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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 March 31, 2006
¨ | 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. Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨ Nox
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, 9,043,099 shares outstanding as of May 8, 2006.
Table of Contents
EXCELLIGENCE LEARNING CORPORATION
Forward-Looking Statements | 1 | |||
PART I: | FINANCIAL INFORMATION | 2 | ||
Item 1. | Financial Statements | 2 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 11 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 15 | ||
Item 4. | Controls and Procedures | 16 | ||
PART II: | OTHER INFORMATION | 19 | ||
Item 1. | Legal Proceedings | 19 | ||
Item 1A. | Risk Factors | 19 | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 19 | ||
Item 3. | Defaults Upon Senior Securities | 19 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 19 | ||
Item 5. | Other Information | 19 | ||
Item 6. | Exhibits | 19 | ||
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Certain information included in this Quarterly Report on Form 10-Q and other materials filed or to be filed by the Excelligence Learning Corporation, a Delaware corporation (the “Company”), with the Securities and Exchange Commission (as well as information in oral statements and other written statements made or to be made by the Company) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary language noting important factors that could cause actual results to differ materially from those projected in such statements. Such forward-looking statements involve risks and uncertainties that could significantly affect anticipated results in the future and include information relating to:
• | plans for future expansion and other business development activities, as well as other capital spending; |
• | financing sources and the effects of regulation; |
• | competition; |
• | integration of acquired businesses; |
• | the outcome of pending legal or administrative proceedings; and |
• | protection of the Company’s intellectual property. |
As such, actual results may vary materially from those projected, anticipated or indicated in any forward-looking statements. The Company has based its forward-looking statements on current expectations and projections about future events and assumes no obligation to update publicly any forward-looking information that may be made by or on behalf of the Company in this Quarterly Report on Form 10-Q or otherwise, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so.
When used in this Quarterly Report on Form 10-Q and in other statements made by or on behalf of the Company, the words “believes,” “anticipates,” “expects,” “plans,” “intends,” “expects,” “estimates,” “projects,” “could” and other similar words or expressions, which are predictions of or indicative of future events, conditions and trends, identify forward-looking statements. Such forward-looking statements are subject to a number of important risks, uncertainties and assumptions that could significantly affect anticipated results in the future. These risks, uncertainties and assumptions about the Company and its subsidiaries have not changed since the Company filed its 2005 Annual Report on Form 10-K and include, but are not limited to, the following:
• | the Company’s ability to diversify product offerings or expand in new and existing markets; |
• | changes in general economic and business conditions and in the educational products, catalog or e-retailing industry in particular; |
• | the impact of competition, specifically, if competitors were to either adopt a more aggressive pricing strategy than the Company or develop a competing line of proprietary products; |
• | the level of demand for the Company’s products; |
• | fluctuations in currency exchange rates, which could potentially result in a weaker U.S. dollar in overseas markets, increasing the Company’s cost of inventory purchased; and |
• | other factors discussed in “Item 1A. Risk Factors” in the Company’s 2005 Annual Report on Form 10-K. |
In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Quarterly Report on Form 10-Q might not occur.
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FINANCIAL INFORMATION
Item 1. | Financial Statements. |
EXCELLIGENCE LEARNING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except for par value and share amounts)
(Unaudited)
March 31, 2006 | December 31, 2005* | |||||||
ASSETS | ||||||||
Current assets : | ||||||||
Cash and cash equivalents | $ | 3,614 | $ | 9,862 | ||||
Accounts receivable, net of allowance for doubtful accounts of $236 and $348 at March 31, 2006 and December 31, 2005, respectively | 5,733 | 6,383 | ||||||
Inventories | 28,769 | 22,018 | ||||||
Prepaid expenses and other current assets | 4,257 | 2,614 | ||||||
Deferred income taxes | 911 | 885 | ||||||
Total current assets | 43,284 | 41,762 | ||||||
Property and equipment, net | 4,375 | 4,362 | ||||||
Deferred income taxes | 4,760 | 4,558 | ||||||
Other assets | 300 | 246 | ||||||
Goodwill | 5,878 | 5,878 | ||||||
Other intangible assets, net | 528 | 571 | ||||||
Total assets | $ | 59,125 | $ | 57,377 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 8,444 | $ | 6,462 | ||||
Accrued expenses | 4,746 | 4,300 | ||||||
Other current liabilities | 263 | 210 | ||||||
Total current liabilities | 13,453 | 10,972 | ||||||
Stockholders’ equity: | ||||||||
Common stock, $0.01 par value; 15,000,000 shares authorized; 9,040,432 and 9,036,199 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively | 90 | 90 | ||||||
Additional paid-in capital | 64,005 | 63,834 | ||||||
Accumulated deficit | (18,423 | ) | (17,519 | ) | ||||
Total stockholders’ equity | 45,672 | 46,405 | ||||||
Total liabilities and stockholders’ equity | $ | 59,125 | $ | 57,377 | ||||
* | Derived from audited consolidated financial statements filed in the Company’s 2005 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 for share and per share amounts)
(Unaudited)
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Revenues | $ | 24,960 | $ | 22,578 | ||||
Cost of goods sold | 15,695 | 14,458 | ||||||
Gross profit | 9,265 | 8,120 | ||||||
Operating expenses: | ||||||||
Selling, general and administrative | 10,788 | 8,879 | ||||||
Amortization of intangible assets | 43 | 43 | ||||||
Operating loss | (1,566 | ) | (802 | ) | ||||
Other (income) expense: | ||||||||
Interest expense | — | 5 | ||||||
Interest income | (69 | ) | (11 | ) | ||||
Loss before income taxes | (1,497 | ) | (796 | ) | ||||
Income tax benefit | 593 | 357 | ||||||
Net loss | $ | (904 | ) | $ | (439 | ) | ||
Net Loss Per Share Calculation: | ||||||||
Net loss per share – basic and diluted | $ | (0.10 | ) | $ | (0.05 | ) | ||
Weighted average shares used in net loss per share calculation – basic and diluted | 9,038,999 | 8,926,231 |
See accompanying notes to condensed consolidated financial statements.
