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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 OCTOBER 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 November 30, 2004, the registrant had outstanding 106,172,756 Ordinary Shares
(issued or issuable in exchange for the registrant's outstanding American
Depository Shares).
SKILLSOFT PLC
FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 31, 2004
INDEX
PAGE NO.
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):........................................................ 3
Condensed Consolidated Balance Sheets as of October 31, 2004 and January 31, 2004.............................. 3
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended October 31, 2004 and 2003.. 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 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........................... 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................................... 31
Item 4. Controls and Procedures......................................................................................... 32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................................................... 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..................................................... 32
Item 3. Defaults Upon Senior Securities................................................................................. 32
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)
OCTOBER 31, JANUARY 31,
2004 2004
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 43,103 $ 42,866
Short-term investments 16,290 18,474
Restricted cash 400 25,044
Accounts receivable, net 46,215 72,775
Prepaid expenses and other current assets 14,173 24,759
--------- ---------
Total current assets 120,181 183,918
Property and equipment, net 9,289 6,447
Acquired intangible assets, net 18,544 25,745
Goodwill 125,444 125,878
Long-term investments 7,580 266
Other assets 163 124
--------- ---------
Total Assets $ 281,201 $ 342,378
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,661 $ 6,588
Accrued expenses 51,089 92,117
Deferred revenue 104,982 134,328
--------- ---------
Total current liabilities 159,732 233,033
Long term liabilities 6,238 23,587
Stockholders' equity:
Ordinary Shares, E0.11 par value: 250,000,000 shares authorized at October
31, 2004 and January 31, 2004, respectively; 106,080,734 and 101,857,714
shares issued and outstanding at October 31, 2004 and January 31, 2004,
respectively 11,598 11,031
Additional paid-in capital 558,623 538,493
Accumulated deficit (452,240) (460,916)
Deferred compensation (1,603) (2,404)
Accumulated other comprehensive loss (1,147) (446)
--------- ---------
Total stockholders' equity 115,231 85,758
--------- ---------
Total liabilities and stockholders' equity $ 281,201 $ 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 NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
----------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------ ------------- ------------
Revenue $ 52,507 $ 49,992 $ 155,949 $ 138,714
Cost of revenue 5,597 4,557 15,932 14,234
------------- ------------ ------------- ------------
Gross profit 46,910 45,435 140,017 124,480
Operating expenses:
Research and development 10,505 15,171 32,587 40,603
Selling and marketing 22,441 20,830 69,467 67,404
General and administrative 6,388 6,946 18,625 20,031
Litigation settlement -- 16,000 -- 62,250
Amortization of intangible assets 2,390 2,574 7,202 7,498
Amortization of stock-based compensation (1) 296 676 944 1,637
Restructuring and other non-recurring charges 796 5,287 2,470 16,825
------------- ------------ ------------- ------------
Total operating expenses 42,816 67,484 131,295 216,248
------------- ------------ ------------- ------------
Operating income/(loss) 4,094 (22,049) 8,722 (91,768)
Other income/(expense), net 75 251 (164) 272
Interest income, net 88 87 481 680
Gain on sale of investments, net -- -- -- 3,682
------------- ------------ ------------- ------------
Income/(loss) before provision for income taxes 4,257 (21,711) 9,039 (87,134)
Provision for income taxes 142 150 363 528
------------- ------------ ------------- ------------
Net income/(loss) $ 4,115 $ (21,861) $ 8,676 $ (87,662)
============= ============ ============= ============
Net income/(loss) per share (Note 9):
Basic $ 0.04 $ (0.22) $ 0.08 $ (0.88)
============= ============ ============= ============
Basis weighted average ordinary shares outstanding 105,935,620 99,993,573 104,851,577 99,745,570
============= ============ ============= ============
Diluted $ 0.04 $ (0.22) $ 0.08 $ (0.88)
============= ============ ============= ============
Diluted weighted average ordinary shares outstanding 108,941,334 99,993,573 109,974,424 99,745,570
============= ============ ============= ============
(1) The following summarizes the departmental allocation of the stock-based
compensation
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------ -----------------
2004 2003 2004 2003
------ ------ ------ ------
Cost of revenue $ -- $ 2 $ -- $ 4
Research and development 66 115 224 354
Selling and marketing 219 355 683 691
General and administrative 11 204 37 588
------ ------ ------ ------
$ 296 $ 676 $ 944 $1,637
====== ====== ====== ======
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)
NINE MONTHS ENDED
OCTOBER 31,
--------------------------
2004 2003
----------- ------------
Cash flows from operating activities:
Net income/(loss) $ 8,676 $ (87,662)
Adjustments to reconcile net income/(loss) to net cash used in operating activities -
Stock-based compensation 944 1,637
Depreciation and amortization 3,439 6,948
Amortization of intangible assets 7,202 7,498
Provision for bad debts (1) 266
Provision for income tax - non-cash 226 --
Realized gain on sale of investments -- (3,673)
Changes in current assets and liabilities:
Accounts receivable 26,903 20,995
Prepaid expenses and other current assets 10,706 (3,667)
Accounts payable (2,917) (2,480)
Accrued expenses (58,900) 20,832
Deferred revenue (29,907) (2,431)
----------- -----------
Net cash used in operating activities (33,629) (41,737)
Cash flows from investing activities:
Purchases of property and equipment (6,423) (2,253)
Purchases of investments (40,481) (74,127)
Maturity of investments 35,258 124,058
Sale of investments -- 6,119
Other assets -- 96
Net cash used for a business combination -- (5,000)
Release/(designation) of restricted cash 24,600 (25,000)
----------- -----------
Net cash provided by investing activities 12,954 23,893
Cash flows from financing activities:
Proceeds from exercise of stock options and employee stock purchase plan 20,553 4,689
Repayment of note receivable -- 58
----------- -----------
Net cash provided by financing activities 20,553 4,747
Effect of exchange rate changes on cash and cash equivalents 359 1,143
----------- -----------
Net increase/(decrease) in cash and cash equivalents 237 (11,954)
Cash and cash equivalents, beginning of period 42,866 45,990
----------- -----------
Cash and cash equivalents, end of period $ 43,103 $ 34,036
=========== ===========
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 complementary 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 October 31, 2004, the results of its
operations for the three and nine months ended October 31, 2004 and 2003 and its
cash flows for the nine months ended October 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 October 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 October 31, 2004, the Company's investments had an average maturity of
approximately 148 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 online 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 (examples of which are; 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, online 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.
