SkillSoft 10-Q 2008
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2008
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-25674
SKILLSOFT PUBLIC LIMITED COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (603) 324-3000
(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 þ No o
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 o No þ
On August 31, 2008, the registrant had outstanding 104,293,600 Ordinary Shares (issued or issuable in exchange for the registrants outstanding American Depositary Shares).
FOR THE QUARTER ENDED JULY 31, 2008
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SKILLSOFT PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these condensed consolidated financial statements.
SKILLSOFT PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS
(UNAUDITED, IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
The accompanying notes are an integral part of these condensed consolidated financial statements.
SKILLSOFT PLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
The accompanying notes are an integral part of these condensed consolidated financial statements.
SKILLSOFT PLC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 July 31, 2008, the results of its operations for the three and six months ended July 31, 2008 and 2007 and cash flows for the six months ended July 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 Companys 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 July 31, 2008 and January 31, 2008, cash equivalents consisted mainly of commercial paper and federal agency notes.
At July 31, 2008, the Company had approximately $4.0 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 $1.3 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 July 31, 2008, the Companys investments were classified as available for sale and had an average maturity of approximately 23 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 Companys products and services. The pricing for the Companys courses varies based upon the content offering selected by a customer, the number of users within the customers 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. 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 Companys 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.
SkillSoft contracts often include an uptime guarantee for solutions hosted on the Companys 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 Companys 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 July 31, 2008, 2,393,263 ordinary shares remain available for future grant under the Companys share option plans. Please see Note 9 of the Notes to the Consolidated Financial Statements in the Companys Annual Report on Form 10-K as filed with the SEC on March 31, 2008 for a detailed description of the Companys share option plans.
A summary of share option activity under the Companys plans during the six months ended July 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 July 31, 2008 of $10.25 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 July 31, 2008. The total intrinsic value of options exercised during the three months ended July 31, 2008 and 2007 was approximately $5.2 million and $2.6 million, respectively. The total intrinsic value of options exercised during the six months ended July 31, 2008 and 2007 was approximately $10.9 million and $5.7 million, respectively.
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 SkillSofts 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 Companys consolidated financial statements since the date of acquisition.
SUPPLEMETAL PRO-FORMA INFORMATION
The Company has concluded that the NETg acquisition represents a material business combination. The following unaudited pro forma information presents the consolidated results of operations of the Company and NETg as if the acquisition had occurred at the beginning of fiscal 2008 (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 are not necessarily indicative of the results that the Company would have attained had the acquisition of NETg occurred at the beginning of the periods presented.
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 Companys 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 Companys operating expenses with existing economic conditions, business requirements and the Companys 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 will total approximately 360 employees from the administrative, sales, marketing and development functions, and amounted to a liability of approximately $8.9 million. Approximately $8.6 million was paid against the exit plan accrual through July 31, 2008, and the remaining amount of $0.3 million, net of adjustments for foreign currency translation, is expected to be paid by the end of fiscal 2009.
In connection with the exit plan, the Company abandoned certain leased facilities resulting in a facilities consolidation liability of $0.4 million as of July 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 Companys 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 Companys 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 six month period ended July 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 are being 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 decided to discontinue four businesses acquired from NETg because the Company believes these product offerings do not represent areas that can grow in a manner consistent with the Companys operating model or be consistent with the Companys profit model or strategic initiatives. The businesses that have been identified as discontinued operations are 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 three months ended July 31, 2008 from the Companys sale of the assets related to the NETg Press business in October 2007, are as follows (in thousands):
Activity in the Companys 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
Goodwill and intangible assets are as follows (in thousands):
The change in goodwill at July 31, 2008 from the amount recorded at January 31, 2007 is as follows:
The Company will be conducting its annual impairment test of goodwill for fiscal 2009 in the fourth quarter. $900,000 of intangible assets within trademarks of our Books24X7 business unit are considered indefinite-lived and accordingly no amortization expense is recorded.
