UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(D) of the Securities Exchange Act
of 1934
For the Fiscal Year ended December 31, 2004
[ ] Transition Report Pursuant to Section 13 or 15(D) of the Securities Exchange
Act of 1934
For the transition period from _______________ to _______________
Commission File Number 001-32300
SMARTPROS LTD.
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(Name of Small Business Issuer in its Charter)
Delaware 13-4100476
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or
organization)
12 Skyline Drive, Hawthorne, New York 10532
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(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number (914) 345-2620
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Common Stock, par value $.0001 American Stock Exchange
per share Warrants
Securities Registered under Section 12(g) of the Exchange Act: NONE
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 past 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if there is no disclosure of delinquent filers
pursuant to Item 405 of Regulation S-B in this form and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
For the year ended December 31, 2004, the revenues of the registrant
were $10,150,738.
The aggregate market value of the voting Common Stock of the registrant
held by non-affiliates of the registrant, based on the closing price on the
American Stock Exchange on March 24, 2005 of $3.95 per share, was approximately
$15,789,000.
As of March 24, 2005, the registrant has a total of 5,082,539 shares of
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The definitive proxy statement relating to the registrant's Annual
Meeting of Stockholders to be held on or about June 9, 2005, is incorporated by
reference in Part III to the extent described therein.
SMARTPROS LTD.
FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. Description of Business......................................2
Item 2. Description of Property.....................................23
Item 3. Legal Proceedings...........................................23
Item 4. Submission of Matters to a Vote of Security Holders.........23
PART II
Item 5. Market for Common Equity and Related Stockholder Matters....23
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operation....................................24
Item 7. Financial Statements........................................33
Item 8. Change in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................33
Item 8A. Controls and Procedures.....................................33
Item 8B. Other Information...........................................33
PART III
Item 9. Directors and Executive Officers of the Registrant..........34
Item 10. Executive Compensation......................................34
Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters..................34
Item 12. Certain Relationships and Related Transactions..............34
Item 13. Exhibits....................................................34
Item 14. Principal Accountant Fees and Services......................36
FORWARD-LOOKING STATEMENTS
Certain statements made in this Annual Report on Form 10-KSB are
"forward-looking statements" within the meaning of Section 21E of the Securities
and Exchange Act of 1934 regarding the plans and objectives of management for
future operations and market trends and expectations. Such statements involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements. The forward-looking statements included herein are
based on current expectations that involve numerous risks and uncertainties. Our
plans and objectives are based, in part, on assumptions involving the continued
expansion of our business. Assumptions relating to the foregoing involve
judgments with respect to, among other things, future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond our control.
Although we believe that our assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate and,
therefore, there can be no assurance that the forward-looking statements
included in this report will prove to be accurate. In light of the significant
uncertainties inherent in the forward-looking statements included herein,
particularly in view of our early stage operations, the inclusion of such
information should not be regarded as a representation by us or any other person
that our objectives and plans will be achieved. The terms "we," "our," "us," or
any derivative thereof, as used herein shall mean SmartPros Ltd., a Delaware
corporation.
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PART I
ITEM 1 DESCRIPTION OF BUSINESS
OVERVIEW
We provide learning solutions for accounting/finance and engineering
professionals, two large vertical markets with mandatory continuing education
requirements. We also provide corporate governance, ethics and compliance
training for the general corporate market. Our products are available in
multiple formats, including downloadable print, videotape and digital. Digital
format is used to deliver our products on CD-ROM, DVD and online. We offer
"off-the-shelf" courses and custom designed programs with delivery methods
suited to the specific needs of our clients. Our customers include approximately
half of the Fortune 500 companies and a large number of midsize and small
companies.
Our learning solutions for professionals are designed to meet the
initial and ongoing licensing and continuing professional education requirements
imposed by state licensing agencies and professional standards organizations.
Most of the courses in our accounting/finance library are designed to meet these
standards and adhere to the requirements of all state boards of accountancy as
well as those of the American Institute of Certified Public Accountants,
Financial Executives International, Institute of Management Accountants,
Institute of Internal Auditors, the Association of Finance Professionals and the
Association of Government Accountants. In the engineering area, most of our
courses have been approved for continuing professional development credit by one
or more organizations, including the American Society of Civil Engineers, the
National Society of Professional Engineers, the American Council of Engineering
Companies, the American Society of Mechanical Engineers and the Project
Management Institute. In the general corporate market, our training solutions
are designed to meet corporate learning objectives regarding issues of integrity
and corporate culture. Our corporate ethics and compliance training programs are
designed to align corporate behavior with applicable laws and regulations, as
well as generally accepted codes of conduct. So, for example, our programs may
deal with issues prompted by the Sarbanes-Oxley Act of 2002 and the U.S. Federal
Sentencing Guidelines, as well laws addressing workplace misconduct such as
harassment.
Our products are available in one or more of the following formats:
print, videotapes and digital. Digital format can be delivered on CD-ROM, DVD or
over the Internet. The Internet has become our fastest growing delivery channel,
attracting new and existing subscribers. This has had a positive effect on our
revenue as well as our gross margins since online sales eliminate the cost for
materials, i.e., videotapes, boxes and shipping.
We believe that our learning solutions effectively address the needs of
professionals and companies seeking comprehensive learning resources for
themselves and their employees. Our solutions are flexible, cost-efficient and
easy to use. They alleviate many of the inefficiencies associated with
traditional classroom training, such as travel costs, scheduling difficulties
and opportunity costs. In addition, we also offer our clients a learning content
management system, which allows the professionals and their employers to track
usage and performance.
CORPORATE HISTORY
We were organized in April 1981 under the laws of Delaware as Center
for Video Education, Inc. In 1998 we changed our name to Creative Visual
Enterprises, Ltd. ("CVE"). In January 2000 we changed our name to KeepSmart.com,
Inc. and in June 2001 we changed our name to SmartPros Ltd. Our wholly owned
subsidiary, Working Values, Ltd., was formed on March 21, 2003 under the name
WVG Acquisition Corp under the laws of the Commonwealth of Massachusetts. The
name change was effective April 4, 2003.
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In October 1999, in connection with a pending merger with Virtual
Education Corporation, a California corporation ("VEC California"), we organized
a new company, also named Virtual Education Corporation, under the laws of
Delaware ("VEC Delaware") solely for the purpose of holding all of the stock of
both CVE and VEC California. Eventually, both CVE and VEC California merged into
VEC Delaware. VEC Delaware never engaged in any business before the merger and
all of its shareholders were the historical shareholders of CVE and VEC
California based on the relative values of those two entities as agreed to in
the merger transaction. VEC California provided continuing professional
education programs to the engineering profession. We did not have any
relationship with VEC or any of its affiliates before the merger.
In May 2001, we purchased some of the assets of Pro2Net Corporation,
formed in 1998 under laws of the State of Washington. Pro2Net provided
continuing professional education programs to accounting and finance
professionals. The assets we purchased included course content, customer lists,
a functioning learning content management system, and computer hardware. In
April 2003, through our wholly owned subsidiary, Working Values, we acquired
assets, particularly course content and customer lists, from The Working Values
Group Ltd., a Massachusetts corporation. The principal stockholder of The
Working Values Group was David Gebler who, as part of the transaction, joined us
as President of Working Values. We did not have any relationship with Pro2Net or
The Working Values Group, or any of their respective affiliates, before these
acquisitions.
INDUSTRY BACKGROUND
The accounting and finance market includes certified public
accountants, certified management accountants, certified internal auditors and
other accounting professionals, as well as corporate accounting, finance and
management professionals, most of whom have mandatory continuing education
requirements. According to the Bureau of Labor Statistics, in 2002 there were
over two million accountants and finance professionals in the United States.
Based on the fact that the American Institute of Certified Public Accountants
claims it has over 300,000 members representing approximately 60% of all the
certified public accountants in the United States, we estimate there are
currently more than 500,000 accountants that require continuing professional
education credit to maintain their CPA licenses and hundreds of thousands of
other financial management professionals that require continuing professional
education credit to maintain their certifications.
To maintain their licenses, accounting professionals must satisfy the
continuing professional educational requirements mandated by the State Boards of
Accountancy of the states in which they practice. Although states may differ in
terms of specific course requirements or the cycle of the licensing period,
every state as well as the District of Columbia and the U.S. Territories, other
than Wisconsin and the Virgin Islands, which do not have any continuing
professional education requirement, requires at least 40 hours of continuing
professional education credit annually to maintain an accounting license. In
addition, in terms of whether a particular course will qualify for CPE credit,
36 states, the District of Columbia and Puerto Rico accept courses offered by
the National Registry of CPE Sponsors, also known as NASBA. The remaining
states, other than Wisconsin, and U.S. Territories, other than the Virgin
Islands, have standards that mirror those of NASBA. In effect, a course offered
by a NASBA registered sponsor will qualify for CPE credit in 49 out of 50
states, the District of Columbia and the U.S. Territories other than the Virgin
Islands.
According to the Bureau of Labor Statistics, in 2003 there were 1.5
million engineers in the United States, as well as over 600,000 construction
managers and engineers. In addition, there are over 475,000 engineering
technicians who may need additional specialized training. All 50 states require
engineers to take and pass a certification exam to become a licensed
professional engineer. The basic entry-level exam, Fundamentals of Engineering,
is given twice each year, in April and October. According to the National
Council of Examiners for Engineering and Surveying (NCEES), in 2003 over 42,000
engineers sat for the exam and less than 75% passed. In addition, engineers who
pass the Fundamentals of Engineering exam
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must then take a second exam to be licensed as a professional engineer in a
specific area such as civil engineering or mechanical engineering. For example,
the Professional Engineering, or PE, exam for civil engineering is the
highest-level exam for civil engineers. This exam is also given twice a year, in
April and October. According to NCEES, in 2003, 16,000 civil engineers sat for
this exam and only 52% passed.
Currently, 29 states require licensed professional engineers to
complete a minimum number of professional development hours to maintain their
professional licenses. Unlike the accounting and finance market where there is a
reasonable amount of uniformity, in the engineering market each of the states
requiring professional development hours sets its own standards. The number of
hours required by the states varies from 16 per year to 30 every two years. In
most instances, the states rely on various professional organizations to certify
whether a particular course qualities for professional development credit.
Over the last few years, legislators, government and market regulators,
the investment community and the general public have become more aware of issues
involving corporate governance, ethics and compliance. This awareness results in
allegations of sexual harassment, accounting fraud and mismanagement, excessive
executive compensation, breach of fiduciary duties and insider trading at some
of the largest corporations, mutual funds and market specialists as well as the
New York Stock Exchange. In some cases, corporate mismanagement and misbehavior
have resulted in substantial investor losses and fines, penalties or damages. In
response to some of these occurrences, Congress passed the Sarbanes-Oxley Act of
2002, which imposes certain corporate governance standards on publicly traded
companies and authorizes the national exchanges and other regulatory bodies to
impose their own strict standards. As a result, public companies, mutual funds,
market specialists and corporations in general are more accountable to their
stockholders and regulatory overseers and the public. We anticipate that
corporate spending on compliance and ethics training programs will increase.
Although professional and corporate training has historically been
dominated by traditional classroom instruction, advances in communications
technology are changing the manner in which corporate training is developed,
delivered and tracked. In addition, competition demands that professionals spend
more of their time on revenue-generating matters. The increasing demands made on
professionals and corporate managers have led and, we believe, will continue to
drive the demand for continuing professional education and corporate training
solutions that are available in multiple, flexible and cost-effective formats.
OUR BUSINESS
Our business is designed to satisfy the growing needs of:
o professionals and their employers to comply with initial and
continuing professional education requirements in a flexible
cost-effective manner;
o businesses to provide their employees and managers with training
programs addressing corporate governance, ethics and compliance
issues; and
o professionals and businesses to be able to track and monitor their
and their employees' compliance with continuing education
requirements and to assess the effectiveness of their educational
programs.
To address these needs, we have over 1,200 hours of programs that
currently are available in one or more formats including videotape, CD-ROM or
online - approximately 1,000 in accounting/finance, 200 in engineering and 11 in
Working Values. In addition, we develop customized courses based on
specifications provided to us by our clients. Most of our courses are designed
to accommodate both group and self-study.
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All of our courses in the accounting and finance professional libraries
are designed to meet the standards and adhere to the requirements of all state
boards of accountancy as well as those of the American Institute of Certified
Public Accountants (AICPA), Institute of Management Accountants (IMA), Institute
of Internal Auditors (IIA), the Association of Financial Professionals (AFP) and
the Association of Government Accountants (AGA). We are a registered sponsor of
continuing professional education with NASBA and in New York and Texas, the only
two states that have not adopted the NASBA standards. NASBA also confers the
status of Quality Assurance Service on organizations that offer self-study
courses that meet the requisite standards. We have met those standards and
received that status. As a result, our designated programs qualify for
continuing professional education credit in all fifty states for certified
public accountants, certified management accountants, certified internal
auditors and certified financial managers.
Our engineering products include courses that are designed to help
prepare engineers for the basic entry level licensing exam and the civil
engineering professional engineer licensing exam as well as courses that are
designed to meet the ongoing professional development requirements mandated by
various states. We generally jointly develop with or license these programs from
an independent third party. Most of our engineering courses are available both
in CD-ROM format and online.
Our Working Values subsidiary develops ethics and compliance training
programs for corporations and other organizations. These programs are designed
to align workplace behavior with legal standards and prevailing community
expectations regarding corporate conduct. We also develop training techniques
and strategies focusing on modular development of resources that track specific
risk areas identified by the client. Our library of customizable communication
and learning tools and templates, in digital and print formats, enables us to
develop training and communication solutions and strategies tailored to the
unique corporate cultures of the client at competitive price points. The result
is an integrated program that more closely reflects the unique culture of, and
the specific issues facing, the client organization while still maintaining the
cost advantages of a generic solution.
We have relationships with a number of professional organizations and
societies that we believe are strategic either because we have co-marketing or
co-branding arrangements with them or because we jointly develop products with
them. While no single relationship is material to overall business, if all of
these relationships were to terminate simultaneously, our competitive position
in the market place would be adversely affected. The partners and the nature of
our relationship with them are as follows:
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS. We have a joint
production and marketing arrangement with the AICPA for the AICPA Practice
Report and AICPA Practice Pro. We produce the product with the AICPA assisting
in topic selection and in providing speakers. We both independently market and
sell the product through our own distribution channels.
ASSOCIATION OF GOVERNMENT ACCOUNTANTS. AGA offers most of our
accounting/finance products to its members through a co-branded Professional
Education Center.
FINANCIAL EXECUTIVES INTERNATIONAL AND INSTITUTE OF MANAGEMENT
ACCOUNTANTS. FEI and IMA both market Financial Management Network. We are
responsible for producing the product with FEI and IMA assisting in topic
selection and with providing speakers. We also are primarily responsible for
selling the product. We also sell our SmartPros Advantage line of products
through FEI and IMA.
INSTITUTE OF INTERNAL AUDITORS. IIA offers the online version of
Financial Management Network and SmartPros Advantage to its members through a
co-branded Professional Education Center.
NEW YORK STATE SOCIETY OF CPAS AND VIRGINIA SOCIETY OF CPAS. Both of
these societies offer various products on their own co-branded Professional
Education Center.
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AMERICAN SOCIETY OF CIVIL ENGINEERS AND BOSTON SOCIETY OF CIVIL
ENGINEERS. We jointly developed our PE Exam Review course with these
organizations. In addition, the ASCE and we jointly developed 37.5 hours of
technical civil engineering courses. The ASCE markets our courses to its
members.
NATIONAL SOCIETY OF PROFESSIONAL ENGINEERS. The NSPE sells our courses
through a co-branded web site as well as directly on their web site.
AMERICAN COUNCIL OF ENGINEERING COMPANIES. The ACEC sells our courses
on their web site, on a co-branded web site and via direct mail. They
co-developed some of our business and management courses.
AMERICAN SOCIETY OF MECHANICAL ENGINEERS. The ASME sells our products.
OUR STRATEGY
Our objective is to become a leading provider of continuing
professional education and corporate training solutions in the United States. To
achieve this goal, we will pursue the following strategies.
EXPAND LIBRARY OF CONTENT. We believe that our future success depends,
in part, on our ability to develop and acquire new content. The new content
could either expand or supplement our existing libraries or could constitute a
new library for one or more additional vertical markets. Toward this end, we
continuously develop new courses for our accounting library, we are in the
process of developing one new major course for our engineering library and we
have recently developed a series of ten new courses for our Working Values
library. In particular, in light of the recent focus on corporate governance,
compliance and ethics, we believe that there is an increasing demand for
training programs that address different topics on these issues. Our strategy is
to create a library of modular programs on compliance, ethics and governance
issues that can be customized to meet specific client demands.
EXPAND WITHIN EXISTING MARKETS AND INTO NEW MARKETS. We will focus on
expanding our presence in the markets we currently serve, particularly
engineering where we feel our market share is relatively small and corporate
ethics and compliance training where we believe the opportunity is significant.
We plan to sell new products that we acquire or develop to our existing
customers. In addition, we will investigate expanding into completely new
markets that we think are potentially lucrative, such as insurance, financial
services and healthcare.
