UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 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: July 29, 2000 Commission File Number: 0-3713 NATIONAL COMPUTER SYSTEMS, INC. ----------------------------------------------------------------- (Exact name of registrant as specified in its charter) Minnesota 41-0850527 ------------------------------- -------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 11000 Prairie Lakes Drive Eden Prairie, Minnesota 55344 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (952)829-3000 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 and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date: The number of shares of common August 28, 2000, was 32,820,972. PART I. FINANCIAL INFORMATION Item 1. Financial Statements NATIONAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (unaudited) For the periods ended July 29, 2000 and July 31, 1999 Second Quarter Year-to-date -------------------- -------------------- 2000 1999 2000 1999 -------- -------- -------- -------- (In thousands, except per share amounts) REVENUES Services $154,801 $114,591 $287,958 $200,256 Product sales 49,897 53,073 91,103 93,225 -------- -------- -------- -------- Total revenues 204,698 167,664 379,061 293,481 COST OF REVENUES Cost of services 107,901 75,877 202,628 137,915 Cost of product sales 21,164 21,623 38,781 37,271 -------- -------- -------- -------- Gross profit 75,633 70,164 137,652 118,295 OPERATING EXPENSES Sales and marketing 17,731 18,969 35,002 35,541 Research and development 7,050 4,740 13,158 8,413 General and administrative 23,060 24,270 46,714 40,525 -------- -------- -------- -------- INCOME FROM OPERATIONS 27,792 22,185 42,778 33,816 Interest expense 412 266 530 428 Other expense, net (327) (41) 72 325 -------- -------- -------- -------- INCOME BEFORE INCOME TAXES 27,707 21,960 42,176 33,063 Income taxes 11,000 8,800 16,700 13,250 -------- -------- -------- -------- NET INCOME $ 16,707 $ 13,160 $ 25,476 $ 19,813 ======== ======== ======== ======== EARNINGS PER SHARE Basic $0.51 $0.42 $0.78 $0.63 Diluted 0.50 0.40 0.76 0.60 See Notes to Consolidated Financial Statements. NATIONAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited) July 29, January 29, 2000 2000 -------- ----------- (In thousands) ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,457 $ 26,592 Marketable securities 24,956 - Receivables 176,687 151,870 Inventories: Finished products 5,724 5,880 Scoring services and work in process 32,336 23,158 Raw materials and purchased parts 4,163 4,581 -------- -------- Total inventories 42,223 33,619 Prepaid expenses and other 9,955 9,932 -------- -------- TOTAL CURRENT ASSETS 260,278 222,013 PROPERTY, PLANT AND EQUIPMENT Land, buildings and improvements 72,658 67,928 Machinery and equipment 208,816 189,835 Accumulated depreciation (136,065) (125,654) -------- -------- Net property, plant and equipment 145,409 132,109 INTELLECTUAL PROPERTIES, NET Acquired and internally developed software products 8,611 9,371 Educational content and assessment instruments 22,109 23,306 -------- -------- Net intellectual properties 30,720 32,677 OTHER ASSETS, NET Goodwill 51,205 50,263 Other assets 12,334 12,818 -------- -------- Net other assets 63,539 63,081 -------- -------- TOTAL ASSETS $499,946 $449,880 ======== ======== See Notes to Consolidated Financial Statements. NATIONAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited) July 29, January 29, 2000 2000 --------- ----------- (In thousands) LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of long-term debt $ 302 $ 1,270 Accounts payable 27,880 38,546 Accrued expenses 82,777 73,163 Deferred income 54,088 51,785 Income taxes 14,028 6,570 -------- -------- TOTAL CURRENT LIABILITIES 179,075 171,334 LONG-TERM DEBT -- less current maturities 516 516 DEFERRED INCOME TAXES 1,094 1,642 COMMITMENTS AND CONTINGENCIES - - STOCKHOLDERS' EQUITY Preferred stock - - Common stock--issued and outstanding - 32,770 and 32,348 shares, respectively 983 970 Paid-in capital 28,092 22,596 Retained earnings 279,414 257,195 Accumulated other comprehensive income - Unrealized gain on marketable securities 15,354 - Foreign currency translation adjustment (3,639) (2,969) Deferred compensation (943) (1,404) -------- -------- TOTAL STOCKHOLDERS' EQUITY 319,261 276,388 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $499,946 $449,880 ======== ======== See Notes to Consolidated Financial Statements. NATIONAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) For the six-month periods ended July 29, 2000 and July 31, 1999 July 29, July 31, 2000 1999 -------- -------- (In thousands) OPERATING ACTIVITIES Net income $ 25,476 $ 19,813 Depreciation and amortization 21,445 17,991 Deferred income taxes and other (470) (499) Changes in operating assets and liabilities: Accounts receivable (24,817) (5,087) Inventory and other current assets (8,627) (8,375) Accounts payable and accrued expenses 4,655 11,302 Deferred income 2,303 6,593 ------- ------- Net cash provided by operating activities 19,965 41,738 ------- ------- INVESTING ACTIVITIES Purchases of property, plant and