UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2004
OR
[ ] 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 000-25674
SKILLSOFT PUBLIC LIMITED COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
REPUBLIC OF IRELAND N/A
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
107 NORTHEASTERN BOULEVARD 03062
NASHUA, NEW HAMPSHIRE
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (603) 324-3000
Not Applicable
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT)
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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
On August 31, 2004, the registrant had outstanding 105,740,369 Ordinary Shares
(issued or issuable in exchange for the registrant's outstanding American
Depository Shares).
SKILLSOFT PLC
FORM 10-Q
FOR THE QUARTER ENDED JULY 31, 2004
INDEX
PAGE NO.
PART I - FINANCIAL INFORMATION 3
Item 1. Condensed Consolidated Financial Statements (Unaudited):........................................................ 3
Condensed Consolidated Balance Sheets as of July 31, 2004 and January 31, 2004................................. 3
Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 31, 2004 and 2003...... 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 31, 2004 and 2003................ 5
Notes to Condensed Consolidated Financial Statements........................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 14
Item 3. Quantitative and Qualitative Disclosure about Market Risk....................................................... 31
Item 4. Controls and Procedures......................................................................................... 32
PART II - OTHER INFORMATION 33
Item 1. Legal Proceedings............................................................................................... 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..................................................... 33
Item 3. Defaults Upon Senior Securities................................................................................. 33
Item 4. Submission of Matters to a Vote of Security Holders............................................................. 33
Item 5. Other Information............................................................................................... 33
Item 6. Exhibits ....................................................................................................... 33
SIGNATURES.............................................................................................................. 34
2
PART I
ITEM 1. - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SKILLSOFT PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
JULY 31, JANUARY 31,
2004 2004
--------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 72,816 $ 42,866
Short-term investments 14,027 18,474
Restricted cash 400 25,044
Accounts receivable, net 42,202 72,775
Prepaid expenses and other current assets 16,947 24,759
--------- ----------
Total current assets 146,392 183,918
Property and equipment, net 8,532 6,447
Acquired intangible assets, net 20,934 25,745
Goodwill 125,570 125,878
Long-term investments 209 266
Other assets 71 124
--------- ----------
Total Assets $ 301,708 $ 342,378
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,220 $ 6,588
Accrued expenses 52,069 92,117
Deferred revenue 112,972 134,328
--------- ----------
Total current liabilities 170,261 233,033
Long term liabilities 21,678 23,587
Stockholders' equity:
Ordinary Shares, E0.11 par value: 250,000,000 shares authorized at July 31,
2004 and January 31, 2004, respectively; 105,707,513 and 101,857,714
shares issued and outstanding at July 31, 2004 and January 31, 2004,
respectively 11,549 11,031
Additional paid-in capital 556,907 538,493
Accumulated deficit (456,356) (460,916)
Deferred compensation (1,900) (2,404)
Accumulated other comprehensive loss (431) (446)
--------- ----------
Total stockholders' equity 109,769 85,758
--------- ----------
Total liabilities and stockholders' equity $ 301,708 $ 342,378
========= ==========
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
3
SKILLSOFT PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Revenue $ 50,625 $ 45,109 $ 103,442 $ 88,722
Cost of revenue 5,257 4,180 10,335 9,677
---------------- -------------- -------------- --------------
Gross profit 45,368 40,929 93,107 79,045
Operating expenses:
Research and development 12,639 12,650 22,083 25,432
Selling and marketing 22,664 23,227 47,026 46,574
General and administrative 6,182 6,401 12,236 13,085
Litigation settlement -- 44,000 -- 46,250
Amortization of intangible assets 2,390 2,518 4,812 4,924
Amortization of stock-based compensation (1) 300 471 648 961
Restructuring and other non-recurring charges 1,090 4,986 1,675 11,538
---------------- -------------- -------------- --------------
Total operating expenses 45,265 94,253 88,480 148,764
---------------- -------------- -------------- --------------
Operating income/(loss) 103 (53,324) 4,627 (69,719)
Other (expense)/income, net (32) 17 (211) 21
Interest income, net 241 231 364 594
Gain on sale of investments, net -- -- -- 3,682
---------------- -------------- -------------- --------------
Income/(loss) before provision for income taxes 312 (53,076) 4,780 (65,422)
(Benefit from)/provision for income taxes (1,045) 150 220 379
---------------- --------------- -------------- --------------
Net income/(loss) $ 1,357 $ (53,226) $ 4,560 $ (65,801)
================ ============== ============== ==============
Net income/(loss) per share (Note 9):
Basic $ 0.01 $ (0.53) $ 0.04 $ (0.66)
================ ============== ============== ==============
Basis weighted average common shares outstanding 105,421,510 99,615,128 104,304,852 99,609,891
================ ============== ============== ==============
Diluted $ 0.01 $ (0.53) $ 0.04 $ (0.66)
================ ============== ============== ==============
Diluted weighted average common shares outstanding 110,555,106 99,615,128 110,647,070 99,609,891
================ ============== ============== ==============
(1) The following summarizes the departmental allocation of the stock-based
compensation
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Cost of revenue $ -- $ 1 $ -- $ 2
Research and development 79 116 158 239
Selling and marketing 208 163 464 336
General and administrative 13 191 26 384
------ ------ ------ ------
$ 300 $ 471 $ 648 $ 961
====== ====== ====== ======
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
4
SKILLSOFT PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
SIX MONTHS ENDED
JULY 31,
2004 2003
---- ----
Cash flows from operating activities:
Net income/(loss) $ 4,560 $ (65,801)
Adjustments to reconcile net income/(loss) to net cash used in operating activities -
Stock-based compensation 648 961
Depreciation and amortization 2,385 4,896
Amortization of intangible assets 4,812 4,924
Provision for bad debts 34 272
Provision for income tax - non-cash 158 --
Realized gain on sale of investments -- (3,671)
Changes in current assets and liabilities:
Accounts receivable 30,421 14,495
Prepaid expenses and other current assets 7,762 (1,136)
Accounts payable (1,663) (3,354)
Accrued expenses (41,115) 5,548
Deferred revenue (20,884) 1,980
---------- ----------
Net cash used in operating activities (12,882) (40,886)
Cash flows from investing activities:
Purchases of property and equipment (4,682) (838)
Purchases of investments (21,768) (45,983)
Maturity of investments 26,208 50,262
Sale of investments -- 58,706
Other assets -- 11
Net cash used for a business combination -- (5,000)
Release/(designation) of restricted cash 24,600 (25,000)
---------- ----------
Net cash provided by investing activities 24,358 32,158
Cash flows from financing activities:
Proceeds from exercise of stock options and employee stock purchase plan 18,787 --
Repayment of note receivable -- 58
---------- ----------
Net cash provided by financing activities 18,787 58
Effect of exchange rate changes on cash and cash equivalents (313) 1,181
---------- ----------
Net increase/(decrease) in cash and cash equivalents 29,950 (7,489)
Cash and cash equivalents, beginning of period 42,866 45,990
---------- ----------
Cash and cash equivalents, end of period $ 72,816 $ 38,501
========== ==========
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
5
SKILLSOFT PLC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. THE COMPANY
SkillSoft PLC, formerly known as SmartForce PLC (the Company or SkillSoft), was
incorporated in Ireland on August 8, 1989. The Company is a leading provider of
content resources and complimentary technologies for integrated enterprise
learning. On September 6, 2002, the Company completed its merger with SkillSoft
Corporation (the Merger). Due to a number of factors, including composition of
the board of directors, management team, and concentrated shareholder interest,
all of which had SkillSoft Corporation being in a control or majority position,
the Merger was accounted for as a reverse acquisition, with SkillSoft
Corporation as the accounting acquirer. Accordingly, the historical financial
statements of SkillSoft Corporation are the historical financial statements of
the combined company, and the assets and liabilities of the Company are
accounted for as required under the purchase method of accounting. The results
of operations and cash flow of the former SmartForce PLC, the acquired entity
for accounting purposes, are included in the financial statements of the
combined company from September 6, 2002, the date on which the Merger was
consummated. In connection with the Merger, the Company changed its name to
SkillSoft PLC and its fiscal year end to January 31 (the fiscal year end of
SkillSoft Corporation) from December 31 (the Company's historical fiscal year
end).
2. BASIS OF PRESENTATION
The accompanying, unaudited condensed consolidated financial statements included
herein have been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission (the SEC). Certain information and
footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles in the United States
have been condensed or omitted pursuant to such SEC rules and regulations. In
the opinion of management, the condensed consolidated financial statements
reflect all material adjustments (consisting only of those of a normal and
recurring nature) which are necessary to present fairly the consolidated
financial position of the Company as of July 31, 2004, the results of its
operations for the three and six months ended July 31, 2004 and 2003 and its
cash flows for the six months ended July 31, 2004 and 2003. These condensed
consolidated financial statements and notes thereto should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
January 31, 2004. The results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the full
year.
3. CASH, CASH EQUIVALENTS, RESTRICTED CASH, AND INVESTMENTS
The Company considers all highly liquid investments with original maturities of
90 days or less at the time of purchase to be cash equivalents. At July 31, 2004
and January 31, 2004, cash equivalents consisted mainly of commercial paper,
short-term notes and money market funds. The Company considers the cash held in
certificates of deposit with a commercial bank to secure its letter of credit to
be restricted cash. The Company accounts for its investments in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (SFAS No. 115). Under SFAS
No. 115, securities that the Company does not intend to hold to maturity are
reported at market value, and are classified as available-for-sale. At July 31,
2004, the Company's investments had an average maturity of approximately 38
days. These investments are classified as current assets in the accompanying
consolidated balance sheets as they mature within one year.
4. REVENUE RECOGNITION
The Company generates revenue from the license of products and services and from
providing hosting/ASP services.
The Company follows the provisions of the American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue
Recognition, as amended by SOP 98-4 and SOP 98-9 to account for revenue derived
pursuant to license agreements under which customers license the Company's
products and services. The pricing for the Company's courses varies based upon
the number of course titles or the courseware bundle licensed by a customer, the
number of users within the customer's organization and the length of the license
agreement (generally one, two or three years). License agreements permit
customers to exchange course titles, generally on the contract anniversary date.
Additional product features, such as hosting and on-line mentoring services, are
separately licensed for an additional fee.
6
The pricing for the Company's SkillChoice multi-modal learning (SMML) licenses
varies based on the choice of SMML, content offering selected by the customer,
the number of users within the customer's organization and the length of the
license agreement. A SMML license provides customers access to a full range of
learning products including courseware, Referenceware, simulations, mentoring
and prescriptive assessment.
A Referenceware license gives users access to the full library within one or
more collections (ITPro, BusinessPro, FinancePro and OfficeEssentials) from
Books24x7.com, Inc. (Books). The pricing for the Company's Referenceware
licenses varies based on the collections specified by a customer, the number of
users within the customer's organization and the length of the license
agreement.
The Company offers discounts from its ordinary pricing, and purchasers of
licenses for larger numbers of courses, for larger user bases or for longer
periods generally receive discounts. Generally, customers may amend their
license agreements, for an additional fee, to gain access to additional courses
or product lines and/or to increase the size of the user base. The Company also
derives revenue from hosting fees for clients that use its solutions on an
application service provider (ASP) basis, on-line mentoring services and
professional services. In selected circumstances, the Company derives revenue on
a pay-for-use basis under which some customers are charged based on the number
of courses accessed by users. Revenue derived from pay-for-use contracts has
been minimal to date.
The Company recognizes revenue ratably over the license period if the number of
courses that a customer has access to is not clearly defined, available, or
selected at the inception of the contract, or if the contract has additional
undelivered elements for which the Company does not have vendor specific
objective evidence (VSOE) of the fair value of the various elements. This may
occur if the customer does not specify all licensed courses at the outset, the
customer chooses to wait for future licensed courses on a when and if available
basis, the customer is given exchange privileges that are exercisable other than
on the contract anniversaries, or the customer licenses all courses currently
available and to be developed during the term of the arrangement. Nearly all of
the Company's contractual arrangements result in the recognition of revenue
ratably over the license period; consequently, substantially all of the
Company's revenue is recognized on a ratable basis.
The Company also derives revenue from extranet hosting/ASP services and online
mentoring services. The Company recognizes revenue related to extranet
hosting/ASP services and online mentoring services on a straight-line basis over
the period the services are provided.
The Company generally bills the annual license fee for the first year of a
multi-year agreement in advance and license fees for subsequent years of
multi-year license arrangements are billed on the anniversary date of the
agreement. Occasionally, the Company will bill customers on a quarterly basis.
In some circumstances, the Company offers payment terms of up to six months from
the initial shipment date or anniversary date for multi-year agreements to its
customers. To the extent that a customer is given extended payment terms,
revenue is recognized as cash becomes due, assuming all of the other elements of
revenue recognition have been satisfied.
The Company recognizes revenue on Referenceware and SMML licenses ratably over
the term of the agreement, which matches the period the future products or
services are delivered.
The Company commences the recognition of revenue from resellers upon both the
final sale to the end user and the receipt of cash from the reseller. With
respect to reseller agreements with minimum commitments, the Company recognizes
revenue related to the portion of the minimum commitment that exceeds the end
user sales at the expiration of the commitment period provided the Company has
received payment.
The Company provides professional services, including instructor led training,
customized content, websites, and implementation services. The Company
recognizes professional service revenue as the services are performed.
