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, 2005
[ ] 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 of incorporation or (I.R.S. Employer
organization) Identification No.)
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
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Common Stock, par value $.0001 American Stock Exchange
per share Warrants
Securities registered under Section 12(g) of the Exchange Act: NONE
Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act. [ ]
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of 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|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No |X|
State issuer's revenues for its most recent fiscal year. $10,430,210
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as a
specified date within the past 60 days. (See definition of affiliate in Rule
12b-2 of the Exchange Act.) Approximately, $14,353,685 as of March 24, 2006
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date. 5,035,716
DOCUMENTS INCORPORATED BY REFERENCE
The definitive proxy statement, which we expect to file before April
30, 2006, relating to the registrant's Annual Meeting of Stockholders to be held
on or about June 15, 2006, is incorporated by reference in Part III to the
extent described therein.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No |X|
SMARTPROS LTD.
FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Description of Business..............................................2
Item 2. Description of Property.............................................19
Item 3. Legal Proceedings...................................................19
Item 4. Submission of Matters to a Vote of Security Holders.................19
PART II
Item 5. Market for Common Equity and Related Stockholder Matters............19
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operation............................................21
Item 7. Financial Statements................................................30
Item 8. Change in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................30
Item 8A. Controls and Procedures.............................................30
Item 8B. Other Information...................................................30
PART III
Item 9. Directors and Executive Officers of the Registrant..................31
Item 10. Executive Compensation..............................................31
Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters..........................31
Item 12. Certain Relationships and Related Transactions......................31
Item 13. Exhibits............................................................31
Item 14. Principal Accountant Fees and Services..............................33
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.
1
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. We offer "off-the-shelf" courses and
custom designed programs with delivery methods suited to the specific needs of
our clients. Our customers include professional firms of all sizes as well as
many of the Fortune 500 companies and a large number of midsize and small
companies. In addition, we made two acquisitions in February 2006. As a result,
through our new subsidiary, Skye Multimedia Ltd., we develop custom interactive
marketing and training applications for CD, DVD, the Internet and learning
management systems. Skye offers a broad range of services including content
development, design, animation, audio/video production and application
development. Skye's clients are a diverse group of companies from
pharmaceutical, financial, technology and other industries. Second, we acquired
a library of 58 nationally certified online training solutions for the banking,
securities and insurance industries.
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 various professional and certifying organizations. 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
as 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 is our fastest growing delivery channel,
attracting new and existing subscribers. 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.
2
In October 1999, we acquired through merger Virtual Education
Corporation which provided continuing professional education programs to the
engineering profession. In May 2001, we purchased most of the operating assets
of Pro2Net Corporation, which 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, we acquired assets,
including course content and customer lists, from The Working Values Group Ltd.,
which developed training programs on corporate governance, compliance and
ethics.
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 2005 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 and financial professionals that require
continuing professional education credit to maintain their professional
accreditations 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 automatically accept courses
offered by the National Registry of CPE Sponsors, also known as NASBA. Three
states require registration with their licensing agencies. The remaining states,
other than Wisconsin, and the U.S. Territories, other than the Virgin Islands,
have standards that mirror those of NASBA and have no formal registration
requirements.
According to the Bureau of Labor Statistics, in 2005 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 2005 over 41,000
engineers sat for the exam and 68% passed. In addition, engineers who pass the
Fundamentals of Engineering exam 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 2005,
59% of the total candidates taking the exam, which covers multiple disciplines,
passed.
Many 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 qualifies for professional development credit.
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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 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 40 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.
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, Nebraska and
Texas, the only three 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.
4
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:
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.
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.
5
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, engineering and general
corporate libraries. 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 continue to
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.
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.
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. 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 are important to our growth and competitive
position in the industry. We plan to try to broaden these existing relationships
as well as seek new ones.
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 in most states 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. All prices are as of January 1,
2006.
SMARTPROS ADVANTAGE. SPA is a skills-based learning library containing
over 150 courses, varying in length from one to eight hours. In total, this
library includes more than 500 hours of courses qualifying
6
for continuing professional education credits. We produce these programs in our
own production facility. 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 $159.92 per course. The list price for a one-year subscription purchased
online is $ 369.
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. 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 $ 5,295 and for the online version is
$ 369 per user.
CPA PRACTICE REPORT ("APR") AND CPA PRACTICE PRO ("APP"). 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. 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 $ 369 per user. As of July 31, 2006
both sides have agreed to terminate this agreement. We will continue to market
the APR product under the name "CPA Report" and APP subscribers will be given
the opportunity to convert their existing subscriptions to the FMN product.
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. 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. This product will be discontinued in July 2006 and will be replaced
with FMN.
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
7
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. 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. 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 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. 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 either the combination CD-ROM/online version or 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 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
Working Values develops custom built training and compliance programs
for companies based on their specific needs through its Integrity Alignment
Process. The intent is usually to meet the best practices standards of the
Federal Sentencing Guidelines as well as other regulators. These products help
create a culture of compliance through assessment methodolgies and deployment of
live and web-based training and communication tools.
Working Values has developed assessment tools to assess employee
attitudes and awareness of critical integrity and antifraud risks and also an
assessment which provides an objective snapshot of the values that underlie
employee behavior, making it possible to translate qualitative data into
quantitative data.
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TRAINING PRODUCTS AND SERVICES
Working Values' "ethics training" is a curriculum of specific learning
experiences designed to meet specific integrity risks. Training can be designed
to meet the specific needs of various audiences; senior leaders, managers or all
employees.
Working Values has created ready-to-deploy tools to help an
organization customize its ethics program. These tools can be deployed as-is or
customized to meet an organization's needs. Working Value Integrity Toolkit
Learning Management System (LMS) offers enterprise distribution and
administration of education content and information.
