agreements under which customers license the Company’s products and services. The pricing for the Company’s courses varies based upon the content offering selected by a customer, the number of users within the customer’s organization and the lengthterm of the license agreement (generally one, two or three years). License agreements permit customers to exchange course titles, generally on the contract anniversary date. Hosting services are separately licensed for an additional fee. A license can provide customers access to a range of learning products including courseware, Referenceware®Referenceware®, simulations, mentoring and prescriptive assessment.
The Company offers discounts from its ordinary pricing, and purchasers of licenses for a larger number of courses, larger user bases or longer periods of time generally receive discounts. Generally, customers may amend their license agreements, for an additional fee, to gain access to additional courses or product lines and/or to increase the size of the user base. The Company also derives revenue from hosting fees for clients that use its solutions on an ASP basis and from the provision of professional services. In selected circumstances, the Company derives revenue on a pay-for-use basis under which some customers are charged based on the number of courses accessed by users. Revenue derived from pay-for-use contracts has been minimal to date.
The Company recognizes revenue ratably over the license period if the number of courses that a customer has access to is not clearly defined, available, or selected at the inception of the contract, or if the contract has additional undelivered elements for which the Company does not have vendor specific objective evidence (VSOE) of the fair value of the various elements. This may occur if the customer does not specify all licensed courses at the outset, the customer chooses to wait for future licensed courses on a when and if available basis, the customer is given exchange privileges that are exercisable other than on the contract anniversaries, or the customer licenses all courses currently available and to be developed during the term of the arrangement. Revenue from nearly all of the Company’s contractual arrangements is recognized on a subscription or straight-line basis over the contractual period of service. The Company also derives revenue from extranet hosting/ASP services which is recognized on a straight-line basis over the period the services are provided. Upfront fees are recorded over the contract period.
The Company generally bills the annual license fee for the first year of a multi-year license agreement in advance and license fees for subsequent years of multi-year license arrangements are billed on the anniversary date of the agreement. Occasionally, the Company bills customers on a quarterly basis. In some circumstances, the Company offers payment terms of up to six months from the initial shipment date or anniversary date for multi-year license agreements to its customers. To the extent that a customer is given extended payment terms (defined by the Company as greater than six months), revenue is recognized as payments become due, assuming all of the other elements of revenue recognition have been satisfied.
The Company typically recognizes revenue from resellers when both the sale to the end user has occurred and the collectibility of cash from the reseller is probable. With respect to reseller agreements with minimum commitments, the Company recognizes revenue related to the portion of the minimum commitment that exceeds the end user sales at the expiration of the commitment period provided the Company has received payment. If a definitive service period can be determined, revenue is recognized ratably over the term of the minimum commitment period, provided that payment has been received or collectibility is probable.
The Company provides professional services, including instructor led training, customized content development, website development/hosting and implementation services. If the Company determines that the professional services are not separable from an existing customer arrangement, revenue from these services is recognized over the existing contractual terms with the customer; otherwise the Company typically recognizes professional service revenue as the services are performed.
The Company records revenue net of applicable sales tax collected. Taxes collected from customers are recorded as part of accrued expenses on the balance sheet and are remitted to state and local taxing jurisdictions based on the filing requirements of each jurisdiction.
digitized books and an on-line video library as well as complementary learning technologies. The acquisition supports SkillSoft’s mission to deliver comprehensive and high quality learning solutions and positions the Company to serve the demands of this growing marketplace.
The acquisition of NETg was accounted for as a business combination under SFAS No. 141, “Business Combinations”(SFAS No. 141), using the purchase method. Accordingly, the results of NETg have been included in the Company’s consolidated financial statements since the date of acquisition.