7
The Company records as deferred revenue amounts that have been billed in advance
of products or services provided. Deferred revenue includes the unrecognized
portion of revenue associated with license fees for which the Company has
received payment or for which amounts have been billed and are currently due for
payment in 90 days or less for resellers and 180 days or less for direct
customers. In addition, deferred revenue includes amounts which have been billed
and not collected for which revenue is being recognized ratably over the license
period.
5. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for its stock-based employee compensation plans on the
intrinsic value method under the recognition and measurement principles of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB No. 25) and related Interpretations under APB No. 25. The
Company provides pro forma disclosures only of the compensation expense
determined under the fair value provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123).
SFAS No. 123 requires the measurement of the fair value of stock options to
employees to be included in the statements of operations or disclosed in the
notes to financial statements. The Company elected the disclosure-only
alternative under SFAS No. 123, which requires disclosure of the pro forma
effects on earnings as if the fair-value-based method of accounting under SFAS
No. 123 had been adopted, as well as certain other information. In accordance
with SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure" (SFAS No. 148), the Company has computed the pro forma disclosures
required under SFAS No. 123 for options granted using the Black-Scholes
option-pricing model prescribed by SFAS No. 123. The weighted average
information and assumptions used for the grants were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rates 4.11% - 4.35% 2.84% - 3.45% 3.31%-4.35% 2.84%-3.45%
Expected dividend yield -- -- -- --
Volatility factor 89% 98% 90% 103%
Expected lives 7 years 7 years 7 years 7 years
Weighted average fair value of options granted $ 7.50 $ 3.75 $ 9.44 $ 3.56
Weighted average remaining contractual life of
options outstanding 7.31 years 8.04 years 7.31 years 8.04 years
Had compensation expense for its plans been determined consistent with SFAS No.
123, the Company's net income/(loss) and basic and diluted net income/(loss) per
share would have been increased to the following pro forma amounts (in
thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Net income/(loss) --
As reported $ 1,357 $ (53,226) $ 4,560 $ (65,801)
Add: Stock-based compensation expense recognized under
APB No. 25 300 471 648 961
Less: Total stock-based compensation expense determined
under fair value based method for all awards (6,640) (5,220) (12,573) (6,478)
--------- ---------- ---------- ----------
Pro forma net loss $ (4,983) $ (57,975) $ (7,365) $ (71,318)
========= ========== ========== ==========
Basic and diluted net income/(loss) per share --
As reported $ 0.01 $ (0.53) $ 0.04 $ (0.66)
========= ========== ========== ==========
Pro forma net loss $ (0.05) $ (0.58) $ (0.07) $ (0.72)
========= ========== ========== ==========
Because additional option grants may be made in future periods, the above pro
forma disclosures may not be representative of pro forma effects on results for
future periods.
6. RESTRUCTURING AND OTHER NON-RECURRING CHARGES
MERGER AND EXIT COSTS
8
In connection with the Merger, the Company's management approved and initiated
plans prior to December 31, 2002 to restructure the operations of pre-Merger
SmartForce PLC to eliminate redundant facilities and headcount, reduce cost
structure, and better align the Company's operating expenses with existing
economic conditions. Consequently, the Company recorded $30.3 million of costs
relating to exiting activities of pre-Merger SmartForce PLC, such as severance
and related benefits, costs to vacate leased facilities and other pre-Merger
liabilities. These costs were accounted for under Emerging Issues Task Force
(EITF) 95-3, "Recognition of Liabilities in Connection with Purchase Business
Combinations." These costs were recognized as a liability assumed in the
purchase business combination and included in the allocation of the purchase
price, and have increased goodwill.
The reductions in employee headcount totaled approximately 632 employees from
the administrative, sales, marketing and development functions, and amounted to
a charge of approximately $14.4 million. Approximately $11.9 million was paid
out against the exit plan accrual through July 31, 2004, and the remaining
amount of $2.5 million, is expected to be paid by January 2005.
In connection with the exit plan, the Company decided to abandon or downsize
certain leased facilities. For the year ended January 31, 2003, facilities
consolidation charges of $12.7 million, consisting of sublease losses, broker
commissions and other facility costs, were recorded in connection with the
downsizing and closing of sites. As part of the plan, 11 sites have been vacated
and 4 sites have been downsized. To determine the sublease loss, which is the
loss after the Company's cost recovery efforts from subleasing the building,
certain assumptions were made related to the (1) time period over which the
property will remain vacant, (2) sublease terms and (3) sublease rates. The
lease loss is an estimate under SFAS No. 5 "Accounting for Contingencies" (SFAS
No. 5). In the year ended January 31, 2004, the Company revised certain of its
estimates made in connection with the original purchase price pertaining to
unoccupied facilities under lease as a result of the Merger. This adjustment to
the exit plan accrual falls within the one year purchase price allocation period
prescribed by SFAS No. 141 "Business Combinations" (SFAS No. 141). The net
present value of these obligations was approximately $14.5 million.
During the six months ended July 31, 2004, activity in the Company's merger and
exit costs, which are included in accrued expenses (see Note 13) and long-term
liabilities, was as follows (in thousands):
EMPLOYEE
SEVERANCE AND CLOSEDOWN OF
RELATED COSTS FACILITIES OTHER TOTAL
Merger and exit accrual January 31, 2004 $ 2,831 $ 9,073 $ 484 $ 12,388
Payments made during the three months ended April 30, 2004 (241) (1,035) (38) (1,314)
-------- -------- -------- --------
Merger and exit accrual April 30, 2004 2,590 8,038 446 11,074
Payments made during the three months ended July 31, 2004 (45) (917) (6) (968)
-------- -------- -------- --------
Merger and exit accrual July 31, 2004 $ 2,545 $ 7,121 $ 440 $ 10,106
======== ======== ======== ========
The Company anticipates that the remainder of the merger and exit accrual will
be paid out by October 2011 as follows (in thousands):
Year ended January 31, 2005 $ 4,400
Year ended January 31, 2006 1,965
Year ended January 31, 2007 1,105
Year ended January 31, 2008 1,099
Thereafter 1,537
----------
Total $ 10,106
==========
RESTRUCTURING AND OTHER NON-RECURRING CHARGES
The Company recorded a $14.2 million restructuring charge for the year ended
January 31, 2003, which was included in the statement of operations.
Approximately $10.2 million of this charge represents the compensation cost of
terminated SmartForce PLC employees for services rendered from the date of the
Merger through such employees' termination dates and certain other non-recurring
compensation costs to terminated and continuing employees of the Company. Also
included in the $14.2 million charge are certain other non-recurring costs
incurred by SkillSoft Corporation as a result of the Merger. These costs
primarily consist of employee severance and related costs and contractual
obligations.
During the six months ended July 31, 2004, the Company recorded and paid an
additional $322,000 of restructuring and non-recurring charges related to
further restructuring of the pre-Merger SmartForce PLC operations. These
restructuring costs included additional compensation to pre-Merger SmartForce
PLC employees as well as additional facilities obligations as a result of the
Merger. During the six month period ended July 31, 2004, activity in the
Company's restructuring accrual related to the Merger was as follows (in
9
thousands):
EMPLOYEE SEVERANCE CONTRACTUAL
AND RELATED COSTS OBLIGATIONS TOTAL
------------------ ----------- -----
Restructuring accrual January 31, 2004 $ -- $ 84 $ 84
Restructuring charge for the quarter ended April 30, 2004 53 94 147
Payments made during the quarter ended April 30, 2004 (53) (94) (147)
------ ----- -----
Restructuring accrual April 30, 2004 -- 84 84
Restructuring charge for the quarter ended July 31, 2004 175 -- 175
Payments made during the quarter ended July 31, 2004 (175) (84) (259)
------ ===== -----
Restructuring accrual July 31, 2004 $ -- $ -- $ --
====== ===== =====
The restructuring charges for the three and six months ended July 31, 2004 would
have been allocated as follows had the Company recorded the expense within the
functional department of the restructured activities (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, 2004 JULY 31, 2004
------------- -------------
Cost of sales $ -- $ --
Research and development 63 72
Sales and marketing (18) 26
General and administrative 130 224
----- -----
Total $ 175 $ 322
===== =====
Consistent with the Company's accounting policy and historical treatment
regarding annual audit fees, the Company accrued the estimated audit fees
related to the restatement of the historical SmartForce PLC financial
statements, the acquired business, in the year ended January 31, 2003. All other
costs associated with the restatement, the resulting SEC investigation, and the
2002 shareholder lawsuit are expensed as the work is performed. For the three
and six months ended July 31, 2004, the Company recorded $914,000 and $1.4
million, respectively, in expenses related to the re-filing of statutory tax
returns as a result of the restatement of the historical SmartForce PLC
financial statements and the ongoing SEC investigation. For the three and six
months ended July 31, 2003, the Company recorded $4.6 million and $10.0 million,
respectively, in expenses related to the restatement, consisting primarily of
professional fees, including legal, accounting and other consulting fees.
7. GOODWILL AND INTANGIBLE ASSETS
On February 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangibles" (SFAS No. 142), which requires companies to discontinue amortizing
goodwill and certain intangible assets with indefinite useful lives and requires
an annual review for impairment. The non-amortization provisions of SFAS No. 142
apply to goodwill and intangible assets acquired after June 30, 2001. The
Company's goodwill and intangible assets relate to both the Merger and its
acquisitions of Books and GoTrain Corp. (GoTrain), which were accounted for in
accordance with the non-amortization provisions of SFAS No. 142. Therefore,
there is no impact on the comparability of the accompanying condensed
consolidated statements of operations as a result of discontinuing the
amortization of goodwill.
Goodwill and intangible assets were as follows (in thousands):
JULY 31, 2004 JANUARY 31, 2004
-------------------------------------- --------------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
------ ------------ ------ ------ ------------ ------
Internally developed software/courseware $ 26,610 $ 13,065 $ 13,545 $ 26,610 $ 9,612 $ 16,998
Customer contracts 13,018 6,529 6,489 13,018 5,171 7,847
Trademarks and trade name 900 -- 900 900 -- 900
--------- -------- --------- --------- -------- ---------
40,528 19,594 20,934 40,528 14,783 25,745
Goodwill 125,570 -- 125,570 125,878 -- 125,878
--------- -------- --------- --------- -------- ---------
$ 166,098 $ 19,594 $ 146,504 $ 166,406 $ 14,783 $ 151,623
========= ======== ========= ========= ======== =========
Customer contracts are existing contracts that relate to underlying customer
relationships pertaining to the services provided by the acquired company. The
Company is amortizing the fair value of customer contracts on an accelerated
basis over a weighted average estimated useful life. Internally developed
software/courseware relates to the Books platform, GoTrain content and platform,
and the SmartForce PLC content.
10
Course content includes courses in both soft skills and information technology.
All courseware is deployable via the Internet or corporate intranets.
The change in goodwill at July 31, 2004 from the amount recorded at January 31,
2004 was due to collections of accounts receivable in excess of the estimated
realizable value at the purchase date and the company's utilization of net
operating loss carryforwards obtained as part of the Merger.
Amortization expense for the three and six months ended July 31, 2004 was as
follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, 2004 JULY 31, 2004
------------- -------------
Internally developed software/courseware $ 1,714 $ 3,454
Customer contracts 676 1,358
-------- --------
$ 2,390 $ 4,812
======== ========
Amortization expense for the next five fiscal years is expected to be as follows
(in thousands):
FISCAL YEAR AMORTIZATION EXPENSE
----------- --------------------
2005 $ 9,575
2006 8,592
2007 5,345
2008 1,321
2009 13
The Company will be conducting its annual impairment test of goodwill in the
fourth quarter of the fiscal year ending January 31, 2005.
8. COMPREHENSIVE INCOME/(LOSS)
SFAS No. 130, "Reporting Comprehensive Income" requires disclosure of all
components of comprehensive income/(loss) on an annual and interim basis.
Comprehensive income/(loss) is defined as the change in equity of a business
enterprise during a period resulting from transactions, other events and
circumstances related to non-owner sources. The components of comprehensive
income/(loss) for the three and six months ended July 31, 2004 and 2003 were as
follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Comprehensive income/(loss):
Net income/(loss) $ 1,357 $ (53,226) $ 4,560 $ (65,801)
Other comprehensive income/(loss):
Foreign currency adjustment (243) 567 77 549
Unrealized holding (losses)/gains during the period (58) 50 (62) 208
Less: reclassification adjustment for gains
included in net income /(loss) -- -- -- (1,984)
-------- ---------- ---------- ----------
Comprehensive income /(loss) $ 1,056 $ (52,609) $ 4,575 $ (67,028)
======== ========== ========== ==========
9. NET INCOME/(LOSS) PER SHARE
Basic net income/(loss) per share was computed using the weighted average number
of shares outstanding during the period. Diluted net income/(loss) per share was
computed by giving effect to all dilutive potential shares outstanding. Basic
and diluted net loss per share for the three and six months ended July 31, 2003
are the same as outstanding options, and unvested restricted shares, which
aggregated 25,291,366 shares, are antidilutive as the Company recorded a net
loss for the periods. The weighted average number of shares outstanding used to
compute basic net income/(loss) per share and diluted net income/(loss) per
share was as follows:
11
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Basic weighted average shares outstanding 105,421,510 99,615,128 104,304,852 99,609,891
Effect of dilutive shares outstanding 5,133,596 -- 6,342,218 --
----------- ---------- ----------- ----------
Weighted average common shares outstanding, as adjusted 110,555,106 99,615,128 110,647,070 99,609,891
=========== ========== =========== ==========
10. INCOME TAXES
The Company operates as a holding company with operating subsidiaries in several
countries, and each subsidiary is taxed based on the laws of the jurisdiction in
which it operates.
