000 in outstanding advances under the
Company's $30,000 revolving credit facility, which bears interest at
approximately 4.6% for eurodollar rate advances and 6.4% for base rate advances
as of September 30, 2003. The Company has a stand-by letter of credit, renewable
annually, in the amount of $2,000 which serves as security for a real estate
lease entered into by the Company. While this letter of credit is in effect, the
Company's available borrowing under the revolving credit facility is reduced by
$2,000.
6. FINANCIAL INSTRUMENTS
Pursuant to the terms of the Amended and Restated Credit Agreement, the Company
is required to enter into and maintain interest rate protection agreements
(interest rate swaps, caps, collars or similar agreements) in a notional amount
equal to at least 50% of the aggregate principal amount of the senior secured
term loans. On November 15, 2002, the Company entered into a one year interest
rate cap agreement with a notional principle of $64,800, 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 September 30, 2003 is de-minimus.
7. INVENTORIES
Inventories are comprised of the following:
December 31, September 30,
2002 2003
---- ----
Finished goods $ 18,178 $ 19,419
Raw materials 181 614
Less - impaired excess and obsolete inventory (3,072) (3,288)
----------- -----------
Carrying value, net $ 15,287 $ 16,745
=========== ===========
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method. The Company periodically evaluates the
realizability of inventories and adjusts the carrying value as necessary.
8. GOODWILL AND INTANGIBLES
The Company completed the transitional impairment tests on its goodwill and
indefinite lived intangibles during the second quarter ended June 30, 2002. The
Company has five reporting units with goodwill. Goodwill was tested for
impairment at the reporting unit level. The Company's measurement of fair value
was based on an evaluation of future discounted cash flows. As a result, the
Company recorded a transitional goodwill and indefinite lived intangible asset
impairment charge of $72,022 at American Guidance Service, Inc., a subsidiary of
Weekly Reader Corporation. This charge is reported as a cumulative effect of
accounting change, as of January 1, 2002, in the Condensed Consolidated
Statements of Operations for the nine-months ended September 30, 2002. The
Company is required to perform impairment tests on an annual basis, or between
yearly tests under certain circumstances for goodwill and indefinite lived
intangibles. The Company performed its annual impairment tests during the fourth
quarter of 2002. No further impairment of goodwill and indefinite lived
intangibles was required. There can be no assurance that future impairment tests
will not result in a charge to earnings.
12
The Company also recorded non-cash deferred income tax expense of $8,700 on
January 1, 2002, related to the adoption of SFAS 142. The non-cash charge of
$8,700 on January 1, 2002 was recorded as an increase in the valuation allowance
related to the deferred tax asset associated with the Company's net operating
losses. Historically, the Company did not need a valuation allowance for the
portion of its net operating loss equal to the excess of tax over book
amortization on tax-deductible goodwill and trademarks since the liability was
expected to reverse during the carryforward period of the net operating losses.
As a result of the adoption of SFAS 142, the timing of the reversal of this
liability is indefinite and can no longer be offset by the Company's net
operating loss carryforwards. While book amortization of tax-deductible goodwill
and trademarks ceased on January 1, 2002, the Company continues to amortize
these assets for tax purposes. As a result, the Company will have deferred tax
liabilities that will arise each quarter as the taxable temporary differences
related to the amortization of these assets will not reverse prior to the
expiration period of the Company's deductible temporary differences unless the
related assets are sold or an impairment of the assets is recorded. Accordingly,
the Company has recorded non-cash deferred income tax expense of $1,500 for each
of the nine-months ended September 30, 2002 and 2003. The Company expects that
it will record an additional $500 of deferred tax expense during the remaining
three-months of 2003.
Changes in Goodwill during the nine-months ended September 30, 2003, are as
follows:
December 31, Other September 30,
2002 Adjustment 2003
---- ---------- ----
Goodwill $ 163,349 $ (78) $ 163,271
============== =========== ===========
In the above table, other adjustment represents $78 of acquisition reserves that
were reversed against goodwill. These were related to differences in actual
costs incurred from initial estimates in implementing staffing integrations that
arose as a result of WRC Media's ChildU acquisition. As a result of this
adjustment, reserves related to the acquisition were reversed and recorded as a
reduction in goodwill.
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, 2002 September 30, 2003
-------------------------------- ------------------------------
Accumulated Accumulated
Useful Lives Gross Amortization Net Gross Amortization Net
------------ ----- ------------ --- ----- ------------ ---
Customer Lists 7-9 yrs $ 62,911 $ (21,456) $ 41,455 $ 62,911 $(26,249) $ 36,662
Copyrights 8 yrs 21,053 (8,139) 12,914 21,053 (10,841) 10,212
Product Titles 7 yrs 13,475 (10,256) 3,219 13,475 (11,422) 2,053
Trade name 5 yrs 3,520 (3,049) 471 3,520 (3,276) 244
Databases 4-10 yrs 560 (551) 9 560 (560) -
Other 1-5 yrs 628 (396) 232 394 (394) -
----------- --------- --------- -------- ---------- ---------
Total: $ 102,147 $ (43,847) $ 58,300 $101,913 $ (52,742) $ 49,171
=========== ========= ========= ======== ========== =========
For trademarks not subject to amortization, which are included in other
intangible assets, the total carrying amount was $42,199 as of December 31, 2002
and September 30, 2003, respectively. The intangible amortization was $3,152 and
$2,785 for the three-months ended September 30, 2002 and 2003, respectively. The
intangible amortization expense recorded was $10,289 and $8,895 for the
nine-months ended September 30, 2002 and 2003, respectively.
The estimated amortization expense for intangible assets still subject to
amortization for the following periods is as follows:
Three months ended 2003 ............................. $ 2,753
Year ended 2004 ............................. $ 9,296
Year ended 2005 ............................. $ 7,786
Year ended 2006 ............................. $ 5,969
Year ended 2007 and thereafter ............................. $ 23,367
13
9. 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.
10. NOTES OFFERING AND GUARANTOR AND NON-GUARANTOR FINANCIAL INFORMATION
In connection with the recapitalization and purchase of Weekly Reader during
November 1999, the Company, Weekly Reader and Compass as co-issuers, completed
an offering of $152.0 million 12 3/4% Senior Subordinated Notes due 2009 (the
"Old Notes"). In June 2000, the Old Notes were exchanged in full for $152.0
million of new 12 3/4% Senior Subordinated Notes due 2009 (the "Notes"), which
have terms that are substantially the same as Old Notes except that the Notes
were registered with the Securities and Exchange Commission. Interest on the
Notes is payable semi-annually, on May 15 and November 15 of each year. The
Notes are jointly, severally, fully and unconditionally guaranteed by certain
subsidiaries of the Company, including CompassLearning, a 100% wholly owned
subsidiary and Weekly Reader, a non-wholly owned subsidiary of the Company
(collectively, the "Subsidiary Guarantors").
The following tables present condensed consolidating financial information as of
and for the three-month and nine-month periods ended September 30, 2002 and 2003
for: (1) the Company on a standalone basis, (2) Weekly Reader Corporation, a
non-wholly owned guarantor subsidiary, (3) CompassLearning, Inc., a wholly owned
guarantor subsidiary on a standalone basis, (4) the non-guarantor subsidiary of
the Company (ChildU, Inc.), and (5) the Company on a consolidated basis.
CompassLearning is not filing a separate report under the Securities Exchange
Act of 1934 as it is a wholly-owned subsidiary of the WRC Media Inc.
Subsidiary Guarantors
-----------------------------------
Compass
WRC Media Weekly Reader Learning WRC Media Inc.
Inc. Corporation Inc. ChildU Elimination Consolidated
--------- ------------- ---------- --------- ----------- --------------
(In thousands)
Balance Sheet as of September 30, 2003
Assets:
Current assets $ 9,503 142,491 $ 17,141 $ 5,032 $ (98,425) $ 75,742
Property and equipment, net - 4,518 798 184 - 5,500
Goodwill and other intangible assets, net 166,002 50,510 24,794 13,335 - 254,641
Other assets 104,757 48,431 6,560 2,304 (118,719) 43,333
--------- --------- --------- --------- --------- ---------
Total assets $ 280,262 245,950 $ 49,293 $ 20,855 $(217,144) $ 379,216
========= ========= ========= ========= ========= =========
Liabilities and stockholders deficit:
Current liabilities $ 101,632 66,953 $ 27,066 $ 13,227 $ (98,416) $ 110,462
Long-term debt, less current portion 147,606 102,565 15,465 - - 265,636
Other liabilities 21,471 2,480 2,864 - - 26,815
Common stock subject to redemption 940 - - - - 940
Redeemable preferred stock, plus accrued
dividends 124,551 75,000 - - (75,000) 124,551
Stockholders equity (deficit): (115,938) (129,587) 1,280 7,628 87,429 (149,188)
Interdivisional equity - 128,539 2,618 (131,157) -
--------- --------- --------- --------- --------- ---------
Total liabilities and stockholders equity (deficit) $ 280,262 245,950 $ 49,293 $ 20,855 $(217,144) $ 379,216
========= ========= ========= ========= ========= =========
14
Subsidiary Guarantors
-----------------------------------
Compass
WRC Media Weekly Reader Learning WRC Media Inc.
Inc. Corporation Inc. ChildU Elimination Consolidated
--------- ------------- ---------- --------- ----------- --------------
(In thousands)
Statements of operations for three months
ended September 30, 2003
Revenue, net $ - $ 44,205 $ 9,682 $ 1,435 $ - $ 55,322
Operating costs and expenses 1,044 30,872 10,745 880 - 43,541
Interest expense, net 5,224 7,148 - - (4,959) 7,413
Other (income) expense 256 (6) - - - 250
Provision for income taxes 370 168 1 - - 539
--------- --------- --------- --------- --------- ---------
Net income (loss) $ (6,894) $ 6,023 (1,064) 555 4,959 $ 3,579
========= ========= ========= ========= ========= =========
Statements of operations for the nine months
ended September 30, 2003
Revenue, net $ - $ 108,259 $ 33,192 $ 4,341 $ - $ 145,792
Operating costs and expenses 3,613 84,996 35,681 2,888 - 127,178
Interest expense, net 15,669 20,881 1 - (14,868) 21,683
Other (income) expense 667 202 - - - 869
Provision for income taxes 1,150 392 39 - - 1,581
--------- --------- --------- --------- --------- ---------
Net income (loss) $ (21,099) $ 1,788 $ (2,529) $ 1,453 $ 14,868 $ (5,519)
========= ========= ========= ========= ========= =========
Cash flow for the nine months
ended September 30, 2003
Cash flow provided by (used in) operations $ (11,504) $ (10,782) $ 5,143 $ 2,272 $ 14,534 $ (337)
Cash flow used in investing activities - (395) (2,299) (1,343) - (4,037)
Cash flow provided by (used in) financing 10,492 7,910 (2,844) (982) (14,534) 42
activities
Cash at beginning of period 1,154 7,819 4 118 - 9,095
--------- --------- --------- --------- --------- ---------
Cash at end of period $ 142 $ 4,552 $ 4 $ 65 $ - $ 4,763
========= ========= ========= ========= ========= =========
Subsidiary Guarantors
-------------------------
Compass Non-
WRC Media Weekly Reader Learning Guarantor WRC Media Inc.
