UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
Commission File Number 001-32300
SMARTPROS LTD.
(Exact name of small business issuer as specified in its charter)
Delaware 13-4100476
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(State or other jurisdiction (I.R.S. Employer of
incorporation or organization) Identification No.)
12 Skyline Drive, Hawthorne, New York 10532
-------------------------------------------
(Address of principal executive office)
(914) 345-2620
(Issuer's telephone number, including area code)
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 issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes |_| No |X|
Number of shares outstanding of each of the issuer's classes of common equity,
as of the latest practicable date: As of May 11, 2005, there were 5,082,539
shares of common stock outstanding.
Transitional Small Business Disclosure Format. Yes |_| No |X|
SMARTPROS LTD.
FORM 10-QSB REPORT
March 31, 2005
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited) 3
Balance Sheets - March 31, 2005 and December 31, 2004 3
Statements of Operations for the three-month periods ended March 31, 2004 and 2005 4
Statements of Cash Flows for the three-month periods ended March 31, 2004 and 2005 5
Notes to Interim Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis or Plan of Operation 8
Item 3. Controls and Procedures 15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 15
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits 16
SIGNATURES 16
FORWARD-LOOKING STATEMENTS
Certain statements made in this Quarterly Report on Form 10-QSB 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, 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 refer to SmartPros
Ltd., a Delaware corporation, and its predecessors.
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SMARTPROS LTD. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2005 2004
(UNAUDITED)
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ASSETS
Current Assets:
Cash and cash equivalents $ 2,916,498 $ 1,756,991
Investment securities available-for-sale 4,000,000 5,000,000
Accounts receivable, net of allowance for doubtful accounts
of $71,000 1,068,525 985,259
Prepaid expenses and other current assets 143,395 175,270
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TOTAL CURRENT ASSETS 8,128,418 7,917,520
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Property and equipment, net 570,708 544,176
Goodwill 53,434 53,434
Other intangible, net 2,387,267 2,482,653
Other assets, including restricted cash of $150,000 150,000 167,196
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3,161,409 2,703,283
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TOTAL ASSETS $ 11,289,827 $ 11,164,979
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 292,936 $ 358,867
Accrued expenses 283,627 373,993
Current portion of capital lease and equipment financing obligations 50,400 56,119
Deferred revenue 3,802,676 3,741,466
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TOTAL CURRENT LIABILITIES 4,429,639 4,530,445
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Long-Term Liabilities:
Capital lease and equipment financing obligations 53,671 64,020
Other liabilities 163,818 164,907
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TOTAL LONG-TERM LIABILITIES 217,489 228,927
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Commitments and Contingencies
Stockholders' Equity:
Convertible preferred stock, $.001 par value, authorized 1,000,000 shares,
no shares issued and outstanding -- --
Common stock, $.0001 par value, authorized 30,000,000 shares,
5,140,545 issued and 5,082,539 outstanding 514 514
Common stock in treasury, at cost - 58,006 shares (220,000) (220,000)
Additional paid-in capital 16,407,495 16,407,495
Accumulated (deficit) (9,238,810) (9,454,902)
------------ ------------
6,949,199 6,733,107
Deferred compensation (106,500) (127,500)
Note receivable from stockholder (200,000) (200,000)
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TOTAL STOCKHOLDERS' EQUITY 6,642,699 6,405,607
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,289,827 $ 11,164,979
============ ============
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3
SMARTPROS LTD. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------------------
2005 2004
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Net Revenues $ 2,848,951 $ 2,218,351
Cost of Revenues 1,082,709 853,474
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Gross Profit 1,766,242 1,364,877
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Operating Expenses:
Selling, general and administrative 1,435,160 1,185,190
Depreciation and amortization 141,243 170,971
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1,576,403 1,356,161
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Operating Income (Loss) 189,839 8,716
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Other Income (Expense):
Interest income 29,554 3,718
Interest expense (3,301) (19,794)
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26,253 (16,076)
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Income (loss) before provision for income taxes 216,092 (7,360)
Provision for Income Taxes -- --
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Net Income (Loss) $ 216,092 $ (7,360)
============ ============
