<PAGE> 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, 1997
[ ] 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.)
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 [ ] No [ X ]
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 NOVEMBER 10, 1997
----- -----------------
Common Stock, $0.01 par value 16,902,383
<PAGE> 2
ADVANTAGE LEARNING SYSTEMS, INC.
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
Number
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<S> <C>
ITEM 1. FINANCIAL STATEMENTS (unaudited)
Consolidated and Combined Condensed Balance Sheets at
- September 30, 1997 and December 31, 1996 .................. 1
Consolidated and Combined Condensed Statements of Income
- Three Months and Nine Months Ended
September 30, 1997 and September 30, 1996 ........... 2
Consolidated and Combined Condensed Statements of Cash Flows
For the Nine Months Ended
September 30, 1997 and September 30, 1996 ........... 3
Notes to Consolidated and Combined Condensed 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....................................................... 9
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ........................ 10
ITEM 5. OTHER INFORMATION ................................................ 10
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................. 11
</TABLE>
- Index -
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ADVANTAGE LEARNING SYSTEMS, INC.
CONSOLIDATED AND COMBINED CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997 DECEMBER 31, 1996
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<S> <C> <C>
ASSETS
------
Current assets:
Cash and cash equivalents $43,549,904 $ 1,755,866
Accounts receivable, less allowance of $701,000
and $161,000, respectively 4,899,058 2,523,388
Inventories 399,084 543,902
Prepaid expenses 470,392 265,026
Deferred tax asset 2,250,000 -
------------------ -----------------
Total current assets 51,568,438 5,088,182
------------------ -----------------
Property, plant and equipment: 12,334,094 11,324,688
Less accumulated depreciation (1,448,386) (746,979)
------------------ -----------------
Net property, plant and equipment 10,885,708 10,577,709
------------------ -----------------
Other assets:
Building held for sale 740,461 747,392
Deferred tax asset 1,255,000 1,601,708
Intangibles, net 1,675,834 1,445,798
Capitalized software, net 225,409 393,956
------------------ -----------------
Total other assets 3,896,704 4,188,854
------------------ -----------------
Total assets $66,350,850 $19,854,745
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Mortgage note payable $ 6,800,000 $ -
Notes payable to shareholders 4,700,000 -
Accounts payable 1,260,546 332,689
Deferred revenue 2,051,937 1,442,356
Accrued payroll and employee benefits 2,411,595 577,613
Retainage & amounts due under construction contract 198,382 1,151,157
Other current liabilities 1,930,835 668,421
Due to former owner of IPS - 350,000
Distribution payable to shareholders 10,000,000 -
------------------ -----------------
Total current liabilities 29,353,295 4,522,236
------------------ -----------------
Noncurrent liabilities and deferred credits:
Long-term debt 50,000 5,750,000
Notes payable to shareholders - 4,700,000
Deferred revenue 1,525,162 1,109,519
------------------ -----------------
Total noncurrent liabilities and deferred credits 1,575,162 11,559,519
Total shareholders' equity 35,422,393 3,772,990
------------------ -----------------
Total liabilities and shareholders' equity $66,350,850 $19,854,745
================== =================
</TABLE>
See accompanying notes to consolidated and combined condensed financial
statements.
-1-
<PAGE> 4
ADVANTAGE LEARNING SYSTEMS, INC.
CONSOLIDATED AND COMBINED CONDENSED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
1997 1996 1997 1996
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales:
Products $ 7,492,763 $ 4,948,897 $21,236,237 $13,088,380
Services 2,159,991 1,002,955 4,961,298 2,337,344
---------- ---------- ----------- -----------
Total net sales 9,652,754 5,951,852 26,197,535 15,425,724
---------- ---------- ----------- -----------
Cost of sales:
Products 856,534 595,008 2,531,994 1,560,937
Services 898,624 522,478 2,203,364 1,155,404
---------- ---------- ----------- -----------
Total cost of sales 1,755,158 1,117,486 4,735,358 2,716,341
---------- ---------- ----------- -----------
Gross profit 7,897,596 4,834,366 21,462,177 12,709,383
Operating expenses:
Product development 904,818 408,645 2,279,469 903,055
Selling and marketing 2,554,182 1,499,825 7,006,112 4,558,530
General and administrative 1,516,911 950,357 4,138,336 2,334,620
Purchased research and development - 3,400,000 - 3,400,000
Phantom stock plan termination 1,617,106 - 1,617,106 -
---------- ---------- ----------- -----------
Total operating expenses 6,593,017 6,258,827 15,041,023 11,196,205
---------- ---------- ----------- -----------
Operating income (loss) 1,304,579 (1,424,461) 6,421,154 1,513,178
Other income (expense):
Interest income 35,377 6,316 84,293 15,068
Interest expense (274,666) (76,667) (643,586) (76,667)
Other, net 68,547 4,626 24,247 13,705
---------- ---------- ----------- -----------
Total other income (expense) (170,742) (65,725) (535,046) (47,894)
---------- ---------- ----------- -----------
Income (loss) before taxes 1,133,837 (1,490,186) 5,886,108 1,465,284
Income tax benefit 3,505,000 1,466,883 1,903,292 1,466,883
---------- ---------- ----------- -----------
Net income (loss) $ 4,638,837 $ (23,303) $ 7,789,400 $ 2,932,167
========== ========== =========== ===========
Primary and fully diluted earnings per share $ 0.34 N/A $ 0.57 N/A
========== ========== =========== ===========
</TABLE>
See accompanyng notes to consolidated and combined condensed financial
statements.
-2-
<PAGE> 5
ADVANTAGE LEARNING SYSTEMS, INC.
CONSOLIDATED AND COMBINED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30
---------------------------
1997 1996
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<S> <C> <C>
Reconciliation of net income to net cash provided by operating activities:
Net income $ 7,789,400 $ 2,932,167
Noncash (income) expenses included in net income -
Depreciation and amortization 1,064,637 403,875
Purchased research and development - 3,400,000
Deferred income taxes (1,903,292) (1,466,883)
Change in assets and liabilities -
Accounts receivable (2,289,671) (1,868,484)
Inventory 144,816 (260,977)
Prepaid expenses (205,367) (212,821)
Accounts payable and other current liabilities 4,024,256 1,372,060
Retainage and amounts due under construction contract (952,775) 706,512
Deferred revenue 1,025,224 768,830
------------ ------------
Net cash provided by operating activities 8,697,228 5,774,279
------------ ------------
Cash flows from investing activities:
Purchase of property, plant and equipment (1,009,406) (6,319,592)
Capitalized software development costs (3,787) (380,676)
Acquisition of IPS - (4,610,000)
------------ ------------
Net cash (used in) investing activities (1,013,193) (11,310,268)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of stock 40,914,003 200,000
Proceeds from long-term debt and notes payable to shareholders 1,100,000 7,850,000
Payments on debt (350,000) -
Distributions to shareholders (7,554,000) (2,100,000)
------------ ------------
Net cash provided by financing activities 34,110,003 5,950,000
------------ ------------
Net increase in cash 41,794,038 414,011
Cash and cash equivalents, beginning of period 1,755,866 275,762
------------ ------------
Cash and cash equivalents, end of period $ 43,549,904 $689,773
============ ============
</TABLE>
See accompanying notes to consolidated and combined condensed financial
statements.
- 3 -
<PAGE> 6
ADVANTAGE LEARNING SYSTEMS, INC.
NOTES TO CONSOLIDATED AND COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. COMBINATION AND CONSOLIDATION
The 1996 financial statements present the combined results of Advantage
Learning Systems, Inc. ("ALS"), the Institute for Academic Excellence, Inc.
("Institute") and, since its acquisition on August 1, 1996, IPS Publishing,
Inc. ("IPS"), collectively the "Company". ALS, the Institute and IPS are
all under common ownership. ALS, the Institute and IPS conduct their
activities within one industry segment.
Effective January 2, 1997, the Institute and IPS became wholly owned
subsidiaries of ALS. As a result, periods subsequent to 1996 are presented on
a consolidated basis. All significant intercompany transactions have been
eliminated in the combined and consolidated financial statements.
