PLATO Learning 10-K 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2009
p TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934>
For the transition period from _________________to__________________.
Commission File Number: 0-20842
PLATO LEARNING, INC.
(Exact name of Registrant as specified in its charter)
10801 Nesbitt Avenue South, Bloomington, MN 55437
(Address of principal executive offices)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes p No x
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes p No x
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 p
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes p No p
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
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)
Yes p No x
The aggregate market value of common stock held by non-affiliates of the registrant, as of April 30, 2009 (the last business day of the Registrant’s most recently completed second fiscal quarter) was approximately $60,000,000.
The number of shares outstanding of the registrant’s common stock as of December 31, 2009 was 24,379,414.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company’s definitive Proxy Statement for the Company’s Annual Meeting of Stockholders to be held on March 25, 2010 (the “2010 Proxy Statement”) are incorporated by reference in Part III.
Fiscal Year Ended October 31, 2009
TABLE OF CONTENTS
In addition to historical information, this Form 10-K contains forward-looking statements. These forward-looking statements are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (“the Act”). The words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “forecast,” “project,” “should” and similar expressions are intended to identify “forward-looking statements” within the meaning of the Act. Forward-looking statements include, among others, statements about our future performance, future releases of our products, new courses we intend to make available to our customers, the sufficiency of our sources of capital for future needs, and the expected impact of recently issued accounting pronouncements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Part I Item 1A of this Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release any revision to these forward-looking statements based on circumstances or events, which occur in the future. Readers should carefully review the risk factors described in Part I Item 1A of this report on Form 10-K and in other documents we file from time to time with the Securities and Exchange Commission.
Trademark and Copyright References
PLATO®, Straight Curve® and Academic Systems® are registered trademarks of PLATO Learning, Inc. PLATO Learning, PLATO Learning Environment™ and PLE™ are trademarks of PLATO Learning, Inc. Solely for convenience, we refer to our trademarks in this Form 10-K without the ™ and ® symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights to these trademarks.
PLATO Learning, Inc. is a Delaware corporation that was incorporated in 1989 and is headquartered in Bloomington, Minnesota. We are a leading provider of on-line instruction, curriculum management, assessment, and related professional development services to K–12 schools, community colleges and other educational institutions across the country. Our products are used by customers principally to provide alternative instruction to students performing below their grade level in order to help those students return to the classroom, recover course credits, pass high school exit exams or prepare for college and other post-secondary studies. In addition to the value provided to students, our solutions allow school districts to retain state and federal funding tied to student enrollment, and help educators meet the demands of state and federal student achievement initiatives for intervention, dropout prevention and college readiness. We also offer online and onsite staff professional development services to ensure optimal use of our products and to help schools meet their accountability requirements and school improvement plans.
Our research-based courseware library includes thousands of hours of mastery-based instruction covering discrete learning objectives in the subject areas of reading, writing, language arts, mathematics, science, and social studies. Our web-based assessment and alignment tools allow instruction to be personalized to each student’s unique needs with curriculum that is aligned to local, state, and national standards. Using our web-based products, educators are able to identify each student’s instructional needs and prescribe an individual learning program of PLATO Learning courseware, educational web sites, the school’s textbooks and other core and supplemental instructional materials. A variety of reports are available to help educators identify gaps in student understanding, monitor student progress and ensure that standard learning objectives are being addressed.
Beginning in late fiscal year 2005, we implemented a strategy to deliver our products and solutions on a subscription basis using a new internet-based learning management platform we market as the PLATO Learning Environment, or PLE. As of October 31, 2009, approximately 1,360 school districts, community colleges and other educational institutions across 50 states subscribed to our instructional solutions delivered on PLE, and over 1.7 million students, teachers and administrators at these institutions were registered to use PLE.
Our principal business is the development and marketing of online curriculum solutions and related services.
Based on recent market data from Simba Information (“Simba”), approximately $9.3 billion is spent annually on print and electronic instructional materials in the U.S. K-12 education market. Of that spending, approximately $1.75 billion is spent on K-12 digital content.
Our instructional products are delivered on a subscription basis over the internet, via our learning management system, the PLATO Learning Environment, or PLE. Today, 99% of the nation’s K-12 public schools have Internet access, and as a result, schools are increasingly turning to web-based methods of instruction as a supplement to their instructor-led programs due to their flexibility, cost-efficiency, and effectiveness.
Our instructional solutions are primarily used as alternative programs for students that have not been successful in the traditional classroom environment, as well as for online programs that offer first time credit for students at, below, and/or above grade level. Additionally, many of our customers have integrated our products into their core classroom instruction. Earning a high-school diploma represents a key milestone in an individual's schooling and social and economic advancement, but according to the National Center for Education Statistics, more than 25% of incoming freshman do not finish high school. Statistics like these raise the awareness of the effectiveness of U.S. public schools and have led to legislative requirements and public demand for increased accountability and improvements in U.S. K-12 schools. These trends have led to increasing demand for solutions like ours and others that address the need to improve school effectiveness and graduation rates. As a result, we believe that technology-based instructional materials have the ability to cost effectively create an individualized and flexible instructional environment, and are generally preferred over print-based materials by today’s students. We believe that these ongoing market dynamics will cause technology-based instructional materials to continue to grow faster than the total instructional materials market.
Our strategy is focused on the following strategic initiatives:
Our products consist of a comprehensive portfolio of technology-based instructional content, classroom assessment, and related professional development that we market to K–12 schools, community colleges and other educational institutions. Our products are used by these customers principally to provide individualized instruction to students performing at or below their grade level. Our programs are most frequently leveraged for students returning to the classroom, course credits recovery, high school exit exam preparation and/or preparation for college and other post-secondary studies.
Our content library consists of rich, interactive, multimedia instructional content that is highly engaging for both students and teachers. This research-based courseware library includes more than 6,000 hours of mastery-based instruction material covering the primary K-12 subject areas of mathematics, science, reading/language arts, and social studies.
Our content can be applied to multiple student learning profiles (e.g. general education, special education, at-risk) and tailored for students across multiple grade-levels. Content offerings are classified as intervention solutions when applied to students performing below grade-level, as core or supplemental instructional solutions for mainstream students performing at grade level, and as advanced placement offerings for students performing above grade level. We believe our content provides the following differentiating factors:
Learning Management System
The PLATO Learning Environment (PLE), a web-based platform to deliver all of our instructional solutions, provides a unified curriculum management and delivery system that requires only an Internet connection and a browser. In addition to anytime-anywhere delivery of our products, PLE provides the following differentiating factors:
Classroom Formative Assessment
Formative assessment involves collecting feedback from learning activities to adapt instruction to a learner’s needs. Our assessment database consists of more than 180,000 test items linked to state, district, and national learning objectives across all subject areas of reading, math, science and social studies. In conjunction with powerful data management tools, our assessment solutions can provide assessment results by student demographic category and facilitate data-driven decision making for school curriculum development, textbook choices and providing personalized learning. PLATO Test Packs with Prescriptions prescribe individual learning paths to PLATO content based on student performance, which can then be completed at the student’s own learning pace. As a result, PLATO Test Packs give teachers the flexibility to allow PLE to automatically prescribe assignments or to make manual adjustments before assigning lessons.
