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, 2006
or
[ ] 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.
(Name of Small Business Issuer 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
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(Address of Principal Executive Office) (Zip Code)
(914) 345-2620
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Issuer's Telephone Number Including Area Code
Securities registered under Section 12(b) of the Exchange Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------------------
Common Stock, par value $.0001 per share American Stock Exchange
Warrants American Stock Exchange
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|
Issuer's revenues for its most recent fiscal year: $12,462,086
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, $25,400,000 as of March 21, 2007
The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 5,186,505
DOCUMENTS INCORPORATED BY REFERENCE
The definitive proxy statement, which the issuer expects to file before
April 30, 2007, relating to the issuer's Annual Meeting of Stockholders to be
held on or about June 14, 2007, 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..........................................................................21
Item 3.......Legal Proceedings................................................................................21
Item 4.......Submission of Matters to a Vote of Security Holders..............................................21
PART II
Item 5.......Market for Common Equity and Related Stockholder Matters and Issuer Purchases Of
Equity Securities................................................................................21
Item 6.......Management's Discussion and Analysis of Financial Condition and Results of
Operation........................................................................................22
Item 7.......Financial Statements.............................................................................30
Item 8.......Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.......................................................................................31
PART III
Item 9.......Directors, Executive Officers, Promoters, Control Persons and Corporate Governance;
Compliance with Section 16(a) of the Exchange Act................................................31
Item 10......Executive Compensation...........................................................................31
Item 11......Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters..............................................................................32
Item 12......Certain Relationships and Related Transactions, and Director Independence........................32
Item 13......Exhibits.........................................................................................32
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, the
inclusion of such information should not be regarded as a representation by us
or any other person that our objectives and plans will be achieved. The terms
"we," "our," "us," or any derivative thereof, as used herein shall mean
SmartPros Ltd., a Delaware corporation.
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PART I
ITEM 1 DESCRIPTION OF BUSINESS
OVERVIEW
We provide learning solutions for accounting/finance, legal and
engineering professionals--three large vertical markets with mandatory
continuing education requirements. In addition, we provide learning and training
solutions for the pharmaceutical, banking, securities, insurance and technology
industries. 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.
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.
Our entire continuing legal education library is approved in 12 states
and some or all of the continuing legal education courses are approved in 24
states. Unlike the accounting and engineering professions, where a national
organization overseas the approval process for continuing education courses, in
the legal profession each state's bar, state judiciary or other organization
controls the approval process.
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, videotape 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.
RECENT ACQUISITIONS
We made four acquisitions during 2006. In February 2006 we acquired
Skye Multimedia Ltd. and substantially all of the assets of Sage Group
International, Inc. Skye develops 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. Sage's assets included 58 online training solutions totaling
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over 190 hours, for the banking, securities and insurance industries, which are
now part of our financial services training division.
In October 2006, we acquired substantially all of the assets of MGI
Management Institute (MGI). MGI designs, develops and conducts distance
education courses covering a wide variety of professional topics for engineers,
manufacturing professionals and quality managers. These courses are delivered
primarily in self-study format.
In November 2006, through our Working Values subsidiary, we acquired
substantially all of the assets of Cognistar Interactive Corporation
(Cognistar). Cognistar offers 167 online courses in continuing legal education
(CLE) and business ethics, reflecting over 200 hours of course material. Some or
all of these courses qualify for CLE credit in 24 states. Cognistar also
produces and hosts various custom-designed courses, which meet specific client
needs.
On March 1, 2007, we acquired substantially all of the assets of The
Selbst Group Inc. The Selbst Group, founded in 1974, is a specialized consulting
firm providing sales, sales management training, product training and marketing
support for the financial services industry.
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 in March 2003 under the laws of the
Commonwealth of Massachusetts. Skye Multimedia Ltd. was formed in February 2006
under the laws of the State of New Jersey for the purpose of acquiring certain
assets and liabilities of Skye Multimedia Inc.
INDUSTRY BACKGROUND
The American Society for Training and Development, in its 2006 STATE OF
THE INDUSTRY report, estimates that in 2006 U.S. organizations spent $109
billion on employee learning and development. 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 330,000 members
representing approximately 60% of all the certified public accountants in the
United States, we estimate there are currently more than 500,000 certified
public 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
(National Association of State Boards of Accountancy). Three states require
registration with their licensing
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agencies. The remaining states, other than Wisconsin, and 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 2006 over 40,000
engineers sat for the exam and 73% 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 2006,
64% 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.
Forty-one states require some form of continuing legal education with
requirements ranging between ten hours per year to a total of 45 hours every
three years. All courses have to be approved by the respective bar associations
of each state. Unlike other professions, each state rather than a national
organization exercises control over the requirements and content approval of
continuing legal education courses, which makes the approval process more
difficult.
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 resulted
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.
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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 the needs of their respective industries, 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 approximately 2,000 hours of programs
that currently are available in one or more formats including print, videotape,
CD-ROM or online--approximately 1,000 in accounting/finance, 600 in engineering,
190 hours in banking and 200 hours in legal training, not including
custom-designed courses. We develop customized courses based on specifications
provided to us by our clients in both financial and non-financial industries.
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.
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 in
print, CD-ROM format and/or 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.
Working Values' Cognistar division develops programs and provides
services to the legal and corporate compliance market. These solutions include
self-paced courses in a content-rich, engaging environment, that take full
advantage of the Internet, and, most importantly, can be provided at
significantly
5
lower cost than other continuing education experiences. Cognistar products
include accredited continuing legal education programs as well as customized
corporate training programs.
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 marketplace 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, with the ASCE 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.
ASSOCIATION OF OPERATIONS MANAGEMENT. APICS sells our supply chain,
inventory and production courses.
AMERICAN INTELLECTUAL PROPERTY LAWYERS ASSOCIATION. We convert the
AIPLA's live seminars to online format. The AIPLA markets our course catalog and
their members are entitled to a discount off the list price.
WESTERN INDEPENDENT BANKERS ASSOCIATION. The WIBA sells our banking
course library to their members on their own co-branded Professional Education
Center.
OUR STRATEGY
Our objective is to become a leading provider of continuing
professional education and corporate training solutions in the United States. To
achieve this goal, we will pursue the following strategies:
EXPAND LIBRARY OF CONTENT. We believe that our future success depends,
in part, on our ability to develop and acquire new content. The new content
could either expand or supplement our existing libraries
6
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 as evidenced by our
recent acquisitions in the legal and banking markets.
KEEP PACE WITH TECHNOLOGY. We believe that our ability to deliver our
products in multiple formats is critical to our continued success. 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. In 2006, we standardized our course delivery into
a Flash-based streaming media model which we call our e-Learning Player (eLP).
As a result, we are now able to deliver our content online to a greater number
of Fortune 1000 and other companies. We plan to continue to monitor the
development and market acceptance of new technologies and will make the
necessary investment to adapt our products and services to them.
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 credit 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, DVD and online. The videotape and DVD formats 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, 2007.
SMARTPROS ADVANTAGE. SPA is a skills-based learning library containing
over 150 courses, varying in length from one to six credit hours. We produce
these programs in our own production facility. We pay
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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 $22.95 to $183.60 per course. The list
price for a one-year subscription purchased online is $389.
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 equal to 96 credit hours each year.
We also maintain an online archive containing the most recent 72 programs
representing 144 credit hours 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 $389 per user.
CPA REPORT ("CPAR"). This library of programs covers topics in public
accounting and is distributed primarily to accountants in public practice. 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 representing 132 credit hours.
The list price for a one-year subscription to CPAR is $1,675 and $389 for the
online version.
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 representing 64 credit hours. The list price for a
one-year subscription to the CPAR Government and Not-for-Profit edition is $475
for the video and $189 for the online version.
In addition to the libraries described above, the contents of which are
available on a subscription basis, we also produce customized programs for our
clients. In some cases, the client will author the content and retain us to
videotape the program and convert it into a digital format that can be
distributed via the Internet or internally through the corporate intranet. In
other cases, we will write and produce the entire program for the client. We
then deliver this custom content either through our proprietary learning content
management system or that of the client. These customized products can be
designed to qualify for CPE credit.
ENGINEERING
Our engineering library includes the following:
PE EXAM REVIEW. Our interactive PE exam review course for civil
engineers was developed jointly with the American Society of Civil Engineers and
the Boston Society of Civil Engineers Section and is designed to prepare
engineers to meet the entry-level requirements for civil engineering. The PE
Exam Review course, with over 50 hours of material, is an interactive multimedia
tool that simulates the actual professional engineering exam using demonstration
problems that are comparable to the problems that are found on the actual exam.
The course includes seven complete, self-contained course modules that cover the
following subjects: Transportation; Sanitary and Environmental; Hydraulics and
Hydrology; Structures; Geotechnical; Surveying; and Economics. The list price
for the review course is $645.
In October 2006, we purchased certain assets, including the course
content of MGI, a provider of self-study courses to prepare for the PE exam. The
MGI course work covers the same set of modules as our CD-ROM or online version,
in a paper-based, self-study format that provides for instructor mentoring via
email, telephone or submission of mini-exams for grading. The list price for the
MGI review course is $390.
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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, one of the largest engineering firms 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 one of the first completely online
interactive project management courses. 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 $299 for either the combination CD-ROM/online version or for the online
version. We also private label the course for our strategic partners so they can
market it to their members.