2. BASIS OF PRESENTATION
The condensed 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
presented. These financial statements should be read in conjunction with the
Company's financial information contained in the Company's Registration
Statement on Form S-1 (Reg. No. 333-22519) which is on file with the U.S.
Securities and Exchange Commission.
The results of operations for the three and nine month periods ended September
30, 1997 and 1996, are not necessarily indicative of the results to be expected
for the full year.
3. EARNINGS PER SHARE
Earnings per share is computed on the basis of the weighted average number of
common shares outstanding during the periods. The assumed exercise of all
outstanding common stock options was excluded from the computation of shares
outstanding for primary earnings per share because the result has a dilutive
effect of less than 3% and is therefore considered not to be material in
accordance with Accounting Principles Board Opinion No. 15. The assumed
exercise of all outstanding common stock options was included in the
computation of shares outstanding for fully diluted earnings per share using
the treasury stock method.
The weighted average number of shares outstanding for primary EPS during the
three and nine months ended September 30, 1997 was 13,681,909 and 13,660,330,
respectively. The weighted average number of shares outstanding for the fully
diluted EPS during the three and nine months ended September 30, 1997 was
13,731,336 and 13,709,757, respectively. Earnings per share on a primary and
fully diluted basis are the same because the dilutive effect of the assumed
exercise of all outstanding stock options is less than one cent for the three
and nine months ended September 30, 1997. Since the 1996 financial statements
are presented on a combined basis, no earnings per share information can be
computed for 1996 results.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 "Earnings Per Share" ("SFAS No. 128").
The Company will adopt SFAS No. 128 effective for the year ending December 31,
1997. On a pro forma basis, if the Company had adopted SFAS No. 128 for the
three and nine months ended September 30, 1997, earnings per share would have
been presented as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1997 September 30, 1997
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<S> <C> <C>
Basic and diluted earnings
per share $ .34 $ .57
===== =====
</TABLE>
-4-
<PAGE> 7
ADVANTAGE LEARNING SYSTEMS, INC.
NOTES TO CONSOLIDATED AND COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
4. OFFERING OF COMMON STOCK
On September 30, 1997 the Company completed an initial public offering ("IPO")
of 2,800,000 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 $750,000 in costs
associated with the offering. This resulted in an increase to cash of
$41,664,000 and an increase to shareholders' equity of $40,914,000. In
connection with the IPO, the liabilities for the mortgage note and notes
payable to shareholders were reclassified as current liabilities because the
Company used the IPO proceeds to pay the entire amount of these liabilities in
October 1997.
Subsequently, on October 2, 1997, an additional 420,000 shares of the Company's
common stock were sold pursuant to the exercise of an over-allotment option
granted in connection with the IPO. The Company received additional net
proceeds of $6,249,600 in connection with the exercise of this over-allotment
option.
In October 1997, the Company used the proceeds from the offering as follows:
(i) Approximately $1.6 million was used to pay employee compensation
expenses related to the termination of the Company's phantom stock plan.
(ii) Approximately $7.0 million was used to pay the entire principal and
accrued interest on the mortgage note related to the construction of the
Company's new headquarters 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 $700,000 was used to pay distributions of S corporation
retained profits to S corporation shareholders. The Company expects to pay
additional distributions of S corporation retained profits to S corporation
shareholders of approximately $9.3 million on or before December 31, 1997.
The Company has broad discretion with respect to the use of the remaining
proceeds.
5. INCOME TAXES
On September 29, 1997 the Company became subject to federal and state income
taxes as a C corporation. Consequently, the Company is now required to account
for income taxes in accordance with Statement of Financial Accounting Standards
No. 109 "Accounting for Income Taxes" ("SFAS 109"). In connection with this
change in the Company's tax status, SFAS 109 requires the Company to record
deferred taxes on the balance sheet for all book to tax basis differences
existing on the date of change. The related effect of recording the basis
differences is charged or credited to current earnings. The change in tax
status resulted in recognition of a deferred tax asset and corresponding
benefit of $3.5 million.
-5-
<PAGE> 8
Item 2. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations
THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Net Sales. The Company's net sales increased by $3.7 million, or 62.2%,
to $9.7 million in the third quarter of 1997 from $6.0 million in the third
quarter of 1996. Product sales increased by $2.6 million, or 51.4%, to $7.5
million in the third quarter of 1997 from $4.9 million in the third quarter of
1996. The increase in product sales is primarily attributable to (i) the sale
of the Accelerated Reader to approximately 2,000 new customer schools, (ii)
increased sales of Accelerated Reader test disks to a larger base of
Accelerated Reader schools, (iii) revenues from S.T.A.R. for which shipments
and recognition of revenue began in September 1996, and (iv) inclusion of IPS
sales commencing August 1, 1996. Sales of Accelerated Reader software and
supplemental Accelerated Reader test disks accounted for approximately 63.6%
and 46.9% of net sales in the third quarter of 1996 and 1997, respectively.
Service revenue, which consists of revenue from sales of: (i) training
seminars and programs and (ii) software support agreements, increased by $1.2
million, or 115.4%, to $2.2 million in the third quarter of 1997 from $1.0
million in the third quarter of 1996. This increase is primarily attributable
to an increased number of Reading Renaissance training sessions, and, to a
lesser extent, additional revenue from software support agreements principally
associated with increased new product sales.
Cost of Sales. The cost of sales of products increased by $262,000, or
44.0%, to $857,000 in the third quarter of 1997 from $595,000 in the third
quarter of 1996. As a percentage of product sales, the cost of sales of
products remained relatively constant at 11.4% in the third quarter of 1997
compared to 12.0% in the third quarter of 1996. The cost of sales of services
increased by $377,000, or 72.0%, to $899,000 in the third quarter of 1997 from
$522,000 in the third quarter of 1996. As a percentage of sales of services,
the cost of sales of services declined somewhat to 41.6% in the third quarter
of 1997 compared to 52.1% in the third quarter of 1996 primarily as a result of
decreased costs of delivering training sessions. The Company's overall gross
profit margin remained relatively constant at 81.8% in the third quarter of
1997 compared to 81.2% in the third quarter of 1996.
Product Development. Product development expenses increased by $496,000,
or 121.4%, to $905,000 in the third quarter of 1997 from $409,000 in the third
quarter of 1996. These expenses increased primarily due to: (i) increased
development staff and consulting costs associated with new products, and (ii)
the inclusion of IPS product development costs commencing August 1, 1996. As a
percentage of net sales, product development costs increased to 9.4% in the
third quarter of 1997 from 6.9% in the third quarter of 1996. The Company
anticipates that the total dollar amount of product development costs will
continue to increase as the Company extends its product offerings into other
areas of the K-12 curriculum.
Selling and Marketing. Selling and marketing expenses increased by $1.1
million, or 70.3%, to $2.6 million in the third quarter of 1997 from $1.5
million in the third quarter of 1996. These expenses increased due to an
increase in the number of marketing personnel, participation in more trade
shows, the publication of additional catalogs, mailings to an increased
customer and prospect base, and increased advertising in publications. As a
percentage of net sales, selling and marketing expenses increased somewhat to
26.5% in the third quarter of 1997 from 25.2% in the third quarter of 1996.
General and Administrative. General and administrative expenses increased
by $567,000, or 59.6%, to $1.5 million in the third quarter of 1997 from
$950,000 in the third quarter of 1996. The higher expenses for the third
quarter of 1997 are largely due to increased costs associated with: (i) the
hiring of additional personnel, including wages and related benefits, and (ii)
increased costs associated with the Company's new headquarters building. As a
percentage of net sales, general and administrative costs remained relatively
constant at 15.7% in the third quarter of 1997 compared to 16.0% in the third
quarter of 1996.
Purchased Research and Development. In connection with the acquisition of
IPS, $3.4 million of the purchase price was allocated to purchased research and
development which was expensed in August 1996.
-6-
<PAGE> 9
Phantom Stock Plan Termination. The Company's phantom stock plan
terminated on September 30, 1997 in connection with the closing of the initial
public offering of its common stock on that date. The one time charge of
approximately $1.6 million associated with the plan termination was expensed in
September 1997.
Operating Income. Operating income increased by $2.7 million, or 191.6%,
to $1.3 million in the third quarter of 1997 from a loss of $1.4 million in
the third quarter of 1996 primarily due to the $3.4 million of purchased
research and development expense in the third quarter of 1996 and the $1.6
million phantom stock plan termination expense in the third quarter of 1997.
