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SkillSoft 10-Q 2008 UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(MARK
ONE)
COMMISSION
FILE NUMBER 000-25674
 SKILLSOFT
PUBLIC LIMITED COMPANY
(EXACT
NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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 R No £
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate
by check mark whether the registrant is a shell company (as defined by Rule
12b-2 of the Exchange Act). Yes £ No R
On
December 5, 2008, the registrant had outstanding 101,672,676 Ordinary Shares
(issued or issuable in exchange for the registrant’s outstanding American
Depositary Shares).
SKILLSOFT
PLC
FORM
10-Q
FOR THE
QUARTER ENDED OCTOBER 31, 2008
SKILLSOFT
PLC AND SUBSIDIARIES
(IN
THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
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3 ~
SKILLSOFT
PLC AND SUBSIDIARIES
(UNAUDITED,
IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
________
† Does
not add due to rounding.
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
~
4 ~
SKILLSOFT
PLC AND SUBSIDIARIES
(UNAUDITED,
IN THOUSANDS)
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
~
5 ~
SKILLSOFT
PLC AND SUBSIDIARIES
(UNAUDITED)
1. THE
COMPANY
SkillSoft
PLC (the Company or SkillSoft) was incorporated in Ireland on August 8, 1989.
The Company is a leading software as a service (SaaS) provider of on-demand
e-learning and performance support solutions for global enterprises, government,
education and small to medium-sized businesses. SkillSoft helps companies to
maximize business performance through a combination of content, online
information resources, flexible technologies and support services. SkillSoft is
the surviving corporation in a merger between SmartForce PLC and SkillSoft
Corporation on September 6, 2002 (the SmartForce Merger). On May 14, 2007, the
Company acquired NETg from The Thomson Corporation for approximately $254.7
million in cash (see Note 6).
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, 2008, the results of its
operations for the three and nine months ended October 31, 2008 and 2007 and
cash flows for the nine months ended October 31, 2008 and 2007. 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, 2008. The results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the full
fiscal 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, 2008
and January 31, 2008, cash equivalents consisted mainly of commercial paper,
federal agency notes and treasury bills.
At
October 31, 2008, the Company had approximately $3.7 million of restricted cash:
approximately $2.7 million is held voluntarily to defend named former executives
and board members of SmartForce PLC for actions arising out of the SEC
investigation and litigation related to the 2002 securities class action and
approximately $1.0 million is held in certificates of deposits with a commercial
bank pursuant to terms of certain facilities lease agreements.
The
Company accounts for certain investments in commercial paper, corporate debt
securities, certificates of deposit and federal agency notes 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 or for trading
purposes are reported at market value, and are classified as available for sale.
At October 31, 2008, the Company’s investments were classified as available for
sale and had an average maturity of approximately 26 days.
4.
REVENUE RECOGNITION
The
Company generates revenue primarily from the license of its products, the
provision of professional services and from the provision of hosting/application
service provider (ASP) services. The
Company follows the provisions of the American Institute of Certified Public
Accountants Statement of Position (SOP) 97-2, “Software Revenue
Recognition,” as amended by SOP 98-4 and SOP 98-9, as well as Emerging
Issues Task Force (EITF) Issue No. 00-21, “Revenue Arrangements with Multiple
Deliverables” and SEC Staff Accounting Bulletin No. 104, “Revenue Recognition,” 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 content offering selected by a customer, the
number of users within the customer’s organization and the term of the license
agreement (generally one, two or three years). License agreements permit
customers to exchange course titles, generally on the contract anniversary date.
Hosting services are separately licensed for an additional fee. A license can
provide customers access to a range of learning products including courseware,
Referenceware®, simulations, mentoring and prescriptive assessment.
The
Company offers discounts from its ordinary pricing, and purchasers of licenses
for a larger number of courses, larger user bases or longer periods of time
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 ASP
basis and from the provision of 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. Revenue from
nearly all of the Company’s contractual arrangements is recognized on a
subscription or straight-line basis over the contractual period of service. The
Company also derives revenue from extranet hosting/ASP services which is
recognized on a straight-line basis over the period the services are provided.
Upfront fees are recorded over the contract period.
The
Company generally bills the annual license fee for the first year of a
multi-year license 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 bills 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 license agreements
to its customers. To the extent that a customer is given extended payment terms
(defined by the Company as greater than six months), revenue is recognized as
payments become due, assuming all of the other elements of revenue recognition
have been satisfied.
The
Company typically recognizes revenue from resellers when both the sale to the
end user has occurred 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. If a definitive service period can be
determined, revenue is recognized ratably over the term of the minimum
commitment period, provided that payment has been received or collectibility is
probable.
The
Company provides professional services, including instructor led training,
customized content development, website development/hosting and implementation
services. If the Company determines that the professional services are not
separable from an existing customer arrangement, revenue from these services is
recognized over the existing contractual terms with the customer; otherwise the
Company typically recognizes professional service revenue as the services are
performed.
The
Company records reimbursable out-of-pocket expenses in both revenue and as a
direct cost of revenue, as applicable, in accordance with EITF Issue No. 01-14,
“Income Statement
Characterization of Reimbursements Received for “Out-of-Pocket” Expenses
Incurred.” The
Company records revenue net of applicable sales tax collected. Taxes collected
from customers are recorded as part of accrued expenses on the balance sheet and
are remitted to state and local taxing jurisdictions based on the filing
requirements of each jurisdiction.
