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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934: FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NO. 0-22187
ADVANTAGE LEARNING SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
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<S> <C>
WISCONSIN 39-1559474
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2911 PEACH STREET 54495-8036
P.O. BOX 8036 (Zip Code)
WISCONSIN RAPIDS, WISCONSIN
(Address of principal executive offices)
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Registrant's telephone number, including area code: (715) 424-3636
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant was approximately $343,153,427 as of March 1, 1999. As of March 1,
1999, there were 33,878,817 of the Registrant's shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III is incorporated by reference from the Proxy Statement for the
Annual Meeting of Shareholders to be held on April 14, 1999.
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ITEM 1. BUSINESS
Unless the context requires otherwise, references to the Company include
its consolidated subsidiaries.
OVERVIEW
Advantage Learning Systems, Inc. (the "Company" or "ALS") is a leading
provider of learning information systems to kindergarten through senior high
("K-12") schools in the United States and Canada. The Company's learning
information systems consist of computer software and related training designed
to improve student academic performance by increasing the quality, quantity and
timeliness of performance data available to educators and by facilitating
increased student practice of essential skills. Learning information systems
provide to educators benefits similar to those management information systems
provide to business managers. As of December 31, 1998, the Company has sold its
products to approximately 41,500, or approximately 33%, of the K-12 schools in
the United States and Canada.
The Company's flagship product, the Accelerated Reader,* is software for
motivating and monitoring increased literature-based reading practice. The
Company believes that the Accelerated Reader has achieved a leading market
position as a result of its demonstrated effectiveness in improving student
reading levels and overall academic performance. The Company's other primary
learning information system products include STAR Reading,* Accelerated Math,*
STAR Math* and Perfect Copy*. In addition, the Company provides professional
development training for educators through its Reading Renaissance* and Math
Renaissance* programs.
Originally introduced in 1986, the Accelerated Reader administers
computer-based multiple choice quizzes on books popular among students in grades
K-12 and provides educators with more than 20 reports from which to monitor the
amount and quality of each student's reading practice. Through December 31,
1998, the Company had developed quizzes on approximately 20,500 book titles. In
1994, the Company began offering Reading Renaissance training seminars to
provide educators with professional development training to most effectively use
the Accelerated Reader and the information it generates. As of December 31,
1998, approximately 110,000 educators have attended Reading Renaissance training
seminars. In 1996, the Company released STAR Reading which is a
computer-adaptive reading test and database which enables educators to quickly
obtain student reading scores statistically correlated to national norms. The
results from STAR Reading provide educators with a database of statistically
accurate reading level information on their students from which they can
generate useful reports and adjust instructional strategies accordingly.
In 1998, the Company introduced STAR Math, Accelerated Math and Perfect
Copy. STAR Math is a computer-adaptive math test and database which enables
educators to quickly determine a student's level of math proficiency and monitor
progress throughout the year from third grade through high school. Results from
STAR Math are correlated to major national and state-mandated standardized
tests, and educators are provided with a variety of useful reports. Accelerated
Math is a task-level learning information system that helps teachers ensure
student achievement in math. Accelerated Math uses an algorithm problem
generator to ensure that each student works problems geared to his or her
proficiency level and to learning objectives specified by the teacher.
Accelerated Math handles all scoring and record-keeping chores, minimizing
teacher paperwork. Perfect Copy is the Company's first product targeted to
improving student's writing skills. Perfect Copy allows students to work at the
computer correcting common grammar, punctuation and word usage errors in short
articles and stories. The Company began shipping Perfect Copy in January 1999.
The Company was founded in 1986 and is incorporated under the laws of the
State of Wisconsin. The Company's Common Stock is listed on the Nasdaq National
Market under the symbol "ALSI." The Company's principal executive offices are
located at 2911 Peach Street, P.O. Box 8036, Wisconsin Rapids, Wisconsin
54495-8036 (telephone: 715-424-3636).
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* The Accelerated Reader(R) and Reading Renaissance(R) are registered trademarks
of the Company. STAR Reading, Accelerated Math, STAR Math, Math Renaissance
and Perfect Copy are common law trademarks of the Company.
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INDUSTRY BACKGROUND
Educators, parents and opinion leaders in the United States are
increasingly focusing on improving essential academic skills of students, and,
in particular, their reading and math proficiency. The emphasis on education by
government leaders at all levels, the Department of Education's Goals 2000
program, the Learning to Read, Reading to Learn campaign, the federal
Comprehensive School Reform program, an increase in Title I funding and the
activities of the Education Commission of the States are indicative of this
growing focus. While certain aspects of these initiatives may not endorse, or be
complementary to, the Company's products, this focus and the resulting
initiatives have generally contributed to an increased demand for more effective
methods to improve academic performance. The Company believes that the general
impact of the Goals 2000 program and programs similar to it is to pressure
schools and educators to take action to improve the academic performance of
students. Schools have responded to these demands by investing in computers,
software and other educational technology, testing and other assessment programs
to measure students' progress, and professional development training to help
enhance educators' effectiveness in the classroom.
Based on 1998 data from Quality Education Data, Inc. ("QED"), the K-12
marketplace in the United States consists of approximately 111,000 public and
private schools. According to the U.S. Department of Education, the number of
students enrolled in these schools was approximately 52.7 million in 1998 and is
expected to increase to 54.3 million by 2008. According to industry sources,
U.S. educational technology expenditures were $4.16 billion in 1997 and are
expected to increase to $9.88 billion by 2002. Of this amount, approximately
$770 million was spent on educational software and training, which amount is
expected to increase to $1.39 billion by 2002. Moreover, the installed base of
computers in K-12 schools in the United States was 6.4 million units in 1997 and
is expected to grow to 13.7 million by 2002.
In addition to this increased spending on educational technologies, the
Company believes that there is a growing trend towards requiring better
assessment of student performance and increased accountability of educators and
school systems. The Company also believes there is a growing trend towards
requiring more and better professional development training for educators, as
highlighted in the Department of Education's Goals 2000 program.
The increased public concern over the effectiveness of K-12 schools in
teaching essential academic skills and the rapidly growing role of technology in
the K-12 marketplace have created an increased demand for technology-based
solutions which measure and improve student academic performance and for
professional development training which enables educators to effectively
implement these solutions. However, few providers of educational technology
products have developed tools with demonstrated effectiveness in improving
student academic performance because most products (i) provide inadequate
feedback useful to educators in tailoring instruction to individual students,
(ii) seek to replace educators by attempting to teach skills rather than support
their efforts by encouraging extensive practice on those skills, (iii) compete
with existing curricula and instructional methodologies, (iv) fail to maintain
student interest, and (v) require more advanced technology and/or larger numbers
of computers than are typically available in schools. The Company believes there
is a growing market demand for technology-based learning information systems
that motivate students and achieve measurable results.
THE ADVANTAGE LEARNING SYSTEMS SOLUTION
The Company develops, markets and supports learning information systems
that improve student academic performance by intensifying skills practice and
increasing the quality, quantity and timeliness of information available to
educators. Originally, the Company's products focused exclusively on improving
reading because reading is fundamental to a student's overall academic
performance. The Company now offers products in reading, math and language arts
and expects to expand its product offering in other curriculum areas. The
Company offers Reading Renaissance and Math Renaissance professional development
training to combine the Company's learning information systems technology and
classroom techniques to improve student performance.
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The Company believes its learning information systems offer the following
key benefits:
Improved Student Academic Performance. The Company is committed to
developing and releasing only those products which have demonstrated
effectiveness in improving student academic performance. The Company's software
products, coupled with the techniques taught in the Renaissance training
programs, improve student academic performance by providing educators with an
effective system to motivate students to spend more time "on-task." Independent
studies on the effectiveness of the Accelerated Reader have demonstrated that
use of the Accelerated Reader improves standardized test performance in reading.
Studies conducted by the Company based on publicly available quantitative data
confirm this result and indicate that use of the Accelerated Reader improves
standardized test performance in other academic subject areas as well, including
math, science, social studies and writing.
Ability to Assess Student Progress. The Company's software products
provide educators with timely, accurate information to manage the learning
process within their existing curricula. The objective measurement data derived
from the Company's products enable teachers to continually monitor students'
academic progress and easily identify individual students who may require
special attention.
Suitability for K-12 School Environment. The Company's software products
are easy to use by both students and educators and are capable of running on
computers and hardware platforms commonly found in K-12 schools. Even schools
with a limited number of computers can use most of the Company's products since
these products do not require extensive individual time on the computer. In
addition, the Company's products are used in conjunction with books and
textbooks already commonly found in most K-12 schools.
Supportive of Educators. Rather than attempting to teach skills, thereby
replacing educators, the Company's products and services provide educators with
tools to encourage increased skills practice and to track student academic
performance. Due to this focus on practice and measurement, the Company's
products complement, rather than compete with, existing curricula and
instructional methodologies. As a result, educators remain in control of the
learning process.
Cost-Effective Solution. The cost of the Company's products generally
enables schools to purchase such products within their normal budgets. In
addition, schools may purchase the Company's products for use in a single
classroom, and have the flexibility to acquire additional products for more
classrooms as usage increases.
GROWTH STRATEGY
The Company seeks to establish its products as the de facto standard for
facilitating growth in essential academic skill areas in grades K-12. The key
elements of this strategy are as follows:
Add New Customer Schools. The Company intends to increase its market
penetration by continuing to add new customer schools. As of December 31, 1998,
the Company's products had been sold to approximately 41,500 K-12 schools, which
represents approximately 33% of the total number of schools in the United States
and Canada. The Company plans to add new customer schools by increasing its
direct marketing efforts and extending its strategic alliances.
Intensify and Expand Use of Products by Existing Customer Schools. The
Company intends to intensify and expand the use of its products by existing
customers. Although the Company's products have been sold to approximately 33%
of the K-12 schools in the United States and Canada, most schools begin using
the products as a supplementary or voluntary program in a small percentage of
classrooms, thereby creating the opportunity for the Company to intensify usage
in these classrooms and expand usage to other classrooms and other grade levels.
The Company's experience with its reading products has been that increased use
of the Accelerated Reader leads to increased sales of supplemental title disks,
STAR Reading and Reading Renaissance professional development training. The
Company expects similar patterns to occur with its math products. To increase
the use of its products, the Company continuously publishes newsletters,
catalogs and research relating to the effectiveness of its products, sponsors
seminars and maintains communication with customers through its telephone sales
force.
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Offer New Products in Other Curriculum Areas. The Company intends to
develop groups of products similar to its reading and math products for other
areas of the K-12 curriculum. The Company plans to continue to expand the
language arts products and is exploring other areas such as science and social
studies.
Expand International Marketing and Sales. The Company intends to expand its
international marketing and sales. From its Canadian subsidiary near Toronto,
the Company will actively market all its products to current Accelerated Reader
customers and prospects. Additionally, in Australia and the United Kingdom, the
Company has launched reading and math pilot school programs and has begun
establishing operations in each country. As the Company develops new products,
it plans to expand its marketing and sales efforts into other foreign countries.
Expand Market Presence Through Strategic Alliances. In order to penetrate
the K-12 marketplace more rapidly, the Company has established strategic
alliances with educational book distributors and publishers. These firms are
particularly receptive to such alliances because use of the Company's products
in schools encourages, rather than competing with, the sale of books and other
products sold by these firms. The Company believes that such firms are under
increasing pressure from many customers to offer products supported by the
Accelerated Reader.
PRODUCTS
SOFTWARE AND SUPPORT SERVICES
As of March 1, 1999, the Company offered software products for use in the
K-12 marketplace, as well as support services to the users of its software
products. These software products improve student academic performance by
intensifying skills practice and increasing the quality, quantity and timeliness
of information available to educators. The Company's software and support
services accounted for approximately 86%, 84% and 86% of the Company's net sales
in 1998, 1997 and 1996, respectively.
ACCELERATED READER
The Accelerated Reader is a learning information system for motivating and
monitoring increased literature-based reading practice. The Accelerated Reader
is designed to be very easy to use by students and educators alike. A student
selects a book from a list of books for which the school has an Accelerated
Reader quiz at an appropriate reading level and reads the book. The student then
takes a multiple choice quiz on a computer. The questions contained in the
quizzes are carefully drafted to ensure that a student who has thoroughly read a
book at the appropriate level will pass. For each book read, the Accelerated
Reader tracks amount of reading practice achieved by calculating points based on
the length and difficulty of the book and the student's performance on the quiz.
The information generated from this process -- titles read, percent of
comprehension and amount of reading done -- creates a database of student
reading achievement. From this database, the Accelerated Reader generates more
than 20 different reports from which educators can monitor the amount and
quality of reading practice for each of their students and easily identify
individual students who may require special attention. The Company currently has
a library of computerized book quizzes on more than 20,500 book titles. The
Company developed quizzes on approximately 7,000 book titles in 1998 and expects
to develop quizzes on at least 8,000 additional book titles in 1999. Titles on
disk are organized by reading level and subject matter. Continued usage of the
Accelerated Reader creates demand for additional quizzes, STAR Reading, Reading
Renaissance training and related products.
The Company has successfully developed several products which complement
the Accelerated Reader, including a Spanish/English version of the Accelerated
Reader for bilingual students, AR BookGuide* and AR TitleFinder.* AR BookGuide
is a database listing of all books covered by Accelerated Reader quizzes, in a
format allowing searches by author, reading level, topic and other variables to
facilitate creation of custom book lists for students and for ordering
additional quizzes. AR TitleFinder is a free CD-ROM catalog which the Company
provides to customers to enable them to easily locate and order Accelerated
Reader quizzes.
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*AR BookGuide(TM) and AR TitleFinder(TM) are common law trademarks of the
Company.
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STAR READING
STAR Reading is a computer-adaptive reading test which the Company believes
is the first software to provide to classroom teachers reading scores
statistically correlated to national norms in ten minutes or less at the
computer. STAR Reading administers a series of multiple choice questions for
which students choose the best word to complete each sentence. STAR Reading
adapts itself to each student's reading level by applying a proprietary
branching logic which evaluates the pattern of the student's answers to
determine the level of difficulty required for subsequent questions. The results
from this test provide educators with a database of statistically accurate
reading level information on their students from which they can generate useful
reports and adjust instructional strategies accordingly. STAR Reading is easy to
use and can be administered several times per year. Revenues from sales of STAR
Reading contributed significantly to the Company's net sales in 1998 and 1997
and to a lesser extent in 1996.
ACCELERATED MATH
Accelerated Math is a task-level learning information system that helps
every student to meet all math objectives, third grade through calculus. It
employs algorithm technology to automatically align assignments to academic
objectives and tracks mastery of each objective. Like Accelerated Reader,
Accelerated Math encourages and monitors student practice of foundational
skills, while providing immediate feedback on performance to students and
teachers. Accelerated Math also eliminates manual grading of papers and
generates detailed reports that enable teachers to individualize instruction
without increasing their workload.
STAR MATH
STAR Math computer-adaptive math test and database provides the same
benefits as STAR Reading. Quick, accurate and easy to administer STAR Math
provides math scores for third grade through high school in approximately 15
minutes. Like STAR Reading, it can be administered throughout the school year to
track growth.
PERFECT COPY
Perfect Copy is software that helps educators improve students' core
writing skills. It uses in-context editing to cover the rules of grammar,
punctuation and word usage. The Company expects to develop other language arts
products in the future.
EXPERT SUPPORT PLANS
The Company offers Expert Support Plans ("ESPs") which provide users of its
products access to telephone support and other benefits such as free or
reduced-cost upgrades. Packaged with kits and also sold as add-ons, ESPs entitle
educators to expert help resolving questions regarding technical problems with
Company products, networks and other software interacting with Company products.
PROFESSIONAL DEVELOPMENT
The Company offers professional development programs and products that
train educators to effectively use the Company's software products. Revenues
from professional development accounted for approximately 14%, 16% and 14% of
the Company's net sales in 1998, 1997 and 1996, respectively.
READING RENAISSANCE
The Reading Renaissance program provides educators with professional
development training to most effectively use the Accelerated Reader, STAR
Reading and the learning information they generate. This training combines
technology and classroom techniques to increase in-school accountable reading
practice. The Company offers a variety of Reading Renaissance seminars and
workshops, including one- and two-day scheduled training programs, which are
conducted throughout the year at various hotel locations in the United States,
and on-site training programs pursuant to which the Company's training staff
visit an individual school,
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school district or region to conduct a seminar or workshop. As of March 1, 1999,
the Company's training staff consisted of 94 presenters, both full and
part-time, most of whom are K-12 educators who use the Reading Renaissance
techniques in their own classrooms. Since its inception in late 1993 to December
31, 1998, the Company has trained approximately 110,000 educators, of whom
approximately 50,000 were trained in 1998.
To encourage educators who have completed Reading Renaissance training to
implement the methodology fully, the Company in 1995 initiated the "Model
Classroom" certification program. This program recognizes educators who meet
certain objective implementation standards related to the amount of accountable
reading among students, regular diagnosis and intervention with at-risk
students, and other key variables. As of March 1, 1999, the program has received
approximately 6,850 applications and certified 3,331 "Model Classroom" teachers,
and 106 "Model Schools" in which the majority of classrooms have "Model
Classroom" teachers.
MATH RENAISSANCE
Offered both on-site and at hotel sites throughout the United States, new
one-day Math Renaissance seminars instruct educators in techniques to enhance
their math curriculum and instruction methods. The Company expects Math
Renaissance to grow along with utilization of its STAR Math and Accelerated Math
software.
OTHER PROFESSIONAL DEVELOPMENT
The Company also produces videotapes and manuals to be used in conjunction
with its training programs. Further, the Company conducts research on best
practices, performs field validation of techniques, and gathers information to
guide the development of the Company's learning information systems.
PRODUCT DEVELOPMENT
The Company believes that continued investment in product development is
required to remain competitive in the K-12 marketplace. The Company invests
continuously in the development of new products, enhancement of existing
products and development of tools to increase the efficiency of product
development. For the years ended December 31, 1998, 1997 and 1996, the Company
expended approximately $5.2 million, $3.4 million and $1.9 million,
respectively, on product development (including amounts capitalized).
As of March 1, 1999, the Company employed 118 persons, both full and
part-time, dedicated to product development and software design. The Company
expects this number to increase in the next year. The Company's product
development staff has a high level of expertise in learning information theory,
quiz writing, interface design, software engineering, quality assurance and
technical writing.
The Company generates new software product concepts that it believes will
help educators improve student academic performance, based on the Company's
understanding of learning information theory and the need for practice of
essential academic skills. These product concepts are then refined based on
feedback from its customers, which the Company continuously solicits and
incorporates throughout the new product development process. Based on the
refined product concepts, product proposals are then formulated by the marketing
and software engineering groups and reviewed by management to determine which
should be developed into prototypes. These prototypes are then tested in
customer schools. Before beginning production, management makes a final
evaluation of each new product to determine that it is both desired by educators
and effective in meeting their needs.
The professional development training programs were originally developed,
and are continually refined, through field experience with the Company's
products and research by the Company's staff. The Company conducts research into
effective education techniques related to the Company's products and services.
This research provides the staff with a standard against which to develop and
refine training programs to help educators accelerate learning.
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SALES, MARKETING AND DISTRIBUTION
The Company markets its products primarily to individual educators in the
K-12 market, including teachers, school librarians and principals. The Company
is also beginning to market its products to entire schools and school districts.
The Company's sales and marketing strategy consists primarily of direct
marketing to potential and existing customers. The Company uses a variety of
lead generating techniques, including trade shows, advertisements in educational
publications, direct mail, Web sites and referrals. Once product literature has
been forwarded to a current or potential customer, one of the Company's in-house
staff of telephone sales representatives contacts the customer to answer
questions and, ultimately, direct the customer to a purchase. Having an in-house
sales force affords the Company better control over its marketing efforts.
In addition, the Company has resale arrangements with four U.S. and three
Canadian book distributors that are authorized to sell the Company's products to
their customers. Sales to Perma-Bound, a division of Hertzberg-New Method, Inc.
("Perma-Bound"), accounted for 13.9%, 14.4% and 15.2% of the Company's net sales
in 1998, 1997 and 1996, respectively. Under these resale arrangements,
distributors take orders which are then filled by the Company. This control over
product shipment ensures premium customer service and retention of customer
contacts for future marketing and sales opportunities.
In addition to the book distributors which resell the Company's products,
approximately 15 other book distributors and publishers promote the sale of the
Accelerated Reader by publishing special catalogs that advertise book sets
assembled specifically for Accelerated Reader title disks. The Company intends
to seek additional strategic alliances with book distributors and publishers and
to use alliances to expand its base of strategic partners to sell its products.
Furthermore, the Company plans to continue to develop other cross-marketing
arrangements with third-party firms selling non-competing products into the
education market.
The Company believes it maintains a very high level of customer
satisfaction. Historically, the Company has experienced less than a 2% rate of
return for its products.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
Most of the Company's customers have moderate to low levels of computer
knowledge and do not have any technical support on-site to assist them. The
Company therefore provides a variety of customer and technical support services
to purchasers of its software products. In order to provide the level of
customer service that results in a consistently high level of customer
satisfaction, the Company employs an experienced staff of technical service
representatives who are capable of answering technical questions relating to the
Company's software products, regardless of platform, as well as questions
regarding hardware and networks. In the case of unusually complex problems, the
Company's full-time test services staff support the telephone service
representatives by recreating the customer's problem in the Company's simulation
laboratory.
PRODUCTION
Currently, all of the Company's software products are distributed on
diskettes or CD-ROM. The diskettes are duplicated and packaged at Company
headquarters. The CD-ROM disks are produced by a third-party contractor. Other
related products, including videotapes, books, graphics and motivational items,
are produced by third-party vendors.
COMPETITION
The K-12 educational technology and professional development markets in
which the Company operates are very competitive. The Company competes primarily
against more traditional methods of education, training and testing, including
pencil and paper testing. In addition, the Company competes with other companies
offering educational software products to schools, including larger companies
with greater resources than the Company, such as International Business Machines
Corporation, Apple Computer, Inc. and Broderbund Software, Inc. The Company's
reading products also compete more directly with products
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such as Electronic Bookshelf which was recently purchased by Scholastic Inc.
Many other companies, including Microsoft Corp. and Walt Disney Co., provide
educational software products which the Company believes are not marketed
primarily to schools. While the Company's existing competitors may broaden their
product lines, and potential competitors, including large hardware
manufacturers, software developers and educational publishers, may enter or
increase their focus on the school market, the Company believes it is well
positioned to continue to compete favorably in the markets in which it
participates.
INTELLECTUAL PROPERTY
The Company regards certain of its technologies as proprietary and relies
primarily on a combination of copyright, trademark and trade secret laws and
employee non-disclosure agreements to establish and protect its proprietary
rights. Although the Company has filed a patent application which covers the
technology developed to automatically generate and format examinations that
include math expressions, the Company does not currently possess any patents or
other registered intellectual property rights with respect to its software.
There can be no assurance that the steps taken by the Company to protect its
rights will be adequate to prevent or deter misappropriation. The Company
believes that factors such as the technological and creative skills of its
personnel and the quality of the content of its products may be more important
in establishing and maintaining a leadership position within the industry than
are the various legal protections of its technology, but that such legal
protections may also be a part of the Company's long-term strategy.
While the Company believes that its products, trademarks and other
proprietary rights do not infringe upon the proprietary rights of third parties,
as the number of software products in the educational technology industry
increases and the functionality of these products begins to overlap, software
developers may become increasingly subject to infringement claims. There can be
no assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products, trademarks or
other Company works or that any such assertion may not require the Company to
enter into royalty arrangements or result in costly litigation.
The software market has traditionally experienced widespread unauthorized
reproduction of products in violation of intellectual property rights. Such
activity is difficult to detect and legal proceedings to enforce intellectual
property rights are often burdensome and involve a high degree of uncertainty
and costs. While the Company electronically codes its software products to
protect against unauthorized copying and use, there can be no assurance that the
Company's software products will not experience unauthorized reproduction.