The Company has significant net operating loss (NOL) carryforwards, some of
which are subject to potential limitations based upon the change in control
provisions of Section 382 of the Internal Revenue Code.
The (benefit from)/provision for income tax was ($1.1) million and $150,000 in
the three months ended July 31, 2004 and 2003, respectively. During the three
months ended July 31, 2004, the Company reversed approximately $1.1 million of
tax expense as the Company now expects to utilize tax attributes other than
acquired NOL carryforwards, and as such has adjusted its tax provision
accordingly. For the three months ended July 31, 2003 the tax provision consists
of income taxes payable in certain foreign locations, which cannot be offset
through NOL carryforwards, and minimum taxes.
For the six months ended July 31, 2004, the Company recorded a tax provision of
approximately $220,000, representing an effective tax rate of approximately 4.6%
because the Company expects to utilize tax attributes other than acquired NOL
carryforwards, and therefore, the tax provision reflects primarily foreign taxes
and US alternative minimum tax.
11. COMMITMENTS AND CONTINGENCIES
The Company leases certain of its facilities and certain equipment and furniture
under operating lease agreements that expire at various dates through 2023.
Future minimum payments, net of estimated rentals, under these agreements are as
follows (in thousands):
PAYMENTS DUE BY PERIOD
LESS THAN 1-3 3-5 MORE THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
----- ------ ----- ----- -------
Operating Lease Obligations $ 41,016 $ 7,304 $ 10,581 $ 7,424 $ 15,707
--------- ------- -------- ------- ---------
TOTAL $ 41,016 $ 7,304 $ 10,581 $ 7,424 $ 15,707
========= ======= ======== ======= =========
The Company has entered into agreements to settle certain litigation matters,
and the future commitments under these agreements are as follows (in thousands):
PAYMENTS DUE BY PERIOD
LITIGATION SETTLEMENT LESS THAN 1-3
COMMITMENTS TOTAL 1 YEAR YEARS
---------------------------- ----- ------ -----
2002 Securities class action $ 31,500 $ 16,250 $ 15,250
---------- -------- ---------
TOTAL $ 31,500 $ 16,250 $ 15,250
========== ========= ==========
In March 2004, the Company reached a settlement of the class action litigation
filed in 2002, which alleged the Company misrepresented or omitted to state
material facts in its SEC filings and press releases regarding its revenues and
earnings and failed to correct such false and misleading SEC filings and press
releases, which are alleged to have artificially inflated the price of the
Company's ADSs. Under the terms of the settlement, the Company has agreed to pay
$30.5 million, with one-half paid in August 2004 (following preliminary approval
of the settlement by the court) and the second-half to be paid in fiscal 2006.
The Company is in discussions with its insurers and hopes they will contribute a
portion of the settlement amount. The settlement is subject to final court
approval. The Company recorded the aggregate settlement as a charge in its
fiscal 2004 fourth quarter; any reimbursement from the Company's insurers will
be recorded in the period in which it is executed and finalized.
On July 21, 2003, the Company entered into a settlement agreement with NETg
relating to patent infringement, which resulted in a final dismissal and
termination of the NETg litigation. Under the terms of the settlement agreement,
the Company has agreed to pay a total of $44,000,000 in two equal installments
of $22,000,000.
12
The Company made the first payment of $22,000,000 on July 25, 2003. The second
payment of $22,000,000 was made on July 21, 2004. The Company expensed this
settlement in the three months ended July 31, 2003.
On December 1, 2003, the Company agreed to settle the securities class action
lawsuit filed against it, one of its subsidiaries and certain of its former and
current officers and directors in 1998. The lawsuit, which was filed in the
United States District Court for the Northern District of California, asserted
violations of the federal securities laws. Under the terms of the settlement,
the Company made a $10 million cash payment in January 2004 and made an
additional $6 million payment on July 2, 2004. The Company's insurance carriers
will pay an additional $16 million for total settlement payments of $32 million.
The court granted final approval of the settlement and the litigation was
dismissed with prejudice on February 27, 2004.
12. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE
The Company follows the provisions of SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" (SFAS No. 131). SFAS No. 131
established standards for reporting information regarding operating segments in
annual financial statements and requires selected information for those segments
to be presented in interim financial reports issued to shareholders. SFAS No.
131 also established standards for related disclosures about products and
services and geographic areas. Operating segments are identified as components
of an enterprise about which separate discrete financial information is
available for evaluation by the chief operating decision maker, or
decision-making group, in making decisions of how to allocate resources and
assess performance. The Company's chief operating decision makers, as defined
under SFAS No. 131, are the Chief Executive Officer and the Chief Financial
Officer. Prior to the Merger, the Company had viewed its operations and managed
its business as principally one operating segment. Subsequent to the Merger, the
Company has viewed its operations and manages its business as principally two
operating segments -- SkillChoice multi-modal learning and retail certification.
Revenue for the three months ended July 31, 2004 for the SkillChoice multi-modal
learning and retail certification segments was approximately $45.8 million and
$4.8 million, respectively. Revenue for the six months ended July 31, 2004 for
the SkillChoice multi-modal learning and retail certification segments was
approximately $94.1 million and $9.3 million, respectively. Revenue for the
three months ended July 31, 2003 for the SkillChoice multi-modal learning and
retail certification segments was approximately $41.9 million and $3.2 million,
respectively. Revenue for the six months ended July 31, 2003 for the SkillChoice
multi-modal learning and retail certification segments was approximately $83.2
million and $5.5 million, respectively. Net income for the three months ended
July 31, 2004 for the SkillChoice multi-modal learning and retail certification
segments was approximately $1.3 million and $0.1 million, respectively. Net
income for the six months ended July 31, 2004 for the SkillChoice multi-modal
learning and retail certification segments was approximately $4.4 million and
$0.2 million, respectively. Net loss for the three months ended July 31, 2003
for the SkillChoice multi-modal learning and retail certification segments was
approximately $52.3 million and $0.9 million, respectively. Net loss for the six
months ended July 31, 2003 for the SkillChoice multi-modal learning and retail
certification segments was approximately $63.4 million and $2.4 million,
respectively.
The Company attributes revenues to different geographical areas on the basis of
the location of the customer. Revenues by geographical area for the three and
six months ended July 31, 2004 and 2003 were as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Revenue:
United States $ 40,014 $ 35,356 $ 80,936 $ 71,996
United Kingdom 4,071 3,234 8,351 5,196
Canada 1,881 1,674 3,917 2,619
Europe, excluding UK 2,214 3,685 4,677 7,032
Australia/New Zealand 1,532 951 3,279 1,568
Other 913 209 2,282 311
--------- --------- --------- ---------
Total revenue $ 50,625 $ 45,109 $ 103,442 $ 88,722
========= ========= ========= =========
Long-lived tangible assets at international facilities are not significant.
13. ACCRUED EXPENSES
Accrued expenses in the accompanying condensed consolidated balance sheets
consist of the following (in thousands):
13
JULY 31, 2004 JANUARY 31, 2004
------------- ----------------
Accrued compensation and benefits $ 12,176 $ 19,787
Course development fees 1,249 1,518
Professional fees 2,594 3,410
Accrued payables 1,873 2,703
Accrued misc. taxes 2,357 2,357
Accrued merger related costs* 6,515 6,919
Sales tax payable/VAT payable 2,140 2,513
Accrued royalties 1,747 1,351
Accrued litigation settlements 16,250 44,250
Other accrued liabilities 5,168 7,309
---------- ---------
Total accrued expenses $ 52,069 $ 92,117
========== =========
------------
* Includes $2,238 of accrued income taxes
14. LINE OF CREDIT
On July 23, 2004, the Company entered into a $25 million two year, working
capital line of credit with a bank. Under the terms of the line of credit, the
bank has a first security interest in all domestic business assets. All
borrowings under the line of credit bear interest at the bank's prime rate. The
facility is subject to a commitment fee of $50,000 to secure the line of credit
and unused commitment fees of 0.125% based upon the daily average of un-advanced
amounts under the revolving line of credit. In addition, the line of credit
contains certain financial and non-financial covenants. At July 31, 2004, the
Company is in compliance with all financial and non-financial covenants. As of
July 31, 2004, there were no borrowings on the line of credit; however, the
Company had an outstanding letter of credit of $400,000 that was secured with a
certificate of deposit.
15. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2003, the FASB issued Interpretation No. 46 (FIN 46R) (revised
December 2003), "Consolidation of Variable Interest Entities, an Interpretation
of Accounting Research Bulletin No. 51" (ARB 51), which addressed how a business
enterprise should evaluate whether it has a controlling interest in an entity
through means other than voting rights and accordingly should consolidate the
entity. FIN 46R replaced FASB Interpretation No. 46 (FIN 46), which was issued
in January 2003. Before concluding that it is appropriate to apply ARB 51 voting
interest consolidation model to an entity, an enterprise must first determine
that the entity is not a variable interest entity (VIE). As of the effective
date of FIN 46R, an enterprise must evaluate its involvement with all entities
or legal structures created before February 15, 2003 and no later than the end
of the first reporting period that ends after March 15, 2004 for all other
entities. The adoption of FIN 46 had no effect on the Company's consolidated
financial position, results of operations or cash flows.
In August 2003, the FASB issued EITF 03-05 ("EITF 03-05"), "Applicability of
AICPA Statement of Position 97-2, Software Revenue Recognition, to Non-Software
Deliverables in an Arrangement Containing More-Than-Incidental Software," which
provides guidance on whether non-software deliverables (e.g., non-software
related equipment or services) included in an arrangement that contains software
that is more than incidental to the products or services as a whole are included
within the scope of AICPA Statement of Position 97-2, Software Revenue
Recognition. The guidance in EITF 03-05 is effective for arrangements entered
into in the first reporting period (annual or interim) beginning after August
13, 2003. The adoption of EITF 03-05 did not have a material impact on the
Company's financial position or results of operations.
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Any statement in this Quarterly Report on Form 10-Q about our future
expectations, plans and prospects, including statements containing the words
"believes," "anticipates," "plans," "expects," "will" and similar expressions,
constitute forward-looking statements within the meaning of The Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those indicated by such forward-looking statements as a result of various
important factors, including those set forth in this Item 2 under the heading
"Future Operating Results."
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements and notes
appearing elsewhere in this Quarterly Report on Form 10-Q.
14
OVERVIEW
We are the result of the merger of SmartForce PLC (SmartForce or SmartForce PLC)
and SkillSoft Corporation. The new combined SkillSoft PLC is a global leader in
corporate e-learning and brings together SmartForce's leading portfolio of
information technology (IT) e-learning content with SkillSoft Corporation's
extensive suite of business skills e-learning courseware, as well as its IT and
business Referenceware libraries.
The merger of SmartForce PLC and SkillSoft Corporation (the Merger) closed on
September 6, 2002. For accounting purposes, the Merger was accounted for as a
reverse acquisition, with SkillSoft Corporation as the accounting acquirer. The
historical financial statements of SkillSoft Corporation have become our
historical financial statements, and the results of operations of SkillSoft PLC
(formerly known as SmartForce PLC) are included in our results of operations
only from September 6, 2002. For accounting purposes, the purchase price was
approximately $371.7 million, which consisted of the value of stock and options
issued, and transaction and merger costs. The excess purchase price over the net
tangible assets was primarily allocated to goodwill, content and customer base.
We are a leading provider of multi-modal content resources and complimentary
technologies for integrated enterprise learning. SkillChoice multi-modal
learning (SMML) solutions offer powerful tools to support and enhance the speed
and effectiveness of both formal and informal learning processes. SMML solutions
integrate our in-depth courseware, learning management platform technology and
support services to meet our customers' learning needs.
We primarily derive revenue from license agreements under which customers
license our products and services. The pricing for our courses varies based upon
the number of course titles or the courseware bundle licensed by a customer, the
number of users within the customer's organization and the length of the license
agreement (generally one, two or three years). Our license agreements permit
customers to exchange course titles, generally on the contract anniversary date.
Additional product features, such as hosting and on-line mentoring services, are
separately licensed for an additional fee.
The pricing for our SMML licenses varies based on the choice of SMML, content
offering selected by the customer, the number of users within the customer's
organization and the length of the license agreement. Our SMML license provides
customers access to a full range of learning products including courseware,
Referenceware, simulations, mentoring and prescriptive assessment.
A Referenceware license from our subsidiary, Books24x7.com (Books), gives users
access to the full library within one or more collections (ITPro, BusinessPro,
FinancePro and OfficeEssentials). The pricing for our Referenceware licenses
varies based on the collections specified by a customer, the number of users
within the customer's organization and the length of the license agreement.
We offer discounts from our ordinary pricing, and purchasers of licenses for
larger numbers of courses, for larger user bases or for longer periods generally
receive discounts. Generally, customers may amend their license agreements, for
an additional fee, to gain access to additional courses or product lines and/or
to increase the size of the user base. We also derive revenue from hosting fees
for clients that use our solutions on an application service provider (ASP)
basis, on-line mentoring services and professional services. In selected
circumstances, we derive revenue on a pay-for-use basis under which some
customers are charged based on the number of courses accessed by users. Revenue
derived from pay-for-use contracts has been minimal to date.
