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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934: FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NO. 0-22187
ADVANTAGE LEARNING SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
WISCONSIN 39-1559474
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2911 PEACH STREET 54495-8036
P.O. BOX 8036 (Zip Code)
WISCONSIN RAPIDS, WISCONSIN
(Address of principal executive offices)
Registrant's telephone number, including area code: (715) 424-3636
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant was approximately $145,523,191 as of February 28, 2000. As of
February 28, 2000, there were 34,214,773 of the Registrant's shares of common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III is incorporated by reference from the Proxy Statement for the
Annual Meeting of Shareholders to be held on April 19, 2000.
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PART I
ITEM 1. BUSINESS
Unless the context requires otherwise, all references to the "Company"
refer to Advantage Learning Systems, Inc., a Wisconsin corporation, and its
consolidated subsidiaries. Except as otherwise indicated, all share data has
been adjusted for a two-for-one stock split in the form of a stock dividend
which was payable on February 26, 1999.
OVERVIEW
Advantage Learning Systems, Inc. is a leading provider of learning
information systems to kindergarten through senior high ("K-12") schools in the
United States and Canada. The Company's learning information systems consist of
computer software and related training designed to improve student academic
performance by increasing the quality, quantity and timeliness of performance
data available to educators and by facilitating increased student practice of
essential skills. Learning information systems provide to educators benefits
similar to those management information systems provide to business managers. As
of December 31, 1999, the Company has sold its products to approximately 48,900,
or approximately 40%, of the K-12 schools in the United States and Canada.
The Company's flagship product, Accelerated Reader,* is software for
motivating and monitoring increased literature-based reading practice. The
Company believes that Accelerated Reader has achieved a leading market position
as a result of its demonstrated effectiveness in improving student reading
levels and overall academic performance. The Company's other primary learning
information system products include STAR Reading,* Accelerated Math,* STAR Math*
and Perfect Copy.* In addition, the Company provides professional development
training for educators through its Reading Renaissance,* Math Renaissance* and
School Renaissance* programs, test-generation software to educational publishers
and Total Knowledge Management* enterprise software for training and management
throughout organizations.
The Company was founded in 1986 and is incorporated under the laws of the
State of Wisconsin. The Company's common stock trades on The Nasdaq Stock
Market(R) under the symbol "ALSI." The Company's principal executive offices are
located at 2911 Peach Street, P.O. Box 8036, Wisconsin Rapids, Wisconsin
54495-8036 (telephone: (715) 424-3636).
PRODUCTS
SOFTWARE AND SUPPORT SERVICES
The Company offers software products for use in the K-12 marketplace, as
well as support services to the users of its software products. These software
products improve student academic performance by intensifying skills practice
and increasing the quality, quantity and timeliness of information available to
educators. The Company also sells training and knowledge management software to
corporate customers. The Company's software and support services accounted for
approximately 86%, 86% and 84% of the Company's net sales in 1999, 1998 and
1997, respectively.
ACCELERATED READER
In 1999, the Company began shipment of a new, completely upgraded version
of its Accelerated Reader learning information system for motivating and
monitoring increased literature-based reading practice. Accelerated Reader is
designed to be very easy to use by students and educators alike. A student
selects a book at an appropriate reading level from a list of books for which
the school has an Accelerated Reader quiz and reads the book. The student then
takes a multiple choice quiz on a computer. The questions contained in the
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* Accelerated Reader(R), Reading Renaissance(R) and Math Renaissance(R) are
registered trademarks of the Company. STAR Reading(TM), Accelerated Math(TM),
STAR Math(TM), Perfect Copy(TM), School Renaissance(TM) and Total Knowledge
Management(TM) are common law trademarks of the Company.
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quizzes are carefully drafted to ensure that a student who has thoroughly read a
book at the appropriate level will pass. For each book read, Accelerated Reader
tracks the amount of reading practice achieved by calculating points based on
the length and difficulty of the book and the student's performance on the quiz.
The information generated from this process--titles read, percent of
comprehension and amount of reading done--creates a database of student reading
achievement. From this database, Accelerated Reader generates more than 30
different reports from which educators can monitor the amount and quality of
reading practice for each of their students and easily identify individual
students who may require special attention. The new, upgraded version of
Accelerated Reader includes built-in Spanish-English capabilities and supports
the new Literacy Skills* quizzes. Literacy Skills quizzes allow teachers using
Accelerated Reader to assess students' proficiency on 24 specific skills found
in state and district language arts standards and many standardized tests. The
Company developed quizzes on over 8,000 book titles in 1999 and currently has a
library of computerized book quizzes on more than 28,600 titles. Titles on disk
are organized by reading level and subject matter. Continued usage of
Accelerated Reader creates demand for additional quizzes, STAR Reading, Reading
Renaissance training and related products.
STAR READING
STAR Reading is a computer-adaptive reading test that the Company believes
is the first software to provide to classroom teachers reading scores
statistically correlated to national norms in ten minutes or less at the
computer. STAR Reading administers a series of multiple choice questions for
which students choose the best word to complete each sentence. STAR Reading
adapts itself to each student's reading level by applying a proprietary
branching logic that evaluates the pattern of the student's answers to determine
the level of difficulty required for subsequent questions. The results from this
test provide educators with a database of statistically accurate reading level
information on their students from which they can generate useful reports and
adjust instructional strategies accordingly. STAR Reading is easy to use and can
be administered several times per year. In 1999, the Company began shipment of a
new, upgraded version of STAR Reading that includes a 70-percent-larger item
bank of test questions and a new, two-stage test to help educators pinpoint
students' reading levels faster and more accurately.
ACCELERATED MATH
Accelerated Math is a task-level learning information system that helps
every student to meet all math objectives, first grade through calculus. It
employs algorithm technology to automatically align assignments to academic
objectives and tracks mastery of each objective. Like Accelerated Reader,
Accelerated Math encourages and monitors student practice of foundational
skills, while providing immediate feedback on performance to students and
teachers. An optical-mark card scanner is included with the sale of Accelerated
Math software to handle all scoring and record-keeping chores, minimizing
teacher paperwork.
STAR MATH
STAR Math is a computer-adaptive math test and database that provides the
same benefits as STAR Reading. STAR Math reports provide objective information
to help educators instantly place new students, monitor progress and match
instruction to individual student levels. Quick, accurate and easy to
administer, STAR Math provides math scores for third grade through high school
in approximately 15 minutes. Like STAR Reading, it can be administered
throughout the school year to track math development.
PERFECT COPY
Perfect Copy is software that helps educators improve students' core
writing skills. It uses in-context editing to cover the rules of grammar,
punctuation and word usage. The Company expects to develop other language arts
products in the future.
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* Literacy Skills(TM) is a common law trademark of the Company.
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TOTAL KNOWLEDGE MANAGEMENT
The Total Knowledge Management system is integrated, enterprise-wide
training and knowledge management software. The system supports training in all
media including intranet, internet, CD-ROM, print and instructor-led training.
The Company intends to use the system in professional development training for
teachers and large school districts and the software will also be sold to
businesses and government agencies.
EXPERT SUPPORT PLANS
The Company offers Expert Support Plans ("ESPs") that provide users of its
products access to telephone support and other benefits such as free or
reduced-cost upgrades. Packaged with kits and also sold as add-ons, ESPs entitle
educators to expert help resolving questions regarding technical problems with
Company products, networks and other software interacting with Company products.
PROFESSIONAL DEVELOPMENT
The Company offers professional development programs and products that
train educators to effectively use the Company's software products. Revenues
from professional development accounted for approximately 14%, 14% and 16% of
the Company's net sales in 1999, 1998 and 1997, respectively.
READING RENAISSANCE
The Reading Renaissance program provides educators with professional
development training to most effectively use the Accelerated Reader, STAR
Reading and the learning information they generate. This training combines
technology and classroom techniques to increase in-school accountable reading
practice. The Company offers a variety of Reading Renaissance seminars and
workshops, including one- and two-day training programs, which are conducted
throughout the year at various hotel locations in the United States, and on-site
training programs pursuant to which the Company's training staff visit an
individual school, school district or region to conduct a seminar or workshop.
Since its inception in late 1993 to December 31, 1999, the Company has trained
over 190,000 educators, of whom approximately 80,000 were trained in 1999.
To encourage educators who have completed Reading Renaissance training to
fully implement the methodology, the Company in 1995 initiated the "Model
Classroom" certification program. This program recognizes educators who meet
certain objective implementation standards related to the amount of accountable
reading among students, regular diagnosis and intervention with at-risk
students, and other key variables. As of February 1, 2000, the program has
received approximately 8,600 applications and certified over 5,000 "Model
Classroom" teachers, and 172 "Model Schools" in which the majority of classrooms
have "Model Classroom" teachers.
MATH RENAISSANCE
Offered both on-site and at hotel sites throughout the United States,
one-day Math Renaissance seminars instruct educators in techniques to enhance
their math curriculum and instruction methods. The Company expects Math
Renaissance to grow along with utilization of its STAR Math and Accelerated Math
software.
SCHOOL RENAISSANCE
School Renaissance is a comprehensive multi-year school and district-wide
improvement program. School Renaissance combines implementation of the Company's
major software products, professional development training and consulting
services over a period of several years to entire schools and districts.
OTHER PROFESSIONAL DEVELOPMENT
The Company also produces videotapes and manuals to be used in conjunction
with its training programs. Further, the Company conducts research on best
practices, performs field validation of techniques, publishes internally
generated as well as third-party research and gathers information to guide the
development of the Company's learning information systems.
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PRODUCT DEVELOPMENT
The Company believes that continued substantial investment in product
development is required to remain competitive and grow in the K-12 marketplace.
The Company invests continuously in the development of new products, enhancement
of existing products and development of tools to increase the efficiency of
product development. For the years ended December 31, 1999, 1998 and 1997, the
Company expended approximately $8.9 million, $5.2 million and $3.3 million,
respectively, on product development (including amounts capitalized).
The Company generates new software product concepts that it believes will
help educators improve student academic performance, based on the Company's
understanding of learning information theory and the need for practice of
essential academic skills. These product concepts are then refined based on
feedback from its customers, which the Company continuously solicits and
incorporates throughout the new product development process. Based on the
refined product concepts, product proposals are then formulated by the marketing
and software engineering groups and reviewed by management to determine which
should be developed into prototypes. These prototypes are then tested in
customer schools. Before beginning production, management makes a final
evaluation of each new product to determine that it is both desired by educators
and effective in meeting their needs.
The professional development training programs were originally developed,
and are continually refined, through field experience with the Company's
products and research by the Company's staff. The Company conducts research into
effective education techniques related to the Company's products and services.
This research provides the staff with a standard against which to develop and
refine training programs to help educators accelerate learning.
SELLING AND MARKETING
The Company markets its products primarily to individual educators in the
K-12 market, including teachers, school librarians and principals. The Company
is beginning to market its products to entire schools and school districts, as
well as internationally through its subsidiaries in the United Kingdom and
Australia. The Company's training and knowledge management software is currently
sold primarily to corporate customers. The Company's sales and marketing
strategy consists primarily of direct marketing to potential and existing
customers. The Company uses a variety of lead generating techniques, including
trade shows, advertisements in educational publications, direct mail, Web sites
and referrals. Once product literature has been forwarded to a current or
potential customer, one of the Company's in-house staff of telephone sales
representatives contacts the customer to answer questions and, ultimately,
direct the customer to a purchase. Having an in-house sales force affords the
Company better control over its marketing efforts.
In addition, the Company has resale arrangements with various book dealers
and book publishers that are authorized to sell the Company's products to their
customers. These firms are particularly receptive to such alliances because use
of the Company's products in schools encourages, rather than competing with, the
sale of books and other products sold by these firms. Sales to one of the
distributors, Perma-Bound, a division of Hertzberg-New Method, Inc.
("Perma-Bound"), accounted for 11.5%, 13.9% and 14.3% of the Company's net sales
in 1999, 1998 and 1997, respectively. The Company intends to seek additional
strategic alliances with book distributors and publishers and to use alliances
to expand its base of strategic partners to sell its products. Furthermore, the
Company plans to continue to develop other cross-marketing arrangements with
third-party firms selling non-competing products into the education market.
The Company presented its first National School Renaissance Conference in
February 2000 in Nashville, Tennessee. The conference provided the opportunity
for almost 6,000 educators to learn more, to network and inspire others with
their success stories, and to see all the latest products and services that
support the Company's Renaissance professional development training. The Company
expects to present the conference again in 2001.
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PRODUCTION
Currently, most of the Company's software products are distributed on
CD-ROM or diskettes. The CD-ROM disks are produced by a third-party contractor.
The diskettes are duplicated and packaged at Company headquarters. Other related
products, including videotapes, books, graphics and motivational items, are
produced by third-party vendors. In 1999, the Company introduced on-line
ordering and delivery of Accelerated Reader quizzes over the Internet.