The
Company records as deferred revenue amounts that have been billed in advance for
products or services to be provided. Deferred revenue includes the unamortized
portion of revenue associated with license fees for which the Company has
received payment or for which amounts have been billed and are due for payment
in 90 days or less for resellers and 180 days or less for direct
customers.
The
Company’s contracts often include an uptime guarantee for solutions hosted on
its servers whereby customers may be entitled to credits in the event of
non-performance. The Company also retains the right to remedy any nonperformance
event prior to issuance of any credit. Historically, the Company has not
incurred substantial costs relating to this guarantee and the Company currently
accrues for such costs as they are incurred. The Company reviews these costs on
a regular basis as actual experience and other information becomes available;
and should these costs become substantial, the Company would accrue an estimated
exposure and consider the potential related effects of the timing of recording
revenue on its license arrangements. The Company has not accrued any costs
related to these warranties in the accompanying consolidated financial
statements.
5.
ACCOUNTING FOR SHARE-BASED COMPENSATION
The
Company has several share-based compensation plans under which employees,
officers, directors and consultants may be granted options to purchase the
Company’s ordinary shares, generally at the market price on the date of grant.
The options become exercisable over various periods, typically four years, and
have a maximum term of up to ten years. As of October 31, 2008, 2,363,263
ordinary shares remain available for future grant under the Company’s share
option plans. Please see Note 9 of the Notes to the Consolidated Financial
Statements in the Company’s Annual Report on Form 10-K as filed with the SEC on
March 31, 2008 for a detailed description of the Company’s share option
plans.
A summary
of share option activity under the Company’s plans during the nine months ended
October 31, 2008 is as follows:
___________
The
aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (the difference between the closing price of the shares on
October 31, 2008 of $7.70 and the exercise price of each in-the-money option)
that would have been received by the option holders had all option holders
exercised their options on October 31, 2008. The total
intrinsic value of options exercised during the three months ended October 31,
2008 and 2007 was approximately $10.8 million and $0.6 million, respectively.
The total intrinsic value of options exercised during the nine months ended
October 31, 2008 and 2007 was approximately $21.7 million and $6.3 million,
respectively.
6.
ACQUISITION
On May
14, 2007, the Company acquired NETg from The Thomson Corporation for
approximately $254.7 million in cash. The combined entity offers a more robust
multi-modal solution that includes online courses, simulations, digitized books
and an on-line video library as well as complementary learning technologies. The
acquisition supports SkillSoft’s mission to deliver comprehensive and high
quality learning solutions and positions the Company to serve the demands of
this growing marketplace.
The
acquisition of NETg was accounted for as a business combination under SFAS No.
141, “Business Combinations”
(SFAS No. 141), using the purchase
method. Accordingly, the results of NETg have been included in the Company’s
consolidated financial statements since the date of acquisition.
SUPPLEMENTAL
PRO-FORMA INFORMATION
The
Company concluded that the NETg acquisition represented a material business
combination. The following are unaudited pro forma results of operations of the
Company and NETg assuming the NETg acquisition occurred on February 1, 2007,
with pro forma adjustments to give effect to amortization of intangible assets,
an increase in interest expense on acquisition financing and certain other
adjustments:
The
unaudited pro forma results above are not necessarily indicative of results of
operations that may have actually occurred had the acquisition of NETg occurred
on the date noted.
7.
SPECIAL CHARGES
MERGER
AND EXIT COSTS
(a) Merger
and Exit Costs Recognized as Liabilities in Purchase Accounting
In
connection with the closing of the NETg acquisition on May 14, 2007, the
Company’s management effected an acquisition integration effort to eliminate
redundant facilities and employees and to reduce the overall cost structure of
the acquired business to better align the Company’s operating expenses with
existing economic conditions, business requirements and the Company’s operating
model. Pursuant to this restructuring, the Company recorded $11.6 million of
costs related to severance and related benefits, costs to vacate leased
facilities and other pre-Acquisition liabilities. These costs were accounted for
under EITF Issue No. 95-3, “Recognition of Liabilities in
Connection with Purchase Business Combinations.” These costs, which were
recognized as a liability assumed in the purchase business combination, were
included in the allocation of the purchase price.
The
reductions in employee headcount totaled approximately 360 employees from the
administrative, sales, marketing and development functions, and amounted to a
liability of approximately $8.9 million, which was paid against the exit plan
accrual through October 31, 2008.
In
connection with the exit plan, the Company abandoned certain leased facilities
and has a remaining facilities consolidation liability of $0.1 million as of
October 31, 2008, consisting of lease termination costs, broker commissions and
other facility costs. As part of the plan, two larger sites and a number of
small locations were vacated. The fair value of the lease termination costs was
calculated with certain assumptions related to the Company’s estimated cost
recovery efforts from subleasing vacated space, including (i) the time period
over which the property will remain vacant, (ii) the sublease terms and (iii)
the sublease rates.
The
Company’s merger and exit liabilities which include previous merger and
acquisition transactions are recorded in accrued expenses and long-term
liabilities (see Note 16). Activity in the nine month period ended October 31,
2008 is as follows (in thousands):
The
Company anticipates that the remainder of the merger and exit accrual will be
paid by October 2011 as follows (in thousands):
In
accordance with SFAS No. 146, “Accounting for Costs Associated with
Exit or Disposal Activities,” the costs of continued employment of
certain former NETg employees during the transition period were expensed as
incurred and are included in merger and integration related expenses in the
accompanying statements of income.