MAKE STRATEGIC ACQUISITIONS. We believe that the most efficient way for
us to expand our libraries, increase our share of the markets we currently serve
and penetrate new markets is through strategic acquisitions. As of this date, we
have not identified any potential future acquisition nor can we assure you that
we will be able to acquire any companies in the future.
KEEP PACE WITH TECHNOLOGY. We believe that our ability to continue to
deliver our products in multiple formats will be critical to our future success.
For example, we believe the broad acceptance of the Internet for business
communication will continue, making it an increasingly important medium for
distributing our products. Had we not adapted our content for online delivery,
our rate of growth would have been impaired. At the same time we recognize that
new technologies may emerge that will complement our model for flexible delivery
of content. We plan to closely monitor the development and market acceptance of
these technologies and make the necessary investment to adapt our products and
services to these technologies.
EXPAND EXISTING ALLIANCES AND ENTER INTO NEW STRATEGIC ALLIANCES. We
believe that alliances with professional organizations and associations and
commercial content providers have been a key factor in the growth of our
business until now. While we do not view any single relationship as material to
our overall business, these alliances create a modest barrier to entry. For this
reason, we plan to try to broaden these
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existing relationships as well as seek new ones. New strategic relationships
will be particularly critical as we expand into new markets.
OUR PRODUCTS AND SERVICES
The following are our products and services.
ACCOUNTING AND FINANCE
Our accounting and finance libraries contain over 1,000 hours of
content, of which 900 are generally available and the balance is custom-designed
for specific clients. Except for SmartPros Advantage, discussed below, which is
only available online, our accounting and finance programs are available in both
videotape and digital formats. The videotape format can be used for either
group- or self-study. The online format is for self-study only and is usually
available as text only, text with audio or in a multimedia format that includes
text, audio and streaming video. All video courses come with a hard copy of the
program and are used primarily for group study. All online courses include
downloadable text materials, easy-to-follow course outlines, interactive quizzes
and the ability to track credits and print completion certificates. Video and
online self-study programs qualify for two hours of continuing professional
education credits while video group study qualifies for one hour of continuing
professional education credit. Our clients can purchase either a single program
or a subscription to a series of programs. Prices depend on the length of the
subscription, whether one, two or three years, the number of users, and the
number of libraries covered.
SMARTPROS ADVANTAGE. SPA is a skills-based learning library containing
over 150 courses, varying in length from one to six hours. In total, this
library includes more than 500 hours of courses qualifying for continuing
professional education credits. We produce these programs in our own production
facility. A sample of the available courses include "Auditing Cash and Cash
Equivalents," "Understanding Entity-Level Controls" and "Valuation of an
Entity." We pay the authors of these programs a royalty. This library is
marketed primarily to corporate accounting and finance professionals as well as
public accountants. The courses are offered individually from $19.99 to $79.96
per course. The list price for a one-year subscription purchased online is $349.
FINANCIAL MANAGEMENT NETWORK. FMN is a library of update programs
dealing with currently relevant topics. Each month, we create four new programs,
or segments, or a total of 48 new segments each year. The segments created for
March 2005 are: "After the Tsunami: Outlook for Global Trade," "Corporate
Self-Investigation: Avoiding the Pitfalls," "RFID: What You Need to Know," and
"States Declare War on Out-of-State Businesses." We also maintain an online
archive containing the most recent 72 programs for our subscribers. The segments
are written and produced by our staff and generally involve an independent
industry professional as the interviewee. The material is presented in a
question and answer format. These programs are marketed primarily to corporate
accounting and finance professionals. The list price for a one-year subscription
to the group study video version starts at $4,975 and for the online version is
$349 per user.
AICPA PRACTICE REPORT AND AICPA PRACTICE PRO. This library of programs
covers topics in public accounting and is distributed primarily to accountants
in public practice through our alliance with the AICPA. Each month, other than
March, we add six new segments in the following areas: Individual Tax, Business
Tax, Estate and Financial Planning, Specialized Tax Topics, Auditing and
Accounting and Financial Reporting. The February 2005 segments included the
following: "What's Included in Income: End of the Debate," "Making the Most of
the Production Deduction," "Independent Contractors: Controversy Won't Go Away,"
"Buy-Sell Agreements and True Family Values," "Computer Fraud: Are You Still a
Target?," and "Accountable Accounting and Standard Setting." The programs are
available in video (APR) and online (APP). We also offer an online archive
containing the most recent 66 programs. The list price for a one year
subscription to APR is $1,995 and to APP is $349 per user.
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THE CPA REPORT GOVERNMENT AND NOT-FOR-PROFIT. CPAR is a library of
programs designed specifically for accounting professionals employed by federal,
state and local governmental agencies and not-for-profit organizations. Each
quarter we distribute four new programs: two for government accountants and two
for not-for-profit accountants. For example, the Fall 2004 programs were:
"Post-Retirement Benefits: Progress and Problems," "Crisis Management: Are You
Prepared?," "Indirect Costs: Trap for the Unwary," and "Accountability: Threat
or Benefit?" We also publish an online archive containing 32 of the most recent
programs. The list price for a one-year subscription to CPAR is $750 for the
video and $169 for the online version.
AICPA FINANCIAL PRO. AFIN is produced for and sold through the AICPA,
which distributes it to their members directly and through CPA2Biz, a for profit
company that is principally owned by the AICPA. AFIN targets accountants in
business and industry. Each month we produce four new programs, typically
including two current FMN programs and two APP programs or archived FMN
programs.
In addition to the libraries described above, the contents of which are
available on a subscription basis, we also produce customized programs for our
clients. In some cases, the client will author the content and retain us to
videotape the program and convert it into a digital format that can be
distributed via the Internet or internally through the corporate intranet. In
other cases, we will write and produce the entire program for the client. We
then deliver this custom content either through our proprietary learning content
management system or that of the client. These customized products can be
designed to qualify for CPE credit.
ENGINEERING
Our engineering library includes the following:
PE EXAM REVIEW. Our interactive PE exam review course for civil
engineers was developed jointly with the American Society of Civil Engineers and
the Boston Society of Civil Engineers Section and is designed to prepare
engineers to meet the entry-level requirements for civil engineering. The PE
Exam Review course, with over 50 hours of material, is an interactive multimedia
tool that simulates the actual professional engineering exam using demonstration
problems that are comparable to the problems that are found on the actual exam.
The course includes seven, complete, self-contained course modules that cover
the following subjects: Transportation, Sanitary and Environmental, Hydraulics
and Hydrology; Structures; Geotechnical; Surveying; and Economics. This one
product accounts for over 50% of the engineering department's revenues. The list
price for the review course is $645.
ONLINE PROFESSIONAL DEVELOPMENT HOURS. We have a library, consisting of
65 hours, of engineering and management courses that qualify for professional
development hours. For example, in the General Engineering: Business Management
area we have over a dozen courses on various topics relating to managing a small
professional practice. Some of the titles in this library include "Recruiting
Stars," "Increasing Production and Profits," "Managing Relationships and
Protecting Your License." Our library of civil engineering courses includes
"Roadside Design," "Stormwater," "Windloads" and "Slope Stability." Over half of
the content in this library was developed with the ASCE. Other courses in this
library were developed with the ACEC. The list prices for these courses range
from $30 to $449.
PROJECT MANAGEMENT FOR ENGINEERS. Introduced in 2002, this course was
co-developed with URS Corporation, the second largest engineering firm in the
United States. The Project Management Institute (PMI) certifies this course for
professional development unit credit for certified project managers and for
professional development hours credit for civil engineers. Developed by
engineers specifically for engineers, it was the first completely online
interactive project management course. The online format is enriched with audio
and interactive graphics and allows the user to proceed at his or her own pace.
The program is divided into 11 critical sections with over 60 individual
learning modules. The Project
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Management Institute has certified the program. It provides over 35 hours
continuing professional development credit. The list price for this course is
$995 for 12-month access or $695 for six-month access.
FUNDAMENTALS OF ENGINEERING EXAM REVIEW. This is a preparatory course
for the basic entry-level licensing exam that all engineers are required to
take. We began shipping this course in June 2004. It is a flash-based,
interactive review course that is being marketed directly and through
professional associations to engineers as well as to engineering firms for their
internal skill building and competency testing programs. It is available in
CD-ROM and online. The list price for this course is $249 for the combination
CD-ROM/online version and for the online version. We also private label the
course for our strategic partners including ASCE and ASME so they can market it
to their members.
CORPORATE GOVERNANCE, COMPLIANCE AND ETHICS
Working Values, our subsidiary, develops corporate governance,
compliance and ethics programs for major corporations and other business
enterprises. In addition to developing custom-made programs, Working Values has
created new modular products that address new compliance and disclosure
standards. Working Values currently offers the following products and services:
CONSULTING SERVICES
The Integrity Alignment(TM) Process (IAP) is an ethics and compliance
framework for organizations to manage risks to their reputation and to develop
effective compliance and ethics training and communication programs. We use the
IAP to: o identify the risks to finances and reputation associated with
compliance and ethics violations;
o identify a vision of integrity for the organization that supports
its business goals;
o mitigate future risks and support an integrity-based culture; and
o narrow the gap between company standards and employee behavior.
Organizations are increasingly using ethics and compliance risk
assessments to determine the sufficiency of their programs in order to meet
best-practices standards of the Federal Sentencing Guidelines as well as to
demonstrate the effectiveness of the program to regulators.
The IAP has three core components:
INTEGRITY VISION
Working Values helps clients articulate their vision and balance their
strategic goals with their values and standards. To support this process, we
offer a range of consulting services and products, consisting of senior
leadership workshops, focus groups, interviews and surveys, to identify the
organization's vision. Once the organization articulates its goals for the
integrity program, it can begin a baseline assessment of the current state of
its culture and then develop and implement an action plan that will affect
change.
INTEGRITY RISK ASSESSMENT
We help clients focus on those barriers that prevent an organization
and its people from meeting the organization's integrity objectives. Integrity
Risks are approached as a complement to legal risks (e.g. compliance with
Sarbanes-Oxley, insider training and sexual harassment). We assess four key risk
areas that determine how effectively an organization will embrace a culture of
integrity. Goals are established in
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each category to demonstrate how well the organization is meeting the
expectations of stakeholders and regulators. The risk areas are:
o Individual awareness (the individual's understanding of the
organization's standards, values and commitment to integrity);
o Corporate culture (the environmental factors that shape individual
behaviors);
o Role of managers and leadership (the behavior of managers in
modeling behavior consistent with the organization's integrity); and
o Ethical governance (the systems and processes established by the
organization to support its integrity-based decisions and actions).
Through focus groups, surveys, and interviews, Working Values evaluates each
integrity risk area to determine the level of vulnerability and develops an
analysis for the organization to use in setting annual goals, and in designing a
customized action plan.
INTEGRITY ACTION
Working Values provides a number of varied products and services that
permits organizations to build an integrated communication and learning program
that reflects its culture, a recent standard of an effective ethics and
compliance program.
PRODUCTS & SERVICES
COMMUNICATION TOOLS
The following products and services were designed to help an
organization communicate its standards, values and integrity vision.
COMMUNICATION AND LEARNING PLAN
A comprehensive communication and learning plan helps the company
establish integrity as a value and a priority across the organization and
establishes measurable objectives in monitoring progress in reducing integrity
risks and meeting integrity goals.
THE INTEGRITY TOOLKIT(TM)
This is our proprietary learning content management system developed
specifically for Working Values. The Integrity Toolkit is a comprehensive set of
web-based tools and a web platform for delivery of print and video elements to
help an organization build and sustain an integrity-based culture. The Toolkit
is the home base for employees, managers and senior leaders to get specific and
tailored ongoing information about the company's integrity program, including
support materials, and online access to ethics and compliance training as well
as the Code of Business Conduct. The Toolkit provides administrative access to
manage certification and assessment aspects of the program.
CODE OF BUSINESS CONDUCT
A well-written Code of Business Conduct is not just a legal document,
but the centerpiece of the organization's integrity efforts. The Code of
Business Conduct communicates expectations and is a reference point for ongoing
training and communication. Working Values develops interactive codes that
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support employee affirmations and templates to create customized codes that
reflect each client's unique culture.
LEARNING TOOLS
Working Values tailors its existing library of online, video, print and
live courses and modules to meet the needs of its clients, and also develops
fully customized program elements to meet specific learning objectives.
Designed to meet the needs of each target audience, Working Values'
compliance tools are designed to convey critical information about the
organization's standards and expected behavior, while the ethics tools address
the organization's integrity risks and the steps needed to change behavior to
meet the organization's integrity goals.
These products and services are designed to meet the needs of the
following audiences:
Board of Directors -Tailored workshops and training for Board and
Committee members to meet new oversight standards and fulfill training
requirements.
Senior Leaders-Workshops for senior leaders to review integrity risks
and develop strategies to build the team needed to manage the integrity program.
Managers-Training and communication tools and modules to address key
behaviors expected from managers in role modeling ethical behavior and in
building work environments conducive to ethical conduct.
Employees -Online, video, and live modules that go beyond the rules in
helping create the type of environment needed for employees to feel confident
and secure in "doing the right thing."
ETHICS AWARENESS AND COMPLIANCE MODULES
Working Values maintains a library of customizable course elements
developed over a period of 10 years. These course elements, addressing an array
of topics are inserted into training programs in a wide variety of formats
designed to address the specific needs of the client for whom they were
developed. These programs can be adapted and/or modified for and incorporated
into programs for new clients. Based on the notion that rules awareness is
tightly linked to the working environment, these programs are designed to create
a context that links behavior to compliance goals. Ethics Awareness courses are
geared to address the challenges organizations face in creating a culture that
integrates compliance standards into day-to-day work. The courses focus on
encouraging the employees to integrate the learning obtained from the compliance
training into their daily work. Using a variety of learning activities, our
ethics awareness and compliance modules communicate the legal standards of
compliance, integrating ethics and values and their impact on the company, its
employees, customers, and other stakeholders.
The specific subject matter of these course elements includes:
Anti-money Laundering Equal Opportunity
Antitrust Gifts and Entertainment
Bribery, Fraud and False Statements Political Activity and Solicitations
Confidential Information Foreign Corrupt Practices Act
Conflicts of Interest Sales and Marketing Integrity
Drug-free Workplace Sexual Harassment Prevention
E-communications and Information Security Integrity of Books & Records
Health and Safety Intellectual Property
Respect in the Workplace Insider Trading (Securities Trading)
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Use of Company Assets
ETHICS TRAINING
Ethics training is a curriculum of specific courses designed to meet
specific integrity risks and includes topics such as:
o Code of Business Conduct awareness and the importance of doing the
right thing
o Warning signs for managers and employees to identify integrity risks
before they become integrity problems
o Integrity leadership and responsibilities of managers to model
ethical behavior
o Consequences of one's actions and the impact on stakeholders
o Decision-making skills for employees and for managers
COMPLIANCE TRAINING
Working Values' catalog of compliance training covers the core
knowledge that employees, managers as well as auditors and board members need to
have in order to meet heightened ethical standards. o Online Code of Ethics
training on key compliance standards
o Interactive Code of Conduct
o Financial Integrity Suite of ten modules to support new auditing and
disclosure requirements
o Antifraud training for auditors and for general employee and manager
audiences
VIDEO PRODUCTION AND DUPLICATION
All of our programs are produced in our state-of-the-art production
facility, which includes high-end tape duplication equipment. In addition, the
video production and duplication department generates its own revenue, by
leasing the facility to third parties and by filming third-party programs, which
may or may not be related to education.
CONSULTING AND E-COMMERCE
Our technology department is principally a service department. Its
primary function is to convert the accounting/finance and engineering programs
from videotape to digital format for distribution on CD-ROM and the Internet.
This department also maintains our various websites as well as our learning
content management system, the SmartPros Professional Education Center (PEC),
for subscribers to our accounting/finance and engineering products, and the
Integrity Training Center, for subscribers to our ethics and compliance training
programs. The SmartPros Professional Education Center is a turnkey system
designed to manage the educational subscriptions, student accounts, e-commerce
and reporting needs of our clients. Using the SmartPros PEC, our clients can
review and assess usage of our programs by their employees and their employees'
performance and the effectiveness of these programs. The SmartPros PEC is
co-branded with the client's logo and delivered using an application service
provider hosted infrastructure model that requires no client technology
resources. For those clients who have their own learning management system, we
develop an interface that allows them to access our system through their
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technology. These systems are not marketed as stand alone products. Rather they
are offered together with our library of content and allow subscribers to track
usage and performance. We charge our clients a license fee and often times a
development fee as well as annual maintenance fees.
The technology department also generates fees through website
development and consulting arrangements. For example, companies that have
internal education programs have engaged us to convert those programs from
workbook, instructor led or video taped based courses to an e-learning format.
We also offer our customers a broad range of support services, including
technical support for our learning content management system. We believe that
providing a high level of customer service and technical support is necessary to
achieve a high level of customer satisfaction and sustained revenue growth.
