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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2003
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-32613
EXCELLIGENCE LEARNING CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 77-0559897 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
2 Lower Ragsdale Drive | ||
Monterey, CA | 93940 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrant’s Telephone Number, Including Area Code: (831) 333-2000
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $.01 par value, 8,580,248 shares outstanding as of November 5, 2003.
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EXCELLIGENCE LEARNING CORPORATION
PART I: | FINANCIAL INFORMATION | 1 | ||||
Item 1. | Financial Statements | 1 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 9 | ||||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 15 | ||||
Item 4. | Controls and Procedures | 16 | ||||
PART II: | OTHER INFORMATION | 16 | ||||
Item 1. | Legal Proceedings | 16 | ||||
Item 2. | Changes in Securities and Use of Proceeds | 16 | ||||
Item 3. | Defaults Upon Senior Securities | 16 | ||||
Item 4. | Submission of Matters to a Vote of Security Holders | 16 | ||||
Item 5. | Other Information | 17 | ||||
Item 6. | Exhibits and Reports on Form 8-K | 17 | ||||
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EXCELLIGENCE LEARNING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and share amounts)
(Unaudited)
September 30, 2003 | December 31, 2002* | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 3,493 | $ | 2,713 | ||||
Accounts receivable, net | 15,912 | 5,018 | ||||||
Inventories | 15,302 | 13,938 | ||||||
Prepaid expenses and other current assets | 3,285 | 2,701 | ||||||
Deferred income taxes | 1,511 | 1,672 | ||||||
Total current assets | 39,503 | 26,042 | ||||||
Property and equipment, net | 4,289 | 4,305 | ||||||
Deferred income taxes | 3,851 | 1,998 | ||||||
Other assets | 846 | 1,046 | ||||||
Goodwill | 5,878 | 4,701 | ||||||
Other intangible assets, net | 980 | 1,084 | ||||||
Total assets | $ | 55,347 | $ | 39,176 | ||||
LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 10,378 | $ | 3,524 | ||||
Accrued expenses | 3,947 | 4,297 | ||||||
Income tax liabilities | 1,965 | 216 | ||||||
Other current liabilities | 535 | 529 | ||||||
Total current liabilities | 16,825 | 8,566 | ||||||
Redeemable common shares, 100,000 shares authorized, issued and outstanding at September 30, 2003 | 400 | — | ||||||
Stockholders’ equity: | ||||||||
Common stock, $0.01 par value; 15,000,000 shares authorized; 8,480,248 and 8,401,914 shares issued and outstanding at September 30, 2003 and December 31, 2002, respectively | 85 | 84 | ||||||
Additional paid-in capital | 62,274 | 62,206 | ||||||
Deferred stock compensation | (1,059 | ) | (1,482 | ) | ||||
Accumulated deficit | (23,178 | ) | (30,198 | ) | ||||
Total stockholders’ equity | 38,122 | 30,610 | ||||||
Total liabilities, redeemable securities and stockholders’ equity | $ | 55,347 | $ | 39,176 | ||||
* | Derived from audited consolidated financial statements filed in the Company’s 2002 Annual Report on Form 10-K. |
See accompanying notes to condensed consolidated financial statements.
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EXCELLIGENCE LEARNING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
Revenues | $ | 50,951 | $ | 46,264 | $ | 92,014 | $ | 83,929 | ||||||||
Cost of goods sold | 32,297 | 29,048 | 58,500 | 52,836 | ||||||||||||
Gross profit | 18,654 | 17,216 | 33,514 | 31,093 | ||||||||||||
Operating expenses: | ||||||||||||||||
Selling, general and administrative | 9,711 | 8,694 | 25,733 | 24,659 | ||||||||||||
Amortization of other intangible assets | 71 | 72 | 218 | 216 | ||||||||||||
Operating income | 8,872 | 8,450 | 7,563 | 6,218 | ||||||||||||
Other (income) expense: | ||||||||||||||||
Interest expense | 116 | 137 | 257 | 401 | ||||||||||||
Interest income | (2 | ) | (7 | ) | (9 | ) | (24 | ) | ||||||||
Debt extinguishment and other (income) | 216 | (1 | ) | 216 | (1 | ) | ||||||||||
Income before income taxes | 8,542 | 8,321 | 7,099 | 5,842 | ||||||||||||
Income tax | 694 | 2,395 | 79 | 2,395 | ||||||||||||
Net income | $ | 7,848 | $ | 5,926 | $ | 7,020 | $ | 3,447 | ||||||||
Net income per share calculation: | ||||||||||||||||
Net income per share – basic | $ | 0.92 | $ | 0.71 | $ | 0.83 | $ | 0.41 | ||||||||
Net income per share – diluted | $ | 0.84 | $ | 0.69 | $ | 0.77 | $ | 0.40 | ||||||||
Weighted average shares used in basic net income per share calculation | 8,545,683 | 8,367,073 | 8,508,321 | 8,365,208 | ||||||||||||
Weighted average shares used in diluted net income per share calculation | 9,300,615 | 8,560,457 | 9,119,281 | 8,534,951 |
See accompanying notes to condensed consolidated financial statements.
