1
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 SEPTEMBER 30, 1999.
[ ] 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: 0-22187
ADVANTAGE LEARNING SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WISCONSIN 39-1559474
(STATE OR OTHER (IRS EMPLOYER
JURISDICTION OF INCORPORATION) IDENTIFICATION NO.)
PO BOX 8036
2911 PEACH STREET
WISCONSIN RAPIDS, WISCONSIN
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
54495-8036
(ZIP CODE)
(715) 424-3636
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
OUTSTANDING AT
CLASS OCTOBER 31, 1999
----- ----------------
Common Stock, $0.01 par value 34,112,035
2
ADVANTAGE LEARNING SYSTEMS, INC.
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
PART I - FINANCIAL INFORMATION
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Page
Number
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ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Balance Sheets at September 30, 1999
and December 31, 1998 ......................................... 1
Unaudited Consolidated Statements of Income for
the Three Months and Nine Months Ended
September 30, 1999 and 1998 ................................... 2
Unaudited Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1999 and 1998....................... 3
Notes to Unaudited Consolidated Financial Statements.................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.......................................................... 12
PART II - OTHER INFORMATION
- ---------------------------
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................. 13
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...................................... 14
- Index -
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ADVANTAGE LEARNING SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1999 1998
---------------- --------------
(In thousands)
ASSETS
------
Current assets:
Cash and cash equivalents $ 39,398 $ 14,264
Short term investments - 18,869
Accounts receivable, less allowance of
$1,045,000 in 1999 and $1,058,000 in 1998 11,296 8,863
Inventories 1,231 794
Prepaid expenses 1,407 689
Deferred tax asset 2,251 2,242
---------------- --------------
Total current assets 55,583 45,721
Property, plant and equipment, net 23,515 19,210
Deferred tax asset 1,594 1,647
Intangibles, net 2,308 1,445
Capitalized software, net 485 257
---------------- --------------
Total assets $ 83,485 $ 68,280
================ ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable $ 2,218 $ 1,848
Deferred revenue 3,662 3,443
Payroll and employee benefits 1,962 1,080
Income taxes payable 1,015 2,157
Other current liabilities 2,342 3,000
---------------- --------------
Total current liabilities 11,199 11,528
Deferred revenue 1,411 1,398
---------------- --------------
Total liabilities 12,610 12,926
Minority interest 259 295
Shareholders' equity 70,616 55,059
---------------- --------------
Total liabilities and shareholders' equity $ 83,485 $ 68,280
================ ==============
See accompanying notes to consolidated financial statements.
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ADVANTAGE LEARNING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
-------------- -------------- --------------- --------------
(In thousands, except per share amounts)
Net sales:
Products $ 17,785 $ 11,410 $ 49,810 $ 29,981
Services 5,203 3,694 12,318 7,723
-------------- -------------- --------------- --------------
Total net sales 22,988 15,104 62,128 37,704
-------------- -------------- --------------- --------------
Cost of sales:
Products 2,049 907 5,526 3,111
Services 2,192 1,394 5,421 3,006
-------------- -------------- --------------- --------------
Total cost of sales 4,241 2,301 10,947 6,117
-------------- -------------- --------------- --------------
Gross profit 18,747 12,803 51,181 31,587
Operating expenses:
Product development 2,332 1,276 5,687 3,612
Selling and marketing 4,801 3,627 15,189 10,052
General and administrative 2,716 1,866 7,276 5,404
Purchased research and development - - 180 475
-------------- -------------- --------------- --------------
Total operating expenses 9,849 6,769 28,332 19,543
-------------- -------------- --------------- --------------
Operating income 8,898 6,034 22,849 12,044
Other income (expense):
Interest income 397 423 1,209 1,279
Other, net (185) 25 240 139
-------------- -------------- --------------- --------------
Total other income 212 448 1,449 1,418
-------------- -------------- --------------- --------------
Income before taxes 9,110 6,482 24,298 13,462
Income taxes 3,674 2,676 10,018 5,575
-------------- -------------- --------------- --------------
Net income $ 5,436 $ 3,806 $ 14,280 $ 7,887
============== ============== =============== ==============
Basic earnings per share $ 0.16 $ 0.11 $ 0.42 $ 0.23
============== ============== =============== ==============
Diluted earnings per share $ 0.16 $ 0.11 $ 0.42 $ 0.23
============== ============== =============== ==============
See accompanying notes to consolidated financial statements.