Net Income (Loss) Per Common Share:
Basic net income (loss) per common share $ 0.04 $ --
============ ============
Diluted net income (loss) per common share $ 0.04 $ --
============ ============
Weighted Average Number of Shares Outstanding
Basic 5,082,539 2,604,178
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Diluted 5,117,294 2,604,178
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4
SMARTPROS LTD. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2005 2004
-------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income (loss) $ 216,092 $ (7,360)
------------ ------------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 141,243 170,971
Reduction in deferred compensation 21,000 --
Changes in operating assets and liabilities:
(Increase) decrease in operating assets:
Accounts receivable (83,266) 120,938
Prepaid expenses and other current assets 31,875 (44,662)
Other assets 17,196 --
(Decrease) increase in operating liabilities:
Accounts payable and accrued expenses (156,297) (219,240)
Deferred revenue 61,210 209,050
Other liabilities (1,089) --
------------ ------------
Total adjustments 31,872 237,050
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Net Cash Provided by Operating Activities 247,964 229,697
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Cash Flows from Investing Activities:
Reduction in investment securities available-for-sale 1,000,000 --
Acquisition of property and equipment (72,389) (25,500)
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Net Cash Provided by (Used in) Investing Activities 927,611 (25,500)
Cash Flows from Financing Activities:
Payments on note payable - treasury stock -- (18,000)
Proceeds from issuance of long-term debt -- 10,135
Payments on long-term debt -- (76,000)
Payments under capital lease obligations (16,068) (22,724)
------------ ------------
Net Cash Used in Financing Activities (16,068) (106,589)
------------ ------------
Net Increase in Cash and Cash Equivalents 1,159,507 97,608
Cash and Cash Equivalents, beginning of period 1,756,991 546,993
------------ ------------
Cash and Cash Equivalents, end of period $ 2,916,498 $ 644,601
============ ============
Supplemental Disclosure:
Cash paid for interest $ 3,301 $ 18,624
============ ============
Supplemental Disclosure of Non Cash Investing and Financing Activities:
Equipment purchased under capital leases $ -- $ 10,135
============ ============
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5
SMARTPROS LTD. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
----------------------------------------------------------------
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of SmartPros Ltd. ("SmartPros" or the "Company"), included herein have been
prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and with instructions to Form
10-QSB. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. However, in the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The accompanying unaudited condensed consolidated financial
statements should be read in conjunction with the Company's audited consolidated
financial statements for the year ended December 31, 2004 and the notes thereto
included in the Company's Annual Report on Form 10-KSB with the United States
Securities and Exchange Commission. Results of consolidated operations for the
interim period are not necessarily indicative of the operating results to be
attained for the entire fiscal year. The unaudited condensed consolidated
financial statements herein include the accounts of the Company and its wholly
owned subsidiary, Working Values, Ltd., since its inception (April 2003). All
material inter-company accounts and transactions have been eliminated.
NOTE 2. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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, financial managers and accountants in public practice. 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. Through its Working Values
subsidiary, the Company also develops various programs on governance, compliance
and ethics for corporations. 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 the
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.
USE OF 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 revenues from its subscription services as
earned. Video subscriptions are generally billed on an annual basis, while
on-line subscriptions are paid by credit card at point of sale. Both of these
types of sales are deferred at the time of billing or payment and amortized into
revenue on a monthly basis over the term of the subscription, which is generally
one year. Engineering products are non-subscription based and revenue is
recognized upon shipment or, in the case of on-line sales, payment. Revenues
from non-subscription services provided to customers, such as website 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 sale or service to be provided. Otherwise, such 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 the Company's
obligations are complete and realization of receivable amounts is assured.
6
NOTE 2. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONT'D)
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. The amortization period is three years. Other
course costs incurred in connection with any of the Company's monthly
subscription products or custom work are charged to expense as incurred.