(b) Discontinued
Operations
In
connection with the NETg acquisition, the Company discontinued four businesses
acquired from NETg because the Company believed those product offerings did not
represent areas that could grow in a manner consistent with the Company’s
operating model or be consistent with the Company’s profit model or strategic
initiatives. The businesses that were identified as discontinued operations were
Financial Campus, NETg Press, Interact Now and Wave.
Summarized
results of operations for discontinued operations, which includes a gain of $2.0
million, net of income tax resulting from proceeds received during the second
quarter of fiscal 2009 from the Company’s sale of the assets related to the NETg
Press business in October 2007, are as follows (in thousands):
(c) Restructuring
Activity
in the Company’s restructuring accrual was as follows (in
thousands):
The
Company anticipates that the remainder of the restructuring accrual will be paid
out in fiscal 2009.
8.
GOODWILL AND INTANGIBLE ASSETS
Intangible
assets are as follows (in thousands):
$900,000
of intangible assets within trademarks of our Books24x7 business unit are
considered indefinite-lived and accordingly, no amortization expense is
recorded.
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The change in goodwill at October 31, 2008 from the amount recorded
at January 31, 2008 is as follows:
The
Company will be conducting its annual impairment test of goodwill for fiscal
2009 in the fourth quarter.
9.
COMPREHENSIVE INCOME
SFAS No.
130, “Reporting Comprehensive
Income,” requires disclosure of all components of comprehensive income on
an annual and interim basis. Comprehensive income 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. Comprehensive
income for the three and nine months ended October 31, 2008 and 2007 was as
follows (in thousands):
Accumulated
other comprehensive income as of October 31, 2008 and January 31, 2008 was as
follows (in thousands):
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10. NET
INCOME PER SHARE
Basic net
income per share was computed using the weighted average number of shares
outstanding during the period. Diluted net income per share was computed by
giving effect to all dilutive potential shares outstanding. The weighted average
number of shares outstanding used to compute basic net income per share and
diluted net income per share was as follows:
The
following share equivalents have been excluded from the computation of diluted
weighted average shares outstanding for the three and nine months ended October
31, 2008 and 2007, respectively, as they would be
anti-dilutive:
11.
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 United States Internal Revenue Code.
For the
nine months ended October 31, 2008 and 2007, the Company’s effective tax rates
were 38.5% and (44.3%), respectively. For the nine month period ended October
31, 2008, the provision for income taxes consisted of a cash tax provision of
$3.1 million and a non-cash tax provision of $15.7 million. Included in the
non-cash tax provision of $15.7 million is a $1.1 million provision related to
tax return positions not likely to be sustained under audit. For the nine month
period ended October 31, 2007, the tax benefit of $7.9 million (44.3%) consisted
of a cash tax provision of $1.1 million and a non-cash tax benefit of $9.0
million. The non-cash tax benefit of $9.0 million was primarily the result of a
$25 million reduction in the Company’s U.S. deferred tax valuation allowance on
NOL carryforwards which was partially offset by the Company’s projected non-cash
provision for income taxes and the impact of certain tax adjustments required in
purchase accounting for the NETg acquisition.
At
October 31, 2008, the Company had $3.1 million of unrecognized tax benefits. If
recognized, $2.4 million would lower the Company’s effective tax rate. However,
upon the adoption of SFAS No. 141 (revised), “Business Combinations” (SFAS
No. 141(R)), changes in unrecognized tax benefits following an acquisition
generally will affect income tax expense, including any changes associated with
acquisitions that occurred prior to the effective date of SFAS No. 141(R). The
Company recognizes interest and penalties accrued related to unrecognized tax
benefits as income tax expense. As of October 31, 2008, the Company had
approximately $0.9 million of accrued interest and penalties related to
uncertain tax positions.
The
Company conducts business globally and, as a result, the Company and its
subsidiaries file income tax returns in the U.S. and foreign jurisdictions. In
the normal course of business the Company is subject to examination by taxing
authorities throughout the world, including, but not limited to, such major
jurisdictions as Canada, the United Kingdom and the United States. With few
exceptions, the Company is no longer subject to U.S. and international income
tax examinations for years before 2003.
12.
COMMITMENTS AND CONTINGENCIES
In
January 2007, the Boston District Office of the SEC informed the Company that it
was the subject of an informal investigation concerning option granting
practices at SmartForce for the period beginning April 12, 1996 through July 12,
2002 (the Option Granting Investigation). These grants were made prior to the
September 6, 2002 merger with
SmartForce PLC. The Company has produced documents in response to requests from
the SEC. The SEC staff has informed the Company that the staff has not
determined whether to close the Option Granting Investigation.
The
Company believes that it accounted for SmartForce stock option grants
appropriately in the merger. When SkillSoft Corporation and SmartForce merged on
September 6, 2002, SkillSoft Corporation was for accounting purposes deemed to
have acquired SmartForce. Accordingly, the pre-merger financial statements of
SmartForce are not included in the historical financial statements of the
Company, and the Company’s financial statements include the results of
SmartForce only from the date of the merger. Under applicable accounting rules,
the Company valued all of the outstanding SmartForce stock options assumed in
the merger at fair value upon consummation of the merger. Accordingly, the
Company believes that its accounting for SmartForce stock options will not be
affected by any error that SmartForce may have made in its own accounting for
stock option grants and that that the Option Granting Investigation should not
require any change in the Company’s financial statements.
The
Company has cooperated with the SEC in the Option Granting Investigation. At the
present time, the Company is unable to predict the outcome of the Option
Granting Investigation or its potential impact on its operating results or
financial position.