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EXCELLIGENCE LEARNING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | ||||||||
2003 | 2002 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 7,020 | $ | 3,447 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 1,272 | 1,165 | ||||||
Provision for losses on accounts receivable | 197 | 206 | ||||||
Equity-based compensation | 423 | 429 | ||||||
Deferred income taxes | (1,692 | ) | 2,395 | |||||
Changes in operating assets and liabilities, net of assets and liabilities assumed in acquisition: | ||||||||
Accounts receivable | (11,091 | ) | (9,546 | ) | ||||
Inventories | (1,364 | ) | 4,799 | |||||
Prepaid expenses and other current assets | (584 | ) | 263 | |||||
Other assets | 200 | 51 | ||||||
Accounts payable | 6,854 | 6,440 | ||||||
Accrued expenses | (350 | ) | (659 | ) | ||||
Income tax related liabilities | 1,749 | — | ||||||
Other current liabilities | 6 | 71 | ||||||
Net cash provided by operating activities | 2,640 | 9,061 | ||||||
Cash flows from investing activities: | ||||||||
Purchase of property and equipment | (1,038 | ) | (789 | ) | ||||
Receivable from related party | — | 139 | ||||||
Acquisition of Marketing Logistics, Inc. | (891 | ) | — | |||||
Net cash used in investing activities | (1,929 | ) | (650 | ) | ||||
Cash flows from financing activities: | ||||||||
Borrowings on line of credit | 72,671 | 78,229 | ||||||
Principal payments on line of credit | (72,671 | ) | (83,818 | ) | ||||
Issuance of equity, net of fees | 69 | 8 | ||||||
Principal payments on notes payable | — | (14 | ) | |||||
Net cash provided by (used in) financing activities | 69 | (5,595 | ) | |||||
Net increase in cash and cash equivalents | 780 | 2,816 | ||||||
Cash and cash equivalents at beginning of period | 2,713 | 1,623 | ||||||
Cash and cash equivalents at end of period | $ | 3,493 | $ | 4,439 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Issuance of redeemable common shares in acquisition | $ | 400 | $ | — | ||||
Cash payments during the period: | ||||||||
Cash paid for interest | $ | 257 | $ | 314 | ||||
Cash paid for taxes | $ | 179 | $ | 548 | ||||
See accompanying notes to condensed consolidated financial statements.
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EXCELLIGENCE LEARNING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) The Business
Excelligence Learning Corporation, a Delaware corporation, is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. Excelligence Learning Corporation’s business is primarily conducted through its wholly-owned subsidiaries, Earlychildhood LLC, a California limited liability company (“Earlychildhood”), Educational Products, Inc., a Texas corporation (“EPI”), SmarterKids.com, Inc., a Delaware corporation (“SmarterKids.com”), and Marketing Logistics, Inc., a Minnesota corporation, d.b.a. Early Childhood Manufacturers’ Direct (“ECMD”).
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature) considered necessary for a fair presentation have been included. The balance sheet at December 31, 2002 was derived from the audited consolidated financial statements of Excelligence Learning Corporation (together with its wholly-owned subsidiaries, the “Company”) for the fiscal year ended December 31, 2002. For further information, refer to the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
Seasonality
The Company’s seasonal sales trends coincide with the start of each school year. Accordingly, approximately 45% to 50% of the Company’s consolidated annual sales are generated in the third calendar quarter. The working capital needs of the Company are greatest in the second calendar quarter as inventory levels are increased to meet seasonal demands.
Income Taxes
The Company is taxed as a C corporation. The Company has recorded an income tax expense of $694,000 and $79,000 for the three and nine months ended September 30, 2003, respectively, and an income tax expense of $2.4 million for each of the three and nine months ended September 30, 2002. During the third quarter of 2003, the Company determined that it would be able to realize a larger portion of its deferred tax assets related to net operating losses in excess of the recorded amount and, accordingly, eliminated a portion of its deferred tax asset valuation allowance. The decrease in the Company’s deferred tax asset valuation allowance reduced by $3.0 million the Company’s expected provision for income tax expense of $3.7 million and $3.1 million for the three and nine months ended September 30, 2003, respectively.
Equity-Based Compensation
The Company has adopted SFAS No. 123,Accounting for Stock-Based Compensation. As permitted by SFAS No. 123, the Company measures compensation cost in accordance with APB Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations. Accordingly, no accounting recognition is given at the date of grant to stock options granted to employees with an exercise price equal to the fair market value of the underlying common stock. Upon exercise, net proceeds, including income tax benefits realized, are credited to equity. Compensation cost for stock options granted with exercise prices below the fair market value of the underlying common stock is recognized over the vesting period.
SFAS No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure, amended SFAS No. 123,Accounting for Stock-Based Compensation. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amended the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation.
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The following table illustrates the effect on net income and earnings per share of applying the fair value recognition provisions of SFAS No. 123 to the Company’s stock-based employee compensation:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||
Net income, as reported | $ | 7,848 | $ | 5,926 | $ | 7,020 | $ | 3,447 | ||||
Add: stock-based employee compensation expense included in reported net income, net of related tax effects | 138 | 143 | 423 | 429 | ||||||||
Deduct: stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | 456 | 142 | 1,363 | 401 | ||||||||
Pro forma net income | $ | 7,530 | $ | 5,927 | $ | 6,080 | $ | 3,475 | ||||
Net income per share calculation: | ||||||||||||
Net income per share – basic, as reported | $ | 0.92 | $ | 0.71 | $ | 0.83 | $ | 0.41 | ||||
Net income per share – diluted, as reported | $ | 0.84 | $ | 0.69 | $ | 0.77 | $ | 0.40 | ||||
Net income per share – basic, pro forma | $ | 0.88 | $ | 0.71 | $ | 0.71 | $ | 0.42 | ||||
Net income per share – diluted, pro forma | $ | 0.81 | $ | 0.69 | $ | 0.67 | $ | 0.41 | ||||
Weighted average shares used in income per share calculation - basic | 8,545,683 | 8,367,073 | 8,508,321 | 8,365,208 | ||||||||
Weighted average shares used in income per share calculation - diluted | 9,300,615 | 8,560,457 | 9,119,281 | 8,534,951 |
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) approved for issuance Statement of Financial Accounting Standards (“SFAS”) No. 143,Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The provisions of SFAS No. 143 became effective for financial statements issued for fiscal years beginning after June 15, 2002. The effects of adopting SFAS No. 143 did not have an impact on the Company’s financial position, results of operations or footnote disclosures.
