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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 29, 2004
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
[ ] 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 0-14669
THE ARISTOTLE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 06-1165854
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
96 CUMMINGS POINT ROAD, STAMFORD, CONNECTICUT
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
06902
(ZIP CODE)
(203) 358-8000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NOT APPLICABLE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE ("COMMON STOCK")
(TITLE OF CLASS)
SERIES I $6.00 CONVERTIBLE, VOTING, CUMULATIVE 11% PREFERRED STOCK,
$.01 PAR VALUE ("SERIES I PREFERRED STOCK")
(TITLE OF CLASS)
Indicate by check mark whether 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]
Indicate by check mark whether registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 30, 2003, the aggregate market value of the Common Stock outstanding
and held by nonaffiliates (without admitting that any person whose shares are
not included in such calculation is an affiliate) was approximately $3.9 million
and the aggregate market value of the Series I Preferred Stock outstanding and
held by nonaffiliates (without admitting that any person whose shares are not
included in such calculation is an affiliate) was approximately $7.4 million. In
each case, the market value of outstanding securities was based on the closing
price of such securities as reported by the NASDAQ SmallCap Stock Market.
As of March 29, 2004, 17,111,354 shares of Common Stock, 1,096,622 shares of
Series I Preferred Stock and 10,984,971 shares of Series J Preferred Stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Exhibit index is located on page 49 of this filing.
Part III incorporates certain information by reference to registrant's Proxy
Statement for its 2004 Annual Meeting of Shareholders.
FORM 10-K CROSS REFERENCE INDEX
PART I
Item 1. Business 1
Item 2. Properties 7
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 8
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 21
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 48
Item 9A. Controls and Procedures 48
PART III
Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 48
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 48
Item 13. Certain Relationships and Related Transactions 48
Item 14 Principal Accountant Fees and Services 49
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 49
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
The Aristotle Corporation ("Aristotle") and its subsidiaries (together with
Aristotle, the "Company"), founded in 1986, and headquartered in Stamford, CT,
is a leading manufacturer and global distributor of educational, health, medical
technology and agricultural products. A selection of over 80,000 items is
offered, primarily through catalogs carrying the brand of Nasco (founded in
1941), as well as those bearing the brands of Simulaids, Triarco, Summit
Learning, Hubbard Scientific, Scott Resources, Spectrum Educational Supplies,
Haan Crafts and To-Sew. Products include educational materials and supplies for
substantially all K-12 curricula, molded plastics, biological materials and
items for the agricultural, senior care and food industries. In addition, the
Company offers simulation kits and manikins used for training in cardiopulmonary
resuscitation and the fire and emergency rescue and patient care fields. The
Company markets proprietary product lines throughout all of its catalogs that
provide exclusive distribution rights. The proprietary product lines are
developed internally through the Company's research and development efforts and
acquired externally through licensing rights from third parties.
Prior to June 17, 2002, Aristotle was a holding company which, through its
subsidiaries, Simulaids, Inc. ("Simulaids") and Safe Passage International, Inc.
("Safe Passage"), conducted business in two segments, the medical education and
training products market and the computer-based training market. On June 17,
2002, Aristotle merged (the "Merger") with Nasco International, Inc. ("Nasco"),
an indirect subsidiary of Geneve Corporation ("Geneve"), a privately-held
diversified financial services company. Pursuant to the Merger, the separate
corporate existence of Nasco ceased and Aristotle was the surviving entity.
Immediately following the Merger, Aristotle's business was comprised of the
operations of the Nasco group of companies, Simulaids and Safe Passage. Due to
the relative sizes of the parties and conditions to the Merger, the transaction
was accounted for as a reverse acquisition using the purchase method of
accounting under accounting principles generally accepted in the United States
of America ("GAAP"). Accordingly, for accounting and reporting purposes, Nasco
is deemed to be the acquiring company, and financial information reported for
periods prior to the Merger is that of Nasco. In applying purchase accounting to
the Merger, the assets and liabilities of Aristotle were adjusted to their fair
market values at June 17, 2002. This included recognition of a significant
deferred tax asset of approximately $30.7 million, which was principally
attributable to Aristotle's Federal net operating tax loss carryforwards. As a
result of such recognition, Aristotle's pre-merger goodwill and long-term assets
of $8.3 million were reduced to zero and negative goodwill of $20.2 million was
recognized as an extraordinary gain at the Merger date.
ACQUISITIONS AND DIVESTITURES
On May 31, 2003, Aristotle purchased 100% of the outstanding capital stock
of Haan Crafts Corporation ("Haan"). Haan is a manufacturer and catalog
distributor of sewing kits used in middle school and junior high school family
and consumer science classrooms. The acquisition has complemented the Company's
current product lines in the educational segment. The aggregate purchase price,
net of cash acquired, was $5.3 million, including $3.5 million of cash and $1.8
million in seller financing. The seller financing was paid in full during the
fourth quarter of 2003.
On May 31, 2003, Aristotle acquired 100% of the outstanding ownership
interests in NHI, LLC ("NHI") from Nasco Holdings, Inc. ("Holdings"), a
subsidiary of Geneve. This transaction was consummated in satisfaction of a
contractual obligation entered into in connection with the Merger. The sole
purpose of NHI is the ownership and management of a 300,000 square foot
warehouse facility and 40,000 square foot office facility, which had been leased
to Aristotle. In connection with the purchase of NHI, Aristotle paid to Holdings
an amount equal to the book value of NHI, which includes a $3.6 million mortgage
related to the properties held by NHI.
On December 31, 2002, Aristotle sold its 80% ownership interest in Safe
Passage in exchange for certain contingent payments. It is unlikely that
contingent payments, if any, which are payable through 2008 and based upon the
financial performance of Safe Passage, will be material to the financial
statements.
In March 2001, Nasco completed the stock acquisition for $5.3 million in
cash of that portion of American Educational Products, Inc. ("AMEP"), a
manufacturer and distributor of math and science products, which it did not
already own. In April 2001, Nasco acquired 100% of the stock ownership of
Spectrum Educational Supplies, Ltd. ("Spectrum"), a Canadian provider of
educational products, for $5.2 million in cash.
1
DESCRIPTION AND FINANCIAL INFORMATION OF BUSINESS SEGMENTS
The Company operates in two business segments: educational and commercial.
The contribution of each business segment to net sales and gross profit, and the
identifiable assets attributable to each business segment are set forth in Note
17 of the Notes to the Consolidated Financial Statements included in Item 8 of
this Form 10K.
Educational Segment
The Company's educational segment consists primarily of the sale of
supplemental educational supplies and equipment to school districts, individual
schools, teachers and curriculum specialists, who purchase products for school
and classroom use.
In addition to its business in the school supply market, the Company,
through its Nasco Life/Form'r' and Simulaids product lines, sells medical
technology training products including manikins and simulation kits used for
training in cardiopulmonary resuscitation and the emergency rescue and patient
care fields. The Company's primary customers for its health care training
products are fire and emergency medical departments, and nursing and medical
schools.
Commercial Segment
The Company markets products to farmers and ranchers to assist in animal
livestock production and products.
In addition, the Company provides sterile sampling bags and containers
worldwide under the Whirl-Pak'r' trademark. The product line is primarily sold
in the food industry, including water treatment facilities. The product lines
provide a stable vehicle for the containment and transporting of food and water
samples to laboratories without threat of sample contamination.
In the senior care industry, the Company offers a broad product selection
of activities used by nursing home and senior care facilities to support therapy
programs.
INDUSTRY OVERVIEW
Educational Segment
According to the U.S. Department of Education, $770 billion was spent
nationwide on education at all levels for the 2002-2003 school year. As the
market is affected by prevailing political and social trends, the attitude of
the government towards education determines, to some extent, total expenditures
on education. In 2002, President Bush signed into law the "No Child Left Behind
Act of 2001," designed to improve student achievement and change the culture of
America's schools. States and local school districts are now receiving more
federal funding, approximately $23.7 billion, than ever before for all programs
under the "No Child Left Behind Act of 2001." This represents an increase of
59.8% from 2000 to 2003. State governments are the major source of funding for
the educational segment. State governments have been affected by the weak U.S.
economy of recent years, resulting in significant state budget deficits in
fiscal years 2003-2004. According to the National Conference of State
Legislatures, states reported a $25.7 billion budget deficit in February 2003
with projections of more than $35.0 billion in budget deficits for the fiscal
year ending June 30, 2005. Management believes these shortfalls in state budgets
will be reduced in the near future as the U.S. economy continues to improve,
eventually resulting in increased expenditures on education. Although very few
companies or industries are recession-proof, management believes that the
Company's educational segment is essentially recession-resistant.
Factors that contribute to the expansion of the education sector include:
o increases in school enrollment, which according to the U.S. Department
of Education, is projected to grow by 4% to 56.4 million by the year
2013,
o consistent growth in the supplemental education market, and
o a national political and social climate that promotes increasing
federal and state education funding.
The traditional school model of lectures, workbooks, written assignments
and text memorization has been criticized for failing to engage students, as
opposed to methods that emphasize active learning techniques. The prevailing
inclination among educators to use manipulatives, models, or other hands-on
tools places the Company within a particularly favorable segment of the already
well-positioned education industry.
2
According to the U.S. Department of Education, there are approximately
16,000 school districts, 118,500 elementary and secondary schools, 3.6 million
teachers and 54.3 million students in the United States. The Company believes
that American school systems have shown a clear trend toward decentralization,
which enables school teachers and administrators at the school to make many of
the key decisions regarding instruction methods and school purchases.
Administrators for both school districts and individual schools usually make the
decision to purchase the general school supplies needed to operate the school.