VIDEO PRODUCTION AND DUPLICATION
All of our programs are produced in our production facility, which also
includes 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.
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
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.
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.
NEW PRODUCTS AND SERVICES
As a result of our acquisition of Sage Online Learning in February
2006, we have expanded our core e-learning product offerings beyond financial,
accounting and engineering into the professional fields of banking, securities
and insurance. We have already begun the process of integrating Sage's content
library, currently featuring 58 accredited courses. Course offerings include
banking compliance, general banking, general bank management, insurance,
lending, retirement and estate planning, and industry-related sales and service.
Courses are accredited by the Institute of Certified Bankers (ICB) and many
state insurance departments. In addition, these courses meet the requirements of
the Certified Financial Planner (CFP(R)) Board of Standards, Inc.
9
To further support and enhance SmartPros' design and production
capabilities, we also recently acquired Skye Multimedia, a leader in the
development of custom interactive marketing and training applications for
delivery on CD, DVD, Internet and learning management systems. Skye has an
established customer base stemming from a diverse range of industry, including
pharmaceutical, financial and technology, among others which will give us the
opportunity to cross-sell our products to those clients that are not currently
using them.
PRODUCT DEVELOPMENT
Our product development team includes Jeffrey Jacobs, Jack
Fingerhut, Allen S. Greene and Denise Stefano 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. Mr. Fingerhut is a certified public accountant.
Ms. Stefano is a certified public accountant and a professor of accounting.
Mr. Gebler was the founder of Working Values Group Ltd. and 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.
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 Senior Vice President of
Sales, a Vice President of Marketing, and a sales staff of 13 people, exclusive
of those employees involved in these functions in our two recent acquisitions.
The remaining sales staff, 10 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, Jack Fingerhut and David Gebler,
dedicate varying portions of their time and efforts to sales and marketing
activities. Finally, Joseph Fish, our Chief Technology Officer, spends a portion
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.
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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.
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.
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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. 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;
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
12
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.
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 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. We
sometimes compete directly with CPA2Biz, they also sell some of our products. In
addition, our competitors include, SkillSoft and Saba who are both relatively
large companies. 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 currently do not market our learning management system
as a stand-alone product, we do not compete presently 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.
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HISTORY AND REPUTATION. We have been providing learning solutions for
accounting and finance professionals for more than 24 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. We believe that our reputation in the accounting/finance
market will assist us as we expand our presence in the engineering and general
corporate markets, as well as 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.
EXPERIENCED MANAGEMENT. Our management team is comprised of experienced
and successful accounting and legal professionals and sales and marketing 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 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
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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, including WWW.SMARTPROS.COM, WWW.WORKINGVALUES.COM, WWW.SKYEMM.COM and
WWW.SAGEONLINELEARNING.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. 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 (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
15
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.
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, 2006 we had 75 employees of which 67 were full-time and
eight were part-time. We have 49 employees based in our executive offices in
Hawthorne, New York and five employees based in our office in Sharon,
Massachusetts. Our newly acquired subsidiary Skye Multimedia employs 10 people
in their Bridgewater NJ office. In addition, we have an aggregate of 11
employees that work out of their homes in New York, Washington, California 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 LIMITED REVENUE GROWTH OVER THE LAST TWO YEARS AND OUR NET
INCOME HAS DECREASED.
For the years ended December 31, 2004 and 2005 our net revenues only
increased 2.8% and our net income decreased 6.0%. We believe that the primary
reason for this decrease is our increased operating expenses, particularly those
related to our status as a public company. In 2005 we were not able to grow our
revenues to keep up with our additional operating expenses. This, in turn, has
had a negative impact on our
16
stock price. If we fail to increase our revenues significantly in 2006, the
price of our stock may further erode causing investors to lose money.
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.
OUR GROWTH STRATEGY ASSUMES THAT WE WILL MAKE TARGETED STRATEGIC
ACQUISITIONS. WE DID NOT MAKE ANY SUCH ACQUISITIONS IN 2004 OR 2005.
ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE OR DISTRACT
MANAGEMENT'S ATTENTION FROM OPERATIONS.
A key feature of our growth strategy is strategic acquisitions. We did
not make any such acquisitions in 2004 or 2005, which, we believe, has
contributed to a decline in our stock price. 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 profitability will be difficult to sustain.
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 sustain
profitability will be impaired.
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;
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.
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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.
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. 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 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 was named its
president as of March 1, 2006. Mr. Fingerhut is actively involved in sales and
marketing and identifying acquisition targets. Mr. Fingerhut also has overall
responsibility for the accounting products and video production business. 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 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.
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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. Our strategic relationship with the AICPA will
terminate in July 2006. 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 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. We lease 800 square
feet in Sharon, Massachusetts, where Working Values is based. This lease expires
March 1, 2007. Finally, Skye Multimedia leases 2,320 square feet in Bridgewater,
New Jersey, which expires in August 2006.
ITEM 3. LEGAL PROCEEDINGS
None.
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.
19
PRICE RANGE OF COMMON STOCK
--------------------------------------------------------------------------------
SALES INFORMATION
---------------------------------
HIGH LOW
--------------- -------------
2005
----
First Quarter $4.10 $3.71
Second Quarter $4.30 $3.85
Third Quarter $4.29 $3.15
Fourth Quarter $3.50 $2.45
2004
----
*Fourth Quarter $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, 2006, the closing sale price per share for our common
stock, as reported on the American Stock Exchange was $3.22.
(b) HOLDERS
As of March 24, 2006, the number of record holders of our common stock
was 173.
(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 2004 and
2005 and in any subsequent period for which financial information is required,
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
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 for services
rendered. 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
back to us. 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. The issuance was exempt from registration under Sections 4(2) and 4(6) of
the Act.