EMPLOYEES
As of March 1, 1999, the Company had 518 full and part-time employees. The
Company believes its relations with employees are good. None of the Company's
employees is represented by a union or subject to collective bargaining
agreements.
BACKLOG
As of December 31, 1998 and 1997, the Company had backlogs which aggregated
approximately $4.4 million and $1.4 million, respectively. A significant portion
of the backlog at December 31, 1998, was due to the introduction of new products
near year end. All of the backlog is expected to be eliminated during 1999.
FORWARD-LOOKING STATEMENTS
In accordance with the Private Securities Litigation Reform Act of 1995,
the Company can obtain a "safe-harbor" for forward-looking statements by
identifying those statements and by accompanying those statements with
cautionary statements which identify factors that could cause actual results to
differ materially from those in the forward-looking statements. Accordingly, the
following information contains or may contain forward-looking statements: (1)
information included or incorporated by reference in this Annual Report on Form
10-K, including, without limitation, statements made under Item 1, Business and
Item 7,
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Management's Discussion and Analysis of Financial Condition and Results of
Operations, including, without limitation, statements with respect to growth
plans, projected sales, revenues, earnings and costs, and product development
schedules and plans, (2) information included or incorporated by reference in
future filings by the Company with the Securities and Exchange Commission
including, without limitation, statements with respect to growth plans,
projected sales, revenues, earnings and costs, and product development schedules
and plans and (3) information contained in written material, releases and oral
statements issued by, or on behalf of, the Company including, without
limitation, statements with respect to growth plans, projected sales, revenues,
earnings and costs, and product development schedules and plans. The Company's
actual results may differ materially from those contained in the forward-looking
statements identified above. Factors which may cause such a difference to occur
include, but are not limited to, the following:
Reliance on Single Product Line and Significant Distributor. The Company's
Accelerated Reader software and supplemental Accelerated Reader quiz disks
accounted for approximately 48%, 51% and 69% of the Company's net sales in 1998,
1997 and 1996, respectively. Sales of the Company's products through one book
distributor accounted for 13.9%, 14.4% and 15.2% of net sales in 1998, 1997 and
1996, respectively. An overall decline in sales of the Accelerated Reader,
supplemental quiz disks, STAR Reading and related products, including sales
through book distributors, would have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Continued Product Development. The K-12 educational
technology and professional development markets in which the Company competes
are characterized by evolving industry standards, frequent product introductions
and, to a lesser extent, technological change. The Company's future success will
depend, to a significant extent, on a number of factors, including the Company's
ability to enhance its existing products and develop and successfully introduce
new products, including new products designed for use in other areas of the
curriculum. There can be no assurance that products designed for use in other
areas of the curriculum besides reading will be as well received as the
Company's reading products, particularly since such other products may require
technology and/or resources not generally available in all schools. The Company
attempts to maintain high standards for the demonstrated academic effectiveness
of its products. The Company's adherence to these standards could delay or
inhibit the introduction of new products. Moreover, there can be no assurance
that the Company's products will not be rendered obsolete or that the Company
will have sufficient resources to make the necessary investments or be able to
develop and market the products required to maintain its competitive position.
Management of Growth. The Company has recently experienced rapid growth. If
such growth continues, it may place a strain on the Company's financial,
management and other resources. The Company's ability to manage its growth
effectively will require it to attract, train, motivate, manage and retain key
employees and to improve its operational, financial and management information
systems. If the Company is unable to maintain and manage growth effectively, the
Company's business, financial condition and results of operations would be
adversely affected.
Opposing Educational Philosophies. The Company focuses on developing and
marketing educational products and services that demonstrate effectiveness
through measurable results. This approach, however, is not accepted by all
academics and educators, some of whom formulate opinions about the desirability
of a particular educational product or service based on philosophical or other
concerns rather than the effectiveness of the product. Certain academics and
educators are opposed to the principles and methodologies underlying and
associated with the Company's products, such as the use of objective standards,
standardized testing, computers and motivational techniques, among others. Some
of these philosophical opponents of the Company's products and services have the
capacity to influence the market for the Company's products, and such influence
could have a material adverse impact on demand for the Company's products and,
thus, the Company's business, financial condition and results of operations.
Dependence on Educational Institutions and Government
Funding. Substantially all of the Company's revenue is derived from sales to
educational institutions, individual educators and suppliers thereto. There can
be no assurance that educational institutions and/or individual educators will
continue to invest in technology-based products and professional development for
reading and other curricula or continue to respond favorably
9
<PAGE> 11
to the Company's marketing. The inability of the Company to increase the number
of products sold or number of schools served would adversely affect the
Company's business, financial condition and results of operations. Because of
the Company's dependence on educational institutions, the funding of which is
largely dependent on government support, a substantial decrease in government
budgets or funding for educational software or technology would have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, certain aspects of government sponsored education
initiatives may not endorse, or be complementary to, the principles and
methodologies underlying and associated with the Company's products, which could
adversely affect the Company's business, financial condition and results of
operations.
Geographic Concentration of Sales. A substantial portion of the Company's
sales is concentrated in several states, including Texas, Florida, California,
Georgia and Illinois, which accounted for approximately $6.4 million, $3.6
million, $3.2 million, $2.8 million and $2.3 million, respectively, of the
Company's net sales in 1998. If large numbers of schools or a district
controlling a large number of schools in such states were to discontinue
purchasing the Company's products, the Company's business, financial condition
and results of operations would be materially adversely affected.
Highly Competitive Industry. The K-12 educational technology and
professional development markets in which the Company operates are very
competitive. The Company competes primarily against more traditional methods of
education, training and testing, including pencil and paper testing. In
addition, the Company competes with other companies offering educational
software products to schools, including larger companies with greater resources
than the Company, such as International Business Machines Corporation, Apple
Computer, Inc. and Broderbund Software, Inc. The Company's reading products also
compete more directly with products such as Electronic Bookshelf which was
recently purchased by Scholastic Inc. Many other companies, including Microsoft
Corp. and Walt Disney Co., provide educational software products which the
Company believes are not marketed primarily to schools. Existing competitors may
continue to broaden their product lines, and potential competitors, including
large hardware manufacturers, software developers and educational publishers,
may enter or increase their focus on the school market, resulting in greater
competition for the Company. The Company's success in selling its products,
particularly its reading products, may cause competitors to focus on the
Company's products in their marketing efforts thereby increasing direct
competition. There can be no assurance that the Company will continue to be able
to market its products successfully or compete effectively in the educational
products marketplace.
Dependence on Key Personnel. The Company's success depends to a significant
extent upon the continued active participation of certain key members of
management, including Judith Paul and Terrance Paul, the Chairman and Vice
Chairman of the Company, respectively. In addition to serving as Chairman of the
Company, Ms. Paul is a spokesperson for the Company and coordinates the
Company's public relations and customer communications policies. Mr. Paul is
primarily responsible for the Company's long-term strategic planning and new
product development strategy. Mr. Paul also coordinates the research activities
conducted by the Institute. The Company does not have employment agreements with
either of these persons and has no current intention of entering into any such
employment agreements. The loss of services of either of these persons would
have a material adverse effect on the Company's business, financial condition
and results of operations.
Ability to Attract and Retain Qualified Personnel. The Company's future
success will depend, in part, upon its continuing ability to retain the
employees, including senior management personnel, who have assisted in the
development and marketing of the Company's products and to attract and retain
qualified additional employees trained in computer technology, marketing and
finance to enhance the Company's product offerings and broaden its operations.
There can be no assurance that the Company will continue to be able to attract
and retain such personnel. The failure to attract or retain the necessary
personnel would have a material adverse effect on the Company's business,
financial condition and results of operations.
Seasonality; Limited Backlog; Fluctuations in Quarterly Performance. The
Company's business may experience a certain degree of seasonality due to the
budget cycles of the Company's school customers. The Company generally ships
products as orders are received, and, therefore, the Company has historically
operated without significant backlog. Thus, revenues in any quarter are
substantially dependent on the quantity
10
<PAGE> 12
of product orders received in that quarter. However, it is the Company's
practice to announce new products prior to the time at which such products will
be ready for shipment to allow customers sufficient lead time for budgeting and
curriculum purposes. This practice can result in a significant backlog for
orders of new products. These orders are generally filled within a relatively
short period of time after the product is ready for shipment. The introduction
of products in certain periods could cause those periods to have significantly
higher sales and higher sales growth rates than subsequent periods. Seasonal
variations in demand may also cause significant variations in the Company's
results of operations. The Company's overall gross margins fluctuate based upon
the mix of product sales and service sales. The Company realizes significantly
higher margins on its product sales. Service revenues tend to be more seasonal
than product revenues. Quarterly service revenues are typically highest in the
third quarter. This results in the Company experiencing seasonal variations in
margins. The Company's operating margins also fluctuate based upon a number of
other factors including, but not limited to, the amount of product development
expenditures, the timing of the capitalization of product development
expenditures and the timing of certain marketing activities.
Limited Protection of Intellectual Property and Proprietary Rights. The
Company regards certain of its technologies as proprietary and relies primarily
on a combination of copyright, trademark and trade secret laws and employee
non-disclosure agreements to establish and protect its proprietary rights.
Although the Company has filed a patent application which covers the technology
developed to automatically generate and format examinations that include math
expressions, the Company does not currently possess any patents or other
registered intellectual property rights with respect to its software. There can
be no assurance that the steps taken by the Company to protect its rights will
be adequate to prevent or deter misappropriation. In addition, while the Company
does not believe that its products, trademarks or other proprietary rights
infringe upon the proprietary rights of third parties, there can be no assurance
that a third party will not make a contrary assertion. The cost of responding to
such an assertion may be material, whether or not the assertion is validated.
The software market has traditionally experienced widespread unauthorized
reproduction of products in violation of intellectual property rights. Such
activity is difficult to detect and legal proceedings to enforce intellectual
property rights are often burdensome and involve a high degree of uncertainty
and costs. There can be no assurance that the Company's software products will
not experience unauthorized reproduction, which would have a material adverse
effect on the Company's business, financial condition and results of operations.
Concentration of Share Ownership; Control by Principal
Shareholders/Management. As of March 1, 1999, the principal shareholders of the
Company, Judith Paul and Terrance Paul, who are also the Chairman and Vice
Chairman of the Company, respectively, beneficially owned approximately 73.0% of
the outstanding Common Stock. As a result, such principal shareholders have the
ability to control the Company and direct its business and affairs.
Share Price Volatility. Numerous factors, many of which are beyond the
control of the Company, may cause the market price of the Common Stock to
fluctuate significantly. These factors include announcements of technological
innovations, customer orders of new products by the Company and its competitors,
earnings releases by the Company and its competitors, market conditions in the
industry and the general state of the securities markets. The market price of
the Common Stock may be adversely affected by the Company's failure to meet the
earnings estimates of analysts and others. In addition, the timing of orders by
the Company's customers may cause quarterly fluctuations of the Company's
results of operations which may, in turn, affect the market price of the Common
Stock.
Shares Eligible for Future Sale. Sales of a substantial number of shares of
Common Stock in the public market could adversely affect the market price for
the Common Stock. Approximately 26,800,000 shares are held by "affiliates" of
the Company and may be publicly sold only if registered under the Securities Act
of 1933 or sold in accordance with an applicable exemption from registration,
such as Rule 144. In addition, the Company has filed a registration statement
under the Securities Act to register an aggregate of 3,000,000 shares of Common
Stock reserved for issuance under the Company's 1997 Stock Incentive Plan, which
will, when issued in accordance with such plan, be eligible for immediate sale
in the public market, subject to the Rule 144 resale limitations for affiliates.
11
<PAGE> 13
No Payment of Cash Dividends. The Company does not anticipate paying any
cash dividends in the foreseeable future.
Possible Antitakeover Effects of Certain Articles and By-Law Provisions and
Provisions of Wisconsin Law. The Company's Amended and Restated Articles of
Incorporation and Amended and Restated By-Laws, along with Wisconsin statutory
law, contain provisions that could discourage potential acquisition proposals
and might delay or prevent a change in control of the Company. Such provisions
could result in the Company being less attractive to a potential acquiror and
could result in the shareholders receiving less for their Common Stock than
otherwise might be available in the event of a takeover attempt.
12
<PAGE> 14
ITEM 2. PROPERTIES
The Company owns or leases the following properties:
<TABLE>
<CAPTION>
APPROXIMATE
LOCATION USE SQUARE FEET TITLE
- -------- --- ----------- -----
<S> <C> <C> <C>
Wisconsin Rapids, Wisconsin................... Corporate 125,000 Owned
Headquarters
Madison, Wisconsin............................ Professional Training 74,000 Owned*
Operations
Vancouver, Washington......................... IPS Operations 9,200 Leased
Ontario, Canada............................... ALS Canada Operations 8,000 Leased
</TABLE>
- -------------------------
* This property is owned by Athena Holdings LLC. The Company owns 70% of Athena
Holdings LLC. The Company leases 34,633 square feet of the 74,000-square foot
property from Athena Holdings LLC.
The Company also owns its former headquarters facility in Wisconsin Rapids,
Wisconsin, which is leased to an unaffiliated tenant.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material pending legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no matter submitted during the fourth quarter of fiscal 1998 to a
vote of the security holders of the Company.
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<PAGE> 15
EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
NAME OF OFFICER OFFICE
--------------- ------
<S> <C>
Judith A. Paul................. Ms. Paul is the co-founder of the Company and has been
Age 52 Chairman of the Board of Directors since 1986. Ms. Paul acts
as the Company spokesperson and coordinates the Company's
public relations and customer communication policies. Ms.
Paul has co-written Great Ways to Motivate Students to Read
(1998) and is the author of The Family Reading Night Kit
(1996) and The Literacy Partnership Kit (1997). Ms. Paul
holds a bachelors degree in elementary education from the
University of Illinois.
Terrance D. Paul............... Mr. Paul is the co-founder of the Company and has been Vice
Age 52 Chairman of the Board of Directors since July 1996. Mr. Paul
is primarily responsible for the Company's long-term
strategic planning and new product development strategy. Mr.
Paul also coordinates the research activities conducted by
the Institute. From November 1995 until July 1996, Mr. Paul
served as the Company's Chief Executive Officer. From
January 1992 until August 1993 and again from September 1994
until November 1995, Mr. Paul served as President of the
Company. For the 12 years prior to 1992, Mr. Paul was
President of Best Power Technology, a manufacturer of
uninterruptible power systems. Mr. Paul is the author of
several publications, including How to Create World-Class
Readers (1993), Patterns of Reading Practice (1996) and The
New Technology of Learning Information Systems (1997). He is
also the general editor of Fundamentals of Reading
Renaissance (1994-1996), the textbook used in seminars on
reading improvement by the Institute. Mr. Paul holds a law
degree from the University of Illinois and an MBA from
Bradley University. Terrance Paul is Judith Paul's husband.
Michael H. Baum................ Mr. Baum has been Chief Executive Officer of the Company
Age 51 since July 1996 and a Director since September 1994. Mr.
Baum served as President of the Company between November
1995 and June 1996. From September 1994 until November 1995,
Mr. Baum served as the Managing Director of the Institute
and from June 1994 until September 1994, he served as the
Director of Educational Consulting for the Institute. From
1984 until June 1994, Mr. Baum held a variety of positions
with Francorp, Inc., an international management consulting
firm based in Chicago, his last position being that of
Executive Vice President, which he held from September 1991
until June 1994. Mr. Baum holds a bachelors degree and a
masters degree in teaching from Yale University and an MBA
from Northwestern University.
</TABLE>
14
<PAGE> 16
<TABLE>
<CAPTION>
NAME OF OFFICER OFFICE
--------------- ------
<S> <C>
John R. Hickey................. Mr. Hickey has been President of the Company since July 1996
Age 43 and a Director of the Company since October 1996. From
January 1996 until June 1996, Mr. Hickey served as Executive
Vice President of R.F. Technologies, Inc., a manufacturer of
protection devices, and from September 1995 until December
1995, he served as Executive Vice President of Liebert
Corporation (a subsidiary of Emerson Electric), a
manufacturer of uninterruptible power supplies. From January
1989 until June 1995, Mr. Hickey held various senior
management positions with Best Power Technology, including
Executive Vice President of Operations, Senior Vice
President of Sales and Marketing and Vice
President-International. In addition, Mr. Hickey spent
approximately ten years with Briggs and Stratton, a
manufacturer of air-cooled gasoline engines for outdoor
power equipment, headquartered in Milwaukee, Wisconsin.
While at Briggs and Stratton, Mr. Hickey served in various
management positions, eventually rising to the position of
the Director of International Sales and Finance
Administration, a position he held from October 1985 until
January 1989. Mr. Hickey holds a bachelors degree in
international business from the University of Wisconsin.
Timothy Sherlock............... Mr. Sherlock has been Vice President, Chief Financial
Age 46 Officer and Secretary of the Company since January 1998.
From February 1996 until January 1998, Mr. Sherlock served
as the Company's Corporate Controller. From May 1995 until
February 1996, Mr. Sherlock served as the Corporate
Controller of Decisionmark Corporation, an Iowa-based
information software development firm. From May 1987 until
April 1995, Mr. Sherlock served as Finance Manager for the
software division of super computer maker Cray Research,
Inc. Mr. Sherlock holds a bachelors degree in business
administration from the University of St. Thomas, and is a
Certified Public Accountant.
</TABLE>
The term of office of each executive officer is from one annual meeting of
the Board of Directors until the next annual meeting of the Board of Directors
or until a successor for each is selected.
There are no arrangements or understandings between any of the executive
officers of the Company and any other person (not an officer or director of the
Company acting as such) pursuant to which any of the executive officers were
selected as an officer of the Company.
15
<PAGE> 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Common Stock is traded under the symbol "ALSI" on the Nasdaq National
Market, and quotations are supplied by the National Association of Securities
Dealers, Inc. The table below sets forth the reported high and low closing sale
prices for shares of the Company's Common Stock on the Nasdaq National Market
during the indicated quarters. Per share data have been restated to reflect a
two-for-one stock split in the form of a dividend effective February 26, 1999.
The prices set forth below reflect prices between dealers of the Company's
Common Stock without retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Fiscal year ended December 31, 1998
First Quarter............................................ $17.188 $10.719
Second Quarter........................................... 19.375 12.375
Third Quarter............................................ 20.250 12.000
Fourth Quarter........................................... 33.188 16.375
Fiscal year ended December 31, 1997
Third Quarter (September 25 to September 30)............. $12.625 $11.063
Fourth Quarter........................................... 14.125 10.000
</TABLE>
Information on the price range for shares of the Company's Common Stock for
the first half of 1997 is omitted since the Common Stock did not become publicly
traded until September 25, 1997.
HOLDERS
As of March 1, 1999, there were approximately 310 record holders of the
Common Stock.
HISTORICAL DIVIDENDS
For the year ended December 31, 1997, the Company declared S corporation
distributions to its shareholders of $18.1 million. The Company's status as an S
corporation for federal tax purposes was terminated in connection with
completion of the Company's initial public offering in September 1997. For the
year ended December 31, 1998, the Company paid distributions of S corporation
retained profits of $302,000 to S corporation shareholders. The Company intends
to retain all of its future earnings to fund growth and the operation of its
business and therefore does not anticipate paying any cash dividends in the
foreseeable future. Future cash dividends, if any, will be at the discretion of
the Company's Board of Directors and will depend upon, among other things, the
Company's future operations and earnings, capital requirements and surplus,
general financial condition, contractual restrictions and such other factors as
the Board of Directors may deem relevant.
RECENT SALES OF UNREGISTERED SECURITIES
There were no sales of unregistered securities during the year ended
December 31, 1998. During the year ended December 31, 1997, in addition to any
unregistered sales of the Company's equity securities reported by the Company on
Form 10-Q, the Company sold the following equity securities in a transaction
that was not registered under the Securities Act of 1933:
On January 2, 1997, ALS issued an aggregate of 480 shares of Class A common
stock and 1,920 shares of Class B common stock (representing 640,266 shares of
Common Stock after (i) the filing of the Company's Amended and Restated Articles
of Incorporation which reclassified the Class A and Class B common stock as
Common Stock, and (ii) completion of a 133.31 for 1 stock split in the form of
two separate stock dividends) to Judith and Terrance Paul in exchange for their
shares of IPS and the Institute pursuant to a reorganization which resulted in
IPS and the Institute becoming wholly-owned subsidiaries of the Company. The
shares of
16
<PAGE> 18
Class A and Class B common stock were issued without registration under the
Securities Act in reliance on Section 3(a)(9) and Section 4(2) thereunder.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
The Company's Registration Statement on Form S-1 was declared effective by
the Securities and Exchange Commission on September 24, 1997 (File No.
333-22519), and the initial public offering of the Common Stock began on
September 25, 1997. All of the 5.6 million shares offered by the Company, in
addition to the 840,000 shares subject to an over-allotment option, were sold on
September 30, 1997 and October 2, 1997, respectively.
The net proceeds to the Company from the initial public offering, after
deducting underwriting discounts of $3,606,400 and other expenses of
approximately $941,000, were approximately $46,972,000. From September 24, 1997
through December 31, 1998, the Company used the net proceeds as follows:
(1) Approximately $1.6 million was used to pay compensation expenses
related to the termination of the Company's phantom stock plan.
(2) Approximately $7.2 million was used to pay the entire principal and
accrued interest on the mortgage note and an unsecured note, both
related to the construction of the Company's facility in Wisconsin
Rapids, Wisconsin.
(3) Approximately $5.1 million was used to pay the entire principal and
accrued interest on notes from the Company's principal shareholders
related to the 1996 acquisition of IPS.
(4) Approximately $10.9 million was used to pay distributions of S
corporation retained profits to S corporation shareholders.
(5) Approximately $6.4 million was used to invest in Athena Holdings LLC, a
limited liability company formed for the purpose of constructing the
Company's facility in Madison, Wisconsin.
(6) Approximately $700,000 was used for pilot operations in various markets
and miscellaneous acquisitions.
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<PAGE> 19
ITEM 6. SELECTED FINANCIAL DATA
SELECTED HISTORICAL CONSOLIDATED AND COMBINED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
CONSOLIDATED AND COMBINED
INCOME STATEMENT DATA:
Net sales:
Products...................................... $43,680 $29,060 $18,930 $11,602 $8,088
Services...................................... 11,084 6,964 3,451 1,003 163
------- ------- ------- ------- ------
Total net sales.......................... 54,764 36,024 22,381 12,605 8,251
Cost of sales:
Products...................................... 4,005 3,438 2,329 1,468 937
Services...................................... 4,496 3,013 1,898 595 166
------- ------- ------- ------- ------
Total cost of sales................... 8,501 6,451 4,227 2,063 1,103
------- ------- ------- ------- ------
Gross profit.......................... 46,263 29,573 18,154 10,542 7,148
Operating expenses:
Product development........................... 4,998 3,427 1,555 802 358
Selling and marketing......................... 13,614 9,682 6,639 4,201 2,551
General and administrative.................... 7,262 5,750 3,547 2,090 1,240
Purchased research and development............ 475 -- 3,400 -- --
Phantom stock plan termination................ -- 1,617 -- -- --
------- ------- ------- ------- ------
Total operating expenses.............. 26,349 20,476 15,141 7,093 4,149
Operating income................................ 19,914 9,097 3,013 3,449 2,999
Other income (expense), net..................... 1,657 (71) (155) 13 23
------- ------- ------- ------- ------
Income before taxes............................. 21,571 9,026 2,858 3,462 3,022
Income tax provision (benefit).................. 8,844 (673) (1,602) -- --
------- ------- ------- ------- ------
Net income...................................... $12,727 $ 9,699 $ 4,460 $ 3,462 $3,022
======= ======= ======= ======= ======
Basic earnings per share(1)..................... $ 0.38 $ 0.33 $ 0.16 $ 0.13 $ 0.11
Diluted earnings per share(1)................... 0.37 0.33 0.16 0.13 0.11
======= ======= ======= ======= ======
CONSOLIDATED AND COMBINED
BALANCE SHEET DATA:
Working capital................................. $34,938 $28,675 $ 566 $ 1,105 $2,213
Total assets.................................... 67,996 50,883 19,855 4,761 4,070
Notes payable and long-term debt................ -- -- 10,450 -- --
Shareholders' equity............................ 55,626 42,835 3,773 2,613 3,065
</TABLE>
- -------------------------
(1) Per share data have been restated to reflect a 2-for-1 stock split in the
form of a dividend effective February 26, 1999.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leading provider of learning information systems to
kindergarten through senior high ("K-12") schools in the United States and
Canada. The Company's learning information systems consist of computer software
and related training designed to improve student academic performance by
increasing the quality, quantity, and timeliness of performance data available
to educators and by facilitating increased student practice of essential skills.