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EXCELLIGENCE LEARNING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | (904 | ) | $ | (439 | ) | |||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 533 | 453 | ||||||
Allowance for doubtful accounts | (112 | ) | (126 | ) | ||||
Stock-based compensation | 73 | 81 | ||||||
Deferred income taxes | (136 | ) | (181 | ) | ||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 762 | 2,170 | ||||||
Inventories | (6,751 | ) | (11,297 | ) | ||||
Prepaid expenses and other current assets | (1,651 | ) | 714 | |||||
Other assets | (54 | ) | 6 | |||||
Accounts payable | 1,982 | 8,089 | ||||||
Accrued expenses | 446 | (593 | ) | |||||
Other current liabilities | 53 | 29 | ||||||
Net cash used in operating activities | (5,759 | ) | (1,094 | ) | ||||
Cash flows from investing activities: | ||||||||
Purchase of property and equipment | (503 | ) | (401 | ) | ||||
Cash flows from financing activities: | ||||||||
Excess tax benefits from stock-based compensation | 8 | — | ||||||
Exercise of employee stock options | 6 | 120 | ||||||
Net cash provided by financing activities | 14 | 120 | ||||||
Net decrease in cash and cash equivalents | (6,248 | ) | (1,375 | ) | ||||
Cash and cash equivalents at beginning of period | 9,862 | 2,657 | ||||||
Cash and cash equivalents at end of period | $ | 3,614 | $ | 1,282 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash payments during the period for: | ||||||||
Income taxes | $ | 235 | $ | 2 |
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 (the “Company”), is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. The Company was incorporated in the State of Delaware on November 6, 2000 for the purpose of effecting the combination (the “Combination”) of the businesses of Earlychildhood LLC, a California limited liability company (“Earlychildhood”), and SmarterKids.com, Inc., a Delaware corporation (“SmarterKids.com”). The Company’s business is primarily conducted through its wholly-owned subsidiaries, Earlychildhood, Educational Products, Inc., a Texas corporation (“EPI”), and Marketing Logistics, Inc., a Minnesota corporation dba Early Childhood Manufacturers’ Direct (“ECMD”).
Seasonality
The Company’s seasonal sales trends coincide with the start of each school year. For the fiscal year ended December 31, 2005, 43% of the Company’s consolidated annual sales were generated in the third calendar quarter. The Company’s working capital needs are greatest during the first and second quarters as inventory levels are increased to meet seasonal demands.
(2) | 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, 2005 was derived from the Company’s audited consolidated financial statements for the fiscal year ended December 31, 2005. 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, 2005.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R,Share-Based Payment. SFAS No. 123R eliminates accounting for share-based compensation transactions using the intrinsic value method as prescribed by Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, as provided for by SFAS No. 123,Accounting for Stock-Based Compensation, and requires instead that such transactions be accounted for using a fair-value-based method and recognized as expenses in the Company’s condensed consolidated statement of operations. SFAS No. 123R was effective for the Company beginning January 1, 2006. See note 3 for a discussion on the impact of the adoption of SFAS No. 123R on the Company’s financial position, results of operations, and cash flows. See Note 3 for additional information regarding the Company’s adoption of SFAS No. 123R.
In November 2004, FASB issued SFAS No. 151,Inventory Costs, an amendment of ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges, and that fixed production overheads should be allocated to inventory based on normal capacity of production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted SFAS No. 151 as of January 1, 2006. The adoption of SFAS No. 151 did not have a significant impact on the Company’s financial position, results of operations, or cash flows.
In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error Corrections.SFAS No. 154 replaces Accounting Principles Board Opinion No. 20,Accounting Changes in Interim Financial Statements, and is effective for fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effects of the changes. The Company adopted SFAS No. 154 as of January 1, 2006. The adoption of SFAS No. 154 did not have a significant impact on the Company’s financial position, results of operations, or cash flows.
