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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2006
Commission File Number 0-20842
PLATO LEARNING, INC.
(Exact name of Registrant as specified in its charter)
Delaware | 36-3660532 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) |
10801 Nesbitt Avenue South, Bloomington, MN 55437
(Address of principal executive offices)
(Address of principal executive offices)
(952) 832-1000
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
(Former name, former address and former fiscal year, if changed since last report)
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.
Yesþ Noo
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.
(Check one): Large accelerated filero Accelerated filerþ Non-accelerated filero
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date. 23,715,497 shares of common stock, $.01 par value, outstanding as of May 31, 2006.
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PLATO LEARNING, INC.
Form 10-Q
Quarterly Period Ended April 30, 2006
Form 10-Q
Quarterly Period Ended April 30, 2006
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION
ITEM 1.FINANCIAL STATEMENTS
PLATO Learning, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)
Three Months Ended | Six Months Ended | |||||||||||||||
April 30, | April 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Revenues: | ||||||||||||||||
License fees | $ | 6,920 | $ | 15,299 | $ | 15,969 | $ | 27,301 | ||||||||
Subscriptions | 4,054 | 4,517 | 8,410 | 9,050 | ||||||||||||
Services | 9,001 | 11,613 | 19,082 | 20,533 | ||||||||||||
Total revenues | 19,975 | 31,429 | 43,461 | 56,884 | ||||||||||||
Cost of revenues: | ||||||||||||||||
License fees | 2,681 | 4,243 | 5,654 | 8,647 | ||||||||||||
Subscriptions | 2,656 | 2,142 | 4,897 | 4,455 | ||||||||||||
Services | 4,480 | 6,719 | 9,262 | 13,573 | ||||||||||||
Total cost of revenues | 9,817 | 13,104 | 19,813 | 26,675 | ||||||||||||
Gross profit | 10,158 | 18,325 | 23,648 | 30,209 | ||||||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 9,576 | 13,410 | 19,310 | 26,736 | ||||||||||||
General and administrative | 4,314 | 4,842 | 8,962 | 9,052 | ||||||||||||
Product maintenance and development | 1,225 | 1,222 | 2,764 | 2,693 | ||||||||||||
Amortization of intangibles | 933 | 1,080 | 1,902 | 2,172 | ||||||||||||
Restructuring and other charges | 259 | 632 | 339 | 2,921 | ||||||||||||
Total operating expenses | 16,307 | 21,186 | 33,277 | 43,574 | ||||||||||||
Operating loss | (6,149 | ) | (2,861 | ) | (9,629 | ) | (13,365 | ) | ||||||||
Other income (expense): | ||||||||||||||||
Interest income | 406 | 168 | 871 | 380 | ||||||||||||
Interest expense | (6 | ) | (28 | ) | (27 | ) | (43 | ) | ||||||||
Other expense, net | — | (83 | ) | (11 | ) | (153 | ) | |||||||||
Loss before income taxes | (5,749 | ) | (2,804 | ) | (8,796 | ) | (13,181 | ) | ||||||||
Income tax expense | 150 | 150 | 300 | 300 | ||||||||||||
Net loss | $ | (5,899 | ) | $ | (2,954 | ) | $ | (9,096 | ) | $ | (13,481 | ) | ||||
Loss per share: | ||||||||||||||||
Basic and diluted | $ | (0.25 | ) | $ | (0.13 | ) | $ | (0.38 | ) | $ | (0.58 | ) | ||||
Weighted average common shares outstanding: | ||||||||||||||||
Basic and diluted | 23,674 | 23,378 | 23,652 | 23,240 | ||||||||||||
See Notes to Condensed Consolidated Financial Statements.
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PLATO Learning, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except per share amounts)
April 30, | October 31, | |||||||
2006 | 2005 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 30,794 | $ | 46,901 | ||||
Marketable securities | 229 | 213 | ||||||
Accounts receivable, net | 13,784 | 22,768 | ||||||
Inventories | 3,330 | 4,026 | ||||||
Other current assets | 5,002 | 6,351 | ||||||
Total current assets | 53,139 | 80,259 | ||||||
Equipment and leasehold improvements, net | 5,174 | 5,711 | ||||||
Product development costs, net | 20,387 | 14,753 | ||||||
Goodwill | 71,865 | 71,865 | ||||||
Identified intangible assets, net | 20,000 | 22,505 | ||||||
Other long-term assets | 1,896 | 2,235 | ||||||
Total assets | $ | 172,461 | $ | 197,328 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 1,499 | $ | 2,938 | ||||
Accrued compensation | 5,259 | 7,772 | ||||||
Accrued liabilities | 7,222 | 8,933 | ||||||
Deferred revenue | 24,703 | 35,218 | ||||||
Total current liabilities | 38,683 | 54,861 | ||||||
Long-term deferred revenue | 4,262 | 5,213 | ||||||
Deferred income taxes | 2,231 | 1,931 | ||||||
Other long-term liabilities | 300 | 496 | ||||||
Total liabilities | 45,476 | 62,501 | ||||||
Stockholders’ equity: | ||||||||
Common stock, $.01 par value, 50,000 shares authorized; 23,732 shares issued and 23,712 shares outstanding at April 30, 2006; 23,637 shares issued and 23,617 shares outstanding at October 31, 2005 | 237 | 236 | ||||||
Additional paid-in capital | 167,594 | 166,295 | ||||||
Treasury stock at cost | (205 | ) | (205 | ) | ||||
Accumulated deficit | (39,633 | ) | (30,537 | ) | ||||
Accumulated other comprehensive loss | (1,008 | ) | (962 | ) | ||||
Total stockholders’ equity | 126,985 | 134,827 | ||||||
Total liabilities and stockholders’ equity | $ | 172,461 | $ | 197,328 | ||||
See Notes to Condensed Consolidated Financial Statements.
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PLATO Learning, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
Six Months Ended | ||||||||
April 30, | ||||||||
2006 | 2005 | |||||||
Operating activities: | ||||||||
Net loss | $ | (9,096 | ) | $ | (13,481 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Deferred income taxes | 300 | 300 | ||||||
Amortization of capitalized product development costs | 3,526 | 3,463 | ||||||
Amortization of identified intangible and other long-term assets | 2,672 | 4,280 | ||||||
Depreciation and amortization of equipment and leasehold improvements | 1,288 | 1,743 | ||||||
Provision for doubtful accounts | 335 | 674 | ||||||
Stock-based compensation | 803 | 39 | ||||||
Loss on disposal of equipment | 83 | 32 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 8,649 | 12,589 | ||||||
Inventories | 696 | (926 | ) | |||||
Other current and long-term assets | 1,529 | (244 | ) | |||||
Accounts payable | (1,439 | ) | (3,092 | ) | ||||
Other current and long-term liabilities | (5,453 | ) | (2,667 | ) | ||||
Deferred revenue | (11,466 | ) | (12,306 | ) | ||||
Total adjustments | 1,523 | 3,885 | ||||||
Net cash used in operating activities | (7,573 | ) | (9,596 | ) | ||||
Investing activities: | ||||||||
Capitalized internal product development costs | (6,160 | ) | (5,211 | ) | ||||
Purchased product development | (2,000 | ) | — | |||||
Purchases of equipment and leasehold improvements | (828 | ) | (1,375 | ) | ||||
Purchases of marketable securities | — | (9,266 | ) | |||||
Sales of marketable securities | — | 4,559 | ||||||
Maturities of marketable securities | — | 15,000 | ||||||
Net cash (used in) provided by investing activities | (8,988 | ) | 3,707 | |||||
Financing activities: | ||||||||
Net proceeds from issuance of common stock | 587 | 1,925 | ||||||
Repayments of capital lease obligations | (58 | ) | (127 | ) | ||||
Net cash provided by financing activities | 529 | 1,798 | ||||||
Effect of currency exchange rate changes on cash and cash equivalents | (75 | ) | 390 | |||||
Net decrease in cash and cash equivalents | (16,107 | ) | (3,701 | ) | ||||
Cash and cash equivalents at beginning of period | 46,901 | 29,235 | ||||||
Cash and cash equivalents at end of period | $ | 30,794 | $ | 25,534 | ||||
See Notes to Condensed Consolidated Financial Statements.