PRODUCT DEVELOPMENT
Our product development team includes Jeffrey Jacobs, William Grollman,
Jack Fingerhut and Allen S. Greene in the accounting/finance area and David
Gebler in the corporate governance, compliance and ethics area. Mr. Jacobs, who
is the head of the department, is an attorney and has been developing continuing
education programs for accounting and finance professionals since 1987. Messrs.
Grollman and Fingerhut, in addition to being our founders, are both certified
public accountants. Each of Messrs. Grollman, Fingerhut and Greene has a
financial background. Mr. Gebler was the founder of Working Values Group Ltd., a
company that custom-designed governance, compliance and ethics programs. Mr.
Gebler joined us in 2003 when we purchased assets from Working Values Group. Mr.
Gebler is an attorney who has focused on corporate governance, compliance and
ethics matters for much of his career.
We are planning to devote more internal resources to developing
programs. We may hire independent contractors to develop programs for us or
purchase programs from third parties. In those instances where we are relying on
outside sources for content or where we purchase existing content, our design
and development team will develop or oversee the development of an effective
format that focuses on performance objectives, instructional anti practice
strategies, interactivity and assessments. This process includes creating and
designing study guides and course material, scripts and, in some cases, visual
aids. The design and development team includes subject matter experts,
instructional designers, technical writers and developers, graphic designers,
content editors and quality assurance reviewers. After final assembly and
integration of all course components, we test to ensure all functional
capabilities work as designed and deliver the desired learning experience and
result.
In March 2005 we added one person, who is a Certified Public
Accountant, to our product development team who will focus on developing courses
for SPA.
SALES AND MARKETING
Our sales and marketing strategy is designed to attract new customers
and build brand awareness. We market our products through our alliances with
professional organizations and associations, through our own inside
telemarketing sales force, our outside sales force and through our web sites. We
believe that this strategy allows us to focus our resources on the largest sales
opportunities while simultaneously leveraging our strategic relationships.
Our sales and marketing department includes a Vice President of
Marketing, an Assistant Vice President-Director of Sales, and a sales staff of
14 people, including two people dedicated to video production and one person
dedicated to video duplication. The remaining sales staff, 11 people, is divided
between inside, or telesales, and field sales. The field sales force focuses on
larger accounts. In addition, our senior executives, Allen S. Greene, William
Grollman and Jack Fingerhut, dedicate varying portions of their time and efforts
to sales and marketing activities. Also, David Gebler, the President of Working
Values spends approximately 50% of his time on sales and
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marketing efforts on behalf of Working Values and Steve Murtha, Vice President -
Engineering, spends approximately 50% of his time on sales and marketing efforts
relating to our engineering products. Finally, Joseph Fish, our Chief Technology
Officer, spends approximately 50% of his time selling and marketing our
technology services.
To supplement the efforts of our sales staff, we use comprehensive,
targeted marketing programs, including direct mail to our customers as well as
to members of the professional organizations with whom we partner: public
relations activities; advertising on our website and the websites of our
strategic partners; participating in trade shows; and ongoing customer
communication programs. We build brand awareness through our strategic
relationships with the leading professional associations and organizations and
the leading commercial content providers within the markets we serve. These
strategic relationships include co-branding initiatives on new and existing
products, joint advertising campaigns and e-commerce relationships.
TECHNOLOGY
Our proprietary learning content management system, the SmartPros
Professional Education Center, employs a logical and physical architecture that
facilitates rapid development, deployment and customization of Internet-based
solutions for organizational e-learning. Our core systems use a series of
scalable application web servers, XML and MS-SQL data sources, and utilize
industry standard Web-browser and Internet technologies for content delivery to
the end users. To ensure limited downtime and product lines that are free of
bandwidth limitations as they grow, our redundant server system is located at a
secure MCI co-location data center one mile from our Hawthorne, New York main
office. Currently, we use three co-location cabinets in their facility to house
our server network infrastructure. This co-location allows the freedom to
completely control our server infrastructure while providing us with 24/7
monitoring, support, redundant Internet connectivity, and full generator power
backup.
The SmartPros Professional Education Center includes a scalable suite
of applications and features that can be streamed via the Internet or a
corporate intranet. The basic features of the system allow asynchronous
streaming of video and audio courses combined with media timed synchronization
of supplemental material, online quizzes and final exams. Student interaction is
enhanced through the use of real time questions to content experts with quick
response. This full service solution includes a complementary array of
communication tools such as e-mail, chat, message boards and learner tracking.
The tracking of educational needs both internal to the system as well as
external education opportunities, such as stand-up and leader-led training, are
maintained using a student-managed course tracking feature called "My Courses."
Some key features of the PEC include:
o SCALABILITY. Scalability is accomplished using a combination of
load-balancing hardware and software. Multiple, redundant servers are
deployed to handle peak periods when the largest numbers of concurrent
users are expected on the system,
o SCORM/AICC CONNECTIVITY LAYER. Where required, we use both Shareable
Content Object Reference Model (SCORM) and Aviation Industry CBT
Committee (AICC) connectivity layers to ensure our content is
deliverable through a variety of enterprise e-learning systems other
than the PEC. Additionally, the core foundation is capable of
exchanging data with third-party legacy systems with minimal effort.
o STANDARD RELATIONAL DATABASE SERVER. We use standard relational
database servers. To enhance performance and ensure that users are
served efficiently, the core foundation executes database-stored
procedures to optimize intense database processing. The core foundation
currently supports Microsoft SQL Server databases.
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o ASP-BASED APPLICATION SERVER. The business and application logic
resides on an ASP-based application server. This architecture allows us
to deploy a site across multiple servers using Microsoft Windows 2000
and 2003 Servers.
o ELECTRONIC COMMERCE ENABLED. The core foundation includes interfaces to
external electronic payment services, enabling real-time electronic
commerce. This allows the instant purchase of both one-off and
subscription-based e-learning courseware.
o INTERNET MULTIMEDIA CONTENT DELIVERY. We deliver high quality, low
bandwidth video and audio via the Internet, intranets and extranets.
This multimedia content enhances and personalizes the learning
experience. We use Windows Media as the primary delivery mechanism for
this content.
o LOW BANDWIDTH/HIGH IMPACT ANIMATIONS. Using Macromedia's Flash
technology, we deliver both animated and spoken educational material
with minimal load on corporate networks.
COMPETITION
The market for continuing professional education and corporate learning
solutions is large, fragmented and highly competitive. We expect these
characteristics to persist for the foreseeable future based on the following
factors:
o The expected growth of this market as demand for highly-skilled
professional increases;
o The increased scrutiny on corporate culture, ethics and compliance; and
o Relatively low barriers to entry.
Of the markets we currently serve, we believe that the accounting
profession has the highest barriers to entry. Specifically, it would be
extremely difficult to compete in this market without NASBA sponsor designation.
Obtaining this designation requires an investment of time and a modest amount of
capital. Nevertheless, for companies with even modest resources in terms of
talent and capital, these barriers are not overwhelming. The barriers to entry
in the engineering market are somewhat lower as the certification process in
that profession is less centralized. Specifically, each state sets its own
standards, as does each engineering specialty. In the corporate education
market, the barriers to entry are virtually non-existent.
We believe that the principal competitive factors in our industry are
the following;
o The breadth, depth and relevancy of the course content
o Performance support and other features of the training solution;
o Reputation of presenter;
o Adaptability, flexibility and scalability of the products offered;
o Liquidity and capital resources;
o The deployment options offered to customers;
o Customer service and support;
o Price;
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o Industry and professional certifications;
o Brand identity; and
o Strategic relationships.
We believe that we compete favorably on most of these issues. While
price is always a competitive factor, we do not believe that we should compete
solely on that basis and, in fact, many of our competitors sell their products
for less than we sell ours. Particularly, in the accounting market, we believe
that our reputation and the quality of our offerings as well as our other
competitive advantages, including the breadth, depth and relevancy of our
libraries, our status as a NASBA registered sponsor, strategic relationships,
our learning content management system, our customer service and support and the
flexibility of our delivery options, allow us to price our products accordingly.
In the engineering and general corporate markets, where we have not established
our reputation to the same extent, we have less flexibility when it comes to
price. In the corporate compliance area, we believe that what will ultimately
differentiate us from our competitors will be our ability to create programs
that are designed to meet the specific corporate cultures of our clients.
While we believe that our lack of liquidity has been the most
significant obstacle to our growth, we believe that most of our direct
competitors are small, undercapitalized private businesses. While this makes it
difficult to accurately assess our relative competitive position within this
industry with any degree of certainty, it also presents us with an opportunity.
We believe that with the proceeds of our just completed initial public offering,
we have the resources we need to execute an acquisition strategy aimed at
growing quickly and achieving a meaningful level of profitability. These
resources include cash, a publicly traded security and management expertise. We
have not identified any potential acquisition candidates, and we cannot assure
you that we will be able to successfully consummate any acquisitions.
Our competitors vary in size and in the scope and breadth of the
products and services they offer. They include public companies such as
SkillSoft plc and Saba Software, Inc.; private companies such as CPA2Biz, Inc.,
Bisk Education, Inc., and MicroMash in the accounting market; Red Vector.com
Inc., AEC Direct and NetGen Learning Systems in the engineering market; and LRN,
The Legal Knowledge Company, Integrity-Interactive Corporation, MIDI, Inc. and
PLI-Corpedia in the corporate compliance and ethics market. In addition, we also
compete with universities, professional and other not-for-profit organizations
and associations, some of whom are also our strategic partners and/or clients.
In addition, potential competitors include large diversified publishing
companies, such as The Washington Post Company, Thomson Financial and Pearson
Education, other education companies, including traditional providers of
in-classroom instruction and remote learning solutions, such as DeVry University
as well as professional service companies, such as accounting firms, who are
looking for alternative sources of revenue. Competition may also come from
technology and e-commerce solutions providers. Internet-based learning solutions
have become increasingly popular in recent years along with the increased demand
for flexible, cost-effective alternatives.
Some of our existing competitors have and some of our potential
competitors will have greater resources, financial and other and/or market
penetration, and more extensive libraries than we have, which has enabled or
will enable them to establish a stronger competitive position than we have. For
example, although CPA2Biz was organized and is principally owned by the AICPA,
both Thomson Financial and Microsoft have minority stakes in the company. We
sometimes compete directly with CPA2Biz, they also sell some of our products. In
addition, among our competitors, SkillSoft and Saba are both relatively large
and well-capitalized organizations. However, SkillSoft's primary focus is
e-learning content and software products for business and information technology
professionals, markets that we do not currently serve. Saba principally provides
software solutions that are used to manage people in large organizations
although they do sell content as well. Since we do not market our learning
management system as a stand-alone
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product, we do not compete with Saba in this area. However, many of our larger
clients use the Saba system or another system for their learning content
management. In those cases, we will interface with the learning management
system and allow the client to access our courseware while cross-posting student
progress between ours and the client's learning management system.
The largest solutions providers to the general corporate compliance
training market are Integrity-Interactive and LRN. We rarely face either of
these companies in the marketplace since they both focus principally on Fortune
100 companies and have extensive off-the-shelf libraries. However, their
products tend to be more expensive than ours, and we believe that our ability to
adapt programs to address unique cultures of different organizations is greater
than theirs. Our more frequent competitors are PLI-Corpedia, a joint venture
between the Practising Law Institute (PLI) and Corpedia Education, two leaders
in the field of compliance education, and Midi, Inc. Both market off-the-shelf
and customized programs to mid- and large-cap public companies. PLI-Corpedia has
the advantage of access to PLI's vast library. Midi uses video-based modules and
tends to attract customers that like their particular training technique. We
believe that we have more diverse tools and can offer an integrated ethics and
compliance program that contains live, video and web-based communication and
learning elements.
OUR COMPETITIVE ADVANTAGES
Our objective is to become a leading provider of learning solutions for
the professional, pre-professional and business communities. We believe that the
following competitive advantages will help us achieve this goal.
HISTORY AND REPUTATION. We have been providing learning solutions for
accounting and finance professionals for more than 23 years and VEC, which we
acquired in 2000, has been providing online and other digital education for
engineering professionals since 1997. In addition, the president of our Working
Values subsidiary has been developing values, ethics and compliance education
programs since 1993. We believe that in the corporate accounting/finance market
we have the reputation of being a leading provider of continuing professional
education programs, as evidenced by our continued growth in that market and a
high renewal rate of more than 85% for our FMN products. We believe that our
reputation in the corporate market will assist us as we expand our presence in
the engineering and general corporate markets, as well as potential entry into
new markets.
PROFESSIONAL DESIGNATIONS AND STRATEGIC ALLIANCES. We believe that
because we are a NASBA-registered sponsor of continuing professional education
programs and have been awarded the prestigious QAS status, we enjoy a
competitive advantage in the accounting/finance market. In addition, our
relationships with some of the largest and most respected professional
organizations and associations in the accounting and engineering professions:
o give us instant credibility in the marketplace:
o provide us with a distribution channel for our products;
o are a source for programs; and
o provide us with access to a faculty around which to build other
programs.
EXTENSIVE LIBRARY. Our accounting/finance library consists of over
1,000 hours, and our engineering library contains almost 200 hours, of
proprietary education content including skills-based and update programs. We
believe that our libraries are among the most extensive in the industry and help
attract new subscribers.
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EXPERIENCED MANAGEMENT. Our management team is comprised of experienced
and successful accounting and legal professionals and administrative executives.
This has enabled us to develop high quality programs, enter into strategic
relationships with the major professional organizations in the markets we serve,
attract well-known personalities around whom we develop new programs, cut costs
and make strategic acquisitions.
VALUE ADDED SERVICES. In addition to our extensive library of
courseware, we also offer our customers a proprietary learning content
management system, an administrative tool that enables organizations to monitor
the use and efficacy of our programs.
LARGE AND DIVERSIFIED CUSTOMER BASE. We have over 3,000 customers,
consisting of accountants, engineers, and large, medium and small companies as
well as accounting firms. Our customers include approximately half of the
Fortune 500 companies. In the aggregate, we estimate that our corporate clients
employ tens of thousands of accounting and finance professionals, representing a
substantial universe of potential users. In addition, our corporate customers
are a diversified group in terms of the industries and markets in which they
operate. For example, our customers are some of the leading businesses in the
following industries: accounting, banking and finance, insurance, technology,
telecommunications, retail, aerospace, natural resources, construction and
chemicals.
END-TO-END SERVICE. All of our accounting/finance programs and our
corporate training programs are produced, filmed, edited, duplicated and
converted in-house. Our engineering programs are usually licensed from or
developed in conjunction with an independent third-party but are filmed, edited,
duplicated and converted into digital format in-house. Finally, we have a
fulfillment center from which we ship our course materials, tapes as well as
hard copies to our customers. We believe our vertically integrated operation
results in a more efficient production process and enhances the quality of our
products.
ONLINE RESOURCE AND CONTENT PROVIDER. We own and operate multiple
websites. Our two primary websites are: www.smartpros.com and
www.workingvalues.com. Our SmartPros website has over 20,000 pages of
proprietary content as well as links to other professional organizations,
associations and institutions and is a marketing and distribution channel for
our products. We believe that this website has become a destination for
professionals based on the following data:
o As a result of maintaining the website, we have built a database with
over 120,000 profiled users.
o The website logs over 300,000 visits per month.
o Through our web sites, we serve over 1.5 million ads and 200,000 opt-in
e-mails per month.
INTELLECTUAL PROPERTY
We own a variety of intellectual property, including trademarks, trade
names, copyrights, proprietary software, technical know-how and expertise,
designs, process techniques and inventions. We believe that the trademarks and
trade names we use to identify our products and services are material to our
business. All of the following trademarks/trade names have been federally
registered, or applications have been filed, with the United States Patent and
Trademark Office seeking federal registration: SMARTPROS, KEEPSMART, WORKING
VALUES, PROFESSIONAL EDUCATION CENTER and Design, PEC, FMN FINANCIAL MANAGEMENT
NETWORK and Design, FMN, CPAR CPA REPORT and Design, CPAR, Integrity Alignment
Process, Integrity Training Center, INTEGRITY TOOLKIT, INTEGRITY ALIGNMENT and
WORKING VALUES. In addition, under our agreement with the AICPA we have a right
to use "AICPA" in connection with the following products: AICPA Financial Pro,
AICPA Practice Report, and AICPA Practice Pro. Finally, we use the following
trademarks and trade names to which we claim common law rights: SmartPros
Advantage (SPA), The CPA Report Government & Not-for-Profit
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(CPARGov/NFP), Integrity Alignment Process and Integrity Training Center.
Despite our efforts to protect our proprietary rights, unauthorized persons may
attempt to copy aspects of our products or to obtain and use information that we
regard as proprietary. Policing unauthorized use of our products is extremely
difficult, and the means we use to protect our proprietary rights may be
inadequate. We believe that, ultimately, our success depends to a larger extent
on the innovative skills, know-how, technical competence and abilities of our
personnel.
All of our internally developed content is protected by copyright.
