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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004 Commission File No. 333-96119
WRC MEDIA INC. WEEKLY READER CORPORATION
(Exact name of Registrant as specified in its charter) (Exact name of Registrant as specified in its charter)
DELAWARE DELAWARE
(State or other jurisdiction of incorporation or organization) (State or other jurisdiction of incorporation or organization)
2731 2721
(Primary Standard Industrial Classification Number) (Primary Standard Industrial Classification Number)
13-4066536 13-3603780
(I.R.S. Employer Identification Number) (I.R.S. Employer Identification Number)
COMPASSLEARNING, INC.
(Exact name of Registrant as specified in its charter)
2731
DELAWARE
(State or other jurisdiction of incorporation or organization)
7372
(Primary Standard Industrial Classification Number)
7372
13-4066535
(I.R.S. Employer Identification Number)
WRC MEDIA INC. WEEKLY READER CORPORATION COMPASSLEARNING, INC.
512 7th AVENUE, 22nd FLOOR 512 7th AVENUE, 22nd FLOOR 512 7th AVENUE, 22nd FLOOR
NEW YORK, NY 10018 NEW YORK, NY 10018 NEW YORK, NY 10018
(212) 768-1150 (212) 768-1150 (212) 768-1150
(Address, including zip code, and telephone number, including area code, of each
Registrant's principal executive offices)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12-months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| Yes |_| No
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act.
|_| Yes |X| No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
- -------------------------------------------------------------------------------------------
TITLE OF CLASS | NAME OF EACH EXCHANGE ON WHICH REGISTERED
- -------------------------------------------------------------------------------------------
12 3/4% Senior Subordinated Notes due 2009 | OVER-THE-COUNTER MARKET
- -------------------------------------------------------------------------------------------
2
PART 1 FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
3
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, June 30,
2003 2004
--------- ----------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,432 $ 5,080
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,519 and $2,583, respectively) 30,027 38,854
Inventories 16,652 14,894
Prepaid expenses 3,367 3,174
Other current assets (including restricted assets of $1,006
and $842, respectively) 1,889 1,317
--------- ---------
Total current assets 53,367 63,319
Property and equipment, net 5,792 4,996
Capitalized software, net 7,293 7,333
Goodwill 241,324 241,324
Other intangible assets, net 76,860 71,539
Deferred financing costs, net 5,675 9,559
Other assets 29,896 32,843
--------- ---------
Total assets $ 420,207 $ 430,913
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 16,963 $ 14,430
Accrued payroll, commissions and benefits 9,356 8,800
Current portion of deferred revenue 35,900 35,930
Other accrued liabilities 17,166 17,857
Current portion of long-term debt 8,477 -
--------- ---------
Total current liabilities 87,862 77,017
Deferred revenue, net of current portion 959 1,203
Deferred tax liabilities 10,800 12,250
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,966,119 shares outstanding), (Liquidation preference of $149,228) - 141,771
Long-term debt 262,925 300,973
--------- ---------
Total liabilities 362,546 533,214
--------- ---------
Commitments and contingencies
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,508,080 shares outstanding) 130,701 -
Warrants on common stock of subsidiaries 11,751 11,751
Common stock subject to redemption 940 950
--------- ---------
Stockholders' deficit:
Common stock, ($.01 par value, 20,000,000 shares authorized;
7,008,406 shares outstanding in 2003 and 2004) 70 70
18% convertible preferred stock, ($.01 par value, 750,000 shares
authorized, 547,980 and 572,639 outstanding, respectively) 21,919 23,936
Additional paid-in capital 131,753 131,753
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (237,574) (268,862)
--------- ---------
Total stockholders' deficit (85,731) (115,002)
--------- ---------
Total liabilities and stockholders' deficit $ 420,207 $ 430,913
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- --------
(As Restated
See Note 17)
Revenue, net $ 44,141 $ 45,849
Cost of goods sold 13,084 13,915
-------- --------
Gross profit 31,057 31,934
-------- --------
Costs and expenses:
Sales and marketing 10,301 11,170
Research and development 213 984
Distribution, circulation and fulfillment 2,905 2,769
Editorial 2,565 2,474
General and administrative 5,370 7,328
Restructuring costs and other non-recurring expenses 1,001 632
Depreciation 599 495
Amortization of intangible assets 4,374 4,076
-------- --------
Total operating costs and expenses 27,328 29,928
-------- --------
Income from operations 3,729 2,006
Interest expense, including amortization
of deferred financing costs (7,236) (13,408)
Other expense, net (688) (274)
-------- --------
Loss before income tax provision (4,195) (11,676)
Income tax provision 679 840
-------- --------
Net loss $ (4,874) $(12,516)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------ --------
(As Restated
See Note 17)
Revenue, net $ 91,179 $ 88,609
Cost of goods sold 26,357 26,835
-------- --------
Gross profit 64,822 61,774
-------- --------
Costs and expenses:
Sales and marketing 21,782 22,725
Research and development 924 1,731
Distribution, circulation and fulfillment 6,415 6,321
Editorial 5,144 5,347
General and administrative 11,013 14,449
Restructuring costs and other non-recurring expenses 1,481 697
Depreciation 1,220 926
Amortization of intangible assets 8,691 8,295
-------- --------
Total operating costs and expenses 56,670 60,491
-------- --------
Income from operations 8,152 1,283
Interest expense, including amortization
of deferred financing costs (14,368) (27,910)
Other expense, net (919) (524)
-------- --------
Loss before income tax provision (7,135) (27,151)
Income tax provision 1,492 1,642
-------- --------
Net loss $ (8,627) $(28,793)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
WRC MEDIA INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- ----------
(As Restated
See Note 17)
Cash flows from operating activities:
Net loss $ (8,627) $ (28,793)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 1,450 1,450
Depreciation and amortization 11,432 10,406
Management fees forgiven by principal shareholder 300 -
(Loss) gain on disposition of property and equipment (1) 1
Accrual of manditorily redeemable preferred stock dividends - 10,593
Amortization of debt discount 218 249
Amortization of deferred financing costs 725 2,783
Changes in operating assets and liabilities:
Accounts receivable (900) (8,827)
Inventories 744 1,758
Prepaid expenses and other current assets (308) 763
Other noncurrent assets (8,153) (5,925)
Accounts payable (7,575) (2,534)
Deferred revenue (1,451) 273
Accrued liabilities (1,806) 144
--------- ---------
Net cash used in operating activities (13,952) (17,659)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (610) (553)
Capitalized software (2,066) (1,225)
Landlord reimbursement for leasehold improvements - 421
Proceeds from the disposition of property and equipment 4 -
--------- ---------
Net cash used in investing activities (2,672) (1,357)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 27,000 31,000
Repayments of revolving line of credit (3,000) (28,000)
Repayment of senior bank debt (3,945) (118,678)
Deferred financing fees (20) (6,668)
Proceeds from issuance of long-term debt - 145,000
Purchase and issuance of common stock subject to redemption (25) 10
--------- ---------
Net cash provided by financing activities 20,010 22,664
--------- ---------
Increase in cash and cash equivalents 3,386 3,648
Cash and cash equivalents, beginning of period 9,095 1,432
--------- ---------
Cash and cash equivalents, end of period $ 12,481 $ 5,080
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
7
WRC MEDIA INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. DESCRIPTION OF BUSINESS
The accompanying condensed consolidated financial statements include the
accounts of WRC Media Inc. ("WRC Media") and its subsidiaries - Weekly Reader
Corporation ("Weekly Reader"), CompassLearning, Inc. ("CompassLearning") and
ChildU, Inc. ("ChildU"). WRC Media was incorporated on May 14, 1999. The term
"Company" refers to WRC Media and its subsidiaries.
The Company is in the business of developing, publishing and marketing print and
electronic supplemental education materials. Certain of the Company's products
have been sold in the education marketplace for as long as 100 years. The
Company's customers are primarily within the United States.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of the Company as
of June 30, 2004 and for the three- and six-month periods ended June 30, 2003
and 2004 have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") for interim financial
information and the instructions for Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by GAAP for complete financial statements. In the opinion of management, all
adjustments, consisting of only normal recurring adjustments necessary to
present fairly the financial position, the results of operations and cash flows
for the periods presented, have been made.
These condensed consolidated financial statements should be read in conjunction
with the Company's annual financial statements and related notes thereto as
reported in the Company's Annual Report on Form 10-K dated June 15, 2004. The
operating results for the three- and six-month periods ended June 30, 2003 and
2004 are not necessarily indicative of the results that may be expected for a
full year.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variables Interest Entities ("FIN 46").
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements" to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. In
December 2003, the FASB issued FIN No. 46 (Revised) ("FIN 46R") to address
certain FIN 46 implementation issues. This interpretation requires that the
assets, liabilities, and results of activities of a Variable Interest Entity
("VIE") be consolidated into the financial statements of the enterprise that is
the primary beneficiary of the VIE. FIN 46R also requires additional disclosures
by primary beneficiaries and other significant variable interest holders. This
interpretation is effective no later than the end of the first interim or
reporting period ending after March 15, 2004, except for those VIE's that are
considered to be special purpose entities, for which the effective date is no
later than the end of the first interim or annual reporting period ending after
December 15, 2003. The adoption of FIN 46R, effective March 31, 2004, did not
have any effect on the Company's consolidated financial position or results of
operations.
In April 2003, the FASB issued Statements of Financial Accounting Standards
("SFAS") No. 149 "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS 149"), which amends and clarifies accounting for
derivative instruments, and for hedging activities under SFAS 133. Specifically,
SFAS 149 requires that contracts with comparable characteristics be accounted
for similarly. Additionally, SFAS 149 clarifies the circumstances in which a
contract with an initial net investment meets the characteristics of a
derivative and when a derivative contains a financing component that requires
special reporting in the statement of cash flows. This Statement is generally
effective for contracts entered into or modified after June 30, 2003 and its
adoption did not have any effect on the Company's consolidated financial
position or results of operations.
8
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement was effective for the
Company beginning January 1, 2004. For financial instruments created before the
issuance date of this statement and still existing at the beginning of the
interim period of adoption, transition shall be achieved by reporting the
cumulative effect of a change in an accounting principle by initially measuring
the financial instruments at fair value or other measurement attribute required
by this statement. The adoption of this statement required the Company to
reclassify its 15% Senior Preferred Stock from the mezzanine section of the
balance sheet to long-term liabilities at March 31, 2004. Effective January 1,
2004 dividend payments for the 15% Senior Preferred Stock ("15% Senior
Preferred") are recorded as interest expense in the consolidated statement of
operations. The adoption of this statement did not result in any adjustment to
the book value of its 15% Senior Preferred as of January 1, 2004 as book value
approximated fair value at January 1, 2004. For the three- and six-month periods
ended June 30, 2004 the Company recognized $5,394 and $10,593, respectively, of
accrued dividends on 15% Senior Preferred as interest expense.
On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits, an amendment of
FASB Statements No. 87, 88 and 106." It requires additional disclosures to those
in the original Statement 132 about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension plans and other defined benefit
post-retirement plans. The majority of the provisions of this statement apply to
financial statements issued for fiscal years ending after December 15, 2003. The
Company has adopted such disclosure provisions (See Note 15).
On March 17, 2004, the Emerging Issues Task Force of the FASB reached a
consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments." ("Issue 03-1") Issue 03-1 provides
guidance for determining when an investment is other-than-temporarily impaired
specifically, whether an investor has the ability and intent to hold an
investment until recovery. In addition, Issue 03-1 contains disclosure
requirements about impairments that have not been recognized as other than
temporary for investments. Issue 03-1 also requires the investor to disclose
investments with unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance for evaluating whether an
investment is other-than-temporarily impaired shall be applied in
other-than-temporary impairment evaluations made in reporting periods beginning
after June 15, 2004. The disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003, for investments
accounted for under Statements 115 and 124. For all other investments within the
scope of this Issue, the disclosures are effective in annual financial
statements for fiscal years ending after June 15, 2004. The additional
disclosures for cost method investments are effective for fiscal years ending
after June 15, 2004. The adoption of this consensus is not expected to have any
impact on the Company's consolidated results of operations or financial
position.
4. SEGMENT INFORMATION
The Company has four reporting segments: Weekly Reader, World Almanac, American
Guidance Service ("AGS"), and CompassLearning and ChildU ("Compass/ChildU").
This classification reflects the nature of the Company's organizational
structure by which the chief operating decision-maker reviews and assesses the
operating performance of the reporting segment and allocates corporate
resources.
o Weekly Reader is a publisher of classroom periodicals, grade-specific
workbooks and custom publisher of instructional materials paid for by
various sponsors.
o World Almanac publishes print reference materials sold into the trade
channel; publishes nonfiction and fiction children's books under three
imprints for K-12 students; publishes print and electronic reference
materials sold into the library channel; and distributes third-party
books targeted for K-12 students through its catalogs.
o AGS is a publisher of testing and assessment products and supplemental
instructional materials. AGS products are sold into the school
channel. Testing and assessment products are primarily for K-12
students and supplemental instructional materials are primarily for
low-performing students in middle and secondary schools.
o Compass/ChildU produce research-based technology learning solutions,
including web-based e-learning solutions that bring into being
educational assessment, curriculum and management tools for grades
Pre-K through 12, all of which are aligned to local, state and
national standards.
Information regarding the operations of the Company's reporting segments is set
forth below. Parent Company expenses and assets not allocated are included in
Corporate. WRC Media evaluates segment performance based on several factors, of
which the primary financial measure is operating income (loss).
9
Weekly World Compass /
Reader Almanac AGS ChildU Corporate Eliminations Total
------ ------- --- ------ --------- ------------ -----
Three months ended June 30, 2004
- --------------------------------
Revenue, net $ 4,138 $ 10,506 $ 17,867 $ 13,338 $ - $ - $ 45,849
Income (loss) from operations (2,073) 969 5,816 (1,735) (971) - 2,006
Depreciation and amortization 119 530 1,809 1,843 942 - 5,243
Restructuring costs and other non-recurring items - - - 603 29 - 632
Assets 55,620 99,146 192,861 52,501 280,348 (249,563) 430,913
Capital expenditures 126 25 122 717 10 1,000
Three months ended June 30, 2003
- --------------------------------
Revenue, net 5,588 10,666 13,457 14,430 - - 44,141
Income (loss) from operations (1,094) 877 4,094 688 (836) - 3,729
Depreciation and amortization 179 543 1,856 2,249 942 - 5,769
Restructuring costs and other non-recurring items - 21 - 875 105 1,001
Assets 57,133 91,726 174,009 58,697 275,177 (215,568) 441,174
Capital expenditures 37 30 7 1,592 - 1,666
Weekly World Compass /
Reader Almanac AGS ChildU Corporate Eliminations Total
------ ------- --- ------ --------- ------------ -----
Six-months ended June 30, 2004
- ------------------------------
Revenue, net $ 14,252 $ 22,387 $ 30,300 $ 21,670 $ - $ - $ 88,609
Income (loss) from operations (172) 2,339 7,354 (6,325) (1,913) - 1,283
Depreciation and amortization 250 1,016 3,795 3,462 1,883 - 10,406
Restructuring costs and other non-recurring items - - - 667 30 - 697
Capital expenditures 160 45 182 1,376 15 1,778
Six-months ended June 30, 2003
- ------------------------------
Revenue, net 16,085 23,259 25,186 26,649 - - 91,179
Income (loss) from operations 1,595 3,173 5,975 (459) (2,130) - 8,154
Depreciation and amortization 364 1,099 3,648 4,437 1,884 - 11,432
Restructuring costs and other non-recurring items - 21 - 875 585 1,481
Capital expenditures 104 54 23 2,493 2 2,676
5. RESTRUCTURING COSTS AND OTHER NON-RECURRING EXPENSES
During the six-months ended June 30, 2004, the Company reviewed its
restructuring reserve established in 2002 and increased the reserve $697 for
lease terminations primarily resulting from the updating of the sublease
assumptions used in determining the fair value of the remaining lease
obligations associated with facilities vacated during 2002.
Components of the Company's restructuring plan initiated in the fourth quarter
of 2002 are shown in the following table.
Balance at Additional Balance at
December 31, 2003 Charges Amounts Paid June 30, 2004
----------------- ------------ ------------ -------------
Severance and other benefits $ 32 $ - $ (32) $ -
Lease terminations 3,243 697 (807) 3,133
------ ------ ------ ------
Total $3,275 $ 697 $ (839) $3,133
====== ====== ====== ======
The restructuring reserve totaling approximately $3,133 at June 30, 2004, is
expected to be paid as follows: remaining nine months of 2004 - $796, 2005 and
beyond - $2,337. These charges are included in other accrued liabilities on the
condensed consolidated balance sheets.
6. STOCK-BASED COMPENSATION
Stock based compensation arrangements with employees are accounted for using the
intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). The Company applies SFAS No. 123, "Accounting for Stock-Based
Compensation and Related Interpretations" ("SFAS 123") for stock-based
compensation arrangements with non-employees. The Company applies the additional
disclosure requirements of SFAS 123, as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure," for employee stock
arrangements.
10
The following table details the effect on net loss had compensation expense for
stock-based compensation arrangements with employees been recorded based on the
fair value method under SFAS 123, as amended.
Three-Months Ended June 30, Six-Months Ended June 30,
2003 2004 2003 2004
-------- -------- -------- --------
Net loss, as reported $ (4,874) $(12,516) $ (8,627) $(28,793)
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all
awards, net of related tax effects (46) (4) (91) (8)
-------- -------- -------- --------
Pro forma net loss $ (4,920) $(12,520) $ (8,718) $(28,801)
======== ======== ======== ========
The Company has outstanding stock options issued to certain of its executives
that are required to be accounted for as variable options. During the three- and
six-month periods ended June 30, 2003 and 2004, no compensation expense was
recognized for these options as the fair market value of the Company's common
stock, as estimated by the Company's Board of Directors, was less than the
exercise price of these options.
7. DEBT
On March 29, 2004, the Company refinanced all of its term loans under its Senior
Bank Credit Facilities (the "First-Lien Facility") with a $145,000 senior,
second-priority lien secured financing that was provided to the Company pursuant
to a term loan facility (the "Second-Lien Facility"). The proceeds of the
Second-Lien Facility were used (i) to refinance in full all term loans
outstanding under the First-Lien Facility, (ii) to pay fees and expenses related
to the Second-Lien Facility and all transactions contemplated in connection
therewith and (iii) for general corporate purposes of the Company.
All payment obligations under the Second-Lien Facility are secured by a
second-priority lien on the collateral securing the First-Lien Facility;
provided that all obligations under the Second-Lien Facility will rank equally
in right of payment with all payment obligations under the First-Lien Facility
and will not otherwise be subordinated in any respect to the First-Lien
Facility. The final maturity of the Second-Lien Facility is March 29, 2009. At
the Company's option, the loans will bear interest at either the Administrative
Agent's (i) alternate base rate ("base rate loans") or (ii) reserve-adjusted
LIBO rate ("LIBO rate loans") plus, in each case, the "Applicable Margin" (as
defined). "Applicable Margin" means, with respect to (i) Base Rate Loans, a rate
of 4.00% per annum and (ii) LIBO Rate Loans, a rate of 5.00% per annum.
The Second-Lien Facility is subject to mandatory prepayment with:
o the proceeds of the incurrence of certain indebtedness
o the proceeds of certain asset sales or other dispositions
o a change in control
o annually, 50% of the Company's excess cash flow (as defined) from the
prior year.
The Second-Lien Facility provide for certain restrictions, including
restrictions on asset sales, dividend payments, additional indebtedness payments
for restricted investments. In addition, the Second-Lien Facility provides for
the maintenance of a financial covenant, a maximum ratio (the "Senior Leverage
Ratio") of Senior Secured Debt to trailing four quarter EBITDA (as defined
therein) not to exceed 4.25:1.00 for any fiscal quarter, except the fiscal
quarter ended June 30, 2005 for which the Senior Leverage Ratio shall not exceed
4.50:1.00, in each case to be tested on the last day of each fiscal quarter and
computed for the Parent and its consolidated subsidiaries. In connection with
entering into the Second-Lien Facility, the Company entered into an amendment
and restatement of its First-Lien Facility, which now consists solely of a
$30,000 revolving credit facility.
11
The First-Lien Facility, as amended and restated, has a maturity of December 29,
2008, and has one financial covenant, a Senior Leverage Ratio of senior secured
debt to trailing four quarter EBITDA (as defined therein) not to exceed
4.00:1.00 for any fiscal quarter, except the fiscal quarter ended June 30, 2005
for which the Senior Leverage Ratio may not exceed 4.25:1.00, in each case to be
tested on the last day of the fiscal quarter and computed for the Company and
its consolidated subsidiaries. Interest on revolving loan borrowings under the
First-Lien Facility bear interest at a rate per annum equal to the LIBO rate as
defined in the First-Lien Facility plus 2.0% or the alternate base rate as
defined in the First-Lien Facility plus 1.0%.
As a result of the refinancing of the Company wrote-off the remaining balances
of deferred financing costs associated with the First Lien Facility of
approximately $1,914. These costs are included in interest expense, including
amortization of deferred financing costs, on the condensed consolidated
statement of operations for the six-months ended June 30, 2004.
In connection with the refinancing the Company incurred costs and expenses,
primarily investment banking and legal fees, of approximately $6,668. These
amounts have been recorded as deferred financing fees at June 30, 2004 and are
being amortized over the term of the Second Lien Facility using the effective
interest method.
At June 30, 2004, there were $8,000 in outstanding advances under the Company's
$30,000 revolving credit facility, which bears interest at approximately 3.5%
for Eurodollar rate advances and 5.0% for base rate advances as of June 30,
2004. The Company has stand-by letters of credit, renewable annually, in the
amount of $2,050 of which $2,000 serves as security for a real estate lease
entered into by the Company and $50 serves as security for certain surety bonds
issued on behalf of the Company. While these letters of credit are in effect,
the Company's available borrowing under the revolving credit facility is reduced
by $2,050. At June 30, 2004, the Company had $19,950 of available credit under
the revolving credit facility.