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PLATO LEARNING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1. General
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The October 31, 2005 condensed balance sheet data was derived from our audited financial statements at that date. Accordingly, these financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. We have included all normal recurring and other adjustments considered necessary to give a fair statement of our operating results for the interim periods shown. Operating results for these interim periods are not necessarily indicative of the results to be expected for the full fiscal year. For further information, refer to the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2005.
Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts of PLATO Learning, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Fiscal Periods
Our fiscal year is from November 1 to October 31. Unless otherwise stated, references herein to our second quarter relate to the three-month period ended April 30.
Reclassifications
Other Revenues:Amounts previously reported as other revenues and other cost of revenues in the consolidated statement of operations for fiscal 2005 periods have been reclassified to conform to the current year presentation. The reclassifications had no effect on previously reported total revenues, total cost of revenues, or gross profit. The table below presents the reconciliation of amounts as previously reported in fiscal year 2005 to the amounts as reported in fiscal year 2006. Amounts reclassified to license fees revenue represent third-party software sold in conjunction with PLATO software, and third party devices, which are the exclusive hardware platform for our Achieve Now software product. Amounts reclassified to services revenue represent third-party hardware related to our technical services offering and to bundled software, services, and hardware provided under a Navy contract with the U.S. Department of Defense. We believe the 2006 reclassification of these amounts results in a presentation of revenues and related cost of revenues that is most representative of management’s current view of the Company’s revenue activities.
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Revenue | Cost of Revenue | |||||||||||||||||||||||
In thousands | License | Service | Other | License | Service | Other | ||||||||||||||||||
Quarter Ended January 31, 2005: | ||||||||||||||||||||||||
As previously classified | $ | 11,095 | $ | 8,196 | $ | 1,631 | $ | 3,432 | $ | 6,126 | $ | 1,700 | ||||||||||||
Reclassifications | 907 | 724 | (1,631 | ) | 972 | 728 | (1,700 | ) | ||||||||||||||||
As reclassfied | $ | 12,002 | $ | 8,920 | $ | — | $ | 4,404 | $ | 6,854 | $ | — | ||||||||||||
Quarter Ended April 30, 2005: | ||||||||||||||||||||||||
As previously classified | $ | 14,233 | $ | 10,908 | $ | 1,771 | $ | 2,869 | $ | 6,108 | $ | 1,985 | ||||||||||||
Reclassifications | 1,066 | 705 | (1,771 | ) | 1,374 | 611 | (1,985 | ) | ||||||||||||||||
As reclassfied | $ | 15,299 | $ | 11,613 | $ | — | $ | 4,243 | $ | 6,719 | $ | — | ||||||||||||
Quarter Ended July 31, 2005: | ||||||||||||||||||||||||
As previously classified | $ | 16,747 | $ | 7,440 | $ | 2,652 | $ | 3,001 | $ | 4,892 | $ | 2,560 | ||||||||||||
Reclassifications | 1,857 | 795 | (2,652 | ) | 1,857 | 703 | (2,560 | ) | ||||||||||||||||
As reclassfied | $ | 18,604 | $ | 8,235 | $ | — | $ | 4,858 | $ | 5,595 | $ | — | ||||||||||||
Year Ended October 31, 2005: | ||||||||||||||||||||||||
As previously classified | $ | 57,803 | $ | 38,342 | $ | 7,662 | $ | 12,353 | $ | 21,809 | $ | 7,876 | ||||||||||||
Reclassifications | 4,724 | 2,938 | (7,662 | ) | 5,327 | 2,549 | (7,876 | ) | ||||||||||||||||
As reclassfied | $ | 62,527 | $ | 41,280 | $ | — | $ | 17,680 | $ | 24,358 | $ | — | ||||||||||||
Cash Flow Statement:Certain prior period amounts in the operating activities and investing activities sections of the condensed consolidated statement of cash flows have been reclassified to conform to the current year presentation. These reclassifications had no effect on net cash flows previously reported for operating or investing activities.
Note 2. Summary of Significant Accounting Policies
General
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We continually evaluate our critical accounting policies and estimates, and have identified the policies relating to the following areas as the critical accounting policies and estimates that are significant to the financial statement presentation, and that require difficult, subjective, or complex judgments:
• | Revenue recognition | ||
• | Allowance for doubtful accounts | ||
• | Capitalized product development costs | ||
• | Valuation of our deferred income taxes | ||
• | Valuation and impairment analysis of goodwill and identified intangible assets |
There have been no significant changes to our accounting policies in these areas during the first two quarters of 2006. For a more complete discussion of these policies refer to Note 1 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2005.
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Stock-Based Compensation
Effective November 1, 2005, we began recording compensation expense associated with stock options and other forms of equity compensation to employees in accordance with Statement of Financial Accounting Standards No. 123(R),Share-Based Payment(“SFAS 123(R)”),as interpreted by SEC Staff Accounting Bulletin No. 107. Prior to November 1, 2005, we accounted for our stock-based employee compensation arrangements according to the provisions of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees,Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation(“SFAS 123”), and related interpretations. Accordingly, no related compensation expense was recorded for awards granted with no intrinsic value and the pro forma disclosures required by SFAS 123 were presented in the notes to our consolidated financial statements. See Note 3 for additional stock-based compensation disclosures under FAS 123(R).
As a result of the adoption of SFAS 123(R), our pre-tax loss and net loss was increased by $481,000 and $803,000 for the three and six months ended April 30, 2006, respectively, and our loss per share for these periods was increased by $0.02 and $0.03, respectively.
The adoption of SFAS 123(R) is expected to result in pre-tax stock-based compensation expense of approximately $1,400,000 in fiscal year 2006. SFAS 123(R) also requires that the cash retained as a result of the tax deductibility of the increase in the value of share-based arrangements be presented as a component of cash flows from financing activities in the consolidated statement of cash flows. Prior to the adoption of SFAS 123(R), such amounts were presented as a component of cash flows from operating activities. The adoption SFAS 123(R) had no effect on our cash flows from operations or financing activities for the six months ended April 30, 2006.
Loss Per Share
Basic and diluted loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Potential common shares, which consist of stock options and warrants and restricted stock, are anti-dilutive in a net loss situation and are therefore disregarded in the calculation of diluted loss per share.
New Accounting Pronouncements
There were no new accounting pronouncements issued during the quarter ended April 30, 2006 that had or are expected to have a significant impact on our consolidated financial statements.