As a percentage of net sales, operating income increased to 13.5% in the third
quarter of 1997 compared to -23.9% in the third quarter of 1996. Excluding the
effects of the purchased research and development expense and the phantom stock
plan termination expense, operating income would have been $2.9 million in the
third quarter of 1997 and $2.0 million in the third quarter of 1996.
Interest Expense. Interest expense increased $198,000 to $275,000 in the
third quarter of 1997 from $77,000 in the third quarter of 1996 primarily as a
result of interest expense incurred in connection with loans to finance the
Company's new corporate headquarters building.
Income Tax Expense. A tax benefit of $3.5 million was recorded in
September 1997 in connection with the Company's change in tax status from S
corporation status to C corporation status on September 29, 1997. In August
1996, a deferred tax asset and corresponding benefit of $1.5 million was
recorded in connection with the operations of IPS which was a C corporation at
the time. This benefit was reversed in January 1997 when IPS elected S
corporation status.
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Net Sales. The Company's net sales increased by $10.8 million, or 69.8%,
to $26.2 million in the nine months ended September 30, 1997 from $15.4 million
in the nine months ended September 30, 1996. Product sales increased by $8.1
million, or 62.3%, to $21.2 million in the nine months ended September 30, 1997
from $13.1 million in the nine months ended September 30, 1996. The increase
in product sales is primarily attributable to (i) the sale of the Accelerated
Reader to approximately 5,700 new customer schools, (ii) increased sales of
Accelerated Reader test disks to a larger base of Accelerated Reader schools,
including the introduction of approximately 2,900 new book titles on
Accelerated Reader test disks since September 30, 1996, (iii) revenues from
S.T.A.R. for which shipments and recognition of revenue began in September
1996, and (iv) inclusion of IPS sales commencing August 1, 1996. Sales of
Accelerated Reader software and supplemental Accelerated Reader test disks
accounted for approximately 74.3% and 52.4% of net sales in the nine months
ended September 30, 1996 and 1997, respectively.
Service revenue increased by $2.7 million, or 112.3%, to $5.0 million in
the nine months ended September 30, 1997 from $2.3 million in the nine months
ended September 30, 1996. This increase is primarily attributable to an
increased number of Reading Renaissance training sessions, and, to a lesser
extent, additional revenue from software support agreements principally
associated with increased new product sales.
Cost of Sales. The cost of sales of products increased by $971,000, or
62.2%, to $2.5 million in the nine months ended September 30, 1997 from $1.6
million in the nine months ended September 30, 1996. As a percentage of
product sales, the cost of sales of products remained constant at 11.9% in the
nine months ended September 30, 1997 and 1996. The cost of sales of services
increased by $1.0 million, or 90.7%, to $2.2 million in the nine months ended
September 30, 1997 from $1.2 million in the nine months ended September 30,
1996. As a percentage of sales of services, the cost of sales of services
declined somewhat to 44.4% in the nine months ended September 30, 1997 compared
to 49.4% in the nine months ended September 30, 1996 primarily as a result of
decreased costs of delivering training sessions. The Company's overall gross
profit margin declined somewhat to 81.9% in the nine months ended September 30,
1997 from 82.4% in the nine months ended September 30, 1996 due primarily to
increased sales of services, particularly Reading Renaissance training
sessions, which have a lower gross margin than the Company's products.
-7-
<PAGE> 10
Product Development. Product development expenses increased by $1.4
million, or 152.4%, to $2.3 million in the nine months ended September 30, 1997
from $903,000 in the nine months ended September 30, 1996. These expenses
increased primarily due to: (i) increased development staff and consulting
costs associated with new products, and (ii) the inclusion of IPS product
development costs commencing August 1, 1996. As a percentage of net sales,
product development costs increased to 8.7% in the nine months ended September
30, 1997 from 5.9% in the nine months ended September 30, 1996. The Company
anticipates that the total dollar amount of product development costs will
continue to increase as the Company extends its product offerings into other
areas of the K-12 curriculum.
Selling and Marketing. Selling and marketing expenses increased by $2.4
million, or 53.7%, to $7.0 million in the nine months ended September 30, 1997
from $4.6 million in the nine months ended September 30, 1996. These expenses
increased due to an increase in the number of marketing personnel,
participation in more trade shows, the publication of additional catalogs,
mailings to an increased customer and prospect base, and increased advertising
in publications. However, as a percentage of net sales, selling and marketing
expenses decreased to 26.7% in the nine months ended September 30, 1997 from
29.6% in the nine months ended September 30, 1996. This decrease is primarily
due to economies of scale associated with significantly increased product sales
and service sales.
General and Administrative. General and administrative expenses increased
by $1.8 million, or 77.3%, to $4.1 million in the nine months ended September
30, 1997 from $2.3 million in the nine months ended September 30, 1996. The
higher expenses for the nine months ended September 30, 1997 are largely due to
increased costs associated with the hiring of additional personnel, including
wages and related benefits, and increased costs associated with the Company's
new headquarters building. As a percentage of net sales, general and
administrative costs increased somewhat to 15.8% in the nine months ended
September 30, 1997 from 15.1% in the nine months ended September 30, 1996.
Purchased Research and Development. In connection with the acquisition of
IPS, $3.4 million of the purchase price was allocated to purchased research and
development which was expensed in August 1996.
Phantom Stock Plan Termination. The Company's phantom stock plan
terminated on September 30, 1997 in connection with the closing of the initial
public offering of its common stock on that date. The one time charge of
approximately $1.6 million associated with the plan termination was expensed in
September 1997.
Operating Income. Operating income increased by $4.9 million, or 324.3%,
to $6.4 million in the nine months ended September 30, 1997 from $1.5 million
in the nine months ended September 30, 1996. As a percentage of net sales,
operating income increased to 24.5% in the nine months ended September 30, 1997
from 9.8% in the nine months ended September 30, 1996. Excluding the effects
of the purchased research and development expense, and phantom stock plan
termination expense, operating income would have been $8.0 million in the nine
months ended September 30, 1997 and $4.9 million in the nine months ended
September 30, 1996.
Interest Expense. Interest expense increased $567,000 to $644,000 in the
nine months ended September 30, 1997 from $77,000 in the nine months ended
September 30, 1996 primarily as a result of interest expense incurred in
connection with loans to finance the acquisition of IPS and the Company's new
corporate headquarters building.
Income Tax Expense. A tax benefit of $3.5 million was recorded in
September 1997 in connection with the Company's change in tax status from S
corporation status to C corporation status on September 29, 1997. In August
1996, a deferred tax asset and corresponding benefit of $1.5 million was
recorded in connection with the operations of IPS which was a C corporation at
the time. This benefit was reversed in January 1997 when IPS elected S
corporation status.
-8-
<PAGE> 11
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1997, the Company's cash and cash equivalents increased to
$43.5 million from the December 31, 1996 total of $1.8 million. For the nine
months ended September 30, 1997, net cash provided by operating activities was
$8.6 million compared with $5.8 million for the nine months ended September 30,
1996. The increase is due primarily to increased operating income offset by
relatively modest increased working capital demands. Cash flows used by
investing activities were $927,000 for the nine moths ended September 30, 1997
compared with $11.3 million for the nine months ended September 30, 1996. The
decrease is due to the purchase of IPS and the Company's new corporate
headquarters building in 1996. Cash flows provided by financing activities
were $34.1 million for the nine months ended September 30, 1997 compared with
$6.0 million for the nine months ended September 30, 1996. The increase is due
primarily to proceeds from the public offering of common stock offset by: (i)
lower borrowings of long term obligations in 1997 and, (ii) higher
distributions to shareholders in 1997.
On September 30, 1997, the Company completed an initial public offering ("IPO")
of 2,800,000 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 $750,000 in costs
associated with the offering. This resulted in an increase to cash of
$41,664,000 and an increase to shareholders' equity of $40,914,000. In
connection with the IPO, the liabilities for the mortgage note and notes
payable to shareholders were reclassified as current liabilities because the
Company paid the entire amount of these liabilities in October 1997.