We combine our large library of interactive content and assessments with the unique features of PLE to deliver a variety of instructional solutions to educational institutions. In K-12 schools, these solutions primarily address at-risk students who have fallen behind in the classroom, allowing these students to recover credits, move to the next grade level, avoid dropping out of school or prepare for their high school exit exam. In the post-secondary market, our developmental algebra products, sold under the Academic Systems brand, are primarily intended for students who have completed high school but are not yet ready for college level math courses. We also provide instructional solutions to adult education markets for GED preparation, workforce readiness and life and career skills.
Services and Product Support
Our professional services offerings ensure that customers receive the consultation, training and services needed to successfully implement our solutions and integrate educational technology into their day-to-day teaching and learning environment. Services are delivered in face-to-face sessions as well as synchronous and asynchronous online delivery methods.
We provide telephone and online product support to our customers. Subscription customers are entitled to support as part of their subscription fees to our online products. Customers who purchased perpetual license products can choose to obtain telephone support by paying an annual software maintenance fee.
Sales and Marketing
Our sales channel consists of direct sales representatives located throughout the U.S. and inside sales representatives operating out of our corporate headquarters in Bloomington, Minnesota. We also utilize distributors and resellers in certain geographic markets.
In the K–12 market we sell to school districts of all sizes, but generally target larger school districts. In the post-secondary market, we target community colleges, four-year universities, adult education centers, and correctional institutions.
The market for electronic instructional materials is served by hundreds of companies that offer a range of instructional products and services. At one end of the market are companies offering modular software applications or videos that consist of a single element of instructional content or an individual course or application. At the other end are companies like PLATO Learning that provide full course offerings that span multiple grade levels and/or subject areas. These companies are “comprehensive” in terms of being able to package a solution that covers multiple grade levels, subjects, and associated reports and assessments. Between the comprehensive and non-comprehensive categories there are as many variations as there are companies.
In the individualized instruction market we compete nationally with comprehensive providers, such as Pearson Education, however we most frequently compete against a number of smaller competitors, including Compass Learning, OdysseyWare, Class.com, Apex Learning, American Education Corporation (A+), E2020, and others. Many of these smaller companies focus on a geographic segment or district size, rather than the national market. The needs, size, and location of school districts often influence the opportunities for which companies choose to compete.
When competing with any company, we differentiate our solutions by emphasizing the depth of our multimedia rich courseware aligned to standards, the benefits of a single learning management system that delivers all content over the Internet for all grades and core subject areas, the completeness of alignments to state and national standards, and the unique diagnostic and prescriptive capabilities of our products to improve performance on state exams and standards. We also believe that our record of student improvement and product development capabilities differentiate us from the competition. Based on our experience, we believe that these are key factors that buyers use in evaluating competitive offerings.
Our product development group develops, enhances, and maintains our courseware, assessment, instructional management software, and delivery system platforms. We utilize both domestic and offshore resources. In fiscal year 2009, approximately 40% of our total software development spending was incurred offshore.
Our courseware is proprietary and we attempt to protect it primarily under a combination of the laws of copyrights, trademarks, and trade secrets. We also utilize license agreements, employment agreements, employment termination agreements, third-party non-disclosure agreements, and other methods to protect our proprietary rights. We regard certain of our intellectual property rights as essential to our business and enforce our intellectual property rights when we become aware of any infringements or potential infringements and believe they warrant such action.
We define revenue backlog as the total of deferred revenue reported on our balance sheet plus unbilled amounts due under non-cancelable subscription agreements which is not included in the balance sheet. Following is a reconciliation of deferred revenue to revenue backlog, and the components of revenue backlog, as of the end of fiscal years 2009 and 2008:
At October 31, 2009, we expect approximately $24.1 million of our deferred revenue to be recognized subsequent to fiscal year 2010.
Our quarterly financial results fluctuate as a result of a number of factors including public education budget cycles and the mix of perpetual license fee and subscription product sales. Historically we have experienced our lowest order levels, cash balances and revenues in the first and second quarters of our fiscal year and higher levels of orders, cash and revenues in our third and fourth quarters. More recently, our increasing emphasis on sales of subscription products has moderated the seasonality of our revenues. Because of these factors, the results for interim periods are not necessarily indicative of the results to be expected for the full fiscal year.
As of October 31, 2009, we had approximately 300 employees. We also contract with offshore resources in the development of new products. We have never experienced a work stoppage as a result of a labor dispute, and none of our employees are represented by a labor organization.
Non-Audit Services Performed by Independent Registered Public Accounting Firm
Pursuant to Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for disclosing to investors the non-audit services approved by our Audit Committee to be performed by, our independent registered public accounting firm. Non-audit services are defined as services other than those provided in connection with an audit or a review of our financial statements. During the period covered by this Annual Report on Form 10-K, our Audit Committee pre-approved non-audit services, consisting of fees paid for online research materials.
Web Site Access to Reports
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Definitive Proxy Statements on Schedule 14A, Current Reports on Form 8-K, and any amendments to those reports, are made available free of charge on our web site (www.plato.com) as soon as reasonably practical after such reports are filed with the Securities and Exchange Commission (“SEC”). Statements of changes in beneficial ownership of our securities on Form 4 by our executive officers and directors are made available on our web site by the end of the business day following the submission of such filings to the SEC. All reports mentioned above are also available from the SEC’s web site (www.sec.gov).
We operate in a market environment that involves significant risks, many of which are beyond our control. The following risk factors may adversely impact our results of operations, financial position, cash flow and the market price of our common stock. Although we believe that we have identified and discussed below the key risk factors affecting our business, they are not the only ones facing us. There may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that also may affect our results of operations and financial condition.
Risks Relating to Our Industry>
We derive a substantial portion of our revenues from public school funding, which is dependent on support from federal, state, and local governments. Changes or reductions in funding for public school systems could reduce our revenues and cash flows and negatively impact our margins and impede the growth of our business.
The availability of funding to purchase our products is subject to many factors that affect government spending. These factors include downturns in general economic conditions, like those which we are currently experiencing, that can reduce government tax revenues and may affect education funding, emergence of other priorities that can divert government funding from educational objectives, periodic changes in government leadership that can change spending priorities, and the government appropriations process, which is often slow and unpredictable. In many instances, customers rely on specific funding appropriations to purchase our products. Curtailments, delays, or reductions in this funding can delay or reduce revenues and cash flow we had otherwise forecasted to receive.
The growth of our business depends on continued investment by public school systems in interactive educational technology and products. Changes to funding of public school systems can slow this type of investment and adversely affect our revenues and market opportunities.
If national educational standards and assessments are adopted, or if existing metrics for applying state standards are revised, new competitors could more easily enter our markets or the demands in the markets we currently serve may change.