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(3) | Stock-Based Compensation |
Adoption of SFAS No. 123R
Effective January 1, 2006, the Company began recording compensation expense associated with the issuance of stock options in accordance with SFAS No. 123R,Share-Based Payment, and Securities and Exchange Commission Staff Accounting Bulletin No. 107. Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value method in accordance with APB Opinion No. 25 and as allowed by SFAS No. 123.
The Company adopted the modified prospective transition method pursuant to SFAS No. 123R, and consequently has not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock-based compensation recognized in the first quarter of fiscal year 2006 now includes: (a) quarterly amortization related to the remaining unvested portion of all stock-based compensation awards granted prior to January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and (b) quarterly amortization related to all stock option awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R.
The compensation expense for stock based compensation awards includes an estimate for forfeitures and is recognized over the expected term of the options using the straight-line method. The Company recorded no cumulative effect adjustment for estimated forfeitures for previously issued stock options upon the adoption of SFAS No. 123R.
Impact of the Adoption of SFAS No. 123R
As a result of the adoption of SFAS No. 123R, the Company’s loss from continuing operations before income taxes was $73,000 higher and the Company’s net loss for the quarter ended March 31, 2006 was $69,000 higher than what would have been recorded under the Company’s previous accounting methodology for stock-based compensation. The impact on basic and diluted earnings per share was $(0.01) per share.
Prior to adopting SFAS No. 123R, the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in the statement of cash flows. Excess tax benefits are realized tax benefits from tax deductions for exercised options in excess of the deferred tax asset attributable to stock compensation costs for such options. As a result of adopting SFAS No. 123R, $8,000 of excess tax benefits for the three months ended March 31, 2006 have been classified as a financing cash inflow. Cash received from option exercises under all share-based payment arrangements for the three-month periods ended March 31, 2006 and 2005, was $6,000 and $120,000, respectively. The total income tax benefit recognized in the income statement for stock-based compensation costs was $4,000 and $32,000 for the three-month periods ended March 31, 2006 and 2005, respectively.
Valuation Assumptions
The Company’s stock option plans provide its employees and directors the right to purchase common stock at the fair market value of such shares on the grant date. As of March 31, 2006, 2.1 million shares were authorized under these plans, and 792,502 shares were available for issuance. The Company issues shares upon the exercise of stock options from such shares authorized and available under the plans. The stock options generally cliff vest 33% at the end of each year over a period of three years. The contract term of the options is ten years.
The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton valuation model. No stock options were granted for the quarter ended March 31, 2006 or March 31, 2005.
The Company has applied the fair value recognition provisions of SFAS No. 123R to record stock-based employee compensation in the form of stock options. During the three-month period ended March 31, 2006, the Company recorded stock-based compensation expense for awards granted prior to, but not yet vested as of, January 1, 2006, as if the fair value method required for pro forma disclosure under SFAS No. 123 were in effect for expense recognition purposes, adjusted for estimated future forfeitures. For these awards, the Company has continued to recognize compensation expense using a straight-line amortization method. No stock-based awards were granted during the three months ended March 31, 2006. When estimating forfeitures, the Company considers trends of actual option forfeitures. The impact on the Company’s results of operations of recording stock-based compensation for the three-month period ended March 31, 2006 was an increase in selling, general and administrative expenses of $73,000 (before tax benefit).
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Stock-based Payment Award Activity
The following table summarizes activity under the Company’s stock option plan for the three months ended March 31, 2006 (in thousands, except per share and year amounts):
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value | ||||||||
Outstanding at January 1, 2006 | 748 | $ | 2.51 | 6.2 | |||||||
Granted | — | — | — | ||||||||
Exercised | (4 | ) | $ | 1.38 | 6.1 | ||||||
Forfeited/expired/cancelled | (8 | ) | $ | 1.41 | 5.8 | ||||||
Outstanding at March 31, 2006 | 736 | $ | 2.53 | 5.9 | $ | 3,876 | |||||
Options exercisable at March 31, 2006 | 652 | $ | 2.21 | 5.6 | $ | 3,646 | |||||
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for the options that were in-the-money at March 31, 2006. During the three months ended March 31, 2006 and 2005, the aggregate intrinsic value, determined as of the date of option exercise of options exercised under the Company’s stock option plan was $25,000 and $290,000, respectively. As of March 31, 2006, there was approximately $238,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Company’s stock award plans. That cost is expected to be recognized over a weighted-average period of 1.2 years.
Pro forma Information for Periods Prior to the Adoption of SFAS No. 123R
Prior to the adoption of SFAS No. 123R, the Company provided the disclosures required under SFAS No. 123, as amended by SFAS No. 148. Stock-based compensation expense recognized under SFAS No. 123R was not reflected in the Company’s results of operations for the three-month period ended March 31, 2005 for stock option awards as all options were granted with an exercise price equal to the market value of the underlying common stock on the date of grant. Forfeitures of awards were recognized as they occurred.
