Form 10-Q

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SVDkO+voRZHOevhTaL3HMFJdcNfpxgmxhRsn3I6K45KrGhQkPmgjsi72Z4JU2j8x dBs2viL1DyIn6gJDndIMow== 0001193125-06-018920.txt : 20060203 0001193125-06-018920.hdr.sgml : 20060203 20060203061743 ACCESSION NUMBER: 0001193125-06-018920 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20060203 DATE AS OF CHANGE: 20060203 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EXCELLIGENCE LEARNING CORP CENTRAL INDEX KEY: 0001130950 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-CATALOG & MAIL-ORDER HOUSES [5961] IRS NUMBER: 770559897 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-32613 FILM NUMBER: 06575505 BUSINESS ADDRESS: STREET 1: 2 LOWER RAGSDALE DRIVE STREET 2: SUITE 200 CITY: MONTEREY STATE: CA ZIP: 93940 BUSINESS PHONE: 8313332000 MAIL ADDRESS: STREET 1: 2 LOWER RAGSDALE DRIVE STREET 2: SUITE 200 CITY: MONTEREY STATE: CA ZIP: 93940 FORMER COMPANY: FORMER CONFORMED NAME: LEARNINGSTAR CORP DATE OF NAME CHANGE: 20010504 FORMER COMPANY: FORMER CONFORMED NAME: LEARNINGSTAR INC DATE OF NAME CHANGE: 20001229 10-Q 1 d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

¨	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 0-32613

EXCELLIGENCE LEARNING CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Delaware

77-0559897

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

2 Lower Ragsdale Drive

Monterey, CA

93940

(Address of Principal Executive Offices)

(Zip Code)

Registrant’s Telephone Number, Including Area Code: (831) 333-2000

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer ¨		Accelerated filer ¨		Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $.01 par value, 9,039,132 shares outstanding as of January 26, 2006.

EXPLANATORY NOTE

Due to the matters discussed below and as previously announced, Excelligence Learning Corporation (the “Company”) has restated its previously issued financial statements for the fiscal year ended December 31, 2004 and for the fiscal quarter ended March 31, 2005. Accordingly, the Company has amended its annual report of Form 10-K for the fiscal year ended December 31, 2004 and its quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2005. Please also refer to Item 4 “Controls and Procedures,” included in this Form 10-Q for a further discussion of those restatements.

On August 12, 2005, the Company announced a delay in the filing of this Form 10-Q for the three and six months ended June 30, 2005 pending the completion of an internal investigation of allegations by current and former accounting personnel that the Company had failed to record and accrue for certain obligations for the fiscal year ended December 31, 2004. The Company’s Audit Committee retained independent legal counsel to lead the internal investigation and to direct forensic accounting consultants retained to assist in the investigation. On September 7, 2005, after considering the results of its investigation, the Company determined that certain liabilities related to inventory, catalog costs, and certain operating expenses were understated at December 31, 2004. The Company concluded that adjusting the effect of these items would be material to its previously reported results for fiscal year 2004 and the first quarter of 2005. Therefore, the Company has restated its previously issued financial statements for such year as set forth in its Form 10-K/A and its previously issued financial statements for such quarter in its Form 10-Q/A, both of which were filed with the Securities and Exchange Commission (the “Commission”) on February 1, 2006. No other fiscal periods prior to the fiscal year ended December 31, 2004 were affected by the restatement, as the issues identified did not have any significant impact on those periods. On November 14, 2005, the Company also announced a delay in filing its Form 10-Q for the three and nine months ended September 30, 2005 pending the completion of the restatements.

The Company determined that these restatements are attributable to a number of factors. The most significant factor was the Company’s failure to timely pay or accrue its obligations for certain invoices for inventory on hand as of year end. The Company determined, based upon the results of its internal investigation that its accrual for accounts payable for inventory did not include certain inventory items that had been received but had not been paid for by the Company prior to the end of fiscal 2004. As a result of the in-depth review procedures performed by the Company, the forensic accountants and its registered independent public accountants, certain additional accounting errors were identified relating to 2004 which are also reflected in the restatement. Those additional errors included an understatement of costs capitalized into inventory, an understatement of the provision for sales returns, an understatement of certain selling, general and administrative expenses, an understatement of expense for deferred compensation amounts relating to previously issued stock options, and an understatement of income taxes related to stock option exercises.

The staff in the Division of Enforcement in the San Francisco District Office of the Commission informed the Company in October 2005 that it was conducting an informal inquiry into the Company’s restatement and the related circumstances. At that time, the staff requested that the Company preserve certain documents related to this inquiry and provide on a voluntary basis certain documents to the staff for its review. The Company has cooperated with the informal inquiry and provided documents and information in response to the staff’s requests. The staff obtained a non-public formal order of investigation from the Commission in January 2006. The Company intends to continue to cooperate with the staff and Commission in connection with the formal investigation.

EXCELLIGENCE LEARNING CORPORATION

TABLE OF CONTENTS


	Forward-Looking Statements	1

PART I:	FINANCIAL INFORMATION	2

Item 1.	Financial Statements	2

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16

Item 4.	Controls and Procedures	16

PART II:	OTHER INFORMATION	19

Item 1.	Legal Proceedings	19

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19

Item 3.	Defaults Upon Senior Securities	19

Item 4.	Submission of Matters to a Vote of Security Holders	19

Item 5.	Other Information	19

Item 6.	Exhibits	19

SIGNATURE		20

Forward-Looking Statements

Certain information included in this Quarterly Report on Form 10-Q and other materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information in oral statements and other written statements made or to be made by the Company) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary language noting important factors that could cause actual results to differ materially from those projected in such statements. Such forward-looking statements involve risks and uncertainties that could significantly affect anticipated results in the future and include information relating to:

•

projections of net revenues and operating income;

•

plans for future expansion and other business development activities, as well as other capital spending;

•

financing sources and the effects of regulation;

•

competition;

•

the outcome of pending legal or regulatory investigations or proceedings; and

•

protection of the Company’s intellectual property.

As such, actual results may vary materially from those projected, anticipated or indicated in any forward-looking statements. The Company has based its forward-looking statements on current expectations and projections about future events and assumes no obligation to update publicly any forward-looking information that may be made by or on behalf of the Company in this Quarterly Report on Form 10-Q or otherwise, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so.