We recognize revenue ratably over the license period if the number of courses
that a customer has access to is not clearly defined, available, or selected at
the inception of the contract, or if the contract has additional undelivered
elements for which we do not have vendor specific objective evidence (VSOE) of
the fair value of the various elements. This may occur if the customer does not
specify all licensed courses at the outset, the customer chooses to wait for
future licensed courses on a when and if available basis, the customer is given
exchange privileges that are exercisable other than on the contract
anniversaries, or the customer licenses all courses currently available and to
be developed during the term of the arrangement. Nearly all of our contractual
arrangements result in the recognition of revenue ratably over the license
period; consequently, substantially all of our revenue is recognized on a
ratable basis.
We also derive revenue from extranet hosting/ASP services and online mentoring
services. We recognize revenue related to extranet hosting/ASP services and
online mentoring services on a straight-line basis over the period the services
are provided.
We generally bill the annual license fee for the first year of a multi-year
agreement in advance and license fees for subsequent years of multi year license
arrangements are billed on the anniversary date of the agreement. Occasionally,
we bill customers on a quarterly basis. In some circumstances, we offer payment
terms of up to six months from the initial shipment date or anniversary date for
15
multi-year agreements to our customers. To the extent that a customer is given
extended payment terms, revenue is recognized as cash becomes due, assuming all
of the other elements of revenue recognition have been satisfied.
We recognize revenue on Referenceware and SMML licenses ratably over the term of
the agreement, which matches the period the future products or services are
delivered.
We commence the recognition of revenue from resellers upon both the final sale
to the end user and the receipt of cash from the reseller. With respect to
reseller agreements with minimum commitments, we recognize revenue related to
the portion of the minimum commitment that exceeds end user sales at the
expiration of the commitment period provided we have received payment.
We provide professional services, including instructor led training, customized
content, websites and implementation services. We recognize professional service
revenue as the services are performed.
We record as deferred revenue amounts that have been billed in advance of
products or services provided. Deferred revenue that includes the unrecognized
portion of revenue associated with license fees for which we have received
payment or for which amounts have been billed and are currently due for payment
in 90 days or less for resellers and 180 days or less for direct customers. In
addition, deferred revenue includes amounts, which have been billed and not
collected, for which revenue is being recognized ratably over the license
period.
Cost of revenue includes the cost of materials (such as storage media),
packaging, shipping and handling, CD duplication, the cost of online mentoring
and hosting services, royalties and certain infrastructure and occupancy
expenses. We generally recognize these costs as incurred. Research and
development expenses consist primarily of salaries and benefits, certain
infrastructure and occupancy expenses, fees to consultants and course content
development fees. We account for software development costs in accordance with
Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," which
requires the capitalization of certain computer software development costs
incurred after technological feasibility is established. To date we have
expensed all software development costs as incurred. Selling and marketing
expenses consist primarily of salaries, commissions and benefits, advertising
and promotion, travel and certain infrastructure and occupancy expenses. General
and administrative expenses consist primarily of salaries and benefits,
consulting and service expenses, legal expenses, other public company costs and
certain infrastructure and occupancy expenses.
Deferred compensation consists of two components: (1) the value of unvested
options assumed in the Books acquisition and the Merger, and (2) difference
between the exercise or sale price of share options granted or restricted common
stock sold during the year ended January 31, 2000 and the fair market value of
the common stock as determined for accounting purposes. The deferred
compensation is amortized over the vesting period of the underlying share option
or shares.
Amortization of intangibles represents the amortization of intangibles, such as
customer value and content, from the Books acquisition, the GoTrain acquisition
and the Merger.
Restructuring and other non-recurring charges primarily consist of charges
associated with, and as a result of, the restatement of SmartForce's financial
statements for 1999, 2000, 2001 and the first two quarters of 2002, the
re-filing of statutory tax returns as a result of the restatement, charges for
the ongoing SEC investigation, and costs associated with international
restructuring activities.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are more fully described in Note 2 of the
Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K
as filed with the SEC on April 15, 2004. However, we believe the accounting
policies described below are particularly important to the portrayal and
understanding of our financial position and results of operations and require
application of significant judgment by our management. In applying these
policies, management uses its judgment in making certain assumptions and
estimates.
REVENUE RECOGNITION
We recognize revenue in accordance with American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) No. 97-2 "Software Revenue
Recognition," as amended by SOP No. 98-4 and SOP No. 98-9. Additionally, for
agreements under which we are selling licenses and services, we recognize
revenue under EITF 00-3 "Application of AICPA Statement of Position 97-2 to
Arrangements That Include the Right to Use Software Stored on Another's
Hardware" and Staff Accounting Bulletin (SAB) No. 104 "Revenue Recognition".
16
These statements require that four basic criteria must be satisfied before
revenue can be recognized:
- Persuasive evidence of an arrangement between us and a third party exists;
- Delivery of our product has occurred;
- The sales price for the product is fixed or determinable; and
- Collection of the sales price is probable.
Our management uses its judgment concerning the satisfaction of these criteria,
particularly criteria relating to the collectibility of the receivables relating
to such sales. Should changes and conditions cause management to determine that
these criteria are not met for certain future transactions, revenue recognized
for any period could be adversely affected. However, this is mitigated by the
fact that the majority of our revenue is recognized ratably over the term of the
respective license. Please see the discussion under the "Overview" section of
this Item 2 concerning how we recognize revenue.
IMPAIRMENT OF GOODWILL
We review the carrying value of goodwill in each fiscal fourth quarter based
upon the expected future and discounted operating cash flows of our business.
Our cash flow estimates are based on historical results adjusted to reflect our
best estimate of future markets and operating conditions. Actual results may
differ materially from these estimates. The timing and size of impairment
charges involves the application of management's judgment and could
significantly affect our operating results. As a result of the Merger, one of
our largest assets is goodwill. We reevaluate goodwill for possible impairment
quarterly. An independent third party valuation of the goodwill asset is
conducted in each fiscal fourth quarter.
LEGAL CONTINGENCIES
In connection with any material legal proceedings that we may become involved
in, management periodically reviews estimates of potential costs to be incurred
by us in connection with the adjudication or settlement, if any, of these
proceedings. These estimates are developed in consultation with our outside
counsel and are based on an analysis of potential litigation outcomes and
settlement strategies. In accordance with SFAS No. 5, "Accounting for
Contingencies", loss contingencies are accrued if, in the opinion of management,
an adverse outcome is probable and such outcome can be reasonably estimated. In
accordance with SFAS No. 5, gain contingencies are accrued if, in the opinion of
management, a favorable outcome is probable and such outcome can be reasonably
estimated. We note that legal costs are expensed as incurred.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JULY 31, 2004 VERSUS THREE MONTHS ENDED JULY 31, 2003
DOLLAR QUARTER ENDED JULY 31,
INCREASE/(DECREASE) PERCENT CHANGE
2003/2004 INCREASE/(DECREASE) PERCENTAGE OF REVENUE
(IN THOUSANDS) 2003/2004 2004 2003
------------------- --------------------- ---- ----
Revenue $ 5,516 12% 100% 100%
Cost of revenue 1,077 26% 10% 9%
----------- ------ ---- ----
Gross margin 4,439 11% 90% 91%
----------- ------ ---- ----
Operating expenses:
Research and development (11) 0% 25% 28%
Selling and marketing (563) (2%) 45% 51%
General and administrative (219) (3%) 12% 14%
Legal settlements (44,000) (100%) -- 98%
Amortization of intangible assets (128) (5%) 5% 6%
Amortization of stock-based compensation (171) (36%) 1% 1%
Restructuring and other non-recurring charges (3,896) (78%) 2% 11%
----------- ------ ---- ----
Total operating expenses (48,988) (52%) 90% 209%
----------- ------ ---- ----
Operating income/(loss) 53,427 100% 0% (118%)
----------- ------ ---- ----
17
DOLLAR QUARTER ENDED JULY 31,
INCREASE/(DECREASE) PERCENT CHANGE
2003/2004 INCREASE/(DECREASE) PERCENTAGE OF REVENUE
(IN THOUSANDS) 2003/2004 2004 2003
------------------- --------------------- ---- ----
Other income/(expense), net (49) (288%) -- -
Interest income, net 10 4% -- 1%
Gain on sale of investments, net -- -- -- --
----------- ------ ---- ----
Income/(loss) before provision for income taxes 53,388 101% 1% (118%)
(Benefit from)/provision for income taxes (1,195) (797%) (2%) --
----------- ------ ---- ----
Net income/(loss) $ 54,583 103% 3% (118%)
=========== ====== ==== ====
COMPARISON OF THE QUARTERS ENDED JULY 31, 2004 AND 2003
REVENUE
Revenue increased $5.5 million, or 12%, to $50.6 million in the quarter
ended July 31, 2004 from $45.1 million in the quarter ended July 31, 2003. This
increase was primarily due to revenue generated from new business and renewal
business. For the fiscal year ended January 31, 2004, we experienced improvement
in renewal rates. We exited the year ended January 31, 2004 with noncancellable
backlog, which consists of deferred revenue and committed contracts, of
approximately $170 million as compared to $135 million at January 31, 2003. The
increase in noncancellable backlog was due primarily to improved renewal rates,
expanded offerings for SMML customers and new customers. These factors
contributed favorably to revenue in the quarter ended July 31, 2004 when
compared to the year ago quarter. Our review of the sales forecast for the
remainder of the fiscal year indicates we expect to achieve our planned total
annual booking number.
QUARTERS ENDED JULY 31,
(IN THOUSANDS) 2004 2003 CHANGE
-------------- ---- ---- ------
Revenue:
United States $ 40,014 $ 35,356 $ 4,658
International 10,611 9,753 858
--------- --------- ---------
Total $ 50,625 $ 45,109 $ 5,516
========= ========= =========
Revenue increased by 13% and 9% in the United States and internationally,
respectively, in the quarter ended July 31, 2004 as compared to the quarter
ended July 31, 2003. The international revenue increase was due, in addition to
the factors discussed above, to increased reseller revenue due to the timing of
receipt of sell-through reporting and cash from resellers. The United States
represented 79% and 78% of revenue for the quarters ended July 31, 2004 and
2003, respectively.
QUARTERS ENDED JULY 31,
(IN THOUSANDS) 2004 2003 CHANGE
-------------- ---- ---- ------
Revenue:
SkillChoice Multi-Modal Learning $ 45,848 $ 41,901 $ 3,947
Retail Certification 4,777 3,208 1,569
--------- --------- ---------
Total $ 50,625 $ 45,109 $ 5,516
========= ========= =========
The SkillChoice multi-modal learning segment represented 91% and 93% of revenue
for the quarters ended July 31, 2004 and 2003, respectively.
COSTS AND EXPENSES
Cost of revenue increased $1.1 million, or 26%, to $5.3 million in the quarter
ended July 31, 2004 from $4.2 million in the quarter ended July 31, 2003. Cost
of revenue as a percentage of total revenue was 10% in the quarter ended July
31, 2004 versus 9% in the quarter ended July 31, 2003. These increases were
primarily due to a higher mix of royalty bearing revenue as well as increased
headcount and infrastructure charges incurred in connection with the our efforts
to consolidate hosting sites.
Research and development expenses decreased nominally in the quarter ended July
31, 2004 as compared to the quarter ended July 31, 2003. Research and
development expenses as a percentage of total revenue decreased to 25% in the
quarter ended July 31, 2004 from 28% in the quarter ended July 31, 2003.
Research and development expenses for the quarter ended July 31, 2004 included a
charge of $2.3 million related to the purchase of technology and costs to modify
and enhance the technology related to the development of our Virtual Classroom
product offerings. We anticipate incurring approximately $2.2 million of
additional development expenses over the second half of fiscal 2005 to bring our
Virtual Classroom offerings to market.
18
Excluding the effects of the charge of $2.3 million in the quarter ended July
31, 2004, research and development expenses decreased even more significantly
when compared to the quarter ended July 31, 2003. This decrease was primarily
due to the completion of initiatives related to content and platform
improvements in the quarter ended January 31, 2004. With the substantial
completion of the incremental investment in research and development, we expect
research and development expenses to decrease in both absolute dollars and as a
percentage of total revenue in the fiscal year ending January 31, 2005 when
compared to the prior year.
Selling and marketing expenses decreased $563,000, or 2%, to $22.7 million in
the quarter ended July 31, 2004 from $23.2 million in the quarter ended July 31,
2003. The decrease was primarily due to lower marketing expenditures as well as
a decline in certain infrastructure and occupancy charges. Selling and marketing
expenses as a percentage of total revenue decreased to 45% in the quarter ended
July 31, 2004 from 51% in the quarter ended July 31, 2003. The percentage
decrease was primarily due to the increase in revenue from the quarter ended
July 31, 2003 to the quarter ended July 31, 2004. We anticipate incurring
incremental selling and marketing expenses over the second half of the year to
introduce the Virtual Classroom offerings to the market. We believe that a
significant investment in selling and marketing to expand our distribution
channels worldwide is required to remain competitive, and we therefore expect
selling and marketing expenses to increase in absolute dollars, but decrease as
a percentage of total revenue when comparing fiscal 2005 results to fiscal 2004
results.