Inc. Corporation Inc. Subsidiary Elimination Consolidated
--------- ------------- ---------- ---------- ----------- --------------
(In thousands)
Statements of operations for three months
ended September 30, 2002
Revenue, net $ - $ 44,458 $ 10,502 $ 1,282 $ - $ 56,242
Operating costs and expenses 1,045 30,084 11,277 1,406 - 43,812
Interest expense, net 5,196 7,325 1 (1) (4,945) 7,576
Other (income) expense 1,219 (1,423) (4) - - (208)
Provision for income taxes 340 161 - - - 501
--------- --------- --------- --------- --------- ---------
Net income (loss) $ (7,800) $ 8,311 $ (772) $ (123) $ 4,945 $ 4,561
========= ========= ========= ========= ========= =========
Statements of operations for the nine months
ended September 30, 2002
Revenue, net $ - $ 109,061 $ 35,767 $ 2,011 $ - $ 146,839
Operating costs and expenses 3,133 84,540 37,166 3,503 - 128,342
Interest expense, net 15,550 21,646 10 - (14,826) 22,380
Other (income) expense 2,860 (1,651) 2 - - 1,211
Provision for income taxes 8,390 1,958 36 - - 10,384
Cumulative effect of change in accounting principle - 72,022 - - - 72,022
--------- --------- --------- --------- --------- ---------
Net income (loss) $ (29,933) $ (69,454) $ (1,447) $ (1,492) $ 14,826 $ (87,500)
========= ========= ========= ========= ========= =========
Cash flow for the nine months
ended September 30, 2002
Cash flow provided by (used in) operations $ (14,402) $ (3,979) $ 5,014 $ (1,685) $ 14,537 $ (515)
Cash flow used in investing activities - (121) (2,502) (1,329) - (3,952)
Cash flow provided by (used in) financing
activities 13,557 5,632 (2,901) 2,914 (14,537) 4,665
Cash at beginning of period 2,643 5,691 394 191 - 8,919
--------- --------- --------- --------- --------- ---------
Cash at end of period $ 1,798 $ 7,223 $ 5 $ 91 $ - $ 9,117
========= ========= ========= ========= ========= =========
11. RELATED PARTY TRANSACTIONS
In connection with the acquisition of Weekly Reader and Compass, the Company
entered into management agreements with a significant shareholder. The
significant provisions of these management agreements are as follows-
Prior to 2000, Compass and the shareholder amended the terms of Compass
management agreement with the shareholder, which relieved Compass of its
obligation to pay management fees to the shareholder. In accordance with Weekly
Reader's management agreement, the shareholder provides to Weekly Reader
management consulting and financial advisory services. As a result of Weekly
Reader's management agreement and the amendment of Compass' management
agreement, Compass and Weekly Reader will reimburse the shareholder for
reasonable out-of-pocket costs and expenses incurred in connection with the
performance of its services and, beginning in the first quarter of 2001, must
pay to the shareholder annual aggregate management fees for services to both
Compass and Weekly Reader. During the nine month periods ended September 30,
2002 and 2003, the Company incurred management fees of $714 and $414,
respectively.
15
12. SUBSEQUENT EVENTS
We announced on October 15, 2003, that Mr. Robert Lynch, Executive Vice
President, Chief Operating Officer, and Director, resigned. WRC Media and Mr.
Lynch, however, have not yet been able to reach a definitive agreement regarding
the terms relating to his departure from the Company. Among other unresolved
matters, Mr. Lynch takes the position that he has not yet resigned. Whether or
not we reach an agreement with Mr. Lynch, certain payments and benefits will be
due to him upon his departure. We do not expect that the payments and benefits
made to him will be material to WRC Media. Mr. Lynch is no longer performing his
former duties for WRC Media.
16
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
December 31, September 30,
2002 2003
------------ -------------
(unaudited)
ASSETS
Current Assets:
Cash $ 7,819 $ 4,552
Accounts receivable (net of allowance for doubtful
accounts of $1,389 and $1,795) 22,881 39,786
Inventories, net 14,210 15,631
Due from related party 9,438 9,238
Prepaid expenses 2,957 2,764
Other current assets 1,797 1,678
--------- ---------
Total current assets 59,102 73,649
Property and equipment, net 5,409 4,518
Goodwill 35,018 35,018
Deferred financing costs, net 692 557
Other intangible assets, net 18,833 15,492
Other assets and investments 25,033 31,698
--------- ---------
Total assets $ 144,087 $ 160,932
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 18,883 $ 16,465
Deferred revenue 20,369 31,415
Accrued expenses and other current liabilities 18,706 16,613
Current portion of long-term debt 7,721 8,863
--------- ---------
Total current liabilities 65,679 73,356
Deferred tax liabilities 2,000 2,480
Long-term debt 266,219 265,636
--------- ---------
Total liabilities 333,898 341,472
--------- ---------
Commitments and contingencies
15% Series B redeemable preferred stock,
including accrued dividends and accretion of warrant
value (3,000,000 shares outstanding)
(Liquidation preference of $132,486) 118,846 132,723
--------- ---------
Stockholders' deficit:
Common stock, ($.01 par value, 20,000,000
shares authorized; 2,830,000 shares
issued & outstanding) 28 28
Additional paid-in capital 9,133 9,133
Due from parent (63,464) (55,981)
Accumulated comprehensive loss (3,357) (3,357)
Accumulated deficit (250,997) (263,086)
--------- ---------
Total stockholders' deficit (308,657) (313,263)
--------- ---------
Total liabilities and stockholders' deficit $ 144,087 $ 160,932
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
17
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2002 2003
-------- --------
Revenue, net $ 44,458 $ 44,205
Cost of goods sold 10,247 10,328
-------- --------
Gross profit 34,211 33,877
-------- --------
Costs and expenses:
Sales and marketing 6,853 7,199
Distribution, circulation and fulfillment 3,497 3,697
Editorial 2,606 2,266
General and administrative 4,339 4,997
Restructuring costs - (647)
Depreciation 462 420
Amortization of intangible assets 2,080 2,612
-------- --------
Total operating costs and expenses 19,837 20,544
-------- --------
Income from operations 14,374 13,333
Other income (expense):
Interest expense, including amortization
of deferred financing costs (7,325) (7,148)
Other income, net 1,423 6
-------- --------
Income before income tax provision 8,472 6,191
Income tax provision 161 168
-------- --------
Net income $ 8,311 $ 6,023
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
18
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2002 2003
-------- --------
Revenue, net $109,061 $108,259
Cost of goods sold 27,149 26,521
-------- --------
Gross profit 81,912 81,738
-------- --------
Costs and expenses:
Sales and marketing 20,364 19,131
Distribution, circulation and fulfillment 9,494 10,112
Editorial 7,476 7,410
General and administrative 12,181 13,878
Restructuring costs - (521)
Depreciation 1,396 1,287
Amortization of intangible assets 6,480 7,178
-------- --------
Total operating costs and expenses 57,391 58,475
-------- --------
Income from operations 24,521 23,263
Other income (expense):
Interest expense, including amortization
of deferred financing costs (21,646) (20,881)
Other income (expense), net 1,651 (202)
-------- --------
Loss before income tax provision 4,526 2,180
Income tax provision 1,958 392
-------- --------
Net loss before cumulative effect of change
in accounting principle 2,568 1,788
Cumulative effect of change in accounting principle (72,022) -
-------- --------
Net (loss) income $(69,454) $ 1,788
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
19
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Amounts in thousands)
2002 2003
--------- --------
Cash flows from operating activities:
Net (loss) income $ (69,454) $ 1,788
Adjustments to reconcile net (loss) income to net cash
used in operating activities:
Cumulative effect of change in accounting principle 72,022 -
Deferred income tax provision 1,840 480
Depreciation and amortization 7,876 8,465
Unrealized gain from hedging transactions (1,619) -
Amortization of deferred financing costs 135 135
Gain (loss) on disposition of property and equipment 43 (1)
Interest expense, accretion of debt discount 291 333
Changes in operating assets and liabilities:
Increase in accounts receivable (17,082) (16,905)
Increase in inventories (1,157) (1,421)
Increase in prepaid expenses and other assets (5,604) (10,191)
Increase (decrease) in accounts payable 1,365 (2,418)
Increase in deferred revenue 14,483 11,046
Decrease in accrued expenses and other liabilities (7,118) (2,093)
--------- --------
Net cash used in operating activities (3,979) (10,782)
--------- --------
Cash flows from investing activities:
Purchase of property and equipment (699) (399)
Proceeds from disposition of property and equipment 578 4
--------- --------
Net cash used in investing activities (121) (395)
--------- --------
Cash flows from financing activities:
Proceeds from revolving line of credit 29,000 27,000
Repayments of revolving line of credit (19,000) (21,000)
Retirement of senior bank debt (4,337) (5,773)
Decrease in due from parent, net 5,045 7,483
(Increase) decrease in due from related party (5,076) 200
--------- --------
Net cash provided by financing activities 5,632 7,910
--------- --------
Increase (decrease) in cash and cash equivalents 1,532 (3,267)
Cash, beginning of period 5,691 7,819
--------- --------
Cash, end of period $ 7,223 $ 4,552
========= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 16,128 $ 16,222
========= ========
Cash paid during the period for income taxes $ 163 $ 39
========= ========
Non-cash financing activities:
Preferred stock dividends accrued $ 11,977 $ 13,877
========= ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
20
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 AND BASIS OF PRESENTATION
Weekly Reader Corporation ("WRC"), PRIMEDIA Reference, Inc. ("PRI") and American
Guidance Services, Inc. ("American Guidance") were wholly owned subsidiaries of
PRIMEDIA Inc. ("PRIMEDIA"). On August 13, 1999, PRIMEDIA entered into a
Redemption, Stock Purchase and Recapitalization Agreement (as amended as of
October 6, 1999, the "Recapitalization Agreement") with WRC Media Inc. ("WRC
Media"). The consolidated financial statements include the accounts of WRC and
its subsidiary, Lifetime Learning System, Inc. ("Lifetime Learning"), PRI and
its subsidiaries, Funk & Wagnalls Yearbook Corporation and Gareth Stevens, Inc.
("Gareth Stevens"), and American Guidance and its subsidiary, AGS International
Sales, Inc. (all are collectively referred to as "Weekly Reader"). As a result
of the recapitalization, WRC Media owns 94.9% and PRIMEDIA 5.1% of the common
stock of Weekly Reader. On November 17, 1999 PRI legally changed its name to
World Almanac Education Group ("WAE"). On May 9, 2001 American Guidance acquired
through a subsidiary all of the operating assets of Lindy Enterprises, Inc.
("Lindy") for approximately $7,500. The transaction was accounted for as an
asset purchase. Lindy develops curriculum-based skills assessment and test
preparation products that correlate to national and state curriculum.
The accompanying condensed consolidated financial statements of the Company as
of September 30, 2003 and for the three and nine month periods ended September
30, 2003 and 2002 have been prepared in accordance with generally accepted
accounting principles for interim financial information and the instructions for
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements In the opinion of management, all
adjustments, consisting of only normal recurring adjustments necessary to
present fairly the financial position, the results of operations and cash flows
for the periods presented, have been made.
These condensed consolidated financial statements should be read in conjunction
with Weekly Reader Corporation and Subsidiaries annual financial statements and
related notes for the year ended December 31, 2002 included in WRC's Annual
Report on Form 10-K. The operating results for the three-month and nine-month
periods ended September 30, 2002 and 2003 are not necessarily indicative of the
results that may be expected for a full year. Certain reclassifications have
been made in the prior year's consolidated financial statements to conform them
with current year presentation.