8. FINANCIAL INSTRUMENTS
Pursuant to the terms of the First and Second-Lien Credit Agreements, the
Company is required to enter into or maintain interest rate protection
agreements (interest rate swaps, caps, collars or similar agreements) in a
notional amount that, when taken together with the aggregate principal amount of
Total Debt, as defined subject to a fixed interest rate, is at least equal to at
least 50% of the aggregate principal amount of all Total Debt. On November 15,
2003, the Company entered into a one year interest rate cap agreement with a
notional principal of $61,000, which caps the LIBOR based rate, as defined, on
those loans at 2.5%. The interest rate protection agreement did not qualify for
hedge accounting treatment and as such the Company marks to market the contract
at the end of each period. The fair value of the interest rate cap at June 30,
2004 is de-minimis.
9. INVENTORIES
Inventories as of December 31, 2003 and June 30, 2004 are as follows:
December 31, June 30,
2003 2004
-------- ---------
Finished goods $ 16,533 $ 14,803
Raw materials 119 91
-------- ---------
$ 16,652 $ 14,894
======== =========
12
10. GOODWILL AND TRADEMARKS
At December 31, 2003 and June 30, 2004, goodwill and indefinite lived intangible
assets are as follows:
December 31, June 30,
2003 2004
----------- ----------
Goodwill $ 241,324 $ 241,324
Long Lived Assets - Trademarks and
copyrights 23,772 23,772
----------- ----------
$ 265,096 $ 265,096
=========== ==========
There were no changes in goodwill and indefinite lived intangible assets during
the three- and six-months ended June 30, 2004.
The Company recorded non-cash deferred income tax expense of $725 and $1,450 for
the three- and six-month periods ended June 30, 2003 and 2004, respectively, for
taxable temporary differences that will not reverse prior to expiration of the
Company's net operating loss carryforward periods. Book amortization of
tax-deductible goodwill and trademarks ceased on January 1, 2002 upon the
Company's adoption of SFAS 142; however, the Company continues to amortize these
assets for tax purposes. As a result, the Company will have deferred tax
liabilities that will arise each quarter as the taxable temporary differences
related to the amortization of these assets will not reverse prior to the
expiration period of the Company's deductible temporary differences unless the
related assets are sold or an impairment of the assets is recorded. The Company
expects that it will record an additional $1,450 to increase deferred tax
liabilities during the remaining six-months of 2004.
11. OTHER INTANGIBLE ASSETS
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill and indefinite lived intangible are as
follows:
-------------------------------------- -------------------------------------
December 31, 2003 June 30, 2004
-------------------------------------- -------------------------------------
Accumulated Accumulated
Useful Lives Gross Amortization Net Gross Amortization Net
------------ ---------- -------------- --------- ---------- -------------- ---------
Customer Lists 6-15 yrs $ 48,600 $ (24,948) $ 23,652 $ 48,600 $ (27,865) $ 20,735
Copyrights 10-20 yrs 30,800 (6,462) 24,338 30,800 (7,248) 23,552
Software 3-5 yrs 14,789 (10,027) 4,762 14,789 (11,577) 3,212
Trademark 4-10 yrs 200 (82) 118 200 (92) 108
Distributor relationships 6 yrs 700 (482) 218 700 (540) 160
-------- ---------- -------- --------- ---------- ---------
Total: $ 95,089 $ (42,001) $ 53,088 $ 95,089 $ (47,322) $ 47,767
======== ========== ======== ========= ========== =========
Included in other intangible assets, are trademarks and copyrights not subject
to amortization, for which the total carrying amount was $23,772 at December 31,
2003 and June 30, 2004.
Amortization of intangibles for the three-months ended June 30, 2003 and 2004
was $3,081 and $2,501, respectively. Amortization of intangibles for the
six-months ended June 30, 2003 and 2004 was $6,195 and $5,321, respectively.
Amortization of intangibles is included in amortization of intangible assets on
the condensed consolidated statement of operations. The estimated amortization
expense for intangible assets subject to amortization for the next five years is
as follows:
Remaining six months of 2004............................. $ 4,610
2005..................................................... 9,197
2006..................................................... 6,843
2007..................................................... 4,600
2008..................................................... 3,461
2009..................................................... 3,253
Thereafter............................................... 15,803
13
12. COMMITMENTS AND CONTINGENCIES
The Company is a party to litigation arising in the normal course of business.
Management regularly analyzes current information and, as necessary, provides
accruals for probable liabilities on the eventual disposition of these matters.
Management believes that the effect on its results of operations and financial
position, if any, for the disposition of these matters, will not be material.
The Securities and Exchange Commission ("SEC") is conducting a preliminary
inquiry concerning the Company and has requested that the Company voluntarily
provide the SEC with various documents and information, and that certain
officers and employees of the Company voluntarily give testimony or be
interviewed. The Company is cooperating fully with the SEC inquiry, and has
continued to provide all documents, information and testimony requested by the
SEC, and has arranged all interviews requested by the SEC with Company
employees. The Company cannot predict the final outcome of this inquiry at this
time.
15% Senior Preferred Stock due 2011
In 1999, the Company issued 3,000,000 shares of 15% Senior Preferred Stock due
in 2011 with a liquidation preference of $25.00 per share. The 15% Senior
Preferred Stock shall accrue dividends at a rate of 15% per annum, subject to
adjustment if the Company fails to redeem all outstanding shares of such 15%
Senior Preferred Stock in connection with a mandatory redemption or change of
control. Such accrued dividends reflect penalty dividends of 0.5% for periods
prior to November 17, 2001. While the Company believes that no penalty dividend
is due for subsequent periods, the preferred shareholders may disagree with that
conclusion.
13. NOTES OFFERING AND GUARANTOR AND NON-GUARANTOR FINANCIAL INFORMATION
In connection with the recapitalization and purchase of Weekly Reader during
November 1999, the Company, Weekly Reader and CompassLearning as co-issuers,
completed an offering of $152,000 of 12 3/4% Senior Subordinated Notes due 2009
(the "Old Notes"). In June 2000, the Old Notes were exchanged in full for $152.0
million of new 12 3/4% Senior Subordinated Notes due 2009 (the "Notes"), which
have terms that are substantially identical to the Old Notes. Interest on the
Notes is payable semi-annually, on May 15 and November 15 of each year. The
Notes are jointly, severally, fully and unconditionally guaranteed by certain
subsidiaries of the Company, including CompassLearning, a wholly-owned
subsidiary and Weekly Reader, a majority (94.9%) owned subsidiary of the Company
(collectively, the "Subsidiary Guarantors").
The following tables present condensed consolidating financial information for
WRC Media and the subsidiary guarantors as of and for the three- and six-month
periods ended June 30, 2003 and 2004 for: (1) WRC Media, (2) Weekly Reader, a
majority-owned subsidiary, (3) CompassLearning, a wholly-owned subsidiary, (4)
ChildU a wholly-owned subsidiary, and (5) the Company on a consolidated basis.
SUBSIDIARY GUARANTORS
-----------------------------------
COMPASS
WEEKLY READER LEARNING WRC MEDIA INC.
WRC MEDIA INC. CORPORATION INC. CHILDU ELIMINATIONS CONSOLIDATED
-------------- ----------- --------- --------- ------------ ------------
(IN THOUSANDS)
Balance Sheet as of June 30, 2004
Assets:
Current assets $ 1,761 $ 84,995 $ 15,648 $ 2,563 $ (41,648) $ 63,319
Property and equipment, net - 4,280 584 132 - 4,996
Goodwill and other intangible assets, net 154,572 132,235 22,844 3,212 - 312,863
Other assets 109,484 32,658 5,100 2,418 (99,925) 49,735
--------- --------- --------- --------- --------- ---------
Total assets $ 265,817 $ 254,168 $ 44,176 $ 8,325 $(141,573) $ 430,913
========= ========= ========= ========= ========= =========
Liabilities and stockholders' deficit:
Current liabilities $ 114,022 $ 49,725 $ 48,649 $ 7,404 $(142,783) $ 77,017
Redeemable preferred stock, plus accrued dividends 141,771 149,228 - - (149,228) 141,771
Long-term debt 147,973 300,973 - - (147,973) 300,973
Other liabilities 7,100 5,150 1,203 - - 13,453
Warrants on common stock of subsidiaries 11,751 - - - - 11,751
Common stock subject to redemption 950 - - - - 950
Stockholders' deficit (157,750) (250,908) (5,676) 921 298,411 (115,002)
--------- --------- --------- --------- --------- ---------
Total liabilities and stockholders' deficit $ 265,817 $ 254,168 $ 44,176 $ 8,325 $(141,573) $ 430,913
========= ========= ========= ========= ========= =========
14
SUBSIDIARY GUARANTORS
-----------------------------------
COMPASS
WEEKLY READER LEARNING WRC MEDIA INC.
WRC MEDIA INC. CORPORATION INC. CHILDU ELIMINATIONS CONSOLIDATED
-------------- ----------- --------- --------- ------------ ------------
(IN THOUSANDS)
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED JUNE 30, 2004
Revenue, net $ - $ 32,511 $ 8,271 $ 5,067 $ - $ 45,849
Operating costs and expenses 930 27,839 11,726 3,348 - 43,843
Interest expense, net 10,885 12,890 - - (10,367) 13,408
Other (income) expense 274 199 1 - (200) 274
Provision for income taxes 616 198 26 - - 840
-------- -------- -------- -------- -------- --------
Net income (loss) $(12,705) $ (8,615) $ (3,482) $ 1,719 $ 10,567 $(12,516)
======== ======== ======== ======== ======== ========
STATEMENTS OF OPERATIONS FOR THE SIX MONTHS
ENDED JUNE 30, 2004
Revenue, net $ - $ 66,939 $ 14,940 $ 6,730 $ - $ 88,609
Operating costs and expenses 1,859 57,472 21,927 6,068 - 87,326
Interest expense, net 22,803 25,638 - - (20,531) 27,910
Other (income) expense 527 396 1 - (400) 524
Provision for income taxes 1,225 356 61 - - 1,642
-------- -------- -------- -------- -------- --------
Net income (loss) $(26,414) $(16,923) $ (7,049) $ 662 $ 20,931 $(28,793)
======== ======== ======== ======== ======== ========
CASH FLOW FOR THE SIX MONTHS
ENDED JUNE 30, 2004
Cash flow provided by (used in) operations $ (9,865) $ (9,835) $ (9,831) $ 2,182 $ 9,690 $(17,659)
Cash flow used in investing activities - (402) (668) (287) - (1,357)
Cash flow provided by (used in) financing activities 9,850 13,933 10,499 (1,928) (9,690) 22,664
Cash and cash equivalents at beginning of period 100 1,267 4 61 - 1,432
-------- -------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 85 $ 4,963 $ 4 $ 28 $ - $ 5,080
======== ======== ======== ======== ======== ========
SUBSIDIARY GUARANTORS
----------------------------------
COMPASS
WEEKLY READER LEARNING WRC MEDIA INC.
WRC MEDIA INC. CORPORATION INC. CHILDU ELIMINATIONS CONSOLIDATED
-------------- ----------- --------- --------- ------------ ------------
(IN THOUSANDS)
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED JUNE 30, 2003
Revenue, net $ - $ 29,711 $ 12,497 $ 1,933 $ - $ 44,141
Operating costs and expenses 929 25,740 12,260 1,483 - 40,412
Interest expense, net 5,281 6,911 - - (4,956) 7,236
Other (income) expense 474 114 - - 100 688
Provision for income taxes 592 64 23 - - 679
-------- -------- -------- -------- -------- --------
Net loss $ (7,276) $ (3,118) $ 214 $ 450 $ 4,856 $ (4,874)
======== ======== ======== ======== ======== ========
STATEMENTS OF OPERATIONS FOR THE SIX MONTHS
ENDED JUNE 30, 2003
Revenue, net $ - $ 64,530 $ 23,743 $ 2,906 $ - $ 91,179
Operating costs and expenses 2,338 53,579 24,266 2,844 - 83,027
Interest expense, net 10,543 13,733 - - (9,908) 14,368
Other (income) expense 711 308 - - (100) 919
Provision for income taxes 1,200 254 38 - - 1,492
-------- -------- -------- -------- -------- --------
Net income (loss) $(14,792) $ (3,344) $ (561) $ 62 $ 10,008 $ (8,627)
======== ======== ======== ======== ======== ========
CASH FLOW FOR THE SIX MONTHS
ENDED JUNE 30, 2003
Cash flow provided by (used in) operations $(11,756) $(15,082) $ 803 $ 1,293 $ 10,790 $(13,952)
Cash flow used in investing activities - (179) (1,546) (947) - (2,672)
Cash flow provided by (used in) financing activities 10,807 19,483 743 (233) (10,790) 20,010
Cash and cash equivalents at beginning of period 1,154 7,819 4 118 - 9,095
-------- -------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 205 $ 12,041 $ 4 $ 231 $ - $ 12,481
======== ======== ======== ======== ======== ========
14. RELATED PARTY TRANSACTIONS
Management Agreements
In connection with the acquisition of Weekly Reader and CompassLearning, the
Company entered into management agreements with its principal shareholder. In
accordance with the management agreements, the shareholder provides to Weekly
Reader and CompassLearning management consulting and advisory services. As a
result, Weekly Reader and CompassLearning are obligated to pay to the
shareholder annual aggregate management fees for services to both Weekly Reader
and CompassLearning totaling $950, which are payable quarterly.
In addition, the Company will reimburse the principal shareholder for reasonable
out-of-pocket costs and expenses incurred in connection with the performance of
its services. During each of the three- and six-month periods ended June 30,
2003 and 2004, the Company recognized general and administrative expense of $238
and $476, respectively, for management fees. In June 2003, the shareholder
waived the payment of $300 in management fees for 2003. The waived amount has
been recorded as a capital contribution. At June 30, 2004, other accrued
liabilities include approximately $1,126 of accrued management fees.
15. PENSION BENEFITS
The following table provides components of net periodic benefit cost for the
Company's defined benefit pension plan for the three- and six-months ended June
30, 2003 and 2004:
15
Three-months ended June 30,
---------------------------
2003 2004
----- -----
Service cost $ 229 $ 225
Interest Cost 221 238
Expected return on plan assets (169) (242)
Amortization of net loss 74 42
----- -----
Net periodic benefit cost $ 355 $ 263
===== =====
Six-months ended June 30,
-------------------------
2003 2004
---- ----
Service cost $ 458 $ 450
Interest Cost 442 476
Expected return on plan assets (338) (484)
Amortization of net loss 148 84
----- -----
Net periodic benefit cost $ 710 $ 526
===== =====
16. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Six-Months Ended June 30,
-------------------------
2003 2004
---- ----
Cash paid during the period for interest $13,558 $13,234
Cash paid during the period for income taxes $ 169 $ 228
Non-cash financing activities:
Preferred stock dividends accrued $10,833 12,610(1)
Accretion of preferred stock $ 471 $ 478
(1) During the six-months ended June 30, 2004, $10,593 of such preferred stock
dividends have been recorded as interest expense in the statement of
operations, resulting from the Company's adoption of SFAS 150 effective
January 1, 2004.
17. RESTATEMENT
In connection with the audit of the Company's 2003 consolidated financial
statements (the "Initial Restatement") and the reaudit of its 2001 consolidated
financial statements (the "Further Restatement), the Company has restated its
previously audited consolidated balance sheets as of December 31, 2001, 2002 and
2003 and the related statements of operations, stockholders' deficit and cash
flows for the years ended December 31, 2001, 2002 and 2003.
In connection with the Initial Restatement, management had restated its
financial statements for the three- and six-months ended June 30, 2003 because
it had incorrectly accounted for (i) the revenue recognition of a software and
services sale in December 2002; (ii) the purchase price related to the ChildU
acquisition in 2001 (iii) revenue recognition for distributor sales; (iv) rent
expense; (v) other items including an adjustment relating the amortization
period for certain capitalized prepublication costs .
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and six-months ended June
30, 2003 in connection with the Initial Restatement.
o Software and Services Sale. In December 2002, the Company recorded a
$1,860 receivable of revenue from the sale of educational software and
services to a school district. Of this amount, $1,169 was recognized
as revenue during the fiscal quarter ended December 31, 2002, and $691
was recorded as a deferred revenue liability as of December 31, 2002.
Accrued sales commissions of $342 also were recorded. In the first
quarter of 2003, this $1,169 of revenue previously recognized in
December 2002 was offset by recording a bad debt reserve of $920 and
by retaining an excess of $249 in the Company's allowance for doubtful
accounts, which excess amount would have otherwise been reversed. The
Company has concluded that the sale did not meet the criteria under
GAAP for revenue recognition for the year ended December 31, 2002, and
that it incorrectly recorded the related bad debt reserve and retained
the excess allowance for doubtful accounts in 2003. The Company has
corrected these errors by reversing these transactions. The net effect
for the six-months ended June 30, 2003 was to decrease net loss by
approximately $920.
16
o ChildU Goodwill Reduction. The Company's subsidiary, ChildU, was
acquired in 2001. In connection with such acquisition, the Company
issued shares of its common stock to the holders of notes issued by
ChildU. The Company has determined that the value assigned to these
shares when the Company recorded the purchase price for this
acquisition in its historical financial statements for 2001 exceeded
the fair market value of these shares. Accordingly, the Company has
restated its financial statements to record correctly the fair market
value of these shares, which had the effect of reducing the purchase
price for ChildU, goodwill and additional paid-in capital, by
approximately $3,419 as of December 31, 2001. In addition, the Company
allocated the entire purchase price to goodwill, and had assigned that
goodwill an estimated life of 40 years. The asset acquired was
software technology and not goodwill. The Company has restated its
financial statements to record the software technology and to amortize
such acquired technology over its estimated useful life of five years,
which had the effect of increasing net loss by $418 and $837,
respectively in the three- and six-months ended June 30, 2003.
Following the determination to restate the Company's financial statements for
matters described above, the Company also determined that it would correct for
certain errors made in the application of GAAP that had not previously been
corrected because in each such case it believed that the amount of any such
error was not material to its condensed consolidated financial statements. These
matters are described below.
o Distributor Sales. Historically the Company recognized revenue under a
distribution contract between its subsidiary, World Almanac Education
Group, and a distributor at the time that the Company shipped its
products to the distributor rather than at the time those products
were resold by the distributor. The Company also recorded distribution
fees under this contract as operating costs and expenses, based on its
understanding of the distribution contract. The Company has determined
to recognize revenue only at the time the distributor ships these
products to its customer. The Company has restated its financial
statements which decreased its net loss by $89 and $258 respectively
for the three- and six-months ended June 30, 2003.
o Rent. The Company has two leases that have "free rent" incentives at
the commencement of the leases and also contain rent escalation
clauses (which clauses provide for rent increases over time) for which
it was required under GAAP to record the average rent expense ratably
over the lease term. In its historical 2001 financial statements,
however, the Company recorded the rent expense from these leases as it
was paid. In its historical 2002 financial statements, the Company
began correctly recording the average rent expense for these leases,
but it calculated the average rent using the remainder of the lease
term instead of the entire lease term. The Company has restated its
financial statements to correct these errors, which had the net effect
of decreasing its net loss by $194 and $352, respectively for the
three- and six-months ended June 30, 2003.
o Other. The Company also made an adjustment relating to the
amortization period for certain capitalized pre-publication costs
which had the effect of increasing net loss by $105 and $210
respectively for the three- and six-months ended June 30, 2003 and it
reclassified $462 and $927, respectively of software development
amortization from amortization of intangibles to cost of goods sold in
the condensed consolidated statement of operations for the three- and
six-months ended June 30, 2003. An adjustment was also made related to
the waiver, by the Company's principal shareholder, of certain
management fees owed to it. The adjustment increased operating
expenses and additional paid in capital by $300 in the three and
six-months ended June 30, 2003.
In connection with the re-audit of the Company's 2001 consolidated financial
statements, management determined that it had incorrectly accounted for the
following items, which comprise the Further Restatement: (i) intangible assets
acquired in 1999 in connection with the Company's acquisition of Weekly Reader;
(ii) acquisition reserves for acquisitions in 1999; (iii) its adoption of SFAS
142 and the preparation of its transitional impairment analysis; (iv) deferred
tax liabilities recognized upon the adoption of SFAS 142; (v) 15% Senior
Preferred Stock dividends; and (vi) a number of other items which had been
previously identified and collectively determined to be immaterial but which the
Company has now decided to correct. In addition, the Company corrected certain
errors in its disclosures regarding stock options granted to its employees.
17
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and six-months ended June 30,
2003 in connection with the Further Restatement.
o WRC Media Goodwill and Intangible Assets. In connection with the
reaudit of the Company's 2001 consolidated financial statements, the
Company reconsidered the assumptions used to determine the estimated
fair value and economic lives of the intangible assets acquired in
connection with the 1999 acquisition and recapitalization of Weekly
Reader by WRC Media (the "1999 Intangible Assets"). The Company has
determined that the original basis for estimating the fair value and
economic lives of the intangible assets was a valuation report that
the former owners of Weekly Reader had provided to WRC Media at the
time of the 1999 acquisition. Accordingly, in 2004, the Company
engaged a valuation consulting firm to assist management in assessing
the fair values and economic lives of the 1999 Intangible Assets as of
the acquisition date. As a result, certain estimated fair values and
economic lives of the 1999 Intangible Assets have been revised.