Note 3. Stock-Based Compensation
Prior to November 1, 2005, we adopted various stock incentive and stock option plans (“Prior Stock Plans”) that authorized the granting of stock options, stock appreciation rights, and stock awards to directors, officers, and key employees, subject to certain conditions, including continued employment. Stock options under these plans were granted with an exercise price equal to the fair market value of our common stock on the date of grant. Options granted to our outside directors were exercisable immediately. All other options granted become exercisable ratably over a service period of two to four years and expire, if unexercised, after eight or ten years from the grant date.
On December 8, 2005, our Board of Directors approved the 2006 Stock Incentive Plan (“2006 Plan”), which was ratified at the annual meeting of stockholders on March 2, 2006. The Plan permits the grant of stock options, stock appreciation rights, restricted stock, performance
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shares, and other stock awards. The total number of shares available for issuance under the 2006 Plan is equal to the sum of (a) the shares remaining under the Prior Stock Plans, and (b) any shares issued under the Prior Stock Plans that are forfeited, canceled, or expire without being exercised. Effective with the adoption of the 2006 Plan, shares will no longer be issued under the Prior Stock Plans. Stock options under the 2006 Plan are granted with an exercise price equal to the fair market value of our common stock on the date of grant. Options granted to our outside directors are exercisable immediately. All other options granted become exercisable ratably over a service period of four years and expire, if unexercised, after eight years from the grant date.
In addition to these plans, we also have an Employee Stock Purchase Plan under which employees are entitled to purchase our common stock at a 15% discount to the market price at the beginning or end of the quarterly purchase period as defined in the plan, which ever is lower. In December 2005, we also entered into “Bonus Unit” agreements with certain employees under which these employees are eligible for cash compensation equal to the number of bonus units multiplied by the market price of our common stock on each of October 31, 2006, 2007 and 2008, provided they are employed with us on those dates. A total of 58,500 bonus units have been granted under these agreements. As these awards are payable in cash, estimated amounts payable under these agreements are classified as a liability in the condensed consolidated balance sheet.
As described in Note 2, effective November 1, 2005, we adopted the provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”), using the modified prospective transition application method. Under this method, compensation expense is recognized for employee awards granted, modified, or settled subsequent to October 31, 2005, and the unvested portion of awards granted to employees prior to November 1, 2005. We use the straight-line method to recognize compensation expense over the requisite service period of the award, which we have determined to be the vesting period, and an annual pre-vesting forfeiture rate of 8%, which was determined based on historical pre-vesting forfeiture data. The fair value of option awards was determined using the Black-Scholes option pricing model utilizing the following assumptions:
Fiscal Year | ||||||||
2006 | Fiscal Year | |||||||
Awards to | 2005 | |||||||
Date | Awards | |||||||
Expected life | 4.3 years | 5.0 years | ||||||
Risk-free rate of return | 4.0%- 4.5% | 3.9% | ||||||
Volatility | 49.0% | 62.0% | ||||||
Dividend yield | 0.0% | 0.0% |
In accordance with SFAS 123(R), we review our current assumptions on a periodic basis and adjust them as necessary to ensure proper option valuation. The expected life of an award was determined based on our analysis of historical exercise behavior taking into consideration various participant demographics and option characteristic criteria. The risk-free rate of return is based on the yield on zero coupon U.S. Treasury strips with a remaining life that is consistent with the expected life of the options being valued. Our estimate of volatility incorporated a number of the factors outlined in SFAS 123(R), but was principally determined by examining our historical stock price volatility.
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Total stock-based compensation expense recorded for the three and six months ended April 30, 2006 was as follows (in thousands):
Three Months | Six Months | |||||||
Ended | Ended | |||||||
April 30, 2006 | April 30, 2006 | |||||||
Stock options granted after the adoption of SFAS 123(R) | $ | 252 | $ | 393 | ||||
Stock options granted prior to the adoption of SFAS 123(R) | 112 | 253 | ||||||
Restricted stock awards | 59 | 59 | ||||||
Bonus unit agreements | 54 | 90 | ||||||
Employee stock purchase plan | 4 | 8 | ||||||
$ | 481 | $ | 803 | |||||
No income tax benefits were recognized related to this compensation expense due to the full valuation allowance provided on our deferred income tax assets as fully described in Note 14 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2005.
Our pro forma net loss and pro forma loss per share for the three and six months ended April 30, 2005, including pro forma stock-based compensation expense as if the fair-value-based method of accounting had been used on awards being accounted for under APB Opinion No. 25, were as follows (in thousands, except per share amounts):
Three Months | Six Months | |||||||
Ended | Ended | |||||||
April 30, 2005 | April 30, 2005 | |||||||
Net loss, as reported | $ | (2,954 | ) | $ | (13,481 | ) | ||
Stock-based compensation expense included in reported net loss | 39 | 39 | ||||||
Stock-based compensation expense determined using the fair value based method for all awards | (775 | ) | (1,505 | ) | ||||
Pro forma net loss | $ | (3,690 | ) | $ | (14,947 | ) | ||
Basic and diluted loss per share: | ||||||||
As reported | $ | (0.13 | ) | $ | (0.58 | ) | ||
Pro forma | $ | (0.16 | ) | $ | (0.64 | ) | ||
As discussed in our 2005 Annual Report on Form 10-K, on October 25, 2005 our Board of Directors approved the acceleration of vesting on a total of approximately 760,000 options which had an exercise price greater than the market price on that date. The effect of this acceleration was to reduce stock-based compensation expense that would otherwise have been reported in our year-to-date statement of operations by approximately $774,000 In addition, under SFAS 123, we accounted for the effect of pre-vesting forfeitures on compensation expense as they actually occurred. Under SFAS 123(R), we are required to apply an estimate of these forfeitures in determining periodic compensation expense. This estimate is applied to all outstanding options, including those issued prior to the adoption of SFAS 123(R). The effect of this required change was to also reduce the amount of expected compensation expense related to options issued prior to November 1, 2005 relative to the amounts that would have been reported under SFAS 123.
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A summary of stock option activity is as follows (in thousands, except per share amounts):
Weighted | ||||||||||||||||
Weighted | Average | |||||||||||||||
Average | Contractual | Aggregate | ||||||||||||||
Options | Exercise Price | Term (in | Intrinsic | |||||||||||||
Outstanding | per Share | years) | Value | |||||||||||||
Options outstanding at October 31, 2005 | 2,652 | $ | 9.51 | |||||||||||||
Options granted | 797 | 7.68 | ||||||||||||||
Options exercised | (85 | ) | 6.61 | |||||||||||||
Options forfeited or cancelled | (356 | ) | 11.15 | |||||||||||||
Options outstanding at April 30, 2006 | 3,008 | $ | 8.91 | 6.2 | $ | 6,051 | ||||||||||
Options exercisable at April 30, 2006 | 2,093 | $ | 9.54 | 5.7 | $ | 3,733 | ||||||||||
The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. The total intrinsic value of all options exercised during the six months ended April 30, 2006 and 2005 was approximately $154,000 and $470,000, respectively. The weighted average fair value of options granted during the six months ended April 30, 2006 and 2005 was $3.42 per share and $4.19 per share, respectively.
As of April 30, 2006 the total unrecognized compensation cost related to unvested stock-based compensation arrangements was approximately $2.3 million and the related weighted average period over which it is expected to be recognized is approximately three years.