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 typically recognizes revenue from resellers when both the final sale
to the end user has been made and the collectibility of cash from the reseller
is probable. 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.
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.
7
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 NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
---------------------------------------- ----------------------------------
2004 2003 2004 2003
------------- ------------- ----------- -----------
Risk-free interest rates 3.75% - 3.90% 3.74% - 3.96% 3.31%-4.35% 2.84%-3.96%
Expected dividend yield -- -- -- --
Volatility factor 84% 89% 88% 98%
Expected lives 7 years 7 years 7 years 7 years
Weighted average fair value of
options granted $ 4.55 $ 5.53 $ 9.12 $ 3.19
Weighted average remaining
contractual life of options
outstanding 7.03 years 7.80 years 7.03 years 7.80 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 NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income/(loss) --
As reported $ 4,115 $(21,861) $ 8,676 $ (87,662)
Add: Stock-based compensation expense recognized under APB No. 25 296 676 944 1,637
Less: Total stock-based compensation expense determined under fair
value based method for all awards (6,677) (8,652) (19,644) (23,601)
-------- -------- -------- --------
Pro forma net loss $ (2,266) $(29,837) $(10,024) $(109,626)
======== ======== ======== ========
Basic and diluted net income/(loss) per share --
As reported $ 0.04 $ (0.22) $ 0.08 $ (0.88)
======== ======== ======== ========
Pro forma net loss $ (0.02) $ (0.30) $ (0.10) $ (1.10)
======== ======== ======== ========
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
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, which were recognized as a liability assumed in the
8
purchase business combination, were 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 October 31, 2004, and the remaining
amount of $2.6 million, net of adjustments for foreign currency translation, is
expected to be paid within fiscal 2006.
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 fell 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 $14.6 million.
During the nine months ended October 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
Payments made during the three months ended October 31, 2004 (34) (480) (33) (547)
Adjustment to accrual 78 179 -- 257
-------- -------- -------- --------
Merger and exit accrual October 31, 2004 $ 2,589 $ 6,820 $ 407 $ 9,816
======== ======== ======== ========
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 $4,110
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 $9,816
======
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 nine months ended October 31, 2004, the Company recorded and paid an
additional $315,000 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 nine months ended October 31, 2004, activity in the Company's
restructuring accrual related to the Merger was as follows (in thousands):
9
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 -- -- --
Restructuring charge for the quarter ended October 31, 2004 (7) -- (7)
Refunds received during the quarter ended October 31, 2004 13 -- 13
Payments made during the quarter ended October 31, 2004 (6) -- (6)
----- ----- -----
Restructuring accrual October 31, 2004 $ -- $ -- $ --
===== ===== =====
The restructuring charges for the three and nine months ended October 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 NINE MONTHS ENDED
OCTOBER 31, 2004 OCTOBER 31, 2004
---------------- ----------------
Cost of sales $ -- $ --
Research and development (13) 59
Sales and marketing -- 26
General and administrative 6 230
---- ----
Total $ (7) $315
==== ====
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 nine months ended October 31, 2004, the Company recorded $803,000 and $2.2
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 nine
months ended October 31, 2003, the Company recorded $5.0 million and $15.0
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):
OCTOBER 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 $ 14,779 $ 11,831 $ 26,610 $ 9,612 $ 16,998
Customer contracts 13,018 7,205 5,813 13,018 5,171 7,847
Trademarks and trade name 900 -- 900 900 -- 900
--------- -------- --------- --------- -------- ---------
40,528 21,984 18,544 40,528 14,783 25,745
Goodwill 125,444 -- 125,444 125,878 -- 125,878
--------- -------- --------- --------- -------- ---------
$ 165,972 $ 21,984 $ 143,988 $ 166,406 $ 14,783 $ 151,623
========= ======== ========= ========= ======== =========
10
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.
Course content includes courses in both business skills and information
technology. All courseware is deployable via the Internet or corporate
intranets.