The Company's flagship product, the Accelerated Reader, is software for
18
<PAGE> 20
motivating and monitoring increased literature-based reading practice. The
Company's learning information system products also include STAR Reading, a
computer-adaptive reading test and database, and the Reading Renaissance
program, through which the Company provides professional development training
for educators. In 1998, the Company introduced Accelerated Math and STAR Math,
software products that apply to math the principles that have made the reading
software effective in improving academic performance, Perfect Copy,writing
skills development software, and Math Renaissance, professional development
training in math.
The Company's sales are derived primarily from the sale of software
products, software support agreements, and training seminars and programs. The
Company recognizes revenue from sales of its off-the-shelf software products at
the time of shipment to customers. The Company records the estimated cost of
returns at the time of sale. The Company also develops custom software products
through its subsidiary, IPS. The Company recognizes revenue from the sale of
custom software on the percentage of completion method. Service revenue includes
both revenue relating to the Reading Renaissance professional development
training and revenue from software support agreements for ongoing customer
support and product upgrades. The Company recognizes revenue from sales of its
training seminars and programs primarily at the time the seminar or training
program is conducted. Revenue from separately sold software support agreements
is reflected as deferred revenue and is amortized ratably over the term of the
maintenance period. The Company's deferred revenue represents payments received
from customers for services still to be rendered.
Because software products are generally shipped as orders are received, the
Company has historically operated without significant backlog. However, it is
the Company's practice to announce new products prior to the time at which such
products will be ready for shipment to allow customers sufficient lead time for
budgeting and curriculum purposes. This practice can result in a significant
backlog for orders of new products. These orders are generally filled within a
relatively short period of time after the product is ready for shipment. The
introduction of products in certain periods could cause those periods to have
significantly higher sales and higher sales growth rates than subsequent
periods.
Cost of sales consists of expenses associated with sales of software
products and training seminars and programs. These costs include: (i)
personnel-related costs, (ii) costs associated with the manufacture and assembly
of the Company's products, and (iii) an allocation of facilities costs. The
Company recognizes significantly higher gross margins on its product sales than
on its service sales. Product sales as a percentage of total sales have remained
relatively constant while gross profit margins on products have improved due to
operating leverage associated with increased dollar volume of product sales.
Gross margins on service sales have increased due to decreased costs of
delivering training sessions. Consequently, the Company's total gross profit
margin has increased. Management anticipates that overall gross profit margin
percentage will remain relatively constant as growth in product sales continues,
countered by an increase in service sales as a percentage of total sales.
The Company expenses all product development costs associated with a
product until technological feasibility is established, after which time such
costs are capitalized until the product is available for general release to
customers. Capitalized product development costs are amortized into cost of
sales generally using the straight-line method over 24 months.
In June 1998, the Company acquired 100% of the stock of Logicus
Incorporated ("Logicus"), an Ontario, Canada-based firm specializing in writing
skills development software. The transaction was accounted for using the
purchase method of accounting. Accordingly, the results of operations of Logicus
have been included in the consolidated financial statements since the date of
acquisition. As part of the acquisition, $475,000 of the purchase price was
allocated to purchased research and development which was expensed in the second
quarter of 1998. The acquisition of Logicus had no material effect on the
results of operations of the Company in 1998.
In August 1996, an affiliate of the Company acquired substantially all of
the assets of IPS for $5.0 million plus the assumption of certain liabilities
and the obligation to make certain contingent payments, which obligation was
satisfied in connection with the Company's initial public offering of common
stock in September 1997 (the "Offering"). Effective January 2, 1997, all of the
outstanding capital stock of IPS was contributed to the Company in return for
shares of capital stock of ALS. The acquisition was accounted for
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<PAGE> 21
using the purchase method of accounting. Accordingly, the results of operations
of IPS are included in the combined results of operations of the Company
effective as of August 1, 1996. As part of the acquisition, $3.4 million of the
purchase price was allocated to purchased research and development which was
expensed in August 1996. See Notes 3 and 5 of Notes to the Company's Financial
Statements.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated and combined income
statement data as a percentage of net sales, except that individual components
of cost of sales and gross profit are shown as a percentage of their
corresponding component of net sales:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net sales:
Products............................................... 79.8% 80.7% 84.6%
Services............................................... 20.2 19.3 15.4
----- ----- -----
Total net sales................................... 100.0% 100.0% 100.0%
===== ===== =====
Cost of sales:
Products............................................... 9.2 11.8 12.3
Services............................................... 40.6 43.3 55.0
Total cost of sales............................... 15.5 17.9 18.9
Gross profit:
Products............................................... 90.8 88.2 87.7
Services............................................... 59.4 56.7 45.0
Total gross profit................................ 84.5 82.1 81.1
Operating expenses:
Product development.................................... 9.1 9.5 6.9
Selling and marketing.................................. 24.9 26.9 29.7
General and administrative............................. 13.3 16.0 15.8
Purchased research and development..................... .9 -- 15.2
Phantom stock plan termination......................... -- 4.5 --
----- ----- -----
Operating income......................................... 36.3 25.2 13.5
Other income (expense), net.............................. 3.0 (0.2) (0.7)
----- ----- -----
Income before taxes...................................... 39.3 25.0 12.8
Income tax provision (benefit)........................... 16.1 (1.9) (7.1)
----- ----- -----
Net income............................................... 23.2% 26.9% 19.9%
===== ===== =====
</TABLE>
YEARS ENDED DECEMBER 31, 1998 AND 1997
Net Sales. The Company's net sales increased by $18.8 million, or 52.0%, to
$54.8 million in 1998 from $36.0 million in 1997. Product sales increased by
$14.6 million, or 50.3%, to $43.7 million in 1998 from $29.1 million in 1997.
The increase in product sales is primarily attributable to (i) increased sales
of Accelerated Reader title disks to a larger base of Accelerated Reader
schools, including the introduction of approximately 7,000 new book titles on
Accelerated Reader title disks since December 31, 1997 (ii) the addition of
about 7,500 new customer schools in 1998, (iii) the continuation of very strong
STAR Reading sales, and (iv) sales of the Company's new math products which
began shipping in late 1998.
Reading software sales were positively impacted in 1998 by several large
orders: Dade County, Florida, adopted the Company's reading software on a
county-wide basis; a six-district consortium in Washington state received a
federal grant for software and training; and a large number of Idaho schools
received from the Albertson Foundation a grant to purchase software. While the
Company anticipates continued growth over the
20
<PAGE> 22
long term in the sale of its software products, large scale sales such as those
described above are unlikely to recur in every period. This may cause periods in
which such sales occur to have higher sales and higher sales growth rates than
subsequent periods.
Service revenue, which consists of revenue from sales of training sessions
and software support agreements, increased by $4.1 million, or 59.2%, to $11.1
million in 1998 from $7.0 million in 1997. This increase is primarily
attributable to revenue from software support agreements associated with new
product sales along with renewals of agreements by an expanding base of existing
customers, and to an increased number of Reading Renaissance training sessions.
Cost of Sales. The cost of sales of products increased by $567,000, or
16.5%, to $4.0 million in 1998 from $3.4 million in 1997. As a percentage of
product sales, the cost of sales of products declined to 9.2% in 1998 compared
to 11.8% in 1997 due to operating leverage associated with increased product
sales. The cost of sales of services increased by $1.5 million, or 49.2%, to
$4.5 million in 1998 from $3.0 million in 1997 primarily due to increased costs
of providing technical support relating to software support agreements. As a
percentage of sales of services, the cost of sales of services declined to 40.6%
in 1998 compared to 43.3% in 1997, primarily as a result of decreased costs of
delivering training sessions. The Company's overall gross profit margin improved
2.4% to 84.5% in 1998 from 82.1% in 1997 due to improved gross profit margins on
both products and services.
Product Development. Product development expenses increased by $1.6
million, or 45.8%, to $5.0 million in 1998 from $3.4 million in 1997. These
expenses increased primarily due to increased development staff and consulting
costs associated with the new products and seminars introduced in 1998. As a
percentage of net sales, product development costs decreased to 9.1% in 1998
from 9.5% in 1997. The Company anticipates that the total dollar amount of
product development costs will increase as the Company enhances and extends its
product offerings into other areas of the K-12 curriculum.
Selling and Marketing. Selling and marketing expenses increased by $3.9
million, or 40.6%, to $13.6 million in 1998 from $9.7 million in 1997. These
expenses increased due to (i) the publication of additional catalogs, mailings
to an increased customer and prospect base, and increased advertising in
publications and (ii) salary and recruiting costs associated with the hiring of
additional personnel. As a percentage of net sales, selling and marketing
expenses decreased to 24.9% in 1998 from 26.9% in 1997. This decrease is
primarily due to economies of scale associated with significantly increased
product and service sales. Management anticipates that selling and marketing
expenses will generally continue to rise, while remaining relatively constant as
a percentage of sales, as the Company expands its customer and prospect base and
number of curricular areas its products cover.
General and Administrative. General and administrative expenses increased
by $1.5 million, or 26.3%, to $7.3 million in 1998 from $5.7 million in 1997.
The higher expenses for 1998 are largely due to increased costs associated with
the hiring of additional personnel, including wages and related benefits. As a
percentage of net sales, general and administrative costs decreased to 13.3% in
1998 from 16.0% in 1997. The Company anticipates that general and administrative
expenses will remain relatively constant as a percentage of sales in future
periods.
Purchased Research and Development. In connection with the acquisition of
Logicus, Incorporated, $475,000 of the purchase price was allocated to purchased
research and development which was expensed in June 1998.
Phantom Stock Plan Termination. The Company's phantom stock plan terminated
on September 30, 1997 in connection with the closing of the Offering on that
date. The one-time charge of $1.6 million associated with the plan termination
was expensed in September 1997.
Operating Income. Operating income increased by $10.8 million, or 118.9%,
to $19.9 million in l998 from $9.1 million in 1997. As a percentage of net
sales, operating income increased to 36.3% in 1998 from 25.2% in 1997. Excluding
the effects of the purchased research and development expense in 1998, and the
phantom stock plan termination expense in 1997, operating income would have
increased by $9.7 million, or 90.3%, to $20.4 million in 1998 from $10.7 million
in 1997, or 37.2% of net sales compared to 29.7% of net sales in 1997.
21
<PAGE> 23
Interest Income. Interest income increased $1.2 million to $1.7 million in
1998 from $483,000 in 1997 due to an increase in interest earning short-term
investments purchased with proceeds from the Company's initial public offering
in late 1997.
Interest Expense. Interest expense decreased $637,000 to $8,000 in 1998
from $645,000 in 1997. In late 1997, proceeds from the Company's initial public
offering were used to pay all outstanding indebtedness.
Income Taxes. Income tax expense of $8.8 million was recorded in 1998 at an
effective income tax rate of 41.0%. In January 1997, a deferred tax asset of
$1.6 million was written off when IPS elected S corporation status. In September
1997, a tax benefit of $3.5 million was recorded in connection with the
Company's change in tax status from S corporation to C corporation status. The
Company became subject to corporate level income taxes effective with the
closing of the Offering and consequently provided for current and deferred
income taxes on income subsequent to September 30, 1997. The Company expects
that the effective rate of tax on its income will be approximately 41% during
1999. See Note 6 of Notes to the Company's Financial Statements.
YEARS ENDED DECEMBER 31, 1997 AND 1996
Net Sales. The Company's net sales increased by $13.6 million, or 61.0%, to
$36.0 million in 1997 from $22.4 million in 1996. Product sales increased by
$10.2 million, or 53.5%, to $29.1 million in 1997 from $18.9 million in 1996.
The increase in product sales is primarily attributable to (i) revenues from
STAR Reading for which shipments and recognition of revenue began in September
1996, (ii) increased sales of Accelerated Reader title disks to a larger base of
Accelerated Reader schools, including the introduction of approximately 3,000
new book titles on Accelerated Reader title disks in 1997 (iii) the sale of the
Accelerated Reader to approximately 7,100 new customer schools in 1997, and (iv)
inclusion of IPS sales commencing August l, 1996.
Service revenue from sales of training seminars and software support
agreements increased by $3.5 million, or 101.8%, to $7.0 million in 1997 from
$3.5 million in 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 $1.1 million, or
47.6%, to $3.4 million in 1997 from $2.3 million in 1996. As a percentage of
product sales, the cost of sales of products declined to 11.8% in 1997 compared
to 12.3% in 1996. The cost of sales of services increased by $1.1 million, or
58.7%, to $3.0 million in 1997 from $1.9 million in 1996. As a percentage of
sales of services, the cost of sales of services declined to 43.3% in 1997
compared to 55.0% in 1996, primarily as a result of decreased costs of
delivering training sessions. The Company's overall gross profit margin improved
1.0% to 82.1% in 1997 from 81.1% in 1996 due primarily to improved gross profit
margins on services.
Product Development. Product development expenses increased by $1.8
million, or 120.3%, to $3.4 million in 1997 from $1.6 million in 1996. These
expenses increased primarily due to: (i) increased development staff and
consulting costs associated with new products, and (ii) the inclusion of IPS's
product development commencing August 1, 1996. As a percentage of net sales,
product development costs increased to 9.5% in 1997 from 6.9% in 1996.
Selling and Marketing. Selling and marketing expenses increased by $3.1
million, or 45.8%, to $9.7 million in 1997 from $6.6 million in 1996. These
expenses increased due to an increase in 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 26.9% in 1997 from 29.7% in 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 $2.2 million, or 62.1%, to $5.7 million in 1997 from $3.5 million in 1996.
The higher expenses for 1997 are largely due to increased costs associated with
the hiring of additional personnel, including wages and related benefits, and
increased costs
22
<PAGE> 24
associated with the Company's new headquarters building. As a percentage of net
sales, general and administrative costs increased somewhat to 16.0% in 1997 from
15.8% in 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 Offering on that
date. The one-time charge of $1.6 million associated with the plan termination
was expensed in September 1997.
Operating Income. Operating income increased by $6.1 million, or 201.9%, to
$9.1 million in l997 from $3.0 million in 1996. As a percentage of net sales,
operating income increased to 25.2% in 1997 from 13.5% in 1996. Excluding the
effects of the purchased research and development expense in 1996 and the
phantom stock plan termination expense in 1997, operating income would have
increased by $4.3 million, or 67.2%, to $10.7 million in 1997 from $6.4 million
in 1996, or 29.7% of net sales compared to 28.7% of net sales in 1996.
Interest Income. Interest income increased $448,000 to $483,000 in 1997
from $35,000 in 1996 due to increased levels of funds available for investment
primarily from the Offering proceeds and to a lesser extent cash flow generated
by operations.
Interest Expense. Interest expense increased $439,000 to $645,000 in 1997
from $206,000 in 1996 primarily as a result of interest expense incurred in
connection with loans to finance the acquisition of IPS and the construction of
the Company's new corporate headquarters building in Wisconsin Rapids,
Wisconsin.
Income Tax Benefit. 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 $1.6 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. The Company
became subject to corporate level income taxes effective with the closing of the
Offering and consequently provided for current and deferred income taxes from
September 30, 1997 to December 31, 1997. See Note 6 of Notes to the Company's
Financial Statements.
YEAR 2000
The Company has investigated the extent to which its operations are subject
to Year 2000 issues and assessed the measures it believes will be necessary to
avoid any material disruption to its operations relating to Year 2000 issues. On
the basis of this investigation and assessment, the Company has taken steps to
ensure that its systems and products will not be adversely impacted by Year 2000
issues. As of December 31, 1998, substantially all of the Company's systems and
products are Year 2000 compliant. The cost to the Company for such compliance
measures has been approximately $100,000, and management believes that the cost
of additional modifications will be approximately $300,000. The cost of the
Company's internal Year 2000 compliance measures is being funded through
operating cash flows.
In addition to assessing its own readiness for the Year 2000, the Company
has initiated formal communications with all of its significant suppliers to
determine the extent to which the Company is vulnerable to those third parties'
potential failure to remediate their own Year 2000 issues. A significant
percentage of these suppliers have responded in writing to the Company's Year
2000 readiness inquiries. The Company plans to continue assessment of its
third-party business partners, including face-to-face meetings with management
and/or on site visits as deemed appropriate. Despite the Company's diligence,
there can be no guarantee that the systems of other companies, on which the
Company's systems rely, will be timely converted or that a failure to convert by
another company or a conversion that is incompatible with the Company's systems
would not have a material adverse effect on the Company. The cost to the Company
for its third party compliance efforts as of December 31, 1998 has been
approximately $500,000, and management believes that the cost of additional
efforts in this regard will be approximately $300,000. The cost of the Company's
external Year 2000 compliance measures is being funded through operating cash
flows.
23
<PAGE> 25
With respect to Year 2000 risks associated with the Company's systems, the
Company believes that the most reasonably likely worst case scenario is that the
Company will experience a number of minor systems malfunctions and errors in the
early part of the Year 2000 that were not detected during its compliance
efforts. The Company believes that these problems will not be overwhelming and
will not have a material effect on the Company's operations or financial
results.
With respect to Year 2000 risks associated with the Company's software
products, the Company cannot be certain that the software will operate error
free, or that the Company will not be subject to litigation, whether the
software operates error free or not. However, the Company believes that based on
its efforts to ensure compliance, it is not reasonably likely that the Company
will be subject to such litigation.
With respect to Year 2000 risks associated with third party suppliers, the
Company believes that the most reasonably likely worst case scenario is that
some of the Company's significant suppliers will not be Year 2000 compliant.
Management also believes that the number of such suppliers will have been
minimized by the Company's program of identifying non-compliant suppliers and
replacing or jointly developing alternative supply or delivery solutions prior
to the Year 2000.
The Company has limited the scope of its risk assessment to those factors
which it can reasonably be expected to have an influence upon. For example, the
Company has made the assumption that government agencies, utility companies and
national telecommunication providers will continue to operate. Obviously, the
lack of such services could have a material effect on the Company's ability to
operate, but the Company has little, if any, ability to influence such an
outcome, or to make alternative arrangements in advance for such services in the
event they are not available.
The Company has not yet established a contingency plan to handle the most
reasonably likely worst case scenarios described above. Nevertheless, the
Company has begun to develop such a plan. If the Company and/or its significant
suppliers are unable to resolve issues related to the Year 2000 on a timely
basis, it could result in a material financial risk to the Company.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998, the Company's cash, cash equivalents and
short-term investments increased $3.9 million to $33.1 million from the December
31, 1997 total of $29.2 million. The net increase is due primarily to $13.5
million in net cash provided by operating activities offset by $8.5 million used
in the purchase of property, plant and equipment, including $6.4 million related
to the development of an office and training products development facility in
Madison, Wisconsin. 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.
Effective June 30, 1998, the Company acquired 100% of the stock of Logicus
Incorporated. The acquisition did not have a material impact on 1998 financial
results.
In March 1998, Athena Holdings LLC ("AHL") was formed by the Company and an
unaffiliated party to develop a facility in the Madison, Wisconsin area to house
the offices, marketing and sales functions, training development staff, and
training support staff of the Institute for Academic Excellence. The Company
received a 70% interest in AHL in return for its capital contribution of
$700,000. The other party will also utilize part of the facility. Additionally,
a portion of the property will be leased to third parties. The estimated total
cost of the project is approximately $6.7 million, of which approximately $6.4
million had been incurred in 1998. The Company is providing permanent financing
for the project in the form of a mortgage note with interest at a market rate.
The net proceeds to the Company from its initial public offering in 1997,
after deducting underwriting discounts of $3,606,400 and other expenses of
approximately $941,000 were approximately $46,972,000. The Company has thus far
used the proceeds from the Offering as follows:
(i) Approximately $1.6 million was used to pay compensation expenses
related to the termination of the Company's phantom stock plan.
24
<PAGE> 26
(ii) Approximately $7.2 million was used to pay the entire principal
and accrued interest on the mortgage note and an unsecured note, both
related to the construction of the Company's facility in Wisconsin Rapids,
Wisconsin.
(iii) Approximately $5.1 million was used to pay the entire principal
and accrued interest on notes from the Company's principal shareholders
related to the 1996 acquisition of IPS.
(iv) Approximately $10.9 million was used to pay distributions of S
corporation retained profits to S corporation shareholders.
(v) Approximately $6.4 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 $700,000 was used for pilot operations in various
markets and miscellaneous acquisitions.
The Company has broad discretion with respect to the use of the remaining
proceeds.
At December 31 1998, the Company had a $10.0 million unsecured revolving
line of credit with a bank which is available until March 31, 2000. The line of
credit bears interest at either a floating rate based on the prime rate less
1.0%, or a fixed rate for a period of up to 90 days based on LIBOR plus 1.25%.
The rate is at the option of the Company and is determined at the time of
borrowing. As of December 31, 1998, the line of credit had not been used.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
At December 31, 1998, the Company had no material market risk exposure
(e.g., interest rate risk, foreign currency exchange rate risk or commodity
price risk).
25
<PAGE> 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES:
We have audited the accompanying consolidated balance sheets of Advantage
Learning Systems, Inc. (a Wisconsin corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated and combined statements of
income, equity and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements are the responsibility of the
company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated and combined financial statements referred
to above present fairly, in all material respects, the financial position of
Advantage Learning Systems, Inc. and subsidiaries as of December 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Milwaukee, Wisconsin
February 2, 1999
26
<PAGE> 28
FINANCIAL STATEMENTS
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $14,222 $22,320
Short term investments.................................... 18,869 6,865
Accounts receivable, less allowance of $1,058,000 in 1998
and $638,000 in 1997................................... 8,832 3,317
Inventories............................................... 794 345
Prepaid expenses.......................................... 656 746
Deferred tax asset........................................ 2,242 1,831
------- -------
Total current assets.............................. 45,615 35,424
------- -------
Property, plant and equipment, net.......................... 19,101 12,042
Deferred tax asset.......................................... 1,647 1,661
Intangibles, net............................................ 1,445 1,599
Capitalized software, net................................... 188 157
------- -------
Total assets...................................... $67,996 $50,883
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,815 $ 982
Deferred revenue.......................................... 3,443 2,854
Payroll and employee benefits............................. 1,080 657
Income taxes payable...................................... 2,157 --
Other current liabilities................................. 2,182 1,701
Distribution payable to shareholders...................... -- 555
------- -------
Total current liabilities......................... 10,677 6,749
------- -------
Deferred revenue.......................................... 1,398 1,299
------- -------
Total liabilities................................. 12,075 8,048
------- -------
Minority interest......................................... 295 --
Shareholders' equity:
Common stock, $.01 par; shares authorized: 50,000,000;
issued and outstanding:33,835,580 -- 1998
33,804,766 -- 1997................................... 338 338
Additional paid in capital............................. 40,674 40,588
Retained earnings...................................... 14,636 1,909
Accumulated other comprehensive income................. (22) --
------- -------
Total shareholders' equity........................... 55,626 42,835
------- -------
Total liabilities and shareholders' equity........ $67,996 $50,883
======= =======
</TABLE>
The accompanying notes to the financial statements are an integral part of these
balance sheets.