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ADVANTAGE LEARNING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
1999 1998
--------------------- ---------------------
(In thousands)
Reconciliation of net income to net cash provided by operating activities:
Net income $ 14,280 $ 7,887
Noncash (income) expenses included in net income -
Depreciation and amortization 2,213 1,474
Purchased research and development 180 475
Deferred income taxes 43 (95)
Change in assets and liabilities -
Accounts receivable (2,266) (3,984)
Inventory (437) (308)
Prepaid expenses (714) (326)
Accounts payable and other current liabilities (708) 3,346
Deferred revenue 232 477
Other (35) (36)
--------------------- ---------------------
Net cash provided by operating activities 12,788 8,910
--------------------- ---------------------
Cash flows provided by (used in) investing activities:
Purchase of property, plant and equipment (5,967) (4,834)
Proceeds from (purchase of) short-term investments, net 18,869 (16,769)
Capitalized software development costs (350) (94)
Acquisition (920) (634)
--------------------- ---------------------
Net cash provided by (used in) investing activities 11,632 (22,331)
--------------------- ---------------------
Cash flows provided by (used in) financing activities:
Proceeds from issuance of stock 222 -
Equity contribution from minority partner - 66
Distribution to shareholders - (857)
Proceeds from exercise of stock options 492 122
--------------------- ---------------------
Net cash provided by (used in) financing activities 714 (669)
--------------------- ---------------------
Net increase (decrease) in cash 25,134 (14,090)
Cash and cash equivalents, beginning of period 14,264 22,345
===================== =====================
Cash and cash equivalents, end of period $ 39,398 $ 8,255
===================== =====================
See accompanying notes to consolidated financial statements.
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ADVANTAGE LEARNING SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. CONSOLIDATION
The consolidated financial statements include the financial results of
Advantage Learning Systems, Inc. ("ALS") and its consolidated subsidiaries
(collectively the "Company"). All significant intercompany transactions have
been eliminated in the consolidated financial statements.
2. BASIS OF PRESENTATION
The consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of the results of the interim
periods, and are presented on an unaudited basis. These financial statements
should be read in conjunction with the Company's financial information contained
in the Company's Annual Report on Form 10-K which is on file with the U.S.
Securities and Exchange Commission.
Effective July 1, 1999, the Company acquired Generation21 Learning
Systems LLC ("Generation21"), a training and knowledge management enterprise
software firm in Golden, Colorado. The transaction was accounted for as a
pooling-of-interests. Accordingly, financial information for all periods
presented has been restated to include the results of Generation21.
The results of operations for the three and nine month periods ended
September 30, 1999 are not necessarily indicative of the results to be expected
for the full year.
3. ACQUISITIONS
Effective July 1, 1999, the Company acquired Generation21, a training
and knowledge management enterprise software firm in Golden, Colorado. The
transaction was accounted for as a pooling-of-interests. Accordingly, financial
information for all periods presented has been restated to include the results
of Generation21. The impact of Generation21 on previously reported historical
information is not significant. The Company issued 166,443 shares with a market
value of $4.0 million to effect the transaction. Third quarter 1999 results
include a non-recurring pre-tax charge of $365,000 for transaction costs
associated with the acquisition. The Company expects to make significant
investments in marketing, administration and related areas with respect to
Generation21. Based on management's current expectations as to the Company's
growth, the anticipated investments in Generation21 are not expected to have a
material impact on the Company's overall results of operations in the near term.
Effective June 9, 1999, the Company acquired the assets of Humanities
Software, Incorporated ("Humanities"), an Oregon-based firm specializing in
writing software. The transaction was accounted for using the purchase method of
accounting. The operating results of Humanities are included in the consolidated
financial statements of the Company since the date of acquisition. The allocated
purchase price includes valuation of certain acquired in-process research and
development costs which resulted in a pre-tax charge of $180,000 in the second
quarter of 1999. The acquisition is not expected to have a material impact on
the Company's overall results of operations in the near term.
4. EARNINGS PER COMMON SHARE
Basic earnings per common share has been computed based on the weighted
average number of common shares outstanding. Diluted earnings per common share
has been computed based on the weighted average number of common shares
outstanding, increased by the number of additional common shares that would have
been outstanding if the potential dilutive common shares had been issued.
On January 18, 1999, the board of directors of the Company authorized a
2-for-1 split of common stock in the form of a stock dividend payable on
February 26, 1999 to shareholders of record on February 11, 1999. Accordingly,
all share and per share data presented herein have been restated to reflect this
split.
