-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NMs6ucPOrJ/cdtUxnL+hUzx0kNboly9gTRaflxjQQtpliplutFW1NuEIMW48Xx2E yNSaQbdwyZ8oEA51MXiJIA== 0000950124-00-001117.txt : 20000310 0000950124-00-001117.hdr.sgml : 20000310 ACCESSION NUMBER: 0000950124-00-001117 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000309 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANTAGE LEARNING SYSTEMS INC CENTRAL INDEX KEY: 0001030484 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 391559474 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22187 FILM NUMBER: 564260 BUSINESS ADDRESS: STREET 1: 2911 PEACH STREET STREET 2: PO BOX 8036 CITY: WISCONSIN RAPIDS STATE: WI ZIP: 54495-8036 BUSINESS PHONE: 7154243636 MAIL ADDRESS: STREET 1: PO BOX 8361 CITY: WISCONSIN RAPIDS STATE: WI ZIP: 54495 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ [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. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 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 - ------------------------- * 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. 3 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. - ------------------------- * Literacy Skills(TM) is a common law trademark of the Company. 2 4 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. 3 5 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. 4 6 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. 5 7 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 6 8 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 7 9 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 8 10 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 11 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. 10 12 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.
11 13
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. 12 14 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. 13 15 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. 14 16 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. 15 17 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 16 18 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% ===== ===== =====
17 19 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. 18 20 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. 24 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. 25 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. 26 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. 27 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 28 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. EX-10.16 2 EXPENSE ALLOCATION AGREEMENT 1 EXHIBIT 10.16 October 19, 1999 The Board of Directors Advantage Learning Systems, Inc. 2911 Peach Street Wisconsin Rapids, WI 54495-8036 Ladies and Gentlemen: As you are aware, we have in the past several months considered the sale of some of our shares of Common Stock of Advantage Learning Systems, Inc. in a public offering (a "secondary offering"). One of our primary reasons for considering a secondary offering was the advice we have received that a secondary offering would be beneficial to the market for ALSI Common Stock. While we have determined not to go forward with a secondary offering at this time, we believe it would be beneficial to ALSI and to us to set forth the expense allocation with respect to a secondary offering if we should determine to proceed with such a transaction in the future. Based upon our mutual expectation that a secondary offering will be beneficial both to us and to ALSI, we and ALSI hereby agree that the expenses of any secondary offering of our ALSI Common Stock will be allocated as follows: ALSI will bear the following expenses: - registration and filing fees, and fees and expenses of compliance with securities or blue sky laws, - printing and printing related expenses, - fees and disbursements of counsel for ALSI, - fees and disbursements of accountants, - travel costs (to the extent not paid or reimbursed by third parties), - the expenses and fees for listing or admitting the ALSI Common Stock to be sold on The Nasdaq Stock Market, and - other incidental costs. 2 We (Terrance D. Paul and Judith A. Paul) will bear the following expenses: - underwriting discounts and commissions relating to the sale of our shares of ALSI Common Stock, and - the fees and expenses of separate counsel, if any, that we retain to represent us. All parties acknowledge that this letter agreement does not obligate ALSI or the Pauls to proceed with any secondary offering. This letter agreement only sets forth the expense allocation if the parties determine to proceed with a secondary offering. This agreement shall be governed and construed in accordance with the laws of Wisconsin. If you are in agreement with the foregoing, please sign and return one copy of this letter which will constitute an agreement with respect to the subject matter of this letter. Very truly yours, /s/ Judith A. Paul ----------------------- Judith A. Paul /s/ Terrance D. Paul ----------------------- Terrance D. Paul Agreed: ADVANTAGE LEARNING SYSTEMS, INC. By: /s/ Michael H. Baum --------------------------- Michael H. Baum Chief Executive Officer EX-21.1 3 SUBIDIARIES OF ADVANTAGE LEARNING SYSTEMS 1 EXHIBIT 21.1 SUBSIDIARIES OF ADVANTAGE LEARNING SYSTEMS, INC. (As of March 1, 2000)