In May 2002, the FASB approved for issuance SFAS No. 145,Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 requires gains and losses from extinguishment of debt to be classified as an extraordinary item only if the criteria in Accounting Principles Board (APB) Opinion No. 30 have been met. In addition, lease modifications with economic effects similar to sale-leaseback transactions must be accounted for in the same manner as sale-leaseback transactions. While the technical corrections to existing pronouncements are not substantive in nature, in some instances they may change accounting practice. SFAS No. 145 became effective for financial statements with fiscal years beginning after May 15, 2002. The Company adopted the provisions of SFAS No. 145 on January 1, 2003 and, accordingly, recorded a loss on extinguishment of debt of $216,000 as other expense during the three and nine months ended September 30, 2003. Furthermore, any future losses from extinguishments of debt will be recorded as other expense.
In June 2002, the FASB approved for issuance SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses accounting and reporting for costs associated with exit and disposal activities and supercedes Emerging Issues Task Force Issue No. 94-3 (EITF 94-3),Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, as defined by SFAS No. 146. Under EITF 94-3, an exit cost was recognized at the date an entity committed to an exit plan. Additionally, SFAS No. 146 provides that exit and disposal costs should be measured at fair value and that the associated liability be adjusted for changes in estimated cash flows. SFAS No. 146 became effective for exit or disposal activities initiated after December 31, 2002. The Company did not participate in any exit or disposal activities during the first nine months of 2003.
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On May 15, 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of SFAS No. 150 on July 1, 2003. The Company does not have any financial instruments that fall within the scope of SFAS No. 150.
(2) Business Combinations
On February 19, 2003, the Company consummated its acquisition of Marketing Logistics, Inc., an online retailer of early childhood furniture and equipment now doing business as ECMD. Consideration for the acquisition included $800,000 in cash and 100,000 redeemable shares of the Company’s common stock. The seller has a one-time opportunity, exercisable during the thirty-day period prior to February 19, 2004, to exchange the shares received by him in the acquisition for $400,000 in cash.
The allocation of the purchase price of $1.2 million plus transaction costs of $71,000 is summarized as follows (in thousands):
Goodwill | $ | 1,177 | |
Trademarks | 94 | ||
Total purchase price | $ | 1,271 | |
In April 2001, the Company completed the combination of Earlychildhood and SmarterKids.com. In conjunction with the combination, the Company terminated certain SmarterKids.com employees and determined that an acquired lease for a facility in Needham, Massachusetts was unfavorable. As a result, liabilities of $1.5 million and $1.1 million were recorded for severance and the unfavorable lease, respectively.
In the fourth quarter of 2001, the Company approved a restructuring plan to aid in the reduction of operating costs. Specifically, the Company closed its Needham facility in January 2002. In accordance with the plan, the closure of the Needham facility consolidated information systems and marketing functions in Monterey, California and reduced the administrative costs associated with operating an additional facility. Additional charges related to the planned closure of the Needham facility and various equipment leases that are no longer being used in the Company’s operations totaled $1.3 million and were expensed in 2001. During the fiscal year ended December 31, 2001, the Company paid $1.3 million and $112,000 related to severance and facility costs, respectively.
During fiscal year 2002, the Company paid $401,000 and $1.3 million related to severance and Needham facility costs, respectively. Of these costs, $226,000 related to severance costs for terminations announced in 2002 and therefore was recorded as an expense in the first quarter of 2002. The remaining payments for severance related to charges taken in 2001. Also during fiscal year 2002, the Company determined that, due to a continued decline in the Needham, Massachusetts real estate market, its assumptions for sublease income should be reduced and an additional charge of $653,000 related to the unfavorable lease was expensed.
During the nine months ended September 30, 2003, the Company paid $749,000 related to Needham facility costs.
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A rollforward of activity in merger integration related liabilities follows (in thousands):
Severance | Needham Facility (a) | Total | ||||||||||
Balance at December 31, 2001 | $ | 175 | $ | 2,257 | $ | 2,432 | ||||||
Additional 2002 charges | 226 | 653 | 879 | |||||||||
Amounts paid | (401 | ) | (1,340 | ) | (1,741 | ) | ||||||
Balance at December 31, 2002 | — | 1,570 | 1,570 | |||||||||
Additional 2003 charges | — | — | — | |||||||||
Amounts paid | — | (749 | ) | (749 | ) | |||||||
Balance at September 30, 2003 | $ | — | $ | 821 | $ | 821 | ||||||
(a) | The liability related to the Needham facility lease has been determined based on the actual payments remaining over the life of the lease, net of estimated sublease income. The Company has entered into two sublease agreements collectively covering approximately 74% of the facility through the remaining term of the lease. The Company is actively seeking a subtenant for the remaining space, but can offer no assurances as to when, or if, a subtenant will be found. |
(3) Unaudited Basic and Diluted Net Income Per Share
The basic and diluted net income per share information for the three and nine months ended September 30, 2003 and 2002 included in the accompanying statements of operations is based on the weighted average number of shares of common stock outstanding during the period.
The following table sets forth the computation of basic and diluted net income per share for the three and nine months ended September 30, 2003 and 2002 (in thousands, except for share and per share amounts):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||
Net income | $ | 7,848 | $ | 5,926 | $ | 7,020 | $ | 3,447 | ||||
Weighted average shares used in basic income per share calculation | 8,545,683 | 8,367,073 | 8,508,321 | 8,365,208 | ||||||||
Weighted average shares used in diluted income per share calculation | 9,300,615 | 8,560,457 | 9,119,281 | 8,534,951 | ||||||||
Net income per share – basic | $ | 0.92 | $ | 0.71 | $ | 0.83 | $ | 0.41 | ||||
Net income per share – diluted | $ | 0.84 | $ | 0.69 | $ | 0.77 | $ | 0.40 | ||||
Common stock equivalents of 754,932 and 193,384 are included in the diluted weighted average shares for the three months ended September 30, 2003 and 2002, respectively. Common stock equivalents of 610,960 and 169,743 are included in the diluted weighted average shares for the nine months ended September 30, 2003 and 2002, respectively. Common equivalent shares consist of shares issuable upon the exercise of stock options.