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 six months ended July 31, 2008 and 2007 was as follows (in thousands):
Accumulated other comprehensive income as of July 31, 2008 and January 31, 2008 was as follows (in thousands):
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 six months ended July 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 six months ended July 31, 2008 and 2007, the Companys effective tax rates were 38.7% and (72.9%), respectively. For the six month period ended July 31, 2008, the provision for income taxes consisted of a cash tax provision of $2.0 million and a non-cash tax provision of $9.4 million. Included in the non-cash tax provision of $9.4 million are adjustments of approximately $0.4 million related to the Companys deferred tax asset associated with FAS 123R stock based compensation charges and approximately $0.2 million related to the Companys U.S. based deferred tax assets and liabilities resulting from newly enacted State legislation. In accordance with FAS 109, the adjustment for the effect of the change in state tax law is included in income from continuing operations for the period that includes the enactment date. For the six month period ended July 31, 2007, the tax benefit of $8.2 million (72.9%) consisted of a cash tax provision of $1.0 million and a non-cash tax benefit of $9.2 million. The non-cash tax benefit of $9.2 million was primarily the result of a $25 million reduction in the Companys U.S. deferred tax valuation allowance on NOL carryforwards which was partially offset by the Companys projected non-cash provision for income taxes and the impact of certain tax adjustments required in purchase accounting for the NETg acquisition.
At July 31, 2008, the Company had $4.1 million of unrecognized tax benefits. If recognized, $0.9 million would lower the Companys effective tax rate. The Company recognizes interest and penalties accrued related to
unrecognized tax benefits as income tax expense. As of July 31, 2008, the Company had approximately $0.6 million of accrued interest 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 2002.
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 Companys 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 Companys 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 Companys 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 other material legal proceedings.
13. GEOGRAPHICAL DISTRIBUTION OF REVENUES
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 six month periods ended July 31, 2008 and 2007 were as follows (in thousands):
Long-lived tangible assets at international locations are not significant.
14. ACCRUED EXPENSES
Accrued expenses in the accompanying condensed combined balance sheets consisted of the following (in thousands):
15. OTHER ASSETS
Other assets in the accompanying consolidated balance sheets consist of the following (in thousands):
16. OTHER LONG TERM LIABILITIES
Other long term liabilities in the accompanying consolidated balance sheets consist of the following (in thousands):
In Note 17 of Notes to Consolidated Financial Statements presented in the Companys 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 for 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 Companys 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 Companys 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 Companys 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 Companys commercial paper, corporate debt securities, certificates of deposit and federal agency notes 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, 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 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 Companys fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of July 31, 2008 (in thousands):
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. Pursuant to the Credit Agreement, the Company and any subsidiary of the Company have a limited ability to repurchase shares in the Company. The primary purpose of Amendment No. 1 was to expand the ability of the Company and its subsidiaries to be able to make additional repurchases of the Companys Ordinary Shares. The Companys 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 Companys 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 six months ended July 31, 2008, the Company paid approximately $2.5 million and $6.3 million, respectively, in interest. The Company recorded $0.4 million and $0.6 million of amortized interest expense related to the capitalized debt financing costs for the three and six months ended July 31, 2008, respectively. As of July 31, 2008, total unamortized debt financing costs of $1.1 million and $3.7 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 six months ended July, 2008, the Company paid $30.4 million and $54.9 million, respectively, against the term loan amount. As a result, the balance outstanding under the term loan was $144.1 million at July 31, 2008 with a weighted average interest rate for the three month period ended July 31, 2008 of 7.49%.
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 July 31, 2008 and 2007, the notional amount on the interest rate swap was $120.0 million and $160.0 million, respectively.
At July 31, 2008 and 2007, the interest rate swap had a fair value of $(2.0) million and ($0.2) million, respectively, which was included in other liabilities. No hedge ineffectiveness was recognized during the six months ended July 31, 2008 and 2007. For the three months ended July 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 $0.5 million net gain and $0.2 million net loss, respectively. For the six months ended July 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 $0.9 million gain and a $0.2 million loss, net of tax, respectively.
Amounts reported in accumulated other comprehensive income related to derivatives will be incurred as interest expense as payments are made on the Companys variable-rate debt. The change in net unrealized gain (losses) on cash flow hedges reflects a reclassification of $0.8 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 July 31, 2008 and 2007, respectively. The change in net unrealized gain (losses) on cash flow hedges reflects a reclassification of $1.2 million of net unrealized losses and $0.1 million of net unrealized gains from accumulated other comprehensive income to interest expense for the six months ended July 31, 2008 and 2007, respectively. During the twelve month period ending July 31, 2009, the Company estimates that it will incur an additional $1.8 million of interest expense relating to the interest rate swap.