SUPPLEMETAL
SUPPLEMENTAL PRO-FORMA INFORMATION
The Company has concluded that the NETg acquisition representsrepresented a material business combination. The following are unaudited pro forma information presents the consolidated results of operations of the Company and NETg as ifassuming the NETg acquisition had occurred at the beginning of fiscal 2008 (Februaryon February 1, 2007),2007, with pro forma adjustments to give effect to amortization of intangible assets, an increase in interest expense on acquisition financing and certain other adjustments:
| | | | | | | | | |
| | | THREE MONTHS ENDED | | | SIX MONTHS ENDED | |
| | | JULY 31, 2007 | | | JULY 31, 2007 | |
| | | (in thousands except per share data) | |
| Revenue | | $ | 102,719 | | | $ | 191,109 | |
| Net income/loss | | | (7,684 | ) | | | (24,625 | ) |
| Net income/loss per share — basic | | $ | (0.07 | ) | | $ | (0.24 | ) |
| | | | | | | |
| Net income/loss per share — diluted | | $ | (0.07 | ) | | $ | (0.23 | ) |
| | | | | | | |
| | | NINE MONTHS ENDED OCTOBER 31, 2007 | |
| | | | |
| Revenue | | $ | 266,233 | |
| Net income (loss) | | | (18,800 | ) |
| Net income (loss) per share - basic | | $ | (0.18 | ) |
| Net income (loss) per share - diluted | | $ | (0.17 | ) |
The unaudited pro forma results above are not necessarily indicative of the results of operations that the Company wouldmay have attainedactually occurred had the acquisition of NETg occurred aton the beginning of the periods presented.date noted.
7. SPECIAL CHARGES
MERGER AND EXIT COSTS
(a) Merger and Exit Costs Recognized as Liabilities in Purchase Accounting
In connection with the closing of the NETg acquisition on May 14, 2007, the Company’s management effected an acquisition integration effort to eliminate redundant facilities and employees and to reduce the overall cost structure of the acquired business to better align the Company’s operating expenses with existing economic conditions, business requirements and the Company’s operating model. Pursuant to this restructuring, the Company recorded $11.6 million of costs related to severance and related benefits, costs to vacate leased facilities and other pre-Acquisition liabilities. These costs were accounted for under EITF Issue No. 95-3, “Recognition of Liabilities in Connection with Purchase Business Combinations.” These costs, which were recognized as a liability assumed in the purchase business combination, were included in the allocation of the purchase price.
The reductions in employee headcount will totaltotaled approximately 360 employees from the administrative, sales, marketing and development functions, and amounted to a liability of approximately $8.9 million. Approximately $8.6 million, which was paid against the exit plan accrual through JulyOctober 31, 2008, and the remaining amount2008.
In connection with the exit plan, the Company abandoned certain leased facilities resulting inand has a remaining facilities consolidation liability of $0.4$0.1 million as of JulyOctober 31, 2008, consisting of lease termination costs, broker commissions and other facility costs. As part of the plan, two larger sites and a number of small locations were vacated. The fair value of the lease termination costs was calculated with certain assumptions related to the Company’s estimated cost recovery efforts from subleasing vacated space, including (i) the time period over which the property will remain vacant, (ii) the sublease terms and (iii) the sublease rates.
9
The Company’s merger and exit liabilities which include previous merger and acquisition transactions are recorded in accrued expenses and long-term liabilities (see Note 16). Activity in the sixnine month period ended JulyOctober 31, 2008 is as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| | | EMPLOYEE | | | | | | | | | | |
| | | SEVERANCE AND | | | CLOSEDOWN OF | | | | | | | |
| | | RELATED COSTS | | | FACILITIES | | | OTHER | | | TOTAL | |
| Merger and exit accrual January 31, 2008 | | $ | 1,646 | | | $ | 3,224 | | | $ | 1,370 | | | $ | 6,240 | |
| |
| Adjustment to provision for merger and exit costs in connection with the acquisition of NETg | | | 212 | | | | 106 | | | | (967 | ) | | | (649 | ) |
| Payments made during the six months ended July 31, 2008 | | | (597 | ) | | | (845 | ) | | | (140 | ) | | | (1,582 | ) |
| | | | | | | | | | | | | |
| Merger and exit accrual July 31, 2008 | | $ | 1,261 | | | $ | 2,485 | | | $ | 263 | | | $ | 4,009 | |
| | | | | | | | | | | | | |
| | | EMPLOYEE SEVERANCE AND RELATED COSTS | | | CLOSEDOWN OF FACILITIES | | | OTHER | | | TOTAL | |
| Merger and exit accrual January 31, 2008 | | $ | 1,646 | | | $ | 3,224 | | | $ | 1,370 | | | $ | 6,240 | |
| Adjustment to provision for merger and exit costs in connection with the acquisition of NETg | | | 212 | | | | (139 | ) | | | (971 | ) | | | (898 | ) |
| Adjustment to provision for merger and exit costs in connection with the acquisition of SmartForce | | | (899 | ) | | | 266 | | | | - | | | | (633 | ) |
| Payments made during the nine months ended October 31, 2008 | | | (959 | ) | | | (1,723 | ) | | | (164 | ) | | | (2,846 | ) |
| Merger and exit accrual October 31, 2008 | | $ | - | | | $ | 1,628 | | | $ | 235 | | | $ | 1,863 | |
The Company anticipates that the remainder of the merger and exit accrual will be paid by October 2011 as follows (in thousands):
| | | | | |
| Year ended January 31, | | | | |
| 2009 (remaining 6 months) | | $ | 741 | |
| 2010 | | | 458 | |
| 2011 | | | 2,810 | |
| | | | |
| Total | | $ | 4,009 | |
| | | | |
| Year Ended January 31, | | | |
| 2009 (remaining 3 months) | | $ | 409 | |
| 2010 | | | 452 | |
| 2011 | | | 1,002 | |
| Total | | $ | 1,863 | |
In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,”the costs of continued employment of certain former NETg employees during the transition period are beingwere expensed as incurred and are included in merger and integration related expenses in the accompanying statements of income.
