10-Q 1 c58296e10-q.txt FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000. [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM .........TO.......... COMMISSION FILE NUMBER: 0-22187 ADVANTAGE LEARNING SYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) WISCONSIN 39-1559474 (STATE OR OTHER (IRS EMPLOYER JURISDICTION OF INCORPORATION) IDENTIFICATION NO.) PO BOX 8036 2911 PEACH STREET WISCONSIN RAPIDS, WISCONSIN (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) 54495-8036 (ZIP CODE) (715) 424-3636 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. OUTSTANDING AT CLASS OCTOBER 31, 2000 ----- ---------------- Common Stock, $0.01 par value 34,252,792 2 ADVANTAGE LEARNING SYSTEMS, INC. INDEX TO FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000

PART I - FINANCIAL INFORMATION Page Number ------ ITEM 1. FINANCIAL STATEMENTS Unaudited Consolidated Balance Sheets at September 30, 2000 and December 31, 1999 ........................................ 1 Unaudited Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2000 and 1999 .................................. 2 Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2000 and 1999...................... 3 Notes to Unaudited Consolidated Financial Statements................... 4 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................. 6 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......................................................... 10 PART II - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................ 11 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ..................................... 11

- Index - 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements ADVANTAGE LEARNING SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED)

September 30, December 31, 2000 1999 --------------------------- -------------------------- (In thousands) ASSETS Current assets: $ $ Cash and cash equivalents 24,048 23,016 Investment securities 37,555 18,012 Accounts receivable, less allowance of $1,321,000 in 2000 and $1,200,000 in 1999 12,963 11,796 Inventories 1,079 1,707 Prepaid expenses 1,492 1,287 Prepaid income taxes - 292 Deferred tax asset 2,871 2,559 Other current assets 299 - --------------------------- -------------------------- Total current assets 80,307 58,669 Property, plant and equipment, net 24,752 24,256 Deferred tax asset 2,274 2,297 Intangibles, net 2,125 2,702 Capitalized software, net 339 495 --------------------------- -------------------------- Total assets $ 109,797 $ 88,419 =========================== ========================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,955 $ 2,521 Deferred revenue 4,619 4,852 Payroll and employee benefits 2,975 1,981 Income taxes payable 3,065 - Other current liabilities 3,398 2,392 --------------------------- -------------------------- Total current liabilities 16,012 11,746 Deferred revenue 1,451 1,485 --------------------------- -------------------------- Total liabilities 17,463 13,231 Minority interest 184 253 Shareholders' equity 92,150 74,935 ---------------------------- -------------------------- Total liabilities and shareholders' equity $ 109,797 $ 88,419 ============================ ==========================

See accompanying notes to consolidated financial statements. -1- 4 ADVANTAGE LEARNING SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Three Months Nine Months Ended September 30, Ended September 30, 2000 1999 2000 1999 -------------- -------------- --------------- -------------- (In thousands, except per share amounts) Net sales: Products $ 23,236 $ 17,785 $ 63,803 $ 49,810 Services 5,821 5,203 15,746 12,318 -------- -------- -------- -------- Total net sales 29,057 22,988 79,549 62,128 -------- -------- -------- -------- Cost of sales: Products 3,061 2,049 8,458 5,526 Services 2,719 2,192 7,936 5,421 -------- -------- -------- -------- Total cost of sales 5,780 4,241 16,394 10,947 -------- -------- -------- -------- Gross profit 23,277 18,747 63,155 51,181 Operating expenses: Product development 4,127 2,332 11,135 5,687 Selling and marketing 5,367 4,801 18,129 15,189 General and administrative 2,962 2,716 8,825 7,276 Purchased research and development - - - 180 -------- -------- -------- -------- Total operating expenses 12,456 9,849 38,089 28,332 -------- -------- -------- -------- Operating income 10,821 8,898 25,066 22,849 Other income (expense): Interest income 837 397 2,078 1,209 Other, net 13 (185) 276 240 -------- -------- -------- -------- Income before taxes 11,671 9,110 27,420 24,298 Income taxes 4,492 3,674 10,707 10,018 -------- -------- -------- -------- Net income $ 7,179 $ 5,436 $ 16,713 $ 14,280 ======== ======== ======== ======== Basic and diluted earnings per share $ 0.21 $ 0.16 $ 0.49 $ 0.42 ======== ======== ======== ========