(4) Segment Information
The Company operates in two business segments, the Early Childhood segment and the Elementary School segment. The Early Childhood segment includes the brand names Discount School Supply, SmarterKids.com, ECMD, andEarlychildhood NEWS. The Early Childhood segment develops, manufactures and sells educational products through multiple distribution channels to early childhood professionals and parents. The Early Childhood segment also provides information to teachers and other education professionals regarding development of children from infancy through age eight. The Elementary School segment sells school supplies and other products specifically targeted for use by children in first through sixth grade to elementary schools, teachers and other education organizations for fundraising activities.
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The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. There were no intersegment sales. The Company’s supplemental profit measure is EBITDA, a non-GAAP financial measure which represents net income (loss) adding back, net interest, income taxes, depreciation and amortization. EBITDA is presented because the Company uses the measure and believes that it is also used by lenders, analysts, investors and others as an indication of the Company’s ability to service debt and fund future capital expenditure requirements. The Company believes that EBITDA, when combined with other measures, can be a useful measure of its overall performance and results of operations. This information should not be considered as an alternative to any measure of performance as promulgated under generally accepted accounting principles (such as operating income or net income), nor should it be considered as an indicator of the Company’s overall financial performance. The Company’s calculations of EBITDA may be different from the calculations used by other companies and therefore comparability may be limited. Information regarding the Early Childhood and Elementary School segments and reconciliation of net income (loss) to EBITDA is as follows (in thousands):
Early Childhood | Elementary School | Consolidated | |||||||||||||||||||
Three Months Ended September 30, | |||||||||||||||||||||
2003 | 2002 | 2003 | 2002 | 2003 | 2002 | ||||||||||||||||
Net revenues | $ | 28,171 | $ | 24,942 | $ | 22,780 | $ | 21,322 | $ | 50,951 | $ | 46,264 | |||||||||
EBITDA: | |||||||||||||||||||||
Net income | $ | 4,729 | $ | 136 | $ | 3,119 | $ | 5,790 | $ | 7,848 | $ | 5,926 | |||||||||
Net interest | 114 | 134 | — | (4 | ) | 114 | 130 | ||||||||||||||
Income taxes | (1,678 | ) | 2,395 | 2,372 | — | 694 | 2,395 | ||||||||||||||
Depreciation and amortization | 288 | 301 | 144 | 99 | 432 | 400 | |||||||||||||||
EBITDA | $ | 3,453 | $ | 2,966 | $ | 5,635 | $ | 5,885 | $ | 9,088 | $ | 8,851 | |||||||||
Early Childhood | Elementary School | Consolidated | |||||||||||||||||||
Nine Months Ended September 30, | |||||||||||||||||||||
2003 | 2002 | 2003 | 2002 | 2003 | 2002 | ||||||||||||||||
Net revenues | $ | 62,578 | $ | 55,246 | $ | 29,436 | $ | 28,683 | $ | 92,014 | $ | 83,929 | |||||||||
EBITDA: | |||||||||||||||||||||
Net income (loss) | $ | 5,053 | $ | (1,354 | ) | $ | 1,967 | $ | 4,801 | $ | 7,020 | $ | 3,447 | ||||||||
Net interest | 248 | 391 | — | (14 | ) | 248 | 377 | ||||||||||||||
Income taxes | (1,437 | ) | 2,395 | 1,516 | — | 79 | 2,395 | ||||||||||||||
Depreciation and amortization | 869 | 877 | 403 | 288 | 1,272 | 1,165 | |||||||||||||||
EBITDA | $ | 4,733 | $ | 2,309 | $ | 3,886 | $ | 5,075 | $ | 8,619 | $ | 7,384 | |||||||||
The Early Childhood segment performs limited administrative activities, including certain accounting and information system functions, for the Elementary School segment. Intersegment charges are based on estimates of actual costs for such activities. Intersegment charges have been eliminated in consolidation and amounted to $144,922 and $144,168 for the three months ended September 30, 2003 and 2002, respectively, and $434,765 and $432,504 for the nine months ended September 30, 2003 and 2002, respectively.
The segment asset information available is as follows (in thousands):
September 30, 2003 | December 31, 2002 | |||||||
Assets | ||||||||
Early Childhood | $ | 41,869 | $ | 32,128 | ||||
Elementary School | 24,788 | 18,358 | ||||||
Eliminations | (11,310 | ) | (11,310 | ) | ||||
Total | $ | 55,347 | $ | 39,176 | ||||
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(5) Goodwill and Intangibles
On January 1, 2002, the Company adopted SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations and that certain acquired intangible assets be recognized as assets apart from goodwill. SFAS No. 142 provides that goodwill should not be amortized, but should instead be tested for impairment annually at the reporting unit level.
The Company has reevaluated its intangible asset lives and no adjustments to the useful lives were determined to be necessary. In accordance with SFAS No. 142, the Company completed a transitional goodwill impairment test as of January 1, 2002 in the second quarter of 2002 and determined that no additional impairment charge was necessary. The Company performs its annual impairment test required by SFAS No. 142 in the fourth quarter. No reclassification of intangible assets apart from goodwill was necessary as a result of the adoption of SFAS No. 142.