Accordingly, the Company has restated its financial statements to
correctly state the estimated fair value and economic lives of the
1999 Intangible Assets acquired as of November 17, 1999. This had the
effect of increasing goodwill by $36,238 and decreasing other
intangibles in the aggregate by the same amount. Other intangible
assets include Copyrights, Customer lists and Trademarks. Copyrights
increased by $4,733 and their estimated useful life was amended from
10 years to approximately 20 years, Customer lists decreased by
$13,680 and their estimated useful life decreased from 10 years to
approximately 8.5 years and Trademarks decreased by $27,291 and their
estimated useful life decreased from 40 years to approximately 39
years. In addition, the Company has restated its financial statements
to correct amortization expense for other intangible assets, which had
the effect of reducing amortization expense of intangible assets for
the three- and six-months ended June 30, 2003 by $376 and $750,
respectively.
o CompassLearning/Weekly Reader Additional Goodwill Reduction. As
discussed above the Company recorded certain reserves for a planned
restructuring in connection with the acquisitions of CompassLearning
and Weekly Reader. In connection with the reaudit of its 2001
consolidated financial statements the Company determined that it had
incorrectly recorded reserves of $3,106 related to estimated
liabilities it believed it had assumed at the date of such
acquisitions. The Company concluded that the acquisition reserves
associated with these liabilities should have been reversed in 1999.
The estimated liabilities associated with the excess reserves included
$1,522 of debt issuance costs, $1,157 of severance and consulting
fees, primarily attributable to employees or consultants hired
subsequent to the acquisition date, $362 of leasehold improvements for
space to be occupied by employees of World Almanac Group and other
administrative costs of $65. The Company determined that goodwill and
the related acquisition reserves should be reduced by $3,106. The
Company has restated its financial statements to correct for these
errors. The net effect of such adjustments was to increase net loss
for the three- and six-months ended June 30, 2003 by $54 and $110,
respectively.
o Goodwill and Long-lived Intangible Asset Impairment. On January 1,
2002, the Company adopted SFAS 142 for its goodwill and intangible
assets. Upon adoption, the Company ceased amortization of goodwill and
other indefinite lived intangible assets, which primarily consist of
trademarks. As required by SFAS 142, the Company reviewed its
indefinite lived intangibles (goodwill and trademarks) for impairment
as of January 1, 2002. The Company has four reporting units with
goodwill. Goodwill was tested for impairment at the reporting unit
level. As a result, the Company recorded a transitional goodwill and
indefinite lived intangible asset impairment charge of $72,022 at
American Guidance Service, Inc. ("AGS") a subsidiary of Weekly Reader.
This charge was reported as a cumulative effect of accounting change,
as of January 1, 2002, in the consolidated statements of operations.
In connection with the reconsideration of the assumptions used to
determine the estimated fair value and economic lives of the 1999
Intangible Assets discussed above, the Company updated its
transitional impairment analysis and determined that it had
incorrectly calculated the fair value of its reporting units.
Accordingly, the impairment charge of $72,022 at AGS was incorrect and
not required. The Company's measurement of fair value was based on an
evaluation of future discounted cash flows. This evaluation utilized
the best information available in the circumstances, including
reasonable and supportable assumptions and projections. The discounted
cash flow evaluation considered several earnings scenarios and the
likelihood of possible outcomes. Collectively, this evaluation was
management's best estimate of projected future cash flows. The
Company's discounted cash flow evaluation used a range of discount
rates that corresponds to the Company's weighted-average cost of
capital. This discount rate range assumed was consistent with that
used for investment decisions and takes into account the specific and
detailed operating plans and strategies of the WRC Media's reporting
units. Certain other key assumptions utilized, including changes in
revenue, operating expenses, working capital requirements and capital
expenditures including pre-publication costs, are based on reasonable
estimates related to the Company's strategic initiatives and current
market conditions. Such assumptions also are consistent with those
utilized in the Company's annual planning process. The Company has
restated its December 31, 2002 and 2003 balance sheets to correct for
this error. The net effect of such adjustment was to increase goodwill
and decrease accumulated deficit by $72,022 as of December 31, 2002
and 2003.
18
o Deferred Tax Liabilities. The Company recognized non-cash deferred
income tax expense and a deferred tax liability on January 1, 2002 in
connection with its adoption of SFAS 142. The deferred tax liability
relates to the excess of tax over book amortization of tax-deductible
goodwill and trademarks since the timing of the reversal of this
liability is indefinite, unless the related assets are sold or an
impairment of the assets is recorded, and can no longer be offset by
the Company's net operating loss carryforwards, which expire within a
statutory period. During 2003, the Company recorded additional
deferred tax expense. The non-cash income tax expense recorded during
the three- and six-months ended June 30, 2003 increased by $225, from
$454 to $679 and by $450, from $1,042 to $1,492, respectively. These
restatements are principally due to the reversal of the impairment
charges and the revision of estimated fair value and economic lives of
the 1999 Intangible Assets discussed above.
o 15% Senior Preferred Stock due 2011. In 1999, the Company issued
3,000,000 shares of 15% Senior Preferred Stock due in 2011. The 15%
Senior Preferred Stock accrued dividends at a rate of 15% per annum.
The Certificate of Designation provides that the 15% Senior Preferred
Stock was subject to a default or penalty dividend of 0.5% in the
event of certain registration defaults. A penalty dividend was
applicable from mid-August of 2000 through November 17, 2001. While
the Company believes that no penalty dividend is due for subsequent
periods, the preferred shareholders may disagree with that conclusion.
The Company had not previously recorded this penalty dividend. The
recording of the penalty dividends (and required compounding in
subsequent periods) resulted in the Company increasing accrued
dividends on 15% Senior Preferred Stock by $31 and $61 during the
three- and six-months ended June 30, 2003, respectively.
o Segment Information. The Company previously disclosed one reportable
segment. The Company now discloses four reportable segments.
o Other. In connection with the re-audit of the Company's 2001 financial
statements, the Company has made a number of other corrections to the
financial statements, which collectively were immaterial.
Summarized below are the significant effects of the Initial Restatement and the
Further Restatement.
19
Three Months Ended June 30, 2003
---------------------------------------------------
As Previously
Reported in
August 13, 2003 Restatement
Form 10-Q Adjustment As Restated
------------- ----------- -----------
Revenue, net $ 43,493 $ 648 $ 44,141
Cost of goods sold 12,542 542 13,084
-------- -------- --------
Gross profit 30,951 106 31,057
-------- -------- --------
Costs and expenses:
Sales and marketing 10,051 250 10,301
Research and development 213 213
Distribution, circulation and fulfillment 2,905 2,905
Editorial 2,565 2,565
General and administrative 5,614 (244) 5,370
Restructuring costs and other non-recurring expenses 1,001 1,001
Depreciation 591 8 599
Amortization of intangible assets 4,691 (317) 4,374
-------- -------- --------
Total operating costs and expenses 27,631 (303) 27,328
-------- -------- --------
Income from operations 3,320 409 3,729
Interest expense, including amortization
of deferred financing costs (7,188) (48) (7,236)
Other expense, net (388) (300) (688)
-------- -------- --------
Loss before income tax provision (4,256) 61 (4,195)
Income tax provision 454 225 679
-------- -------- --------
Net loss $ (4,710) $ (164) $ (4,874)
======== ======== ========
20
Six Months Ended June 30, 2003
----------------------------------------------------
As Previously
Reported in
August 13, 2003 Restatement
Form 10-Q Adjustment As Restated
------------- ------------ -----------
Revenue, net $ 90,470 $ 709 $ 91,179
Cost of goods sold 25,276 1,081 26,357
-------- -------- --------
Gross profit 65,194 (372) 64,822
-------- -------- --------
Costs and expenses:
Sales and marketing 21,532 250 21,782
Research and development 924 924
Distribution, circulation and fulfillment 6,415 6,415
Editorial 5,144 5,144
General and administrative 12,334 (1,321) 11,013
Restructuring costs and other non-recurring expenses 1,481 1,481
Depreciation 1,207 13 1,220
Amortization of intangible assets 9,324 (633) 8,691
-------- -------- --------
Total operating costs and expenses 58,361 (1,691) 56,670
-------- -------- --------
Income from operations 6,833 1,319 8,152
Interest expense, including amortization
of deferred financing costs (14,270) (98) (14,368)
Other expense, net (619) (300) (919)
-------- -------- --------
Loss before income tax provision (8,056) 921 (7,135)
Income tax provision 1,042 450 1,492
-------- -------- --------
Net loss $ (9,098) $ 471 $ (8,627)
======== ======== ========
21
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
December 31, June 30,
2003 2004
------------ ---------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,267 $ 4,963
Accounts receivable (net of allowance for doubtful accounts
and sales returns of $2,179 and $2,367, respectively.) 20,880 28,162
Inventories 15,890 14,232
Due from related party 11,502 33,864
Prepaid expenses 2,882 2,457
Other current assets (including restricted assets of $1,006
and $842, respectively) 1,889 1,317
--------- ---------
Total current assets 54,310 84,995
Property and equipment, net 4,665 4,280
Goodwill 101,978 101,978
Other intangible assets, net 31,580 30,257
Deferred financing costs, net 512 -
Other assets 29,711 32,658
--------- ---------
Total assets $ 222,756 $ 254,168
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 15,446 $ 12,917
Deferred revenue 17,565 21,044
Accrued expenses and other current liabilities 15,865 15,764
Current portion of long-term debt 8,477 -
--------- ---------
Total current liabilities 57,353 49,725
Deferred tax liability 4,800 5,150
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,966,119 shares outstanding)
(Liquidation preference of $149,228) - 149,228
Long-term debt 262,925 300,973
--------- ---------
Total liabilities 325,078 505,076
--------- ---------
Commitments and contingencies
15% senior preferred stock,
including accrued dividends and accretion of warrant value
(5,508,000 shares outstanding) 138,636 -
Stockholders' deficit:
Common stock, ($.01 par value, 20,000,000 shares authorized;
2,830,000 shares outstanding in 2003 and 2004) 28 28
Additional paid-in capital 9,133 9,133
Due from parent (56,464) (49,491)
Accumulated other comprehensive loss (1,899) (1,899)
Accumulated deficit (191,756) (208,679)
--------- ---------
Total stockholders' deficit (240,958) (250,908)
--------- ---------
Total liabilities and stockholders' deficit $ 222,756 $ 254,168
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
22
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- --------
(As Restated
See Note 15)
Revenue, net $ 29,711 $ 32,511
Cost of goods sold 7,908 8,622
-------- --------
Gross profit 21,803 23,889
-------- --------
Costs and expenses:
Sales and marketing 5,605 6,246
Distribution, circulation and fulfillment 2,905 2,769
Editorial 2,565 2,474
General and administrative 4,040 5,230
Restructuring costs 126 29
Depreciation 434 393
Amortization of intangible assets 2,157 2,076
-------- --------
Total operating costs and expenses 17,832 19,217
-------- --------
Income from operations 3,971 4,672
Other expense:
Interest expense, including amortization
of deferred financing costs (6,911) (12,890)
Other expense, net (114) (199)
-------- --------
Loss before income tax provision (3,054) (8,417)
Income tax provision 64 198
-------- --------
Net loss $ (3,118) $ (8,615)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
23
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------ --------
(As Restated
See Note 15)
Revenue, net $ 64,530 $ 66,939
Cost of goods sold 16,347 17,123
-------- --------
Gross profit 48,183 49,816
-------- --------
Costs and expenses:
Sales and marketing 11,932 13,271
Distribution, circulation and fulfillment 6,415 6,321
Editorial 5,144 5,347
General and administrative 8,479 10,295
Restructuring costs 126 30
Depreciation 879 786
Amortization of intangible assets 4,257 4,299
-------- --------
Total operating costs and expenses 37,232 40,349
-------- --------
Income from operations 10,951 9,467
Other expense:
Interest expense, including amortization
of deferred financing costs (13,733) (25,638)
Other expense, net (308) (396)
-------- --------
Loss before income tax provision (3,090) (16,567)
Income tax provision 254 356
-------- --------
Net loss $ (3,344) $(16,923)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
24
WEEKLY READER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
(Amounts in thousands)
2003 2004
------------- ---------
(As Restated
See Note 15)
Cash flows from operating activities:
Net loss $ (3,344) $ (16,923)
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income tax provision 350 350
Depreciation and amortization 5,136 5,085
Accrual of manditorily redeemable preferred stock dividends - 10,593
Amortization of debt discount 218 249
Amortization of deferred financing costs 90 512
Changes in operating assets and liabilities:
Accounts receivable (2,854) (7,282)
Inventories 881 1,658
Prepaid expenses and other current assets (7) 995
Other non-current assets (8,153) (5,925)
Accounts payable (7,172) (2,530)
Deferred revenue 1,500 3,478
Accrued liabilities (1,727) (95)
--------- ---------
Net cash used in operating activities (15,082) (9,835)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (183) (402)
Proceeds from the disposition of property and equipment 4 -
--------- ---------
Net cash used in investing activities (179) (402)
--------- ---------
Cash flows from financing activities:
Proceeds from revolving line of credit 27,000 31,000
Repayments of borrowings under revolving line of credit (3,000) (28,000)
Repayment of senior bank debt (3,945) (118,678)
Proceeds from issuance of long term debt - 145,000
Due from parent, net 2,450 6,973
Due from related party (3,022) (22,362)
--------- ---------
Net cash provided by financing activities 19,483 13,933
--------- ---------
Increase in cash and cash equivalents 4,222 3,696
Cash and cash equivalents, beginning of period 7,819 1,267
--------- ---------
Cash and cash equivalents, end of period $ 12,041 $ 4,963
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
25
WEEKLY READER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. DESCRIPTION OF BUSINESS
The condensed consolidated financial statements of Weekly Reader Corporation
("WRC") include the accounts of WRC and its subsidiary, Lifetime Learning
System, Inc. ("Lifetime Learning"), World Almanac Education Group ("WAE") and
its subsidiaries, Funk & Wagnalls Yearbook Corporation and Gareth Stevens, Inc.
("Gareth Stevens"), and American Guidance Service, Inc. and its subsidiaries,
AGS International Sales, Inc. and Lindy Acquisition Co., LLC (all are
collectively referred to as "Weekly Reader" or the "Company"). At December 31,
2003 and June 30, 2004, WRC Media Inc. (the "Parent") owns 94.9% and PRIMEDIA,
Inc. owns 5.1% of the common stock of Weekly Reader.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of the Company as
of June 30, 2004 and for the three and six-month periods ended June 30, 2003 and
2004 have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") for interim financial
information and the instructions for Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by GAAP for complete financial statements In the opinion of management, all
adjustments, consisting of only normal recurring adjustments necessary to
present fairly the financial position, the results of operations and cash flows
for the periods presented, have been made.
These condensed consolidated financial statements should be read in conjunction
with Weekly Reader Corporation and Subsidiaries annual financial statements and
related notes thereto for the year ended December 31, 2003 included in the
Company's Annual Report on Form 10-K dated June 15, 2004. The operating results
for the three- and six-month periods ended June 30, 2003 and 2004 are not
necessarily indicative of the results that may be expected for a full year.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variables Interest Entities ("FIN 46").
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements" to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. In
December 2003, the FASB issued FIN 46 (Revised) ("FIN 46R") to address certain
FIN 46 implementation issues. This interpretation requires that the assets,
liabilities, and results of activities of a Variable Interest Entity ("VIE") be
consolidated into the financial statements of the enterprise that is the primary
beneficiary of the VIE. FIN 46R also requires additional disclosures by primary
beneficiaries and other significant variable interest holders. This
interpretation is effective no later than the end of the first interim or
reporting period ending after March 15, 2004, except for those VIE's that are
considered to be special purpose entities, for which the effective date is no
later than the end of the first interim or annual reporting period ending after
December 15, 2003. The adoption of FIN 46R effective March 31, 2004 did not have
a significant impact on the Company's consolidated financial position or results
of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149 "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS 149"), which amends and clarifies accounting for
derivative instruments, and for hedging activities under SFAS 133. Specifically,
SFAS 149 requires that contracts with comparable characteristics be accounted
for similarly. Additionally, SFAS 149 clarifies the circumstances in which a
contract with an initial net investment meets the characteristics of a
derivative and when a derivative contains a financing component that requires
special reporting in the statement of cash flows. This statement is generally
effective for contracts entered into or modified after June 30, 2003 and did not
have a significant impact on the Company's consolidated financial position or
results of operations.
26
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement was effective for the
Company beginning January 1, 2004. For financial instruments created before the
issuance date of this statement and still existing at the beginning of the
interim period of adoption, transition shall be achieved by reporting the
cumulative effect of a change in an accounting principle by initially measuring
the financial instruments at fair value or other measurement attribute required
by this statement. The adoption of this statement required the Company to
reclassify its 15% Senior Preferred Stock ("15% Senior Preferred") from the
mezzanine section of the balance sheet to long-term liabilities at March 31,
2004. Effective January 1, 2004 dividend payments for the 15% Senior Preferred
are recorded as interest expense in the consolidated statement of operations.
The adoption of this statement did not result in any adjustment to the book
value of its 15% Senior Preferred as of January 1, 2004 as book value
approximated fair value at January 1, 2004. For the three- and six-month periods
ended June 30, 2004 the Company recognized $5,394 and $10,593, respectively, of
accrued dividends on 15% Senior Preferred as interest expense.
On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits, an amendment of
FASB Statements No. 87, 88 and 106". It requires additional disclosures to those
in the original Statement 132 about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension plans and other defined benefit
post-retirement plans. The majority of the provisions of this statement apply to
financial statements issued for fiscal years ending after December 15, 2003. The
Company has adopted such disclosure provisions (see Note 13).
On March 17, 2004, the Emerging Issues Task Force of the FASB reached a
consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments." ("Issue 03-1") Issue 03-1 provides
guidance for determining when an investment is other-than-temporarily impaired
specifically, whether an investor has the ability and intent to hold an
investment until recovery. In addition, Issue 03-1 contains disclosure
requirements about impairments that have not been recognized as other than
temporary for investments. Issue 03-1 also requires the investor to disclose
investments with unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance for evaluating whether an
investment is other-than-temporarily impaired shall be applied in
other-than-temporary impairment evaluations made in reporting periods beginning
after June 15, 2004. The disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003, for investments
accounted for under Statements 115 and 124. For all other investments within the
scope of this Issue, the disclosures are effective in annual financial
statements for fiscal years ending after June 15, 2004. The additional
disclosures for cost method investments are effective for fiscal years ending
after June 15, 2004. The adoption of this consensus is not expected to have any
impact on the Company's consolidated results of operations or financial
position.
4. SEGMENT INFORMATION
The Company has three reporting segments: Weekly Reader, World Almanac, and
American Guidance Service ("AGS"). This classification reflects the nature of
the Company's organizational structure by which the chief operating
decision-maker reviews and assesses the operating performance of the reporting
segment and allocates corporate resources.
o Weekly Reader is a publisher of classroom periodicals, grade-specific
workbooks and custom publisher of instructional materials paid for by
various sponsors.
o World Almanac publishes print reference materials sold into the trade
channel; publishes nonfiction and fiction children's books under three
imprints for K-12 students; publishes print and electronic reference
materials sold into the library channel; and distributes third-party
books targeted for K-12 students through its catalogs.
o AGS is a publisher of testing and assessment products and supplemental
instructional materials. AGS products are sold into the school channel.
Testing and assessment products are primarily for K-12 students and
supplemental instructional materials are primarily for low-performing
students in middle and secondary schools.
Information regarding the operations of the Company's reporting segments is set
forth below. Parent Company expenses and assets not allocated to reporting
segments are included in Corporate. Weekly Reader evaluates performance based on
several factors, of which the primary financial measure is operating income
(loss).
27
Weekly World
Reader Almanac AGS Corporate Eliminations Total
------ ------- --- --------- ------------ -----
Three months ended June 30, 2004
- --------------------------------
Revenue, net $ 4,138 $ 10,506 $ 17,867 $ - $ - $ 32,511
Income (loss) from operations (2,073) 969 5,816 (40) - 4,672
Depreciation and amortization 119 530 1,809 11 - 2,469
Restructuring costs - - - 29 - 29
Assets 55,620 99,146 192,861 14,531 (107,990) 254,168
Capital expenditures 126 25 122 10 - 283
Three months ended June 30, 2003
- --------------------------------
Revenue, net 5,588 10,666 13,457 - - 29,711
Income (loss) from operations (1,094) 877 4,094 94 - 3,971
Depreciation and amortization 179 543 1,856 13 - 2,591
Restructuring costs - 21 - 105 126
Assets 57,133 91,726 174,009 525 (84,983) 238,410
Capital expenditures 37 30 7 - - 74
Weekly World
Reader Almanac AGS Corporate Eliminations Total
------ ------- --- --------- ------------ -----
Six months ended June 30, 2004
- ------------------------------
Revenue, net $ 14,252 $ 22,387 $ 30,300 $ - $ - $ 66,939
Income (loss) from operations (172) 2,339 7,354 (54) - 9,467
Depreciation and amortization 250 1,016 3,795 24 - 5,085
Restructuring costs - - - 30 - 30
Capital expenditures 160 45 182 15 - 402
Six months ended June 30, 2003
- ------------------------------
Revenue, net 16,085 23,259 25,186 - - 64,530
Income (loss) from operations 1,595 3,173 5,975 208 - 10,951
Depreciation and amortization 364 1,099 3,648 25 - 5,136
Restructuring costs - 21 - 105 126
Capital expenditures 104 54 23 2 - 183
5. RESTRUCTURING AND OTHER NON-RECURRING EXPENSES
During the six-months ended June 30, 2004, the Company reviewed its
restructuring reserve established in 2002 and adjusted the reserve by $30 due to
updating the assumptions used in determining the fair value of the remaining
lease obligations associated with facilities vacated during 2002.