Subsequently, on October 2, 1997, an additional 420,000 shares of the Company's
common stock were sold pursuant to the exercise of an over-allotment option
granted in connection with the IPO. The Company received additional net
proceeds of $6,249,600 in connection with the exercise of this over-allotment
option.
In October 1997, the Company 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 $7.0 million was used to pay the entire principal
and accrued interest on the mortgage note related to the construction of
the Company's new headquarters 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 $700,000 was used to pay distributions of S corporation
retained profits to S corporation shareholders. The Company expects to
pay additional distributions of S corporation retained profits to S
corporation shareholders of approximately $9.3 million on or before
December 31, 1997.
The Company has broad discretion with respect to the use of the remaining
proceeds.
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
-9-
<PAGE> 12
Part II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(a) Not applicable.
(b) Not applicable.
(c) In the three month period ending September 30, 1997, the Registrant has
issued the following securities which were not registered under the Securities
Act of 1933:
On September 30, 1997, the Registrant issued 31,250 shares of the
Registrant's Common Stock to the Timothy Peter Welch Revocable Trust, of which
Timothy P. Welch is the beneficial owner, and two current employees of IPS as
partial consideration for the Registrant's acquisition of IPS. The shares of
Common Stock were sold without registration under the Securities Act in
reliance on Section 4(2) thereunder.
(d) The Registrant'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 ("IPO") of the Registrant's Common
Stock, par value $0.01 per share, began on September 25, 1997. All of the 2.8
million shares offered by the Registrant, in addition to the 420,000 shares
subject to an over-allotment option, were sold on September 30, 1997 and
October 2, 1997, respectively. The managing underwriters for the Registrant's
IPO were Piper Jaffray Inc. and Montgomery Securities. The number of shares of
Common Stock registered under the Registrant's Form S-1 was 3,220,000 shares;
the aggregate price of the offering amount registered was $45,080,000; the
amount of shares of Common Stock sold was 3,220,000; and the aggregate offering
price of the Common Stock sold was $51,520,000.
From September 24, 1997 through September 30, 1997, the Registrant
incurred the following expenses in connection with the issuance and
distribution of the Common Stock registered: $3,606,400 in underwriting
discounts (which includes discounts incurred in connection with the
underwriters' exercise of the over-allotment option, which occurred on
September 30, 1997); and approximately $750,000 in other expenses (this figure
represents a reasonable estimate of the amount of expenses incurred). None of
the payments made by the Registrant in connection with these expenses were paid
to directors, officers, principal shareholders or other affiliates of the
Registrant.
The net proceeds from the IPO to the Registrant, after deducting the
underwriting discounts and other expenses, was $47,163,600. As of September 30,
1997, however, only $41,664,000 of this total (before other expenses) had been
received by the Registrant. The remaining $6,249,600 (before other expenses)
was received on October 2, 1997 in connection with the closing of the shares
which were subject to an over-allotment option. From September 24, 1997 through
September 30, 1997, the Registrant did not use any of the proceeds received in
connection with the IPO.
Item 5. Other Information
From time to time, the Company may make certain forward-looking statements in
its annual and quarterly reports, proxy statements, press releases and other
written and verbal communications to the public and/or its shareholders. Any
such statements must be viewed in light of the considerations set forth under
the caption "Risk Factors" in the Company's Prospectus as filed pursuant to
Rule 424(b) under the Securities Act of 1933, which Prospectus is part of the
Company's Registration Statement on Form S-1 (Reg. No. 333-22519) and which
portion of the Prospectus is hereby incorporated by reference.
-10-
<PAGE> 13
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
4.1 Stock Certificate
10.1 Tax Indemnification Agreement dated as of
August 29, 1997 between Terrance Paul, Judith Paul,
Mark J. Bradley as Trustee of the Terrance and Judith
Paul Descendants' Trust, and Advantage Learning
Systems, Inc.
10.2 Tax Indemnification Agreement dated as of August 29,
1997 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.
27.1 Financial Data Schedule
99.1 Information included under the caption "Risk Factors" in
the Registrant's Rule 424(b) Prospectus, included as
part of Registrant's Registration Statement on Form S-1
(Reg No. 333-22519) (incorporated herein by reference
to such Rule 424(b) Prospectus).
</TABLE>
(b) The Company filed no reports on Form 8-K during the quarter covered by this
report.
-11-
<PAGE> 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 14, 1997 /s/ Michael H. Baum
----------------- ------------------------------
Date Michael H. Baum
Chief Executive Officer
(Principal Executive Officer)
November 14, 1997 /s/ Richard W. Fickey
----------------- ------------------------------
Date Richard W. Fickey
Secretary and Vice President, Finance and
Administration
(Principal Financial and Accounting Officer)
<PAGE> 15
Index to Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------------
<S> <C>
4.1 Stock Certificate
10.1 Tax Indemnification Agreement dated as of August 29, 1997
between Terrance Paul, Judith Paul, Mark J. Bradley as
Trustee of the Terrance and Judith Paul Descendants'
Trust, and Advantage Learning Systems, Inc.
10.2 Tax Indemnification Agreement dated as of August 29, 1997
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.
27.1 Financial Data Schedule
99.1 Information included under the caption "Risk Factors" in the
Registrant's Rule 424(b) Prospectus, included as part of
Registrant's Registration Statement on Form S-1 (Reg No.
333-22519) (incorporated herein by reference to such Rule
424(b) Prospectus).
</TABLE>
<PAGE> 1
<TABLE>
<S> <C> <C>
[NUMBER] [COMPANY LOGO] [SHARES]
- ----------------------------------- --------------------------------------------- -------------------
SEE REVERSE SIDE FOR INCORPORATED UNDER THE LAWS OF THE STATE OF CUSIP 00757K 10 0
CERTAIN DEFINITIONS WISCONSIN
ADVANTAGE LEARNING SYSTEMS, INC.
PAR VALUE $0.01 EACH
This is to certify that
-------------------------------------------------------------------------------------
is the owner of
---------------------------------------------------------------------------------------------
FULLY PAID AND NON-ASSESSABLE (EXCEPT AS PROVIDED IN CHAPTER 180 OF THE WISCONSIN STATUTES)
COMMON SHARES OF ADVANTAGE LEARNING SYSTEMS, INC.
transferable on the books of the Corporation in person or by duly authorized Attorney upon surrender of this Certificate properly
endorsed.
In Witness Whereof the Corporation has caused this Certificate to be signed by its duly authorized officers and sealed with the
Seal of the Corporation.
Dated
/s/Judith A. Paul /S/ Michael H. Baum /s/ Richard W. Fickey
----------------- [CORPORATE SEAL] --------------------- ----------------------
CHAIRMAN CHIEF EXECUTIVE SECRETARY
OFFICER
Countersigned and Registered:
FIRSTAR TRUST COMPANY
(Milwaukee, WI) Transfer Agent
By: Authorized Signature
</TABLE>
<PAGE> 2
<TABLE>
<CAPTION>
The following abbreviations, when used in the inscription on the face of
this certificate shall be construed as though they were written out in full
according to applicable laws or regulations:
<S> <C> <C>
UNIF GIFT MIN ACT Custodian
--------- ---------
(Cust) (Minor)
Under Uniform Gift to Minors
TEN COM - as tenants in common Act:
TEN ENT - as tenants by the entireties --------------
JT TEN - as joint tenants with right of survivorship (State)
and not as tenants in common
UNIF TRANS MIN ACT Custodian
--------- ---------
(Cust) (Minor)
Under Uniform Gift to Minors
Act:
--------------
(State)
Additional abbreviations may also be used though not in the above list.
For Value Received, hereby sell, assign and transfer unto
----------------------
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------
- --------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Shares
- ----------------------------------------------------------------------------------------------------------------------
of the common stock represented by the within Certificate and do hereby irrevocably constitute and appoint
------------------------
Attorney, to transfer the said stock on the books of the within-named Corporation with full power of substitution in the premises.
Date
--------------------------------------------------- ----------------------------------------------------------------
SIGNATURE
NOTICE: THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME
AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR,
WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER
- ------------------------------------------------------
SIGNATURE GUARANTEED
SIGNATURES MUST BE GUARANTEED BY A COMMERCIAL BANK OR
STOCK BROKER AFFILIATED WITH ONE OF THE MAJOR STOCK EXCHANGES
</TABLE>
<PAGE> 1
Advantage Learning Systems, Inc.