Teachers and curriculum specialists generally decide on curriculum-specific
products for use in their classrooms and individual disciplines. In prior years,
larger government agencies usually made these decisions for entire school
districts or states. Under the new structure, teachers and curriculum
specialists have the ability to choose the curricular materials that the
teachers need to teach effectively. Site-based management is forcing the
industry to rethink its sales and marketing strategies in order to address the
added challenge and added cost of delivering goods and services to an
increasingly decentralized marketplace. In terms of purchasing methods, direct
mail ordering by catalog, as well as the internet, is on the rise among
administrators in charge of budgets as purchasing mechanisms.
The industry is also highly fragmented with a substantial number of direct
marketers of supplemental educational supplies, many of which are family- or
employee-owned businesses that operate in a single geographic region. The
Company believes the increasing demand for single-source suppliers, prompt order
fulfillment and competitive pricing, along with the related need for suppliers
to invest in automated inventory and electronic ordering systems, are fostering
consolidation within the industry. Increased purchasing at the school and
classroom levels, which increases individual schools' and teachers' roles in
educational supply procurement decisions, is also driving this trend. The
Company's selection of products and vendors allows it to offer an extensive
selection of products for each product line. The Company believes that by having
available to school teachers and administrators all of the items they need in
one place, the inclination to search other sources is reduced. This "one
stop shopping" approach is the Company's hallmark.
Moreover, the Company seeks to be competitive with its catalog prices
rather than offering large discounts to single customers. With many products,
two or more choices are offered in order to give customers a lower price point
with a product that will meet their budget yet perform to required standards.
In the Canadian educational market, the provincial government is
responsible for the funding, curriculum and other standards of elementary and
secondary educational programs. During 2003, the Canadian economy was adversely
affected by an outbreak of Severe Acute Respiratory Syndrome ("SARS"), a case of
Bovine Spongiform Encephalopathy ("Mad Cow Disease" or "BSE"), and a provincial
power outage, resulting in budget deficits and decreased educational spending.
Management believes these shortfalls in provincial budgets will be reduced as
the Canadian economy improves, eventually resulting in increased expenditures on
education. In addition, the Canadian economy is impacted by the overall
conditions of the U.S. economy.
The health and medical education teaching aids industry is highly
competitive. The Company competes for customers with numerous manufacturers of
well-known brands of teaching products. The principal competitive factors in the
health and medical education teaching aids market are quality, price and design
of products, engineering and customer service. Although some of the Company's
competitors have greater financial and other resources, and are, therefore, able
to expend more resources than the Company in areas such as marketing and
business development, the Company believes that it is aggressively marketing its
products and competing in an effective and competitive manner.
Commercial Segment
The United States Department of Agriculture indicates there were 2.16
million farms in the U.S. in 2002. The Company not only markets to various
groups within this total but its catalog is also directed to the "hobby farmer"
as well. One of the largest groups marketed to is the "Dairy Farmer". As the
number of farms declines, which is a national trend, the remaining farms are
becoming larger. With its extensive farm catalog offering, the Company is well
positioned to supply the market with the types of small hand tools and equipment
needed.
Commercial distribution of sterile sampling bags and containers experienced
growth in recent years as food and water quality standards gained emphasis in
global markets. Product lines in this segment are key tools in measuring and
enforcing government standards at water treatment facilities, and have gained a
role in meat and other food-related industries. International sales growth for
these product lines is driven by a developing consciousness of water quality
standards in third-world countries. Domestically, the food industry is
challenged with additional testing requirements for meat, poultry and fruit
products in reaction to biosecurity risks. These increasing government
regulations and growing product liability exposures should continue expansion in
the amount and frequency of product sampling.
3
In the senior care market, federal government funding in recent years has
been cut significantly, which has limited the sales growth to the nursing home
industry. In the Fall of 2003, two new funding increases by the federal
government occurred, a one-time $10 billion boost to the states in Medicaid
funding, which will run through October 2004, and a 3.26% increase in the
Medicare payment rate to nursing homes. These two funding increases are expected
to strengthen the senior care market in mid-2004.
GROWTH STRATEGY
Key members of the Company's management team develop and execute multiple
action plans in an effort to continue its steady growth in revenues and
earnings. These action plans are continuously monitored by senior management to
assess the progress in achieving the planned goals. The principal action plans
are as follows:
o Continue strategic evaluation and execution of complementary
acquisitions in existing market segments.
o Consistently dedicate resources to the discovery of new product lines
to meet the ever-changing needs of customers, including closely
observing the evolution in classroom curricula and continuously
updating product selection to meet these changing needs.
o Commit resources to the internal development of new products with
features that meet changing customer demands, as proprietary items
carry the added benefits of higher profit margins and exclusive
availability. Research and development staffs maintain a constant flow
of proprietary items to the catalog offerings.
o Exploit the revenue and earnings potential of its recent acquisitions,
including:
o continued expansion into the Canadian educational markets through
Spectrum by supplementing existing Canadian catalogs with Nasco
product lines; and
o energizing the research and development efforts of recently
acquired businesses to develop and market competitive proprietary
products.
o Through senior management evaluation of the relative profitability of
catalog performance and operational efficiencies, pursue options for
consolidation of overhead costs. Particularly with acquisitions of new
businesses, all appropriate opportunities to consolidate overhead and
service support functions will be pursued to maximize earnings
benefits.
o With minimal investment of capital and manpower, penetrate
international markets outside of North America in the health care and
agricultural product lines.
o Expand the promotional efforts of the e-commerce website to encourage
customer awareness and use of the website.
PRODUCT LINES
The Company markets the following product lines through its various
catalogs and websites, including www.eNASCO.com, www.summitlearning.com,
www.to-sew.com, www.etriarco.com, www.hubbardscientific.com, www.spectrumed.com,
www.haan.com and www.simulaids.com:
Educational Offerings
o Arts and Crafts - Complete offering of supplies to nurture the
creative artistic spirit of all ages and skill levels. A source for
the specialty art teacher as well as anyone interested in this
discipline. Target - grades kindergarten to twelve, camps and
recreation centers.
o Science - Complete catalog of equipment and supplies for general
science, biology, chemistry, physical science, earth science and
technology education. Also, offers live and preserved specimens as
well as alternatives to dissection. Target - science teachers in
grades three to twelve and specimens for the college instructor.
o Math - Provide teaching aids for the primary grades through
pre-algebra and geometry. Includes manipulatives, calculators, games,
overhead math items, software and other math products. Target - grades
kindergarten to twelve.
4
o Health Care - Features the proprietary Nasco Life/Form'r' and
Simulaids product lines, anatomical replicas and medical procedure
simulators to aid in the training of the medical profession. Includes
videos, software, games, charts and replicas. Also includes hands-on
teaching aids developed to make learning about health fun and
interesting for kindergarten through twelfth grade students. Target -
nursing and medical schools, emergency training professionals and
health teachers.
o Family and Consumer Sciences - A broad listing of products, including
products to teach life skills, cooking, sewing and teaching resources
for the entire family and consumer science teaching profession. Also
features teaching aids for dieticians in hospitals, schools and
diabetes education. Target - family and consumer science teachers,
dieticians and nutrition instructors.
o Learning Fun - Features a selection of teaching materials, learning
toys and games that were developed to make learning fun. A carefully
chosen selection of items for the early childhood market. Target -
grades pre-kindergarten to three.
o Physical Education - Over 3,000 items specifically for physical
education professionals. Target - physical education teachers in
grades kindergarten to twelve.
Commercial Offerings
o Farm and Ranch - Includes products for identification, showing,
grooming, breed promotion, artificial insemination, animal
health, crops and soils and equine supplies. Also features
instructional teaching aids for agricultural education. Target -
farmers and ranchers.
o Activity Therapy - Products developed to assist the activity therapist
in providing the best activity programs in the nursing home and
assisted living industries. Includes products for sensory, memory and
musical activities plus games and arts and crafts. Target - activity
therapists in nursing homes and assisted living homes.
o Assisted Living - Resources beneficial to conduct an outstanding
activity program in an assisted living home, including products for
all levels of residents. Target - activity therapists in assisted
living homes.
o Whirl-Pak Sampling Products - Features sterile Whirl-Pak'r' sampling
bags, the industry leader in sampling containers for over 35 years.
This laboratory product is sold in the U.S. and throughout the world.
Target - food and microbiology laboratories throughout the world.
SALES AND MARKETING
The Company offers a wide variety of products, both proprietary products
and products manufactured by others, primarily through catalogs distributed to
customers throughout the United States and internationally. The Company also
sells products through distributors. Additionally, many of the Company's
products are available for sale on its websites. After a sector is identified,
research is conducted by sales and marketing personnel to identify needed
products. The Company often hires consultants or sales directors from the niche
served. The Company's catalog teams continually search for new, improved and
unique products. Catalog teams pursue sales growth goals through efforts to
present more than 5,300 catalog pages with broad selections of popular and new
products at competitive catalog prices, and with choices of similar types of
products with different price points, qualities, or features. If the Company is
unable to find products to meet a specified demand, it has the option of
attempting to manufacture the product in its own plants or contract
manufacturing under a private label.
The Company attempts to time the distribution of catalogs to meet the peak
buying periods and mails the catalogs to the individuals whom the Company
believes make the buying decision. The Company's experience indicates that the
actual user of the materials usually makes the buying decision, except for those
items that are a part of school bid requests. The Company's mailing concentrates
on putting the catalog in the hands of these decision makers. All catalogs are
annually reviewed for revision. The Company's bid request goal is also
competitively priced. The Company issues most major catalogs annually to over
three million potential customers. The Company relies mainly on its 60 catalogs
as its "sales staff," which relieves the need for expensive sales calls on
customers.
5
In recent years, the Company has expanded its efforts in international
markets outside of North America, primarily in the health care and agricultural
product lines. While these international sales still only represent less than 8%
of 2003 total net sales, the acceptance of product lines by international
markets has been a significant growth contributor for these particular product
lines.