The MGI self-study version of this course also provides for instructor
mentoring and has a list price of $390.
SUPPLY CHAIN AND CPIM CERTIFICATION. MGI provides to members of APICS a
series of five courses that can be taken as either stand alone coursework or to
become certified in Production and Inventory Management (CPIM). The courses are
designed to help the user develop knowledge and skills in the essential areas of
materials management and integrated resource management. Each APICS home-study
course requires approximately 25 to 30 hours to complete. The list price for
non-members for each course is $325.
CORPORATE GOVERNANCE, COMPLIANCE AND ETHICS
Working Values develops corporate governance, compliance and ethics
programs for major corporations and other business enterprises. Working Values
currently offers the following products and 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 regulations. These products help
create a culture of compliance through assessment methodologies 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 that 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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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.
LEGAL
Working Values' Cognistar division offers 167 online courses in
continuing legal education and business ethics. One or more of these courses are
accredited for over 200 hours of CLE credit in approximately 24 states. In
addition, Cognistar develops customized courses for its clients on a consulting
basis.
BANKING AND INSURANCE
Through our financial services training division, we have added 58
courses totaling over 190 hours, in the banking, securities and insurance areas.
Course offerings include banking compliance, general banking, general bank
management, insurance, lending, retirement and estate planning, and
industry-related sales and service. Most of these courses are certified by
either the Institute of Certified Bankers or state insurance departments--and in
addition, some courses meet the requirements of the Certified Financial Planner
(CFP) Board of Standards, Inc.
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 producing 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 Web sites 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 Web site
development and hosting, and consulting arrangements. For example, companies
that have internal education programs have engaged us to convert those programs
from workbook, instructor-led or videotaped-based courses to an e-learning
format. We also offer our customers a broad range of support services, including
technical support for our learning
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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.
To further support and enhance our design and production capabilities,
we 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 industries, 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 and Stephen Henn in the areas of corporate governance, compliance, ethics
and legal. Mr. Jacobs, who is the head of the department and the executive
producer of our FMN product, is an attorney and has been developing continuing
education programs for accounting and finance professionals since 1987. Mr.
Fingerhut, the Company's Co-Founder and President, is a certified public
accountant and oversees the development of our accounting and banking programs
and new product development. Ms. Stefano is a certified public accountant and a
professor of accounting and is currently responsible for updating existing and
introducing new courses in our SPA catalog. 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. Mr. Henn is
also an attorney who was the former president of Cognistar and joined us as part
of the acquisition. He is responsible for the development of course content and
customized design in the legal area.
Seth Oberman, the President of Skye, is responsible for the development
and marketing of customized courses and training programs for the
pharmaceutical, financial services and other industries that Skye services.
We are planning to devote more internal resources to developing
programs. We hire independent contractors to update, develop or assist in
developing programs for us. 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 17 people. The sales
staff 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, David Gebler, Seth Oberman and Stephen Henn, dedicate
varying portions of their time and
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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 which we partner; public
relations activities; advertising on our Web site and the Web sites of our
strategic partners; participating in trade shows; and ongoing customer
communication programs. We build brand awareness through our strategic
relationships with the leading professional associations and organizations and
the leading commercial content providers within the markets we serve. These
strategic relationships include co-branding initiatives on new and existing
products, joint advertising campaigns and e-commerce relationships.
TECHNOLOGY
Our proprietary learning content management system, the SmartPros
Professional Education Center, employs a logical and physical architecture that
facilitates rapid development, deployment and customization of Internet-based
solutions for organizational e-learning. Our core systems use a series of
scalable application Web servers, XML and MS-SQL data sources, and utilize
industry standard Web-browser and Internet technologies for content delivery to
the end users. To ensure limited downtime and product lines that are free of
bandwidth limitations as they grow our redundant server system is located at a
secure Verizon co-location data center one mile from our Hawthorne, New York,
main office. Currently, we use three co-location cabinets in their facility to
house our server network infrastructure. This co-location allows the freedom to
completely control our server infrastructure while providing us with 24/7
monitoring, support, redundant Internet connectivity and full generator power
backup.
The SmartPros Professional Education Center includes a scalable suite
of applications and features that can be streamed via the Internet or a
corporate intranet. The basic features of the system allow asynchronous
streaming of video and audio courses combined with media-timed synchronization
of supplemental material, online quizzes and final exams. Student interaction is
enhanced through the use of real-time questions to content experts with quick
response. This full service solution includes a complementary array of
communication tools such as e-mail, chat, message boards and learner tracking.
The tracking of educational needs both internal to the system as well as
external education opportunities, such as stand-up and leader-led training, are
maintained using a student-managed course tracking feature called "My Courses."
Some key features of the PEC include:
o SCALABILITY. Scalability is accomplished using a combination of
load-balancing hardware and software. Multiple, redundant servers are
deployed to handle peak periods when the largest numbers of concurrent
users are expected on the system,
o SCORM/AICC CONNECTIVITY LAYER. Where required, we use both Shareable
Content Object Reference Model (SCORM) and Aviation Industry CBT
Committee (AICC) connectivity layers to ensure our content is
deliverable through a variety of enterprise e-learning systems other
than the PEC. Additionally, the core foundation is capable of
exchanging data with third-party legacy systems with minimal effort.
o STANDARD RELATIONAL DATABASE SERVER. We use standard relational
database servers. To enhance performance and ensure that users are
served efficiently, the core foundation executes database-stored
procedures to optimize intense database processing. The core foundation
currently supports Microsoft SQL Server databases.
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o ASP-BASED APPLICATION SERVER. The business and application logic
resides on an ASP-based application server. This architecture allows us
to deploy a site across multiple servers using Microsoft Windows 2000
and 2003 Servers.
o ELECTRONIC COMMERCE ENABLED. The core foundation includes interfaces to
external electronic payment services, enabling real-time electronic
commerce. This allows the instant purchase of both one-off and
subscription-based e-learning courseware.
o INTERNET MULTIMEDIA CONTENT DELIVERY. We deliver high quality, low
bandwidth video and audio via the Internet, intranets and extranets.
This multimedia content enhances and personalizes the learning
experience. We use Flash Media as the primary delivery mechanism for
this content.
o LOW BANDWIDTH/HIGH IMPACT ANIMATIONS. Using Macromedia's Flash
technology, we deliver both animated and spoken educational material
with minimal load on corporate networks.
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
professionals 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 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 Deployment options offered to customers;
o Customer service and support;
o Price;
o Industry and professional certifications;
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o Brand identity; and
o Strategic relationships.
We believe that we compete favorably on most of these issues. While
price is always a competitive factor, we do not believe that we should compete
solely on that basis and, in fact, many of our competitors sell their products
for less than we sell ours. Particularly, in the accounting market, we believe
that our reputation and the quality of our offerings as well as our other
competitive advantages, including the breadth, depth and relevancy of our
libraries, our status as a NASBA registered sponsor, strategic relationships,
our learning content management system, our customer service and support and the
flexibility of our delivery options, allow us to price our products accordingly.
In the engineering and general corporate markets, where we have not established
our reputation to the same extent, we have less flexibility when it comes to
price. In the corporate compliance area, we believe that what will ultimately
differentiate us from our competitors will be our ability to create programs
that are designed to meet the specific corporate cultures of our clients.
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 and potential competitors have greater resources,
financial capabilities, market penetration, and more extensive libraries, which
has enabled or will enable them to establish a stronger competitive position
than we have. We sometimes compete directly with CPA2Biz. 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-
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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 principal competitors in the area of providing continuing legal
education are the Practicing Law Institute (PLI), West Legal Education Center,
ALI-ABA Direct to Desktop CLE, CLEonline, and various state bar associations.
Our principal competitors in the area of banking compliance training
and continuing education for bankers include Bankers Edge, Bankers Academy (The
Edcomm Group) and banking associations such as BAI, Bankers Training and
Certification Center, and Independent Bankers Association.
OUR COMPETITIVE ADVANTAGES
Our objective is to become a leading provider of learning solutions for
the professional, pre-professional and business communities. We believe that the
following competitive advantages will help us achieve this goal.
HISTORY AND REPUTATION. We have been providing learning solutions for
accounting and finance professionals for more than 25 years. We believe that in
the 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, legal, banking/insurance and general corporate markets, as well as
into new markets. In addition, the president of our Working Values subsidiary
has been developing values, ethics and compliance education programs since 1993.
We have been providing learning solutions for engineering professionals
since 1997. Our recently acquired legal and financial services training
divisions have been in business for eight years and five years respectively.
Our financial services training division offers banks and other
financial institutions a complete answer to many of their training needs with
access to over 200 hours of online courses and a branded PEC customized for each
bank at a reasonable price. The systems are easy for banks to set up and easy
for employees to use.
Our Skye subsidiary was originally founded in 1995 by its president and
has been providing training solutions to its customers since then.
PROFESSIONAL DESIGNATIONS AND STRATEGIC ALLIANCES. We believe that 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.
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As a NASBA-registered sponsor of continuing professional education
programs for the accounting profession, and because we have been awarded the
prestigious QAS (Quality Assurance Service) status, we believe we enjoy a
competitive advantage in the accounting/finance market. Our registration with
NASBA is renewed annually and our QAS certification was recently extended for
two more years through December 1, 2008.
EXTENSIVE LIBRARY. Our content library consists of over 2000 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. In the market for continuing legal education, we offer
national courses compared to those offered by the local bar associations which
usually deal with issues particular to that state. We also believe that our
content and delivery technology is better than that of our competitors.