20. SHARE REPURCHASE PROGRAM
On April 8, 2008, the Companys shareholders approved a program for the repurchase by the Company of up to an aggregate of 10,000,000 ADSs. During the three and six months ended July 31, 2008, the Company repurchased a total of 1,511,819 and 2,723,719 shares, respectively, for a total purchase price, including commissions, of $15.0 million and $27.2 million, respectively. The repurchased shares were not retired or canceled but rather held as treasury stock at cost; however, the Company does intend to retire these shares in the near future. As of July 31, 2008, 7,276,281 remained available for repurchase, subject to certain limitations, under the shareholder approved repurchase program which expires on October 7, 2009. The Company has submitted a proposal to its shareholders to increase the number of shares that may be repurchased under the repurchase program from 10,000,000 to 25,000,000 and to extend the duration of the repurchase program until March 23, 2010. The proposal will be voted on by the Companys shareholders at the Companys annual general meeting to be held on September 24, 2008. As discussed in Note 18, the Company has amended provisions of its Credit Agreement to expand the ability of the Company and its subsidiaries to repurchase shares.
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 Companys 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 acquirers 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 parents controlling ownership interest. SFAS No. 160 is effective for the Company in fiscal 2009, with early adoption prohibited. Currently, the Company does not anticipate that SFAS No. 160 will have a material impact on the Companys financial statements.
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 entitys 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 Companys interest rate swap agreement.
ITEM 2. MANAGEMENTS 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 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.
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 customers 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 six months of fiscal 2009 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 SECs review of SmartForces option granting practices prior to the SmartForce Merger, and historically, the SEC investigation relating to the restatement of SmartForces financial statements for 1999, 2000, 2001 and the first two quarters of 2002.
In the three and six months ended July 31, 2008, we generated revenues of $83.3 million and $165.0 million, respectively, as compared to $71.5 million and $128.6 million in the three and six months ended July 31, 2007, respectively. We reported net income in the three and six months ended July 31, 2008 of $12.9 million and $20.0 million, respectively, as compared to $12.4 million and $19.9 million in the three and six months ended July 31, 2007, respectively.
While we have achieved increased revenues from last fiscal years comparable periods and remain profitable, we continue to find ourselves in a challenging business environment due to (i) the relatively slow overall market adoption rate for e-learning solutions, (ii) budgetary constraints on information technology (IT) spending by our current and potential customers and (iii) price competition and value based competitive offerings from a broad array of competitors in the learning market. Despite these challenges, we have seen some stability in the marketplace and our core business has performed in accordance with our expectations. Our recent revenue growth was primarily derived from the realization of additional revenue resulting from an increased customer base associated with the NETg acquisition as well as from 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 business markets, we continue to invest in our telesales unit, but we will need to see renewal rates consistent with those of our direct sales business to determine its growth potential. We plan to continue to invest in our new business direct field sales team and lead generator organization.
On May 14, 2007, we acquired NETg for approximately $254.7 million, after giving effect to certain customary post-closing adjustments. NETg was a global enterprise-learning company delivering integrated learning solutions for businesses, professional associations and government agencies that include instructional content, multiple delivery options, enabling technologies, and a range of expert consulting services. NETg offered many of the same financial and operating characteristics as our business model, including an annual recurring subscription-based
licensing model for access to its learning resources library, a direct sales force distribution system complemented by resellers and telesales support, and a Global 2000 client base offering visibility through multi-year contracts and renewal rates. The acquisition added to our existing offerings through the addition of complementary NETg offerings such as live virtual instructor-led training, blended learning, learning content and custom development services among others. The acquisition supports our overall strategy to continually increase the quality, breadth and flexibility of the learning solutions we can make available to our corporate, government, education and small-to-medium size business customers and we anticipate the integrated assets and services will result in an increase in value to our customers. Also, the addition of NETgs capabilities strengthens our ability to compete for a greater share of the $13.2 billion corporate training market that includes many larger players with more comprehensive product offerings and broader distribution.
In the six months ended July 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 Managements 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 JULY 31, 2008 VERSUS THREE MONTHS ENDED JULY 31, 2007
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 fiscal 2009.