Orders are received via mail, phone, facsimile, or internet. The Company
aims to exceed customer expectations based on customers' directions. The
Company's business is transacted by open order and purchase orders. The Company
ships many orders the same day received and most orders are shipped within three
days. Sale terms are typically net 30 days.
The Company is not dependent upon a single customer, or a few customers,
the loss of one or more of which would have a material adverse effect on the
Company or either of its business segments.
PURCHASING
Although the educational products market has historically been extremely
stable, it is inherently seasonal. There are wide variations in sales from
season to season and as a result, accounts receivable, inventories and accounts
payable also vary. The summer months are the most active as educational
institutions restock their supplemental materials for the upcoming school year.
Substantial portions of the products distributed by the Company are
purchased from manufacturers and distributors worldwide. The purchasing group is
in contact with over 5,000 vendors to insure awareness of new products, timely
delivery and competitive pricing. With its broad range of vendors, including
alternative product sources, the Company does not maintain contractual
fulfillment agreements for purchase quantity commitments. To broaden its product
mix to meet specific customer needs, the Company operates manufacturing
facilities that produce proprietary items. Sales of proprietary products
generally result in a higher profit margin and enable the Company to sell such
products at wholesale in the U.S. and foreign markets where the Company often
develops distribution relationships. The Company has historically been able to
obtain sufficient quantities of the raw materials necessary for the manufacture
of proprietary products.
Vendors often review catalog pages and make suggestions for the following
year's offering. Alternate vendors are reviewed on a continuous basis.
INTELLECTUAL PROPERTY
The Company has a number of trademarks and trade names that it applies to
various product lines such as Nasco Life/Form'r' and Whirl-Pak'r'. Except for
the "Nasco" trademark, the various trademarks and trade names are not considered
material or vital to on-going business operations. To protect the unique product
lines developed under the Nasco name, the Company has applied for and received
patents for four product lines, two in the U.S. and two in Canada. The Company
also has applied for two additional U.S. patents. None of these issued or
pending patents are considered vital or material to on-going business
operations.
COMPETITION
Although there are several large general school suppliers and wholesale and
retail stores which compete with the Company, the Company believes that it
offers more specialty items in more disciplines in the educational, health and
agricultural markets than any competitor. Although the Company faces competition
with regard to each of its catalogs from businesses that specialize in limited
numbers of curriculum subjects, few, if any, of the Company's competitors have
as broad a range of products that serve as many market areas.
INFORMATION SYSTEMS
The Company's main computer system, housed in Fort Atkinson, Wisconsin, is
an IBM AS 400 computer. The Company's business is highly computerized, with
almost all functions including sales, order processing, purchasing, quotes,
phone orders, billing, receivables, payables and warehousing running on this
system. The system is routinely upgraded. In recent years, increased capacity
has been added to handle the Company's needs. To facilitate and continuously
improve the software system, a staff of programmers responds to suggestions from
all departments and management.
CATALOG PREPARATION
Catalog preparation is primarily handled in Fort Atkinson. A staff of
graphic artists and editors works with Macintosh desktop publishing systems to
complete all production work in-house, with the exception of printing.
6
EMPLOYEES
At December 31, 2003, the Company had approximately 750 full time
employees. In addition, the Company engages approximately 180 temporary
employees to accommodate the peak business season during the late spring and
summer months. All employees at all locations are employed at-will and none are
represented by a labor union.
ITEM 2. PROPERTIES
The Company leases approximately 1,000 square feet of executive office
space in Stamford, Connecticut from Geneve, the Company's majority stockholder.
The Company's primary distribution center is located in Fort Atkinson,
Wisconsin. The 220,000 square foot owned distribution center is the headquarters
for all Nasco marketing efforts. A graphics arts center houses the creative
staff and equipment for the maintenance of the catalog pages. The Company also
leases space for plastics and biological production to support the catalog
product lines. The Company owns approximately 300,000 square feet of adjacent
warehouse space and 40,000 square feet of adjacent office space. The Company
currently occupies 200,000 square feet of the warehouse space, and leases the
office space and remaining warehouse space to a third party under lease
agreements expiring on various dates in the next two years. These facilities
afford the Company the necessary expansion capacity for the foreseeable future.
In 2003, the Company became the owner of these facilities as a result of the
acquisition of 100% of the outstanding interest in NHI from Holdings. For more
information regarding this and other acquisitions of the Company, please refer
to the Acquisitions and Divestitures section above.
To service the western United States, the Company owns and operates a
68,000 square foot distribution center in Modesto, California. This distribution
center services all Nasco catalogs for customers in the 12 western states.
The Company operates its Triarco arts and crafts catalog operation, along
with three other independent catalogs, from a 4,000 square foot leased office
facility in Plymouth, Minnesota. The distribution center in Fort Atkinson,
Wisconsin services the Triarco catalogs.
The Company also maintains an educational materials catalog distribution
center in Fort Collins, Colorado from an 18,000 square foot owned facility. From
this location and a 37,500 square foot leased facility in Chippewa Falls,
Wisconsin, the Company's AMEP business unit services math and science teachers
and distributors worldwide. Light manufacturing operations are situated at both
of these locations, producing mainly proprietary items.
An 83,000 square foot owned facility, purchased on February 28, 2003,
located near Toronto, Canada, currently operates as a distribution center of
math, science and technology teaching aids and materials sold by Spectrum via
catalog mailings to schools throughout Canada. The Company believes that its
operations in Canada will continue to expand and that it will eventually utilize
all of the space at this new facility.
The Company owns two buildings comprising 72,800 square feet of office and
manufacturing space in Woodstock, New York. The Company also leases 8,000 square
feet of nearby warehouse space. The Company produces manikins and simulation
kits used for training in the health care field at this location for its
Simulaids operations.
During 2003, the Company leased, under a capital lease, a 43,000 square
foot light manufacturing and distribution facility in Otterbein, Indiana. The
capital lease was extinguished in the first quarter of 2004 for $1.1 million,
with the Company becoming the owner of this facility. The Company produces
sewing kits used in middle school and junior high school family and consumer
science classrooms at this location for its Haan operations.
The locations in Fort Atkinson, Wisconsin, Modesto, California, Plymouth,
Minnesota and near Toronto, Canada service both of the Company's business
segments. The locations in Fort Collins, Colorado, Chippewa Falls, Wisconsin,
Woodstock, New York and Otterbein, Indiana service the Company's educational
segment.
7
The Company's owned properties in Fort Atkinson, Wisconsin, Modesto,
California and Fort Collins, Colorado are each subject to a mortgage in favor of
the Company's principal lender, Bank One, NA, as additional security pursuant to
a Revolving Credit Facility entered into by the Company on October 15, 2003. For
more information regarding this Revolving Credit Facility, please refer to Note
8 of the Notes to the Consolidated Financial Statements included in Item 8 of
this Form 10K.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of the year ended December 31, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on the NASDAQ SmallCap Market under
the symbol "ARTL." The table below sets forth the high and low sale prices per
share of Common Stock during the fiscal quarters indicated.
MARKET PRICE $
--------------
HIGH LOW
------ -----
FISCAL YEAR ENDED DECEMBER 31, 2002:
March 31 9.360 7.000
June 30 10.100 3.000*
September 30 4.590 2.900
December 31 5.380 3.300
FISCAL YEAR ENDED DECEMBER 31, 2003:
March 31 4.760 3.630
June 30 4.200 3.190
September 30 5.500 3.320
December 31 5.750 4.030
* On June 17, 2002, the Company issued, as a stock dividend, one share of
Series I Preferred Stock, valued at $6.00 per share, on each share of the
Company's Common Stock outstanding on June 10, 2002. Following this stock
dividend, separate trading markets existed for the Company's Common Stock and
Series I Preferred Stock.
Since the issuance of the Company's Series I Preferred Stock on June 17,
2002, the Company's Series I Preferred Stock has traded on the NASDAQ SmallCap
Market under the symbol "ARTLP." The table below sets forth the high and low
sale prices per share of Series I Preferred Stock during the fiscal quarters
indicated.
MARKET PRICE $
--------------
HIGH LOW
----- -----
FISCAL YEAR ENDED DECEMBER 31, 2002:
March 31 -- --
June 30 9.000 6.100
September 30 7.750 6.040
December 31 7.900 6.900
FISCAL YEAR ENDED DECEMBER 31, 2003:
March 31 7.850 5.100
June 30 8.000 6.300
September 30 8.500 7.010
December 31 8.420 7.000
The Series J $6.00 non-convertible, non-voting cumulative 12% preferred
stock, par value $.01 per share ("Series J Preferred Stock") is privately-held
and no trading market exists for such shares.
8
HOLDERS OF RECORD
As of March 25, 2004, there were approximately 2,154 holders of record of
the Company's Common Stock and approximately 2,034 holders of record of the
Company's Series I Preferred Stock.
DIVIDENDS
The Company has not paid any cash dividends on its Common Stock since its
inception and does not intend to pay any cash dividends on its Common Stock in
the foreseeable future.
Dividends on the Company's Series I Preferred Stock and Series J Preferred
Stock are payable on March 31 and September 30, if and when declared by the
Company's Board of Directors. In 2003 and 2002, the Company paid the following
dividends per share on its outstanding shares of Series I Preferred Stock and
Series J Preferred Stock:
SERIES I SERIES J
-------- --------
FISCAL YEAR ENDED DECEMBER 31, 2002:
September 30 (1) .19 .21
FISCAL YEAR ENDED DECEMBER 31, 2003:
March 31 .33 .36
September 30 .33 .36
(1) The dividends paid by the Company on September 30, 2002 represented the
pro-rata dividend from June 17, 2002, the date of issuance of the Series I
Preferred Stock and the Series J Preferred Stock, through September 30, 2002.