The pro forma information for the three months ended March 31, 2005 was as follows (in thousands, except per share amounts):
Net loss, as reported | $ | (439 | ) | |
Add: Stock-based compensation expense included in reported net loss, net of related tax effects | 81 | |||
Deduct: Stock-based employee compensation expense determined under fair value based method, net of related tax effects | (85 | ) | ||
Pro forma net (loss) | $ | (443 | ) | |
Net loss per share: | ||||
Basic and diluted, as reported | $ | (0.05 | ) | |
Basic and diluted, pro forma | $ | (0.05 | ) | |
Weighted average shares used in net loss per share calculation, basic and diluted | 8,926,231 |
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(4) | Basic and Diluted Net Loss Per Share |
The basic and diluted net loss per share information for the three months ended March 31, 2006 and 2005 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 loss per share for the three months ended March 31, 2006 and 2005 (in thousands, except for share and per share amounts):
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Numerator: | ||||||||
Net (loss) | $ | (904 | ) | $ | (439 | ) | ||
Denominator: | ||||||||
Denominator for basic and diluted net (loss) per common share: | 9,038,999 | 8,926,231 | ||||||
Basic and diluted net (loss) per common share | $ | (0.10 | ) | $ | (0.05 | ) | ||
The following potential shares of common stock have been excluded from the computation of diluted net loss per share because the effect of including these shares would have been anti-dilutive:
Three Months Ended March 31, | ||||
2006 | 2005 | |||
Options to purchase common stock | 735,550 | 889,091 |
The weighted-average exercise price of options to purchase common stock excluded from the computation of diluted net (loss) per share was $2.53 and $2.70 for the three months ended March 31, 2006 and 2005, respectively.
(5) | 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, 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.
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, 2005. Revenues and operating income (loss) by segment follows (in thousands):
Early Childhood | Elementary School | Consolidated | ||||||||||||||||
Three Months Ended March 31, | ||||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||
Net revenues | $ | 23,400 | 21,101 | 1,560 | 1,477 | 24,960 | 22,578 | |||||||||||
Cost of goods sold | 14,672 | 13,458 | 1,023 | 1,000 | 15,695 | 14,458 | ||||||||||||
Gross profit | 8,728 | 7,643 | 537 | 477 | 9,265 | 8,120 | ||||||||||||
Operating expenses: | ||||||||||||||||||
Selling, general, and administrative | 8,833 | 6,878 | 1,955 | 2,001 | 10,788 | 8,879 | ||||||||||||
Amortization of intangible assets | 8 | 8 | 35 | 35 | 43 | 43 | ||||||||||||
Operating (loss) income | $ | (113 | ) | 757 | (1,453 | ) | (1,559 | ) | (1,566 | ) | (802 | ) | ||||||
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The Early Childhood segment performs limited administrative activities, including certain accounting and information system functions, on behalf of the Elementary School segment and charges the Elementary School segment for such activities. These inter-segment charges are based on estimates of actual costs for such activities. Inter-segment charges, which are a reduction in selling, general and administrative expenses in the Early Childhood segment and an increase in such expenses in the Elementary School segment in the table above, have been eliminated in consolidation and amounted to $128,000 in each of the three month periods ended March 31, 2006 and 2005, respectively.
The Company had no customer comprising greater than 10% of its revenue or accounts receivable as of and for the three-month period ended March 31, 2006 or 2005.
The segment asset information available is as follows (in thousands):
March 31, 2006 | December 31, 2005 | |||||||
Assets | ||||||||
Early Childhood | $ | 48,541 | 51,327 | |||||
Elementary School | 21,894 | 17,360 | ||||||
Eliminations | (11,310 | ) | (11,310 | ) | ||||
Total | $ | 59,125 | $ | 57,377 | ||||
The eliminations represent the investment by the Early Childhood segment in the Elementary School segment.
(6) | Inventories |
Inventories, stated at lower of cost or market, consisted of the following amounts (in thousands):
March 31, 2006 | December 31, 2005 | |||||
Raw materials and work in progress | $ | 1,036 | $ | 915 | ||
Finished goods | 27,733 | 21,103 | ||||
$ | 28,769 | $ | 22,018 | |||
(7) | Goodwill and Intangible Assets |
The following table identifies the major classes of intangible assets at March 31, 2006 and December 31, 2005 (in thousands):
March 31, 2006 | December 31, 2005 | |||||||||||||
Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | |||||||||||
Trademarks, trade names and formulas | $ | 953 | $ | (860 | ) | $ | 953 | $ | (852 | ) | ||||
Customer lists | 1,410 | (975 | ) | 1,410 | (940 | ) | ||||||||
$ | 2,363 | $ | (1,835 | ) | $ | 2,363 | $ | (1,792 | ) | |||||
Total amortization expense on intangible assets was $43,000 for the three months ended March 31, 2006 and 2005.