Note 4. Accounts Receivable
The components of accounts receivable were as follows (in thousands):
April 30, | October 31, | |||||||
2006 | 2005 | |||||||
Trade accounts receivable | $ | 14,105 | $ | 21,930 | ||||
Installment accounts receivable | 1,789 | 2,485 | ||||||
Allowance for doubtful accounts | (2,110 | ) | (1,647 | ) | ||||
$ | 13,784 | $ | 22,768 | |||||
Installment receivables to be billed one year from the balance sheet date are included in other long-term assets on the consolidated balance sheets and were $112,000 at April 30, 2006 and $132,000 at October 31, 2005.
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A reconciliation of the allowance for doubtful accounts from the beginning of the fiscal year through the end of the second quarter is as follows (in thousands):
2006 | 2005 | |||||||
Balance, beginning of fiscal year | $ | 1,647 | $ | 2,712 | ||||
Provision for doubtful accounts (included in general and administrative expenses): | ||||||||
Three months ended January 31 | 227 | 305 | ||||||
Three months ended April 30 | 108 | 369 | ||||||
Recoveries (write-offs) of doubtful accounts, net | 128 | (422 | ) | |||||
Balance, April 30 | $ | 2,110 | $ | 2,964 | ||||
Note 5. Inventories
Supplemental information regarding our inventories is as follows (in thousands):
April 30, | October 31, | |||||||
2006 | 2005 | |||||||
Third-party hardware | $ | 1,448 | $ | 1,779 | ||||
Media, documentation, and packaging materials | 1,882 | 2,247 | ||||||
$ | 3,330 | $ | 4,026 | |||||
Note 6. Product Development Costs
A reconciliation of capitalized product development costs for the period ended April 30, 2006 is as follows (in thousands):
Gross Carrying | Accumulated | |||||||||||
Value | Amortization | Net Carrying Value | ||||||||||
Balance, October 31, 2005 | $ | 29,142 | $ | (14,389 | ) | $ | 14,753 | |||||
Capitalized internal product development costs | 6,160 | — | 6,160 | |||||||||
Purchased product development | 3,000 | — | 3,000 | |||||||||
Write-off of fully amortized costs | (6,881 | ) | 6,881 | — | ||||||||
Amortization of product development costs | — | (3,526 | ) | (3,526 | ) | |||||||
Balance, April 30, 2006 | $ | 31,421 | $ | (11,034 | ) | $ | 20,387 | |||||
Purchased product development represents non-refundable amounts due under a revised license agreement, signed in the second quarter of 2006, for software used in one of our subscription products. The amount is being amortized on a straight-line basis through April 2008.
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Note 7. Goodwill and Identified Intangible Assets
There were no changes in goodwill from October 31, 2005.
Identified intangible assets subject to amortization, resulting from our previous acquisitions, were as follows (in thousands):
April 30, 2006 | October 31, 2005 | |||||||||||||||||||||||
Gross | Net | Gross | Net | |||||||||||||||||||||
Carrying | Accumulated | Carrying | Carrying | Accumulated | Carrying | |||||||||||||||||||
Value | Amortization | Value | Value | Amortization | Value | |||||||||||||||||||
Acquired technology | $ | 23,029 | $ | (17,247 | ) | $ | 5,782 | $ | 23,029 | $ | (16,645 | ) | $ | 6,384 | ||||||||||
Trademarks and tradenames | 3,680 | (2,390 | ) | 1,290 | 3,680 | (2,036 | ) | 1,644 | ||||||||||||||||
Customer relationships and lists | 21,100 | (8,172 | ) | 12,928 | 21,100 | (6,644 | ) | 14,456 | ||||||||||||||||
Noncompete agreements | 1,000 | (1,000 | ) | — | 1,000 | (979 | ) | 21 | ||||||||||||||||
$ | 48,809 | $ | (28,809 | ) | $ | 20,000 | $ | 48,809 | $ | (26,304 | ) | $ | 22,505 | |||||||||||
Amortization expense for the identified intangible assets presented above was as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
April 30, | April 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Amortization of intangible assets included in: | ||||||||||||||||
Cost of license fees and subscriptions revenues | $ | 302 | $ | 957 | $ | 603 | $ | 2,108 | ||||||||
Operating expenses | 933 | 1,080 | 1,902 | 2,172 | ||||||||||||
$ | 1,235 | $ | 2,037 | $ | 2,505 | $ | 4,280 | |||||||||
The estimated future annual amortization expense for the identified intangible assets presented above is as follows (in thousands):
Cost of | Operating | |||||||||||
Revenues | Expenses | Total | ||||||||||
Remainder of 2006 | $ | 603 | $ | 1,808 | $ | 2,411 | ||||||
2007 | 1,206 | 3,529 | 4,735 | |||||||||
2008 | 1,206 | 3,105 | 4,311 | |||||||||
2009 | 1,069 | 2,829 | 3,898 | |||||||||
2010 | 647 | 2,829 | 3,476 | |||||||||
Thereafter | 1,051 | 118 | 1,169 | |||||||||
$ | 5,782 | $ | 14,218 | $ | 20,000 | |||||||
The future annual amortization amounts presented above are estimates. Actual future amortization expense may be different due to future acquisitions, impairments, changes in amortization periods, or other factors.
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Note 8. Debt
Our revolving loan agreement with Wells Fargo Bank, N.A., which provided for a maximum $12.5 million line of credit, expired January 31, 2006. There were no borrowings outstanding at January 31, 2006 or October 31, 2005.
Note 9. Deferred Revenue
The components of deferred revenue were as follows (in thousands):
April 30, | October 31, | |||||||
2006 | 2005 | |||||||
License fees | $ | 1,101 | $ | 4,476 | ||||
Subscriptions | 10,237 | 12,546 | ||||||
Services and other | 17,627 | 23,409 | ||||||
Total | 28,965 | 40,431 | ||||||
Less: long-term amounts | (4,262 | ) | (5,213 | ) | ||||
Current portion | $ | 24,703 | $ | 35,218 | ||||
Note 10. Commitments and Contingent Liabilities
License Agreement
On March 3, 2006 we signed a revised agreement with a third-party provider of content used in certain of our software products. Under the revised agreement we are required to pay a total of $3,000,000 in non-refundable license fees, $2,000,000 of which was paid at the time of signing the agreement, with the balance due in May 2006. Theses payments are recorded in our balance sheet as product development costs and are being amortized to cost of subscription revenues. The agreement also requires us to pay additional fees on a per-license basis. The agreement expires in October 2007. Total amounts payable under the revised agreement, including the prepayments, are expected to be comparable to those under the former agreement.
Legal Proceedings
As previously disclosed in Note 11 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2005, Credit Suisse First Boston and several of its clients, including Lightspan, Inc. (which we acquired in November 2003), are defendants in a securities class action lawsuit captioned Liu, et al. v. Credit Suisse First Boston Corp., et al. pending in the United States District Court for the Southern District of New York. The complaint alleges that Credit Suisse First Boston, its affiliates, and the securities issuer defendants (including Lightspan, Inc.) manipulated the price of the issuer defendants’ shares in the post-initial public offering market. On April 1, 2005, the complaint was dismissed with prejudice, and all subsequent plaintiff motions and appeals to date have been denied or rejected. We continue to believe this lawsuit is without merit; however, we can give no assurance as to its ultimate outcome.