COMPETITION
The K-12 educational technology and professional development markets in
which the Company operates are very competitive. The Company competes primarily
against more traditional methods of education, training and testing, including
pencil and paper testing. In addition, the Company competes with other companies
offering educational software products to schools, including larger companies
with greater resources than the Company, such as International Business Machines
Corporation, Apple Computer, Inc. and Mattel Inc. The Company's reading products
also compete more directly with products such as Scholastic's Reading Counts
(formerly Electronic Bookshelf). Many other companies, including Microsoft Corp.
and Walt Disney Co., provide educational software products which the Company
believes are not marketed primarily to schools. The Company's existing
competitors may continue to broaden their product lines, and potential
competitors, including large hardware manufacturers, software developers and
educational publishers, may enter or increase their focus on the school market,
resulting in greater competition for the Company. Success in selling the
Company's products, particularly its reading products, may cause competitors to
focus on the Company's products in their marketing efforts thereby increasing
direct competition. There can be no assurance that the Company will continue to
be able to market its products successfully or compete effectively in the
educational products marketplace.
INTELLECTUAL PROPERTY
The Company regards certain of its technologies as proprietary and relies
primarily on a combination of copyright, trademark and trade secret laws and
employee non-disclosure agreements to establish and protect its proprietary
rights. There can be no assurance that the steps taken by the Company to protect
its rights will be adequate to prevent or deter misappropriation. In addition,
while the Company does not believe that its products, trademarks or other
proprietary rights infringe upon the proprietary rights of third parties, there
can be no assurance that a third party will not make a contrary assertion. The
cost of responding to such an assertion may be material, whether or not the
assertion is validated. The software market has traditionally experienced
widespread unauthorized reproduction of products in violation of intellectual
property rights. Such activity is difficult to detect and legal proceedings to
enforce intellectual property rights are often burdensome and involve a high
degree of uncertainty and costs. There can be no assurance that the Company's
software products will not experience unauthorized reproduction, which would
have a material adverse effect on the Company's business, financial condition
and results of operations.
EMPLOYEES
As of February 1, 2000, the Company had 776 full and part-time employees.
The Company believes its relations with employees are good. None of the
Company's employees is represented by a union or subject to collective
bargaining agreements.
BACKLOG
As of December 31, 1999 and 1998, the Company had backlogs that aggregated
approximately $5.3 million and $4.4 million, respectively. The backlog at
December 31, 1999 was primarily related to registrations for the Company's
National School Renaissance Conference presented in February 2000 and for
training seminars and programs not yet conducted. All of the backlog is expected
to be realized during 2000.
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The backlog at December 31, 1998 was due to the introduction of new products
near year end and to training seminars and programs not yet conducted.
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
following information contains or may contain forward-looking statements: (1)
information included or incorporated by reference in this Annual Report on Form
10-K, including, without limitation, statements made under Item 1, Business and
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, including, without limitation, statements with respect to growth
plans, projected sales, revenues, earnings and costs, and product development
schedules and plans, (2) information included or incorporated by reference in
future filings by the Company with the Securities and Exchange Commission
including, without limitation, statements with respect to growth plans,
projected sales, revenues, earnings and costs, and product development schedules
and plans and (3) information contained in written material, releases and oral
statements issued by, or on behalf of, the Company including, without
limitation, statements with respect 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 identified above. Factors which may cause such a difference to occur
include, but are not limited to, the following:
Reliance on Single Product Line and Significant Distributor. The Company's
Accelerated Reader software and supplemental Accelerated Reader quiz disks
accounted for approximately 40%, 48% and 49% of the Company's net sales in 1999,
1998 and 1997, respectively. Sales of the Company's products through one book
distributor accounted for 11.5%, 13.9% and 14.3% of net sales in 1999, 1998 and
1997, respectively. An overall decline in sales of Accelerated Reader,
supplemental quiz disks, STAR Reading and related products, including sales
through book distributors, would have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Continued Product Development. The K-12 educational
technology and professional development markets in which the Company competes
are characterized by evolving industry standards, frequent product introductions
and, to a lesser extent, sudden technological change. The Company's future
success will depend, to a significant extent, on a number of factors, including
the Company's ability to enhance its existing products and develop and
successfully introduce new products, including new products designed for use in
other areas of the curriculum, the Company's ability to ship new products in a
timely fashion and the Company's ability to respond quickly and in a cost
efficient manner to technological change, including shifts in operating systems,
languages, alternative delivery systems and other environments. There can be no
assurance that products designed for use in other areas of the curriculum
besides reading will be as well received as the Company's reading products,
particularly since such other products may require technology and/or resources
not generally available in all schools. The Company attempts to maintain high
standards for the demonstrated academic effectiveness of its products. The
Company's adherence to these standards could delay or inhibit the introduction
of new products. Moreover, there can be no assurance that the Company's products
will not be rendered obsolete or that the Company will have sufficient resources
to make the necessary investments or be able to develop and market the products
required to maintain its competitive position.
Management of Growth. The Company has experienced rapid growth. If such
growth continues, it may place a strain on the Company's financial, management,
systems and other resources. The Company's ability to manage its growth
effectively will require it to attract, train, motivate, manage and retain key
employees and to improve its operational, financial and management information
systems. If the Company is unable to maintain and manage growth effectively, the
Company's business, financial condition and results of operations would be
adversely affected.
Risks of New Products and Services for New Markets. The Company's business
strategy includes the introduction of new products and services directed at new
markets. Specifically, through its Generation21
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Learning Systems subsidiary, the Company intends to sell enterprise software for
training development and management to businesses and government organizations.
The Company has historically focused on the education market and has little, if
any, experience in developing and marketing products and services to business or
government customers. There can be no assurance that the Company will be
successful in offering new products and services and entering new markets as
planned or that any such products or services, if introduced, will achieve
acceptance in the marketplace.
Risks of International Expansion. A key component of the Company's growth
strategy is to continue to expand its operations into international markets.
Doing business in international markets is subject to a number of risks,
including, among others: acceptance by foreign educational systems of the
Company's approach to educational products; lack of existing customer base;
unexpected changes in regulatory requirements; potentially adverse tax
consequences; tariffs and other trade barriers; difficulties in staffing and
managing foreign operations; changing economic conditions; exposure to different
legal standards (particularly with respect to intellectual property); burdens of
complying with a variety of foreign laws; and fluctuations in currency exchange
rates. If any of these risks were to materialize, the Company's business,
financial condition and results of operations could be adversely affected.
Opposing Educational Philosophies. The Company focuses on developing and
marketing educational products and services that demonstrate effectiveness
through measurable results. This approach, however, is not accepted by all
academics and educators, some of whom formulate opinions about the desirability
of a particular educational product or service based on philosophical or other
concerns rather than the effectiveness of the product. Certain academics and
educators are opposed to the principles and methodologies underlying and
associated with the Company's products, such as the use of objective standards,
standardized testing, computers and motivational techniques, among others. Some
of these philosophical opponents of the Company's products and services have the
capacity to influence the market for the Company's products, and such influence
could have a material adverse impact on demand for the Company's products and,
thus, the Company's business, financial condition and results of operations.
Dependence on Educational Institutions and Government
Funding. Substantially all of the Company's revenue is derived from sales to
educational institutions, individual educators and suppliers thereto. There can
be no assurance that educational institutions and/or individual educators will
continue to invest in technology-based products and professional development for
reading and other curricula or continue to respond favorably to the Company's
marketing. The inability of the Company to increase the number of products sold
or number of schools served would adversely affect the Company's business,
financial condition and results of operations. Because of the Company's
dependence on educational institutions, the funding of which is largely
dependent on government support, a substantial decrease in government budgets or
funding for educational software or technology would have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, certain aspects of government sponsored education initiatives may
not endorse, or be complementary to, the principles and methodologies underlying
and associated with the Company's products, which could adversely affect the
Company's business, financial condition and results of operations.
Geographic Concentration of Sales. A substantial portion of the Company's
sales is concentrated in several states, including Texas, California, Florida,
Georgia and Illinois, which accounted for approximately $9.6 million, $7.8
million, $5.0 million, $4.4 million and $3.8 million, respectively, of the
Company's net sales in 1999. If large numbers of schools or a district
controlling a large number of schools in such states were to discontinue
purchasing the Company's products, the Company's business, financial condition
and results of operations would be materially adversely affected.
Highly Competitive Industry. The K-12 educational technology and
professional development markets in which the Company operates are very
competitive. The Company competes primarily against more traditional methods of
education, training and testing, including pencil and paper testing. In
addition, the Company competes with other companies offering educational
software products to schools, including larger companies with greater resources
than the Company, such as International Business Machines Corporation, Apple
Computer, Inc. and Mattel Inc. The Company's reading products also compete more
directly with products such as Scholastic's Reading Counts (formerly Electronic
Bookshelf). Many other companies, including
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Microsoft Corp. and Walt Disney Co., provide educational software products which
the Company believes are not marketed primarily to schools. The Company's
existing competitors may continue to broaden their product lines, and potential
competitors, including large hardware manufacturers, software developers and
educational publishers, may enter or increase their focus on the school market,
resulting in greater competition for the Company. Success in selling the
Company's products, particularly its reading products, may cause competitors to
focus on the Company's products in their marketing efforts thereby increasing
direct competition. There can be no assurance that the Company will continue to
be able to market its products successfully or compete effectively in the
educational products marketplace.
Dependence on Key Personnel. The Company's success depends to a significant
extent upon the continued active participation of certain key members of
management, including Judith Paul and Terrance Paul, the Chairman and Vice
Chairman of the Company, respectively. In addition to serving as Chairman of the
Company, Ms. Paul is a spokesperson for the Company and coordinates the
Company's public relations and customer communications policies. Mr. Paul is
primarily responsible for the Company's long-term strategic planning and new
product development strategy. The Company does not have employment agreements
with either of these persons and has no current intention of entering into any
such employment agreements. The loss of services of either of these persons
would have a material adverse effect on the Company's business, financial
condition and results of operations.
Ability to Attract and Retain Qualified Personnel. The Company's future
success will depend, in part, upon its continuing ability to retain the
employees, including senior management personnel, who have assisted in the
development and marketing of the Company's products and to attract and retain
qualified additional employees trained in computer technology, marketing and
finance to enhance the Company's product offerings and broaden its operations.
There can be no assurance that the Company will continue to be able to attract
and retain such personnel. The failure to attract or retain the necessary
personnel would have a material adverse effect on the Company's business,
financial condition and results of operations.
Fluctuations in Quarterly Performance. The Company generally ships products
as orders are received, and therefore, has historically operated without
significant backlog. Thus, revenues in any quarter are substantially dependent
on the quantity of product orders received in that quarter. The quantity of
product orders in any quarter can be affected by a variety of factors, including
the following:
- delays in the development and/or shipment of new products can adversely
affect the Company's revenue in one or more quarters;
- the shipment of new products for which orders have been building for some
period of time can cause the revenues in the quarter in which shipment
occurs to be higher than revenues in preceding or subsequent quarters;
and
- seasonal variations due to, among other things, the budget and
school-year cycles of the Company's school customers.
In addition to fluctuations in product orders, the Company's quarterly
results can also be affected by the following:
- charges related to acquisitions, including acquisition expenses, the
write-off of in-process research and development, the amortization of
goodwill, and similar items;
- charges related to obsolete or impaired assets; and
- expenses related to product development and marketing initiatives.
The Company's overall gross margins also fluctuate based upon the mix of
product sales and service sales. The Company realizes significantly higher
margins on its product sales. Service revenues tend to be more seasonal than
product revenues, resulting in seasonal variations in margins. Quarterly service
revenues are typically highest in the third quarter.
Share Price Volatility. Numerous factors, many of which are beyond the
control of the Company, may cause the market price of its common stock to
fluctuate significantly. These factors include announcements of
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technological innovations and/or new products by the Company and its
competitors, earnings releases and earnings warnings by the Company and its
competitors, market conditions in the industry and the general state of the
securities markets. The market price of its common stock may decline
significantly if the Company fails to meet the published earnings estimates of
analysts and others. In addition, quarterly fluctuations of the Company's
results of operations as described above may cause a significant variation in
the market price of its common stock.
Limited Protection of Intellectual Property and Proprietary Rights. The
Company regards certain of its technologies as proprietary and relies primarily
on a combination of copyright, trademark and trade secret laws and employee
non-disclosure agreements to establish and protect its proprietary rights. There
can be no assurance that the steps taken by the Company to protect its rights
will be adequate to prevent or deter misappropriation. In addition, while the
Company does not believe that its products, trademarks or other proprietary
rights infringe upon the proprietary rights of third parties, there can be no
assurance that a third party will not make a contrary assertion. The cost of
responding to such an assertion may be material, whether or not the assertion is
validated. The software market has traditionally experienced widespread
unauthorized reproduction of products in violation of intellectual property
rights. Such activity is difficult to detect and legal proceedings to enforce
intellectual property rights are often burdensome and involve a high degree of
uncertainty and costs. There can be no assurance that the Company's software
products will not experience unauthorized reproduction, which would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Concentration of Share Ownership; Control by Principal
Shareholders/Management. As of March 1, 2000, the principal shareholders of the
Company, Judith Paul and Terrance Paul, who are also the Chairman and Vice
Chairman of the Company, respectively, beneficially owned approximately 72% of
the Company's outstanding common stock. As a result, such principal shareholders
have the ability to control the Company and direct its business and affairs.