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.
20
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
December 31, 2005, we used approximately $490,000 of the net proceeds to repay
certain long-term debt. In February 2006, we used $750,000 of those proceeds for
the Sage and Skye acquisitions.
COMPANY PURCHASES OF ITS EQUITY SECURITIES
On December 15, 2005, the Board of Directors approved a stock buy back
program under which $750,000 of company funds was allocated to purchase shares
of our common stock on the American Stock Exchange. We repurchased 51,725 shares
during the month of December at a cost of $164,600. Due to the fact that we were
in active negotiations with both Skye and Sage Online Learning during the months
of January and February, we self-imposed a temporary freeze on the buyback.
However, now that these asset purchases have been completed, we expect to
re-activate our buyback program in the coming months.
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
(C)
TOTAL (D)
NUMBER OF MAXIMUM NUMBER
SHARES (OR (OR APPROXIMATE
UNITS) DOLLAR VALUE) OF
(A) (B) PURCHASED AS SHARES (OR UNITS)
TOTAL NUMBER AVERAGE PART OF THAT MAY YET BE
OF SHARES PRICE PAID PUBLICLY PURCHASED UNDER
(OR UNITS) PER SHARE ANNOUNCED PLANS THE PLANS OR
PERIOD PURCHASED (OR UNIT) OR PROGRAMS PROGRAMS
------------------------- ---------------------- -------------------- ----------------- -------------------
Month #1
(October 1-31, 2005) -- -- -- --
Month #2
(November 1-30, 2005) -- -- -- --
Month #3
(December 1-31, 2005) 51,725 $3.18 51,725 $585,400
------ ----- ------ --------
Total 51,725 $3.18 51,725 $585,400
====== ===== ====== ========
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
21
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. In February 2006, we acquired substantially all of the
operating assets of Skye Multimedia and Sage Online Learning. As a result,
through our new subsidiary, Skye Multimedia, we develop custom interactive
marketing and training applications for CD, DVD, Internet and Learning
Management Systems. Skye offers a broad range of services including content
development, design, animation, audio/video production and application
development. Skye's clients are a diverse group of companies from
pharmaceutical, financial, technology and other industries.
As a result of the Sage transaction, we acquired a library consisting
of 58 nationally certified online training solutions for the banking, securities
and insurance industries. 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.
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.
In 2000 we acquired Virtual Education Corporation, or VEC, a provider
of license preparation and continuing professional development programs for
engineers. 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. In 2004 we recorded our first net profit since 1999.
Since 2001, we have successfully completed four acquisitions. 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.
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.
22
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.
In February 2006 we acquired the operating assets and certain
liabilities of Skye Multimedia, Inc. for approximately $520,000.
In addition, the current owners of Skye are entitled to an additional payment
based on the average earnings of Skye between March 1, 2006 and December 31,
2008 less adjustments for use of capital and other costs. In no event will the
total additional payment exceed $1.2 million. The additional payment may be paid
50% in cash and 50% in SmartPros common stock at our discretion. If the
additional payment is paid partly in stock, the price of the stock will be
determined by the average price for the twenty business days subsequent to
December 31, 2008. Skye's sales for the year 2005 were in excess of $1 million.
Also in February 2006, we acquired substantially all of the operating
assets of Sage Group International Inc. for $225,000. Sage's primary asset is 58
on-line courses designed for the banking industry. Although Sage's sales were
approximately $115,000 in 2005, we believe that with proper marketing,
integration into our professional education center and the ability to cross-sell
our other products to Sage's existing customers, we believe that we can increase
that amount fairly quickly.
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, (ii) on-line sales, (iii) cash flows and (iv) EBITDA.
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 a portion of the remaining $4.8 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.
23
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.
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.
24
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. Effective January 1, 2006 we adopted the provisions of
SFAS No.123R which requires these costs to be reflected in the operating
statements of the Company.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2005 AND 2004
The following table compares our statement of operations data for the
years ended December 31, 2004 and 2005. 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,
-----------------------------------------------------------------------------------
2004 2005
-------------------------------- -------------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE CHANGE
-------------- ------------- --------------- ------------ ------------
(ALL DOLLAR AMOUNTS ARE IN THOUSANDS)
Net revenues $ 10,150,738 100.0% $ 10,430,210 100.0% 2.8%
------------ ----- ------------ ----- ------
Cost of revenues 4,002,738 39.4% 4,161,939 39.9% 4.0%
------------ ----- ------------ ----- ------
Gross profit 6,148,000 60.6% 6,268,271 60.1% 2.0%
------------ ----- ------------ ----- ------
General & administrative 4,692,748 46.2% 5,231,101 50.2% 11.5%
Depreciation and amortization 716,378 7.1% 580,991 5.6% -18.9%
------------ ----- ------------ ----- ------
Total operating expenses 5,409,126 53.3 5,812,092 55.7% 7.4%
------------ ----- ------------ ----- ------
Operating income (loss) 738,874 7.3% 456,179 4.4% -38.3%
------------ ----- ------------ ----- ------
Interest income 37,802 0.9% 220,805 5.3% 484.1%
Interest expense (65,307) -1.0% (8,017) -0.1% -87.7%
------------ ----- ------------ ----- ------
Net interest (expense) income (27,505) -0.3% 212,788 2.0% -873.6%
------------ ----- ------------ ----- ------
Net income $ 711,369 7.0% $ 668,967 6.4% -6.0%
============ ===== ============ ===== ======
NET REVENUES
Net revenues for 2005 increased 2.8% compared to net revenues for 2004.