Included in other intangible assets at March 31, 2005 are capitalized course
costs of $181,316, net of accumulated amortization of $75,549.
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.
CAPITAL STOCK
On September 10, 2004, the Company filed an amendment to its
Certificate of Incorporation, effecting a reverse stock split in which each
issued share of its Common Stock was converted into 0.5169925 new shares. The
financial statements reflect this reverse split.
EARNINGS (LOSS) PER SHARE
Basic earnings or loss per common share is net income or loss, as the
case may be, divided by the weighted average number of common shares outstanding
during the year. Basic earnings or loss per share exclude any dilutive effects
of options, warrants and convertible securities. Diluted earnings per common
share include the dilutive effect of shares of Common Stock issuable under stock
options, warrants and the Company's Series A Convertible Preferred Stock.
Diluted earnings per share are computed using the weighted average number of
Common Stock and Common Stock equivalent shares outstanding during the period.
Common Stock equivalent shares of 34,755 for the period ended March 31, 2005
include the Company's stock options and warrants that are dilutive. At March 31,
2004, all Common Stock equivalents are excluded from the computation because the
effect of their inclusion would be anti-dilutive.
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 loss and net earnings
per share if expense was measured using the fair value recognition provisions of
FASB Statement No. 123 "Accounting for Stock-Based Compensation":
7
NOTE 2. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONT'D)
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2005 2004
-------------------------------
Net income (loss) as reported $ 216,092 $ (7,360)
Add: Stock-based employee compensation expense
included in reported net income (loss), net of
related tax effects -- --
Deduct: Stock-based compensation expense
determined under fair value-based method (7,606) (39,038)
--------- ---------
Pro forma net income (loss) $ 208,486 $ (46,398)
========= =========
Basic earnings (loss) per share, as reported $ .04 $ --
========= =========
Diluted earnings (loss) per share, as reported $ .04 $ --
========= =========
Pro forma basic earnings (loss) per share $ .04 $ --
========= =========
Pro forma diluted earnings (loss) per share $ .04 $ --
========= =========
The fair value of options granted in 2004 were estimated on the date of
grant using the Black-Scholes Option Pricing model with an average assumed
risk-free interest rate of 4.0%, an average expected life of 10 years, an
expected volatility of close to zero and the assumption that no dividends will
be paid. The weighted average fair value per option of options granted in 2004
was $1.40. In October 2004, subsequent to the Company's initial public offering,
the company granted 22,925 options to employees at an exercise price of $4.27.
On May 10, 2005 the Company awarded a grant of 10,000 options to the Chairman of
the Audit Committee of which 2,500 vested immediately and 2,500 will vest on
each May 10, 2006 - 2008. The options have an exercise price of $4.00 each.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS REPORT.
CERTAIN STATEMENTS IN THIS DISCUSSION AND ELSEWHERE IN THIS REPORT CONSTITUTE
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES
AND EXCHANGE ACT OF 1934. SEE THE "FORWARD LOOKING STATEMENT" IMMEDIATELY
FOLLOWING THE TABLE OF CONTENTS. BECAUSE THIS DISCUSSION INVOLVES RISK AND
UNCERTAINTIES, OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS.
We provide learning solutions for accounting/finance and engineering
professionals, as well as ethics and compliance training for the general
corporate community. We offer "off-the-shelf" courses and custom designed
programs with delivery methods suited to the specific needs of our clients. Our
customers include approximately half of the Fortune 500 companies and a large
number of midsize and small companies.
Our learning solutions for professionals are designed to meet the
initial and ongoing licensing and continuing professional education requirements
imposed by state licensing agencies and professional standards organizations.
Most of the courses in our accounting/finance library are designed to meet these
standards and adhere to the requirements of all state boards of accountancy as
well as those of the American Institute of Certified Public Accountants,
Institute of Management Accountants, Institute of Internal Auditors, the
Association of Finance Professionals, Financial Executives International and the
Association of Government Accountants. In the engineering area, most of our
courses have been approved for continuing professional development credit by one
or more organizations, including the American
8
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. Our corporate ethics and
compliance training programs are designed to align corporate behavior with
applicable laws and regulations, as well as generally accepted codes of conduct.