From time
to time, the Company is a party to or may be threatened with other litigation in
the ordinary course of its business. The Company regularly analyzes current
information, including, as applicable, the Company’s defenses and insurance
coverage and, as necessary, provides accruals for probable and estimable
liabilities for the eventual disposition of these matters. The Company is not a
party to any material legal proceedings.
13.
GEOGRAPHICAL DISTRIBUTION OF REVENUE
The
Company attributes revenue to different geographical areas on the basis of the
location of the customer. Revenues by geographical area for the three and nine
month periods ended October 31, 2008 and 2007 were as follows (in
thousands):
14.
ACCRUED EXPENSES
Accrued
expenses in the accompanying condensed combined balance sheets consist of the
following (in thousands):
15. OTHER
ASSETS
Other
assets in the accompanying condensed consolidated balance sheets consist of the
following (in thousands):
16. OTHER
LONG TERM LIABILITIES
Other
long term liabilities in the accompanying condensed consolidated balance sheets
consist of the following (in thousands):
In Note
17 of “Notes to Consolidated Financial Statements” presented in the Company’s
Annual Report on Form 10-K for the fiscal year ended January 31, 2008, the
Company had unintentionally included approximately $2.5 million in “Merger
accrual – long term” instead of “Other”. Such amount has been reclassified above
to reflect the correct presentation.
17. FAIR
VALUE OF FINANCIAL INSTRUMENTS
In
September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No.
157, “Fair Value
Measurements,” which defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting principles
and expands disclosures about fair value measurements. As defined in SFAS No.
157, fair value is the amount that would be received if an asset was sold or a
liability transferred in an orderly transaction between market participants at
the measurement date.
Effective
February 1, 2008, the Company adopted the provision of SFAS No. 157 with respect
to its financial assets and liabilities that are measured at fair value within
the condensed consolidated financial statements. The adoption of SFAS No. 157
did not have a material impact on the Company’s financial position, results of
operations or cash flows.
In
February 2008, the FASB issued FASB Staff Position (FSP) SFAS No. 157-1, “Application of FASB Statement No.
157 to FASB Statement No. 13 and Its Related Interpretive Accounting
Pronouncements That Address Leasing Transactions” (FSP SFAS No. 157-1),
and FSP SFAS No. 157-2, “Effective Date of FASB Statement No.
157” (FSP SFAS No. 157-2). FSP SFAS No. 157-1 removes leasing from the
scope of SFAS No. 157, “Fair
Value Measurements.” FSP SFAS No. 157-2 delays the effective date of SFAS
No. 157 from 2008 to 2009 for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). The adoption of
FSP SFAS No. 157-1, effective February 1, 2008, did not impact the Company’s
financial position, results of operations or cash flows. The Company has
deferred the application of the provisions of this statement to its
non-financial assets and liabilities in accordance with FSP SFAS No. 157-2. The
Company does not expect that its adoption of the provisions of FSP SFAS 157-2
will have a material impact on its financial position, results of operations or
cash flows. SFAS No.
157 establishes a fair value hierarchy that prioritizes the inputs used to
measure fair value that maximizes the use of observable inputs and minimizes the
use of unobservable inputs. Observable inputs are inputs that reflect the
assumptions that market participants would use in pricing the asset or liability
developed based on market data obtained from sources independent of the Company.
Unobservable inputs are inputs that reflect the Company’s assumptions about the
assumptions market participants would use in pricing the asset or liability
developed based on the best information available in the
circumstances.
The three
levels of the fair value hierarchy established by SFAS No. 157 in order of
priority are as follows:
The
Company’s commercial paper, corporate debt securities, certificates of deposit,
federal agency notes and treasury bills are classified as cash equivalents or
available for sale securities based on the original maturity period and carried
at fair value. These assets, except for federal agency notes and treasury bills,
are generally classified within Level 1 of the fair value hierarchy because they
are valued using quoted market prices. The Company classifies federal agency
notes and treasury bills within Level 2 of the fair value hierarchy because they
are valued using pricing inputs other than quoted prices in active markets
included in Level 1, which are either directly or indirectly observable as of
the reporting date.
The
Company recognizes all derivative financial instruments in its consolidated
financial statements at fair value in accordance with FASB Statement No. 133,
“Accounting for Derivative
Instruments and Hedging Activities.” The Company determines the fair
value of these instruments using the framework prescribed by SFAS No. 157 by
considering the estimated amount the Company would receive to terminate these
agreements at the reporting date and by taking into account current interest
rates and the creditworthiness of the counterparty. In certain instances, the
Company may utilize financial models to measure fair value. Generally, the
Company uses inputs that include quoted prices for similar assets or liabilities
in active markets, quoted prices for identical or similar assets or liabilities
in markets that are not active, other observable inputs for the asset or
liability and inputs derived principally from, or corroborated by, observable
market data by correlation or other means. The Company has classified its
derivative liability within Level 2 of the fair value hierarchy because these
observable inputs are available for substantially the full term of the
derivative instrument.
The
following table summarizes the Company’s fair value hierarchy for its financial
assets and liabilities measured at fair value on a recurring basis as of October
31, 2008 (in thousands):
(1)
Consists of high-grade commercial paper and federal agency notes with original
and remaining maturities of less than 90 days.
(2)
Consists of high-grade commercial paper, corporate debt securities and
certificates of deposit with original maturities of 90 days or more and
remaining maturities of less than 365 days.