On March 1, 2004, the Company announced that it had declared a cash
dividend of $.33 and $.36 per share, respectively, on its outstanding shares of
Series I Preferred Stock and Series J Preferred Stock. Such dividends are
payable on March 31, 2004, to holders of record on March 15, 2004.
RECENT SALES OF UNREGISTERED SECURITIES
On June 17, 2002, in connection with the Merger, the Company issued shares
of its Series J Preferred Stock to Holdings. In addition, following the Series I
Preferred Stock dividend paid on the Company's Common Stock, on the Merger date,
Geneve exchanged its shares of Series I Preferred Stock for an identical number
of shares of Series J Preferred Stock. The shares of Series J Preferred Stock
were issued in reliance upon an exemption from the registration requirements of
the Securities Act of 1933, as amended ("Securities Act") as a private placement
of securities under Section 4(2) of the Securities Act. No underwriter was
involved in the issuance of the Series J Preferred Stock or the exchange of the
Series I Preferred Stock for the Series J Preferred Stock.
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes the Company's Equity Compensation Plans as
of December 31, 2003:
(A) Number Of Securities (B) Weighted Average (C) Number Of Securities Remaining
To Be Issued Upon Exercise Exercise Price Of Available For Future Issuance Under
Of Outstanding Options, Outstanding Options, Equity Compensation Plans (Excluding
Plan Category Warrants And Rights Warrants And Rights Securities Reflected In Column (A))
- ------------------------------- -------------------------- -------------------- ------------------------------------
Equity Compensation Plans
Approved by Security Holders
1997 Plan 68,000(1) $5.58 --
2002 Plan 855,167(2) 2.99 606,066
Equity Compensation Plans Not
Approved by Security Holders -- -- --
------- ----- -------
923,167 $3.31 606,066
======= ===== =======
9
(1) Includes 34,000 shares of the Company's Common Stock and 34,000 shares
of the Company's Series I Preferred Stock to be issued upon the exercise of
outstanding options granted pursuant to the Company's 1997 Employee and Director
Stock Plan ("1997 Plan"). Options granted under the 1997 Plan are exercisable
for one share of Common Stock and one share of Series I Preferred Stock. The
Company does not currently intend to grant any additional options under the 1997
Plan.
(2) Options granted under the 2002 Employee, Director and Consultant Stock
Plan are exercisable for one share of the Company's Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
Due to the relative sizes of the parties and conditions to the Merger, the
transaction was accounted for as a reverse acquisition using the purchase method
of accounting under accounting rules generally accepted in the United States of
America. As a result, for accounting and reporting purposes, Nasco is deemed to
be the acquiring company, and the selected consolidated financial data set forth
below for periods prior to June 17, 2002 (the date of the Merger) represents the
historical information for Nasco. For periods following the Merger, the
financial data set forth below represents the results for the Company as a
consolidated entity. For more information regarding acquisitions and
divestitures made by the Company during the years 1999-2003, please refer to the
Acquisitions and Divestitures section above. The selected consolidated financial
data presented below should be read in conjunction with the Consolidated
Financial Statements of the Company, together with the Notes to Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this report.
SELECTED CONSOLIDATED FINANCIAL DATA (1)
(AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA)
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Consolidated Statements of Earnings Data:
Net sales $163.2 $165.9 $162.0 $143.8 $124.8
Cost of sales 101.9 107.0 105.5 93.8 81.2
------ ------ ------ ------ ------
Gross profit 61.3 58.9 56.5 50.0 43.6
Selling and administrative 38.2 39.0 36.6 31.7 26.6
------ ------ ------ ------ ------
23.1 19.9 19.9 18.3 17.0
Other selling and administrative
Severance costs-management -- .4 -- -- --
Special charges: AMEP -- -- .6 .8 --
Goodwill amortization -- -- .5 .3 --
Stock option compensation .5 .3 -- -- --
Management fees/administrative charges .8 .9 1.6 1.5 1.4
------ ------ ------ ------ ------
Earnings from operations 21.8 18.3 17.2 15.7 15.6
Other expense (income) 1.5 1.6 2.7 2.5 .6
------ ------ ------ ------ ------
Earnings before income taxes, minority
interest and extraordinary gain 20.3 16.7 14.5 13.2 15.0
Income taxes:
Current 1.6 3.2 5.7 5.3 5.8
Deferred 6.7 3.4 .1 (.1) --
------ ------ ------ ------ ------
8.3 6.6 5.8 5.2 5.8
------ ------ ------ ------ ------
Earnings before minority interest and
extraordinary gain 12.0 10.1 8.7 8.0 9.2
Minority interest -- -- .1 .2 --
Extraordinary gain -- 20.2 -- -- --
------ ------ ------ ------ ------
Net earnings 12.0 30.3 8.8 8.2 9.2
Preferred dividends 8.6 4.6 -- -- --
------ ------ ------ ------ ------
Net earnings applicable to common shareholders $ 3.4 $ 25.7 $ 8.8 $ 8.2 $ 9.2
====== ====== ====== ====== ======
Basic earnings per common share:
Earnings before extraordinary gain,
applicable to common shareholders $ .20 $ .34 $ .59 $ .54 $ .61
Extraordinary gain -- 1.26 -- -- --
------ ------ ------ ------ ------
Net earnings applicable to common shareholders $ .20 $ 1.60 $ .59 $ .54 $ .61
====== ====== ====== ====== ======
Diluted earnings per common share:
Earnings before extraordinary gain,
applicable to common shareholders $ .20 $ .33 $ .59 $ .54 $ .61
Extraordinary gain -- 1.25 -- -- --
------ ------ ------ ------ ------
Net earnings applicable to common shareholders $ .20 $ 1.58 $ .59 $ .54 $ .61
====== ====== ====== ====== ======
10
2003 2002 2001 2000 1999
------ ------ ----- ----- -----
Weighted average shares:
Basic 17.0 16.1 15.0 15.0 15.0
Diluted 17.2 16.2 15.0 15.0 15.0
EBITDA (2) $ 23.6 $ 20.0 $19.4 $17.6 $16.6
Consolidated Balance Sheets Data:
Working capital $ 46.8 $ 44.9 $32.5 $20.3 $20.9
Total assets $105.1 $105.1 $67.4 $56.2 $39.6
Long-term debt $ 31.3 $ 27.6 $36.0 $23.4 $ 4.8
Stockholders' equity $ 59.8 $ 55.7 $13.9 $ 6.8 $23.7
(1) The consolidated financial data include the operating results of the
following acquired and divested businesses:
o AMEP for 2003, 2002, 2001 and the period from March 1, 2000 to
December 31, 2000;
o Spectrum for 2003, 2002 and the period from April 1, 2001 to December
31, 2001;
o Simulaids for 2003 and the period from June 17, 2002 (the date of the
Merger) to December 31, 2002;
o Safe Passage for the period from the date of the Merger to December
31, 2002; and
o Haan and NHI for the period from June 1, 2003 to December 31, 2003.
(2) "EBITDA," which may be considered a non-GAAP financial measure, is defined
as earnings before interest and other income (including minority interest and
extraordinary gain), income taxes, depreciation and amortization. A non-GAAP
financial measure is a numerical measure of a company's historical or future
financial performance, financial position or cash flows that either excludes or
includes amounts that are normally excluded or included in a comparable measure
calculated and presented under GAAP. EBITDA is not presented as an alternative
measure of operating results (such as earnings from operations or net earnings)
or cash flow from operations, as determined in accordance with GAAP, but is
presented because the Company's management believes it is a widely accepted
indicator of our ability to incur and service debt. EBITDA does not give effect
to cash used for debt service requirements and thus does not reflect funds
available for dividends, reinvestment or other discretionary uses. In addition,
EBITDA as presented herein may not be comparable to similarly titled measures
reported by other companies. The following table provides a reconciliation of
earnings from operations to EBITDA for the years ended December 31:
2003 2002 2001 2000 1999
----- ----- ----- ----- -----
Earnings from operations $21.8 $18.3 $17.2 $15.7 $15.6
Add: depreciation and amortization 1.8 1.7 2.2 1.9 1.0
----- ----- ----- ----- -----
EBITDA $23.6 $20.0 $19.4 $17.6 $16.6
===== ===== ===== ===== =====
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company is a leading manufacturer and global distributor of
educational, health, medical technology and agricultural products, primarily
offered through catalogs. The state budget deficits and weak U.S. economy had a
significant adverse impact on the educational and commercial segments during
2003.
The following is a summary of key events for 2003:
o acquisitions of Haan and NHI in May 2003;
o gross profit increased 4.1% to $61.3 million despite a 1.6%
decrease in net sales;
o 19.3% and 18.8% increase in earnings from operations and earnings
before minority interest and extraordinary gain, respectively;
o $4.6 million increase in cash retained in the Company as a result
of the increased utilization of Federal net operating tax loss
carryforwards;
o execution of a new, five-year $45.0 million revolving credit
agreement; and
o payment of $8.6 million of dividends on the Company's Series I
Preferred Stock and Series J Preferred Stock.
Over the previous four years, the Company has experienced compound annual
growth rates on net sales, gross profit and earnings before minority interest
and extraordinary gain of 6.9%, 8.9% and 6.9%, respectively, primarily due to
acquisitions, the Merger and improved purchasing efforts and cost controls.
A key strength of the Company's business is its ability to consistently
generate cash. The Board of Directors and management use cash generated as a
measure of our performance. The Company uses the cash generated in operations to
strengthen the balance sheet, including reducing liabilities such as pensions
and debt, and for paying dividends on its preferred stock. The Company's
management believes that looking at the ability to generate cash provides
investors with additional insight into the Company's performance.