Revenue increased by 6% and 59% in the United States and internationally, respectively, in the three months ended July 31, 2008 as compared to the three months ended July 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 July 31, 2008 versus the three months ended July 31, 2007 was primarily due to increased revenues. Gross margin increased less than 1% during these periods.
The increase in research and development expense in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to an increase in compensation and benefits of $1.0 million associated with additional headcount and an increase in outsource partner costs of $0.2 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.
The increase in selling and marketing expense in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to an increase in compensation and benefits of $3.0 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. This was partially offset by a reduction in costs related to sales meetings and marketing events of $0.5 million.
The increase in general and administrative expense in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to an increase of $0.5 million of professional fees primarily related to an on-going feasibility analysis related to our business realignment strategy.
The decrease in amortization of intangible assets in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to certain assets becoming fully amortized.
The decrease in merger and integration related expenses in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to the significant charges in last years second quarter, when the NETg acquisition was consummated, and the near completion of efforts undertaken to integrate NETgs operations into ours. We do not expect to incur additional material merger-related expenses related to the NETg acquisition after the third quarter of fiscal 2009.
SEC investigation expenses decreased in the three months ended July 31, 2008 versus the three months ended July 31, 2007 due to a decrease in legal activities related to the SECs informal inquiry into the pre-merger option granting practices at SmartForce.
Other Expense, Net
The change in other income expense, net, in the three months ended July 31, 2008 versus the three months ended July 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.
The reduction of interest income in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to lower interest rates and a reduction in our short-term investments.
The decrease in interest expense in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to a reduction of our debt as a result of prepayments made in the first half of fiscal 2009.
Provision for Income Taxes
For the three months ended July 31, 2008, we had a tax provision of $6.8 million versus a tax benefit of $10.8 million for the three months ended July 31, 2007. For the three months ended July 31, 2008, the effective tax rate is 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 July 31, 2007 was influenced significantly by certain purchase accounting tax adjustments as a result of the NETg acquisition and the release of approximately $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.
During the three months ended July 31, 2008, the acquirer of our former NETg Press business prepaid the remaining portion of the purchase price for the NETg Press business resulting in a gain from the disposal of $2.0 million, net of income tax.
SIX MONTHS ENDED JULY 31, 2008 VERSUS SIX MONTHS ENDED JULY 31, 2007
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. We expect revenue growth to continue through fiscal 2009.
Revenue increased by 19% and 64% in the United States and internationally, respectively, in the six months ended July 31, 2008 as compared to the six months ended July 31, 2007 as a result of increased revenue generated from the NETg acquisition and from existing customers and new business.
Costs and Expenses
The increase in cost of revenue amortization of intangible assets in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to the amortization of the intangible assets acquired in the acquisition of NETg, which was partially offset by certain intangible assets becoming fully amortized since July 31, 2007.
The increase in cost of revenue in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to increased revenue. Gross margin increased less than 1% during these periods.
The increase in research and development expense in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to additional contractor and outsource partner costs of $2.2 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 of $2.0 million as a result of an increase in the research and development headcount.
The increase in selling and marketing expense in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to an increase in compensation and benefits of $7.5 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. In addition, we incurred incremental marketing costs of $0.9 million to support our larger customer base.
The increase in general and administrative expense in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to an increase of $2.7 million of professional fees primarily related to our share capital reduction initiative aimed at increasing distributable profits in our Irish parent entity as well as a feasibility analysis related to our business realignment strategy.
The increase in amortization of intangible assets in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to the amortization of the intangible assets acquired in the acquisition of NETg, which was partially offset by certain intangible assets becoming fully amortized since July 31, 2007.
The decrease in merger and integration related expenses in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to the significant charges in last years second quarter when the NETg acquisition was consummated, and the near completion of efforts undertaken to integrate NETgs operations into ours.
SEC investigation expenses decreased in the six months ended July 31, 2008 versus the six months ended July 31, 2007 due to a decrease in legal activities related to the SECs informal inquiry into the pre-merger option granting practices at SmartForce.
Other Expense, Net
The change in other income expense, net, in the six months ended July 31, 2008 versus the six months ended July 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.
The reduction of interest income in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to lower interest rates and a reduction in our short-term investments.