So, for example, our programs may deal with issues prompted by the
Sarbanes-Oxley Act of 2002 and the U.S. Federal Sentencing Guidelines, as well
laws addressing workplace misconduct such as harassment.
Our products are available in one or more of the following formats:
print, videotapes and digital. Digital format can be delivered on CD-ROM, DVD or
over the Internet. The Internet has become our fastest growing delivery channel,
attracting new and existing subscribers. This has had a positive effect on our
revenue as well as our gross margins since online sales eliminate the cost for
materials, i.e., videotapes, packaging and shipping.
We believe that our learning solutions effectively address the needs of
professionals and companies seeking comprehensive learning resources for
themselves and their employees. Our solutions are flexible, cost-efficient and
easy to use. They alleviate many of the inefficiencies associated with
traditional classroom training, such as travel costs, scheduling difficulties
and opportunity costs. In addition, we also offer our clients a learning content
management system, which allows the professionals and their employers to track
usage and performance.
Accounting/finance continuing professional education was our original
market. This market covers corporate accountants and financial managers as well
as accountants in public practice. Initially, our accounting/finance programs
were delivered on videotape. In 1998, we recognized that, to remain competitive,
we would have to make our products available in digital format for distribution
over the Internet and corporate intranets. Towards that end, we hired
information technology professionals to build a new media department that, among
other things, would convert our programs to digital format for online delivery
and who would oversee the development of a learning content management system.
To take advantage of financing opportunities that were then available
to technology companies, we were advised to pursue an acquisition strategy that
focused on building revenues and diversifying into new markets. Based on
assurances we received from a specific financing source, we identified several
viable acquisition targets, including Virtual Education Corporation, or VEC, a
provider of license preparation and continuing professional development programs
for engineers. However, the dynamics of the capital markets changed and our
financing source was unable to raise any funds. At that point, we had already
consummated our acquisition of VEC.
The acquisition of VEC put a tremendous strain on our internal capital
resources. Although our accounting division continued to grow and generate
operating profits, overall we began losing money. In the four-year period
beginning in 2000 and ending in 2003 we generated over $10 million of losses. In
2001, we hired a new chief executive officer, Allen S. Greene, who had been the
chief operating officer of a publicly traded specialty finance company. Mr.
Greene successfully refocused on our core competencies, cut overhead,
substantially reduced debt and raised additional equity capital. By the end of
2003, we had reduced our annual loss to $315,000 and were EBITDA positive for
the second consecutive year. In 2004, we recorded our first annual profit since
1999 and completed our initial public offering.
Since 2001, we have successfully completed two key acquisitions. First,
in May 2001, we acquired substantially all of the assets of Pro2Net. In so
doing, we acquired a library of "how to" programs, a functional learning content
management system that we could market with our programs, customer lists, trade
names and computer hardware. As a result, we were able to terminate a contract
with a third party to develop a learning content management system, saving us
approximately $2 million in development costs. Our ability to provide the
value-added services represented by the learning management system is, we
believe, key to our recent revenue growth and future success.
Second, in April 2003, we acquired a library of custom-designed
integrity-based courses and other assets from Working Values Group Ltd., a
company that specialized in building custom-designed learning solutions for the
general corporate community using traditional and alternative instructional
techniques. As part of the transaction, we also hired the development team from
Working Values Group. With the increased focus on corporate governance and
ethics and the passage of the Sarbanes-Oxley Act of 2002 along with new rules
and regulations adopted by the national stock exchanges and markets, we believe
that there is a significant growth opportunity in supplying training that
addresses corporate culture as a significant risk factor.
9
The aggregate purchase price for the Pro2Net and Working Values assets
was $1.1 million in cash, stock (based on the value at the time of the
acquisition) and assumption of liabilities. In comparison, the sellers of these
assets had collectively raised more than $30 million to develop these assets and
fund their operations.