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Note 11. Restructuring and Other Charges
Restructuring and other charges primarily include severance costs for headcount reductions, committed costs of vacated facilities, and costs paid to terminated executive officers under employment agreements. These charges are summarized as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
April 30, | April 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Restructuring charges: | ||||||||||||||||
Severance and related benefits for U.K. headcount reduction | $ | — | $ | 22 | $ | — | $ | 452 | ||||||||
Severance and related benefits for U.S. headcount reduction | 161 | 26 | 241 | 299 | ||||||||||||
U.K. facility closure liabilities | — | 313 | — | 313 | ||||||||||||
Other | 98 | 92 | 98 | 92 | ||||||||||||
259 | 453 | 339 | 1,156 | |||||||||||||
Other charges: | ||||||||||||||||
Executive officer changes | — | 9 | — | 1,595 | ||||||||||||
Other | — | 170 | — | 170 | ||||||||||||
$ | 259 | $ | 632 | $ | 339 | $ | 2,921 | |||||||||
In the first half of 2006, we reduced additional positions in the United States as a continuation of the restructuring activities initiated in October 2005. For more information on these activities and the restructuring and other charges incurred in 2005, refer to Note 13 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2005.
The restructuring reserve activity was as follows (in thousands):
Severance | ||||||||||||||||
and related | Facility | |||||||||||||||
benefits | closings | Other | Total | |||||||||||||
Reserve balance at October 31, 2005 | $ | 1,598 | $ | 177 | $ | 401 | $ | 2,176 | ||||||||
Provision for restructuring | 241 | — | 98 | 339 | ||||||||||||
Cash payments | (1,770 | ) | (131 | ) | (127 | ) | (2,028 | ) | ||||||||
Other | — | — | 67 | 67 | ||||||||||||
Reserve balance at April 30, 2006 | $ | 69 | $ | 46 | $ | 439 | $ | 554 | ||||||||
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Note 12. Comprehensive Loss
Total comprehensive loss was as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
April 30, | April 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Net loss | $ | (5,899 | ) | $ | (2,954 | ) | $ | (9,096 | ) | $ | (13,481 | ) | ||||
Unrealized gains on available for sale securities | 8 | 10 | 16 | 52 | ||||||||||||
Foreign currency translation adjustments | (39 | ) | 81 | (69 | ) | 298 | ||||||||||
Total comprehensive loss | $ | (5,930 | ) | $ | (2,863 | ) | $ | (9,149 | ) | $ | (13,131 | ) | ||||
Income tax effects for the components of other comprehensive loss were not significant because our deferred tax assets are fully reserved. Accumulated other comprehensive loss was $1,008,000 and $962,000 at April 30, 2006 and October 31, 2005, respectively.
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Business Description
PLATO Learning, Inc. is a leading provider of computer and web-based instruction, curriculum planning and management, assessment, and related professional development and support services to K-12 schools. We also provide these products and services to two- and four-year colleges, job training programs, correctional institutions, military education programs, corporations, and individuals. We also offer online and onsite staff development, alignment, and correlation services to ensure optimal classroom integration of our products and to help schools meet their accountability requirements and school improvement plans.
Our extensive, research-based courseware library includes thousands of hours of mastery-based instruction covering the subject areas of mathematics, science, reading, writing, language arts, social studies, and work skills. These courseware components are aligned to local, state, provincial, and national performance standards, and along with our web-based accountability and assessment software, is designed to help educators meet the demands of federal and state accountability legislation such as No Child Left Behind and Reading First federal legislation, special programs such as Title I and special education, as well as U.S. Department of Education initiatives on mathematics and science and ensuring teacher quality.
We operate our principal business in one industry segment, which is the development and marketing of educational software and related services.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We continually evaluate our critical accounting policies and estimates, and have identified the policies relating to the following areas as the critical accounting policies and estimates that are significant to the financial statement presentation, and that require difficult, subjective, or complex judgments:
• | Revenue recognition | ||
• | Allowance for doubtful accounts | ||
• | Capitalized product development costs | ||
• | Valuation of our deferred income taxes | ||
• | Valuation and impairment analysis of goodwill and identified intangible assets |
There have been no significant changes to our accounting policies in these areas during the first two quarters of 2006. For a complete discussion of these policies refer to Note 1 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2005.
As more fully described in Notes 2 and 3 to the condensed consolidated financials statements, in the first quarter of 2006 we adopted the provisions of Statement of Financial Accounting Standards No. 123(R),Share-Based Payment(“SFAS 123(R)”),as interpreted by SEC Staff Accounting Bulletin No. 107.
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General Factors Affecting our Financial Results
There are a number of general factors that affect our results from period to period. These factors are discussed below.
Revenue. A large portion of our revenues are derived from the sale of one-time, perpetual licenses to our software products. These sales are reported as license fees in our consolidated statement of operations. Changes in the quantity and size of these individual sales can have a significant impact on the comparability of revenues from period to period. In addition, as is common in the software industry, a large portion of our customer orders tend to occur in the final weeks or days of each fiscal quarter. As a result, license revenues can be heavily influenced by events such as funding approvals that may be outside our control during this short span of time. Subscription-based license fees are earned ratably over the course of the subscription period. Historically these revenues have made up less than 15% of total revenues. However, as these revenues grow as a percentage of total revenues, our period to period revenues will become more comparable and predictable. Our business is also seasonal, with the largest portion of our license fees typically coming in the third and fourth quarters of our fiscal year, and professional service fees being the greatest during periods in which schools are in session. While this seasonality does not generally impact the comparability of our annual results, it can significantly impact our results from quarter to quarter.
Gross Margin. Our gross margin during a period is dependent on a number of factors. License fee revenues have high gross margins due to the low direct cost of delivering these products. As a result, the mix of license fee revenues to total revenues in a given period significantly influences reported total gross margins. In addition, a large portion of our costs of revenue are fixed in nature. These costs include amortization of capitalized software development and purchased technology, depreciation and other infrastructure costs to support our hosted subscription services, customer support operations, and full-time professional services personnel who deliver our training services. Accordingly, increases in revenues allow us to leverage these costs resulting in higher gross margins, while decreases in revenues have the opposite effect.
Operating Expenses. Incentive compensation is a significant variable component of our sales and marketing expenses, approximating 7% to 9% of total revenues in any given period. Sales and marketing expenses also include costs such as travel, tradeshows, and conferences that can vary with revenue activity or individual events that occur during the period.
General and administrative expenses are substantially fixed in nature. However, certain components such as our provision for bad debts, professional fees, and other expenses can vary based on business results, individual events, or initiatives we may be pursuing at various times throughout the year.
Product maintenance and development expense in our consolidated statement of operations does not reflect our total level of spending in these areas. Costs to enhance or maintain existing products, or to develop products prior to achieving technological feasibility, are charged to product maintenance and development expense as incurred. Costs incurred to develop new products after technological feasibility is achieved, which represent the majority of our total development spending, are capitalized and amortized to cost of revenues. Accordingly, product
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maintenance and development expense in our consolidated statement of operations can fluctuate from period to period, in terms of both total dollars and as a percentage of revenue, based on the nature and timing of activities occurring during the period.
Amortization of intangibles represents the amortization of certain identified intangible assets acquired through various acquisitions. These expenses are generally predictable from period to period because they are fixed over the course of their individual useful lives.
Overview of Financial Results
Our financial results for the second quarter of 2006 continue to reflect the effects of low order volumes. These effects, relative to the second quarter of 2005, include lower revenues and gross margins, an increase in our net loss, and decreases in deferred revenue, receivables and cash balances.