The following table sets forth selected financial data for the fiscal years
ended December 31:
% of Balance % of Balance % of
Net Sales % Net Sales % Net Sales
2003 Change 2002 Change 2001
--------- ------- --------- ------- ---------
Net sales 100.0% (1.6)% 100.0% 2.5% 100.0%
Cost of sales 62.4 (4.8) 64.5 1.5 65.1
----- ----- -----
Gross profit 37.6 4.1 35.5 4.3 34.9
Selling and administrative expense 24.2 (2.7) 24.5 5.1 23.9
Special charges: AMEP -- -- -- (100.0) .4
----- ----- -----
Earnings from operations 13.4 19.3 11.0 6.1 10.6
Other expense (income):
Interest expense .9 (15.7) 1.1 (42.5) 2.0
Interest income -- (59.7) -- (73.9) (.2)
Other, net -- (155.0) (.1) (31.9) (.1)
----- ----- -----
.9 (4.3) 1.0 (39.7) 1.7
----- ----- -----
Earnings before income taxes, minority
interest and extraordinary gain 12.5 21.6 10.0 14.7 8.9
Income taxes:
Current 1.0 (52.1) 2.0 (43.4) 3.5
Deferred 4.1 101.2 2.0 2,364.7 .1
----- ----- -----
5.1 25.8 4.0 12.5 3.6
----- ----- -----
Earnings before minority interest and
extraordinary gain 7.4% 18.8 6.0% 16.1 5.3%
===== ===== =====
12
The following discussion and analysis of financial condition and results of
operations reviews and compares the results of operations of the Company (after
giving effect to the Merger), on a consolidated basis, for the fiscal years
ended December 31, 2003, 2002 and 2001. This discussion and analysis of
financial condition and results of operations has been derived from, and should
be read in conjunction with, the Consolidated Financial Statements and Notes to
Consolidated Financial Statements contained in Item 8 of this Form 10-K.
RESULTS OF OPERATIONS - FISCAL YEAR 2003 AS COMPARED TO FISCAL YEAR 2002
Net Sales
In 2003, net sales decreased 1.6% to $163.2 million from $165.9 million in
2002. The decline in net sales reflects the influence of state budget deficits
incurred in fiscal years 2002 and 2003. Net sales for 2003 are positively
impacted by the inclusion of net sales from Simulaids and Haan. Simulaids and
Haan contributed an aggregate of $11.6 million in net sales in 2003, compared to
$4.7 million in 2002. Excluding the net sales from Simulaids and Haan, net sales
decreased 5.7% from 2002. Net sales in the educational segment, totaling $138.7
million, increased less than 1.0% in 2003 from $138.1 million in 2002. Excluding
the net sales from Simulaids and Haan, educational net sales decreased 6.1% from
2002. The commercial segment recorded net sales of $29.9 million in 2003 versus
$30.4 million for 2002. The lack of growth in the commercial segment is
primarily due to the downward trend in sales of agricultural products and the
overall instability of general national and international economic conditions.
Gross Profit
Gross profit for 2003 increased 4.1% to $61.3 million from $58.9 million in
2002 despite the 1.6% decrease in net sales. In 2003, the gross profit margin
increased to 37.6% from 35.5% in 2002. The increase in the gross profit margin
is primarily due to: (i) the continued focus on improvements in purchasing
efforts to reduce merchandise costs; (ii) the inclusion of Simulaids in
operations for the entire twelve months of 2003 compared to six and one-half
months in 2002, which made an incremental contribution to gross margin of $3.1
million; (iii) the inclusion of Haan in operations for the seven months ended
December 31, 2003 compared to none in 2002, which made an incremental
contribution to gross margin of $1.2 million; and (iv) a non-recurring, non-cash
purchase accounting adjustment of $.9 million recorded in the third quarter of
2002. In connection with the Merger and in accordance with the purchase method
of accounting under GAAP, certain inventories were valued at fair value on the
Merger date, which was $.9 million greater than their historical cost. This
purchase accounting adjustment was expensed in cost of sales in the Consolidated
Statements of Earnings during the third quarter of 2002 as the associated
inventories were sold. Excluding the gross profit realized from Simulaids and
Haan and 2002 expenses related to purchase accounting, the gross profit margin
would be 36.3% in 2003, compared to the gross profit margin of 35.4% in 2002.
The educational segment yielded a gross profit margin of 38.7% in 2003,
improving on the 2002 gross profit margin of 38.4%. Excluding the incremental
Simulaids and Haan gross profit and 2002 expenses related to purchase
accounting, the educational gross profit margin was 37.8% in 2003 compared to
38.6% in 2002. The commercial gross profit margin of 36.4% for 2003 remained
consistent with 2002.
In 2003, the overall inflationary impact on costs of materials was less
than 1%. Due to the limited increase in the cost of merchandise, aggregate price
increases to customers were less than 3%.
Selling and Administrative Expenses
Selling and administrative expenses for 2003 decreased 2.7% to $39.5
million from $40.6 million in 2002. As a percent of net sales, selling and
administrative expenses decreased slightly to 24.2% in 2003 from 24.5% in 2002.
Expenses included in this total include advertising and catalog costs, warehouse
and shipping activities, customer service and general administrative functions.
Selling and administrative expenses for 2003 were positively impacted by the
following: (i) implementation of cost control measures and labor efficiencies;
(ii) reduction in advertising and catalog costs, excluding the impact of
Simulaids and Haan, of $.7 million from 2002; (iii) elimination of $.7 million
in expenses of Safe Passage as a result of the sale of the business in 2002; and
(iv) $.4 million in expenses in 2002 related to severance payments due in
connection with management changes. The decrease in advertising and catalog
costs is attributed to technological efficiencies in catalog production through
prior year capital expenditures in state of the art graphic design equipment
programs.
13
Selling and administrative expenses for 2003 were negatively impacted by
the following: (i) inclusion of $1.4 million in expenses of Simulaids in
operations for 2003 as compared to $1.1 million in 2002 (from the Merger date to
December 31, 2002); (ii) inclusion of $.4 million in expenses of Haan in
operations for 2003 (the period from June 1, 2003 to December 31, 2003) as
compared to none for 2002; (iii) a significant increase in group health care
costs to $3.1 million in 2003; and (iv) an increase of $.2 million in non-cash
stock compensation expense related to grants of stock options to certain
employees and directors.
During 2003, the Company incurred and paid expenses of $.8 million to
Geneve for certain administrative services. Prior to the Merger, the Company
paid a management fee to Holdings. Under the terms of the management agreement,
Holdings provided to the Company specified legal, tax and other corporate
services. In 2002, through the Merger date, the management fee paid to Holdings
was $.9 million.
Interest Expense
Interest expense decreased 15.7% to $1.5 million in 2003, compared to $1.8
million in 2002. The decrease in interest expense is due to the decline in the
weighted average interest rate on the Company's debt to 3.6% in 2003 from 4.1%
in 2002 and reductions in borrowings under the Company's primary credit
facility, net of the following events:
o Mortgage of $1.8 million entered into by the Company on March 12,
2003, related to the purchase of an office and warehouse facility for
the Company's Spectrum operations.
o Mortgage and note payable of $3.6 million and $.5 million,
respectively, acquired by the Company on May 31, 2003, related to the
acquisition of NHI.
o Note payable, seller financing and capital lease of $2.5 million, $1.8
million and $1.2 million, respectively, entered into by the Company on
May 31, 2003, related to the acquisition and operations of Haan. The
note payable and seller financing were paid in full during the fourth
quarter of 2003. The capital lease was extinguished in the first
quarter of 2004.
The Company's credit agreements assessed interest at a weighted average
rate of 3.6% and 3.3% at December 31, 2003 and 2002, respectively.
Income Tax Provision
Aristotle and its qualifying domestic subsidiaries are included in the
Federal income tax return and certain State income tax returns of Geneve. The
provision for income taxes for the Company is determined on a separate return
basis in accordance with the terms of a tax sharing agreement with Geneve, and
payments for current Federal and certain State income taxes are made to Geneve.
The income tax provision for 2003 was $8.3 million compared to a provision
amounting to $6.6 million in 2002. These tax provisions reflect effective tax
rates of 40.9% and 39.6% for 2003 and 2002, respectively. The increase in the
effective tax rate from 2002 to 2003 is primarily due to revisions made by
management to other deferred tax assets, net of the decrease in the valuation
allowance. The difference between the Federal statutory income tax rate of 35%
and the effective income tax rate results principally from Foreign and State
income taxes and changes in the valuation allowance. Approximately $8.1 million
of the income tax provision for 2003 relates to the utilization of the Company's
Federal net operating tax loss carryforwards compared to approximately $3.5
million in 2002. Although the reported earnings for 2003 and 2002 are shown
after-tax, approximately $8.1 million and $3.5 million, respectively, of cash
from operations was retained in the Company as a result of the utilization of
these Federal net operating tax loss carryforwards. Except for Federal
Alternative Minimum Tax obligations arising from limitations on the utilization
of Federal net operating tax loss carryforwards in 2003 and future years, the
Company anticipates that the utilization of the available Federal net operating
tax loss carryforwards to offset future Federal taxable income will result in
the Company not having to use its cash resources to pay Federal income taxes for
approximately the next three years.
At December 31, 2003, the balance sheet contains a net deferred tax asset
of $23.3 million, net of a valuation allowance of $11.0 million. Substantially
all of the net deferred tax asset relates to Federal net operating tax loss
carryforwards, which were recognized in applying purchase accounting to the
Merger. The valuation allowance has been established to reflect the estimate of
Federal net operating tax loss carryforwards that will expire unused. During
2003, the valuation allowance decreased $1.3 million.
