Exhibit 99.1
PLATO LEARNING, INC
FISCAL YEAR 2004 Q3 FINANCIAL RELEASE
CONFERENCE CALL
AUGUST 26, 2004
JOHN MURRAY
Good afternoon, this is John Murray, Chairman, President and CEO of PLATO
Learning, Inc. Thank you for joining us today for our regularly scheduled
quarterly conference call. With me today are Greg Melsen, our Vice President and
Chief Financial Officer, Larry Betterley, our Vice President Finance and Chief
Accounting Officer and Steve Schuster, our Vice President and Treasurer.
As is customary, let me first remind you that any forward-looking statements
made by the Company are subject to the risks and uncertainties as outlined in
the Company's filings with the Securities and Exchange Commission, including our
annual report as filed on Form 10-K for our fiscal year ended October 31, 2003.
The content of our web cast contains time-sensitive information that is accurate
only as of today, August 26, 2004. This call is the property of PLATO Learning,
Inc. Any redistribution, or rebroadcast of this call in any form without the
express written consent of PLATO Learning, Inc. is strictly prohibited.
I will now make a few opening remarks, Greg Melsen will comment on the financial
results and then I will make some concluding comments. We will then all be
available to answer your questions.
The revenue results we announced today for our third quarter of fiscal 2004 were
consistent with the guidance shared in our August 11 press release and
subsequent conference call. As our investors understand, our business model is
heavily dependent on revenues and revenue growth. While this quarter's proforma
revenue growth of 6% did not meet our internal expectations, we believe this
growth is more significant than any of our competitors, as is the 9% proforma
growth we have achieved in the first nine months of this fiscal year. Due to
stronger expense leverage and control, our earnings per share were stronger than
the revenue shortfall might have indicated.
This lower than anticipated revenue growth should not overshadow the significant
accomplishments achieved this quarter. Consider these milestones and successes:
o Our $40.6 million of revenues were the largest quarterly revenues in
the Company's history
o Our $6.9 million of operating income this quarter were also the
highest in the Company's history and more than triple the operating
income earned in the third quarter of fiscal 2003
o We again demonstrated our ability to control and leverage our expense
structure
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o We substantially improved our comparable, proforma bottom line per
share metrics for both the quarter and fiscal year
o We added over $9 million to our cash and marketable securities
balances
o We added over $5 million to our deferred revenue balances during the
third quarter
o And during August, we passed $100 million of annual revenues for the
first time in Company history. This is a huge accomplishment for PLATO
Learning or any other company.
These advancements have also positioned us to take advantage of additional
opportunities. I have spent the past couple of weeks visiting with our field
sales personnel and sales management and talking with educators, educational
administrators, politicians and independent market analysts. These discussions
highlighted the continuing difficulties and struggles in the education industry,
but confirmed our belief that the funding environment is slowly improving.
There are also a number of factors and trends that are impacting our business
and a number of matters to which we need to devote additional attention. First,
we remain heavily dependent on license fee revenues, despite our progress in
building our subscription business and deferred revenue balances. License fee
revenues were over $25 million and more than 60% of this quarter's revenues.
This level of sales requires a tremendous number of transactions and can only be
accomplished with large deals.
This leads to my second observation regarding the size of transactions this
quarter and during the first nine months of the fiscal year. On a proforma
basis, the number of our large deals this quarter was lower than in the
comparable quarter of last year but of approximately the same total value.
However, the number of our large deals was up 11% during the first nine months
of this fiscal year and the value of these orders was up about 21%. These
transactions are the drivers of our growth in both revenues and deferred
revenues this year. This analysis summarizes our reliance on these larger deals
and should also remind all of us that closing of a large deal or two, or the
failure to close such deals, can have a huge impact on any given quarter's
revenues.
My third observation focuses on areas where we have fallen short of our original
expectations and on the actions we need to take. On our August 11 conference
call we discussed both external factors, such as general economic and market
conditions, and a number of internal issues including the status of integrating
the Lightspan transaction, the structure, compensation and training of our sales
force and the predictability and monitoring of revenue results.