The carrying amount of goodwill was $5.9 million at March 31, 2006 and December 31, 2005. There was no impairment loss recorded during the three months ended March 31, 2006 and 2005.
(8) | Credit Facility |
Effective October 1, 2005, the Company entered into an amendment extending the Bank of America Facility for $20.0 million from April 16 to October 15 of each year and $10.0 million from October 16 to April 15 of each year until its maturity date of October 1, 2007. As of March 31, 2006 and December 31, 2005, the Company had no outstanding borrowings under the Bank of America Facility. Available borrowing capacity as of March 31, 2006 and December 31, 2005 was $10.0 million.
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The Bank of America Facility also includes the availability of up to $5.0 million through a reducing revolving term loan. The Bank of America Facility, which is secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property, 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 March 31, 2006, the Company was in compliance with all of the financial covenants set forth in the Bank of America Facility.
(9) | Legal Matters |
The staff in the Division of Enforcement in the San Francisco District Office of the Commission informed the Company in October 2005 that it was conducting an informal inquiry into the Company’s restatement and the related circumstances. At that time, the staff requested that the Company preserve certain documents related to this inquiry and provide on a voluntary basis certain documents to the staff for its review. The Company has cooperated with the informal inquiry and provided documents and information in response to the staff’s requests. The staff obtained a non-public formal order of investigation from the Commission in January 2006. The Company intends to continue to cooperate with the staff and Commission in connection with the formal investigation.
In addition to the above-referenced administrative proceeding, 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.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
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, primarily including:
• | its Discount School Supply catalog and website, through which the Company develops, markets and sells educational products to early childhood professionals and, to a lesser extent, consumers; |
• | EPI’s fundraising programs, through which the Company 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; |
• | its ECMD catalog and website, through which the Company markets and sells furniture and equipment to early childhood professionals, 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 March 31, 2006, numbered 61 people.
The Company operates in two business segments: Early Childhood and Elementary School. The Early Childhood segment includes the brand names Discount School Supply, ECMD andEarlychildhood NEWS. The Early Childhood segment develops, manufactures and sells educational products through multiple distribution channels to early childhood professionals and, to a lesser extent, consumers. 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.
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 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 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 revenue recognition, bad debts, product returns, intangible assets, inventories and deferred income taxes. 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 condensed consolidated financial statements:
Revenue Recognition and Accounts Receivable
The Company recognizes revenue from product sales upon the delivery of products to an unrelated third party customer when (a) the customer takes title of the goods; (b) the price to the customer is fixed or determinable; (c) the customer is obligated to pay the Company and the obligation is not contingent on resale of the product; (d) the customer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product; (e) the Company does not have significant obligations for future performance to directly bring about resale of the product by the customer; and (f) collectibility is probable. 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.
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Inventories
The Company uses the lower of cost or market under both the first-in, first-out and average cost methods to value inventories. In the Early Childhood segment, the Company uses the first-in, first-out method for its finished goods inventory and the average cost method for its raw materials inventory related to paint manufacturing. The Elementary School segment uses the average cost method for all inventories. 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.
While the majority of the Company’s inventory is purchased from domestic vendors, a significant percentage is sourced from overseas. Inventory ordered from foreign vendors constituted 33% of the Company’s total inventory for the three months ended March 31, 2006, compared to 31% for the same period in 2005. The Company takes title to inventory purchased from overseas at point of shipment; the Company takes title to inventory purchased domestically upon receipt for certain vendors, and at point of shipment for certain other vendors.
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 comparing the carrying value of 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.
The Company applies SFAS No. 142,Goodwill and Other Intangible Assets to account for its goodwill and intangible assets. SFAS No. 142 provides that goodwill should not be amortized but instead be tested for impairment annually at the reporting unit level. In accordance with SFAS No. 142, the Company conducts its annual impairment test on December 31. The Company’s goodwill impairment test is based on a comparison of carrying values and fair value of the Company’s reporting units, its Early Childhood and Elementary School segments.
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 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, a decrease to the deferred tax asset would be charged to income in the period such determination was made.
Results of Operations
Revenues
Revenues were $25.0 million and $22.6 million for the first quarters of 2006 and 2005, respectively. The increase in revenues in 2006 over 2005 of 10.6%, or $2.4 million, was primarily due to growth of 10.9%, or $2.3 million, in the Early Childhood segment. Overall growth in the Early Childhood segment was achieved through new product offerings, which generated $344,000 in increased revenues, new customer solicitation and improved sales and marketing strategies. Average sales price per unit for the Early Childhood segment increased 5.5% from 2005, with total units sold in the segment up 6.3% from 2005, slightly offset by changes to other revenue items in minor amounts.