14
RESULTS OF OPERATIONS - FISCAL YEAR 2002 AS COMPARED TO FISCAL YEAR 2001
Net Sales
Net sales increased 2.5% to $165.9 million in 2002 from $162.0 million in
2001. The growth in net sales is positively impacted by the acquisition of
Spectrum in April 2001, and the inclusion of net sales of Simulaids and Safe
Passage from the Merger date. Spectrum contributed $8.9 million in net sales in
2002, compared to $5.4 million in 2001 (from April 1, 2001 to December 31,
2001). Simulaids and Safe Passage contributed $4.7 million from the Merger date
to December 31, 2002, compared to none in the fiscal year 2001. Excluding the
net sales from Spectrum, Simulaids and Safe Passage, net sales decreased 2.7%
from 2001. Net sales in the educational segment, totaling $138.1 million,
increased 1.6% in 2002 from $136.0 million in 2001. Excluding the net sales from
Spectrum and Simulaids, educational net sales decreased $6.4 million, or 4.9%.
The commercial segment recorded net sales of $30.4 million in 2002, increasing
2.9% versus the prior year. Commercial sales in 2002, excluding net sales from
Spectrum and Safe Passage, decreased by $.2 million to $29.2 million. The lack
of growth in net sales reflects the downturn in the U.S. economy as well as
budgetary uncertainty in the U.S. education sector.
Gross Profit
Gross profit increased 4.3% to $58.9 million in 2002 from $56.5 million in
2001. Gross profit margin increased to 35.5% in 2002 from 34.9% in 2001. In
connection with the Merger and in accordance with the purchase method of
accounting under GAAP, certain inventories were valued at fair value on the
Merger date, which was $.9 million greater than their historical cost. This
purchase accounting adjustment was expensed in cost of sales in the Consolidated
Statements of Earnings during the third quarter of 2002 as the associated
inventories were sold. Spectrum produced $3.5 million in gross profit in 2002,
compared to $2.2 million in 2001. Simulaids and Safe Passage, subsequent to the
Merger, generated $2.8 million in incremental gross profit in 2002. Excluding
the gross profit realized from Spectrum, Simulaids and Safe Passage, the gross
profit margin would be 35.2% in 2002, compared to the 2001 gross profit margin
of 34.7%. The educational segment yielded a gross profit margin of 38.4% in
2002, improving on the 2001 gross profit margin of 36.5%. Excluding the
incremental Spectrum and Simulaids gross profit and 2002 expenses related to
purchase accounting, educational gross profit margin increased in 2002 to 38.7%
compared to 36.4% in 2001. The increase in educational gross profit margin is
caused by improved purchasing efforts to reduce merchandise costs. Large
customer tenders through quote sales, which generally carry lower margins than
those resulting from standard catalog pricing, had minimal impact on the change
in educational gross profit margin from 2001 to 2002. The commercial gross
profit margin, excluding the Spectrum and Safe Passage business, was 36.8% in
2002, remaining consistent with the 2001 gross profit margin of 36.7%.
In 2002, the overall inflationary impact on costs of materials was less
than 1%. Due to the limited increase in the cost of merchandise, aggregate price
increases to customers were less than 3%.
Selling and Administrative Expenses
Selling and administrative expenses increased 5.1% in 2002, compared to
2001, to $40.6 million. Excluding Spectrum, Simulaids and Safe Passage, selling
and administrative expenses decreased by $.2 million, or .7%. Total advertising
and catalog costs, primarily catalog production and delivery costs, decreased
$.2 or 2.4% in 2002 compared to 2001. This decrease is attributed to
technological efficiencies in catalog production through current year capital
expenditures in state of the art graphic design equipment programs. Group health
care costs increased significantly to $2.5 million in 2002. In the second
quarter of 2002, the Company adopted a change in accounting principles to
recognize the fair value of stock options granted on or after January 1, 2002 as
an expense on its Consolidated Statements of Earnings. In 2002, the Company
recorded $.3 million in compensation expense related to grants of stock options
to certain employees and directors.
In the third quarter of 2002, the Company recorded $.4 million in expense
in connection with severance arrangements with former executive officers. The
Company has no further expenses under these arrangements.
15
During 2001, AMEP incurred certain non-recurring costs classified as
special charges in the accompanying Consolidated Statements of Earnings. These
costs include approximately $.3 million related to the redemption of AMEP stock
options held by AMEP employees, $.2 million related to the satisfaction of AMEP
employment agreements and $.1 million of various legal, accounting and
regulatory fees incurred by AMEP as a result of the AMEP acquisition. The
special charges are reported as a reduction to earnings from operations.
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets
("SFAS 142") and no longer amortizes goodwill as a reduction to earnings. In
2001, goodwill amortization amounted to $.5 million.
Prior to the Merger, the Company paid a management fee to Holdings. Under
the terms of the management agreement, Holdings provided to the Company
specified legal, tax and other corporate services. In 2002, through the Merger
date, the management fee paid to Holdings was $.9 million, compared to $1.6
million in 2001.
Interest Expense
Interest expense decreased to $1.8 million in 2002, compared to $3.2
million in 2001. The decrease in interest expense is due to the decline in the
average interest rate on the Company's debt and the reduction in debt of $8.4
million. At December 31, 2001, the Company's credit agreements assessed interest
at an annual average rate of 4.1%. The applicable interest rate declined
throughout 2002, to 3.3% by December 31, 2002. The average annual rate of
interest on the debt was 4.1% in 2002, compared to 6.1% in 2001.
Income Tax Provision
The income tax provision for 2002 was $6.6 million compared to a provision
amounting to $5.8 million for 2001. These tax provisions reflect effective tax
rates of 39.6% and 40.3% for 2002 and 2001, respectively. The decrease in the
effective tax rate from 2001 to 2002 is primarily due to non-deductible goodwill
amortization. The difference between the Federal statutory income tax rate of
35% and the effective income tax rate results principally from Foreign and State
income taxes. Approximately $3.5 million of the income tax provision for 2002
relates to the utilization of the Company's Federal net operating tax loss
carryforwards subsequent to the Merger. Although the reported earnings for 2002
are shown after-tax, approximately $3.5 million of cash from post-merger
operations was retained in the Company as a result of the utilization of these
Federal net operating tax loss carryforwards.
At December 31, 2002, the balance sheet contains a net deferred tax asset
of $29.0 million, net of a valuation allowance of $12.3 million. Substantially
all of the net deferred tax asset relates to Federal net operating tax loss
carryforwards, which were recognized in applying purchase accounting to the
Merger. The valuation allowance has been established to reflect the estimate of
Federal net operating tax loss carryforwards that will expire unused.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, the Company had working capital of $46.8 million,
increasing from $44.9 million at December 31, 2002. Cash and cash equivalents
decreased $5.7 million in 2003, ending the year at $5.6 million. Cash and cash
equivalents increased $6.8 million in 2002, ending the year at $11.3 million.
This decrease in cash and cash equivalents during 2003 is primarily due to the
following activities:
o The Company generated cash of $21.5 million, $15.1 million and $8.6
million from operations during 2003, 2002 and 2001, respectively. In
2003, the increase in cash generated from operations was principally
the result of the following: (i) a $3.5 million increase in earnings
from operations and (ii) a $4.6 million increase in the cash retained
in the Company as a result of the increased utilization of Federal net
operating tax loss carryforwards.
The increase in cash generated from operations in 2002 compared to
2001 was principally the result of the following: (i) improved
management of working capital and (ii) $3.5 million of cash retained
in the Company as a result of the utilization of Federal net operating
tax loss carryforwards recognized in the Merger.
16
o The Company used $7.8 million for investing activities in 2003,
compared to the generation of $2.7 million from investing activities
in 2002. In 2003, the Company used cash of $2.5 million to purchase an
office and warehouse facility for the Company's Spectrum operations.
No significant acquisitions of this nature occurred in 2002. Capital
expenditures to replace and upgrade existing capital equipment and
install new equipment and fixtures to provide additional operating
efficiencies totaled $1.8 million and $1.4 million in 2003 and 2002,
respectively.
In 2003, investing activities included a $3.5 million net cash outlay
for the acquisitions of Haan and NHI. In 2002, investing activities
included the acquisition of $3.3 million of cash in the Merger with
Nasco.
o Financing activities used $19.4 million and $11.0 million in 2003 and
2002, respectively. In 2003, the net principal payments on debt of
$11.0 million were due to the following: (i) reduction of $11.0
million in the amounts outstanding on the Company's primary credit
facility; (ii) payment in full of $1.8 million on seller financing
related to the acquisition of Haan; and (iii) proceeds of $1.8 million
from a mortgage on an office and warehouse facility for the Company's
Spectrum operations. A note payable of $2.5 million entered into by
the Company on May 31, 2003, related to the acquisition of Haan, was
paid in full during the fourth quarter of 2003. The debt payments of
$8.5 million in 2002 were for principal payments on the Company's
primary credit facility, mortgage, existing capital leases and other
seller notes payable incurred by AMEP in connection with previous
acquisitions.
The Company paid dividends of $8.6 million and $2.5 million in 2003
and 2002, respectively, on its Series I Preferred Stock and Series J
Preferred Stock issued on June 17, 2002.
On October 15, 2003, the Company entered into a five-year, non-amortizing,
$45.0 million Revolving Credit Facility. The proceeds from the Revolving Credit
Facility were initially used to extinguish the $31.2 million in borrowings
outstanding under the then-existing credit facility and $2.2 million in notes
payable of the Company. The Revolving Credit Facility will provide the Company
with seasonal working capital, letters of credit and funds for appropriate
acquisitions of businesses similar in nature to the Company's current business
segments. This debt carries a variable rate of interest that is based on Prime
or LIBOR rates plus applicable margins. At December 31, 2003, the weighted
average interest rate on this debt was 3.03%. The Revolving Credit Facility
currently has a committed weighted average rate of interest (including
applicable margins) of less than 3.00%. Such rate commitments expire on various
dates through April 14, 2004. The Company's Revolving Credit Facility is
collateralized by certain accounts receivable, certain inventories, certain
property, plant and equipment, shares of a certain subsidiary's capital stock
outstanding and ownership interests of certain of the Company's limited
liability subsidiaries. The Revolving Credit Facility contains various financial
and operating covenants, including, among other things, requirements to maintain
certain financial ratios and restrictions on additional indebtedness, common
dividend payments, capital disposals and intercompany management fees.