Components of the Company's restructuring plan initiated in the fourth quarter
of 2002 are shown in the following table:
Balance at Balance at
December 31, Additional June 30,
2003 Adjustments Amounts Paid 2004
------------ ----------- ------------ ----------
Severance and other benefits $ 20 $ - $ (20) $ -
Lease terminations 988 30 (54) 964
--------- ----- ------ -------
Total $ 1,008 $ 30 $ (74) $ 964
========= ===== ====== =======
The restructuring reserve totaling approximately $964 at June 30, 2004 is
expected to be paid as follows: remaining nine months of 2004 - $119 and 2005
and beyond - $845 and is included in accrued expenses and other current
liabilities in the condensed consolidated balance sheets.
6. DEBT
On March 29, 2004, the Company refinanced all of its term loans under its Senior
Bank Credit Facilities (the "First-Lien Facility") with a $145,000 senior,
second-priority lien secured financing that was provided to the Company pursuant
to a term loan facility (the "Second-Lien Facility"). The proceeds of the
Second-Lien Facility were used (i) to refinance in full all term loans
outstanding under the First-Lien Facility, (ii) to pay fees and expenses related
to the Second-Lien Facility and all transactions contemplated in connection
therewith and (iii) for general corporate purposes of the Company.
28
All payment obligations under the Second-Lien Facility are secured by a
second-priority lien on the collateral securing the First-Lien Facility;
provided that all obligations under the Second-Lien Facility will rank equally
in right of payment with all payment obligations under the First-Lien Facility
and will not otherwise be subordinated in any respect to the First-Lien
Facility. The final maturity of the Second-Lien Facility will be March 29, 2009.
At the Company's option, the loans will bear interest at either the
Administrative Agent's (i) alternate base rate ("base rate loans") or (ii)
reserve-adjusted LIBO rate ("LIBO rate loans") plus, in each case, the
"Applicable Margin" (as defined). "Applicable Margin" means, with respect to (i)
Base Rate Loans, a rate of 4.00% per annum and (ii) LIBO Rate Loans, a rate of
5.00% per annum.
The Second-Lien Facility is subject to mandatory prepayment with:
o the proceeds of the incurrence of certain indebtedness
o the proceeds of certain asset sales or other dispositions
o a change in control
o annually, 50% of the Company's excess cash flow (as defined) from the
prior year.
The Second-Lien Facility provide for certain restrictions, including
restrictions on asset sales, dividend payments, additional indebtedness payments
for restricted investments. In addition, the Second-Lien Facility provides for
the maintenance of a financial covenant, a maximum ratio (the "Senior Leverage
Ratio") of Senior Secured Debt to trailing four quarter EBITDA (as defined
therein) not to exceed 4.25:1.00 for any fiscal quarter, except the fiscal
quarter ended June 30, 2005 for which the Senior Leverage Ratio shall not exceed
4.50:1.00, in each case to be tested on the last day of each fiscal quarter and
computed for WRC Media (as defined within the agreement) and its consolidated
subsidiaries. In connection with entering into the Second-Lien Facility, the
Company entered into an amendment and restatement of its First-Lien Facility,
which now consists solely of a $30,000 revolving credit facility.
The First-Lien Facility, as amended and restated, has a maturity of December 29,
2008, and has one financial covenant, a Senior Leverage Ratio of senior secured
debt to trailing four quarter EBITDA (as defined therein) not to exceed
4.00:1.00 for any fiscal quarter, except the fiscal quarter ended June 30, 2005
for which the Senior Leverage Ratio may not exceed 4.25:1.00, in each case to be
tested on the last day of the fiscal quarter and computed for the Company and
its consolidated subsidiaries. Interest on revolving loan borrowings under the
First-Lien Facility bear interest at a rate per annum equal to the LIBO rate as
defined in the First-Lien Facility plus 2.0% or the alternate base rate as
defined in the First-Lien Facility plus 1.0%.
As a result of the refinancing, the Company wrote-off the remaining balances of
deferred financing costs associated with the First Lien Facility of
approximately $467. These costs are included in interest expense, including
amortization of deferred financing costs on the condensed consolidated statement
of operations for the six-months ended June 30, 2004.
In connection with the refinancing the Company incurred costs and expenses,
primarily investment banking and legal fees, of approximately $6,668. These
amounts have been recorded as deferred financing fees at June 30, 2004 and are
being amortized over the term of the Second Lien Facility using the effective
interest method.
At June 30, 2004, there were $8,000 in outstanding advances under the Company's
$30,000 revolving credit facility, which bears interest approximately 3.5% for
Eurodollar rate advances and 5.0% for base rate advances as of June 30, 2004.
The Company has stand-by letters of credit, renewable annually, in the amount of
$2,050 of which $2,000 serves as security for a real estate lease entered into
by the Company and $50 serves as security for certain surety bonds issued on
behalf of the Company. While these letters of credit are in effect, the
Company's available borrowing under the revolving credit facility is reduced by
$2,050. At June 30, 2004, the Company had $19,950 of available credit under the
revolving credit facility.
29
7. FINANCIAL INSTRUMENTS
Pursuant to the terms of the First and Second-Lien Credit Agreements, the
Company is required to enter into or maintain interest rate protection
agreements (interest rate swaps, caps, collars or similar agreements) in a
notional amount that, when taken together with the aggregate principal amount of
the Company's Total Debt subject to a fixed interest rate, is at least equal to
at least 50% of the aggregate principal amount of all Total Debt. On November
15, 2003, the Company entered into a one year interest rate cap agreement with a
notional principal of $61,000, which caps the LIBOR based rate, as defined, on
those loans at 2.5%. The interest rate protection agreement did not qualify for
hedge accounting treatment and as such the Company marks the contract to market
at the end of each period. The fair value of the interest rate cap at June 30,
2004 is de-minimis.
8. INVENTORIES
At December 31, 2003 and June 30, 2004, inventories are comprised of the
following:
December 31, June 30,
2003 2004
------------- ---------
Finished goods $ 15,853 $ 14,215
Raw materials 37 17
-------- --------
$ 15,890 $ 14,232
======== ========
9. GOODWILL AND TRADEMARKS
At December 31, 2003 and June 30, 2004, Goodwill and indefinite lived intangible
assets are as follows:
December 31, June 30,
2003 2004
------------ --------
Goodwill $ 101,978 $ 101,978
Long Lived Assets - Trademarks and
copyrights
15,675 15,675
----------- -----------
$ 117,653 $ 117,653
=========== ===========
There were no changes to goodwill and indefinite lived intangible assets during
the three- and six-months ended June 30, 2004.
WRC recorded non-cash deferred income tax expense of $175 and $350 during the
three- and six-month periods ended June 30, 2003 and 2004, respectively, for
taxable temporary differences that will not reverse prior to expiration of the
Company's net operating loss carryforward periods. Book amortization of
tax-deductible goodwill and trademarks ceased on January 1, 2002 upon the
Company's adoption of SFAS 142; however, WRC will continue to amortize these
assets for tax purposes. As a result, WRC will have deferred tax liabilities
that will arise each quarter because the taxable temporary differences related
to the amortization of these assets will not reverse prior to the expiration
period of WRC's deductible temporary differences unless the related assets are
sold or an impairment of the assets is recorded. The Company expects that it
will record an additional $350 to increase deferred tax liabilities during the
remaining six months of 2004.
10. OTHER INTANGIBLE ASSETS
The gross carrying amount and accumulated amortization of the WRC's intangible
assets other than goodwill and indefinite lived intangible assets are as
follows:
30
----------------------------------------------------------------------------
December 31, 2003 June 30, 2004
----------------------------------------------------------------------------
Accumulated Accumulated
Useful Lives Gross Amortization Net Gross Amortization Net
------------ -------- ------------- --------- -------- -------------- ---------
Customer Lists 6-15 yrs $ 318 $ (161) $ 157 $ 318 $ (183) $ 135
Copyrights 10-20 yrs 19,936 (4,901) 15,035 19,936 (5,489) 14,447
Software 3 yrs 6,420 (5,707) 713 6,420 (6,420) -
-------- --------- --------- -------- ---------- ---------
Total: $ 26,674 $ (10,769) $ 15,905 $ 26,674 $ (12,092) $ 14,582
======== ========= ========= ======== ========== =========
Included in other intangible assets, are trademarks and copyrights not subject
to amortization, for which the total carrying amount was $15,675 as of December
31, 2003 and June 30, 2004.
Amortization of intangibles for the three-months ended June 30, 2003 and 2004
was $864 and $499, respectively. Amortization of intangibles for the six-months
ended June 30, 2003 and 2004 was $1,761 and $1,323, respectively. Amortization
is included in amortization of intangible assets on the condensed consolidated
statement of operations. The estimated amortization expense for intangible
assets still subject to amortization for the next five years is as follows:
Remaining six months ended of 2004.............................. $ 620
2005............................................................ 1,225
2006............................................................ 1,184
2007............................................................ 1,181
2008............................................................ 1,144
2009............................................................ 1,123
Thereafter...................................................... 8,105
11. COMMITMENTS AND CONTINGENCIES
The Company is a party to litigation arising in the normal course of business.
Management regularly analyzes current information and, as necessary, provides
accruals for probable liabilities on the eventual disposition of these matters.
Management believes that the effect on its results of operations and financial
position, if any, for the disposition of these matters, will not be material.
The Securities and Exchange Commission ("SEC") is conducting a preliminary
inquiry concerning the Company and has requested that the Company voluntarily
provide the SEC with various documents and information, and that certain
officers and employees of the Company voluntarily give testimony or be
interviewed. The Company is cooperating fully with the SEC inquiry, and has
continued to provide all documents, information and testimony requested by the
SEC, and has arranged all interviews requested by the SEC with Company
employees. The Company cannot predict the final outcome of this inquiry at this
time.
15% Senior Preferred Stock due 2011
In 1999, the Company issued 3,000,000 shares of 15% Senior Preferred Stock due
in 2011 with a liquidation preference of $25.00 per share. The 15% Senior
Preferred Stock shall accrue dividends at a rate of 15% per annum, subject to
adjustment if the Company fails to redeem all outstanding shares of such 15%
Senior Preferred Stock in connection with a mandatory redemption or change of
control. Such accrued dividends reflect penalty dividends of 0.5% for periods
prior to November 17, 2001. While the Company believes that no penalty dividend
is due for subsequent periods, the preferred shareholders may disagree with that
conclusion.
12. RELATED PARTY TRANSACTIONS
In connection with the acquisition of Weekly Reader, the Company entered into a
management agreement with the principal shareholder of WRC Media Inc. In
accordance with the management agreement, the shareholder provides Weekly Reader
management consulting and financial advisory services. As a result, the Company
is obligated to pay to the shareholder annual aggregate management fees for
services totaling $800, which are payable quarterly. At June 30, 2004, other
accrued liabilities include approximately $900 of accrued management fees.
31
In addition, the Company will reimburse the principal shareholder for reasonable
out-of-pocket costs and expenses incurred in connection with the performance of
its services. During each of the three- and six-month periods ended June 30,
2003 and 2004, the Company recognized general and administrative expense of $200
and $400, respectively, for management fees.
13. PENSION BENEFITS
The following table provides components of net periodic benefit cost for the
Company's defined benefit pension plan for the three- and six-months ended June
30, 2003 and 2004:
Three-months ended June 30,
---------------------------
2003 2004
---- ----
Service cost $ 229 $ 225
Interest Cost 221 238
Expected return on plan assets (169) (242)
Amortization of net loss 74 42
----- -----
Net periodic benefit cost $ 355 $ 263
===== =====
Six-months ended June 30,
-------------------------
2003 2004
---- ----
Service cost $ 458 $ 450
Interest Cost 442 476
Expected return on plan assets (338) (484)
Amortization of net loss 148 84
----- -----
Net periodic benefit cost $ 710 $ 526
===== =====
14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Six-Months Ended June 30,
-----------------------------
2003 2004
---- ----
Cash paid during the period for interest $ 13,558 $ 13,234
Cash paid during the period for income taxes $ 31 $ 42
Non-cash financing activity:
Preferred stock dividends accrued $ 9,142 $ 10,593 (1)
(1) During the six-months ended June 30, 2004, $10,593 of such preferred stock
dividends have been recorded as interest expense in the statement of
operations, resulting from the Company's adoption of SFAS 150 effective
January 1, 2004.
15. RESTATEMENT
In connection with the audit of the Company's 2003 consolidated financial
statements (the "Initial Restatement") and the reaudit of its 2001 consolidated
financial statements (the "Further Restatement"), the Company has restated its
previously audited consolidated balance sheets as of December 31, 2001, 2002 and
2003 and the related statements of operations, stockholders' deficit and cash
flows for the years ended December 31, 2001, 2002 and 2003.
32
In connection with the Initial Restatement, management had restated its
financial statements for the three- and six-months ended June 30, 2003 because
it had incorrectly accounted for (i) revenue recognition for distributor sales;
(ii) rent expense; and (iii) other items including an adjustment relating the
amortization period for certain capitalized prepublication costs.
Described below are the matters for which the Company had restated its condensed
consolidated financial statements for the three- and six-months ended June 30,
2003 in connection with the Initial Restatement.
o Distributor Sales. Historically the Company recognized revenue under a
distribution contract between its subsidiary, World Almanac Education
Group, and a distributor at the time that the Company shipped its
products to the distributor rather than at the time those products
were resold by the distributor. The Company also recorded distribution
fees under this contract as operating costs and expenses, based on its
understanding of the distribution contract. The Company has determined
to recognize revenue only at the time the distributor ships these
products to its customer. The Company has restated its financial
statements which decreased its net loss by $89 and $258, respectively
for the three- and six-months ended June 30, 2003.
o Rent. The Company has two leases that have "free rent" incentives at
the commencement of the leases and also contain rent escalation
clauses (which clauses provide for rent increases over time) for which
it was required under GAAP to record the average rent expense ratably
over the lease term. In its historical 2001 financial statements,
however, the Company recorded the rent expense from these leases as it
was paid. In its historical 2002 financial statements, the Company
began correctly recording the average rent expense for these leases,
but it calculated the average rent using the remainder of the lease
term instead of the entire lease term. The Company has restated its
financial statements to correct these errors, which had the net effect
of decreasing its net loss by $194 and $352, respectively for the
three- and six-months ended June 30, 2003.
o Other. The Company also made an adjustment relating to the
amortization period for certain capitalized pre-publication costs
which had the effect of increasing net loss by $105 and $210 for the
three- and six-months ended June 30, 2003.
In connection with the reaudit of the Company's 2001 consolidated financial
statements, management determined that it had incorrectly accounted for the
following items, which comprise the Further Restatement: (i) intangible assets
acquired in 1999 in connection with the Parent's acquisition of Weekly Reader;
(ii) acquisition reserves for acquisitions in 1999; (iii) its adoption of SFAS
142 and the preparation of its transitional impairment analysis; (iv) deferred
tax liabilities recognized upon adoption of SFAS 142; (v) 15% Senior Preferred
Stock dividends; and (vi) a number of other items which had been previously
identified and collectively determined to be immaterial.
Described below are the matters for which the Company has restated its condensed
consolidated financial statements for the three- and six-months ended June 30,
2003 in connection with the Further Restatement.
o Weekly Reader Intangible Assets. In connection with the reaudit of the
Company's 2001 consolidated financial statements, the Company
reconsidered the assumptions used to determine the estimated fair
value and economic lives of the intangible assets acquired in
connection with the 1999 acquisition and recapitalization of Weekly
Reader by its Parent (the "1999 Intangible Assets"). The Company has
determined that the original basis for estimating the fair value and
economic lives of the intangible assets was a valuation report that
the former owners of Weekly Reader had provided to the Parent at the
time of the 1999 acquisition. Accordingly, in 2004, the Parent engaged
a valuation consulting firm to assist management in assessing the fair
values and economic lives of the 1999 Intangible Assets as of the
acquisition date. As a result, certain economic lives of the 1999
Intangible Assets have been revised. Accordingly, the Company has
restated its financial statements to correctly state the estimated
economic lives of the 1999 Intangible Assets acquired as of November
17, 1999. Other intangible assets include copyrights, customer lists
and trademarks. Copyrights estimated useful life was amended from 10
years to approximately 20 years; Customer lists estimated useful life
decreased from 10 years to approximately 8.5 years and Trademarks
estimated useful life decreased from 40 years to approximately 39
years. The Company has restated its financial statements to correct
the amortization expense for these intangible assets which had the
effect of decreasing amortization expense of intangible assets for the
three- and six-months ended June 30, 2003 by $260 and $519,
respectively.
33
o Goodwill and Long-lived Intangible Asset Impairment. On January 1,
2002, the Company adopted SFAS 142 for its goodwill and intangible
assets. Upon adoption, the Company ceased amortization of goodwill and
indefinite lived intangible assets, which consist primarily of
trademarks. As required by SFAS 142, the Company reviewed its
indefinite lived intangibles (goodwill and trademarks) for impairment
as of January 1, 2002. The Company has three reporting units with
goodwill. Goodwill was tested for impairment at the reporting unit
level. As a result, the Company recorded a transitional goodwill and
indefinite lived intangible asset impairment charge of $72,022 at AGS.
This charge was reported as a cumulative effect of accounting change,
as of January 1, 2002, in the consolidated statements of operations.
In connection with the reconsideration of the assumptions used to
determine the estimated fair value and economic lives of 1999
Intangible Assets discussed above, the Company updated its
transitional impairment analysis and determined that it incorrectly
calculated the fair value of its reporting units. Accordingly, the
impairment charge of $72,022 at AGS was incorrect and not required.
The Company's measurement of fair value was based on an evaluation of
future discounted cash flows. This evaluation utilized the best
information available in the circumstances, including reasonable and
supportable assumptions and projections. The discounted cash flow
evaluation considered several earnings scenarios and the likelihood of
possible outcomes. Collectively, this evaluation was management's best
estimate of projected future cash flows. The Company's discounted cash
flow evaluation used a range of discount rates that corresponds to the
Company's weighted-average cost of capital. This discount rate range
assumed was consistent with that used for investment decisions and
takes into account the specific and detailed operating plans and
strategies of the WRC's reporting units. Certain other key assumptions
utilized, including changes in revenue, operating expenses, working
capital requirements and capital expenditures including
pre-publication costs, are based on reasonable estimates related to
the Company's strategic initiatives and current market conditions.
Such assumptions also are consistent with those utilized in the
Company's annual planning process. The Company has restated its
December 31, 2002 and 2003 balance sheets to correct for this error.
The net effect of such adjustment was to increase goodwill and
decrease accumulated deficit by $72,022 at December 31, 2002 and 2003.
o Weekly Reader Goodwill Reduction. The Company recorded certain
reserves for a planned restructuring in connection with its
acquisition by WRC Media in 1999. In connection with the reaudit of
its 2001 consolidated financial statements the Company determined that
it had incorrectly recorded reserves of $602 related to estimated
liabilities it believed it had assumed at the date of such
acquisition. The Company concluded that the acquisition reserves
associated with these liabilities should have been reversed in 1999.
The estimated liabilities were associated with the excess reserves for
severance, primarily attributable to employees hired subsequent to the
acquisition date. The Company has restated its financial statements to
correct for these errors. The net effect of such adjustments was to
increase net loss for the three- and six-month period ended June, 2003
by $6 and $12, respectively.
o Deferred Tax Liabilities. The Company recognized non-cash deferred
income tax expense and a deferred tax liability on January 1, 2002 in
connection with its adoption of SFAS 142. The deferred tax liability
relates to the excess of tax over book amortization of tax-deductible
goodwill and trademarks since the timing of the reversal of this
liability is indefinite, unless the related assets are sold or an
impairment of the assets is recorded, and can no longer be offset by
the Company's net operating loss carryforwards, which expire within a
statutory period. The non-cash income tax expense recorded during
the three- and six-months ended June 30, 2003 increased by $15 from
$49 to $64 and by $30 from $224 to $254, respectively. These
restatements are principally due to the reversal of the impairment
charges and the revision of the economic lives of the 1999 Intangible
Assets discussed above.
o 15% Senior Preferred Stock due 2011. In 1999, the Company issued
3,000,000 shares of 15% Senior Preferred Stock due in 2011. The 15%
Senior Preferred Stock accrues dividends at a rate of 15% per annum.
The Certificate of Designation provides that the 15% Senior Preferred
Stock was subject to a default or penalty dividend of 0.5% in the
event of certain registration defaults. A penalty dividend was
applicable from mid-August of 2000 through November 17, 2001. While
the Company believes that no penalty dividend is due for subsequent
periods, the preferred shareholders may disagree with that conclusion.
The Company had not previously recorded this penalty dividend. The
recording of the penalty dividends (and required compounding in
subsequent periods) resulted in the Company increasing accrued
dividends on 15% Senior Preferred Stock by $31 and $61 during the
three- and six-months ended June 30, 2003, respectively.
34
o Segment Information. The Company previously disclosed one reportable
segment. The Company now discloses three reportable segments.
o Other. In connection with the re-audit of the Company's 2001 financial
statements, the Company has made a number of other corrections to the
financial statements, which collectively were immaterial.
Summarized below are the significant effects of the Initial Restatement and the
further Restatement.