Exhibit 10.1 - Tax Indemnification Agreement dated as of August 29, 1997
between Terrance Paul, Judith Paul, Mark J. Bradley as Trustee
of the Terrance and Judith Paul Descendants' Trust, and
Advantage Learning Systems, Inc.
TAX INDEMNIFICATION AGREEMENT
THIS TAX INDEMNIFICATION AGREEMENT, dated as of the 29th day of August,
1997, is entered into by Advantage Learning Systems, Inc., a Wisconsin
corporation (the "Company"), and Judith A. Paul, Terrance D. Paul and Mark J.
Bradley, as Trustee of the Terrance and Judith Paul Descendants' Trust
(individually, a "Stockholder" and collectively, the "Stockholders");
RECITALS:
WHEREAS, the Stockholders hold all of the outstanding shares of the
Company's Common Stock, par value $.01 per share (the "Common Stock").
WHEREAS, the Company has elected to be taxed as an S corporation under the
Code.
WHEREAS, the Company is now contemplating offering and selling shares of
its Common Stock to the public (the "Public Offering").
WHEREAS, the Company plans, just prior to the completion of the Public
Offering, to terminate its S corporation election.
WHEREAS, after the termination of the Company's S corporation election,
the Stockholders individually will continue to be liable for their own federal,
state, and local income taxes on the Company's Tax Items that pass through to
the Stockholders under the provisions of Subchapter S of the Code and any
similar provisions of state and local law for all periods prior to the time the
Company ceases to be an S Corporation.
NOW, THEREFORE, for good and valuable consideration, the receipt and legal
sufficiency of which hereby are acknowledged, the parties agree as follows:
Article I
PURPOSE
The purpose of this Agreement is to set forth the agreement of the Company
and its Stockholders with respect to certain adjustments to the federal, state
and local personal income tax liability of the Stockholders attributable to the
Tax Items of the Company that pass through to the Stockholders under the
provisions of Subchapter S of the Code and any similar provisions of state and
local law for periods during which the Company is an S Corporation, which
adjustments arise after the termination of the Company's S election.
Article II
DEFINITIONS
Section 2.1 For purposes of this Agreement, the following definitions
shall apply:
(a) "Adjustment" shall mean any proposed or final change in any S
Corporation Tax Liability initiated by the IRS, state or local taxing authority
or any other relevant taxing authority or as a result of the filing of an
amended return for the Company.
<PAGE> 2
(b) "Code" shall mean the Internal Revenue Code of 1986, as amended and in
effect for the taxable period in question.
(c) "Final Determination" shall mean the final resolution of any Income
Tax liability (including all related interest and penalties) for a taxable
period. A Final Determination shall result from the first to occur of:
(i) the expiration of thirty (30) days after IRS acceptance of a
Waiver, unless, within such period, the taxpayer gives notice to the
other party of the taxpayer's intention to attempt to recover all or part
of any amount paid pursuant to the Waiver by the filing of a timely claim
for refund;
(ii) a decision, judgment, decree or other order by a court of
competent jurisdiction that is not subject to further judicial review
(by appeal or otherwise) and has become final;
(iii) the execution of a closing agreement under Section 7121 of the
Code or the acceptance by the IRS or its counsel of an offer in compromise
under Section 7122 of the Code or comparable agreements under the laws of
other jurisdictions;
(iv) the expiration of the time for filing a claim for refund or for
instituting suit in respect of a claim for refund disallowed in whole or
part by the IRS or other relevant taxing authority;
(v) any other final disposition of the Income Tax liability for such
period by reason of the expiration of the applicable statute of
limitations; or
(vi) any other event that the parties agree is a determination of the
liability at issue, including the filing of an amended return.
(d) "Income Tax" shall mean federal income taxes and state and local taxes
imposed upon, or measured by, income. Income Tax includes interest, penalties,
additions to tax and additional amounts and any related reasonable professional
fees and costs or other expenses.
(e) "IRS" shall mean the United States Internal Revenue Service or any
successor, including, but not limited to, its agents, representatives and
attorneys.
(f) "Pro Rata Share" shall mean each Stockholder's proportionate share of
Common Stock owned on the relevant date or held during the relevant period,
which proportionate share shall be a fraction, the numerator of which is the
number of shares of Common Stock held by the Stockholder on the relevant date
or during the relevant period and the denominator of which is the number of
shares of Common Stock held by all Stockholders as of the relevant date or
during the relevant period.
(g) "S Corporation" shall mean an S Corporation within the meaning of
Section 1361 of the Code.
(h) "S Corporation Tax Liability" shall mean the personal Income Tax
liability of a Stockholder for Income Taxes attributable to (a) the Company's
Tax Items that pass through to the Stockholder under the provisions of
Subchapter S of the Code and any similar provisions of state and local law. or
(b) a Stockholder's receipt of indemnity payments hereunder.
(i) "Tax Benefit" shall mean a reduction in the personal Income Tax
liability of a Stockholder (as a result of Tax Items of the Company and all
other Tax Items reflected on the Stockholder's tax return) for any taxable
period and any interest paid in connection therewith by the relevant taxing
authority. The Stockholder shall be deemed to have realized or received a Tax
Benefit from a Tax Item in a taxable period only if and to the extent that the
Stockholder's personal Income Tax liability for such period is less than it
would have been if such liability were determined without regard to such Tax
Item. The Stockholder shall be deemed to have realized or received a Tax
Benefit with respect to a carryover only if, when and to the extent the
carryover is used to produce a Tax Benefit.
(j) "Tax Item" shall mean any item of income, gain, loss, deduction,
credit, recapture of credit, or any other item which increases or decreases
Income Taxes paid or payable by the Stockholder (when the Company is an S
Corporation) or by the Company.
<PAGE> 3
(k) "Waiver" shall mean a Waiver of Restrictions on Assessment and
Collection of Deficiency in Tax and Acceptance of Overassessment on Federal
Revenue Form 870 or 870-AD (or any successor comparable form or the expiration
of a comparable period with respect to any comparable agreement or form under
the laws of other jurisdictions).
Article III
INDEMNIFICATION FOR CERTAIN TAXES
Section 3.1 Each Stockholder severally, but not jointly, shall pay to the
Company an amount equal to any Tax Benefit realized or received by such
Stockholder arising from an Adjustment with respect to a Tax Item of the
Company for any taxable period in which the Company was taxable as an S
Corporation to the extent such Adjustment would reduce the Accumulated
Adjustments Account (the "AAA") below the amount determined as of the last day
of the short S year ending in 1997 for purposes of distributing cash to the
Shareholders in connection with the Public Offering (ignoring any
post-termination distributions to Stockholders).
Section 3.2 The Company shall pay and indemnify the Stockholders for
any S Corporation Tax Liability arising from an Adjustment with respect to a
Tax Item of the Company to the extent such Adjustment would increase the AAA
above the amount determined as of the last day of the short S year ending in
1997 for purposes of distributing cash to the Shareholders in connection with
the Public Offering (ignoring any post-termination distributions to
Stockholders).
Section 3.3 Any payment required under this Article II shall be made by
the earlier of (i) thirty (30) days after a Stockholder receives a refund or
credit, (ii) thirty (30) days after a Final Determination with respect to such
tax, (iii) with respect to a carry over, thirty (30) days after a Stockholder
files a tax return on which the carryover produces a Tax Benefit, or (iv) thirty
(30) days after the determination by the parties or pursuant to Article IV that
such payment is due.
Article IV
COOPERATION AND EXCHANGE OF INFORMATION
Section 4.1 Whenever any Stockholder or the Company becomes aware of an
issue which it believes gives rise to payment or indemnification from the other
party under Article III, the Stockholder or the Company (as the case may be)
shall promptly give notice of the issue to the other party. The Company shall
provide copies of any such notice it gives or receives under this Section 4.1
to each of the Stockholders within ten (10) days after giving or receiving such
notice. The indemnitor and its representatives, at the indemnitor's expense,
shall be entitled to participate in all conferences, meetings or proceedings
with the IRS or other taxing authority with respect to the issue. If the
indemnitor is more than one Stockholder, the Stockholders liable to provide
such indemnification shall agree among themselves upon one representative to
participate in such conferences, meetings and proceedings with the Company, the
IRS or the applicable taxing authority.