Online sales continue to be an important factor contributing to our overall
revenue growth, a trend that began in 2003. In 2005, net revenues from online
sales of subscription-based products and other sales accounted for approximately
$2.8 million, or 26%, of our net revenues. In 2004, online sales accounted for
$2.6 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 2005, net revenues from
our accounting/finance and related products were $7.9 million compared to $6.7
million in 2004. This increase was due in part to a subscription price increase
that went into effect on January 1, 2005 and to an increased level of sales. For
2005, net revenues from
25
accounting/finance products include subscription-based revenue of $7.0 million
and direct sales of course material on a non-subscription basis, net revenues
from custom work and advertising of $900,000. For 2004, subscription-based
revenue was $6.1 million and direct sales of course material on a
non-subscription basis, custom work and advertising was $ 600,000.
Net revenues from sales of our engineering products, which are not
subscription-based products, were $489,000 in 2005 compared to $509,000 in 2004.
This decrease is primarily attributable to a change in product mix and not
indicative of any trends in this area.
Net revenues from video production, duplication, consulting services
for both 2005 and 2004 were relatively flat. Although revenue from consulting
services increased, video production and duplication decreased by a comparable
amount. Other factors contributing to the fluctuation in revenue include:
o the general decline in the videotape industry reflecting the popularity
of digital formats such as CD-ROM and DVD resulting in a substantial
decrease in our tape duplication business;
o inconsistency of consulting contracts; and
o sales are credited to the department from where they originate and not
to the department where the work is performed.
We recently hired a new head of video production who has many years of
experience in this industry. We hope to generate new business from different
sources.
Net revenues from Working Values decreased from $1,270,000 in 2004 to
$432,000 in 2005, a decrease of 66%. This decrease was primarily due to the
nature of the company's business, which are custom jobs and the completion of
two large jobs in 2004. In addition, in 2005, Working Values concentrated on
building its course library of ethics-based courses called Learning Moments &
Living the Code.
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 2004, cost of revenues in 2005 increased by $159,000. The increase
was primarily attributable to the hiring of additional personnel in the
technology area. The increase in payroll is offset by a decrease in the use of
outside personnel. 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
2004 to 2005 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 by $25,000 while the cost of video
production and outside technology personnel decreased by $203,000.
Direct production costs, which are costs relating to producing videos
other than labor costs, such as the cost of renting equipment and
locations and purchase of material decreased $ 39,000. 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 approximately $364,000. The increase was
primarily attributable to our technology group,
26
$339,000. On the other hand, compensation expense in our video
production/duplication personnel increased by only $25,000. Recent
staff changes in this area should reduce these costs in future periods.
o OTHER COSTS. Travel and entertainment expenses decreased by $49,000
primarily related to the decrease in Working Values projects. Our
shipping costs decreased by $9,000 as a result of controlling costs and
the shift by many customers to on-line delivery of our products.
As our business grows we may be required to hire additional production
personnel, increasing our cost of revenues.
Royalty expense increased in 2005 as compared to 2004 for a number of
reasons. While we renegotiated new rates with one of our strategic partners in
the accounting area, increased sales resulted in an increase of royalty expense
of approximately $20,000. In addition, the introduction of a new product in
engineering and a change in the mix of sales in that area resulted in an
increase of approximately $47,000 in royalty expense. However, if volume
increases or if we enter into new agreement or modify existing agreements, the
actual royalty payments in 2006 under these agreements may be either higher or
lower than they were in 2005.
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. General and administrative expenses in 2005 were higher
than they were in 2004, primarily due to the costs of being a public company.
These additional costs were approximately $320,000. The 2004 amount includes a
$92,000 payment to terminate a lease in California that we had inherited in the
VEC acquisition. The other major component of the increase in general and
administrative costs are salaries and related costs due to additional marketing
efforts of approximately $102,000 and the additional cost associated with hiring
a full time chief financial officer of approximately $78,000. We anticipate that
general and administrative expenses inclusive of additional costs related to
acquisitions will increase in 2006 as a result of increased marketing and
product development costs.
DEPRECIATION and AMORTIZATION
Depreciation and amortization expenses were lower in 2005 than they
were in 2004. The decrease is attributable to the fact that many of our older
assets are fully depreciated. We have also begun to amortize the capitalized
costs related to the Sarbanes-Oxley toolkit product and related course content.
We expect our depreciation and amortization expenses on our current assets to
decrease in 2006 as many of our older assets continue to become fully
depreciated.
INCOME/LOSS FROM OPERATIONS
For 2005 net income from operations was $456,000 compared to $739,000
in 2004. Although our sales have increased, costs related to being a public
company of approximately $ 400,000 resulted in reduced operating income.
27
OTHER EXPENSES
Other income and expense items consist of interest paid on indebtedness
and interest earned on deposits. The increase in our net interest income is due
primarily to our investing the proceeds of initial public offering. As of the
end of 2005 we have repaid all of our outstanding indebtedness, other than
capital lease obligations.
NET INCOME AND LOSS
For 2005, we recorded a net profit of $669,000 compared to $711,000 for
2004. The decrease in net income is primarily due to the increased costs
attributable to our being a public company.
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 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, 2005 was approximately $4.3
million compared to a $3.4 million working capital as of December 31, 2004. The
increase is attributable to positive cash flow from operations and earnings. Our
current ratio at December 31, 2005 is 2.02 to 1. 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, 2005, 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, 2005, net cash generated by operating
activities was approximately $1.2 million and we had a net increase in cash of
$5.7 million, of which $5 million was a result of converting securities
available-for-sale into money market funds at year-end. 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, 2005 were
approximately $206,000, of which $149,000 consisted of equipment purchases and
$58,000 in capitalizing the cost of producing various Working Value courses.