The change in goodwill at October 31, 2004 from the amount recorded at January
31, 2004 was due primarily 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 nine months ended October 31, 2004 was as
follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, 2004 OCTOBER 31, 2004
---------------- ----------------
Internally developed software/courseware $1,714 $5,168
Customer contracts 676 2,034
------ ------
$2,390 $7,202
====== ======
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 nine months ended October 31, 2004 and 2003 were
as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------------- -------------------------
2004 2003 2004 2003
--------- ----------- --------- -----------
Comprehensive income/(loss):
Net income/(loss) $ 4,115 $ (21,861) $ 8,676 $ (87,662)
Other comprehensive income/(loss):
Foreign currency adjustment (720) 30 (643) 581
Unrealized holding gains/(losses) during the period 4 76 (58) 285
Less: reclassification adjustment for gains
included in net income /(loss) -- -- -- (1,984)
--------- ----------- --------- -----------
Comprehensive income /(loss) $ 3,399 $ (21,755) $ 7,975 $ (88,780)
========= =========== ========= ===========
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 nine months ended October 31,
2003 are the same as outstanding options, and unvested restricted shares, which
11
aggregated 24,514,810 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:
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------------- -------------------------
2004 2003 2004 2003
----------- ---------- ----------- ----------
Basic weighted average shares outstanding 105,935,620 99,993,573 104,851,577 99,745,570
Effect of dilutive shares outstanding 3,005,714 -- 5,122,847 --
----------- ---------- ----------- ----------
Weighted average common shares outstanding, as adjusted 108,941,334 99,993,573 109,974,424 99,745,570
=========== ========== =========== ==========
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 provision for income tax was $142,000 and $150,000 in the three months ended
October 31, 2004 and 2003, respectively. For the three months ended October 31,
2004 and 2003, the tax provision consists of income taxes payable in certain
foreign locations and alternative minimum taxes payable in the United States.
For the nine months ended October 31, 2004, the Company recorded a tax provision
of approximately $363,000, representing an effective tax rate of approximately
4.0% 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 $ 43,319 $ 7,541 $12,111 $ 7,829 $15,838
========= ======= ======= ======= =======
On November 18, 2004, Jody Glidden, Michael LeBlanc and Trish Glidden filed a
lawsuit against the Company, David C. Drummond, Gregory M. Priest, Patrick E.
Murphy and Jack Hayes in the United States District Court for the Northern
District of California. Plaintiffs had previously opted out of the class action
settlement that received final approval from the court on September 29, 2004.
The lawsuit sets forth substantially the same claims as were alleged in the
class action litigation. In particular, the lawsuit alleges that the Company
misrepresented or omitted to state material facts in its SEC filings and press
releases regarding the Company's 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 in connection with
its acquisition of IC Global in early 2001. The lawsuit seeks compensatory
damages of approximately $3.7 million and other unspecified damages.
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 regarding their potential
reimbursement for a portion of the settlement amount. The settlement was
approved by the court on September 29, 2004. 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.
12
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 agreed to pay a total of $44,000,000 in two equal installments of
$22,000,000. 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 October 31, 2004 for the SkillChoice
multi-modal learning and retail certification segments was approximately $47.2
million and $5.3 million, respectively. Revenue for the nine months ended
October 31, 2004 for the SkillChoice multi-modal learning and retail
certification segments was approximately $141.3 million and $14.6 million,
respectively. Revenue for the three months ended October 31, 2003 for the
SkillChoice multi-modal learning and retail certification segments was
approximately $46.0 million and $3.9 million, respectively. Revenue for the nine
months ended October 31, 2003 for the SkillChoice multi-modal learning and
retail certification segments was approximately $129.2 million and $9.5 million,
respectively. Net income/(loss) for the three months ended October 31, 2004 for
the SkillChoice multi-modal learning and retail certification segments was
approximately $4.1 million and ($12,000), respectively. Net income for the nine
months ended October 31, 2004 for the SkillChoice multi-modal learning and
retail certification segments was approximately $8.5 million and $0.2 million,
respectively. Net (loss)/income for the three months ended October 31, 2003 for
the SkillChoice multi-modal learning and retail certification segments was
approximately ($22.0) million and $100,000, respectively. Net loss for the nine
months ended October 31, 2003 for the SkillChoice multi-modal learning and
retail certification segments was approximately $85.4 million and $2.3 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
nine months ended October 31, 2004 and 2003 were as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
Revenue:
United States $ 40,946 $ 40,591 $121,882 $112,587
United Kingdom 5,207 2,066 13,558 7,261
Canada 2,040 1,955 5,957 4,574
Europe, excluding UK 1,897 3,662 6,574 10,694
Australia/New Zealand 1,811 1,454 5,090 3,021
Other 606 264 2,888 577
-------- -------- -------- --------
Total revenue $ 52,507 $ 49,992 $155,949 $138,714
======== ======== ======== ========
Long-lived tangible assets at international facilities are not significant.
13
13. ACCRUED EXPENSES
Accrued expenses in the accompanying condensed consolidated balance sheets
consist of the following (in thousands):
OCTOBER 31, 2004 JANUARY 31, 2004
---------------- ----------------
Accrued compensation and benefits $11,934 $19,787
Course development fees 1,735 1,518
Professional fees 2,397 3,410
Accrued payables 1,363 2,703
Accrued misc. taxes 2,357 2,357
Accrued merger related costs* 6,027 6,919
Sales tax payable/VAT payable 1,481 2,513
Accrued royalties 2,007 1,351
Accrued litigation settlements 16,250 44,250
Other accrued liabilities 5,538 7,309
------- -------
Total accrued expenses $51,089 $92,117
======= =======
- ------------
* Includes $2,264 of accrued income taxes in October 31, 2004 and January 31,
2004.