As discussed in our Form 10-K for fiscal year 2005, significant changes were made throughout the company in 2005 to better position us for long-term growth. Our execution of these changes continued in 2006, and as a result, we continue to manage a number of significant transitions for the Company. These transitions, which include new products, new subscription licensing programs, new account managers, new customer markets, and new business processes, have resulted in lower than expected productivity in our sales organization due to factors such as training of new account managers, new product training for all account managers, and establishing customer relationships in new target markets.
Low order volumes have the greatest impact on our license fees revenues, which declined 55% from the second quarter of 2005 to $6.9 million. Subscription and services revenues are also affected by the decline in order volumes, but to a lesser degree due to the time lag between when these orders are received and when the related revenues are recognized. As a result, total second quarter 2006 revenues declined $11.4 million, or 36%, from the second quarter of 2005. Since the second quarter of 2005, we have achieved significant cost reductions in cost of revenue and operating expenses, which are largely made up of fixed costs, but these declines only partially offset the lower revenues, resulting in an increase in our second quarter net loss from $3.0 million, or $0.13 per share, in 2005 to $5.9 million, or $0.25 per share in 2006.
Our 2006 year-to-date financial results also reflect the factors contributing to our second quarter results. However, despite a year-to-date revenue decline of $13.4 million, or 24%, our cost reduction activities have resulted in a reduction of our year-to-date net loss from $13.5 million in 2005 to $9.1 million in 2006.
We believe the low sales productivity we experienced in the first half of the year is temporary. Our account managers continue to gain product and customer experience and our sales pipeline continues to grow. We have focused more resources on support of the sales process, marketing programs, and training, and have several important new product introductions planned for the balance of the fiscal year, all of which are on track and on budget. These products include 16 new full semester courses, which will bring the total of such courses released this year to 32, elementary math products, which will expand our math offering in this segment across grades K through 6, and our next generation content delivery platform, which will be released in the third quarter.
We expect these sales improvements and new product introductions will result in increased order growth in the second half of the 2006 over the same period last year resulting in order levels for the full fiscal year 2006 that are similar to fiscal year 2005. However, we expect second half 2006 orders to be more heavily weighted toward subscription license products, for which revenue is recognized over the subscription
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period, rather than perpetual license products, for which revenue is recognized up-front upon delivery. Accordingly, order growth is not expected to result in comparable revenue growth. Service revenue is expected to decline as a result of timing of receipt of orders during the fiscal year. These factors are expected to result in a decrease in revenues of at least 15% to 20% for the full year 2006 from 2005. However, the timing difference between the receipt of orders and related revenue recognition is expected to result in the growth of deferred revenue for the remainder of the year.
The range of expected net loss, excluding restructuring and other charges, related to a 15% to 20% decline in revenues would be between $6.5 million and $11.5 million. Actual results, however, could vary significantly from these estimates, depending on the level of orders and the mix of subscription and perpetual license orders actually booked. This mix is difficult to predict as we transition toward subscription products.
This lack of predictability of product order mix during this transition period is one of several risks and uncertainties we continue to face in our business. We also face the risk that we are not able to successfully execute the transitions discussed above on timely basis, or to release new products within the time frames expected. Achieving our outlook for 2006 is dependent on a fully productive sales force for the balance of the year and on the successful introduction of planned new products. We also face other risks and uncertainties in our business as discussed in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Results of Operations
Revenues
See Note 1 to condensed consolidated financial statements for discussion of the reclassification of certain revenues and related cost of revenues previously reported as “other” in our statements of operations.
The following tables summarize certain key information to aid in the understanding of our discussion and analysis of revenues:
Orders Greater Than $100,000
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
April 30, | April 30, | |||||||||||||||||||||||
2006 | 2005 | % Change | 2006 | 2005 | % Change | |||||||||||||||||||
Number | 19 | 29 | -34.5 | % | 45 | 58 | -22.4 | % | ||||||||||||||||
Value ($000) | $ | 4,046 | $ | 8,081 | -49.9 | % | $ | 9,371 | $ | 15,534 | -39.7 | % | ||||||||||||
Average Value ($000) | $ | 213 | $ | 279 | -23.7 | % | $ | 208 | $ | 268 | -22.4 | % |
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Revenue By Category (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
April 30, | April 30, | |||||||||||||||||||||||
2006 | 2005 | % Change | 2006 | 2005 | % Change | |||||||||||||||||||
License fees | $ | 6,920 | $ | 15,299 | -54.8 | % | $ | 15,969 | $ | 27,301 | -41.5 | % | ||||||||||||
Subscriptions | 4,054 | 4,517 | -10.3 | % | 8,410 | 9,050 | -7.1 | % | ||||||||||||||||
Services | 9,001 | 11,613 | -22.5 | % | 19,082 | 20,533 | -7.1 | % | ||||||||||||||||
$ | 19,975 | $ | 31,429 | -36.4 | % | $ | 43,461 | $ | 56,884 | -23.6 | % | |||||||||||||
Total revenues for the second quarter of 2006 declined 36.4% to $20.0 million, from $31.4 million for the same period in 2005, reflecting a significant decrease in order volumes in the quarter as compared to the same period in 2005. The same holds true for the first six months of 2006, where total revenues declined 23.6% to $43.5 million.
The declines in order volumes in 2006 reflect the significant transitions we continue to manage in our business including new products, new subscription licensing programs, new account managers, new customer markets, and new business processes. These transitions have resulted in lower than expected productivity in our sales organization due to factors such as training of new account managers, new product training for all account managers, and establishing customer relationships in new target markets. As a result of the sales organization restructuring activities in the second half of fiscal 2005, including voluntary and involuntary turnover, more than half of our account managers had less than six months experience with the company going into the second quarter of 2006.
License fees revenues are impacted the greatest by lower order volumes. License fees revenues in the second quarter of 2006 declined by $8.3 million from the same period last year due to the order volume decline, and to a lesser degree, to the increase in the mix of subscription orders. Subscription revenues declined $0.5 million, or 10%, and were also affected by the low year-to-date orders. Service revenues declined $2.6 million, or 23%, due primarily to lower order volumes, but also to a decline in Supplemental Educational Services due to our exit from this line of business in 2006, and a decline in installation services which are closely tied to license order volume. Partially offsetting these declines was an increase in software support revenues reflecting improved pricing and increased renewal rates during that last half of fiscal year 2005.
Gross Margin
See Note 1 to condensed consolidated financial statements for discussion of the reclassification of revenues and related cost of revenues previously reported as “other” in our statement of operations.
The following tables summarize the percentage of total revenue, and the gross margin for each revenue category to aid in the understanding of our discussion and analysis of gross margin:
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Percentage of Total Revenue
Three Months Ended | Six Months Ended | |||||||||||||||
April 30, | April 30, | |||||||||||||||
Revenue Category | 2006 | 2005 | 2006 | 2005 | ||||||||||||
License fees | 34.6 | % | 48.7 | % | 36.7 | % | 48.0 | % | ||||||||
Subscriptions | 20.3 | % | 14.4 | % | 19.4 | % | 15.9 | % | ||||||||
Services | 45.1 | % | 36.9 | % | 43.9 | % | 36.1 | % | ||||||||
Total | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Gross Margin Percentage
Three Months Ended April 30, | Six Months Ended April 30, | |||||||||||||||||||||||
Increase | Increase | |||||||||||||||||||||||
Revenue Category | 2006 | 2005 | (Decrease) | 2006 | 2005 | (Decrease) | ||||||||||||||||||
License fees | 61.3 | % | 72.3 | % | (11.0 | %) | 64.6 | % | 68.3 | % | (3.7 | %) | ||||||||||||
Subscriptions | 34.5 | % | 52.6 | % | (18.1 | %) | 41.8 | % | 50.8 | % | (9.0 | %) | ||||||||||||
Services | 50.2 | % | 42.1 | % | 8.1 | % | 51.5 | % | 33.9 | % | 17.6 | % | ||||||||||||
Total | 50.9 | % | 58.3 | % | (7.4 | %) | 54.4 | % | 53.1 | % | 1.3 | % |
Total gross margin decreased to 50.9% for the second quarter of 2006, from 58.3% for the same period in 2005. This decrease primarily reflects the decrease in license fees and subscriptions revenues. Total gross margin increased to 54.4% for the six months of 2006, from 53.1% for the same period in 2005.