18. LINE
OF CREDIT
The
Company has an agreement (the Credit Agreement) with certain lenders (the
Lenders) providing for a $225 million senior secured credit facility comprised
of a $200 million term loan facility and a $25 million revolving credit
facility. The term loan was used to finance the NETg acquisition and the
revolving credit facility may be used for general corporate
purposes.
On July
7, 2008, the Company entered into an amendment (Amendment No. 1) to the Credit
Agreement, and the related Guarantee and Collateral Agreement, dated May 14,
2007. The primary purpose of Amendment No. 1 was to expand the ability of the
Company and its subsidiaries to make repurchases of the Company’s Ordinary
Shares. The Company’s expanded repurchase ability under Amendment No. 1 is
conditioned on the absence of an event of default and a requirement that (i) the
leverage ratio shall be no greater than 2.75:1.0 as of the most recently
completed fiscal quarter ending prior to the date of such repurchase and (ii)
that the Company make a prepayment of the term loan under the Credit Agreement
in an amount equal to the dollar amount of any such repurchase. Such term loan
prepayments will not, however, be required in connection with the first $24.0
million of repurchases made from and after July 7, 2008.
Amendment
No. 1 also provides for an increase in the interest rate on the term loan
outstanding under the Credit Agreement and the payment of additional fees to the
Lenders upon execution of Amendment No. 1. Pursuant to Amendment No. 1, the term
loan will bear interest at a rate per annum equal to, at the Company’s election,
(i) a base rate plus a margin of 2.50% (increased from 1.75%) or (ii) adjusted
LIBOR plus a margin of 3.50% (increased from 2.75%).
In
connection with the Credit Agreement and Amendment No. 1, the Company incurred
debt financing costs of $5.9 million and $0.3 million, respectively, which were
capitalized and are being amortized as additional interest expense over the term
of the loans using the effective-interest method. During the three and nine
months ended October 31, 2008, the Company paid approximately $2.3 million and
$8.6 million, respectively, in interest. The Company recorded $0.3 million and
$0.9 million of amortized interest expense related to the capitalized debt
financing costs for the three and nine months ended October 31, 2008,
respectively. As of October 31, 2008, total unamortized debt financing costs of
$1.0 million and $3.5 million are recorded within prepaid expenses and other
current assets and non-current other assets, respectively, based on scheduled
future amortization.
During
the three and nine months ended October 31, 2008, the Company paid $0.4 million
and $55.3 million, respectively, against the term loan amount. As a result, the
balance outstanding under the term loan was $143.7 million at October 31, 2008,
with a weighted average interest rate for the three month period ended October
31, 2008 of 8.21%.
Future
scheduled minimum payments under this credit facility are as follows (in
thousands):
19.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The
Company has an interest rate swap to hedge the variable cash flows associated
with existing variable-rate debt. As of October 31, 2008 and 2007, the notional
amount on the interest rate swap was $100.4 million and $159.6 million,
respectively.
At
October 31, 2008 and 2007, the interest rate swap had a fair value of $(1.5)
million and $(1.1) million, respectively, which was included in other long-term
liabilities. No hedge ineffectiveness was recognized during the nine months
ended October 31, 2008 and 2007. For the three months ended October 31, 2008 and
2007, the change in net unrealized gains (losses) on the interest rate swap
designated as a cash flow hedge and reported as a component of comprehensive
income was a $0.3 million net gain and a $0.8 million net loss, respectively.
For the nine months ended October 31, 2008 and 2007, the change in net
unrealized gains (losses) on the interest rate swap designated as a cash flow
hedge and reported as a component of comprehensive income was a $1.2 million net
gain and a $1.1 million net loss, respectively.
Amounts
reported in accumulated other comprehensive income related to derivatives will
be incurred as interest expense as payments are made on the Company’s
variable-rate debt. The change in net unrealized gains (losses) on cash flow
hedges reflects a reclassification of $0.6 million of net unrealized losses and
$0.1 million of net unrealized gains from accumulated other comprehensive income
to interest expense for the three months ended October 31, 2008 and 2007,
respectively. The change in net unrealized gains (losses) on cash flow hedges
reflects a reclassification of $1.8 million of net unrealized losses and $0.2
million of net unrealized gains from accumulated other comprehensive income to
interest expense for the nine months ended October 31, 2008 and 2007,
respectively. During the twelve month period ending October 31, 2009, the
Company estimates that it will incur an additional $1.5 million of interest
expense relating to the interest rate swap.
20. SHARE
REPURCHASE PROGRAM
On April
8, 2008, the Company’s shareholders approved a program for the repurchase by the
Company of up to an aggregate of 10,000,000 ADSs. On September 24, 2008, the
Company’s shareholders approved an increase in the number of shares that may be
repurchased under the program to 25,000,000 and an extension of the repurchase
program until March 23, 2010. During the three and nine months ended October 31,
2008, the Company repurchased a total of 2,985,680 and 5,709,399 shares,
respectively, for a total purchase price, including commissions, of $29.3
million and $56.5 million, respectively. The Company retired 11,586,183 shares
during the three months ended October 31, 2008, including 6,533,884 shares
repurchased in prior fiscal years. As of October 31, 2008, 657,100 of the
repurchased shares have not been retired or canceled and are held as treasury
stock at cost; the Company intends to retire these shares in the near future. As
of October 31, 2008, 19,290,601 shares remain available for repurchase, subject
to certain limitations, under the shareholder approved repurchase
program.