The increase in interest expense in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to the interest expense on the debt incurred for the acquisition of NETg being incurred for the full six months through July 31, 2008 versus only three months through July 31, 2007. This was partially offset by a reduction of the debt as a result of prepayments made during fiscal 2009.
Provision for Income Taxes
For the six months ended July 31, 2008, we had a tax provision of $11.4 million versus a tax benefit of $8.2 million for the six months ended July 31, 2007. For the six months ended July 31, 2008, the effective tax rate is higher than the Irish statutory rate of 12.5% primarily due to earnings realized in higher tax jurisdictions outside of Ireland. For the six month period ended July 31, 2007, the $8.2 million tax benefit was comprised of a $25 million deferred tax
benefit related to the reduction in our deferred tax asset valuation allowance, which was partially offset by the effects of certain purchase accounting tax adjustments related to the NETg acquisition.
During the six months ended July 31, 2008, the acquirer of our former NETg Press business prepaid the remaining portion of the purchase price for the NETg Press business resulting in a gain from the disposal of $2.0 million, net of income tax.
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 2008, our principal source of liquidity was our cash and cash equivalents and short-term investments, which totaled $82.0 million. This compares to $89.6 million at January 31, 2008.
Net cash provided by operating activities of $59.7 million for the six months ended July 31, 2008 was primarily due to a decrease in accounts receivable of $88.8 million. Net cash provided by operating activities was also a result of net income from continuing operations of $18.0 million, which included the impact of non-cash expenses for depreciation and amortization and amortization of intangible assets of $12.1 million, non-cash provision for income taxes of $9.4 million and share-based compensation expense of $3.1 million. These amounts were partially offset by a decrease in accrued expenses of $19.8 million as well as a decrease in deferred revenue of $53.0 million. These decreases in accounts receivable, accrued expenses and deferred revenue are primarily a result of the seasonality of our operations, with the fourth quarter of our fiscal year historically generating the most activity, including order intake and billing.
Net cash provided by investing activities was $2.6 million for the six months ended July 31, 2008, which includes the maturities of investments, net of purchases, generating a cash inflow of approximately $5.5 million. This was partially offset by the purchases of capital assets of approximately $2.7 million.
Net cash used in financing activities was $71.7 million for the six months ended July 31, 2008. During this period, we made a principal payment on our long-term debt of $54.9 million and purchased shares having a value of $27.2 million under our shareholder-approved share repurchase program. These uses of cash were partially offset by proceeds of $9.8 million received from the exercise of share options under our various share option programs and share purchases made under our 2004 Employee Share Purchase Plan.
Cash provided from discontinued operations for the six months ended July 31,2008 included the gross proceeds of $6.9 million from the sale of NETg Press.
We had working capital of approximately $1.7 million as of July 31, 2008 and approximately $30.4 million as of January 31, 2008. The decrease in working capital was primarily due to a principal payment on debt of $54.9 million and the purchase of shares having a value of $27.2 million under our shareholder-approved share repurchase program. This was partially offset by net income from continued operations of $18.0 million, which includes non-cash charges for depreciation and amortization of $12.1 million, share-based compensation expense of $3.1 million and a non-cash tax charge of $9.4 million. Additionally, we received proceeds of $9.8 million from the exercise of share options under our various share option programs and from share purchases made under our 2004 Employee Share Purchase Plan.
As of January 31, 2008, we had U.S. NOL carryforwards of approximately $258.3 million. These NOLs represent the gross carrying value of operating loss carryforwards. These NOL carryforwards, which are subject to potential limitations based upon change in control provisions of Section 382 of the Internal Revenue Code, are available to reduce future taxable income, if any, through 2025. Included in the $258.3 million at January 31, 2008 is approximately $36.3 million of NOL carryforwards in the United States resulting from disqualifying dispositions. We will realize the benefit of these losses through increases to shareholders equity in the periods in which the losses are utilized to reduce tax payments. Additionally, we had approximately $193.0 million of NOL carryforwards in jurisdictions outside of the U.S. Included in the $193.0 million is approximately $142.2 million of NOL carryforwards in jurisdictions outside the U.S. which were acquired in the SmartForce Merger, the purchase of Books24x7 and the purchase of NETg foreign entities. We will realize the benefits of these acquired NOL
carryforwards through reductions to goodwill and non-goodwill intangible assets during the period that the losses are utilized. We also had U.S. federal tax credit carryforwards of approximately $2.5 million at January 31, 2008.