Our conclusions after a couple of more weeks of review are the same. The bottom
line is that there is nothing fundamentally broken in the business, but that
much opportunity remains for us to tighten our operations. For example, we can
do better at marketing and selling certain of our products. Our Assessment and
Early Reading products are good illustrations. We are achieving reasonable
growth from sales of these products, but could achieve deeper market penetration
with better focus.
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We are striving for continuous improvement and are confident that we are
building a business with market dominance and ultimately, greater predictability
and more steady, profitable revenue growth. We have successfully grown revenues
and deferred revenues at rates greater than our competitors, despite softer than
expected market conditions. We are focused on continually improving our
operations and we have more accomplish in order to maximize the return on our
assets. Before providing more commentary on our operations and prospects, I will
ask Greg to provide you the financial details underlying today's press release.
GREG MELSEN - Thank you, John.
Q3 OPERATIONS:
Revenues for third quarter of fiscal year 2004 totaled $40.6 million, a $2.3
million or a 6% increase versus the $38.3 million of combined revenues reported
by PLATO Learning and Lightspan in the comparable period of fiscal 2003. Our net
income for the third quarter of fiscal 2004 was $6.7 million, or $0.29 per
diluted share, as compared to net income of $285,000, or $0.02 per diluted
share, for the same period of 2003. The third quarter results for the period
ended July 31, 2003 included tax expense of $1.6 million, or $0.10 per diluted
share, without which the Q3 fiscal 2003 income would have been $0.12 per share.
And finally, only $150,000 or tax expense was recorded for the quarter ended
July 31, 2004, equivalent to a penny per share, because of cumulative losses
incurred year-to-date in fiscal 2004.
Our revenues for the first half of the fiscal year have grown 9% on a combined
basis.
Let's review more detail regarding various aspects of our operations and
financial position, starting with the components of revenue.
REVENUES:
Our overall revenue results for the quarter were again propelled by strong
subscription and services growth. We have included supplemental information in
today's press release that reconciles from the revenue PLATO Learning reported
last year to that which we reported today, with consideration to the acquisition
of Lightspan. Our year-to-date results also reflect the fact that the
acquisition did not close until mid-November.
License fee revenues in the third quarter of fiscal 2004 were $25.4 million, a
$1.1 million or a 5% increase versus the $24.3 million of combined revenue that
would have been reported had PLATO Learning and Lightspan been consolidated for
the comparable period of 2003. Despite this improvement in license revenues
growth, we continue to see a shift away from perpetual licenses to our
subscription-based products, partly due to our move in this direction and partly
due to the current funding climate. This is evidenced by subscription revenues
growth of over $1 million or a 22% increase versus the combined subscription
revenues the two entities reported last year in the period ended July 31, 2003.
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Professional services revenue increased about $1.1 million or 17% in the third
quarter of fiscal 2004 as compared to the same quarter of last year, assuming
the entities were combined in both periods. Similar to previous quarters, most
of this growth derives from increased services to correlate curriculum to
standards and to aid in the professional development of teachers.
Our July 31, 2004 deferred revenue balance was $42.9 million and almost $5
million or 12% higher than at April 30, 2004. This increase was aided by normal
seasonality trends. The July 31, 2004 deferred revenue balance is, however, $3.2
million or 8% higher than the $39.7 million of deferred revenue the combined
PLATO Learning and Lightspan entities had at July 31, 2003.
GROSS PROFIT:
The overall gross profit margin of 71.7%, or 370 basis points higher than the
68.0% gross margin earned in the third quarter of fiscal 2003 and 950 basis
points higher than the 62.2% gross margin earned in the second quarter of fiscal
2004. These gross margin improvements occurred despite the increases in services
revenues, which carry gross margins lower than gross margins of the entire
Company.
Our gross margins for license and subscription revenue are impacted by the
amortization being charged against these categories for the cost of acquired
technologies. As we grow quarterly and annual revenues in these classifications,
we expect to achieve gross margin improvement because growing revenues will be
matched against a fixed or straight-line amortization cost. The improvement you
see in the gross margins associated with license fee and subscription revenues
supports this guidance.