Based on the Company's current forecast, it expects that as of December 31,
2003, it will not be in compliance with certain of the financial covenants in
its credit agreement. Because these financial covenants become more stringent as
of March 31, 2004, the Company also does not currently expect to be in
compliance after December 31, 2003. If the Company is unable to comply with one
or more of its financial covenants, it will be in default under the credit
agreement. Among other consequences, the Company will be unable to borrow
additional amounts under its revolving credit facility unless it is able to
obtain a waiver from the lenders. For the January through June time period, the
Company usually experiences negative cash flow due to the seasonality of its
business. As a result of this business cycle, borrowings usually increase during
the period January through June. Accordingly, if the Company is unable to borrow
additional amounts under its revolving credit facility, based on its current
forecast and cash position, the Company believes it will have sufficient cash to
pay its current obligations during the first fiscal quarter of 2004. The Company
expects it will have shortfalls in liquidity starting at some point in the
second fiscal quarter of 2004.
The Company's potential alternatives for resolving the liquidity issues
described above include (1) amending certain financial covenants the credit
agreement, (2) refinancing certain components of its capital structure and (3)
raising additional debt or equity capital. The Company is evaluating these
alternatives, and no assurances can be given that it will be successful in
achieving any of these alternatives, on reasonable terms or at all. The Company
can also give no assurances as to when in 2003 or 2004 any such alternatives, if
successful, would be completed, or what their impact on the Company's costs of
financing would be.
21
As of September 30, 2003, $120,900 was outstanding under the Company's term loan
facilities and there was $6,000 of outstanding borrowings under its revolving
credit facility. Upon the occurrence of an event of default under the Company's
credit agreement, our lenders have no obligation to grant the Company a waiver
or extend additional loans under the revolving facility and have the right to
accelerate in full the repayment of all amounts outstanding under the credit
agreement, including all amounts outstanding under the term loan facilities and
revolving credit facility. If any such event of default occurs under our credit
agreement and the lenders take steps to accelerate the amounts due, the Company
would not be able to repay such amounts. The credit agreement is secured by
liens on substantially all of the Company's assets.
In the event that the lenders were to accelerate the Company's prepayment
obligations under the term loan facilities and the revolving facility, such
action would constitute an event of default under the Company's Notes. If such
an event of default occurs under the Notes, the holders of the Notes would have
the right to accelerate in full the repayment of all amounts outstanding
thereunder, and the Company would be unable to repay such amounts. As of
September 30, 2003, $152,000 in aggregate principal amount of the Notes was
outstanding.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
FIN 45 elaborates on the disclosures to be made by a guarantor in its interim
and annual financial statements about its obligations under certain guarantees
that it has issued. FIN 45 requires a guarantor to recognize, at the inception
of a guarantee, a liability for the fair value of the obligations undertaken in
issuing the guarantee. The disclosure provisions of FIN 45 were effective for
financial statements of periods ending after December 15, 2002. The Company
adopted the disclosure provisions of FIN 45 effective December 31, 2002. The
recognition provisions of FIN 45 regarding a guarantor's obligation must be
applied to guarantees issued after December 31, 2002. The adoption of the
recognition provisions of FIN 45, effective January 1, 2003, did not have a
significant effect on the Company's consolidated financial position or results
of operations.
In January 2003, the 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. The provisions of FIN 46 apply to all variable
interest entities created after January 31, 2003. FIN 46 is effective for
variable interest entities created before February 1, 2003 in the first
interim or annual period ending after December 15, 2003. The adoption of FIN 46
is not expected to have any significant impact on the Company's consolidated
financial position or results of operations.
In August 2001, the FASB issued Statement of Financial Accounting
Standards("SFAS") No. 143 "Accounting for Asset Retirement Obligations"("SFAS
143") which requires entities to record the fair value of a liability for an
asset retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing the
carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. The standard was effective for the
Company beginning January 1, 2003. The adoption of SFAS 143 did not have any
impact on the Company's consolidated financial position or results of
operations.
In April 2003, the FASB issued 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.
22
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 will become effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
shall be effective for the Company at the beginning of the first interim period
beginning after December 15, 2003. 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 Company is evaluating the impact the adoption of this
statement will have on the Company's consolidated financial position or results
of operations.
3. RESTRUCTURING AND OTHER NON-RECURRING EXPENSES
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred rather than the date an entity commits to an exit
plan. SFAS 146 establishes that fair value is the objective for initial
measurement of the liability. The provisions of SFAS 146 are effective for exit
or disposal activities that are initiated after December 31, 2002 with earlier
adoption encouraged. The Company adopted SFAS 146 in December 2002.
During the nine-months ended September 30, 2003, the Company reviewed its
restructuring reserve established in 2002 and adjusted the reserve by $521. The
adjustment resulted from a $785 reduction of liability due to updating the
assumptions used in determining the fair value of the remaining lease
obligations associated with facilities vacated during 2002 combined with $225 of
interest accretion expense related to the vacated facilities and a $39 charge
related to an employee severed in 2002.
The restructuring reserve totaling approximately $1,195 at September 30, 2003 is
expected to be paid as follows: remaining three months of 2003 $120 and 2004 and
beyond - $1,075 and is included in accrued expenses and other current
liabilities in the condensed consolidated balance sheet.
Components of the company's restructuring plan initiated in the fourth quarter
of 2002 are shown in the following table:
Balance at Balance at
December 31, Additional September 30,
2002 Adjustments Amounts Paid 2003
---- ----------- ------------ ----
Severance and other benefits $ 649 $ 39 $ (560) $ 128
Lease terminations 2,121 (560) (494) 1,067
------------- ---------- ---------- -------------
Total $ 2,770 $ (521) $ (1,054) $ 1,195
============= ========== ========== =============
4. DEBT
At September 30, 2003, there was $6,000 in outstanding advances under WRC's
$30,000 revolving credit facility, which bears interest at approximately 4.6%
for Eurodollar rate advances and 6.4% base rate advances as of September 30,
2003. The Company has a stand-by letter of credit, renewable annually, in the
amount of $2,000 which serves as security for a real estate lease entered into
by the Company. While this letter of credit is in effect, WRC's available
borrowing under the revolving credit facility is reduced by $2,000.
23
5. FINANCIAL INSTRUMENTS
Pursuant to the terms of the Amended and Restated Credit Agreement, the Company
is required to enter into and maintain interest rate protection agreements
(interest rate swaps, caps, collars or similar agreements) in a notional amount
equal to at least 50% of the aggregate principal amount of the senior secured
term loans. On November 15, 2002, the Company entered into a one year interest
rate cap agreement with a notional principal of $64,800, 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 September 30, 2003 is de-minimus.
6. INVENTORIES
Inventories are comprised of the following:
December 31, September 30,
2002 2003
---- ----
Finished goods $ 17,186 $ 18,384
Raw materials 96 535
Less - impaired excess and obsolete inventory (3,072) (3,288)
------------- ----------
Carrying value, net $ 14,210 $ 15,631
============= ==========
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method. The Company periodically evaluates the
realizability of inventories and adjusts the carrying value as necessary.
7. GOODWILL AND INTANGIBLES
WRC completed the transitional impairment tests on its goodwill and
indefinite-lived intangibles during the second quarter ended June 30, 2002. WRC
has three reporting units with goodwill. Goodwill was tested for impairment at
the reporting unit level. As a result, WRC recorded a transitional goodwill and
indefinite lived intangible asset impairment charge of $72,022 at its
subsidiary, American Guidance Service, Inc. This charge is reported as
cumulative effect of accounting change, as of January 1, 2002, in the Condensed
Consolidated Statement of Operations for the nine-months ended September 30,
2002. WRC is required to perform impairment tests on an annual basis, or between
yearly tests under certain circumstances for goodwill and indefinite lived
intangibles. WRC performed its annual impairment tests during the fourth quarter
of 2002. No further impairment of goodwill and indefinite lived intangibles was
required. There can be no assurance that future impairment tests will not result
in a charge to earnings.
WRC also recorded non-cash deferred income tax expense of approximately $1,360
on January 1, 2002 related to the adoption of SFAS 142. The non-cash charge of
$1,360 on January 1, 2002 was recorded as an increase in the valuation allowance
related to the deferred tax asset associated with WRC's net operating losses.
Historically, WRC did not need a valuation allowance for the portion of its net
operating loss equal to the excess of tax over book amortization on
tax-deductible goodwill and trademarks since the liability was expected to
reverse during the carryforward period of the net operating losses. As a result
of the adoption of SFAS 142, the timing of the reversal of this liability is
indefinite and can no longer be offset by WRC's net operating loss
carryforwards. While book amortization of tax-deductible goodwill and trademarks
ceased on January 1, 2002, WRC will continue to amortize these assets for tax
purposes. As a result, WRC will have deferred tax liabilities that will arise
each quarter because the taxable temporary differences related to the
amortization of these assets will not reverse prior to the expiration period of
WRC's deductible temporary differences unless the related assets are sold or an
impairment of the assets is recorded. Accordingly, WRC has recorded non-cash
deferred income tax expense of $480 for each of the nine-months ended September
30, 2002 and 2003, respectively. WRC expects that it will record an additional
$160 of deferred tax expense during the remaining three months of 2003.
24
The gross carrying amount and accumulated amortization of the WRC's intangible
assets other than goodwill and indefinite-lived intangible assets are as
follows:
December 31, 2002 September 30, 2003
--------------------------------- --------------------------------
Accumulated Accumulated
Gross Amortization Net Gross Amortization Net
----- ------------ --- ----- ------------ --------
Customer Lists 7-9 yrs $ 36,748 $(34,002) $ 2,746 $ 36,748 $ (34,562) $ 2,186
Copyrights 8 yrs 17,520 (14,666) 2,854 17,520 (16,271) 1,249
Product Titles 7 yrs 22,400 (19,181) 3,219 22,400 (20,347) 2,053
Databases 4-10 yrs 5,812 (5,803) 9 5,812 (5,812) -
Other 2-5 yrs 215 (215) - 215 (215) -
-------- --------- -------- -------- -------- --------
Total: $ 82,695 $ (73,867) $ 8,828 $ 82,695 $(77,207) $ 5,488
-------- --------- -------- -------- -------- --------
For trademarks not subject to amortization, which is included in other
intangible assets, the total carrying amount is $10,004 as of December 31, 2002
and September 30, 2003. The intangible amortization expense recorded was $1,201
and $1,060 for the three-months ended September 30, 2002 and 2003, respectively.
The intangible amortization expense recorded was $4,014 and $3,340 for the
nine-months ended September 30, 2002 and 2003, respectively.
The estimated amortization expense for intangible assets still subject to
amortization for the following periods is as follows:
Three months ended 2003 ............................. $ 1,061
Year ended 2004 ............................. $ 2,518
Year ended 2005 ............................. $ 1,008
Year ended 2006 ............................. $ 398
Year ended 2007 and thereafter ............................. $ 503
8. 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.
9. RELATED PARTY TRANSACTIONS
In connection with the acquisition of Weekly Reader and Compass, the Company
entered into management agreements with a significant shareholder. The
significant provisions of these management agreements are as follows-
Prior to 2000, Compass and the shareholder amended the terms of Compass
management agreement with the shareholder, which relieved Compass of its
obligation to pay management fees to the shareholder. In accordance with Weekly
Reader's management agreement, the shareholder provides to Weekly Reader
management consulting and financial advisory services. As a result of Weekly
Reader's management agreement and the amendment of Compass' management
agreement, Compass and Weekly Reader will reimburse the shareholder for
reasonable out-of-pocket costs and expenses incurred in connection with the
performance of its services and, beginning in the first quarter of 2001, must
pay to the shareholder annual aggregate management fees for services to both
Compass and Weekly Reader. During the nine month periods ended September 30,
2002 and 2003, the Company incurred management fees of $714 and $414,
respectively.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is intended to assist in understanding the financial
condition as of September 30, 2003 of WRC Media Inc. ("WRC Media") and its
subsidiaries and their results of operations for the three-months and
nine-months ended September 30, 2002 and 2003. You should read the following
discussion in conjunction with the financial statements of WRC Media and Weekly
Reader Corporation ("Weekly Reader") attached to this discussion and analysis.