With the reauthorization of the Elementary and Secondary Education Act, known as No Child Left Behind, or NCLB, in 2001, Congress conditioned the receipt of federal funding for education on the establishment of educational standards, annual assessments and the achievement of adequate yearly progress milestones. These standards are established at the state level, and there are currently no national educational standards that are required to be assessed pursuant to NCLB. As part of NCLB, each state is required to establish clear performance standards for each grade level in reading, math and science in grades 3 through 8, and for high school exit or end-of-course exams. Our products are specifically built to align to the educational and assessment standards in all 50 states, which we believe differentiates them from the products offered by our competitors. If a uniform set of national standards and assessments were to replace individual state level standards, it would be easier for competitors to develop similar products. If such an increase in competition occurred, our ability to compete effectively could be negatively impacted and our revenue and profitability could materially decline.
Competition in our industry is intense and growing, which could adversely affect our performance.
Our industry is intensely competitive, rapidly evolving, and subject to technological change. We compete primarily against organizations offering educational and training software and services, including comprehensive curriculum software publishers, companies providing single-title retail products, and Internet content and service providers. Some of our competitors have substantially greater financial, technical and marketing resources than us. The demand for e-learning products and services has grown significantly with the advent of on-line educational institutions, improvements in Internet access and reductions in the cost of technology. While this growing demand presents opportunities for us, it also results in the addition or consolidation of competitors. Increased competition in our industry could result in price reductions, reduced operating margins, or loss of market share, which could seriously harm our business, cash flows, and operating results.
Risks Relating to Our Company
The success of our business model is dependent on growth in market acceptance of online subscription products delivered over the Internet. If this acceptance does not grow or is otherwise diminished, our revenues will continue to decline and may affect our ability to maintain profitability.
Our ability to generate revenue growth and to continue to be profitable is dependent on significant growth of subscription fees to our Internet-based products. Market acceptance of software solutions delivered over the Internet can be negatively affected by factors such as customers’ confidentiality concerns with regard to student information that is stored outside of their controlled computing environments, existing investments in owned courseware, technology infrastructure and related personnel, customer preferences with regard to perpetual licenses vs. annual subscription decisions, and availability, reliability and security of access to the Internet within a school district.
Adverse changes in these factors could result in a decline in the acceptance of web-based courseware solutions making it difficult for us to execute our current business model. As a result, we may need to reevaluate that business model, which may affect our ability to continue to achieve profitability.
The success of our product investment strategy and our ability to remain competitive against companies with access to larger amounts of capital is dependent on our ability to maintain our cost-effective off-shore development resources. If we are unable to do so, we would experience significant product delays and increases in product development costs which would adversely affect our strategy, competitive position, revenues and profitability.
More than 40% of our total software development and maintenance spending in fiscal year 2009 was incurred on off-shore development resources. We believe the use of these resources provides us greater flexibility, cost savings, and a greater return on our development investments. These resources are also critical to our ability to respond quickly to market changes and to compete against companies with access to larger amounts of capital than we have. However, this dependence introduces risks common to many outsourcing relationships. These risks include the supplier’s ability to maintain sufficient capacity, control costs, and hire, train, and retain qualified resources, as well as risks associated with our limited direct control and physical access to these resources including the ability to protect and enforce our intellectual property rights. In our supplier agreements we strive to include provisions intended to limit some of these risks; however, that is not always possible and there can be no assurance that they will be effective at doing so. If our supplier relationships are suddenly and adversely affected, it would cause significant product delays, increased development costs and could impact product usability, which would have a material negative effect on our competitive position, revenues and profitability.
Our future success may be dependent on our ability to compete in the broader instructional materials market against larger competitors with significantly greater resources than we have.
The instructional materials market has been dominated for many years by a small number of large publishers that provide textbooks and other printed materials to the school market. These companies have well-established distribution channels and significantly greater marketing, curriculum and financial resources than us. As electronic instructional materials continue to grow and take market share from print materials, competition from these companies will increase and we may not be able to compete effectively.
If we are unable to adapt our products and services to technological changes, to the emergence of new computing devices and to more sophisticated online services, we may lose market share and service revenue, and our business could suffer.
We need to anticipate, develop and introduce new products, services and applications on a timely and cost effective basis that keeps pace with technological developments and changing customer needs. We may encounter difficulties responding to these changes that could delay our introduction of products and services or require us to make larger than anticipated investments to maintain existing products. Software industries are characterized by rapid technological change and obsolescence, frequent product introductions, and evolving industry standards. For example, the number of individuals who access the internet through devices other than a personal computer, such as personal digital assistants, mobile telephones, televisions and set-top box devices, has increased dramatically, and this trend is likely to continue. Our subscription services were designed for internet use on desktop and laptop computers. The lower resolution, functionality and memory associated with alternative devices currently available may make the use of our products through such devices difficult. We have no experience to date in operating versions of our products and services developed or optimized for users of alternative devices. Accordingly, it is difficult to predict the problems we may encounter in developing versions of our products and services for use on these alternative devices, and we may need to devote significant resources to the creation, support and maintenance of such versions. If we fail to develop or sell products and services cost effectively that respond to these or other technological developments and changing customer needs, we may lose market share and revenue and our business could materially suffer.
Since fiscal 2005 we have transitioned our business from products that are licensed on a perpetual basis to those that are licensed on a subscription basis. The different revenue recognition characteristics of these products affect the comparability of our financial results. As a result, our business will be difficult to compare from period to period. Our business is also seasonal. As a result of these factors, we may continue to experience unexpected fluctuations in our quarterly cash flows, revenues and results from operations, which may adversely affect our stock price and the implementation of our strategy.
We expect sales of perpetual license products and related software maintenance to continue to decline because we completed the transition of our business model to subscription-based products. As a result, our operating results may be difficult to compare to historical periods, and may fluctuate from quarter-to-quarter due to factors such as the size, timing, and product mix of license vs. subscription orders. In addition, public school budget cycles result in purchases that have historically been concentrated in the last two quarters of our fiscal year. Accordingly, our annual operating performance can be materially and adversely affected if factors such as school budget constraints, availability of federal and state funding, sales productivity and new product introductions do not align with these purchasing patterns. If such annual results are not achieved we may have to delay or adjust components of our strategy implementation which may affect our ability to maintain profitability.
Our transition from perpetual to subscription-based products has resulted in an increasing trend whereby cash receipts from the sale of our products has shifted from payment shortly after the time of sale, to payment over the subscription period. This trend, together with the seasonality of our business previously discussed, may adversely affect our short-term liquidity.
We generally require that one-year subscriptions and sales of perpetual licenses be paid in full within a short time after completion of the sale. Multi-year subscription customers may be given an option to pay for these subscriptions annually in advance, and these customers are increasingly electing, or negotiating, to make multi-year payments. This increasing delay in the receipt of payment for the sales of our products, together with the seasonality of our business discussed above, has adversely affected our cash flows and may increase our short-term liquidity needs.
Misuse or misappropriation of our proprietary rights or inadvertent infringement by us on the rights of others could adversely affect our results of operations.
We regard certain of our intellectual property rights as essential to our business. We rely on a combination of the laws of copyrights, trademarks, and trade secrets, as well as license agreements, employment and employment termination agreements, third-party non-disclosure agreements, and other methods to protect our proprietary rights. We enforce our intellectual property rights when we become aware of any infringements or potential infringements and believe they warrant such action. If we were unsuccessful in our ability to protect these rights, our operating results could be adversely affected.