(b) Discontinued Operations
In connection with the NETg acquisition, the Company decided to discontinuediscontinued four businesses acquired from NETg because the Company believes thesebelieved those product offerings dodid not represent areas that cancould grow in a manner consistent with the Company’s operating model or be consistent with the Company’s profit model or strategic initiatives. The businesses that have beenwere identified as discontinued operations arewere Financial Campus, NETg Press, Interact Now and Wave.
Summarized results of operations for discontinued operations, which includes a gain of $2.0 million, net of income tax resulting from proceeds received during the three months ended July 31, 2008second quarter of fiscal 2009 from the Company’s sale of the assets related to the NETg Press business in October 2007, are as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | | SIX MONTHS ENDED | |
| | | JULY 31, | | | JULY 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Revenue from discontinued operations | | $ | 107 | | | $ | 3,629 | | | $ | 288 | | | $ | 3,629 | |
| | | | | | | | | | | | | |
| Gain from discontinued operations before income taxes | | | 3,459 | | | | 911 | | | | 3,305 | | | | 911 | |
| Income tax | | | 1,392 | | | | 387 | | | | 1,331 | | | | 387 | |
| | | | | | | | | | | | | |
| Gain from discontinued operations | | $ | 2,067 | | | $ | 524 | | | $ | 1,974 | | | $ | 524 | |
| | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | | NINE MONTHS ENDED | |
| | | OCTOBER 31, | | | OCTOBER 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | |
| Revenue from discontinued operations | | $ | (64 | ) | | $ | 3,134 | | | $ | 224 | | | $ | 6,760 | |
| (Loss) gain from discontinued operations before income tax | | | (62 | ) | | | (662 | ) | | | 3,243 | | | | 249 | |
| Income tax (benefit) provision | | | (25 | ) | | | (311 | ) | | | 1,306 | | | | 76 | |
| (Loss) gain from discontinued operations | | $ | (37 | ) | | $ | (351 | ) | | $ | 1,937 | | | $ | 173 | |
(c) Restructuring
Activity in the Company’s restructuring accrual was as follows (in thousands):
| | | | | |
| Total restructuring accrual as of January 31, 2008 | | $ | 961 | |
| Payments made during the six months ended July 31, 2008 | | | (232 | ) |
| Restructuring charges incurred during the six months ended July 31, 2008 | | | — | |
| | | | |
| Total restructuring accrual as of July 31, 2008 | | $ | 729 | |
| | | | |
10
| Total restructuring accrual as of January 31, 2008 | | $ | 961 | |
| Payments made during the nine months ended October 31, 2008 | | | (464 | ) |
| Restructuring charges incurred during the nine months ended October 31, 2008 | | | - | |
| Total restructuring accrual as of October 31, 2008 | | $ | 497 | |
The Company anticipates that the remainder of the restructuring accrual will be paid out in fiscal 2009.
8. GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible
Intangible assets are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | JULY 31, 2008 | | | JANUARY 31, 2008 | |
| | | GROSS | | | | | | | NET | | | GROSS | | | | | | | NET | |
| | | CARRYING | | | ACCUMULATED | | | CARRYING | | | CARRYING | | | ACCUMULATED | | | CARRYING | |
| | | AMOUNT | | | AMORTIZATION | | | AMOUNT | | | AMOUNT | | | AMORTIZATION | | | AMOUNT | |
| Internally developed software/ courseware | | $ | 38,717 | | | $ | 36,740 | | | $ | 1,977 | | | $ | 38,717 | | | $ | 33,259 | | | $ | 5,458 | |
| Customer contracts | | | 36,848 | | | | 23,523 | | | | 13,325 | | | | 36,848 | | | | 19,846 | | | | 17,002 | |
| Non-compete | | | 6,900 | | | | 3,450 | | | | 3,450 | | | | 6,900 | | | | 2,070 | | | | 4,830 | |
| Trademarks and trade names | | | 2,725 | | | | 1,707 | | | | 1,018 | | | | 2,725 | | | | 1,028 | | | | 1,697 | |
| Books trademark | | | 900 | | | | — | | | | 900 | | | | 900 | | | | — | | | | 900 | |
| | | | | | | | | | | | | | | | | | | |
| | | | 86,090 | | | | 65,420 | | | | 20,670 | | | | 86,090 | | | | 56,203 | | | | 29,887 | |
| Goodwill | | | 257,519 | | | | — | | | | 257,519 | | | | 256,196 | | | | — | | | | 256,196 | |
| | | | | | | | | | | | | | | | | | | |
| | | $ | 343,609 | | | $ | 65,420 | | | $ | 278,189 | | | $ | 342,286 | | | $ | 56,203 | | | $ | 286,083 | |
| | | | | | | | | | | | | | | | | | | |
| | OCTOBER 31, 2008 | | JANUARY 31, 2008 | |
| | GROSS | | | | NET | | GROSS | | | | NET | |
| | CARRYING | | ACCUMULATED | | CARRYING | | CARRYING | | ACCUMULATED | | CARRYING | |
| | AMOUNT | | AMORTIZATION | | AMOUNT | | AMOUNT | | AMORTIZATION | | AMOUNT | |
| Internally developed software/ courseware | | $ | 38,717 | | | $ | 38,430 | | | $ | 287 | | | $ | 38,717 | | | $ | 33,259 | | | $ | 5,458 | |
| Customer contracts | | | 36,848 | | | | 25,231 | | | | 11,617 | | | | 36,848 | | | | 19,846 | | | | 17,002 | |
| Non-compete | | | 6,900 | | | | 4,140 | | | | 2,760 | | | | 6,900 | | | | 2,070 | | | | 4,830 | |
| Trademarks and trade names | | | 2,725 | | | | 2,047 | | | | 678 | | | | 2,725 | | | | 1,028 | | | | 1,697 | |
| Books trademark | | | 900 | | | | - | | | | 900 | | | | 900 | | | | - | | | | 900 | |
| | | $ | 86,090 | | | $ | 69,848 | | | $ | 16,242 | | | $ | 86,090 | | | $ | 56,203 | | | $ | 29,887 | |
$900,000 of intangible assets within trademarks of our Books24x7 business unit are considered indefinite-lived and accordingly, no amortization expense is recorded.
The change in goodwill at JulyOctober 31, 2008 from the amount recorded at January 31, 20072008 is as follows:
| | | | | |
| | | Total | |
| Gross carrying amount of goodwill, January 31, 2008 | | $ | 256,196 | |
| Payment of contingent purchase price of Targeted Learning Corporation | | | 250 | |
| Adjustments to allocation of purchase price for NETg acquisition | | | 1,073 | |
| | | | |
| Gross carrying amount of goodwill, July 31, 2008 | | $ | 257,519 | |
| | | | |
| | | | |
| Gross carrying amount of goodwill, January 31, 2008 | | $ | 256,196 | |
| Payment of contingent purchase price of Targeted Learning Corporation | | | 250 | |
| Adjustments to allocation of purchase price for NETg acquisition | | | 953 | |
| Utilization of acquired tax benefit | | | (793 | ) |
| Gross carrying amount of goodwill, October 31, 2008 | | $ | 256,606 | |
The Company will be conducting its annual impairment test of goodwill for fiscal 2009 in the fourth quarter. $900,000 of intangible assets within trademarks of our Books24X7 business unit are considered indefinite-lived and accordingly no amortization expense is recorded.