When used in this Quarterly Report on Form 10-Q and in other statements made by or on behalf of the Company, the words “believes,” “anticipates,” “expects,” “plans,” “intends,” “expects,” “estimates,” “projects,” “could” and other similar words or expressions, which are predictions of or indicative of future events, conditions and trends, identify forward-looking statements. Such forward-looking statements are subject to a number of important risks, uncertainties and assumptions that could significantly affect anticipated results in the future. These risks, uncertainties and assumptions about the Company and its subsidiaries have not changed since the Company filed its Annual Report on Form 10-K/A and include, but are not limited to, the following:

•

the Company’s ability to diversify product offerings or expand in new and existing markets;

•

changes in general economic and business conditions and in the educational products, catalog or e-retailing industry in particular;

•

the impact of competition, specifically, if competitors were to either adopt a more aggressive pricing strategy than the Company or develop a competing line of proprietary products;

•

the level of demand for the Company’s products;

•

fluctuations in currency exchange rates, which could potentially result in a weaker U.S. dollar in overseas markets, increasing the Company’s cost of inventory purchased; and

•

other factors discussed in Item 1 under “Risk Factors” in the Company’s Annual Report on Form 10-K/A.

In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Quarterly Report on Form 10-Q might not occur.

PART I

FINANCIAL INFORMATION

Item 1.

Financial Statements.

EXCELLIGENCE LEARNING CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except for par value and share amounts)

(Unaudited)


	June 30, 2005			December 31, 2004(1)
				*Restated*
ASSETS
Current assets :
Cash and cash equivalents	$	—		$	2,657
Accounts receivable, net		11,763			8,286
Inventories		34,843			16,478
Prepaid expenses and other current assets		3,238			4,195
Deferred income taxes		701			700

Total current assets		50,545			32,316
Property and equipment, net		4,475			4,401
Deferred income taxes		6,339			6,373
Other assets		232			238
Goodwill		5,878			5,878
Other intangible assets, net		658			745

Total assets	$	68,127		$	49,951

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Revolving line of credit	$	5,000		$	—
Bank overdraft		485			—
Accounts payable		16,496			4,125
Accrued expenses		3,180			3,638
Other current liabilities		229			162

Total current liabilities		25,390			7,925

Stockholders’ equity:
Common stock, $0.01 par value; 15,000,000 shares authorized; 8,956,128 and 8,840,354 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		89			88
Additional paid-in capital		63,547			63,257
Deferred stock compensation		(53	)		(214	)
Accumulated deficit		(20,846	)		(21,105	)

Total stockholders’ equity		42,737			42,026

Total liabilities and stockholders’ equity	$	68,127		$	49,951

(1)	Derived from restated audited consolidated financial statements filed in the Company’s 2004 Amended Annual Report on Form 10-K/A.

See accompanying notes to condensed consolidated financial statements.

EXCELLIGENCE LEARNING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except for share and per share amounts)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Revenues	$	29,780		$	26,549		$	52,359		$	46,385
Cost of goods sold		19,833			17,265			34,291			30,193

Gross profit		9,947			9,284			18,068			16,192

Operating expenses:
Selling, general and administrative		8,758			8,970			17,637			17,476
Amortization of intangible assets		43			44			87			87

Operating income (loss)		1,146			270			344			(1,371	)

Other (income) expense:
Gain on sale of assets		—			(5	)		—			(5	)
Interest expense		53			40			58			45
Interest income		(24	)		—			(35	)		(2	)

Income (loss) before income tax (benefit)		1,117			235			321			(1,409	)
Income tax (benefit)		419			99			62			(602	)

Net income (loss)	$	698		$	136		$	259		$	(807	)

Net income (loss) per share calculation:
Net income (loss) per share – basic	$	0.08		$	0.02		$	0.03		$	(0.09	)

Net income (loss) per share – diluted	$	0.07		$	0.01		$	0.03		$	(0.09	)

Weighted average shares used in basic net income (loss) per share calculation		8,941,992			8,767,111			8,934,155			8,702,192
Weighted average shares used in diluted net income (loss) per share calculation		9,370,485			9,301,837			9,338,575			8,702,192

See accompanying notes to condensed consolidated financial statements.

EXCELLIGENCE LEARNING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Six Months Ended June 30,
	2005			2004
Cash flows from operating activities:
Net income (loss)	$	259		$	(807	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		912			842
Gain on sale of assets		—			(5	)
Allowance for doubtful accounts		(226	)		(22	)
Stock-based compensation		161			276
Deferred income taxes		34			(485	)
Changes in operating assets and liabilities, net of assets and liabilities assumed in acquisition:
Accounts receivable		(3,251	)		(4,821	)
Inventories		(18,366	)		(16,597	)
Prepaid expenses and other current assets		957			29
Other assets		6			10
Accounts payable		12,371			13,015
Accrued expenses		(458	)		(162	)
Other current liabilities		67			(44	)

Net cash used in operating activities		(7,534	)		(8,771	)

Cash flows from investing activities:
Purchase of property and equipment		(899	)		(1,717	)

Cash flows from financing activities:
Borrowings on line of credit		5,000			9,250
Bank overdraft		485			—
Exercise of employee stock options		291			276

Net cash provided by financing activities		5,776			9,526

Net decrease in cash and cash equivalents		(2,657	)		(962	)
Cash and cash equivalents at beginning of period		2,657			3,620

Cash and cash equivalents at end of period	$	—		$	2,658

Supplemental disclosure of cash flow information:
Cash payments during the period for:
Interest	$	—		$	23
Income taxes	$	—		$	210

See accompanying notes to condensed consolidated financial statements.

EXCELLIGENCE LEARNING CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1)

The Business

Excelligence Learning Corporation, a Delaware corporation (the “Company”), is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. The Company was incorporated in the State of Delaware on November 6, 2000 for the purpose of effecting the combination (the “Combination”) of the businesses of Earlychildhood LLC, a California limited liability company (“Earlychildhood”), and SmarterKids.com, Inc., a Delaware corporation (“SmarterKids.com”). The Company’s business is primarily conducted through its wholly-owned subsidiaries, Earlychildhood, Educational Products, Inc., a Texas corporation (“EPI”), and Marketing Logistics, Inc., a Minnesota corporation dba Early Childhood Manufacturers’ Direct (“ECMD”).

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which are normal and recurring in nature) considered necessary for a fair presentation have been included. The balance sheet at December 31, 2004 was derived from the Company’s restated audited consolidated financial statements for the fiscal year ended December 31, 2004. For further information, refer to the audited consolidated financial statements and notes thereto included in the Company’s Amended Annual Report on Form 10-K/A for the year ended December 31, 2004.

Seasonality

The Company’s seasonal sales trends coincide with the start of each school year. For the fiscal year ended December 31, 2004, approximately 44% of the Company’s consolidated annual sales were generated in the third calendar quarter. The Company’s working capital needs are greatest during the first and second quarters as inventory levels are increased to meet seasonal demands.