Shares Eligible for Future Sale. Sales of a substantial number of shares of
common stock in the public market could adversely affect the market price for
the common stock. Approximately 26,600,000 shares are held by "affiliates" of
the Company and may be publicly sold only if registered under the Securities Act
of 1933 or sold in accordance with an applicable exemption from registration,
such as Rule 144. In addition, the Company has filed registration statements
under the Securities Act of 1933 to register an aggregate of 3,000,000 shares of
common stock reserved for issuance under the Company's 1997 Stock Incentive Plan
and an aggregate of 500,000 shares of common stock reserved for issuance under
the Company's Employee Stock Purchase Plan, which will, when issued in
accordance with such plans, be eligible for immediate sale in the public market,
subject to the Rule 144 resale limitations for affiliates.
No Payment of Cash Dividends. The Company does not anticipate paying any
cash dividends in the foreseeable future.
Possible Antitakeover Effects of Certain Articles and By-Law Provisions and
Provisions of Wisconsin Law. The Company's Amended and Restated Articles of
Incorporation and Amended and Restated By-Laws, along with Wisconsin statutory
law, contain provisions that could discourage potential acquisition proposals
and might delay or prevent a change in control of the Company. Such provisions
could result in the Company being less attractive to a potential acquirer and
could result in the shareholders receiving less for their common stock than
otherwise might be available in the event of a takeover attempt.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located in Wisconsin Rapids,
Wisconsin, in a 125,000 square foot facility owned by the Company. The Company's
training operations are located in a 74,000 square foot facility in Madison,
Wisconsin owned by Athena Holdings LLC ("Athena"). The Company owns 70% of
Athena and the Company's training subsidiary leases 40,981 square feet of the
facility from Athena. The Company also leases other office space to accommodate
subsidiaries and support operations.
9
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ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material pending legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no matter submitted during the fourth quarter of fiscal 1999 to a
vote of the security holders of the Company.
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EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AND AGE OF OFFICER OFFICE
----------------------- ------
Judith A. Paul................. Ms. Paul is the co-founder of the Company and has been
Age 53 Chairman of the Board of Directors since 1986. Ms. Paul acts
as the Company's spokesperson and coordinates the Company's
public relations and customer communication policies. Ms.
Paul is a leading teacher advocate, an education activist
and the Executive Editor of Horizons, a magazine published
by the Institute for Academic Excellence, Inc., one of the
Company's wholly-owned subsidiaries (the "Institute"). Ms.
Paul serves on the Board of Trustees of Lawrence University,
the Advisory Board of the University of Wisconsin Children's
Hospital and the Board of Directors of Community Foundation
of South Wood County. Ms. Paul holds a bachelors degree in
elementary education from the University of Illinois.
Terrance D. Paul............... Mr. Paul is the co-founder of the Company and has been Vice
Age 53 Chairman of the Board of Directors since July 1996. Mr. Paul
is primarily responsible for the Company's long-term
strategic planning and new product development strategy. He
conceptualized and led the development of Accelerated Math,
STAR Reading, STAR Math and Renaissance professional
development. Mr. Paul coordinates the research activities
conducted by the Institute, and supervises the research
activities of Generation21 Learning Systems, LLC, which is
one of the Company's wholly-owned subsidiaries. From
November 1995 until July 1996, Mr. Paul served as the
Company's Chief Executive Officer. From January 1992 until
August 1993 and again from September 1994 until November
1995, Mr. Paul served as President of the Company. For the
12 years prior to 1992, Mr. Paul was President of Best Power
Technology, a manufacturer of uninterruptible power systems.
Mr. Paul has authored numerous research reports, including
Patterns of Reading Practice (1996) and Theoretical
Foundations of Learning Information Systems (1997). Mr. Paul
holds a law degree from the University of Illinois and an
MBA from Bradley University. Terrance Paul is Judith Paul's
husband.
Michael H. Baum................ Mr. Baum has been Chief Executive Officer of the Company
Age 52 since July 1996 and a Director since September 1994. Mr.
Baum served as President of the Company between November
1995 and June 1996. From September 1994 until November 1995,
Mr. Baum served as the Managing Director of the Institute
and from June 1994 until September 1994, he served as the
Director of Educational Consulting for the Institute. From
1984 until June 1994, Mr. Baum held a variety of positions
with Francorp, Inc., an international management consulting
firm based in Chicago, his last position being that of
Executive Vice President, which he held from September 1991
until June 1994. Mr. Baum holds a bachelors degree and a
masters degree in teaching from Yale University and an MBA
from Northwestern University.
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NAME AND AGE OF OFFICER OFFICE
----------------------- ------
John R. Hickey................. Mr. Hickey has been President of the Company since July 1996
Age 44 and a Director of the Company since October 1996. From
January 1996 until June 1996, Mr. Hickey served as Executive
Vice President of R.F. Technologies, Inc., a manufacturer of
protection devices, and from September 1995 until December
1995, he served as Executive Vice President of Liebert
Corporation (a subsidiary of Emerson Electric), a
manufacturer of uninterruptible power supplies. From January
1989 until June 1995, Mr. Hickey held various senior
management positions with Best Power Technology, including
Executive Vice President of Operations, Senior Vice
President of Sales and Marketing and Vice
President-International. In addition, Mr. Hickey spent
approximately ten years with Briggs and Stratton, a
manufacturer of air-cooled gasoline engines for outdoor
power equipment, headquartered in Milwaukee, Wisconsin.
While at Briggs and Stratton, Mr. Hickey served in various
management positions, eventually rising to the position of
the Director of International Sales and Finance
Administration, a position he held from October 1985 until
January 1989. Mr. Hickey holds a bachelors degree in
international business from the University of Wisconsin.
Steven A. Schmidt.............. Mr. Schmidt joined the Company in August 1999 as Vice
Age 45 President, Chief Financial Officer and Secretary. From
January 1998 until December 1998, he served as Corporate
Controller for Wausau-Mosinee Paper Corporation, a specialty
paper manufacturer. From June 1993 until December 1997, Mr.
Schmidt was Vice President Finance, Secretary and Treasurer
for Wausau Paper Mills Company, a publicly traded specialty
paper manufacturer headquartered in Wausau, Wisconsin, after
having served the company since August 1992 as Corporate
Controller. From March 1990 until August 1992, Mr. Schmidt
was employed by Georgia Pacific Corporation as Controller,
Wisconsin Operations in Port Edwards, Wisconsin. From June
1980 until March 1990, he worked for Nekoosa Papers, Inc., a
division of Great Northern Nekoosa Corp., in Port Edwards,
Wisconsin, in various financial management positions before
the company was acquired by Georgia Pacific Corporation. Mr.
Schmidt holds a bachelors degree in accountancy from the
University of Wisconsin-LaCrosse, and is a Certified Public
Accountant.
The term of office of each executive officer is from one annual meeting of
the Board of Directors until the next annual meeting of the Board of Directors
or until a successor for each is selected.
There are no arrangements or understandings between any of the executive
officers of the Company and any other person (not an officer or director of the
Company acting as such) pursuant to which any of the executive officers were
selected as an officer of the Company.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The common stock is traded under the symbol "ALSI" on The Nasdaq Stock
Market(R), and quotations are supplied by the National Association of Securities
Dealers, Inc. The table below sets forth the reported high and low closing sale
prices for shares of the Company's common stock on The Nasdaq Stock Market(R)
during the indicated quarters. The prices set forth below reflect prices between
dealers of the Company's common stock without retail mark-ups, mark-downs or
commissions and may not necessarily represent actual transactions.
HIGH LOW
---- ---
Fiscal year ended December 31, 1999
First Quarter............................................ $41.500 $28.531
Second Quarter........................................... 31.625 16.875
Third Quarter............................................ 33.000 16.563
Fourth Quarter........................................... 29.438 10.500
Fiscal year ended December 31, 1998
First Quarter............................................ $17.188 $10.719
Second Quarter........................................... 19.375 12.375
Third Quarter............................................ 20.250 12.000
Fourth Quarter........................................... 33.188 16.375
HOLDERS
As of February 10, 2000, there were 613 record holders of the common stock.
HISTORICAL DIVIDENDS
The Company's status as an S corporation for federal tax purposes was
terminated in connection with completion of the Company's initial public
offering in September 1997. For the year ended December 31, 1998, the Company
paid distributions of S corporation retained profits of $302,000 to S
corporation shareholders. For the year ended December 31, 1999, no S
corporation-related or other distributions were paid. The Company intends to
retain all of its future earnings to fund growth and the operation of its
business and therefore does not anticipate paying any cash dividends in the
foreseeable future. Future cash dividends, if any, will be at the discretion of
the Company's Board of Directors and will depend upon, among other things, the
Company's future operations and earnings, capital requirements and surplus,
general financial condition, contractual restrictions and such other factors as
the Board of Directors may deem relevant.
RECENT SALES OF UNREGISTERED SECURITIES
There were no sales of unregistered securities during the year ended
December 31, 1998. During the year ended December 31, 1999, in addition to any
unregistered sales of the Company's equity securities reported on Form 10-Q, the
Company sold the following equity securities in transactions that were not
registered under the Securities Act of 1933:
On November 29, 1999, the Company issued 4,445 shares of common stock to
Jon Madian, Alan Madian and Karen Jostad as part of a post-closing adjustment in
connection with the Company's acquisition of Humanities Software, Inc. on June
9, 1999. 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 accounts 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.
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On December 29, 1999, the Company issued 31,260 shares of common stock to
Kevin Ford, Debra Ford and the Kevra Family Trust (collectively, the "cA
Shareholders") in connection with the Company's acquisition of computerActive,
Inc. The shares were issued under Section 4(2) of the Securities Act. The cA
Shareholders acquired the shares for investment only, for their own accounts and
not with a view to resale or other disposition thereof. Because of their
business and financial experience and sophistication, the cA Shareholders were
capable of evaluating the merits and risks of an investment in the shares. The
cA Shareholders agreed not to offer, sell or otherwise transfer the shares until
such shares are registered under the Securities Act or exempt from registration
thereunder.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
The Company's Registration Statement on Form S-1 was declared effective by
the Securities and Exchange Commission on September 24, 1997 (File No.
333-22519), and the initial public offering of the common stock began on
September 25, 1997. All of the 5.6 million shares offered by the Company, in
addition to the 840,000 shares subject to an over-allotment option, were sold on
September 30, 1997 and October 2, 1997, respectively.
The net proceeds to the Company from the 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
through December 31, 1999, the Company used the net proceeds as follows:
(1) Approximately $1.6 million was used to pay compensation expenses
related to the termination of the Company's phantom stock plan.
(2) 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.
(3) 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.
(4) Approximately $10.9 million was used to pay distributions of S
corporation retained profits to S corporation shareholders.
(5) 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.
(6) Approximately $2.4 million was used for pilot operations in various
markets and miscellaneous acquisitions.
(7) Approximately $2.7 million was used for capital expenditures for
expansion of operations.
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
CONSOLIDATED INCOME STATEMENT DATA:(1)
Net sales:
Products..................................... $67,608 $44,064 $29,350 $18,930 $11,602
Services..................................... 15,980 11,084 6,964 3,451 1,003
------- ------- ------- ------- -------
Total net sales...................... 83,588 55,148 36,314 22,381 12,605
------- ------- ------- ------- -------
Cost of sales:
Products..................................... 7,768 4,375 3,788 2,329 1,468
Services..................................... 7,557 4,496 3,013 1,898 595
------- ------- ------- ------- -------
Total cost of sales.................. 15,325 8,871 6,801 4,227 2,063
------- ------- ------- ------- -------
Gross profit......................... 68,263 46,277 29,513 18,154 10,542
Operating expenses:
Product development.......................... 8,500 5,140 3,496 1,555 802
Selling and marketing........................ 21,546 13,712 9,709 6,639 4,201
General and administrative................... 10,115 7,529 5,817 3,547 2,090
Purchased research and development........... 1,080 475 -- 3,400 --
Phantom stock plan termination............... -- -- 1,617 -- --
------- ------- ------- ------- -------
Total operating expenses............. 41,241 26,856 20,639 15,141 7,093
------- ------- ------- ------- -------
Operating income..................... 27,022 19,421 8,874 3,013 3,449
Other income (expense), net.................... 2,067 1,615 (81) (155) 13
------- ------- ------- ------- -------
Income before taxes............................ 29,089 21,036 8,793 2,858 3,462
Income tax provision (benefit)................. 11,943 8,844 (673) (1,602) --
------- ------- ------- ------- -------
Net income................................... $17,146 $12,192 $ 9,466 $ 4,460 $ 3,462
======= ======= ======= ======= =======
Basic earnings per share(2).................... $ 0.50 $ 0.36 $ 0.33 $ 0.16 $ 0.13
Diluted earnings per share(2).................. 0.50 0.36 0.32 0.16 0.13
CONSOLIDATED BALANCE SHEET DATA:
Working capital................................ $46,923 $34,193 $28,452 $ 566 $ 1,105
Total assets................................... 88,419 68,280 51,177 19,855 4,761
Notes payable and long-term debt............... -- -- -- 10,450 --
Shareholders' equity........................... 74,935 55,059 42,803 3,774 2,613
- -------------------------
(1) In July 1999, the Company acquired Generation21 Learning Systems, LLC in a
transaction accounted for as a pooling-of-interests. Accordingly, financial
information for all periods presented has been restated to include the
results of Generation21.