9. COMPREHENSIVE INCOME
SFAS No. 130, “Reporting Comprehensive Income,” requires disclosure of all components of comprehensive income on an annual and interim basis. Comprehensive income is defined as the change in equity of a business enterprise during a period resulting from transactions, other events and circumstances related to non-owner sources. Comprehensive income for the three and sixnine months ended JulyOctober 31, 2008 and 2007 was as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | | SIX MONTHS ENDED | |
| | | JULY 31, | | | JULY 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Comprehensive income: | | | | | | | | | | | | | | | | |
| Net income | | $ | 12,882 | | | $ | 12,388 | | | $ | 19,956 | | | $ | 19,877 | |
| Other comprehensive (loss) income — Foreign currency adjustment | | | (95 | ) | | | (263 | ) | | | 296 | | | | (415 | ) |
| Change in fair value of interest rate hedge, net of tax | | | 524 | | | | (232 | ) | | | 895 | | | | (232 | ) |
| Unrealized losses on available-for-sale securities | | | (9 | ) | | | (8 | ) | | | (24 | ) | | | (86 | ) |
| | | | | | | | | | | | | |
| Comprehensive income | | $ | 13,302 | | | $ | 11,885 | | | $ | 21,123 | | | $ | 19,144 | |
| | | | | | | | | | | | | |
11
| | | THREE MONTHS ENDED | | | NINE MONTHS ENDED | |
| | | OCTOBER 31, | | | OCTOBER 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Comprehensive income: | | | | | | | | | | | | |
| Net income | | $ | 12,029 | | | $ | 5,825 | | | $ | 31,985 | | | $ | 25,702 | |
| Other comprehensive income (loss) — Foreign currency adjustment | | | 2,013 | | | | (701 | ) | | | 2,309 | | | | (1,116 | ) |
| Change in fair value of interest rate hedge, net of tax | | | 260 | | | | (842 | ) | | | 1,155 | | | | (1,074 | ) |
| Unrealized losses on available-for-sale securities | | | - | | | | 22 | | | | (24 | ) | | | (65 | ) |
| Comprehensive income | | $ | 14,302 | | | $ | 4,304 | | | $ | 35,425 | | | $ | 23,447 | |
Accumulated other comprehensive income as of JulyOctober 31, 2008 and January 31, 2008 was as follows (in thousands):
| | | | | | | | | |
| | | SIX MONTHS | | | YEAR ENDED | |
| | | ENDED JULY 31, | | | JANUARY 31, | |
| | | 2008 | | | 2008 | |
| Unrealized (loss) gains on available-for-sale securities | | $ | (2 | ) | | $ | 22 | |
| Change in fair value of interest rate hedge | | | (1,185 | ) | | | (2,080 | ) |
| Foreign currency adjustment | | | (2,071 | ) | | | (2,367 | ) |
| | | | | | | |
| Total accumulated other comprehensive loss | | $ | (3,258 | ) | | $ | (4,425 | ) |
| | | | | | | |
| | | NINE MONTHS ENDED OCTOBER 31, 2008 | | | YEAR ENDED JANUARY 31, 2008 | |
| Unrealized (loss) gains on available-for-sale securities | | $ | (2 | ) | | $ | 22 | |
| Change in fair value of interest rate hedge | | | (925 | ) | | | (2,080 | ) |
| Foreign currency adjustment | | | (58 | ) | | | (2,367 | ) |
| Total accumulated other comprehensive loss | | $ | (985 | ) | | $ | (4,425 | ) |
10. NET INCOME PER SHARE
Basic net income per share was computed using the weighted average number of shares outstanding during the period. Diluted net income per share was computed by giving effect to all dilutive potential shares outstanding. The weighted average number of shares outstanding used to compute basic net income per share and diluted net income per share was as follows:
| | | | | | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | SIX MONTHS ENDED |
| | | JULY 31, | | JULY 31, |
| | | 2008 | | 2007 | | 2008 | | 2007 |
| Basic weighted average shares outstanding | | | 104,877,548 | | | | 104,400,895 | | | | 105,081,727 | | | | 103,848,299 | |
| Effect of dilutive shares outstanding | | | 3,834,676 | | | | 4,022,698 | | | | 4,149,667 | | | | 3,891,310 | |
| | | | | | | | | | | | | | | | | |
| Weighted average shares outstanding, as adjusted | | | 108,712,224 | | | | 108,423,593 | | | | 109,231,394 | | | | 107,739,609 | |
| | | | | | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | | NINE MONTHS ENDED | |