27
<PAGE> 29
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net Sales:
Products.................................................. $43,680 $29,060 $18,930
Services.................................................. 11,084 6,964 3,451
------- ------- -------
Total net sales...................................... 54,764 36,024 22,381
------- ------- -------
Cost of sales:
Products.................................................. 4,005 3,438 2,329
Services.................................................. 4,496 3,013 1,898
------- ------- -------
Total cost of sales.................................. 8,501 6,451 4,227
------- ------- -------
Gross profit......................................... 46,263 29,573 18,154
Operating expenses:
Product development....................................... 4,998 3,427 1,555
Selling and marketing..................................... 13,614 9,682 6,639
General and administrative................................ 7,262 5,750 3,547
Purchased research and development........................ 475 -- 3,400
Phantom stock plan termination............................ -- 1,617 --
------- ------- -------
Total operating expenses............................. 26,349 20,476 15,141
------- ------- -------
Operating income..................................... 19,914 9,097 3,013
Other income (expense):
Interest income........................................... 1,709 483 35
Interest expense.......................................... (8) (645) (206)
Other, net................................................ (44) 91 16
------- ------- -------
Income before taxes......................................... 21,571 9,026 2,858
Income tax provision (benefit).............................. 8,844 (673) (1,602)
------- ------- -------
Net income.................................................. $12,727 $ 9,699 $ 4,460
======= ======= =======
Earnings per share:
Basic..................................................... $ 0.38 $ 0.33 $ 0.16
Diluted................................................... 0.37 0.33 0.16
</TABLE>
The accompanying notes to the financial statements are an integral part of these
statements.
28
<PAGE> 30
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED AND COMBINED EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK (1) ADDITIONAL OTHER
----------------- PAID IN RETAINED COMPREHENSIVE TOTAL
SHARES AMOUNT CAPITAL EARNINGS INCOME EQUITY
------ ------ ---------- -------- ------------- ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995.................... -- $ -- $ -- $ -- $ -- $ 2,613
Net income.................................. -- -- -- -- -- 4,460
Distributions to shareholders............... (3,500)
Contribution from shareholders.............. -- -- -- -- -- 200
------- ---- ------- -------- ---- --------
Balance, December 31, 1996.................... -- -- -- -- -- 3,773
Net income.................................. -- -- -- 9,699 -- 9,699
Recapitalization............................ 27,302 273 (6,819) 10,319 -- --
Distributions to shareholders............... -- -- -- (18,109) -- (18,109)
Public offering............................. 6,440 64 46,908 -- -- 46,972
Settlement of IPS purchase(2)............... 63 1 499 -- -- 500
------- ---- ------- -------- ---- --------
Balance, December 31, 1997.................... 33,805 338 40,588 1,909 -- 42,835
Net income.................................. -- -- -- 12,727 -- 12,727
Foreign currency translation................ (22) (22)
--------
Comprehensive income...................... 12,705
Distribution to shareholders................ -- -- (302) -- -- (302)
Tax benefit on stock options................ -- -- 133 -- -- 133
Exercise of stock options................... 31 -- 246 -- -- 246
Stock option grants......................... -- -- 9 -- -- 9
------- ---- ------- -------- ---- --------
Balance, December 31, 1998.................... 33,836 $338 $40,674 $ 14,636 $(22) $ 55,626
======= ==== ======= ======== ==== ========
</TABLE>
- -------------------------
(1) Common Stock, $0.01 par value, 50,000,000 shares authorized.
(2) See Note 3 of Notes to Financial Statements.
The accompanying notes to the financial statements are an integral part of these
statements.
29
<PAGE> 31
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Reconciliation of net income to net cash provided by
operating activities:
Net income................................................ $ 12,727 $ 9,699 $ 4,460
Noncash (income) expenses included in net income --
Depreciation and amortization.......................... 2,087 1,478 711
Loss on building held for sale......................... -- -- 200
Purchased research and development..................... 475 -- 3,400
Deferred income taxes.................................. (397) (1,890) (1,602)
Change in assets and liabilities --
Accounts receivable.................................... (5,459) (793) (755)
Inventory.............................................. (421) 198 (311)
Prepaid expenses....................................... 89 (481) 60
Accounts payable and other current liabilities......... 3,758 1,745 858
Retainage and amounts due under construction
contract............................................. (17) (1,135) 1,151
Deferred revenue....................................... 688 1,601 1,031
Other..................................................... (20) 1 --
-------- -------- --------
Net cash provided by operating activities............ 13,510 10,423 9,203
-------- -------- --------
Cash flows from investing activities:
Purchase of property, plant & equipment................... (8,465) (1,693) (9,898)
Purchase of short term investments, net................... (12,004) (6,865) --
Capitalized software development costs.................... (194) (4) (365)
Acquisitions.............................................. (634) (265) (4,610)
-------- -------- --------
Net cash used in investing activities................ (21,297) (8,827) (14,873)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of stock........................... -- 46,972 200
Proceeds from exercise of stock options................... 246 -- --
Equity contribution from minority partner................. 300 -- --
Proceeds from long-term debt & notes payable to
shareholders........................................... -- -- 10,600
Payments on debt.......................................... -- (10,450) (150)
Distributions to shareholders............................. (857) (17,554) (3,500)
-------- -------- --------
Net cash provided by (used in) financing
activities........................................ (311) 18,968 7,150
-------- -------- --------
Net increase (decrease) in cash............................. (8,098) 20,564 1,480
Cash and cash equivalents, beginning of period.............. 22,320 1,756 276
-------- -------- --------
Cash and cash equivalents, end of period.................... $ 14,222 $ 22,320 $ 1,756
======== ======== ========
</TABLE>
The accompanying notes to the financial statements are an integral part of these
statements.
30
<PAGE> 32
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(1) CONSOLIDATION
The consolidated financial statements include the financial results of
Advantage Learning Systems, Inc. ("ALS") and its subsidiaries, collectively the
"Company". The Company's significant subsidiaries include the Institute for
Academic Excellence, Inc. ("Institute") and IPS Publishing, Inc. ("IPS"). The
Company also owns 70% of Athena Holdings LLC which was formed for the purpose of
constructing a facility in Madison, Wisconsin. Combined equity represents the
combination of the common stock, paid-in capital and retained earnings of ALS,
the Institute, and IPS. Effective January 2, 1997, the Institute and IPS became
wholly owned subsidiaries of ALS. As a result, subsequent periods are presented
on a consolidated basis. All significant intercompany transactions have been
eliminated in the consolidated and combined financial statements.
(2) NATURE OF OPERATIONS
ALS is a provider of learning information systems to K-12 schools in the
United States and Canada. ALS's flagship product is the Accelerated Reader, a
learning information system for motivating and monitoring increased
literature-based reading practice. ALS has also developed STAR Reading, a
computer-adaptive reading test and database. In 1998, the Company introduced
Accelerated Math and STAR Math, software products that apply to math the
principles that have made the reading software effective in improving academic
performance, Perfect Copy, writing skills development software, and Math
Renaissance, professional development training in math.
The Institute develops and conducts Renaissance training programs, which
provide educators with professional development training to most effectively use
ALS products and the learning information they generate.
IPS provides customized software to publishers for assessment and skills
practice in math, science, and other subjects. Additionally, IPS develops
content for math products distributed by the Company.
(3) ACQUISITIONS
Effective June 30, 1998, the Company acquired 100% of the stock of Logicus
Incorporated ("Logicus"), an Ontario, Canada-based firm specializing in writing
skills development software. The transaction was accounted for using the
purchase method of accounting, and the results of operations of Logicus have
been included in the consolidated financial statements since the date of
acquisition. The purchase price included the acquisition of certain in process
research and development which resulted in a pre-tax charge of $475,000 in the
second quarter of 1998. The acquisition of Logicus had no material effect on the
results of operations of the Company in 1998. Pro forma results for 1998 and
1997 would not be materially different from actual.
Effective August 1, 1996, IPS Acquisition, Inc. ("Acquisition") acquired
substantially all of the assets of IPS. Acquisition was formed by the
shareholders of ALS for the sole purpose of acquiring certain assets of IPS.
Acquisition was capitalized with $200,000 of equity and $4.7 million of loans
from shareholders. Subsequent to the transaction, Acquisition changed its name
to IPS Publishing, Inc.
The acquisition was accounted for under the purchase method of accounting.
The net purchase price was comprised of $4,610,000 cash paid at closing,
$265,177 cash paid in 1997 and $500,000 of ALS common stock given at the closing
date of the Initial Public Offering of the Company's common stock in 1997 (see
Note 5). The purchase price included the acquisition of certain in process
research and development which resulted in a pre-tax charge to income of
$3,400,000 for the year ended December 31, 1996.
31
<PAGE> 33
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(4) SIGNIFICANT ACCOUNTING POLICIES
(a) Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(b) Revenue recognition
In 1997 the Accounting Standards Executive Committee of the AICPA issued
Statement of Position No. 97-2 ("SOP 97-2") "Software Revenue Recognition". This
SOP was issued to provide guidance on applying generally accepted accounting
principles to software transactions and to narrow the range of revenue
recognition practices that were in use before its issuance. SOP 97-2 is
generally effective for transactions entered into in fiscal years beginning
after December 15, 1997. The adoption of SOP 97-2 had no material impact on the
Company's results of operations in 1998.
Revenue from product sales is recognized when the products are shipped, net
of estimated allowances for product returns and exchanges. Allowances for bad
debts and post-contract support obligations, primarily telephone support
provided by ALS, are also accrued for at the time of the sale.
Revenue from IPS's custom products is recognized on the percentage of
completion method. IPS defers revenue for advance payments from customers that
are in excess of revenues earned. Included in receivables at December 31, 1998
and 1997 is $198,000 and $49,000, respectively, of amounts earned on contracts
which are not yet billable.
The Institute generates service revenue both from (i) conducting seminars
and (ii) contracts with schools and school districts to provide training
programs and consulting services. The Institute recognizes revenue from the
seminars at the time the seminar actually takes place. For school and school
district contracts, revenue is generally recognized when the training session is
performed, while certain support services are recognized on a straight-line
basis over the life of the contract. The Institute includes as deferred revenue
(i) prepayments on contract revenues and (ii) payments received for seminars not
yet held.
Service revenues include software support provided as part of the software
product sale and separately sold maintenance fees whereby ALS provides ongoing
customer support and product upgrades. Such separately sold contracts are
reflected as deferred revenue and are amortized ratably over the term of the
maintenance period which begins after the expiration of any support included
with the purchase of the software. Revenue from support agreements included with
the purchase of software is included in service revenue at the time the software
is shipped.
(c) Cash and cash equivalents
The Company considers cash amounts on deposit at banks and highly liquid
debt instruments purchased with a maturity date of three months or less to be
cash equivalents. Commercial paper is carried at cost plus
32
<PAGE> 34
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
accrued interest, which approximates market value. Cash and cash equivalents
consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Cash and time deposits..................................... $ 4,756 $ 6,395
Commercial paper........................................... 9,466 15,925
------- -------
$14,222 $22,320
======= =======
</TABLE>
(d) Supplemental disclosure of cash flow information
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid for:
Interest.......................................... $ 8 $ 696 $ 94
Income taxes...................................... 6,606 1,564 --
</TABLE>
(e) Short term investments
Short term investments have an original maturity of more than three months
and a remaining maturity of less than one year. As of December 31, 1998 and 1997
short term investments consisted entirely of commercial paper. These securities
are considered to be held to maturity in accordance with Statement of Financial
Accounting Standards No. 115 ("SFAS 115") "Accounting for Certain Investments in
Debt and Equity Securities". Accordingly, these investments are carried at cost
plus accrued interest which approximates market value.
(f) Inventories
Inventories are carried at the lower of first-in, first-out (FIFO) cost or
market. Inventories primarily consist of purchased materials which include
manuals, diskettes and motivational items.
(g) Catalog and advertising costs
Costs related to direct response advertising, primarily catalogs, are
capitalized over their expected period of future benefits, generally three to
six months. At December 31, 1998 and 1997 capitalized catalog costs of
approximately $113,000 and $43,000, respectively, are included in prepaid
expenses. All other advertising costs are expensed the first time the
advertising takes place. Advertising expenses for 1998, 1997 and 1996 were
approximately $6,202,000, $4,377,000 and $2,999,000, respectively.
(h) Property, plant and equipment
Property, plant and equipment are recorded at cost and are depreciated over
the estimated useful lives of the assets using principally the straight-line
method for financial reporting purposes. Maintenance and repair costs are
charged to expense as incurred, and renewals and improvements that extend the
useful life of the assets are added to the plant and equipment accounts.
Depreciation expense was approximately $1,401,000, $975,000 and $401,000 for
1998, 1997 and 1996, respectively.
The estimated useful lives for property, plant and equipment are as
follows: buildings -- 25 to 40 years; furniture, fixtures and office equipment
- -- 5 to 8 years; computer and production equipment -- 3 to 5 years; and vehicles
- -- 5 years.
33
<PAGE> 35
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Net property, plant and equipment consisted of the following at December
31:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Land and improvements...................................... $ 1,429 $ 819
Buildings.................................................. 14,469 8,738
Furniture, fixtures and office equipment................... 2,298 1,536
Computer and production equipment.......................... 3,600 2,265
Vehicles................................................... 77 19
Construction in progress................................... 10 385
------- -------
Total property, plant and equipment...................... 21,883 13,762
Less -- accumulated depreciation........................... (2,782) (1,720)
------- -------
Property, plant and equipment, net......................... $19,101 $12,042
======= =======
</TABLE>
(i) Software development costs
In accordance with Statement of Financial Accounting Standards No. 86
("SFAS 86") "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," the Company capitalizes certain software development costs
incurred after technological feasibility is achieved. Capitalized costs are
reported at the lower of unamortized cost or net realizable value. Capitalized
software development costs are amortized on a product-by-product basis based on
the greater of the amount computed using (a) the ratio that current gross
revenues for a product bear to the total of current and anticipated future gross
revenues for that product or (b) the straight-line method over the estimated
economic life of the products which is generally estimated to be 24 months.
Amortization begins when the products are available for general release to
customers. All other research and development expenditures are charged to
product development expense in the period incurred. Amounts capitalized were
approximately $194,000, $4,000 and $365,000 in 1998, 1997 and 1996,
respectively. Amortization expense of approximately $163,000, $241,000 and
$208,000 for 1998, 1997 and 1996, respectively, is included in cost of
sales-products in the statements of income. At December 31, 1998 and 1997
accumulated amortization of capitalized software development costs was $733,000
and $570,000, respectively.
(j) Sales and concentration of credit risks
For the years ended December 31, 1998, 1997 and 1996, one customer (a book
distributor) contributed 13.9%, 14.4% and 15.2% of total revenues, respectively.
No other customer represented more than 10% of total revenues. On December 31,
1998 and 1997, this customer had a receivable balance of 11.9% and 10.3% of
total trade receivables, respectively.
The Company grants credit to customers in the ordinary course of business.
The majority of the Company's customers are schools. Concentrations of credit
risk with respect to trade receivables are limited due to the significant number
of customers and their geographic dispersion.
(k) Stock-based compensation
The Company elected, as permitted by Statement of Accounting Standards No.
123 ("SFAS 123") "Accounting for Stock Based Compensation" to follow the
intrinsic value based method of accounting for stock options consistent with
Accounting Principles Board Opinion No. 25 ("APB 25") "Accounting for Stock
Issued to Employees" and to provide the pro forma disclosures of net income and
earnings per share as if the fair value based method had been applied. Under the
intrinsic method, compensation cost for stock options is measured by the excess,
if any, of the quoted price of the company's stock at the measurement date over
the exercise price. The Black-Scholes option-pricing model was used to compute
the fair value of each option granted for purposes of the pro forma disclosures
required by SFAS 123.
34
<PAGE> 36
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(l) Earnings per common share
In February 1997 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS 128") "Earnings Per Share."
This statement established new standards for computing and presenting earnings
per share which was adopted by the Company in 1997. SFAS 128 supercedes
Accounting Principles Board Opinion No. 15 "Earnings Per Share" and purports to
simplify the standards for computing earnings per share and make such
computations comparable with international standards.
Basic earnings per common share ("Basic EPS") has been computed based on
the weighted average number of common shares outstanding. Diluted earnings per
common share ("Diluted EPS") has been computed based on the weighted average
number of common shares outstanding, increased by the number of additional
common shares that would have been outstanding if the dilutive potential common
shares had been issued. All share and per share data has been retroactively
adjusted to reflect a 2-for-1 stock split in the form of a stock dividend
effective February 26, 1999 (see Note 13).
The weighted average shares outstanding for 1998, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Basic weighted average shares outstanding................ 33,812,062 28,954,466 27,302,266
Dilutive effect of stock options......................... 163,998 93,210 --
---------- ---------- ----------
Diluted weighted average shares outstanding.............. 33,976,060 29,047,676 27,302,266
========== ========== ==========
</TABLE>
(m) Comprehensive income
During 1997 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 130 ("SFAS 130") "Reporting Comprehensive
Income". Effective for periods beginning after December 15, 1997, SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components. SFAS 130 requires that the total of other comprehensive income
for a period be transferred to a component of equity that is displayed
separately from retained earnings and additional paid-in capital. The Company's
only component of comprehensive income, foreign currency translation
adjustments, is included in accumulated other comprehensive income in the
"Statements of Consolidated and Combined Equity."
(n) Reclassifications
Certain previously reported amounts have been reclassified to conform with
the 1998 presentation.
(5) INTANGIBLE ASSETS
Intangible assets, including goodwill, are amortized on the straight-line
basis over their estimated useful lives. In connection with the acquisition of
Logicus, intangibles of $344,000 were acquired during 1998. Intangibles of
$1,548,000 were acquired during 1996 in connection with the acquisition of IPS.
Subsequently, in February 1997, the IPS purchase agreement was amended providing
for the release of the $1.5 million held in escrow and the issuance of $500,000
in Common Stock in settlement of the contingent consideration upon closing of
the Offering. This caused goodwill to increase by $415,177 ($500,000 in stock
less $84,823 in interest related to the escrow funds).
35
<PAGE> 37
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997 USEFUL LIFE
---- ---- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Algorithms and software code....................... $ 854 $ 510 2-5 years
Tradename.......................................... 210 210 10 years
Assembled workforce................................ 90 90 7 years
Goodwill........................................... 1,153 1,153 7 years
------ ------
Total intangibles.................................. 2,307 1,963
Less -- accumulated amortization................... (862) (364)
------ ------
Net intangibles.................................... $1,445 $1,599
====== ======
</TABLE>
Management periodically reviews the carrying value of its intangible
assets, including goodwill, for potential impairment. To date, no impairment of
these assets exists.
(6) INCOME TAXES
Prior to September 29, 1997, the shareholders of ALS and the Institute had
elected to have these companies treated as "S corporations" under the Internal
Revenue Code. As an S corporation, a company's taxable income or loss is
included in the individual tax returns of its shareholders for Federal and state
income tax purposes. Accordingly, the financial statements do not include any
provision or liability for current or deferred Federal or state income taxes
related to ALS or the Institute for any periods prior to September 29, 1997.
IPS was taxed as a C corporation under the provisions of the Internal
Revenue Code and similar state tax laws from the time of its acquisition on
August 1, 1996 through December 31, 1996. Therefore, included in the 1996
combined financial statements is an income tax provision and related deferred
income taxes for IPS from the date of its acquisition until the end of 1996.
Subsequently, IPS elected to be taxed as an S corporation effective January 1,
1997. Consequently, the deferred tax asset recognized in 1996 was written off in
1997.
On September 29, 1997 the Company became subject to federal and state
income taxes as a C corporation. Consequently, the Company is now required to
account for income taxes in accordance with Statement of Financial Accounting
Standards No. 109 ("SFAS 109") "Accounting for Income Taxes." In connection with
this change in the Company's tax status, SFAS 109 required the Company to record
deferred taxes on the balance sheet for all book to tax basis differences
existing on the date of change to C corporation status. The financial statement
effect of recording the basis differences resulted in recognition of a deferred
tax asset and corresponding tax benefit of $3.5 million in 1997.
36
<PAGE> 38
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The provision (benefit) for income taxes consisted of:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current tax provision:
U.S. Federal.............................................. $ 7,428 $ 1,026 $ --
State and local........................................... 1,813 191 --
------- ------- -------
Total current tax provision................................. 9,241 1,217 --
------- ------- -------
Deferred tax (benefit):
U.S. Federal.............................................. (329) (1,618) (1,602)
State and local........................................... (68) (272) --
------- ------- -------
Total deferred tax (benefit)................................ (397) (1,890) (1,602)
------- ------- -------
Provision (benefit) for income taxes........................ $ 8,844 $ (673) $(1,602)
======= ======= =======
</TABLE>
Effective rate reconciliation:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
U.S. statutory rate......................................... 35% 35% 35%
------- ------- -------
Income tax provision at statutory tax rate.................. $ 7,550 $ 3,159 $ 1,000
State and local taxes, net of Federal tax benefit........... 1,134 175 --
(Benefit) of IPS losses..................................... -- -- (1,602)
Deferred taxes written off in connection with IPS S
corporation election...................................... -- 1,602 --
S-corporation income not subject to tax..................... -- (2,060) (1,000)
Deferred tax reinstatement related to Termination of S
corporation elections..................................... -- (3,549) --
Other....................................................... 160 -- --
------- ------- -------
Provision (benefit) for income taxes........................ $ 8,844 $ (673) $(1,602)
======= ======= =======
</TABLE>
Deferred tax assets (liabilities) consisted of the following at December
31:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Current deferred tax assets (liabilities):
Deferred revenue.......................................... $ 1,334 $ 1,234
Expenses not currently deductible......................... 908 597
------- -------
Net current deferred tax assets............................. 2,242 1,831
------- -------
Noncurrent deferred tax assets (liabilities):
Operating losses.......................................... 155 150
Deferred revenue.......................................... 458 523
Depreciation and amortization............................. (43) (144)
Intangibles............................................... 1,221 1,153
Other..................................................... (144) (21)
------- -------
Net noncurrent deferred tax assets.......................... 1,647 1,661
------- -------
Total deferred tax assets................................... $ 3,889 $ 3,492
======= =======
</TABLE>
37
<PAGE> 39
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
No valuation allowance has been recorded as the net deferred tax asset
related to the operating losses are assumed to be realizable through the future
profitable operations of IPS. The tax operating loss carryforward expires in
2011.
(7) LINE OF CREDIT
The Company has obtained a $10.0 million unsecured revolving line of credit
with a bank which is available until March 31, 2000. The line of credit bears
interest at either a floating rate based on the prime rate less 1.0%, or a fixed
rate for a period of up to 90 days based on LIBOR plus 1.25%. The rate is at the
option of the Company and is determined at the time of borrowing. As of December
31, 1998 the line of credit had not been used.
(8) LEASE COMMITMENTS
The Company is party to various operating leases for equipment and for the
IPS office facility. Rent expense for 1998, 1997 and 1996 was approximately
$395,000, $203,000 and $159,000, respectively.
Future approximate minimum rental payments (including estimated operating
costs) required under the operating leases as of December 31, 1998 are as
follows:
<TABLE>
(IN THOUSANDS)
--------
<S> <C>
1999................................................... $160
2000................................................... 135
2001................................................... 137
2002................................................... 140
2003................................................... 143
</TABLE>
(9) DEFINED CONTRIBUTION BENEFIT PLAN
The Company has a defined contribution benefit plan covering all of its
full-time employees meeting certain service requirements. The plan provides for
matching employer contributions based on 67% of employees' elective
contributions up to 6% of compensation. The plan allows employee contributions
of up to 15% of compensation. Discretionary employer contributions may also be
made to the plan. There were no discretionary contributions made in 1998, 1997
or 1996. Expense under the plan totaled approximately $370,000 in 1998, $297,000
in 1997 and $192,000 in 1996.
(10) PHANTOM STOCK PLAN
As an incentive for certain key employees, ALS had a phantom stock plan. A
total of 585 phantom shares were issued prior to termination of the plan. Under
the terms of the plan, the completion of the Offering triggered a payout and
termination of the plan. Under the plan, each phantom share was paid an amount
equal to .001% of the market capitalization immediately after completion of the
Offering. This resulted in phantom stock plan termination expense of
approximately $1.6 million in the third quarter of 1997. Compensation expense of
approximately $21,000 was incurred in 1996 with respect to the plan.