Section 4.2 The parties agree to consult and cooperate with each other in
the negotiation and settlement or litigation of any Adjustment that may give
rise to any payment or an indemnification obligation under this Agreement. All
decisions with respect to such negotiation and settlement or litigation shall
be made by the parties after full, good faith consultation or pursuant to the
dispute resolution provisions set forth in Article V hereof. No such
representative of the Stockholders shall be permitted to settle any litigation
or agree to any Adjustment or indemnification payment without the prior consent
of the Stockholders whose combined Pro Rata Shares exceed fifty percent (50%)
of the outstanding number of shares of Common Stock held by all Stockholders as
of the relevant or the period in controversy.
Article V
DISPUTES
Section 5.1. If the parties are, after negotiation in good faith, unable
to agree upon the appropriate application of this Agreement, the controversy
shall be settled by the accounting firm remaining on the list of firms set
forth on Schedule A hereto after the Company and the representative of the
Stockholders, commencing with the
<PAGE> 4
Company, shall have objected seriatim to the other firms on the list (the
"Accounting Firm"). The decision of the Accounting Firm shall be final, and
each of the Company and the Stockholders agree immediately to pay to the other
any amount due under this Agreement pursuant to such decision. The expenses of
the Accounting Firm shall be borne one-half by the company and one-half by the
Stockholders, on a Pro Rata Share basis, unless the Accounting Firm specifies
otherwise.
Article VI
MISCELLANEOUS
Section 6.1. Term of Agreement. This Agreement shall become effective as
of the date of its execution and shall continue in full force and effect until
terminated by mutual written agreement of all of the parties hereto.
Section 6.2. Severability. If any term of this Agreement is held by a
court of competent jurisdiction to be unenforceable, the remainder of the terms
set forth herein shall remain in full force and effect and shall in no way be
impaired. The parties stipulate that they would have executed the remaining
terms without including any which may hereafter be declared unenforceable. In
the event that any term is held to be unenforceable, the parties shall use
their best efforts to find an alternative means to achieve the same or
substantially the same result as that contemplated by such term.
Section 6.3. Assignment. Except by operation of law or in connection with
the sale of all or substantially all the assets of a party, this Agreement
shall not be assignable, in whole or in part, directly or indirectly, by any
Stockholder without the written consent of the Company or by the Company
without the written consent of the Stockholders whose combined Pro Rata Shares
exceed fifty percent (50%) of the outstanding number of shares of Common Stock
held by all Stockholders at the time such consent is requested. Any attempt to
assign any right or obligations arising under this Agreement without such
consent shall be void. However, the provisions of this Agreement shall be
binding upon, inure to the benefit of and be enforceable by the parties and
their respective successors and permitted assigns.
Section 6.4. Further Assurances. Subject to the provisions of this
Agreement, the parties shall acknowledge such other instruments and documents,
and take all other actions, as may be reasonably required in order to
effectuate the purposes of this Agreement.
Section 6.5. Parties in Interest. Except as herein otherwise specifically
provided, nothing in this Agreement expressed or implied is intended to confer
any right or benefit upon any person, firm or corporation other than the
parties and their respective successors and permitted assigns.
Section 6.6. Waivers, Etc. No failure or delay on the part of any party
in exercising any power or right under this Agreement shall operate as a waiver
thereof, nor shall any single or partial exercise of any such right or power,
or any abandonment or discontinuance of steps to enforce such right or power,
preclude any other or further exercise thereof or the exercise of any other
right or power. No modification or waiver of any provision of this Agreement
nor consent to any departure by any party therefrom shall in any event be
effective unless it shall be in writing, and then such waiver or consent shall
be effective only in the specific instance and for the purpose which given.
Section 6.7. Set-off. All payments to be made by any party under this
Agreement shall be made without set-off, counterclaim or withholding, all of
which are expressly waived.
Section 6.8. Change of Law. If, due to any change in applicable law or
regulation or the interpretation thereof by any court or other governing body
having jurisdiction subsequent to the date of this Agreement, performance of
any provision of this Agreement shall be impracticable or impossible, the
parties shall use their best efforts to find alternative means to achieve the
same or substantially the same results as are contemplated by such provision.
Section 6.9. Headings. Descriptive headings are for convenience only and
shall not control or affect the meaning of any provision of this Agreement.
<PAGE> 5
Section 6.10. Counterparts. For the convenience of the parties, any
number of counterparts of this Agreement may be executed by the parties and
each executed counterpart shall be an original instrument.
Section 6.11. Notices. All notices provided of in this Agreement shall be
validly given if in writing and (i) delivered personally or (ii) sent by
certified mail, postage prepaid, return receipt requested to the address set
forth below:
If to the Company:
2911 Peach Street
P.O. Box 8036
Wisconsin Rapids, Wisconsin 54495-8036
If to a Stockholder:
At the address set forth in Schedule B hereto
or to such other address as any party may, from time to time, designate in a
written notice given in a like manner to each other party hereto. Notice given
in person shall be deemed delivered when received (or when delivery is first
refused) and notice given by mail shall be deemed delivered five (5) calendar
days after the date mailed.
Section 6.12. Governing Law. This Agreement shall be governed by the
laws of the State of Wisconsin.
IN WITNESS WHEREOF, the undersigned have caused this Tax Indemnification
Agreement to be duly executed as of the day and year first written above.
ADVANTAGE LEARNING SYSTEMS, INC.
By: /s/ Michael H. Baum
--------------------
Michael H. Baum, Chief Executive Officer
/s/ Judith A. Paul
---------------------
JUDITH A. PAUL
/s/ Terrance D. Paul
-------------------------
TERRANCE D. PAUL
TERRANCE AND JUDITH PAUL DESCENDANTS'
TRUST
By: /s/ Mark J. Bradley
------------------------
Mark J. Bradley, Trustee
<PAGE> 6
SCHEDULE A
Accounting Firms
Arthur Andersen, LLP
KPMG Peat Marwick LLP
Coopers & Lybrand LLP
Deloitte & Touche
Price Waterhouse LLP
Ernst & Young LLP
<PAGE> 7
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Advantage Learning Systems, Inc. (the "Company") and Judith A. Paul, Terrance
D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement") and (b)
agrees that if she receives a Tax Benefit arising from an Adjustment with
respect to a Tax Item of the Company in the circumstances set forth in Section
3.2 of the Agreement, that she will, on behalf of the Trust, repay same to the
Company. All words used herein which are not otherwise defined shall have the
meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Mia T. Paul
---------------
Mia T. Paul
<PAGE> 8
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Advantage Learning Systems, Inc. (the "Company") and Judith A. Paul, Terrance
D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement") and (b)
agrees that if she receives a Tax Benefit arising from an Adjustment with
respect to a Tax Item of the Company in the circumstances set forth in Section
3.2 of the Agreement, that she will, on behalf of the Trust, repay same to the
Company. All words used herein which are not otherwise defined shall have the
meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Alyssa M. Paul
------------------
Alyssa M. Paul
<PAGE> 9
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Advantage Learning Systems, Inc. (the "Company") and Judith A. Paul, Terrance
D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement") and (b)
agrees that if she receives a Tax Benefit arising from an Adjustment with
respect to a Tax Item of the Company in the circumstances set forth in Section
3.2 of the Agreement, that she will, on behalf of the Trust, repay same to the
Company. All words used herein which are not otherwise defined shall have the
meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Bliss Paul Cohen
--------------------
Bliss Paul Cohen
<PAGE> 10
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Advantage Learning Systems, Inc. (the "Company") and Judith A. Paul, Terrance
D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement") and (b)
agrees that if he receives a Tax Benefit arising from an Adjustment with
respect to a Tax Item of the Company in the circumstances set forth in Section
3.2 of the Agreement, that he will, on behalf of the Trust, repay same to the
Company. All words used herein which are not otherwise defined shall have the
meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Alexander F. Paul
---------------------
Alexander F. Paul
<PAGE> 1
Advantage Learning Systems, Inc.
Exhibit 10.2 - Tax Indemnification Agreement dated as of August 29, 1997
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.