We measure our operations using both financial and other metrics. The
financial metrics include revenues, gross margins, operating expenses and income
from continuing operations. Other key metrics include (i) revenues by sales
source, i.e., accounting/finance, engineering, Working Values and video
production and e-commerce. (ii) online sales, (iii) cash flows and (iv) EBITDA.
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 October 2004 we successfully completed our initial public offering.
The net proceeds to us from the offering were $6.0 million of which we have used
$500,000 to repay certain indebtedness. We intend to use the balance, $5.5
million, cash from operations and our publicly traded stock to execute our
growth strategy, which contemplates acquiring other companies and businesses
that provide learning solutions. We intend to focus on acquisitions that will
allow us to 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 in the short term, as opposed to those that are dilutive, but
ultimately the decision will be based on maximizing shareholder value rather
than short-term profits. The size of the acquisitions will be determined, in
part, by our size, the capital available to us and the liquidity and price of
our stock. We may use debt to enhance or augment our ability to consummate
larger transactions.
There are many risks involved with acquisitions. 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. At the present time, we have no agreements or commitments for any
acquisitions. We cannot assure you that we will successfully complete any
acquisitions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations is based on our condensed 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.
10
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 website design, software development, tape
duplication, video production, video conversion, course design and development,
ongoing maintenance of our clients' online learning content management system
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. 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. Larger transactions are usually dealt with by contract,
the financial terms of which depend on the services being provided. The
contracts may have different billing arrangements resulting in either unbilled
or deferred revenue. 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 website 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. Otherwise, these services are recognized as revenues
after completion and delivery to the customer. Duplication and related services
are generally recognized upon shipment or, if later, when our obligations are
complete and realization of receivable amounts is assured. Working Values
recognizes revenue on a proportional performance basis.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Fixed, tangible assets are carried at cost less accumulated
depreciation and are depreciated using the straight-line method over the
estimated useful lives, which range from 3 years for course content to 10 years
for customer lists. Leasehold improvements are amortized over the lesser of
their estimated lives or the life of the lease. Major expenditures for renewals
and improvements are capitalized and amortized over their useful lives.
IMPAIRMENT OF LONG-LIVED ASSETS
We review long-lived assets and certain intangible assets annually for
impairment whenever circumstances and situations change such that there is an
indication that the carrying amounts may not be recovered.
STOCK-BASED COMPENSATION
We have adopted the disclosure only requirements of SFAS No. 123. As a
result, no compensation costs are recognized for stock options granted to
employees. Options and warrants granted to non-employees are recorded as an
expense at the date of grant based on the then estimated fair value of the
security in question.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2005 AND 2004
We experienced a significant improvement in operating performance in
the first quarter of 2005 compared to the first quarter of 2004. The following
table compares our statement of operations data for the three months ended March
31, 2005 and 2004. The trends suggested by this table may not he indicative of
future operating results, which will depend on various factors including the
relative mix of products sold (accounting/finance, engineering or corporate
training) and the method of sale (video or online).
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THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------
2004 2005
-------------------------- ---------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE CHANGE
----------- ----------- ----------- ------------ -------------
(all dollar amounts are in thousands)
Net revenues $ 2,218 100.0% $ 2,849 100.0% 28.4%
Cost of revenues 853 38.5% 1,083 38.0% 27.0%
----------- ---------------------------- ------------------------------
Gross profit 1,365 61.5% 1,766 62.0% 29.4%
----------- ---------------------------- ------------------------------
Selling, general and administrative 1,185 53.4% 1,435 50.4% 21.1%
Depreciation and amortization 171 7.7% 141 4.9% (17.5)%
----------- ---------------------------- ------------------------------
Total operating expenses 1,356 61.1% 1,576 55.3% 16.2%
----------- ---------------------------- ------------------------------
Operating income (loss) 9 .4% 190 6.7% 2078.1%
Other (expense), net (16) (0.7)% 26 0.9% (263.3)%
----------- ---------------------------- ------------------------------
Net income (loss) $ (7) (.3)% $ 216 7.6% (3036.0)%
----------- ---------------------------- ------------------------------
NET REVENUES
Net revenues for the quarter ended March 31, 2005 increased 28.4%
compared to net revenues for the three months ended March 31, 2004. Online sales
continue to be an important factor contributing to our overall revenue growth, a
trend that began in 2003. In the 2005 period, net revenues from online sales
accounted for approximately $685,000, or 24%, of net revenues. In the 2004
period, online sales accounted for $560,000, or 25%, of net revenues.