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 October 31, 2004, the
Company was in compliance with all financial and non-financial covenants. As of
October 31, 2004, there were no borrowings on the line of credit; however, the
Company had outstanding letters of credit of $15.9 million that were secured by
the line of credit and 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.
In October 2004, the FASB concluded that the proposed Statement 123R,
Share-Based Payment, which would require all companies to measure compensation
cost for all share-based payments, including employee stock options, at fair
value, would be effective for public companies (except small business issuers as
defined in SEC Regulation S-B) for interim or annual periods beginning after
June 15, 2005. The FASB has tentatively concluded that companies could adopt the
new standard using either the "modified prospective transition method" or the
"modified retrospective transition method". Under the modified prospective
transition method, a company would recognize share-based employee compensation
cost from the beginning of the fiscal period in which the recognition provisions
are first applied as if the fair-value-based accounting method had been used to
account for all employee awards granted, modified, or settled after the
effective date and to any awards that were not fully vested as of the effective
date. Measurement and attribution of compensation cost for awards that are not
vested as of the effective date of the proposed Statement would be based on the
same
14
estimate of the grant-date fair value and the same attribution method used
previously under Statement 123 (either for recognition or pro forma purposes).
Under the modified retrospective transition method, a company would recognize
employee compensation cost for periods presented prior to the adoption of
Statement 123R in accordance with the original provisions of Statement 123; that
is, an entity would recognize employee compensation cost in the amounts reported
in the pro forma disclosures provided in accordance with Statement 123. A
company would not be permitted to make any changes to those amounts upon
adoption of the proposed Statement unless those changes represent a correction
of an error (and are disclosed accordingly). For periods after the date of
adoption of Statement 123R, the modified prospective transition method described
above would be applied. The Company is in the process of determining the impact
of this statement on its consolidated financial statements.
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.
OVERVIEW
Financial Model
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 complementary
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 online 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 (examples of which
are; 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.
15
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, online 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.
See Note 4 of Notes to Condensed Consolidated Financials Statements for a
description of our revenue recognition policies.
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.
Business Outlook
In the quarter ended October 31, 2004, we generated increased revenues ($52.5
million) as compared to both the immediately preceding quarter and the
corresponding quarter of the prior fiscal year, and also reported our largest
quarterly net income since the Merger. However, we find ourselves in a
challenging business environment. The overall market adoption rate for
e-learning solutions continues to be relatively slow and we are seeing
constraints on IT spending. As a result, we are experiencing delays in customer
orders and some non-renewals of contracts from existing customers. In addition,
price competition in the e-learning market is having a negative impact on the
revenue we are generating from the new contracts and the contract renewals we do
succeed in obtaining.
On the positive side, our recent revenue growth and our growth prospects are
strongest in our product lines focused on informal learning, such as our
Books24x7 products. We have decided to increase our research and development
spending in order to invest aggressively in those areas and accelerate the time
by which our planned new products are available to our customers.
In addition, we have initiated a restructuring of our content development
organization to more efficiently manage costs and capitalize further on the
flexibility inherent in our existing outsourcing model. The goal of the
restructuring is to enable us to meet our existing content production targets at
a reduced cost and with greater flexibility with respect to the product
offerings in which we elect to make investments. The restructuring will involve
the elimination of approximately 120 jobs in Dublin, Ireland and 13 in Nashua,
New Hampshire, as well as facilities consolidation in Dublin. We will shift the
remainder of our IT skills content development activities to our outsourcing
suppliers, while continuing to maintain project management and quality control
internally. We expect to incur restructuring charges relating to payments to
terminated employees, facilities consolidation and the repayment of grants
previously awarded by Irish agencies. We currently estimate that these charges
will not exceed $15 million, with a majority of that amount expected to be
incurred in the fourth quarter of this fiscal year. We believe that the
restructuring will result in content development cost savings of approximately
$5 million per year at current production levels, beginning in the next fiscal
year. This will afford us more flexibility to reinvest dollars that can be
recaptured in an outsourcing model for other research and development
initiatives
16
and/or to increase the profitability of the organization. We cannot yet estimate
the impact on our facilities costs in future periods until negotiations with
respect to our leased facilities in Dublin are completed.
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".
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 in Note 4 of Notes to Condensed
Financial Statements 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.