equipment (25,964) (15,597) Purchases of business systems (4,431) (7,683) Acquisitions, net (5,734) (19,059) Other, net (404) 1,317 ------- ------- Net cash used in investing activities (36,533) (41,022) ------- ------- FINANCING ACTIVITIES Net increase in revolving credit borrowings - 5,000 Net repayment of other borrowings (568) (268) Issuance of common stock, net 256 1,084 Dividends paid (3,255) (3,163) ------- ------- Net cash provided (used) by financing activities (3,567) 2,653 ------- ------- Increase (decrease) in cash and cash equivalents (20,135) 3,369 CASH AND CASH EQUIVALENTS - beginning of period 26,592 16,310 ------- ------- CASH AND CASH EQUIVALENTS - end of period $ 6,457 $19,679 ======= ======= See Notes to Consolidated Financial Statements. NATIONAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share data) Note A - The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations and cash flows for all periods presented have been made. The consolidated results of operations for the periods ended July 29, 2000 are not necessarily indicative of the operating results that may be expected for the entire fiscal year ending February 3, 2001. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in National Computer Systems, Inc. and Subsidiaries' Annual Report on Form 10-K for the year ended January 29, 2000. Note B - Earnings per share are calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share." The following table is a reconciliation of the earnings numerator and the weighted-average shares denominator used in the calculations of basic and diluted earnings per share: Quarter Ended Year-to-date July 29, July 31, July 29, July 31, 2000 1999 2000 1999 -------- -------- ------- ------- Earnings: Net income for basic earnings per share $16,707 $13,160 $25,476 $19,813 Adjustments for dilutive securities: Interest expense on convertible debentures, net of tax - 43 5 84 ------- ------- ------- ------- Adjusted net income for diluted earnings per share $16,707 $13,203 $25,481 $19,897 ======= ======= ======= ======= Weighted Average Share: Basic average shares 32,611 31,714 32,483 31,597 Adjustments for dilutive securities: Employee stock options, net of tax proceeds 980 895 986 920 Contingent stock awards, net of tax proceeds 17 35 23 36 Convertible debentures - 383 5 387 ------- ------- ------- ------- Diluted average shares 33,608 33,027 33,497 32,940 ======= ======= ======= ======= Basic earnings per share $ 0.51 $ 0.42 $ 0.78 $ 0.63 ======= ======= ======= ======= Diluted earnings per share $ 0.50 $ 0.40 $ 0.76 $ 0.60 ======= ======= ======= ======= Note C - Marketable Securities: On January 29, 2000 the Company held a minority investment in a privately held company and carried the investment at cost of $350. During the first quarter, the shares of that company began trading on The Nasdaq Stock Market(R), and therefore, NCS has begun accounting for this marketable security under Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. In accordance with this Statement, the Company accounts for this investment as available for sale, and has recorded the asset at the current market value of $24,956, with the unrealized gain, net of tax, as a separate component of Stockholders' Equity. Under the terms of the initial public offering, the Company will not be able to sell the securities until September 1, 2000. Future fluctuations in value will be recorded in Stockholders' Equity until the time of sale. Note D - The Company has 10,000,000 shares of $.01 par value Preferred Stock authorized of which none is outstanding. 100,000,000 shares of $.03 par value Common Stock are authorized. Note E - The components of comprehensive income for the quarter and year-to-date ended July 29, 2000 and July 31, 1999 are as follows (in thousands): Second quarter Year-to-date 2000 1999 2000 1999 ------- ------- ------- ------- Net income $16,707 $13,160 $25,476 $19,813 Increase in market value of marketable securities, net of tax 4,088 - 15,354 - Foreign currency translation adjustments (102) 344 (672) 1,347 ------- ------- ------- ------- Comprehensive income $20,693 $13,504 $40,158 $21,160 ======= ======= ======= ======= Note F - In March 2000 the Company purchased the minority interest in its Australian joint venture for $5.7 million. The purchase price has been allocated principally to goodwill. Note G - On July 31, 2000 the Company announced that it had entered into a definitive agreement under which NCS would be acquired by Pearson plc (Pearson), a U.K.-based international media, publishing and education company. On August 7, 2000Pearson commenced a cash tender offer to purchase all of the outstanding shares of NCS common stock. Completion of the transaction was subject to customary conditions, including certain regulatory approvals. The tender period ended on September 7, 2000; 94.76% of the shares were validly tendered and not withdrawn. The articles of merger will be filed in accordance with the Agreement and Plan of Merger, dated July 30, 2000. Note H - The Company has five reportable business segments; the table below presents information by segment.