Unless the context otherwise requires, references to "Weekly Reader" herein are
to Weekly Reader and its subsidiaries, including American Guidance Service, Inc.
("AGS" or "American Guidance") and World Almanac Education Group, Inc. ("World
Almanac"). Unless the context otherwise requires, the terms "we," "our," and
"us" refer to WRC Media and its subsidiaries, CompassLearning, Inc.
("CompassLearning"), Weekly Reader Corporation and its subsidiaries and ChildU,
Inc. This discussion and analysis contains forward-looking statements. Although
we believe that our plans, intentions and expectations reflected in or suggested
by these forward-looking statements are reasonable, we cannot assure you that
these plans, intentions or expectations will be achieved. These forward-looking
statements are subject to risks, uncertainties and assumptions about us.
Results of Operations for the three-months ended September 30, 2003-- WRC Media
Inc. and Subsidiaries
The results of operations of WRC Media and its subsidiaries encompass the
operations of Weekly Reader and its subsidiaries, including AGS and World
Almanac, CompassLearning, and ChildU, Inc. ("ChildU"). The results of operations
of WRC Media and its subsidiaries should be read together with the separate
discussion of the results of operations of Weekly Reader.
In analyzing WRC Media's results for the three-months ended September 30, 2002
and 2003, the seasonal nature of WRC Media's business should be considered. As a
result of seasonality, approximately 20% of WRC Media's publication and related
service revenues usually occur in its first quarter, 20% in its second quarter,
and 60% in the third and fourth quarters combined. However, unlike this revenue
stream, many of WRC Media's expenses are incurred evenly throughout the year.
WRC Media analyzes its revenues, expenses and operating results on a percentage
of net revenue basis. The following table sets forth, for the periods indicated,
consolidated statements of operations data for WRC Media and its subsidiaries,
expressed in millions of dollars and as a percentage of net revenue.
26
Three-Months Ended September 30,
2002 2003
------------------------ -------------------------
Amount % of Net Revenue Amount % of Net Revenue
------ ---------------- ------ ----------------
(Dollars in millions)
Revenue, net $ 56.2 100.0% $ 55.3 100.0%
Cost of goods sold 15.1 26.9% 14.7 26.6%
------- ----- ------- -----
Gross profit 41.1 73.1% 40.6 73.4%
Costs and expenses:
Sales and marketing 11.1 19.8% 11.8 21.3%
Research and development 0.3 0.5% 0.6 1.1%
Distribution, circulation and fulfillment 3.5 6.2% 3.7 6.7%
Editorial 2.6 4.6% 2.3 4.2%
General and administrative 5.9 10.5% 6.1 11.0%
Restructuring costs -- 0.0% (0.6) (1.1%)
Depreciation 0.7 1.2% 0.5 0.9%
Amortization of intangible assets 4.5 8.0% 4.4 8.0%
------- ----- ------- -----
28.6 50.8% 28.8 52.1%
------- ----- ------- -----
Income from operations 12.5 22.3% 11.8 21.3%
------- ----- ------- -----
Interest expense, including amortization
of deferred financing costs (7.6) (13.5%) (7.4) (13.4%)
Loss on investments (1.0) (1.8%) -- 0.0%
Other income (expense), net 1.2 2.1% (0.3) (0.5%)
------- ----- ------- -----
Income before income tax provision 5.1 9.1% 4.1 7.4%
Income tax provision 0.5 0.9% 0.5 0.9%
------- ----- ------- -----
Net Income $ 4.6 8.2% $ 3.6 6.5%
======= ===== ======= =====
Adjusted EBITDA (a) $ 16.5 29.4% $ 16.3 29.5%
======= ===== ======= =====
(a) Adjusted EBITDA is defined as income or (loss) before interest expense,
taxes, depreciation, amortization and other income (expense) charges
excluding an unrealized hedge gain of $1.4 million for the three-months
ended September 30, 2002 and restructuring costs adjustment of ($0.6)
million for the three-months ended September 30, 2003. Adjusted EBITDA data
is a non-GAAP measure and is included in our discussion because we believe
that this information may be considered by investors as an additional basis
on which to evaluate WRC Media's performance. Because all companies do not
calculate Adjusted EBITDA identically, the presentation of Adjusted EBITDA
in this report is not necessarily comparable to similarly titled measures
of other companies. Adjusted EBITDA is not intended to represent cash flow
from operating activities and should not be considered an alternative to
net income or loss (as determined in conformity with GAAP) as an indicator
of the Company's operating performance or to cash flow as a measure of
liquidity. It is presented herein as the Company evaluates and measures
each business' performance based on their Adjusted EBITDA results.
Three-months ended September 30, 2003 Compared to Three-months ended
September 30, 2002
Net revenue. For the three-months ended September 30, 2003, net revenue
decreased $0.9 million, or 1.6%, to $55.3 million from $56.2 million for the
same period in 2002. This decrease was primarily due to a decrease in net
revenue at World Almanac of $1.6 million, or 12.4%, to $11.3 million from $12.9
million for the same period in 2002 combined with a decrease in net revenue at
CompassLearning of $0.8 million, or 7.6%, to $9.7 million from $10.5 million for
the same period in 2002 partially offset by an increase in net revenue at AGS of
$0.8 million, or 4.0%, to $20.6 million from $19.8 million for the same period
in 2002 combined with an increase at Weekly Reader of $0.5 million, or 4.3%, to
$12.2 million from $11.7 million for the same period in 2002.
Weekly Reader, excluding AGS and World Almanac, net revenue increased $0.5
million, or 4.3%, to $12.2 million from $11.7 million for the same period in
2002. This was attributable to higher custom publishing shipments by Weekly
Reader's subsidiary Lifetime Learning Systems ("LLS") and greater licensing
revenue. LLS revenue increased $0.2 million, or approximately 8.7% for the three
months ended September 30, 2003 compared to the same period in 2002 and
licensing revenue was up $0.2 million or 40.0% for the three-months ended
September 30, 2003 compared to the same period in 2002 driven by higher sales
through its relationship with the telemarketer QVC.
27
AGS net revenue increased by $0.8 million, or 4.0%, to $20.6 million for the
three months ended September 30, 2003 from $19.8 million for the same period in
2002, primarily due to a $0.8 million increase in core curriculum and assessment
products.
World Almanac net revenue decreased by $1.6 million, or 12.4%, to $11.3 million
from $12.9 million for the same period in 2002. This decrease was primarily due
to lower net revenue due to the continuing weak environment for school library
funding.
CompassLearning net revenue decreased $0.8 million, or 7.6%, to $9.7 million
from $10.5 million for the same period in 2002. This decrease was primarily due
to (1) a decrease in service revenue from technical support of $0.4 million, or
11.4%, to $3.1 million from $3.5 million for the same period in 2002, and (2) a
decrease in hardware revenue of $0.4 million, or 80.0%, to $0.1 million from
$0.5 million for the same period in 2002.
At ChildU, a subsidiary of WRC, net revenue increased $0.1 million or 7.7% to
$1.4 million from $1.3 million for the same period in 2002 driven by slightly
higher sales of its web-enabled curriculum products.
The K-12 funding environment continues to be impacted by growing state budget
deficits, which have been causing reductions in state and local educational
spending, including spending on supplemental educational materials. While it is
believed that WRC Media will benefit from numerous provisions in the Federal No
Child Left Behind Act (the "NCLB Act"), most of this Federal educational funding
will not be available until late in 2003 and possibly 2004. Although we expect
that Federal educational funding will improve as a result of the NCLB Act, we do
not believe this funding improvement will be sufficient to offset cuts in state
and local education funding. We expect these cuts and delayed purchases will
negatively affect our top-line net revenue in the fourth quarter and may
continue to affect our top-line revenue in the future.
Gross profit. For the three-months ended September 30, 2003, gross profit
decreased by $0.5 million, or 1.2%, to $40.6 million from $41.1 million for the
same period in 2002. This decrease was primarily attributable to $1.3 million
lower gross profit at World Almanac resulting from its revenue decline and $0.2
million lower gross profit at CompassLearning resulting from its revenue
decline, partially offset by $0.5 million of higher gross profit at Weekly
Reader and $0.4 million of higher gross profit at AGS driven by their higher
revenue. WRC Media's gross profit as a percentage of net revenue increased
slightly to 73.4% in 2003 from 73.1% for the same period in 2002.
Costs and expenses. For the three-months ended September 30, 2003, costs and
expenses increased by $0.2 million, or 0.7%, to $28.8 million from $28.6 million
for the same period in 2002. This increase was primarily due to increased sales
and marketing expenses and higher research and development expense. The Company
recorded $0.6 million of restructuring costs in the three-month period ended
September 30, 2003. The restructuring cost adjustment represents $0.2 million of
interest accretion expense recorded for the three months ended September 30,
2003, net of a $0.8 million reduction of the restructuring reserve attributable
to updating the assumptions used in determining the fair value of the remaining
lease obligations associated with facilities vacated in 2002.
28
Income from operations. For the three-months ended September 30, 2003, income
from operations decreased $0.7 million or 5.6%, to $11.8 million from $12.5
million for the same period in 2002. This decrease was primarily due to the
factors described above.
Interest expense, including amortization of deferred financing costs. For the
three-months ended September 30, 2003, interest expense decreased by $0.2
million, or 2.6%, to $7.4 million from $7.6 million for the same period in 2002
and interest expense as a percentage of net revenue decreased to 13.4% from
13.5% for the same period in 2002.
Loss on investments. During the three-months ended September 30, 2002, the
Company recorded a loss on investments of $1.0 million. The loss in the 2002
period related to a write-down of WRC Media's minority investment in ThinkBox,
Inc. There were no losses on investments during the 2003 period.
Income tax provision. For the three-months ended September 30, 2003, the
provision for income taxes remained constant at $0.5 million. The Company
recorded non-cash deferred income tax expense of $0.5 million during each of the
three-months ended September 30, 2002 and 2003, which is required as a result of
the Company's adoption of Statement of Financial Accounting Standards No. 142
("SFAS 142") effective January 1, 2002. As a result of the adoption of SFAS 142,
book amortization will no longer occur during the carry-forward period of the
Company's operating losses. As a result of book amortization of tax-deductible
goodwill and trademarks ceasing on January 1, 2002, the Company will have
deferred tax liabilities that will arise each year because 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.
Net income. For the three-months ended September 30, 2003, net income decreased
by $1.0 million, or 21.7%, to $3.6 million from $4.6 million for the same period
in 2002 primarily due to the factors described above.
29
Adjusted EBITDA. For the three-months ended September 30, 2003, Adjusted EBITDA
decreased $0.2 million or 1.2% to $16.3 million from $16.5 million for the same
period in 2002. The decrease was primarily attributable to the lower revenue
contribution discussed above. Adjusted EBITDA is defined as income (loss) before
interest expense, income taxes, depreciation, amortization, and other (income)
charges excluding unrealized hedge gain of $1.4 million for the three-months
ended September 30, 2002 and restructuring costs adjustment of ($0.6) million
for the three-months ended September 30, 2003. Adjusted EBITDA data is a
non-GAAP measure and is included in our discussion because we believe that this
information may be considered by investors as an additional basis on which to
evaluate WRC Media's performance. Because all companies do not calculate
Adjusted EBITDA identically, the presentation of Adjusted EBITDA in this report
is not necessarily comparable to similarly titled measures of other companies.