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. Our
customers include Fortune 500 companies, professional firms, small- and
medium-sized companies and individuals. 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, law, insurance, technology, telecommunications, retail, aerospace,
natural resources, construction and chemicals.
END-TO-END SERVICE. All of our accounting/finance programs and our
corporate training programs are produced, filmed, edited, duplicated and
converted in-house. Our engineering programs are usually licensed from or
developed in conjunction with an independent third-party but are filmed, edited,
duplicated and converted into digital format in-house. Finally, we have a
fulfillment center from which we ship our course materials, tapes as well as
hard copies, to our customers. We believe our vertically integrated operation
results in a more efficient production process and enhances the quality of our
products.
ONLINE RESOURCE AND CONTENT PROVIDER. We own and operate multiple Web
sites, including www.smartpros.com, www.workingvalues.com, www.skyemm.com,
www.cognistar.com, www.mgi.org and www.sageonlinelearning.com. Our SmartPros Web
site has over 20,000 pages of proprietary content as well as links to
professional organizations, associations and institutions, and is a marketing
and distribution channel for our products. We believe that this Web site has
become a destination for professionals based on the following data:
o As a result of maintaining the Web site, we have built a database with
over 350,000 profiled users.
o The Web site logs over 450,000 visits per month.
o Through our Web sites, we serve over one million ads and 200,000
opt-in e-mails per month.
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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. We own all of the following trademarks, trade names and/or service
marks, which have either been federally registered or applications have been
filed with the United States Patent and Trademark Office seeking federal
registration: SMARTPROS, PRO2NET, KEEPSMART, WORKING VALUES, PROFESSIONAL
EDUCATION CENTER (PEC), FINANCIAL MANAGEMENT NETWORK (FMN), CPA REPORT (CPAR),
INTEGRITY TOOLKIT, INTEGRITY ALIGNMENT, COGNISTAR, SAGE, ACCOUNTINGNET and
FINANCE JOBS. Despite our efforts to protect our proprietary rights,
unauthorized persons may attempt to copy aspects of our products or 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 that we will be able
to continue to license or support this technology on terms that we consider
reasonable, if at all. If these licenses or maintenance agreements expire and we
cannot renew them, they are substantially modified or if they were terminated
for any reason, we would have to purchase, license or internally develop
comparable products and systems. Anyone of these options may be expensive and/or
time consuming, which could have a material adverse effect on our business and
financial performance.
We cannot prevent third parties from independently developing similar
or competing systems, software and content that do not infringe on our rights.
In addition, we cannot prevent third parties from asserting infringement claims
against us relating to these systems and software. These claims, even if they
are frivolous, could be expensive to defend and could divert management's
attention from our operations. If we are ultimately found to be liable to third
parties for infringing on their proprietary rights, we may be required to pay
damages, which may be significant, and to either pay royalties to the owner or
develop non-infringing technology, the cost of which may be significant.
GOVERNMENT REGULATION
Government regulation is important to our business. Every state sets
its own continuing professional education requirements in terms of the number of
credits needed and the cycle in which those credits need to be earned, for
accountants and lawyers. In addition, specific content will only qualify for
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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.
The market for continuing legal education programs is regulated by the
state bar association, state courts or other organizations in each state. The
regulatory landscape is complex and varies from state to state.
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, 2007, we had 77 employees of which 70 were full-time and
seven were part-time. We have 43 employees based in our executive offices in
Hawthorne, New York, four employees based in our office in Sharon,
Massachusetts, and five employees in our Westborough, Massachusetts, office.
Skye Multimedia employs 10 people in their Bridgewater, New Jersey, office. In
addition, we have an aggregate of 15 employees that work out of their homes in
New York, Washington, California, Illinois and Texas. We believe that our
relationship with all of our employees is generally good.
CERTAIN RISK FACTORS THAT MAY AFFECT GROWTH AND PROFITABILITY
The following factors may affect our growth and profitability and
should be considered by any prospective purchaser of our securities:
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; and the Practicing Law
Institute, West and ABA Direct in the legal 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.
A key feature of our growth strategy is strategic acquisitions. 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.
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In 2006, we made four strategic acquisitions in the legal,
banking/insurance, engineering and custom development markets.
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.
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 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 GROWTH AND COMPETITIVENESS DEPENDS ON OUR ABILITY TO ADAPT
TO NEW TECHNOLOGIES AND CHANGES TO EXISTING TECHNOLOGIES AND NEW APPLICATIONS TO
MEET MARKET DEMAND.
One of our principal competitive advantages is our ability to deliver
content in multiple formats. This flexibility has enabled us to keep pace with
changes in technology and has contributed to our growth. For example, we
recently converted our entire course content to a Flash-based format because a
Windows-based format could not get through the firewall of many potential
clients. Keeping pace with technological developments can be difficult and
expensive, adversely impacting our operating results. However, our continued
growth depends on our ability to anticipate our customers' needs and
preferences, and to adapt to those needs and preferences. If we fail to do that,
the potential adverse impact could be significant to our business, operating
results and financial condition. We cannot assure that we will be able to keep
pace and adapt to changes in technology or customer preferences.
19
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 is an experienced senior corporate executive who has been
instrumental in cutting costs, raising capital and identifying and consummating
six acquisitions that have helped us refocus on our core competencies. Mr.
Fingerhut is one of our founders and is actively involved in sales and marketing
and identifying acquisition targets. Mr. Fingerhut also has overall
responsibility for the accounting and banking products and video production
business. He 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. In
addition, if any of our division heads were to leave, it could effect our
revenues adversely. For example, in early 2006 the head of our video production
division left and we have not yet been able to find a permanent replacement for
him. As a result revenues in that division have declined significantly.
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.
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
terminated 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 relationships 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 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,
20
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 are 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 on a
month-to -month basis. We lease 1,800 square feet in Westborough, Massachusetts,
where Cognistar is based. The lease expires January 31, 2009. Finally, Skye
Multimedia leases 2,320 square feet in Bridgewater, New Jersey, at which the
lease expires in August 2008.
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 AND ISSUER
PURCHASES OF EQUITY SECURITIES
(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.
PRICE RANGE OF COMMON STOCK
--------------------------------------------------------------------------------
SALES INFORMATION
--------------------------------------
HIGH LOW
--------------- ------------------
2006
First Quarter $3.40 $2.91
Second Quarter $3.34 $2.99
Third Quarter $3.13 $2.48
Fourth Quarter $4.21 $2.61
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
21
As of March 21, 2007, the closing sale price per share for our common
stock, as reported on the American Stock Exchange was $5.52.
(b) HOLDERS
As of March 21, 2007, the number of record holders of our common stock
was 148.
(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 2005 and
2006, 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
None
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, 2006, we used approximately $490,000 of the net proceeds to repay
certain long-term debt. In 2006, we used $1,300,000 of the proceeds for
acquisitions.
COMPANY PURCHASES OF ITS EQUITY SECURITIES
There were no company purchases of its equity securities in the fourth
quarter of 2006.
On November 7, 2006, 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.
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 FORM 10-KSB. CERTAIN STATEMENTS IN THIS DISCUSSION AND
ELSEWHERE IN THIS REPORT CONSTITUTE FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 21E OF THE SECURITIES AND EXCHANGE ACT OF 1934. SEE
"FORWARD-LOOKING STATEMENTS" FOLLOWING THE TABLE OF CONTENTS OF THIS 10-KSB.
BECAUSE THIS DISCUSSION INVOLVES RISK AND UNCERTAINTIES, OUR ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.
22
OVERVIEW
We provide learning solutions for accounting/finance, legal and
engineering professionals, three large vertical markets with mandatory
continuing education requirements. In addition, we provide training solutions
for the pharmaceutical, banking, securities, insurance and technology
industries. 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.
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) 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; and
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. The net
proceeds from the offering were approximately $6 million. To date, we have
expended approximately $1.8 million of those proceeds, $500,000 to repay debt
and the balance for acquisitions. We intend to use the remaining $4.2 million
net proceeds from the offering and our publicly traded common stock to execute
our growth strategy, which contemplates acquiring other companies (or their
assets) 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
markets. 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.
In furtherance of this strategy, we made four acquisitions during 2006
for a total of $1.3 million. 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 20 business days subsequent to December 31, 2008. For
the 10-month period ended December 31, 2006, Skye Multimedia contributed $1.7
million to our net revenues.
23
Also in February 2006 we acquired the assets of Sage Online
International for approximately $225,000. Sage's primary asset was 58 online
courses designed for the banking industry. For the 10-month period ended
December 31, 2006, the Sage assets generated net revenues of $72,000.
In October 2006 we acquired substantially all of the operating assets
and assumed certain liabilities of MGI Management Institute Inc. for $100,000.
For the three-month period ended December 31, 2006, the MGI assets generated net
revenues of $77,000.
In November 2006, through our Working Values subsidiary, we acquired
substantially all of the operating assets and assumed certain liabilities of
Cognistar Interactive Corporation for $320,000. The Cognistar assets contributed
approximately $83,000 to our 2006 net revenues.
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 that we will be able to identify appropriate
acquisition 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 library of accounting, banking and
legal courses. 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
online 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 available. 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-
24
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 and
Skye recognize revenue on a proportional performance basis.