Assessments Education Data & Testing Software & NCS Collection Services Services Services Systems International Totals ----------- ----------- ---------- ---------- -------------- --------- Second Quarter Ended 47/29/00 Revenues $ 5071,~~890~~113 $3240,~~307~~987 $56 54,~~240~~217 $2021,~~289~~661 $1416,~~637~~720 $~~174~~204,~~363~~698 Income from operations 816,~~601~~863 ~~(885)~~3,989 118,~~280~~023 4,~~990~~258 12,~~068~~137 2535,~~054~~270 Second Quarter Ended 57/131/99 Revenues $ 3153,~~927~~930 $2844,~~326~~481 $33 35,~~797~~437 $2021,~~830~~823 $1011,~~937~~993 $~~125~~167,~~817~~664 Income from operations 315,~~734~~084 15,~~131~~758 54,~~486~~818 5,~~246~~771 1,~~028~~037 1632,~~625~~468 Year-to-date through 7/29/00 Revenues $122,003 $73,294 $110,457 $41,950 $31,357 $379,061 Income from operations 25,463 3,260 19,167 9,288 3,204 60,382 Year-to-date 7/31/99 Revenues $ 85,857 $72,807 $ 69,234 $42,653 $22,930 $293,481 Income from operations 18,818 6,889 10,304 11,018 2,065 49,094 The difference between segment totals and the Company's consolidated totals for income from operations is central general and administrative expenses and non-operating expenses, which are not allocated to the segments.

Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition National Computer Systems, Inc. (NCS or the Company)is a global information services company providing software, services, systems and Internet-based technologies for the collection, management and interpretation of data. The Company serves segments of the education, testing, assessment and complex data management markets. Recap of 2000 Second Quarter Results For the quarter ended July 29, 2000, total revenues increased by $37.0 million or 22.1% from the quarter ended July 31, 1999. Gross profit increased $5.5 million, or 7.8%, but decreased as a percent of revenue from 41.8% to 36.9%. Income from operations for the quarter increased $5.6 million or 25.3% over the prior year second quarter. Net income increased 27.0% over the quarter ended July 31, 1999, and diluted earnings per share increased 25.0% to $0.50 per share from $0.40 in the prior year second quarter. On a year-to-date basis, total revenues increased by $85.6 million or 29.2% over the same period in the prior year. As measured against the same period in the prior year, overall gross margin decreased 4.0% as a percent of revenue, and gross margin dollars increased $19.4 million or 16.4%. Income from operations year-to-date increased $9.0 million or 26.5% compared to the prior year. Net income increased 28.6%, and earnings per share (diluted) increased 26.7% to $0.76 per share from $0.60 in the prior year. Revenues By revenue category, Services revenue increased 35.1% (43.8% year-to-date) and Product sales decreased 6.0% (2.3% year-to-date). By reportable segment, revenues comparisons to the last year are as follows: Quarter Year-to-date Assessments and Testing Services +31.9% +42.1% Educational Software and Services - 7.9 - 0.7 NCS Services +53.0 +59.5 Data Collection Systems - 0.7 - 1.6 International +39.4 +36.8 For both the second quarter and year-to-date, increases in Assessments and Testing Services were the result of increased state educational tests and electronic testing. Educational Software and Services had increases in service revenue from software support and software product licensing, offset by lower revenue in network services and network related hardware. NCS Services revenues were higher due greatly to $18 million of revenue related to the U.S. Census project ($37 million year-to-date). Data Collection Systems revenues were relatively flat, year-on-year, in both documents and data collection hardware. International revenues increased as a result of the Argentine telecommunications project and increases in Australian educational testing. Cost of Revenues and Gross Margins For the quarter ended July 29, 2000, the Company's overall gross margin was 36.9%, compared to 41.8% in the earlier period. The decrease reflects the continued general change in revenue mix towards services, which has a lower gross margin percent and also some lower margins on certain state assessment contracts. On a quarter-to-quarter basis, the gross margin in service revenue decreased as a percentage of revenue, with declines in state assessments and government services, principally the impact of the Census project, offsetting slight percentage improvements in education software support and electronic testing. Product sales gross profit decreased slightly in several areas, including