Adjusted EBITDA is not intended to represent cash flow from operating activities
and should not be considered an alternative to net income or loss (as determined
in conformity with GAAP) as an indicator of the Company's operating performance
or to cash flow as a measure of liquidity. It is presented herein as the Company
evaluates and measures each business' performance based on their Adjusted EBITDA
results. As of September 30, 2003, there were $120.9 million senior secured term
loans under the senior credit facilities, of which Adjusted EBITDA as defined in
the credit agreement is utilized for assessing compliance with the financial
covenants of the agreement. If either of the covenants was violated, the debt
would become callable which could adversely affect the Company's financial
condition and liquidity. The current minimum ratio for the leverage ratio is no
greater than 5.50 to 1 and for the fixed charge ratio is no less than 1.05 to 1.
The reconciliation of Adjusted EBITDA to net income is as follows (also see
Liquidity, Working Capital and Capital Resources):
For the three-months ended September 30,
Adjusted EBITDA reconciliation to Net Income ($in 000's) 2002 2003
------------------------ ------------------------
Net income $ 4,561 $ 3,579
Depreciation and amortization of intangibles** 5,292 5,354
Income taxes 501 539
Interest expense 7,576 7,413
Un-realized hedge gain (1,412) -
Restructuring costs - (576)
------------ -------------
Adjusted EBITDA $ 16,518 $ 16,309
============ =============
** Amount includes amortization of capitalized software costs of $104 and $410
for 2002 and 2003, respectively which are included in operating costs and
expenses.
30
Results of Operations for the three-months ended September 30, 2003 -- Weekly
Reader Corporation and Subsidiaries
The following table sets forth, for the periods indicated combined statements of
operations data for Weekly Reader and its subsidiaries expressed in millions of
dollars and as a percentage of net revenue.
Three-Months Ended September 30,
2002 2003
------------------------ ------------------------
Amount % of Net Revenue Amount % of Net Revenue
------ ---------------- ------ ----------------
(Dollars in millions)
Revenue, net $ 44.4 100.0% $ 44.2 100.0%
Cost of goods sold 10.2 23.0% 10.3 23.3%
------- ----- ------- -----
Gross profit 34.2 77.0% 33.9 76.7%
Costs and expenses:
Sales and marketing 6.8 15.3% 7.2 16.3%
Distribution, circulation and fulfillment 3.5 7.9% 3.7 8.4%
Editorial 2.6 5.9% 2.3 5.2%
General and administrative 4.3 9.7% 5.0 11.3%
Restructuring costs -- 0.0% (0.7) (1.6%)
Depreciation 0.5 1.1% 0.4 0.9%
Amortization of intangible assets 2.1 4.7% 2.6 5.9%
------- ----- ------- -----
19.8 44.6% 20.5 46.4%
------- ----- ------- -----
Income from operations 14.4 32.4% 13.4 30.3%
Interest expense (7.3) (16.4%) (7.2) (16.3%)
Other income (expense), net 1.4 3.2% -- 0.0%
------- ----- ------- -----
Income before income tax provision 8.5 19.2% 6.2 14.0%
Income tax provision 0.2 0.5% 0.2 0.5%
------- ----- ------- -----
Net Income $ 8.3 18.7% $ 6.0 13.5%
======= ===== ======= =====
Adjusted EBITDA(a) $ 16.9 38.1% $ 15.7 35.5%
======= ===== ======= =====
(a) Adjusted EBITDA is defined as income (loss) before interest expense, income
taxes, depreciation, amortization, other income (expense) charges excluding
an unrealized hedge gain of $1.4 million for three-months ended September
30, 2002 and restructuring costs adjustment of ($0.7) million for the
three-months ended September 30, 2003. Adjusted EBITDA data is a non-GAAP
measure and is included in our discussion because we believe that this
information may be considered by investors as an additional basis on which
to evaluate Weekly Reader's performance. Because all companies do not
calculate Adjusted EBITDA identically, the presentation of Adjusted EBITDA
in this report is not necessarily comparable to similarly titled measures
of other companies. Adjusted EBITDA is not intended to represent cash flow
from operating activities and should not be considered an alternative to
net income or loss (as determined in conformity with GAAP) as an indicator
of the Company's operating performance or to cash flow as a measure of
liquidity. It is presented herein as the Company evaluates and measures
each business' performance based on their Adjusted EBITDA results.
31
Three-months ended September 30, 2003 compared to three-months ended
September 30, 2002
Net Revenue. For the three-months ended September 30, 2003, net revenue
decreased $0.2 million or 0.5% to $44.2 million from $44.4 million for the same
period in 2002. This decrease was primarily due to a decrease in net revenue at
World Almanac of $1.6 million, or 12.4%, to $11.3 million from $12.9 million for
the same period in 2002, partially offset by an increase in net revenue at AGS
of $0.8 million, or 4.0%, to $20.6 million for the three months ended September
30, 2003 from $19.8 million for the same period in 2002 combined with an
increase at Weekly Reader of $0.5 million, or 4.3%, to $12.2 million for the
three months ended September 30, 2003 from $11.7 million for the same period in
2002.
Weekly Reader, not including AGS and World Almanac, net revenue increased $0.5
million, or 4.3%, to $12.2 million from $11.7 million for the same period in
2002. This was primarily attributable to higher custom publishing shipments by
Weekly Reader's subsidiary Lifetime Learning Systems ("LLS") and greater
licensing revenue. LLS revenue increased $0.2 million, or approximately 8.7% for
the three months ended September 30, 2003 compared to the same period in 2002
and licensing revenue increased by $0.2 million or 40.0% for the three-months
ended September 30, 2003 compared to the same period in 2002 driven by higher
sales through its relationship with the telemarketer QVC.
AGS net revenue increased by $0.8 million, or 4.0%, to $20.6 million from $19.8
million for the same period in 2002, primarily due a $0.8 million increase in
core curriculum and assessment products.
World Almanac net revenue decreased by $1.6 million, or 12.4%, to $11.3 million
from $12.9 million for the same period in 2002. This decrease was primarily due
to the continuing weak environment for school library funding.
Gross profit. For the three-months ended September 30, 2003, gross profit
decreased $0.3 million, or 0.9% to $33.9 million from $34.2 million for the same
period in 2002. Gross profit as a percentage of net revenue decreased slightly
to 76.7% for the three-months ended September 30, 2003 from 77.0% for the same
period in 2002.
Costs and expenses. For the three-months ended September 30, 2003, costs and
expenses increased $0.7 million, or 3.5% to $20.5 million from $19.8 million for
the same period in 2002, and costs and expenses as a percentage of net revenue
increased to 46.4% for the three-months ended September 30, 2003 from 44.6% for
the same period in 2002. This increase was primarily driven by an increase in
general and administrative costs of $0.7 million, or 16.3% and an increase in
sales and marketing expenses of $0.4 million, or 5.9%. The restructuring cost
adjustment of ($0.7) million recorded in the three-months ended September 30,
2003 includes a ($0.8) million reduction of the reserve due to sublease income
exceeding original assumptions net of $0.1 million of interest accretion expense
related to the vacated space. This adjustment relates to the reserve established
in 2002.
32
Income from operations. For the three-months ended September 30, 2003, income
from operations decreased by $1.0 million, or 6.9%, to $13.4 million from $14.4
million for the same period in 2002 and income from operations as a percentage
of net revenue decreased to 30.3% from 32.4% for the same period in 2002. This
decrease was primarily due to the factors described above.
Interest expense. For the three-months ended September 30, 2003, interest
expense decreased by $0.1 million, or 1.4%, to $7.2 million from $7.3 million
for the same period in 2002 and interest expense as a percentage of revenue
decreased to 16.3% from 16.4% for the same period in 2002.
Income tax provision. For the three-months ended September 30, 2003 and 2002,
the provision for income taxes was constant at $0.2 million. Historically,
Weekly Reader did not need a valuation allowance for the portion of its net
operating loss equal to the excess of tax over book amortization on
tax-deductible goodwill and trademarks since the liability was expected to
reverse during the carryforward period of the net operating losses. As a result
of the adoption of SFAS 142, the timing of the reversal of this liability is
indefinite and can no longer be offset by Weekly Reader's net operating loss
carryforwards. While book amortization of tax-deductible goodwill and trademarks
ceased on January 1, 2002, Weekly Reader will continue to amortize these assets
for tax purposes. As a result, Weekly Reader will have deferred tax liabilities
that will arise each quarter because the taxable temporary differences related
to the amortization of these assets will not reverse prior to the expiration
period of Weekly Reader's deductible temporary differences unless the related
assets are sold or an impairment of the assets is recorded. Accordingly, Weekly
Reader recorded non-cash deferred income tax expense of $0.2 million for each of
the three-months ended September 30, 2002 and 2003.
Net income. For the three-months ended September 30, 2003, net income decreased
by $2.3 million, or 27.7%, to $6.0 million from $8.3 million for the same
period in 2002 for the reasons discussed above. Net income as a percentage of
net revenue decreased to 13.6% for the three-months ended September 30, 2003
from 18.7% for the same period in 2002.
33
Adjusted EBITDA. For the three-months ended September 30, 2003, Adjusted EBITDA
decreased by $1.2 million, or 7.1%, to $15.7 million from $16.9 million for the
same period in 2002. This decrease is primarily attributable to the factors
described above. Adjusted EBITDA is defined as income (loss) before interest
expense, income taxes, depreciation, amortization, other (income) charges
excluding unrealized hedge gain of $1.4 million for three-months ended September
30, 2002 and restructuring costs adjustment of ($0.7) million for the
three-months ended September 30, 2003. Adjusted EBITDA data is a non-GAAP
measure and is included in our discussion because we believe that this
information may be considered by investors as an additional basis on which to
evaluate Weekly Reader's performance. Because all companies do not calculate
Adjusted EBITDA identically, the presentation of Adjusted EBITDA in this report
is not necessarily comparable to similarly titled measures of other companies.
Adjusted EBITDA is not intended to represent cash flow from operating activities
and should not be considered an alternative to net income or loss (as determined
in conformity with GAAP) as an indicator of the Company's operating performance
or to cash flow as a measure of liquidity. It is presented herein as the Company
evaluates and measures each business' performance based on their Adjusted EBITDA
results. The reconciliation of Adjusted EBITDA to our net loss below is as
follows:
34
For the three-months ended September 30,
Adjusted EBITDA reconciliation to Net Income ($in 000's) 2002 2003
------------------------ ------------------------
Net income $ 8,311 $ 6,023
Depreciation and amortization of intangibles 2,542 3,032
Income taxes 161 168
Interest expense 7,325 7,148
Un-realized hedge gain (1,412) -
Restructuring costs - (647)
------------ -------------
Adjusted EBITDA $ 16,927 $ 15,724
============ =============
35
Results of Operations for the nine-months ended September 30, 2003-- WRC Media
Inc. and Subsidiaries
The results of operations of WRC Media and its subsidiaries encompass the
operations of Weekly Reader and its subsidiaries, including AGS and World
Almanac, CompassLearning, and ChildU, Inc. ("ChildU"). The results of operations
of WRC Media and its subsidiaries should be read together with the separate
discussion of the results of operations of Weekly Reader.