(11) STOCK OPTION PLAN
The Company has established the 1997 Stock Incentive Plan for its officers,
key employees, non-employee directors and consultants. A combined maximum of
3,000,000 options, SARs and share awards may be granted under the Plan. In
addition, not more than 1,500,000 shares may be subject to incentive stock
options. The exercise price of the stock options is market value of the common
stock at the date of grant.
38
<PAGE> 40
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Generally, the options vest and become exercisable ratably over a four-year
period, commencing one year after the grant date. The options expire 10 years
from the grant date.
Had compensation cost been determined for the Company's stock option
portion of the Plan based on the fair value at the grant dates for awards
consistent with the alternative method set forth under SFAS 123, the Company's
net income and earnings per share would have been reduced to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS
EXCEPT
PER SHARE
AMOUNTS)
<S> <C> <C>
Net income:
As reported................................... $12,727 $9,699
Pro forma..................................... 11,772 9,441
Diluted net income per common share:
As reported................................... $ 0.37 $ 0.33
Pro forma..................................... 0.35 0.33
The weighted average fair value of options
granted under the Plan during the year is:.... $ 10.91 $ 5.60
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for 1998 and 1997, respectively: dividend yield of 0% and 0%,
expected volatility of 58.94% and 48.14%, risk-free interest rates of 5.14% and
6.31%, and expected lives of 10 years for the options.
As of December 31, 1998, no SARs or share awards have been granted under
the plan. A summary of stock option activity under the plan for 1998 and 1997 is
as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------- -------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ -------------- ------ --------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year............ 479,910 $ 8.22 -- $ --
Granted..................................... 422,952 14.88 490,536 8.21
Exercised................................... (30,814) 8.00 -- --
Cancelled................................... (92,572) 9.70 (10,626) 8.00
------- ------ ------- -----
Outstanding at end of year.................. 779,476 11.66 479,910 8.22
======= ====== ======= =====
Options exercisable at end of year.......... 95,135 8.24 -- --
======= ====== ======= =====
</TABLE>
(12) EMPLOYEE STOCK PURCHASE PLAN
Effective July 1, 1998, the Company adopted an Employee Stock Purchase Plan
which allows employees to purchase shares of common stock through payroll
deductions, up to 10% of eligible compensation. The purchase price is equal to
85% of the fair market value of the common stock on either the first or last day
of the subscription period, whichever is lower. A total of 500,000 shares are
available for purchase under the plan. The Company has elected to apply
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees," in accounting for its stock-based plans. Accordingly, the Company
will not recognize compensation expense for employee stock purchases. In January
1999, approximately 18,800 shares were issued to employees at $11.85 with
respect to the 1998 plan.
39
<PAGE> 41
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(13) SHAREHOLDERS' EQUITY
The Company's amended and restated articles of incorporation includes
authorization to issue up to 50,000,000 shares of common stock with a $.01 par
value and up to 5,000,000 shares of preferred stock with a $.01 par value. No
preferred stock has been issued. On January 18, 1999, the board of directors of
the Company authorized a 2-for-1 split of common stock in the form of a stock
dividend payable on February 26, 1999 to shareholders of record on February 11,
1999. Accordingly, all share and per share data presented herein have been
restated to reflect this split.
In 1997 a 133.31-for-1 stock split was effected in the form of two common
stock dividends which took place on March 28 and August 21, 1997. Also, in 1997,
640,266 common shares were issued in exchange for all of the outstanding shares
of the Institute and IPS. Accordingly, shares issued and outstanding on the face
of the balance sheet and all historical weighted average share and per share
amounts have been restated to reflect the stock split and the common stock
issued in exchange for the shares of the Institute and IPS.
The Company issued a total of 6,440,000 common shares during 1997 in a
public offering (see Note 14). Additionally, 62,500 common shares were issued in
settlement of the purchase of IPS (see Note 3). As of December 31, 1998,
3,000,000 common shares were reserved for issuance under the 1997 Stock
Incentive Plan (see Note 11).
(14) OFFERING OF COMMON STOCK
On September 30, 1997, the Company completed the Offering of 5,600,000
shares of common stock. As a result of this Offering, the Company received net
cash proceeds of $41,664,000 on the September 30, 1997 closing date. In
addition, the Company incurred approximately $941,000 in costs associated with
the Offering. This resulted in a net increase to shareholders' equity of
$40,723,000. Subsequently, on October 2, 1997, an additional 840,000 shares of
the Company's common stock were sold pursuant to the exercise of an over-
allotment option granted in connection with the Offering. The Company received
additional net proceeds of $6,249,200 in connection with the exercise of this
over-allotment option all of which was accounted for as an increase to
shareholders' equity.
From September 1997 through December 31, 1998, the proceeds from the
Offering were used as follows:
- Approximately $1.6 million was used to pay compensation expenses related
to the termination of the Company's phantom stock plan.
- Approximately $7.2 million was used to pay the entire principal and
accrued interest on the mortgage note and an unsecured note, both related
to the construction of the Company's facility in Wisconsin Rapids,
Wisconsin.
- Approximately $5.1 million was used to pay the entire principal and
accrued interest on notes from the Company's principal shareholders
related to the 1996 acquisition of IPS.
- Approximately $10.9 million was used to pay distributions of S
corporation retained profits to S corporation shareholders.
- Approximately $6.4 million was used to invest in Athena Holdings LLC, a
limited liability company formed for the purpose of constructing the
Company's facility in Madison, Wisconsin.
- Approximately $700,000 was used for pilot operations in various markets
and miscellaneous acquisitions.
40
<PAGE> 42
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(15) SEGMENT REPORTING
During 1997 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 131 ("SFAS 131") "Disclosures about Segments
of an Enterprise and Related Information." SFAS 131 significantly changes the
disclosures required for the segments of a business but does not change income
measurement principles. The annual reporting requirements of SFAS 131 are
effective for fiscal years beginning after December 15, 1997. The adoption of
SFAS 131 did not have any impact on financial results of the Company.
The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires different technology and marketing strategies. The Company has
two reportable segments: software and training.
The software segment produces learning information system software for the
K-12 school market in the United States and Canada. The software assists
educators in assessing and monitoring student development by increasing the
quantity, quality, and timeliness of student performance data in the areas of
reading, math and writing. 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.
The program trains educators how to accelerate learning in the classroom through
use of the information that the Company's learning information systems provide.
The training program includes a variety of seminars presented in hotels and
schools across the country.
The accounting policies of the reportable segments are the same as those
described in Note 4 of Notes to Financial Statements. The Company evaluates the
performance of its operating segments based on operating income before
nonrecurring items. Intersegment sales and transfers and revenue derived outside
of the United States are not significant.
Summarized financial information concerning the Company's reportable
segments is shown in the following table:
<TABLE>
<CAPTION>
SOFTWARE TRAINING TOTAL
-------- -------- -----
(IN THOUSANDS)
<S> <C> <C> <C>
1998
Revenues.................................................. $46,859 $7,905 $54,764
Operating income(1)....................................... 20,663 (274) 20,389
Total assets.............................................. 56,480 11,516 67,996
Capital expenditures...................................... 1,069 7,396 8,465
Depreciation and amortization............................. 1,875 212 2,087
1997
Revenues.................................................. $30,098 $5,926 $36,024
Operating income(1)....................................... 10,609 105 10,714
Total assets.............................................. 49,210 1,673 50,883
Capital expenditures...................................... 1,291 402 1,693
Depreciation and amortization............................. 1,362 116 1,478
1996
Revenues.................................................. $19,347 $3,034 $22,381
Operating income(1)....................................... 7,318 (905) 6,413
Total assets.............................................. 18,843 1,012 19,855
Capital expenditures...................................... 9,587 311 9,898
Depreciation and amortization............................. 655 56 711
</TABLE>
41
<PAGE> 43
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
- -------------------------
(1) Operating income Total differs from Operating income in the Consolidated and
Combined Statements of Income due to nonrecurring items not included above:
$475,000 purchased research and development in 1998; $1.6 million phantom
stock plan termination in 1997; and $3.4 million purchased research and
development in 1996.
The information about the segments presented above is in compliance with
SFAS 131 reporting requirements. The reported measures are consistent with those
used in measuring amounts in the consolidated financial statements. Such
measurements are generally along legal entity lines as aggregated.
It is management's opinion, however, that because many flows of value
between the reporting entities can not be precisely quantified, this information
provides an incomplete measure of the training segment profit or loss, and may
be subject to misinterpretation. The chief operating officer evaluates the
performance of the training segment based on many factors not captured by the
financial accounting system and often evaluates the company's financial
performance on a total entity basis.
(16) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth unaudited consolidated and combined income
statement data for each quarter of the Company's last two fiscal years. The
unaudited quarterly financial information has been prepared on the same basis as
the annual information presented in the financial statements and, in
management's opinion, reflects all adjustments (consisting of normal recurring
entries) necessary for a fair presentation of the information provided. The
operating results for any quarter are not necessarily indicative of results for
any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
1998:
Net sales................................. $10,623 $11,721 $15,019 $17,401
Gross profit.............................. 8,857 9,917 12,800 14,688
Operating income.......................... 2,742 3,349 6,221 7,601
Income tax provision...................... 1,347 1,551 2,676 3,269
Net income................................ 1,899 2,274 4,009 4,545
Basic and diluted earnings per share...... 0.06 0.07 0.12 0.13
Common stock price per share:
High................................... 17.188 19.375 20.250 33.188
Low.................................... 10.719 12.375 12.000 16.375
1997:
Net sales................................. $ 7,813 $ 8,732 $ 9,653 $ 9,826
Gross profit.............................. 6,314 7,250 7,898 8,110
Operating income.......................... 2,310 2,806 1,305 2,675
Income tax provision (benefit)............ 1,602 -- (3,505) 1,231
Net income................................ 541 2,609 4,639 1,909
Basic and diluted earnings per share...... 0.02 0.10 0.17 0.06
Common stock price per share:
High................................... -- -- 12.625 14.125
Low.................................... -- -- 11.063 10.000
</TABLE>
1. Per share data have been restated to reflect a 2-for-1 stock split in
the form of a dividend effective February 26, 1999 (see Note 13).
42
<PAGE> 44
ADVANTAGE LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. In connection with the acquisition of Logicus, $475,000 of the purchase
price was allocated to purchased research and development which was
expensed in June 1998 (see Note 3).
3. The Company's phantom stock plan terminated in connection with
completion of the Offering of its common stock, resulting in a $1.6
million charge to operating income in September 1997 (see Note 10).
4. The Company's S corporation election was terminated in connection with
completion of the Offering of its common stock. The Company was required
to adopt SFAS 109 and to record a deferred tax asset and corresponding
tax benefit for all timing differences existing on the date of the tax
status change. This resulted in a $3.5 million tax benefit in September
1997 (see Note 6).
5. Effective January 1, 1997, IPS elected S corporation status and wrote
off the deferred tax asset associated with its 1996 net operating losses
(see Note 6).
43
<PAGE> 45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers. Reference is made to "Executive Officers of the
Registrant" in Part I hereof.
(b) Directors. The information required by this Item is set forth in the
Company's Proxy Statement for the Annual Meeting of Shareholders to be held on
April 14, 1999 under the caption "Election of Directors," which information is
incorporated by reference herein.
(c) Section 16 Compliance. The information required by this Item is set
forth in the Company's Proxy Statement for the Annual Meeting of Shareholders to
be held on April 14, 1999 under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance," which information is incorporated by reference herein.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Company's Proxy
Statement for the Annual Meeting of Shareholders to be held on April 14, 1999
under the captions "Executive Compensation," "Employment Agreements,"
"Non-Employee Director Compensation," "Compensation Committee Report," and
"Performance Graph," which information is incorporated by reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the Company's Proxy
Statement for the Annual Meeting of Shareholders to be held on April 14, 1999
under the caption "Security Ownership of Management and Certain Beneficial
Owners," which information is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
44
<PAGE> 46
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS.
Combined and Consolidated Financial Statements.
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated and Combined Statements of Income for the years ended
December 31, 1998, 1997 and 1996
Statements of Consolidated and Combined Equity for the years ended
December 31, 1998, 1997, and 1996
Consolidated and Combined Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
Notes to Financial Statements
(A)(2) FINANCIAL STATEMENT SCHEDULES.
See the Exhibit Index, which is incorporated by reference herein.
(A)(3) EXHIBITS.
See (c) below.
(B) REPORTS ON FORM 8-K.
There were no reports on Form 8-K filed for the three months ended December
31, 1998.
(C) EXHIBITS.
See the Exhibit Index, which is incorporated by reference herein.
(D) FINANCIAL STATEMENTS EXCLUDED FROM ANNUAL REPORT TO SHAREHOLDERS.
Not applicable.
45
<PAGE> 47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ADVANTAGE LEARNING SYSTEMS, INC.
By: /s/ MICHAEL H. BAUM
-----------------------------------
Michael H. Baum
Chief Executive Officer
Date: March 11, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<S> <C> <C>
/s/ MICHAEL H. BAUM Chief Executive Officer
- -------------------------------------------------------- and a Director (Principal
Michael H. Baum Executive Officer) March 11, 1999
/s/ TIMOTHY SHERLOCK Secretary, Vice President
- -------------------------------------------------------- and Chief Financial
Timothy Sherlock Officer (Principal March 11, 1999
Financial and Accounting
Officer)
Directors: Judith A. Paul, Terrance D. Paul, John R. Hickey, Timothy P. Welch, Perry S. Akins and
John H. Grunewald
By: /s/ MICHAEL H. BAUM March 11, 1999
-----------------------------------------------------
Michael H. Baum
Attorney-In-Fact*
</TABLE>
- -------------------------
*Pursuant to authority granted by powers of attorney, copies of which are filed
herewith.
46
<PAGE> 48
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
------- -------
<C> <S>
3.1 Amended and Restated Articles of Incorporation of Advantage
Learning Systems, Inc.(1)
3.2 Amended and Restated By-laws of Advantage Learning Systems,
Inc.(1)
4.1 Form of Stock Certificate.(2)
10.1 Asset Purchase Agreement dated as of August 1, 1996 by and
among IPS Acquisition, Inc., IPS Publishing, Inc. and
Timothy P. Welch, individually and as sole Trustee of the
Timothy P. Welch Revocable Trust.(1)
10.2 Supplement to Asset Purchase Agreement dated as of February
25, 1997, by and among IPS Publishing, Inc. (f/k/a IPS
Acquisition, Inc.), Welch Publishing, Inc. (f/k/a IPS
Publishing, Inc.) and Timothy P. Welch, individually and as
sole Trustee of the Timothy P. Welch Revocable Trust.(1)
10.3 Employment Agreement between IPS Publishing, Inc. (f/k/a IPS
Acquisition, Inc.) and Timothy P. Welch dated as of August
1, 1996.(1)*
10.4 1997 Stock Incentive Plan (as amended and restated).(3)*
10.5 Advantage Learning Systems, Inc. Phantom Stock Plan.(1)*
10.6 Institute for Academic Excellence, Inc. Phantom Stock
Plan.(1)*
10.7 Accelerated Reader Resale Agreement dated May 1, 1994,
between Advantage Learning Systems, Inc. and Perma-Bound, a
division of Hertzberg-New Method, Inc.(1)
10.8 Promissory Note dated August 1, 1996 in the principal amount
of $2,350,000 from IPS Publishing, Inc. to Judith A.
Paul.(1)
10.9 Promissory Note dated August 1, 1996 in the principal amount
of $2,350,000 from IPS Publishing, Inc. to Terrance D.
Paul.(1)
10.10 Credit Agreement dated as of December 31, 1997, by and
between Norwest Bank Wisconsin, National Association and
Advantage Learning Systems, Inc.(4)
10.11 Tax Indemnification Agreement between Terrance Paul, Judith
Paul, Mark J. Bradley, as Trustee of the Terrance and Judith
Paul Descendants' Trust, and Advantage Learning Systems,
Inc.(2)
10.12 Tax Indemnification Agreement between Terrance Paul, Judith
Paul, Mark J. Bradley, as Trustee of the Terrance and Judith
Paul Descendants' Trust, and the Institute for Academic
Excellence, Inc.(2)
10.13 Advantage Learning Systems, Inc. Employee Stock Purchase
Plan(5)*
10.14 Office Lease dated as of December 17, 1998 by and between
Athena Holdings LLC and Institute for Academic Excellence,
Inc.
10.15 Real Estate Mortgage dated December 17, 1998 between Athena
Holdings LLC and Advantage Learning Systems, Inc.
21.1 Subsidiaries of Advantage Learning Systems, Inc.
23.1 Consent of Arthur Andersen LLP.
24.1 Directors' Powers of Attorney.
27.1 Financial Data Schedule.
99.1 Schedule II -- Valuation and Qualifying Accounts.
</TABLE>
- -------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-22519).
(2) Incorporated by reference to the Company's Form 10-Q for the quarter ended
September 30, 1997 (SEC File No. 0-22187).
(3) Incorporated by reference to the Company's Form S-8 filed on October 28,
1997 (Registration No. 333-38867).
(4) Incorporated by reference to the Company's Form 10-K for the fiscal year
ended December 31, 1997 (SEC File No. 0-22187).
(5) Incorporated by reference to the Company's Proxy Statement for the 1999
Annual Meeting of shareholders.
* Management contracts or compensatory plans or arrangements.
<PAGE> 1
EXHIBIT 10.14
OFFICE LEASE
Landlord: Athena Holdings LLC
Tenant: Institute for Academic Excellence, Inc.
Premises: 34,633 square feet of the Office Building to be
constructed on Lot 23 of Old Sauk Trails Business Park,
Madison, Wisconsin
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
1. Basic Provisions........................................................1
2. Demise and Possession...................................................4
3. Quiet Enjoyment.........................................................4
4. Use Limitations.........................................................5
5. Common Areas............................................................5
6. Tenant's Work...........................................................5
7. Rent....................................................................5
8. Taxes...................................................................6
9. Utilities and Energy....................................................6
10. Services...............................................................7
11. Repairs................................................................7
12. Alterations............................................................7
13. Right of Entry.........................................................7
14. Release and Indemnification............................................8
15. Insurance..............................................................8
16. Casualty...............................................................9
17. Public Taking..........................................................9
18. Default...............................................................10
19. Termination...........................................................12
20. Holdover..............................................................13
21. Limitation of Remedies................................................13
22. Assignment and Subletting.............................................13
23. Definitions...........................................................14
24. Miscellaneous.........................................................16
24.1. Building Rules................................................16
24.2. Interpretation................................................17
24.3. Subordination.................................................17
24.4. Estoppel Certificates.........................................17
24.5. Notices.......................................................18
24.6. Execution.....................................................18
24.7. Binding Effect................................................18
24.8. Parking.......................................................18
24.9. Signs.........................................................18
</TABLE>
Exhibits
I. Floor Plan of Premises
II. Real Estate Legal Description
III. Work Letter
IV. Rent Schedule
(i)
<PAGE> 3
OFFICE LEASE
This Lease is entered into as of the 17th day of December, 1998 by and
between Athena Holdings LLC, as Landlord, and Institute for Academic Excellence,
Inc., as Tenant.
R E C I T A L S:
A. Landlord is the owner of Lot 23 in the Old Sauk Trails Business Park,
Madison, Wisconsin and is in the process of constructing an office building
containing approximately 67,560 rentable square feet thereon.
B. Landlord is willing to lease to Tenant and Tenant desires to lease from
Landlord space in the office building upon the terms and conditions set forth
below.
NOW, THEREFORE, in consideration mutual covenants set forth herein, the
parties do hereby agree as follows:
1. Basic Provisions: The following terms shall have the meaning set forth
in this Section unless specifically modified by other provisions of this Lease:
1.1. Landlord: Athena Holdings LLC
University Research Park
455 Science Drive, Suite 200
Madison, Wisconsin 53711-1058
Attn: Michael Baum
1.2. Tenant: Institute for Academic Excellence, Inc.
University Research Park
455 Science Drive, Suite 200
Madison, Wisconsin 53711-1058
Attn: Stuart Udell
1.3. Premises: Approximately 34,633 rentable square feet of space
as depicted on Exhibit I as the IAE Rentable Area
located in the building ("Building") to be
constructed on the real estate described in
Exhibit II.
1.4. Term: Approximately 10 Years
1.4.1. Approximate Commencement Date: December 18,
1998, subject to adjustment as set forth in
Paragraph 23.4.
<PAGE> 4
1.4.2. Approximate Termination Date: December 18, 2008,
subject to adjustment as set forth in Paragraph 23.4.
1.4.3. Provided that Tenant is not then in default and has not
assigned or sublet this Lease, Tenant shall have the
right to extend the term of the Lease for two (2)
periods of five (5) years each, on all of the same
terms and conditions contained herein (and rent shall
increase in accordance with Section 1.5 herein) by
providing written notice of its intent to extend the
term to Landlord at least six (6) months prior to the
expiration date of the initial term.
1.5. Rent:
1.5.1. Monthly Base Rent: As set forth in the Rent Schedule
attached hereto as Exhibit IV.
1.5.2. Beginning Monthly Payment of estimated Operating
Expenses: $11,977.25 (Based on $4.15 per rentable square
foot)
1.6. Permitted Use: General Office Use. Tenant shall have the right
to have one (1) dog on the Premises.
1.7. Tenant's Proportionate Share: 51.3% (Based on Premises'
rentable square footage of 34,633 sq. ft. divided by total
rentable square footage of 67,560 for the Building)
1.8. Option to Lease Planning Associates Space: Landlord has as of
the date hereof entered into a written lease ("Planning
Associates Lease") with Planning Associates, Inc. ("Planning
Associates") for certain space in the Project described on
Exhibit I as the PAI Rentable Area ("Planning Associates
Space"). Provided that Tenant is not then in default under any
term or condition of this Lease, Tenant shall have the right to
lease the Planning Associates Space for a term commencing on or
after the fifth anniversary of the commencement date under the
Planning Associates Lease; provided, further, that Tenant shall
give Landlord and the then tenant occupying the Planning
Associates Space written notice of Tenant's exercise of this
option to lease the Planning Associates Space at least two (2)
years prior to the effective date of Tenant's leasing of the
Planning Associates Space. The Tenant's notice exercising its
option to lease the Planning Associates Space ("Planning
Associates Space Notice") shall state the date on which Tenant
desires to commence leasing the Planning Associates Space
("Option Commencement Date"), which Option Commencement Date
shall occur on or after the fifth (5th) anniversary of the
commencement date of the Planning Associates Lease and which
shall be at least two (2) years after the date of Landlord's
receipt of the "Planning Associates Space Notice." Upon proper
exercise of Tenant's Option hereunder, Landlord and Tenant shall
execute an amendment to this Lease which shall (i) expand the
definition of Premises to include the Planning Associates Space,
(ii) increase the Monthly
2
<PAGE> 5
Base Rent set forth in the Exhibit IV Rent Schedule by the product of the
rentable square footage of the Planning Associates Space multiplied by the
per square foot annual rental rate in effect at the time of the Option
Commencement Date, which rental amount shall increase in the same manner
as rent increases under the Exhibit IV Rent Schedule, and (iii) amend
Tenant's Proportionate Share to reflect the new rentable square footage of
the Premises.
If Tenant exercises its option under this Section 1.8, Tenant shall pay to
the then current tenant of the Planning Associates Space within thirty
(30) days after the Option Commencement Date an amount equal to the
product of $6,725.00 multiplied by the number of years and any fraction
thereof between the Option Commencement Date and the scheduled termination
date of the original ten-year term of the Planning Associates Lease to
compensate such tenant for its leasehold improvements. If the Option
Commencement Date occurs after the scheduled termination of the original
ten-year term of the Planning Associates Lease, no payment shall be due
from Tenant to the occupant of the Planning Associates Space for leasehold
improvements. If Tenant exercises this option, Tenant shall also pay to
the then current tenant of the Planning Associates Space, within thirty
(30) days after the Option Commencement Date, the sum of $100,000.00 to
compensate such tenant for its moving and business interruption expenses.