The following table identifies the major classes of intangible assets at September 30, 2003 and December 31, 2002 (in thousands):
September 30, 2003 | December 31, 2002 | |||||||||||||
Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | |||||||||||
Trademarks, trade names and formulas | $ | 953 | $ | (760 | ) | $ | 840 | $ | (649 | ) | ||||
Customer lists | 1,410 | (623 | ) | 1,410 | (517 | ) | ||||||||
$ | 2,363 | $ | (1,383 | ) | $ | 2,250 | $ | (1,166 | ) | |||||
Total amortization expense on intangible assets was $71,000 and $72,000 for the three months ended September 30, 2003 and 2002, respectively, and $217,000 and $216,000 for the nine months ended September 30, 2003 and 2002, respectively. The carrying amount of goodwill was $5.9 million and $4.7 million at September 30, 2003 and December 31, 2002, respectively. During the nine months ended September 30, 2003, the Company recorded $1.2 million in goodwill through its acquisition of Marketing Logistics, Inc. There was no impairment loss recorded during either the three or nine months ended September 30, 2003 or the three or nine months ended September 30, 2002.
(6) Debt
On September 29, 2003, the Company entered into a $20.0 million secured credit facility with Bank of America, N.A. (the “Bank of America Facility”). The Bank of America Facility replaced the Company’s credit facility with GMAC Business Credit, LLC (the “GMAC Facility”).
The Bank of America Facility includes a $15.0 million revolving line of credit with a maturity date of October 1, 2005 and an interest rate of LIBOR plus 1.75% (2.87% at September 30, 2003). The Bank of America Facility also includes up to $5.0 million through a reducing revolving term loan with a maturity date of October 1, 2008 and an interest rate of LIBOR plus 2.00% (3.12% at September 30, 2003). The Bank of America Facility is secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property. As of September 30, 2003, the Company had no borrowings and available credit of $20.0 million under the Bank of America Facility.
The Bank of America Facility requires adherence to certain financial covenants and limitations related to capital expenditures and acquisitions during the term of the Bank of America Facility. As of September 30, 2003, the Company was in compliance with the financial covenants as set forth in the Bank of America Facility.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion contains forward-looking statements that involve risks and uncertainties that could significantly affect anticipated results in the future. Those risks and uncertainties include, but are not limited to, (1) changes in general economic and business conditions and in e-retailing, or the educational products industry in particular, (2) the impact of competition, including the development of competing proprietary products by the Company’s competitors, (3) the level of demand for the Company’s products, (4) fluctuations in the value of the U.S. dollar and (5) the Company’s inability to diversify its product offerings and expand in new and existing markets. Excelligence Learning Corporation makes these forward-looking statements under the provision of the “Safe
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Harbor” section of the Private Securities Litigation Reform Act of 1995. Actual results may vary materially from those projected, anticipated or indicated in any forward-looking statements. The Company assumes no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so in connection with its ongoing requirements under federal securities laws to disclose material information. In this Form 10-Q, the words “anticipates,” “believes,” “expects,” “intends,” “future,” “could,” and similar words or expressions (as well as other words or expressions referencing future events, conditions, or circumstances) identify forward-looking statements. The following discussion and analysis should be read in conjunction with the financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. Investors should also refer to Item 1 —“Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 for a discussion of various risk factors relating to the Company’s business. Given these risks and uncertainties, we can give no assurance that any forward-looking statements, which speak only as of the date of this report, will in fact transpire and, therefore, we caution investors not to place undue reliance on them.
Overview
The Company is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. Through a predecessor entity, the Company began operations in 1985. The Company utilizes multiple sales, marketing and distribution channels, including:
• | its Discount School Supply catalog, through which the Company develops, markets and sells educational products to early childhood professionals and parents; |
• | Educational Products, Inc.’s (“EPI”) fundraising programs, through which the Company sells school supplies and other products specifically targeted for use by children in first through sixth grade to elementary schools, teachers and other education organizations; |
• | Early Childhood Manufacturers’ Direct’s (“ECMD”) website and newly-created catalog mailed in the second quarter of 2003, through which the Company markets and sells furniture and equipment delivered directly from the manufacturer to schools and early childhood programs; |
• | the SmarterKids.com website, through which the Company sells its educational products online to consumers; and |
• | Earlychildhood NEWS, an award winning print and web-based magazine focused on the growth and development of children from infancy through age eight. |
All of the foregoing is supported by a national sales force which, as of September 30, 2003, numbered 51 people.
The Company operates in two business segments, Early Childhood and Elementary School. The Early Childhood segment includes the brand names Discount School Supply, SmarterKids.com, ECMD, andEarlychildhood NEWS. The Early Childhood segment develops, manufactures and sells educational products through multiple distribution channels to early childhood professionals and parents. The Early Childhood segment also provides information to teachers and other education professionals regarding the development of children from infancy through age eight. The Elementary School segment sells school supplies and other products specifically targeted for use by children in kindergarten through sixth grade to elementary schools, teachers and other education organizations for fundraising activities.
Results of Operations
Revenues
Revenues were $51.0 million and $46.3 million for the three months ended September 30, 2003 and 2002, respectively, and $92.0 million and $83.9 million for the nine months ended September 30, 2003 and 2002, respectively. For the three months ended September 30, 2003, revenues increased $4.7 million, or 10.1%, over the three months ended September 30, 2002. The increase was attributable to revenue growth of $3.2 million in the Early Childhood segment and $1.5 million in the Elementary School segment. For the nine months ended September 30, 2003, revenues increased $8.1 million, or 9.6%, over the nine months ended September 30, 2002. The increase was attributable to revenue growth of $7.3 million in the Early Childhood segment and an increase of $753,000 in the Elementary School segment. The increase in the Early Childhood segment was achieved through new product offerings, new customer solicitation and improved sales and marketing strategies.
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The Company will continue with its goal to achieve revenue growth in the Early Childhood and Elementary School segments by increasing circulation of its catalogs, offering new proprietary products, soliciting new customers, implementing more aggressive sales and marketing strategies and enhancing the Company’s websites. The Company’s ability to realize growth may be negatively affected by changes in the national economy that reduce government or private funding of educational programs or that increase joblessness and may result in parents removing their children from childcare programs.