In analyzing WRC Media's results for the nine-months ended September 30, 2002
and 2003, the seasonal nature of WRC Media's business should be considered. As a
result of seasonality, approximately 20% of WRC Media's publication and related
service revenues usually occur in its first quarter, 20% in its second quarter,
and 60% in the third and fourth quarters combined. However, unlike this revenue
stream, many of WRC Media's expenses are incurred evenly throughout the year.
WRC Media analyzes its revenues, expenses and operating results on a percentage
of net revenue basis. The following table sets forth, for the periods indicated,
consolidated statements of operations data for WRC Media and its subsidiaries,
expressed in millions of dollars and as a percentage of net revenue.
Nine-Months Ended September 30,
2002 2003
-------------------------- ------------------------
Amount % of Net Revenue Amount % of Net Revenue
------- ---------------- ------ ----------------
(Dollars in millions)
Revenue, net $ 146.8 100.0% $ 145.8 100.0%
Cost of goods sold 41.2 28.1% 40.0 27.4%
-------- ------ -------- -----
Gross profit 105.6 71.9% 105.8 72.6%
Costs and expenses:
Sales and marketing 36.1 24.6% 33.3 22.8%
Research and development 1.2 0.8% 1.6 1.1%
Distribution, circulation and fulfillment 9.5 6.5% 10.1 6.9%
Editorial 7.5 5.1% 7.4 5.1%
General and administrative 16.4 11.2% 18.4 12.6%
Restructuring costs and other non-recurring - 0.0% 0.9 0.6%
expenses
Depreciation 2.3 1.6% 1.8 1.2%
Amortization of intangible assets 14.1 9.6% 13.7 9.4%
-------- ------ -------- -----
87.1 59.4% 87.2 59.7%
-------- ------ -------- -----
Income from operations 18.5 12.5% 18.6 12.9%
-------- ------ -------- -----
Interest expense, including amortization
of deferred financing costs (22.4) (15.3%) (21.7) (14.9%)
Loss on investments (2.1) (1.4%) - 0.0%
Other income (expense), net 0.9 0.6% (0.8) (0.5%)
-------- ------ -------- -----
Loss before income tax provision (5.1) (3.6%) (3.9) (2.6%)
Income tax provision 10.4 7.1% 1.6 1.1%
-------- ------ -------- -----
Loss before cumulative effect of change
in accounting principle (15.5) (10.7%) (5.5) (3.7%)
Cumulative effect of change in accounting principle (72.0) (49.0%) - 0.0%
-------- ------ -------- -----
Net loss $ (87.5) (59.7%) $ (5.5) (3.7%)
======== ====== ======== =====
Adjusted EBITDA (a) $ 32.2 21.9% $ 35.1 24.1%
======== ====== ======== =====
(a) Adjusted EBITDA is defined as income or (loss) before interest expense,
taxes, depreciation, amortization and other (income) expense charges
excluding an unrealized hedge gain of $1.6 million for the nine-months ended
September 30, 2003, restructuring costs of $0.7 million for the nine-months
ended September 30, 2003 and other non-recurring expenses of $0.2 million
for the nine-months ended September 30, 2003. Adjusted EBITDA data is a
non-GAAP measure and is included in our discussion because we believe that
this information may be considered by investors as an additional basis on
which to evaluate WRC Media's performance. Because all companies do not
calculate Adjusted EBITDA identically, the presentation of Adjusted EBITDA
in this report is not necessarily comparable to similarly titled measures of
other companies. Adjusted EBITDA is not intended to represent cash flow from
operating activities and should not be considered an alternative to net
income or loss (as determined in conformity with GAAP) as an indicator of
the Company's operating performance or to cash flow as a measure of
liquidity. It is presented herein as the Company evaluates and measures each
business' performance based on their Adjusted EBITDA results.
36
Nine-months ended September 30, 2003 compared to nine-months ended
September 30, 2002
Net revenue. For the nine-months ended September 30, 2003, net revenue decreased
$1.0 million, or 0.7%, to $145.8 million from $146.8 million for the same period
in 2002. The revenue decline was primarily driven by a decrease in net revenue
at World Almanac of $3.0 million, caused by the continuing weak environment for
school library funding; partially offset by an increase in revenue at Weekly
Reader of $2.5 million.
At Weekly Reader, excluding AGS and World Almanac, net revenue increased $2.5
million, or 9.8%, to $28.0 million from $25.5 million for the same period in
2002. This revenue increase was primarily attributable to higher custom
publishing shipments by Weekly Reader's subsidiary Lifetime Learning Systems and
increased sales through its relationship with the telemarketer QVC.
AGS net revenue decreased $0.3 million, or 0.7%, to $45.8 million for the
nine-months ended September 30, 2003 from $46.2 million for the same period in
2002, primarily due to a $1.4 million decrease in backlist curriculum products
sold, partially offset by growth in assessment products of $1.1 million.
World Almanac net revenue decreased $3.0 million, or 8.0%, to $34.4 million from
$37.4 million for the same period in 2002. This decrease was primarily due to
lower shipments at WAE Library Services and Gareth Stevens resulting from the
continuing weak environment for school library funding.
CompassLearning net revenue decreased $2.6 million, or 7.3%, to $33.2 million
for the nine months ended September 30, 2003 from $35.8 million for the same
period in 2002. This decrease was primarily due to a decrease in service revenue
from technical support of $0.9 million, or 8.7%, to $9.4 million from $10.3
million in for the same period in 2002, a decrease in professional development
revenue of $0.8 million, or 10.5%, to $6.8 million from $7.6 million for the
same period in 2002 combined with a decrease in hardware revenue of $0.5
million, or 50.0%, to $0.5 million from $1.0 million for the same period in
2002. At ChildU, net revenue increased $2.3 million or 115.0% to $4.3 million
for the nine months ended September 30, 2003 from $2.0 million for the same
period in 2002 driven by significantly higher sales of its web-enabled
curriculum products.
The K-12 funding environment continues to be impacted by growing state budget
deficits, which have been causing reductions in state and local educational
spending, including spending on supplemental educational materials. While we
believe WRC will benefit from numerous provisions in the Federal No Child Left
Behind Act (the "NCLB Act"), most of this Federal educational funding will not
be available until later in 2003 and early 2004. Although we expect that Federal
educational funding will increase in late 2003 as a result of the NCLB Act, we
do not believe this funding improvement will be sufficient to offset cuts in
state and local education funding. We expect these cuts and delayed purchases
will negatively affect our top-line net revenue in the fourth quarter and may
continue to affect our top-line performance into fiscal year 2004. The
uncertainty in the current operating environment makes it difficult to forecast
future results.
37
Gross profit. For the nine-months ended September 30, 2003, gross profit
increased by $0.2 million, or 0.2%, to $105.8 million from $105.6 million for
the same period in 2002. This increase was primarily attributable to $2.0
million of higher gross profit at ChildU combined with higher gross profit at
Weekly Reader of $2.0 million resulting from the increase in revenues discussed
above, partially offset by a lower gross profit at CompassLearning of $1.7
million and lower gross profit at World Almanac of $2.2 million. WRC Media's
gross profit as a percentage of net revenue increased to 72.6% for the
nine-months ended September 30, 2003 from 71.9% for the same period in 2002.
Costs and expenses. For the nine-months ended September 30, 2003, costs and
expenses increased by $0.1 million, or 0.1%, to $87.2 million from $87.1 million
for the same period in 2002. This was primarily attributable to an increase of
$2.0 million in general and administrative expenses and $0.9 million in
restructuring costs and non-recurring expenses partially offset by $2.8 million
or 7.8% decrease in sales and marketing expenses. The higher general and
administrative expenses were primarily due to bad debt expense of $0.9 million
at CompassLearning. The higher bad debt expense was recorded due to the
uncertainty of collection of a receivable which resulted from a change in
financial condition of a customer. The restructuring cost adjustment of $0.9
million recorded in the nine-months ended September 30, 2003 is attributable
primarily to the Company's update of its assumptions used in determining the
fair value of the remaining lease obligations associated with the facilities
vacated during 2002.
Income from operations. For the nine-months ended September 30, 2003, income
from operations increased $0.1 million or 0.5%, to $18.6 million from $18.5
million for the same period in 2002, due to the factors described above.
Interest expense, including amortization of deferred financing costs. For the
nine-months ended September 30, 2003, interest expense decreased by $0.7
million, or 3.1%, to $21.7 million from $22.4 million for the same period in
2002 and interest expense as a percentage of net revenue decreased to 14.9% from
15.3% for the same period in 2002.
Loss on investment. During the nine-months ended September 30, 2003, the Company
recorded a loss on investment of $2.1 million. The loss in the prior period
related to equity losses attributable to WRC Media's minority investment in
ThinkBox, Inc. There were no losses on investments during the 2003 period.
Income tax provision. For the nine-months ended September 30, 2003, the
provision for income taxes decreased $8.8 million or 84.6% to an income tax
provision of $1.6 million from $10.4 million for the same period in 2002. The
Company recorded non-cash deferred income tax expense of $8.7 million on January
1, 2002 and $1.5 million during the nine-months ended September 30, 2002 and
2003, which would not have been required prior to the adoption of SFAS 142. The
non-cash charge of $8.7 million on January 1, 2002 was recorded to increase the
valuation allowance related to the Company's net operating losses. As a result
of the adoption of SFAS 142, book amortization will not occur during the
carry-forward period of the operating losses. In addition, since book
amortization of tax-deductible goodwill and trademarks ceased on January 1,
2002, the Company will have deferred tax liabilities that will arise each year
because 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.
38
Net loss. For the nine-months ended September 30, 2003, net loss decreased by
$82.0 million, or 93.7%, to $5.5 million from $87.5 million for the same period
in 2002 primarily due to the non-cash charges recorded in the prior period
resulting in the Company's adoption of SFAS 142 as described above.
Adjusted EBITDA. Adjusted EBITDA is defined as income or (loss) before interest
expense, income taxes, depreciation, amortization, other (income) charges
excluding unrealized hedge gain of $1.6 million for the nine-months ended
September 30, 2002, restructuring costs of $0.7 million for the nine-months
ended September 30, 2003 and non-recurring expenses of $0.2 million for the
nine-months ended September 30, 2003. Adjusted EBITDA data is a non-GAAP measure
and is included in our discussion because we believe that this information may
be considered by investors as an additional basis on which to evaluate WRC
Media's performance. Because all companies do not calculate Adjusted EBITDA
identically, the presentation of Adjusted EBITDA in this report is not
necessarily comparable to similarly titled measures of other companies. Adjusted
EBITDA is not intended to represent cash flow from operating activities and
should not be considered an alternative to net income or loss (as determined in
conformity with GAAP) as an indicator of the Company's operating performance or
to cash flow as a measure of liquidity. It is presented herein as the Company
evaluates and measures each business' performance based on their Adjusted EBITDA
results. As of September 30, 2003, there were $120.9 million senior secured term
loans under the senior credit facilities, of which Adjusted EBITDA as defined in
the credit agreement is utilized in for assessing compliance with the financial
covenants of the agreement. If either of the covenants was to be violated, the
debt would become callable which could adversely affect the Company's financial
condition and liquidity. The current minimum ratio for the leverage ratio is no
greater than 5.50 to 1 and for the fixed charge ratio is no less than 1.05 to 1.