Equity-Based Compensation

The Company accounts for its equity-based compensation plans in accordance with Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. As permitted by SFAS No. 123, the Company measures compensation cost in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As a result, no accounting recognition is given at the date of grant to stock options granted to employees with an exercise price equal to the fair market value of the underlying common stock. Upon exercise, net proceeds, including income tax benefits realized, if any, are credited to equity. Compensation cost for stock options granted with exercise prices below the fair market value of the underlying common stock is recognized over the vesting period. The pro forma impact on earnings of equity-based compensation expense as if the Company were using the fair-value method has been disclosed in the notes to the financial statements as allowed by SFAS No. 123.

The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except for share and per share amounts):


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Net income (loss), as reported	$	698	$	136	$	259	$	(807	)
Add: stock-based employee compensation expense included in reported net income (loss), net of related tax effects		48		85		97		170
Deduct: stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		54		89		105		204

Pro forma net income (loss)	$	692	$	132	$	251	$	(840	)

Net income (loss) per share calculation:
Net income (loss) per share – basic, as reported	$	0.08	$	0.02	$	0.03	$	(0.09	)

Net income (loss) per share – diluted, as reported	$	0.07	$	0.01	$	0.03	$	(0.09	)

Net income (loss) per share – basic, pro forma	$	0.08	$	0.02	$	0.03	$	(0.10	)

Net income (loss) per share – diluted, pro forma	$	0.07	$	0.01	$	0.03	$	(0.10	)

Weighted average shares used in net income (loss) per share calculation – basic, as reported and pro forma		8,941,992		8,767,111		8,934,155		8,702,192
Weighted average shares used in net income (loss) per share calculation – diluted, as reported and pro forma		9,370,485		9,301,837		9,338,575		8,702,192

The fair value of these options was estimated using the Black-Scholes model, with the following weighted average assumptions:


	Three Months Ended June 30,				Six Months Ended June 30,
Stock Options	2005		2004		2005		2004
Expected life (in years)	6.0		7.2		6.0		7.2
Risk-free interest rate	4.07	%	4.18	%	4.04	%	3.84	%
Volatility	80.6	%	92.2	%	82.1	%	94.4	%
Dividend yield	0.0	%	0.0	%	0.0	%	0.0	%

The Company has revised its weighted average assumptions used in the fair value calculation of its pro forma disclosures from those previously reported.

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges, and that fixed production overheads should be allocated to inventory based on normal capacity of production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a significant impact on the Company’s results of operations or financial position.

In December 2004, FASB issued a revised version of Statements of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (“SFAS 123R”), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R requires recognition of the cost of employee services received in share-based payment transactions, thereby reflecting the economic consequences of those transactions in the financial statements. The accounting provisions of SFAS 123R are effective beginning with the first interim or annual reporting period that begins after June 15, 2005, and the Company will be required to adopt SFAS 123R in the first quarter of 2006. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. See “Equity-Based Compensation” above for the pro forma net income (loss) and net income (loss) per share amounts for the three and six months ended June 30, 2005 and 2004 as if the Company had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although it has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123, the Company expects the adoption of SFAS 123R to have a significant adverse impact on the Company’s consolidated statements of operations and net income (loss) per share.

In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error Corrections. SFAS No. 154 replaces Accounting Principles Board Opinion No. 20, Accounting Changes in Interim Financial Statements and is effective for fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effects of the changes.

(2)

Unaudited Basic and Diluted Net Income (Loss) Per Share

Basic net income (loss) per share for the three and six months ended June 30, 2005 and 2004 included in the accompanying statements of operations is based on the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share for the three and six months ended June 30, 2005 and 2004 is the weighted average number of shares of common stock and common stock equivalents outstanding during the period. Common stock equivalents consist of stock options.

The following table sets forth the computation of basic and diluted net income (loss) per share for the three and six months ended June 30, 2005 and 2004 (in thousands, except for share and per share amounts):


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Net income (loss)	$	698	$	136	$	259	$	(807	)

Weighted average shares used in basic net income (loss) per share calculation		8,941,992		8,767,111		8,934,155		8,702,192
Weighted average shares used in diluted net income (loss) per share calculation		9,370,485		9,301,837		9,338,575		8,702,192
Net income (loss) per share – basic	$	0.08	$	0.02	$	0.03	$	(0.09	)

Net income (loss) per share – diluted	$	0.07	$	0.01	$	0.03	$	(0.09	)

Exercisable options outstanding of 421,096 for the six months ended June 30, 2004 are excluded from the computation of diluted net income (loss) per share because the effect would have been anti-dilutive. Exercisable stock options with an exercise price in excess of market value are excluded from the computation of diluted net income per share because the effect would have been anti-dilutive. There were 5,156 and 82,156 such shares for the three and six months ended June 30, 2005, respectively.

(3)

Segment Information

The Company operates in two business segments, the Early Childhood segment and the Elementary School segment. The Early Childhood segment includes the brand names Discount School Supply, ECMD and Earlychildhood NEWS. The Early Childhood segment develops, manufactures and sells educational products through multiple distribution channels to early childhood professionals and parents. The Early Childhood segment also provides information to teachers and other education professionals regarding the development of children from infancy through age eight. The Elementary School segment sells school supplies and other products specifically targeted for use by children in kindergarten through sixth grade to elementary schools, teachers and other education organizations for fundraising activities.

The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in the Company’s Amended Annual Report on Form 10-K/A for the year ended December 31, 2004. Revenues and operating income (loss) by segment follows (in thousands):


	Early Childhood				Elementary School						Consolidated
	Three Months Ended June 30,
	2005		2004		2005			2004			2005		2004
Net revenues	$	24,643	$	21,542	$	5,137		$	5,007		$	29,780	$	26,549
Cost of goods sold		16,137		13,881		3,716			3,384			19,853		17,265

Gross profit		8,526		7,661		1,422			1,623			9,947		9,284

Operating expenses:
Selling, general and administrative		7,040		6,625		1,800			2,345			8,840		8,970
Amortization of intangible assets		8		8		35			36			43		44

Operating income (loss)	$	1,560	$	1,028	$	(414	)	$	(758	)	$	1,146	$	270


	Early Childhood				Elementary School						Consolidated
	Six Months Ended June 30,
	2005		2004		2005			2004			2005		2004
Net revenues	$	45,744	$	39,714	$	6,614		$	6,671		$	52,359	$	46,385
Cost of goods sold		29,595		25,592		4,716			4,601			34,311		30,193

Gross profit		16,169		14,122		1,898			2,070			18,068		16,192

Operating expenses:
Selling, general and administrative		13,918		13,100		3,802			4,376			17,719		17,476
Amortization of intangible assets		16		16		71			71			87		87

Operating income (loss)	$	2,317	$	1,006	$	(1,975	)	$	(2,377	)	$	637	$	(1,371	)

The Early Childhood segment performs limited administrative activities, including certain accounting and information system functions, on behalf of the Elementary School segment and charges the Elementary School segment for such activities. These inter-segment charges are based on estimates of actual costs for such activities. Inter-segment charges have been eliminated in consolidation and amounted to $128,063 and $144,922 for the three months ended June 30, 2005 and 2004, respectively, and $256,125 and $289,844 for the six months ended June 30, 2005 and 2004, respectively. The Company allocates income tax expense for the current year based on a percentage of each segment’s pre-tax income.