While this may offer some protection against unauthorized persons copying the
material, it does not prevent anyone from independently developing material on
the same topic or in the same format. Regarding content created, owned or
licensed by third parties, we enter into license agreements that permit us to
market, use and distribute that content. These licenses may be exclusive or
non-exclusive. We usually obtain a representation from the licensor that he or
she has the right to license the content to us, that the license granted to us
does not violate the terms of any other license, that the license granted does
not violate any applicable law, rule or regulation or the proprietary rights of
any third party, including, without limitation, patents, copyrights, trade
secrets, or any license or sublicense, covenant or contract with any third party
and that there is currently no actual or threatened suit by any such third party
based upon an alleged violation by such licensor of any such proprietary rights.
However, we do not make any independent investigation to verify if these
representations are accurate. If the representation is not true, we may be
enjoined from using that content further and may also be liable for damages to
the true owner of the content or the exclusive licensee.
In connection with our learning content management systems, our license
agreement restricts use of the system and prohibits users from copying or
sharing the system without our express written consent. Our learning content
management systems incorporate products and systems and technology that we
license and purchase from third parties. We cannot assure you that we will be
able to continue to license or support this technology on terms that we consider
reasonable, if at all. If these licenses or maintenance agreements expire and we
cannot renew them, they are substantially modified or if they were terminated
for any reason, we would have to purchase, license or internally develop
comparable products and systems. Anyone of these options may be expensive and/or
time consuming, which could have a material adverse effect on our business and
financial performance.
We cannot prevent third parties from independently developing similar
or competing systems, software and content that do not infringe on our rights.
In addition, we cannot prevent third-parties from asserting infringement claims
against us relating to these systems and software. These claims, even if they
are frivolous, could be expensive to defend and could divert management's
attention from our operations. If we are ultimately found to be liable to third
parties for infringing on their proprietary rights, we may be required to pay
damages, which may be significant, and to either pay royalties to the owner or
develop non-infringing technology, the cost of which may be significant.
GOVERNMENT REGULATION
Government regulation is important to our business. Every state sets
its own continuing professional education requirements, in terms of the number
of credits needed and the cycle in which those credits need to be earned. In
addition, specific content will only qualify for continuing professional
education credit if it meets specific criteria, which varies from state to
state. In the accounting/finance area, most states have adopted the NASBA
standards to address the quality of course content. We are a certified NASBA
sponsor, meaning that the courses we offer to the general public on a
subscription basis qualify for continuing professional education credits in
those states that have either adopted the NASBA standards or their own standards
similar to NASBA's, the District of Columbia and Puerto Rico. In the engineering
area, there is less uniformity and each of our courses must be certified by the
particular professional organization that oversees that particular specialty.
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In addition, laws, rules and regulations enacted by governments and
their agencies play an important role in the growth of our business. For
example, we anticipate that the Sarbanes-Oxley Act of 2002 will help drive the
growth of our Working Values subsidiary as companies seek to educate their
employees on matters relating to corporate ethics, compliance and governance.
EMPLOYEES
As of March 1, 2005 we had 68 employees of which 64 were full-time and
four were part-time. We have 51 employees based in our executive offices in
Hawthorne, New York and five employees based in our office in Sharon,
Massachusetts. In addition, we have an aggregate of 12 employees that work out
of their homes in New York, New Jersey, Washington, California, Illinois and
Texas. We believe that our relationship with all of our employees is generally
good.
CERTAIN RISK FACTORS THAT MAY AFFECT GROWTH AND PROFITABILITY
The following factors may affect our growth and profitability and
should be considered by any prospective purchaser of our securities:
WE HAVE HAD SIGNIFICANT OPERATING LOSSES IN FOUR OUT OF THE FIVE MOST
RECENT FISCAL YEARS.
From 2000 through 2003, we incurred cumulative losses of $10.2 million.
Although we were profitable in 2004, we cannot assure you that we will continue
to achieve profitability in 2005 or thereafter.
THE INDUSTRY IN WHICH WE OPERATE IS HIGHLY COMPETITIVE AND HAS
RELATIVELY LOW BARRIERS TO ENTRY. INCREASED COMPETITION COULD RESULT IN MARGIN
EROSION AS WELL AS LOSS OF MARKET SHARE AND BRAND RECOGNITION.
Our competitors include public companies, such as SkillSoft plc and
Saba Software, Inc. and privately held companies, such as CPA2Biz, Inc. and Bisk
Education, Inc. in the accounting area, and Red Vector.com Inc. and NetGen
Learning Systems in the engineering market and Integrity-Interactive
Corporation, LRN, The Legal Knowledge Company and Corpedia in the general
corporate compliance and ethics training market. We also compete with
universities (traditional and online) and professional and not-for-profit
organizations and associations. Potential competitors include traditional
education and publishing companies as well as e-commerce providers. Many of our
existing and potential competitors have greater financial resources, larger
market share, broader and more varied libraries, technology and delivery systems
that are more flexible or cost-effective, stronger alliances and/or lower cost
structures than we do, which may enable them to establish a stronger competitive
position than we have, in part through greater marketing opportunities. If we
fail to address competitive developments quickly and effectively, we will not be
able to grow.
IF WE FAIL TO KEEP UP WITH CHANGES AFFECTING THE MARKETS THAT WE SERVE,
WE WILL BECOME LESS COMPETITIVE, ADVERSELY AFFECTING OUR FINANCIAL PERFORMANCE.
In order to remain competitive and serve our customers effectively, we
must respond on a timely and cost-efficient basis to changes in technology,
industry standards and procedures and customer preferences. We need to
continuously develop new course material that addresses new developments, laws,
regulations, rules, standards, guidelines, releases and other pronouncements
that are periodically issued by legislatures, government agencies, courts,
professional associations and other regulatory bodies. In some cases these
changes may be significant and the cost to comply with these changes may be
substantial. For example, the National Registry of CPE Sponsors, known as NASBA,
which sets the standards that have been adopted by 36 states, the District of
Columbia and Puerto Rico and whose standards have been copied by most of the
other states and U.S. Territories, imposed the requirement that, to qualify for
continuing professional education credit, beginning in 2003 all new courses
designed for self-study must be interactive and beginning in 2004 all courses
designed for self-study had to be interactive. Had we not complied with
20
this new requirement, our courses would have been far less attractive to
practitioners in the field and our business would have declined appreciably. We
cannot assure you that we will be able to adapt to any changes in the future or
that we will have the financial resources to keep up with changes in the
marketplace. Also, the cost of adapting our products and services may have a
material and adverse effect on our operating results.
OUR FUTURE SUCCESS DEPENDS ON RETAINING OUR EXISTING KEY EMPLOYEES AND
HIRING AND ASSIMILATING NEW KEY EMPLOYEES. THE LOSS OF KEY EMPLOYEES OR THE
INABILITY TO ATTRACT NEW KEY EMPLOYEES COULD LIMIT OUR ABILITY TO EXECUTE OUR
GROWTH STRATEGY, RESULTING IN LOST SALES AND A SLOWER RATE OF GROWTH.
Our success depends in part on our ability to retain our key employees
including our chief executive officer, Allen S, Greene, and our senior executive
vice president, Jack Fingerhut. Mr. Greene, who joined us in 2001, is an
experienced senior corporate executive who has been instrumental in cutting
costs, raising capital and identifying and consummating two acquisitions that
have helped us refocus on our competencies. Mr. Fingerhut was a founder of the
company and the president of our accounting division. Mr. Fingerhut is actively
involved in sales and marketing and in writing and producing many of our
accounting programs. He also has extensive contacts within and knowledge of the
accounting profession. Although we have employment agreements with both of these
executives, each executive can terminate his agreement at any time. Also, we do
not carry, nor do we anticipate obtaining, "key man" insurance on either Mr.
Greene or Mr. Fingerhut. It would be difficult for us to replace either one of
these individuals. In addition, as we grow we may need to hire additional key
personnel. We may not be able to identify and attract high quality employees or
successfully assimilate new employees into our existing management structure.
OUR SALES CYCLE CAN BE LONG AND UNPREDICTABLE, WHICH COULD DELAY OUR
GROWTH AND MAKE IT DIFFICULT FOR US TO PREDICT EARNINGS. THIS COULD LEAD TO
STOCK PRICE VOLATILITY.
Our sales cycle is unpredictable and can last as long as 24 months for
large, enterprise wide or custom designed programs. Most of our revenue is
derived from corporate customers. Identifying the decision maker in these
enterprises is often time consuming. Also, sales of online products, which we
believe are essential to our future growth and success, take longer than sales
of video or CD-ROM products. Other variables also complicate the purchasing
process, including the timing of disbursement of funds and the person-to-person
sales contact process. Sales may take much longer than anticipated, may fall
outside the approved budget cycle and, therefore, may not occur due to the loss
of funding. This unpredictability has, in the past, caused and may, in the
future, cause our net revenue and financial results to vary significantly from
quarter to quarter.
OUR GROWTH STRATEGY ASSUMES THAT WE WILL MAKE TARGETED STRATEGIC
ACQUISITIONS. ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE OR
DISTRACT MANAGEMENT'S ATTENTION FROM OPERATIONS.
Unless we develop or acquire new content that we can market to our
existing and new clients, our rate of revenue growth will continue to be slow
and achieving profitability will be slow and difficult. We believe that the
quickest and most efficient way for us to acquire new content is through
targeted strategic acquisitions. If we fail to execute on this strategy, our
revenues may not increase and our ability to achieve significant profitability
will be delayed. Until now, our ability to acquire complimentary businesses has
been hampered by our limited capital resources and the lack of a public market
for our stock.
An acquisition strategy is inherently risky. Some of the risks we may
face in connection with acquisitions include:
o identifying appropriate targets in an efficient and timely fashion;
o negotiating terms that we believe are reasonable;
21
o failing to accurately assess the true cost of entering new markets or
marketing new products;
o integrating the operations, technologies, products, personnel and
customers of the acquired enterprise;
o maintaining our focus on our existing business;
o losing key employees; and
o reducing earnings because of disproportionately large depreciation and
amortization deductions relating to the acquired assets.
We may not be able to identify any appropriate targets or acquire them on
reasonable terms. Even if we make strategic acquisitions, we may not be able to
integrate these businesses into our existing operations in a cost-effective and
efficient manner.
WE MAY NEED ADDITIONAL CAPITAL FOR EXPANSION PURPOSES. THE AVAILABILITY
OF CAPITAL AND THE TERMS ON WHICH IT WILL BE AVAILABLE ARE UNCERTAIN.
We may need to raise additional funds to take advantage of expansion or
acquisition opportunities in the future. We have no arrangements or commitments
for additional financings. If we cannot expand or make acquisitions that we
believe are necessary to maintain our competitive position, we may not be able
to maintain a reasonable growth rate. If we raise additional capital by selling
equity or equity-linked securities, these securities would dilute the ownership
percentage of our existing stockholders. Also, these securities could also have
rights, preferences or privileges senior to those of our common stock.
Similarly, if we raise additional capital by issuing debt securities, those
securities may contain covenants that restrict us in terms of how we operate our
business, which could also affect the value of our common stock. We may not be
able to raise capital on reasonable terms or at all.
OUR STRATEGIC RELATIONSHIPS ARE USUALLY SHORT-TERM, NONEXCLUSIVE
ARRANGEMENTS AND OUR STRATEGIC PARTNERS MAY PROVIDE THE SAME OR SIMILAR SERVICES
TO OUR COMPETITORS, DILUTING ANY COMPETITIVE ADVANTAGE WE GET FROM THESE
RELATIONSHIPS.
We rely on our strategic partners to provide us with access to content
as well as to sell our content. Our strategic partners may and some have entered
into identical or similar relationships with our competitors, which could
diminish the value of our products. Our strategic partners could terminate their
relationship with us at any time. While we do not depend on any single strategic
relationship for a significant amount of revenue or to develop content, if a
number of these organizations were to terminate their relationship with us at
the same time, our ability to develop new content on a timely basis and our
ability to distribute content would be impaired. We may not be able to maintain
our existing relationships or enter into new strategic relationships.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY ADEQUATELY OR
COST EFFECTIVELY, WHICH MAY CAUSE US TO LOSE MARKET SHARE OR REDUCE OUR PRICES.
Our success depends in part on our brand identity and our ability to
protect and preserve our proprietary rights. We cannot assure you that we will
be able to prevent third parties from using our intellectual property rights and
technology without our authorization. We do not own any patents on our
technology. Rather, to protect our intellectual property, we rely on trade
secrets, common law trademark rights, trademark registrations, copyright
notices, copyright registrations, as well as confidentiality and work for hire,
development, assignment and license agreements with our employees, consultants,
third party developers, licensees and customers. However, these measures afford
only limited protection and may be
22
flawed or inadequate. Also, enforcing our intellectual property rights could be
costly and time-consuming and could distract management's attention from
operating business matters.
ITEM 2. DESCRIPTION OF PROPERTY
Our executive offices, production facility, technology center and
fulfillment center is located on Route 9A in Hawthorne, New York, where we lease
17,850 square feet. The lease expires February 28, 2010. In addition, we lease
800 square feet in Sharon, Massachusetts, where Working Values is based. This
lease expires March 1, 2006.
ITEM 3. LEGAL PROCEEDINGS
We are not presently a party to any legal proceeding that we deem
material.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) MARKET INFORMATION
Our common stock is traded on The American Stock Exchange under the
symbol "PED". The following table sets forth, for the periods indicated, the
high and low sales information for our Common Stock. Such quotations reflect
inter-dealer prices, without retail mark-up, markdown or commission and may not
necessarily represent actual transactions.
SALES INFORMATION
--------------------------------
PRICE RANGE OF COMMON STOCK HIGH LOW
----------------------------------------------- -------------- -----------------
YEAR ENDED DECEMBER 31, 2004
Fourth quarter (beginning November 22, 2004)* $4.10 $3.45
--------------
* Our common stock began trading on the AMEX on November 22, 2004 upon
separation of the units offered in our initial public offering
commencing on October 19, 2004.
As of March 24, 2005, the closing bid price per share for our common
stock, as reported on the American Stock Exchange was $3.95.
(b) HOLDERS
As of March 24, 2005, the number of record holders of our common stock
was 201. We believe that there are more than 1,000 beneficial holders of our
common stock.
(c) DIVIDENDS
The holders of our common stock are entitled to receive such dividends
as may be declared by the Board of Directors. During the years ended 2003 and
2004, we did not pay any dividends, and we do not expect to declare or pay any
dividends in the foreseeable future. Payment of future dividends will be within
23
the discretion of our Board of Directors and will depend on, among other
factors, our retained earnings, capital requirements and operating and financial
condition.
RECENT SALES OF UNREGISTERED SECURITIES.
On August 3, 2004, the Board authorized the issuance of 40,000 shares
of common stock to Allen S. Greene, our chief executive officer. The shares were
issued to Mr. Greene on October 19, 2004. Of the 40,000 shares issued, 10,000
shares vested immediately and 10,000 shares will vest on each of October 19,
2005, 2006 and 2007. Mr. Greene is deemed the owner of these shares as of the
date of grant and, as such, will be entitled to vote them on all matters
presented to stockholders for a vote and will be entitled to dividends, if any,
payable on our common stock. If Mr. Greene terminates his employment with us
voluntarily or we terminate him for "cause," as defined in his employment
agreement, any unvested shares will be forfeited and will revert to the company.
If Mr. Greene's employment with us is terminated without "cause," or if his
employment is terminated as a result of his death or disability (as defined in
his employment agreement), or if we experience a change in control (as defined
in his employment agreement) any unvested shares will immediately vest.
In January 2005, we issued to KS Partners, a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, 42,539 shares of restricted common stock
and 21,269 shares of our warrants exercisable at a price $7.125 per share, in
consideration for legal services rendered in connection with our initial public
offering. This issuance is exempt from registration, as it was made pursuant to
Sections 4(2) and 4(6) of the Act.
USE OF PROCEEDS.
On October 19, 2004, our registration statement on Form SB-2,
commission file number 333-115454 (the "Registration Statement") registering the
offer and sale of units (each a "Unit" and collectively the "Units"), each Unit
consisting of three shares of our common stock, par value $.0001 per share, and
one and one-half common stock purchase warrants, was declared effective by the
U.S. Securities and Exchange Commission. The warrants included in the Units have
a term of five years and an exercise price of $7.125 per share. We sold all
600,000 Units covered by the Registration Statement. The gross proceeds to us
from the offering were $7,650,000. Paulson Investment Company, Inc. was the
representative of the underwriters of the offering. The net proceeds to us after
underwriting discounts and other expenses were approximately $6,000,000. As of
the date hereof, we have used approximately $490,000 of the net proceeds to
repay certain long-term debt.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS INCLUDED
ELSEWHERE IN THIS ANNUAL REPORT. CERTAIN STATEMENTS IN THIS DISCUSSION AND
ELSEWHERE IN THIS REPORT CONSTITUTE FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 21E OF THE SECURITIES AND EXCHANGE ACT OF 1934. SEE
"FORWARD-LOOKING STATEMENTS" FOLLOWING THE TABLE OF CONTENTS OF THIS 10-KSB.
BECAUSE THIS DISCUSSION INVOLVES RISK AND UNCERTAINTIES, OUR ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.
OVERVIEW
We provide learning solutions for accounting/finance and engineering
professionals, as well as ethics and compliance training for the general
corporate community. We offer "off-the-shelf" courses and custom designed
programs with delivery methods suited to the specific needs of our clients. Our
customers
24
include approximately half of the Fortune 500 companies and a large number of
midsize and small companies.