TAX INDEMNIFICATION AGREEMENT
THIS TAX INDEMNIFICATION AGREEMENT, dated as of this 29th day of August,
1997, is entered into by Institute for Academic Excellence, Inc., a Wisconsin
corporation (the "Company"), and Judith A. Paul, Terrance D. Paul and Mark J.
Bradley, as Trustee of the Terrance and Judith Paul Descendants' Trust
(individually, a "Stockholder" and collectively, the "Stockholders");
RECITALS:
WHEREAS, the Stockholders held all of the outstanding shares of the
Company's Common Stock, par value $.01 per share (the "Common Stock") prior to
January 2,1997.
WHEREAS, the Company has elected to be taxed as an S corporation under the
Code.
WHEREAS, the Company's parent, Advantage Learning Systems, Inc., is now
contemplating offering and selling shares of its Common Stock to the public
(the "Public Offering").
WHEREAS, the Company plans, just prior to the completion of the Public
Offering, to terminate its S corporation election.
WHEREAS, after the termination of the Company's S corporation election,
the Stockholders individually will continue to be liable for federal, state,
and local income taxes on the Company's Tax Items that pass through to the
Stockholders under the provisions of Subchapter S of the Code and any similar
provisions of state and local law for all periods prior to the time the Company
ceases to be an S corporation.
NOW, THEREFORE, for good and valuable consideration, the receipt and legal
sufficiency of which hereby are acknowledged, the parties agree as follows:
Article I
PURPOSE
The purpose of this Agreement is to set forth the agreement of the Company
and its Stockholders with respect to certain adjustments to the federal, state
and local personal income tax liability of the Stockholders attributable to the
Tax Items of the Company that pass through to the Stockholders under the
provisions of Subchapter S of the Code and any similar provisions of state and
local law for periods during which the Company is an S Corporation, which
adjustments arise after the termination of the Company's S election.
Article II
DEFINITIONS
Section 2.1 For purposes of this Agreement, the following definitions
shall apply:
(a) "Adjustment" shall mean any proposed or final change in any S
Corporation Tax Liability initiated by the IRS, state or local taxing authority
or any other relevant taxing authority or as a result of the filing of an
amended return for the Company.
<PAGE> 2
(b) "Code" shall mean the Internal Revenue Code of 1986, as amended and in
effect for the taxable period in question.
(c) "Final Determination" shall mean the final resolution of any Income
Tax liability (including all related interest and penalties) for a taxable
period. A Final Determination shall result from the first to occur of:
(i) the expiration of thirty (30) days after IRS acceptance of a
Waiver, unless, within such period, the taxpayer gives notice to the other
party of the taxpayer's intention to attempt to recover all or part of any
amount paid pursuant to the Waiver by the filing of a timely claim for
refund;
(ii) a decision, judgment, decree or other order by a court of
competent jurisdiction that is not subject to further judicial review (by
appeal or otherwise) and has become final;
(iii) the execution of a closing agreement under Section 7121 of the
Code or the acceptance by the IRS or its counsel of an offer in compromise
under Section 7122 of the Code or comparable agreements under the laws of
other jurisdictions;
(iv) the expiration of the time for filing a claim for refund or for
instituting suit in respect of a claim for refund disallowed in whole or
part by the IRS or other relevant taxing authority;
(v) any other final disposition of the Income Tax liability for such
period by reason of the expiration of the applicable statute of
limitations; or
(vi) any other event that the parties agree is a determination of the
liability at issue, including the filing of an amended return.
(d) "Income Tax" shall mean federal income taxes and state and local taxes
imposed upon, or measured by, income. Income Tax includes interest, penalties,
additions to tax and additional amounts and any related reasonable professional
fees and costs or other expenses.
(e) "IRS" shall mean the United States Internal Revenue Service or any
successor, including, but not limited to, its agents, representatives and
attorneys.
(f) "Pro Rata Share" shall mean each Stockholder's proportionate share of
Common Stock owned on the relevant date or held during the relevant period,
which proportionate share shall be a fraction, the numerator of which is the
number of shares of Common Stock held by the Stockholder on the relevant date
or during the relevant period and the denominator of which is the number of
shares of Common Stock held by all Stockholders as of the relevant date or
during the relevant period.
(g) "S Corporation" shall mean an S Corporation within the meaning of
Section 1361 of the Code.
(h) "S Corporation Tax Liability" shall mean the personal Income Tax
liability of a Stockholder for Income Taxes attributable to (a) the Company's
Tax Items that pass through to the Stockholder under the provisions of
Subchapter S of the Code and any similar provisions of state and local law. or
(b) a Stockholder's receipt of indemnity payments hereunder.
(i) "Tax Benefit" shall mean a reduction in the personal Income Tax
liability of a Stockholder (as a result of Tax Items of the Company and all
other Tax Items reflected on the Stockholder's tax return) for any taxable
period and any interest paid in connection therewith by the relevant taxing
authority. The Stockholder shall be deemed to have realized or received a Tax
Benefit from a Tax Item in a taxable period only if and to the extent that the
Stockholder's personal Income Tax liability for such period is less than it
would have been if such liability were determined without regard to such Tax
Item. The Stockholder shall be deemed to have realized or received a Tax
Benefit with respect to a carryover only if, when and to the extent the
carryover is used to produce a Tax Benefit.
(j) "Tax Item" shall mean any item of income, gain, loss, deduction,
credit, recapture of credit, or any other item which increases or decreases
Income Taxes paid or payable by the Stockholder (when the Company is an S
Corporation) or by the Company.
<PAGE> 3
(k) "Waiver" shall mean a Waiver of Restrictions on Assessment and
Collection of Deficiency in Tax and Acceptance of Overassessment on Federal
Revenue Form 870 or 870-AD (or any successor comparable form or the expiration
of a comparable period with respect to any comparable agreement or form under
the laws of other jurisdictions).
Article III
INDEMNIFICATION FOR CERTAIN TAXES
Section 3.1 Each Stockholder severally, but not jointly, shall pay to the
Company an amount equal to any Tax Benefit realized or received by such
Stockholder arising from an Adjustment with respect to a Tax Item of the
Company for any taxable period in which the Company was taxable as an S
Corporation to the extent such Adjustment would reduce the Accumulated
Adjustments Account (the "AAA") below the amount determined as of the last day
of the short S year ending in 1997 for purposes of distributing cash to the
Shareholders in connection with the Public Offering (ignoring any
post-termination distributions to Stockholders).
Section 3.2 The Company shall pay and indemnify the Stockholders for
any S Corporation Tax Liability arising from an Adjustment with respect to a
Tax Item of the Company to the extent such Adjustment would increase the AAA
above the amount determined as of the last day of the short S year ending in
1997 for purposes of distributing cash to the Shareholders in connection with
the Public Offering (ignoring any post-termination distributions to
Stockholders).
Section 3.3 Any payment required under this Article II shall be made by
the earlier of (i) thirty (30) days after a Stockholder receives a refund or
credit, (ii) thirty (30) days after a Final Determination with respect to such
tax, (iii) with respect to a carry over, thirty (30) days after a Stockholder
files a tax return on which the carryover produces a Tax Benefit, or (iv)
thirty (30) days after the determination by the parties or pursuant to Article
IV that such payment is due.
Article IV
COOPERATION AND EXCHANGE OF INFORMATION
Section 4.1 Whenever any Stockholder or the Company becomes aware of an
issue which it believes gives rise to payment or indemnification from the other
party under Article III, the Stockholder or the Company (as the case may be)
shall promptly give notice of the issue to the other party. The Company shall
provide copies of any such notice it gives or receives under this Section 4.1
to each of the Stockholders within ten (10) days after giving or receiving such
notice. The indemnitor and its representatives, at the indemnitor's expense,
shall be entitled to participate in all conferences, meetings or proceedings
with the IRS or other taxing authority with respect to the issue. If the
indemnitor is more than one Stockholder, the Stockholders liable to provide
such indemnification shall agree among themselves upon one representative to
participate in such conferences, meetings and proceedings with the Company, the
IRS or the applicable taxing authority.