Tenant shall have no obligation to pay the amounts described above in this
Section 1.8 to the then current tenant of the Planning Associates Space if
the Option Commencement Date occurs on the first (1st) day after the
scheduled termination date of the original term of the Planning Associates
Lease or the first (1st) day after the scheduled termination date of any
extended term under the Planning Associates Lease. Promptly upon request,
Landlord shall deliver to Tenant confirmation of the scheduled expiration
date for the then current term of the Planning Associates Lease.
1.9. Option to Lease the Spec Space: Provided Tenant is not then in
default under any term or condition of this Lease, Tenant shall have the
right to lease the space described on Exhibit I as the Spec Space Rentable
Area ("Spec Space") effective at any time after the third (3rd)
anniversary of the Commencement Date, by providing to Landlord written
notice of its intent to exercise the option to lease the Spec Space ("Spec
Space Notice") at any time during the term of this Lease, but not later
than six (6) months prior to the date on which Tenant desires to commence
leasing the Spec Space ("Spec Space Commencement Date"). The Spec Space
Notice shall state the Spec Space Commencement Date, which date shall
occur on or after the third (3rd) anniversary of the Commencement Date and
which shall be at least six (6) months after the date of Landlord's
receipt of the Spec Space Notice. Upon receipt of the Spec Space Notice,
Landlord and Tenant shall execute an amendment to this Lease which shall
(i) expand the definition of Premises to include the Spec Space, (ii)
increase the Monthly Base Rent set forth in the Exhibit IV Rental Schedule
by the product of the rentable square footage of the Spec Space multiplied
by the per square foot rental rate in effect at the time of the Spec Space
Commencement Date, which rental amount shall increase in the same manner
3
<PAGE> 6
as rent increases under the Exhibit IV Rent Schedule and (iii) amend
Tenant's Proportionate Share to reflect the new square footage of the
Premises.
If Tenant exercises this option during the initial term of this Lease, it
shall pay to the then current tenant of the Spec Space ("Spec Space
Tenant"), within thirty (30) days after the Spec Space Commencement Date,
the unamortized value (based on a 10 year straight-line amortization) of
all leasehold improvements that were (1) paid for by that tenant; (2)
situated on the Spec Space and in existence on the Spec Space Commencement
Date of Spec Space, and (3) actually used in the Spec Space by the Spec
Space Tenant.
Notwithstanding anything contained in this Section 1.9 to the contrary, if
the Spec Space is vacant, Tenant may exercise its right to lease the Spec
Space prior to the third (3rd) anniversary of the Commencement Date, the
Spec Space Commencement Date may occur prior to the third (3rd)
anniversary of the Commencement Date, and Tenant shall not be required to
make any payment for leasehold improvements.
1.10 Break/Presentation Room: Included in the Common Areas of the
Project is a break/presentation room shown on Exhibit I ("Break Room").
Notwithstanding designation of the Break Room as a part of the Common
Areas, Tenant shall have control over the use of the Break Room and may
establish reasonable rules for the use of the Break Room by other tenants
of the Project. Tenant may reserve the Break Room from time to time for
exclusive use by Tenant for company functions. When not reserved by Tenant
for the exclusive use of Tenant, the Break Room will be made available to
other tenants of the Project, subject to the reasonable rules and/or
scheduling procedures established by Tenant from time to time. The seminar
room located immediately adjacent to the Break Room as designated on
Exhibit I is part of the Premises demised to Tenant hereunder, and shall
remain under the exclusive control of Tenant.
1.11 Landlord's Contribution: The sum of $1,063,395.15 to be applied
by Landlord toward the costs of completing the Tenant's Work in accordance
with the provisions of Section 6 and Exhibit III.
2. Demise and Possession. Landlord leases the Premises to Tenant and
Tenant leases the Premises from Landlord for the term set forth in Paragraph
1.4, subject to the provisions of this Lease. Landlord will correct and repair
any "punch list" items of which Landlord is notified in writing within sixty
(60) days after the date Tenant takes possession.
3. Quiet Enjoyment. Landlord covenants that it has full right, title and
authority to enter into this Lease. So long as Tenant shall duly and punctually
perform and observe all of its obligations under this Lease, Tenant shall
peaceably and quietly enjoy the Premises free from hindrance by Landlord or any
party claiming by, through or under Landlord, subject, however, to zoning laws
and ordinances, recorded easements and recorded building and use restrictions
and covenants.
4
<PAGE> 7
4. Use Limitations. The Premises shall be used for the purpose described in
Paragraph 1.6, above, and for no other purpose without Landlord's prior written
consent. Tenant shall not do or permit anything to be done in or about the
Premises which in any way will obstruct or interfere with the rights of any
other tenants or users of the Building, or injure or annoy them or use or allow
the Premises to be used for any improper, immoral, unlawful or objectionable
purpose, or injure or tend to injure the reputation of the Building or otherwise
violate any recorded covenant or restriction affecting the Building. Tenant
shall not cause or maintain or permit any nuisance or commit or suffer the
commission of any waste in, on or about the Premises, or cause or allow any
hazardous or flammable material to be stored or used within the Premises.
5. Common Areas. Tenant and its employees, customers and invitees shall
have the reasonable non-exclusive right to use, in common with Landlord and the
other tenants and occupants of the Building and their respective employees,
customers and invitees, and all others to whom Landlord has or may hereafter
grant rights to use the same, the public portion of the Common Areas as may from
time to time exist. Landlord shall have the right to close any or all portions
of the Common Areas to such extent as may, in Landlord's opinion, be necessary
to prevent a dedication thereof or the accrual of any rights to any person or
the public therein. Landlord shall at all times have full control, management
and direction of the Common Areas. Landlord reserves the right at any time and
from time to time to reduce, increase, enclose or otherwise change the size,
number, location, lay-out and nature of the Common Areas, to construct
additional buildings and stories, and to create additional rentable areas
through use and/or enclosure of Common Areas, to place signs in the Common Areas
and on the Building, to change the name of the Building and/or the nature of the
use of any other portion of the Building.
6. Tenant's Work. The initial improvement of the Premises shall be
performed in accordance with the provisions of Exhibit III and Paragraph 12. All
subsequent improvements shall be made in accordance with the provisions of
Paragraph 12.
7. Rent. Tenant agrees to pay to Landlord, without any right of offset or
deduction, the following rent, which shall be delivered to Landlord at the
address set forth in Paragraph 1.1, above, or to such other address as may be
from time to time specified in writing by Landlord:
7.1. Base Rent: The amount or amounts specified in Paragraph 1.51
shall be payable in advance on the first day of each month during the term
hereof. A pro rata amount shall be due and payable at the start of any
partial month during the term hereof.
7.2. Operating Expenses Payment: Tenant shall pay Tenant's
Proportionate Share of Operating Expenses (as defined in Paragraph 23.6)
incurred by Landlord.
A. From time to time Landlord shall estimate the Operating Expenses
for each calendar year. Tenant shall pay to Landlord, together with and in
addition to base rent and other charges for such calendar year an amount
equal to Tenant's Proportionate Share of any estimated Operating Expenses,
which amount shall be paid in equal monthly installments over the
remaining portion of the calendar year. Within forty-five (45) days after
the expiration of each calendar year, Landlord shall notify Tenant of the
actual
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Operating Expenses for such calendar year. Within fifteen (15) days after
such notice, Tenant shall pay to Landlord Tenant's Proportionate Share of
Operating Expenses, less estimated payments made by Tenant; or if the
estimated payments exceed Tenant's Proportionate Share, the overpayment
shall be credited against the next payment of estimated Operating Expenses
due from Tenant.
B. If Tenant shall dispute any item or items included by Landlord in
determining Operating Expenses, Tenant shall nevertheless pay to Landlord
in full the amount claimed by Landlord and shall not offset or withhold
any payment while its dispute is pending. If such dispute is not amicably
settled between Landlord and Tenant within thirty (30) days after such
notice, either party may during the fifteen (15) days after the expiration
of such thirty (30) days refer such disputed item or items to a reputable
firm of independent certified public accountants selected by Landlord for
decision and the decision of such firm shall be conclusive and binding
upon Landlord and Tenant. The expenses involved in such determination
shall be borne by the party against whom a decision is rendered by such
accountants, provided that if more than one item is disputed and the
decision shall be against each party in respect to any item or number of
items disputed, then the expenses shall be apportioned according to the
monetary value of the items decided against each party. If Tenant shall
not dispute any item or items of any such statements within thirty (30)
days after such notice, Tenant shall be deemed to have approved such
statement.
C. Tenant's Proportionate Share of Operating Expenses for the years
in which the term of this Lease commences and ends shall be prorated based
upon the number of days of the term of this Lease in such years.
7.3. Independent Covenant. The obligation to pay rent is hereby
declared and agreed to be an independent covenant.
8. Taxes. Tenant agrees to pay, before delinquency, any and all taxes
levied or assessed and which become payable during the term hereof upon Tenant's
equipment, furniture, fixtures, and other personal property located in the
Premises, whether said taxes are assessed against Landlord or Tenant, and upon
all alterations, additions or leasehold improvements made by or for Tenant, and
if any such alteration, addition or leasehold improvement is nevertheless
included in Landlord's real estate or personal property tax assessment and bill,
Tenant shall reimburse Landlord with respect thereto.
9. Utilities and Energy. Landlord shall furnish water, heat, gas and air
conditioning for the permitted use of the Premises, which costs will be included
in Operating Expenses. HVAC service to the Building shall be provided at least
Monday through Friday, holidays excepted, from 7:00 a.m. through 6:00 p.m.
Tenant shall be responsible for all other utility services to the Premises,
including telephone and electricity. Tenant agrees at all times to cooperate
fully with Landlord and to abide by all regulations and requirements which
Landlord may prescribe for the proper functioning and protection of all
plumbing, electrical, heating, ventilating and air-conditioning systems.
Tenant will not, without the prior written consent of
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Landlord, use any apparatus or device in the Premises, which will in any way
increase the amount of any utilities service used over that usually furnished or
supplied for use of comparable general office space; nor connect with electric
current, except through existing electrical outlets in the Premises, or water
pipes or airpipes, if any, any apparatus or device for the purpose of using
electrical current, water or air. Landlord shall install separate meters for
electricity for the Premises, and Tenant shall pay for such electricity usage
directly to the electric utility, as and when due.
No discontinuance of any utility service shall relieve Tenant from
performing any of its obligations under this Lease, and Landlord shall not be
liable for any discontinuation in or failure of any utility service, and no such
failure or discontinuation shall be deemed a constructive eviction. If Tenant's
disproportionate use of any utility or form of energy should subject the
Building or Landlord to any cost, fee or tax, Tenant shall pay to or reimburse
Landlord for same.
10. Services. Landlord shall provide janitor service for the Common Areas
Monday through Friday, excluding holidays, the cost of which shall be included
in Operating Expenses. All janitorial and cleaning services performed in or
consumed on the Premises shall be performed by and paid for by Tenant.
11. Repairs. Landlord shall maintain (i) the exterior walls, roof and
foundation of the Building, (ii) the heating, ventilating, air-conditioning,
electrical, plumbing and mechanical systems in the Building, including light
fixtures, and (iii) the Common Areas. Except as set forth above, Tenant shall,
at its expense, keep the Premises and every part thereof in good condition and
repair and, if required by reason of acts or negligence of Tenant, its agents,
employees, customers or invitees, or the particular nature of Tenant's use of
the Premises, all repairs and replacements otherwise the responsibility of
Landlord as set forth above. Tenant shall, at its expense, also repair or
replace with glass of equal quality any broken or cracked interior plate or
other glass in doors, windows and elsewhere in the Premises. Tenant shall be
responsible for lamp replacements.
12. Alterations. Tenant shall not make or suffer to be made, any
alterations, additions or improvements ("Alterations") in, on or to the Premises
or any part thereof without the prior written consent of Landlord which shall
not be unreasonably withheld; and any such Alteration, except movable furniture
and trade fixtures, shall at once become a part of the realty and belong to
Landlord. Landlord's consent to an Alteration, if granted, may be made
contingent upon Tenant agreeing to such conditions relating thereto as Landlord
shall impose. Tenant shall not suffer or permit any liens under any construction
lien law to be filed or recorded against the Premises or against the interest of
either Landlord or Tenant therein. If any such lien is filed or recorded, Tenant
shall immediately cause such lien to be discharged of record.
13. Right of Entry. Landlord reserves and shall at all times have the right
to enter the Premises to inspect the same, to supply any service to be provided
by Landlord to Tenant hereunder, to show the Premises, and to alter, improve, or
repair the Premises and any portion of the Building without abatement of rent,
and may for that purpose erect, use and maintain scaffolding, pipes, conduits
and other necessary structures in and through the Premises where
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required by the character of the work to be performed; provided entrance to the
Premises shall not be denied Tenant, and further provided that the business of
Tenant shall not be interfered with unreasonably. Tenant hereby waives any claim
for damages for any injury or inconvenience to or interference with Tenant's
business, any loss of occupancy or quiet enjoyment of the Premises, and any
other loss occasioned thereby. For each of the aforesaid purposes, Landlord
shall at all times have and retain a key with which to unlock all of the doors
in, upon or about the Premises, and Landlord shall have the right to use any and
all means which Landlord may deem necessary or proper to open such doors in an
emergency in order to obtain entry. Any entry to the Premises shall not under
any circumstances be construed or deemed to be a forcible or unlawful entry
into, or a detainer of, the Premises, or an eviction, of Tenant. Tenant shall
permit Landlord (or its designees) to enter the Premises to erect, use,
maintain, replace and repair, pipes, cables, conduits, plumbing, vents and
telephone, electric and other wires or other items, in, to and through the
Premises, as and to the extent that Landlord may now or hereafter deem to be
necessary or appropriate for the proper operation and maintenance of the
Building. In the event Landlord needs access to any under floor duct, Landlord's
liability for carpet replacement shall be limited to replacement of the piece
removed to gain such access. All such work shall be done, so far as practicable,
in such manner as to minimize interference with Tenant's use of the Premises.
14. Release and Indemnification. Landlord shall not be liable to Tenant,
and Tenant hereby waives all claims against Landlord, for any injury or damage
to any person or property in or about the Premises by or from any cause
whatsoever, including, without limiting the generality of the foregoing, the
following: (a) those caused by snow, ice or water leakage of any character from
the roof, walls, basement or other portion of the Premises or the Building; (b)
those caused by gas, fire, oil, electricity or any cause whatsoever in, on or
about the Premises or the Building; or (c) those caused by the acts of
negligence of other tenants or occupants of Premises or the Building.
Tenant shall hold Landlord harmless from and defend Landlord against any
and all claims or liability for any injury or damage to any person or property
whatsoever: (a) occurring in, on or about the Premises or any part thereof
unless caused by the malicious or negligent acts of Landlord or its agents or
employees, or (b) occurring in, on or about any Common Areas in the Building
when such injury or damage shall be caused in part or in whole by the act,
neglect, fault of, or omission of any duty with respect to the same, by Tenant,
its employees, customers or invitees; or (c) arising out of or resulting from
Tenant's use and occupancy of the Premises or any equipment therein or
appurtenances thereto.
15. Insurance. Tenant shall, at its expense, obtain and carry at all times
during the term of this Lease (a) public liability insurance covering the
Premises with limits of at least One Million Dollars ($1,000,000.00) combined
single limit and Two Million Dollars ($2,000,000.00) umbrella coverage (or such
higher amounts as Landlord shall from time to time determine); (b) fire
insurance, with extended coverage, vandalism and malicious mischief and theft
and mysterious disappearance endorsements and without co-insurance, covering the
contents of the Premises in the amount of their full replacement value; and (c)
such other insurance as may be required from time to time by any mortgagee of
the Building. All of such policies shall cover
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both Landlord and Tenant, as their interests may appear, and all insurers
thereon shall agree not to cancel or change same without at least ten (10) days
prior written notice to Landlord. A certificate of Tenant's insurers evidencing
such insurance shall be furnished to Landlord from time to time. Landlord shall,
at its expense, obtain and carry at all times during the term of this Lease,
fire insurance, with extended coverage, vandalism and malicious mischief
endorsements and without co-insurance, covering the Building.
Whenever (i) any loss, cost, damage or expense resulting from any peril
described in subpart (b) of the first sentence of this Paragraph 15 is incurred
by any party to this Lease in connection with the Premises, or any part or
contents thereof, and (ii) such party is then covered in whole or in part by
insurance with respect to such loss, cost, damage or expense, then the party so
insured hereby releases the other party from any liability it may have on
account of such loss, cost, damage or expense to the extent of any amount
recovered by reason of such insurance and waives any right of subrogation which
might otherwise exist in or accrue to any person on account thereof, provided
that such release of liability and waiver of the right of subrogation shall not
be operative in any case where the effect thereof is to invalidate such
insurance coverage (or increase the cost thereof, unless the other party
reimburses the insured for any cost increase). If Tenant or Landlord fails to
maintain in force any insurance required by this Lease to be carried by it, then
for purposes of this waiver of subrogation it shall be deemed to have been fully
insured and to have recovered the entire amount of its loss.
16. Casualty. If the Premises are destroyed or damaged by fire or other
casualty covered by a standard fire and extended coverage policy, Landlord shall
(unless this Lease shall be terminated by Landlord as hereinafter provided)
proceed, after adjustment of such loss, to repair or restore the Building and
the Premises to the condition in which they existed immediately prior to such
destruction or damage. If the Premises or any part thereof shall be rendered
untenantable by any destruction or damage, a just proportion of the rent based
upon the number of square feet of area in the Premises which are untenantable,
shall be abated until the Premises or such part thereof shall have been put in
tenantable condition. If, however, either (i) any destruction or damage to the
Premises or to the Building (regardless of whether or not the Premises are
affected) is so extensive that Landlord or Tenant's architect reasonably
determines that it will take longer than six (6) months to repair or restore the
Premises or Building, then either party may terminate this Lease (effective as
of the date of the destruction or damage) by written notice to the other party
given within six (6) months after adjustment of the loss thereon. The provisions
of this Paragraph are subject to the rights of Landlord's mortgagees, if any.
17. Public Taking. If all or substantially all of the Premises are sold to
or taken by any public authority under its power of condemnation or the threat
thereof, this Lease shall terminate as of the date possession shall be
transferred to the acquiring authority, and the rental payable hereunder shall
be apportioned accordingly. If any material part of the Building and/or the
Common Areas is sold or taken (whether or not the Premises are affected),
Landlord shall have the right to terminate this Lease as of the date possession
is transferred to the acquiring authority, upon giving written notice thereof to
Tenant within sixty (60) days after such transfer, and the rental payable
hereunder shall be apportioned accordingly. Upon any taking of less than
substantially all of the Premises, this Lease shall continue in force as to the
part of the Premises
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not taken, and the rent payable thereafter shall be reduced in proportion to the
amount of total floor area of the Premises taken. In the event of any such
taking, Landlord, at its expense, (but subject to the limitations set forth
below and the limitation that Landlord need not expend more than the amount of
the award or payment made available to Landlord) and after the receipt of the
condemnation award or compensation from the acquiring authority, shall, unless
this Lease has been terminated, diligently rebuild or restore the remainder of
the Premises to the approximate condition in which they existed at the time of
such taking. In any event, all damages awarded by or amounts paid by the
acquiring authority for any such taking, whether for the whole or a part of the
Premises or the Building or the Common Areas, shall belong to and be the
property of Landlord whether such damages are awarded as compensation for loss
of, or diminution in value to, the leasehold or the fee thereof; provided,
however, that Landlord shall not be entitled to any separate award which may be
made to Tenant for the cost of realigning, relocating or removing its personal
property and which does not reduce the amount payable to Landlord. In the event
that this Lease is terminated as hereinabove provided, Tenant shall not have any
claim against Landlord for the value of the unexpired term hereof. The
provisions of this Paragraph are subject to the rights of Landlord's mortgagees,
if any.
18. Default. If (a) default is made in the payment of the rent or any
additional charge payable hereunder by Tenant, and such default shall continue
for five (5) days after written notice of such default, or (b) default is made
in any of the other covenants or conditions herein contained on the part of
Tenant and such default shall continue for thirty (30) days after written notice
thereof shall have been given to Tenant (except that such thirty (30) day period
shall be automatically extended for an additional period of time reasonably
necessary to cure such default not to exceed sixty (60) days, if such default
cannot be cured within such thirty (30) day period and provided Tenant commences
the process of curing such default within said thirty (30) day period and
diligently pursues such cure), or (c) if this Lease shall, by act of Tenant or
by operation of law or otherwise, pass to any party other than Tenant, except
with the prior written consent of Landlord, (d) if Tenant shall abandon or
vacate the Premises or permit same to become vacant, or (e) Tenant shall become
Bankrupt, then and in any of the above-described events, Tenant shall be in
breach of this Lease and Landlord shall have the rights and remedies herein
referred to and/or provided and as provided by law, including the right to
immediate possession and to accelerate the rent due for the term hereof.
Upon the occurrence of any such default, Landlord shall have the option to
pursue any one or more of the following remedies (or any other remedy available
to it) without notice or demand whatsoever:
(a) Give Tenant written notice of intent to terminate this Lease
on the date of such notice or on any later date as may be specified
therein, whereupon Tenant's right to possession of the Premises
shall cease and this Lease, except as to Tenant's liability, shall
be terminated. In the event this Lease is terminated in accordance
with the provisions of this paragraph, Tenant shall remain liable to
Landlord for damages in an amount equal to the rent and other sums
which would have been owing by Tenant hereunder for the balance of
the term had this Lease not been terminated, less the net proceeds,
if any, of any reletting of the Premises by
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Landlord subsequent to such termination, after deducting all
Landlord's expenses including, without limitation, all
repossession costs, brokerage commissions, legal expenses,
attorney's fees, expenses of employees, alteration and repair
costs and expenses of preparation for such reletting. Landlord
shall be entitled to collect such damages from Tenant monthly
on the days on which the rent and other charges would have been
payable hereunder if this Lease had not been terminated.
Alternatively, at the option of the Landlord, in the event this
Lease is so terminated, Landlord shall be entitled to recover
forthwith against Tenant as damages for loss of the bargain and
not as a penalty an aggregate sum, which at the time of such
termination of this Lease, represents the excess, if any, of
the aggregate of the rent and all other charges payable by
Tenant hereunder that would have accrued for the balance of the
term over the aggregate rental value of the Premises (such
rental value to be computed on the basis of Tenant paying not
only a rent to Landlord for the use and occupation of the
Premises, but also such other charges as are required to be
paid by Tenant under the terms of this Lease) for the balance
of such term, both discounted to present worth at the rate of
eight percent (8%) per annum.
(b) Reenter and take possession of the Premises or any part
thereof, and repossess the same as of Landlord's former estate and
expel Tenant and those claiming through or under Tenant, and remove
the effects of both or either, using such force for such purposes as
may be necessary, without being liable for prosecution thereof,
without being deemed guilty of any manner of trespass, and without
prejudice to any remedies for arrears of rent or preceding breach of
covenants or conditions. Should Landlord elect to reenter as
provided in this subparagraph, or should Landlord take possession
pursuant to legal proceedings or pursuant to any notice provided for
by law, Landlord may, from time to time, without terminating this
Lease, relet the Premises or any part thereof in Landlord's or
Tenant's name, but for the account of Tenant, for such term or terms
(which may be greater or less than the period which would otherwise
have constituted the balance of the term of this Lease) and on such
conditions and upon other terms (which may include concessions of
free rent and alteration and repair of the Premises) as Landlord, in
its sole discretion, may determine, and Landlord may collect and
receive the rents therefor. Landlord shall in no way be responsible
or liable for any failure to relet the Premises, or any part
thereof, or for any failure to collect any rent due upon such
reletting. No such reentry or taking possession of the Premises by
Landlord shall be construed as an election on Landlord's part to
terminate this Lease unless a written notice of such intention be
given to Tenant. No notice from Landlord hereunder or under a
forcible entry and detainer statute or similar law shall constitute
an election by Landlord to terminate this Lease unless such notice
specifically so states. Landlord reserves the right following any
such reentry and/or reletting to exercise its right to terminate
this Lease by giving Tenant such written notice, in which event the
Lease will terminate as specified in said notice. In the event that
Landlord does not elect to terminate this Lease but takes possession
as provided for in this subparagraph, Tenant shall pay to Landlord
(i)
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the rent and other charges as herein provided which would be payable
hereunder if such repossession had not occurred, less (ii) the net
proceeds, if any, of any reletting of the Premises after deducting
all Landlord's expenses including, without limitation, all
repossession costs, brokerage commissions, legal expenses,
attorney's fees, expenses of employees, alteration and repair costs
and expenses of preparation for such reletting. Tenant shall pay
such rent and other sums to Landlord monthly on the days on which
the rent would have been payable hereunder if possession had not
been retaken.