Three Months Ended June 30, 2003
---------------------------------------------------
As Previously
Reported in
August 13, 2003 Restatement
Form 10-Q Adjustments As Restated
--------------- ----------- ------------
Revenue, net $ 29,296 $ 415 $ 29,711
Cost of goods sold 7,828 80 7,908
-------- -------- --------
Gross profit 21,468 335 21,803
-------- -------- --------
Costs and expenses:
Sales and marketing 5,605 5,605
Distribution, circulation and fulfillment 2,905 2,905
Editorial 2,565 2,565
General and administrative 4,284 (244) 4,040
Restructuring costs 126 126
Depreciation 428 6 434
Amortization of intangible assets 2,312 (155) 2,157
-------- -------- --------
Total operating costs and expenses 18,225 (393) 17,832
-------- -------- --------
Income from operations 3,243 728 3,971
Interest expense, including amortization
of deferred financing costs (6,911) (6,911)
Other expense, net (214) 100 (114)
-------- -------- --------
Loss before income tax provision (3,882) 828 (3,054)
Income tax provision 49 15 64
-------- -------- --------
Net loss $ (3,931) $ 813 $ (3,118)
======== ======== ========
35
Six Months Ended June 30, 2003
-------------------------------------------------
As Previously
Reported in
August 13, 2003 Restatement
Form 10-Q Adjustments As Restated
--------------- ------------ -----------
Revenue, net $ 64,054 $ 476 $ 64,530
Cost of goods sold 16,193 154 16,347
-------- -------- --------
Gross profit 47,861 322 48,183
-------- -------- --------
Costs and expenses:
Sales and marketing 11,932 11,932
Distribution, circulation and fulfillment 6,415 6,415
Editorial 5,144 5,144
General and administrative 8,881 (402) 8,479
Restructuring costs 126 126
Depreciation 867 12 879
Amortization of intangible assets 4,566 (309) 4,257
-------- -------- --------
Total operating costs and expenses 37,931 (699) 37,232
-------- -------- --------
Income from operations 9,930 1,021 10,951
Interest expense, including amortization
of deferred financing costs (13,733) (13,733)
Other expense, net (208) (100) (308)
-------- -------- --------
Loss before income tax provision (4,011) 921 (3,090)
Income tax provision 224 30 254
-------- -------- --------
Net loss $ (4,235) $ 891 $ (3,344)
======== ======== ========
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Management's Discussion and Analysis of Financial Condition and Results of
Operation set forth in this Item 2 has been revised to reflect the restatement
of the Company's condensed consolidated financial statements for the three- and
six-months ended June 30, 2003. For a discussion of the restatement adjustments,
see "Item 1. Consolidated Financial Statements -WRC Media Inc. and
Subsidiaries--Note 17. Restatement" and "Item 1. Consolidated Financial
Statements - Weekly Reader Corporation and Subsidiaries - Note 15. Restatement."
The following discussion is intended to assist in understanding the financial
condition as of June 30, 2004 of WRC Media Inc. ("WRC Media") and its
subsidiaries, and Weekly Reader Corporation and its subsidiaries, and their
results of operations for the three- and six-months ended June 30, 2003 and
2004. You should read the following discussion in conjunction with the Condensed
Consolidated Financial Statements of WRC Media and its subsidiaries and Weekly
Reader Corporation and its subsidiaries ("Weekly Reader") attached to this
discussion and analysis. Unless the context otherwise requires, the terms "we,"
"our," and "us" refer to WRC Media and its subsidiaries and their predecessor
companies. This discussion and analysis contains forward-looking statements.
These forward-looking statements are subject to certain risks and uncertainties,
including the Company's ability to continue to produce successful supplemental
education material and software products; reductions in state and local funding
for educational spending materials resulting, among other things, from
increasing state budget deficits; uncertainty in the current operating
environment which makes it difficult to forecast future results; and other risks
and factors identified in this report and in the Company's Annual Report on Form
10-K for the year ended December 31, 2003. 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.
OVERVIEW
We are a leading publisher of supplemental education materials for the Pre K-12
education market. Our portfolio of products includes a broad range of both print
and electronic supplemental instructional materials, testing and assessment
products and library materials, several of which have been published for over
100 years. Weekly Reader is a leading publisher of classroom periodicals based
on the 2002-2003 school year circulation of 7.0 million subscribers. In addition
to our well-recognized classroom periodicals, such as Weekly Reader and Current
Events, we publish distinct, grade-specific basic and life skills workbooks.
American Guidance Service, Inc. ("AGS") has been a leading publisher of
individually administered and group testing and assessment products, and
supplemental instructional materials for over 45 years. AGS's testing and
assessment products are primarily for K-12 students and its supplemental
instructional materials are primarily for low-performing students in middle and
secondary schools. CompassLearning is a research-based technology learning
solutions company that produces educational assessment, curriculum and
management tools for grades Pre-K through 12, all of which are aligned to local,
state and national standards. Offering more than 8,000 hours of interactive
standards-based managed curriculum that inspires educators and students to
explore and achieve success, CompassLearning has been serving the Pre-K to 12
market for over 30 years. World Almanac has been a leading publisher of
reference and informational materials targeted to K-12 students, as well as
other well-known general reference and informational materials, for over 130
years. World Almanac publishes well-known print reference materials, such as The
World Almanac and Book of Facts and nonfiction and fiction books for K-12
students under three Gareth Stevens imprints. In addition, World Almanac
publishes electronic reference materials such as the Funk & Wagnalls
Encyclopedia database and an Internet-based version of Facts On File World News
Digest, which in its print version is World Almanac's leading subscription-based
product. World Almanac also distributes third-party products that are targeted
for K-12 students through its World Almanac Education Library Services ("WAELS")
catalogs.
37
During 2003, the education market was impacted by the sluggish U.S. economy. The
economy which has been slow moving since early 2002 has significantly impacted
state budgets in fiscal 2002 and 2003. Education budgets, which typically
represent over 20% of state budgets, have suffered as a result with forty of the
fifty states under pressure to make cuts in the elementary and secondary
programs in the 2003-2004 school year (Source: MCH Education Data, August 2003).
All K-12 supplemental educational publishers were confronted in 2002 and 2003
with this lack of funding availability and delayed purchasing decisions. We
expect this funding environment to continue at least through to the end of 2004.
The No Child Left Behind Act ("NCLB") which was passed in 2002 has resulted in
an increase in federal funding; but most of this increased funding has been
offset by reduced state and local education funding. In addition, the new
guidelines to qualify for federal funding under NCLB have contributed to delayed
purchase decisions. Under these new guidelines:
o More federal funds will now flow through states;
o There is a change in the mix for formula-based grants and competitive
grants which will require school districts to change the way they seek
and receive funding from states;
o The federal government has given state guidelines for distributing
funds and each of the states is defining the rules to satisfy these
guidelines;
o The federal government's new requirements, like the need for
professionals with a minimum two-year degree and the emphasis on
scientifically based programs, caused some confusion at the school
level in 2002 and 2003; and
o All these changes have caused delays in the movement of funds from the
federal and state sources to the school district level
As a result, 2002 and 2003 have been extremely challenging for the education
marketplace in terms of both funding and spending. According to our market
research (Veronis Suhler Stevenson's Communications Industry Forecast & Report
2003-2007), the Elementary and High School (ELHI) instructional spending will
increase 1.5% in 2004 and according to Quality Education Data report published
in the fall of 2003; an increase in instructional technology spending is
projected at 1% for 2004.
38
Our revenues consist primarily of: subscription revenues from our periodicals;
revenues from sales of printed products including nonfiction and fiction books,
workbooks, worktexts, reference materials and test preparation materials;
computer courseware and hardware; professional development services; and
technical support services.
CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED JUNE 30, 2004 --
WRC MEDIA INC. AND SUBSIDIARIES
The results of operations of WRC Media and its subsidiaries encompass the
operations of Weekly Reader and its subsidiaries, including AGS and World
Almanac, CompassLearning, and ChildU, Inc. ("ChildU"). The results of operations
of WRC Media and its subsidiaries should be read together with the separate
discussion of the results of operations of Weekly Reader.
In analyzing WRC Media's results for the three-months ended June 30, 2003 and
2004, the seasonal nature of WRC Media's business should be considered. As a
result of seasonality, approximately 20% of WRC Media's publication and related
service revenues usually occur in its first quarter, 20% in its second quarter,
and 60% in the third and fourth quarters combined. However, unlike this revenue
stream, many of WRC Media's expenses are incurred evenly throughout the year.
WRC Media analyzes its revenues, expenses and operating results on a percentage
of net revenue basis. The following table sets forth, for the periods indicated,
consolidated statements of operations data for WRC Media and its subsidiaries,
expressed in millions of dollars and as a percentage of net revenue.
Three months ended June 30,
2003 2004
------------------------------ -----------------------------
Amount % of Net Revenue Amount % of Net Revenue
------------ ---------------- ---------- -----------------
(Dollars in millions)
Revenue, net $ 44.1 100.0% $ 45.8 100.0%
Cost of goods sold 13.1 29.7% 13.9 30.3%
------- ----- ------- -----
Gross profit 31.0 70.3% 31.9 69.7%
Costs and expenses:
Sales and marketing 10.3 23.4% 11.2 24.5%
Research and development 0.2 0.5% 1.0 2.2%
Distribution, circulation and fulfillment 2.9 6.6% 2.7 5.9%
Editorial 2.5 5.7% 2.5 5.5%
General and administrative 5.4 12.2% 7.3 15.9%
Restructuring costs and other non-recurring expenses 1.0 2.3% 0.6 1.3%
Depreciation 0.6 1.4% 0.5 1.1%
Amortization of intangible assets 4.4 10.0% 4.1 9.0%
------- ----- ------- -----
Total costs and expenses 27.3 61.9% 29.9 65.3%
------- ----- ------- -----
Income from operations 3.7 8.4% 2.0 4.4%
------- ----- ------- -----
Interest expense, including amortization
of deferred financing costs (7.2) (16.3%) (13.4) (29.3%)
Other expense, net (0.7) (1.6%) (0.3) (0.7%)
------- ----- ------- -----
Loss before income tax provision (4.2) (9.5%) (11.7) (25.5%)
Income tax provision 0.7 1.6% 0.8 1.7%
------- ----- ------- -----
Net loss $ (4.9) (11.1%) $ (12.5) (27.3%)
======= ===== ======= =====
Adjusted EBITDA (a) $ 9.8 22.2% $ 7.6 16.6%
======= ===== ======= =====
39
(a) Adjusted EBITDA represents (loss) before interest expense, taxes,
depreciation, amortization and other (income) charges including
restructuring costs of $1.0 million for the three-months ended June 30,
2003 and restructuring costs of $0.6 million for the three-months ended
June 30, 2004. 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 our
operating performance or to cash flow as a measure of liquidity. It is
presented herein as we use it, in addition to operating income, to evaluate
and measure each business unit's performance. We also use Adjusted EBITDA
to evaluate management performance. Adjusted EBITDA may not be available
for our discretionary use as there are requirements to repay debt, among
other payments.
Three-Months Ended June 30, 2004 Compared to Three-Months Ended June 30, 2003
Revenue, net. For the three-months ended June 30, 2004, net revenue increased
$1.7 million, or 3.9%, to $45.8 million from $44.1 million for the same period
in 2003. This increase was primarily due to a increase in net revenue at Weekly
Reader of $2.8 million, or 9.4% to $32.5 million from $29.7 million for the same
period in 2003 partially offset by a decrease in net revenue at
CompassLearning/Child U of $1.1 million, or 7.6% to $13.3 million from $14.4
million for the same period in 2003.
The increase in net revenue at Weekly Reader was due to (1) an increase in net
revenue at AGS of $4.4 million or 32.6% to $17.9 million from $13.5 million for
the same period in 2003. The increase at AGS was partially offset by (2) a
decrease in net revenue at World Almanac of $0.1 million or 0.9% to $10.5
million from $10.6 million for the same period in 2003.; (3) a decrease in net
revenue at Weekly Reader, excluding World Almanac and AGS, of $1.5 million, or
26.8%, to $4.1 million from $5.6 million for the same period in 2003.
The revenue decrease at CompassLearning/ChildU was primarily due to a decrease
in educational software revenue of $1.7 million from the same period in 2003
primarily attributable to delayed purchasing decisions resulting from the weak
education funding environment. The K-12 funding environment continues to be
impacted by state budget deficits, which have been causing reductions in state
and local educational spending, including spending for teachers, training and
supplemental educational materials. While we believe WRC Media will benefit from
the provisions in the Federal NCLB Act, most of the increase in Federal
educational funding for the 2003-2004 school year was offset by lower state and
local education funding for the same period. These cuts and delayed purchases
have negatively affected our top-line net revenue and may continue to affect our
top-line performance at least through the remainder of fiscal year 2004. The
uncertainty in the current operating environment also makes it difficult to
forecast future results.
Gross profit. For the three-months ended June 30, 2004, gross profit increased
by $0.9 million or 2.9%, to $31.9 million from $31.0 million from the same
period in 2003. This increase was due to the revenue increase discussed above.
Gross profit at Weekly Reader increased $2.1 million or 9.6% to $23.9 million
from $21.8 million from the same period in 2003 primarily as a result of (1) an
increase in gross profit at AGS of $3.2 million from the same period in 2003
driven by the AGS volume increase described above. The increase at AGS was
partially offset by (2) a decrease in gross profit at Weekly Reader, excluding
AGS and World Almanac of $0.9 million from the same period in 2003 driven by the
volume decrease described above. (3) a decrease in gross profit at World Almanac
of $0.2 million from the same period in 2003 due to the volume decrease
described above. At CompassLearning/ChildU gross profit decreased $1.2 million
from the same period in 2003 driven by fixed costs of sales components applied
to a lower revenue base and a low margin services sale to the Los Angeles
Unified School District. WRC Media gross profit as a percent of revenue
decreased to 69.7% from 70.3% from the same period in 2003 due to the factors
discussed above.
40
Costs and expenses. For the three-months ended June 30, 2004, operating costs
and expenses increased by $2.6 million, or 9.5%, to $29.9 million from $27.3
million from the same period in 2003. Costs and expenses as a percentage of net
revenue increased to 65.3% from 61.9% from the same period in 2003. This
increase was primarily the result of: (i) $1.9 million or 35.2% increase in
general and administrative expenses due to increases in legal, audit, tax and
consulting professional fees of $1.1 million primarily related to the previously
disclosed SEC inquiry, higher employee separation costs of $0.2 million and a
reversal of accruals for an excess property tax assessment and building repairs
in the second quarter of 2003 of $0.2 million; (ii) higher sales and marketing
expenses of $0.9 million or 8.7% primarily at AGS resulting from initiatives
relating to the reorganization of its sales department and new product launches;
(iii) higher research and development expenses of $0.8 million or 400.0%
incurred at CompassLearning/ChildU as a result of more time and resources being
spent on product maintenance and research. These higher expenses were partially
offset by (iv) lower restructuring and non-recurring costs of $0.4 or 40.0%; and
(v) lower amortization of intangible assets of $0.3 million.
Interest expense, including amortization of deferred financing costs. For the
three-months ended June 30, 2004, interest expense, including amortization of
deferred financing costs, increased by $6.2 million, or 86.1%, to $13.4 million
from $7.2 million for the same period in 2003 as the adoption of SFAS 150
requires dividends on the 15% Senior Preferred Stock to be recorded as interest
expense in the condensed consolidated statement of operations for all periods
starting January 1, 2004. The dividends on the 15% Senior Preferred Stock for
the three-months ended June 30, 2004 increased interest expense by $5.4 million.
Interest expense on long term-debt increased by $0.6 million primarily due to
higher interest rates in 2004 as opposed to 2003. Interest expense as a
percentage of net revenue increased to 33.9% from 15.1% for the same period in
2003.
Adjusted EBITDA. For the three-months ended June 30, 2004, Adjusted EBITDA
decreased $2.2 million, or 22.4%, to $7.6 million from $9.8 million for the same
period in 2003. This decrease was primarily attributable to the factors
described above. Adjusted EBITDA represents (loss) before interest expense,
taxes, depreciation, amortization and other (income) charges including
restructuring costs of $1.0 million for the three-months ended June 30, 2003 and
restructuring costs of $0.6 million for the three-months ended June 30, 2004.
Adjusted EBITDA 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 our operating performance
or to cash flow as a measure of liquidity. It is presented herein as we use it,
in addition to operating income, to evaluate and measure each business unit's
performance. We also use Adjusted EBITDA to evaluate management performance.
Adjusted EBITDA may not be available for our discretionary use as there are
requirements to repay debt, among other payments. The reconciliation of Adjusted
EBITDA to net loss is as follows:
41
For the three-months ended June 30,
Adjusted EBITDA reconciliation to Net Loss 2003 2004
-------- --------
(Dollars in thousands)
Net Loss $ (4,874) $(12,516)
Depreciation and amortization of intangibles** 5,770 5,243
Income taxes 679 840
Interest expense 7,236 13,408
Restructuring costs 1,001 632
Non-recurring expenses - -
-------- --------
Adjusted EBITDA $ 9,812 $ 7,607
======== ========
** Amount includes amortization of capitalized software costs of $797 and
$672 for 2003 and 2004, respectively which are included in cost of goods
sold in the condensed consolidated statements of operations.
RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED JUNE 30, 2004 -- WRC MEDIA INC.
AND SUBSIDIARIES - SEGMENTS
WEEKLY READER
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 5.6 $ 4.1
Loss from operations (1.1) (2.1)
Percentage of Net Revenue -19.6% -51.2%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the Weekly
Reader segment decreased by $1.5 million, or 26.8%, to $4.1 million from $5.6
million for the same period in 2003 as a result of lower licensing revenue of
$1.0 million due to the absence of a spring book club offering on the QVC
Shopping Network and a decrease in revenue of $0.4 million at Lifetime Learning
Systems, Inc., a subsidiary of Weekly Reader as a result of fewer shipments of
custom publishing projects.
Loss from Operations. For the three months-ended June 30, 2004, the segment loss
from operations increased by $1.0 million or 90.9% to $2.1 million from $1.1
million as gross profit decreased by $0.8 million as a result of the volume
decrease described above. General and administrative expense increased by $0.3
million from the same period in 2003 primarily due to greater employee
separation costs and sales and marketing costs increased by $0.2 million from
the same period in 2003 due to an increase in new customer acquisition costs.
These increases were partially offset by a decrease in distribution, circulation
and fulfillment expenses of $0.2 million from the same period in 2003 as a
result of the absence of a spring book club offering on the QVC Shopping
Network.
42
WORLD ALMANAC
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 10.6 $ 10.5
Income from operations 0.9 1.0
Percentage of Net Revenue 8.5% 9.5%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the World
Almanac segment decreased by $0.1 million or 0.9% to $10.5 million from $10.6
million for the same period in 2003. This decrease was due to lower net revenue
of $0.2 million at World Almanac Books ("WA Books") that resulted from an
increase in expected sales returns recognized in 2004 and lower net revenue of
$0.3 million at World Almanac Education Library Services ("WAE Library
Services") as a result of the elimination of their Prospect catalog partially
offset by higher sales of $0.5 million at Gareth Stevens from its Wholesale and
Field Rep channels.
Income from Operations. For the three months-ended June 30, 2004 segment income
from operations increased by $0.1 million or 11.1% to $1.0 million from $0.9
million primarily due to a reduction in sales and marketing expense of $0.2
million from the same period in 2003 on the promotion of The World Almanac and
Books of Facts.
AGS
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 13.5 $ 17.9
Income from operations 4.1 5.8
Percentage of Net Revenue 30.4% 32.4%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the AGS
segment increased by $4.4 million or 32.6% to $17.9 million from $13.5 million
for the same period in 2003. AGS net assessment revenue increased by $3.3
million from the same period in 2003 as a result of the continued acceptance of
new product releases and net curriculum revenue increased by $1.1 million over
the same period last year driven by its new product releases and revisions of
textbooks.
Income from Operations. For the three-months ended June 30, 2004 segment income
from operations increased by $1.7 million or 41.5% to $5.8 million from $4.1
million for the same period in 2003 as gross profit increased by $3.2 million as
a result of the volume increase described above. The increase in gross profit
was partially offset by increases in sales and marketing expense of $0.7 million
and general and administrative expense of $0.5 million over the same period in
2003. The increase in sales and marketing expense resulted from an increase in
expenditures related to the reorganization of the sales department and marketing
initiatives related to new product launches. The increase in general and
administrative expense was due to increases in other compensation driven by the
performance of the segment and medical benefits of $0.3 million and a reversal
of accruals for an excess property tax assessment and building repairs in the
second quarter of 2003 of $0.2 million.
43
COMPASSLEARNING/CHILDU
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 14.4 $ 13.3
Income (loss) from operations 0.7 (1.7)
Percentage of Net Revenue 4.9% -12.8%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the
CompassLearning/ChildU segment decreased by $1.1 million or 7.6% to $13.3
million from $14.4 million for the same period in 2003. This decrease was
primarily due to a decrease in software revenue of $1.7 million and a decrease
in technical support revenue of $0.4 million from the same period in 2003
partially offset by an increase in service revenue from professional development
of $0.9 million from the same period in 2003. The software decline was primarily
attributable to delayed purchasing decisions resulting from the weak education
funding environment. The K-12 funding environment continues to be impacted by
state budget deficits, which have been causing reductions in state and local
educational spending, including spending for teachers, training and supplemental
educational materials.
Income (loss) from Operations. For the three-months ended June 30, 2004 segment
income (loss) from operations decreased by $2.4 million or 342.9% to a loss of
$1.7 million from income of $0.7 million for the same period in 2003 as gross
profit decreased by $1.2 million as a result of the volume decrease described
above as fixed costs of sales components were applied to a lower software
revenue base and also as a result of a low margin services sale to the Los
Angeles Unified School District in the second quarter of 2004. In addition,
research and development expense increased by $0.8 million and general and
administrative expense increased by $ 0.6 million from the same period in 2003.
The increase in research and development expense was a result of more time and
resources being spent on product maintenance and research. The increase in
general and administrative expense was due to professional fees incurred as a
result of the previously disclosed SEC inquiry. These increases were partially
offset by a decrease in amortization of intangible assets of $0.2 million from
the same period in 2003 due to certain intangible assets becoming fully
amortized at the end of 2003.
44
CONSOLIDATED RESULTS OF OPERATIONS FOR THE SIX-MONTHS ENDED JUNE 30, 2004 --
WRC MEDIA INC. AND SUBSIDIARIES
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.