Initially, our accounting/finance programs were delivered on videotape.
In 1998, we recognized that, to remain competitive, we would have to make our
products available in digital format for distribution over the Internet and
corporate intranets. Towards that end, we hired information technology
professionals to build a new media department that, among other things, would
convert our programs to digital format for online delivery and who would oversee
the development of a learning content management system. To take advantage of
financing opportunities that were then available to technology companies, we
were advised to pursue an acquisition strategy that focused on building revenues
and diversifying into new markets. Based on assurances we received from a
specific financing source, we identified several viable acquisition targets,
including Virtual Education Corporation, or VEC, a provider of license
preparation and continuing professional development programs for engineers.
However, the dynamics of the capital markets changed and our financing source
was unable to raise any funds. At that point, we had already consummated our
acquisition of VEC.
The acquisition of VEC put a tremendous strain on our internal capital
resources. Although our accounting division continued to grow and generate
operating profits, overall we began losing money. In the four-year period
beginning in 2000 and ending in 2003, we generated over $10 million of losses.
In 2001, we hired a new chief executive officer, Allen S. Greene, who had
previously been the chief operating officer of a publicly traded specialty
finance company. Since becoming our CEO, Mr. Greene has successfully refocused
on our core competencies, cut overhead, substantially reduced debt and raised
additional equity capital. By the end of 2003, we had narrowed our annual losses
to $315,000 and were EBITDA positive for the second consecutive year. Finally,
in 2004 we recorded our first net profit since 1999.
Since 2001, we have successfully completed two key acquisitions. First,
in May 2001, we acquired substantially all of the assets of Pro2Net. In so
doing, we acquired a library of "how to" programs, a functional learning content
management system that we could market with our programs, customer lists, trade
names and computer hardware. As a result, we were able to terminate a contract
with a third party to develop a learning content management system, saving us
approximately $2 million in development costs. Our ability to provide the
value-added services represented by the learning management system is, we
believe, key to our recent revenue growth and future success.
Second, in April 2003, we acquired a library of custom-designed
integrity-based courses and other assets from Working Values Group Ltd., a
company that specialized in building custom-designed learning solutions for the
general corporate community using traditional and alternative instructional
techniques. As part of the transaction, we also hired the development team from
Working Values Group. With the increased focus on corporate governance and
ethics and the passage of the Sarbanes-Oxley Act of 2002 along with new rules
and regulations adopted by the national stock exchanges and markets, we believe
that there is a significant growth opportunity in supplying training that
addresses corporate culture as a significant risk factor.
The aggregate purchase price for the Pro2Net and Working Values assets
was $1.1 million in cash, stock (based on the value at the time of the
acquisition) and assumption of liabilities. In comparison, the sellers of these
assets had collectively raised more than $30 million to develop these assets and
fund their operations.
We measure our operations using both financial and other metrics. The
financial metrics include revenues, gross margins, operating expenses and income
from continuing operations. Other key metrics include (i) revenues by sales
source, i.e., accounting/finance, engineering, Working Values and video
production and e-commerce. (ii) online sales, (iii) cash flows and (iv) EBITDA.
25
Some of the most significant trends affecting our business are the
following:
o The increasing recognition by professionals and corporations that they
must continually improve their skills and those of their employees in
order to remain competitive.
o The plethora of new laws and regulations affecting the conduct of
business and the relationship between a corporation and its employees.
o The increased competition in today's economy for skilled employees and
the recognition that effective training can be used to recruit and
train employees.
o The development and acceptance of the Internet as a delivery channel
for the types of products and services we offer.
In 2004 we successfully completed our initial public offering. We
intend to use the $6 million net proceeds from the offering and our
publicly-traded common stock to execute our growth strategy, which contemplates
acquiring other companies that provide learning solutions or their assets. We
intend to focus on acquisitions that will allow us increase the breadth and
depth of our current product offerings, including the general corporate market
for compliance, governance and ethics. We will also consider acquisitions that
will give us access to new market segments such as insurance, health care and
financial services. We prefer acquisitions that are accretive, as opposed to
those that are dilutive, but ultimately the decision will be based on maximizing
shareholder value rather than short-term profits. The size of the acquisitions
will be determined, in part, by our size, the capital available to us and the
liquidity and price of our stock. We may use debt to enhance or augment our
ability to consummate larger transactions.
There are a number of factors that make our acquisition strategy
viable. We believe that many of the companies currently providing learning
solutions are small and under-capitalized. Also, our senior management team
includes experienced mergers and acquisition executives who have demonstrated an
ability to identify and acquire companies that have enhanced our product
offerings and provided us with a platform for future growth. At the present
time, we have no agreements or commitments for any acquisitions. We cannot
assure you that we will successfully complete any acquisitions.
There are many risks involved with acquisitions, some of which are
discussed in Item 1 of Part 1 of this report above under the caption "Certain
Risk Factors That May Affect Our Growth and Profitability." These risks include
integrating the acquired business into our existing operations and corporate
structure, retaining key employees and minimizing disruptions to our existing
business. We cannot assure you that we will be able to identify appropriate
acquisitions opportunities or negotiate reasonable terms or that any acquired
business or assets will deliver the shareholder value that we anticipated at the
outset.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations is based on our consolidated financial statements that have been
prepared according to accounting principles generally accepted in the United
States. In preparing these financial statements, we are required to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosures of contingent assets and
liabilities. We evaluate these estimates on an ongoing basis. We base these
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates under different assumptions or
conditions. We consider the following accounting policies to be the most
important to the portrayal of our financial condition.
26
REVENUES
Most of our revenue is in the form of subscription fees for one of our
monthly accounting update programs or our course library. Other sources of
revenue include direct sales of programs on a non-subscription basis, fees for
various services, including web design, software development, tape duplication,
video production, video conversion, course design and development, ongoing
maintenance of a SmartPros Professional Education Center, and licensing fees.
Subscriptions are billed on an annual basis, payable in advance and deferred at
the time of billing. Sales made over the Internet are by credit card only.
Renewals are usually sent out 60 days before the subscription period ends.
Larger transactions are usually dealt with by contract, the financial terms of
which depend on the services being provided. Contracts for development and
production services typically provide for a significant upfront payment and a
series of payments based on deliverables specifically identified in the
contract.
Revenues from subscription services are recognized as earned; deferred
at the time of billing or payment and amortized into revenue on a monthly basis
over the term of the subscription. Engineering products are non-subscription
based and revenue is recognized upon shipment of the product or, in the case of
on-line sales, payment. Revenues from non-subscription services provided to
customers, such as web-site design, video production, consulting services and
custom projects are generally recognized on a proportional performance basis
where sufficient information relating to project status and other supporting
documentation is avai1able. The contracts may have different billing
arrangements resulting in either unbilled or deferred revenue. We usually obtain
either a signed agreement or purchase orders from our non-subscription customers
outlining the terms and conditions of the sale or service to be provided.
Otherwise, these services are recognized as revenues after completion and
delivery to the customer. Duplication and related services are generally
recognized upon shipment or, if later, when our obligations are complete and
realization of receivable amounts is assured. Working Values recognizes revenue
on a proportional performance basis.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Fixed, tangible assets are carried at cost less accumulated
depreciation and are depreciated using the straight-line method over the
estimated useful lives, which range from 3 years for course content to 10 years
for customer lists. Leasehold improvements are amortized over the lesser of
their estimated lives or the life of the lease. Major expenditures for renewals
and improvements are capitalized and amortized over their useful lives.
IMPAIRMENT OF LONG-LIVED ASSETS
We review long-lived assets and certain intangible assets annually for
impairment whenever circumstances and situations change such that there is an
indication that the carrying amounts may not be recovered.
STOCK-BASED COMPENSATION
We have adopted the disclosure only requirements of SFAS No. 123. As a
result, no compensation costs are recognized for stock options granted to
employees. Options and warrants granted to non-employees are recorded as an
expense at the date of grant based on the then estimated fair value of the
security in question.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2004 AND 2003
We experienced a significant improvement in operating performance in
2004 as compared to 2003. The following table compares our statement of
operations data for the years ended December 31, 2003 and
27
2004. The trends suggested by this table may not he indicative of future
operating results, which will depend on various factors including the relative
mix of products sold (accounting/finance, engineering or corporate training) and
the method of sale (video or online).
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
2003 2004
-------------------------------- -------------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE CHANGE
-------------- ------------- --------------- ------------ ------------
(ALL DOLLAR AMOUNTS ARE IN THOUSANDS)
Net revenues $ 8,580 100.0% $ 10,151 100.0% 18.3%
Cost of revenues 3,484 40.6% 4,003 39.4% 14.9%
-------------- ------------- --------------- ------------ ------------
Gross profit 5,096 59.4% 6,148 60.6% 20.6%
-------------- ------------- --------------- ------------ ------------
Selling, general and administrative 4,663 54.3% 4,693 46.2% 0.6%
Depreciation and amortization 676 7.9% 716 7.1% 5.9%
-------------- ------------- --------------- ------------ ------------
Total operating expenses 5,339 62.2% 5,409 53.3% 1.3%
-------------- ------------- --------------- ------------ ------------
Operating income (loss) (243) (2.8)% 739 7.3% (404.4)%
Other (expense), net (72) (0.9)% (28) (0.3)% (61.1)%
-------------- ------------- --------------- ------------ ------------
Net income (loss) $ (315) (3.7)% $ 711 7.0% (326.0)%
============== ============= =============== ============ ============
NET REVENUES
Net revenues for 2004 increased 18.3% compared to net revenues for
2003. Online sales continue to be an important factor contributing to our
overall revenue growth, a trend that began in 2003. In 2004, net revenues from
online sales of subscription-based products and other sales accounted for
approximately $2.6 million, or 26%, of our net revenues. In 2003, online sales
accounted for $1.8 million, or 21%, of our net revenues.
Net revenues from sales of our accounting/finance products grew in both
absolute terms and as a percentage of total revenues. In 2004, net revenues from
our accounting/finance and related products were $6.7 million compared to $6.2
million in 2003. This increase was due in part to a subscription price increase
that went into effect on January 1, 2004 and to an increased level of sales. For
2004, net revenues from accounting/finance products include subscription-based
revenue of $6.1 million and direct sales of course material on a
non-subscription basis, net revenues from custom work and advertising of
$600,000. For 2003, subscription-based revenue was $5.5 million and direct sales
of course material on a non-subscription basis, custom work and advertising was
$657,000.
Net revenues from sales of our engineering products, which are not
subscription-based products, were $509,000 in 2004 compared to $381,000 in 2003.
This increase is primarily attributable to a growth in sales of our licensing
preparation and project management courses.
Net revenues from video production and duplication and consulting and
e-commerce services for 2004 were $1.6 million compared to $1.8 million for
2003, continuing a trend that began in 2003. This decline is primarily
attributable to a number of factors, including a company policy that revenue is
credited to the originating department regardless of the type of service that is
performed. For example, a contract to convert videotapes to digital format is
credited to the accounting department if that is where the sale originated, even
if the technology group performed all the services necessary to fulfill the
terms of that contract. Other factors contributing to the decline in this
revenue include:
o the general decline in the videotape industry reflecting the popularity
of digital formats such as CD-ROM and DVD;
o the maturity of the web; and
28
o increased competition for web design services.
Despite the decline in revenues, our video and technology departments
continue to operate at full capacity producing videotapes and web-enabled
programs for our accounting and engineering departments. At this time we cannot
predict whether the trend of declining revenues from these departments will
continue.
Net revenues from our Working Values division increased from $185,000
in 2003 to $1,270,000 in 2004, an increase of 586%. This increase was primarily
due to consulting jobs for a number of large multi-national companies.
COST OF REVENUES
Cost of revenues includes production costs - I.E., the salaries,
benefits and other costs related to personnel, whether our employees or
independent contractors, who are used directly in production, including
producing our educational programs; royalties paid to third parties; the cost of
materials, such as videotape and packaging supplies; and shipping costs.
Compared to 2003, cost of revenues in 2004 increased by $519,000 but decreased
as a percent of net revenues. The increase was primarily attributable to the
cost of sub-contracted labor related to a large Working Values project and an
increase in personnel costs in the technology department.
There are many different types of expenses that are characterized as
production costs and many of them vary from period to period depending on many
factors. The expenses that showed the greatest variations from 2003 to 2004 and
the reasons for those variations were as follows:
o OUTSIDE LABOR AND DIRECT PRODUCTION COSTS. Outside labor includes the
cost of hiring actors and production personnel such as directors,
producers and cameramen and the out-sourcing of non-video technology.
The cost of actors increased minimally while the cost of video
production personnel increased by $50,000 and the cost of technology
personnel increased by $340,000. Direct production costs, which are
costs relating to producing videos other than labor costs, such as the
cost of renting equipment and locations, decreased $121,000. These
variations are related to the type of video production projects and do
not reflect any trends in our business.
o SALARIES. Overall, payroll and related costs attributable to production
personnel increased by $190,000. The increase was primarily
attributable to Working Values, $90,000, and our technology group,
$155,000. On the other hand, compensation expense in our video
production/duplication personnel decreased by $55,000. This decrease is
primarily attributable to the fact that the head of our video
production/duplication department resigned in October 2003.
o TRAVEL AND ENTERTAINMENT; SHIPPING. Travel and entertainment expenses
increased by $18,000 primarily related to Working Values projects. By
controlling costs and the way in which we ship our products there was
no material change in shipping costs.
As our business grows we may be required to hire additional production
personnel, increasing our cost of revenues.
Royalty expense decreased in 2004 as compared to 2003 for a number of
reasons. First, we terminated one of our royalty agreements in late 2003 with a
reseller of our CPA exam review course. Second, royalty payments to two other
partners decreased because sales through these partners decreased. Third, we
renegotiated our rates with one of our strategic partners, resulting in a total
savings of approximately $26,000. Ultimately, the savings we realize under these
new agreements will depend on the volume of sales. Assuming the same level of
sales in 2005 as in 2004, our royalty payments under these
29
agreements will be constant. However, if volume increases or if we enter into
new agreement or modify existing agreements, the actual royalty payments in 2005
under these agreements may be either higher or lower than they were in 2004.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include normal corporate overhead
such as compensation and benefits for administrative, sales and marketing and
finance personnel, rent, insurance, professional fees, travel and entertainment
and office expenses. While general and administrative expenses in 2004 were
slightly higher than they were in 2003, as a percentage of net revenues they
decreased significantly. General and administrative expenses for Working Values
were significantly higher in 2004 than they were in 2003 because Working Values
only had nine months of operations in 2003. In particular, Working Values' sales
costs were much higher in 2004 than they were in 2003. These increases were
offset by company-wide reductions in our telecommunication and other expenses.
In particular, legal expenses in 2004 were lower than they were in 2003 because
in the earlier year we incurred a one time legal expense of approximately
$150,000. We anticipate that general and administrative expenses will increase
in 2005 as a result of increased accounting, legal and insurance costs
attributable to the fact that we are now a public company.
DEPRECIATION and AMORTIZATION
Depreciation and amortization expenses were higher in 2004 than they
were in 2003, although as a percentage of net revenues they decreased. The
increase is attributable to the fact that in 2003 we acquired $368,000 of
depreciable and amortizable assets, including the assets acquired by Working
Values, that we began to fully amortize in 2004. We have also begun to fully
amortize the capitalized costs related to the Sarbanes-Oxley toolkit product
developed in 2003. We expect our depreciation and amortization expenses on our
current assets to decrease in 2005 as many of our older assets are either fully
or almost fully depreciated.
INCOME/LOSS FROM OPERATIONS
For 2004 net income from operations was $739,000 compared to a $243,000
loss from operations in 2003. This is primarily attributable to our ability to
increase net revenues without significantly increasing the cost of revenues and
our operating expenses.
OTHER EXPENSES
Other income and expense items consist of interest paid on indebtedness
and interest earned on deposits. The decrease in our net interest expense is due
primarily to our ability to pay down debt. As of the end of 2004 we have repaid
all of our outstanding indebtedness, other than capital lease obligations, with
the proceeds from our initial public offering. Also, we had more cash on hand at
the end of the year as a result of the public offering.
NET INCOME AND LOSS
For 2004, we recorded a net profit of $711,000 compared to a net loss
of $315,000 for 2003. The change from a net loss to a net profit is attributable
to increased revenue and our continuing efforts to reduce our costs and
expenses.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND CONTINGENCIES
Historically, we have financed our working capital requirements through
internally generated funds, sales of equity and debt securities and proceeds
from short-term bank borrowings. In October 2004 we
30
consummated an initial public offering of our common stock. The net proceeds to
us from the offering were approximately $6.0 million.