The 11.0 percentage point decline in license fees gross margins in the second quarter was due primarily to the decline in license fees revenues, which have low variable costs. Also contributing to the decline was the impact of pricing promotions in the quarter on certain license products. The 3.7 percentage point decline in year-to-date license fee margins is largely attributable to the related revenue decline, offset partially by a reduction in amortization of product development costs and purchased intangible assets. The reduction in amortization is due to impairment charges on the related assets recorded in the fourth quarter 2005, and to a reduction in the portion of these costs allocated to license revenues due to the lower mix of license fees to subscriptions revenues.
Subscription margins in the quarter declined by 18.1 percentage points to 34.5% due to the decline in subscription revenues, which have very low variable costs, and to an increase in product development amortization. This increase is the result of an increase in the portion of these costs allocated to subscription revenues due to the increased mix of subscription to license revenues, and to the renegotiation of an existing license agreement related to software used in one of our subscription products. Under the revised agreement, the portion of license fees paid in advance is being amortized over the agreement term. This amortization is incremental to remaining expenses recognized under the prior agreement, which will decline over the remainder of the year as customer subscription periods that began under the old agreement end. Subscription margins for the year-to-date period declined 9.0 percentage points due largely to the same factors affecting the second quarter margins.
Total amortization of capitalized product development costs and technology-related purchased intangible assets declined approximately $1.1 million from 2005 on a year-to-date basis as a result of impairment charges on the related assets in the fourth quarter of 2005. For the
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second quarter, these costs were relatively unchanged from 2005 due to the offsetting increase attributable to the revised license agreement as discussed above.
The improvements in service gross margins for both the second quarter and year-to-date periods were driven by higher productivity resulting from 2005 restructuring activities in our services organization, and to a lesser degree, by the increase in software support revenues which have very little incremental costs.
Operating Expenses
The following table summarizes the percentage of total revenue and percentage change in total spending from the previous year for certain operating expense line items to aid in the understanding of our discussion and analysis of our operating expenses:
Percentage of | Percentage of | |||||||||||||||||||||||
Total Revenue | Percent | Total Revenue | Percent | |||||||||||||||||||||
Three Months Ended | Increase | Six Months Ended | Increase | |||||||||||||||||||||
April 30, | (Decrease) | April 30, | (Decrease) | |||||||||||||||||||||
2006 | 2005 | in Amount | 2006 | 2005 | in Amount | |||||||||||||||||||
Sales and marketing | 47.9 | % | 42.7 | % | (28.6 | %) | 44.4 | % | 47.0 | % | (27.8 | %) | ||||||||||||
General and administrative | 21.6 | % | 15.4 | % | (10.9 | %) | 20.6 | % | 15.9 | % | (1.0 | %) | ||||||||||||
Product maintenance and development | 6.1 | % | 3.9 | % | 0.2 | % | 6.4 | % | 4.7 | % | 2.6 | % | ||||||||||||
Amortization of intangibles | 4.7 | % | 3.4 | % | (13.6 | %) | 4.4 | % | 3.8 | % | (12.4 | %) | ||||||||||||
Operating expenses excluding restructuring and other charges | 80.3 | % | 65.4 | % | (21.9 | %) | 75.8 | % | 71.4 | % | (19.0 | %) | ||||||||||||
Restructuring and other charges | 1.3 | % | 2.0 | % | (59.0 | %) | 0.8 | % | 5.1 | % | (88.4 | %) | ||||||||||||
Total operating expenses | 81.6 | % | 67.4 | % | (23.0 | %) | 76.6 | % | 76.5 | % | (23.6 | %) | ||||||||||||
Total operating expenses in 2006 declined approximately 23% from 2005 in both the second quarter and year-to-date periods due primarily to lower sales and marketing expenses. Operating expenses in 2006 include stock-based compensation expense of $0.5 million and $0.8 million in the second quarter and year-to-date periods, respectively.
Sales and marketing expenses decreased 28.6%, or $3.8 million from the second quarter of 2005 to the second quarter of 2006, and 27.8%, or $7.4 million, from the first six months of 2005 to the first six months of 2006. These declines reflect the reorganization and cost reduction activities we initiated in 2005, and to lower variable compensation costs due to lower revenue.
General and administrative expense declined $0.5 million, or 10.9% in the second quarter of 2006 compared to 2005 due primarily to a decrease in the provision for bad debts as a result of lower revenues and improved credit and collection policies. The effect of the increase in stock-based compensation from 2005 to 2006 was largely offset by a reduction in the provision for cash-based incentive compensation plans due to our overall lower financial performance in the second quarter. The decrease in general and administrative expenses on a year-to-date basis was less significant as the increase in stock based compensation had a larger offsetting impact to other cost declines.
Restructuring and other charges primarily include severance costs for headcount reductions, committed costs of vacated facilities, and costs paid to terminated executive officers under employment agreements. In the first half of 2006, we reduced additional positions in the United
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States as a continuation of the restructuring activities initiated in October 2005. For more information on these activities and the restructuring and other charges incurred in 2005, refer to Note 13 to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2005.
Interest Income
Other income and expense consists primarily of interest income on our cash and cash equivalent balances. The increases in interest income from 2005 to 2006 reflect the increase in investment yields due to the general rise in interest rates over these periods.
Liquidity and Capital Resources
Cash and Cash Equivalents
At April 30, 2006, cash and cash equivalents were $30.8 million, a decrease of $16.1 million from October 31, 2005. Approximately $8.2 million, or half of this decrease, represents investments made in internal and purchased product development in the first six months of 2006, reflecting our plans to introduce several significant new products in the second half of 2006 and in 2007. The balance of the decrease primarily is due to cash used in operations in 2006 of $7.6 million. This net use of cash is attributable to the previously discussed lower sales order volumes which have resulted in a decline in operating results and net unfavorable changes in non-cash working capital components such as accounts receivable and deferred revenues.
Working Capital and Liquidity
At April 30, 2006, our principal sources of liquidity were cash and cash equivalents of $30.8 million and net accounts receivable of $13.8 million. Working capital, defined as current assets less current liabilities, was $14.5 million at April 30, 2006 and $25.4 million at October 31, 2005.