See Accompanying notes to consolidated financial statements. -2- 5 ADVANTAGE LEARNING SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Nine Months Ended September 30, 2000 1999 ----------------------- ---------------------- (In thousands) Reconciliation of net income to net cash provided by operating activities: Net income $ 16,713 $ 14,280 Noncash (income) expenses included in net income - Depreciation and amortization 3,371 2,213 Purchased research and development - 180 Deferred income taxes (289) 43 Change in assets and liabilities - Accounts receivable (1,174) (2,266) Inventory 628 (437) Prepaid expenses 87 (714) Accounts payable and other current liabilities 4,527 (708) Deferred revenue (267) 232 Other current assets (292) - Other (27) (35) --------------- ------------- Net cash provided by operating activities 23,277 12,788 --------------- ------------- Cash flows provided by (used in) investing activities: Purchase of property, plant and equipment (3,031) (5,967) Proceeds from (purchase of) short-term investments, net (19,542) 18,869 Capitalized software development costs (110) (350) Acquisition - (920) --------------- ------------- Net cash provided by (used in) investing activities (22,683) 11,632 --------------- ------------- Cash flows provided by financing activities: Proceeds from issuance of stock 490 222 Return of capital to minority interest (60) - Purchase of treasury stock (325) - Proceeds from exercise of stock options 333 492 --------------- ------------- Net cash provided by financing activities 438 714 --------------- ------------- Net increase in cash 1,032 25,134 Cash and cash equivalents, beginning of period 23,016 14,264 --------------- ------------- Cash and cash equivalents, end of period $ 24,048 $ 39,398 =============== =============

See accompanying notes to consolidated financial statements. -3- 6 ADVANTAGE LEARNING SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. CONSOLIDATION The consolidated financial statements include the financial results of Advantage Learning Systems, Inc. ("ALS") and its consolidated subsidiaries (collectively the "Company"). All significant intercompany transactions have been eliminated in the consolidated financial statements. In September of 2000, the Company announced plans to change its corporate name to Renaissance Learning, Inc. While the Company immediately commenced doing business as Renaissance Learning, Inc., the formal legal name change is subject to shareholder approval at the Company's 2001 annual meeting in April. After shareholder approval of the new name, the Company expects to change its stock trading symbol. A new symbol has not yet been announced. 2. BASIS OF PRESENTATION The consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results of the interim periods, and are presented on an unaudited basis. These financial statements should be read in conjunction with the Company's financial information contained in the Company's Annual Report on Form 10-K which is on file with the U.S. Securities and Exchange Commission. Effective July 1, 1999, the Company acquired Generation21 Learning Systems LLC ("Generation21"), a training and knowledge management enterprise software firm in Golden, Colorado. The transaction was accounted for as a pooling-of-interests. Accordingly, financial information for all periods presented has been restated to include the results of Generation21. The results of operations for the three and nine month periods ended September 30, 2000 and 1999 are not necessarily indicative of the results to be expected for the full year. 3. EARNINGS PER COMMON SHARE Basic earnings per common share has been computed based on the weighted average number of common shares outstanding. Diluted earnings per common share has been computed based on the weighted average number of common shares outstanding, increased by the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. 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. Repurchased shares will become treasury shares and will be used for stock-based employee benefit plans and for other general corporate purposes. As of September 30, 2000, the Company had repurchased 25,100 shares. The weighted average shares outstanding during the three months and nine months ended September 30, 2000 and 1999 are as follows:

Three Months Ended September 30, Nine Months Ended September 30, 2000 1999 2000 1999 ---------------- ---------------- --------------- ----------------- Basic Weighted Average Shares 34,220,030 34,085,015 34,218,268 34,059,477 Impact of Stock Options 282,360 240,368 168,681 267,798 Diluted Weighted Average Shares 34,502,390 34,325,383 34,386,949 34,327,275

-4- 7 4. SEGMENT REPORTING The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The Company has two reportable segments: software and training. The software segment produces learning information systems software for the K-12 school market in the United States, Canada, the United Kingdom and Australia. 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 training and knowledge management enterprise software, which is currently sold primarily to corporate customers. Revenue from the software segment includes product revenue from the sale of software and service revenue from the sale of software support agreements. The training segment provides professional development training seminars. Its programs train educators on how to accelerate learning in the classroom through use of the information that the Company's learning information systems provide. Revenue from the training segment includes service revenue from a variety of seminars presented in hotels and schools across the country, and product revenue from training materials. The Company evaluates the performance of its operating segments based on operating income before nonrecurring items. Intersegment sales and transfers and revenue derived outside of the United States are not significant. Summarized financial information concerning the Company's reportable segments is shown in the following table:

Three Months Ended Nine Months Ended September 30, September 30, 2000 1999 2000 1999 -------------- ------------- -------------- -------------- (In thousands) Revenues: Software $ 24,358 $ 18,852 $ 67,044 $ 53,462 Training 4,699 4,136 12,505 8,666 -------------- ------------- ------------- -------------- Total revenues $ 29,057 $ 22,988 $ 79,549 $ 62,128 ============== ============= ============= ============== Operating income: Software $ 10,049 $ 8,320 $ 24,947 $ 23,907 Training 772 578 119 (878) -------------- ------------- ------------- -------------- Total operating income (1) $ 10,821 $ 8,898 $ 25,066 $ 23,029 ============== ============= ============= ==============

(1) Total operating income differs from Operating income in the Consolidated Statements of Income due to a nonrecurring charge of $180,000 for purchased research and development in the second quarter of 1999 not included above. 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. Effective January 1, 2000, the Company re-evaluated and changed certain cost allocations between the software and training segments. The result of the re-evaluation on previously reported segment disclosures is not material. 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. 5. COMPREHENSIVE INCOME Total comprehensive income was $ 16,689,000 and $14,281,000 in the first nine months of 2000 and 1999, respectively. The Company's comprehensive income includes foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. -5- 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table sets forth certain consolidated income statement data as a percentage of net sales, except that individual components of costs of sales and gross profit are shown as a percentage of their corresponding component of net sales:

Three Months Nine Months Ended September 30, Ended September 30, 2000 1999 2000 1999 ----------------- ----------------- ---------------- --------------- Net Sales: Products 80.0 % 77.4 % 80.2 % 80.2 % Services 20.0 22.6 19.8 19.8 ----------------- ----------------- -------------- -------------- Total net sales 100.0 % 100.0 % 100.0 % 100.0 % ================= ================= ============== ============== Cost of sales: Products 13.2 % 11.5 % 13.3 % 11.1 % Services 46.7 42.1 50.4 44.0 Total cost of sales 19.9 18.4 20.6 17.6 Gross profit: Products 86.8 88.5 86.7 88.9 Services 53.3 57.9 49.6 56.0 Total gross profit 80.1 81.6 79.4 82.4 Operating expenses: Product development 14.2 10.1 14.0 9.2 Selling and marketing 18.5 20.9 22.8 24.4 General and administrative 10.2 11.8 11.1 11.7 Purchased research and development 0.0 0.0 0.0 0.3 ----------------- ----------------- ---------------- -------------- Total operating expenses 42.9 42.8 47.9 45.6 ----------------- ----------------- ---------------- -------------- Operating income 37.2 38.8 31.5 36.8 Other income (expense): Interest income 2.9 1.7 2.6 1.8 Other, net 0.1 -0.9 0.4 0.5 ----------------- ----------------- ---------------- -------------- Total other income 3.0 0.8 3.0 2.3 ----------------- ----------------- ---------------- -------------- Income before taxes 40.2 39.6 34.5 39.1 Income taxes 15.5 16.0 13.5 16.1 ----------------- ----------------- ---------------- -------------- Net income 24.7 % 23.6 % 21.0 % 23.0 % ================= ================= ================ ==============