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
Effective January 1, 2006, we have adopted the recognition and
measurement requirements of SFAS No. 123R. As a result, compensation costs are
now recognized in the financial statements for stock options or grants awarded
to employees and directors. Options and warrants granted to non-employees are
recorded as an expense at the date of grant based on the then estimated fair
value of the security in question.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2005 AND 2006
The following table compares our statement of operations data for the
years ended December 31, 2005 and 2006. 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,
-----------------------------------------------------------------------------------
2005 2006
----------------------------- ------------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE CHANGE
------------ ------------ ------------ ------------ ------------
Net revenues $ 10,430,210 100.0% $ 12,462,086 100.0% 19.5%
Cost of revenues 4,161,939 39.9% 5,176,525 41.5% 24.4%
------------ ------------ ------------ ------------ -------------
Gross profit 6,268,271 60.1% 7,285,561 58.4% 16.2%
------------ ------------ ------------ ------------ -------------
General and administrative 5,231,101 50.2% 5,820,403 46.7% 11.3%
Depreciation and amortization 580,991 5.6% 653,091 5.2% 12.4%
------------ ------------ ------------ ------------ -------------
Total operating expenses 5,812,092 55.7% 6,473,494 51.9% 11.4%
------------ ------------ ------------ ------------ -------------
Operating income 456,179 4.4% 812,057 6.5% 78.0%
------------ ------------ ------------ ------------ -------------
Interest income 220,805 2.1% 330,843 2.6% 49.8%
Interest expense (8,017) -0.1% (4,299) .0% 46.4%
------------ ------------ ------------ ------------ -------------
Net interest income 212,788 2.0% 326,544 2.6% 53.5%
------------ ------------ ------------ ------------ -------------
Income before benefit for income taxes $ 668,967 6.4% 1,138,611 9.1% 70.2%
Income tax benefit
-- -- (372,500) (3.0%) 100.0%
------------ ------------ ------------ ------------ -------------
Net income $ 668,967 6.4% $ 1,511,111 12.1% 125.9%
============ ============ ============ ============ =============
NET REVENUES
Net revenues for 2006 increased 19.5% compared to net revenues for
2005. Online sales continue to be an important factor contributing to our
overall revenue growth, a trend that began in 2003. In 2006, net revenues from
online sales of subscription-based products and other sales accounted for
approximately $3.2
25
million, or 24%, of our net revenues. In 2005, online sales accounted for $2.8
million, or 26%, of our net revenues.
Net revenues from sales of our accounting/finance products grew in
absolute terms but decreased as a percentage of net revenues due to the increase
in revenues resulting from our acquisitions. In 2006, net revenues from our
accounting/finance and related products were $8.4 million compared to $7.9
million in 2005. This increase was due in part to a subscription price increase
that went into effect on January 1, 2006, and to an increased level of sales.
For 2006 net revenues from accounting/finance products include
subscription-based revenue of $7.4 million and direct sales of course material
on a non-subscription basis, net revenues from custom work and advertising of
$1.0 million. For 2005, subscription-based revenue was $7.0 million and direct
sales of course material on a non-subscription basis, custom work and
advertising was $900,000.
Net revenues from sales of our engineering products, which are not
subscription-based products, were $703,000 in 2006 compared to $489,000 in 2005.
This increase is primarily attributable to a change in product mix and sales
from MGI of $77,000 which we acquired in the fourth quarter of this year. Sales
from existing products increased from $489,000 in 2005 to $626,000 in 2006.
Net revenues from video production, duplication and consulting services
decreased in 2006 by $902,000 from $1.6 million in 2005 to $730,000 in 2006. Of
the decrease, $604,000 was in video and $298,000 was in consulting services.
Factors contributing to the fluctuation in revenue include:
o In 2006, the former head of our video department resigned, he was
subsequently replaced and the person who replaced him was unable to
generate adequate sales. That person subsequently resigned as well. We
are actively seeking someone with a sales background to manage that
department;
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.
Net revenues from Working Values increased 69% from $432,000 in 2005 to
$729,000 in 2006. This increase was primarily due to the nature of the company's
business, which is developing customized learning solutions. In 2005, Working
Values concentrated on building its course library of ethics-based courses
called Learning Moments and Living the Code which contributed to the lower sales
in that year. In addition, Working Values' newly acquired Cognistar division
generated $83,000 in revenue since its acquisition in the fourth quarter of
2006. Cognistar concentrates on delivering online continuing legal education.
Skye Multimedia, which we acquired in February 2006, generated $1.7
million of revenue in 2006. Skye produces customized training and educational
material for the pharmaceutical industry, professional firms and others.
Our financial services training division which was also acquired in
February 2006 sells online training courses for the banking, insurance and
securities industries. This division's sales in 2006 were $72,000.
26
COST OF REVENUES
Cost of revenues includes production costs such as 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 2005, cost of revenues in 2006 increased by $1,000,000. The increase
was primarily attributable to the addition of our Skye subsidiary.
There are many different types of expenses that are characterized as
production costs and many vary from period to period depending on many factors.
The expenses that showed the greatest variations from 2005 to 2006 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 outsourcing of non-video technology.
The cost of actors decreased by $12,000 offset by the increased cost of
video production and outside technology personnel of $553,000. Both
Skye and our consulting/technology departments employ a number of
consultants to write scripts, edit course material and provide
technology services. In 2006 we began outsourcing some of the
programming and content development functions that were previously done
by our employees to a firm in India. Direct production costs, which are
costs related to producing videos other than labor costs--such as the
cost of renting equipment and locations, and the purchase of
materials--decreased by $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 $228,000. The increase was
primarily attributable to Skye salaries and related costs of $395,000,
our technology group's salaries and related costs decreased by $98,000,
and our video group's salaries and related costs decreased by $119,000.
Working Values salaries and related costs increased by $50,000,
primarily due to the Cognistar acquisition.
o OTHER COSTS. Travel and entertainment expenses increased by $56,000,
primarily related to the increase in Working Values and Skye projects.
Our shipping costs decreased by $3,000 as a result of controlling costs
and the shift by some customers to online 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 2006 as compared to 2005 by $99,000 for a
number of reasons. Increased sales of our accounting products resulted in an
increase of royalty expense of approximately $92,000. In addition, the
introduction of new products in engineering and a change in the mix of sales in
that area resulted in an increase of approximately $7,000 in royalty expense.
However, if volume increases or if we enter into new agreement or modify
existing agreements, the actual royalty payments in 2007 under these agreements
may be either higher or lower than they were in 2006.
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 2006 were higher
than they were in 2005 by $590,000, primarily due to the acquisitions we made
which resulted in increased rents, administrative payroll and other costs. The
major components of the increase in general and administrative expenses are
salaries and related costs due to additional marketing, and additional corporate
overhead due to the acquisitions. These costs were approximately $632,000. In
addition, in conformity with
27
SFAS No. 123R we are now expensing the cost of issuing stock options. This
expense in 2006 was $35,000. These increases were offset by a decrease in our
investor relations expense by approximately $70,000. We anticipate that general
and administrative expenses, inclusive of additional costs related to the
acquisitions made in the fourth quarter of 2006, will increase in 2007.
DEPRECIATION and AMORTIZATION
Depreciation and amortization expenses were higher in 2006 than they
were in 2005. The increase is attributable to the four acquisitions that we made
in 2006. We are also amortizing the capitalized costs related to the
Sarbanes-Oxley toolkit product and related course content and development of new
courses in our SPA library. We expect our depreciation and amortization expenses
on our current assets to increase in 2007 as we amortize the costs related to
these acquisitions.
INCOME FROM OPERATIONS
For 2006 net income from operations was $812,000 compared to $456,000
in 2005, an increase of 78%. Although some of our recent acquisitions have lower
profit margins than our subscription-based products, the volume of sales and the
efficiencies of scale have contributed to the increase in operating income.
OTHER INCOME
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 the net proceeds we realized from our initial public offering. As
of the end of 2006 we have repaid all of our outstanding indebtedness, other
than capital lease obligations. Net interest income increased by $114,000 due to
the general rise in interest rates.
INCOME TAX BENEFIT
The Company has begun to recognize the benefits of its net operating
loss carryforwards pursuant to SFAS No. 109. This has resulted in a $372,500
benefit for the current year. The company has taken an allowance for recognizing
the full value of the benefit because of the short-term history of profits.
NET INCOME AND LOSS
For 2006, we recorded a net profit of $1,511,000 compared to $669,000
for 2005. The increase in net income is primarily due to the increased operating
profit of $356,000, interest income of $114,000, and the income tax benefits
available through our net operating loss carryforwards.
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, 2006, was approximately $4.7
million compared to a $4.3 million working capital as of December 31, 2005. The
increase is attributable to positive cash flow from operations and earnings. Our
current ratio at December 31, 2006, is 1.88 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, $4.0 million at December 31, 2006,
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
28
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, 2006, net cash generated by operating
activities was approximately $1.6 million. We had a net decrease in cash of
$112,000, due to the acquisitions we made which required approximately $1.3
million in cash and the purchase of treasury shares for $538,000. 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, 2006 were
approximately $137,000, of which $91,000 consisted of equipment purchases and
$45,000 in capitalizing the cost of producing various 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, 2006, we made debt principal payments
of approximately $38,000. At year-end, our total indebtedness for borrowed
money, including capital lease financings, was approximately $26,000, which
consisted of the following:
o EQUIPMENT LEASING. At December 31, 2006, the balance on all existing
equipment leases was $10,000. In 2004 we leased certain equipment,
through 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 $10,000.
o EQUIPMENT PURCHASES. At December 31, 2006, we had an outstanding
balance of $16,000 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, 2006, we had
commitments under the lease for executive offices in Hawthorne, New York, the
Working Values and Cognistar executive offices in Sharon and Westborough,
Massachusetts, and Skye's executive offices in Bridgewater, New Jersey,
aggregating $1.2 million through February 2010. The Sharon lease was renewed
effective March 1, 2006, at a monthly rent of $1525. The Cognistar lease expires
in January 2009 and calls for monthly rent of $3,089. The Skye lease was
recently extended to August 2008 at a monthly rental of $3,670.