In 2005, net revenues from our accounting/finance and related products
were $2.0 million, as compared to $1.6 million in the prior period. This
increase is due to various factors, including converting a number of our
existing video customers to our online services, partnering with more
professional organizations and our continued marketing efforts to increase
sales. For 2005, net revenues from accounting/finance products include
subscription-based revenue of $1.6 million and direct sales of course material
on a non-subscription basis, net revenues from custom work and advertising of
$410,000. For 2004, subscription-based revenue was $1.4 million and direct sales
of course material on a non-subscription basis, custom work and advertising was
$223,000.
Net revenues from sales of our engineering products, which are not
subscription-based, were $246,000 in the first quarter of 2005 compared to
$202,000 in the first quarter of 2004. This increase is primarily attributable
to a growth in the sales of our licensing preparation and project management
courses.
Net revenues from video production, duplication, consulting and
e-commerce services for the first quarter of 2005 were $483,000 compared to
$399,000 for the first quarter of 2004. This increase is primarily attributable
to a number of special projects in our technology department and one large video
duplication sale. Under our long-standing policy, revenue is credited to the
originating department regardless of the type of service that is performed. For
example, a contract to convert videotapes to digital format is credited to the
accounting education department if that is where the sale originated, even if
the technology group performed all the services necessary to fulfill the terms
of that contract.
For the first quarter of 2005 Working Values contributed $70,000 to net
revenues compared to $12,000 in the first quarter of 2004.
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. 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.
Compared to the first quarter of 2004, cost of revenues in the first
quarter of 2005 increased by $230,000 but decreased slightly - 0.5% -- as a
percent of net revenues. The increase was primarily attributable to additional
personnel and the cost of sub-contracted labor related to various projects in
the technology department. The expenses that showed the greatest variations from
2004 to 2005 and the reasons for those variations were as follows:
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o OUTSIDE LABOR AND DIRECT PRODUCTION COSTS. Outside labor includes the
cost of hiring actors and production personnel such as directors,
producers and cameramen and the out-sourcing of non-video technology.
The cost of actors increased minimally; the cost of video production
and technology personnel increased by $150,000. Direct production
costs, which are costs related to producing videos other than labor
costs, such as the cost of renting equipment and locations, decreased
$9,000. These variations are related to the type of video production
and other projects and do not ref1ect any trends in our business. As
our business grows we may be required to hire additional production
personnel, increasing our cost of revenues.
o ROYALTIES. Royalty expense decreased in 2005 compared to 2004 by
$32,000. We have temporarily reduced royalties to one of our partners
until such time as their course material is updated. In addition, we
overestimated our expense in the first quarter of 2004, because some of
our partners were behind in providing us with information at that time.
Assuming the same level of sales in 2005 as in 2004, our royalty
payments under these agreements will be constant. However, if volume
increases or if we enter into new agreements or modify existing
agreements, the actual royalty payments in 2005 under these agreements
may be either higher or lower than they were in 2004.
o SALARIES. Overall, payroll and related costs attributable to production
personnel increased by $125,000. Most of the increase - I.E., $95,000 -
was attributable to our technology group. In addition, compensation
paid to our video production and duplication personnel increased by
$17,000. The other $13,000 is attributable to salary increases to
Working Values personnel.