21.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In
February 2007, the FASB, issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities — Including an
Amendment of FASB Statement No. 115 ” (SFAS No. 159), which permits
entities to choose to measure many financial instruments and certain other items
at fair value and is effective for fiscal years beginning after
November 15, 2007, or February 1, 2008 for SkillSoft. The Company
adopted SFAS No. 159 on February 1, 2008 and elected not to measure any
additional financial instruments or other items at fair value. Adoption of SFAS
No. 159 did not have a material impact on the Company’s financial position or
results of operations.
In
December 2007, the FASB issued SFAS No. 141 (revised), “Business Combinations” (SFAS
No. 141(R)). SFAS No. 141(R) changes the accounting for business combinations
including the measurement of acquirer shares issued in consideration for a
business combination, the recognition of contingent consideration, the
accounting for pre-acquisition gain and loss contingencies, the recognition of
capitalized in-process research and development, the accounting for
acquisition-related restructuring cost accruals, the treatment of acquisition
related transaction costs and the recognition of changes in the acquirer’s
income tax valuation allowance. SFAS No. 141(R) is effective for the Company for
any business combinations for which the acquisition date is on or after February
1, 2009, with early adoption prohibited. In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51” (SFAS
No. 160). SFAS No. 160 changes the accounting for noncontrolling (minority)
interests in consolidated financial statements including the requirements to
classify noncontrolling interests as a component of consolidated stockholders’
equity, and the elimination of “minority interest” accounting in results of
operations with earnings attributable to noncontrolling interests reported as
part of consolidated earnings. Additionally, SFAS No. 160 revises the accounting
for both increases and decreases in a parent’s controlling ownership interest.
SFAS No. 160 is effective for the Company in fiscal 2009, with early adoption
prohibited. Adoption of SFAS No. 160 did not have a material impact on the
Company’s financial position or results of operations.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
(SFAS No. 161). SFAS No. 161 applies to all derivative instruments and
nonderivative instruments that are designated and qualify as hedging instruments
pursuant to paragraphs 37 and 42 of Statement 133 and related hedged items
accounted for under FASB Statement No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (SFAS No. 133). SFAS No. 161 requires
entities to provide greater transparency through additional disclosures about
(a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under Statement 133 and
its related interpretations, and (c) how derivative instruments and related
hedged items affect an entity’s financial position, results of operations, and
cash flows. SFAS No. 161 is effective for the Company on February 1, 2009. The
Company is currently analyzing the effect, SFAS No. 161 will have on
its disclosures related to the Company’s interest rate swap
agreement.
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 under Part II, Item 1A, “Risk
Factors.”
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
We are a
leading Software as a Service (SaaS) provider of on-demand e-learning and
performance support solutions for global enterprises, government, education and
small to medium-sized businesses. We enable business organizations to maximize
business performance through a combination of comprehensive e-learning content,
online information resources, flexible learning technologies and support
services. Our multi-modal learning solutions support and enhance the speed and
effectiveness of both formal and informal learning processes and integrate our
in-depth content resources, learning management system, virtual classroom
technology and support services.
We
generate revenue primarily from the license of our products, the provision of
professional services as well as from the provision of hosting and application
services. The pricing for our courses varies based upon the content offering
selected 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
agreements permit customers to exchange course titles, generally on the contract
anniversary date. Hosting services are separately licensed for an additional
fee.
Cost of
revenues includes the cost of materials (such as storage media), packaging,
shipping and handling, CD duplication, custom content development and hosting
services, royalties and certain infrastructure and occupancy expenses and
share-based compensation. We generally recognize these costs as incurred. Also
included in cost of revenues is amortization expense related to capitalized
software development costs and intangible assets related to developed software
and courseware acquired in business combinations. 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” (SFAS No. 86), which
requires the capitalization of certain computer software development costs
incurred after technological feasibility is established. No software development
costs incurred during the three and nine months of ended October 31, 2008 met
the requirements for capitalization in accordance with SFAS No. 86.
Research
and development expenses consist primarily of salaries and benefits, share-based
compensation, certain infrastructure and occupancy expenses, fees to consultants
and course content development fees. Selling and marketing expenses consist
primarily of salaries and benefits, share-based compensation, commissions,
advertising and promotion expenses, travel expenses and certain infrastructure
and occupancy expenses. General and administrative expenses consist primarily of
salaries and benefits, share-based compensation, consulting and service
expenses, legal expenses, audit and tax preparation costs, regulatory compliance
costs and certain infrastructure and occupancy expenses.
Amortization
of intangible assets represents the amortization of customer value, non-compete
agreements, trademarks and tradenames from our acquisitions of NETg, Targeted
Learning Corporation (TLC), Books24x7 and GoTrain Corp. and our merger with
SkillSoft Corporation (the SmartForce Merger).
Merger
and integration related expenses primarily consist of salaries paid to NETg
employees for transitional work assignments, facilities, systems and process
integration activities.
SEC
investigation expenses primarily consist of legal and consulting fees incurred
related to the SEC’s review of SmartForce’s option granting practices prior to
the SmartForce Merger, and historically, the SEC investigation relating to the
restatement of SmartForce’s financial statements for 1999, 2000, 2001 and the
first two quarters of 2002.
BUSINESS
OUTLOOK
In the
three and nine months ended October 31, 2008, we generated revenues of $83.1
million and $248.0 million, respectively, as compared to $75.1 million and
$203.7 million in the three and nine months ended October 31, 2007,
respectively. We reported net income in the three and nine months ended October
31, 2008 of $12.0 million and $32.0 million, respectively, as compared to $5.8
million and $25.7 million in the three and nine months ended October 31, 2007,
respectively.