The shareholders of Skye are also entitled to a contingent payment
based on certain levels of sales through December 31, 2008.
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 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
29
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 July 2006 the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES
("FIN 48"), as an interpretation of SFAS No. 109, ACCOUNTING FOR INCOME TAXES.
FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS No. 109 and prescribes
a recognition threshold of "more-likely-than-not" to be sustained upon
examination. Measurement of the tax uncertainty occurs if the recognition
threshold has been met. FIN 48 also provides guidance on derecognition,
classification, interest, penalties, accounting in interim periods, disclosure,
and transition. FIN 48 will be effective beginning January 1, 2007. Differences
between the amounts recognized in the statements of financial position prior to
the adoption of FIN 48 and the amounts reported after adoption should be
accounted for as a cumulative-effect adjustment recorded to the beginning
balance of retained earnings. We are in the process of evaluating the impact, if
any, the adoption of this interpretation will have on our financial position,
cash flows, and results of operations.
In September 2006, the Securities and Exchange Commission ("SEC")
issued Staff Accounting Bulletin No. 108, CONSIDERING THE EFFECTS OF PRIOR YEAR
MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL
STATEMENTS ("SAB 108"). SAB 108 provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be
considered in quantifying a current year misstatement. The SEC staff believes
that registrants should quantify errors using both a balance sheet and an income
statement approach and evaluate whether either approach results in quantifying a
misstatement that, when all relevant quantitative and qualitative factors are
considered, is material. SAB 108 is effective for our fiscal year ending
December 31, 2006. SAB 108 did not have a material impact on our consolidated
financial statements.
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE
MEASUREMENTS, which clarifies the definition of fair value, establishes
guidelines for measuring fair value, and expands disclosures regarding fair
value measurements. SFAS No. 157 does not require any new fair value
measurements and eliminates inconsistencies in guidance found in various prior
accounting pronouncements. SFAS No. 157 will be effective for us on January 1,
2008. We do not expect SFAS No. 157 to have a material impact on our
consolidated financial statements.
ITEM 7. FINANCIAL STATEMENTS
See the index to Financial Statements below, beginning on page F-1.
30
SMARTPROS LTD. AND SUBSIDIARIES
CONTENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005 PAGES
--------------------------------------------------------------------------------
FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheet F-3
Consolidated Statements of Income F-4
Consolidated Statement of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7 - F-19
================================================================================
F-1
SMARTPROS LTD. AND SUBSIDIARIES
================================================================================
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
SmartPros Ltd. and Subsidiaries
Hawthorne, New York
We have audited the accompanying consolidated balance sheet of SmartPros Ltd.
and Subsidiaries as of December 31, 2006, and the related consolidated
statements of income, stockholders' equity and cash flows for the two years
ended December 31, 2006 and 2005. 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 Subsidiaries as of December 31, 2006, and the results of
their operations and their cash flows for the two years ended December 31, 2006
and 2005, in conformity with accounting principles generally accepted in the
United States of America.
As discussed in Note 1 to the financial statements, effective January 1, 2006,
the Company adopted Statement of Financial Accounting Standards No. 123(R),
SHARE-BASED PAYMENT.
Melville, New York
February 23, 2007
================================================================================
F-2
SMARTPROS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
================================================================================
DECEMBER 31, 2006
--------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 7,393,789
Accounts receivable, net of allowance for
doubtful accounts of $39,000 1,960,939
Prepaid expenses and other current assets 277,393
------------
Total Current Assets 9,632,121
------------
Property and Equipment, net 438,260
Goodwill 130,684
Other Intangibles, net 2,651,132
Other Assets, including restricted cash of $150,000 154,673
Deferred Tax Asset 378,000
------------
3,752,749
------------
Total Assets $ 13,384,870
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 552,630
Accrued expenses 380,464
Current portion of capital lease and equipment
financing obligations 25,991
Deferred revenue 4,007,074
------------
Total Current Liabilities 4,966,159
------------
Long-Term Liabilities:
Other liabilities 120,137
------------
Total Long-Term Liabilities 120,137
------------
Commitments and Contingencies
Stockholders' Equity:
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,
5,186,505 issued and 4,875,774 outstanding 519
Common stock in treasury, at cost - 310,731 shares (922,625)
Additional paid-in-capital 16,572,944
Accumulated deficit (7,274,824)
------------
8,376,014
Deferred compensation (77,440)
------------
Total Stockholders' Equity 8,298,574
------------
Total Liabilities and Stockholders' Equity $ 13,384,870
============
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-3
SMARTPROS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
================================================================================
YEARS ENDED DECEMBER 31, 2006 2005
--------------------------------------------------------------------------------
Net Revenues $ 12,462,086 $ 10,430,210
Cost of Revenues 5,176,525 4,161,939
----------------------------
Gross Profit 7,285,561 6,268,271
----------------------------
Operating Expenses:
Selling, general and administrative 5,820,403 5,231,101
Depreciation and amortization 653,091 580,991
----------------------------
6,473,494 5,812,092
----------------------------
Operating Income 812,067 456,179
----------------------------
Other Income (Expense):
Interest and dividend income 330,843 220,805
Interest expense (4,299) (8,017)
----------------------------
326,544 212,788
----------------------------
Net Income before Benefit for Income Taxes 1,138,611 668,967
Income Tax Benefit 372,500 --
----------------------------
Net Income $ 1,511,111 $ 668,967
============================
Net Income Per Common Share:
Basic net income per common share $ 0.30 $ 0.13
============================
Diluted net income per common share $ 0.30 $ 0.13
============================
Weighted Average Number of Shares Outstanding
Basic 4,994,090 5,082,359
============================
Diluted 5,008,164 5,111,158
============================
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4
SMARTPROS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
====================================================================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
------------------------------------------------------------------------------------------------------------------------------------
Common Stock Preferred Stock Additional
----------------------------------------- Paid-in Accumulated Deferred
Shares Amount Shares Amount Capital Deficit Compensation
------------------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2005 5,140,545 $ 514 -- $ -- $16,407,495 $(9,454,902) $ (127,500)
Common Stock Issued by Exercise of Options 4,902 -- -- -- 10,539 -- --
Purchase of Treasury Shares (51,725) -- -- -- -- -- -- --
Amortization of Deferred Compensation -- -- -- -- -- -- 52,500
Net Income -- -- -- -- -- 668,967 --
------------------------------------------------------------------------------------
Balance at, December 31, 2005 5,145,447 514 -- -- 16,418,034 (8,785,935) (75,000)
Common Stock Issued by Exercise of Options 24,558 3 -- -- 52,797 -- --
Purchase of Treasury Shares (201,000) -- -- -- -- -- -- --
Amortization of Deferred Compensation -- -- -- -- -- -- 42,000
Payment of Note Receivable from Shareholder -- -- -- -- -- -- --
Issuance of Shares from Restricted Stock Plan 16,500 2 -- -- 66,658 -- (44,440)
Stock Option Expense -- -- -- -- 35,455 -- --
Net Income -- -- -- -- -- 1,511,111 --
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2006 5,186,505 $ 519 -- $ -- $16,572,944 $(7,274,824) $ (77,440)
====================================================================================================================================
--------------------------------------------------------------------------------------
Receivable Total
from Treasury Stockholders'
Stockholder Stock Equity
--------------------------------------------------------------------------------------
Balance, January 1, 2005 $(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
Net Income -- -- 668,967
--------------------------------------
Balance at, December 31, 2005 (200,000) (384,600) 6,973,013
Common Stock Issued by Exercise of Options -- -- 52,800
Purchase of Treasury Shares (201,000) -- (538,025) (538,025)
Amortization of Deferred Compensation -- -- 42,000
Payment of Note Receivable from Shareholder 200,000 -- 200,000
Issuance of Shares from Restricted Stock Plan -- -- 22,220
Stock Option Expense -- -- 35,455
Net Income -- -- 1,511,111
---------------------------------------------------------------------------------------
Balance at December 31, 2006 $ -- $(922,625) $ 8,298,574
=======================================================================================
---------------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-5
SMARTPROS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
YEARS ENDED DECEMBER 31, 2006 2005
--------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 1,511,111 $ 668,967
Adjustments to reconcile net income to -------------------------
net cash provided by operating activities:
Depreciation and amortization 653,091 580,991
Bad debts -- (30,571)
Stock compensation expense 35,455 --
Deferred compensation 64,220 52,500
Deferred income tax benefit (378,000) --
Changes in operating assets and liabilities:
(Increase) decrease in operating assets:
Accounts receivable (905,008) 238,702
Prepaid expenses and other current assets 783 (78,906)
Other assets -- 17,196
(Decrease) increase in operating liabilities:
Accounts payable and accrued expenses 371,966 (227,072)
Deferred revenue 317,588 (51,974)
Other liabilities (40,056) (4,714)
-------------------------
Total adjustments 120,039 496,152
-------------------------
Net Cash Provided by Operating Activities 1,631,150 1,165,119
-------------------------
Cash Flows from Investing Activities:
Investment in securities available-for-sale -- 5,000,000
Acquisition of property and equipment (91,414) (148,526)
Capitalized course costs (45,358) (57,833)
Cash paid for business acquisitions (1,282,906) --
-------------------------
Net Cash (Used in) Provided by Investing Activities (1,419,678) 4,793,641
-------------------------
Cash Flows from Financing Activities:
Purchase of treasury shares (538,025) (164,600)
Payments of note receivable from stockholder 200,000 --
Net proceeds from exercise of stock options 52,800 10,539
Payments under capital lease obligations (38,149) (55,999)
-------------------------
Net Cash Used in Financing Activities (323,374) (210,060)
-------------------------
Net (Decrease) Increase in Cash and Cash Equivalents (111,902) 5,748,700
Cash and Cash Equivalents, beginning of year 7,505,691 1,756,991
-------------------------
Cash and Cash Equivalents, end of year $ 7,393,789 $ 7,505,691
=========================
Supplemental Disclosure:
Cash paid for interest $ 4,299 $ 8,017
=========================
Cash paid for income taxes $ 4,866 $ 9,864
=========================
--------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-6
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS - 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,
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. Finally, through its
wholly-owned subsidiaries, Working Values Ltd. ("Working Values"), the
Company produces ethics, governance, and compliance programs for corporate
clients. In November 2006, Working Values acquired certain assets and
assumed certain liabilities of Cognistar Interactive Corporation
("Cognistar"). Cognistar produces on-line and customized training courses
for the legal profession. SmartPros also produces custom videos and rents
out its studios. In 2006, the Company made various acquisitions. In
February 2006, certain assets were acquired and certain liabilities of Skye
Multimedia Inc. were assumed by our wholly-owned subsidiary, Skye
Multimedia Ltd. ("Skye"). In addition, the Company acquired certain assets
and assumed certain liabilities of Sage International Group, Inc. ("Sage").