Although we believe our products and services have been independently developed and that none of our products or services infringes on the rights of others, third parties may assert infringement claims against us in the future. We may be required to modify our products, services or technologies or obtain a license to permit our continued use of those rights. We may not be able to do so in a timely manner or upon reasonable terms and conditions. Failure to do so could harm our business and operating results. In addition, we leverage certain third party generated products through license and/or royalty agreements and we have the risk that certain of these relationships will not continue or that the underlying products will not be properly supported or updated by the third parties.
We have a number of technological mechanisms to prevent or inhibit unauthorized copying of our software products and generally require the execution of a written license agreement, which restricts use and copying of our software products. However, if such copying or misuse were to occur to any substantial degree, our operating results could be adversely affected.
If our security measures are breached and unauthorized access is obtained to our web-based products, they may be perceived as not being secure, customers may curtail or stop using these products and we may incur significant legal and financial exposure and liabilities.
The use of our web-based subscription products involves the storage of certain personal information with regard to the teachers and students using these products. If our security measures are breached and unauthorized access to this information occurs, our reputation will be damaged, our business may suffer and we could incur significant liability. Because the techniques used to attempt unauthorized access to systems such as ours change frequently and generally are not recognized until attempted on a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the security of our system could be harmed and we could lose sales and customers.
Claims relating to content available on or accessible from, our web sites may subject us to liabilities and additional expense.
Our web-based subscription products incorporate content not under our direct control including content from, and links to, third-party web sites, and content uploaded by our customers. As a result, we could be subject to claims relating to this content. In addition to exposing us to potential liability, claims of this type could require us to change our web sites in a manner that could be less attractive to our customers and divert our financial and development resources.
Interruptions or delays in service from our third-party Web hosting facilities could impair the delivery of our service and harm our business.
Our subscription products are delivered using standard computer hardware located in two, third-party Web hosting facilities, with the primary facility located on the west coast of the United States. We do not control the operation of these facilities, and they are vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunications failures and similar events. Despite precautions taken at these facilities, the occurrence of a natural disaster or other unanticipated problems at these facilities could result in lengthy interruptions in our service. Even with disaster recovery arrangements in place, our service could be interrupted. Interruptions in our service may reduce our revenue, cause us to issue credits, cause customers to terminate their subscriptions and adversely affect our renewal rates and our ability to attract new customers. Our business will also be harmed if our customers and potential customers believe our service is unreliable.
We lease all of our facilities, including our corporate headquarters in Bloomington, Minnesota, which expires in June 2010. We currently anticipate that in 2010 we will likely execute a new lease for a different facility in or near Bloomington, although we may renew our current lease for less square footage. We also continue to be a party to two leases for unoccupied office space in the United Kingdom. Other than our plans to address the expiration of our headquarters facility lease discussed above, our leased facilities are adequate to meet our current and expected business requirements.
From time to time, we may become involved in litigation arising out of operations in the normal course of business. As of October 31, 2009, we were not party to any pending legal proceedings the outcome of which could reasonably be expected to have a material unfavorable or favorable effect on our operating results, financial position or cash flows.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock has traded publicly on the NASDAQ Global Market under the symbol “TUTR” since December 23, 1992. The quarterly ranges of high and low prices per share of our common stock were as follows:
As of December 31, 2009, there were approximately 480 record holders of our common stock, excluding stockholders whose stock is held either in nominee name and/or street name brokerage accounts. Based on information available to us, there were approximately 1,727 holders of our common stock whose stock is held either in nominee name and/or street name brokerage accounts.
Stock Performance Graph
The following stock performance graph does not constitute soliciting material, and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates this stock performance graph by reference therein.
In accordance with Securities and Exchange Commission regulations, the following performance graph compares the cumulative total stockholder return on our common stock to the cumulative total return on the NASDAQ Composite Index and the weighted average return of our peer group (described below) for the five years ended October 31, 2009, assuming an initial investment of $100 and the reinvestment of all dividends.
Our current peer group consists of the following: LeapFrog Enterprises, Inc., Nobel Learning Communities, Princeton Review, Inc., Renaissance Learning, Inc., Scholastic Corp., School Specialty, Inc. and Scientific Learning, Inc.
We did not declare or pay cash dividends on our common stock in fiscal years 2009, 2008 or 2007. While future cash dividend payments are at the discretion of our Board of Directors, our current intentions are to reinvest all earnings in the development and growth of our business.
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by Item 201(d) of Regulation S-K is set forth under Item 12 of this Annual Report on Form 10-K.
We repurchased 1,471 shares of our common stock for an aggregate cost of approximately $4,000 during the second quarter of fiscal 2009. The shares were repurchased in accordance with employee elections to withhold shares to fund tax withholdings due upon vesting of restricted stock. Shares repurchased but not reissued are presented as treasury stock in the Consolidated Balance Sheet.
Our fiscal year is from November 1 to October 31. Unless otherwise stated, references to the years 2009, 2008, and 2007 relate to the fiscal years ended October 31, 2009, 2008, and 2007, respectively. References to future years also relate to our fiscal year ending October 31.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We continually evaluate our critical accounting policies and estimates, and have identified the policies relating to the following areas as those that are significant to our financial statement presentation, and require difficult, subjective, or complex judgments:
Our discussion of these policies is intended to supplement, but not replace, the more detailed discussion of these and other accounting policies and disclosures contained in the Notes to Consolidated Financial Statements.
Revenue Recognition. We derive our revenues from three sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing our online, web-based products; (2) license revenues from non-cancelable perpetual license agreements; and (3) related professional and support services and other revenue.
We recognize revenue when all of the following conditions are met:
Revenue from the licensing of software under subscription arrangements is recognized on a ratable basis over the subscription period starting the later of the first day of the subscription period or when all revenue recognition criteria identified above have been met. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Amounts due under non-cancelable subscription agreements are not recognized in accounts receivable or deferred revenue until such amounts are invoiced to the customer.
We also provide professional services, which consist of training and implementation services, as well as ongoing customer support and maintenance. Training and implementation services are not essential to the functionality of our software products. Revenues from these services are recognized separately upon delivery where there is objective and reliable evidence of fair value of each deliverable. Software support revenue is deferred and recognized ratably over the support period.
For revenue arrangements with multiple deliverables, we allocate the total amount the customer will pay to the separate units of accounting based on their relative fair values, as determined by the price of the undelivered items when sold separately.
If collectability of the fee is not probable, revenue is recognized as payments are received from the customer provided all other revenue recognition criteria have been met. If the fee due from the customer is not fixed or determinable, revenue is recognized as the payments become due provided all other revenue recognition criteria have been met.
Capitalized Software Development Costs. Our investments in software development are significant, and the rules that govern how these costs are accounted for in our financial statements can have a significant impact on our operating results from period to period.
At the end of fiscal year 2008, we completed our transition to a software-as-a-service business model in which substantially all of our products are now delivered on a hosted, subscription service basis. Effective for fiscal year 2009, we have applied authoritative guidance that accounts for the costs of computer software developed for internal use. The guidance provides that hosting arrangements in which customers do not have a contractual right to take possession of the software are service arrangements, and such software, subject to certain exceptions, is considered internal use software.