The reconciliation of Adjusted EBITDA to net loss is as follows:
39
For the three-months ended September 30,
Adjusted EBITDA reconciliation to Net Income ($in 000's) 2002 2003
------------------------ ------------------------
Net income $ (87,500) $ (5,519)
Depreciation and amortization of intangibles** 16,537 16,477
Income taxes 10,384 1,581
Interest expense 22,380 21,683
Cumulative effect of change in accounting principle 72,022 -
Un-realized hedge gain (1,619) -
Restructuring costs - 713
Non-recurring expenses - 192
------------ -------------
Adjusted EBITDA $ 32,204 $ 35,127
============ =============
** Amount includes amortization of capitalized software costs of $104 and
$1,002 for 2002 and 2003, respectively, which are included in operating
costs and expenses.
40
Results of Operations for the nine-months ended September 30, 2003 -- Weekly
Reader Corporation and Subsidiaries
The following table sets forth, for the periods indicated combined statements of
operations data for Weekly Reader and its subsidiaries expressed in millions of
dollars and as a percentage of net revenue.
Nine-Months Ended September 30,
2002 2003
-------------------------- ------------------------
Amount % of Net Revenue Amount % of Net Revenue
------- ---------------- ------ ----------------
(Dollars in millions)
Revenue, net $ 109.0 100.0% $ 108.3 100.0%
Cost of goods sold 27.1 24.9% 26.5 24.5%
-------- ------- -------- -------
Gross profit 81.9 75.1% 81.8 75.5%
Costs and expenses:
Sales and marketing 20.3 18.6% 19.1 17.6%
Distribution, circulation and fulfillment 9.5 8.7% 10.1 9.3%
Editorial 7.5 6.9% 7.4 6.8%
General and administrative 12.2 11.2% 13.9 12.8%
Restructuring costs - 0.0% (0.5) (0.5%)
Depreciation 1.4 1.3% 1.3 1.2%
Amortization of intangible assets 6.5 6.0% 7.2 6.6%
-------- ------- -------- -------
57.4 52.7% 58.5 53.8%
-------- ------- -------- -------
Income from operations 24.5 22.4% 23.3 21.6%
Interest expense (21.7) (19.9%) (20.9) (19.3%)
Other income (expense), net 1.7 1.6% (0.2) (0.2%)
-------- ------- -------- -------
Loss before income tax provision 4.5 4.1% 2.2 2.2%
Income tax provision 2.0 1.8% 0.4 0.4%
-------- ------- -------- -------
Loss before cumulative effect of change
in accounting principle 2.5 2.3% 1.7 1.8%
Cumulative effect of change in accounting principle (72.0) (66.1%) - 0.0%
-------- ------- -------- -------
Net (loss) income $ (69.5) (63.8%) $ 1.7 1.8%
======== ======= ======== =======
Adjusted EBITDA(a) $ 32.4 29.7% $ 31.0 28.6%
======== ======= ======== =======
(a) Adjusted EBITDA is defined as income (loss) before interest expense, income
taxes, depreciation, amortization, other income (expense) charges excluding
an unrealized hedge gain of $1.6 million in 2002 and restructuring cost of
($0.5) million for the nine-months ended September 30, 2003. Adjusted
EBITDA data is a non-GAAP measure and is included in our discussion because
we believe that this information may be considered by investors as an
additional basis on which to evaluate Weekly Reader's performance. Because
all companies do not calculate Adjusted EBITDA identically, the
presentation of Adjusted EBITDA in this report is not necessarily
comparable to similarly titled measures of other companies. Adjusted EBITDA
is not intended to represent cash flow from operating activities and should
not be considered an alternative to net income or loss (as determined in
conformity with GAAP) as an indicator of the Company's operating
performance or to cash flow as a measure of liquidity. It is presented
herein as the Company evaluates and measures each business' performance
based on their Adjusted EBITDA results.
41
Nine-months ended September 30, 2003 compared to nine-months ended
September 30, 2002
Net revenue. For the nine-months ended September 30, 2003, net revenue decreased
$0.7 million or 0.6% to $108.3 million from $109.0 million for the same period
in 2002.
At Weekly Reader, excluding AGS and World Almanac, net revenue increased $2.5
million, or 9.8%, to $28.0 million from $25.5 million for the same period in
2002. This was primarily attributable to higher custom publishing shipments by
Weekly Reader's subsidiary Lifetime Learning Systems and increased sales through
its relationship with the telemarketer QVC.
AGS net revenue decreased $0.3 million, or 0.7%, to $45.8 from $46.1 million for
the same period in 2002, primarily due to a $1.4 million decrease in backlist
curriculum products sold, partially offset by the growth in assessment products
of $1.1 million.
World Almanac net revenue decreased $3.0 million, or 8.0%, to $34.4 million from
$37.4 million for the same period in 2002. This decrease was primarily due to
lower shipments at WAE Library Services and Gareth Stevens resulting from the
continued weak environment for school library funding.
Gross profit. For the nine-months ended September 30, 2003, gross profit
decreased $0.1 million, or 0.1% to $81.8 million from $81.9 million for the same
period in 2002. Gross profit as a percentage of net revenue slightly increased
to 75.5% for the nine-months ended September 30, 2003 from 75.1% for the same
period in 2002.
Costs and expenses. For the nine-months ended September 30, 2003, costs and
expenses increased $1.1 million, or 1.9% to $58.5 million from $57.4 million for
the same period in 2002. Costs and expenses as a percentage of net revenue
increased to 53.8% for the nine-months ended September 30, 2003 from 52.7% for
the same period in 2002. The increase in costs and expenses was primarily driven
by an increase in general and administrative expenses of $1.7 million, or 13.9%.
A restructuring cost adjustment of $0.8 million was recorded to reduce the
restructuring reserve established in 2002 due to higher than anticipated future
sublease income, partially offset by $0.3 million in interest accretion expense
in the nine-months ended September 30, 2003.
Income from operations. For the nine-months ended September 30, 2003, income
from operations decreased by $1.2 million, or 4.9%, to $23.3 million from $24.5
million for the same period in 2002 for the reasons discussed above. Income from
operations as a percentage of net revenue decreased to 21.6% from 22.4% for the
same period in 2002. This decrease was primarily due to the factors described
above.
Interest expense. For the nine-months ended September 30, 2003, interest expense
decreased by $0.8 million, or 3.7%, to $20.9 million from $21.7 million for the
same period in 2002. Interest expense as a percentage of net revenue decreased
to 19.3% from 19.9% for the same period in 2002.
42
Income tax provision. For the nine-months ended September 30, 2003, the
provision for income taxes decreased by $1.6 million, or 80.0%, to $0.4 million
from $2.0 million for the same period in 2002. Weekly Reader recorded non-cash
deferred income tax expense of approximately $1.4 million on January 1, 2002
related to the adoption of SFAS 142. The non-cash charge of $1.4 million on
January 1, 2002 was recorded to increase the valuation allowance related to the
deferred tax asset associated with Weekly Reader's net operating losses.
Historically, Weekly Reader did not need a valuation allowance for the portion
of its net operating loss equal to the excess of tax over book amortization on
tax-deductible goodwill and trademarks since the liability was expected to
reverse during the carryforward period of the net operating losses. As a result
of the adoption of SFAS 142, the timing of the reversal of this liability is
indefinite and can no longer be offset by Weekly Reader's net operating loss
carryforwards. While book amortization of tax-deductible goodwill and trademarks
ceased on January 1, 2002, Weekly Reader will continue to amortize these assets
for tax purposes. As a result, Weekly Reader will have deferred tax liabilities
that will arise each quarter because the taxable temporary differences related
to the amortization of these assets will not reverse prior to the expiration
period of Weekly Reader's deductible temporary differences unless the related
assets are sold or an impairment of the assets is recorded. Accordingly, Weekly
Reader recorded non-cash deferred income tax expense of $0.5 million for each of
the nine-months ended September 30, 2002 and 2003.
Net income(loss). For the nine-months ended September 30, 2003, net income
increased by $71.3 million to net income of $1.8 million from a net loss of
$69.5 million for the same period in 2002 primarily due to the non-cash charges
recorded in the prior period resulting in the Company's adoption of SFAS No. 142
as described above. Net income (loss) as a percentage of net revenue improved to
1.8% for the nine-months ended September 30, 2003 from negative 63.8% for the
same period in 2002.
ADJUSTED EBITDA. For the nine-months ended September 30, 2003, adjusted EBITDA
decreased $1.4 million, or 4.3%, to $31.0 million from $32.4 million for the
same period in 2002. This decrease is primarily attributable to the factors
described above. Adjusted EBITDA is defined as income (loss) before interest
expense, income taxes, depreciation, amortization, other (income) charges
including an unrealized hedge gain of $1.6 million for nine-months ended
September 30, 2002 and ($0.5) restructuring costs adjustment for the nine-months
ended September 30, 2003. Adjusted EBITDA data is a non-GAAP measure and is
included in our discussion because we believe that this information may be
considered by investors as an additional basis on which to evaluate Weekly
Reader's performance. Because all companies do not calculate Adjusted EBITDA
identically, the presentation of Adjusted EBITDA in this report is not
necessarily comparable to similarly titled measures of other companies. Adjusted
EBITDA is not intended to represent cash flow from operating activities and
should not be considered an alternative to net income or loss (as determined in
conformity with GAAP) as an indicator of the Company's operating performance or
to cash flow as a measure of liquidity. It is presented herein as the Company
evaluates and measures each business' performance based on their Adjusted EBITDA
results. The reconciliation of Adjusted EBITDA our net loss is as follows:
43
For the three-months ended September 30,
Adjusted EBITDA reconciliation to Net (loss) Income 2002 2003
($in 000's) ------------------------ ------------------------
Net (loss) income $ (69,454) $ 1,788
Depreciation and amortization of intangibles 7,876 8,465
Income taxes 1,958 392
Interest expense 21,646 20,881
Un-realized hedge gain (1,619) -
Cumulative effect of change in accounting principle 72,022 -
Restructuring costs - (521)
------------ -------------
Adjusted EBITDA $ 32,429 $ 31,005
============ =============
Liquidity, Working Capital and Capital Resources
General
WRC Media's sources of cash are its (1) operating subsidiaries, Weekly Reader
Corporation and CompassLearning, Inc., and (2) a $30.0 million revolving credit
facility. As of September 30, 2003, $6.0 million of the revolving credit
facility has been drawn down which bears interest that approximated 4.6%.
Additionally, the Company has a stand-by letter of credit, renewable annually,
in the amount of $2.0 million, which serves as security for a real estate lease
entered into by the Company. While this letter of credit is in effect, it
reduces available borrowing under the revolving credit facility by $2.0 million.
Based on our current forecast, we expect that as of December 31, 2003, we will
not be in compliance with certain of the financial covenants in our credit
agreement. Because these financial covenants become more stringent as of March
31, 2004, we also currently do not expect we will be in compliance after
December 31, 2003. If we are unable to comply with one or more of our financial
covenants, we will be in default under our credit agreement. Among other
consequences, we will be unable to borrow additional amounts under our revolving
credit facility unless we are able to obtain a waiver from our lenders. For the
January through June time period, WRC Media and its subsidiaries usually
experience negative cash flow due to the seasonality of its business. As a
result of this business cycle, borrowings usually increase during the period
January through June. Accordingly, if we are unable to borrow additional amounts
under our revolving credit facility, based on our current forecast and cash
position, we believe we will have sufficient cash to pay our current obligations
during the first fiscal quarter of 2004, but that we will have shortfalls in
liquidity starting at some point in the second fiscal quarter of 2004.
Our potential alternatives for resolving the liquidity issues described above
include (1) amending certain financial covenants in our credit agreement, (2)
refinancing certain components of our capital structure and (3) raising
additional debt or equity capital. We are evaluating these alternatives, and no
assurances can be given that we will be successful in achieving any of these
alternatives, on reasonable terms or at all. We also can give no assurances as
to when in 2003 or 2004 any such alternatives, if successful, would be
completed, or what their impact on our costs of financing would be.