Our gross margins in the services area were about 43%. We do not expect the
gross profit margins for this revenue category to greatly improve or decline
over time. We expect services gross margins to remain about 40% in the future.
OPERATING EXPENSES:
Our total operating expenses in the third quarter of fiscal 2004 were $22.2
million. This compares to $27.8 million of operating expenses for the combined
companies during last year's quarter ended July 31, 2003. On a standalone basis,
both PLATO Learning and Lightspan had operating expense of about $13.9 million
(excluding restructuring charges), in their quarters ended July 31, 2003.
Excluding amortization, combined operating expenses decreased by about $4.8
million this quarter versus the same quarter last year, again assuming that the
companies were combined in both periods. This change quantifies the achievement
of our third quarter goal of extracting this amount of costs from the combined
entity. When measuring the improvement in operating expenses, it is also
important to realize that combined revenues increased by over $2 million this
quarter versus the comparable quarter last year. This increased revenue added
about $300,000 of variable commissions, bad debt, marketing and other costs to
this quarters cost structure.
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Similar progress is shown if you compare our combined operating expenses in the
third quarter of fiscal 2004 to the combined operating expenses of our previous
quarter, the quarter ended April 30, 2004. In Q2 of this fiscal year, our
combined operating expenses totaled $23.3 million. Thus, our combined operating
expenses dropped by almost $1.0 million when comparing sequential quarters. This
again exceeded our third quarter goal of extracting another $600,000 million of
synergies from the combined PLATO Learning and Lightspan entities. This
improvement is even more significant when considering the $8 million revenue
increase that occurred between Q2 and Q3, adds about $1.2 million of variable
commissions, bad debt, marketing and other costs to this quarter's cost
structure.
The progress we have achieved thus far this fiscal year, supports the likelihood
of us reaching our goal of $17.5 million of cost reductions in this fiscal year,
which equates to $22.5 million if annualized.
EFFECTIVE INCOME TAX RATE:
Now, allow me to remind you of our tax position. You will see we have recorded
only minimal tax expense in this period even though we achieved about $6.9
million of pretax income. The $150,000 of tax expense this quarter relates to
nondeductible goodwill.
At October 31, 2003, PLATO Learning had federal net operating loss carryforwards
in the United States of approximately $18.5 million. At that time, we had
sufficient prior profitability to give us comfort that we could utilize this
asset. However, the merger with Lightspan required us to reassess our ability to
recover these deferred assets, especially in light of the significant operating
losses Lightspan had accumulated during its history.
As a result of this reassessment, we have provided a full valuation allowance
against both PLATO Learning's deferred tax asset and Lightspan's deferred tax
asset in our accounting for the acquisition. This position also means we will
not record any tax credits or any tax expense, other than that for nondeductible
goodwill, until we begin accumulating pretax profits. We expect that we will
again be profitable in Q4 and, if we accomplish this goal, we will only record a
tax expense to the extent that pretax income exceeds the pretax losses
accumulated in prior periods.
Our internal financial models are now assuming a consolidated tax rate of about
60% for the entire fiscal year. As explained on prior conference calls and in
our SEC filings, our effective tax rate for the fiscal year and future quarters
and fiscal years is extremely dependent on us achieving both our overall
operational goals and our operational goals in each of the United States, Canada
and in the U.K. The extent of any effective rate variance versus that planned is
highly dependent on our operating results in the U.K. A larger than expected
loss in the U.K. will likely result in a higher effective rate for the
consolidated company. Conversely, if our U.K. subsidiary is more profitable than
planned, our assumed effective tax rate could decline.