General and administrative expenses decreased $219,000, or 3%, to $6.2 million
in the quarter ended July 31, 2004 from $6.4 million in the quarter ended July
31, 2003. General and administrative expenses as a percentage of total revenue
decreased to 12% in the quarter ended July 31, 2004 from 14% in the quarter
ended July 31, 2003. General and administrative expenses decreased primarily due
to a reduction of litigation costs of $681,000 and a decline in certain
infrastructure and occupancy charges of $150,000. These decreases were offset in
part by increases in accounting and other consulting services of $620,000. We
anticipate that general and administrative expenses will increase in absolute
dollars in the next several quarters, as compared to the three months ended July
31, 2004, due primarily to increases in the costs of operating as a public
company such as Sarbanes-Oxley Act compliance, audit, legal and insurance.
Restructuring and other non-recurring charges decreased $3.9 million, or 78%, to
$1.1 million in the quarter ended July 31, 2004 from $5.0 million in the quarter
ended July 31, 2003. The restructuring and non-recurring charges relate to the
SmartForce-SkillSoft merger. The restructuring costs primarily consist of
compensation costs for certain terminated SmartForce employees. The other
non-recurring charges primarily consist of costs directly related to the
restatement of the SmartForce historical financial statements. This was
completed in the fiscal year ended January 31, 2004 and is the primary reason
for the decrease in restructuring and other non-recurring items when comparing
the three months ended July 31, 2004 to the three months ended July 31, 2003.
Charges for the three months ended July 31, 2004 consist primarily of the
re-filing of statutory tax returns as a result of the restatement of the
SmartForce PLC historical financial statements, the ongoing SEC investigation
and costs associated with international restructuring activities.
OTHER INCOME/(EXPENSE), NET
Other income/(expense) in the quarter ended July 31, 2004 was ($32,000) as
compared to $17,000 in the quarter ended July 31, 2003. This change was
primarily due to foreign currency fluctuations. Due to our multinational
operations, our business is subject to fluctuations based upon changes in the
exchange rates between the currencies we do business in.
(BENEFIT FROM)/PROVISION FOR INCOME TAXES
The (benefit from)/provision for income taxes was ($1.1) million and $150,000 in
the quarters ended July 31, 2004 and 2003, respectively. During the second
quarter ended July 31, 2004, we reversed approximately $1.1 million of tax
expense as we now expect to utilize tax attributes other than acquired NOL
carryforwards, and as such have adjusted the tax provision accordingly.
SIX MONTHS ENDED JULY 31, 2004 VERSUS SIX MONTHS ENDED JULY 31, 2003
DOLLAR SIX MONTHS ENDED JULY 31,
INCREASE/(DECREASE) PERCENT CHANGE
2003/2004 INCREASE/(DECREASE) PERCENTAGE OF REVENUE
(IN THOUSANDS) 2003/2004 2004 2003
------------------- ------------------------- ---- ----
Revenue $ 14,720 17% 100% 100%
Cost of revenue 658 7% 10% 11%
----------- ------ ---- ----
Gross margin 14,062 18% 90% 89%
----------- ------ ---- ----
19
DOLLAR SIX MONTHS ENDED JULY 31,
INCREASE/(DECREASE) PERCENT CHANGE
2003/2004 INCREASE/(DECREASE) PERCENTAGE OF REVENUE
(IN THOUSANDS) 2003/2004 2004 2003
-------------- --------- ---- ----
Operating expenses:
Research and development (3,349) (13%) 21% 29%
Selling and marketing 452 1% 45% 52%
General and administrative (849) (6%) 12% 15%
Legal settlements (46,250) (100%) -- 52%
Amortization of intangible assets (112) (2%) 5% 6%
Amortization of stock-based compensation (313) (33%) 1% 1%
Restructuring and other non-recurring charges (9,863) (85%) 2% 13%
----------- ------ ---- ----
Total operating expenses (60,284) (41%) 86% 168%
----------- ------ ---- ----
Operating income/(loss) 74,346 107% 4% (79%)
----------- ------ ---- ----
Other income/(expense), net (232) (1,105%) -- -
Interest income, net (230) (39%) -- 1%
Gain on sale of investments, net (3,682) (100%) -- 4%
----------- ------ ---- ----
Income/(loss) before provision for income taxes 70,202 107% 5% (74%)
(Benefit from)/provision for income taxes (159) (42%) -- --
----------- ------ ---- ----
Net income/(loss) $ 70,361 107% 4% (74%)
=========== ====== ==== ====
COMPARISON OF THE SIX MONTHS ENDED JULY 31, 2004 AND 2003
REVENUE
Revenue increased $14.7 million, or 17%, to $103.4 million in the six months
ended July 31, 2004 from $88.7 million in the six months ended July 31, 2003.
This increase was primarily due to revenue generated from new business and
renewal business. For the fiscal year ended January 31, 2004, we experienced
improvement in renewal rates. We exited the year ended January 31, 2004 with
noncancellable backlog, which consists of deferred revenue and committed
contracts, of approximately $170 million as compared to $135 million at January
31, 2003. The increase in noncancellable backlog was due primarily to improved
renewal rates, expanded offerings for SMML customers and new customers. These
factors contributed favorably to revenue in the six months ended July 31, 2004
when compared to the year ago six month period.
QUARTERS ENDED JULY 31,
(IN THOUSANDS) 2004 2003 CHANGE
-------------- ---- ---- ------
Revenue:
United States $ 80,936 $ 71,996 $ 8,940
International 22,506 16,726 5,780
--------- --------- ---------
Total $ 103,442 $ 88,722 $ 14,720
========= ========= =========
Revenue increased by 12% and 35% in the United States and internationally,
respectively, in the six months ended July 31, 2004 as compared to the six
months ended July 31, 2003. The international revenue increase was due, in
addition to the factors discussed above, to increased reseller revenue due to
the timing of receipt of sell-through reporting and cash from resellers. The
United States represented 78% and 81% of revenue for the six months ended July
31, 2004 and 2003, respectively.
QUARTERS ENDED JULY 31,
(IN THOUSANDS) 2004 2003 CHANGE
-------------- ---- ---- ------
Revenue:
SkillChoice Multi-Modal Learning $ 94,081 $ 83,166 $ 10,915
Retail Certification 9,361 5,556 3,805
--------- --------- ---------
Total $ 103,442 $ 88,722 $ 14,720
========= ========= =========
The SkillChoice multi-modal learning segment represented 91% and 94% of revenue
for the six months ended July 31, 2004 and 2003, respectively.
COSTS AND EXPENSES
20
Cost of revenue increased $658,000, or 7%, to $10.3 million in the six months
ended July 31, 2004 from $9.7 million in the six months ended July 31, 2003.
This increase was primarily due to a higher mix of royalty bearing revenue as
well as increased headcount and infrastructure charges incurred in connection
with our efforts to consolidate hosting sites. Cost of revenue as a percentage
of total revenue was 10% in the six months ended July 31, 2004 versus 11% in the
six months ended July 31, 2003. The percentage decrease was primarily due to the
increase in revenue from the six months ended July 31, 2003 to the six months
ended July 31, 2004.
Research and development expenses decreased $3.3 million, or 13%, to $22.1
million in the six months ended July 31, 2004 from $25.4 million in the six
months ended July 31, 2003. Research and development expenses as a percentage of
total revenue decreased to 21% in the six months ended July 31, 2004 from 29% in
the six months ended July 31, 2003. Research and development for the six months
ended July 31, 2004 included a charge of $2.3 million related to the purchase of
technology and costs to modify and enhance the technology related to the
development of our Virtual Classroom product offerings. We anticipate incurring
approximately $2.2 million of additional development expenses over the second
half of fiscal 2005 to bring our Virtual Classroom offerings to market.
Excluding the effects of the $2.3 million charge in the six months ended
July 31, 2004, research and development decreased even more significantly when
compared to the six months ended July 31, 2003. This decrease was primarily due
to our completion of the initiative for content and platform improvements in the
quarter ended January 31, 2004. With the substantial completion of the
incremental investment in research and development we expect research and
development expenses to decrease in both absolute dollars and as a percentage of
total revenue in the fiscal year ending January 31, 2005 when compared to the
prior year.
Selling and marketing expenses increased $452,000, or 1%, to $47.0 million in
the six months ended July 31, 2004 from $46.6 million in the six months ended
July 31, 2003. The increase was primarily due to increased compensation and
benefit costs of approximately $1.5 million. This increase was partially offset
by a decline in certain infrastructure and occupancy charges of $830,000.
Selling and marketing expenses as a percentage of total revenue decreased to 45%
in the six months ended July 31, 2004 from 52% in the six months ended July 31,
2003. The percentage decrease was primarily due to the increase in revenue from
the six months ended July 31, 2003 to the six months ended July 31, 2004. We
anticipate incurring incremental selling and marketing expenses over the second
half of the year to introduce the Virtual Classroom offerings to the market. We
believe that a significant investment in selling and marketing to expand our
distribution channels worldwide is required to remain competitive, and we
therefore expect selling and marketing expenses to increase in absolute dollars,
but decrease as a percentage of total revenue when comparing fiscal 2005 results
to fiscal 2004 results.
General and administrative expenses decreased $849,000, or 6%, to $12.2 million
in the six months ended July 31, 2004 from $13.1 million in the six months ended
July 31, 2003. General and administrative expenses as a percentage of total
revenue decreased to 12% in the six months ended July 31, 2004 from 15% in the
six months ended July 31, 2003. General and administrative expenses decreased
primarily due to a reduction of litigation costs of $2.5 million and decline in
certain infrastructure and occupancy charges of $324,000 in the six months ended
July 31, 2004 compared to the six months ended July 31, 2003. This decrease was
offset in part by increases in accounting and other consulting services of $1.6
million and increases in compensation related expenses of $437,000. We
anticipate that general and administrative expenses will increase in absolute
dollars over the second half of the year due primarily to increases in the costs
of operating as a public company such as Sarbanes-Oxley Act compliance, audit,
legal and insurance.
Restructuring and other non-recurring charges decreased $9.8 million, or 85%, to
$1.7 million in the six months ended July 31, 2004 from $11.5 million in the six
months ended July 31, 2003. The restructuring and non-recurring charges relate
to the SmartForce-SkillSoft merger. The restructuring costs primarily consist of
compensation costs for certain terminated SmartForce employees. The other
non-recurring charges primarily consist of costs directly related to the
restatement of the SmartForce historical financial statements. This was
completed in the fiscal year ended January 31, 2004 and is the primary reason
for the decrease in restructuring and other non-recurring items when comparing
the six months ended July 31, 2004 to the six months ended July 31, 2003.
Charges for the six months ended July 31, 2004 consist primarily of the
re-filing of statutory tax returns as a result of the restatement of the
SmartForce PLC historical financial statements, the ongoing SEC investigation
and costs associated with international restructuring activities.
OTHER INCOME/(EXPENSE), NET
Other (expense)/income in the six months ended July 31, 2004 was ($211,000) as
compared to $21,000 in the six months ended July 31, 2003. This change was
primarily due to foreign currency fluctuations. Due to our multinational
operations, our business is subject to fluctuations based upon changes in the
exchange rates between the currencies we do business in.
21
PROVISION FOR INCOME TAXES
The provision for income taxes was $220,000 and $379,000 in the six months ended
July 31, 2004 and 2003, respectively. For the six months ended July 31, 2004 we
have recorded an income tax provision of $220,000, reflecting management's
expectations that the effective tax rate for fiscal 2005 will be in a range of
4.5% to 6.0%.
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 2004, our principal source of liquidity was our cash and cash
equivalents and short-term investments, which totaled $86.8 million. This
compares to $61.3 million at January 31, 2004. In addition, we have $400,000 in
restricted cash securing a letter of credit.
Net cash used in operating activities was $12.9 million for the six months ended
July 31, 2004. Our net cash used in operating activities in the six months ended
July 31, 2004 reflects primarily our net income of $4.6 million, depreciation
and amortization of $7.2 million, a decrease in prepaid expenses and other
current assets of $7.8 million, and a decrease in accounts receivable of $30.4
million, which was partially offset by a decrease of $41.1 million in accrued
expenses, primarily due to payments of $28.0 million in litigation settlements,
and a decrease in deferred revenue of $20.9 million due to an increase in the
percentage of quarterly billings as well as the seasonality of renewals.
Net cash provided by investing activities was $24.4 million for the six months
ended July 31, 2004. Maturity of investments, net of purchases (short and
long-term), generated a net cash inflow of approximately $4.4 million in the six
months ended July 31, 2004. In addition, the reduction of designated restricted
cash generated a cash inflow of $24.6 million. These inflows were partially
offset by expenditures for property, plant and equipment of $4.7 million.
Net cash provided by financing activities was $18.8 million for the six months
ended July 31, 2004. These proceeds related to the exercise of stock options and
stock purchases under our various stock plans and stock purchases under our 1995
Employee Share Purchase Plan.
Working capital deficit was approximately ($23.9) million and ($49.1) million as
of July 31, 2004 and January 31, 2004, respectively. The increase in working
capital in the six months ended July 31, 2004 was primarily due to net income of
$4.6 million, proceeds from exercises of stock options under our various stock
plans and stock purchases under the 1995 Employee Share Purchase Plan of $18.8
million, depreciation and amortization of $7.2 million, which was offset
primarily by purchases of property and equipment of $4.7 million. Total assets
were approximately $301.7 million and $342.4 million as of July 31, 2004 and
January 31, 2004, respectively. As of July 31, 2004 and January 31, 2004,
goodwill and separately identifiable intangible assets were $146.5 million and
$151.6 million, respectively.