Six-months ended June 30,
2003 2004
--------------------------------- -----------------------------
Amount % of Net Revenue Amount % of Net Revenue
---------- ------------------- ---------- -----------------
(Dollars in millions)
Revenue, net $ 91.2 100.0% $ 88.6 100.0%
Cost of goods sold 26.4 28.9% 26.8 30.2%
------- ----- ------- -----
Gross profit 64.8 71.1% 61.8 69.8%
Costs and expenses:
Sales and marketing 21.8 23.9% 22.7 25.6%
Research and development 0.9 1.0% 1.7 1.9%
Distribution, circulation and fulfillment 6.4 7.0% 6.3 7.1%
Editorial 5.1 5.6% 5.4 6.1%
General and administrative 11.0 12.1% 14.5 16.4%
Restructuring costs and other non-recurring expenses 1.5 1.6% 0.7 0.8%
Depreciation 1.2 1.3% 0.9 1.0%
Amortization of intangible assets 8.7 9.5% 8.3 9.4%
------- ----- ------- -----
Total costs and expenses 56.6 62.1% 60.5 68.3%
------- ----- ------- -----
Income from operations 8.2 9.0% 1.3 1.5%
------- ----- ------- -----
Interest expense, including amortization
of deferred financing costs (14.4) (15.8%) (28.0) (31.6%)
Other expense, net (0.9) (1.0%) (0.5) (0.6%)
------- ----- ------- -----
Loss before income tax provision (7.1) (7.8%) (27.2) (30.7%)
Income tax provision 1.5 1.6% 1.6 1.8%
------- ----- ------- -----
Net loss $ (8.6) (9.4%) $ (28.8) (32.5%)
======= ==== ======= =====
Adjusted EBITDA (a) $ 20.1 22.0% $ 11.9 13.4%
======= ==== ======= =====
(a) Adjusted EBITDA represents (loss) before interest expense, taxes,
depreciation, amortization and other (income) charges including
restructuring costs of $1.3 million and non-recurring costs of $0.2 million
for the six-months ended June 30, 2003 and restructuring costs of $0.7
million for the six-months ended June 30, 2004. 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 our operating performance or to cash flow as a measure of liquidity. It
is presented herein as we use it, in addition to operating income, to
evaluate and measure each business unit's performance. We also use Adjusted
EBITDA to evaluate management performance. Adjusted EBITDA may not be
available for our discretionary use as there are requirements to repay
debt, among other payments.
Six-Months Ended June 30, 2004 Compared to Six-Months Ended June 30, 2003
Revenue, net. For the six-months ended June 30, 2004, net revenue decreased $2.6
million, or 2.9%, to $88.6 million from $91.2 million for the same period in
2003. This decrease was primarily due to a decrease in net revenue at
CompassLearning/ChildU of $5.0 million, or 18.7% to $21.7 million from $26.7
million for the same period in 2003. This decrease was partially offset by an
increase in net revenue at Weekly Reader of $2.4 million or 3.7%, to $66.9
million from $64.5 million for the same period in 2003.
45
The revenue decrease at CompassLearning/ChildU was primarily due to a decrease
in educational software revenue of $5.5 million from the same period in 2003
primarily attributable to delayed purchasing decisions resulting from the weak
education funding environment. The K-12 funding environment continues to be
impacted by state budget deficits, which have been causing reductions in state
and local educational spending, including spending for teachers, training and
supplemental educational materials. While we believe WRC Media will benefit from
the provisions in the Federal No Child Left Behind Act (the "NCLB Act"), most of
the increase in Federal educational funding for the 2003-2004 school year was
offset by lower state and local education funding for the same period. These
cuts and delayed purchases have negatively affected our top-line net revenue and
may continue to affect our top-line performance at least through the remainder
of 2004. The uncertainty in the current operating environment makes it difficult
to forecast future results.
The increase in net revenue at Weekly Reader was primarily due to (1) an
increase in net revenue at AGS of $5.1 million or 20.2% to $30.3 million from
$25.2 million from the same period in 2003. The increase at AGS was partially
offset by (2) a decrease in net revenue at World Almanac of $0.8 million or 3.4%
to $22.4 million from $23.2 million from the same period in 2003; (3) a decrease
in net revenue at Weekly Reader, excluding World Almanac and AGS, of $1.9
million, or 11.8%, to $14.2 million from $16.1 million from the same period in
2003.
Gross profit. For the six-months ended June 30, 2004, gross profit decreased by
$3.0 million or 4.6%, to $61.8 million from $64.8 million from the same period
in 2003. This decrease was due to the revenue decrease discussed above. At
CompassLearning/ChildU gross profit decreased by $4.6 million, from the same
period in 2003 driven by fixed costs of sales components applied to a lower
revenue base and a low margin services sale to the Los Angeles Unified School
District. Gross profit at Weekly Reader increased $1.6 million or 3.3% to $49.8
million from $48.2 million from the same period in 2003 primarily as a result of
(1) an increase in gross profit at AGS of $3.6 million from the same period in
2003 driven by the volume increase described above. The increase at AGS was
partially offset by (2) a decrease in gross profit at Weekly Reader, excluding
AGS and World Almanac of $1.1 million, from the same period in 2003 driven by
the volume decrease described above; (3) a decrease in gross profit at World
Almanac of $0.9 million from the same period in 2003 due to the volume decrease
described above, a write off of inventory at WA Books in the first quarter of
2004 and the impact of a discount offer at WAE Library Services that was not in
effect during the same period in 2003. WRC Media gross profit as a percentage of
revenue decreased to 69.8% from 71.1% from the same period in 2003 due to the
factors discussed above.
Costs and expenses. For the six-months ended June 30, 2004, operating costs and
expenses increased by $3.9 million, or 6.9%, to $60.5 million from $56.6 million
from the same period in 2003. Costs and expenses as a percentage of net revenue
increased to 68.3% from 62.1% from the same period in 2003. This increase was
primarily the result of: (i) $3.5 million or 31.8% increase in general and
administrative expenses due to increases in legal, audit, tax and consulting
professional fees of $2.6 million primarily related to the previously disclosed
SEC inquiry, higher employee separation costs of $0.2 million and a reversal of
accruals for an excess property tax assessment and building repairs in the
second quarter of 2003 of $0.2 million; (ii) higher sales and marketing expenses
of $0.9 million or 4.1% primarily at AGS resulting from initiatives relating to
the reorganization of its sales department and product launches; (iii) higher
research and development expenses of $0.8 million or 88.9% incurred at
CompassLearning/ChildU as a result of more time and resources being spent on
product maintenance and research. These higher expenses were partially offset by
(iv) lower restructuring and non-recurring costs of $0.8 or 53.3%; and (v) lower
amortization of intangible assets of $0.4 million.
46
Interest expense, including amortization of deferred financing costs. For the
six-months ended June 30, 2004, interest expense, including amortization of
deferred financing costs, increased by $13.6 million, or 94.4%, to $28.0 million
from $14.4 million for the same period in 2003 as the adoption of SFAS 150
requires dividends on the 15% Senior Preferred Stock to be recorded as interest
expense in the statement of operations for all periods starting January 1, 2004.
The dividends on the 15% Senior Preferred Stock for the three-months ended June
30, 2004 increased interest expense by $10.6 million. In addition, deferred
financing fees of $1.9 million attributable to the First-Lien Credit Facility
that was refinanced in part by the Second-Lien Credit Facility, which closed on
March 29, 2004 were written off in the first quarter of 2004. Interest expense
on long term-debt increased by $0.9 million primarily due to higher interest
rates in 2004 as opposed to 2003. Interest expense as a percentage of net
revenue increased to 31.6% from 15.8% for the same period in 2003.
Adjusted EBITDA. For the six-months ended June 30, 2004, Adjusted EBITDA
decreased $8.2 million, or 40.8%, to $11.9 million from $20.1 million for the
same period in 2003. This decrease was primarily attributable to the factors
described above. Adjusted EBITDA represents (loss) before interest expense,
taxes, depreciation, amortization and other (income) charges including
restructuring costs and other non-recurring expenses of $1.5 million for the
six-months ended June 30, 2003 and restructuring costs of $0.7 million for the
six-months ended June 30, 2004. Adjusted EBITDA 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 our operating performance or to cash flow as a measure of
liquidity. It is presented herein as we use it, in addition to operating income,
to evaluate and measure each business unit's performance. We also use Adjusted
EBITDA to evaluate management performance. Adjusted EBITDA may not be available
for our discretionary use as there are requirements to repay debt, among other
payments. The reconciliation of Adjusted EBITDA to net loss is as follows:
47
For the six-months ended June 30,
Adjusted EBITDA reconciliation to Net Loss 2003 2004
--------------- ----------
(Dollars in thousands)
Net Loss $ (8,627) $ (28,793)
Depreciation and amortization of intangibles** 11,432 10,406
Income taxes 1,492 1,642
Interest expense 14,368 27,910
Restructuring costs 1,481 697
--------------- --------------
Adjusted EBITDA $ 20,146 $ 11,862
=============== ==============
** Amount includes amortization of capitalized software costs of $1,521 and
$1,185 for 2003 and 2004, respectively which are included in costs of goods
sold in the condensed consolidated statement of operations.
RESULTS OF OPERATIONS FOR THE SIX-MONTHS ENDED JUNE 30, 2004-- WRC MEDIA INC.
AND SUBSIDIARIES - SEGMENTS
WEEKLY READER
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 16.1 $ 14.2
Income (loss) from operations 1.6 (0.2)
Percentage of Net Revenue 9.9% -1.4%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the Weekly
Reader segment decreased by $1.9 million, or 11.8%, to $14.2 million from $16.1
million for the same period in 2003 as a result of lower licensing revenue of
$0.8 million due to the absence of a spring book club offering on the QVC
Shopping Network, lower periodical net revenue of $0.6 million as a result of a
weak educational funding environment and competitive pressures in the school
magazine market and a decrease in revenue of $0.3 million at Lifetime Learning
Systems, Inc., a subsidiary of Weekly Reader as a result of fewer shipments of
custom publishing projects.
Income (loss) from Operations. For the six months-ended June 30, 2004 segment
loss from operations increased by $1.8 million or 112.5% to a loss of $0.2
million from income of $1.6 million as gross profit decreased by $1.1 million as
a result of the volume decrease described above. General and administrative
expense increased by $0.4 million from the same period in 2003 primarily due to
higher employee separation costs and higher salary and fringes. Sales and
marketing costs increased by $0.5 million from the same period in 2003 due to an
increase in new customer acquisition costs. These increases were partially
offset by a decrease in distribution, circulation and fulfillment expenses of
$0.3 million from the same period in 2003 as a result of the absence of a spring
book club offering on the QVC Shopping Network.
48
WORLD ALMANAC
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 23.2 $ 22.4
Income from operations 3.2 2.3
Percentage of Net Revenue 13.8% 10.3%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the World
Almanac segment decreased by $0.8 million or 3.4% to $22.4 million from $23.2
million for the same period in 2003. This decrease was due to lower net revenue
of $0.4 million at World Almanac Books that resulted from a timing difference
related to consignment sales in the first quarter of 2004 and an increase in
expected sales returns recognized in the second quarter of 2004, lower net
revenue of $0.5 million at WAE Library Services as a result of the elimination
of their Prospect catalog and lower net revenue at Funk and Wagnalls of $0.3
million due to the attrition in its customer base. These decreases at World
Almanac were partially offset by higher sales of $0.4 million at Gareth Stevens
from its Wholesale and Field Rep channels,
Income from Operations. For the six-months-ended June 30, 2004 segment income
from operations decreased by $0.9 million or 28.1% to $2.3 million from $3.2
million primarily due to a reduction in gross profit of $1.0 million as a result
of the volume decrease described above, a write off of inventory at WA Books in
the first quarter of 2004 and the impact of a discount offer at WAE Library
Services that was not in affect during the same period in 2003. This decrease in
gross margin was partially offset by a reduction in sales and marketing expense
of $0.1 million from the same period in 2003 primarily due to a decrease in
expenses on the promotion of The World Almanac and Books of Facts.
AGS
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 25.2 $ 30.3
Income from operations 6.0 7.4
Percentage of Net Revenue 23.8% 24.4%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the AGS
segment increased by $5.1 million or 20.2% to $30.3 million from $25.2 million
for the same period in 2003. AGS Assessment net revenue increased by $4.3
million from the same period in 2003 as a result of the continued acceptance of
new product releases and net curriculum revenue increased $0.8 million over the
same period last year driven by its new product releases and revisions of
textbooks.
Income from Operations. For the six-months ended June 30, 2004 segment income
from operations increased by $1.4 million or 23.3% to $7.4 million from $6.0
million for the same period in 2003 as gross profit increased by $3.8 million as
a result of the volume increase described above. The increase in gross profit
was partially offset by increases in sales and marketing expense of $1.0
million, general and administrative expense of $0.7 million and editorial
expense of $0.2 million over the same period in 2003. The increase in sales and
marketing expense resulted from an increase in expenditures related to the
reorganization of the sales department and marketing initiatives related to new
product launches. The increase in general and administrative expense was due to
increases in other compensation driven by the performance of the segment and
medical benefits of $0.5 million and a reversal of accruals for an excess
property tax assessment and building repairs in the second quarter of 2003 of
$0.2 million. The increase in editorial expense was due to testing expenditures
associated with a high stakes test developed for the NY City Department of
Education in the first quarter of 2004.
49
COMPASSLEARNING/CHILDU
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 26.7 $ 21.7
Loss from operations (0.5) (6.3)
Percentage of Net Revenue -1.9% -29.0%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the
CompassLearning/ChildU segment decreased by $5.0 million or 18.7% to $21.7
million from $26.7 million for the same period in 2003. This decrease was
primarily due to a decrease in software revenue of $5.5 million and a decrease
in technical support revenue of $0.5 million from the same period in 2003
partially offset by an increase in service revenue from professional development
of $1.0 million from the same period in 2003. The software decline was primarily
attributable to delayed purchasing decisions resulting from the weak education
funding environment. The K-12 funding environment continues to be impacted by
state budget deficits, which have been causing reductions in state and local
educational spending, including spending for teachers, training and supplemental
educational materials.
Loss from Operations. For the six-months ended June 30, 2004 segment loss from
operations increased by $5.8 million or 1,160.0% to $6.3 million from $0.5
million for the same period in 2003 as gross profit decreased by $4.6 million as
a result of the volume decrease described above as fixed costs of sales
components were applied to a lower software revenue base and also as a result of
a low margin services sale to the Los Angeles Unified School District in the
second quarter of 2004. In addition, research and development expense increased
by $0.8 million and general and administrative expense increased by $ 1.3
million from the same period in 2003. The increase in research and development
expense was a result of more time and resources being spent on product
maintenance and research. The increase in general and administrative expense was
due to professional fees incurred as a result of the previously disclosed SEC
inquiry. These increases were partially offset by decreases in sales and
marketing expense of $0.3 million and amortization of intangible assets of $0.5
million from the same period in 2003. The decrease in sales and marketing
expense was due to a decrease in compensation expense, including commissions,
partially offset by higher advertising and outside services expenses. The
decrease in amortization of intangible assets was due to certain intangible
assets becoming fully amortized at the end of 2003.
50
CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED JUNE 30, 2004 --
WEEKLY READER CORPORATION AND SUBSIDIARIES
Weekly Reader 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 Weekly Reader and its
subsidiaries expressed in millions of dollars and as a percentage of net
revenue.
Three months ended June 30,
2003 2004
---------------------------- ------------------------------
Amount % of Net Revenue Amount % of Net Revenue
-------- ----------------- -------- ----------------
(Dollars in millions)
Revenue, net $ 29.7 100.0% $ 32.5 100.0%
Cost of goods sold 7.9 26.6% 8.6 26.5%
------- ----- ------- -----
Gross profit 21.8 73.4% 23.9 73.5%
Costs and expenses:
Sales and marketing 5.6 18.9% 6.2 19.2%
Distribution, circulation and fulfillment 2.9 9.8% 2.8 8.6%
Editorial 2.6 8.8% 2.5 7.7%
General and administrative 4.0 13.5% 5.2 16.0%
Restructuring costs 0.1 0.3% - 0.0%
Depreciation 0.4 1.3% 0.4 1.2%
Amortization of intangible assets 2.2 7.4% 2.1 6.5%
------- ----- ------- -----
Total costs and expenses 17.8 59.9% 19.2 59.1%
------- ----- ------- -----
Income from operations 4.0 13.5% 4.7 14.5%
Interest expense (6.9) (23.2%) (12.9) (39.7%)
Other expense, net (0.1) (0.3%) (0.2) (0.6%)
------- ----- ------- -----
Loss before income tax provision (3.0) (10.1%) (8.4) (25.8%)
Income tax provision 0.1 0.3% 0.2 0.6%
------- ----- ------- -----
Net loss $ (3.1) (10.4%) $ (8.6) (26.5%)
======= ===== ======= =====
Adjusted EBITDA(a) $ 6.6 22.2% $ 7.0 21.5%
======= ===== ======= =====
(a) Adjusted EBITDA represents loss before interest expense, taxes,
depreciation, amortization and other (income) charges including
restructuring costs of $0.1 million for the three-months ended June 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 our
operating performance or to cash flow as a measure of liquidity. It is
presented herein as we use it, in addition to operating income, to evaluate
and measure each business unit's performance. We also use Adjusted EBITDA
to evaluate management performance. Adjusted EBITDA may not be available
for our discretionary use as there are requirements to repay debt, among
other payments.
51
Three-Months Ended June 30, 2004 Compared to Three-Months Ended June 30, 2003
Revenue, net. For the three-months ended June 30, 2004, net revenue increased
$2.8 million, or 9.4%, to $32.5 million from $29.7 million for the same period
in 2003. The increase in net revenue at Weekly Reader was primarily due to (1)
an increase in net revenue at AGS of $4.4 million or 32.6% to $17.9 million from
$13.5 million from the same period in 2003. The increase at AGS was partially
offset by (2) a decrease in net revenue at World Almanac of $0.1 million or 0.9%
to $10.5 million from $10.6 million from the same period in 2003.; (3) a
decrease in net revenue at Weekly Reader, excluding World Almanac and AGS, of
$1.5 million, or 26.8%, to $4.1 million from $5.6 million from the same period
in 2003.
Gross profit. Gross profit at Weekly Reader increased $2.1 million or 9.6% to
$23.9 million from $21.8 million from the same period in 2003 primarily as a
result of (1) an increase in gross profit at AGS of $3.2 million from the same
period in 2003 driven by the AGS volume increase described above. The increase
at AGS was partially offset by (2) a decrease in gross profit at Weekly Reader,
excluding AGS and World Almanac of $0.9 million from the same period in 2003
driven by the volume decrease described above. (3) a decrease in gross profit at
World Almanac of $0.2 million from the same period in 2003 due to the volume
decrease described above. Weekly Reader gross profit as a percentage of revenue
increased slightly to 73.5% from 73.4% from the same period in 2003.
Costs and expenses. For the three-months ended June 30, 2004, operating costs
and expenses increased by $1.4 million, or 7.9%, to $19.2 million from $17.8
million from the same period in 2003. Costs and expenses as a percentage of net
revenue increased to 59.9% from 59.1% from the same period in 2003. This
increase was primarily the result of: (i) $1.2 million or 30.0% increase in
general and administrative expenses due to increases in legal, audit, tax and
consulting professional fees of $0.5 million primarily related to the previously
disclosed SEC inquiry, the reaudit of our 2001 financial statements and higher
employee separation costs of $0.2 million and a reversal of accruals for an
excess property tax assessment and building repairs in the second quarter of
2003 of $0.2 million; (ii) higher sales and marketing expenses of $0.6 million
or 10.7% primarily at AGS resulting from initiatives relating to the
reorganization of its sales department and new product launches. These higher
expenses were partially offset by (iii) lower restructuring and non-recurring
costs of $0.1 million or 100.0%; and (iv) lower amortization of intangible
assets of $0.1 million.
Interest expense. For the three-months ended June 30, 2004, interest expense,
including amortization of deferred financing costs, increased by $6.0 million,
or 87.0%, to $12.9 million from $6.9 million from the same period in 2003 as the
adoption of SFAS 150 requires dividends on the 15% Senior Preferred Stock to be
recorded as interest expense in the condensed consolidated statement of
operations for all periods starting January 1, 2004. The dividends on the 15%
Senior Preferred Stock for the three-months ended June 30, 2004 increased
interest expense by $5.4 million. Interest expense on long term-debt increased
by $0.6 million primarily due to higher interest rates in 2004 as opposed to
2003. Interest expense as a percentage of net revenue increased to 39.7% from
23.2% for the same period in 2003.
52
Adjusted EBITDA. For the three-months ended June 30, 2004, Adjusted EBITDA
increased $0.4 million, or 6.1%, to $7.0 million from $6.6 million for the same
period in 2003. This decrease is primarily attributable to the factors described
above. Adjusted EBITDA represents (loss) before interest expense, taxes,
depreciation, amortization and other (income) charges including restructuring
costs $0.1 million for the three-months ended June 30, 2003. Adjusted EBITDA 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 our operating performance or to cash
flow as a measure of liquidity. It is presented herein as we use it, in addition
to operating income, to evaluate and measure each business unit's performance.