44
As of September 30, 2003, $120.9 million was outstanding under our term loan
facilities and there was $6.0 million of outstanding borrowings under our
revolving credit facility. Upon the occurrence of an event of default under our
credit agreement, our lenders have no obligation to grant us a waiver or extend
additional loans under the revolving facility and have the right to accelerate
in full the repayment of all amounts outstanding under our credit agreement,
including all amounts outstanding under the term loan facilities and revolving
credit facility. If any such event of default occurs under our credit agreement
and the lenders take steps to accelerate the amounts due, we would not be able
to repay such amounts. Our credit agreement is secured by liens on substantially
all of our assets.
In the event that the lenders were to accelerate our prepayment obligations
under the term loan facilities and the revolving facility, such action would
constitute an event of default under our Notes. If such an event of default
occurs under our Notes, the holders of the Notes would have the right to
accelerate in full the repayment of all amounts outstanding thereunder, and we
would be unable to repay such amounts. As of September 30, 2003, $152,000,000 in
aggregate principal amount of the Notes was outstanding.
Credit Agreement Financial Covenants
The terms of our senior secured credit agreement require us on an ongoing basis
to meet certain financial covenants, including a maximum leverage ratio covenant
and a minimum fixed charge coverage ratio covenant. Compliance with these
covenants is measured as of the last day of each fiscal quarter. Each ratio
becomes more stringent periodically through March 31, 2004. With respect to the
first two fiscal quarters of 2003, we were required to have a leverage ratio no
greater than 5.75:1.0 and a fixed charge coverage ratio no less than 1.05:1.0.
With respect to the third quarter ended September 30, 2003, we were required to
have a leverage ratio no greater than 5.50:1.0 and a fixed charge coverage ratio
no less than 1.05:1.0. For the fiscal quarter ended September 30, 2003, our
leverage ratio was 5.41:1.0 and our fixed charge coverage ratio was 1.12:1.0.
With respect to the fourth quarter ending December 31, 2003, we are required to
have a leverage ratio no greater than 5.00:1.0 and a fixed charge coverage ratio
no less than 1.10:1.0 and thereafter beginning with the quarter ending March 31,
2004, we are required to have a leverage ratio no greater than 4.00:1.0 and a
fixed charge ratio no less than 1.50:1.0. Based on our current forecast, we
expect we will not be in compliance with these covenants as of December 31, 2003
and thereafter.
Third Quarter Liquidity, Working Capital and Capital Resources
As of September 30, 2003, WRC Media and its subsidiaries had negative working
capital of $35.2 million. WRC Media's cash and cash equivalents were
approximately $4.8 million at September 30, 2003. WRC Media and its
subsidiaries' operations used approximately $0.3 million in cash for the
nine-months ended September 30, 2003. WRC Media and its subsidiaries' principal
uses of cash are for debt service, working capital and potential acquisitions.
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WRC Media and its subsidiaries' investing activities for the nine-months ended
September 30, 2003, included investments in software development of
approximately $3.1 million and capital expenditures of approximately $1.0
million.
WRC Media and its subsidiaries' financing activities consist of making drawings
from, and repayments to, our revolving credit facility and retiring amounts due
under our senior secured term loans. For the nine-months ended September 30,
2003, financing activities provided net cash of $0.0 million, which primarily
resulted from net borrowings of $6.0 million under the revolving credit facility
which were offset by a $5.8 million repayment of the senior secured term loans
and $0.2 million of financing costs.
Recent Events
We announced on October 15, 2003, that Mr. Robert Lynch, Executive Vice
President, Chief Operating Officer, and Director, resigned. WRC Media and Mr.
Lynch, however, have not yet been able to reach a definitive agreement regarding
the terms relating to his departure from the Company. Among other unresolved
matters, Mr. Lynch takes the position that he has not yet resigned. Whether or
not we reach an agreement with Mr. Lynch, certain payments and benefits will be
due to him upon his departure. We do not expect that the payments and benefits
made to him will be material to WRC Media. Mr. Lynch is no longer performing his
former duties for WRC Media.
Accounting Policies and Estimates
There have been no changes in accounting policies or estimates that would have a
material effect on the financial statements. See Note 2 to the consolidated
financial statements filed in WRC Media's annual report on Form 10-K for the
year ended December 31, 2002.
Seasonality
Operating results have varied and are expected to continue to vary from quarter
to quarter as a result of seasonal patterns. Weekly Reader and CompassLearning's
net revenue are significantly affected by the school year. Weekly Reader's net
revenue in the third, and to a lesser extent the fourth, quarters are generally
the strongest as products are shipped for delivery during the school year.
CompassLearning's revenues were historically strongest in the second quarter,
and to a lesser extent the fourth quarter. However, due to tight funding
environment in the last couple of year, the trend is shifting towards the fourth
quarter being the strongest, followed by the second quarter. The strength in the
second quarter is generally attributed to the end of the school fiscal year
(June 30th) and the need for the schools to spend the money prior to year end.
In addition, by purchasing in the second quarter, schools are able to have the
software products purchased and installed over the summer and ready to train
teachers when they return from summer vacation. However, due to budget cuts,
schools do not have excess money by the end of their fiscal year resulting in
lower sales for CompassLearning in our second fiscal quarter. CompassLearning's
fourth quarter revenue is strong as a result of sales patterns driven by new
school year money being appropriated and funded, CompassLearning's commissioned
sales force seeking to meet year-end sales goals as well as schools purchasing
software to be installed in time to take advantage of it during the second half
of the school year.
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Inflation
We do not believe that inflation has had a material impact on our financial
position or results of operations for the periods discussed above. Although
inflationary increases in paper, postage, labor or operating costs could
adversely affect operations, we have generally been able to offset increases in
costs through price increases, labor scheduling and other management actions.
Factors that may affect the future results and financial condition
This Quarterly Report on Form 10-Q contains forward-looking statements.
Additional written and oral forward-looking statements may be made by the
Company from time to time in Securities and Exchange Commission ("SEC") filings
and otherwise. The Company cautions readers that results predicted by
forward-looking statements, including, without limitation, those relating to the
Company's future business prospects, revenues, working capital, liquidity,
capital needs, interest costs and income, are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
indicated in the forward-looking statements, due to factors including the
following and other risks and factors identified from time to time in the
Company's filings with the SEC:
The Company's ability (1) to cure its expected default under its credit facility
through one of the alternatives described under "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity, Working
Capital and Capital Resources," (2) to avoid the acceleration of all amounts due
under the credit facility and its Notes if such a default does occur and (3) to
find alternatives to fund its operations if such a default occurs, as is
expected.
The Company's ability to continue to produce successful supplemental education
material and software products;
Reductions in state and local funding for educational spending materials
resulting, among other things, from increasing state budget deficits.
Uncertainty in the current operating environment which makes it difficult to
forecast future results.
The ability of the Company's print and electronic supplemental instructional
materials to continue to successfully meet market needs;
The Company's ability to maintain relationships with its creative talent;
Changes in purchasing patterns in and the strength of educational, trade and
software markets;
Competition from other supplemental education materials companies;
Significant changes in the publishing industry, especially relating to the
distribution and sale of supplemental educational materials;
47
The effect on the Company of volatility in the price of paper and periodic
increases in postage rates;
The Company's ability to effectively use the Internet to support its existing
businesses and to launch successful new Internet initiatives;
The general risks inherent in the market and the impact of rising interest rates
with regard to its variable debt facilities; and
The foregoing list of factors should not be construed as exhaustive or as any
admission regarding the adequacy of disclosures made by the Company prior to the
date hereof. The Company disclaims any intention or obligation to update or
revise forward-looking statements, whether as a result of new information,
future events or otherwise.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
WRC Media is exposed to market risk. Market risk, with respect to the business,
is the potential loss arising from adverse changes in interest rates. Exposure
to this market risk is managed through regular operating and financing
activities and, when deemed appropriate, through the use of derivatives.
Derivatives are used as risk management tools and not for trading purposes.
WRC Media is subject to market risk exposure related to changes in interest
rates on the $126.9 million (as of September 30, 2003) senior secured term loans
and the revolving credit facility under the senior credit facilities. Interest
on borrowings under the senior credit facilities will bear interest at a rate
per annum equal to:
(1) For the revolving credit facility maturing in two years and the
$15.5 million senior secured term loan A facility maturing in
three years, the LIBO rate as defined in the credit agreement plus
3.50% or the alternate base rate as defined in the credit
agreement plus 2.50% subject to performance-based step downs; and
(2) For the $95.8 million senior secured term loan B facility maturing
in three years, the LIBO rate plus 4.25% or the alternate base
rate plus 3.25%.
(3) For the $9.6 million senior secured new term A loan facility
maturing in three years, the LIBO rate plus 4.25% or the alternate
base rate plus 3.25%
The senior credit facilities require WRC Media to obtain interest rate
protection for at least 50% of the senior secured term loans for the duration of
the senior credit facilities. On November 15, 2002, we entered into an
arrangement with a notional value of $64.8 million, which terminates on November
15, 2003 and requires us to pay a floating rate of interest based on the three
month LIBO rate as defined in that arrangement with a cap rate of 2.5%. The fair
value of the interest rate cap as of September 30, 2003 was de-minimus.
49
ITEM 4. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures. WRC Media Inc.'s management, with the
participation of Chief Executive Officer and Principal Financial Officer,
has evaluated the effectiveness of the Company's disclosure controls and
procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as
of the end of the period covered by this Report. Based on such evaluation,
the Company's Chief Executive Officer and Principal Financial Officer have
concluded that, as of the end of such period, the Company's disclosure
controls and procedures are effective.
(b) Internal Control Over Financial Reporting. There have not been any changes
in WRC Media Inc.'s internal controls over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
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PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Martin E. Kenney, Jr., Chief Executive Officer of WRC
Media Inc., CompassLearning, Inc. and Weekly Reader Corporation,
pursuant to Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange
Act of 1934, as amended, dated November 14, 2003.
31.2 Certification of Richard Nota, Senior Vice President of Finance and
Principal Financial Officer of WRC Media Inc., CompassLearning, Inc.
and Weekly Reader Corporation dated November 14, 2003.
32 Certification of Chief Executive Officer and Principal Financial
Officer of WRC Media Inc. and Subsidiaries and Weekly Reader
Corporation pursuant to 18 U.S.C. ss. 1350, dated November 14, 2003
(b) Reports on Form 8-K
1. Form 8-K, filed August 12, 2003, reporting operating results for the
quarter ended June 30, 2003.
2. Form 8-K, filed August 13, 2003, reporting the transcript of an investor
conference call held August 13, 2003.
3. Form 8-K, filed October 15, 2003, reporting on certain executive changes
and creation of a new operating unit.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
/s/ Martin E. Kenney, Jr.
Date: November 14, 2003
- ----------------------------------------------------- ---------------------
Martin E. Kenney, Jr.
Director: WRC Media Inc., Weekly Reader Corporation
and CompassLearning, Inc.; Chief Executive Officer:
WRC Media Inc. and CompassLearning, Inc.;
Principal Executive Officer and
Executive Vice President: Weekly Reader Corporation
/s/ Richard Nota
Date: November 14, 2003
- ----------------------------------------------------- ---------------------
Richard Nota
Senior Vice President-Finance: WRC Media Inc.;
Principal Financial Officer WRC Media Inc.,
CompassLearning, Inc., Weekly Reader Corporation
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