(2) Per share data have been restated to reflect a 2-for-1 stock split in the
form of a dividend effective February 26, 1999.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leading provider of learning information systems to
kindergarten through senior high ("K-12") schools in the United States and
Canada. The Company's learning information systems consist of computer software
and related training designed to improve student academic performance by
increasing the quality, quantity, and timeliness of performance data available
to educators and by facilitating increased student practice of essential skills.
The Company's flagship product, Accelerated Reader, is software for motivating
and monitoring increased literature-based reading practice. The Company's
software products also include STAR Reading, a computer-adaptive reading test
and database; Accelerated Math and STAR Math, software products that apply to
math the principles that have made the reading software effective in improving
academic performance; and Perfect Copy, writing skills development software. In
1999, the Company began shipment of new, improved versions of its Accelerated
Reader and STAR Reading software products.
The Company's learning information system products also include the Reading
Renaissance, Math Renaissance and Effective Teaching programs, through which the
Company provides professional development training for educators. In 1999, the
Company introduced School Renaissance, a comprehensive package of software,
professional development training, and consulting services aimed at accelerating
learning and improving test scores in reading, math, and writing. In addition,
the Company provides test generation software to educational publishers, and in
1999, began selling enterprise software for training and knowledge management to
corporate customers. The Company acquired a software development firm in late
1999 specializing in Web-based applications to assist in creating Web versions
of the Company's existing products and new Web products.
The Company's sales are derived primarily from the sale of software
products, software support agreements, and training seminars and programs. The
Company recognizes revenue from sales of its off-the-shelf software products at
the time of shipment to customers. The Company records the estimated cost of
returns at the time of sale. The Company also develops custom software products
through its subsidiary, IPS Publishing, Inc. The Company recognizes revenue from
the sale of custom software on the percentage of completion method. Service
revenue includes both revenue relating to Renaissance professional development
training and revenue from software support agreements for ongoing customer
support. The Company recognizes revenue from sales of its training seminars and
programs primarily at the time the seminar or training program is conducted.
Revenue from separately sold software support agreements is reflected as
deferred revenue and is amortized ratably over the term of the maintenance
period. The Company's deferred revenue represents payments received from
customers for services still to be rendered.
Because software products are generally shipped as orders are received, the
Company has historically operated without significant backlog. However, it is
the Company's practice to announce new products prior to the time at which such
products will be ready for shipment to allow customers sufficient lead time for
budgeting and curriculum purposes. This practice can result in a significant
backlog for orders of new products. These orders are generally filled within a
relatively short period of time after the product is ready for shipment. The
introduction of products in certain periods could cause those periods to have
significantly higher sales and higher sales growth rates than subsequent
periods.
Cost of sales consists of expenses associated with sales of software
products, support agreements, and training seminars and programs. These costs
include: (i) personnel-related costs, (ii) costs associated with the manufacture
and assembly of the Company's products, including the cost of purchased
optical-mark card scanners, and (iii) an allocation of facilities costs. The
Company recognizes significantly higher gross margins on its product sales than
on its service sales. Product sales as a percentage of total sales have remained
relatively constant. Gross profit margins on products have decreased due to mix
associated with the hardware component of the Company's new math products. 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
1998. Management anticipates that product gross profit margins will
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continue to decrease somewhat in 2000 due to the impact of anticipated increased
sales of Accelerated Math software and hardware as a percentage of total product
sales.
Gross profit margins on service sales have decreased primarily due to lower
profitability of seminars in 1999. While the Company trained over 78,000
educators in its Renaissance training programs in 1999, an increase of 51.5%
over educators trained in 1998, increased numbers of seminars in smaller markets
resulted in lower average attendance at seminars for which costs are relatively
fixed, resulting in an increase in costs as a percentage of sales for training.
Increased costs of providing technical support related to software support
agreements associated with the Company's broader product lines also had a
negative impact on service gross profit margins in 1999. Management anticipates
that service margins may continue to decrease somewhat in 2000 as increased
costs related to providing technical support for the Company's new products will
continue in 2000.
The Company expenses all product development costs associated with a
product until technological feasibility is established, after which time such
costs are capitalized until the product is available for general release to
customers. Capitalized product development costs are amortized into cost of
sales generally using the straight-line method over 24 months.
In 1999, the Company acquired three software firms: computerActive, Inc.
("computerActive"), an Ottawa, Canada-based software development firm
specializing in Web-based applications; Generation21 Learning Systems, LLC
("Generation21"), a training and knowledge management enterprise software firm
in Golden, Colorado; and Humanities Software, Incorporated ("Humanities"), an
Oregon-based firm specializing in writing software. The acquisitions are not
expected to have a material impact on the Company's overall results of
operations in the near term. In 1998, the Company acquired 100% of the stock of
Logicus Incorporated ("Logicus"), an Ontario, Canada-based firm specializing in
writing skills development software.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated income statement data
as a percentage of net sales, except that individual components of cost of sales
and gross profit are shown as a percentage of their corresponding component of
net sales:
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------
1999 1998 1997
---- ---- ----
Net sales:
Products.......................................... 80.9% 79.9% 80.8%
Services.......................................... 19.1 20.1 19.2
----- ----- -----
Total net sales.............................. 100.0% 100.0% 100.0%
===== ===== =====
Cost of sales:
Products.......................................... 11.5% 9.9% 12.9%
Services.......................................... 47.3 40.6 43.3
Total cost of sales.......................... 18.3 16.1 18.7
Gross profit:
Products.......................................... 88.5 90.1 87.1
Services.......................................... 52.7 59.4 56.7
Total gross profit........................... 81.7 83.9 81.3
Operating expenses:
Product development............................... 10.2 9.3 9.6
Selling and marketing............................. 25.8 24.9 26.8
General and administrative........................ 12.1 13.6 16.0
Purchased research and development................ 1.3 0.9 --
Phantom stock plan termination.................... -- -- 4.5
----- ----- -----
Operating income.................................... 32.3 35.2 24.4
Other income (expense).............................. 2.5 2.9 (0.2)
----- ----- -----
Income before taxes................................. 34.8 38.1 24.2
Income tax provision (benefit)...................... 14.3 16.0 (1.9)
----- ----- -----
Net income.......................................... 20.5% 22.1% 26.1%
===== ===== =====
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YEARS ENDED DECEMBER 31, 1999 AND 1998
Net Sales. The Company's net sales increased by $28.4 million, or 51.6%, to
$83.6 million in 1999 from $55.1 million in 1998. Product sales increased by
$23.5 million, or 53.4%, to $67.6 million in 1999 from $44.1 million in 1998.
The increase in product sales is primarily attributable to (i) sales of the
Company's new math products into more than 6,000 schools since shipment began in
late 1998 and (ii) increased sales of Accelerated Reader title disks, with over
28,000 available book titles, to a larger base of Accelerated Reader schools.
Service revenue, which consists of revenue from sales of training sessions
and software support agreements, increased by $4.9 million, or 44.2%, to $16.0
million in 1999 from $11.1 million in 1998. This increase is primarily
attributable to an increased number of Renaissance training sessions and to an
increase in revenue from one-year software support agreements associated with
new product sales.
While revenue growth was more than 70% over 1998 levels for both products
and services in the first half of 1999, growth rates over the previous year were
considerably lower in the third and fourth quarters of 1999. Because the
Company's new version of Accelerated Reader shipped in late September and
October, the Company missed the prime fall buying season for schools, which
slowed follow-on purchases of Accelerated Reader title disks as well as
adoptions by new schools in late 1999. Management expects the effects of this
delay in shipment to continue to have some impact into early 2000, as schools
take time to install the new Accelerated Reader software before returning to
their normal buying patterns.
The Company anticipates that several new initiatives announced in 1999 will
positively impact continued growth over the long term in the sale of its reading
software products. In June 1999, the Company announced that its reading and
language arts software products won approval in California's state adoption of
curriculum materials. Gaining approval means that schools that want to purchase
the Company's reading and writing skills software can pay for them using certain
state curriculum materials funds. Other key events during the year 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
Accelerated Reader and STAR Reading software; the introduction of Web-based
on-line ordering and delivery of Accelerated Reader quizzes; and an alliance
with the McGraw-Hill School Division to provide educators and students with
access to hundreds of interactive computer quizzes aligned to the McGraw-Hill
elementary school reading series.
Cost of Sales. The cost of sales of products increased by $3.4 million, or
77.5%, to $7.8 million in 1999 from $4.4 million in 1998. As a percentage of
product sales, the cost of sales of products increased to 11.5% in 1999 compared
to 9.9% in 1998 due primarily to mix associated with the hardware component of
the Company's new math products. 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. Management anticipates
that product margins will continue to decrease somewhat in 2000 due to the
impact of anticipated increased sales of Accelerated Math software and hardware
as a percentage of total product sales.
The cost of sales of services increased by $3.1 million, or 68.1%, to $7.6
million in 1999 from $4.5 million in 1998 primarily due to increased costs of
delivering more training sessions in 1999 and of providing technical support
related to software support agreements. As a percentage of sales of services,
the cost of sales of services increased to 47.3% in 1999 compared to 40.6% in
1998. While the Company trained over 78,000 educators in its Renaissance
training programs in 1999, an increase of 51.5% over educators trained in 1998,
increased numbers of seminars in smaller markets resulted in lower average
attendance at seminars for which costs are relatively fixed, resulting in an
increase in costs as a percentage of sales for training. Additionally, costs of
providing software technical support increased as the Company broadened its
product lines and introduced new versions of existing products. Management
anticipates that service margins will continue to decrease somewhat in 2000 as
increased costs related to providing technical support for the Company's new
products will continue in 2000. Management expects that service revenues will be
positively impacted in the first quarter of 2000 as the Company presented its
first annual National School Renaissance Conference in February 2000.
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The Company's overall gross profit margin decreased 2.2% to 81.7% in 1999
from 83.9% in 1998 due to decreased gross profit margins on both products and
services.
Product Development. Product development expenses increased by $3.4
million, or 65.4%, to $8.5 million in 1999 from $5.1 million in 1998. These
expenses increased primarily due to increased staff and consulting costs
associated with developing new products and seminars including new versions of
the Company's Accelerated Reader and STAR Reading software, additional
Accelerated Reader quizzes, the new School Renaissance district-wide improvement
program, and several products not yet released. As a percentage of net sales,
product development costs increased to 10.2% in 1999 from 9.3% in 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 $7.8
million, or 57.1%, to $21.5 million in 1999 from $13.7 million in 1998. These
expenses increased due to (i) direct mailings to an increased customer and
prospect base, (ii) an increase in special promotions and (iii) increased wage
and benefit costs associated with the hiring of additional personnel. As a
percentage of net sales, selling and marketing expenses increased to 25.8% in
1999 from 24.9% in 1998. 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 $2.6 million, or 34.3%, to $10.1 million in 1999 from $7.5 million in 1998.
The higher expenses for 1999 are largely due to increased costs associated with
the hiring of additional personnel, including wages and related benefits. As a
percentage of net sales, general and administrative costs decreased to 12.1% in
1999 from 13.6% in 1998. Management anticipates that general and administrative
expenses will continue to rise to support the Company's growth and new business
initiatives.
Purchased Research and Development. In connection with the acquisitions of
computerActive and Humanities in 1999, $900,000 and $180,000, respectively, of
the purchase price was allocated to purchased research and development which was
expensed in 1999. In connection with the acquisition of Logicus, $475,000 of the
purchase price was allocated to purchased research and development which was
expensed in 1998.
Operating Income. Operating income increased by $7.6 million, or 39.1%, to
$27.0 million in 1999 from $19.4 million in 1998. As a percentage of net sales,
operating income decreased to 32.3% in 1999 from 35.2% in 1998. Excluding the
effects of the purchased research and development expense in 1999 and 1998,
operating income would have increased by $8.2 million, or 41.2%, to $28.1
million in 1999 from $19.9 million in 1998, or 33.6% of net sales compared to
36.1% of net sales in 1998.