17
RESULTS OF OPERATIONS
THREE MONTHS ENDED OCTOBER 31, 2004 VERSUS THREE MONTHS ENDED OCTOBER 31, 2003
DOLLAR QUARTER ENDED OCTOBER 31,
INCREASE/(DECREASE) PERCENT CHANGE
2003/2004 INCREASE/(DECREASE) PERCENTAGE OF REVENUE
(IN THOUSANDS) 2003/2004 2004 2003
-------------- --------- ---- ----
Revenue $ 2,515 5% 100% 100%
Cost of revenue 1,040 23% 11% 9%
-------- -------- -------- --------
Gross margin 1,475 3% 89% 91%
-------- -------- -------- --------
Operating expenses:
Research and development (4,666) (31%) 20% 30%
Selling and marketing 1,611 8% 43% 42%
General and administrative (558) (8%) 12% 14%
Litigation settlements (16,000) (100%) -- 32%
Amortization of intangible assets (184) (7%) 5% 5%
Amortization of stock-based compensation (380) (56%) 1% 1%
Restructuring and other non-recurring charges (4,491) (85%) 2% 11%
-------- -------- -------- --------
Total operating expenses (24,668) (37%) 82% 135%
-------- -------- -------- --------
Operating income/(loss) 26,143 119% 8% (44%)
-------- -------- -------- --------
Other income/(expense), net (176) (70%) -- 1%
Interest income, net 1 1% -- --
Gain on sale of investments, net -- -- -- --
-------- -------- -------- --------
Income/(loss) before provision for income taxes 25,968 120% 8% (43%)
Provision for income taxes (8) (5%) -- --
-------- -------- -------- --------
Net income/(loss) $ 25,976 119% 8% (44%)
======== ======== ======== ========
COMPARISON OF THE QUARTERS ENDED OCTOBER 31, 2004 AND 2003
REVENUE
Revenue increased $2.5 million, or 5%, to $52.5 million in the quarter
ended October 31, 2004 from $50.0 million in the quarter ended October 31, 2003.
This increase was primarily due to revenue generated from new business . 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 expanded offerings for SMML
customers, competitive wins with new customers, and an increased percentage of
extended term offerings from retail certification. In addition, we had an
increase in revenue derived from our product lines focused on informal learning.
These factors contributed favorably to revenue in the quarter ended October 31,
2004 when compared to the quarter ended October 31, 2003.
QUARTERS ENDED
OCTOBER 31,
(IN THOUSANDS) 2004 2003 INCREASE
- -------------- ---- ---- --------
Revenue:
United States $ 40,946 $ 40,591 $ 355
International 11,561 9,401 2,160
---------- -------- ------
Total $ 52,507 $ 49,992 $2,515
========== ======== ======
Revenue increased by 1% and 23% in the United States and internationally,
respectively, in the quarter ended October 31, 2004 as compared to the quarter
ended October 31, 2003. The increase in international revenue is primarily due
to the factors discussed above, as well as higher levels of revenue earned from
reseller arrangements resulting from the receipt of sell-through reporting and
cash from resellers. The United States represented 78% and 81% of revenue for
the quarters ended October 31, 2004 and 2003, respectively.
QUARTERS ENDED
OCTOBER 31,
(IN THOUSANDS) 2004 2003 INCREASE
- -------------- ---- ---- --------
Revenue:
SkillChoice multi-modal learning $47,241 $46,050 $ 1,191
Retail certification 5,266 3,942 1,324
------- ------- -------
Total $52,507 $49,992 $ 2,515
======= ======= =======
18
The SMML segment represented 90% and 92% of revenue for the quarters ended
October 31, 2004 and 2003, respectively. The increase in SMML revenue and retail
certification revenue is primarily due to the factors discussed above.
COSTS AND EXPENSES
Cost of revenue increased $1.0 million, or 23%, to $5.6 million in the quarter
ended October 31, 2004 from $4.6 million in the quarter ended October 31, 2003.
Cost of revenue as a percentage of total revenue was 11% in the quarter ended
October 31, 2004 versus 9% in the quarter ended October 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 $4.7 million, or 31%, to $10.5
million in the quarter ended October 31, 2004 from $15.2 million in the quarter
ended October 31, 2003. Research and development expenses as a percentage of
total revenue decreased to 20% in the quarter ended October 31, 2004 from 30% in
the quarter ended October 31, 2003. Research and development expenses for the
quarter ended October 31, 2004 included expenses of $852,000 to modify and
enhance the technology we purchased that will underlie our virtual classroom
product offerings. We anticipate approximately $1.4 million of additional
development expenses over the remainder of fiscal 2005 to bring our virtual
classroom offerings to market. The decreased expenses compared to the third
quarter of fiscal 2004 were primarily due to the completion of initiatives
related to content and platform improvements in the quarter ended January 31,
2004. We plan to incur incremental costs of approximately $2.0 million in the
fiscal 2005 fourth quarter to pursue informal learning opportunities and
accelerate their market introduction.
Selling and marketing expenses increased $1.6 million, or 8%, to $22.4 million
in the quarter ended October 31, 2004 from $20.8 million in the quarter ended
October 31, 2003. Selling and marketing expenses as a percentage of total
revenue increased to 43% in the quarter ended October 31, 2004 from 42% in the
quarter ended October 31, 2003. These increases are primarily due to increased
commissions as a result of higher revenue, as well as 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 full year fiscal 2005 results to full year fiscal 2004 results.
General and administrative expenses decreased $558,000, or 8%, to $6.4 million
in the quarter ended October 31, 2004 from $6.9 million in the quarter ended
October 31, 2003. General and administrative expenses as a percentage of total
revenue decreased to 12% in the quarter ended October 31, 2004 from 14% in the
quarter ended October 31, 2003. These decreases were primarily due to a decline
in certain infrastructure and occupancy charges, litigation costs and consulting
services. We anticipate that general and administrative expenses will increase
in absolute dollars in the next several quarters due primarily to increases in
the costs of operating as a public company such as compliance with Section 404
of the Sarbanes-Oxley Act, advisory, legal and insurance.