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The Company will continue with its goal to achieve revenue growth in the Early Childhood and Elementary School segments by improving circulation of its catalogs, offering new proprietary products, soliciting new customers, implementing more aggressive sales and marketing strategies and enhancing the Company’s websites. Certain factors that could cause actual results to differ materially from the Company’s expectations are discussed in “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Gross Profit
Gross profit was $9.3 million for the three-month period ended March 31, 2006, a $1.2 million increase over the gross profit of $8.1 million for the same period in 2005. The increase in gross profit in 2006 was primarily due to an increase in gross profit of 14.2%, or $1.1 million, in the Early Childhood segment. The increase in gross profit within the Early Childhood segment was achieved through more effective sales and marketing strategies.
Gross profit as a percentage of sales was 37.1% and 36.0% for the first quarters of 2006 and 2005, respectively. Gross profit as a percentage of sales increased from 2005 to 2006 due to improved product sourcing from China, increased sales of proprietary products with higher margins and improved freight management.
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 March 31, 2006 and 2005 was $1.7 million and $1.6 million, respectively, or 6.9% and 7.2% 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 March 31, 2006 and 2005 was $1.1 million and $963,000, respectively, or 4.4% and 4.3% as a percentage of sales, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include wages, commissions and stock based compensation, catalog costs, operating expenses (which include customer service and certain warehouse costs), administrative costs (which include information systems, accounting, legal and human resources), e-business costs, stock-based compensation and depreciation of property and equipment. Selling, general and administrative expenses increased $1.9 million, or 21.5.%, to $10.8 million for the three months ended March 31, 2006, compared to $8.9 million for the same period in 2005. The $1.9 million increase in selling, general and administrative expenses in 2006 over 2005 was primarily attributable to the Company having incurred significant expenses related to an internal investigation, the subsequent restatement of its previously issued financial statements for fiscal year 2004 and the first quarter of 2005 and the related Securities and Exchange Commission investigation. These expenses, consisting of billings from third parties, totaled $1.2 million during the first quarter of 2006, and included legal and investigative expenses of $379,000, audit and review accounting expenses of $652,000, and consultancy expenses of $123,000. The Company has continued to incur these expenses in the second quarter of 2006.
Amortization of Other Intangible Assets
Amortization of other intangible assets was $43,000 for the three months ended March 31, 2006 and 2005.
Interest Expense
Interest expense was zero and $5,000 for the three months ended March 31, 2006 and 2005, respectively.
Income Taxes
The Company is taxed as a C corporation. The Company recorded an income tax benefit of $593,000 and $357,000 for the three-month periods ended March 31, 2006 and 2005, respectively. The effective tax rate for the three months ended March 31, 2006 and 2005 approximates the Company’s combined federal and state statutory tax rate of 39.6% and 44.9%, respectively.
The Company has recorded a deferred tax asset in an amount that is more likely than not to be realized. In the event 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
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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.
Liquidity and Capital Resources
Effective October 1, 2005, the Company entered into an amendment to its secured credit facility with Bank of America, N.A. (the “Bank of America Facility”), extending the Bank of America Facility for $20.0 million from April 16 to October 15 of each year and $10.0 million from October 16 to April 15 of each year, through its maturity date of October 1, 2007. As of March 31, 2006 and December 31, 2005, the Company had no outstanding borrowings under the Bank of America Facility. Available borrowing capacity as of March 31, 2006 and December 31, 2005 was $10.0 million. The Company’s primary cash needs are for operations and capital expenditures. Additionally, there may be future cash needs for any potential acquisitions. The Company’s primary source of liquidity is cash flow from operations and the Bank of America Facility. As of March 31, 2006, the Company had net working capital of $29.8 million.
The Bank of America Facility also includes the availability of up to $5.0 million through a reducing revolving term loan. The Bank of America Facility, which is secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property, 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 March 31, 2006, the Company was in compliance with all of the financial covenants set forth in the Bank of America Facility.
During the three months ended March 31, 2006, the Company’s operating activities used $5.8 million of cash. The cash was used by net loss, increased balances in inventories and prepaid expenses, which were partially offset by increased balances in accounts payable and accrued expenses and decreased balances in accounts receivable. The Company used $503,000 in cash for investing activities during the first quarter of 2006, with which the Company purchased property and equipment. The Company obtained $6,000 in cash from financing activities as a result of exercised stock options and related tax benefit.
As of March 31, 2006, the Company did not have any guarantees, including loan guarantees, standby letters of credit or indirect guarantees.
The following table summarizes the Company’s contractual obligations as of March 31, 2006 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 | 3-5 years | More than 5 years | ||||||||||
Non-cancelable Operating Lease Obligations | $ | 7,721 | $ | 3,078 | $ | 4,033 | $ | 610 | $ | — |
Off-Balance Sheet Arrangements
There are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have a material effect on the Company’s financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Seasonality
The Company’s seasonal sales trends coincide with the start of each school year. For the fiscal year ended December 31, 2005, 43% of the Company’s consolidated annual sales were generated in the third calendar quarter. The Company’s working capital needs are greatest during the first and second quarters 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.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
The following discussion of market risk includes 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. See “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 March 31, 2006, the Company had no borrowings under the Bank of America Facility and available borrowing capacity of $10.0 million. 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.