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The weighted average shares outstanding during the three and nine
months ended September 30, 1999 and 1998 are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
1999 1998 1999 1998
----------------- ---------------- ---------------- ----------------
Basic Weighted Average Shares 34,085,015 33,973,501 34,059,477 33,971,981
Impact of Stock Options 240,368 168,226 267,798 141,912
Diluted Weighted Average Shares 34,325,383 34,141,727 34,327,275 34,113,893
5. SEGMENT REPORTING
The Company's reportable segments are strategic business units that
offer different products and services. They are managed separately because each
business requires different technology and marketing strategies. The Company has
two reportable segments: software and training.
The software segment produces learning information systems software for
the K-12 school market in the United States and Canada. The software assists
educators in assessing and monitoring student development by increasing the
quantity, quality and timeliness of student performance data in the areas of
reading, math and writing. The software segment also includes Generation21
training and knowledge management enterprise software, which is currently sold
primarily to corporate customers. Revenue from the software segment includes
product revenue from the sale of software and service revenue from the sale of
software support agreements.
The training segment provides professional development training
seminars. Its programs train educators on how to accelerate learning in the
classroom through use of the information that the Company's learning information
systems provide. Revenue from the training segment includes service revenue from
a variety of seminars presented in hotels and schools across the country, and
product revenue from training materials.
The Company evaluates the performance of its operating segments based
on operating income before nonrecurring items. Intersegment sales and transfers
and revenue derived outside of the United States are not significant. Summarized
financial information concerning the Company's reportable segments is shown in
the following table:
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------------- -------------- --------------- ---------------
(In thousands)
Revenues:
Software $ 18,852 $ 12,479 $ 53,462 $ 31,954
Training 4,136 2,625 8,666 5,750
--------------- -------------- --------------- ---------------
Total revenues $ 22,988 $ 15,104 $ 62,128 $ 37,704
=============== ============== =============== ===============
Operating income:
Software $ 8,320 $ 5,664 $ 23,907 $ 12,767
Training 578 370 (878) (248)
--------------- -------------- --------------- ---------------
Total operating income (1) $ 8,898 $ 6,034 $ 23,029 $ 12,519
=============== ============== =============== ===============
(1) Total operating income differs from Operating income in the Consolidated
Statements of Income due to nonrecurring items not included above: $180,000
and $475,000 purchased research and development in the nine months ended
September 30, 1999 and 1998, respectively.
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The information about the segments presented above is in compliance
with SFAS 131 reporting requirements. The reported measures are consistent with
those used in measuring amounts in the consolidated financial statements. Such
measurements are generally along legal entity lines as aggregated.
It is management's opinion, however, that because many flows of value
between the segments cannot be precisely quantified, this information provides
an incomplete measure of the training segment profit or loss, and should not be
viewed in isolation. Management evaluates the performance of the training
segment based on many factors not captured by the financial accounting system
and often evaluates the Company's financial performance on a total entity basis.
6. COMPREHENSIVE INCOME
Total comprehensive income was $14,281,000 and $7,868,000 in the first
nine months of 1999 and 1998, respectively. The difference between net income
and total comprehensive income resulted from foreign currency translations.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following table sets forth certain consolidated income statement
data as a percentage of net sales, except that individual components of costs of
sales and gross profit are shown as a percentage of their corresponding
component of net sales:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
---------------- ----------------- ---------------- ---------------
Net Sales:
Products 77.4 % 75.5 % 80.2 % 79.5 %
Services 22.6 24.5 19.8 20.5
================ ================= ================ ===============
Total net sales 100.0 % 100.0 % 100.0 % 100.0 %
================ ================= ================ ===============
Cost of sales:
Products 11.5 % 7.9 % 11.1 % 10.4 %
Services 42.1 37.7 44.0 38.9
Total cost of sales 18.4 15.2 17.6 16.2
Gross profit:
Products 88.5 92.1 88.9 89.6
Services 57.9 62.3 56.0 61.1
Total gross profit 81.6 84.8 82.4 83.8
Operating expenses:
Product development 10.1 8.4 9.2 9.6
Selling and marketing 20.9 24.0 24.4 26.7
General and administrative 11.8 12.4 11.7 14.3
Purchased research and development 0.0 0.0 0.3 1.3
---------------- ----------------- ---------------- ---------------
Total operating expenses 42.8 44.8 45.6 51.9
---------------- ----------------- ---------------- ---------------
Operating income 38.8 40.0 36.8 31.9
Other income (expense):
Interest income 1.7 2.8 1.9 3.4
Other, net -0.9 0.1 0.4 0.4
---------------- ----------------- ---------------- ---------------
Total other income 0.8 2.9 2.3 3.8
---------------- ----------------- ---------------- ---------------
Income before taxes 39.6 42.9 39.1 35.7
Income taxes 16.0 17.7 16.1 14.8
================ ================= ================ ===============
Net income 23.6 % 25.2 % 23.0 % 20.9 %
================ ================= ================ ===============
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THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net Sales. The Company's net sales increased by $7.9 million, or 52.2%,
to $23.0 million in the third quarter of 1999 from $15.1 million in the third
quarter of 1998. Product sales increased by $6.4 million, or 55.9%, to $17.8
million in the third quarter of 1999 from $11.4 million in the third quarter of
1998. The increase in product sales is primarily attributable to (i) sales of
the Company's new math products which began shipping in late 1998 and (ii)
increased sales of Accelerated Reader title disks, with over 25,000 available
book titles, to a larger base of Accelerated Reader schools. Last year, third
quarter 1998 revenues were positively impacted by several large orders: Dade
County, Florida adopted the Company's reading software on a county-wide basis; a
six-district consortium in Washington state received a federal grant for
software and training; and a large number of Idaho schools received grants from
the Albertson Foundation to purchase software from the Company.