Our working capital as of December 31, 2004 was approximately $3.4
million compared to a $3.6 million working capital deficit as of December 31,
2003. The increase is attributable to the proceeds from our public offering. Our
current ratio at December 31, 2004 and December 31, 2003 was 1.75 to 1 and .27
to 1, respectively. The current ratio is derived by dividing current assets by
current liabilities and is a measure used by lending sources to assess our
ability to repay short-term liabilities. The largest component of our current
liabilities, $3.7 million at December 31, 2004 and $3.4 million at December 31,
2003, is deferred revenue, which is revenue collected or billed but not yet
earned under the principles of revenue recognition. Most of this revenue is in
the form of subscription fees and will be earned over the next 12 months. The
cost of fulfilling our monthly subscription obligation does not exceed this
revenue and is booked to expense as incurred. For some of our products, there
are no additional costs, other than shipping costs, required to complete this
obligation as the material is already in our library.
For the year ended December 31, 2004, net cash generated by operating
activities was approximately $1.1 million and we had a net increase in cash and
investments in available-for-sale securities of $6.2 million, most of which was
attributable to the public offering. The primary components of our operating
cash flows are our net income adjusted for non-cash expenses, such as
depreciation and amortization, and the changes in accounts receivable, accounts
payable and deferred revenues.
Capital expenditures for the year ended December 31, 2004 were
approximately $119,000, of which $115,000 consisted of equipment purchases and
$4,000 in intangible assets. Although we are constantly upgrading our
technology, we do not anticipate any significant increase in capital
expenditures relating to equipment purchases over the next 12 months.
For the year ended December 31, 2004 we made debt principal payments of
approximately $824,000. We used $491,000 from the proceeds of our initial public
offering to fully repay the outstanding balances on all of our existing
indebtedness other than capital leases. At year-end, our total indebtedness for
borrowed money, including capital lease financings, was approximately $120,000,
which consisted of the following:
o EQUIPMENT LEASING. At December 31, 2004, the balance on all existing
equipment leases was $97,000. In 2003 we leased $118,000 of new
computer and video equipment, through IDB Leasing. One lease has a
48-month term, an imputed interest rate of 7.0% and monthly payments of
$2,055. The second lease has a 36-month term, an imputed interest rate
of 7.5% and monthly payments of $996. In January 2004 we entered into
an additional capital lease obligation of $10,000 with IDB Leasing.
This lease has a term of 36 months and an imputed interest rate of
6.05%. The total amount due IDB Leasing at year-end was $81,000. In
addition, we have outstanding balances on other equipment leases of
approximately $16,000 at December 31, 2004.
o EQUIPMENT PURCHASES. At December 31, 2004, we had an outstanding
balance of $23,000 on a loan relating to a vehicle we purchased in
August 2004. The loan is for a term of 36 months, bears interest at
4.99% per annum and requires 35 monthly payments of $358 and a final
payment of approximately $13,800 due in August 2007. The lender has
agreed to repurchase the vehicle at our option for the amount of the
final payment, less any applicable expenses, at the end of the term.
In addition to the foregoing, as of December 31, 2004 we had
commitments under operating leases - principally the leases for executive
offices in Hawthorne, New York and the Working Values executive offices in
Sharon, Massachusetts aggregating $1.8 million through February 2010. In May
2004 we paid $92,000 in connection with our termination of a sublease in Irvine,
California. Finally, in connection with our acquisition of the Working Values
assets, the seller is entitled to receive up to $200,000 of additional
31
consideration if Working Values attains specific performance objectives during
the two-year period following the acquisition. At December 31, 2004 none of this
contingent consideration had been accrued.
In the future, we may issue additional debt or equity securities to
satisfy our cash needs. Any debt incurred or issued may be secured or unsecured,
at a fixed or variable interest rates and may contain other terms and conditions
that our board of directors deems prudent. Any sales of equity securities may be
at or below current market prices. We cannot assure you that we will be
successful in generating sufficient capital to adequately fund our liquidity
needs.
SEASONALITY AND CYCLICALITY
Historically, the fourth quarter has been our strongest in terms of
revenue generation. This is due to the fact that most of our subscriptions
follow the calendar year and renewals are mailed out 60 days before the end of
the year. Also, for internal budgeting reasons, corporate clients tend to defer
their decisions to the end of the year.
In general, since most of our business relates to continuing
professional education and is non-discretionary, we do not believe that business
cycles have a material impact on our financial performance. Adverse business
conditions and developments, however, would negatively affect the performance of
Working Values and the ability of our video production and consulting
departments to generate revenues independently.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,"
as revised, A Variable Interest Entity ("VIE") is an entity with insufficient
equity investment or in which the equity investors lack some of the
characteristics of a controlling financial interest. Pursuant to FIN 46, an
enterprise that absorbs a majority of the expected losses of the VIE must
consolidate the VIE. The full adoption of FIN 46 in fiscal 2004 did not have a
material effect on our financial position and results of operations.
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. The provisions of
this statement are effective for small business filers the first interim
reporting period that begins after December 15, 2005.
In November 2004, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 151 "Inventory Costs." This statement amends Accounting
Research Bulletin No. 43, Chapter 4, "Inventory Pricing" and removes the "so
abnormal" criterion that under certain circumstances could have led to the
capitalization of these items. SFAS No. 151 requires that idle facility expense,
excess spoilage, double freight and re-handling costs be recognized as
current-period charges regardless of whether they meet the criterion of "so
abnormal." SFAS 151 also requires that allocation of fixed production overhead
expenses to the costs of conversion be based on the normal capacity of the
production facilities. SFAS No. 151 is effective for all fiscal years beginning
after June 15, 2005. Management does not believe there will be a significant
impact as a result of adopting this statement.
On December 16, 2004, the FASB issued SFAS No. 153, "Exchange of
Non-monetary Assets", an amendment of Accounting Principles Board ("APB")
Opinion No. 29, which differed from the International Accounting Standards
Board's ("IASB") method of accounting for exchanges of similar productive
assets. Statement No. 153 replaces the exception from fair value measurement in
APB No. 29, with a general
32
exception from fair value measurement for exchanges of non-monetary assets that
do not have commercial substance. The statement is to be applied prospectively
and is effective for non-monetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. We do not believe that SFAS No. 153 will have a
material impact on our results of operations or cash flows.
ITEM 7. FINANCIAL STATEMENTS
See the index to Financial Statements below, beginning on page F-1.
ITEM 8. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None, except as previously reported on our Current Report on Form 8-K
filed with the Securities and Exchange Commission on November 29, 2004.
ITEM 8A. CONTROLS AND PROCEDURES
a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Management, with the
participation of our chief executive officer and the chief financial officer,
carried out an evaluation of the effectiveness of our "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 (the "Exchange
Act") Rules 13a-15(e) and 15-d-15(e)) as of the end of the period covered by
this report (the "Evaluation Date"). Based upon that evaluation, the chief
executive officer and the chief financial officer concluded that, as of the
Evaluation Date, our disclosure controls and procedures are effective, providing
them with material information relating to us as required to be disclosed in the
reports we file or submit under the Exchange Act on a timely basis.
b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
changes in our internal controls over financial reporting, known to the chief
executive officer or the chief financial officer, that occurred during our
fiscal fourth quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
ITEM 8B. OTHER INFORMATION
None.
33
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to our directors and executive officers that is
responsive to Item 9 of Form 10-KSB will be included in our Proxy Statement in
connection with our 2005 annual meeting of stockholders, which information is
incorporated by reference herein.
CODE OF ETHICS
We have adopted a Code of Ethics that applies to our principal
executive officer, principal financial officer and other persons performing
similar functions, as well as all of our other employees and directors. The Code
of Ethics is posted on our website at www.smartpros.com and is filed as Exhibit
14.1 to this report.
ITEM 10. EXECUTIVE COMPENSATION
Information relating to our directors and executive officers that is
responsive to Item 10 of Form 10-KSB will be included in our Proxy Statement in
connection with our 2005 annual meeting of stockholders, which information is
incorporated by reference herein.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information relating to our directors and executive officers that is
responsive to Item 11 of Form 10-KSB will be included in our Proxy Statement in
connection with our 2005 annual meeting of stockholders, which information is
incorporated by reference herein.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to our directors and executive officers that is
responsive to Item 12 of Form 10-KSB will be included in our Proxy Statement in
connection with our 2005 annual meeting of stockholders, which information is
incorporated by reference herein.
ITEM 13. EXHIBITS
EXHIBITS:
EXHIBIT
NO. DESCRIPTION
-------- -----------
3.1 Certificate of Incorporation as amended (1)
3.2 Amended and Restated By-Laws, as amended (1)
4.1 Specimen stock certificate (1)
4.2 Form of warrant agreement including form of warrant (1)
4.3 Form of unit certificate (1)
4.4 Form of representative's warrant issued (1)
10.1 1999 Stock Option Plan, as amended (1)
10.2 Third Amended Employment Agreement between SmartPros Ltd. and Allen S.
Greene (1)
34
10.3 Second Amended Employment Agreement between SmartPros Ltd. and Jack
Fingerhut (1)
10.4 Second Amended Employment Agreement between SmartPros Ltd. and William
K. Grollman (1)
10.5 Employment Agreement between SmartPros Ltd. and David M. Gebler (1)
10.6.1 Lease for premises at 12 Skyline Drive, Hawthorne, New York (1)
10.6.2 Lease for premises at 28 South Main Street Rear, Sharon, Massachusetts
(1)
10.7 $200,000 Secured Promissory Note and Stock Pledge Agreement (1)
10.8 The Asset Purchase Agreement between the SmartPros Ltd. and Working
Values Group, Ltd. (1)
10.9.1(a) Loan Agreement dated August 28, 2001 between SmartPros Ltd. and
Freshstart Venture Capital Corp. (1)
10.9.1(b) Negotiable Promissory Note dated August 28, 2001 made by SmartPros Ltd
to Freshstart Venture Capital Corp. with a principal amount of
$500,000 (1)
10.9.1(c) Security Agreement dated as of August 28, 2001 between SmartPros Ltd.
and Freshstart Venture Capital Corp. in connection with Exhibits
10.9.1(a) and (b) (1)
10.9.1(d) Participation Agreement dated August 28, 2001 between Veral & Co.,
L.L.C. and Freshstart Venture Capital Corp. in connection with Exhibit
10.9.1(a) (1)
10.9.2(a) Loan Agreement dated May 9, 2003 between SmartPros Ltd. and Freshstart
Venture Capital Corp. (1)
10.9.2(b) Negotiable Promissory Note dated May 9, 2003 made by SmartPros Ltd to
Freshstart Venture Capital Corp. with a principal amount of $100,000
(1)
10.9.2(c) Security Agreement dated as of May 9, 2003 between SmartPros Ltd. and
Freshstart Venture Capital Corp. in connection with Exhibits 10.9.2(a)
and (b) (1)
10.10 Form of Lock-up Agreement between the underwriter and the Officers and
Directors of SmartPros Ltd. (1)
10.11 Agreement and Plan of Merger among Deerfield Video Productions, Inc.,
Daniel Sladkus and William Doscher and Virtual Education Corporation
and Deerfield Acquisition Corp. (1)
10.12 Letter Agreement between SmartPros Ltd. and Allen S. Greene re
restricted stock (1)
14.1 Code of Ethics (3)
16.1 Letter from McGladrey & Pullen LLP dated November 24, 2004 (2)
21.1 Subsidiaries (1)
31.1 Chief Executive Officer Certification pursuant to section 302 of the
Sarbanes-Oxley Act of 2002*
31.2 Chief Financial Officer Certification pursuant to section 302 of the
Sarbanes-Oxley Act of 2002*
32.1 Chief Executive Officer Certification pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
32.2 Chief Financial Officer Certification pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
------------------------
35
NOTES TO EXHIBITS
-----------------
* Filed herewith
(1) Filed as an exhibit with the same number to Registration Statement on
Form SB-2 (No. 333-115454), effective as of October 19, 2004 and
incorporated herein by reference.
(2) Filed on November 29, 2004 as an exhibit with the same number to our
Current Report on Form 8-K and incorporated herein by reference.
(3) Filed on March 14, 2005 as an exhibit with the same number to our
Current Report on Form 8-K and incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information that is responsive to Item 14 of Form 10-KSB will be
included in our Proxy Statement in connection with our 2005 annual meeting of
stockholders, which information is incorporated by reference herein.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SmartPros Ltd.
By: /s/ Allen S. Greene
---------------------------------
Allen S. Greene,
Chief Executive Officer
Date: March 25, 2005
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the Registrant and in the capacities
indicated on March 25, 2005.
SIGNATURE TITLE
Principal Executive Officer
/s/ ALLEN S. GREENE Chief Executive Officer and Vice
-------------------------------- Chairman of the Board of Directors
Allen S. Greene
Principal Financial Officer
/s/ STANLEY P. WIRTHEIM Chief Financial Officer
--------------------------------
Stanley P. Wirtheim
Directors
/s/ JOHN F. GAMBA Chairman of the Board of Directors
--------------------------------
John F. Gamba
/s/ ALLEN S. GREENE Vice Chairman of the Board of Directors
--------------------------------
Allen S. Greene
/s/ WILLIAM K. GROLLMAN Director
--------------------------------
William K. Grollman
/s/ JACK FINGERHUT Director
--------------------------------
Jack Fingerhut
/s/ BRUCE JUDSON Director
--------------------------------
Bruce Judson
/s/ MARTIN H. LAGER Director
--------------------------------
Martin H. Lager
/s/ JOSHUA A. WEINREICH Director
--------------------------------
Joshua A. Weinreich
SMARTPROS LTD. AND SUBSIDIARY
CONTENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003 PAGES
--------------------------------------------------------------------------------
FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms F-2 - F-3
Consolidated Balance Sheet F-4
Consolidated Statements of Operations F-5
Consolidated Statement of Stockholders' Equity (Deficiency) F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8 - F-19
--------------------------------------------------------------------------------
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
SmartPros Ltd. and Subsidiary
We have audited the accompanying consolidated balance sheet of SmartPros Ltd.
and Subsidiary as of December 31, 2004, and the related consolidated statements
of operations, stockholders' equity (deficiency) and cash flows for the year
then ended. The consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SmartPros Ltd. and
Subsidiary as of December 31, 2004, and the results of their operations and
their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Holtz Rubenstein Reminick LLP
Melville, New York
February 28, 2005
--------------------------------------------------------------------------------
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
SmartPros Ltd. and Subsidiary
We have audited the accompanying consolidated statements of operations,
stockholders' deficit and cash flows of SmartPros, Ltd. and Subsidiary for the
year ended December 31, 2003. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of SmartPros, Ltd. and
Subsidiary's operations and their cash flows for the year then ended December
31, 2003, in conformity with U.S. generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
New York, New York March 12, 2004 except for the second paragraph of note 8 as
to which the date is September 10, 2004
McGladrey & Pullen, LLP is an independent member firm of RSM International, an
affiliation of independent accounting and consulting firms.