Credit Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and accounts receivable. 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 the Company’s 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.
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Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
The Company has established and currently maintains disclosure controls and procedures designed to ensure that material information required to be disclosed in its reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and that any material information relating to the Company is recorded, processed, summarized and reported to its principal officers to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving desired control objectives. In reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Due to the matters discussed below and as previously reported, the Company restated its previously issued financial statements for the fiscal year ended December 31, 2004 and for the fiscal quarter ended March 31, 2005. Accordingly, the Company amended its annual report of Form 10-K for the fiscal year ended December 31, 2004 and its quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2005, both of which were filed with the Commission on February 1, 2006.
In conjunction with the close of the period covered by this report, the Company conducted a review and evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (who is also serving as the Company’s Principal Financial Officer and Principal Accounting Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. As further discussed below, material weaknesses were identified in the Company’s internal control over financial reporting. The Public Company Accounting Oversight Board’s Auditing Standard No. 2 defines a material weakness as a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
Subsequent to the filing of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, it came to the attention of management that certain current and former accounting personnel alleged that the Company had improperly failed to record and accrue for certain obligations for the period and fiscal year ended as of that date. In accordance with the Company’s Complaint and Investigation Procedures for Accounting, Internal Accounting Controls, Fraud and Auditing Matters, following a preliminary inquiry by the Company’s General Counsel, the matter was reported to the Audit Committee of the Board of Directors. The Audit Committee engaged independent counsel to conduct an investigation and to direct forensic accounting consultants to assist in the investigation. The results of that investigation were reported to the Audit Committee and the Board of Directors, and included findings which, upon the recommendation of management, the Board determined would require a material adjustment to, and restatement of, the previously reported financial statements for the year ended December 31, 2004 and for the quarter ended March 31, 2005. These restatements were filed with the Commission on February 1, 2006.
The Company determined that this restatement is attributable to a number of factors. The most significant factor was the Company’s failure to timely record and to accrue for certain invoices relating to inventory on hand as of year end. The Company determined, based upon the results of its internal investigation, that its accrual of accounts payable for inventory did not include certain inventory items that had been received but had not been paid for by the Company prior to the end of fiscal 2004. As a result of additional review procedures, certain other accounting errors were identified relating to 2004 which are also reflected in the restatement. Those additional errors included an understatement of costs capitalized to inventory, an understatement of the provision for sales returns, an understatement of certain selling, general and administrative expenses, an understatement of compensation expense for deferred compensation amounts relating to previously issued stock options, and an understatement of income taxes related to stock option exercises.
The restatement of previously issued financial statements is a strong indicator that one or more material weaknesses in controls over financial reporting may exist. As a result, the Company’s Chief Executive Officer and Board of Directors have concluded that, as of March 31, 2006, the end of the period covered by this quarterly report, the Company’s disclosure controls and procedures were not effective to ensure that information required to be disclosed under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
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The material weaknesses that were found to exist are:
• | Inadequate staffing and training in the accounting function over the Company’s processing of certain financial information. |
Management identified this material weakness based on the internal investigation conducted at the direction of the Audit Committee, including review of the work product of the forensic accountants retained to assist in the investigation. The Company believes that invoices relating to inventory on hand as of December 31, 2004 were not timely processed for payment and were not adequately accrued. The internal investigation revealed that the Company set aside certain invoices pending completion of the year end audit without determining whether the invoices were properly accrued and that some of the Company’s accounting personnel were aware of this treatment of invoices, but failed to bring the matter to the attention of appropriate senior management, the Audit Committee, or the independent auditors. The Company has determined that this material weakness contributed to the failure to timely record and to properly accrue for certain invoices (relating primarily to inventory and catalog costs) as of December 31, 2004. These conditions also contributed to the other errors that were noted and corrected during the review procedures.
• | Improper segregation of duties over the processing and review of journal entries. |
Management identified this material weakness based on an incorrect journal entry directed by the former Chief Financial Officer, which was found during the course of the investigation and reduced the accounts payable expense for inventory on hand as of December 31, 2004. The investigation revealed and management confirmed that the adjusting journal entry was not adequately justified and was not consistent with the Company’s ordinary practices. Although the investigation revealed that other accounting employees, including the former Controller, were aware of and disagreed with the adjusting entry, they did not raise the matter with other senior management, the Audit Committee, or the Company’s independent registered public accounting firm.
Evaluation of Disclosure Controls and Procedures
Certain changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2006 that materially affected, or were reasonably likely to affect, the Company’s control over financial reporting are described below.