Service revenue, which consists of revenue from sales of training
seminars and software support agreements, increased by $1.5 million, or 40.8%,
to $5.2 million in the third quarter of 1999 from $3.7 million in the third
quarter of 1998. This increase is primarily attributable to an increased number
of Renaissance training sessions. During the quarter, the Company trained about
26,000 educators in its Reading Renaissance and Math Renaissance professional
development programs, compared to about 18,000 in the third quarter 1998.
The Company announced several new initiatives in the third quarter of
1999 that are expected to enhance growth over the long term. An alliance with
the McGraw-Hill Companies will provide educators and students with access to
hundreds of interactive computer quizzes aligned to the McGraw-Hill elementary
school reading series. Through a recently completed agreement with Troll
Communications, a leading publisher and distributor of children's books, the
Company will market Accelerated Reader software at Troll's book clubs and book
fairs in over 16,000 schools a year. Other key events during the quarter
included the first district-wide sale of School Renaissance, the Company's
comprehensive school improvement program; shipment of the Company's improved
version of its flagship Accelerated Reader software, and the announcement for
planned fourth-quarter shipment of a new and improved version of the Company's
STAR Reading software.
Cost of Sales. The cost of sales of products increased by $1.1 million,
or 126.0%, to $2.0 million in the third quarter of 1999 from $907,000 in the
third quarter of 1998. As a percentage of product sales, the cost of sales of
products increased to 11.5% in third quarter 1999 from 7.9% in third quarter
1998. The increase in cost of sales of products is primarily due to mix
associated with the hardware component of the Company's new math products and to
the positive impact on third quarter 1998 of the three large one-time orders
noted above. An optical-mark card scanner is included with the sale of all
Accelerated Math software and in many cases, additional scanners are sold.
Although scanners are profitable, the gross profit margin on hardware is not as
high as the gross profit margin on software. The Company began shipment of math
products late in the third quarter of 1998.
The cost of sales of services increased by $798,000, or 57.3%, to $2.2
million in the third quarter of 1999 from $1.4 million in the third quarter of
1998. The increase in cost of sales of services is primarily due to costs
associated with increased Renaissance training sessions, with a 44% increase in
educators trained in third quarter 1999 over third quarter 1998. As a percentage
of sales of services, the cost of sales of services increased to 42.1% in the
third quarter of 1999 compared to 37.7% in the third quarter of 1998, primarily
due to increased costs of providing technical support for software support
agreements associated with the Company's new math and Accelerated Reader
products, with activity increasing as educators began the new school year.
The Company's overall gross profit margin decreased to 81.6% in the
third quarter of 1999 from 84.8% in the third quarter of 1998, due to decreased
gross profit margins on both products and services. Gross profit margins on
products declined from 92.1% in third quarter 1998 to 88.5% in third quarter
1999 due to i) increased sales of hardware included with the Company's
Accelerated Math products in 1999, and ii) the positive impact on the third
quarter 1998 product margin related to the three large one-time orders noted
above. Gross profit margins on services declined to 57.9% in third quarter 1999
from 62.3% in third quarter 1998 due to increased costs of providing technical
support for software support agreements associated with the Company's new
products. Management expects that the gross profit margin on products will
remain relatively constant for the remainder of 1999. Management expects service
margins to decline due to the seasonality of the training segment and the
increase in support levels associated with the new product releases. Service
revenue as a percentage of total revenue is expected to decline in the fourth
quarter compared to the third quarter of 1999.