Section 4.2 The parties agree to consult and cooperate with each other in
the negotiation and settlement or litigation of any Adjustment that may give
rise to any payment or an indemnification obligation under this Agreement. All
decisions with respect to such negotiation and settlement or litigation shall
be made by the parties after full, good faith consultation or pursuant to the
dispute resolution provisions set forth in Article V hereof. No such
representative of the Stockholders shall be permitted to settle any litigation
or agree to any Adjustment or indemnification payment without the prior consent
of the Stockholders whose combined Pro Rata Shares exceed fifty percent (50%)
of the outstanding number of shares of Common Stock held by all Stockholders as
of the relevant or the period in controversy.
Article V
DISPUTES
Section 5.1. If the parties are, after negotiation in good faith, unable
to agree upon the appropriate application of this Agreement, the controversy
shall be settled by the accounting firm remaining on the list of firms
<PAGE> 4
set forth on Schedule A hereto after the Company and the representative of the
Stockholders, commencing with the Company, shall have objected seriatim to the
other firms on the list (the "Accounting Firm"). The decision of the
Accounting Firm shall be final, and each of the Company and the Stockholders
agree immediately to pay to the other any amount due under this Agreement
pursuant to such decision. The expenses of the Accounting Firm shall be borne
one-half by the company and one-half by the Stockholders, on a Pro Rata Share
basis, unless the Accounting Firm specifies otherwise.
Article VI
MISCELLANEOUS
Section 6.1. Term of Agreement. This Agreement shall become effective as
of the date of its execution and shall continue in full force and effect until
terminated by mutual written agreement of all of the parties hereto.
Section 6.2. Severability. If any term of this Agreement is held by a
court of competent jurisdiction to be unenforceable, the remainder of the terms
set forth herein shall remain in full force and effect and shall in no way be
impaired. The parties stipulate that they would have executed the remaining
terms without including any which may hereafter be declared unenforceable. In
the event that any term is held to be unenforceable, the parties shall use
their best efforts to find an alternative means to achieve the same or
substantially the same result as that contemplated by such term.
Section 6.3. Assignment. Except by operation of law or in connection with
the sale of all or substantially all the assets of a party, this Agreement
shall not be assignable, in whole or in part, directly or indirectly, by any
Stockholder without the written consent of the Company or by the Company
without the written consent of the Stockholders whose combined Pro Rata Shares
exceed fifty percent (50%) of the outstanding number of shares of Common Stock
held by all Stockholders at the time such consent is requested. Any attempt to
assign any right or obligations arising under this Agreement without such
consent shall be void. However, the provisions of this Agreement shall be
binding upon, inure to the benefit of and be enforceable by the parties and
their respective successors and permitted assigns.
Section 6.4. Further Assurances. Subject to the provisions of this
Agreement, the parties shall acknowledge such other instruments and documents,
and take all other actions, as may be reasonably required in order to
effectuate the purposes of this Agreement.
Section 6.5. Parties in Interest. Except as herein otherwise specifically
provided, nothing in this Agreement expressed or implied is intended to confer
any right or benefit upon any person, firm or corporation other than the
parties and their respective successors and permitted assigns.
Section 6.6. Waivers, Etc. No failure or delay on the part of any party
in exercising any power or right under this Agreement shall operate as a waiver
thereof, nor shall any single or partial exercise of any such right or power,
or any abandonment or discontinuance of steps to enforce such right or power,
preclude any other or further exercise thereof or the exercise of any other
right or power. No modification or waiver of any provision of this Agreement
nor consent to any departure by any party therefrom shall in any event be
effective unless it shall be in writing, and then such waiver or consent shall
be effective only in the specific instance and for the purpose which given.
Section 6.7. Set-off. All payments to be made by any party under this
Agreement shall be made without set-off, counterclaim or withholding, all of
which are expressly waived.
Section 6.8. Change of Law. If, due to any change in applicable law or
regulation or the interpretation thereof by any court or other governing body
having jurisdiction subsequent to the date of this Agreement, performance of
any provision of this Agreement shall be impracticable or impossible, the
parties shall use their best efforts to find alternative means to achieve the
same or substantially the same results as are contemplated by such provision.
Section 6.9. Headings. Descriptive headings are for convenience only and
shall not control or affect the meaning of any provision of this Agreement.
<PAGE> 5
Section 6.10. Counterparts. For the convenience of the parties, any
number of counterparts of this Agreement may be executed by the parties and
each executed counterpart shall be an original instrument.
Section 6.11. Notices. All notices provided of in this Agreement shall be
validly given if in writing and (i) delivered personally or (ii) sent by
certified mail, postage prepaid, return receipt requested to the address set
forth below:
If to the Company:
455 Science Drive
Suite 200
Madison, Wisconsin 53711
If to a Stockholder:
At the address set forth in Schedule B hereto
or to such other address as any party may, from time to time, designate in a
written notice given in a like manner to each other party hereto. Notice given
in person shall be deemed delivered when received (or when delivery is first
refused) and notice given by mail shall be deemed delivered five (5) calendar
days after the date mailed.
Section 6.12. Governing Law. This Agreement shall be governed by the
laws of the State of Wisconsin.
IN WITNESS WHEREOF, the undersigned have caused this Tax Indemnification
Agreement to be duly executed as of the day and year first written above.
INSTITUTE FOR ACADEMIC EXCELLENCE, INC.
By: /s/ Michael H. Baum
-------------------
Title: /s/ Chief Executive Officer
----------------------------
/s/ Judith A. Paul
------------------
JUDITH A. PAUL
/s/ Terrance D. Paul
--------------------
TERRANCE D. PAUL
TERRANCE AND JUDITH PAUL DESCENDANTS'
TRUST
By: /s/ Mark J. Bradley
------------------------
Mark J. Bradley, Trustee
<PAGE> 6
SCHEDULE A
Accounting Firms
Arthur Andersen, LLP
KPMG Peat Marwick LLP
Coopers & Lybrand LLP
Deloitte & Touche
Price Waterhouse LLP
Ernst & Young LLP
<PAGE> 7
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Institute for Academic Excellence, Inc. (the "Company") and Judith A. Paul,
Terrance D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement")
and (b) agrees that if she receives a Tax Benefit arising from an Adjustment
with respect to a Tax Item of the Company in the circumstances set forth in
Section 3.2 of the Agreement, that she will, on behalf of the Trust, repay same
to the Company. All words used herein which are not otherwise defined shall
have the meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Mia T. Paul
---------------
Mia T. Paul
<PAGE> 8
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Institute for Academic Excellence, Inc. (the "Company") and Judith A. Paul,
Terrance D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement")
and (b) agrees that if she receives a Tax Benefit arising from an Adjustment
with respect to a Tax Item of the Company in the circumstances set forth in
Section 3.2 of the Agreement, that she will, on behalf of the Trust, repay same
to the Company. All words used herein which are not otherwise defined shall
have the meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Bliss Paul Cohen
--------------------
Bliss Paul Cohen
<PAGE> 9
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Institute for Academic Excellence, Inc. (the "Company") and Judith A. Paul,
Terrance D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement")
and (b) agrees that if she receives a Tax Benefit arising from an Adjustment
with respect to a Tax Item of the Company in the circumstances set forth in
Section 3.2 of the Agreement, that she will, on behalf of the Trust, repay same
to the Company. All words used herein which are not otherwise defined shall
have the meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Alyssa M. Paul
------------------
Alyssa M. Paul
<PAGE> 10
ACKNOWLEDGMENT
The undersigned beneficiary of a subtrust created under the Terrance and
Judith Paul Descendants' Trust (the "Trust") hereby (a) acknowledges receipt of
a copy of the Tax Indemnification Agreement dated August 29, 1997 between
Institute for Academic Excellence, Inc. (the "Company") and Judith A. Paul,
Terrance D. Paul and Mark J. Bradley, as Trustee of the Trust (the "Agreement")
and (b) agrees that if he receives a Tax Benefit arising from an Adjustment
with respect to a Tax Item of the Company in the circumstances set forth in
Section 3.2 of the Agreement, that he will, on behalf of the Trust, repay same
to the Company. All words used herein which are not otherwise defined shall
have the meanings set forth in the Agreement.
Dated as of the 29th day of August, 1997.
/s/ Alexander F. Paul
---------------------
Alexander F. Paul
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