o TRAVEL AND ENTERTAINMENT; SHIPPING. Travel and entertainment and
shipping expenses increased by only $3,000, reflecting our continuing
effort to control costs.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include corporate overhead such as
compensation and benefits for administrative, sales and marketing and finance
personnel, rent, insurance, professional fees, travel and entertainment and
office expenses. While general and administrative expenses in the first quarter
of 2005 were $250,000 higher than they were in 2004, as a percentage of net
revenues they decreased by 3%. Part of the increase is attributable to the costs
of being a public company such as legal, accounting, investor relations,
insurance and regulatory expenses, which we did not have in the first quarter of
2004. The increase in these expenses was $88,000. In addition, personnel costs
increased by $56,000. Selling costs, which includes advertising, promotion,
travel and entertainment, increased by $50,000. The remaining $56,000 reflects a
general increase in operating costs. We anticipate that general and
administrative expenses will continue to increase primarily as a result of
increased accounting, legal and insurance costs, attributable to the fact that
we are now a public company.
DEPRECIATION and AMORTIZATION
Depreciation and amortization expenses decreased in the first quarter
of 2005 compared to the first quarter of 2004 as a number of our assets became
fully depreciated. We expect our depreciation and amortization expenses on our
current assets to decrease in 2005 as many of our older assets are either fully
or almost fully depreciated and we do not anticipate replacing them at the same
rate.
INCOME/LOSS FROM OPERATIONS
For the three months ended March 31, 2005 net income from operations
was $190,000 compared to $9,000 in the comparable period of 2004. This is
primarily attributable to the increase innet revenues and gross profit margin
without significantly increasing our operating expenses.
OTHER INCOME/EXPENSES
Other income and expense items consist of interest paid on indebtedness
and interest earned on deposits. As a result of the successful completion of our
initial public offering, we were able to retire all of our debt (other than
capital lease obligations), reducing our interest expense. At the same time,
since we have not yet used the balance of the net proceeds, our interest income
has increased. As a result, for the
13
first quarter of 2005 we had net interest income compared to a net interest
expense for the first quarter of 2004.
NET INCOME AND LOSS
For the three months ended March 31, 2005, we recorded a net profit of
$216,000, or $0.04 per share (basic and diluted), compared to a net loss of
$7,000 for the three months ended March 31, 2004. The change from a net loss to
a net profit is attributable to increased revenue and our continuing efforts to
control our costs and expenses.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND CONTINGENCIES
Historically, we have financed our working capital requirements through
internally generated funds, sales of equity and debt securities and proceeds
from short-term bank borrowings. In October 2004 we completed our initial public
offering, which resulted in net proceeds to us of approximately $6 million.
Our working capital as of March 31, 2005 was approximately $3.7 million
compared to $3.4 at December 31, 2004. Our current ratio at March 31, 2005 was
1.84 to 1 compared to 1.75 to 1 at December 31, 2004. 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, $3.8 million at March 31, 2005
compared to $3.7 million at December 31, 2004, was 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 already
exists.
For the three months ended March 31, 2005, net cash generated by
operating activities was $248,000 and we had a net cash increase of $1.16
million, which includes a $1 million transfer from investment securities held
for sale. Exclusive of that transfer, net cash increased by $160,000 after
purchasing $72,000 of fixed assets and debt reduction of $16,000 during the
quarter. The primary components of our operating cash flows are 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 three months ended March 31, 2005 were
approximately $72,000, which consisted primarily of computer equipment
purchases. Although, we continually upgrade our technology hardware, we do not
anticipate any significant capital expenditures relating to equipment purchases
over the next 12 months.
At March 31, 2005 our only indebtedness consisted of capital lease
obligations, the balance of which was $105,000 compared to $121,000 at December
31, 2004. We have three leases with IDB Leasing, which had an aggregate
outstanding balance at March 31, 2005 of $73,000. One lease has a 48-month term
that expires in 2007, an imputed interest rate of 7.0% and monthly payments of
$2,055. A second lease has a 36-month term that expires in 2006, an imputed
interest rate of 7.5% and monthly payments of $996. The third lease has a
36-month term that expires in 2007, an imputed interest rate of 6.05% and a
monthly payment of $313. In addition, we have outstanding balances on other
capital leases of approximately $10,000. In August 2004 we financed the purchase
of a van. 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. At March 31, 2005, the balance on the loan was $22,000.