Our software development costs relate to the research, development, enhancement, and maintenance of our software products. Costs related to the initial design and development of new products and the routine enhancement and maintenance of existing products are expensed as incurred. When projects reach the application development stage we begin capitalization of the related project costs. Capitalization ends when a product is available for general release to our customers, at which time amortization of the capitalized costs begins. The amortization of these costs is included in cost of revenues.
Prior to fiscal year 2009, we accounted for our software development costs as computer software to be sold, leased or otherwise marketed. Capitalization began when technological feasibility was achieved and an allocation of indirect costs was included in the amounts capitalized. Capitalization ended when a product was available for general release to our customers, at which time amortization of the capitalized costs began.
We evaluate our capitalized costs whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Prior to 2009, we evaluated our capitalized costs on a quarterly basis to determine if the unamortized cost related to any product, or group of products, exceeded its estimated net realizable value. Estimating net realizable value requires us to use judgment in projecting future revenues and cash flows to be generated by the product and thereby quantifying the amount, if any, to be written off. Actual cash flows realized could differ materially from those estimated. In addition, any future changes to our software product offerings could result in write-offs of previously capitalized costs and have a significant impact on our consolidated results of operations. Our analysis as of October 31, 2008 resulted in impairment charges on these assets of $4.6 million. There were no impairment charges on capitalized software development costs 2009.
Valuation of Deferred Income Taxes. Our accounting policy for the valuation of deferred income taxes is considered critical for several reasons. Significant judgment is required in the assessment of the need for a valuation allowance. In addition, income tax accounting rules, in combination with purchase accounting rules applied in the acquisition of Lightspan in 2004, resulted in a complex tax accounting situation in which, until 2008, we had not recognized tax benefits on operating losses or on the realization of deferred tax assets, but regardless of our operating results, had been recognizing tax expense on future tax liabilities related to tax deductible goodwill.
The majority of our deferred tax assets represent net operating loss carryforwards which are available to offset future taxable income. These loss carryforwards include those acquired in the acquisition of Lightspan in 2004, as well as carryforward losses that existed prior to, or were incurred after, the acquisition. Our ability to realize the benefit of these loss carryforwards is dependent upon our ability to generate future taxable income., Our history of cumulative operating losses over the past several years has led to our current assessment that it is more likely than not that our net deferred taxes will not be realized. As a result, our deferred tax assets are fully reserved and will remain fully reserved until the related tax benefits are realized through the generation of taxable income in a particular year, or until we can demonstrate a history of generating taxable income.
Until 2008, our calculation of net deferred tax assets excluded a deferred tax liability related to tax deductible goodwill. The timing of the reversal of this difference was considered indefinite because it would not reverse until the underlying assets that created the goodwill were disposed of or sold. In 2008, the goodwill was determined to by fully impaired, and as a result, the deferred tax liability associated with tax deductible goodwill was reversed.
Goodwill and Identified Intangible Assets. Goodwill and identified intangible assets are recorded when the purchase price paid for an acquisition exceeds the fair value of the tangible assets acquired. Most of the companies we have acquired have not had significant tangible assets. As a result, a significant portion of the purchase price paid in acquisitions has been allocated to identified intangible assets and/or goodwill.
Identified intangible assets are amortized to expense over their expected useful lives and goodwill was not amortized. Once established, these assets are subject to periodic impairment assessments to determine if their current carrying values are recoverable based on information available at the time these assessments are made. Significant assumptions and estimates are required in making these assessments.
Accordingly, the assumptions and estimates we use in implementing this policy affect the amount of identified intangible asset amortization and impairment charges, if any, reflected in our operating results. Our impairment assessments at October 31, 2008 resulted in the elimination of goodwill and a related impairment charge of $71.9 million, and impairment charges of $1.9 million on identified intangible technology, trademark and customer assets acquired in previous acquisitions. There were no impairment charges in 2009.
General Factors Affecting our Financial Results
There are a number of general factors that affect our results from period to period. These factors are discussed below.
Revenue. In 2008, we completed a transition of our business model from one that sells one-time perpetual licenses to software, for which revenue is generally recognized up-front upon delivery, to one that sells subscription-based products, for which revenue is recognized over the subscription period. The transition began in late fiscal 2005 when we introduced many of our new subscription-based products and affects the comparability of our revenues over this period. In 2009, a meaningful, but declining portion of our revenues continued to be derived from sales of perpetual licenses of our software products and related maintenance. These revenues are reported as license fees and software maintenance (included in services revenue) in our consolidated statement of operations. As subscription revenues grow as a percentage of total revenues, we expect our period to period revenues to become more comparable and predictable.
Cost of Revenues and Gross Profit. Our cost of revenues and gross profit during a period is dependent on a number of factors. License fee and software maintenance revenues historically have had high gross profit due to the low direct cost of delivering these products and services. As a result, the mix of license fee revenues to total revenues in a given period significantly influences reported total gross profit. In addition, a large portion of our costs of revenue are fixed in nature. These costs include amortization of capitalized software development and purchased technology, depreciation and other infrastructure costs to support our hosted subscription services, customer support operations, and full-time professional services personnel who deliver our training services. Accordingly, increases in revenues allow us to leverage these costs resulting in higher gross profit, while decreases in revenues have the opposite effect.
Operating Expenses. General and administrative expenses are substantially fixed in nature. However, certain components such as our provision for bad debts, professional fees, and other expenses can vary based on business results, individual events, or initiatives we may be pursuing at various times throughout the year.
Incentive compensation is a significant variable component of our sales and marketing expenses, approximating 8% to 9% of total revenues in any given period. Sales and marketing expenses also include costs such as travel, tradeshows, and conferences that can vary with revenue activity or individual events that occur during the period.
Software maintenance and development expense in our consolidated statement of operations does not reflect our total level of software product spending. Costs to enhance or maintain existing products, or to develop products prior to the application development stage, are charged to software maintenance and development expense as incurred. Costs incurred to develop new products after the preliminary project stage is completed, which represent the majority of our total development spending, are capitalized and amortized to cost of revenues. Accordingly, software maintenance and development expense in our consolidated statement of operations can fluctuate from period to period, in terms of both total dollars and as a percentage of revenue, based on the nature and timing of activities occurring during the period.
Amortization of intangibles represents the amortization of certain identified intangible assets acquired through various acquisitions. While these expenses are generally predictable from period to period because they are fixed over the course of their individual useful lives, they can be affected by events and other factors that result in impairment of these assets and a corresponding reduction in future amortization.
Non-GAAP Financial Measures
The following discussion and analysis of our financial condition and results of operations includes non-GAAP financial measures, identified in the reconciliations below, that is not prepared in accordance with generally accepted accounting principles and may be different from non-GAAP financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. Investors are encouraged to review the following reconciliations of the non-GAAP financial measures used herein to their most directly comparable GAAP financial measures as provided in our consolidated financial statements.