While we
have achieved increased revenues and profitability from last fiscal year’s
comparable periods, we have experienced a more cautious customer environment due
to the current challenging global economic climate. In addition, we continue to
find ourselves in a challenging business environment due to (i) budgetary
constraints on information technology (IT) spending by our current and potential
customers, (ii) price competition and value-based competitive offerings from a
broad array of competitors in the learning market and (iii) the relatively slow
overall market adoption rate for e-learning solutions. In recent months the
challenging U.S. and global economic environment has put additional pressure on
potential budgetary constraints on IT and spending by our current and potential
customers. While we have seen some customers put spending on hold, we
have seen others increase spending and utilize e-learning as a cost effective
alternative to traditional learning. Despite the challenges, our core
business has performed predominately in accordance with our expectations. Our
recent revenue growth, as compared to last fiscal year, was primarily the result
of the realization of additional revenue from the increased customer base
associated with the NETg acquisition, third party resellers of our product and
international sales. Our growth prospects are strongest in developing our
expanded core business, which leverages our various product lines in a strategy
of bundled product offerings, as well as continued distribution partnerships
with third party resellers and international distribution growth. As a result,
we have increased our sales and marketing investment related to these areas to
help capitalize on the recent growth and potential continued growth. We have
also invested aggressively in research and development in those areas to
accelerate the time by which our planned new products will be available to our
customers. In order to pursue the small and medium-sized business markets, we
continue to invest in our telesales business unit; however, we have not seen
results in line with our expectations and as a result we have made and will
continue to make organizational changes as needed to achieve our expected
growth. We plan to continue to invest in our new business direct field sales
team and lead generator organizations. In the
nine months ended October 31, 2008 and for the remainder of fiscal 2009, we have
and will continue to focus on revenue and earnings growth, excluding normal and
anticipated acquisition and integration related expenses, primarily
by:
CRITICAL
ACCOUNTING POLICIES
We
believe that our critical accounting policies are those related to revenue
recognition, amortization of intangible assets and impairment of goodwill,
share-based compensation, deferral of commissions, restructuring charges, legal
contingencies, income taxes and valuation of business combinations. We believe
these accounting policies 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. Our critical accounting policies are more fully described under the
heading “Critical Accounting Policies” in Note 2 of the Notes to the
Consolidated Financial Statements and under “Management’s Discussion and
Analysis of Financial Conditions and Results of Operations – Critical Accounting
Policies” in our Annual Report on Form 10-K as filed with the SEC on March 31,
2008. The policies set forth in our Form 10-K have not changed.
RESULTS
OF OPERATIONS
THREE
MONTHS ENDED OCTOBER 31, 2008 VERSUS THREE MONTHS ENDED OCTOBER 31,
2007
Revenue
Revenue
increased primarily due to the realization of additional revenue resulting from
an increased customer base associated with the NETg acquisition in May 2007 as
well as from continued additional revenue earned under agreements with third
party resellers of our products. We expect revenue growth to continue through
the fourth quarter of fiscal 2009 compared to the fourth quarter of fiscal
2008.
Revenue
increased by 5% and 31% in the United States and internationally, respectively,
in the three months ended October 31, 2008 as compared to the three months ended
October 31, 2007 as a result of increased revenue generated from the NETg
acquisition and from existing customers and new business. We exited
the fiscal year ended January 31, 2008 with non-cancelable backlog of
approximately $255 million compared to $181 million at January 31, 2007. This
amount is calculated by combining the amount of deferred revenue at each fiscal
year end with the amounts to be added to deferred revenue throughout the next
twelve months from billings under committed customer contracts and determining
how much of these amounts are scheduled to amortize into revenue during the
upcoming fiscal year. The amount scheduled to amortize into revenue during
fiscal 2009 is disclosed as “backlog” as of January 31, 2008. Amounts to be
added to deferred revenue during fiscal 2009 include subsequent installment
billings for ongoing contract periods as well as billings for committed contract
renewals. We have included this non-GAAP disclosure as it is directly related to
our subscription based revenue recognition policy. This is a key business
metric, which factors into our forecasting and planning activities and provides
visibility into fiscal 2009 revenue.
Costs
and Expenses
The
increase in cost of revenue in the three months ended October 31, 2008 versus
the three months ended October 31, 2007 was primarily due to increased
revenues.
The
decrease in research and development expense in the three months ended October
31, 2008 versus the three months ended October 31, 2007 was primarily due to a
reduction in professional fees of $0.8 million as a result of last year’s third
fiscal quarter incurring costs attributable to the acquisition of NETg and the
subsequent integration initiatives, which were materially completed by July 31,
2008. This included maintaining multiple platforms and fulfilling obligations of
acquired customer contracts and product commitments assumed in the acquisition
of NETg. In addition, there was a decrease in compensation and benefits expense
of $0.2 million primarily due to performance bonuses being paid in the third
quarter of last fiscal year which were related to the acquisition of NETg and
the integration efforts of our employees. There was also a decrease
in facility charges of $0.4 million for the three months ended October 31, 2008
due to a reduction in redundant leased space assumed in the acquisition of
NETg.
The
increase in selling and marketing expense in the three months ended October 31,
2008 versus the three months ended October 31, 2007 was primarily due to an
increase in compensation and benefits of $1.1 million as a result of an increase
in sales and marketing headcount, which includes additional direct sales,
telesales and field support personnel required to service our increased customer
base as a result of the NETg acquisition, as well as incremental commissions
resulting from increased order intake and billings from our larger base business
and from the acquired NETg customer base. The decrease in selling and marketing
expense as a percentage of revenue in the three months ended October 31, 2008
versus the three months ended October 31, 2007 reflects the growth of revenue
partially offset by the aforementioned factors.