As a result, we acquired a library of 58 nationally certified online
training solutions for the banking, securities and insurance industries. In
October 2006, we acquired substantially all of the assets and assumed
certain liabilities of MGI Management Institute Inc. ("MGI"). MGI provides
training courses for the engineering profession and is an enhancement to
our existing series of courses. 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 subsidiaries,
Working Values and Skye. 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.
--------------------------------------------------------------------------------
F-7
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
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, 2006 and 2005, 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, money
market funds, or United States Treasury Obligations, or treasury 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, 2006, 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. 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,
2006 and 2005, 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, both
unsold video and non-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, 2006 and
2005.
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 three to ten 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.
--------------------------------------------------------------------------------
F-8
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
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
five to nineteen years.
CAPITALIZED COURSE COSTS - Capitalized course costs include the direct cost
of internally developing proprietary educational products and materials
that have extended useful lives. Amortization of these capitalized course
costs commences when the courses are available for sale from the Company's
catalog. For the year ended December 31, 2006, the Company has expended
approximately $45,000 on such costs. The amortization period is five years,
except for the Sarbanes-Oxley courses that have a three year amortization
period. Other course costs incurred in connection with any of the Company's
monthly subscription products or custom work is charged to expense as
incurred. As a result of the acquisition of the assets of Sage On-Line, the
Company acquired an additional $250,000 of course costs which are being
amortized over a five year period, as well. Included in other intangible
assets at December 31, 2006, are capitalized course costs of $709,519, net
of accumulated amortization of $286,120.
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, 2006 and 2005 is as
follows:
YEARS ENDED DECEMBER 31, 2006 2005
-------------------------------------------------------- ------------------- ------------------
Weighted Average Number of Shares Outstanding $ 4,994,090 $ 5,082,359
Effect of Dilutive Securities, common stock equivalents 14,074 28,799
------------------- ------------------
Weighted Average Number of Shares Outstanding, used for $ 5,008,164 $ 5,111,158
computing diluted earnings per share =================== ==================
--------------------------------------------------------------------------------
F-9
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
STOCK-BASED COMPENSATION - The Company's 1999 Stock Option Plan (the
"Plan") permits the grant of options and restricted stock to employees,
directors and consultants. The total number of shares reserved for grants
under the Plan is 882,319, provided that restricted stock grants may not
exceed 200,000 shares. As of December 31, 2006, there were 385,607 options
outstanding, of which 311,923 are currently exercisable and 450,752 options
are available for future grants. To date, 29,460 options have been
exercised. All stock options under the Plan are granted at the fair market
value of the common stock at the grant date. Employee stock options vest
ratably over either a three or four year period and generally expire ten
years from the grant date. Stock options granted to non-employee directors
vest in the same manner. Restricted stock awards are subject to forfeiture,
unless certain time and/or performance requirements are satisfied. In
January 2007, the Company granted 16,500 shares in restricted stock to its
management team, of which, one-third vested immediately and the remaining
shares will vest pro-ratably in each of January 2008 and 2009.
Effective January 1, 2006, the grants under the Plan are accounted for in
accordance with the recognition and measurement provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123 (revised 2004), Share-Based
Payment ("SFAS No. 123(R)"), which replaces SFAS No. 123, Accounting for
Stock-Based Compensation, and supersedes Accounting Principles Board
Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and
related interpretations. SFAS No. 123(R) requires compensation costs
related to share-based payment transactions, including employee stock
options, to be recognized in the financial statements. In addition, the
Company adheres to the guidance set forth within Securities and Exchange
Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 107, which
provides the Staff's views regarding the interaction between SFAS No.
123(R) and certain SEC rules and regulations and provides interpretations
with respect to the valuation of share-based payments for public companies.
Prior to January 1, 2006, the Company accounted for similar transactions in
accordance with APB No. 25 which employed the intrinsic value method of
measuring compensation cost. Accordingly, compensation expense was not
recognized for fixed stock options, if the exercise price of the option
equaled or exceeded the fair value of the underlying stock at the grant
date.
While SFAS No. 123 encouraged recognition of the fair value of all
stock-based awards on the date of grant, as expense over the vesting
period, companies were permitted to continue to apply the intrinsic
value-based method of accounting prescribed by APB No. 25 and disclose
certain pro forma amounts as if the fair value approach of SFAS No. 123 had
been applied. In December 2002, SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of SFAS No. 123, was
issued, which, in addition to providing alternative methods of transition
for a voluntary change to the fair value method of accounting for
stock-based employee compensation, required more prominent pro forma
disclosures in both the annual and interim financial statements. The
Company complied with these disclosure requirements for all applicable
periods prior to January 1, 2006.
In adopting SFAS No. 123(R), the Company applied the modified prospective
approach to transition. Under the modified prospective approach, the
provisions of SFAS No. 123(R) are to be applied to new awards and to awards
modified, repurchased, or cancelled after the required effective date of
December 15, 2005. Additionally, compensation cost for the portion of
awards for which the requisite service has not been rendered, that are
outstanding as of the required effective date, shall be recognized as the
requisite service is rendered on or after the required effective date. The
compensation cost for that portion of awards shall be based on the grant
date fair value of those awards as calculated for either recognition or pro
forma disclosures under SFAS No. 123(R).
As a result of the adoption of SFAS No. 123(R), the Company's results for
the year ended December 31, 2006 include share-based compensation expense
totaling approximately $35,000. Such amounts have been included in the
Consolidated Statements of Operations within general and administrative
expenses. Stock compensation expense recorded under APB No. 25 in the
Consolidated Statements of Operations for the year ended December 31, 2005
totaled $0.
--------------------------------------------------------------------------------
F-10
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
Stock option compensation expense in 2006 is the estimated fair value of
options granted amortized on a straight-line basis over the requisite
service period for the entire portion of the award.
The following table addresses the additional disclosure requirements of
SFAS No. 123(R) in the period of adoption. The table illustrates the effect
on net income and earnings per share, as if the fair value recognition
provisions of SFAS No. 123(R) had been applied to all outstanding and
unvested awards in the prior year comparable period.
YEAR ENDED DECEMBER 31, 2005
---------------------------------------------------------------------------
Net Income as Reported $ 668,967
Add:
Stock-based compensation included in
Reported net income --
Deduct:
Total stock-based compensation expense
determined under fair value-based method for all
awards (no tax effect) (43,969)
---------------
Pro Forma Net Income $ 624,998
===============
Net Income per Share:
===============
Basic - as reported $ .13
===============
Basic - pro forma $ .13
===============
Diluted - as reported $ .13
===============
Diluted - pro forma $ .13
===============
ADVERTISING - Advertising is expensed as incurred and was approximately
$55,000 and $64,000 for the years ended December 31, 2006 and 2005,
respectively.
NEW ACCOUNTING PRONOUNCEMENTS - In July 2006, the FASB issued Financial
Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES ("FIN
48"), as an interpretation of SFAS No. 109, ACCOUNTING FOR INCOME TAXES.
FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in an enterprise's financial statements in accordance with SFAS No. 109 and
prescribes a recognition threshold of more-likely-than-not to be sustained
upon examination. Measurement of the tax uncertainty occurs if the
recognition threshold has been met. FIN 48 also provides guidance on
derecognition, classification, interest, penalties, accounting in interim
periods, disclosure, and transition. FIN 48 will be effective beginning
January 1, 2007. Differences between the amounts recognized in the
statements of financial position prior to the adoption of FIN 48 and the
amounts reported after adoption should be accounted for as a
cumulative-effect adjustment recorded to the beginning balance of retained
earnings. The Company is still evaluating the impact, if any, the adoption
of this interpretation will have on the Company's financial position, cash
flows, and results of operations.
In September 2006, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 108, CONSIDERING THE EFFECTS OF PRIOR YEAR
MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL
STATEMENTS ("SAB 108"). SAB 108 provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be
considered in quantifying a current year misstatement. The SEC staff
believes that registrants should quantify errors using both a balance sheet
and an income statement approach and evaluate whether either approach
results in quantifying a misstatement that, when all relevant quantitative
and qualitative factors are considered, is material. SAB 108 is effective
for the Company's fiscal year ending December 31, 2006. SAB 108 did not
have a material impact on the consolidated financial statements.
--------------------------------------------------------------------------------
F-11
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS,
which clarifies the definition of fair value, establishes guidelines for
measuring fair value, and expands disclosures regarding fair value
measurements. SFAS No. 157 does not require any new fair value measurements
and eliminates inconsistencies in guidance found in various prior
accounting pronouncements. SFAS No. 157 will be effective for the Company
on January 1, 2008. The Company does not expect SFAS No. 157 to have a
material impact on the consolidated financial statements.
2. ACQUISITIONS
The Company made four acquisitions during 2006. In February 2006, it
acquired substantially all of the assets and assumed certain liabilities of
Skye Multimedia Inc. for approximately $520,000, through its wholly-owned
Skye Multimedia, Ltd subsidiary. In addition, the selling shareholders were
hired by Skye Multimedia, Ltd.. The agreement calls for a contingent
purchase price of up to $1,400,000, based on Skye's earnings before
interest and taxes for the period commencing March 1, 2006, through
December 31, 2008, less adjustments for use of capital and other costs,
computed on an annualized basis. The Company will receive a credit against
the first $200,000 of any contingent payment that may be earned. At the
Company's discretion, such earn out is payable at least 50% in cash and the
remaining 50% in shares of the SmartPros Ltd. common stock, as long as such
stock is traded on either the New York or American Stock Exchange or the
NASDAQ National Market and the Company is current in all of its required
filings.
Also, in February 2006, the Company acquired substantially all of the
operating assets and assumed certain liabilities form Sage International
Group Inc. As a result, a library of 58 nationally certified on-line
training solutions for the banking, securities and insurance industries
were acquired. The purchase price was $225,000, plus the assumption of
certain contracts.
In October 2006, the Company purchased substantially all of the tangible
and intangible assets of MGI Management Institute. The purchase price was
$100,000. MGI designed, developed and conducted distance education courses
covering a wide range of professional topics for engineers, legal
administrators, manufacturers and others.
In November 2006, our Working Values subsidiary acquired substantially all
of the operating assets and assumed certain liabilities from Cognistar
Interactive Corporation for $320,000. Cognistar produces and distributes
on-line training and continuing legal education courses for the law
profession. Some or all of its courses meet the requirements for continuing
legal education in 24 states. It also produces customized courses for its
clients.
3. PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
YEAR ENDED DECEMBER 31, 2006
-------------------------------------------------------- ------------------
Furniture, Fixtures and Equipment $ 3,362,416
Leasehold Improvements 182,549
-----------------
3,544,965
Less Accumulated Depreciation 3,106,705
-----------------
$ 438,260
=================
Depreciation expense for the years ended December 31, 2006 and 2005 were
approximately $179,000 and $199,000, respectively. At December 31, 2006,
property and equipment included assets that were acquired under capitalized
leases of approximately $155,000 and accumulated depreciation of
approximately $90,000.
--------------------------------------------------------------------------------
F-12
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
4. GOODWILL AND INTANGIBLE ASSETS
The components of intangible assets are as follows:
YEAR ENDED DECEMBER 31, 2006
---------------------------------------------------------------------------
Accumulated Carrying
Cost Amortization Value
----------------------------------------
Engineering Courses $ 2,766,837 $ 1,919,775 $ 847,062
Rights to CPA Report ("CPAR") 1,700,000 1,275,018 424,982
Pro2 Net Courses (P2N) 837,504 459,572 377,932
Sarbanes-Oxley Toolkit 248,804 199,631 49,173
Evergreen Client List 3,500 700 2,800
Working Values 104,950 38,550 66,400
Skye Multimedia Ltd. 204,000 15,400 188,600
MGI 54,000 1,875 52,125
Cognistar 380,164 10,919 369,245
Sage Courses 250,012 41,669 208,343
SPA Course Development 35,703 3,570 32,133
Capitalized Acquisition Costs 32,337 -- 32,337
----------------------------------------
$ 6,617,811 $ 3,966,679 $ 2,651,132
========================================
The aggregate amortization expense for each of the years ended December 31,
2006 and 2005 was approximately $474,000 and $382,000, respectively.
Estimated amortization expense for the five years subsequent to December
31, 2006 is as follows:
YEARS ENDING DECEMBER 31,
---------------------------------------------------------------------------
2007 $ 479,000
2008 469,000
2009 363,000
2010 235,000
2011 144,000
The following table presents the changes in the carrying amount of goodwill
and other intangibles during the year ended December 31, 2006:
Other
Goodwill Intangibles
---------------------------------------------------------------------------
Balance, January 1, 2005 $ 53,434 $ 2,482,443
Amortization Expense -- (381,683)
Goodwill and Intangibles Acquired -- 57,833
----------------------------
Balance, December 31, 2005 53,434 2,158,803
Amortization Expense -- (473,332)
Goodwill and Intangibles Acquired 77,250 965,871
----------------------------
Balance, December 31, 2006 $ 130,684 $ 2,651,132
============================
--------------------------------------------------------------------------------
F-13
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
5. CAPITAL LEASE AND EQUIPMENT FINANCING OBLIGATIONS
In August 2004, the Company financed the purchase of a van with a 36 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 balance of the loan at December 31, 2006 was
approximately $15,900.
The Company is obligated under a capital lease for the acquisition of
office and video production equipment. The interest rate on this lease is
6.9% per annum. The balance of the lease as of December 31, 2006 is
$10,113, with monthly payments of $2,055.
6. INCOME TAXES
At December 31, 2006, the Company has net deferred tax assets of
approximately $2,000,000, primarily resulting from the future tax benefit
of net operating loss carryforwards. The net valuation allowance decreased
by approximately $378,000 for the year ended December 31, 2006. Realization
of deferred tax assets depends on sufficient future taxable income during
the period that deductible temporary differences and carryforwards are
expected to be available to reduce taxable income. At December 31, 2006,
the Company has net operating loss carryforwards available to offset future
taxable income of approximately $6,000,000, which expire in 2023.
The components of income tax expense (benefit) for the years ended December
31 2006 and 2005 consist of the following:
2006 2005
---------------------------------------------------------------------------
Current:
Federal $ 5,500 $ --
State -- --
----------------------------
5,500 --
Deferred:
Excess of financial over tax
accounting depreciation -- (130,000)
Net operating loss carryforwards (378,000) 227,000
Valuation allowance -- (97,000)
----------------------------
(378,000) --
============================
Income Tax Benefit $ (372,500) $ --
============================
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:
YEARS ENDED DECEMBER 31, 2006 2005
--------------------------------------------------------------------------
U.S. Federal Statutory Income Tax Rate 34.0% 34.0%
State Income Tax, net of federal benefits 7.5% 7.5%
Valuation Allowance (74.5)% (41.5)%
----------------------------
Income Tax Benefit (33.0)% --
============================
--------------------------------------------------------------------------------
F-14
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
The temporary differences and carryforwards gave rise to the following
deferred tax asset at December 31, 2006:
Depreciation and Amortization $ 1,000
NOL Carryforward 2,039,000
Valuation Allowance (1,662,000)
------------
$ 378,000
============
7. CONVERTIBLE PREFERRED STOCK
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, was repaid in 2006.
8. STOCKHOLDERS' EQUITY
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.
In March 2006, the Company's former chairman of the board of directors
exercised 24,558 options at $2.15 per share for $52,800. Also, in March
2006, 6,100 options exercisable at $3.00 per share and 9,000 options
exercisable at $3.05 per share were granted to employees and a board
member, respectively. These options expire in ten years from date of
issuance and vest pro-ratably, 25% at time of issuance and 25% each year
thereafter.
In October 2006, the president and other officers were granted 26,000
options at $2.75 per share. These options expire in ten years and vest
one-third each year commencing one year from date of issuance.
In November 2006, 10,000 options were issued to the president of Cognistar
in conjunction with its acquisition. These options are exercisable at $4.05
per share. They expire in ten years and vest one-third each year commencing
one year from date of issuance.
In January 2007, the Company's compensation committee granted certain
officers of the Company a total of 16,500 shares of restricted common
stock. The grants vest one-third immediately and one-third each year,
thereafter. The grants were part of a bonus paid for 2006 and were
considered issued as of December 31, 2006 and included in the total
outstanding shares as of that date. The stock is unregistered and subject
to certain forfeiture provisions if the employee leaves the Company prior
to January 29, 2009.