We also use Adjusted EBITDA to evaluate management performance. Adjusted EBITDA
may not be available for our discretionary use as there are requirements to
repay debt, among other payments. The reconciliation of Adjusted EBITDA to net
loss is as follows:
For the three-months ended June 30,
Adjusted EBITDA reconciliation to Net Loss 2003 2004
---------------- --------------------
(Dollars in thousands)
Net loss $ (3,118) $ (8,615)
Depreciation and amortization of intangibles 2,591 2,469
Income taxes 64 198
Interest expense 6,911 12,890
Restructuring costs 126 29
---------------- --------------------
Adjusted EBITDA $ 6,574 $ 6,971
================ ====================
RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED JUNE 30, 2004 -- WEEKLY READER
CORPORATION AND SUBSIDIARIES - SEGMENTS
WEEKLY READER
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 5.6 $ 4.1
Loss from operations (1.1) (2.1)
Percentage of Net Revenue -19.6% -51.2%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the Weekly
Reader segment decreased by $1.5 million, or 26.8%, to $4.1 million from $5.6
million for the same period in 2003 as a result of lower licensing revenue of
$1.0 million due to the absence of a spring book club offering on the QVC
Shopping Network and a decrease in revenue of $0.4 million at Lifetime Learning
Systems, Inc., a subsidiary of Weekly Reader as a result of fewer shipments of
custom publishing projects.
53
Loss from Operations. For the three months-ended June 30, 2004 segment loss from
operations increased by $1.0 million or 90.9% to $2.1 million from $1.1 million
as gross profit decreased by $0.8 million as a result of the volume decrease
described above. General and administrative expense increased by $0.3 million
from the same period in 2003 primarily due to greater employee separation costs
and sales and marketing costs increased by $0.2 million from the same period in
2003 due to an increase in new customer acquisition costs. These increases were
partially offset by a decrease in distribution, circulation and fulfillment
expenses of $0.2 million from the same period in 2003 as a result of the absence
of a spring book club offering on the QVC Shopping Network.
WORLD ALMANAC
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 10.6 $ 10.5
Income from operations 0.9 1.0
Percentage of Net Revenue 8.5% 9.5%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the World
Almanac segment decreased by $0.1 million or 0.9% to $10.5 million from $10.6
million for the same period in 2003. This decrease was due to lower net revenue
of $0.2 million at World Almanac Books ("WA Books") that resulted from an
increase in expected sales returns recognized in 2004 and lower net revenue of
$0.3 million at World Almanac Education Library Services ("WAE Library
Services") as a result of the elimination of their Prospect catalog partially
offset by higher sales of $0.5 million at Gareth Stevens from its Wholesale and
Field Rep channels.
Income from Operations. For the three months-ended June 30, 2004 segment income
from operations increased by $0.1 million or 11.1% to $1.0 million from $0.9
million primarily due to a reduction in sales and marketing expense of $0.2
million from the same period in 2003 on the promotion of The World Almanac and
Books of Facts.
AGS
For the three months ended June 30,
2003 2004
---------------- -----------------
(Dollars in millions)
Revenue, net $ 13.5 $ 17.9
Income from operations 4.1 5.8
Percentage of Net Revenue 30.4% 32.4%
Revenue, net. For the three-months ended June 30, 2004 net revenue at the AGS
segment increased by $4.4 million or 32.6% to $17.9 million from $13.5 million
for the same period in 2003. AGS Assessment net revenue increased by $3.3
million from the same period in 2003 as a result of the continued acceptance of
new product releases and net curriculum revenue increased by $1.1 million over
the same period last year driven by its new product releases and revisions of
textbooks.
54
Income from Operations. For the three-months ended June 30, 2004 segment income
from operations increased by $1.7 million or 41.5% to $5.8 million from $4.1
million for the same period in 2003 as gross profit increased by $3.2 million as
a result of the volume increase described above. The increase in gross profit
was partially offset by increases in sales and marketing expense of $0.7 million
and general and administrative expense of $0.5 million over the same period in
2003. The increase in sales and marketing expense resulted from an increase in
expenditures related to the reorganization of the sales department and marketing
initiatives related to new product launches. The increase in general and
administrative expense was due to increases in other compensation driven by the
performance of the segment and medical benefits of $0.3 million and a reversal
of accruals for an excess property tax assessment and building repairs in the
second quarter of 2003 of $0.2 million.
CONSOLIDATED RESULTS OF OPERATIONS FOR THE SIX-MONTHS ENDED JUNE 30, 2004 --
WEEKLY READER CORPORATION AND SUBSIDIARIES
The following table sets forth, for the periods indicated, consolidated
statements of operations data for Weekly Reader and its subsidiaries expressed
in millions of dollars and as a percentage of net revenue.
Six-months ended June 30,
2003 2004
---------------------------------- ----------------------------------
Amount % of Net Revenue Amount % of Net Revenue
------------ -------------------- ------------ --------------------
(Dollars in millions)
Revenue, net $ 64.5 100.0% $ 66.9 100.0%
Cost of goods sold 16.3 25.3% 17.1 25.6%
------- ----- ------- -----
Gross profit 48.2 74.7% 49.8 74.4%
Costs and expenses:
Sales and marketing 11.9 18.4% 13.3 20.0%
Distribution, circulation and fulfillment 6.4 9.9% 6.3 9.4%
Editorial 5.1 7.9% 5.3 7.9%
General and administrative 8.5 13.2% 10.3 15.4%
Restructuring costs 0.1 0.2% - 0.0%
Depreciation 0.9 1.4% 0.8 1.2%
Amortization of intangible assets 4.3 6.7% 4.3 6.4%
------- ----- ------- -----
Total costs and expenses 37.2 57.7% 40.3 60.2%
------- ----- ------- -----
Income from operations 11.0 17.1% 9.5 14.2%
Interest expense (13.7) (21.2%) (25.6) (38.3%)
Other expense, net (0.3) (0.5%) (0.4) (0.6%)
------- ----- ------- -----
Loss before income tax provision (3.0) (4.7%) (16.5) (24.7%)
Income tax provision 0.3 0.5% 0.4 0.6%
------- ----- ------- -----
Net loss $ (3.3) (5.1%) $ (16.9) (25.3%)
======= ===== ======= =====
Adjusted EBITDA(a) $ 15.9 24.7% $ 14.2 21.2%
======= ===== ======= =====
55
(a) Adjusted EBITDA represents loss before interest expense, taxes,
depreciation, amortization and other (income) charges including
restructuring costs of $0.1 million for the six-months ended June 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 our
operating performance or to cash flow as a measure of liquidity. It is
presented herein as we use it, in addition to operating income, to evaluate
and measure each business unit's performance. We also use Adjusted EBITDA
to evaluate management performance. Adjusted EBITDA may not be available
for our discretionary use as there are requirements to repay debt, among
other payments.
Six-Months Ended June 30, 2004 Compared to Six-Months Ended June 30, 2003
Revenue, net. For the six-months ended June 30, 2004, net revenue increased $2.4
million, or 3.7%, to $66.9 million from $64.5 million for the same period in
2003. The increase in net revenue at Weekly Reader was primarily due to (1) an
increase in net revenue at AGS of $5.1 million or 20.2% to $30.3 million from
$25.2 million from the same period in 2003. The increase at AGS was partially
offset by (2) a decrease in net revenue at World Almanac of $0.8 million or 3.4%
to $22.4 million from $23.2 million from the same period in 2003.; (3) a
decrease in net revenue at Weekly Reader, excluding World Almanac and AGS, of
$1.9 million, or 11.8%, to $14.2 million from $16.1 million from the same period
in 2003.
Gross profit. Gross profit at Weekly Reader increased $1.6 million or 3.3% to
$49.8 million from $48.2 million from the same period in 2003 primarily as a
result of (1) an increase in gross profit at AGS of $3.6 million from the same
period in 2003 driven by the volume increase described above. The increase at
AGS was partially offset by (2) a decrease in gross profit at Weekly Reader,
excluding AGS and World Almanac of $1.1 million from the same period in 2003
driven by the volume decrease described above; (3) a decrease in gross profit at
World Almanac of $0.9 million from the same period in 2003 due to the volume
decrease described above, write off of inventory at WA Books in the first
quarter of 2004 and the impact of a discount offer at WAE Library Services that
was not in effect during the same period in 2003. Weekly Reader gross profit as
a percent of revenue decreased slightly to 74.4% from 74.7% from the same period
in 2003 mainly due to the factors discussed above.
Costs and expenses. For the six-months ended June 30, 2004, operating costs and
expenses increased by $3.1 million, or 8.3%, to $40.3 million from $37.2 million
from the same period in 2003. Costs and expenses as a percentage of net revenue
increased to 60.2% from 57.7% from the same period in 2003. This increase was
primarily the result of: (i) $1.8 million or 21.2% increase in general and
administrative expenses due to increases in legal, audit, tax and consulting
professional fees of $0.9 million primarily related to the previously disclosed
SEC inquiry and the reaudit of our 2001 financial statements, higher employee
separation costs of $0.2 million and a reversal of accruals for an excess
property tax assessment and building repairs in the second quarter of 2003 of
$0.2 million and (ii) an increase in sales and marketing expenses of $1.4
million or 11.8% due to initiatives at AGS relating to the reorganization of its
sales department and new product launches, to an increase in new customer
acquisition costs at Weekly Reader, excluding AGS and World Almanac. These
higher expenses were partially offset by (iii) lower restructuring and
non-recurring costs of $0.1 million or 100.0%.
56
Interest expense, including amortization of deferred financing costs. For the
six-months ended June 30, 2004, interest expense, including amortization of
deferred financing costs, increased by $11.9 million, or 87.1, to $25.6 million
from $13.7 million for the same period in 2003 as the adoption of SFAS 150
requires dividends on the 15% Senior Preferred Stock to be recorded as interest
expense in the statement of operations for all periods starting January 1, 2004.
The dividends on the 15% Senior Preferred Stock for the three-months ended June
30, 2004 increased interest expense by $10.6 million. In addition, deferred
financing fees of $0.4 million attributable to the First-Lien Credit Facility
that was refinanced in part by the Second-Lien Credit Facility, which closed on
March 29, 2004 were written off in the first quarter of 2004. Interest expense
on long term-debt increased by $0.9 million primarily due to higher interest
rates in 2004 as opposed to 2003. Interest expense as a percentage of net
revenue increased to 38.3% from 21.2% for the same period in 2003.
Adjusted EBITDA. For the six-months ended June 30, 2004, Adjusted EBITDA
decreased $1.7 million, or 10.7%, to $14.2 million from $15.9 million for the
same period in 2003. This decrease was primarily attributable to the factors
described above. Adjusted EBITDA represents (loss) before interest expense,
taxes, depreciation, amortization and other (income) charges including
restructuring costs $0.1 million for the six-months ended June 30, 2003.
Adjusted EBITDA 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 our operating
performance or to cash flow as a measure of liquidity. It is presented herein as
we use it, in addition to operating income, to evaluate and measure each
business unit's performance. We also use Adjusted EBITDA to evaluate management
performance. Adjusted EBITDA may not be available for our discretionary use as
there are requirements to repay debt, among other payments. The reconciliation
of Adjusted EBITDA to net loss is as follows:
For the six-months ended June 30,
Adjusted EBITDA reconciliation to Net Loss 2003 2004
-------------------- --------------------
(Dollars in thousands)
Net Loss $ (3,344) $ (16,923)
Depreciation and amortization of intangibles 5,136 5,085
Income taxes 254 356
Interest expense 13,733 25,638
Restructuring costs 126 30
-------------------- --------------------
Adjusted EBITDA $ 15,905 $ 14,186
==================== ====================
57
RESULTS OF OPERATIONS FOR THE SIX-MONTHS ENDED JUNE 30, 2004 -- WEEKLY READER
CORPORATION AND SUBSIDIARIES - SEGMENT
WEEKLY READER
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 16.1 $ 14.2
Income (loss) from operations 1.6 (0.2)
Percentage of Net Revenue 9.9% -1.4%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the Weekly
Reader segment decreased by $1.9 million, or 11.8%, to $14.2 million from $16.1
million for the same period in 2003 as a result of lower licensing revenue of
$0.8 million due to the absence of a spring book club offering on the QVC
Shopping Network, lower periodical net revenue of $0.6 million as a result of a
weak educational funding environment and competitive pressures in the school
magazine market and a decrease in revenue of $0.3 million at Lifetime Learning
Systems, Inc., a subsidiary of Weekly Reader as a result of fewer shipments of
custom publishing projects.
Income (loss) from Operations. For the six months-ended June 30, 2004 segment
loss from operations increased by $1.8 million or 112.5% to a loss of $0.2
million from income of $1.6 million as gross profit decreased by $1.1 million as
a result of the volume decrease described above. General and administrative
expense increased by $0.4 million from the same period in 2003 primarily due to
greater employee separation costs and greater salary and fringes. Sales and
marketing costs increased by $0.5 million from the same period in 2003 due to an
increase of new customer acquisition costs. These increases were partially
offset by a decrease in distribution, circulation and fulfillment expenses of
$0.3 million from the same period in 2003 as a result of the absence of a spring
book club offering on the QVC Shopping Network.
WORLD ALMANAC
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 23.2 $ 22.4
Income from operations 3.2 2.3
Percentage of Net Revenue 13.8% 10.3%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the World
Almanac segment decreased by $0.8 million or 3.4% to $22.4 million from $23.2
million for the same period in 2003. This decrease was due to lower net revenue
of $0.4 million at World Almanac Books that resulted from a timing difference
related to consignment sales in the first quarter of 2004 and an increase in
expected sales returns recognized in the second quarter of 2004, lower net
revenue of $0.5 million at WAE Library Services as a result of the elimination
of their Prospect catalog and lower net revenue at Funk and Wagnalls of $0.3
million due to the attrition in their customer base. These decreases at World
Almanac were partially offset by higher sales of $0.4 million at Gareth Stevens
from its Wholesale and Field Rep channels,
58
Income from Operations. For the six-months-ended June 30, 2004 segment income
from operations decreased by $0.9 million or 28.1% to $2.3 million from $3.2
million primarily due to a reduction in gross profit of $1.0 million as a result
of the volume decrease described above, a write off of inventory at WA Books in
the first quarter of 2004 and the impact of a discount offer at WAE Library
Services that was not in effect during the same period in 2003. This decrease in
gross margin was partially offset by a reduction in sales and marketing expense
of $0.1 million from the same period in 2003 primarily due to a decrease in
expenses on the promotion of The World Almanac and Books of Facts.
AGS
For the six months ended June 30,
2003 2004
--------------- -----------------
(Dollars in millions)
Revenue, net $ 25.2 $ 30.3
Income from operations 6.0 7.4
Percentage of Net Revenue 23.8% 24.4%
Revenue, net. For the six-months ended June 30, 2004 net revenue at the AGS
segment increased by $5.1 million or 20.2% to $30.3 million from $25.2 million
for the same period in 2003. AGS Assessment net revenue increased by $4.3
million from the same period in 2003 as a result of the continued acceptance of
new product releases and net curriculum revenue increased $0.8 million over the
same period last year driven by its new product releases and revisions of
textbooks.
Income from Operations. For the six-months ended June 30, 2004 segment income
from operations increased by $1.4 million or 23.3% to $7.4 million from $6.0
million for the same period in 2003 as gross profit increased by $3.8 million as
a result of the volume increase described above. The increase in gross profit
was partially offset by increases in sales and marketing expense of $1.0
million, general and administrative expense of $0.7 million and editorial
expense of $0.2 million over the same period in 2003. The increase in sales and
marketing expense resulted from an increase in expenditures related to the
reorganization of the sales department and marketing initiatives related to new
product launches. The increase in general and administrative expense was due to
increases in other compensation driven by the performance of the segment and
medical benefits of $0.5 million and a reversal of accruals for an excess
property tax assessment and building repairs in the second quarter of 2003 of
$0.2 million. The increase in editorial expense was due to testing expenditures
associated with a high stakes test developed for the NY City Department of
Education in the first quarter of 2004.
59
For the six-months ended June 30,
Adjusted EBITDA reconciliation to Net Loss (000's) 2003 2004
-------- ---------
(Dollars in thousands)
Net Loss $ (3,344) $ (16,923)
Depreciation and amortization of intangibles 5,136 5,085
Income taxes 254 356
Interest expense 13,733 25,638
Restructuring costs 126 30
---------- ----------
Adjusted EBITDA $ 15,905 $ 14,186
========== ==========
LIQUIDITY AND CAPITAL RESOURCES
General
At June 30, 2004, WRC Media's sources of cash were its (1) operating
subsidiaries, Weekly Reader, CompassLearning, and ChildU and (2) a $30.0 million
revolving credit facility. As of June 30, 2004, $8.0 million of the revolving
credit facility has been drawn down which bears interest that approximated
3.45%. Additionally, the Company has stand-by letters of credit, renewable
annually, in the amount of $2.1 million, which serve as security for a real
estate lease entered into by the Company and certain surety bonds issued on
behalf of the Company. While these letters of credit are in effect, it reduces
available borrowing capacity under the revolving credit facility by $2.1
million. At June 30, 2004, the Company had $19.9 million of available credit
under the revolving credit facility.
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 time period, and borrowings generally will be at its lowest
point in the fourth quarter.
On March 29, 2004, we refinanced all of our term loans under our Senior Bank
Credit Facilities (the "First-Lien Credit Facility") with a $145.0 million
senior, second-priority lien secured financing that was provided to the Company
pursuant to a term loan facility (the "Second-Lien Facility"). The proceeds of
the Second-Lien Facility were used (i) to refinance in full all term loans
outstanding under the First-Lien Facility, (ii) to pay fees and expenses related
to the Second-Lien Facility and all transactions contemplated in connection
therewith and (iii) for general corporate purposes of the Company.
All payment obligations under the Second-Lien Facility are secured by a
second-priority lien on the collateral securing the First-Lien Facility;
provided that all obligations under the Second-Lien Facility will rank equally
in right of payment with all payment obligations under the First-Lien Facility
and will not be subordinated in any respect to the First-Lien Facility. The
final maturity of the Second-Lien Facility is March 29, 2009. At the Company's
option, the loans will bear interest at either the Administrative Agent's (i)
alternate base rate ("base rate loans") or (ii) reserve-adjusted LIBO rate
("LIBO rate loans") plus, in each case, the "Applicable Margin" (as defined).
"Applicable Margin" means, with respect to (i) Base Rate Loans, a rate of 4.00%
per annum and (ii) LIBO Rate Loans, a rate of 5.00% per annum.
60
The Second-Lien Facility has one financial covenant, a maximum ratio (the
"Senior Leverage Ratio") of Senior Secured Debt to trailing four quarter EBITDA
not to exceed 4.25:1.00 for any fiscal quarter, except the fiscal quarter ended
June 30, 2005 for which the Senior Leverage Ratio not exceed 4.50:1.00, in each
case to be tested on the last day of each fiscal quarter and computed for the
Company and its consolidated subsidiaries. We were in compliance with this
financial covenant for the period ended June 30, 2004. The Company's senior
leverage ratio was 3.56:1:00 for the period ended June 30, 2004.
In connection with entering into the Second-Lien Credit Facility, we entered
into an amendment and restatement of our First-Lien Credit Facility, which now
consists solely of a $30.0 million revolving credit facility. The cash available
under our First-Lien Credit Facility, together with the cash from our operating
subsidiaries, Weekly Reader, CompassLearning and ChildU, is considered adequate
for the Company's needs for the foreseeable future.
The First-Lien Credit Facility, as amended and restated, has a maturity of
December 29, 2008, and has one financial covenant, a Senior Leverage Ratio of
senior secured debt to trailing four quarter EBITDA not to exceed 4.00:1.00 for
any fiscal quarter, except the fiscal quarter ended June 30, 2005 for which the
Senior Leverage Ratio may not exceed 4.25:1.00, in each case to be tested on the
last day of the fiscal quarter and computed for the Company and its consolidated
subsidiaries. We were in compliance with this financial covenant for the period
ended June 30, 2004. As discussed above, the Company's senior leverage ratio was
3.56:1:0 for the period ended June 30, 2004. Interest on revolving loan
borrowings under the First-Lien Credit Facility will bear interest at a rate per
annum equal to the LIBO rate as defined in the First-Lien Credit Facility plus
2.00% or the alternate base rate as defined in the First-Lien Credit Facility
plus 1.00%.
The credit agreement for our First-Lien Credit Facility is secured by liens on
substantially all of our assets, and the credit agreement for our Second-Lien
Credit Facility is secured by second-priority liens on all the assets securing
the First-Lien Facility.
Liquidity, Working Capital and Capital Resources
As of June 30, 2004, WRC Media and its subsidiaries had negative working capital
of $ 13.7 million. WRC Media's cash and cash equivalents were approximately $5.1
million at June 30, 2004. WRC Media and its subsidiaries' operations used
approximately $17.7 million in cash for the six-months ended June 30, 2004. WRC
Media and its subsidiaries' principal uses of cash are for debt service and
working capital.
As of June 30, 2004, Weekly Reader and its subsidiaries had positive working
capital of $ 35.3 million. Weekly Reader's cash and cash equivalents were
approximately $5.0 million at June 30, 2004. Weekly Reader and its subsidiaries'
operations used approximately $9.8 million in cash for the six-months ended June
30, 2004. Weekly Reader and its subsidiaries' principal uses of cash are for
debt service and working capital.
61
WRC Media and its subsidiaries' investing activities for the six-months ended
June 30, 2004, included investments in software development of approximately
$1.2 million and capital expenditures of approximately $0.6 million.
Weekly Reader and its subsidiaries' investing activities for the six-months
ended June 30, 2004, included investments in capital expenditures of
approximately $0.4 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 six-months ended June 30, 2004,
financing activities provided net cash of $22.7 million. The Second Lien Credit
Facility does not amortize and we do not expect our financing activities going
forward to include regular periodic retirement of term loans prior to maturity.
The Second Lien Credit Facility matures on March 29, 2009.
Weekly Reader 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 six-months ended June
30, 2004, financing activities provided net cash of $13.9 million. The Second
Lien Credit Facility does not amortize and we do not expect our financing
activities going forward to include regular periodic retirement of term loans
prior to maturity. The Second Lien Credit Facility matures on March 29, 2009.