Gross Profit
Gross profit was $18.7 million and $17.2 million for the three months ended September 30, 2003 and 2002, respectively. The increase is primarily attributable to increased revenues for the period. Gross profit as a percentage of sales decreased from 37.2% for the third quarter of 2002 to 36.6% for the third quarter of 2003. The decrease in gross profit percentage was largely due to changes in product mix and increased inbound freight charges.
Gross profit was $33.5 million and $31.1 million for the nine months ended September 30, 2003 and 2002, respectively. The increase is primarily attributable to increased revenue for the period. Gross profit as a percentage of sales decreased to 36.4% for the nine months ended September 30, 2003 from 37.0% for the same period in 2002. The decrease in gross profit percentage was also largely due to changes in product mix and increased inbound freight charges.
The Company accounts for shipping costs as cost of goods sold for shipments made directly from vendors to customers and also for shipments from the Company’s warehouses. The amount of shipping costs related to shipments from the Company’s warehouses for the three months ended September 30, 2003 and 2002 was $2.6 million and $2.5 million, respectively, or 5.2% and 5.4% as a percentage of sales, respectively. For the nine months ended September 30, 2003 and 2002, these shipping costs totaled $5.3 million and $5.2 million, respectively, or 5.8% and 6.2% as a percentage of sales, respectively. The amount of shipping costs related to shipments made directly from vendors to customers for the three months ended September 30, 2003 and 2002 was $1.2 million and $796,000, respectively, or 2.4% and 1.7% as a percentage of sales, respectively. For the nine months ended September 30, 2003 and 2002, these shipping costs totaled $2.4 million and $1.7 million, respectively, or 2.6% and 2.0% as a percentage of sales, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include wages and commissions, catalog costs, operating expenses (which include customer service and certain warehouse costs), administrative costs (which include information systems, accounting and human resources), e-business costs, equity-based wages and depreciation of property and equipment. Selling, general and administrative expenses were $9.7 million and $8.7 million for the three months ended September 30, 2003 and 2002, respectively. Selling, general and administrative expenses were $25.7 million and $24.7 million for the nine-month periods ended September 30, 2003 and 2002, respectively.
The $1.0 million increase in selling, general and administrative expenses for the three months ended September 30, 2003 over the same period in 2002 was the result of an increase in operating expenses of $632,000 and $385,000 in the Early Childhood and Elementary School segments, respectively. The $1.0 million increase in selling, general and administrative expenses for the nine months ended September 30, 2003 over the same period in 2002 is attributable to increases of $195,000 in the Early Childhood segment and $877,000 in the Elementary School segment. The increases in the Early Childhood segments for the three and nine months ended September 30, 2003 are primarily related to the costs associated with introducing a new catalog initiative as well as increased wages and insurance costs. The increases in the Elementary School segment for the three and nine months ended September 30, 2003 are primarily related to increase in wages related to an increase in the number of sales representatives over the same periods in prior years, increased temporary help hired for the back to school season and increased insurance costs.
Amortization of Other Intangible Assets
Amortization of other intangible assets was $71,000 and $72,000 for the three months ended September 30, 2003 and 2002, respectively, and $218,000 and $216,000 for the nine months ended September 30, 2003 and 2002, respectively.
Interest Expense
Interest expense was $114,000 and $130,000 for the three months ended September 30, 2003 and 2002, respectively, and $248,000 and $377,000 for the nine months ended September 30, 2003 and 2002, respectively. The decrease in interest expense is due to more favorable interest rates and the Company carrying a lower average outstanding balance on its GMAC Facility during 2003 compared to the same periods in 2002.
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Income Taxes
The Company is taxed as a C corporation. The Company has recorded an income tax expense of $694,000 and $79,000 for the three and nine months ended September 30, 2003, respectively, and an income tax expense of $2.4 million for each of the three and nine months ended September 30, 2002. During the third quarter of 2003, the Company determined that it would be able to realize a larger portion of its deferred tax assets related to net operating losses in excess of the recorded amount and, accordingly, eliminated a portion of its deferred tax asset valuation allowance. The decrease in the Company’s deferred tax asset valuation allowance reduced by $3.0 million the Company’s expected provision for income tax expense of $3.7 million and $3.1 million for the three and nine months ended September 30, 2003, respectively.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) approved for issuance Statement of Financial Accounting Standards (“SFAS”) No. 143,Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The provisions of SFAS No. 143 became effective for financial statements issued for fiscal years beginning after June 15, 2002. The effects of adopting SFAS No. 143 did not have an impact on the Company’s financial position, results of operations or footnote disclosures.
In May 2002, the FASB approved for issuance SFAS No. 145,Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 requires gains and losses from extinguishment of debt to be classified as an extraordinary item only if the criteria in Accounting Principles Board (APB) Opinion No. 30 have been met. In addition, lease modifications with economic effects similar to sale-leaseback transactions must be accounted for in the same manner as sale-leaseback transactions. While the technical corrections to existing pronouncements are not substantive in nature, in some instances they may change accounting practice. SFAS No. 145 became effective for financial statements with fiscal years beginning after May 15, 2002. The Company adopted the provisions of SFAS No. 145 on January 1, 2003 and, accordingly, recorded a loss on extinguishment of debt of $216,000 as other expense during the three and nine months ended September 30, 2003. Furthermore, any future losses from extinguishments of debt will be recorded as other expense.