The Company had no customer comprising greater than 10% of its revenue or accounts receivable as of and for the three-month or six-month periods ended June 30, 2005 and 2004.

The segment asset information available is as follows (in thousands):


	June 30, 2005			December 31, 2004
				*Restated*
Assets
Early Childhood	$	56,314		$	41,922
Elementary School		23,072			19,339
Eliminations		(11,310	)		(11,310	)

Total	$	68,076		$	49,951

(4)

Inventories

Inventories, stated at lower of cost or market, consist of the following amounts (in thousands):


	June 30, 2005		December 31, 2004
			*Restated*
Raw materials and work in progress	$	926	$	940
Finished goods		33,917		15,538

	$	34,843	$	16,478

(5)

Goodwill and Intangible Assets

The following table identifies the major classes of intangible assets at June 30, 2005 and December 31, 2004 (in thousands):


	June 30, 2005							December 31, 2004
	Gross Carrying Amount		Accumulated Amortization			Net		Gross Carrying Amount		Accumulated Amortization			Net
Trademarks, trade names and formulas	$	953	$	(836	)	$	117	$	953	$	(819	)	$	134
Customer Lists		1,410		(869	)		541		1,410		(799	)		611

	$	2,363	$	(1,705	)	$	658	$	2,363	$	(1,618	)	$	745

Total amortization expense on intangible assets was $43,000 and $44,000 for the three months ended June 30, 2005 and 2004, respectively, and $87,000 for the six months ended June 30, 2005 and 2004.

The carrying amount of goodwill was $5.9 million at June 30, 2005 and December 31, 2004. There was no impairment loss recorded during either the three or six months ended June 30, 2005 and 2004.

(6)

Credit Facility

During the second quarter of 2005, the Bank of America Facility included a $15.0 million revolving line of credit with a maturity date of October 1, 2005 and an interest rate of LIBOR plus 1.75% (5.03% at June 30, 2005). This line of credit may be used to pay overdrafts in the Company’s checking accounts up to $1.5 million at any one time. As of June 30, 2005 and December 31, 2004, the Company had $485,000 and zero in bank overdrafts, respectively. The Bank of America Facility also included, as of June 30, 2005, up to $3.9 million through a reducing revolving term loan with a maturity date of October 1, 2008 and an interest rate of LIBOR plus 2.00% (5.28% at June 30, 2005). The Bank of America Facility is secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property. As of June 30, 2005 and December 31, 2004, the Company had $5.5 million and zero borrowings, respectively, and available credit of $13.4 million and $19.4 million, respectively, under the Bank of America Facility.

The Bank of America Facility requires adherence to certain financial covenants and contains restrictions related to capital expenditures and acquisitions during the term of the facility. As of June 30, 2005, the Company was in compliance with the financial covenants and capital expenditure and acquisition limitations as set forth in the Bank of America Facility. The Company’s covenant relating to timely filing of financial information has been waived by Bank of America until February 10, 2006.

(7)

Legal Matters

In Excelligence Learning Corporation v. Oriental Trading Company and Teresa Martini (Case no. 03-04947-JF (RS) in the U.S. District Court for the Northern District of California), the Company had asserted claims that included theft of trade secrets, trade dress infringement and copyright infringement against a former employee (Martini) it alleged had taken trade secrets and used them to the benefit of her new employer (Oriental Trading Company). As previously disclosed, on December 20, 2004, the District Court issued an order granting summary judgment in favor of defendants. On January 19, 2005, the Company filed a notice of appeal to the United States Court of Appeals for the Ninth Circuit. On April 21, 2005, the District Court issued a decision on defendants’ bill of costs and motion for attorneys’ fees, allowing approximately $160,000 in costs and granting defendants $250,000 in attorneys’ fees. After considering the costs of pursuing an appeal, the possibility of an additional financial award to defendants and continued diversion of management resources, the Company determined in May 2005 that a settlement was warranted. On May 11, 2005, the Company and the defendants entered into a settlement agreement pursuant to which the Company agreed to pay the defendants $240,000 in exchange for a release of liability from the costs and fees awarded by the District Court, and to dismiss its appeal, with prejudice, thereby settling the dispute. This settlement was recorded by the Company in the first quarter of 2005.

Aside from the above-referenced matters, the Company and its subsidiaries are, from time to time, party to legal proceedings arising in the normal course of business. In management’s opinion, there are no pending claims or litigation, the outcome of which would have a material effect on the Company’s consolidated results of operations, financial position or cash flows.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

The Company is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. Through a predecessor entity, the Company began operations in 1985. The Company utilizes multiple sales, marketing and distribution channels, primarily including:

•

its Discount School Supply catalog and website, through which the Company develops, markets and sells educational products to early childhood professionals and, to a lesser extent, consumers;

•

EPI’s fundraising programs, through which the Company sells school supplies and other products specifically targeted for use by children in kindergarten through sixth grade to elementary schools, teachers and other education organizations;

•

its ECMD catalog and website, through which the Company markets and sells furniture and equipment to early childhood professionals, and

•

Earlychildhood NEWS, an award winning print and web-based magazine focused on the growth and development of children from infancy through age eight.

All of the foregoing is supported by a national sales force, which, as of June 30, 2005, numbered 75 people.

The Company operates in two business segments: Early Childhood and Elementary School. The Early Childhood segment includes the brand names Discount School Supply, ECMD and Earlychildhood NEWS. The Early Childhood segment develops, manufactures and sells educational products through multiple distribution channels to early childhood professionals and, to a lesser extent, consumers. The Early Childhood segment also provides information to teachers and other education professionals regarding the development of children from infancy through age eight. The Elementary School segment sells school supplies and other products specifically targeted for use by children in kindergarten through sixth grade to elementary schools, teachers and other education organizations for fundraising activities.

Recent Developments

On September 7, 2005, after considering the results of its internal investigation, the Company determined that certain liabilities related to inventory, catalog costs and certain operating expenses were understated at December 31, 2004. The Company concluded that adjusting the effect of these items would be material to its previously reported results for fiscal year 2004 and the first quarter of 2005. Therefore, the Company has restated its previously issued financial statements for such year, as set forth in its Form 10-K/A, and such quarter, as set forth in its Form 10-Q/A, in each case recently filed with the Commission. For more information on the restatement, see the “Explanatory Note” that follows the cover page of this Form 10-Q.