Other Income. Other income increased by $422,000 to $379,000 in 1999
primarily due to an increase in rental income at the Company's new office
facility in Madison, Wisconsin, offset by a non-recurring charge of $365,000 for
transaction costs associated with the Generation21 acquisition.
Income Taxes. Income tax expense of $11.9 million was recorded in 1999 at
an effective income tax rate of 41.0% compared to $8.8 million and 42.0%
effective income tax rate in 1998. The Company expects that the effective rate
of tax on its income will be approximately 40.0% during 2000.
YEARS ENDED DECEMBER 31, 1998 AND 1997
Net Sales. The Company's net sales increased by $18.8 million, or 51.9%, to
$55.1 million in 1998 from $36.3 million in 1997. Product sales increased by
$14.7 million, or 50.1%, to $44.1 million in 1998 from $29.3 million in 1997.
The increase in product sales is primarily attributable to (i) increased sales
of Accelerated Reader title disks to a larger base of Accelerated Reader
schools, including the introduction of approximately 7,000 new book titles on
Accelerated Reader title disks in 1998, (ii) the addition of about 7,500
19
21
new customer schools in 1998, (iii) the continuation of very strong STAR Reading
sales, and (iv) sales of the Company's new math products which began shipping in
late 1998.
Reading software sales were positively impacted in 1998 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 from the Albertson Foundation a grant to purchase software. While the
Company anticipates continued growth over the long term in the sale of its
software products, large scale sales such as those described above are unlikely
to recur in every period. This may cause periods in which such sales occur to
have higher sales and higher sales growth rates than subsequent periods.
Service revenue, which consists of revenue from sales of training sessions
and software support agreements, increased by $4.1 million, or 59.2%, to $11.1
million in 1998 from $7.0 million in 1997. This increase is primarily
attributable to revenue from software support agreements associated with new
product sales along with renewals of agreements by an expanding base of existing
customers, and to an increased number of Reading Renaissance training sessions.
Cost of Sales. The cost of sales of products increased by $587,000, or
15.5%, to $4.4 million in 1998 from $3.8 million in 1997. As a percentage of
product sales, the cost of sales of products declined to 9.9% in 1998 compared
to 12.9% in 1997 due to operating leverage associated with increased product
sales. The cost of sales of services increased by $1.5 million, or 49.2%, to
$4.5 million in 1998 from $3.0 million in 1997 primarily due to increased costs
of providing technical support relating to software support agreements. As a
percentage of sales of services, the cost of sales of services declined to 40.6%
in 1998 compared to 43.3% in 1997, primarily as a result of decreased costs of
delivering training sessions. The Company's overall gross profit margin improved
2.6% to 83.9% in 1998 from 81.3% in 1997 due to improved gross profit margins on
both products and services.
Product Development. Product development expenses increased by $1.6
million, or 47.0%, to $5.1 million in 1998 from $3.5 million in 1997. These
expenses increased primarily due to increased development staff and consulting
costs associated with the new products and seminars introduced in 1998. As a
percentage of net sales, product development costs decreased to 9.3% in 1998
from 9.6% in 1997.
Selling and Marketing. Selling and marketing expenses increased by $4.0
million, or 41.2%, to $13.7 million in 1998 from $9.7 million in 1997. These
expenses increased due to (i) the publication of additional catalogs, mailings
to an increased customer and prospect base, and increased advertising in
publications and (ii) salary and recruiting costs associated with the hiring of
additional personnel. As a percentage of net sales, selling and marketing
expenses decreased to 24.9% in 1998 from 26.8% in 1997. This decrease is
primarily due to economies of scale associated with significantly increased
product and service sales.
General and Administrative. General and administrative expenses increased
by $1.7 million, or 29.4%, to $7.5 million in 1998 from $5.8 million in 1997.
The higher expenses for 1998 are largely due to increased costs associated with
the hiring of additional personnel, including wages and related benefits. As a
percentage of net sales, general and administrative costs decreased to 13.6% in
1998 from 16.0% in 1997.
Purchased Research and Development. In connection with the acquisition of
Logicus, $475,000 of the purchase price was allocated to purchased research and
development which was expensed in 1998.
Phantom Stock Plan Termination. The Company's phantom stock plan terminated
on September 30, 1997 in connection with the closing of the Offering on that
date. The one-time charge of $1.6 million associated with the plan termination
was expensed in 1997.
Operating Income. Operating income increased by $10.5 million, or 118.9%,
to $19.4 million in 1998 from $8.9 million in 1997. As a percentage of net
sales, operating income increased to 35.2% in 1998 from 24.4% in 1997. Excluding
the effects of the purchased research and development expense in 1998, and the
phantom stock plan termination expense in 1997, operating income would have
increased by $9.4 million, or
20
22
89.6%, to $19.9 million in 1998 from $10.5 million in 1997, or 36.1% of net
sales compared to 28.9% of net sales in 1997.
Interest Income. Interest income increased $1.2 million to $1.7 million in
1998 from $483,000 in 1997 due to an increase in interest earning short-term
investments purchased with proceeds from the Company's initial public offering
in late 1997.
Interest Expense. Interest expense decreased $604,000 to $51,000 in 1998
from $655,000 in 1997. In late 1997, proceeds from the Company's initial public
offering were used to pay substantially all of the Company's outstanding
indebtedness.
Income Taxes. Income tax expense of $8.8 million was recorded in 1998 at an
effective income tax rate of 42.0%. In January 1997, a deferred tax asset of
$1.6 million was written off when IPS elected S corporation status. In September
1997, a tax benefit of $3.5 million was recorded in connection with the
Company's change in tax status from S corporation to C corporation status. The
Company became subject to corporate level income taxes effective with the
closing of the Offering and consequently provided for current and deferred
income taxes on income subsequent to September 30, 1997. See Note 6 of Notes to
the Company's Financial Statements.
YEAR 2000
The Company's systems and products, as well as those of its third-party
business partners, made an uneventful transition from 1999 to 2000. No material
disruptions occurred and operations continued without interruption in the new
year. However, as the Company had anticipated, on February 29, 2000, some
customers using older versions of the Company's Accelerated Reader product were
unable to test students on that date. Since March 1, 2000, the affected
customers have been able to operate the product error-free. While initial
indications suggest that Year 2000 issues will not adversely affect operations,
the Company will continue to monitor its own systems and products, as well as
those of third-party business partners, to ensure Year 2000 compliance.
With respect to Year 2000 risks associated with the Company's software
products, the Company cannot be certain that the software will continue to
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 efforts to ensure compliance, it is not reasonably likely that
the Company will be subject to such litigation.
The Company incurred costs of approximately $950,000 for internal and third
party Year 2000 compliance measures, which were funded through operating cash
flows in 1998 and 1999.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1999, the Company's cash, cash equivalents and
investment securities increased $7.9 million to $41.0 million from the December
31, 1998 total of $33.1 million. The net increase is due primarily to $16.0
million in net cash provided by operating activities offset by (i) $7.3 million
used in the purchase of property, plant and equipment for facility expansion
necessary to accommodate the Company's growth in operations and (ii) $1.7
million used for acquisitions and international expansion. The Company believes
cash flow from operations and its current cash position will be sufficient to
meet its working capital requirements for the foreseeable future.
At December 31, 1999, the Company had a $10.0 million unsecured revolving
line of credit with a bank which is available until March 31, 2000, and which is
expected to be extended for an additional year. 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 December
31, 1999, the line of credit had not been used.
On January 3, 2000 the Company's Board of Directors authorized the
repurchase of up to 1,000,000 shares of the Company's common stock. No time
limit was placed on the duration of the repurchase program.
21
23
Repurchased shares will become treasury shares and will be used for stock-based
employee benefit plans and for other general corporate purposes.
In March 1998, Athena Holdings LLC ("AHL") was formed by the Company and an
unaffiliated party to develop a facility in the Madison, Wisconsin area to house
the offices, marketing and sales functions, training development staff, and
training support staff of the Institute for Academic Excellence. The Company
received a 70% interest in AHL in return for its capital contribution of
$700,000. The other party also utilizes part of the facility. Additionally, a
portion of the property will be leased to third parties. The total cost of the
project was approximately $7.4 million. The Company financed the project
internally.
The net proceeds to the Company from its initial public offering in 1997,
after deducting underwriting discounts of $3,606,400 and other expenses of
approximately $941,000, were approximately $46,972,000. The Company has thus far
used the 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.
(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 $2.4 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
At December 31, 1999, the Company had no material market risk exposures
(e.g., interest rate risk, foreign currency exchange rate risk or commodity
price risk).
22
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES:
We have audited the accompanying consolidated balance sheets of Advantage
Learning Systems, Inc. (a Wisconsin corporation) and subsidiaries as of December
31, 1999 and 1998, and the related consolidated statements of income, equity and
cash flows for each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Advantage
Learning Systems, Inc. and subsidiaries as of December 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Milwaukee, Wisconsin
January 21, 2000
23
25
FINANCIAL STATEMENTS
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
1999 1998
---- ----
(IN THOUSANDS EXCEPT
SHARE AND PER SHARE
AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents................................. $23,016 $14,264
Investment securities..................................... 18,012 18,869
Accounts receivable, less allowance of $1,200 in 1999 and
$1,058 in 1998......................................... 11,796 8,863
Inventories............................................... 1,707 794
Prepaid expenses.......................................... 1,287 689
Prepaid income taxes...................................... 292 --
Deferred tax asset........................................ 2,559 2,242
------- -------
Total current assets.............................. 58,669 45,721
Property, plant & equipment, net............................ 24,256 19,210
Deferred tax asset.......................................... 2,297 1,647
Intangibles, net............................................ 2,702 1,445
Capitalized software, net................................... 495 257
------- -------
Total assets...................................... $88,419 $68,280
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,521 $ 1,848
Deferred revenue.......................................... 4,852 3,443
Payroll and employee benefits............................. 1,981 1,080
Income taxes payable...................................... -- 2,157
Other current liabilities................................. 2,392 3,000
------- -------
Total current liabilities......................... 11,746 11,528
Deferred revenue.......................................... 1,485 1,398
------- -------
Total liabilities................................. 13,231 12,926
Minority interest........................................... 253 295
Shareholders' equity:
Common stock, $.01 par; Shares authorized: 150,000,000;
Issued and outstanding: 34,182,841 -- 1999
34,002,023 -- 1998............ 342 340
Additional paid in capital............................. 43,621 40,872
Retained earnings...................................... 31,015 13,869
Accumulated other comprehensive income................. (43) (22)
------- -------
Total shareholders' equity........................ 74,935 55,059
------- -------
Total liabilities and shareholders' equity........ $88,419 $68,280
======= =======
The accompanying notes to the financial statements are an integral part of these
balance sheets.
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26
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997
---- ---- ----
(IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
Net Sales:
Products.................................................. $67,608 $44,064 $29,350
Services.................................................. 15,980 11,084 6,964
------- ------- -------
Total net sales...................................... 83,588 55,148 36,314
------- ------- -------
Cost of sales:
Products.................................................. 7,768 4,375 3,788
Services.................................................. 7,557 4,496 3,013
------- ------- -------
Total cost of sales.................................. 15,325 8,871 6,801
------- ------- -------
Gross profit......................................... 68,263 46,277 29,513
Operating expenses:
Product development....................................... 8,500 5,140 3,496
Selling and marketing..................................... 21,546 13,712 9,709
General and administrative................................ 10,115 7,529 5,817
Purchased research and development........................ 1,080 475 --
Phantom stock plan termination............................ -- -- 1,617
------- ------- -------
Total operating expenses............................. 41,241 26,856 20,639
------- ------- -------
Operating income..................................... 27,022 19,421 8,874
Other income (expense):
Interest income........................................... 1,733 1,709 483
Interest expense.......................................... (45) (51) (655)
Other, net................................................ 379 (43) 91
------- ------- -------
Income before taxes......................................... 29,089 21,036 8,793
Income tax provision (benefit).............................. 11,943 8,844 (673)
------- ------- -------
Net income.................................................. $17,146 $12,192 $ 9,466
======= ======= =======
Earnings per share:
Basic..................................................... $ 0.50 $ 0.36 $ 0.33
Diluted................................................... 0.50 0.36 0.32
The accompanying notes to the financial statements are an integral part of these
statements.