We lease certain of our facilities and certain equipment and furniture under operating lease agreements that expire at various dates through 2023. In addition, we have a term loan which will be paid out over the next 5 years. Future minimum lease payments, net of estimated sub-rentals, under these agreements and the debt repayments schedule are as follows (in thousands):
We do not have any off-balance sheet arrangements, as defined under SEC rules, such as relationships with unconsolidated entities or financial partnerships, which are often referred to as structured finance or special purpose entities, established for the purpose of facilitating transactions that are not required to be reflected on our balance sheet.
In May 2007, we entered into a credit agreement with certain lenders providing for a $225 million senior credit facility comprised of a $200 million term loan facility and a $25 million revolving credit facility. On July 7, 2008, we entered into an amendment to the credit agreement dated May 14, 2007. The primary purpose of the amendment was to expand the ability to make additional repurchases of shares. The expanded repurchase ability under the amendment 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 we 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 $24,000,000 of repurchases made from and after July 7, 2008.
Please see Note 10 of The Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K as filed with the SEC on March 31, 2008 and our 8-K filed July 11, 2008, for a detailed description of the credit agreement, as amended.
We will continue to invest in research and development and sales and marketing 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. Capital expenditures for the fiscal year ended January 31, 2009 are expected to be approximately $6.0 million to $8.0 million.
We expect that the principal sources of funding for our operating expenses, capital expenditures, debt payment obligations and other liquidity needs will be a combination of our available cash and cash equivalents and short-term investments, and funds generated from future cash flows from operating activities. We believe our current funds and expected cash flows from operating activities will be sufficient to fund our operations, including our debt repayment obligations, for at least the next 12 months. However, there are several items 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 the marketplace for our products in general or significant acquisitions (in addition to and including NETg). 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 our operations.
EXPLANATION OF USE OF NON-GAAP FINANCIAL RESULTS
In addition to our audited and unaudited financial results in accordance with United States generally accepted accounting principles (GAAP), to assist investors we may on occasion provide certain non-GAAP financial results as an alternative means to explain our periodic results. The non-GAAP financial results typically exclude non-cash or one-time charges or benefits.
Our management uses the non-GAAP financial results internally as an alternative means for assessing our results of operations. By excluding non-cash charges such as share-based compensation, amortization of purchased intangible assets, impairment of goodwill and purchased intangible assets, management can evaluate our operations excluding these non-cash charges and can compare its results on a more consistent basis to the results of other companies in our industry. By excluding charges such as restructuring charges (benefits) and merger and integration related expenses, our management can compare our ongoing operations to prior quarters where such items may be materially different and to ongoing operations of other companies in our industry who may have materially different unusual charges. Our management recognizes that non-GAAP financial results are not a substitute for GAAP results, but believes that non-GAAP measures are helpful in assisting them in understanding and managing our business.
Our management believes that the non-GAAP financial results may also provide useful information to investors. Non-GAAP results may also allow investors and analysts to more readily compare our operations to prior financial results and to the financial results of other companies in the industry who similarly provide non-GAAP results to investors and analysts. Investors may seek to evaluate our business performance and the performance of our competitors as they relate to cash. Excluding one-time and non-cash charges may assist investors in this evaluation and comparisons.
In addition, certain covenants in our Credit Agreement are based on non-GAAP financial measures, such as adjusted EBITDA, and evaluating and presenting these measures allows us and our investors to assess our compliance with the covenants in our Credit Agreement and thus our liquidity situation.
We intend to continue to assess the potential value of reporting non-GAAP results consistent with applicable rules and regulations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of July 31, 2008, 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.
In order to limit our exposure to interest rate changes associated with our term loan, we entered into an interest rate swap agreement with an initial notional amount of $160 million which amortizes over a period consistent with our anticipated payment schedule. This strategy uses an interest rate swap to effectively convert $160 million in variable rate borrowings into fixed rate liabilities at a 5.1015% effective interest rate. The interest rate swap is considered to be a hedge against changes in the amount of future cash flows associated with interest payments on a variable rate loan.