Our management has used these non-GAAP financial measures to gauge the success of our transition to a software-as-a-service business model. This transition affects comparability of our results between periods during the transition, which began in late 2005 and was completed by the end of 2008, because revenue accounting differences and the costs to support and deliver products and services vary significantly between our current and prior business models. Management therefore believes these non-GAAP measures provide transparency to our results by excluding transitory effects of the change to our business model and help gauge the success of our transition. Management believes these non-GAAP measures are useful to investors for the same reasons.
Reconciliation of 2008 and 2007 GAAP Net Loss and Loss Per Share to Non-GAAP Net Loss and Loss Per Share Before Impairments, Restructuring and Other Charges and Benefits (in thousands, except per share amounts)
Reconciliation of 2008 and 2007 GAAP Operating Expenses to Non-GAAP Operating Expenses before Goodwill Impairments, Restructuring and Other Charges (in thousands)
Overview of Financial Results
Fiscal 2009 was a milestone year for our company as we achieved profitability for the first time since 2001 and significantly improved cash flows. We also achieved our first year of growth in total orders since our transition to a software-as-a-service (“SaaS”) business model that began in 2005. Although total revenues in 2009 continued to be adversely affected by declining emphasis on sales of legacy perpetual products and related software maintenance, strong growth in subscription revenues on our SaaS products have now substantially offset these declines. Compared to 2008, total 2009 revenues declined $3.2 million, or 4.7%, to $65.2 million.
Our cost management efforts throughout the transition have led to significant declines in the costs of operating our business. Operating expenses, excluding impairments, restructuring and other charges and benefits (a non-GAAP measure) declined 16.9% to $36.2 million in 2009 from $43.6 million in 2008. Together with the moderating revenue declines, these cost declines led to an improvement in our non-GAAP net income (loss) excluding impairments, restructuring and other charges and benefits, to $1.0 million, or $0.04 per share, from ($11.3) million, or ($0.48) per share, in 2008. On a GAAP basis, our net income was $1.0 million in 2009 compared to a net loss of ($91.9) million for 2008, with the change primarily attributable to the non-cash impairment charge to goodwill and restructuring charges incurred in fiscal year 2008.
In 2010, we will continue to make curriculum and platform investments specifically designed to address the evolving needs of the online instruction market. Early in the year we expect to launch PLE 2.0, our first major new release of PLE since it was introduced four years ago. We also expect to add up to ten new courses for mainstream and advanced placement students, and additional platform features that enable virtual instruction between teachers and students. While our investment and sales efforts are focused exclusively on subscription-based products, the financial effects of the transition to subscription products is not fully complete and may continue to impede the progress of our year-over-year financial results in the near term. This and other risks we face in our business are discussed in more detail in Item 1A of Part I of this report.
Results of Operations
Our discussion and analysis of results of operations should be read in conjunction with the section above captioned “General Factors Affecting our Financial Results”.
The following tables summarize certain key information to aid in the understanding of our discussion and analysis of revenues:
Order Information (in thousands)
Revenue by Category (in thousands)
2009 vs. 2008
Total orders increased 11.9% from $72.1 million in 2008 to $80.7 million in 2009, driven by continued strong demand for our subscription-based products. Subscription orders grew 31.4% while legacy license and software maintenance orders declined 42.3% reflecting our declining emphasis on sales of these products and services.
Total revenues decreased $3.2 million, or 4.7%, to $65.2 million in 2009. Subscription revenues increased $6.0 million, or 17.0%, to $41.2 million on our growing base of subscription customers. While subscription revenue growth was strong, it was not sufficient to fully offset the decline in legacy license fees and software maintenance service revenues. Our strategic shift away from these legacy products and services resulted in a $7.9 million, or 38.4% decline in these revenues to $12.7 million.
2008 vs. 2007
Total revenues decreased $1.2 million, or 1.8%, to $68.4 million in 2008. Subscription revenues increased $11.0 million, or 45.7%, to $35.2 million as strong growth in subscription product orders in 2007 and 2008 were recognized as revenue over the portion of the subscription periods occurring in 2008. While subscription revenue growth was strong, it was not sufficient to fully offset a decline in license fees and software maintenance revenues. Our strategic shift away from legacy perpetual software products resulted in a $9.3 million, or 52.2%, decline in license fee revenues, and a $1.8 million, or 12.8%, decline in software maintenance revenue. Professional services revenues in 2008 declined $1.4 million, or 12.6%, as 2007 professional services revenues benefited from a focused effort to deliver the backlog of services unused by our customers.
Total orders declined from $77.7 million in 2007 to $72.1 million in 2008, reflecting a slowing of orders in the second half of the fourth quarter of 2008 as news worsened on the broader U.S. economy and school districts put spending decisions on hold as they evaluated the effects on their budgets. The order decline also reflects the continuing transition from selling products that are licensed on a perpetual basis, which have higher one-time selling prices, to those that are licensed on a subscription basis, which have lower selling prices but are renewable at the end of each subscription period.
Cost of Revenue
2009 vs. 2008
Total cost of revenue in 2009 decreased $13.6 million, or 32.8%, to $27.9 million compared to the same period in 2008. Cost of revenue in 2008 included $5.1 million of impairment charges on capitalized software development costs and purchased intangible assets. Subscription cost of revenue declined $2.5 million, or 13.4%, in 2009 due to declines in software development amortization and royalty costs. The decline in amortization is due to the above-mentioned asset impairments, and reduced levels of capitalized software development spending in 2009. The decline in royalty costs in 2009 relates to a royalty arrangement with a third party provider of curriculum content that was renegotiated at a lower cost in late 2008.
License fee cost of revenue declined $3.5 million in 2009 compared to 2008 due to a reduction in related revenues, lower product amortization, and cost reduction initiatives undertaken in 2008. The services cost of revenue decreased 20.5% to $9.9 million in 2009 from $12.4 million for 2008 due to the lower professional services costs on lower related revenues, and lower support costs due to our declining base of customers using our legacy perpetual products.
2008 vs. 2007
Total cost of revenue in 2008 increased $3.9 million, or 10.5%, due primarily to an increase in impairment charges on capitalized software development costs and purchased intangible assets from $0.5 million in 2007, to $5.1 million in 2008, as discussed above. Subscription cost of revenue increased $3.1 million or 20.2%, in 2008 on increases in software development amortization and royalty costs. The increase in amortization is due to investments in software development made as we transitioned to a SaaS business model. The increased royalty costs were associated with a third party provider of curriculum content.
License fee cost of revenue in 2008 declined $3.1 million compared to 2007 due to lower product amortization, royalty costs and lower material costs on reduced revenues and changes in the license product mix. The services cost of revenue decreased 4.8% to $12.4 million in 2008 from $13.1 million 2007 due to the lower professional services costs on lower revenue levels, and lower support costs due to our declining base of customers using our legacy perpetual products.
To aid in the understanding of our discussion and analysis of operating expenses, the following table summarizes the amount and percentage change in the amounts from the previous year for certain operating expense line items:
2009 vs. 2008
Total operating expenses in 2009 decreased to $36.2 million from operating expenses excluding impairments, restructuring and other charges of $43.6 million in 2008. See further discussion below and Note 14 to consolidated financial statements for a detailed description of these restructuring, impairment and other charges that occurred in 2008.