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, 2005 we made debt principal payments of
approximately $56,000. 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 in 2004. At year-end, our total
indebtedness for borrowed money, including capital lease financings, was
approximately $ 63,000, which consisted of the following:
o EQUIPMENT LEASING. At December 31, 2005, the balance on all existing
equipment leases was $64,000. 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 $44,000.
28
o EQUIPMENT PURCHASES. At December 31, 2005, we had an outstanding
balance of $19,000 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, 2005 we had
commitments under the lease for executive offices in Hawthorne, New York and the
Working Values executive offices in Sharon, Massachusetts aggregating $1.8
million through February 2010. The Sharon lease was renewed effective March 1,
2006 at a monthly rent of $1525. Finally, in connection with our acquisition of
the Working Values assets, the seller was entitled to receive up to $200,000 of
additional consideration if Working Values attains specific performance
objectives during the two-year period following the acquisition. Upon the
expiration of the two year period, none of this contingent consideration had
been earned.
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 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
29
effective for all fiscal years beginning after June 15, 2005. We do 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. We do not believe
that SFAS No. 153 will have a material impact on its results of operations or
cash flows.
In 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections" which applies to all voluntary changes in accounting
principles and changes required by an accounting pronouncement. FASB 154
requires a retrospective application to new accounting pronouncements. FASB 154
is effective for all fiscal years ending after December 15, 2005. We do not
believe that it is currently affected by this pronouncement.
ITEM 7. FINANCIAL STATEMENTS
See the index to Financial Statements below, beginning on page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective November 22, 2004, we dismissed McGladrey & Pullen, LLP
("M&P"), which had previously served as our independent accountants. As of
November 23, 2004 we engaged Holtz Rubenstein Reminick LLP ("Holtz") as our new
independent accountants. Our Audit Committee recommended that we change audit
firms, directed the process of review of candidate firms to replace M&P and made
the final decision to engage Holtz.
There were no disagreements with M&P or occurrence of any event
described in paragraph (a)(1)(iv) of Item 304 of Regulation S-B.
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 to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act (i) is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms and
(ii) is accumulated and communicated to our management, including its chief
executive and chief financial officers, as appropriate to allow timely decisions
regarding required disclosure.
b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
changes in our internal controls over financial reporting 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.
30
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 2006 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 2006 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 2006 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 2006 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)
31
10.2 Third Amended Employment Agreement between SmartPros Ltd.
and Allen S. Greene (1)
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*
23.1 Consent of Holtz Rubenstein Reminick LLP*
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
32.2 Chief Financial Officer Certification pursuant to section
906 of the Sarbanes-Oxley Act of 2002*
-----------
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 2006 annual meeting of
stockholders, which information is incorporated by reference herein.
33
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 27, 2006
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 27, 2006.
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/ ALLEN S. GREENE Chairman of the Board of Directors
-------------------------------
Allen S. Greene
/s/ JOHN J. GORMAN Director
-------------------------------
John J. Gorman
/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
34
SMARTPROS LTD. AND SUBSIDIARY
================================================================================
REPORT ON AUDITS OF CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
SMARTPROS LTD. AND SUBSIDIARY
CONTENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004 PAGES
--------------------------------------------------------------------------------
FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheet F-2
Consolidated Statements of Operations F-3
Consolidated Statement of Stockholders' Equity (Deficiency) F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-6 - F-16
================================================================================
FINANCIAL STATEMENTS
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, 2005, and the related consolidated statements
of operations, stockholders' equity (deficiency) and cash flows for the two
years ended December 31, 2005 and 2004. 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 audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits 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 audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
SmartPros Ltd. and Subsidiary as of December 31, 2005, and the results of their
operations and their cash flows for the two years ended December 31, 2005 and
2004, in conformity with accounting principles generally accepted in the United
States of America.
Melville, New York
February 24, 2006
F-1
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
================================================================================
DECEMBER 31, 2005
--------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 7,505,691
Accounts receivable, net of allowance for
doubtful accounts of $40,429 777,122
Prepaid expenses and other current assets 254,176
-------------------
Total Current Assets 8,536,989
-------------------
Property and Equipment, net
Goodwill 493,604
Other Intangibles, net 53,434
Other Assets - Restricted Cash 2,158,593
Total Assets 150,000
-------------------
$ 11,392,620
===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable
Accrued expenses $ 228,629
Current portion of capital lease and equipment financing obligations 277,159
Deferred revenue 38,148
Total Current Liabilities 3,689,486
-------------------
4,233,422
-------------------
Long-Term Liabilities:
Capital lease and equipment financing obligations
Other liabilities 25,992
Total Long-Term Liabilities 160,193
-------------------
186,185
-------------------
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 5,035,716 outstanding 514
Additional paid-in-capital 16,418,034
Accumulated deficit (8,785,935)
-------------------
Common stock in treasury, at cost - 109,731 shares 7,632,613
Deferred compensation (384,600)
Note receivable from stockholder (75,000)
Total Stockholders' Equity (200,000)
-------------------
Total Liabilities and Stockholders' Equity 6,973,013
-------------------
$ 11,392,620
===================
================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-2
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
========================================================================================
YEARS ENDED DECEMBER 31, 2005 2004
----------------------------------------------------------------------------------------
Net Revenues $ 10,430,210 $ 10,150,738