Effective October 1, 2005, the Company entered into an amendment extending its secured credit facility with Bank of America. N.A. which includes a revolving line of credit for $20.0 million from April 16 to October 15 of each year and $10.0 million from October 16 to April 15 of each year until its maturity date of October 1, 2007 and an interest rate of LIBOR plus 1.50%. As amended, the credit facility also includes up to $5.0 million through a reducing revolving term loan with a maturity date of September 30, 2010 and an interest rate of LIBOR plus 2.0%. The entire facility remains secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property.

Critical Accounting Policies and Estimates

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, bad debts, product returns, intangible assets, inventories and deferred income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities

that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its condensed consolidated financial statements:

Revenue Recognition and Accounts Receivable

The Company recognizes revenue from product sales upon the delivery of products to an unrelated third party customer when (a) the customer takes title of the goods; (b) the price to the customer is fixed or determinable; (c) the customer is obligated to pay the Company and the obligation is not contingent on resale of the product; (d) the customer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product; (e) the Company does not have significant obligations for future performance to directly bring about resale of the product by the customer; and (f) collectibility is probable. Provisions for estimated returns and allowances are recorded as a reduction to sales and cost of sales based on historical experience. The Company determines that collectibility of accounts receivable is reasonably assured through standardized credit review to determine each customer’s credit worthiness. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

The Company uses the lower of cost or market under both the first-in, first-out and average cost methods to value inventories. In the Early Childhood segment, the Company uses the first-in, first-out method for its finished goods inventory and the average cost method for its raw materials inventory related to paint manufacturing. The Elementary School segment uses the average cost method for all inventories. Inventory cost is based on amounts paid to vendors plus the capitalization of certain labor and overhead costs necessary to prepare inventory to be saleable.

The Company writes down its inventory for estimated obsolescence, damaged or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

While the majority of the Company’s inventory is purchased from domestic vendors, a significant percentage is sourced from overseas. Inventory ordered from foreign vendors constituted 21.1% of the Company’s total inventory for the three months ended June 30, 2005, compared to 11.2% for the same period in 2004. For the six months ended June 30, 2005, inventory ordered from foreign vendors constituted 26.9% of the Company’s total inventory compared to 23.6% for the same period in 2004. The Company takes title to inventory purchased from overseas at point of shipment, whereas the Company takes title to inventory purchased from domestic vendors upon receipt.

Impairment of Long-Lived Assets

The Company assesses the need to record impairment losses on long-lived assets used in operations, including goodwill and other intangibles, when indicators of impairment are present. On an on-going basis, management reviews the value and period of amortization or depreciation of its long-lived assets. Recoverability of long-lived assets to be held and used is measured by comparing the carrying value of the asset group to the undiscounted future cash flow expected to be generated by the asset group. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.

The Company applies SFAS No. 142, Goodwill and Other Intangible Assets, to account for its goodwill and intangible assets. SFAS No. 142 provides that goodwill should not be amortized but instead be tested for impairment annually at the reporting unit level. In accordance with SFAS No. 142, the Company conducts its impairment test on an annual basis. The Company’s goodwill impairment test is based on a comparison of carrying values and fair value of the Company’s reporting units, its Early Childhood and Elementary School segments.

Income Taxes

The Company files a consolidated tax return with its wholly-owned subsidiaries. The Company’s condensed consolidated statements of operations reflect the income tax expense based on the actual tax position of the Company and its subsidiaries in effect for the respective periods.

The Company has recorded a deferred tax asset in an amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the value of the deferred tax asset, in the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax asset in the future, a decrease to the deferred tax asset would be charged to income in the period such determination was made.

Results of Operations

Revenues

Revenues were $29.8 million for the three months ended June 30, 2005, up $3.2 million, or 12.2%, from the $26.5 million recorded for the same period in 2004. The increase was attributable to revenue growth of $3.1 million in the Early Childhood segment, up 14.4% from the prior year period, and $130,000 in the Elementary School segment, up 2.6% from the prior year period. The Early Childhood segment continued its trend of revenue growth through new product offerings, new customer solicitation and improved sales and marketing strategies. Average sales price per unit for the Early Childhood segment increased 7.8%, with total units sold in the segment up 8.3% from the second quarter of 2004. The growth in the Elementary School segment was fueled primarily by back-to-school revenue that was higher than the previous year, which was due to an increase in early deliveries. The average sales price per unit for the Elementary School segment up 17.0% from the second quarter of 2004, with total units sold in the segment down 10.9% from the second quarter of 2004.

For the six months ended June 30, 2005, revenues were $52.4 million, up $6.0 million, or 12.9%, from the $46.4 million recorded for the same period in 2004. The increase was attributable to revenue growth of $6.0 million, or 15.2%, in the Early Childhood segment and a decrease of $57,000, or 0.8%, in the Elementary School segment. The decrease in the Elementary School segment revenues occurred in the first quarter and was primarily related to a declining demand for science fair products. The average sales price per unit for the Early Childhood segment increased 7.3% during the same period in 2004, with total units sold in the segment up 8.8% from the first six months of 2004. The average sales price per unit for the Elementary School segment was up 16.7% from the same period in 2004, with total units sold in the segment down 11.5% from the same period in 2004.

The Company will continue with its goal to achieve revenue growth in the Early Childhood and Elementary School segments by improving circulation of its catalogs, offering new proprietary products, soliciting new customers, implementing more aggressive sales and marketing strategies and enhancing the Company’s websites. Certain factors that could cause actual results to differ materially from the Company’s expectations are discussed in “Item 1. Risk Factors” in the Company’s Amended Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004.

Gross Profit

Gross profit was $9.9 million for the three-month period ended June 30, 2005, a $663,000, or 7.0%, increase over the gross profit of $9.3 million for the same period in 2004. The increase was primarily attributable to increased revenue in the period. Gross profit as a percentage of sales decreased to 33.4 % for the second quarter of 2005 from 35.0% for the second quarter of 2004.

Gross profit was $18.1 million for the six months ended June 30, 2005, a $1.9 million, or 11.5%, increase over the gross profit of $16.2 million for the same period in 2004. The increase was primarily attributable to increased revenue in the period. Gross profit as a percentage of sales decreased slightly to 34.5% for the six months ended June 30, 2005, from 34.9% for the same period in 2004.