As of March 31, 2005 we had commitments under operating leases -
principally the leases for executive offices in Hawthorne, New York and the
Working Values executive offices in Sharon, Massachusetts - aggregating $1.7
million through February 2010. In May 2004 we paid $92,000 in connection with
our termination of a sublease in Irvine, California.
We believe that the net proceeds of our initial public offering in
October 2004 together with cash flow from operations will be sufficient to meet
our working capital and capital expenditure requirements from the next 12
months.
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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.
ITEM 3. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's
management, with the participation of the chief executive officer and the chief
financial officer, carried out an evaluation of the effectiveness of the
Company's "disclosure controls and procedures" (as defined in the Securities
Exchange Act of 1934, as amended (the "Exchange Act") Rules 13a-15(e) and
15-d-15(e)) as of the end of the period covered by this quarterly report (the
"Evaluation Date"). Based upon that evaluation, the chief executive officer and
the chief financial officer concluded that, as of the Evaluation Date, the
Company's disclosure controls and procedures are effective, providing them with
material information relating to the Company as required to be disclosed in the
reports the Company files or submits under the Exchange Act on a timely basis.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
changes in the Company's internal controls over financial reporting, known to
the chief executive officer or the chief financial officer that occurred during
the period covered by this report that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II
OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS.
We are not currently a party to any legal proceeding that we deem
material.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
RECENT SALES OF UNREGISTERED SECURITIES
On August 3, 2004, the Board authorized the issuance of 40,000 shares
of common stock to Allen S. Greene, our chief executive officer. The shares were
issued to Mr. Greene on October 19, 2004. Of the 40,000 shares issued, 10,000
shares vested immediately and 10,000 shares will vest on each of October 19,
2005, 2006 and 2007. Mr. Greene is deemed the owner of these shares as of the
date of grant and, as such, will be entitled to vote them on all matters
presented to stockholders for a vote and will be entitled to dividends, if any,
payable on our common stock with respect to such shares. If Mr. Greene
terminates his employment with us voluntarily or we terminate him for "cause,"
as defined in his employment agreement, any unvested shares will be forfeited
and will revert to the company. If Mr. Greene's employment with us is terminated
without "cause," or if his employment is terminated as a result of his death or
disability (as defined in his employment agreement), or if we experience a
change in control (as defined in his employment agreement) any unvested shares
will immediately vest.
In January 2005, we issued 42,539 shares of restricted common stock and
21,269 warrants having an exercise price of $7.125 per share to KS Partners, an
affiliate of Morse, Zelnick, Rose & Lander LLP, our corporate and securities
attorneys. These securities were issued in connection with our initial public
offering and therefore were treated as outstanding at December 31, 2004. This
issuance is exempt from registration, as it was made pursuant to Sections 4(2)
and 4(6) of the Securities Act of 1933, as amended.
USE OF PROCEEDS
On October 19, 2004, the Company's 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 the Company's common stock, par value $.0001 per
share, and one and one-half common stock purchase warrants, was declared
effective by the
15
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. The Company sold
all 600,000 Units covered by the Registration Statement. Paulson Investment
Company, Inc. was the representative of the underwriters of the offering. The
gross proceeds to the Company from the offering were $7,650,000 and the net
proceeds were $6.0 million. As of the date hereof, we used $490,000 of the net
proceeds to repay indebtedness. The remaining $5.5 million will be used for
working capital and general corporate purposes, including acquisitions.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
a. Exhibits:
Exhibit No. Description
---------- ------------
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SmartPros Ltd.
-------------------
(Registrant)
Date: May 11, 2005 /s/ Allen S. Greene
-------------------
Chief Executive Officer
Date: May 11, 2005 /s/ Stanley P. Wirtheim
-----------------------
Chief Financial Officer
(Principal Financial Officer)
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