Cost of Revenues 4,161,939 4,002,738
-------------------------------------
Gross Profit 6,268,271 6,148,000
-------------------------------------
Operating Expenses:
Selling, general and administrative 5,231,101 4,692,748
Depreciation and amortization 580,991 716,378
-------------------------------------
5,812,092 5,409,126
-------------------------------------
Operating Income 456,179 738,874
-------------------------------------
Other Income (Expense):
Interest income 220,805 37,802
Interest expense (8,017) (65,307)
-------------------------------------
212,788 (27,505)
-------------------------------------
Provision for Income Taxes - -
-------------------------------------
Net Income $ 668,967 $ 711,369
=====================================
Net Income Per Common Share:
Basic net income per common share $ 0.13 $ 0.23
=====================================
Diluted net income per common share $ 0.13 $ 0.23
=====================================
Weighted Average Number of Shares Outstanding
Basic 5,082,359 3,086,359
=====================================
Diluted 5,111,158 3,119,322
=====================================
================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-3
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
Common Stock Preferred Stock Additional
------------------ ------------------ Paid-in
Shares Amount Shares Amount Capital
-----------------------------------------------------------
Balance, January 1, 2004 2,638,484 $ 264 14,979 $ 15 $ 10,213,459
Conversion of Preferred Shares 619,522 62 (14,979) (15) (47)
Common Stock Issued Through Public Offering 1,800,000 180 - - 6,024,091
Common Stock Issued for Services 42,539 4 - - (4)
Restricted Common Stock Granted to Officer 40,000 4 - - 169,996
Amortization of Deferred Compensation - - - - -
Net Income - - - - -
-----------------------------------------------------------
Balance, December 31, 2004 5,140,545 514 - - 16,407,495
Common Stock Issued by Exercise of Options 4,902 - - - 10,539
Purchase of Treasury Shares (51,725) - - - - -
Amortization of Deferred Compensation - - - - -
Net Income - - - - -
-----------------------------------------------------------
Balance, December 31, 2005 5,145,447 $ 514 - $ - $ 16,418,034
===========================================================
Receivable Total
Accumulated Deferred from Treasury Stockholders'
Deficit Compensation Stockholder Stock Equity (Deficiency)
-------------------------------------------------------------------------
Balance, January 1, 2004 $ (10,166,271) $ - $ (200,000) $ (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 - (170,000) - - -
Amortization of Deferred Compensation - 42,500 - - 42,500
Net Income 711,369 - - - 711,369
------------------------------------------------------------------------
Balance, December 31, 2004 (9,454,902) (127,500) (200,000) (220,000) 6,405,607
Common Stock Issued by Exercise of Options - - - - 10,539
Purchase of Treasury Shares (51,725) - - - (164,600) (164,600)
Amortization of Deferred Compensation - 52,500 - - 52,500
Net Income 668,967 - - - 668,967
-----------------------------------------------------------------------
Balance, December 31, 2005 $ (8,785,935) $ (75,000) $ (200,000)$ (384,600) $ 6,973,013
=======================================================================
================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4
SMARTPROS LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
=======================================================================================================================
YEARS ENDED DECEMBER 31, 2005 2004
----------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 668,967 $ 711,369
--------------------------------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 580,991 716,378
Bad debts (30,571) 6,532
Stock compensation 52,500 42,500
Changes in operating assets and liabilities:
(Increase) decrease in operating assets:
Accounts receivable 238,708 (329,423)
Prepaid expenses and other current assets (78,906) (46,690)
Other assets 17,196 9,369
(Decrease) increase in operating liabilities:
Accounts payable and accrued expenses (227,072) (350,080)
Deferred revenue (51,980) 326,242
Other liabilities (4,714) 18,558
--------------------------------------
Total adjustments 496,152 393,386
--------------------------------------
Net Cash Provided by Operating Activities 1,165,119 1,104,755
--------------------------------------
Cash Flows from Investing Activities:
Investment in securities available-for-sale 5,000,000 (5,000,000)
Acquisition of property and equipment (148,526) (115,316)
Capitalized course costs (57,833) -
Cash paid for business acquisition - (3,500)
--------------------------------------
Net Cash Provided by (Used in) Investing Activities 4,793,641 (5,118,816)
--------------------------------------
Cash Flows from Financing Activities:
Purchase of treasury shares (164,600) -
Payments on note payable - treasury stock - (60,000)
Proceeds from issuance of long-term debt - 23,582
Net proceeds from issuance of common stock 10,539 6,024,271
Payments on long-term debt - (683,003)
Payments under capital lease obligations (55,999) (80,791)
--------------------------------------
Net Cash (Used in) Provided by Financing Activities (210,060) 5,224,059
--------------------------------------
Net Increase in Cash and Cash Equivalents 5,748,700 1,209,998
Cash and Cash Equivalents, beginning of year 1,756,991 546,993
--------------------------------------
Cash and Cash Equivalents, end of year $ 7,505,691 $ 1,756,991
======================================
Supplemental Disclosure:
Cash paid for interest $ 8,017 $ 65,307
======================================
Supplemental Disclosure of NonCash Investing and Financing Activities:
Common stock issued in exchange for note receivable $ - $ 170,000
======================================
Equipment purchased under capital leases $ - $ 10,135
======================================
================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-5
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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. 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, 2005 and 2004,
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 that are stated at cost and
approximate market value.
INVESTMENTS - The Company has established a policy to invest proceeds
from its public offering in AAA-rated bonds with short-term maturities
or money market funds. 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, 2005, the Company had no short-term investments.
Unrealized gains and losses on available-for-sale securities are
recorded as a separate component of stockholders' equity.
================================================================================
F-6
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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, 2005 and
2004, 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, 2005
and 2004.
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 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. 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.
================================================================================
F-7
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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, 2005, the Company capitalized the cost of its
Sarbanes-Oxley Toolkit and related course developments in the amount of
$239,149. At December 31, 2005, the Company has included these
capitalized course costs in intangible assets, net of accumulated
amortization of $120,878. 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 PER SHARE - Basic net income per share is computed by
dividing income 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.