Restructuring and other non-recurring charges decreased $4.5 million, or 85%, to
$0.8 million in the quarter ended October 31, 2004 from $5.3 million in the
quarter ended October 31, 2003. The primary reason for the decrease in
restructuring and other non-recurring charges in the current period as compared
to the three months ended October 31, 2003 is the completion of the restatement
of the SmartForce historical financial statements in the fiscal year ended
January 31, 2004. Charges for the three months ended October 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 in the quarter ended October 31, 2004 was $75,000 as compared to
$251,000 in the quarter ended October 31, 2003. This change was primarily due to
foreign currency fluctuations. Due to our multi-national operations, our
business is subject to fluctuations based upon changes in the exchange rates
between the currencies we do business in.
19
NINE MONTHS ENDED OCTOBER 31, 2004 VERSUS NINE MONTHS ENDED OCTOBER 31, 2003
DOLLAR NINE MONTHS ENDED OCTOBER 31,
INCREASE/(DECREASE) PERCENT CHANGE
2003/2004 INCREASE/(DECREASE) PERCENTAGE OF REVENUE
(IN THOUSANDS) 2003/2004 2004 2003
-------------- --------- ---- ----
Revenue $ 17,235 12% 100% 100%
Cost of revenue 1,698 12% 10% 10%
--------- ---- --- ---
Gross margin 15,537 12% 90% 90%
--------- ---- --- ---
Operating expenses:
Research and development (8,016) (20%) 21% 29%
Selling and marketing 2,063 3% 45% 49%
General and administrative (1,406) (7%) 12% 14%
Litigation settlements (62,250) (100%) -- 45%
Amortization of intangible assets (296) (4%) 5% 5%
Amortization of stock-based
compensation (693) (42%) 1% 1%
Restructuring and other
non-recurring charges (14,355) (85%) 2% 12%
--------- ---- --- ---
Total operating expenses (84,953) (39%) 84% 156%
--------- ---- --- ---
Operating income/(loss) 100,490 110% 6% (66%)
--------- ---- --- ---
Other income/(expense), net (436) (160%) -- --
Interest income, net (199) (29%) -- --
Gain on sale of investments, net (3,682) (100%) -- 3%
--------- ---- --- ---
Income/(loss) before provision for
income taxes 96,173 110% 6% (63%)
Provision for income taxes (165) (31%) -- --
--------- ---- --- ---
Net income/(loss) $ 96,338 110% 6% (63%)
========= ==== === ===
COMPARISON OF THE NINE MONTHS ENDED OCTOBER 31, 2004 AND 2003
REVENUE
Revenue increased $17.2 million, or 12%, to $155.9 million in the nine
months ended October 31, 2004 from $138.7 million in the nine months ended
October 31, 2003. This increase was primarily due to revenue generated from new
business. 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 expanded offerings for SMML
customers, competitive wins with new customers, and an increased percentage of
extended term offerings from retail certification. In addition we had an
increase in revenue derived from our product lines focused on informal learning.
These factors contributed favorably to revenue in the nine months ended October
31, 2004 when compared to the year ago nine month period.
NINE MONTHS ENDED
OCTOBER 31,
(IN THOUSANDS) 2004 2003 INCREASE
- -------------- ---- ---- --------
Revenue:
United States $121,882 $112,587 $ 9,295
International 34,067 26,127 7,940
-------- -------- --------
Total $155,949 $138,714 $ 17,235
======== ======== ========
Revenue increased by 8% and 30% in the United States and internationally,
respectively, in the nine months ended October 31, 2004 as compared to the nine
months ended October 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 nine months ended
October 31, 2004 and 2003, respectively.
NINE MONTHS ENDED
OCTOBER 31,
(IN THOUSANDS) 2004 2003 INCREASE
- -------------- ---- ---- --------
Revenue:
SkillChoice multi-modal Learning $141,322 $129,217 $ 12,105
Retail certification 14,627 9,497 5,130
-------- -------- --------
Total $155,949 $138,714 $ 17,235
======== ======== ========
20
The SMML segment represented 91% and 93% of revenue for the nine months ended
October 31, 2004 and 2003, respectively. The increase in SMML revenue and retail
certification revenue is primarily due to the factors discussed above.
COSTS AND EXPENSES
Cost of revenue increased $1.7 million, or 12%, to $15.9 million in the nine
months ended October 31, 2004 from $14.2 million in the nine months ended
October 31, 2003. This increase was primarily due to higher 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 nine months ended October 31, 2004 and October 31, 2003.
Research and development expenses decreased $8.0 million, or 20%, to $32.6
million in the nine months ended October 31, 2004 from $40.6 million in the nine
months ended October 31, 2003. Research and development expenses as a percentage
of total revenue decreased to 21% in the nine months ended October 31, 2004 from
29% in the nine months ended October 31, 2003. Research and development for the
nine months ended October 31, 2004 included expenses of $3.1 million to modify
and enhance the technology we purchased that will underlie our virtual classroom
product offerings. We anticipate incurring approximately $1.4 million of
additional development expenses over the remainder of fiscal 2005 to bring our
virtual classroom offerings to market. The decreased expenses compared to fiscal
2004 were primarily due to our completion of the initiative for content and
platform improvements in the quarter ended January 31, 2004. We plan to incur
incremental costs of approximately $2.0 million in the fiscal 2005 fourth
quarter to pursue informal learning opportunities and accelerate their market
introduction.