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Product Development. Product development expenses increased by $1.1
million, or 82.8%, to $2.3 million in the third quarter of 1999 from $1.3
million in the third quarter of 1998. These expenses increased primarily due to
increased staff and consulting costs associated with developing new products,
new versions of the Company's Accelerated Reader and STAR Reading software, and
with the development of additional Accelerated Reader quizzes. As a percentage
of net sales, product development costs increased to 10.1% in the third quarter
of 1999 from 8.4% in the third quarter of 1998. The Company anticipates that the
total dollar amount and the corresponding percentage of sales of product
development costs will continue to increase with the Company's continued
emphasis on product development and new business initiatives as a key to
achieving continued growth.
Selling and Marketing. Selling and marketing expenses increased by $1.2
million, or 32.4%, to $4.8 million in the third quarter of 1999 from $3.6
million in the third quarter of 1998. These expenses increased primarily due to
(i) direct mailings to an increased customer and prospect base and (ii)
increased costs associated with the hiring of additional personnel, including
wages and related benefits. As a percentage of net sales, selling and marketing
expenses decreased to 20.9% in the third quarter of 1999 from 24.0% in the third
quarter of 1998. Management anticipates that selling and marketing expenses will
continue to rise, and will increase as a percentage of sales over third quarter
1999 levels, due to expanded product offerings, new business initiatives,
international expansion efforts, to an increase in the customer and prospect
base, and to the seasonality of the Company's marketing efforts.
General and Administrative. General and administrative expenses
increased by $850,000, or 45.5%, to $2.7 million in the third quarter of 1999
from $1.9 million in the third quarter of 1998. As a percentage of net sales,
general and administrative costs decreased to 11.8% in the third quarter of 1999
compared to 12.4% in the third quarter of 1998. Management anticipates that
general and administrative expenses will continue to rise as infrastructures are
developed for international operations and with respect to the Generation21
acquisition, and may increase somewhat as a percentage of net sales.
Operating Income. Operating income increased by $2.9 million to $8.9
million in the third quarter of 1999 from $6.0 million in the third quarter of
1998. As a percentage of net sales, operating income decreased to 38.8% in the
third quarter of 1999 compared to 40.0% in the third quarter of 1998, but
improved over the first two quarters of 1999.
Other Income. Other income decreased $236,000 in third quarter 1999 to
$212,000 primarily due to a non-recurring charge of $365,000 for transaction
costs associated with the Generation21 acquisition.
Income Tax Expense. Income tax expense of $3.7 million was recorded in
the third quarter of 1999 at an effective income tax rate, as a percent of
pre-tax income, of 40.3%, compared to $2.7 million, or 41.3% of pre-tax income
in third quarter 1998. The reduction in the effective tax rate was due to the
Generation21 acquisition and to tax planning initiatives. Management expects
that the effective tax rate will remain relatively constant at the third quarter
level for the remainder of 1999.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net Sales. The Company's net sales increased by $24.4 million, or
64.8%, to $62.1 million for the nine months ended September 30, 1999 from $37.7
million in the first nine months of 1998. Product sales increased by $19.8
million, or 66.1%, to $49.8 million in the first nine months of 1999 from $30.0
million in the same period in 1998. The increase in product sales is primarily
attributable to (i) sales of the Company's new math products, with over 5,000
schools purchasing math since the release in late 1998 and (ii) increased sales
of Accelerated Reader title disks, with about 25,000 available book titles, to a
larger base of Accelerated Reader schools.
Service revenue increased by $4.6 million, or 59.5%, to $12.3 million
for the first nine months of 1999 as compared to $7.7 million in the same period
in 1998. This increase is primarily attributable to an increased number of
Renaissance training sessions, and to higher revenues recognized from one-year
software support agreements associated with new product sales and renewals of
support agreements from an expanding base of existing customers.
Cost of Sales. The cost of sales of products increased by $2.4 million,
or 77.7%, to $5.5 million in the first nine months of 1999 from $3.1 million in
1998. As a percentage of product sales, the cost of sales of products increased
to 11.1% in the first nine months of 1999 compared to 10.4% in the first nine
months of 1998. The increase in cost of sales of products is primarily due to
mix associated with the hardware component of the Company's new math products.
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12
An optical-mark card scanner is included with the sale of all Accelerated Math
software and in many cases, additional scanners are sold. Although scanners are
profitable, the gross profit margin on hardware is not as high as the gross
profit margin on software. The Company began shipment of math products late in
the third quarter of 1998.