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27
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
ACCUMULATED
COMMON STOCK(1) ADDITIONAL OTHER
------------------ PAID IN RETAINED COMPREHENSIVE TOTAL
SHARES AMOUNT CAPITAL EARNINGS INCOME EQUITY
------ ------ ---------- -------- ------------- ------
(IN THOUSANDS)
Balance, December 31, 1996.................... -- $ -- $ -- $ -- $ -- $ 3,774
Net income.................................. -- -- -- 9,466 -- 9,466
Recapitalization............................ 27,302 273 (6,819) 10,320 -- --
Distributions to shareholders............... -- -- -- (18,109) -- (18,109)
Public offering............................. 6,440 64 46,908 -- -- 46,972
Inception of Generation21(2)................ 166 2 198 -- -- 200
Settlement of IPS purchase.................. 63 1 499 -- -- 500
------ ---- ------- ------- ---- --------
Balance, December 31, 1997.................... 33,971 340 40,786 1,677 -- 42,803
Net income.................................. -- -- -- 12,192 -- 12,192
Foreign currency translation................ -- -- -- -- (22) (22)
--------
Comprehensive income...................... -- -- -- -- -- 12,170
Distribution to shareholders................ -- -- (302) -- -- (302)
Tax benefit on stock options................ -- -- 133 -- -- 133
Exercise of stock options................... 31 -- 246 -- -- 246
Stock option grants......................... -- -- 9 -- -- 9
------ ---- ------- ------- ---- --------
Balance, December 31, 1998.................... 34,002 340 40,872 13,869 (22) 55,059
Net income.................................. -- -- -- 17,146 -- 17,146
Foreign currency translation................ -- -- -- -- 3 3
Unrealized loss on securities............... -- -- -- -- (24) (24)
--------
Comprehensive income...................... -- -- -- -- -- 17,125
Shares issued to acquire business(2)........ 59 1 1,012 -- -- 1,013
Employee stock purchase plan................ 19 -- 222 -- -- 222
Tax benefit on stock options................ -- -- 581 -- -- 581
Exercise of stock options................... 103 1 922 -- -- 923
Stock option grants......................... -- -- 12 -- -- 12
------ ---- ------- ------- ---- --------
Balance, December 31, 1999.................... 34,183 $342 $43,621 $31,015 $(43) $ 74,935
====== ==== ======= ======= ==== ========
- -------------------------
(1) Common Stock, $0.01 par value, 150,000,000 shares authorized.
(2) See Note 3 of Notes to Financial Statements.
The accompanying notes to the financial statements are an integral part of these
statements.
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28
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997
---- ---- ----
(IN THOUSANDS)
Reconciliation of net income to net cash provided by
operating activities:
Net income................................................ $17,146 $ 12,192 $ 9,466
Noncash (income) expenses included in net income --
Depreciation and amortization.......................... 3,245 2,129 1,502
Purchased research and development..................... 1,080 475 --
Deferred income taxes.................................. (967) (397) (1,890)
Change in assets and liabilities --
Accounts receivable.................................... (2,733) (5,424) (859)
Inventory.............................................. (909) (421) 198
Prepaid expenses....................................... (856) 69 (495)
Accounts payable and other current liabilities......... (1,389) 4,283 2,072
Retainage and amounts due under construction
contract............................................. -- (17) (1,135)
Deferred revenue....................................... 1,496 688 1,601
Other..................................................... (63) (21) 1
------- -------- --------
Net cash provided by operating activities............ 16,050 13,556 10,461
------- -------- --------
Cash flows from investing activities:
Purchase of property, plant & equipment................... (7,267) (8,494) (1,806)
(Purchase) sale of investment securities, net............. 856 (12,004) (6,865)
Capitalized software development costs.................... (432) (194) (104)
Acquisitions.............................................. (1,600) (634) (265)
------- -------- --------
Net cash used in investing activities................ (8,443) (21,326) (9,040)
------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of stock........................... 222 -- 47,172
Proceeds from exercise of stock options................... 923 246 --
Equity contribution from minority partner................. -- 300 --
Payments on debt.......................................... -- -- (10,450)
Distributions to shareholders............................. -- (857) (17,554)
------- -------- --------
Net cash provided by (used in) financing
activities........................................ 1,145 (311) 19,168
------- -------- --------
Net increase (decrease) in cash............................. 8,752 (8,081) 20,589
Cash and cash equivalents, beginning of period.............. 14,264 22,345 1,756
------- -------- --------
Cash and cash equivalents, end of period.................... $23,016 $ 14,264 $ 22,345
======= ======== ========
The accompanying notes to the financial statements are an integral part of these
statements.
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29
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(1) CONSOLIDATION
The consolidated financial statements include the financial results of
Advantage Learning Systems, Inc. ("ALS") and its consolidated subsidiaries,
(collectively the "Company"). The Company's significant subsidiaries include the
Institute for Academic Excellence, Inc. ("Institute") and IPS Publishing, Inc.
("IPS"). The Company also owns 70% of Athena Holdings LLC which was formed for
the purpose of constructing a facility in Madison, Wisconsin. All significant
intercompany transactions have been eliminated in the consolidated financial
statements.
(2) NATURE OF OPERATIONS
ALS is a provider of learning information systems to K-12 schools in the
United States and Canada. ALS's flagship product is the Accelerated Reader, a
learning information system for motivating and monitoring increased
literature-based reading practice. The Company's software products also include
STAR Reading, a computer-adaptive reading test and database; Accelerated Math
and STAR Math, software products that apply to math the principles that have
made the reading software effective in improving academic performance; and
Perfect Copy writing skills software.
The Institute develops and conducts Renaissance training programs, which
provide educators with professional development training to most effectively use
ALS products and the learning information they generate. The firm provides
teacher training through its Reading Renaissance, Math Renaissance, and
Effective Teaching seminars.
IPS provides customized test-generation software to educational publishers
for assessment and skills practice in math, science, and other subjects.
Additionally, IPS develops content for math products distributed by the Company.
Through other subsidiaries, the Company sells enterprise software for
training and knowledge management to corporate customers and develops Web
software for various applications. The Company also has subsidiaries in Canada,
India, Australia, and the United Kingdom.
(3) ACQUISITIONS
Effective December 29, 1999, the Company acquired computerActive, Inc.
("computerActive"), an Ottawa, Canada-based software development firm
specializing in Web-based applications. The transaction was accounted for using
the purchase method of accounting, with a total purchase price of $1.3 million,
representing $680,000 of cash, $346,000 of the Company's common stock and the
assumption of certain liabilities. The purchase price is subject to post-closing
adjustment. The operating results of computerActive 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 $900,000 in
the fourth quarter of 1999.
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, the Company's financial information for all
periods presented has been restated to include the results of Generation21 since
its inception in July 1997. The Company issued 166,443 shares of common stock
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.
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 with a total purchase price of $1.7 million, representing $920,000 of
cash, $666,000 of the Company's common stock and the assumption of certain
liabilities. The operating results
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30
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
Effective June 30, 1998, the Company acquired 100% of the stock of Logicus
Incorporated ("Logicus"), an Ontario, Canada-based firm specializing in writing
skills development software. The transaction was accounted for using the
purchase method of accounting, and the results of operations of Logicus have
been included in the Company's consolidated financial statements since the date
of acquisition. The purchase price included the acquisition of certain
in-process research and development which resulted in a pre-tax charge of
$475,000 in the second quarter of 1998.
Pro forma data is not provided relating to the above acquisitions because
it would not differ significantly from historical results.
(4) SIGNIFICANT ACCOUNTING POLICIES
(a) Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(b) Revenue recognition
In 1997, the Accounting Standards Executive Committee of the AICPA issued
Statement of Position No. 97-2 ("SOP 97-2") "Software Revenue Recognition". This
SOP was issued to provide guidance on applying generally accepted accounting
principles to software transactions and to narrow the range of revenue
recognition practices that were in use before its issuance. SOP 97-2 is
generally effective for transactions entered into in fiscal years beginning
after December 15, 1997. The adoption of SOP 97-2 had no material impact on the
Company's results of operations.
Revenue from product sales is recognized when the products are shipped, net
of estimated allowances for product returns and exchanges. Allowances for bad
debts and post-contract support obligations, primarily telephone support
provided by ALS, are also accrued for at the time of the sale.
Revenue from IPS's custom products is recognized on the percentage of
completion method. IPS defers revenue for advance payments from customers that
are in excess of revenues earned. Included in receivables at December 31, 1999
and 1998 is $370,000 and $198,000, respectively, of amounts earned on contracts
which are not yet billable.
The Institute generates service revenue both from (i) conducting seminars
and (ii) contracts with schools and school districts to provide training
programs and consulting services. The Institute recognizes revenue from the
seminars at the time the seminar actually takes place. For school and school
district contracts, revenue is generally recognized when the training session is
performed, while certain support services are recognized on a straight-line
basis over the life of the contract. The Institute includes as deferred revenue
(i) prepayments on contract revenues and (ii) payments received for seminars not
yet held.
Service revenues include software support provided as part of the software
product sale and separately sold maintenance fees whereby ALS provides ongoing
customer support and product upgrades. Such separately sold contracts are
reflected as deferred revenue and are amortized ratably over the term of the
maintenance period which begins after the expiration of any support included
with the purchase of the
29
31
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
software. Revenue from support agreements included with the purchase of software
is included in service revenue at the time the software is shipped.
(c) Cash and cash equivalents
The Company considers cash amounts on deposit at banks and highly liquid
debt instruments purchased with a maturity date of three months or less to be
cash equivalents. Debt instruments are carried at cost plus accrued interest,
which approximates market value. Cash and cash equivalents consisted of the
following at December 31:
1999 1998
---- ----
(IN THOUSANDS)
Cash and time deposits..................................... $ 7,009 $ 4,798
Municipal obligations...................................... 12,012 2,025
Commercial paper........................................... 2,990 7,441
Corporate notes............................................ 1,005 --
------- -------
$23,016 $14,264
======= =======
(d) Supplemental disclosure of cash flow information
1999 1998 1997
---- ---- ----
(IN THOUSANDS)
Cash paid for:
Interest........................................... $ 84 $ 20 $ 697
Income taxes....................................... 14,757 6,606 1,564
(e) Investment securities
Investment securities have an original maturity of more than three months
and a remaining maturity of less than eighteen months. As of December 31, 1999
and 1998, investment securities consisted entirely of commercial paper and
corporate notes. These securities are considered to be available for sale in
accordance with Statement of Financial Accounting Standards No. 115 ("SFAS 115")
"Accounting for Certain Investments in Debt and Equity Securities". Accordingly,
these investments are stated at fair value plus accrued interest, with the
unrealized gains and losses, net of tax, included in accumulated other
comprehensive income in the Company's consolidated statements of equity.
(f) Inventories
Inventories are carried at the lower of first-in, first-out (FIFO) cost or
market. Inventories primarily consist of purchased materials which include
optical-mark card scanners, manuals and motivational items.
(g) Catalog and advertising costs
Costs related to direct response advertising, primarily catalogs, are
capitalized and amortized over their expected period of future benefits,
generally three to six months. At December 31, 1999 and 1998, capitalized
catalog costs of approximately $404,000 and $113,000, respectively, are included
in prepaid expenses. All other advertising costs are expensed the first time the
advertising takes place. Advertising expenses for 1999, 1998 and 1997 were
approximately $9,206,000, $6,232,000 and $4,403,000, respectively.
30
32
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(h) Property, plant and equipment
Property, plant and equipment are recorded at cost and are depreciated over
the estimated useful lives of the assets using principally the straight-line
method for financial reporting purposes. Maintenance and repair costs are
charged to expense as incurred, and renewals and improvements that extend the
useful life of the assets are added to the plant and equipment accounts.
Depreciation expense was approximately $2,468,000, $1,423,000 and $987,000 for
1999, 1998 and 1997, respectively.
The estimated useful lives for property, plant and equipment are as
follows: buildings-25 to 40 years; furniture, fixtures and office equipment-5 to
8 years; computer and production equipment-3 to 5 years; vehicles-5 years; and
leasehold improvements-the lease term.
Net property, plant and equipment consisted of the following at December
31:
1999 1998
---- ----
(IN THOUSANDS)
Land and improvements...................................... $ 3,361 $ 1,429
Buildings.................................................. 15,330 14,469
Furniture, fixtures and office equipment................... 4,245 2,339
Computer and production equipment.......................... 5,957 3,696
Vehicles................................................... 165 77
Leasehold improvements..................................... 69 5
Construction in progress................................... 382 10
------- -------
Total property, plant and equipment...................... 29,509 22,025
Less - accumulated depreciation............................ 5,253 2,815
------- -------
Property, plant and equipment, net......................... $24,256 $19,210
======= =======
(i) Software development costs
The Company capitalizes certain software development costs incurred after
technological feasibility is achieved. Capitalized costs are reported at the
lower of unamortized cost or net realizable value. Capitalized software
development costs are amortized on a product-by-product basis based on the
greater of the amount computed using (a) the ratio that current gross revenues
for a product bear to the total of current and anticipated future gross revenues
for that product or (b) the straight-line method over the estimated economic
life of the products which is generally estimated to be 24 months. Amortization
begins when the products are available for general release to customers. All
other research and development expenditures are charged to product development
expense in the period incurred. Amounts capitalized were approximately $432,000,
$194,000 and $104,000 in 1999, 1998 and 1997, respectively. Amortization expense
of approximately $194,000, $183,000 and $252,000 for 1999, 1998 and 1997,
respectively, is included in cost of sales-products in the consolidated
statements of income. At December 31, 1999 and 1998, accumulated amortization of
capitalized software development costs was $958,000 and $765,000, respectively.