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BALANCE SHEET AND CASH FLOW:
Let me close with a few balance sheet and cash flow highlights. Our cash
generating ability is one of our greatest strengths and EBITDA is perhaps the
best indicator of cash generation. We calculate EBITDA as our operating income
or loss plus depreciation, amortization and restructuring charges. The
information needed to calculate these amounts is available in our statements of
operations and cash flow as well as a supplemental chart provided with today's
press release. Obviously, you are welcome to adjust this calculation, compute
EBITDA per share or perform any other analysis you desire. Also, because of the
seasonality of our business, performing this computation on a rolling 12-month
basis seems most appropriate. Using this definition:
o We generated about $17.9 million of EBITDA during the past 12 months
as compared to $4.9 million in the 12 month period ended July 31,
2003.
o We generated about $12.4 million of cash from operations this fiscal
quarter versus $5.2 of cash generated from operations during the third
quarter of last year.
o Cash and marketable securities totaled $31.0 million at July 31, 2004,
up over $9 million from our April 30, 2004 balances. Our $6.7 million
of net earnings this quarter, combined with about $2 million of
intangible amortization and improvement in our accounts receivable
metrics drove this cash improvement. We believe our business model
will provide for significant annual cash generation, subject to
seasonal changes in cash usage and generation.
o We remain free of any bank borrowings or similar debt.
o We continue to capitalize courseware development costs and purchase
capital equipment at about the same rate as we amortize these items.
We capitalized about $3.3 million for these items this quarter versus
amortization of about $3.4 million. Courseware capitalization was in
excess of related amortization, primarily in the U.K. where we devoted
substantial resources to develop science and other courseware. These
projects are important if we are to benefit from the relationships
acquired with the New Media transaction.
o And finally, we did not repurchase any common stock during the
quarter. However, about $1.3 million remains available under a stock
repurchase plan approved by our Board. This plan has no termination
date and we will use this remaining authorization to repurchase
shares, subject to prevailing market conditions and typical blackout
periods that precede and follow the end of our quarters.
This concludes my formal comments. Let me turn it back to John for his final
comments.
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JOHN MURRAY
Thank you, Greg.
The last couple of years have been extremely challenging for the education
industry from a funding perspective and in terms of how school districts receive
and spend these funds. As a result of these continued financial pressures,
schools and school districts are reacting in a number of ways. We summarized
these reactions in our second quarter conference call and I believe they are
worth repeating.
First, schools and school districts are willing to invest monies in products and
services that offer measurable results, as well as those that meet their most
critical needs. Certain of our products and services directly help address these
important issues. Our products and services related to assessment and
accountability, curriculum management, early reading and special education all
have tremendous value propositions.
Second, we continue to see customers shift away from perpetual license purchases
and move to accessing our products on a subscription basis. This movement puts
additional pressure on quarterly revenues during a time of funding shortages.
However, it also provides us greater predictability into future revenues,
on-going contact with our customers, and a high likelihood of subscription
renewal.
Finally, we are seeing more requests for proposals and larger district-type
deals. These opportunities are at the request of schools and school districts
that are looking to use the full suite of PLATO products and services to improve
their performance and address their accountability requirements. As stated in
prior quarters, we are finding that a larger percentage of these big deals
include accountability solutions and professional services revenue. Thus, more
revenue on these large deals is being deferred. This trend is a contributing to
the on-goings increases in our 12-month deferred revenues.
A couple of weeks ago we announced that we anticipated revenues for the fiscal
year ending October 31, 2004 would be in the range of $143.0 million to $147.0
million. We still believe this to be a reasonable range for expected fiscal year
revenues, especially considering the continued uncertainties surrounding funding
and purchasing decisions and the positive or negative impact larger deals can
have on our quarterly revenues.
The mid point of our projected revenue range for the year would produce about
10.5% revenue growth. We believe this rate of growth is in excess of that being
accomplished by our competitors and the industry as a whole. Achieving this
level of revenues would also produce net earnings that would be a significant
improvement as compared to the $0.10 loss that PLATO Learning incurred as a
stand-alone company in fiscal 2003 and considering the slightly dilutive impact
of the Lightspan transaction this fiscal year. It is an even greater improvement
against the $0.89 proforma fiscal 2003 losses of the combined PLATO Learning and
Lightspan entities.