The cost of sales of services increased by $2.4 million or 80.3%, to
$5.4 million in the first nine months of 1999 compared to $3.0 million in the
same period in 1998. As a percentage of sales of services, the cost of sales of
services increased to 44.0% in the first nine months of 1999 compared to 38.9%
in 1998 primarily due to increased costs associated with new training programs
and increased costs of providing technical support relating to software support
agreements associated with the Company's broader product lines. The Company's
overall gross profit margin declined to 82.4% in the first nine months of 1999
from 83.8% in the first nine months of 1998, primarily due to decreased gross
profit margin on services. Management expects that the overall gross profit
margin will remain relatively constant for the remainder of 1999.
Product Development. Product development expenses increased by $2.1
million, or 57.5%, to $5.7 million for the nine months ended September 30, 1999
as compared to $3.6 million for the corresponding 1998 period. These expenses
increased primarily due to increased staff and consulting costs associated with
the new math and writing products, new versions of the Company's Accelerated
Reader and STAR Reading software, and with the development of additional
Accelerated Reader quizzes. As a percentage of net sales, product development
costs decreased to 9.2% in the first nine months of 1999 from 9.6% in the first
nine months of 1998. The Company anticipates that the total dollar amount and
the corresponding percentage of sales of product development costs will continue
to increase with the Company's continued emphasis on product development and new
business initiatives as a key to achieving continued growth.
Selling and Marketing. Selling and marketing expenses increased by $5.1
million, or 51.1%, to $15.2 million in the first nine months of 1999 from $10.1
million in the first nine months of 1998. These expenses increased primarily due
to (i) increased wage and benefit costs associated with additional personnel and
(ii) direct mailings to an increased customer and prospect base and increased
lead-generation advertising. As a percentage of net sales, selling and marketing
expenses declined to 24.4% in the first nine months of 1999 from 26.7% of net
sales in the corresponding 1998 period. This decrease is primarily due to
economies of scale associated with increased product sales and service sales.
Management anticipates that selling and marketing expenses will generally
continue to rise as the Company expands its product lines and customer and
prospect base.
General and Administrative. General and administrative expenses
increased by $1.9 million, or 34.6%, to $7.3 million for the nine months ended
September 30, 1999 as compared to $5.4 million for the same period in 1998.
These expenses increased due to salary and recruiting costs associated with the
hiring of additional personnel. As a percentage of net sales, general and
administrative costs decreased to 11.7% in the first nine months of 1999 from
14.3% for the same period in 1998. Management anticipates that general and
administrative expenses will continue to rise as infrastructures are developed
for international operations and with respect to the Generation21 product line,
and may increase somewhat as a percentage of net sales.
Purchased Research and Development. In connection with the acquisitions
in June 1999 and June 1998, a portion of the purchase price of each acquisition
was allocated to acquired in-process research and development costs. This
resulted in a charge of $180,000 in the second quarter of 1999 and a charge of
$475,000 in the second quarter of 1998.
Operating Income. Operating income increased by $10.8 million, or
89.7%, to $22.8 million in the first nine months of 1999 from $12.0 million in
the same period in 1998. As a percentage of net sales, operating income
increased to 36.8% in the first nine months of 1999 compared to 31.9% in the
first nine months of 1998.
Other Income. Other income remained constant at $1.4 million for the
nine months ended September 30, 1999 and 1998. Other income for 1999 includes a
non-recurring charge of $365,000 for transaction costs associated with the
Generation21 acquisition.
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13
Income Tax Expense. Income tax expense of $10.0 million was recorded in
the first nine months of 1999 at an effective income tax rate, as a percent of
pre-tax income, of 41.2% compared to $5.6 million, or 41.4% of pre-tax income in
the first nine months of 1998. Management expects that the effective tax rate of
40.3% recorded in the third quarter of 1999 will be sustainable for the
remainder of 1999.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1999, the Company's cash, cash equivalents and
short-term investments increased by $6.3 million to $39.4 million from $33.1
million at December 31, 1998. The net increase is due primarily to $12.8 million
in net cash provided by operating activities offset in part by $6.0 million used
in the purchase of property, plant and equipment for facility expansion
necessary to accommodate the Company's growth in operations. The Company
believes cash flow from operations and its current cash position will be
sufficient to meet its working capital requirements and fund future growth
acquisition opportunities for the foreseeable future.
At September 30, 1999, the Company had a $10.0 million unsecured
revolving line of credit with a bank which is available until March 31, 2000.
The line of credit bears interest at either a floating rate based on the prime
rate less 1.0%, or a fixed rate for a period of up to 90 days based on LIBOR
plus 1.25%. The rate is at the option of the Company and is determined at the
time of borrowing. As of September 30, 1999, the line of credit had not been
used.