On July 23, 2004, we entered into a $25 million two year, working capital line
of credit with a bank. Under the terms of the line of credit, the bank has a
first security interest in all domestic business assets. All borrowings under
the line of credit bear interest at the bank's prime rate. The facility is
subject to a commitment fee of $50,000 to secure the line of credit and unused
commitment fees of 0.125% based upon the daily average of un-advanced amounts
under the revolving line of credit. In addition, the line of credit contains
certain financial and non-financial covenants. At July 31, 2004, we are in
compliance with all financial and non-financial covenants. As of July 31, 2004,
there were no borrowings on the line of credit; however, we had an outstanding
letter of credit of $400,000 that was secured with a certificate of deposit.
As of January 31, 2004, prior to the filing of the Skillsoft Consolidated
Group's federal tax return for the year ended January 31, 2004, which we
anticipate filing on October 15, 2004, we had U.S. federal net operating loss
carryforwards of approximately $350.1 million, which are subject to potential
limitations based upon change in control provisions of Section 382 of the
Internal Revenue Code, available to reduce future income taxes, if any. We also
had U.S. federal tax credit carryforwards of approximately $3.0 million at
January 31, 2004. Additionally, we had approximately $86.7 million of net
operating loss carryforwards in jurisdictions outside of the U.S. If not
utilized, these carryforwards expire at various dates through the year ending
January 31, 2024. Included in the $350.1 million are approximately $217.7
million of U.S. net operating loss carryforwards and $365,000 of U.S. tax credit
carryforwards that were acquired in the Merger and the purchase of Books. In
addition, included in the $86.7 million we have approximately $62.7 million of
net operating loss carryforwards in jurisdictions outside the U.S. acquired in
the Merger and the purchase of Books. We will realize the benefits of these
acquired net operating losses through reductions to goodwill and non-goodwill
intangibles during the period that the losses are utilized to reduce tax
payments. At January 31, 2004, we have approximately $3.4 million of net
operating loss carryforwards in the United States resulting from disqualifying
dispositions. We will realize the benefit of these losses through increases to
stockholder's equity in the periods in which the losses are utilized to reduce
tax payments.
22
We lease certain of our facilities and certain equipment and furniture under
operating lease agreements that expire at various dates through 2023. Future
minimum payments, net of estimated rentals, under these agreements are as follow
(in thousands):
PAYMENTS DUE BY PERIOD
LESS THAN 1-3 3-5 MORE THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
----- ------ ----- ----- -------
Contractual Obligations
Operating Lease Obligations $ 41,016 $ 7,304 $ 10,581 $ 7,424 $ 15,707
-------- ---------- -------- ------- ----------
TOTAL $ 41,016 $ 7,304 $ 10,581 $ 7,424 $ 15,707
========= ========== ======== ======= ==========
We have entered into agreements to settle certain litigation matters, and the
future commitments under these agreements are as follows (in thousands):
PAYMENTS DUE BY PERIOD
LITIGATION SETTLEMENT LESS THAN 1-3
COMMITMENTS TOTAL 1 YEAR YEARS
----------- ----- ------ -----
2002 Securities class action $ 31,500 $ 16,250 $ 15,250
---------- --------- ----------
TOTAL $ 31,500 $ 16,250 $ 15,250
========== ========= ==========
We expect to continue to experience growth in capital expenditures and operating
expenses, particularly in sales and marketing, through the end of the fiscal
year ending January 31, 2005 as compared to the fiscal year ended January 31,
2004 in order to execute our business plan and achieve expected revenue growth.
To the extent that our execution of the business plan results in increased
sales, we expect to experience corresponding increases in deferred revenue, cash
flow and prepaid expenses. In addition, we are required to make litigation
settlement payments totaling $31.5 million subsequent to July 31, 2004, of which
$15.25 million was paid in August 2004. We anticipate a payout of $1.0 million
before January 31, 2005 with the remaining $15.25 due in the fiscal year ending
January 31, 2006. We are in discussions with our insurers to determine how much,
if any, of the settlement related to the 2002 securities class action lawsuits
will be paid by them. Capital expenditures for the fiscal year ending January
31, 2005 are expected to be approximately $9.5 million of which $4.7 million has
been expended through July 31, 2004. Also, we expect to disburse approximately
$6.9 million throughout the fiscal year ending January 31, 2005 against exit and
restructuring plan accruals recorded in the fiscal years ended January 31, 2003
and 2004. We expect that the principal sources of funding for our operating
expenses, capital expenditures, litigation settlement payments and other
liquidity needs will be a combination of our available cash and cash equivalents
and short-term investments (which totaled approximately $86.8 million as of July
31, 2004), and funds generated from future cash flows. We believe our current
funds and expected cash flows from operating activities will be sufficient to
fund our operations for at least the next 12 months. However, there are a number
of factors that may negatively impact our available sources of funds. In
addition, our cash needs may increase due to factors such as unanticipated
developments in our business or significant acquisitions. The amount of cash
generated from operations will be dependent upon the successful execution of our
business plan. Although we do not foresee the need to raise additional capital,
any unanticipated economic or business events could require us to raise
additional capital to support operations.
FUTURE OPERATING RESULTS
RISKS RELATED TO LEGAL PROCEEDINGS
IN CONNECTION WITH OUR RESTATEMENT OF THE HISTORICAL FINANCIAL STATEMENTS OF
SMARTFORCE, CLASS ACTION LAWSUITS HAVE BEEN FILED AGAINST US AND ADDITIONAL
LAWSUITS MAY BE FILED, AND WE ARE THE SUBJECT OF A FORMAL ORDER OF PRIVATE
INVESTIGATION ENTERED BY THE SEC.
While preparing the closing balance sheet of SmartForce as at September 6,
2002, the date on which we closed our merger with SkillSoft Corporation, certain
accounting matters were identified relating to the historical financial
statements of SmartForce (which, following the Merger, are no longer our
historical financial statements -- see Note 1 of the Notes to the Consolidated
Financial Statements). On November 19, 2002, we announced our intent to restate
the SmartForce financial statements for 1999, 2000, 2001 and the first two
quarters of 2002. We have settled several class action lawsuits that were filed
following the announcement of the restatement.
23
We are the subject of a formal order of private investigation entered by
the SEC. We are cooperating with the SEC in connection with this investigation.
We will likely incur substantial costs in connection with the SEC investigation,
which could cause a diversion of management time and attention. In addition, we
could be subject to substantial penalties, fines or regulatory sanctions, which
could adversely affect our business. In March 2004, we reached a settlement,
subject to final court approval for total settlement payments of $30.5 million,
one-half of which was paid in August 2004 following receipt of preliminary
approval by the court and the balance to be paid one year later. Although we are
in discussions with our insurers to determine how much, if any, of this
settlement amount will be paid by them, we may not be able to recover any amount
from our insurers.
CLAIMS THAT WE INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS COULD
RESULT IN COSTLY LITIGATION OR ROYALTY PAYMENTS TO THIRD PARTIES, OR REQUIRE US
TO REENGINEER OR CEASE SALES OF OUR PRODUCTS OR SERVICES.
Third parties have in the past and could in the future claim that our
current or future products infringe their intellectual property rights. Any
claim, with or without merit, could result in costly litigation or require us to
reengineer or cease sales of our products or services, any of which could have a
material adverse effect on our business. Infringement claims could also result
in an injunction in the use of our products or require us to enter into royalty
or licensing agreements. Licensing agreements, if required, may not be available
on terms acceptable to the combined company or at all.
From time to time we learn of parties that claim broad intellectual
property rights in the e-learning area that might implicate our offerings. These
parties or others could initiate actions against us in the future.
WE COULD INCUR SUBSTANTIAL COSTS RESULTING FROM PRODUCT LIABILITY CLAIMS
RELATING TO OUR CUSTOMERS' USE OF OUR PRODUCTS AND SERVICES.
Many of the business interactions supported by our products and services
are critical to our customers' businesses. Any failure in a customer's business
interaction or other collaborative activity caused or allegedly caused in the
future by our products and services could result in a claim for substantial
damages against us, regardless of our responsibility for the failure. Although
we maintain general liability insurance, including coverage for errors and
omissions, there can be no assurance that existing coverage will continue to be
available on reasonable terms or will be available in amounts sufficient to
cover one or more large claims, or that the insurer will not disclaim coverage
as to any future claim.
WE COULD BE SUBJECTED TO LEGAL ACTIONS BASED UPON THE CONTENT WE OBTAIN FROM
THIRD PARTIES OVER WHOM WE EXERT LIMITED CONTROL.
It is possible that we could become subject to legal actions based upon
claims that our course content infringes the rights of others or is erroneous.
Any such claims, with or without merit, could subject us to costly litigation
and the diversion of our financial resources and management personnel. The risk
of such claims is exacerbated by the fact that our course content is provided by
third parties over whom we exert limited control. Further, if those claims are
successful, we may be required to alter the content, pay financial damages or
obtain content from others.
RISKS RELATED TO THE MERGER BETWEEN SKILLSOFT CORPORATION AND SMARTFORCE
WE HAVE IDENTIFIED SIGNIFICANT DEFICIENCIES IN OUR DISCLOSURE CONTROLS AND
PROCEDURES AND INTERNAL CONTROLS.
During the process of integrating the business processes, human resources,
disclosure controls and procedures, and internal controls of SmartForce PLC and
SkillSoft Corporation, significant deficiencies in disclosure controls and
procedures and internal controls were identified predominantly with respect to
financial reporting at non-U.S. subsidiaries of the former SmartForce PLC and
our ability to process the consolidated financial closing cycle. These
deficiencies resulted in a significant strain to the internal resources and on
the infrastructure of the finance organization and adversely impacted both the
year-end and quarter-end financial closing process for the fiscal year ended
January 31, 2003. External resources were engaged to assist management in both
the year-end and quarter-end financial closing process and in identifying areas
for improvement for the fiscal year ended January 31, 2003. In addition, in
fiscal years ended January 31, 2003 and 2004, permanent resources and accounting
process improvements were added and implemented to improve the non-U.S. finance
operations, the financial closing process, and the overall internal control
environment. Our independent auditors have informed us that they believe we have
no material weaknesses in internal controls at January 31, 2004. However they
have informed us of certain reportable conditions at that date, including
financial and regulatory compliance reporting at non-U.S. subsidiaries of the
former SmartForce PLC and our ability to process the financial closing cycle at
certain subsidiaries.
24
RISKS RELATED TO THE OPERATION OF OUR BUSINESS
SOME OF OUR INTERNATIONAL SUBSIDIARIES HAVE NOT COMPLIED WITH REGULATORY
REQUIREMENTS RELATING TO THEIR FINANCIAL STATEMENTS AND TAX RETURNS.
We operate our business in various foreign countries through subsidiaries
organized in those countries. Due to our restatement of the historical
SmartForce financial statements, some of our subsidiaries have not filed their
audited statutory financial statements and have been delayed in filing their tax
returns in their respective jurisdictions. As a result, some of these foreign
subsidiaries may be subject to regulatory restrictions, penalties and fines.
WE AND SKILLSOFT CORPORATION HAVE EXPERIENCED NET LOSSES IN THE PAST, AND WE MAY
BE UNABLE TO MAINTAIN PROFITABILITY.
SmartForce incurred substantial net losses prior to the Merger, including
net losses of $50.2 million in the six months ended June 30, 2002. SkillSoft
Corporation incurred substantial net losses in every fiscal quarter prior to its
fiscal quarter ended January 31, 2002. In addition, the combined company
recorded a net loss of $284 million for the fiscal year ended January 31, 2003
and $113.3 million for the fiscal year ended January 31, 2004. We achieved
profitability for the first time post-Merger in the first two quarters of the
fiscal year ended January 31, 2005. However, we cannot guarantee that our
combined business will sustain profitability in any future period.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY. THIS LIMITS YOUR
ABILITY TO EVALUATE HISTORICAL FINANCIAL RESULTS AND INCREASES THE LIKELIHOOD
THAT OUR RESULTS WILL FALL BELOW MARKET ANALYSTS' EXPECTATIONS, WHICH COULD
CAUSE THE PRICE OF OUR ADSS TO DROP RAPIDLY AND SEVERELY.
We have in the past experienced fluctuations in our quarterly operating
results, and we anticipate that these fluctuations will continue. As a result,
we believe that our quarterly revenue, expenses and operating results are likely
to vary significantly in the future. If in some future quarters our results of
operations are below the expectations of public market analysts and investors,
this could have a severe adverse effect on the market price of our ADSs.
Our operating results have historically fluctuated, and our operating
results may in the future continue to fluctuate, as a result of factors, which
include (without limitation):
- the size and timing of new/renewal agreements and upgrades;
- royalty rates;
- the announcement, introduction and acceptance of new products, product
enhancements and technologies by us and our competitors;
- the mix of sales between our field sales force, our other direct sales
channels and our telesales channels;
- general conditions in the U.S. or the international economy;
- the loss of significant customers;
- delays in availability of new products;
- product or service quality problems;
- seasonality -- due to the budget and purchasing cycles of our customers,
we expect our revenue and operating results will generally be strongest in
the second half of our fiscal year and weakest in the first half of our
fiscal year;
25
- the spending patterns of our customers;
- litigation costs and expenses, including the costs related to the
restatement of the SmartForce financial statements;
- non-recurring charges related to acquisitions;
- growing competition that may result in price reductions; and
- currency fluctuations.