Selling and marketing expenses increased $2.1 million, or 3%, to $69.5 million
in the nine months ended October 31, 2004 from $67.4 million in the nine months
ended October 31, 2003. The increase was primarily due to increased compensation
and benefit costs of approximately $3.1 million. This increase was partially
offset by a decline in certain infrastructure and occupancy charges of $1.1
million. Selling and marketing expenses as a percentage of total revenue
decreased to 45% in the nine months ended October 31, 2004 from 48% in the nine
months ended October 31, 2003. The percentage decrease was primarily due to the
increase in revenue from the nine months ended October 31, 2003 to the nine
months ended October 31, 2004. We anticipate incurring incremental selling and
marketing expenses over the remainder 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 $1.4 million, or 7%, to $18.6
million in the nine months ended October 31, 2004 from $20.0 million in the nine
months ended October 31, 2003. General and administrative expenses as a
percentage of total revenue decreased to 12% in the nine months ended October
31, 2004 from 14% in the nine months ended October 31, 2003. These decreases
were primarily due to a reduction of litigation costs of $2.6 million in the
nine months ended October 31, 2004 compared to the nine months ended October 31,
2003. This decrease was offset in part by increases in accounting and other
consulting services of $1.5 million. 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 compliance with Section 404 of the Sarbanes-Oxley Act, advisory,
legal and insurance.
Restructuring and other non-recurring charges decreased $14.4 million, or 85%,
to $2.5 million in the nine months ended October 31, 2004 from $16.8 million in
the nine months ended October 31, 2003. The restructuring and non-recurring
charges related to the Merger. The restructuring costs primarily consist of
compensation costs for certain terminated SmartForce employees. The primary
reason for the decrease in restructuring and other non-recurring charges in the
current period as compared to the nine months ended October 31, 2003 is the
completion of the restatement of the SmartForce historical financial statements
in the fiscal year ended January 31, 2004. Charges for the nine months ended
October 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 (EXPENSE)/INCOME, NET
Other (expense)/income in the nine months ended October 31, 2004 was ($164,000)
as compared to $272,000 in the nine months ended October 31, 2003. This change
was primarily due to foreign currency fluctuations. Due to our multi-national
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 $363,000 and $528,000 in the nine months
ended October 31, 2004 and 2003, respectively. The income tax provision for the
nine months ended October 31, 2004 reflects 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 October 31, 2004, our principal source of liquidity was our cash and cash
equivalents and short-term investments, which totaled $59.4 million. This
compares to $61.3 million at January 31, 2004. In addition, we had $400,000 in
restricted cash securing a letter of credit as of October 31, 2004; our
restricted cash as of January 31, 2004 was $25.0 million. The decrease in
restricted cash is the result of our reduction of the amount of cash that we
designated as restricted to secure a letter of credit.
Net cash used in operating activities was $33.6 million for the nine months
ended October 31, 2004. The principal contributions to our net cash from
operating activities in the nine months ended October 31, 2004 were our net
income of $8.7 million, depreciation and amortization of $10.6 million, a
decrease in prepaid expenses and other current assets of $10.7 million, and a
decrease in accounts receivable of $26.9 million. These were more than offset by
a decrease of $58.9 million in accrued expenses, primarily due to payments of
$43.3 million in litigation settlements, and a decrease in deferred revenue of
$29.9 million related to lower year-to-date billings, an increase in the
percentage of quarterly billings as well as the seasonality of renewals.
Net cash provided by investing activities was $13.0 million for the nine months
ended October 31, 2004. The primary factor was the reduction of designated
restricted cash which generated a cash inflow of $24.6 million. This was
partially offset by maturity of investments, net of purchases (short and
long-term), which generated a net cash outflow of approximately $5.2 million in
the nine months ended October 31, 2004. In addition, there were expenditures for
property, plant and equipment of $6.4 million.
Net cash provided by financing activities was $20.6 million for the nine months
ended October 31, 2004. These proceeds related to the exercise of stock options
under our various stock plans and stock purchases under our 1995 Employee Share
Purchase Plan.
Our working capital deficit was approximately $39.6 million and $49.1 million as
of October 31, 2004 and January 31, 2004, respectively. The increase in working
capital in the nine months ended October 31, 2004 was primarily due to net
income of $8.7 million, proceeds from exercises of stock options under our
various stock plans and stock purchases under the 1995 Employee Share Purchase
Plan of $20.6 million, depreciation and amortization of $10.7 million, which was
offset primarily by purchases of property and equipment of $6.4 million,
purchases of long term investments of $7.4, $15.3 million accrued litigation
settlement now due less than 12 months, and payments made towards long term
merger accruals of $1.8 million. Total assets were approximately $281.2 million
and $342.4 million as of October 31, 2004 and January 31, 2004, respectively. As
of October 31, 2004 and January 31, 2004, goodwill and separately identifiable
intangible assets were $144.0 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 October 31, 2004, we are in
compliance with all financial and non-financial covenants. As of October 31,
2004, there were no borrowings on the line of credit; however, we had
outstanding letters of credit of $15.9 million that were secured by the line of
credit and a certificate of deposit.