Subsequent to the discovery of the material weaknesses, the Company has taken and continues to take the following steps to remediate the material weaknesses found to exist during its evaluation of disclosure controls and procedures:
• | The first identified material weakness had already begun being remediated by the Company with its implementation of procedures in May 2005 to ensure that its accounts payable invoices are processed promptly in accordance with standard procedures when received, and that accruals are maintained and reviewed by appropriate senior accounting and financial reporting management on a monthly basis. In addition, the Company’s Chief Financial Officer resigned effective as of September 13, 2005 and the Company is in the process of identifying a new Chief Financial Officer. The Company’s former Controller had been terminated in June 2005, and a new Controller was formally appointed in November 2005. The Company has significantly increased the number and skills and training of management and staff personnel in its accounting and finance departments, including training in the Company’s whistleblower policies and procedures, implemented enhanced segregation of duties, and documented and implemented specific desk-level procedures in the accounting and financial reporting departments. Additional safeguards and controls are being evaluated. The Company believes the steps it has taken, and intends to take, will remediate this material weakness. |
• | To remediate the second identified material weakness, the Company has implemented and documented rigorous and detailed procedures for the closing of each fiscal period that include specific protocols for the timely review by appropriate senior accounting and financial reporting management of all adjusting journal entries. In addition, the Company significantly increased the number and skills and training of management and staff personnel in its accounting and finance departments, including training in the Company’s whistleblower policies and procedures, and implemented enhanced segregation of duties. In addition, as noted, the Company is in the process of identifying a new Chief Financial Officer and has replaced the former Controller. Additional controls and safeguards are being evaluated. The Company believes that the steps it has taken, and intends to take, will remediate this material weakness. |
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In addition to the remediation steps described above, the Company has:
• | Implemented new software enhancements to improve and/or integrate major systems and enhance the control environment in the areas of financial planning and analysis, internal reporting, and integration of the sales order entry and inventory subsystems with the general ledger system; |
• | Initiated training and education of all relevant personnel involved in interactions with the Company’s independent registered public accounting firm designed to ensure that such personnel understand and comply with the provisions of the Securities Exchange Act of 1934, and the rules promulgated thereunder, regarding representations to the Company’s independent registered public accountants; |
• | Communicated with all Company employees reaffirming the Company’s whistleblower protections; and |
• | Accelerated the documentation and internal control evaluation processes contemplated by Section 404 of the Sarbanes-Oxley Act. |
Management believes the measures that have been and will be implemented to remediate the material weaknesses have had a significant and positive impact on the Company’s internal control over financial reporting since December 31, 2004 and anticipates that these measures and other ongoing enhancements will continue to strengthen the Company’s internal control over financial reporting in future periods.
Although the Company has implemented and continues to implement remediation efforts, a material weakness indicates that there is more than a remote likelihood that a material misstatement of the Company’s financial statements will not be prevented or detected. In addition, the Company cannot ensure that it will not in the future identify further material weaknesses or significant deficiencies in its internal control over financial reporting that it has not discovered to date. The Company has taken and is taking steps to improve its internal control over financial reporting. The efforts it has taken and continues to take are subject to continued management review supported by confirmation and testing by management, as well as Audit Committee oversight. As a result, additional changes are expected to be made to the Company’s internal control over financial reporting. Other than the foregoing initiatives since the date of the evaluation supervised by management, there have been no material changes in the Company’s disclosure controls and procedures, or the Company’s internal control over financial reporting, that could have materially affected, or are reasonably likely to materially affect, the Company’s disclosure controls and procedures or the Company’s internal control over financial reporting.
The Company performed additional analyses and other post-closing procedures to address the material weaknesses and to ensure that the condensed consolidated financial statements contained in this report were prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects the Company’s financial position, results of operations and cash flows for the periods presented.
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OTHER INFORMATION
Item 1. | Legal Proceedings. |
The staff in the Division of Enforcement in the San Francisco District Office of the Commission informed the Company in October 2005 that it was conducting an informal inquiry into the Company’s restatement and the related circumstances. At that time, the staff requested that the Company preserve certain documents related to this inquiry and provide on a voluntary basis certain documents to the staff for its review. The Company has cooperated with the informal inquiry and provided documents and information in response to the staff’s requests. The staff obtained a non-public formal order of investigation from the Commission in January 2006. The Company intends to continue to cooperate with the staff and Commission in connection with the formal investigation.
Aside from the above-referenced administrative proceeding, 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 1A. | Risk Factors. |
There have been no material changes in the Company’s risk factors from those disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Item 2. | Unregistered Sales of Equity 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.
Item 5. | Other Information. |
None.
Item 6. | Exhibits. |
* 31.1 | Certification of Chief Executive Officer and Principal 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 and Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Filed herewith. |
** | Furnished herewith. |
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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: May 12, 2006
EXCELLIGENCE LEARNING CORPORATION | ||
By: | /s/ Ronald Elliott | |
Ronald Elliott | ||
Chief Executive Officer and Acting Principal Financial Officer | ||
(Duly Authorized Officer and Principal Financial Officer) |
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