Prior to October 15, 2003, the Company maintained a $2.5 million secured
bank line of credit for working capital purposes. No draws were made against the
facility during 2003 and 2002. The line of credit was terminated on October 15,
2003 upon the execution of the Revolving Credit Facility.
Minimum contractual obligations at December 31, 2003 are as follows (in
thousands):
Less More
Than 1 1-3 3-5 Than 5
Total Year Years Years Years
------- ------ ------ ------- ------
Long-term debt $31,538 $ 248 $4,000 $25,133 $2,157
Capital leases 1,167 1,167 -- -- --
Operating lease commitments, net of sublease
rentals 691 216 380 95 --
------- ------ ------ ------- ------
$33,396 $1,631 $4,380 $25,228 $2,157
======= ====== ====== ======= ======
In 2004, capital expenditures to replace and upgrade existing capital
equipment and install new equipment and fixtures to provide additional operating
efficiencies are expected to be approximately $1.6 million.
17
Capital resources in the future are expected to be used for the development
of catalogs and product lines, to acquire additional businesses and for other
investing activities. The Company anticipates that there will be sufficient
financial resources to meet projected working capital and other cash
requirements for at least the next twelve months. Management of the Company
believes it has sufficient capacity to maintain current operations and support a
sustained level of future growth.
FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS
The Company is subject to seasonal influences with peak levels occurring in
the second and third quarters of the fiscal year primarily due to increased
educational shipments coinciding with the Fall start of new school years. As a
result, the Company recognizes approximately 75% of its annual net earnings in
the second and third quarters of its fiscal year. Inventory levels increase in
March through June in anticipation of the peak shipping season. The majority of
shipments are made between June and August and the majority of cash receipts are
collected from August through October.
Quarterly results may also be materially affected by the timing of
acquisitions, the timing and magnitude of costs related to such acquisitions,
variations in costs of products sold, the mix of products sold and general
economic conditions. Results for any quarter are not indicative of the results
for any subsequent fiscal quarter or for a full fiscal year.
Inflation has had and is expected to have only a minor effect on the
Company's operating results and its sources of liquidity.
See Note 18 of the Notes to the Consolidated Financial Statements included
in Item 8 of this Form 10K for certain unaudited consolidated quarterly
financial data for 2003 and 2002.
SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform to GAAP. The
preparation of the Consolidated Financial Statements in conformity with GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the Consolidated Financial Statements and notes thereto. Actual
results could differ from those estimates. A summary of all of the Company's
significant accounting policies can be found in Note 2 of the Notes to the
Consolidated Financial Statements included in Item 8 of this Form 10K. The
Company believes the following accounting policies affect the more significant
judgments and estimates used in the preparation of the Consolidated Financial
Statements:
Prepaid Catalog Costs and Amortization - The Company accumulates all direct
costs incurred in the development, production and circulation of catalogs on the
Consolidated Balance Sheets until the related catalog is mailed, at which time
they are amortized into selling and administrative expense over the estimated
sales realization cycle of one year, using the straight-line method.
Goodwill - The Company adopted SFAS No. 141, Business Combinations ("SFAS
141") as of July 1, 2001. SFAS 141 requires that the purchase method of
accounting be used for all business combinations. SFAS 141 specifies criteria
that intangible assets acquired in a business combination must meet to be
recognized and reported separately from goodwill. The Company also adopted the
provisions of SFAS 142, effective January 1, 2002. Under SFAS 142, goodwill is
no longer subject to amortization over its estimated useful life. Instead, SFAS
142 requires that goodwill be evaluated for impairment at least annually or more
frequently if events or circumstances indicate that the assets may be impaired,
by applying a fair value based test and, if impairment occurs, the amount of
impaired goodwill must be written off immediately. The Company evaluates
goodwill for impairment based on the expected future cash flows or earnings
projections. Goodwill is deemed impaired if the discounted cash flows or
earnings projections generated do not substantiate the carrying value. The
estimation of such amounts requires significant management judgment with respect
to revenue and expense growth rates, changes in working capital and selection of
an appropriate discount rate, as applicable. The use of different assumptions
would increase or decrease discounted future operating cash flows or earnings
projections and could, therefore, change impairment determination. The Company
has evaluated its goodwill at December 31, 2003 and 2002, and determined that
there has been no impairment of goodwill.
18
Defined Benefit Plans - The Company accounts for the benefits under its
salaried and hourly defined benefit pension plans using actuarial methods
required by SFAS No. 87, "Employers' Accounting for Pensions" ("SFAS 87"). This
model uses an attribution approach that generally spreads individual events over
the service lives of the employees in the plans. Examples of "events" are plan
amendments and changes in actuarial assumptions such as discount rate, expected
return on plan assets and rate of compensation increases. The principle
underlying the required attribution approach is that employees render service
over their service lives on a relatively consistent basis and, therefore, the
statement of earnings effects of pension benefits are earned in, and should be
expensed in, the same pattern.
In calculating net periodic benefit cost and the related benefit
obligation, the Company is required to select certain actuarial assumptions.
These assumptions include discount rate, expected return on plan assets and rate
of compensation increases. The discount rate assumptions reflect the prevailing
market rates for long-term, high-quality, fixed-income debt instruments that, if
the obligation was settled at the measurement date, would provide the necessary
future cash flows to pay the benefit obligation when due. The Company uses
long-term historical actual return experience with consideration of the expected
investment mix of the plans' assets, as well as future estimates of long-term
investment returns to develop its assumptions of the expected return on plan
assets. The rate of compensation increases are based on historical experience
and the Company's long-term plans for such increases.
In 2003, a 25 basis point decline in the discount rate assumptions caused a
decline in the funded status of the Company's salaried and hourly pension plans.
Consequently, the Company's accumulated benefit obligation for both plans
exceeded the fair market value of the plan assets for these plans at December
31, 2003. As required by SFAS 87, the Company recorded a non-cash, after-tax,
net charge of $1.5 million to the Consolidated Statements of Stockholders'
Equity and Comprehensive Earnings in the fourth quarter of 2003. This charge did
not impact the Company's pension expense, earnings or cash contribution
requirements in 2003.
Taxes - At December 31, 2003, the Consolidated Balance Sheet contains a net
deferred tax asset of approximately $23.3 million, net of a valuation allowance
of approximately $11.0 million, related primarily to Federal net operating tax
loss carryforwards. During 2003, the valuation allowance decreased $1.3 million.
The realizability of this asset is dependent upon the Company's generation of
approximately $67.0 million in future taxable income and the ability to retain
its Federal net operating tax loss carryforward position. As of December 31,
2003, the Company had Federal net operating tax loss carryforwards of
approximately $92.0 million. Based upon projected future operating results,
Federal net operating tax loss carryforwards of $60.2 million are expected to be
utilized to offset future Federal taxable income through 2007. The remaining
$31.8 million of Federal net operating tax loss carryforwards are expected to
expire unused. However, events may limit the use of all or a portion of these
Federal net operating tax loss carryforwards, thus potentially resulting in a
higher tax liability for the Company in the future. The net deferred tax asset,
including the valuation allowance, at December 31, 2003 is subject to future
adjustment based upon changes in management's evaluation of the realizability of
the deferred tax asset.
Revenues - Customarily applying FOB-shipping point terms, the Company
recognizes revenue upon shipment of products to its customer, which corresponds
to the time when risk of ownership transfers. The point of shipment is typically
from one of the distribution centers or, on occasion, a vendor's location as a
drop shipment. All drop shipment sales are recorded at gross selling price.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"). SFAS 143
requires the Company to record the fair value of an asset retirement obligation
as a liability in the period in which it incurs a legal obligation associated
with the retirement of tangible long-lived assets that result from the
acquisition, construction, development and/or normal use of the assets. The
Company also records a corresponding asset that is depreciated over the life of
the asset. Subsequent to the initial measurement of the asset retirement
obligation, the obligation will be adjusted at the end of each period to reflect
the passage of time and changes in the estimated future cash flows underlying
the obligation. The Company adopted SFAS 143 on January 1, 2003. The adoption of
SFAS 143 did not have a material effect on the Company's financial statements
for 2003.
19
In June 2002, the FASB issued SFAS No.146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS 146"), which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). SFAS 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. In addition, SFAS 146 establishes that fair value is the
objective for initial measurement of the liability. SFAS 146 is effective for
exit or disposal activities initiated after December 31, 2002. The adoption of
SFAS 146 did not have a material effect on the Company's financial statements
for 2003.
In November 2002, the EITF issued Issue No. 02-16, Accounting for
Consideration Received from a Vendor by a Customer (Including a Reseller of the
Vendor's Products) ("EITF 02-16"), effective for fiscal periods beginning after
December 15, 2002. EITF 02-16 requires cash consideration received from a vendor
be recognized in the customer's financial statements as a reduction to cost of
sales, unless certain limited conditions are met. If these specific requirements
related to individual vendors are met, the consideration is accounted for as a
reduction in the related expense category, such as selling and administrative
expense. The adoption of EITF 02-16 did not have a material effect on the
Company's financial statements for 2003.