--------------------------------------------------------------------------------
F-3
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
--------------------------------------------------------------------------------
DECEMBER 31, 2004
--------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,756,991
Investment securities available-for-sale 5,000,000
Accounts receivable, net of allowance for
doubtful accounts of $71,000 985,259
Prepaid expenses and other current assets 175,270
-------------
Total Current Assets 7,917,520
-------------
Property and Equipment, net 544,176
Goodwill 53,434
Other Intangibles, net 2,482,653
Other Assets, including restricted cash of $150,000 167,196
-------------
Total Assets $ 11,164,979
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 358,867
Accrued expenses 373,993
Current portion of capital lease and
equipment financing obligations 56,119
Deferred revenue 3,741,466
-------------
Total Current Liabilities 4,530,445
-------------
Long-Term Liabilities:
Capital lease and equipment financing obligations 64,020
Other liabilities 164,907
-------------
Total Long-Term Liabilities 228,927
-------------
Commitments and Contingencies
Stockholders' Equity:
Convertible preferred stock, $.001 par value,
authorized 1,000,000 shares,
0 shares issued and outstanding -
Common stock, $.0001 par value,
authorized 30,000,000 shares,
5,140,545 issued and 5,082,539 outstanding 514
Common stock in treasury, at cost - 58,006 shares (220,000)
Additional paid-in-capital 16,407,495
Accumulated deficit (9,454,902)
-------------
6,733,107
Deferred Compensation (127,500)
Note receivable from stockholder (200,000)
-------------
Total Stockholders' Equity 6,405,607
-------------
Total Liabilities and Stockholders' Equity $ 11,164,979
=============
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 2003
--------------------------------------------------------------------------------
Net Revenues $10,150,738 $ 8,579,989
Cost of Revenues 4,002,738 3,483,868
----------------------------------------
Gross Profit 6,148,000 5,096,121
----------------------------------------
Operating Expenses:
Selling, general and administrative 4,692,748 4,662,432
Depreciation and amortization 716,378 676,382
----------------------------------------
5,409,126 5,338,814
----------------------------------------
Operating Income (Loss) 738,874 (242,693)
----------------------------------------
Other Income (Expense):
Interest income 37,802 16,841
Interest expense (65,307) (88,890)
----------------------------------------
(27,505) (72,049)
----------------------------------------
Provision for Income Taxes - -
----------------------------------------
Net Income (Loss) $ 711,369 $ (314,742)
========================================
Net Income (Loss) Per Common Share:
Basic net income (loss)
per common share $ 0.23 $ (0.12)
========================================
Diluted net income (loss)
per common share $ 0.23 $ (0.12)
========================================
Weighted Average Number of
Shares Outstanding
Basic 3,086,359 2,604,178
========================================
Diluted 3,119,322 2,604,178
========================================
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-5
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
Common Stock Preferred Stock
---------------------------------- -------------------------------
Shares Amount Shares Amount
----------------- --------------- ------------- ----------------
Balance, January 1, 2003 2,638,484 $ 264 14,979 $ 15
Purchase of 30,037 Shares of Treasury Stock - - - -
Net Loss - - - -
----------------- --------------- ------------- ----------------
Balance at, December 31, 2003 2,638,484 264 14,979 15
Conversion of Preferred Shares 619,522 62 (14,979) (15)
Common Stock Issued Through Public Offering 1,800,000 180 - -
Common Stock Issued for Services 42,539 4 - -
Restricted Common Stock Granted to Officer 40,000 4 - -
Amortization of Deferred Compensation - - - -
Net Income - - - -
----------------- --------------- ------------- ----------------
Balance at, December 31, 2004 5,140,545 $ 514 - $ -
================= =============== ============= ================
Additional Receivable
Paid-in Accumulated Deferred from
Capital Deficit Compensation Stockholder
-------------------------------------------------------------------------------------
Balance, January 1, 2003 $ 10,213,459 $ (9,851,529) $ - $ (200,000)
Purchase of 30,037 Shares of Treasury Stock - - - -
Net Loss - (314,742) - -
-------------------------------------------------------------------------------------
Balance at, December 31, 2003 10,213,459 (10,166,271) - (200,000)
Conversion of Preferred Shares (47) - - -
Common Stock Issued Through Public Offering 6,024,091 - - -
Common Stock Issued for Services (4) - - -
Restricted Common Stock Granted to Officer 169,996 - (170,000) -
Amortization of Deferred Compensation - - 42,500 -
Net Income - 711,369 - -
-------------------------------------------------------------------------------------
Balance at, December 31, 2004 $ 16,407,495 $ (9,454,902) $ (127,500) $ (200,000)
=====================================================================================
Total
Treasury Stockholders'
Stock Equity (Deficiency)
---------------------------------------------
Balance, January 1, 2003 $ (148,000) $ 14,209
Purchase of 30,037 Shares of Treasury Stock (72,000) (72,000)
Net Loss - (314,742)
---------------------------------------------
Balance at, December 31, 2003 (220,000) (372,533)
Conversion of Preferred Shares - -
Common Stock Issued Through Public Offering - 6,024,271
Common Stock Issued for Services - -
Restricted Common Stock Granted to Officer - -
Amortization of Deferred Compensation - 42,500
Net Income - 711,369
---------------------------------------------
Balance at, December 31, 2004 $ (220,000) $ 6,405,607
=============================================
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-6
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 2003
--------------------------------------------------------------------------------------------------------
Cash Flows from Operating
Activities:
Net income (loss) $ 711,369 $ (314,742)
-----------------------------------------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 716,378 676,382
Bad debts 6,532 -
Stock compensation 42,500 -
Changes in operating assets and liabilities:
(Increase) decrease in operating assets:
Accounts receivable (329,423) 221,559
Prepaid expenses and other current assets (46,690) (73,094)
Other assets 9,369 -
(Decrease) increase in operating liabilities:
Accounts payable and accrued expenses (350,080) 18,272
Deferred revenue 326,242 480,938
Other liabilities 18,558 (104,895)
-----------------------------------------
Total adjustments 393,386 1,219,162
-----------------------------------------
Net Cash Provided by Operating Activities 1,104,755 904,420
-----------------------------------------
Cash Flows from Investing Activities:
Investment in securities available-for-sale (5,000,000) -
Acquisition of property and equipment (115,316) (186,931)
Capitalized course costs - (181,316)
Cash paid for business acquisition (3,500) (104,950)
-----------------------------------------
Net Cash Used in Investing Activities (5,118,816) (473,197)
-----------------------------------------
Cash Flows from Financing Activities:
Payments on note payable - treasury stock (60,000) (12,000)
Proceeds from issuance of long-term debt 23,582 97,813
Net proceeds from issuance of common stock 6,024,271 -
Payments on long-term debt (683,003) (276,664)
Payments under capital lease obligations (80,791) (56,322)
-----------------------------------------
Net Cash Provided by (Used in) Financing Activities 5,224,059 (247,173)
-----------------------------------------
Net Increase in Cash and Cash Equivalents 1,209,998 184,050
Cash and Cash Equivalents, beginning of year 546,993 362,943
-----------------------------------------
Cash and Cash Equivalents, end of year $1,756,991 $ 546,993
=========================================
Supplemental Disclosure:
Cash paid for interest $ 65,307 $ 88,869
=========================================
Supplemental Disclosure of NonCash Investing and
Financing Activities:
Common stock issued in exchange for note receivable $ 170,000 $ -
=========================================
Common stock repurchased in exchange for debt
$ - $ 72,000
=========================================
Equipment purchased under capital leases $ 10,135 $ 120,619
=========================================
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-7
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
SmartPros Ltd. ("SmartPros" or the "Company"), a Delaware Corporation,
was organized in 1981 as Center for Video Education Inc. for the
purpose of producing educational videos primarily directed to the
accounting profession. SmartPros' primary products today are periodic
video and internet subscription services directed to corporate
accountants and financial managers, accountants in public practice and
CPA exam candidates. In addition, the Company also produces a series of
continuing education courses directed to the engineering profession as
well as a series of courses designed for candidates for the
professional engineering exam. Finally, through its wholly-owned
subsidiary, Working Values Ltd. ("Working Values"), the Company
produces ethics, governance, and compliance programs for corporate
clients. SmartPros also produces custom videos and rents out its
studios. SmartPros is located in Hawthorne, New York, where it
maintains its corporate offices, new media lab, video production
studios and tape duplication facilities. While the Company's management
monitors the revenue streams of its various products and services,
operations are managed and financial performance is evaluated on a
company-wide basis. Accordingly, all of the Company's operations are
considered by management to be aggregated in one reportable segment.
BASIS OF PRESENTATION - The consolidated financial statements of
SmartPros include the accounts of SmartPros and its wholly-owned
subsidiary, Working Values, which was formed in 2003. All significant
intercompany balances and transactions have been eliminated.
ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the dates of financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
REVENUE RECOGNITION - The Company recognizes revenue from its
subscription services as earned. Subscriptions are generally billed on
an annual basis, deferred at the time of billing and amortized into
revenue on a monthly basis over the term of the subscription, generally
one year. Engineering products are non-subscription based and revenue
is recognized upon shipment or, in the case of on-line sales, upon
receipt of payment. Revenues from other non-subscription services, such
as web site design, video production, consulting services, and custom
projects, are generally recognized on a proportional performance basis
where sufficient information relating to project status and other
supporting documentation is available. The contracts may have different
billing arrangements resulting in either unbilled or deferred revenue.
The Company obtains either signed agreements or purchase orders from
its non-subscription customers outlining the terms and conditions of
the products or services to be provided. Otherwise, revenues are
recognized after completion and/or delivery of services to the
customer. Duplication and related services are generally recognized
upon shipment or, if later, when the Company's obligations are complete
and realization of receivable amounts are assured.
COMPREHENSIVE INCOME (LOSS) - Comprehensive income (loss) refers to
revenue, expenses, gains and losses that under generally accepted
accounting principles are included in comprehensive income but are
excluded from net income as these amounts are recorded directly as an
adjustment to stockholders' equity. At December 31, 2004 and 2003,
there were no such adjustments required.
CASH AND CASH EQUIVALENTS - All highly liquid instruments with an
original maturity of three months or less are considered cash
equivalents. From time to time, the Company invests a portion of its
excess cash in money market accounts which are stated at cost and
approximate market value.
--------------------------------------------------------------------------------
F-8
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
INVESTMENTS - The Company has established a policy to invest proceeds
from its public offering in AAA-rated bonds with short-term maturities.
The Company determines the appropriate classification of securities at
the time of purchase and reassesses the appropriateness of the
classification at each reporting date. At December 31, 2004, all
marketable securities held by the Company have been classified as
available-for-sale and, as a result, are stated at fair value.
Unrealized gains and losses on available-for-sale securities are
recorded as a separate component of stockholders' equity. Realized
gains and losses on the sale of securities, as determined on a specific
identification basis, are included in the consolidated statements of
operations. For the years ended December 31, 2004 and 2003, the Company
had no unrealized gains or losses on available-for-sale securities.
CONCENTRATION OF CREDIT RISK - Financial instruments that subject the
Company to concentrations of credit risk consist primarily of cash and
cash equivalents, investments, and accounts receivable. No single
customer represents a significant concentration of sales or
receivables.
ACCOUNTS RECEIVABLE - Accounts receivable are recorded at original
invoice amount less an allowance that management believes will be
adequate to absorb estimated losses on existing accounts receivable.
The allowance is established through a provision for bad debts charged
to expense. Accounts receivable are charged against the allowance for
doubtful accounts when management believes that collectibility is
unlikely. The allowance is an amount that management believes will be
adequate to absorb estimated losses on existing accounts receivable,
based on an evaluation of the collectibility of accounts receivable and
prior bad debt experience. This evaluation also takes into
consideration such factors as changes in the nature and volume of the
accounts receivable, overall accounts receivable quality, review of
specific problem accounts receivable, and current economic conditions
that may affect the customer's ability to pay. While management uses
the best information available to make its evaluation, future
adjustments to the allowance may be necessary if there are significant
changes in economic conditions.
Accounts receivable are generally considered to be past due if any
portion of the receivable balance is outstanding for more than 90 days.
INVENTORIES - Inventories are valued at the lower of cost or market on
a first-in, first-out basis and consists primarily of videotape stock,
unsold video courses and related materials. Inventories are included in
prepaid expense and other current assets.
SHIPPING AND HANDLING COSTS - The Company has included freight-out as a
component of cost of goods sold for the years ended December 31, 2004
and 2003.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost and
are depreciated using the straight-line method over their estimated
useful lives, ranging from 3 to 10 years. Leasehold improvements are
amortized over the lesser of their estimated useful lives or the life
of the lease. Expenditures for maintenance and repairs are charged to
operations as incurred and major expenditures for renewals and
improvements are capitalized and depreciated over their useful lives.
LONG-LIVED ASSETS - The Company accounts for long-lived assets in
accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." This statement establishes financial accounting
and reporting standards for the impairment of long-lived assets and
certain intangibles related to those assets to be held and used, and
for long-lived assets and certain intangibles to be disposed of. SFAS
No. 144 requires, among other things, that the Company reviews its
long-lived assets and certain related intangibles for impairment
whenever changes in circumstances indicate that the carrying amount of
an asset may not be fully recoverable. If this review indicates that
the long-lived asset will not be recoverable, as determined based on
the estimated undiscounted cash flows of the Company over the remaining
amortization period, the carrying amount of
--------------------------------------------------------------------------------
F-9
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
the asset is reduced by the estimated shortfall of cash flows. The
Company believes that none of the Company's long-lived assets were
impaired.
GOODWILL - Goodwill results from prior business acquisitions and
represents the excess of the purchase price over the fair value of
acquired tangible assets and liabilities and identified intangible
assets. Upon adopting new accounting guidance in 2002, the Company
ceased amortizing all of its goodwill. Goodwill is assessed at least
annually for impairment and any such impairment will be recognized in
the period identified.
INTANGIBLE ASSETS - Certain intangible assets are being amortized on a
straight-line basis over their estimated useful lives, which vary
between 5 and 19 years.
CAPITALIZED COURSE COSTS - Capitalized course costs include the direct
cost of internally developing proprietary educational products and
materials that have extended useful lives. Amortization of these
capitalized course costs commences with the realization of course
revenues. Other course costs incurred in connection with any of the
monthly subscription products or custom work are charged to expense as
incurred. At December 31, 2004, the Company capitalized the cost of its
Sarbanes-Oxley Toolkit in the amount of $181,316. At December 31, 2004,
the Company has included these capitalized course costs in intangible
assets, net of accumulated amortization of $60,014. The capitalized
course costs are being amortized over a period of three years.
DEFERRED REVENUE - Deferred revenue related to subscription services
represents the portion of unearned subscription revenue, which is
amortized on a monthly, straight-line basis, as earned. Deferred
revenue related to website design and video production services
represents that portion of amounts billed by the Company, or cash
collected by the Company, for which services have not yet been provided
or earned in accordance with the Company's revenue recognition policy.
INCOME TAXES - Deferred tax assets and liabilities are recognized for
temporary differences between the financial reporting basis and the tax
basis of the Company's assets and liabilities. Deferred taxes are
recognized for the estimated taxes ultimately payable or recoverable
based on enacted tax laws. Changes in enacted tax rates and laws are
reflected in the financial statements in the periods they occur.
NET INCOME (LOSS) PER SHARE - Basic net income (loss) per share is
computed by dividing income (loss) available to common shareholders by
the weighted-average number of common shares outstanding. Diluted
earnings per share reflect, in periods in which they have a dilutive
effect, the impact of common shares issuable upon exercise of stock
options and warrants. For the year ended December 31, 2003, common
stock equivalent shares of 1,007,254 are excluded from the computation
because the effect of their inclusion would be anti-dilutive. For the
year ended December 31, 2004, 32,963 shares were included in the
computation.
The reconciliation for the years ended December 31, 2004 and 2003 is as
follows:
YEARS ENDED DECEMBER 31, 2004 2003
--------------------------------------------------------- ------------------- ------------------
Weighted Average Number of Shares Outstanding 3,086,359 2,604,178
Effect of Dilutive Securities, common stock equivalents 32,963 -
------------------- ------------------
Weighted Average Number of Shares Outstanding, used for
computing diluted earnings per share 3,119,322 2,604,178
=================== ==================
--------------------------------------------------------------------------------
F-10
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
STOCK-BASED COMPENSATION - Employee compensation expense under stock
options is reported using the intrinsic value method. No stock-based
compensation cost is reflected in net income, as all options granted
had an exercise price equal to or greater than the market price of the
underlying common stock at date of grant.
The following table illustrates the effect on net income (loss) per
share if expense was measured using the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation":
YEARS ENDED DECEMBER 31, 2004 2003
---------------------------------------------------- --------------------- ----------------------
Net Income (Loss), as reported $ 711,369 $ (314,742)
Deduct Stock-Based Compensation Expense Determined
Under Fair Value-Based Method (165,362) (184,524)
--------------------- ----------------------
Pro Forma Net Income (Loss) $ 546,007 $ (499,266)
===================== ======================
Basic Income (Loss) Per Share, as reported .23 (.12)
===================== ======================
Basic Income (Loss) Per Share, pro forma .18 (.19)
===================== ======================
Diluted Income (Loss) Per Share, as reported .23 (.12)
===================== ======================
Diluted Income (Loss) Per Share, pro forma .18 (.19)
===================== ======================
The fair value of options granted in 2004 and 2003 was estimated on the
date of grant using the Black-Scholes Option Pricing model with an
average assumed risk-free interest rate of 4.0%, an average expected
life of 10 years, an expected volatility of close to zero and the
assumption that no dividends will be paid. The weighted average fair
value per option of options granted during 2004 and 2003 was $1.40 and
$1.74, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's stock options
have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of
the fair value of its stock options.
NEW ACCOUNTING PRONOUNCEMENTS - In January 2003, the FASB issued FASB
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51," as revised in December
2003. A Variable Interest Entity ("VIE") is an entity with insufficient
equity investment or in which the equity investors lack some of the
characteristics of a controlling financial interest. Pursuant to FIN
46, an enterprise that absorbs a majority of the expected losses of the
VIE must consolidate the VIE. The full adoption of FIN 46 in fiscal
2004 did not have a material effect on the Company's financial position
and results of operations.
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R)
establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. This
statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions.
SFAS No. 123(R) requires that the fair value of such equity instruments
be recognized as an expense in the historical financial statements as
services are performed. Prior to SFAS No. 123(R), only certain pro
forma disclosures of fair value were required. The provisions of this
statement are effective for small business filers the first interim
reporting period that begins after December 15, 2005.
--------------------------------------------------------------------------------
F-11
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
In November 2004, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 151 "Inventory Costs." This statement amends
Accounting Research Bulletin No. 43, Chapter 4, "Inventory Pricing" and
removes the "so abnormal" criterion that under certain circumstances
could have led to the capitalization of these items. SFAS No. 151
requires that idle facility expense, excess spoilage, double freight
and re-handling costs be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal." SFAS
151 also requires that allocation of fixed production overhead expenses
to the costs of conversion be based on the normal capacity of the
production facilities. SFAS No. 151 is effective for all fiscal years
beginning after June 15, 2005. Management does not believe there will
be a significant impact as a result of adopting this statement.
On December 16, 2004, the FASB issued SFAS No. 153, "Exchange of
Non-monetary Assets", an amendment of Accounting Principles Board
("APB") Opinion No. 29, which differed from the International
Accounting Standards Board's ("IASB") method of accounting for
exchanges of similar productive assets. Statement No. 153 replaces the
exception from fair value measurement in APB No. 29, with a general
exception from fair value measurement for exchanges of non-monetary
assets that do not have commercial substance. The statement is to be
applied prospectively and is effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The Company
does not believe that SFAS No. 153 will have a material impact on its
results of operations or cash flows.