FOREIGN CURRENCY RISK
Due to our multi-national operations, our business is subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues or pay expenses and the U.S. dollar. Our expenses are not necessarily incurred in the currency in which revenue is generated, and, as a result, we are required from time to time to convert currencies to meet our obligations. These currency conversions are subject to exchange rate fluctuations, in particular with respect to changes in 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 our results of operations. During the six months ended July 31, 2008 and 2007, we incurred foreign currency exchange losses of $677,000 and $407,000, respectively.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of July 31, 2008. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of July 31, 2008, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
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 fiscal quarter ended July 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
See Part I Item 3 of our Annual Report on Form 10-K for the fiscal year ended January 31, 2008 for a discussion of legal proceedings. There were no material developments in these proceedings during the quarter ended July 31, 2008.
ITEM 1A. RISK FACTORS
Investors should carefully consider the risks described below before making an investment decision with respect to our shares. While the following risk factors have been updated to reflect developments subsequent to the filing of our Annual Report on Form 10-K for the fiscal year ended January 31, 2008, there have been no material changes to the risk factors included in that report.
RISKS RELATED TO THE OPERATION OF OUR BUSINESS
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, LIMITING YOUR ABILITY TO EVALUATE HISTORICAL FINANCIAL RESULTS AND INCREASING 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:
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.
PAST AND FUTURE ACQUISITIONS, INCLUDING OUR ACQUISITION OF NETG, MAY NOT PRODUCE THE BENEFITS WE ANTICIPATE AND COULD HARM OUR CURRENT OPERATIONS.
One aspect of our business strategy is to pursue acquisitions of businesses or technologies that will contribute to our future growth. On May 14, 2007, we acquired NETg from The Thomson Corporation. However, we may not be successful in identifying or consummating future attractive acquisition opportunities. Moreover, any acquisitions we do consummate, may not produce benefits commensurate with the purchase price we pay or our expectations for the acquisition. In addition, acquisitions, involve numerous risks, including:
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.
INCREASED COMPETITION MAY RESULT IN DECREASED DEMAND FOR OUR PRODUCTS AND SERVICES, WHICH MAY RESULT IN REDUCED REVENUE 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, vendors of application software and human resource outsourcers, including those vendors with whom we have formed development and marketing alliances.
Our primary sources of direct competition are:
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 pricing pressure 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.
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, our subsidiary, Books24x7 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.
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 on 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. We, along with the rest of the industry, face a challenging and competitive market for IT spending that has resulted in reduced contract value for our formal learning product lines. This pricing pressure has a negative impact on revenue for these product lines and may have a continued or increased adverse impact in the future.
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 companys internal personnel. Many companies have invested heavily in their current training solutions. Although technology-based training applications have been available for several years, they currently account for only a small portion of the overall training market.
Accordingly, our future success will depend upon the extent to which companies adopt technology-based solutions for their training activities, and the extent to which companies utilize the services or purchase products of third-party providers. Many companies that have already invested substantial resources in traditional methods of corporate training may be reluctant to adopt a new strategy that may compete with their existing investments. Even if companies implement technology-based training or e-learning solutions, they may still choose to design, develop, deliver or manage all or part of their education and training internally. If technology-based learning does not become widespread, or if companies do not use the products and services of third parties to develop, deliver or manage their training needs, then our products and service may not achieve commercial success.
NEW PRODUCTS INTRODUCED BY US MAY NOT BE SUCCESSFUL.
An important part of our growth strategy is the development and introduction of new products that open up new revenue streams for us. Despite our efforts, we cannot assure you that we will be successful in developing and introducing new products, or that any new products we do introduce will meet with commercial acceptance. The failure to successfully introduce new products will not only hamper our growth prospects but may also adversely impact our net income due to the development and marketing expenses associated with those new products.
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 revenue 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 are 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 customers 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 revenue 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.
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. 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.
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 revenue is collected or expenses are paid. In particular, the value of the U.S. dollar against the Euro, pound sterling, Canadian dollar, Australian dollar, New Zealand dollar, Singapore dollar 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 these currencies and other currencies relative to the U.S. dollar could adversely affect our business and results of operations.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS. UNAUTHORIZED USE OF OUR INTELLECTUAL PROPERTY MAY RESULT IN DEVELOPMENT OF PRODUCTS OR SERVICES THAT COMPETE WITH OURS.