At December 31, 2006, 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 issued to the
Company's legal counsel in conjunction with its initial public offering.
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
--------------------------------------------------------------------------------
F-15
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
administered by the Board of Directors. Since the initial public offering,
the Plan is being administered by the Compensation Committee established by
the Board of Directors of the Company. The administrator of the Plan
determines the terms of options, including the exercise price, expiration
date, number of shares and vesting provisions. During 2006, 24,558 options
were exercised at a price of $2.15. In addition, 47,466 options at prices
ranging between $2.15 and $5.32 were cancelled. The Company also issued
51,100 options to a board member, officers of the Company and employees at
exercise prices ranging from $2.75 to $4.05. Options totaling 15,100 issued
in 2006 expire in ten years, with 25% vesting immediately and the remainder
vesting equally over the following three years. The remaining 36,000
options that were issued expire in ten years and vest one-third each year
commencing one year from date of issuance. At December 31, 2006, options
covering 385,607 shares of common stock were outstanding and 450,752 shares
of common stock remain available for future grants under the Plan.
The weighted average estimated fair value of stock options granted for the
year ended December 31, 2006 and 2005 was $1.26 and $1.96, respectively.
The fair value of options at the date of grant was estimated using the
Black-Scholes option pricing model. During 2006, the Company took into
consideration guidance under SFAS No. 123(R) and SAB 107 when reviewing and
updating assumptions. The expected volatility is based upon historical
volatility of our stock and other contributing factors. The expected term
is based upon observation of actual time elapsed between date of grant and
exercise of options for all employees. Previously such assumptions were
determined based on historical data.
The assumptions made in calculating the fair values of options for the year
ended December 31, 2006 is as follows:
Contractual Term 10 years
Expected Volatility 33%-35%
Expected Dividend Yield 0%
Risk-Free Interest Rate 4.62%-4.75%
Expected Term 5.5 years
The Company granted 51,100 options under the Plan during the year ended
December 31, 2006 at exercise prices ranging from $2.75 per share to $4.05
per share.
For the year ended December 31, 2006, share-based compensation expense
related to stock options was approximately $35,450. As of December 31,
2006, the fair value of unamortized compensation cost related to unvested
stock option awards was approximately $75,100. Unamortized compensation
cost as of December 31, 2006 is expected to be recognized over a remaining
weighted-average vesting period of three years. As of December 31, 2006,
the total intrinsic value, which is the difference between the exercise
price and closing price of the Company's common stock of options
outstanding and exercisable was $145,100 and $96,500, respectively.
--------------------------------------------------------------------------------
F-16
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
A summary of all stock option activity for the years ended December 31,
2005 and 2006 is as follows:
Number Weighted
of Average
Options Exercise Price
---------------------------------------------------------------------------
Outstanding, January 1, 2005: 389,509 $ 4.72
Options Granted 29,500 3.74
Options Cancelled (6,884) 4.67
Options Expired (692) 16.44
Options Exercised (4,902) 2.15
-------------------------
Outstanding, December 31, 2005: 406,531 4.67
Options Granted 51,100 3.09
Options Cancelled (47,466) 5.06
Options Expired -- --
Options Exercised (24,558) 2.15
-------------------------
Outstanding, December 31, 2006 385,607 4.57
-------------------------
Exercisable, December 31, 2006 311,923 $ 4.80
=========================
Options Outstanding Options Exercisable
-------------------------------------- -------------------------
Weighted Weighted
Average Weighted Average
Remaining Average Remaining
Exercise Number Contractual Exercise Number Contractual
Price Outstanding Life (Years) Price Exercisable Life (Years)
--------------------------------------------------- -------------------------
$ 2.15 24,322 2.5 $ 2.15 24,322 2.5
2.42 25,850 3.1 2.42 25,850 3.1
2.75 26,000 9.8 2.75 -- --
3.00 4,100 9.2 3.00 1,023 9.2
3.05 9,000 9.2 3.05 2,250 9.2
3.44 15,000 8.8 3.44 7,500 8.8
4.00 10,000 8.4 4.00 5,000 8.4
4.05 10,000 9.8 4.05 -- --
4.15 2,300 8.6 4.15 1,150 8.6
4.27 15,475 7.8 4.27 11,608 7.8
5.32 241,168 4.8 5.32 230,828 4.8
8.32 773 3.1 8.32 773 3.1
21.41 1,245 2.5 21.41 1,245 2.5
32.13 374 2.5 32.13 374 2.5
--------------------------------------------------- -------------------------
$ -- 385,607 5.5 $ 4.57 311,923 7.5
=================================================== =========================
--------------------------------------------------------------------------------
F-17
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
10. COMMITMENTS AND CONTINGENCIES
The Company leases office space and production and warehouse facilities in
Hawthorne, New York, Sharon and Westborough, Massachusetts and Bridgewater,
New Jersey. Future minimum lease payments are as follows:
YEARS ENDING DECEMBER 31,
---------------------------------------------------------------------------
2007 $ 436,000
2008 423,000
2009 360,000
2010 59,500
------------
$ 1,278,500
============
Deferred rent credit of approximately $120,000 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, 2006 and 2005 was
approximately $408,000 and $355,000, 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 chief financial officer, its
chief technology officer and the president of Working Values and Skye
Multimedia. The employment agreement with the Company's chief executive
officer was renewed in January 2007, 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 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. The Company has an employment agreement with Stephen
Henn who joined the Company in conjunction with the acquisition of
Cognistar. He is vice president of Working Values Ltd. His contract is for
two years, beginning November 15, 2006 and expiring on November 15, 2008
and has terms similar to the other agreements. Skye's president's agreement
is for three years, beginning March 1, 2006 and expiring January 31, 2009.
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.
At December 31, 2006, the aggregate commitment under the four employment
agreements, exclusive of the presidents was approximately $730,000.
LITIGATION - The Company is currently not a party in any litigation.
--------------------------------------------------------------------------------
F-18
SMARTPROS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------
11. 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.
12. SUBSEQUENT EVENTS
On March 1, 2007, we acquired substantially all of the assets and assumed
certain liabilities of the Selbst Group Inc. for approximately $177,000,
subject to certain adjustments. The Selbst Group Inc. is a specialized
consulting firm, providing various training programs for the financial
services industry. In conjunction with the acquisition, we entered into a
two year employment agreement with its president commencing March 1, 2007
and expiring February 28, 2009.
In addition, the president of Selbst was granted 5,000 options to purchase
the Company's stock at an exercise price of $4.49. Such options expire in
ten years and vest one-third, one year from date of issuance and one-third
each year thereafter. The Company also issued 1,500 options to an assistant
vice-president at an exercise price of $5.50. These options also expire in
ten years and vest one-third, one year from date of issuance and one-third
each year thereafter.
--------------------------------------------------------------------------------
F-19
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 8A. CONTROLS AND PROCEDURES
a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Management, with the
participation of our principal executive officer and the principal 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, our
principal executive officer and principal 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 our principal
executive and 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.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND
CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE
EXCHANGE ACT.
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 Web site 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.
31
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, AND DIRECTOR
INDEPENDENCE
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
EXHIBIT
NO. DESCRIPTION
-------- -------------
3.1 Certificate of Incorporation, as amended (1)
3.2 Amended and Restated By-Laws, as amended (1)
4.1 Specimen stock certificate (1)
4.2 Form of warrant agreement including form of warrant (1)
4.3 Form of unit certificate (1)
4.4 Form of representative's warrant issued (1)
10.1 1999 Stock Option Plan, as amended (1)
10.2 Second Amended Employment Agreement between SmartPros Ltd. and Jack
Fingerhut (1)
10.3 Employment Agreement between SmartPros Ltd. and David M. Gebler (1)
10.4 Employment Agreement between SmartPros Ltd. and Seth Oberman*
10.5 Employment Agreement, dated February 1, 2007, between Allen S. Greene
and SmartPros, Ltd. (3)
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)
10.6.3 Lease for premises at Westborough, Massachusetts*
10.6.4 Lease for premises at Bridgewater, New Jersey*
10.6.4(a) Extension of Term*
10.6.4(b) Second Extension of Term*
10.7 Letter Agreement between SmartPros Ltd. and Allen S. Greene re:
restricted stock (1)
10.8 Final form of Restricted Stock Agreement, dated as of
January 29, 2007, executed by Allen S. Greene, Jack Fingerhut,
Stanley Wirtheim, Joseph Fish and David Gebler (3)
14.1 Code of Ethics (2)
21.1 Subsidiaries (4)
23.1 Consent of Holtz Rubenstein Reminick LLP*
31.1 Principal Executive Officer Certification pursuant to section 302 of
the Sarbanes-Oxley Act of 2002*
32
31.2 Principal Financial Officer Certification pursuant to section 302 of
the Sarbanes-Oxley Act of 2002*
32.1 Principal Executive Officer Certification pursuant to section 906 of
the Sarbanes-Oxley Act of 2002*
32.2 Principal 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 February 2, 2007, as an exhibit to our Current Report on Form 8-K
and incorporated herein by reference. (4) Filed as an exhibit to our Annual
Report on Form 10-KSB for the fiscal year ended December 31, 2006, 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
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the
registrant has 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 22, 2007
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 22, 2007.
SIGNATURE TITLE
------------ --------
Principal Executive Officer
/s/ ALLEN S. GREENE Chief Executive Officer
-----------------------------------
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