The Company accounts for shipping costs as cost of goods sold for shipments made directly from vendors to customers and also for shipments from the Company’s warehouses. The amount of shipping costs related to shipments from the Company’s warehouses for the three months ended June 30, 2005 and 2004 was $1.9 million and $1.5 million, respectively, or 6.5% and 5.8% as a percentage of total sales, respectively. For the six months ended June 30, 2005 and 2004, these shipping costs totaled $3.6 million and

$3.0 million, respectively, or 6.8% and 6.6% as a percentage of total sales, respectively. The amount of shipping costs related to shipments made directly from vendors to customers for the three months ended June 30, 2005 and 2004 was $1.0 million and $1.1 million, respectively, or 3.2% and 4.1% as a percentage of sales, respectively. For the six months ended June 30, 2005 and 2004, these shipping costs totaled $1.9 million and $1.9 million, respectively, or 3.7% and 4.1% as a percentage of sales, respectively.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include wages and commissions, catalog costs, operating expenses (which include customer service and certain warehouse costs), administrative costs (which include information systems, accounting, legal and human resources), e-business costs, equity-based compensation and depreciation of property and equipment. Selling, general and administrative expenses were $8.8 million for the three months ended June 30, 2005, down slightly from the $9.0 million for the same period in 2004. As a percentage of sales, selling, general and administrative expenses were 29.5% for the second quarter of 2005, compared to 33.8% for the second quarter of 2004.

For the six months ended June 30, 2005, selling, general and administrative expenses were $17.7 million, up $161,000 from the $17.5 million for the same period in 2004. The increase, which occurred mainly in the first quarter, was caused by a $240,000 charge related to a legal settlement and growth in warehouse personnel made necessary by the Company’s decision to increase inventory levels to meet seasonal demands earlier in 2005 than it did in 2004. Selling, general and administrative expenses as a percentage of sales were 33.8% and 37.7% for the six months ended June 30, 2005 and 2004, respectively.

Amortization of Other Intangible Assets

Amortization of other intangible assets was $43,000 and $44,000 for the three months ended June 30, 2005 and 2004, respectively, and $87,000 for the six months ended June 30, 2005 and 2004.

Interest Expense

Interest expense was $53,000 and $40,000 for the three months ended June 30, 2005 and 2004, respectively, and $58,000 and $45,000 for the six months ended June 30, 2005 and 2004, respectively. The increase during the 2005 periods mainly occurred in the second quarter and was primarily attributable to increased balances outstanding under the Company’s line of credit.

Income Taxes

The Company recorded an income tax expense of $419,000 and $99,000 for the three-month periods ended June 30, 2005 and 2004, with an effective a tax rate of 39.3% and 42.1%, respectively. For the six-month periods ended June 30, 2005 and 2004, income tax expense (benefit) were $62,000 and $(602 ,000), respectively, resulting in effective rates of 23% and (42.7)%, respectively. The difference between the Company’s effective rate for this six-month period ended June 30, 2005 and its statutory rate is primarily attributable to a discrete benefit reported in the first quarter of 2005 associated with changes in the estimated effective state rate which is anticipated to apply to the Company’s state deferred tax assets and liabilities in the future.

Recent Accounting Pronouncements

In December 2004, FASB issued a revised version of Statements of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (“SFAS 123R”), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R requires recognition of the cost of employee services received in share-based payment transactions, thereby reflecting the economic consequences of those transactions in the financial statements. The accounting provisions of SFAS 123R are effective beginning with the first annual reporting period that begins after June 15, 2005, and the Company will be required to adopt SFAS 123R in the first quarter of 2006. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. See “Equity-Based Compensation” above for the pro forma net income (loss) and net income (loss) per share amounts for the three and six months ended June 30, 2005 and 2004 as if the Company had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although it has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123, the Company expects the adoption of SFAS 123R to have a significant adverse impact on the Company’s consolidated statements of operations and net income (loss) per share.

Liquidity and Capital Resources

On September 26, 2003, the Company entered into a $20.0 million secured credit facility with Bank of America, N.A. (the “Bank of America Facility”). During the last quarter of 2004, pursuant to the financing schedule contained in the Bank of America Facility, the amount available under the facility stepped down to $19.4 million. As of April 1, 2005, the amount available under the Bank of America Facility was further reduced pursuant to the financing schedule to $18.9 million. Effective October 1, 2005, the Company entered into an amendment extending its secured credit facility with Bank of America. N.A. which includes a revolving line of credit for $20.0 million from April 16 to October 15 of each year and $10.0 million from October 16 to April 15 of each year until its maturity date of October 1, 2007 and an interest rate of LIBOR plus 1.50%. As amended, the credit facility also includes up to $5.0 million through a reducing revolving term loan with a maturity date of September 30, 2010 and an interest rate of LIBOR plus 2.0%. The entire facility remains secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property.

The Company’s primary cash needs are for operations and capital expenditures. Additionally, there may be future cash needs for acquisitions. The Company’s primary source of liquidity is cash flow from operations and the Bank of America Facility. As of June 30, 2005, the Company had net working capital of $25.1 million.

During the six months ended June 30, 2005, the Company’s operating activities used $7.5 million of cash. The use of cash was primarily related to increased balances within accounts receivable and inventories, which was partially offset by an increase in accounts payable. The Company used $899,000 in cash for investing activities during the six months ended June 30, 2005, with which the Company purchased property and equipment. The Company obtained $5.8 million in cash from financing activities, primarily from borrowings against its line of credit and as a result of exercised stock options.

The Bank of America Facility includes a $15.0 million revolving line of credit with a maturity date of October 1, 2005 and an interest rate of LIBOR plus 1.75% (5.03% at June 30, 2005). This line of credit may be used to pay overdrafts in the Company’s checking accounts up to $1.5 million at any one time. As of June 30, 2005 and December 31, 2004, the Company had $485,000 and zero in bank overdrafts, respectively. The Bank of America Facility also includes, as of June 30, 2005, up to $3.9 million through a reducing revolving term loan with a maturity date of October 1, 2008 and an interest rate of LIBOR plus 2.00% (5.28% at June 30, 2005). The Bank of America Facility is secured by substantially all of the Company’s assets, including receivables, inventory, equipment and intellectual property. As of June 30, 2005 and December 31, 2004, the Company had $5.0 million and zero borrowings, respectively, and available credit of $13.4 million and $19.4 million, respectively, under the Bank of America Facility.

The Bank of America Facility requires adherence to certain financial covenants and contains restrictions related to capital expenditures and acquisitions during the term of the facility. As of June 30, 2005, the Company was in compliance with the financial covenants and capital expenditure and acquisition restrictions as set forth in the Bank of America Facility. The Company’s covenant relating to timely filing of financial information has been waived by Bank of America until February 10, 2006.

Management believes that available cash on hand and availability under the Bank of America Facility will provide adequate funds for the Company’s foreseeable working capital needs and planned capital expenditures. The Company’s ability to fund its

operations, repay debt, make planned capital expenditures and to remain in compliance with its financial covenants under the Bank of America Facility depends on its future operating performance and cash flow, which in turn, are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond its control.

As of June 30, 2005, the Company did not have any guarantees, including loan guarantees, standby letters of credit or indirect guarantees.