All covenants and agreements to be performed by the Tenant under any of the
terms of this Lease shall be performed by Tenant at Tenant's sole cost and
expense and without any abatement of rent. If the Tenant fails to pay any sum of
money, other than rent, required to be paid by it hereunder or shall fail to
perform any other act on its part to be performed hereunder, and such failure
shall continue for ten (10) days after notice thereof by the Landlord, the
Landlord may, but shall not be obligated to and without waiving or releasing the
Tenant from any of its obligations, make any such payment or perform any such
other act on the Tenant's part to be made or performed as provided herein. All
sums so paid by the Landlord and all necessary incidental costs, and all costs
and expenses (including reasonable attorneys' fees) incurred by Landlord in
enforcing any of the terms, covenants or conditions of this Lease, or in suing
for or obtaining relief by reason of a breach thereof, shall be payable as
additional rent to the Landlord on demand and the Tenant covenants to pay any
such sums, costs and expenses and the Landlord shall have, in addition to any
other right or remedy of the Landlord, the same rights and remedies in the event
of the nonpayment thereof by the Tenant as in the case of default by the Tenant
in the payment of rent.
If Tenant fails to pay rent or any other amount due to Landlord hereunder,
Landlord will be entitled to interest on the unpaid amount at the annual rate of
five percent plus the prime rate of interest charged, from time to time by the
First Wisconsin National Bank of Milwaukee (or the highest contract rate
permitted to be charged by law, whichever is lower) from the date of notice of
default, compounded monthly.
Failure of Landlord to exercise its rights in connection with any breach or
violation of any term, covenant or condition herein contained shall not be
deemed to be a waiver of such term, covenant or condition or any subsequent
breach of the same or any other term, covenant or condition herein contained.
The subsequent acceptance of rent hereunder by Landlord shall not be deemed to
be a waiver of any preceding breach by Tenant of any term, covenant or condition
of this Lease, other than the failure of Tenant to pay the particular rental so
accepted, regardless of Landlord's knowledge of such preceding breach at the
time of acceptance of such rent.
Tenant shall pay all costs, expenses and reasonable attorneys fees that may
be incurred or paid by Landlord in enforcing the covenants and agreements of
this Lease.
19. Termination. Upon the termination of this Lease, by expiration or
otherwise, Tenant shall surrender the Premises to Landlord in as good condition
and repair as when delivered by Landlord, ordinary wear and tear and damage by
insured fire and other casualty
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only excepted. All alterations, additions, improvements and decorations made to
the Premises by Tenant shall remain and become the property of the Landlord
unless Landlord shall require Tenant, at Tenant's expense, to remove any or all
thereof and repair the damage caused by such removal. All trade fixtures and
other equipment and personal property owned by Tenant may (and upon Landlord's
request shall) be removed from the Premises by Tenant no later than the
termination date, provided that all terms and conditions of this Lease have been
complied with and provided further that Tenant shall repair any and all damage
caused by such removal.
20. Holdover. Tenant shall pay Landlord for each day Tenant retains
possession of the Premises or any part thereof after termination hereof, by
lapse of time or otherwise, at two (2) times the daily base rental plus all
other charges payable by Tenant hereunder, for the last period prior to the date
of such termination, and also pay all damages sustained by Landlord by reason of
such retention, or, if Landlord gives written notice to Tenant of Landlord's
election thereof, such holding over shall constitute an extension of this Lease
for a period from month to month, on the terms and conditions of this Lease.
This provision shall not be deemed to waive Landlord's right of re-entry or any
other right hereunder or at law.
21. Limitation of Remedies. In the event of a sale or conveyance by
Landlord of the Building, the same shall operate to release Landlord from any
future liability upon any of the covenants or conditions herein contained, and
in such event Tenant agrees to look solely to the responsibility of the
successor in interest of Landlord in and to this Lease. The Lease shall not be
affected by any such sale or conveyance, and Tenant agrees to attorn to the
purchaser or grantee, which shall be obligated on this Lease only so long as it
is the owner of Landlord's interest in and to this Lease. If Landlord shall fail
to perform any covenant or condition of this Lease upon Landlord's part to be
performed and, as a consequence of such default, Tenant shall recover a money
judgment against Landlord, such judgment shall be satisfied only out of the
proceeds of sale received upon execution of such judgment and levy thereon
against the right, title and interest of Landlord in the Building and Common
Areas and out of rents or other income from such property receivable by Landlord
and Landlord shall not be liable for any deficiency.
22. Assignment and Subletting. Tenant shall not assign, pledge, mortgage or
otherwise transfer or encumber this Lease or sublet any part or all of the
Premises without Landlord's prior written consent which shall not be
unreasonably withheld and shall not permit any transfer of its interest in the
Premises by operation of law. Notwithstanding Landlord's consent to any of the
foregoing, Tenant shall remain liable to Landlord for the payment of rental then
due and thereafter to become due and the performance of all other obligations of
Tenant hereunder for the balance of the term hereof. Landlord's consent to any
of the foregoing shall not constitute a consent to any other assignment, pledge,
mortgage, encumbrance, transfer or sublease. If this Lease is assigned, or if
the Premises or any part thereof are subleased or occupied by anybody other than
Tenant, whether with or without Landlord's consent, Landlord may collect from
the assignee, sublessee or occupant, any rental and other charges herein
required, but such collection by Landlord shall not be deemed an acceptance of
the assignee, sublessee or occupancy, nor a release of Tenant from the
performance by Tenant of this Lease. If Tenant is a non-public corporation, then
the sale, issuance, or transfer of any voting capital stock of Tenant (other
than to existing shareholders, their family members and personal representatives
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or a trust created for any of them), which results in a change in the voting
control of Tenant, shall be deemed to be an assignment of this Lease within the
meaning of this Paragraph.
23. Definitions
23.1. Bankrupt: Tenant shall file a voluntary petition in bankruptcy or
shall be adjudicated a bankrupt or insolvent, or shall file any petition or
answers seeking or acquiescing in any reorganization, arrangement,
composition, readjustment, liquidation, dissolution or similar relief for
Tenant under any present or future federal, state or other statute, law or
regulation relating to bankruptcy, insolvency or other relief for debtors;
or shall seek or consent to or acquiesce in the appointment of any trustee,
receivor or liquidator of Tenant or of all or any part of Tenant's assets
or Tenant's interest in the Premises, or of any or all of the royalties,
revenues, rents, issues or profits thereof, or shall make any general
assignment for the benefit of creditors, or shall admit in writing Tenant's
inability to pay Tenant's debts generally as they become due; or a court of
competent jurisdiction shall enter an order, judgment or decree approving a
petition filed against Tenant seeking any reorganization, dissolution or
similar relief under any present or future federal, state or other statute
law or regulation relating to bankruptcy, insolvency or other relief for
debtors, and such order, judgment or decree shall remain unvacated and
unstayed for an aggregate of sixty (60) days (whether or not consecutive)
from the first date of entry thereof; or any trustee, receivor or
liquidator of Tenant or of all or any part of Tenant's assets or Tenant's
interest in the Premises, or of any or all of the royalties, revenues,
rents, issues or profits thereof shall be appointed without the consent or
acquiescence of Tenant and such appointment shall remain unvacated and
unstayed for an aggregate of sixty (60) days (whether or not consecutive)
or a writ of execution or attachment or any similar process shall be issued
or levied against all or any part of Tenant's assets or interest in the
Premises, or any judgment involving monetary damages shall be entered
against Tenant which shall become a lien on the Tenant's interest in the
Premises or any assets of Tenant or any portion thereof or interest therein
and such execution, attachment or similar process or judgment is not
released, bonded, satisfied, vacated or stayed within sixty (60) days after
its entry or levy.
23.2. Building: The building identified in Paragraph 1.3. and Exhibit
I located in Madison, Wisconsin.
23.3. Building Site: The land identified on Exhibit II.
23.4. Commencement Date: The date on which Landlord tenders possession
of the Premises to Tenant, or the date on which Tenant first enters into
occupancy of any part of the Premises, whichever occurs first. Landlord
will not tender possession of the Premises to Tenant until Landlord has
substantially completed its work as shown on Exhibit III to this Lease.
Landlord will be deemed to have substantially completed its work when such
work is sufficiently complete to enable Tenant to perform Tenant's Work
required elsewhere herein without undue interference from Landlord's
workmen. The anticipated Commencement Date and Termination Date is set
forth in Paragraph 1.4.
14
<PAGE> 17
Landlord and Tenant will execute a supplement to this Lease confirming the
Commencement and Termination Dates once they are determined.
23.5. Common Areas: The areas of the Building and the Building Site
and the other improvements and facilities appurtenant thereto not
regularly and customarily held for lease to tenants, including but not
limited to all vestibules, stairs, elevators, common hallways, Building
mechanical systems, parking areas, driveways, walks and landscaped areas
shown on Exhibit I.
23.6. Operating Expenses: All expenses incurred by Landlord with
respect to the Building and Common Areas, whether or not now foreseen,
determined on an accrual basis (including reasonably foreseeable expenses
not occurring annually), including, but not limited to, the following:
real estate taxes and special assessments (or any substitutes hereafter
collected by any governmental authority in lieu thereof or in addition
thereto), payroll taxes, federal and state unemployment taxes and social
security taxes; insurance, including but not limited to, fire (including
but not limited to endorsements for extended coverage, vandalism and
malicious mischief and theft and mysterious disappearance), public
liability, water damage, workmen's compensation and business and rental
interruption insurance; water and sewer charges; license, permit and
inspection fees; costs of wages and salaries of operating personnel
including other compensation and fringe benefits; management fees payable
to third parties and/or to Landlord or its affiliates, provided the total
of all such management fees shall not exceed the then current market rate;
auditors' fees and legal fees; materials and supplies, including charges
for telephone, telegraph, postage, stationery supplies and other materials
and expenses required for operation of the Building's operations offices;
repairs to and maintenance of the Building and Common Areas, including
costs of materials, supplies, tools and equipment used in connection
therewith and including the repaving of parking areas, replanting of
landscaped areas and replacement of Building components; costs incurred in
providing services under Paragraph 11 hereof; costs incurred in connection
with the operation, maintenance, repair, inspection and servicing
(including outside maintenance contracts) of electrical, plumbing,
heating, air-conditioning and mechanical equipment and the cost of
materials, supplies, tools and equipment used in connection therewith;
cost of services (including heat, air conditioning, electricity, gas,
water and other utilities for the operation and maintenance of the entire
Building and Common Areas, excluding electricity provided to each tenant's
premises which shall be billed directly to and paid by each such tenant);
all other expenses and costs necessary or desirable to be incurred for the
purpose of operating and maintaining the Building and the Common Areas in
good and workmanlike condition as a first class office building, whether
or not similar to the foregoing; and the amortization of capital
improvements, including interest thereon, incurred to reduce the operating
expenses of the Building and Common Areas. Operating Expense shall not
include (i) Landlord's cost of utility or other services, if any,
separately sold by Landlord to tenants or separately metered for the
Premises, (ii) costs incurred by Landlord for alterations, if any, for
other tenants, (iii) depreciation of the Building and major components,
(iv) costs for capital improvements (except as provided herein), and (v)
special assessments to the extent such assessments can be paid in
installments and
15
<PAGE> 18
such installments are not then due. Replacements of the original
components of the Building, including the roof, shall be included in
Operating Expenses, whether such costs are deemed to be capital
expenditures; provided that, if the expenditure for any single component
is greater than $10,000.00, such expenditure shall be amortized over the
lesser of ten (10) years or the useful life of the component as reasonably
determined by Landlord.
23.7. Premises: That portion of the Building described in Section 1.3
and Exhibit I, consisting of all space measured from outside face of
exterior wall or Building line to outside face of corridor walls, if any,
and from mid-point to mid-point of demising walls between tenants, but not
including the Common Areas.
23.8 Rentable Square Footage: Rentable Square Footage for the
Building shall mean a total of 67,560 square feet, calculated as shown on
the floor plan for the Building attached hereto as Exhibit I. The Rentable
Square Footage for the Premises is also as calculated and shown on Exhibit
I, including a pro rata portion of the Breakroom as set forth on Exhibit
I.
23.9. Tenant's Proportionate Share. The percentage set forth in
Paragraph 1.7; provided that in the event Landlord expands or contracts
the Building or otherwise creates more or less rentable areas within the
Building then presently exists, Tenant's Proportionate Share shall be
reduced or increased, as appropriate, proportionately, based solely on
Landlord's calculation of Rentable Space consistently applied to the
entire Building.
23.10. Termination Date: The last day of the term of this Lease, as
set forth in Paragraph 1.42; provided that the Termination Date shall be
adjusted one day for each day that the actual Commencement Date is delayed
beyond the date set forth in Paragraph 1.41.
24. Miscellaneous.
24.1. Building Rules: Tenant shall not use the Premises or permit
anything to be done in or about the Premises which will in any way
conflict with any law, statute, ordinance or governmental rules or
regulation now in force or hereafter enacted or promulgated. Tenant shall
not do or permit anything to be done on or about the Premises or bring or
keep anything therein which will in any way increase the cost of any
insurance now or hereafter carried on the Building or any of its contents,
or that will invalidate any such insurance or grant the insurer a defense
thereon. Tenant shall at its sole cost and expense promptly comply with
all laws, statutes, ordinances and governmental rules, regulations or
requirements now or hereafter in force, and with the requirements of the
local Board of Fire Underwriters or any similar body now or hereafter
constituted relating to or affecting the condition, use or occupancy of
the Premises, excluding structural changes not related to or affected by
Tenant's alterations or improvements or by a change in Tenant's use of the
Premises. Tenant shall also comply with all rules and regulations
16
<PAGE> 19
to regulate the use, occupancy and operation of the Building which may
from time to time be established by Landlord in writing, provided they
shall not materially alter the terms hereof and provided they are applied
uniformly to all tenants. The foregoing laws, regulations and rules are
herein referred to collectively as "Building Rules." Landlord shall not be
responsible to Tenant for the non-compliance by other tenants or occupants
with the Building Rules.
24.2. Interpretation: The laws of the State of Wisconsin shall govern
the validity, performance and enforcement of this Lease. Whenever a period
of time is provided in this Lease for Landlord to do or perform any act or
thing, Landlord shall not be liable or responsible for any delays due to
strikes, lockouts, casualties, acts of God, war, governmental regulation
or control or other causes beyond the reasonable control of Landlord and
in any such event such time period shall be extended for the amount of
time Landlord is so delayed. The invalidity or unenforceability of any
provision of this Lease shall not affect or impair any other provision.
Whenever the singular number is used, the same shall include the plural,
and the masculine gender shall include the feminine and neuter genders.
24.3. Subordination: This Lease is and shall be subject and
subordinate at all times to the lien of any mortgages now or hereafter
placed on or against such property, or on or against Landlord's interest
or estate therein, or any part of or interest in the foregoing (and in all
cases including all extensions, renewals, amendments and supplements to
any mortgage), without the necessity of the execution and delivery of any
further instruments on the part of Tenant to effectuate such
subordination. Tenant covenants and agrees to execute and deliver upon
demand such further instruments evidencing such subordination of this
Lease to the lien of any such mortgages as may be required by Landlord
provided that the mortgagee agrees not to disturb Tenant's rights under
this Lease as long as the Tenant is not in default under the Lease.
Notwithstanding anything hereinabove contained in this paragraph, in the
event the holder of any mortgage shall at any time elect to have this
Lease constitute a prior and superior lien to its mortgage, then and in
such event, upon any such holder notifying Tenant to that effect in
writing, this Lease shall be deemed prior and superior in lien to such
mortgage, whether this Lease is dated prior to or subsequent to the date
of such mortgage.
24.4. Estoppel Certificates. Tenant agrees that at any time and from
time to time upon not less than ten (10) days prior request of Landlord,
Tenant shall execute, acknowledge and deliver to Landlord a statement in
writing certifying (a) that this Lease is unmodified and in full force and
effect (or if there have been modifications, specifying the same), and (b)
the dates to which the rent and other charges have been paid, and (c)
that, so far as the Tenant knows, Landlord is not in default under any
provisions of this Lease (or if Tenant knows of any such default,
specifying the same). It is intended that any such statement may be relied
upon by any person proposing to acquire Landlord's interest in this Lease
or any prospective mortgagee of, or assignee of any mortgage upon, such
interest.
17
<PAGE> 20
24.5. Notices: All notices and demands which may or are required to
be given by either party to the other hereunder shall be in writing, and
delivered in person or sent by United States certified mail, return
receipt requested, postage prepaid. Notices and demands to Tenant shall be
addressed to it at the address indicated in Paragraph 1.2 until the term
commences and thereafter to it at the Premises, or to such other place as
the Tenant may from time to time designate in a written notice to the
Landlord. Notices and demands to the Landlord shall be addressed to it at
the address indicated in Paragraph 1.1, or to such other firm or to such
other place as Landlord may from time to time designate in a written
notice to the Tenant.
24.6. Execution: The submission of this document for examination does
not constitute an offer to lease, or a reservation of, or option for, the
Premises and this document becomes effective and binding only upon the
execution and delivery hereof by Landlord and Tenant. Tenant confirms that
Landlord has made no representations or promises with respect to the
Premises or the making or entry into of this Lease except as is expressly
set forth herein, and agrees that no claim or liability shall be asserted
by Tenant against Landlord for, and Landlord shall not be liable by reason
of, breach of any representations or promises not expressly stated in this
Lease. This Lease can be modified or altered only by agreement in writing
between Landlord and Tenant.
24.7. Binding Effect: The covenants, agreements and obligations
herein contained, except as herein otherwise specifically provided, shall
extend to, bind and inure to the benefit of the parties hereto and their
respective personal representatives, heirs, successors and assigns (but in
the case of assigns only to the extent that assignment is permitted
hereunder). No third party, other than such successors and assigns, shall
be entitled to enforce any or all of the terms of this Lease or shall have
rights hereunder whatsoever.
24.8. Parking. Tenant and Tenant's employees, customers and invitees
shall have the nonexclusive right to use the parking spaces located within
the Common Areas as depicted on Exhibit I. In addition, Tenant shall have
the exclusive use of three (3) enclosed parking spaces within the Project
designated by Landlord. Tenant shall not cause or allow any storage of
materials or equipment outside of the Premises on any of the Common Areas.
24.9. Signs. Landlord shall provide a standard interior building sign
for the Building, which shall identify Tenant as an occupant of the
Building. Tenant shall not, without Landlord's prior written consent,
install, fix or use any other signs or other advertising or identifying
media on the exterior of the Premises, or which is visible from the
exterior of the Premises or the Building.
18
<PAGE> 21
IN WITNESS WHEREOF, the undersigned have executed this Lease as of the date
first set forth above.
INSTITUTE FOR ACADEMIC
EXCELLENCE, INC.
(Tenant)
/s/ STUART J. UDELL
By: ---------------------------
President
Title: ------------------------
ATHENA HOLDINGS LLC
(Landlord)
By: Advantage Learning Systems, Inc.
Managing Member
/s/ TIMOTHY SHERLOCK
By: ----------------------------
CFO
Title: -------------------------
By: DezCon, LLC, Member
/s/ JAMES M. PIANKA
By: ----------------------------
Member
Title: -------------------------
19
<PAGE> 22
EXHIBIT I
---------
Building Floor Plan
<PAGE> 23
EXHIBIT II
----------
REAL ESTATE LEGAL DESCRIPTION
-----------------------------
Lot 23, Old Sauk Trails Park First Addition, in the City of Madison, Dane
County, Wisconsin.
901 Deming Way, Madison, Wisconsin
<PAGE> 24
EXHIBIT III
-----------
WORK LETTER AGREEMENT
---------------------
Athena Holdings LLC, a Wisconsin limited liability company ("Landlord"),
and Institute for Academic Excellence, Inc., a Wisconsin corporation ("Tenant"),
are executing simultaneously with this Work Letter Agreement an Office Lease
("Lease") for certain space ("Premises") located in the building to be
constructed on the real estate described on Exhibit II attached to the Lease.
To induce Landlord and Tenant to enter into the Lease and in consideration
of the mutual covenants hereinafter contained, Landlord and Tenant mutually
agree as follows:
1. All capitalized terms used herein, to the extent not defined herein,
shall have the meaning set forth in the Lease.
2. Landlord agrees at its sole cost and expense to do all of the work shown
on Schedule A appended hereto (the "Standard Work").
3. Any work in excess of the Standard Work desired by Tenant ("Tenant's
Work") shall be paid for by Tenant, subject to Landlord's payment of the
Landlord's Contribution. As Tenant prepares to occupy all or any portion of the
Premises, a schematic drawing of Tenant's Work for all or a portion of the
Premises to be occupied shall be delivered to Landlord. Landlord shall cause its
architect to complete and deliver to Tenant a set of plans and outline drawings
of the Tenant's Work within 30 days after receipt of Tenant's or Tenant's
sublessee's schematic drawings. Tenant shall have 5 business days to object to
the plans and specifications, or Tenant shall be deemed to have accepted the
plans and specifications. If Tenant timely objects to the plans and
specifications, Landlord, Landlord's architect and Tenant shall proceed in good
faith to revise the plans to meet any reasonable objections of Tenant. The costs
of Landlord's architect shall be included in the costs of performing the
Tenant's Work to be paid by Tenant as provided below. In addition, the costs of
any changes or additional work to the base building recommended by Landlord's
architect as a result of the Tenant's Work, shall also be included in the costs
of the Tenant's Work to be paid by Tenant hereunder. By way of example and not
in limitation, if Landlord's architect determines that additional modifications
to the HVAC system (over and above the normal finishing work included in the
Standard Work) are necessary, such additional work shall be added to and deemed
to be a part of the Tenant's Work. Within 30 days after approval of the plans
and drawings for Tenant's Work, Landlord shall provide Tenant with a written
estimate of the cost to complete Tenant's Work and the scheduled substantial
completion date for such work.
4. The Tenant's Work shall be performed by or under the supervision of
Landlord. To the extent the Landlord's estimate of the cost to complete the
Tenant's Work exceeds the amount of the Landlord's Contribution, Tenant shall
pay the difference to Landlord as construction progresses, but no later than
five (5) days after the date of receipt of Landlord's invoice for any
<PAGE> 25
such Tenant's Work. All of the work shall be performed in a good and
workmanlike manner and in accordance with all building codes and regulations.
5. The Premises shall be deemed ready for Tenant's possession and occupancy
upon the substantial completion of the Standard Work and Tenant's Work. Landlord
shall, when construction so permits, notify Tenant of the approximate date that
the Premises shall be so ready, and will notify Tenant when the Premises will,
in fact, be so ready. In no event shall the Premises be deemed unready for
Tenant's possession and occupancy, or shall Tenant refuse to take possession
thereof, if only minor or insubstantial details of construction, decoration or
mechanical adjustment remain to be done therein.