Effective July 1, 1999, the Company acquired Generation21 Learning
Systems LLC ("Generation21"), a training and knowledge management enterprise
software firm in Golden, Colorado. The transaction was accounted for as a
pooling-of-interests. Accordingly, financial information for all periods
presented has been restated to include the results of Generation21. The impact
of Generation21 on previously reported historical information is not
significant. The Company issued 166,443 shares with a market value of $4.0
million to effect the transaction. Third quarter 1999 results include a
non-recurring pretax charge of $365,000 for transaction costs associated with
the acquisition. The Company expects to make significant investments in
marketing and related areas with respect to Generation21. Based on management's
current expectations as to the Company's growth, the anticipated investments in
Generation21 are not expected to have a material impact on the Company's overall
results of operations in the near term.
Effective June 9, 1999, the Company acquired the assets of Humanities
Software, Incorporated ("Humanities"), an Oregon-based firm specializing in
writing software. The transaction was accounted for using the purchase method of
accounting. The operating results of Humanities are included in the consolidated
financial statements of the Company since the date of acquisition. The allocated
purchase price includes valuation of certain acquired in-process research and
development costs which resulted in a pre-tax charge of $180,000 in the second
quarter of 1999. The acquisition is not expected to have a material impact on
the Company's overall results of operations in the near term.
YEAR 2000
The Company has investigated the extent to which its operations are
subject to Year 2000 issues and assessed the measures it believes will be
necessary to avoid any material disruption to its operations relating to Year
2000 issues. On the basis of this investigation and assessment, the Company has
taken steps to ensure that its systems and products will not be adversely
impacted by Year 2000 issues. As of September 30, 1999, substantially all of the
Company's systems and products are Year 2000 compliant. The cost to the Company
for such compliance measures has been approximately $150,000, and management
believes that the cost of additional modifications will be approximately
$50,000. The cost of the Company's internal Year 2000 compliance measures is
being funded through operating cash flows.
In addition to assessing its own readiness for the Year 2000, the
Company has initiated formal communications with all of its significant
suppliers to determine the extent to which the Company is vulnerable to those
third parties' potential failure to remediate their own Year 2000 issues. A
significant percentage of these suppliers have responded in writing to the
Company's Year 2000 readiness inquiries. The Company plans to continue
assessment of its third party business partners. Despite the Company's
diligence, there can be no guarantee that the systems of other companies, on
which the Company's systems rely, will be timely converted or that a failure to
convert by another company or a conversion that is incompatible with the
Company's systems would not have a material adverse effect on the Company. The
cost to the Company for its third party compliance efforts as of September 30,
1999 has been approximately $750,000, and management believes that the cost of
additional efforts in this regard will be approximately $50,000. The cost of the
Company's external Year 2000 compliance measures is being funded through
operating cash flows.
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14
With respect to Year 2000 risks associated with the Company's systems,
the Company believes that the most reasonably likely worst case scenario is that
the Company will experience a number of minor systems malfunctions and errors in
the early part of the Year 2000 that were not detected during its compliance
efforts. The Company believes that these problems will be minor in nature and
will not have a material effect on the Company's operations or financial
results.
With respect to Year 2000 risks associated with the Company's software
products, the Company cannot be certain that the software will operate error
free, or that the Company will not be subject to litigation, whether the
software operates error free or not. However, the Company believes that based on
its substantial efforts to ensure compliance, it is not reasonably likely that
the Company will be subject to such litigation.
With respect to Year 2000 risks associated with third party suppliers,
the Company believes that the most reasonably likely worst case scenario is that
some of the Company's significant suppliers will not be Year 2000 compliant.
Through the Company's formal communications with all of its significant
suppliers, management believes that significant suppliers are in compliance and
that risks of Year 2000 non-compliance are minimized by the Company's
identification of alternative suppliers where alternative suppliers are
available.
The Company has limited the scope of its risk assessment to those
factors which it can reasonably be expected to have an influence upon. For
example, the Company has initiated formal communications with utility companies,
parcel delivery services and national telecommunication providers and, based
upon their responses to the Company's Year 2000 readiness inquiries, the Company
expects that such providers will continue to operate. The lack of such services
could have a material effect on the Company's ability to operate, but the
Company has little, if any, ability to influence such an outcome, or to make
alternative arrangements in advance for such services in the event they are not
available.
Based upon the modifications made to its products, the new internal
systems which have been put in place, and the planning for alternative services
where available, the Company believes it has substantially completed the
contingency plan to handle the most reasonably likely worst case scenarios
described above. However, if unanticipated Year 2000 related problems occur, it
could result in a material financial risk to the Company.