Name Jurisdiction of Organization - ---- ---------------------------- Advantage Learning Systems Australia Proprietary Limited Australia Advantage Learning Systems India Private Limited India Advantage Learning Systems of Canada Co. Nova Scotia, Canada Advantage Learning Systems UK Limited United Kingdom ALS Holdings, Inc. Nevada Athena Holdings LLC Wisconsin Generation21 Learning Systems, LLC Massachusetts Institute for Academic Excellence, Inc. Wisconsin IPS Publishing, Inc. Washington
EX-23.1 4 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K into Advantage Learning Systems, Inc.'s previously filed Registration Statements on Form S-8, File Nos. 333-38867 and 333-53557, and Form S-3, File Nos. 333-82743 and 333-94533. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Milwaukee, Wisconsin, March 8, 2000 EX-24.1 5 DIRECTORS' POWERS OF ATTORNEY 1 EXHIBIT 24.1 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as her true and lawful attorney-in-fact for the purpose of: (i) executing in her name and on her behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in her name and on her behalf in her capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming her signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ Judith A. Paul ------------------------------------ Judith A. Paul 2 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as his true and lawful attorney-in-fact for the purpose of: (i) executing in his name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in his name and on his behalf in his capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming his signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ Terrance D. Paul ------------------------------------- Terrance D. Paul 3 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as his true and lawful attorney-in-fact for the purpose of: (i) executing in his name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in his name and on his behalf in his capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming his signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ Michael M. Baum ------------------------------------ Michael H. Baum 4 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as his true and lawful attorney-in-fact for the purpose of: (i) executing in his name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in his name and on his behalf in his capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming his signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ John R. Hickey ------------------------------------ John R. Hickey 5 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as his true and lawful attorney-in-fact for the purpose of: (i) executing in his name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in his name and on his behalf in his capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming his signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ Timothy P. Welch ------------------------------------- Timothy P. Welch 6 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as his true and lawful attorney-in-fact for the purpose of: (i) executing in his name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in his name and on his behalf in his capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming his signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ Perry S. Akins ------------------------------------ Perry S. Akins 7 DIRECTOR'S POWER OF ATTORNEY (1999 Form 10-K) The undersigned director of Advantage Learning Systems, Inc. designates each of Michael H. Baum and Steven A. Schmidt, with the power of substitution, as his true and lawful attorney-in-fact for the purpose of: (i) executing in his name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the fiscal year ended December 31, 1999 and any related amendments and/or supplements; (ii) generally doing all things in his name and on his behalf in his capacity as a director to enable Advantage Learning Systems, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission; and (iii) ratifying and confirming his signature as it may be signed by the attorney-in-fact to the Form 10-K and any related amendments and/or supplements. Dated this 15th day of February, 2000. /s/ John H. Grunewald ------------------------------------- John H. Grunewald EX-27.1 6 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1999 DEC-31-1999 23,016 18,012 12,996 1,200 1,707 58,669 29,509 5,253 88,419 11,746 0 0 0 342 74,593 88,419 67,608 83,588 7,768 15,325 41,241 0 45 29,089 11,943 17,146 0 0 0 17,146 .50 .50
EX-99.1 7 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS 1 EXHIBIT 99.1 Schedule II - Valuation and Qualifying Accounts
ADDITIONS DEDUCTIONS BEGINNING CHARGED TO CHARGED TO ENDING BALANCE INCOME RESERVE BALANCE ---------------- ----------------- ----------------- --------------- Accounts receivable allowances - 1999 $1,058,000 $3,166,000 $3,024,000 $1,200,000 Accounts receivable allowances - 1998 638,000 2,954,000 2,534,000 1,058,000 Accounts receivable allowances - 1997 161,000 2,790,000 2,313,000 638,000
2 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS We have audited in accordance with generally accepted auditing standards the financial statements included in Advantage Learning Systems, Inc.'s annual report to shareholders included in this Form 10-K, and have issued our report thereon dated January 21, 2000. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index above as Exhibit 99.1 is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commissions rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Milwaukee, Wisconsin January 21, 2000 -----END PRIVACY-ENHANCED MESSAGE-----