-6- 9 THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 Net Sales. The Company's net sales increased by $6.1 million, or 26.4%, to $29.1 million in the third quarter of 2000 from $23.0 million in the third quarter of 1999. Product sales increased by $5.5 million, or 30.6%, to $23.2 million in the third quarter of 2000 from $17.8 million in the third quarter of 1999. The increase in product sales is primarily attributable to (i) increased sales of the Company's Accelerated Math products, including follow-on sales of subject libraries and optical-mark card scanners and (ii) increased sales of Accelerated Reader title disks, with about 36,000 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 $618,000, or 11.9%, to $5.8 million in the third quarter of 2000 from $5.2 million in the third quarter of 1999. This increase is primarily attributable to a 14% increase in Renaissance training revenue over third quarter 1999, while revenue from software support agreements was flat compared to last year. The training segment's shift in sales efforts from single training events to multiple event district-wide School Renaissance contracts, the emphasis on the Spring 2001 National Conference and the usual seasonality of training is expected to result in a slower growth rate for training revenues in the near term compared to the historic training growth rate and the growth of product revenue. Management expects that fourth quarter 2000 revenue may be down somewhat from the third quarter level as a result of the slower growth in training and because certain products, particularly Accelerated Math, exhibit a seasonal sales pattern. Cost of Sales. The cost of sales of products increased by $1.0 million, or 49.4%, to $3.1 million in the third quarter of 2000 from $2.0 million in the third quarter of 1999. As a percentage of product sales, the cost of sales of products increased to 13.2% in the third quarter of 2000 from 11.5% in the third quarter of 1999. The increase in cost of sales of products is primarily due to increased sales of optical-mark card scanners, with scanner sales in third quarter 2000 more than double third quarter 1999. A scanner is included with the sale of all Accelerated Math software and many additional scanners are sold separately. Although scanners are profitable, the gross profit margin on hardware is not as high as the gross profit margin on software. The cost of sales of services increased by $528,000, or 24.1%, to $2.7 million in the third quarter of 2000 from $2.2 million in the third quarter of 1999. As a percentage of sales of services, the cost of sales of services increased to 46.7% in the third quarter of 2000 from 42.1% in the third quarter of 1999. This increase is primarily due to increased costs of providing technical support related to the late 1999 and 2000 shipment of Accelerated Reader and STAR Reading upgrades. The Company's overall gross profit margin decreased to 80.1% in the third quarter of 2000 from 81.6% in the third quarter of 1999, due to decreased gross profit margins on both products and services. Management expects that the overall gross profit margin will remain relatively constant for the remainder of 2000. Product Development. Product development expenses increased by $1.8 million, or 77.0%, to $4.1 million in the third quarter of 2000 from $2.3 million in the third quarter of 1999. These expenses increased primarily due to increased staff and consulting costs associated with new product development including several new products announced in 2000: eSchoolOffice Web-based school administration software, new versions of Generation21's Total Knowledge Management enterprise training software, and STAR Early Literacy diagnostic assessment for grades K-2, all of which are expected to be available in 2001. Increased product development expenses are also attributed to the development of localized versions of the Company's products for international markets; the completion of new Accelerated Reader quizzes; creation of additional Surpass test-preparation libraries; continued development of a suite of Web-based versions of the Company's existing core products; and a number of new products at various stages of development which the Company expects to announce in the future. As a percentage of net sales, product development costs increased to 14.2% in the third quarter of 2000 from 10.1% in the third quarter of 1999. The Company anticipates that 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 future growth. Selling and Marketing. Selling and marketing expenses increased by $566,000, or 11.8%, to $5.4 million in the third quarter of 2000 from $4.8 million in the third quarter of 1999. These expenses increased primarily due to (i) costs of marketing the Company's new Generation21 enterprise-wide training and knowledge management software and (ii) international marketing efforts. As a percentage of net sales, selling and marketing expenses declined to 18.5% in the third quarter of 2000 from 20.9% in the third quarter of 1999. Management anticipates that selling and marketing expenses will generally continue to rise as the Company aggressively promotes its new product lines in late 2000 and 2001 and expects the costs to average more than the 18.5% of sales level achieved in the third quarter of 2000. -7- 10 General and Administrative. General and administrative expenses increased by $246,000, or 9.0%, to $3.0 million in the third quarter of 2000 from $2.7 million in the third quarter of 1999. The higher expenses for the third quarter of 2000 are largely due to increased costs associated with the hiring of additional personnel, including wages and related benefits, to support a larger base of business including new initiatives such as Generation21 and the expansion internationally. As a percentage of net sales, general and administrative costs declined to 10.2% in the third quarter of 2000 from 11.8% in the third quarter of 1999. Management expects some increase in general and administrative costs associated with new business initiatives as well as the normal increase of administrative resources required to support ongoing growth. Operating