The following table summarizes the Company’s contractual obligations as of June 30, 2005 and the effect such obligations are expected to have on liquidity and cash flow in future periods (in thousands):


	Payments due by period
Contractual Obligations	Total		Less than 1 year		1 – 3 years		4 – 5 years		More than 5 years
Revolving line of credit	$	5,000	$	5,000	$	—	$	—	$	—
Non-cancelable Operating Lease Obligations		8,422		2,832		4,666		924		—

Total	$	13,422	$	7,832	$	4,666	$	924	$	—

Business Outlook

The following forward-looking statements reflect the Company’s expectations for the full year 2005. Actual results may differ materially from these expectations. See “Forward-Looking Statements.” Certain factors that could cause actual results to differ materially from the Company’s expectations are discussed in “Item 1. Risk Factors” in the Company’s Amended Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004. The Company does not undertake to update these expectations, except to the extent that it is required to do so.

Management’s goal is to continue revenue growth through improving circulation of its catalogs, offering new proprietary products, soliciting new customers for its Early Childhood and Elementary School segments, and implementing more aggressive pricing strategies in both segments.

For fiscal year 2005:

•

Net revenues are expected to be between $125.0 and $135.0 million; and

•

Operating income is expected to be between $5.0 and $8.0 million.

Off-Balance Sheet Arrangements

There are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have a material effect on the Company’s financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Seasonality

The Company’s seasonal sales trends coincide with the start of each school year. For the fiscal year ended December 31, 2004, 44% of the Company’s consolidated annual sales were generated in the third calendar quarter. The Company’s working capital needs are greatest during the first and second quarters as inventory levels are increased to meet seasonal demands.

Inflation

Inflation has and is expected to have only a minor effect on the Company’s results of operations and sources of liquidity.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

The following discussion of market risk includes statements that involve risks and uncertainties that could significantly offset anticipated results in the future. Actual results could differ materially from those projected in the forward-looking statements. See “Forward-Looking Statements.” The Company does not use derivative financial instruments for speculative or trading purposes.

Interest Rate Risk

The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable and a revolving line of credit. Market risks relating to operations result primarily from a change in interest rates. The Company’s borrowings are primarily dependent upon LIBOR rates. As of June 30, 2005, the Company had borrowings of $5.0 million under the Bank of America Facility and available credit of $13.9 million. The Company also had a bank overdraft of $485,000 which it intends to repay through borrowings against its revolving line of credit. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” The estimated fair value of borrowings under the Bank of America Facility is expected to approximate its carrying value.

Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and accounts receivable. The Company has no customer comprising greater than 10% of its revenues. However, receivables arising from the normal course of business are not collateralized and management continually monitors the payment of its accounts receivable and the financial condition of its customers to reduce the risk of loss. The Company does not believe that its cash and cash equivalents are subject to any unusual credit risk beyond the normal credit risk associated with commercial banking relationships.

Foreign Currency Risk

The Company purchases some of its products from foreign vendors. Accordingly, the Company’s prices of imported products are subject to variability based on foreign exchange rates. However, the Company’s purchase orders are denominated in U.S. dollars and the Company does not enter into long-term purchase commitments.

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company has established and currently maintains disclosure controls and procedures designed to ensure that material information required to be disclosed in its reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and that any material information relating to the Company is recorded, processed, summarized and reported to its principal officers to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving desired control objectives. In reaching a reasonable level of assurance, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

In conjunction with the close of the period covered by this report, the Company conducted a review and evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (who is also serving as the Company’s Principal Financial Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. As further discussed below, material weaknesses were identified in the Company’s internal control over financial reporting. The Public Company Accounting Oversight Board’s Auditing Standard No. 2 defines a material weakness as a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Subsequent to the filing of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, it came to the attention of management that certain current and former accounting personnel alleged that the Company had failed to record and accrue for certain obligations for the fiscal year ended as of that date. In accordance with the Company’s Complaint and Investigation Procedures for Accounting, Internal Accounting Controls, Fraud and Auditing Matters, following a preliminary inquiry by the Company’s General Counsel, the matter was reported to the Audit Committee of the Board of Directors. The Audit Committee engaged independent counsel to conduct an investigation and to direct forensic accounting consultants to assist in the investigation. The results of that investigation were reported to the Audit Committee and the Board of Directors, and included findings which, upon the recommendation of management, the Board determined would require a material adjustment to, and restatement of, the Company’s previously reported financial statements for the year ended December 31, 2004 and the quarter ended March 31, 2005.

The Company determined that this restatement is attributable to a number of factors. The most significant factor was the Company’s failure to timely record and accrue for certain invoices relating to inventory on hand as of year end. The Company determined, based upon the results of its internal investigation, that its accrual of accounts payable for inventory did not include certain inventory items that had been received but had not been paid for by the Company prior to the end of fiscal 2004. As a result of

the in-depth review procedures performed by the Company, the forensic accountants and the Company’s registered independent public accountants, certain additional accounting errors were identified relating to 2004 which are also reflected in the restatement. Those additional errors included an understatement of costs capitalized into inventory, an understatement of the provision for sales returns, an understatement of certain selling, general and administrative expenses, an understatement of compensation expense for deferred compensation amounts relating to previously issued stock options, and an understatement of income taxes related to stock option exercises.

The restatement of previously issued financial statements is a strong indicator that one or more material weaknesses in internal control over financial reporting may exist. As a result, the Company’s Chief Executive Officer and Board of Directors have concluded that, as of June 30, 2005, the end of the period covered by this quarterly report, the Company’s disclosure controls and procedures were not effective to ensure that information required to be disclosed under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

The material weaknesses that were found to exist are:

•

Inadequate staffing and training in the accounting function over the Company’s processing of certain financial information.

Management identified this material weakness based on the internal investigation conducted at the direction of the Audit Committee, including review of the work product of the forensic accountants retained to assist in the investigation. The Company believes that invoices for inventory on hand at year end, catalog costs and certain operating expenses were neither timely processed for payment nor adequately accrued. The internal investigation revealed that certain invoices had been set aside pending completion of the year-end audit without definitively determining whether the invoices were properly accrued, and that some of the Company’s accounting personnel were aware of this treatment of invoices, but failed to bring the matter to the attention of appropriate senior management, the Audit Committee, or the independent auditors. The Company has determined that this material weakness contributed to the failure to timely pay or properly accrue for certain invoices (relating primarily to inventory and catalog costs) as of December 31, 2004. These conditions also contributed to the other errors that were noted and corrected during the in-depth review procedures performed by the Company, the forensic accountants and the Company’s registered independent public accountants.

•

Improper segregation of duties over the processing and review of journal entries.

Management identified this material weakness based on an incorrect journal entry directed by the former Chief Financial Officer, which was found during the course of the investigation and reduced the accounts payable expense for inventory on hand at year end. The investigation revealed and management confirmed that the adjusting journal entry was not adequately justified and was out of line with the Company’s ordinary practices. Although the investigation revealed that other accounting employees, including the former Controller, were aware of and disagreed with the adjusting entry, they did not raise the matter with other senior management, the Audit Committee, or the independent auditors.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2005 that materially affected, or were reasonably likely to affect, the Company’s control over financial reporting.