The reconciliation for the years ended December 31, 2005 and 2004 is as
follows:
YEARS ENDED DECEMBER 31, 2005 2004
-------------------------------------------------------- ------------------- ------------------
Weighted Average Number of Shares Outstanding $ 5,082,359 $ 3,086,359
Effect of Dilutive Securities, common stock equivalents 28,799 32,963
------------------- ------------------
Weighted Average Number of Shares Outstanding, used for
computing diluted earnings per share $ 5,111,158 $ 3,119,322
=================== ==================
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, 2005 2004
------------------------------------------------------------------------ ------------------
Net Income, as reported $ 668,967 $ 711,369
Deduct Stock-Based Compensation Expense Determined
Under Fair Value-Based Method (43,969) (165,362)
------------------- ------------------
Pro Forma Net Income $ 624,998 $ 546,007
=================== ==================
Basic Income Per Share, as reported .13 .23
=================== ==================
=================== ==================
Basic Income Per Share, pro forma .12 .18
=================== ==================
=================== ==================
Diluted Income Per Share, as reported .13 .23
=================== ==================
=================== ==================
Diluted Income Per Share, pro forma .12 .18
=================== ==================
================================================================================
F-8
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
The fair value of options granted in 2005 and 2004 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% to 4.4%, an average
expected life of 10 years, an expected volatility of 32.5% and the
assumption that no dividends will be paid. The weighted average fair
value per option of options granted during 2005 and 2004 was $1.96 and
$1.40, 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 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
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.
In 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections" which applies to all voluntary changes in accounting
principles and changes required by an accounting pronouncement. FASB
154 requires a retrospective application to new accounting
pronouncements. FASB 154 is effective for all fiscal years ending after
December 15, 2005. The company does not believe that it is currently
affected by this pronouncement.
ADVERTISING - Advertising is expensed as incurred and was approximately
$64,000 and $42,000 for the years ended December 31, 2005 and 2004,
respectively.
================================================================================
F-9
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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 was entitled to receive up to $200,000 as
additional consideration based on achieving certain net profits through
April 2005. No such contingent consideration was earned.
3. PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
DECEMBER 31, 2005
-------------------------------------- ------------------
Furniture, Fixtures and Equipment $ 3,238,001
Leasehold Improvements 182,549
------------------
3,420,550
Less Accumulated Depreciation 2,926,946
------------------
$ 493,604
==================
Depreciation expense for the years ended December 31, 2005 and 2004
were approximately $199,000 and $361,000, respectively. At December 31,
2005, property and equipment included assets that were acquired under
capitalized leases of approximately $155,000 and accumulated
depreciation of approximately $75,000.
4. GOODWILL AND INTANGIBLE ASSETS
The components of intangible assets for December 31, 2005 are as
follows:
Accumulated Carrying
Cost Amortization Value
------------------ ------------------ ------------------
Sarbanes-Oxley Toolkit $ 239,149 $ 120,878 $ 118,271
Evergreen Client List 3,500 700 2,800
Engineering Courses 2,766,837 1,863,279 903,558
Rights to CPA Report ("CPAR") 1,700,000 1,105,014 594,986
------------------ ------------------ ------------------
4,709,486 3,089,871 1,619,615
P2N:
Trade names 200,000 40,000 160,000
Courses 200,000 90,000 110,000
Technology documentation 150,000 105,000 45,000
Customer database 100,000 45,000 55,000
Other 187,504 95,976 91,528
------------------ ------------------ ------------------
Total P2N 837,504 375,976 461,528
------------------ ------------------ ------------------
Working Values:
Course content 50,000 25,000 25,000
Trademarks 10,000 - 10,000
Client list, domain names and other 44,950 2,500 42,450
------------------ ------------------ ------------------
104,950 27,500 77,450
------------------ ------------------ ------------------
$ 5,651,940 $ 3,493,347 $ 2,158,593
================== ================== ==================
================================================================================
F-10
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
The aggregate amortization expense for each of the years ended December
31, 2005 and 2004 was approximately $382,000.
Estimated amortization expense for the five years subsequent to
December 31, 2005 is as follows:
YEARS ENDING DECEMBER 31,
-------------------------------- ------------------
2006 $ 421,000
2007 360,000
2008 354,000
2009 237,000
2010 152,000
The following table presents the changes in the carrying amount of
goodwill and other intangibles during the year ended December 31, 2005:
Other
Goodwill Intangibles
--------------------------------- ------------------ ------------------
Balance, January 1, 2004 $ 53,434 $ 2,679,503
Amortization Expense - (381,893)
Goodwill and Intangibles Acquired - 184,818
------------------ -------------------
Balance, December 31, 2004 53,434 2,482,653
Amortization Expense - (381,683)
Goodwill and Intangibles Acquired - 57,833
------------------ -------------------
Balance, December 31, 2005 $ 53,434 $ 2,158,593
================== ===================
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 6.0% and 7.1% per annum. The minimum annual
payments and present values of these payments as of December 31, 2005
are as follows:
2006 $ 40,863
2007 26,649
------------------
67,512
Less Amount Representing Interest 3,372
------------------
64,140
Less Current Portion 38,148
------------------
$ 25,992
==================
6. INCOME TAXES
At December 31, 2005, the Company has net deferred tax assets of
approximately $2,720,000, 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 $97,000 for the year ended
December 31, 2005. Realization of deferred tax assets depends on
sufficient future taxable income during the period that
================================================================================
F-11
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
deductible temporary differences and carryforwards are expected to be
available to reduce taxable income. At December 31, 2005, the Company
has net operating loss carryforwards available to offset future taxable
income of approximately $8,000,000, which expire in 2023.