In December 2003, the FASB issued a revised Interpretation No. 46,
Consolidation of Variable Interest Entities ("Interpretation 46R"), which
addresses how a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting rights and
accordingly should consolidate the entity. Interpretation 46R replaces
Interpretation No. 46, Consolidation of Variable Interest Entities, which was
issued in January 2003. The Company will be required to apply Interpretation 46R
to interests in variable interest entities ("VIE") created after December 31,
2003. For variable interests in VIEs created before January 1, 2004, the
interpretation will be applied beginning on January 1, 2005. For any VIEs that
must be consolidated under Interpretation 46R that were created before January
1, 2004, the assets, liabilities and noncontrolling interests of the VIE
initially would be measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any previously recognized
interest being recognized as the cumulative effect of an accounting change. If
determining the carrying amounts is not practicable, fair value at the date
Interpretation 46R first applies may be used to measure the assets, liabilities
and noncontrolling interest of the VIE. The adoption of Interpretation 46R is
not expected to have a material impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires an issuer to classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). An issuer previously
classified many of those instruments as equity. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective for interim periods beginning after June 15, 2003. The adoption of
SFAS 150 did not have a material effect on the Company's financial statements
for 2003.
FORWARD-LOOKING STATEMENTS
The Company believes that this Annual Report on Form 10-K may contain
forward-looking statements within the meaning of the "safe-harbor" provisions of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements include statements regarding liquidity and are based on management's
current expectations and are subject to a number of uncertainties and risks that
could cause actual results to differ materially from those projected or
suggested in such forward-looking statements. The Company cautions investors
that there can be no assurance that actual results or business conditions will
not differ materially from those projected or suggested in such forward-looking
statements as a result of various factors including, but not limited to, the
following: (i) the ability of the Company to obtain financing and additional
capital to fund its business strategy on acceptable terms, if at all; (ii) the
ability of the Company on a timely basis to find, prudently negotiate and
consummate additional acquisitions; (iii) the ability of the Company to manage
any to-be acquired companies; (iv) the ability of the Company to retain and
utilize its Federal net operating tax loss carryforward position; and (v)
general economic conditions. As a result, the Company's future development
efforts involve a high degree of risk. For further information, please see the
Company's filings with the Securities and Exchange Commission ("SEC"), including
its Forms 10-K, 10-Q and 8-K.
20
Reference is also made to the risk factors set forth in the final
prospectus which constitutes a portion of the Company's Registration Statement
on Form S-4 (Commission File No. 333-86026), which was filed in connection with
the Merger.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As described below, credit risk and interest rate risk are the primary
sources of market risk in the Company's accounts receivable and long-term
borrowings.
QUALITATIVE
Credit Risk: The Company provides credit in the normal course of business
to its customers, which are primarily educational institutions or distributors.
No single customer accounted for more than 10% of sales in 2003, 2002 or 2001.
The Company performs ongoing credit evaluations of its customers and maintains
allowances for potential credit losses and generally does not require collateral
to support its accounts receivable balances.
Interest Rate Risk: Changes in interest rates can potentially impact the
Company's profitability and its ability to realize assets and satisfy
liabilities. Interest rate risk is resident primarily in long-term borrowings,
which typically have variable interest rates based on Prime or LIBOR rates.
Assuming no other change in financial structure, an increase of 1% in the
Company's variable interest rate for long-term borrowings would decrease pre-tax
earnings by approximately $.4 million. This amount is determined by considering
a 1% increase in interest on the average long-term borrowings estimated to be
outstanding in 2004.
QUANTITATIVE
The Company's long-term borrowings as of December 31, 2003 are as follows
(in millions, except percentage data):
MATURITY MATURITY
LESS GREATER
THAN ONE THAN ONE
YEAR YEAR
-------- --------
Amount $1.4 $31.3
Weighted average interest rate 3.6% 3.6%
Fair market value $1.4 $31.3
The fair market value of long-term borrowings equals the face amount of
long-term borrowings outstanding because the underlying rate of interest on
substantially all of the Company's debt is variable based upon Prime or LIBOR
rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company, together with the
related Notes to the Consolidated Financial Statements and the report of the
independent auditors are set forth below.
21
Independent Auditors' Report
The Board of Directors
The Aristotle Corporation:
We have audited the accompanying consolidated balance sheets of The Aristotle
Corporation and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of earnings, stockholders' equity and comprehensive
earnings, and cash flows for each of the years in the three-year period ended
December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 The Aristotle
Corporation and subsidiaries as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for goodwill in 2002.
Milwaukee, Wisconsin
February 15, 2004
22
THE ARISTOTLE CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2003 and 2002
(in thousands, except share and per share data)
2003 2002
-------- -------
Assets
Current assets:
Cash and cash equivalents $ 5,566 11,299
Accounts receivable, less allowance for doubtful
receivables of $487 and $524 at December 31, 2003
and 2002, respectively 11,881 12,452
Inventories 29,157 27,941
Prepaid expenses and other 5,598 7,766
Refundable income taxes 344 --
Deferred income taxes 8,184 7,251
-------- -------
Total current assets 60,730 66,709
Property, plant and equipment, at cost 25,648 15,241
Less accumulated depreciation and amortization (8,308) (6,088)
-------- -------
Net property, plant and equipment 17,340 9,153
Goodwill 11,509 7,008
Deferred income taxes 15,081 21,761
Other assets 454 430
-------- -------
Total assets $105,114 105,061
======== =======
Liabilities and Stockholders' Equity
Current liabilities:
Current installments of long-term debt $ 1,415 9,108
Trade accounts payable 5,874 5,522
Accrued expenses 4,537 3,979
Accrued dividends payable 2,154 2,150
Income taxes -- 1,005
-------- -------
Total current liabilities 13,980 21,764
Long-term debt, less current installments 31,290 27,579
Stockholders' equity:
Preferred stock, Series I, convertible, voting, 11%
cumulative, $6.00 stated value; $.01 par value;
2,400,000 shares authorized, 1,068,622 and
1,046,716 issued and outstanding at
December 31, 2003 and 2002, respectively 6,412 6,280
Preferred stock, Series J, non-voting, 12% cumulative,
$6.00 stated value; $.01 par value; 11,200,000
shares authorized, 10,984,971 issued and outstanding 65,760 65,760
Common stock, $.01 par value; 20,000,000 shares
authorized, 17,082,354 and 17,031,687 shares issued
and outstanding at December 31, 2003 and 2002, respectively 171 170
Additional paid-in capital 860 251
Accumulated deficit (13,257) (16,624)
Accumulated other comprehensive loss (102) (119)
-------- -------
Total stockholders' equity 59,844 55,718
-------- -------
Total liabilities and stockholders' equity $105,114 105,061
======== =======
See accompanying notes to consolidated financial statements.
23
THE ARISTOTLE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Earnings
Years ended December 31, 2003, 2002 and 2001
(in thousands, except share and per share data)
2003 2002 2001
----------- ---------- ----------
Net sales $ 163,228 165,947 161,961
Cost of sales 101,864 107,005 105,448
----------- ---------- ----------
Gross profit 61,364 58,942 56,513
Selling and administrative expense 39,535 40,644 38,661
Special charges: American Educational Products, Inc. -- -- 612
----------- ---------- ----------
Earnings from operations 21,829 18,298 17,240
Other expense (income):
Interest expense 1,532 1,817 3,159
Interest income (31) (77) (295)
Other, net 60 (109) (160)
----------- ---------- ----------
1,561 1,631 2,704
----------- ---------- ----------
Earnings before income taxes, minority interest
and extraordinary gain 20,268 16,667 14,536
Income taxes
Current 1,552 3,242 5,724
Deferred 6,745 3,352 136
----------- ---------- ----------
8,297 6,594 5,860
----------- ---------- ----------
Earnings before minority interest and extraordinary gain 11,971 10,073 8,676
Minority interest -- -- 99
----------- ---------- ----------
Earnings before extraordinary gain 11,971 10,073 8,775
Extraordinary gain -- 20,237 --
----------- ---------- ----------
Net earnings 11,971 30,310 8,775
Preferred dividends 8,604 4,647 --
----------- ---------- ----------
Net earnings applicable to common shareholders $ 3,367 25,663 8,775
=========== ========== ==========
Basic earnings per common share:
Earnings before extraordinary gain,
applicable to common shareholders $ .20 .34 .59
Extraordinary gain -- 1.26 --
----------- ---------- ----------
Net earnings applicable to common shareholders $ .20 1.60 .59
=========== ========== ==========
Diluted earnings per common share:
Earnings before extraordinary gain,
applicable to common shareholders $ .20 .33 .59
Extraordinary gain -- 1.25 --
----------- ---------- ----------
Net earnings applicable to common shareholders $ .20 1.58 .59
=========== ========== ==========
Weighted average common shares outstanding:
Basic 17,037,634 16,102,121 15,000,000
Diluted 17,181,084 16,205,602 15,000,000
See accompanying notes to consolidated financial statements.
24
THE ARISTOTLE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and Comprehensive Earnings
Years ended December 31, 2003, 2002 and 2001
(in thousands)
Preferred Preferred
Comprehensive Stock Stock Common
earnings (loss) Series I Series J stock
--------------- --------- --------- ------
Balance, December 31, 2000 $ -- -- 150
Net earnings $ 8,775 -- -- --
Equity contribution from Holdings -- -- -- --
Other comprehensive earnings (loss):
Foreign currency translation adjustment (139) -- -- --
-------
Comprehensive earnings $ 8,636
=======
Common dividends -- -- --
------- ------ ---
Balance, December 31, 2001 -- -- 150
Net earnings $30,310 -- -- --
Issuance of preferred stock in connection with merger
with Nasco, less transaction costs -- -- 59,850 --
Preferred stock dividend -- 12,190 -- --
Exchange of stock with related party -- (5,910) 5,910 --
Recapitalization -- -- -- 20
Stock option compensation -- -- -- --
Other comprehensive earnings (loss):
Foreign currency translation adjustment 79 -- -- --
-------
Comprehensive earnings $30,389
=======
Preferred dividends -- -- --