As of January 31, 2004, we had U.S. federal net operating loss carryforwards of
approximately $320.0 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 $3.2 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 $320.0 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 $ 43,319 $ 7,541 $ 12,111 $ 7,829 $15,838
--------- ------- -------- ------- -------
TOTAL $ 43,319 $ 7,541 $ 12,111 $ 7,829 $15,838
========= ======= ======== ======= =======
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 $ 16,250 $ 16,250 $ --
========== ========= =========
We expect to continue to experience growth in capital expenditures and operating
expenses, particularly in sales and marketing and research and development,
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 $16.3 million
subsequent to October 31, 2004, with a payout of $1.0 million before January 31,
2005 and the remaining $15.3 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 $6.4 million has been
expended through October 31, 2004. Also, we expect to disburse approximately
$4.1 million during the remainder of 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 have proposed a restructuring plan for the fiscal
2005 fourth quarter which will include the reduction of approximately 133
employees. The primary factors leading to this restructuring are our ability to
more cost effectively utilize outsourcing suppliers to develop course content
and the completion of certain research and development initiatives undertaken
after the Merger and the excess space that now exists following the departure of
contractors used to complete that work. We expect to incur charges in connection
with this restructuring related to payments to terminated employees in Dublin
and the U.S., facilities consolidation resulting from excess space following the
workforce reductions and the completion of the Merger-related work and the
repayment of employment and facilities-related grants previously awarded to us
by agencies in Ireland. We currently estimate that the total amount of the
charges associated with this restructuring will not be more than $15 million. 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 $59.4 million as of October 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
23
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.
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,
which the court approved on September 29, 2004, 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
24
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. If we fail to remediate these
items, it could have an adverse effect on our business.
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;
25
- - 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;
- - 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.
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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 our marketing 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. INCREASED
COMPETITION MAY RESULT IN DECREASED DEMAND OR PRICES 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 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
27
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.
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.
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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
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.
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
29
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 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;
30
- the fact that many customers view training products as discretionary
spending, rather than purchases essential to their business; and
- 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 October 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
31
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.
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 October 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 October 31, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II
ITEM 1. - LEGAL PROCEEDINGS
On November 18, 2004, Jody Glidden, Michael LeBlanc and Trish Glidden filed a
lawsuit against us, David C. Drummond, Gregory M. Priest, Patrick E. Murphy and
Jack Hayes in the United States District Court for the Northern District of
California. Plaintiffs had previously opted out of the class action settlement
that received final approval from the court on September 29, 2004. The lawsuit
sets forth substantially the same claims as were alleged in the class action
litigation. In particular, the lawsuit alleges that we misrepresented or omitted
to state material facts in our SEC filings and press releases regarding our
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 our ADSs in connection with our acquisition of IC Global in early 2001.
The lawsuit seeks compensatory damages of approximately $3.7 million and other
unspecified damages.
ITEM 2. - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
32
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held an extraordinary general meeting of shareholders (the "EGM") on
September 24, 2004 to consider a special resolution to approve the terms of a
share repurchase agreement to be entered into between us, several of our
subsidiaries and Credit Suisse First Boston. The repurchase agreement
facilitates the repurchase by us and/or several of our subsidiaries of up to
seven million ordinary shares (represented by ADSs). 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. Three ordinary shareholders 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 the matter
submitted to a vote of the ordinary shareholders at the EGM.
The following is a summary of the votes of the ordinary share holders tabulated
with respect to the proposal considered at the EGM, as well as a summary of the
proxy votes cast by The Bank of New York based on the ADR facility:
VOTES "FOR" "AGAINST" "ABSTAIN"
Ordinary Shareholders 3 0 0
ADS Holders 78,863,894 36,321 45,473
ITEM 5. - OTHER INFORMATION
On August 26, 2004, our Board of Directors adopted an Amended and Restated
Nominating and Corporate Governance Committee Charter (the "Amended and Restated
Charter"). The Amended and Restated Charter provides a description of the
information that must be provided by a shareholder desiring to recommend a
candidate for consideration as a potential director to the Nominating and
Corporate Governance Committee. In addition, the Amended and Restated Charter
provides that if the Nominating and Corporate Governance Committee determines
not to nominate for election as a director a candidate proposed by a shareholder
(or group of shareholders) submitting a director candidate to the Nominating and
Corporate Governance Committee that, individually or as a group, have
continually beneficially owned at least 5% of our outstanding shares for at
least two years prior to the date the candidate is submitted for consideration,
and continues to beneficially own at least 5% of our outstanding shares through
the date of the next annual general meeting (a "Qualified Nominating
Shareholder"), then the Nominating and Corporate Governance Committee must
provided such Qualified Nominating Shareholder with certain information
regarding the reasons for such decision. For more information regarding the
submission of potential director candidates by shareholders, please refer to the
Amended and Restated Charter available at www.skillsoft.com.
ITEM 6. - EXHIBITS
See the Exhibit Index attached hereto.
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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: December 10, 2004
By: /s/ Thomas J. McDonald
------------------------------
Thomas J. McDonald
Chief Financial Officer
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EXHIBIT INDEX
10.1 Summary of Fiscal 2005 Executive Incentive Compensation 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.
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