Subsequent to the discovery of the material weaknesses, the Company has taken and continues to take the following steps to remediate the material weaknesses found to exist during its evaluation of disclosure controls and procedures:

•

The first identified material weakness had already begun being remediated by the Company with its implementation of procedures in May 2005 to ensure that its accounts payable invoices are processed promptly in accordance with standard procedures when received, and that accruals are maintained and reviewed by appropriate senior accounting and financial reporting management on a monthly basis. In addition, the Company’s Chief Financial Officer resigned effective as of September 13, 2005 and the Company is in the process of identifying a new Chief Financial Officer. The Company’s former Controller had been terminated in June 2005. The Company has significantly increased the number and skills and training of management and staff personnel in its accounting and finance departments, including training in the Company’s whistleblower policies and procedures, implemented enhanced segregation of duties, documented and implemented specific desk-level procedures in the accounting and financial reporting departments. The Company believes that the first identified material weakness has been substantially remediated, and additional controls and safeguards are being evaluated; and

•

To remediate the second identified material weakness, the Company has implemented and documented rigorous and detailed procedures for the closing of each fiscal period that include specific protocols for the timely review by appropriate senior accounting and financial reporting management of all adjusting journal entries. In addition, the Company significantly increased the number and skills and training of management and staff personnel in its accounting and finance departments, including training in the Company’s whistleblower policies and procedures, and implemented enhanced segregation of duties. In addition, as noted, the Company is in the process of identifying a new Chief Financial Officer and has replaced the former Controller. The Company believes that the second identified material weakness has been substantially remediated, and additional controls and safeguards are being evaluated.

In addition to the remediation steps describe above, the Company has:

•

Implemented new software enhancements to improve and/or integrate major systems and enhance the control environment in the areas of financial planning and analysis, internal reporting, and integration of the sales order entry and inventory subsystems with the general ledger system;

•

Initiated training and education of all relevant personnel involved in interactions with the Company’s independent registered public accounting firm designed to ensure that such personnel understand and comply with the provisions of the Securities Exchange Act of 1934, and the rules promulgated thereunder, regarding representations to the Company’s independent registered public accountants;

•

Communicated with all Company employees reaffirming the Company’s whistleblower protections; and

•

Accelerated the documentation and internal control evaluation processes contemplated by Section 404 of the Sarbanes-Oxley Act.

Management believes the measures that have been implemented to remediate the material weaknesses have had a significant and positive impact on the Company’s internal control over financial reporting since December 31, 2004 and anticipates that these measures and other ongoing enhancements will continue to strengthen the Company’s internal control over financial reporting in future periods.

Although the Company has implemented and continues to implement remediation efforts, a material weakness indicates that there is more than a remote likelihood that a material misstatement of the Company’s financial statements will not be prevented or detected. In addition, the Company cannot ensure that it will not in the future identify further material weaknesses or significant deficiencies in its internal control over financial reporting that it has not discovered to date. The Company has taken and is taking steps to improve its internal control over financial reporting to comply with Section 404 of the Sarbanes-Oxley Act as required by the end of 2007. The efforts it has taken and continues to take are subject to continued management review supported by confirmation and testing by management, as well as Audit Committee oversight. As a result, additional changes are likely to be made to the Company’s internal control over financial reporting. Other than the foregoing initiatives since the date of the evaluation supervised by management, there have been no material changes in the Company’s disclosure controls and procedures, or the Company’s internal control over financial reporting, that could have materially affected, or are reasonably likely to materially affect, the Company’s disclosure controls and procedures or the Company’s internal control over financial reporting.

The Company performed additional analyses and other post-closing procedures to address the material weaknesses and to ensure that the consolidated financial statements contained in this report were prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects the Company’s financial position, results of operations and cash flows for the periods presented.

PART II

OTHER INFORMATION

Item 1.

Legal Proceedings.

Aside from the above-referenced administrative proceeding, the Company and its subsidiaries are, from time to time, party to legal proceedings arising in the normal course of business. In management’s opinion, there are no pending claims or litigation, the outcome of which would have a material effect on the Company’s consolidated results of operations, financial position or cash flows.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3.

Defaults Upon Senior Securities.

None.

Item 4.

Submission of Matters to a Vote of Security Holders.

The Company submitted to stockholder vote and its stockholders approved the following items at the Company’s Annual Meeting of Stockholders held on May 10, 2005.

Election of two directors for additional three-year terms:


Name	Votes For	Withheld Authority
Louis Casagrande	7,796,989	13,482
Scott Graves	7,556,673	253,798

In addition to the two directors listed above, the terms of the following five directors continued after the meeting: Dean DeBiase, Richard Delaney, Ronald Elliott, Colin Gallagher, and Robert MacDonald.

Ratification of the appointment of KPMG LLP as the Company’s independent auditors for the fiscal year ending December 31, 2005 by a vote of 7,790,801 “for,” 19,396 “against,” and 274 abstentions.

Item 5.

Other Information.

None.

Item 6.

Exhibits.



* 31.1		Certification of Chief Executive Officer and Principal Financial Officer, pursuant to Rule 13a-14 promulgated under the Exchange Act, as created by Section 302 of the Sarbanes-Oxley Act of 2002.

* 32.1		Certification of Chief Executive Officer and Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith.

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: February 3, 2006


EXCELLIGENCE LEARNING CORPORATION

By:		/s/ Ronald Elliott
		Ronald Elliott
		Chief Executive Officer (Duly Authorized Officer and Acting Principal Financial Officer)

EX-31.1 2 dex311.htm CERTIFICATION OF CEO & PFO Certification of CEO & PFO

Exhibit 31.1

Certification of Chief Executive Officer and Principal Financial Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Ronald Elliott, certify that:

1. I have reviewed this amended quarterly report on Form 10-Q of Excelligence Learning Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 3, 2006

/s/ Ronald Elliott

Ronald Elliott

Chief Executive Officer and

Acting Principal Financial Officer

EX-32.1 3 dex321.htm CERTIFICATION OF CEO & PFO Certification of CEO & PFO

Exhibit 32.1

Certification of Chief Executive Officer and Principal Financial Officer

Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Excelligence Learning Corporation (the “Company”) hereby certifies, to such officer’s knowledge, that:

(i) the accompanying Quarterly Report on Form 10-Q of the Company for the quarterly period ended June 30, 2005 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


Dated: February 3, 2006				/s/ Ronald Elliott
				Ronald Elliott
				Chief Executive Officer and Acting Principal Financial Officer

The foregoing certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. § 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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