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While we still believe it is possible to achieve fiscal 05 revenue growth
consistent with our prior guidance, we now believe the likelihood of
accomplishing this level of growth will only be possible in the event of
significant funding improvement and the securing of a substantial number of
larger deals. In the absence of more confidence regarding short-term funding
improvement, we believe it is more reasonable to expect fiscal 2005 revenues to
grow by around 10% versus fiscal 2004 revenues. Although this revenue growth is
lower than previously anticipated, we are committed to looking for further
expense leverage to soften the earnings impact of this lower revenue growth
rate. Accomplishing 10% revenue growth in fiscal 2005 could enable us to triple
our earnings per share as compared to fiscal 2004, depending on our final fiscal
2004 performance.
Since I have highlighted that net earnings are expected to benefit from the
Company's continued leverage of operations, this topic deserves a couple of
additional comments. Greg has summarized some of the key trends and assumptions
underlying our business model. These include:
o gross margins that should increase with high revenue volumes due to
the fix amortization charges included in cost of sales,
o expense leverage that has resulted with higher revenues and cost
cutting actions taken following the Lightspan merger,
o operating expenses that fluctuate each quarter on revenue volumes due
to variable commission, marketing and bad debt expenses, and
o an annualized effective tax rate that is highly dependent on the
pre-tax earnings and operating performance in both the U.S. and U.K.
We will provide further guidance at the end of the year. As always, these
projections remain highly dependent on continuing availability and steady
improvement of budgets, especially at the state level. If funding improves
further, or if we can close a number of larger deals and/or realize
cross-selling synergies with the former Lightspan sales team we can envision
top-line growth near the upper end of the projected range. Accomplishing the
upper end of the range would provide bottom-line drop-through, due to the
financial leverage of our business model.
There is no question K-12 funding remains under pressure and we expect no
immediate and total cure. However, as we have stated in recent quarters, we see
indications of improvement and are optimistic about our strategic direction and
position in the marketplace.
While the revenue this quarter fell short of our expectation, this was overall
still a good quarter for us. We achieved strong revenue growth and we
substantially reduced the operating expenses of the combined companies. Our
growth in our subscription and services revenue and the related deferred revenue
balances are also extremely important as it helps us build relationships with
teachers which will result in more successful use of our products and more
repeat sales.
I think it is worth noting three things with respect to the importance of our
deferred revenue build-up.
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o First, many companies have shifted from a perpetual license business
model, with fully inclusive services, to a business model where
licenses and services are sold under a subscription or annuity model.
Many of these companies have suffered major year-over-year declines in
revenues, especially during the time of transition. PLATO Learning has
not suffered this. Instead, we have moved to having about 40% of our
revenues being derived from subscriptions and services and not being
dependent on in perpetuity licenses and revenue growth, while still
growing revenues at a rate we believe exceeds market growth.
o Second, had we not made this shift to a subscription or annuity model,
there is no question our revenues would have been higher during the
last three to four years, with significantly higher earnings. However,
this would have come at the expense of our deferred revenue build-up.
While it may have been nice to have these short-term gains, I believe
very strongly that it is better for the Company and its shareholders
to strengthen the Company for the long-term, especially in building
this subscription or annuity model and a stronger balance sheet.
o Third, our deferred revenue balance of $43 million at July 31 does not
include about $15.4 million related to the Idaho state contract and
about $14 million from our contract with the Department of the Navy.
The value of these contracts has been excluded from our balance sheet
because their ultimate realization is dependent on delivery of
services, accomplishment of milestones and customer acceptance. Also
not included in our reported deferred revenue balance is almost $4
million from charter school clients, supplemental service contracts
and other others users of our products and services where we have
moved to cash based revenue recognition or where products and services
will be provided at a later time. This totals about $33 million of
contracts not included in our deferred revenue balances should their
full value be realized.
As stated in prior quarters, I believe PLATO Learning is continually improving
and is stronger and better positioned today than it was a quarter or year ago.
We are excited about the prospects for the fourth quarter of fiscal 2004 and
beyond. The management team and all employees are committed to success and
delivery of improved revenue growth and profitability.
We are now available to answer your questions.
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