Derivative Financial Instruments
The Company uses derivative financial instruments to reduce its exposure to
interest rate volatility. At June 30, 2004, Weekly Reader had one outstanding
derivative financial instrument in place, an interest rate cap on 50% of its
senior secured term loans as required by the First-Lien Facility as then in
effect. Our amended and restated First-Lien Facility and our Second-Lien
Facility require us to obtain interest rate protection that, when taken together
with the aggregate principal amount of our indebtedness subject to a fixed
interest rate, will result in at least 50% of our total indebtedness being
either fixed, hedged or capped for the duration of the applicable facility. On
November 15, 2003, we entered into financial instruments with a notional value
of $61.0 million, which terminates on November 15, 2004 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 this interest rate cap as
of June 30, 2004 was de-minimis.
Accounting Policies and Estimates
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations
is based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements require
us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosures of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to allowances for doubtful accounts, reserves for sales returns
and allowances and the recoverability of long-lived assets. We base our
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances. These form the basis of our
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ materially from
these estimates, which would affect our reported results from operations. The
following is a description of what we believe to be the critical accounting
policies and estimates used in the preparation of our condensed consolidated
financial statements.
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Revenue Recognition
The Company's revenue recognition policies for its principal businesses are as
follows:
o Periodicals - Revenue is deferred and recognized ratably over the
subscription period, as the periodicals are delivered.
o Educational Publishing - For shipments to schools, revenue is
recognized on passage of title, which occurs upon shipment. Shipments
to depositories are on consignment. Revenue is recognized based on
reported shipments from the depositories to the schools. Likewise,
shipments to the distributor of the World Almanac and Book Of Facts
and the World Almanac For Kids books are treated similar to a
consignment sale. Revenue is recognized based on reported shipments
from the distributor to its customers (primarily retail book stores).
For certain software-based product, the Company offers new customers
installation and training. In such cases, revenue is recognized when
installation and training are complete.
o Reference and Trade - Revenue from the sale of children's books
through the wholesale channel are recognized when books are shipped to
wholesalers. Sales to school and public libraries made through the
telemarketing preview channel are recorded upon notification from the
customer of their intention to retain the previewed product. The sale
of children's books to bookstores and mass merchandisers primarily are
recognized by the Company at the time the distributor ships these
products to its customers. Concurrent with the recording of this
revenue, the Company records distribution fees as a reduction of
revenue.
o Educational Software And Related Products And Services - Software
revenues are recognized in accordance with the provisions of Statement
of Position (SOP) 97-2, Software Revenue Recognition, as amended by
SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with
Respect to Certain Transactions. Under SOP 97-2, we recognize revenue
for hardware and software sales upon shipment of the product, provided
collection of the receivable is probable, payment is due within one
year and the fee is fixed or determinable. If an acceptance period is
required, revenues are recognized upon the earlier of customer
acceptance or the expiration of the acceptance period. If significant
post-delivery obligations exist, revenues are deferred until no
significant obligations remain. Revenue from service contracts,
instruction and user training is recognized as the services are
performed and post-contract support is recognized ratably
63
over the related contract. Deferred revenue represents the Company's
obligation to perform under signed contracts. For contracts with
multiple elements (e.g., deliverable and undeliverable products,
maintenance and other post-contract support), the Company allocates
revenue to each undelivered element of the contract based on vendor
specific objective evidence of its fair value, which is specific to
the Company. The Company recognizes revenue allocated to delivered
products on the residual method when the criteria for product revenue
set forth above are met. Certain of the Company's customers are
subject to fiscal funding requirements. If the funding requirements
are subject to governmental approval, the likelihood of cancellation
is assessed. If the likelihood of cancellation is assessed as remote,
revenue is recognized. If the likelihood of cancellation is assessed
as other than remote, revenue is deferred. If the funding requirements
are subject to non-governmental approval, revenue is deferred and
recognized in accordance with the remaining provisions of SOP 97-2.
The Company also enters into lease financing arrangements for its
software products and services. These leases are immediately assigned
to a third-party with no recourse to the Company. The Company retains
no risk in these arrangements and has no history of granting
concessions related to the arrangements. Accordingly, the Company
recognizes revenue upon delivery of its products and services under
these lease arrangements.
o Licensing - Licensing revenue is recorded in accordance with royalty
agreements at the time licensed materials are available to the
licensee and collections are reasonably assured.
o Advertising - Revenue is recognized when the periodicals are shipped
and available to the subscribers.
o Pre-Publication Costs - Marketing, selling, distribution, editorial,
and other general and administrative expenses are generally expensed
as incurred. Certain editorial costs relating to the American Guidance
product lines are deferred and amortized using both straight-line and
accelerated methods over periods ranging from three to ten years. The
amortization is based on the expected life of the publication which is
determined based on the Company's historical experience with similar
publications.
o Direct-Response Advertising Costs - Advertising and subscription
acquisition costs are expensed the first time the advertising takes
place, except for direct-response advertising, the primary purpose of
which is to elicit sales from customers who can be shown to have
responded specifically to the advertising and that result in probable
future economic benefits. Direct-response advertising consists of
product promotional mailings, catalogs and subscription promotions.
These direct-response advertising costs are capitalized and amortized
over the estimated period of future benefit using a ratio of current
period revenues to total current and estimated future period revenues.
The amortization periods range from ten months to thirty months
subsequent to the promotional event. Amortization of direct-response
advertising costs is included in marketing and selling expenses in the
Company's consolidated statement of operations.
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Allowance for Doubtful Accounts
Allowances for doubtful accounts are estimated losses resulting from our
customers' failure to make required payments. The Company continually monitors
collections from customers and provides a provision for estimated credit losses
based upon historical experience. The Company aggressively pursues collection
efforts on these overdue accounts and upon collection reverses the write-off in
future periods. If future payments by our customers were to differ from our
estimates, we may need to increase or decrease our allowances for doubtful
accounts.
Reserve for Sales Returns
Reserves for sales returns and allowances are primarily related to our printed
publications. The Company estimates and maintains these reserves based primarily
on its distributors' historical return practices and our actual return
experience. If actual sales returns and allowances differ from the estimated
return and allowance rates used, we may need to increase or decrease our reserve
for sales returns and allowances.
Impairment of Long-Lived Assets
The Company periodically evaluates the recoverability of our long-lived assets,
including property and equipment, and finite lived intangible assets, whenever
events or changes in circumstances indicate that the carrying amount may not be
recoverable or in connection with its annual financial review process. Our
evaluations include analyses based on the undiscounted cash flows generated by
the underlying assets, profitability information, including estimated future
operating results and/or trends. If the value of the asset determined by these
evaluations is less than its carrying amount, impairment is recognized for the
difference between the fair value and the carrying value of the asset. Future
adverse changes in market conditions or poor operating results of the related
business may indicate an inability to recover the carrying value of the assets,
thereby possibly requiring an impairment charge to the carrying value of the
asset, in the future.
Goodwill and Other Identified Intangible Assets
We test goodwill for impairment annually and whenever events or circumstances
make it more likely than not that impairment may have occurred, such as a
significant adverse change in the business climate or a decision to sell or
dispose of a reporting unit. Determining whether an impairment has occurred
requires valuation of the respective reporting unit, which we estimate using a
discounted cash flow methodology. In applying this methodology, we rely on a
number of factors, including actual operating results, future business plans,
economic projections and market data.
If this analysis indicates goodwill is impaired, measuring its impairment
requires a fair value estimate of each identified tangible and intangible asset.
65
We test other identified intangible assets with defined useful lives and that
are subject to amortization by comparing the carrying amount to the sum of
undiscounted cash flows expected to be generated by the asset. We test
intangible assets with indefinite lives annually for impairment using a fair
value methodology such as discounted cash flows.
Valuation of Equity Instruments
The Company has granted stock options to certain of its employees. Certain of
these options contain a cashless exercise provision which require the Company to
account for such options using variable plan accounting. The Company recognizes
compensation expense related to those options with the cashless exercise
provision if fair market value of the Company's common stock, as estimated by
the Company's Board of Directors, exceeds the exercise price of the options.
The fair market value of the Company's common stock is determined by its Board
of Directors based on information available to the Board of Directors at the
time of determination. The Board considers factors such as the Company's current
and expected future results of operations, current market conditions and the
values of other similar companies.
Software Development Costs
The Company capitalizes software development costs under the provisions of
either Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1") or Statement of
Financial Accounting Standards ("SFAS") 86, "Computer Software to be Sold,
Leased, or Otherwise Marketed" ("SFAS 86"), based on the intended use of the
software.
Research and development costs are charged to expense when incurred.
Additionally, the Company capitalizes acquired and developed technologies that
meet the provisions of SFAS 86. The establishment of technological feasibility
and the ongoing assessment of the recoverability of these costs require
considerable judgment by management with respect to certain external factors,
including, but not limited to, anticipated future gross product revenues,
estimated economic product lives and changes in software and hardware
technology. Software development costs are amortized on a straight-line basis
over four years or the expected life of the product, whichever is less. The
Company periodically evaluates the net realizable value of capitalized software
development costs based on factors such as budgeted sales, product development
cycles and management's market emphasis.
The Company capitalizes the costs of acquiring, developing and testing software
to meet the Company's internal needs. Under the provisions of SOP 98-1, the
Company capitalizes costs associated with software developed or obtained for
internal use when both the preliminary project stage is completed and management
has authorized further funding for the project which it deems probable will be
completed and used to perform the function intended. Capitalized costs include
only (1) external direct costs of materials and services consumed in developing
or obtaining internal-use software, (2) payroll and payroll-related costs for
employees who are directly associated with and devote time to the internal-use
software project and (3) interest costs incurred while developing internal-use
software. Capitalization of such costs ceases no later than the point at which
the project is substantially complete and ready for its intended use. Internal
use software development costs are amortized using the straight-line method over
a five-year period.
66
Valuation of Deferred Tax Assets
The Company is not currently recognizing income and due to its lack of
historical earnings has determined it is not likely to realize the benefit of
its net deferred tax assets, and accordingly, records a 100% valuation reserve
against its net deferred tax assets, exclusive of deferred tax liabilities that
cannot be offset as the result of the adoption of SFAS 142. To the extent the
Company recognizes income in future years, the tax provision will reflect the
realization of such benefits, with the exception of benefits attributable to
acquired deferred tax assets. The recognition of such amount in future years
will be allocated to reduce the excess of the purchase price over the net assets
acquired and other non-current intangible assets.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variables Interest Entities ("FIN 46").
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements" to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. In
December 2003, the FASB issued FIN No. 46 (Revised) ("FIN 46R") to address
certain FIN 46 implementation issues. This interpretation requires that the
assets, liabilities, and results of activities of a Variable Interest Entity
("VIE") be consolidated into the financial statements of the enterprise that is
the primary beneficiary of the VIE. FIN 46R also requires additional disclosures
by primary beneficiaries and other significant variable interest holders. This
interpretation is effective no later than the end of the first interim or
reporting period ending after March 15, 2004, except for those VIE's that are
considered to be special purpose entities, for which the effective date is no
later than the end of the first interim or annual reporting period ending after
December 15, 2003. The adoption of FIN 46R, effective March 31, 2004, did not
have any effect on the Company's consolidated financial position or results of
operations.
In April 2003, the FASB issued Statements of Financial Accounting Standards
("SFAS") No. 149 "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS 149"), which amends and clarifies accounting for
derivative instruments, and for hedging activities under SFAS 133. Specifically,
SFAS 149 requires that contracts with comparable characteristics be accounted
for similarly. Additionally, SFAS 149 clarifies the circumstances in which a
contract with an initial net investment meets the characteristics of a
derivative and when a derivative contains a financing component that requires
special reporting in the statement of cash flows. This Statement is generally
effective for contracts entered into or modified after June 30, 2003 and its
adoption did not have any effect on the Company's consolidated financial
position or results of operations.
67
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement was effective for the
Company beginning January 1, 2004. For financial instruments created before the
issuance date of this statement and still existing at the beginning of the
interim period of adoption, transition shall be achieved by reporting the
cumulative effect of a change in an accounting principle by initially measuring
the financial instruments at fair value or other measurement attribute required
by this statement. The adoption of this statement required the Company to
reclassify its 15% Series B Redeemable Preferred Stock from the mezzanine
section of the balance sheet to long-term liabilities. Effective January 1, 2004
dividend payments for the 15% Senior Preferred Stock ("15% Senior Preferred")
are recorded as interest expense in the consolidated statement of operations.
The adoption of this statement did not result in any adjustment to the book
value of its 15% Senior Preferred as of January 1, 2004 as book value
approximated fair value at January 1, 2004. For the three-month and six-month
periods ended June 30, 2004 the Company recognized $5,394 and $10,593,
respectively, of accrued dividends on 15% Senior Preferred as interest expense.
On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits, an amendment of
FASB Statements No. 87, 88 and 106." It requires additional disclosures to those
in the original Statement 132 about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension plans and other defined benefit
post-retirement plans. The majority of the provisions of this statement apply to
financial statements issued for fiscal years ending after December 15, 2003. The
Company has adopted such disclosure provisions.
On March 17, 2004, the Emerging Issues Task Force of the FASB reached a
consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments." ("Issue 03-1") Issue 03-1 provides
guidance for determining when an investment is other-than-temporarily impaired
specifically, whether an investor has the ability and intent to hold an
investment until recovery. In addition, Issue 03-1 contains disclosure
requirements about impairments that have not been recognized as other than
temporary for investments. Issue 03-1 also requires the investor to disclose
investments with unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance for evaluating whether an
investment is other-than-temporarily impaired shall be applied in
other-than-temporary impairment evaluations made in reporting periods beginning
after June 15, 2004. The disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003, for investments
accounted for under Statements 115 and 124. For all other investments within the
scope of this Issue, the disclosures are effective in annual financial
statements for fiscal years ending after June 15, 2004. The additional
disclosures for cost method investments are effective for fiscal years ending
after June 15, 2004. The adoption of this consensus is not expected to have any
impact on the Company's consolidated results of operations or financial
position.
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/ChildU's net 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 uncommitted budget
resources 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.
CompassLearning's fourth quarter revenue is generally 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 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 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;
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;
69
The general risks inherent in the market and the impact of rising interest rates
with regard to its variable debt facilities; and
The terms of our First-Lien Facility and Second-Lien Facility require us on an
ongoing basis to meet certain maximum secured leverage ratio covenants. A
default under either credit agreement could result in acceleration of payment
obligations thereunder and would have a material adverse effect on our financial
condition and liquidity.
The preliminary SEC inquiry is ongoing, and we cannot predict the final outcome
of the inquiry at this time.
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
We are exposed to market risk. Market risk, with respect to our business, is the
potential loss arising from adverse changes in interest rates. We manage our
exposure to this market risk through daily operating and financing activities
and, when deemed appropriate, through the use of derivatives. We use derivatives
as risk management tools and not for trading purposes.
We were subject to market risk exposure related to changes in interest rates on
our $145.0 million senior secured term loans under our Second Lien Credit
Facility. Interest on revolving loan borrowings under our First Lien Credit
Facility maturing in December 2008 will bear interest at a rate per annum equal
to the LIBO rate as defined in the First Lien Credit Facility plus 3.5% or the
alternate base rate as defined in the First Lien Credit Facility plus 2.5%.
Interest on the term loans under our Second Lien Credit Facility maturing in
March 2009 will bear interest at a rate per annum equal to the LIBO rate as
defined in the Second Lien Credit Facility plus 5.0% or the alternate base rate
as defined in the Second Lien Credit Facility plus 4.0%. A 1% increase in
interest rates would result in an increase in our annual interest costs of
approximately $1.45 million.
The First Lien Credit Facility and the Second Lien Credit Facility require us to
obtain interest rate protection that, when taken together with the aggregate
principal amount of the Company's indebtedness subject to a fixed interest rate,
will result in at least 50% of our total indebtedness being either fixed, hedged
or capped for the duration of the applicable facility. On November 15, 2003, we
entered into an arrangement with a notional value of $61.0 million, which
terminates on November 15, 2004 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 June 30, 2004
was de-minimis.
The following table sets forth information about the Company's debt instruments
as of June 30, 2004:
Debt Less than After
Obligations Total 1 year 2-3 years 4-5 years 5 years
- ------------------------------------ -------------- -------------- -------------- --------------- -------------
Revolving Credit $ 8,000 $ - $ - $ 8,000 $ -
Average Interest Rate
Second Lien Credit Facility 145,000 - - 145,000 -
Average Interest Rate 6.76% (A)
Senior Subordinated Notes 152,000 - - - 152,000
Average Interest Rate 12.75%
(A) Interest rate through April 29, 2005.
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ITEM 4. CONTROLS AND PROCEDURES
WRC Media management, including the Chief Executive Officer and Principal
Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
on that evaluation, the Chief Executive Officer and Principal Financial Officer
concluded that the disclosure controls and procedures are effective in ensuring
that all material information to be filed in this quarterly report has been made
known to them in a timely fashion. There have been no significant changes in the
Company's internal controls, or in other factors that could significantly affect
internal controls, subsequent to the date the Chief Executive Officer and
Principal Financial Officer completed their evaluation. In making this
evaluation, WRC Media management considered the "material weaknesses" (as
defined under standards established by the American Institute of Certified
Public Accountants) that were identified and communicated to us by our
independent auditors in connection with the audit of our consolidated financial
statements for the year ended December 31, 2003. Our independent auditors
identified the following two such "material weaknesses": (1) numerous adjusting
entries proposed as a result of our 2003 audit were recorded by the Company to
correct the underlying books and records, including previously reported results
for 2002 and 2001, and (2) there were an insufficient number of qualified
accounting personnel appropriate for their positions, specifically within the
external financial reporting area. Prior to the identification of these
"material weaknesses" by our independent auditors, the Company began
implementing various policies and procedures in connection with its own review
of its accounting and external reporting functions.
In mid-2003, in connection with our review of the matter which led to the
restatement of revenue relating to a software and services sale, we reviewed our
revenue recognition policy for potential control weaknesses. At that time, our
software revenue recognition policy permitted deviations from our approved forms
of sales documentation with the approval of the operating unit's general
manager. We have changed our software revenue recognition policy to provide that
deviations from approved forms of sales documentation require both the approval
of a financial officer (Principal Financial Officer or Chief Accounting Officer)
of WRC Media, and the approval of legal counsel. We have taken a number of other
steps that will impact the effectiveness of our internal controls, including the
following:
o We have centralized our finance and accounting organization. The
operating unit controllers, who formerly reported to the operating
unit general managers, now report directly to the parent company
Principal Financial Officer;
o We restructured our finance group in a manner that places greater
emphasis on control and accountability issues;
o We have amended our Code of Conduct and Compliance Policies to require
all employees to sign a personal Code of Conduct Statement that states
that they have read the WRC Code of Conduct and represent that they
are in compliance, and that they are not aware of any violations of
the Company's Code of Conduct by others at the Company or its
affiliates. If they are aware of, or become aware of a violation they
are obligated to document and report the incident to the Chief
Executive or Principal Financial Officer of the Company.
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o We have established new policies and procedures for such matters as
complex transactions, and contract management procedures.
o We established a Disclosure Committee, consisting of senior personnel
from the business units and the finance group, as well as legal
counsel, and we now follow an extensive review and certification
process in connection with our filings with the SEC; and
o We hired an Assistant Treasurer/Controller in February 2004 to
increase resources in the external reporting area.
In addition, the Company is currently conducting a recruitment search for a
Chief Financial Officer.
We believe that these efforts address the "material weaknesses" identified by
our independent auditors. The Company continues to improve and refine its
internal controls. This process is ongoing, and the Company seeks to foster an
exemplary internal controls environment. Our management, including our Chief
Executive Officer and Principal Financial Officer, has concluded that, taking
into account the Company's efforts to address the matters described above, as of
the evaluation date, our disclosure controls and procedures are designed, and
are effective, to give reasonable assurance that information we must disclose in
reports filed with the SEC is properly recorded, processed, and summarized, and
then reported within the time periods specified in the rules and forms of the
SEC.
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PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
Pre-approval of Non-Audit Services
In accordance with Section 10A(i) of the Exchange Act, the Audit Committee of
the Board of Directors of the Company will pre-approve the provision of all
non-audit services to be provided to the Company by its independent auditors,
Deloitte & Touche LLP, as permitted by Section 10A.
Investor Relations
The Company posts on its Web site, www.wrcmedia.com, the date of its upcoming
financial press releases and telephone investor calls at least five days prior
to the event. The Company's investor calls are open to the public and remain
available to the public through the Company's Web site for at least five days
thereafter.
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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 August 13, 2004.
31.2 Certification of Richard Nota, Senior Vice President of Finance and
Principal Financial Officer of WRC Media Inc., and Weekly Reader
Corporation dated August 13, 2004.
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 August 13, 2004.
(B) REPORTS ON FORM 8-K
- -----------------------
1. Form 8-K, filed July 26, 2004, reporting date and time of investor call
discussing second quarter results for the period ended June 30, 2004.
2. Form 8-K, filed May 6, 2004, reporting date and time of investor call
discussing first quarter results for the period ended March 31, 2004.
3. Form 8-K, filed April 14, 2004, reporting investor conference call,
Martin E. Kenney, Jr., WRC Media Inc.'s Chief Executive Officer.
4. Form 8-K, filed April 5, 2004, reporting WRC Media Inc. announced the
date and time of its year-end investor conference call which is set
forth in the press release in an Exhibit hereto.
5. Form 8-K, filed April 1, 2004, reporting WRC Media Inc., A Leading
Supplemental Education Publisher, Secures Financial Liquidity By
Closing $145 Million Senior Second-Lien Credit Facility.
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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: August 13, 2004
- ----------------------------------------------------- ---------------------
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: August 13, 2004
- ----------------------------------------------------- ---------------------
Richard Nota
Senior Vice President-Finance and Principal Financial Officer
WRC Media Inc. and Weekly Reader Corporation
76