In June 2002, the FASB approved for issuance SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses accounting and reporting for costs associated with exit and disposal activities and supercedes Emerging Issues Task Force Issue No. 94-3 (EITF 94-3),Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, as defined by SFAS No. 146. Under EITF 94-3, an exit cost was recognized at the date an entity committed to an exit plan. Additionally, SFAS No. 146 provides that exit and disposal costs should be measured at fair value and that the associated liability be adjusted for changes in estimated cash flows. SFAS No. 146 became effective for exit or disposal activities initiated after December 31, 2002. The Company did not participate in any exit or disposal activities during the first nine months of 2003.
On May 15, 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of SFAS No. 150 on July 1, 2003. The Company does not have any financial instruments that fall within the scope of SFAS No. 150.
Liquidity and Capital Resources
On September 29, 2003, the Company entered into a $20.0 million secured credit facility with Bank of America, N.A. (the “Bank of America Facility”). The Bank of America Facility replaced the Company’s credit facility with GMAC Business Credit, LLC (the “GMAC Facility”).
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The Company’s primary cash needs have been for operations, capital expenditures and acquisitions. The Company’s primary source of liquidity through September 29, 2003 was the GMAC Facility. Going forward, the primary source of the Company’s liquidity will be the Bank of America Facility. As of September 30, 2003, the Company had net working capital of $22.7 million.
During the nine months ended September 30, 2003, the Company’s operating activities provided $2.6 million of cash. The increase in cash was primarily related to operating income and working capital. The Company used $1.9 million in cash for investing activities during the nine months ended September 30, 2003 with which the Company acquired Marketing Logistics, Inc. and purchased property and equipment. The Company obtained $69,000 in cash from financing activities through issuance of common stock.
The Bank of America Facility includes a $15.0 million revolving line of credit with a maturity date of October 1, 2005 and an interest rate of LIBOR plus 1.75% (2.87% at September 30, 2003). The Bank of America Facility also includes up to $5.0 million through a reducing revolving term loan with a maturity date of October 1, 2008 and an interest rate of LIBOR plus 2.00% (3.12% at September 30, 2003). The Bank of America Facility is secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property. As of September 30, 2003, the Company had no borrowings and available credit of $20.0 million under the Bank of America Facility.
The Bank of America Facility requires adherence to certain financial covenants and limitations related to capital expenditures and acquisitions during the term of the Bank of America Facility. As of September 30, 2003, the Company was in compliance with the financial covenants as set forth in the Bank of America Facility.
Management believes that availability of cash under the Bank of America Facility will provide adequate funds for the Company’s foreseeable working capital needs and planned capital expenditures. The Company’s working capital needs are greatest during the second calendar quarter as inventory levels are increased to meet seasonal demands. The Company’s ability to fund its operations, repay debt, make planned capital expenditures and to remain in compliance with its financial covenants under the Bank of America Facility depends on its future operating performance and cash flow, which in turn are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond its control.
The following summarizes the Company’s contractual obligations as of September 30, 2003 and the effect such obligations are expected to have on liquidity and cash flow in future periods (in thousands):
Payments due by period | |||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1-3 years | 4-5 years | More than 5 years | ||||||||||
Operating lease obligations | $ | 12,464 | $ | 4,262 | $ | 6,404 | $ | 1,155 | $ | 643 | |||||
Included in non-cancelable operating leases is $1.2 million in future cash requirements related to the abandonment of the Needham, Massachusetts facility. Such charges may be paid out over the remaining lease term, which expires October 2004. On November 12, 2002, the Company signed a 24-month lease agreement to sublease 25.5%, or 10,000 square feet, of the Needham facility. Additionally, on May 30, 2003, the Company signed a 14-month lease agreement to sublease 48.5%, or 19,000 square feet, of the Needham facility. The Company is actively seeking a subtenant for the remaining space but can offer no assurances as to when, or if, a subtenant will be found.
Business Outlook
The following forward-looking statements reflect the Company’s revised expectations for the full fiscal year 2003. Actual results may differ materially given the potential changes in general economic conditions and the various other risks discussed in Item 1—“Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
The Company’s goal in 2003 is to achieve revenue growth in the Early Childhood and Elementary School segments by increasing circulation of its Discount School Supply catalog, increasing childhood furniture sales through expanding the operations of ECMD, offering new proprietary products, soliciting new customers, implementing more aggressive sales and marketing strategies and enhancing the Company’s websites. The Company’s ability to realize this growth may be negatively affected by changes in the national economy that reduce government or private funding of educational programs or that increase joblessness and may result in parents removing their children from childcare programs.
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Revised Full Year 2003 Expectations:
• | Net revenues are expected to be between $108 and $112 million; |
• | EBITDA is expected to be between $6 and $8 million; and |
• | Operating income is expected to be between $4 and $6 million. |
EBITDA, a non-GAAP financial measure which the Company believes is a meaningful supplemental measure of its operating performance, is calculated by adding back to net income (loss): net interest, income taxes, depreciation and amortization. EBITDA is presented because the Company uses the measure and believes that it is also used by lenders, analysts, investors and others as an indication of the Company’s ability to service debt and fund future capital expenditure requirements. The Company believes that EBITDA, when combined with other measures, can be a useful measure of its overall performance and results of operations. This information should not be considered as an alternative to any measure of performance as promulgated under generally accepted accounting principles (such as operating income or income before extraordinary items) nor should it be considered as an indicator of the Company’s overall financial performance. The Company’s calculations of EBITDA may be different from the calculations used by other companies and therefore comparability may be limited. Information regarding the Early Childhood and Elementary School segments and reconciliation of net income (loss) to EBITDA appears in Note (4) to the Company’s condensed consolidated financial statements, which begins on page 7 of this quarterly report on Form 10-Q.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s 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 requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, the Company evaluates its estimates, including those related to bad debts, product returns, intangible assets, inventories, and merger integration. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Revenue Recognition and Accounts Receivable Valuation
The Company recognizes revenues from product sales upon the delivery of products. Provisions for estimated returns and allowances are recorded as a reduction to sales and cost of sales based on historical experience. The Company determines that collectibility of accounts receivable is reasonably assured through standardized credit review to determine each customer’s credit worthiness. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories
The Company values inventories at the lower of cost or market, using the first-in, first-out method. Inventory cost is based on amounts paid to vendors plus the capitalization of certain labor and overhead costs necessary to prepare inventory to be saleable. The Company writes down its inventory for estimated obsolescence, damaged or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Impairment of Long-Lived Assets
The Company assesses the need to record impairment losses on long-lived assets used in operations, including goodwill and other intangibles, when indicators of impairment are present. On an on-going basis, management reviews the value and period of amortization or depreciation of its long-lived assets. Recoverability of long-lived assets to be held and used is measured by comparison of the carrying amount the asset group to the undiscounted future cash flow expected to be generated by the asset group. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.