The $10.9 million, or 43% decrease in working capital from October 2005 to April 2006, is consistent with the decline in business activity during the quarterly periods ended on those dates. This decline reflects both the seasonal factors that affect our business, as well as the general order volume declines in 2006 as previously discussed. Cash and cash equivalents, accounts receivable and deferred revenues are the primary elements of our working capital that fluctuate most significantly with business activity. Cash and cash equivalents declined $16.1 million, as discussed above. The decrease in net accounts receivable of $9.0 million is attributable to lower order volumes in the second quarter compared to the fourth quarter of 2005. Deferred revenue, which increases with orders for subscription products and services, and decreases as those products and services are subsequently delivered, decreased $11.5 million in total, as deliveries in the second quarter outpaced new orders received. Other elements of working capital also fluctuate with business activity and seasonality, but to a lesser degree. Accounts payable, accrued compensation, and accrued liabilities declined $5.7 million due to payment of amounts accrued at October 31, 2005, including year-end incentive compensation, which also declined as of April 30, 2006 due to financial performance which was below expectations in the first half of 2006.
Our revolving loan agreement with Wells Fargo Bank, N.A., which provided for a maximum $12.5 million line of credit, expired on January 31, 2006. Negotiations are in progress to replace this agreement.
Our future liquidity needs will depend on, among other factors, the timing and extent of product development expenditures, order volume, the timing and collection of receivables, and expenditures in connection with possible acquisitions or stock repurchases. From time to time,
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we evaluate potential acquisitions of products or businesses that complement our core business. We may consider and acquire other complementary businesses, products, or technologies in the future. We believe that existing cash and investment balances and anticipated cash flow from operations will be sufficient to fund our operations for the foreseeable future.
Contractual Obligations and Commercial Commitments
Our contractual obligations and commercial commitments consist primarily of future minimum payments due under operating leases, royalty and software license agreements, and capital lease obligations. In addition, any future borrowings under a renegotiated revolving loan agreement as discussed above would require future use of cash. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended October 31, 2005 for a table showing our contractual obligations. As discussed in Note 10 to Condensed Consolidated Financial Statements, we entered into a revised agreement for the license of software used in one of our subscription products. Non-refundable license fees under the agreement total $3.0 million, $2.0 million of which was paid in the second quarter, with the balance due in the third quarter of 2006. Other than this agreement, there were no significant changes to our contractual obligations during the six months ended April 30, 2006.
At April 30, 2006, we had no significant commitments for capital expenditures.
Disclosures about Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as of April 30, 2006.
Fiscal Year 2006 Outlook
Our outlook for the full year 2006 has changed from the outlook we provided in our Form 10-Q for quarter ended January 31, 2006. We expect sales orders in the second half of 2006 to offset declines in the first half, resulting in a comparable level of full year orders in 2006 as in 2005. The content of the orders, however, is expected to be more heavily weighted towards subscription license products, for which revenue is recognized over time, rather than perpetual license products, for which revenue is recognized up-front upon delivery. Service revenue is expected to decline as a result of timing of receipt of service orders during the year. These factors are expected to result in a decrease in revenues of at least 15% to 20% in 2006 from 2005. The expected net loss at this lower revenue range, excluding restructuring and other charges, would be approximately $6.5 million to $11.5 million. The deferred revenue balance is expected to grow for the remainder of 2006. Actual results in 2006, however, could vary significantly from these amounts depending on the level of orders and the mix of subscription and perpetual license orders actually achieved, which is difficult to predict during this period of transition toward subscription products.
We will continue to look for cost reduction opportunities for the remainder of the year to lower the Company’s expected net loss and may incur restructuring costs in addition to the less than $1.0 million we discussed in our previous outlook. We also see a unique window of opportunity to expand our product portfolio and become a dominant supplier of e-learning solutions in the marketplace. Our product development investments are on track and on budget and we will continue to aggressively pursue our product strategy, with total annual internal product development spending increasing at least $10.0 million or more over 2005, with the ratio of capitalized to total internal development costs slightly greater than the first half of 2006.
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Forward-Looking Statements
In addition to historical information, this Form 10-Q contains forward-looking statements. These forward-looking statements are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “forecast,” “project,” “should” and similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, among others, statements about our future performance, the continuation of historical trends, the sufficiency of our sources of capital for future needs, the effect of restructuring activities on our achieve long-term growth, and the expected impact of recently issued accounting pronouncements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Part II Item 1A of this Form 10-Q and Part I Item 1A of our 2005 Annual Report on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements based on circumstances or events, which occur in the future. Readers should carefully review the risk factors described in this report on Form 10-Q and in other documents we file from time to time with the Securities and Exchange Commission.
Interest Rate Risk
At April 30, 2006, our only debt consisted of capital lease obligations at fixed interest rates.
Foreign Currency Exchange Rate Risk
The primary market for our products and services is in the United States, but our products are marketed outside the United States on a selected basis and we have limited operations in Canada and the United Kingdom. These foreign operations are not a significant component of our business, and, as a result, risks relating to foreign currency fluctuation are considered minimal.
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ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See the information set forth under the captions, “Interest Rate Risk” and “Foreign Currency Exchange Rate Risk” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report on Form 10-Q.
ITEM 4.CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1.LEGAL PROCEEDINGS
As previously disclosed in this Item 1 in our Annual Report on Form 10-K for the year ended October 31, 2005, Credit Suisse First Boston and several of its clients, including Lightspan, Inc. (which we acquired in November 2003), are defendants in a securities class action lawsuit captioned Liu, et al. v. Credit Suisse First Boston Corp., et al. pending in the United States District Court for the Southern District of New York. The complaint alleges that Credit Suisse First Boston, its affiliates, and the securities issuer defendants (including Lightspan, Inc.) manipulated the price of the issuer defendants’ shares in the post-initial public offering market. On April 1, 2005, the complaint was dismissed with prejudice, and all subsequent plaintiff motions and appeals to date have been denied or rejected. We continue to believe this lawsuit is without merit; however, we can give no assurance as to its ultimate outcome.
ITEM 1A.RISK FACTORS
Our business is subject to a number of risks and uncertainties, which are discussed in detail in Part 1, Item 1A of our 2005 Annual Report on Form 10-K.
ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Stockholders was held on March 2, 2006. There were 23,647,930 shares of our common stock entitled to vote at the meeting and a total of 21,526,924 shares (91.0%) were represented at the meeting. Voting was as follows:
1. | Election of Director Debra A. Janssen: For 20,134,584 and Withhold 1,392,340. | ||
2. | Election of Director M. Lee Pelton: For 18,287,408 and Withhold 3,239,516. | ||
3. | Election of Director John T. (Ted) Sanders: For 18,210,838 and Withhold 3,316,086. | ||
4. | Approval of the PLATO Learning, Inc. 2006 Stock Incentive Plan: For 11,590,504, Against 6,159,403, Abstain 139,829, and Broker Non-Vote 3,637,188. | ||
5. | Ratification of the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm for the fiscal year ending October 31, 2006: For 21,397,311, Against 51,637, Abstain 77,976, and Broker Non-Vote 0. |
ITEM 6.EXHIBITS
Exhibit Number and Description
31.01 | Certification of Chief Executive Officer under Rule 13a-14(a) adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.02 | Certification of Chief Financial Officer under Rule 13a-14(a) adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32.01 | Certification of Chief Executive Officer under 18 U.S.C. 1350 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
32.02 | Certification of Chief Financial Officer under 18 U.S.C. 1350 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PLATO LEARNING, INC. June 9, 2006 | By | /s/michael a. morache | ||||||
President and Chief Executive Officer | ||||||||
(principal executive officer) | ||||||||
/s/laurence l. betterley | ||||||||
Senior Vice President and Chief Financial Officer | ||||||||
(principal financial officer) |
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