Sales and marketing expenses declined 14.0% to $23.8 million in 2009 as compared to $27.6 million in 2008. This decrease primarily reflects reduced investments in marketing activities and better management of travel costs and inside sales resources. None of the decline was due to a reduction in the number of direct field sales representatives which remained approximately the same from 2008 to 2009.
General and administrative expenses declined 13.3% to $9.0 million in 2009 as compared to $10.4 million in 2008, due primarily to reductions in labor costs and declines in the cost of compliance activities and facility related expenses.
Software maintenance and development expenses for 2009 were $2.6 million compared to $4.1 million for 2008. The reduction in software maintenance and development expenses reflects the increasing stability of our PLE platform and efficiencies built into delivering new releases of the platform. Total software development spending, which represents the combination of spending on projects that are capitalized and those that are expensed, was $7.5 million in 2009, or 11.5% of total revenues, compared to total spending in 2008 of $14.7 million, or 21.5% of total revenues. The decline reflects our intention to align product investment levels with revenues.
Amortization of intangibles represents the amortization of identified intangible assets, other than technology, acquired in acquisitions. Amortization of $0.8 million in 2009 represented a decrease of 45.0% from 2008 as certain assets acquired in earlier acquisitions became fully amortized or were impaired and written off during 2008.
2008 vs. 2007
Total operating expenses in 2008 increased to $122.2 million and included $78.6 million in impairments, restructuring and other charges. See further discussion below and Note 14 to consolidated financial statements for a detailed description of these charges. Operating expenses excluding impairments, restructuring and other charges, declined 9.2% to $43.6 million in 2008 compared to $48.0 million in 2007.
Sales and marketing expenses declined to $27.6 million in 2008 as compared to $29.9 million in 2007. This decrease primarily reflects improved management of indirect sales and marketing costs and better leveraging of our inside sales resources.
General and administrative expenses declined 14.3% to $10.4 million in 2008 as compared to $12.1 million in 2007, due primarily to reductions in labor and incentive costs and declines in the cost of compliance activities and internal business systems support.
Product maintenance and development expenses for 2008 were $4.1 million compared to $4.3 million for 2007. The reduction in product maintenance and development expenses reflects the increasing stability of our PLE platform and efficiencies built into delivering new releases of the platform. Total product development spending, which represents the combination of spending on projects that are capitalized and those that are expensed, was $14.7 million in 2008, or 21.5% of total revenues, compared to total spending in 2007 of $20.0 million, or 28.8% of total revenues. The decline reflects completion of a three year product roadmap for the first phase of our SaaS strategy initiated in late 2005.
Amortization of intangibles represents the amortization of identified intangible assets, other than technology, acquired in acquisitions. Amortization of $1.5 million in 2008 represented a decrease of 10.9% from 2007 as certain assets acquired in earlier acquisitions became fully amortized during 2008.
Operating expenses in 2008 include a non-cash impairment charge of $71.9 million on goodwill acquired in multiple acquisitions between 2000 and 2003, several years prior to launching our SaaS business model strategy. As described in our critical accounting policies, authoritative guidance requires that goodwill be reviewed for potential impairment annually, or when events or changes in circumstances indicate the carrying value of the goodwill might exceed its current fair value. One of the indicators of impairment is a sustained decline in a company’s share price whereby market capitalization of the company is less than its book value for an extended period of time. We began to experience such a decline starting in March 2008. After trading in a range near our book value throughout the summer, we experienced a further decline in our stock price as the financial markets reacted to the credit crisis facing major lending institutions, and worsening conditions in the overall economy. As a result of these factors, we concluded in the fourth quarter of 2008 that our recorded goodwill was impaired.
The determination of the amount of the impairment required that the fair values of our assets and liabilities be determined as if we had been acquired in a hypothetical business combination with a purchase price equal to the market capitalization of our company as of October 31, 2008, adjusted for certain factors that might reasonably affect the value of our company if purchased in an actual acquisition. The estimates and assumptions used in determining the hypothetical purchase price and fair value determinations are inherently subject to uncertainty.
Under accounting rules for business combinations, goodwill exists only if the purchase price exceeds the fair value of the net assets of the acquired entity. Our impairment analysis concluded that the purchase price as determined above was less than the sum of the fair value of our identified tangible and intangible assets, less the fair value of our liabilities. Accordingly, no value was assigned to goodwill resulting in full impairment of goodwill and a related non-cash charge to 2008 operating results of $71.9 million. The impairment of goodwill did not have any impact on our day-to-day business operations, liquidity or long-term SaaS strategy.
Impairment, restructuring and other charges consist of $1.4 million in non-cash impairment charges on previously acquired intangible assets, and $5.3 million in cash and non-cash charges related to achieving continued cost efficiencies in our SaaS business model, and the transition of our CEO in late 2008.
Interest income decreased from $0.5 million in 2008 to $0.2 million in 2009. This decrease reflected a decline in interest rates earned on investments partially offset by a slight increase in average cash and cash equivalents balances.
Interest income decreased from $1.3 million in 2007 to $0.5 million in 2008. This decrease is due to lower average cash and cash equivalents balances as well as a decline in interest rates earned on these balances.
As discussed earlier under the caption “Critical Accounting Policies and Estimates,” our net deferred tax assets are fully reserved. We did not record a current income tax expense related to our current year operating income because we utilized a portion of the net operating loss carryforward.
Prior to 2008, certain tax deductible goodwill could not be used to offset other net deferred tax assets resulting in the recording of income tax expense related to this liability of $0.6 million in 2007. In 2008, the full impairment of the tax-deductible goodwill, as discussed above, resulted in the reversal of the cumulative deferred tax liability and a corresponding income tax benefit of $3.1 million.
Liquidity and Capital Resources
At October 31, 2009, our principal sources of liquidity included cash and cash equivalents totaling $28.2 million, net billed accounts receivable of $10.7 million, and unbilled commitments under non-cancelable subscription contracts totaling $14.6 million, of which $7.8 million is expected to be billed in 2010. We also have a three-year senior secured credit facility that provides us with a revolving line of credit up to the lesser of $20 million or the amount of our trailing twelve months subscription and software maintenance revenues. Under this agreement, which expires in June 2010, we have the option of selecting an interest rate for any drawdown under the facility equal to the applicable Prime or LIBOR Rate plus a sliding margin that is based on the amount of borrowings outstanding. Borrowings under the agreement are secured by all of our assets. Financial covenants apply only when the unused portion of the line of credit, plus cash and cash equivalents on hand, is less than $12.5 million, and are limited to minimum quarterly thresholds of earnings before interest, taxes, depreciation and amortization (EBITDA). At October 31, 2009 and 2008, availability under the line was $20 million and there were no borrowings outstanding.
2009 vs. 2008
Cash provided by operations increased to $13.6 million in 2009 from $6.5 million in 2008, due to the increase in total orders and reductions in overall spending as discussed above. Cash used in investing activities declined to $5.6 million in 2009, from $11.0 million in 2008. This decline reflects a reduction in our product investment requirements based on the completion of the conversion of our extensive content to the PLE environment and our intention to align our level of product investment to our level of revenue. These changes resulted in an $8.1 million increase from 2008 to 2009 in our year end balance of cash and cash equivalents.