(j) Sales and concentration of credit risks
For the years ended December 31, 1999, 1998 and 1997, one customer (a book
distributor) contributed 11.5%, 13.9% and 14.3% of total revenues, respectively.
No other customer represented more than 10% of total revenues. On December 31,
1999 and 1998, this customer had a receivable balance of 6.2% and 11.6% of total
trade receivables, respectively.
31
33
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company grants credit to customers in the ordinary course of business.
The majority of the Company's customers are schools. Concentrations of credit
risk with respect to trade receivables are limited due to the significant number
of customers and their geographic dispersion.
(k) Stock-based compensation
The Company elected, as permitted by Statement of Accounting Standards No.
123 ("SFAS 123") "Accounting for Stock Based Compensation" to follow the
intrinsic value based method of accounting for stock options consistent with
Accounting Principles Board Opinion No. 25 ("APB 25") "Accounting for Stock
Issued to Employees" and to provide the pro forma disclosures of net income and
earnings per share as if the fair value based method had been applied. Under the
intrinsic method, compensation cost for stock options is measured by the excess,
if any, of the quoted price of the Company's stock at the measurement date over
the exercise price. The Black-Scholes option-pricing model was used to compute
the fair value of each option granted for purposes of the pro forma disclosures
required by SFAS 123.
(l) Earnings per common share
Basic earnings per common share ("Basic EPS") has been computed based on
the weighted average number of common shares outstanding. Diluted earnings per
common share ("Diluted EPS") 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 dilutive potential common
shares had been issued. All share and per share data has been adjusted to
reflect a 2-for-1 stock split in the form of a stock dividend effective February
26, 1999 (see Note 13).
The weighted average shares outstanding for 1999, 1998 and 1997 are as
follows:
1999 1998 1997
---- ---- ----
Basic weighted average shares outstanding............ 34,074,617 33,978,505 29,120,909
Dilutive effect of stock options..................... 302,456 163,998 93,210
---------- ---------- ----------
Diluted weighted average shares outstanding.......... 34,377,073 34,142,503 29,214,119
========== ========== ==========
(m) Comprehensive income
The Company's comprehensive income includes foreign currency translation
adjustments and unrealized net loss on available-for-sale securities, which are
included in accumulated other comprehensive income in the Company's consolidated
statements of equity.
(n) Reclassifications
Certain previously reported amounts have been reclassified to conform with
the 1999 presentation.
(5) INTANGIBLE ASSETS
Intangible assets, including goodwill, are amortized on the straight-line
basis over their estimated useful lives. Intangibles acquired in connection with
acquisitions include assembled workforce of $130,000 and goodwill of $741,000 in
1999, and software code of $970,000 and $344,000 in 1999 and 1998, respectively.
32
34
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets consisted of the following at December 31:
1999 1998 USEFUL LIFE
---- ---- -----------
(IN THOUSANDS)
Algorithms and software code....................... $1,824 $ 854 2-5 years
Tradename.......................................... 210 210 10 years
Assembled workforce................................ 220 90 7 years
Goodwill........................................... 1,894 1,153 7 years
------ ------
Total intangibles.................................. 4,148 2,307
Less -- accumulated amortization................... 1,446 862
------ ------
Net intangibles.................................... $2,702 $1,445
====== ======
Management periodically reviews the carrying value of its intangible
assets, including goodwill, for potential impairment. To date, no impairment of
these assets exists.
(6) INCOME TAXES
The provision (benefit) for income taxes consisted of:
1999 1998 1997
---- ---- ----
(IN THOUSANDS)
Current tax provision:
U.S. federal..................................... $10,317 $7,428 $1,026
State and local.................................. 2,593 1,813 191
------- ------ ------
Total current tax provision........................ 12,910 9,241 1,217
------- ------ ------
Deferred tax (benefit):
U.S. federal..................................... (943) (329) (1,618)
State and local.................................. (24) (68) (272)
------- ------ ------
Total deferred tax (benefit)....................... (967) (397) (1,890)
------- ------ ------
Provision (benefit) for income taxes............... $11,943 $8,844 $ (673)
======= ====== ======
Effective rate reconciliation:
1999 1998 1997
---- ---- ----
(IN THOUSANDS)
U.S. statutory rate................................ 35% 35% 35%
------- ------ ------
Income tax provision at statutory tax rate......... $10,181 $7,363 $3,078
State and local taxes, net of federal tax
benefit.......................................... 1,669 1,134 175
Deferred taxes written off in connection with IPS S
corporation election............................. -- -- 1,602
S-corporation income not subject to tax............ -- -- (2,060)
Deferred tax reinstatement related to termination
of S corporation elections....................... -- -- (3,549)
Other.............................................. 93 347 81
------- ------ ------
Provision (benefit) for income taxes............... $11,943 $8,844 $ (673)
======= ====== ======
33
35
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets (liabilities) consisted of the following at December
31:
1999 1998
---- ----
(IN THOUSANDS)
Current deferred tax assets:
Deferred revenue.......................................... $1,321 $1,334
Expenses not currently deductible......................... 1,238 908
------ ------
Net current deferred tax assets............................. 2,559 2,242
------ ------
Noncurrent deferred tax assets (liabilities):
Deferred revenue.......................................... 470 458
Operating losses.......................................... 201 155
Depreciation and amortization............................. (39) (43)
Intangibles............................................... 1,569 1,221
Other..................................................... 96 (144)
------ ------
Net noncurrent deferred tax assets.......................... 2,297 1,647
------ ------
Total deferred tax assets................................... $4,856 $3,889
====== ======
No valuation allowance has been recorded as the net deferred tax asset
related to the operating losses is assumed to be realizable through the future
profitable operations of subsidiaries. The tax operating loss carryforwards
expire between 2011 and 2015.
Prior to September 29, 1997, the shareholders of ALS and the Institute had
elected to have these companies treated as "S corporations" under the Internal
Revenue Code. As an S corporation, a company's taxable income or loss is
included in the individual tax returns of its shareholders for federal and state
income tax purposes. Accordingly, the financial statements do not include any
provision or liability for current or deferred federal or state income taxes
related to ALS or the Institute for any periods prior to September 29, 1997.
IPS was taxed as a C corporation under the provisions of the Internal
Revenue Code and similar state tax laws from the time of its acquisition on
August 1, 1996 through December 31, 1996. Subsequently, IPS elected to be taxed
as an S corporation effective January 1, 1997. Consequently, the deferred tax
asset recognized in 1996 was written off in 1997.
On September 29, 1997, the Company became subject to federal and state
income taxes as a C corporation and, therefore, is now required to account for
income taxes in accordance with Statement of Financial Accounting Standards No.
109 ("SFAS 109") "Accounting for Income Taxes". In connection with this change
in the Company's tax status, SFAS 109 required the Company to record deferred
taxes on the balance sheet for all book to tax basis differences existing on the
date of change to C corporation status. The financial statement effect of
recording the basis differences resulted in recognition of a deferred tax asset
and corresponding tax benefit of $3.5 million in 1997.
(7) LINE OF CREDIT
The Company has a $10.0 million unsecured revolving line of credit with a
bank which is available until March 31, 2000, and which is expected to be
extended for an additional year. 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 December 31, 1999, the
line of credit had not been used.
34
36
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(8) LEASE COMMITMENTS
The Company is party to various operating leases for equipment and for
office facilities at some of its subsidiaries. Rent expense for 1999, 1998 and
1997 was approximately $468,000, $439,000 and $222,000, respectively.
Future approximate minimum rental payments (including estimated operating
costs) required under the operating leases as of December 31, 1999 are as
follows:
(IN THOUSANDS)
2000........................................................ $684
2001........................................................ 633
2002........................................................ 439
2003........................................................ 154
2004........................................................ 2
(9) DEFINED CONTRIBUTION BENEFIT PLAN
The Company has a defined contribution 401(k) benefit plan covering all of
its full-time employees meeting certain service requirements. The plan provides
for matching employer contributions based on 66% of employees' elective
contributions up to 6% of compensation. The plan allows employee contributions
of up to 15% of compensation. Discretionary employer contributions may also be
made to the plan. There were no discretionary contributions made in 1999, 1998
or 1997. Expense under the plan totaled approximately $564,000 in 1999, $370,000
in 1998 and $297,000 in 1997.
(10) PHANTOM STOCK PLAN
As an incentive for certain key employees, ALS had a phantom stock plan. A
total of 585 phantom shares were issued prior to termination of the plan. Under
the terms of the plan, the completion of the Company's initial public offering
in 1997 (the "Offering") triggered a payout and termination of the plan. Under
the plan, each phantom share was paid an amount equal to .001% of the market
capitalization immediately after completion of the Offering. This resulted in
phantom stock plan termination expense of approximately $1.6 million in 1997.
(11) STOCK OPTION PLAN
The Company has established the 1997 Stock Incentive Plan for its officers,
key employees, non-employee directors and consultants. A combined maximum of
3,000,000 options, SARs and share awards may be granted under the plan. Of this
amount, not more than 1,500,000 shares may be subject to incentive stock
options. The exercise price of the stock options is the market value of the
common stock at the date of grant. Generally, the options vest and become
exercisable ratably over a four-year period, commencing one year after the grant
date. The options expire 10 years from the grant date.
Had compensation cost been determined for the Company's stock option
portion of the plan based on the fair value at the grant dates for awards
consistent with the alternative method set forth under SFAS 123, the
35
37
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company's net income and earnings per share would have been adjusted to the pro
forma amounts indicated below:
1999 1998 1997
---- ---- ----
(IN THOUSANDS EXCEPT
PER SHARE AMOUNTS)
Net income:
As reported..................................... $17,146 $12,192 $9,466
Pro forma....................................... 14,558 11,237 9,208
Diluted net income per common share:
As reported..................................... $ 0.50 $ 0.36 $ 0.32
Pro forma....................................... 0.42 0.33 0.32
The weighted average fair value of options granted
under the Plan during the year is:.............. $ 16.94 $ 10.91 $ 5.60
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for 1999, 1998 and 1997, respectively: dividend yield of 0%,
expected volatility of 76.73%, 58.94% and 48.14%, risk-free interest rates of
6.23%, 5.14% and 6.31%, and expected lives of 10 years for the options.
As of December 31, 1999, no SARs or share awards have been granted under
the plan. A summary of stock option activity under the plan for 1999, 1998 and
1997 is as follows:
1999 1998 1997
--------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------ -------- ------ --------
Outstanding at beginning of year..... 779,476 $11.66 479,910 $ 8.22 -- $ --
Granted.............................. 642,488 20.77 422,952 14.88 490,536 8.21
Exercised............................ (102,902) 8.95 (30,814) 8.00 -- --
Cancelled............................ (47,794) 18.19 (92,572) 9.70 (10,626) 8.00
--------- ------ ------- ------ ------- -----
Outstanding at end of year........... 1,271,268 16.24 779,476 11.66 479,910 8.22
========= ====== ======= ====== ======= =====
Options exercisable at end of year... 252,157 11.05 95,135 8.24 -- --
========= ====== ======= ====== ======= =====
(12) EMPLOYEE STOCK PURCHASE PLAN
Effective July 1, 1998, the Company adopted an Employee Stock Purchase Plan
which allows employees to purchase shares of common stock through payroll
deductions, up to 10% of eligible compensation. The purchase price is equal to
85% of the fair market value of the common stock on either the first or last day
of the subscription period, whichever is lower. A total of 500,000 shares are
available for purchase under the plan. The Company has elected to apply
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees", in accounting for its stock-based plans. Accordingly, the Company
will not recognize compensation expense for employee stock purchases. The
Company issued approximately 51,500 and 18,800 shares of common stock in January
2000 and January 1999 with respect to the plan, at a per share price,
representing 85% of the fair market value as described above, of $9.51 and
$11.85, respectively.
(13) SHAREHOLDERS' EQUITY
On January 3, 2000, the Company's Board of Directors authorized the
repurchase of up to 1,000,000 shares of the Company's common stock. No time
limit was placed on the duration of the repurchase program.
36
38
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Repurchased shares will become treasury shares and will be used for stock-based
employee benefit plans and for other general corporate purposes.
On April 14, 1999, the Company's shareholders approved an amendment to the
Company's Amended and Restated Articles of Incorporation to increase the
authorized common stock of the Company from 50,000,000 shares to 150,000,000
shares with a $.01 par value per share. The Company's Amended and Restated
Articles of Incorporation also includes authorization to issue up to 5,000,000
shares of preferred stock with a $.01 par value per share. No preferred stock
has 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.