Income. Operating income increased by $1.9 million to $10.8 million in the third quarter of 2000 from $8.9 million in the third quarter of 1999. As a percentage of net sales, operating income decreased to 37.2% in the third quarter of 2000 from 38.8% in the third quarter of 1999. Management expects operating margins to contract somewhat in the fourth quarter 2000 due to the timing of certain expenses and the increasing seasonal element of the Company's business. Income Tax Expense. Income tax expense of $4.5 million was recorded in the third quarter of 2000 at an effective income tax rate of 38.5% of pre-tax income compared to $3.7 million, or 40.3% of pre-tax income in the third quarter of 1999. The Company expects to maintain its effective tax rate at or below 39%. NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 Net Sales. The Company's net sales increased by $17.4 million, or 28.0%, to $79.5 million in the nine months ended September 30, 2000 from $62.1 million in the first nine months of 1999. Product sales increased by $14.0 million, or 28.1%, to $63.8 million in the first nine months of 2000 from $49.8 million in the same period in 1999. The increase in product sales is primarily attributable to (i) increased sales of the Company's Accelerated Math products, including follow-on sales of subject libraries and optical-mark card scanners, (ii) increased sales of Accelerated Reader title disks, with about 36,000 available book titles, to a larger base of Accelerated Reader schools and (iii) strong sales of the Company's upgraded version of STAR Reading. Service revenue increased by $3.4 million, or 27.8%, to $15.7 million in the first nine months of 2000 from $12.3 million in the same period in 1999. Approximately $2.0 million of this increase is attributable to the Company's first annual National School Renaissance Conference presented in February 2000 and the balance of the increase is due to increased revenue from Renaissance training sessions. Cost of Sales. The cost of sales of products increased by $2.9 million, or 53.1%, to $8.5 million in the first nine months of 2000 from $5.5 million in the first nine months of 1999. As a percentage of product sales, the cost of sales of products increased to 13.3% in the first nine months of 2000 from 11.1% in the first nine months of 1999. The increase in cost of sales of products is primarily due to increased sales of optical-mark card scanners. A scanner is included with the sale of all Accelerated Math software and many additional scanners are sold separately. Although scanners are profitable, the gross profit margin on hardware is not as high as the gross profit margin on software. The cost of sales of services increased by $2.5 million, or 46.4%, to $7.9 million in the first nine months of 2000 from $5.4 million in the same period in 1999. This increase is primarily the result of costs associated with (i) the Company's first annual National School Renaissance Conference presented in the first quarter of 2000 and (ii) increased technical support costs due to broader product lines and the introduction of new versions of existing products. As a percentage of sales of services, the cost of sales of services increased to 50.4% in the first nine months of 2000 from 44.0% in the first nine months of 1999. The Company's overall gross profit margin declined to 79.4% in the first nine months of 2000 from 82.4% in the first nine months of 1999. Management expects that the overall gross profit margin will remain relatively constant for the remainder of 2000. Product Development. Product development expenses increased by $5.4 million, or 95.8%, to $11.1 million in the nine months ended September 30, 2000 as compared to $5.7 million in the corresponding 1999 period. These expenses increased primarily due to increased staff and consulting costs associated with new product development including several new products announced in 2000: eSchoolOffice Web-based school administration software, new versions of Generation21's Total Knowledge Management enterprise training software, and STAR Early Literacy diagnostic assessment for grades K-2, all of which are expected to be available in 2001. Increased product development expenses are also attributed to the development of localized versions of the Company's products for international -8- 11 markets; the completion of new Accelerated Reader quizzes; creation of additional Surpass test-preparation libraries; continued development of a suite of Web-based versions of the Company's existing core products; and a number of new products at various stages of development which the Company expects to announce in the future. As a percentage of net sales, product development costs increased to 14.0% in the first nine months of 2000 from 9.2% in the first nine months of 1999. The Company anticipates that 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 future growth. Selling and Marketing. Selling and marketing expenses increased by $2.9 million, or 19.4%, to $12.8 million in the first nine months of 2000 from $15.2 million in the first nine months of 1999. These expenses increased primarily due to (i) salary and recruiting costs associated with hiring additional personnel to market and promote a broader product line, (ii) costs of marketing the Company's new Generation21 enterprise-wide training and knowledge management software, (iii) expenses related to the Company's National School Renaissance Conference in February 2000 and (iv) international marketing efforts. As a percentage of net sales, selling and marketing expenses declined to 22.8% in the first nine months of 2000 from 24.4% in the first nine months of 1999. Management anticipates that selling and marketing expenses will generally continue to rise as the Company aggressively promotes its new product lines in late 2000 and 2001. General and Administrative. General and administrative expenses increased by $1.5 million, or 21.3%, to $8.8 million in the nine months ended September 30, 2000 from $7.3 million in the same period in 1999. The higher expenses for 2000 are largely due to increased costs associated with the hiring of additional