6. If the actual cost of completing Tenant's Work exceeds the sum of the
Landlord's Contribution and the amount previously paid by Tenant to Landlord
under Paragraph 4, Tenant shall pay such excess to Landlord within 5 days of
receipt of written demand by Landlord for such payment. If the actual total cost
to complete the Tenant's Work is less than the sum of the Landlord's
Contribution and the amount previously paid by Tenant to Landlord under
Paragraph 4, the savings shall be refunded to Tenant upon completion of Tenant's
Work and final settlement with all contractors.
7. If Tenant requests any change, addition or alteration in the Tenant's
Work subsequent to the approval of Tenant's drawings by Landlord, Tenant shall,
at its sole cost and expense, have such working drawings revised to reflect
Tenant's requested changes, additions or alterations. Upon completion of the
revised drawings and approval thereof by Landlord and Landlord's architect,
Landlord shall notify Tenant in writing of the estimated costs, which shall
include any additional review costs of Landlord's architect, of performing such
changes, additions or alterations. Tenant shall, within 3 working days after
receipt of such estimate, notify Landlord in writing whether it desires to
proceed with such changes, additions or alterations. If Tenant agrees to proceed
with such changes, additions or alterations, Tenant shall, along with written
notice thereof to Landlord, pay Landlord 100% of the estimated costs therefor.
If Landlord does not receive Tenant's written authorization and payment, or
notice declining any such changes, additions or alterations, within such 3 day
period, Landlord shall not be obligated to continue with Tenant's Work, and
Tenant shall be chargeable with any delay in the completion of the Premises
resulting therefrom, until Landlord receives either (i) written authorization
and payment or (ii) written withdrawal of Tenant's request for the change.
Dated as of the 17th day of December, 1998.
ATHENA HOLDINGS LLC INSTITUTE FOR ACADEMIC EXCELLENCE,
INC.
/s/ STUART J. UDELL
By: Advantage Learning Systems, Inc., By: -----------------------------
Managing Member
/s/ TIMOTHY SHERLOCK
By: -------------------------------
By: DezCon, LLC, Member
/s/ JAMES M. PIANKA
By: -------------------------------
2
<PAGE> 26
SCHEDULE A
----------
ATHENA OFFICE BUILDING LANDLORD'S WORK
--------------------------------------
The following shall generally describe the shell work provided by the
landlord.
- -- Exposed concrete floor.
- -- Exposed structural steel columns, beams and ceiling joists.
- -- Perimeter walls that are insulated and drywalled to 10' above finish floor.
- -- Restrooms per the designed layout described in the plan set to include
partition walls plumbing fixtures and lighting.
- -- Perimeter glass and glazing per building elevations. Window sills not
included.
- -- A main building security card reader system along with a card reader at the
main entrance door of each tenant suite.
- -- A complete fire protection system per NFPA 13 requirements based on a open
floor plan concept.
- -- Provide toilet rooms per plan design.
- -- Provide a complete HVAC system per tenant layout design. Each floor will
have its own separate air handling unit. The air handling unit provides heat
and ventilation to each floor. Separately controlled VAV boxes control
specifically designed zones. Cooling is supplied to the air handling unit by
a common building chiller. The electrical cost to operate the chiller are
part of the common area expense, and charged back to the tenant on a
pro-rated bases. The gas provided to the central boiler which supplies the
air handling unit with "heat" is part of the common area expense, charged
back to the tenant on a pro-rated basis.
- -- Electrical 277/480 volt, and 120/208 volt service is provided to each floor.
Each floor is independently metered. All lights and outlets is a tenant
cost. No other electrical is provided within the tenant space.
3
<PAGE> 27
EXHIBIT IV
----------
THE INSTITUTE FOR ACADEMIC EXCELLENCE, INC.
SQUARE FOOTAGE: 34,633
DECEMBER 17, 1998
<TABLE>
<CAPTION>
YEAR BASE RENT BASE RENT ESTIMATED TOTAL ANNUAL MONTHLY
$20/SF ADDITIONAL TI'S CAM RENT/SF RENT RENT
- ---- --------- --------------- --------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
1 $10.60 $1.81 $4.15 $16.56 $573,522.48 $47,793.54
2 $10.60 $1.81 $4.27 $16.68 $577,834.29 $48,152.86
3 $10.60 $1.81 $4.40 $16.81 $582,275.45 $48,522.95
4 $10.60 $1.81 $4.53 $16.94 $586,849.85 $48,904.15
5 $10.60 $1.81 $4.67 $17.08 $591,561.48 $49,296.79
6 $10.92 $1.81 $4.81 $17.54 $607,497.02 $50,624.75
7 $11.25 $1.81 $4.96 $18.02 $623,924.47 $51,993.71
8 $11.58 $1.81 $5.10 $18.49 $640,501.89 $53,375.16
9 $11.93 $1.81 $5.26 $19.00 $657,926.42 $54,827.20
10 $12.29 $1.81 $5.41 $19.51 $675,856.37 $56,321.36
</TABLE>
<PAGE> 1
Real Estate Mortgage Exhibit 10.15
DOCUMENT NO. -------------
Athena Holdings LLC ("Mortgagor", whether one or more) mortgages, conveys and
warrants to Advantage Learning Systems, Inc. ("Lender") in consideration of the
sum of Seven Million Dollars ($7,000,000.00) loaned or to be loaned to Athena
Holdings LLC ("Borrower,"), evidenced by Borrower's note(s) or agreement dated
December 17, 1998, the real estate described below, together with all
privileges, hereditaments, easements and appurtenances, all rents, leases,
issues and profits, all awards and payments made as a result of the exercise of
the right of eminent domain, and all existing and future improvements and
fixtures (all called the "Property").
THIS SPACE RESERVED FOR RECORDING DATA
NAME AND RETURN ADDRESS
Michael J. Dwyer
Godfrey & Kahn, S.C.
780 North Walter Street
Milwaukee, Wisconsin 53202
60-0708-154-0402-8
----------------------------------------
PARCEL IDENTIFICATION NUMBER (PIN)
1. DESCRIPTION OF PROPERTY
Lot 23 First Addition Old Sauk Trails Park, City of Madison, Dane County,
Wisconsin
The Property is not the homestead of Mortgagor.
2. TITLE. Mortgagor warrants title to the Property, excepting
only restrictions and easements of record, municipal and zoning ordinances,
current taxes and assessments not yet due and no other.
3. ESCROW. Interest will not be paid on escrowed funds
required under paragraph 7(a).
4. MORTGAGE AS SECURITY. This Mortgage secures prompt payment
to Lender of (a) the sum stated in the first paragraph of this Mortgage, plus
interest and charges, according to the terms of a promissory note(s) or
agreement of Borrower to Lender identified herein, and any extensions, renewals
or modifications of such promissory note(s) or agreement, and (b) any additional
sums which are in the future loaned by Lender to any Mortgagor, to any Mortgagor
and another or to another guaranteed or endorsed by any Mortgagor and agreed in
documents evidencing the transaction to be secured by this Mortgage, plus
interest and charges, (all called the "Note"). This Mortgage also secures the
performance of all covenants, conditions and agreements contained in this
Mortgage, and to the extent not prohibited by law costs and expenses of
collection or enforcement. Unless otherwise required by law, Lender will satisfy
this Mortgage upon request by Mortgagor if (a) the Note has been paid according
to its terms, (b) any commitment to make future advances under the Note has
terminated, (c) Lender has terminated any line of credit under which advances
are to be secured by this Mortgage, and (d) all other payments required under
this Mortgage and the Note and all other terms, conditions, covenants, and
agreements contained in this Mortgage and the Note have been paid and performed.
5. TAXES. To the extent not paid to Lender under paragraph
7(a), Mortgagor shall pay before they become delinquent all taxes, assessments
and other charges which may be levied or assessed against the Property, or
against Lender upon this Mortgage or the Note or other debt secured by this
Mortgage, or upon Lender's interest in the Property, and deliver to Lender
receipts showing timely payment.
<PAGE> 2
6. INSURANCE. Mortgagor shall keep the improvements on the
Property insured against direct loss or damage occasioned by fire, extended
coverage perils and such other hazards as Lender may require, through insurers
approved by Lender, in amounts, without co-insurance, not less than the unpaid
balance of the Note or the full replacement value, whichever is less, and shall
pay the premiums when due. The policies shall contain the standard mortgage
clause in favor of Lender and, unless Lender otherwise agrees in writing, the
original of all policies covering the Property shall be deposited with Lender.
Mortgagor shall promptly give notice of loss to insurance companies and Lender.
All proceeds from such insurance shall be applied, at Lender's option, to the
installments of the Note in the inverse order of their maturities (without
penalty for prepayment) or to the restoration of the improvements on the
Property. In the event of foreclosure of this Mortgage or other transfer of
title to the Property, in extinguishment of the indebtedness secured hereby, all
right, title, and interest of Mortgagor in and to any insurance then in force
shall pass to the purchaser or grantee.
7. MORTGAGOR'S COVENANTS. Mortgagor covenants:
(a) ESCROW. To pay Lender sufficient funds at such times
as Lender designates, to pay (1) the estimated annual
real estate taxes and assessments on the Property,
(2) all property insurance premiums when due, and (3)
if payments owed under the Note are guaranteed by
mortgage guaranty insurance, the premiums necessary
to pay for such insurance which Lender may cancel at
any time. Upon demand, Mortgagor shall pay Lender
such additional sums as are necessary to pay these
items in full when due. Lender shall apply these
amounts against the taxes, assessments and insurance
premiums when due. Escrowed funds may be commingled
with Lender's general funds;
(b) CONDITION AND REPAIR. To keep the Property in good
and tenantable condition and repair, and to restore
or replace damaged or destroyed improvements and
fixtures;
(c) LIENS. To keep the Property free from liens and
encumbrances superior to the lien of this Mortgage
and not described in paragraph 2 herein;
(d) PRIOR MORTGAGES. To perform all of Mortgagor's
obligations and duties under any mortgage or security
agreement with a lien which has priority over this
Mortgage and any obligation to pay secured by such a
mortgage or security agreement;
(e) WASTE. Not to commit waste or permit waste to be
committed upon the Property;
(f) CONVEYANCE. Not to sell, assign, lease, mortgage,
convey or other otherwise transfer any legal or
equitable interest in all or part of the Property, or
permit the same to occur without the prior written
consent of Lender and, without notice to Mortgagor,
Lender may deal with any transferee as to his
interest in the same manner as with Mortgagor,
without in any way discharging the liability of
Mortgagor under this Mortgage or the Note;
(g) ALTERATION OR REMOVAL. Not to remove, demolish or
materially alter any part of the Property, without
Lender's prior written consent, except Mortgagor may
remove a fixture, provided the fixture is promptly
replaced with another fixture of at least equal
utility;
(h) CONDEMNATION. To pay to Lender all compensation
received for the taking of the Property, or any part,
by condemnation proceedings (including payments in
compromise of condemnation proceedings), and all
compensation received as damages for injury to the
Property, or any part. The compensation shall be
applied in such manner as Lender determines to
rebuilding of the Property or to installments of the
Note in the inverse order of their maturities
(without penalty for prepayment);
(i) ORDINANCES; INSPECTION. To comply with all laws,
ordinances and regulations affecting the Property.
Lender and its authorized representatives may enter
the Property at reasonable times to inspect it and,
at Lender's option, repair or restore it; and
(j) SUBROGATION. That the Lender is subrogated to the
lien of any mortgage or other lien discharged, in
whole or in part, by the proceeds of the Note.
8. ENVIRONMENTAL LAWS. Mortgagor represents and warrants to
Lender (a) that no substances or materials, if known to be present on, at or
under the Property, would require cleanup, removal or some other remedial action
under any federal, state or local laws, regulations, ordinances, codes or rules
relating to the discharge of air pollutants, water pollutants or process
wastewater or otherwise relating to hazardous or toxic substances or materials
("Environmental Laws"), (b) that there are no conditions existing currently or
likely to exist during the term of this Mortgage which would subject Mortgagor
to damages, penalties, injunctive relief or cleanup costs under any
Environmental Law, and (c) that Mortgagor is not subject to any judgment,
decree, order or citation relating to or arising out of any Environmental Law.
Mortgagor shall indemnify and hold harmless Lender from all loss, cost
(including reasonable attorneys' fees and legal expenses), liability and damage
whatsoever incurred by Lender by reason of any violation of this paragraph or
any Environmental Law involving the Property, or by reason of the imposition of
any governmental lien of the recovery of environmental cleanup costs expended by
reason of such violation.
2
<PAGE> 3
9. AUTHORITY OF LENDER TO PERFORM FOR MORTGAGOR. If Mortgagor
fails to perform any of Mortgagor's duties set forth in this Mortgage, Lender
may, after giving Mortgagor any notice and opportunity to perform which is
required by law, perform the duties or cause them to be performed, including
without limitation signing Mortgagor's name or paying any amount so required,
and the cost shall be due on demand and secured by this Mortgage, bearing
interest at the highest rate stated in any Note, but not in excess of the
maximum rate permitted by law, from the date of expenditure by Lender to the
date of payment by Mortgagor.
10. DEFAULT; ACCELERATION; REMEDIES. If, (a) there is a
default under any Note secured by this Mortgage, or (b) Mortgagor fails timely
to observe or perform any of Mortgagor's covenants or duties contained in this
Mortgage, then, at the option of Lender the Note will become immediately payable
unless notice to Mortgagor or Borrower and an opportunity to cure is required by
ss.425.105, Wis. Stats., or the Note and, in that event, the Note will become
payable if the default is not cured as provided in that statute or the Note or
as otherwise provided by law. If Lender exercises its option to accelerate, the
unpaid principal and interest owed on the Note, together with all sums paid by
Lender as authorized or required under this Mortgage or the Note, shall be
collectible in a suit at law or by foreclosure of this Mortgage by action, or
both, or by the exercise of any other remedy available at law or equity.
11. WAIVER. Lender may waive any default without waiving any
other subsequent or prior default by Mortgagor.
12. POWER OF SALE. In the event of foreclosure, Lender may
sell the Property at public sale and execute and deliver to the purchasers deeds
of conveyance pursuant to statute.
13. ASSIGNMENT OF RENTS AND LEASES. Mortgagor assigns and
transfers to Lender, as additional security for the Note, all rents, issues and
profits which become or remain due or are paid under any agreement or lease for
the use of occupancy of any part or all of the Property. Upon the occurrence of
an event of default under this Mortgage or the Note, Lender may, after giving
Mortgagor any notice and opportunity to perform which is required by law, notify
any or all tenants to pay directly to Lender all such rents, issues and profits,
and all such payments shall be applied in such manner as Lender determines to
payments required under this Mortgage and the Note. This assignment shall be
enforceable and Lender shall be entitled to take any such action without seeking
or obtaining the appointment of a receiver of possession of the Property.
14. RECEIVER. Upon the commencement or during the pendency of
an action to foreclose this Mortgage, or enforce any other remedies of Lender
under it, without regard to the adequacy or inadequacy of the Property as
security for the Note, Mortgagor agrees that the court may appoint a receiver of
the Property (including homestead interest) without bond, and may empower the
receiver to take possession of the Property and collect the rents, issues and
profits of the Property and exercise such other powers as the court may grant
until the confirmation of sale, and may order the rents, issues and profits,
when so collected, to be held and applied as the court may direct.
15. FORECLOSURE WITHOUT DEFICIENCY JUDGMENT. If the Property
is a one to four family residence that is owner-occupied at the commencement of
a foreclosure, a farm, a church or owned by a tax exempt charitable
organization, Mortgagor agrees to the provisions of ss.846.101, Wis. Stats., and
as the same may be amended or renumbered from time to time, permitting Lender,
upon waiving the right to judgment for deficiency, to hold the foreclosure sale
of real estate of 20 acres or less six months after a foreclosure judgment is
entered. If the Property is other than a one to four family residence that is
owner-occupied at the commencement of a foreclosure, a farm, a church or a tax
exempt charitable organization, Mortgagor agrees to the provisions of
ss.846.103, Wis. Stats., and as the same may be amended or renumbered from time
to time, permitting Lender, upon waiving the right to judgment for deficiency,
to hold the foreclosure sale of real estate three months after a foreclosure
judgment is entered.
16. EXPENSES. To the extent not prohibited by law, Mortgagor
shall pay all reasonable costs and expenses before and after judgment, including
without limitation, attorneys' fees and expenses of obtaining title evidence,
incurred by Lender in protecting or enforcing its rights under this Mortgage.
17. SEVERABILITY. Invalidity or unenforceability of any
provision of this Mortgage shall not affect the validity or enforceability of
any other provision.
18. SUCCESSORS AND ASSIGNS. The obligations of all Mortgagors
are joint and several. This Mortgage benefits Lender, its successors and
assigns, and binds Mortgagor(s) and their respective heirs, personal
representatives, successors and assigns.
19. WAIVER OF ESCROW. So long as Mortgagor is not in default
under this Mortgage or any note secured hereby, including but not limited to the
prompt payment of all real estate taxes assessed against the Property before
they become delinquent, Lender waives escrowing for taxes set forth in Section
7(a), above; provided that upon receipt of notice from Lender of any such
default, Mortgagor shall be required to escrow for taxes as provided under
Section 7(a).
3
<PAGE> 4
The undersigned acknowledges receipt of an exact copy of this Mortgage.
Signed and Sealed this 17 day of December, 1998.
Athena Holdings LLC
By: Advantage Learning Systems, Inc.,
Member
By: /s/ TIMOTHY SHERLOCK
---------------------------
Timothy Sherlock
By: DezCon, LLC, Member
By: /s/ JAMES PIANKA
---------------------------
James Pianka, Member
WI
STATE OF --------------- )
Dane ) SS
COUNTY OF -------------- )
Personally came before me this 17th day of December, 1998, Timothy
Sherlock, as CFO of Advantage Learning Systems, Inc., Member of Athena Holdings
LLC, and to me known to be the person who executed the foregoing instrument and
acknowledged the same in such capacity.
/s/ MICHAEL J. DWYER
-----------------------------------------------
Michael J. Dwyer
-----------------------------------------------
(Printed Name/Title)
Notary Public, State of Wisconsin
My Commission: is permanent
---------------------------------
WI
STATE OF --------------- )
Dane ) SS
COUNTY OF -------------- )
Personally came before me this 17th day of December, 1998, James
Pianka, as Member of DezCon, LLC, Member of Athena Holdings LLC, and to me known
to be the person who executed the foregoing instrument and acknowledged the same
in such capacity.
/s/ MICHAEL J. DWYER
-----------------------------------------------
Michael J. Dwyer
-----------------------------------------------
(Printed Name/Title)
Notary Public, State of Wisconsin
My Commission: is permanent
---------------------------------
THIS INSTRUMENT WAS DRAFTED BY
Michael J. Dwyer
Godfrey & Kahn, S.C.
780 N. Water Street
Milwaukee, WI 53202
4
<PAGE> 1
Exhibit 21.1
SUBSIDIARIES OF ADVANTAGE LEARNING SYSTEMS, INC.
(As of March 1, 1999)
<TABLE>
<CAPTION>
Name Jurisdiction of Organization
- ---- ----------------------------
<S> <C>
Advantage Learning Systems Australia Proprietary Limited Australia
Advantage Learning Systems India Private Limited India
Advantage Learning Systems of Canada Co. Nova Scotia, Canada
Advantage Learning Systems UK Limited United Kingdom
ALS Holdings, Inc. Nevada
Athena Holdings LLC Wisconsin
Institute for Academic Excellence, Inc. Wisconsin
IPS Publishing, Inc. Washington
</TABLE>
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our reports included in this Form 10-K into Advantage Learning
System, Inc.'s previously filed Registration Statements on Form S-8, file Nos.
333-38867 and 333-53557.
ARTHUR ANDERSEN LLP
Milwaukee, Wisconsin,
March 12, 1999
<PAGE> 1
Exhibit 24.1
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
her true and lawful attorney-in-fact for the purpose of: (i) executing in her
name and on her behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in her name and on her behalf in
her capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming her signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 18th day of February, 1999.
/s/ Judith A. Paul
-----------------------
Judith A. Paul
<PAGE> 2
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
his true and lawful attorney-in-fact for the purpose of: (i) executing in his
name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in his name and on his behalf in
his capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming his signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 17th day of February, 1999.
/s/ Terrance D. Paul
------------------------
Terrance D. Paul
<PAGE> 3
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
his true and lawful attorney-in-fact for the purpose of: (i) executing in his
name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in his name and on his behalf in
his capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming his signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 18th day of February, 1999.
/s/ Michael H. Baum
-----------------------
Michael H. Baum
<PAGE> 4
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
his true and lawful attorney-in-fact for the purpose of: (i) executing in his
name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in his name and on his behalf in
his capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming his signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 22nd day of February, 1999.
/s/ John R. Hickey
---------------------
John R. Hickey
<PAGE> 5
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
his true and lawful attorney-in-fact for the purpose of: (i) executing in his
name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in his name and on his behalf in
his capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming his signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 16th day of February, 1999.
/s/ Timothy P. Welch
------------------------
Timothy P. Welch
<PAGE> 6
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
his true and lawful attorney-in-fact for the purpose of: (i) executing in his
name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in his name and on his behalf in
his capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming his signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 16th day of February, 1999.
/s/ Perry S. Akins
---------------------
Perry S. Akins
<PAGE> 7
DIRECTOR'S POWER OF ATTORNEY
(1998 Form 10-K)
The undersigned director of Advantage Learning Systems, Inc. designates
each of Michael H. Baum and Timothy Sherlock, with the power of substitution, as
his true and lawful attorney-in-fact for the purpose of: (i) executing in his
name and on his behalf Advantage Learning Systems, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998 and any related amendments and/or
supplements; (ii) generally doing all things in his name and on his behalf in
his capacity as a director to enable Advantage Learning Systems, Inc. to comply
with the provisions of the Securities Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission; and (iii) ratifying and
confirming his signature as it may be signed by the attorney-in-fact to the Form
10-K and any related amendments and/or supplements.
Dated this 18th day of February, 1999.
/s/ John H. Grunewald
------------------------
John H. Grunewald
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 14,222
<SECURITIES> 18,869
<RECEIVABLES> 9,890
<ALLOWANCES> 1,058
<INVENTORY> 794
<CURRENT-ASSETS> 45,615
<PP&E> 21,883
<DEPRECIATION> 2,782
<TOTAL-ASSETS> 67,996
<CURRENT-LIABILITIES> 10,677
<BONDS> 0
<COMMON> 338
0
0
<OTHER-SE> 55,288
<TOTAL-LIABILITY-AND-EQUITY> 67,996
<SALES> 43,680
<TOTAL-REVENUES> 54,764
<CGS> 4,005
<TOTAL-COSTS> 8,501
<OTHER-EXPENSES> 26,349
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8
<INCOME-PRETAX> 21,571
<INCOME-TAX> 8,844
<INCOME-CONTINUING> 12,727
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,727
<EPS-PRIMARY> .38
<EPS-DILUTED> .37
</TABLE>
<PAGE> 1
Exhibit 99.1
Schedule II - Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
ADDITIONS DEDUCTIONS
BEGINNING CHARGED TO CHARGED TO ENDING BALANCE
BALANCE INCOME RESERVE
---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Accounts receivable allowances - 1998 $638,000 $2,954,000 $2,534,000 $1,058,000
Accounts receivable allowances - 1997 161,000 2,790,000 2,313,000 638,000
Accounts receivable allowances - 1996 48,000 1,656,000 1,543,000 161,000
</TABLE>
<PAGE> 2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
We have audited in accordance with generally accepted auditing standards,
the financial statements included in Advantage Learning Systems, Inc.'s
annual report to shareholders included in this Form 10-K, and have issued
our report thereon dated February 2, 1999. Our audit was made for the
purpose of forming an opinion on those statements taken as a whole. The
schedule listed in the index above are the responsibility of the company's
management and are presented for purposes of complying with the Securities
and Exchange Commissions rules and are not part of the basic financial
statements. These schedules have been subjected to the auditing procedures
applied in the audit of the basic financial statements and, in our opinion,
fairly state in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a
whole.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Milwaukee, Wisconsin
February 2, 1999