Most of our expenses, such as rent and most employee compensation, do not
vary directly with revenue and are difficult to adjust in the short-term. As a
result, if revenue for a particular quarter is below our expectations, we could
not proportionately reduce operating expenses for that quarter. Any such revenue
shortfall would, therefore, have a disproportionate effect on our expected
operating results for that quarter.
DEMAND FOR OUR PRODUCTS AND SERVICES MAY BE ESPECIALLY SUSCEPTIBLE TO ADVERSE
ECONOMIC CONDITIONS.
Our business and financial performance may be damaged by adverse financial
conditions affecting our target customers or by a general weakening of the
economy. Companies may not view training products and services as critical to
the success of their businesses. If these companies experience disappointing
operating results, whether as a result of adverse economic conditions,
competitive issues or other factors, they may decrease or forego education and
training expenditures before limiting their other expenditures or in conjunction
with lowering other expenses.
WE RELY ON A LIMITED NUMBER OF THIRD PARTIES TO PROVIDE US WITH EDUCATIONAL
CONTENT FOR OUR COURSES AND REFERENCEWARE, AND OUR ALLIANCES WITH THESE THIRD
PARTIES MAY BE TERMINATED OR FAIL TO MEET OUR REQUIREMENTS.
We rely on a limited number of independent third parties to provide us
with the educational content for a majority of our courses based on learning
objectives and specific instructional design templates that we provide to them.
We do not have exclusive arrangements or long-term contracts with any of these
content providers. If one or more of our third party content providers were to
stop working with us, we would have to rely on other parties to develop our
course content. In addition, these providers may fail to develop new courses or
existing courses on a timely basis. We cannot predict whether new content or
enhancements would be available from reliable alternative sources on reasonable
terms. In addition, Books relies on third party publishers to provide all of the
content incorporated into its Referenceware products. If one or more of these
publishers were to terminate their license with us, we may not be able to find
substitute publishers for such content. In addition, we may be forced to pay
increased royalties to these publishers to continue our licenses with them.
In the event that we are unable to maintain or expand our current
development alliances or enter into new development alliances, our operating
results and financial condition could be materially adversely affected.
Furthermore, we will be required to pay royalties to some of our development
partners on products developed with them, which could reduce our gross margins.
We expect that cost of revenues may fluctuate from period to period in the
future based upon many factors, including the revenue mix and the timing of
expenses associated with development alliances. In addition, the collaborative
nature of the development process under these alliances may result in longer
development times and less control over the timing of product introductions than
for e-learning offerings developed solely by us. Our strategic alliance partners
may from time to time renegotiate the terms of their agreements with us, which
could result in changes to the royalty or other arrangements, adversely
affecting our results of operations.
The independent third party strategic partners we rely on for educational
content and product marketing may compete with us, harming our results of
operations. Our agreements with these third parties generally do not restrict
them from developing courses on similar topics for our competitors or from
competing directly with us. As a result, our competitors may be able to
duplicate some of our course content and gain a competitive advantage.
WE RELY ON STRATEGIC ALLIANCES FOR MARKETING, WHICH ALLIANCES ARE NOT EXCLUSIVE,
MAY BE TERMINATED OR MAY FAIL TO MEET OUR REQUIREMENTS IN THE FUTURE.
We have developed strategic alliances to market many of our products.
However, these relationships are not exclusive, and ourmarketing partners could
market other products in preference to, and in competition with, those developed
by us. In addition, we may be unable to continue to market future products
through these alliances or may be unable to negotiate additional alliances in
the future on acceptable terms, if at all. The marketing efforts of our
strategic partners may also disrupt our direct sales efforts.
26
OUR SUCCESS DEPENDS ON OUR ABILITY TO MEET THE NEEDS OF THE RAPIDLY CHANGING
MARKET.
The market for education and training software is characterized by rapidly
changing technology, evolving industry standards, changes in customer
requirements and preferences and frequent introductions of new products and
services embodying new technologies. New methods of providing interactive
education in a technology-based format are being developed and offered in the
marketplace, including intranet and Internet offerings. In addition, multimedia
and other product functionality features are being added to educational
software. Our future success will depend upon the extent to which we are able to
develop and implement products which address these emerging market requirements
in a cost effective and timely basis. Product development is risky because it is
difficult to foresee developments in technology, coordinate technical personnel
and identify and eliminate design flaws. Any significant delay in releasing new
products could have a material adverse effect on the ultimate success of our
products and could reduce sales of predecessor products. We may not be
successful in introducing new products on a timely basis. In addition, new
products introduced by us may fail to achieve a significant degree of market
acceptance or, once accepted, may fail to sustain viability in the market for
any significant period. If we are unsuccessful in addressing the changing needs
of the marketplace due to resource, technological or other constraints, or in
anticipating and responding adequately to changes in customers' software
technology and preferences, our business and results of operations would be
materially adversely affected.
THE E-LEARNING MARKET IS A DEVELOPING MARKET, AND OUR BUSINESS WILL SUFFER IF
E-LEARNING IS NOT WIDELY ACCEPTED.
The market for e-learning is a new and emerging market. Corporate training
and education have historically been conducted primarily through classroom
instruction and have traditionally been performed by a company's internal
personnel. Many companies have invested heavily in their current training
solutions. Although technology-based training applications have been available
for several years, they currently account for only a small portion of the
overall training market.
Accordingly, our future success will depend upon the extent to which
companies adopt technology-based solutions for their training activities, and
the extent to which companies utilize the services or purchase products of
third-party providers. Many companies that have already invested substantial
resources in traditional methods of corporate training may be reluctant to adopt
a new strategy that may compete with their existing investments. Even if
companies implement technology-based training or e-learning solutions, they may
still choose to design, develop, deliver or manage all or part of their
education and training internally. If technology-based learning does not become
widespread, or if companies do not use the products and services of third
parties to develop, deliver or manage their training needs, then our products
and service may not achieve commercial success.
THE SUCCESS OF OUR E-LEARNING STRATEGY DEPENDS ON THE RELIABILITY AND CONSISTENT
PERFORMANCE OF OUR INFORMATION SYSTEMS AND INTERNET INFRASTRUCTURE.
The success of our e-learning strategy is highly dependent on the
consistent performance of our information systems and Internet infrastructure.
If our Web site fails for any reason or if it experiences any unscheduled
downtimes, even for only a short period, our business and reputation could be
materially harmed. We have in the past experienced performance problems and
unscheduled downtime, and these problems could recur. We currently rely on third
parties for proper functioning of computer infrastructure, delivery of our
e-learning applications and the performance of our destination site. Our systems
and operations could be damaged or interrupted by fire, flood, power loss,
telecommunications failure, break-ins, earthquake, financial patterns of hosting
providers and similar events. Any system failures could adversely affect
customer usage of our solutions and user traffic results in any future quarters,
which could adversely affect our revenues and operating results and harm our
reputation with corporate customers, subscribers and commerce partners.
Accordingly, the satisfactory performance, reliability and availability of our
Web site and computer infrastructure is critical to our reputation and ability
to attract and retain corporate customers, subscribers and commerce partners. We
cannot accurately project the rate or timing of any increases in traffic to our
Web site and, therefore, the integration and timing of any upgrades or
enhancements required to facilitate any significant traffic increase to the Web
site are uncertain. We have in the past experienced difficulties in upgrading
our Web site infrastructure to handle increased traffic, and these difficulties
could recur. The failure to expand and upgrade our Web site or any system error,
failure or extended down time could materially harm our business, reputation,
financial condition or results of operations.
BECAUSE MANY USERS OF OUR E-LEARNING SOLUTIONS WILL ACCESS THEM OVER THE
INTERNET, FACTORS ADVERSELY AFFECTING THE USE OF THE INTERNET OR OUR CUSTOMERS'
NETWORKING INFRASTRUCTURES COULD HARM OUR BUSINESS.
27
Many of our customer's users access our e-learning solutions over the
Internet or through our customers' internal networks. Any factors that adversely
affect Internet usage could disrupt the ability of those users to access our
e-learning solutions, which would adversely affect customer satisfaction and
therefore our business. For example, our ability to increase the effectiveness
and scope of our services to customers is ultimately limited by the speed and
reliability of both the Internet and our customers' internal networks.
Consequently, the emergence and growth of the market for our products and
services depends upon the improvements being made to the entire Internet as well
as to our individual customers' networking infrastructures to alleviate
overloading and congestion. If these improvements are not made, and the quality
of networks degrades, the ability of our customers to use our products and
services will be hindered and our revenues may suffer.
Additionally, a requirement for the continued growth of accessing
e-learning solutions over the Internet is the secure transmission of
confidential information over public networks. Failure to prevent security
breaches into our products or our customers' networks, or well-publicized
security breaches affecting the Internet in general could significantly harm our
growth and revenue. Advances in computer capabilities, new discoveries in the
field of cryptography or other developments may result in a compromise of
technology we use to protect content and transactions, our products or our
customers' proprietary information in our databases. Anyone who is able to
circumvent our security measures could misappropriate proprietary and
confidential information or could cause interruptions in our operations. We may
be required to expend significant capital and other resources to protect against
such security breaches or to address problems caused by security breaches. The
privacy of users may also deter people from using the Internet to conduct
transactions that involve transmitting confidential information.
OUR RESTRUCTURING PLANS MAY BE INEFFECTIVE OR MAY LIMIT OUR ABILITY TO COMPETE.
Since the Merger, we have recorded an aggregate of $31.4 million in merger
and exit costs and an aggregate of $37.6 million of restructuring and other
non-recurring charges. There are several risks inherent in these efforts to
transition to a new cost structure. These include the risk that we will not be
successful in restoring profitability, and hence we may have to undertake
further restructuring initiatives that would entail additional charges and
create additional risks. In addition, there is the risk that cost-cutting
initiatives will impair our ability to effectively develop and market products
and remain competitive. Each of the above measures could have long-term effects
on our business by reducing our pool of talent, decreasing or slowing
improvements in our products, making it more difficult for us to respond to
customers, limiting our ability to increase production quickly if and when the
demand for our products increases and limiting our ability to hire and retain
key personnel. These circumstances could cause our earnings to be lower than
they otherwise might be.
WE DEPEND ON A FEW KEY PERSONNEL TO MANAGE AND OPERATE THE BUSINESS AND MUST BE
ABLE TO ATTRACT AND RETAIN HIGHLY QUALIFIED EMPLOYEES.
Our success is largely dependent on the personal efforts and abilities of
our senior management. Failure to retain these executives, or the loss of
certain additional senior management personnel or other key employees, could
have a material adverse effect on our business and future prospects. We are also
dependent on the continued service of our key sales, content development and
operational personnel and on our ability to attract, train, motivate and retain
highly qualified employees. In addition, we depend on writers, programmers, Web
designers and graphic artists. We may be unsuccessful in attracting, training,
retaining or motivating key personnel. In particular, the negative consequences
(including litigation) of having to restate SmartForce's historical financial
statements, uncertainties surrounding the Merger, and our recent adverse
operating results and stock price performance could create uncertainties that
materially and adversely affect our ability to attract and retain key personnel.
The inability to hire, train and retain qualified personnel or the loss of the
services of key personnel could have a material adverse effect upon our
business, new product development efforts and future business prospects.
CHANGES IN ACCOUNTING STANDARDS REGARDING STOCK OPTION PLANS COULD LIMIT THE
DESIRABILITY OF GRANTING STOCK OPTIONS, WHICH COULD HARM OUR ABILITY TO ATTRACT
AND RETAIN EMPLOYEES, AND COULD ALSO REDUCE OUR PROFITABILITY.
The Financial Accounting Standards Board is considering whether to require
all companies to treat the value of stock options granted to employees as an
expense. The United States Congress and other governmental and regulatory
authorities have also considered requiring companies to expense stock options.
If this change were to become mandatory, we and other companies would be
required to record a compensation expense equal to the value of each stock
option granted. This expense would be spread over the vesting period of the
stock option. Currently, we are generally not required to record compensation
expenses in connection with stock option grants. If we were required to expense
stock option grants, it could reduce the attractiveness of granting stock
28
options because the additional expense associated with these grants would
reduce our profitability. However, stock options are an important employee
recruitment and retention tool, and we may not be able to attract and retain key
personnel if we reduce the scope of our employee stock option program.
Accordingly, in the event we are required to expense stock option grants, either
our profitability, or our ability to use stock options as an employee
recruitment and retention tool would be adversely impacted.
INCREASED COMPETITION MAY RESULT IN DECREASED DEMAND FOR OUR PRODUCTS AND
SERVICES, WHICH MAY RESULT IN REDUCED REVENUES AND GROSS PROFITS AND LOSS OF
MARKET SHARE.
The market for corporate education and training solutions is highly
fragmented and competitive. We expect the market to become increasingly
competitive due to the lack of significant barriers to entry. In addition to
increased competition from new companies entering into the market, established
companies are entering into the market through acquisitions of smaller
companies, which directly compete with us, and this trend is expected to
continue. We may also face competition from publishing companies and vendors of
application software, including those vendors with whom we have formed
development and marketing alliances.
Our primary sources of direct competition are:
- third-party suppliers of instructor-led information technology,
business, management and professional skills education and training;
- suppliers of computer-based training and e-learning solutions;
- internal education and training departments of potential customers;
and
- value-added resellers and network integrators.