personnel, including wages and related benefits, to support a larger base of business including new initiatives such as Generation21 and the expansion internationally. As a percentage of net sales, general and administrative costs declined to 11.1% in the first nine months of 2000 from 11.7% in the first nine months of 1999. Purchased Research and Development. In connection with an acquisition in June 1999, a portion of the purchase price was allocated to acquired in-process research and development costs. This resulted in a charge of $180,000 in the second quarter of 1999. Operating Income. Operating income increased by $2.2 million, or 9.7%, to $25.1 million in the first nine months of 2000 from $22.8 million in the same period in 1999. As a percentage of net sales, operating income decreased to 31.5% in the first nine months of 2000 from 36.8% in the first nine months of 1999. Income Tax Expense. Income tax expense of $10.7 million was recorded in the first nine months of 2000 at an effective income tax rate of 39.0% of pre-tax income compared to $10.0 million, or 41.2% of pre-tax income in the first nine months of 1999. The Company expects to maintain its effective tax rate at or below 39%. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2000, the Company's cash, cash equivalents and short-term investments increased to $61.6 million from the December 31, 1999 total of $41.0 million. The increase of $20.6 million in the first nine months of 2000 is primarily due to $23.3 million in cash provided by operating activities offset by $3.0 million used in the purchase of property, plant and equipment. The Company believes cash flow from operations and its current cash position will be sufficient to meet its working capital requirements and fund future growth acquisition opportunities for the foreseeable future. At September 30, 2000, the Company had a $10.0 million unsecured revolving line of credit with a bank which is available until March 31, 2001. 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. The Company also has a $1.0 million unsecured revolving line of credit with a bank which is available until April 30, 2001. The line of credit bears interest at a fixed rate of 7.5%. As of September 30, 2000, the lines of credit had not been used. -9- 12 FORWARD-LOOKING STATEMENTS In accordance with the Private Securities Litigation Reform Act of 1995, the Company can obtain a "safe-harbor" for forward-looking statements by identifying those statements and by accompanying those statements with cautionary statements which identify factors that could cause actual results to differ materially from those in the forward-looking statements. Accordingly, the foregoing "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains certain forward-looking statements relating to growth plans, projected sales, revenues, earnings and costs, financial and operating ratios, and product development schedules and plans. The Company's actual results may differ materially from those contained in the forward-looking statements herein. Factors which may cause such a difference to occur include those factors identified in (1) Item 1, Business, Forward-Looking Statements, contained in the Company's Form 10-K for the year ended December 31, 1999, and (2) the Company's subsequent filings with the Securities and Exchange Commission, which factors are incorporated herein by reference. Item 3. Quantitative and Qualitative Disclosures About Market Risk At September 30, 2000, the Company had no material market risk exposure (e.g., interest rate risk, foreign currency exchange rate risk or commodity price risk). -10- 13 Part II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds (a) Not applicable. (b) Not applicable. (c) Not applicable. (d) The net proceeds to the Company from its initial public offering, after deducting underwriting discounts of $3,606,400 and other expenses of approximately $941,000, were approximately $46,972,000. From September 24, 1997 (the effective date of the Company's Form S-1 Registration Statement; SEC Reg. No. 333-22519) through September 30, 2000, the Company used the net proceeds from the offering as follows: (i) Approximately $1.6 million was used to pay compensation expenses related to the termination of the Company's phantom stock plan. (ii) Approximately $7.2 million was used to pay the entire principal and accrued interest on the mortgage note and an unsecured note, both related to the construction of the Company's facility in Wisconsin Rapids, Wisconsin. (iii) Approximately $5.1 million was used to pay the entire principal and accrued interest on notes from the Company's principal shareholders related to the 1996 acquisition of IPS Publishing, Inc. (iv) Approximately $10.9 million was used to pay distributions of S corporation retained profits to S corporation shareholders. (v) Approximately $7.4 million was used to invest in Athena Holdings LLC, a limited liability company formed for the purpose of constructing the Company's facility in Madison, Wisconsin. (vi) Approximately $2.4 million was used for pilot operations in various markets and miscellaneous acquisitions. (vii) Approximately $5.8 million was used for capital expenditures for expansion of operations. (viii) The balance of the net proceeds was used for general corporate purposes, including working capital and new product development. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Exhibit No. Description ----------- ----------- 27.1 Financial Data Schedule (b) The Company filed no reports on Form 8-K during the quarter covered by this report. -11- 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ADVANTAGE LEARNING SYSTEMS, INC. (Registrant) November 6, 2000 /s/ Michael H. Baum ---------------- --------------------------- Date Michael H. Baum Chief Executive Officer (Principal Executive Officer) November 6, 2000 /s/ Steven A. Schmidt ---------------- --------------------------- Date Steven A. Schmidt Secretary, Vice President, and Chief Financial Officer (Principal Financial and Accounting Officer) 15 Index to Exhibits ----------------- Exhibit No. Description ----------- ----------- 27.1 Financial Data Schedule