Our success depends to a degree upon the protection of our rights in intellectual property. We rely upon a combination of patent, copyright, and trademark laws to protect our proprietary rights. We have also entered into, and will continue to enter into, confidentiality agreements with our employees, consultants and third parties to seek to limit and protect the distribution of confidential information. However, we have not signed protective agreements in every case.
Although we have taken steps to protect our proprietary rights, these steps may be inadequate. Existing patent, copyright, and trademark laws offer only limited protection. Moreover, the laws of other countries in which we market our products may afford little or no effective protection of our intellectual property. Additionally, unauthorized parties may copy aspects of our products, services or technology or obtain and use information that we regard as proprietary. Other parties may also breach protective contracts we have executed or will in the future execute. We may not become aware of, or have adequate remedies in the event of, a breach. Litigation may be necessary in the future to enforce or to determine the validity and scope of our intellectual 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 WORLDWIDE 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 and are subject to inherent risks, including:
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.
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 by that customer typically ranges from three to twelve months or more. Factors that contribute to our long sales cycle, include:
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 revenue 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 revenue, 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.
RISKS RELATED TO LEGAL PROCEEDINGS
WE ARE THE SUBJECT OF AN INVESTIGATION BY THE SEC.
We had been the subject of a formal investigation by the United States Securities and Exchange Commission (SEC) into the events and circumstances giving rise to the 2003 restatement of SmartForce PLCs accounts (the Restatement Investigation). On July 19, 2007, the SEC announced that three former officers and one former employee of SmartForce had settled SEC claims in connection with the Restatement Investigation. The former officers/employee have made payments in connection with their settlements. It is possible that they may seek to
require us to indemnify them for such payments. We understand that the Restatement Investigation has now been concluded without any claim being brought against us.
The Boston District Office of the SEC informed us in January 2007 that we are the subject of an informal investigation concerning option granting practices at SmartForce for the period beginning April 12, 1996 through July 12, 2002. These grants were made prior to the September 6, 2002 merger of SkillSoft Corporation and SmartForce PLC. We have produced documents in response to requests from the SEC.
We have cooperated with the SEC in this matter. At the present time, we are unable to predict the outcome of this matter or its potential impact on our operating results or financial position. However, we may incur substantial costs in connection with the SEC option granting practices investigation, and this investigation could cause a diversion of management time and attention. In addition, we could be subject to penalties, fines or regulatory sanctions or claims by our former officers, directors or employees for indemnification of costs they may incur in connection with the SEC investigation. Any or all of those issues could adversely affect our business, operating results and financial position.
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 barring the sale 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 customers 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.
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 and additional taxes.
RISKS RELATED TO OUR ADSs
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.
SALES OF LARGE BLOCKS OF OUR ADSs COULD CAUSE THE MARKET PRICE OF OUR ADSs TO DROP SIGNIFICANTLY, EVEN IF OUR BUSINESS IS DOING WELL.
Some shareholders own 5% or more of our outstanding shares. We cannot predict the effect, if any, that public sales of these shares will have on the market price of our ADSs. If our significant shareholders, or our directors and officers, sell substantial amounts of our ADSs in the public market, or if the public perceives that such sales could occur, this could have an adverse impact on the market price of our ADSs, even if there is no relationship between such sales and the performance of our business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
On April 8, 2008, our shareholders approved the repurchase of up to 10,000,000 of our ADSs. Under the approved share purchase program, we entered into a share purchase agreement, pursuant to which we and certain of our subsidiaries are entitled to purchase our ADSs. ADSs that are repurchased by us or our subsidiaries under the share purchase program shall, at the option of our Board of Directors, be either cancelled upon their purchase or held as treasury shares.
During the three months ended July 31, 2008, certain of our subsidiaries repurchased our ADSs as follows:
We have submitted a proposal to our shareholders to increase the number of shares that may be repurchased under the repurchase program from 10,000,000 to 25,000,000 and to extend the duration of the repurchase program until March 23, 2010. The proposal will be voted on at our annual general meeting to be held on September 24, 2008.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
See the Exhibit Index attached hereto.
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.