Growing competition may result in price reductions, reduced revenue and
gross profits and loss of market share, any one of which would have a material
adverse effect on our business. Many of our current and potential competitors
have substantially greater financial, technical, sales, marketing and other
resources, as well as greater name recognition, and we expect to face increasing
price pressures from competitors as managers demand more value for their
training budgets. Accordingly, we may be unable to provide e-learning solutions
that compare favorably with new instructor-led techniques, other interactive
training software or new e-learning solutions.
OUR BUSINESS IS SUBJECT TO CURRENCY FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.
Due to our multinational operations, our operating results are subject to
fluctuations based upon changes in the exchange rates between the currencies in
which revenues are collected or expenses are paid. In particular, the value of
the U.S. dollar against the euro and related currencies will impact our
operating results. Our expenses will not necessarily be incurred in the currency
in which revenue is generated, and, as a result, we will be required from time
to time to convert currencies to meet our obligations. These currency
conversions are subject to exchange rate fluctuations, and changes to the value
of the euro, pound sterling and other currencies relative to the U.S. dollar
could adversely affect our business and results of operations.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS. UNAUTHORIZED USE OF OUR
INTELLECTUAL PROPERTY MAY RESULT IN DEVELOPMENT OF PRODUCTS OR SERVICES THAT
COMPETE WITH OURS.
Our success depends to a degree upon the protection of our rights in
intellectual property. We rely upon a combination of patent, copyright, and
trademark laws to protect our proprietary rights. We have also entered into, and
will continue to enter into, confidentiality agreements with our employees,
consultants and third parties to seek to limit and protect the distribution of
confidential information. However, we have not signed protective agreements in
every case.
Although we have taken steps to protect our proprietary rights, these
steps may be inadequate. Existing patent, copyright, and trademark laws offer
only limited protection. Moreover, the laws of other countries in which we
market our products may afford little or no effective protection of our
intellectual property. Additionally, unauthorized parties may copy aspects of
our products, services or technology or obtain and use information that we
regard as proprietary. Other parties may also breach protective contracts we
have executed or will in the future execute. We may not become aware of, or have
adequate remedies in the event of, a breach. Litigation may be necessary in the
future to enforce or to determine the validity and scope of our intellectual
29
property rights or to determine the validity and scope of the proprietary rights
of others. Even if we were to prevail, such litigation could result in
substantial costs and diversion of management and technical resources.
OUR NON-U.S. OPERATIONS ARE SUBJECT TO RISKS WHICH COULD NEGATIVELY IMPACT OUR
FUTURE OPERATING RESULTS.
We expect that international operations will continue to account for a
significant portion of our revenues. Operations outside of the United States are
subject to inherent risks, including:
- difficulties or delays in developing and supporting non-English
language versions of our products and services;
- political and economic conditions in various jurisdictions;
- difficulties in staffing and managing foreign subsidiary operations;
- longer sales cycles and account receivable payment cycles;
- multiple, conflicting and changing governmental laws and
regulations;
- foreign currency exchange rate fluctuations;
- protectionist laws and business practices that may favor local
competitors;
- difficulties in finding and managing local resellers;
- potential adverse tax consequences; and
- the absence or significant lack of legal protection for intellectual
property rights.
Any of these factors could have a material adverse effect on our future
operations outside of the United States, which could negatively impact our
future operating results.
THE MARKET PRICE OF OUR ADSs MAY FLUCTUATE AND MAY NOT BE SUSTAINABLE.
The market price of our ADSs has fluctuated significantly since our
initial public offering and is likely to continue to be volatile. In addition,
in recent years the stock market in general, and the market for shares of
technology stocks in particular, have experienced extreme price and volume
fluctuations, which have often been unrelated to the operating performance of
affected companies. The market price of our ADSs may continue to experience
significant fluctuations in the future, including fluctuations that are
unrelated to our performance. As a result of these fluctuations in the price of
our ADSs, it is difficult to predict what the price of our ADSs will be at any
point in the future, and you may not be able to sell your ADSs at or above the
price that you paid for them.
OUR SALES CYCLE MAY MAKE IT DIFFICULT TO PREDICT OUR OPERATING RESULTS.
The period between our initial contact with a potential customer and the
purchase of our products (not including SmartCertify) by that customer typically
ranges from three to twelve months or more. Factors that contribute to our long
sales cycle, include:
- our need to educate potential customers about the benefits of our
products;
- competitive evaluations by customers;
- the customers' internal budgeting and approval processes;
- the fact that many customers view training products as discretionary
spending, rather than purchases essential to their business; and
30
- the fact that we target large companies, which often take longer to
make purchasing decisions due to the size and complexity of the
enterprise.
These long sales cycles make it difficult to predict the quarter in which
sales may occur. Delays in sales could cause significant variability in our
revenues and operating results for any particular period.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF OUR PRODUCTS CONTAIN ERRORS.
Software products as complex as ours contain known and undetected errors
or "bugs" that result in product failures. The existence of bugs could result in
loss of or delay in revenues, loss of market share, diversion of product
development resources, injury to reputation or damage to efforts to build brand
awareness, any of which could have a material adverse effect on our business,
operating results and financial condition.
THE CONVICTION OF ARTHUR ANDERSEN LLP ON OBSTRUCTION OF JUSTICE CHARGES MAY
ADVERSELY AFFECT ARTHUR ANDERSEN LLP'S ABILITY TO SATISFY ANY CLAIMS ARISING
FROM THE PROVISION OF AUDITING SERVICES TO SKILLSOFT CORPORATION AND MAY IMPEDE
OUR ACCESS TO CAPITAL MARKETS AFTER THE MERGER.
Arthur Andersen LLP audited SkillSoft Corporation's financial statements
for the fiscal years ended January 31, 2002, January 31, 2001 and January 31,
2000. On March 14, 2002, an indictment was unsealed charging it with federal
obstruction of justice arising from the government's investigation of Enron
Corp. On June 15, 2002, Arthur Andersen LLP was convicted of these charges. It
is possible that the effect of this conviction on Arthur Andersen LLP's
financial condition may adversely affect the ability of Arthur Andersen LLP to
satisfy any claims arising from its provision of auditing services to SkillSoft
Corporation.
Should we seek to access the public capital markets, SEC rules will
require us to include or incorporate by reference in any prospectus three years
of audited financial statements. The SEC's current rules would require us to
present audited financial statements for one fiscal year audited by Arthur
Andersen LLP and use reasonable efforts to obtain its consent until the audited
financial statements for the fiscal year ending January 31, 2005 become
available. If prior to that time the SEC ceases accepting financial statements
audited by Arthur Andersen LLP, it is possible that the available audited
financial statements for the fiscal years ended January 31, 2002, January 31,
2001 and January 31, 2000 audited by Arthur Andersen LLP might not satisfy the
SEC's requirements. In that case, we would be unable to access the public
capital markets unless Ernst & Young LLP, our current independent accounting
firm, or another independent accounting firm, is able to audit the financial
statements originally audited by Arthur Andersen LLP. Any delay or inability to
access the public capital markets caused by these circumstances could have a
material adverse effect on our business, profitability and growth prospects.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of July 31, 2004, we did not use derivative financial instruments for
speculative or trading purposes.
INTEREST RATE RISK
Our general investing policy is to limit the risk of principal loss and to
ensure the safety of invested funds by limiting market and credit risk. We
currently use a registered investment manager to place our investments in highly
liquid money market accounts and government-backed securities. All highly liquid
investments with original maturities of three months or less are considered to
be cash equivalents. Interest income is sensitive to changes in the general
level of U.S. interest rates. Based on the short-term nature of our investments,
we have concluded that there is no significant market risk exposure.
FOREIGN CURRENCY RISK
Due to our multinational operations, our business is subject to fluctuations
based upon changes in the exchange rates between the currencies in which we
collect revenues or pay expenses and the U.S. dollar. Our expenses are not
necessarily incurred in the currency in which revenue is generated, and, as a
result, we are required from time to time to convert currencies to meet our
obligations. These currency conversions are subject to exchange rate
fluctuations, in particular changes to the value of the euro, Canadian dollar,
Australian dollar, New Zealand dollar, Singapore dollar, and pound sterling
relative to the U.S. dollar, which could adversely affect our business and the
results of operations.
31
ITEM 4. - CONTROLS AND PROCEDURES
Following the merger of SmartForce PLC and SkillSoft Corporation on
September 6, 2002, we integrated the business processes, human resources,
disclosure controls and procedures, and internal controls of the two companies.
During this process, significant deficiencies in disclosure controls and
procedures and internal controls were identified predominantly with respect to
financial reporting at non-U.S. subsidiaries of the former SmartForce PLC and
our ability to process the consolidated financial closing cycle. These
deficiencies resulted in a significant strain to the internal resources and on
the infrastructure of the finance organization and adversely impacted both the
year-end and quarter-end financial closing process for the fiscal year ended
January 31, 2003. External resources were engaged to assist management in both
the year-end and quarter-end financial closing process and in identifying areas
for improvement for the fiscal year ended January 31, 2003. In addition, in
fiscal years ended January 31, 2003 and 2004, permanent resources and accounting
process improvements have been added and implemented to improve the non-U.S.
finance operations, the financial closing process, and the overall internal
control environment. Our independent auditors have informed us that they believe
we had no material weaknesses in internal controls at January 31, 2004. However,
they have informed us of certain reportable conditions at that date, including
financial and regulatory compliance reporting at non-U.S. subsidiaries of the
former SmartForce PLC and our ability to process the financial closing cycle at
certain subsidiaries.
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer we evaluated
the effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of July 31, 2004. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that while we have
implemented mitigating controls and process improvements with respect to our
disclosure controls and procedures and that they are now operating effectively,
we believe that continuous monitoring and improving of these disclosure controls
and procedures will be required. Additionally, we have commenced a process of
reviewing all of our material financial processes in an effort to assess our
Sarbanes-Oxley 404 preparedness, which includes the establishment of an internal
audit function.
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f)) under the Exchange Act occurred during the
quarter ended July 31, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
32
PART II
ITEM 1. - LEGAL PROCEEDINGS
Not applicable.
ITEM 2. - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II - ITEM 4 DISCLOSURE:
We held our 2004 annual general meeting of shareholders (the "AGM") on
August 27, 2004. Under the terms of the deposit agreement, The Bank of New York
is entitled to vote or cause to be voted on behalf of, and in accordance with
the instructions received from, the ADS holders. Two individual shareholders,
the proxy for the ordinary shareholders and a representative of AIB, the
custodian for the ordinary shares representing the ADS's, were present for the
vote. Voting was conducted on a show of hands in accordance with Irish law.
There were no abstentions, broker non-votes or votes withheld with respect to
any matter submitted to a vote of the ordinary shareholders at the AGM.
The following is a brief description of each matter submitted to a vote of
the ordinary shareholders and a summary of the votes tabulated with respect to
each such matter at the AGM, as well as a summary of the votes cast by The Bank
of New York based on the ADR facility:
(1) Receipt and consideration of the consolidated financial statements for
the fiscal year ended January 31, 2004 and the Report of the Directors and
Auditors thereon.
Votes "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 105,620,888 48,666 52,421
(2)(A) Re-election of James Krzywicki, who retired by rotation, as a
director.
Votes "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 103,917,497 1,788,682 15,796
(2)(B) Re-election of Ferdinand von Prondzynski, who retired by rotation,
as a director.
Votes "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 103,970,857 1,732,833 18,285
(3) Election of William F. Meagher, who was appointed as a director in
March 2003, as a director.
Votes "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 104,093,273 1,614,252 14,450
(4) Authorization of the Audit Committee of the Board of Directors to fix
the remuneration of our auditors and reporting accountants for the fiscal year
ending January 31, 2005.
Votes "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 105,603,596 112,338 6,041
(5) Adoption of our 2004 Employee Share Purchase Plan.
Votes "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 104,073,800 1,607,414 40,761
The ordinary shareholders present at the AGM agreed not to put to a vote
the resolution with respect to the approval of the terms of a share repurchase
agreement proposed to be entered into between us and Credit Suisse First Boston,
as an Extraordinary General Meeting will be convened on September 24, 2004 to
consider a special resolution to approve the terms of a share purchase agreement
to be entered into between us, several of our subsidiaries and Credit Suisse
First Boston.
ITEM 5. - OTHER INFORMATION
Not applicable.
ITEM 6. - EXHIBITS
See the Exhibit Index attached hereto.
33
SIGNATURE
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.
SKILLSOFT PUBLIC LIMITED COMPANY
Date: September 9, 2004
By: /s/ Thomas J. McDonald
-----------------------
Thomas J. McDonald
Chief Financial Officer
34
EXHIBIT INDEX
10.1 Lease agreement, dated June 9, 2004, by and between Hewlett-Packard
Company and SkillSoft Corporation.
10.2 Loan and Security Agreement, dated July 23, 2004, by and between Silicon
Valley Bank, SkillSoft Corporation, SmartCertify Direct Inc. and Books
247.com, Inc.
10.3 Form of Director Option Agreement for initial grants under the 2001
Director Option Plan.
10.4 Form of Director Option Agreement for subsequent grants under the 2001
Director Option Plan.
10.5 Form of Option Agreement under 2002 Share Option Plan.
31.1 Certification of the Company's CEO pursuant to Rule 13a-14 under the
Securities Exchange Act of 1934.
31.2 Certification of the Company's CFO pursuant to Rule 13a-14 under the
Securities Exchange Act of 1934.
32.1 Certification of the Company's CEO pursuant to 18 U.S.C. section 1350, as
adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Company's CFO pursuant to 18 U.S.C. section 1350, as
adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
35