2008 vs. 2007
Cash provided by operations declined to $6.5 million in 2008 from $9.7 million, due primarily to the decline from 2007 to 2008 in total orders discussed above, partially offset by reductions in overall spending. Cash used in investing activities declined to $11.0 million in 2008, from $17.9 million in 2007. This decline reflected a reduction in our product investment requirements based on the substantial completion of the conversion of our extensive content to the PLE environment. These changes resulted in a $4.3 million decrease from 2007 to 2008 in our year end balance of cash and cash equivalents.
Our principal commitments consist of future minimum payments due under operating leases, royalty and non-cancelable software license agreements. In addition, any future borrowings under our revolving loan agreement as discussed above would require future use of cash. At October 31, 2009, the future minimum payments under these commitments were as follows:
Also, as discussed in Item 2 of this Form 10-K, the lease of our office facility in Bloomington, MN expires in June 2010. We currently anticipate that in 2010 we will likely execute a new lease for a different facility in or near Bloomington, although we may renew our current lease for less square footage. The table above does not reflect these contemplated actions.
Purchase orders are not included in the table above. Our purchase orders represent authorizations to purchase rather than binding agreements. The contractual commitment amounts in the table above are associated with agreements that are enforceable and legally binding and that specify all significant terms, including fixed or minimum services to be used, fixed minimum or variable price provisions, and the approximate timing of the transaction. Obligations under contracts that we can cancel without significant penalty are not included in the table above.
We believe our existing cash, cash equivalents, anticipated cash provided by operating activities, and availability under our line of credit will be sufficient to meet our working capital and capital expenditure needs over the next 12 months. Our future capital requirements will depend on many factors, including the timing and extent of software development expenditures, order volume, and the timing and collection of receivables.
Disclosures about Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of October 31, 2009 or October 31, 2008.
Interest Rate Risk
On June 4, 2007, we entered into a three-year senior secured credit facility which provides us with a revolving line of credit up to the lesser of $20 million or the amount of our trailing twelve months subscription and software maintenance revenue. Under the agreement, which expires in June 2010, we have the option of selecting an interest rate for any drawdown under the facility equal to the applicable Prime or Libor Rate plus a sliding margin that is based on the amount of borrowings outstanding. There were no borrowings outstanding at October 31, 2009 or 2008.
Foreign Currency Exchange Rate Risk
Our foreign operations are not a significant component of our business, and as a result, risks relating to foreign currency fluctuation are considered minimal.
Recent Accounting Pronouncements
In June 2009, FASB approved the FASB Accounting Standards Codification (“the Codification”) as the single source of authoritative nongovernmental GAAP. All existing accounting standard documents, such as FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force and other related literature, excluding guidance from the Securities and Exchange Commission (“SEC”), have been superseded by the Codification. All other non-grandfathered, non-SEC accounting literature not included in the Codification has become non-authoritative. The Codification did not change GAAP, but instead introduced a new structure that combines all authoritative standards into a comprehensive, topically organized online database. The Codification is effective for interim or annual periods ending after September 15, 2009, and impacts our financial statements as all future references to authoritative accounting literature will be referenced in accordance with the Codification. There have been no changes to the content of our financial statements or disclosures as a result of implementing the Codification during the fiscal year ended October 31, 2009.
In October 2009, the FASB’s Emerging Issues Task Force (EITF) issued authoritative guidance addressing revenue arrangements with multiple deliverables. The guidance eliminates the criterion for objective and reliable evidence of fair value for the undelivered products or services. Instead, revenue arrangements with multiple deliverables should be divided into separate units provided the deliverables meet certain criteria. This guidance also eliminates the use of the residual method of allocation and requires that the arrangement consideration be allocated at the inception of the arrangement to all deliverables based on their relative selling price. The guidance also provides a hierarchy for estimating the selling price of each of the deliverables. The guidance is effective prospectively for revenue arrangements entered into or materially modified at the beginning of our fiscal year 2011; however, earlier application is permitted. We are currently evaluating this guidance and anticipate that we will adopt it in the first quarter of fiscal year 2010, but do not expect it to have a material effect on our consolidated financial statements.
In October 2009, the FASB’s EITF issued authoritative guidance that updated software revenue arrangements that also include tangible products. The amendments exclude tangible products and software essential to the tangible product’s functionality from the software revenue guidance. The guidance is effective prospectively for revenue arrangements entered into or materially modified at the beginning of our fiscal year 2011; however, earlier application is permitted. We do not expect the provisions to have a material effect on our consolidated financial statements.
In August 2009, the FASB issued updated guidance to reduce potential ambiguity in financial reporting when measuring the fair value of liabilities. Among other provisions, this update provides clarification that in circumstances, in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the valuation techniques described in the guidance. The provisions became effective during our fourth quarter 2009 and did not have a material effect on our consolidated financial statements.
In April 2008, the FASB issued authoritative guidance amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of this guidance is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset as provided for under separate accounting guidance topics. The provisions are effective for our fiscal year 2010 and are currently not expected to have a material effect on our consolidated financial statements.
In December 2007, the FASB issued authoritative guidance that establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. The guidance also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The provisions will be adopted by us in the first quarter of fiscal 2010 and are currently not expected to have a material effect on our consolidated financial statements.
In December 2007, the FASB issued a new accounting pronouncement regarding noncontrolling interests and the deconsolidation of a subsidiary. This will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests (NCI) and classified as a component of equity. This new consolidation method will significantly change the accounting for transactions with minority interest holders. The provisions will be adopted by us in the first quarter of fiscal year 2010 and are currently not expected to have a material effect on our consolidated financial statements.
In February 2007, the FASB issued authoritative guidance to permit entities to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions were effective beginning in our fiscal year 2009 and did not have a material effect on our consolidated financial statements.
In September 2006, the FASB issued authoritative guidance to establish a consistent framework for measuring fair value and expand disclosures on fair value measurements. The provisions were effective beginning in our fiscal year 2009 and did not have a material effect on our consolidated financial statements.
The information appearing under the captions “Interest Rate Risk” and “Foreign Currency Exchange Risk” in Item 7 of this Annual Report on Form 10-K is incorporated herein by reference.
(a)(1) Consolidated Financial Statements:
Board of Directors and Stockholders
PLATO Learning, Inc.
We have audited the accompanying consolidated balance sheets of PLATO Learning, Inc. and subsidiaries (the “Company”) as of October 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended October 31, 2009. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PLATO Learning, Inc. and subsidiaries as of October 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), PLATO Learning, Inc. and subsidiaries’ internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated January 14, 2010, expressed an unqualified opinion.
/s/ Grant Thornton LLP
January 14, 2010
Board of Directors and Stockholders
PLATO Learning, Inc.
We have audited PLATO Learning, Inc. and subsidiaries (the “Company”) internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of on PLATO Learning, Inc. and subsidiaries’ internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, PLATO Learning, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of PLATO Learning, Inc. and subsidiaries as of October 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended October 31, 2009, and our report dated January 14, 2010 expressed an unqualified opinion on those consolidated financial statements.
/s/ Grant Thornton LLP
January 14, 2010