In 1997, a 133.31-for-1 stock split was effected in the form of two common
stock dividends which took place on March 28 and August 21, 1997. Also, in 1997,
640,266 shares of common stock were issued in exchange for all of the
outstanding shares of the Institute and IPS. Accordingly, shares issued and
outstanding on the face of the balance sheet and all historical weighted average
share and per share amounts have been restated to reflect the stock split and
the common stock issued in exchange for the shares of the Institute and IPS.
The Company issued a total of 6,440,000 common shares during 1997 in a
public offering (see Note 14). As of December 31, 1999, 3,500,000 common shares
were reserved for issuance under employee benefit plans (see Notes 11 and 12).
(14) OFFERING OF COMMON STOCK
On September 30, 1997, the Company completed the Offering of 5,600,000
shares of common stock. As a result of this Offering, the Company received net
cash proceeds of $41,664,000 on the September 30, 1997 closing date. In
addition, the Company incurred approximately $941,000 in costs associated with
the Offering. This resulted in a net increase to shareholders' equity of
$40,723,000. Subsequently, on October 2, 1997, an additional 840,000 shares of
the Company's common stock were sold pursuant to the exercise of an over-
allotment option granted in connection with the Offering. The Company received
additional net proceeds of $6,249,200 in connection with the exercise of this
over-allotment option, all of which was accounted for as an increase to
shareholders' equity.
From September 1997 through December 31, 1999, the proceeds from the
Offering were used as follows:
- Approximately $1.6 million was used to pay compensation expenses related
to the termination of the Company's phantom stock plan.
- 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.
- 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.
- Approximately $10.9 million was used to pay distributions of S
corporation retained profits to S corporation shareholders.
- 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.
- Approximately $2.4 million was used for pilot operations in various
markets and miscellaneous acquisitions.
- Approximately $2.7 million was used for capital expenditures for
expansion of operations.
37
39
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(15) 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 system 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 accounting policies of the reportable segments are the same as those
described in Note 4 of Notes to Financial Statements. 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.
38
40
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Summarized financial information concerning the Company's reportable
segments is shown in the following table:
SOFTWARE TRAINING TOTAL
-------- -------- -----
(IN THOUSANDS)
1999
Revenues.................................................. $72,169 $11,419 $83,588
Operating income(1)....................................... 29,966 (1,864) 28,102
Total assets.............................................. 75,665 12,754 88,419
Capital expenditures...................................... 5,528 1,739 7,267
Depreciation and amortization............................. 2,548 697 3,245
1998
Revenues.................................................. $47,243 $ 7,905 $55,148
Operating income(1)....................................... 20,170 (274) 19,896
Total assets.............................................. 56,764 11,516 68,280
Capital expenditures...................................... 1,098 7,396 8,494
Depreciation and amortization............................. 1,917 212 2,129
1997
Revenues.................................................. $30,388 $ 5,926 $36,314
Operating income(1)....................................... 10,386 105 10,491
Total assets.............................................. 49,504 1,673 51,177
Capital expenditures...................................... 1,404 402 1,806
Depreciation and amortization............................. 1,386 116 1,502
- -------------------------
(1) Operating income Total differs from Operating income in the Consolidated
Statements of Income due to nonrecurring items not included above:
$1,080,000 and $475,000 purchased research and development in 1999 and 1998,
respectively, and $1.6 million phantom stock plan termination in 1997.
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.
(16) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth unaudited consolidated income statement data
for each quarter of the Company's last two fiscal years. The unaudited quarterly
financial information has been prepared on the same basis as the annual
information presented in the financial statements and, in management's opinion,
reflects all
39
41
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
adjustments (consisting of normal recurring entries) necessary for a fair
presentation of the information provided. The operating results for any quarter
are not necessarily indicative of results for any future period.
QUARTER ENDED
-------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
1999:
Net sales................................. $18,589 $20,551 $22,989 $21,459
Gross profit.............................. 15,281 17,153 18,747 17,082
Operating income.......................... 6,687 7,264 8,899 4,172
Income tax provision...................... 3,001 3,343 3,674 1,925
Net income................................ 4,256 4,588 5,436 2,866
Basic earnings per share.................. 0.13 0.13 0.16 0.08
Diluted earnings per share................ 0.12 0.13 0.16 0.08
Common stock price per share:
High................................... 41.500 31.625 33.000 29.438
Low.................................... 28.531 16.875 16.563 10.500
1998:
Net sales................................. $10,735 $11,864 $15,104 $17,445
Gross profit.............................. 8,861 9,923 12,803 14,690
Operating income.......................... 2,680 3,329 6,034 7,378
Income tax provision...................... 1,347 1,552 2,676 3,269
Net income................................ 1,830 2,250 3,806 4,306
Basic and diluted earnings per share...... 0.05 0.07 0.11 0.13
Common stock price per share:
High................................... 17.188 19.375 20.250 33.188
Low.................................... 10.719 12.375 12.000 16.375
- -------------------------
1. In connection with the acquisition of computerActive, $900,000 of the
purchase price was allocated to purchased research and development which
was expensed in December 1999 (see Note 3).
2. In connection with the acquisition of Humanities, $180,000 of the
purchase price was allocated to purchased research and development which
was expensed in June 1999 (see Note 3).
3. In July 1999, in connection with the acquisition of Generation21, the
Company incurred acquisition charges of $365,000 before tax. The
acquisition was accounted for as a pooling-of-interests and accordingly,
results for 1998 and the first two quarters of 1999 have been restated
to include the results of Generation21 (see Note 3).
4. Per share data have been restated to reflect a 2-for-1 stock split in
the form of a dividend effective February 26, 1999 (see Note 13).
5. In connection with the acquisition of Logicus, $475,000 of the purchase
price was allocated to purchased research and development which was
expensed in June 1998 (see Note 3).
40
42
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers. Reference is made to "Executive Officers of the
Registrant" in Part I hereof.
(b) Directors. The information required by this Item is set forth in the
Company's Proxy Statement for the Annual Meeting of Shareholders to be held on
April 19, 2000 under the caption "Election of Directors," which information is
incorporated by reference herein.
(c) Section 16 Compliance. The information required by this Item is set
forth in the Company's Proxy Statement for the Annual Meeting of Shareholders to
be held on April 19, 2000 under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance," which information is incorporated by reference herein.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Company's Proxy
Statement for the Annual Meeting of Shareholders to be held on April 19, 2000
under the captions "Executive Compensation," "Non-Employee Director
Compensation," "Compensation Committee Report," and "Performance Graph," which
information is incorporated by reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the Company's Proxy
Statement for the Annual Meeting of Shareholders to be held on April 19, 2000
under the caption "Security Ownership of Management and Certain Beneficial
Owners," which information is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
41
43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS.
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Income for the years ended December 31, 1999,
1998 and 1997
Consolidated Statements of Equity for the years ended December 31, 1999,
1998 and 1997
Consolidated Statements of Cash Flows for the years ended December 31,
1999, 1998 and 1997
Notes to Financial Statements
(A)(2) FINANCIAL STATEMENT SCHEDULES.
See the Exhibit Index, which is incorporated by reference herein.
(A)(3) EXHIBITS.
See (c) below.
(B) REPORTS ON FORM 8-K.
A report on Form 8-K dated December 14, 1999 was filed under Items 5 and 7
(no financial statements were filed). The report contains a press release
relating to earnings.
A report on Form 8-K dated December 30, 1999 was filed under Items 5 and 7
(no financial statements were filed). The report contains two press releases,
one relating to the Company's computerActive, Inc. acquisition and the other
relating to the Company's stock repurchase plan.
(C) EXHIBITS.
See the Exhibit Index, which is incorporated by reference herein.
(D) FINANCIAL STATEMENTS EXCLUDED FROM ANNUAL REPORT TO SHAREHOLDERS.
Not applicable.
42
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ MICHAEL H. BAUM
------------------------------------
Michael H. Baum
Chief Executive Officer
Date: March 1, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
NAME TITLE DATE
---- ----- ----
/s/ MICHAEL H. BAUM Chief Executive Officer
- -------------------------------------------------------- and a Director (Principal
Michael H. Baum Executive Officer) March 1, 2000
/s/ STEVEN A. SCHMIDT Secretary, Vice President
- -------------------------------------------------------- and Chief Financial
Steven A. Schmidt Officer (Principal March 1, 2000
Financial and Accounting
Officer)
Directors: Judith A. Paul, Terrance D. Paul, John R. Hickey, Timothy P. Welch, Perry S. Akins and
John H. Grunewald
By: /s/ MICHAEL H. BAUM March 1, 2000
-----------------------------------------------
Michael H. Baum
Attorney-In-Fact*
- -------------------------
*Pursuant to authority granted by powers of attorney, copies of which are filed
herewith.
43
45
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT
------- -------
3.1 Amended and Restated Articles of Incorporation of Advantage
Learning Systems, Inc., as amended.(7)
3.2 Amended and Restated By-laws of Advantage Learning Systems,
Inc.(1)
4.1 Form of Stock Certificate.(2)
10.1 Asset Purchase Agreement dated as of August 1, 1996 by and
among IPS Acquisition, Inc., IPS Publishing, Inc. and
Timothy P. Welch, individually and as sole Trustee of the
Timothy P. Welch Revocable Trust.(1)
10.2 Supplement to Asset Purchase Agreement dated as of February
25, 1997, by and among IPS Publishing, Inc. (f/k/a IPS
Acquisition, Inc.), Welch Publishing, Inc. (f/k/a IPS
Publishing, Inc.) and Timothy P. Welch, individually and as
sole Trustee of the Timothy P. Welch Revocable Trust.(1)
10.3 Employment Agreement between IPS Publishing, Inc. (f/k/a IPS
Acquisition, Inc.) and Timothy P. Welch dated as of August
1, 1996.(1)*
10.4 1997 Stock Incentive Plan (as amended and restated).(3)*
10.5 Advantage Learning Systems, Inc. Phantom Stock Plan.(1)*
10.6 Institute for Academic Excellence, Inc. Phantom Stock
Plan.(1)*
10.7 Accelerated Reader Resale Agreement dated May 1, 1994,
between Advantage Learning Systems, Inc. and Perma-Bound, a
division of Hertzberg-New Method, Inc.(1)
10.8 Promissory Note dated August 1, 1996 in the principal amount
of $2,350,000 from IPS Publishing, Inc. to Judith A.
Paul.(1)
10.9 Promissory Note dated August 1, 1996 in the principal amount
of $2,350,000 from IPS Publishing, Inc. to Terrance D.
Paul.(1)
10.10 Credit Agreement dated as of December 31, 1997, by and
between Norwest Bank Wisconsin, National Association and
Advantage Learning Systems, Inc.(4)
10.11 Tax Indemnification Agreement between Terrance Paul, Judith
Paul, Mark J. Bradley, as Trustee of the Terrance and Judith
Paul Descendants' Trust, and Advantage Learning Systems,
Inc.(2)
10.12 Tax Indemnification Agreement between Terrance Paul, Judith
Paul, Mark J. Bradley, as Trustee of the Terrance and Judith
Paul Descendants' Trust, and the Institute for Academic
Excellence, Inc.(2)
10.13 Advantage Learning Systems, Inc. Employee Stock Purchase
Plan.(5)*
10.14 Office Lease dated as of December 17, 1998 by and between
Athena Holdings LLC and Institute for Academic Excellence,
Inc.(6)
10.15 Real Estate Mortgage dated December 17, 1998 between Athena
Holdings LLC and Advantage Learning Systems, Inc.(6)
10.16 Expense Allocation Agreement dated October 19, 1999 between
Advantage Learning Systems, Inc., Judith A. Paul and
Terrance D. Paul.
21.1 Subsidiaries of Advantage Learning Systems, Inc.
23.1 Consent of Arthur Andersen LLP.
24.1 Directors' Powers of Attorney.
27.1 Financial Data Schedule.
99.1 Schedule II -- Valuation and Qualifying Accounts.
- -------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-22519).
(2) Incorporated by reference to the Company's Form 10-Q for the quarter ended
September 30, 1997 (SEC File No. 0-22187).
46
(3) Incorporated by reference to the Company's Form S-8 filed on October 28,
1997 (Registration No. 333-38867).
(4) Incorporated by reference to the Company's Form 10-K for the fiscal year
ended December 31, 1997 (SEC File No. 0-22187).
(5) Incorporated by reference to the Company's Proxy Statement for the 1999
Annual Meeting of shareholders.
(6) Incorporated by reference to the Company's Form 10-K for the fiscal year
ended December 31, 1998 (SEC File No. 0-22187).
(7) Incorporated by reference to the Company's Form 10-Q for the quarter ended
March 31, 1999 (SEC File No. 0-22187).
* Management contracts or compensatory plans or arrangements.