ADVERTISING - Advertising is expensed as incurred and was approximately
$42,000 and $39,000 for the years ended December 31, 2004 and 2003,
respectively.
2. ACQUISITIONS
In April 2003, the Company, through its newly-formed, wholly-owned
subsidiary, Working Values, acquired course content and intangible
assets from The Working Values Group Ltd. (a Massachusetts
corporation). The results of operations for Working Values are included
herein beginning from the acquisition date of April 1, 2003. The
purchase price for the acquired assets was $104,950. As part of the
purchase price, the seller is entitled to receive up to $200,000 as
additional consideration based on achieving certain net profits through
April 2005. At December 31, 2004, no contingent consideration had been
paid or accrued.
3. PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
DECEMBER 31, 2004
-------------------------------------------------- ------------------
Furniture, Fixtures and Equipment $ 3,089,475
Leasehold Improvements 182,549
------------------
3,272,024
Less Accumulated Depreciation 2,727,848
------------------
$ 544,176
==================
Depreciation expense for the years ended December 31, 2004 and 2003
were approximately $334,000 and $361,000, respectively. At December 31,
2004, property and equipment included assets that were acquired under
capitalized leases of approximately $402,000 and accumulated
depreciation of approximately $392,000.
--------------------------------------------------------------------------------
F-12
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
4. GOODWILL AND INTANGIBLE ASSETS
The components of intangible assets are as follows:
2004
------------------ ------------------ ------------------
Cost Accumulated Carrying
Amortization Value
------------------ ------------------ ------------------
Wiley CPA Exam Review Course $ 102,516 $ 102,516 $ -
Sarbanes-Oxley Toolkit 181,316 60,014 121,302
Evergreen Client List 3,500 350 3,150
Engineering Courses 2,766,837 1,806,576 960,261
Rights to CPA Report ("CPAR") 1,700,000 935,014 764,986
P2N:
Trade names 200,000 20,000 180,000
Courses 200,000 70,000 130,000
Technology documentation 150,000 90,000 60,000
Customer database 100,000 35,000 65,000
Other 187,504 78,000 109,504
------------------ ------------------ ------------------
Total P2N 837,504 293,000 544,504
------------------ ------------------ ------------------
Working Values:
Course content 50,000 8,700 41,300
Trademarks 10,000 - 10,000
Client list, domain names and other 44,950 7,800 37,150
------------------ ------------------ ------------------
104,950 16,500 88,450
------------------ ------------------ ------------------
$ 5,696,623 $ 3,213,970 $ 2,482,653
================== ================== ==================
The aggregate amortization expense for the years ended December 31,
2004 and 2003 was approximately $382,000 and $316,000, respectively.
Estimated amortization expense for the five years subsequent to
December 31, 2004 is as follows:
YEARS ENDING DECEMBER 31,
--------------------------------------------------- ------------------
2005 $ 382,000
2006 382,000
2007 321,000
2008 321,000
2009 236,000
In November 2002, the Company issued 22,100 shares of common stock
valued at $53,434 to two former owners of Deerfield Video Productions,
Inc. as additional consideration pursuant to the merger agreement
signed in 1999. The shares were valued based upon recent financings by
the Company. This contingent consideration was charged to goodwill.
--------------------------------------------------------------------------------
F-13
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
The following table presents the changes in the carrying amount of
goodwill and other intangibles during the year ended December 31, 2004:
Other
Goodwill Intangibles
------------------------------------ ------------------ ---------------
Balance, January 1, 2003 $ 53,434 $ 2,890,153
Amortization Expense - (315,600)
Goodwill and Intangibles Acquired - 104,950
------------------ ---------------
Balance, December 31, 2003 53,434 2,679,503
Amortization Expense - (381,668)
Goodwill and Intangibles Acquired - 184,818
------------------ ---------------
Balance, December 31, 2004 $ 53,434 $ 2,482,653
================== ===============
5. CAPITAL LEASE AND EQUIPMENT FINANCING OBLIGATIONS
In August 2004, the Company financed the purchase of a van with a
thirty-six month loan requiring monthly payments of $358 and a balloon
payment of $13,864. Interest on the loan is 4.99% per annum. The holder
of the loan has guaranteed to repurchase the van at the end of the loan
for $13,864, less any additional charges.
The Company is obligated under capital leases for the acquisition of
office and video production equipment. The interest rates on these
leases vary between 6.8% and 16.3% per annum. The minimum annual
payments and present values of these payments as of December 31, 2004
are as follows:
2005 $ 62,473
2006 40,863
2007 26,649
------------------
129,985
Less Amount Representing Interest 9,846
------------------
120,139
Less Current Portion 56,119
------------------
$ 64,020
==================
6. INCOME TAXES
At December 31, 2004, the Company has net deferred tax assets of
approximately $3,700,000, primarily resulting from the future tax
benefit of net operating loss carryforwards. Such net deferred tax
assets are fully offset by valuation allowances because of the
uncertainty as to their future realizability. The net valuation
allowance decreased by approximately $320,000 for the year ended
December 31, 2004. Realization of deferred tax assets depends on
sufficient future taxable income during the period that deductible
temporary differences and carryforwards are expected to be available to
reduce taxable income. At December 31, 2004, the Company has net
operating loss carryforwards available to offset future taxable income
of approximately $8,900,000 which expire through 2023.
--------------------------------------------------------------------------------
F-14
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
The components of income tax expense for the years ended December 31
2004 and 2003 consist of the following:
2004 2003
-------------------------------------------------------- ------------------- -------------------
Current Income Tax Expenses:
Federal $ - $ -
State - -
------------------- -------------------
Current Tax Expense $ - $ -
=================== ===================
Deferred Tax Expense (Benefit) Arising from:
Excess of financial over tax accounting depreciation $ (80,000) $ (150,000)
Net operating loss carryforwards 400,000 (120,000)
Valuation allowance (320,000) 270,000
------------------- -------------------
Net Deferred Tax Expense $ - $ -
=================== ===================
Deferred income tax expense results primarily from the reversal of
temporary timing differences between tax and financial statement
income.
A reconciliation of income tax expense at the federal statutory rate to
income tax expense at the Company's effective rate is as follows:
2004 2003
----------------------------------------- ------------- -------------
U.S. Federal Statutory Income Tax Rate 34.0% 34.0%
State Income Tax, net of federal benefits 7.5% 7.5%
Valuation Allowance (41.5)% (41.5)%
------------- -------------
Income Tax Expense -% -%
============= =============
The temporary differences, tax credits and carryforwards gave rise to
the following deferred tax asset at December 31, 2004:
Depreciation and Amortization $ 105,000
NOL Carryforward 3,738,000
Valuation Allowance (3,843,000)
-------------------
$ -
===================
7. CONVERTIBLE PREFERRED STOCK
From November 2001 through March 2002, the Company sold an aggregate of
14,979 shares of its Series A Convertible Preferred Stock (the
"Convertible Preferred Stock"). In October 2004, the Convertible
Preferred Stock automatically converted into 619,522 shares of Common
Stock immediately before the closing of the initial public offering
(see Note 8).
The Company sold 2,000 shares of its Convertible Preferred Stock to its
president. The entire purchase price for those shares, $200,000, was
evidenced by a promissory note from the purchaser. The entire principal
balance of the note and all accrued interest, calculated at 5.5% per
annum, is due and payable on February 14, 2007. The note is
collateralized by 124,079 shares of Common Stock owned by the president
of the Company.
--------------------------------------------------------------------------------
F-15
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
8. STOCKHOLDERS' EQUITY
In October 2004, the Company sold 600,000 units in an underwritten
initial public offering. Each unit included three shares of the
Company's common stock, par value $0.0001 per share (the "Common
Stock") and one and one-half common stock purchase warrants (each a
"Warrant" and collectively the "Warrants"). Each Warrant entitles the
holder thereof to purchase one share of Common Stock from the Company
exercisable at a price of $7.125 per share at any time during the
five-year period ending on October 19, 2009. The Company has the right
to call the Warrants, at a price of $0.25 per warrant, at any time
after April 19, 2005 on 30 days notice to the holders provided that the
closing price for the Common Stock, as reported on the principal
exchange on which it trades, for any five consecutive trading days has
equaled or exceeded $9.50 per share. The initial public offering price
of the units was $12.75 per unit, resulting in gross proceeds of
$7,650,000. The net proceeds to the Company, after deducting all cash
expenses incurred in connection with the offering and underwriter
commissions, was $6,000,000. In addition, the Company issued 42,539
shares of Common Stock and 21,270 Warrants to its attorneys in
connection with the offering and a warrant to the underwriter (the
"Underwriter's Warrant") entitling the underwriter to purchase 60,000
units (180,000 shares of Common Stock and 90,000 Warrants) at a price
equal to $15.30 per unit at any time from April 17, 2005 through
October 19, 2009.
On September 10, 2004, the Company filed an amendment to its
Certificate of Incorporation, affecting a reverse stock split in which
each share of the Company's outstanding Common Stock was converted into
0.5169925 new shares of Common Stock. As a result of the reverse stock
split, $246 was transferred from Common Stock to Additional Paid-in
Capital. Total shares outstanding decreased by 2,465,041 as a result of
the reverse stock split. All references to numbers of common shares and
per share information give retroactive effect to the reverse stock
split.
In August 2004, the Board authorized the issuance of 40,000 shares of
restricted Common Stock to the Company's chief executive officer. Under
the terms of the Restricted Stock Agreement, 10,000 shares of Common
Stock vested when the Company's initial public offering was effective
(October 19, 2004) and 10,000 shares will vest on each of October 19,
2005, 2006, and 2007, provided that the chief executive officer has not
voluntarily resigned from or been terminated for cause by the Company
prior to any of the vesting dates. The chief executive officer has full
voting and dividend rights with respect to all of the shares.
In April 2004, the Company's authorization for Common Stock was
increased to 30,000,000 shares and the number of shares reserved under
the 1999 Stock Option Plan was increased to 882,319.
In October 2003, the Company entered into an agreement to purchase
30,037 shares of its Common Stock from a former employee for $72,000 to
be paid in 12 equal monthly installments of $6,000. The purchase was
completed in October 2004 and the shares were placed into treasury.
In November 2002, the Company issued 22,100 shares of Common Stock
valued at $53,434 to two former owners of Deerfield Video Productions,
Inc. ("Deerfield"), which the Company acquired in 1999 by merger. This
issuance pursuant to the agreement, was treated as additional
consideration for the purchase of Deerfield and was charged to
goodwill.
In 2001, the Company issued warrants to purchase up to 10,084 shares of
Common Stock at $24.00 per share. The warrants may be exercised at any
time through March 2005. The warrants' fair value at the time of
issuance was de minimus.
At December 31, 2004, warrants covering 1,201,353 shares of Common
Stock were outstanding, which include the shares of Common Stock
underlying the warrants, the Underwriter's Warrant and the warrants
described in the preceding paragraph.
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F-16
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
9. STOCK OPTION PLAN
The Company's 1999 Stock Option Plan (the "Plan"), as amended, provides
for the grant of incentive or non-qualified stock options and
restricted stock awards for the purchase of up to 882,319 shares of
Common Stock to employees, directors and consultants. Prior to the
Company's initial public offering the Plan was administered by the
Board of Directors. Since the initial public offering the Plan is being
administered by the Compensation Committee established by the Board of
Directors of the Company. The administrator of the Plan determines the
terms of options, including the exercise price, expiration date, number
of shares and vesting provisions. In 2003, the Company granted 31,019
options at an exercise price of $5.32. During 2003, 35,396 options were
surrendered by former employees. In 2004, subsequent to the initial
public offering, the Company granted 22,925 options at an exercise
price of $4.27 to employees. During 2004, 10,857 options were
surrendered by employees who either resigned from or were terminated by
the Company. At December 31, 2004, options covering 389,509 shares of
common stock were outstanding and 492,810 shares of common stock remain
available for future grants under the Plan.
A summary of all stock option activity for the years ended December 31,
2004 and 2003 is as follows:
Weighted
Number Exercise Average
of Options Price Exercise Price
-------------------------------- ------------------ ------------------- ------------------
Outstanding, December 31, 2002 381,818 $ 2.15 - $32.13 $ 4.75
Options Granted 31,019 $ 5.32 5.32
Options Cancelled (35,396) $ 2.15 - $ 5.32 5.13
------------------ ------------------- ------------------
Outstanding, December 31, 2003 377,441 $ 2.15 - $32.13 4.75
------------------ ------------------- ------------------
Options Granted 22,925 $ 4.27 4.27
Options Cancelled (10,857) $ 5.32 5.32
------------------ ------------------- ------------------
Outstanding, December 31, 2004 389,509 $ 2.15 - $32.13 $ 4.72
================== =================== ==================
Exercisable, December 31, 2004 343,237 $ 2.15 - $32.13 $ 4.69
================== =================== ==================
Options Outstanding Options Exercisable
--------------------------------------------------------- --------------------------------------
Weighted Weighted
Average Weighted Average
Remaining Average Remaining
Number Contractual Exercise Number Contractual
Exercise Price Outstanding Life (Years) Price Exercisable Life (Years)
------------------ ------------------- ------------------ ------------------ ------------------ -------------------
$ 2.15 54,295 4.5 $ 2.15 54,295 4.5
$ 2.41 25,850 5.1 $ 2.41 25,850 5.1
$ 4.27 22,925 9.8 $ 4.27 5,733 9.8
$ 5.32 283,355 6.6 $ 5.32 254,275 6.6
$ 8.32 773 5.1 $ 8.32 773 5.1
$ 16.44 692 0.7 $ 16.44 692 0.7
$ 21.41 1,245 4.5 $ 21.41 1,245 4.5
$ 32.13 374 4.5 $ 32.13 374 4.5
------------------- ------------------ ------------------ ------------------ -------------------
389,509 6.3 $ 4.72 343,237 $ 6.3
=================== ================== ================== ================== ===================
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F-17
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
10. COMMITMENTS AND CONTINGENCIES
The Company leases office space and production and warehouse facilities
in Hawthorne, New York and Sharon, Massachusetts. Future minimum lease
payments are as follows:
YEARS ENDING DECEMBER 31,
-------------------------------------------- -------------------
2005 $ 338,100
2006 361,200
2007 357,000
2008 357,000
2009 357,000
Thereafter 59,500
-------------------
$ 1,829,800
===================
Deferred rent credit of approximately $165,000 is included in other
long-term liabilities in the accompanying balance sheet results from
rent reductions provided for at the inception of the Hawthorne, New
York lease. Rent expense is recorded on a straight-line basis over the
lease term. Rent expense for the years ended December 31, 2004 and 2003
was approximately $366,000 and $331,000, respectively.
The Company arranged for a $150,000 letter of credit representing a
security deposit for the Hawthorne, New York lease. The Company has
pledged a $150,000 certificate of deposit to the bank issuing the
letter of credit as collateral for the letter of credit and the
restricted cash account is included in other assets.
EMPLOYMENT AGREEMENTS - The Company has employment agreements with its
chief executive officer, its president, its senior vice president and
the president of Working Values. The employment agreement with the
Company's chief executive officer was signed in May 2004 and is for a
term of three years. The agreement renews automatically for a new
three-year term at the end of the first year of each three-year term
unless either party gives notice of their intent not to renew before
the end of the first year of each three-year term. The other employment
agreements were executed in April 2003 and expire in April 2006. Each
employment agreement provides for specified annual base salaries,
subject to increases at the discretion of the Company's Board of
Directors. Pursuant to the agreements, if the Company terminates any
executive's employment without cause, or if an executive terminates his
employment for good reason, the executive is entitled to receive
certain severance benefits. The employment agreement with the president
of Working Values provides for performance and other bonuses if the
Company reaches certain income levels. To date, no amounts have been
paid or accrued in connection with this provision. At December 31,
2004, the aggregate commitment under all four employment agreements was
approximately $810,000.
LITIGATION - The Company is a party to litigation arising in the normal
course of its business operations. In the opinion of management, it is
not anticipated that the settlement or resolution of any such matters
will have a material adverse impact on the Company's financial
condition, liquidity or results of operations.
11. RESTRUCTURING CHARGE
The Company closed its California technology center in August 2001. At
the time, the Company evaluated the costs to be incurred with respect
to the closure of the facility to be $245,883. The Company subsequently
sub-leased the space and in 2004 pursuant to the terms of the lease
paid a $92,000 lease termination fee.
--------------------------------------------------------------------------------
F-18
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 AND 2003
--------------------------------------------------------------------------------
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The methods and assumptions used to estimate the fair value of the
following classes of financial instruments were:
CURRENT ASSETS AND CURRENT LIABILITIES: The carrying values of cash,
investments securities available-for-sale, accounts receivables,
payables and certain other short-term financial instruments approximate
their fair value.
CAPITAL LEASE AND EQUIPMENT FINANCING OBLIGATIONS: The fair value of
the Company's capital lease and equipment financing obligations,
including the current portion, approximates fair value.
--------------------------------------------------------------------------------
F-19