The
decrease in general and administrative expense in the three months ended October
31, 2008 versus the three months ended October 31, 2007 was primarily due to a
reduction in bad debt expense of $0.5 million resulting from an improvement in
collection efforts on accounts receivable as compared to the third quarter of
fiscal 2008, as well as a reduction in depreciation of fixed assets of $0.3
million and lower facility charges of $0.2 million. This was partially offset by
an increase of $0.6 million in professional fees, primarily related to an
on-going feasibility analysis related to our business realignment
strategy.
Amortization
of intangible assets decreased $0.9 million, or 25%, to $2.7 million in the
three months ended October 31, 2008 from $3.6 million in the three months ended
October 31, 2007. This decrease was primarily due to certain assets becoming
fully amortized during fiscal 2009.
In the
three months ended October 31, 2008, we did not incur material merger and
integration related expenses as compared to the $2.6 million in the three months
ended October 31, 2007. The significant charges in last year’s third quarter
were primarily due to the NETg acquisition. We do not expect to incur any
significant additional merger-related expenses related to the NETg acquisition
in future periods.
____________
* Not
meaningful
Other
Income (Expense), Net
The
increase in other income (expense), net in the three months ended October 31,
2008 versus the three months ended October 31, 2007 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 used in our business. During the three months ended October 31, 2008
the strengthening of the U.S. dollar in relation to certain other foreign
currencies resulted in significant gains, whereas in the same period of the
prior year, the U.S. dollar declined in relation to foreign
currencies. Interest
Income
The
reduction in interest income in the three months ended October 31, 2008 versus
the three months ended October 31, 2007 was primarily due to a reduction in our
short-term investments and lower interest rates.
Interest
Expense
The
decrease in interest expense in the three months ended October 31, 2008 versus
the three months ended October 31, 2007 was primarily due to a reduction of our
debt as a result of $55.3 million in principal debt repayments made in the first
half of fiscal 2009.
Provision
for Income Taxes
For the
three months ended October 31, 2008, the effective tax rate of 38.5% was higher
than the Irish statutory rate of 12.5% primarily due to earnings realized in
higher tax jurisdictions outside of Ireland. The tax benefit for the three
months ended October 31, 2007 was influenced significantly by certain purchase
accounting tax adjustments as a result of the NETg acquisition and the release
of $49.1 million of our valuation allowance primarily related to U.S. net
operating loss (NOL) carryforwards. Approximately $25 million of this valuation
allowance was recorded through reductions to tax expense and $24.1 million was
recorded through adjustments to goodwill.
Discontinued
Operations
In
connection with the NETg acquisition, we decided to discontinue four product
lines that were acquired from NETg because we believed these product offerings
did not represent businesses that could grow or produce operating results
consistent with our profit model. The product lines that have been identified as
discontinued operations are Wave, NETg Press, Interact Now and Financial Campus.
We recorded a loss from discontinued operations, net of tax, of $37
thousand in the three months ended October 31, 2008 versus a loss, net of
tax, of $0.4 million in the three months ended October 31, 2007. This was
primarily due to NETg Press and Financial Campus being sold in the three months
ended October 31, 2007. In addition, we exited the Wave business in the three
months ended October 31, 2007. We do not anticipate operations from discontinued
operation to materially affect our liquidity, financial condition or results of
operations going forward.
NINE
MONTHS ENDED OCTOBER 31, 2008 VERSUS NINE MONTHS ENDED OCTOBER 31,
2007
Revenue
Revenue
increased primarily due to the realization of additional revenue resulting from
an increased customer base associated with the acquisition of NETg in May 2007
as well as from continued additional revenue earned under agreements with third
party resellers of our products.
Revenue
increased by 14% and 52% in the United States and internationally, respectively,
in the nine months ended October 31, 2008 as compared to the nine months ended
October 31, 2007 as a result of increased revenue generated from the NETg
acquisition and from existing customers and new business as well as from
continued additional revenue earned under agreements with third party resellers
of our products.
Costs
and Expenses
The
increase in cost of revenue in the nine months ended October 31, 2008 versus the
nine months ended October 31, 2007 was primarily due to increased revenue. Gross
margin remained consistent during these periods.
The
increase in cost of revenue — amortization of intangible assets in the nine
months ended October 31, 2008 versus the nine months ended October 31, 2007 was
primarily due to the amortization of the intangible assets acquired in the
acquisition of NETg being included for the entire nine month period of fiscal
2009 versus less than six months in fiscal 2008, partially offset by certain
intangible assets becoming fully amortized since October 31, 2007.
The
increase in research and development expense in the nine months ended October
31, 2008 versus the nine months ended October 31, 2007 was primarily due to
additional contractor and outsource partner costs of $1.4 million to support
expanded product and software development initiatives resulting from our larger
customer base. A portion of these incremental costs are attributable to NETg
integration initiatives, which include maintaining multiple platforms,
fulfilling obligations of acquired customer contracts and product commitments
assumed in the acquisition of NETg. In addition, we incurred an increase in
compensation and benefits expense of $1.8 million as a result of an increase in
our research and development headcount. The decrease in research and development
expense as a percentage of revenue in the nine months ended October 31, 2008
versus the nine months ended October 31, 2007 reflects the growth of revenue
partially offset by the aforementioned factors.
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