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On January 1, 2002, the Company adopted SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 142 provides that goodwill should not be amortized, but should instead be tested for impairment annually at the reporting unit level. In accordance with SFAS No. 142, the Company completed a transitional goodwill impairment test as of January 1, 2002 and its annual impairment test as of December 31, 2002. The Company’s goodwill impairment tests were based on a comparison of carrying value and fair value of its two reporting units, the Early Childhood and Elementary School segments. As of January 1, 2002 and December 31, 2002, the fair value of the Company’s reporting units exceeded their carrying value.
Merger Integration Liabilities
The Company has established liabilities relating to the abandonment of the Needham facility. This liability was primarily based on the excess of required lease payments over estimated sublease income. Due to the volatility in the commercial real estate market, the estimate of sublease income is extremely subjective. If there is a further decline in the commercial real estate market, if it takes longer than expected to sublet the remaining space at the facility or if such space when sublet is subleased at rates lower than the Company’s current estimates, the amounts the Company will ultimately realize could be different from the amounts assumed in arriving at the Company’s estimate of the cost of the lease abandonment.
Income Taxes
The Company is taxed as a C corporation and files a consolidated tax return with its wholly-owned subsidiaries. The Company’s condensed consolidated statements of operations reflect the income tax expense based on the actual tax position of the Company and its subsidiaries in effect for the respective periods.
The Company has recorded a deferred tax asset in an amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the value of the deferred tax asset, in the event that the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.
Seasonality
The Company’s seasonal sales trends coincide with the start of each school year. Accordingly, approximately 45% to 50% of the Early Childhood and Elementary School segments’ consolidated annual sales are generated in the third calendar quarter. The Company’s working capital needs are greatest during the second calendar quarter as inventory levels are increased to meet seasonal demands.
Inflation
Inflation has and is expected to have only a minor effect on the Company’s results of operations and sources of liquidity.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The following discussion of market risk includes “forward-looking statements” that involve risks and uncertainties that could significantly offset anticipated results in the future. Actual results could differ materially from those projected in the forward-looking statements. The Company does not use derivative financial instruments for speculative or trading purposes.
Interest Rate Risk
The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable and a revolving line of credit. Market risks relating to operations result primarily from a change in interest rates. The Company’s borrowings are primarily dependent upon LIBOR rates. As of September 30, 2003, the Company had no borrowings and available borrowing capacity of $20.0 million under the Bank of America Facility. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” The estimated fair value of borrowings under the Bank of America Facility is expected to approximate its carrying value.
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Credit Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents, accounts receivable and its revolving line of credit. The Company has no customer comprising greater than 10% of its revenues. However, receivables arising from the normal course of business are not collateralized and management continually monitors the payment of its accounts receivable and the financial condition of its customers to reduce the risk of loss. The Company does not believe that its cash and cash equivalents are subject to any unusual credit risk beyond the normal credit risk associated with commercial banking relationships.
Foreign Currency Risk
The Company purchases some of its products from foreign vendors. Accordingly, the Company’s prices of imported products are subject to variability based on foreign exchange rates. However, the Company’s purchase orders are denominated in U.S. dollars and the Company does not enter into long-term purchase commitments.
Item 4. Controls and Procedures.
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.
There has been no change in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
OTHER INFORMATION
The Company and its subsidiaries are, from time to time, party to legal proceedings arising in the normal course of business. In management’s opinion, there are no pending claims or litigation, the outcome of which would have a material effect on the Company’s consolidated results of operations, financial position or cash flows.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
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None.
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits.
*10.1 Amendment No. 1 to Business Loan Agreement, dated as of October 28, 2003, between Bank of America, N.A. and Excelligence Learning Corporation, Earlychildhood LLC, Educational Products, Inc., SmarterKids.com, Inc., Marketing Logistics, Inc., and Colorations, Inc.
* 31.1 Certification of Chief Executive Officer, pursuant to Rule 13a-14 promulgated under the Exchange Act, as created by Section 302 of the Sarbanes-Oxley Act of 2002.
* 31.2 Certification of Chief Financial Officer, pursuant to Rule 13a-14 promulgated under the Exchange Act, as created by Section 302 of the Sarbanes-Oxley Act of 2002.
* 32.1 Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.
* 32.2 Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.
* | Filed herewith. |
(b) Reports on Form 8-K.
On August 7, 2003, the Company reported the announcement of its earnings for the quarter ended June 30, 2003 on Form 8-K under Item 12, attaching the related press release issued by the Company.
On September 29, 2003, the Company reported on Form 8-K under Item 9 the Company’s entry into a $20.0 million credit facility with Bank of America, N.A., which replaced the Company’s credit facility with GMAC Business Credit, LLC.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 7, 2003 | EXCELLIGENCE LEARNING CORPORATION | |||
By: | /s/ Richard Delaney | |||
Richard Delaney | ||||
Executive Vice President and Chief Financial Officer | ||||
(Duly Authorized Officer and | ||||
Principal Financial Officer) |
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