education software, where subscription based revenues are becoming a greater portion of the total product revenues. The same variances were seen in each category on a year-to-date basis. Operating Expenses Sales and marketing expenses decreased $1.2 million or 6.5% in the quarter ended July 29, 2000 over the prior year second quarter. As a percentage of revenues, second quarter sales and marketing expenses declined by 2.7 percentage points, due primarily to the relatively lower selling costs associated with services revenues. On a year-to-date basis, these expenses decreased 1.5%, and 2.9 percentage points as a percentage of revenue. Research and development costs increased $2.3 million, or 48.7%, in the quarter ended July 29, 2000 as compared to the prior year and increased 56.4% on a year-to-date basis. This increased spending was a result of higher investments in Internet-delivered products and services, primarily for the K-12 Education Software segment, as well as other product and service offerings. General and administrative expenses decreased by $1.2 million, or 5.0%, for the quarter ended July 29, 2000 from the prior year quarter. As a percentage of revenue, second quarter general and administrative expense decreased from 14.5% to 11.3%. On a year-to-date basis these expenses increased $6.2 million but decreased as a percent of revenues from 13.8% to 12.3%. The earlier year's quarter reflected higher employee benefit costs associated with a new vacation policy, as well as variable compensation costs reflecting favorable operating results. On a year-to-date basis, these expenses increased in the current year due to variable compensation accrued because of the Company's first quarter stock price appreciation, as well as increased information technology costs. Non-operating Expenses Interest expense and other expense, net, were insignificant for all periods presented. Provision for Income Taxes The effective income tax rate was 39.7% for the quarter ended July 29, 2000 (39.6% year-to-date), compared to 40.1% for the earlier periods. The higher rate in 1999 reflected non-deductible losses of a foreign operation which was sold in the fourth quarter of 1999. Liquidity and Capital Resources For the six-month period ended July 29, 2000, the Company generated $20.0 million of cash flow from operating activities as compared to $41.7 million in the same period of the prior year. This decrease on a year-to-date basis primarily reflects growth of state assessment receivables to be collected on business conducted in the current quarter. Cash was used principally to fund investments in property, plant and equipment of $26.0 million, which included the build-out of the Austin, Texas facility and nine professional scoring centers, as well as $4.4 million for business systems. The Company expects that its positive cash flows from operations will be adequate to fund its normal financing and investing activities in the remainder of the fiscal year. The statements which are not historical or current facts or are "goals" or "expectations" contained in this report constitute "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties that could cause actual results to differ materially. The Cautionary Statements filed by the Company as Exhibit 99 to the Annual Report on Form 10-K for the year ended January 29, 2000, are incorporated herein by reference, and stockholders and prospective investors are specifically referred to such Cautionary Statements for a discussion of factors which could affect the Company's operations and forward-looking statements contained herein. PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. 10.1 Agreement dated as of July 21, 2000, by and between NCS and Russell A. Gullotti. 27. Financial Data Schedule. (b) The following report on Form 8-K was filed during the three months ended July 29, 2000. Form 8-K dated June 22, 2000 Item 5. Press release dated June 20, 2000 announcing termination of plans to form a joint venture with the University of Cambridge Local Examination Syndicate. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NATIONAL COMPUTER SYSTEMS, INC. /s/ Jeffrey W. Taylor --------------------------- Jeffrey W. Taylor Vice President and Chief Financial Officer Dated: September 12, 2000 FORM 10-Q NATIONAL COMPUTER SYSTEMS, INC. FOR THE QUARTERLY PERIOD ENDED JULY 29, 2000 EXHIBIT INDEX EXHIBIT 10.1 Agreement dated as of July 21, 2000, by and between NCS and Russell A. Gullotti. 27 Financial Data Schedule.

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