FORWARD-LOOKING STATEMENTS
In accordance with the Private Securities Litigation Reform Act of
1995, the Company can obtain a "safe-harbor" for forward-looking statements by
identifying those statements and by accompanying those statements with
cautionary statements which identify factors that could cause actual results to
differ materially from those in the forward-looking statements. Accordingly, the
foregoing "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains certain forward-looking statements relating to
growth plans, projected sales, revenues, earnings and costs, and product
development schedules and plans. The Company's actual results may differ
materially from those contained in the forward-looking statements herein.
Factors which may cause such a difference to occur include those factors
identified in Item 1, Business, Forward-Looking Statements, contained in the
Company's Form 10-K for the year ended December 31, 1998, which factors are
incorporated herein by reference to such Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At September 30, 1999, the Company had no material market risk exposure
(e.g., interest rate risk, foreign currency exchange rate risk or commodity
price risk).
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15
Part II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(a) Not applicable.
(b) Not applicable.
(c) On June 9, 1999, the Company issued 23,475 shares of common stock,
$0.01 par value to Jon Madian, Alan Madian and Karen Jostad in
connection with the acquisition of Humanities Software, Incorporated,
an Oregon-based firm specializing in writing software. The shares were
issued under Section 4(2) of the Securities Act. Messrs. Madian and Ms.
Jostad acquired the shares for investment only, for their own account
and not with a view to resale or other disposition thereof. Because of
their business and financial experience and sophistication, Messrs.
Madian and Ms. Jostad were capable of evaluating the merits and risks
of an investment in the shares. Messrs. Madian and Ms. Jostad agreed
not to offer, sell or otherwise transfer the shares until such shares
are registered under the Securities Act or exempt from registration
thereunder.
On July 1, 1999, the Company issued 166,443 shares of common stock,
$0.01 par value to Harold S. Resnick, Dale R. Zwart, Work Systems
Associates, Inc. and John Connolly, Jr. (the "Gen21 owners") in
connection with the acquisition of Generation21 Learning Systems LLC, a
training and knowledge management enterprise software firm in Golden,
Colorado. The shares were issued under Section 4(2) of the Securities
Act. The Gen21 owners acquired the shares for investment only, for
their own account and not with a view to resale or other disposition
thereof. Because of their business and financial experience and
sophistication, the Gen21 owners were capable of evaluating the merits
and risks of an investment in the shares. The Gen21 owners agreed not
to offer, sell or otherwise transfer the shares until such shares are
registered under the Securities Act or exempt from registration
thereunder.
(d) The net proceeds to the Company from its initial public offering, after
deducting underwriting discounts of $3,606,400 and other expenses of
approximately $941,000, were approximately $46,972,000. From September
24, 1997 (the effective date of the Company's Form S-1 Registration
Statement; SEC Reg. No. 333-22519) through September 30, 1999, the
Company used the net proceeds from the offering as follows:
(i) Approximately $1.6 million was used to pay compensation expenses
related to the termination of the Company's phantom stock plan.
(ii) Approximately $7.2 million was used to pay the entire principal
and accrued interest on the mortgage note and an unsecured note, both
related to the construction of the Company's facility in Wisconsin
Rapids, Wisconsin.
(iii) Approximately $5.1 million was used to pay the entire principal
and accrued interest on notes from the Company's principal shareholders
related to the 1996 acquisition of IPS Publishing, Inc.
(iv) Approximately $10.9 million was used to pay distributions of S
corporation retained profits to S corporation shareholders.
(v) Approximately $7.4 million was used to invest in Athena Holdings
LLC, a limited liability company formed for the purpose of constructing
the Company's facility in Madison, Wisconsin.
(vi) Approximately $1.7 million was used for pilot operations in
various markets and miscellaneous acquisitions.
(vii) Approximately $2.7 million was used for capital expenditures for
expansion of operations.
The Company has broad discretion with respect to the use of the remaining
proceeds.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No. Description
----------- -----------
27.1 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the quarter covered by this
report.
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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.
ADVANTAGE LEARNING SYSTEMS, INC.
(Registrant)
November 12, 1999 /s/ Michael H. Baum
----------------- ------------------------------
Date Michael H. Baum
Chief Executive Officer
(Principal Executive Officer)
November 12, 1999 /s/ Steven A. Schmidt
----------------- ------------------------------
Date Steven A. Schmidt
Secretary, Vice President, and
Chief Financial Officer (Principal
Financial and Accounting Officer)
18
Index to Exhibits
Exhibit No. Description
----------- -----------
27.1 Financial Data Schedule