The components of income tax expense consist of the following:
YEARS ENDED DECEMBER 31, 2005 2004
-------------------------------------------------------- ------------------- -------------------
Current Income Tax Expenses:
Federal $ - $ -
State - -
------------------- -------------------
Current Tax Expense $ - $ -
=================== ===================
Deferred Tax Expense (Benefit) Arising from:
Excess of financial over tax accounting depreciation $ 80,000 $ 130,000
Net operating loss carryforwards (400,000) (227,000)
Valuation allowance 320,000 97,000
------------------- -------------------
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:
2005 2004
------------------------------------------- ------------------- ------------------
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 and carryforwards gave rise to the following
deferred tax asset at December 31, 2005:
Depreciation and Amortization $ 130,000
NOL Carryforward 2,720,000
Valuation Allowance (2,850,000)
-------------------
$ -
===================
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.
In February 2002, 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-12
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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 2005, 4,902 options were exercised at a price of $2.15 per share.
In November 2005, the Company's board of directors authorized the
expenditure of up to $750,000 for the repurchase of common stock
commencing December 1, 2005 and ending December 1, 2006. In December
2005 the Company purchased 51,725 shares at a cost of $165,000.
At December 31, 2005, warrants covering 1,195,000 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.
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
================================================================================
F-13
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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. During 2005, 4902 options were exercised at a price
of $2.15. In addition 6,884 options at prices ranging between $2.15 and
$5.32 were cancelled and 692 options priced at $16.44 expired. The
Company also issued 10,000 options to a board member at an exercise
price of $4.00, issued 15,000 options to another board member at an
exercise price of $3.44 and issued 4,500 options to various employees
at an exercise price of $4.15. Options issued in 2005 expire in ten
years, with 25% vesting immediately and the remainder vesting equally
over the following three years. At December 31, 2005, options covering
406,531 shares of common stock were outstanding and 470,886 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,
2005 and 2004 is as follows:
Weighted
Number Exercise Average
of Options Price Exercise Price
-------------------------------- ------------------ ------------------- -------------------
Outstanding, January 1, 2004 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
------------------ ------------------- -------------------
Options Granted 29,500 3.44 - 4.00 3.74
Options Cancelled (6,884) 2.15 - 5.32 4.67
Options Expired (692) 16.44 16.44
Options Exercised (4,902) 2.15 2.15
------------------ ------------------- -------------------
Outstanding, December 31, 2005 406,531 $2.15 - $32.13 $ 4.67
================== =================== ===================
Exercisable, December 31, 2005 357,490 $2.15 - $32.13 $ 4.71
================== =================== ===================
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 48,880 3.5 $ 2.15 48,880 3.5
$ 2.42 25,850 6.1 2.42 25,850 6.1
$ 3.44 15,000 9.8 3.44 3,750 9.8
$ 4.00 10,000 9.4 4.00 2,500 9.4
$ 4.15 4,500 9.6 4.15 1,124 9.6
$ 4.27 20,225 8.8 4.27 10,111 8.8
$ 5.32 279,684 5.6 5.32 262,883 5.6
$ 8.32 773 4.1 8.32 773 4.1
$ 21.41 1,245 3.5 21.41 1,245 3.5
$ 32.13 374 3.5 32.13 374 3.5
------------------- ------------------ ------------------ -- ------------------ -------------------
406,531 6.3 $ 4.67 $ 357,490 5.8
=================== ================== ================== == ================== ===================
================================================================================
F-14
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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,
---------------------------------------------------- ------------------
2006 $ 361,200
2007 357,000
2008 357,000
2009 357,000
2010 59,500
-------------------
$ 1,491,700
===================
Deferred rent credit of approximately $160,000 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, 2005 and 2004
was approximately $355,000 and $366,000, 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 executive vice
president, its chief financial officer, its chief technology officer
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 chief financial
officer's agreement was executed in June 2005 and expires June 2008.
The employment agreement with the senior executive vice-president was
renewed on October 1, 2005 for a period of three years and the chief
technology officer's agreement was entered into at the same date for a
period of two years. Each employment agreement provides for specified
annual base salaries, subject to increases at the discretion of the
Company's Board of Directors. Under certain 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.
In January 2006, the Company's president tendered his resignation as
both a corporate officer and director effective March 1, 2006. He will
remain a corporate employee through the termination date of his
contract, which is March 31, 2006. At that time, the Company's senior
executive vice-president was named to replace him on March 1, 2006.
At December 31, 2005, the aggregate commitment under the four
employment agreements, exclusive of the president's was approximately
$730,000.
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.
================================================================================
F-15
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------
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.
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.
13. SUBSEQUENT EVENTS
In February 2006, the Company entered into an agreement to purchase
substantially all of the assets of Sage Group International Inc.
("Sage") for $225,000. Sage's primary business is the sale of a series
of training courses designed for the banking industry. In addition, the
president of Sage will become an employee of the Company.
The Company also entered into an agreement in February 2006, through a
wholly-owned subsidiary, to acquire substantially all of the assets and
the assumption of certain liabilities of Skye Multimedia, Inc. ("Skye")
for approximately $520,000. Skye is engaged in the production of
training programs primarily for the pharmaceutical industry. The
current owners of Skye are entitled to an additional payment based on
the average earnings of the unit between March 1, 2006 and December 31,
2008, less certain adjustments for use of capital and other costs. In
no event shall the total additional payments exceed $1,200,000. At
least 50% of the additional payment must be paid in cash. The remaining
amount can be paid in either cash or the Company's common stock at the
sole discretion of the Company. If the additional purchase price is
paid partly in stock, then the price of the stock shall be determined
by the average price for the twenty business day period subsequent to
December 31, 2008. In addition, the current president of Skye entered
into an employment agreement with the Company.
================================================================================
F-16