| | | OCTOBER 31, | | | OCTOBER 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Basic weighted average shares outstanding | | | 104,182,736 | | | | 104,789,720 | | | | 104,779,876 | | | | 104,165,555 | |
| Effect of dilutive shares outstanding | | | 3,317,536 | | | | 3,762,736 | | | | 3,876,512 | | | | 3,853,118 | |
| Weighted average shares outstanding, as adjusted | | | 107,500,272 | | | | 108,552,456 | | | | 108,656,388 | | | | 108,018,673 | |
The following share equivalents have been excluded from the computation of diluted weighted average shares outstanding for the three and sixnine months ended JulyOctober 31, 2008 and 2007, respectively, as they would be anti-dilutive:
| | | | | | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | SIX MONTHS ENDED |
| | | JULY 31, | | JULY 31, |
| | | 2008 | | 2007 | | 2008 | | 2007 |
| Options to purchase shares | | | 2,944,977 | | | | 9,063,349 | | | | 2,951,235 | | | | 9,462,029 | |
| | | THREE MONTHS ENDED | | | NINE MONTHS ENDED | |
| | | OCTOBER 31, | | | OCTOBER 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Options to purchase shares | | | 2,907,621 | | | | 8,540,503 | | | | 2,936,591 | | | | 9,009,160 | |
11. INCOME TAXES
The Company operates as a holding company with operating subsidiaries in several countries, and each subsidiary is taxed based on the laws of the jurisdiction in which it operates.
The Company has significant net operating loss (NOL) carryforwards, some of which are subject to potential limitations based upon the change in control provisions of Section 382 of the United States Internal Revenue Code.
For the sixnine months ended JulyOctober 31, 2008 and 2007, the Company’s effective tax rates were 38.7%38.5% and (72.9%(44.3%), respectively. For the sixnine month period ended JulyOctober 31, 2008, the provision for income taxes consisted of a cash tax provision of $2.0$3.1 million and a non-cash tax provision of $9.4$15.7 million. Included in the non-cash tax provision of $9.4$15.7 million are adjustments of approximately $0.4is a $1.1 million provision related to the Company’s deferred tax asset associated with FAS 123R stock based compensation charges and approximately $0.2 million relatedreturn positions not likely to the Company’s U.S. based deferred tax assets and liabilities resulting from newly enacted State legislation. In accordance with FAS 109, the adjustment for the effect of the change in state tax law is included in income from continuing operations for the period that includes the enactment date.be sustained under audit. For the sixnine month period ended JulyOctober 31, 2007, the tax benefit of $8.2$7.9 million (72.9%(44.3%) consisted of a cash tax provision of $1.0$1.1 million and a non-cash tax benefit of $9.2$9.0 million. The non-cash tax benefit of $9.2$9.0 million was primarily the result of a $25 million reduction in the Company’s U.S. deferred tax valuation allowance on NOL carryforwards which was partially offset by the Company’s projected non-cash provision for income taxes and the impact of certain tax adjustments required in purchase accounting for the NETg acquisition.
At JulyOctober 31, 2008, the Company had $4.1$3.1 million of unrecognized tax benefits. If recognized, $0.9$2.4 million would lower the Company’s effective tax rate. However, upon the adoption of SFAS No. 141 (revised), “Business Combinations” (SFAS No. 141(R)), changes in unrecognized tax benefits following an acquisition generally will affect income tax expense, including any changes associated with acquisitions that occurred prior to the effective date of SFAS No. 141(R). The Company recognizes interest and penalties accrued related to
12
unrecognized tax benefits as income tax expense. As of JulyOctober 31, 2008, the Company had approximately $0.6$0.9 million of accrued interest and penalties related to uncertain tax positions.
The Company conducts business globally and, as a result, the Company and its subsidiaries file income tax returns in the U.S. and foreign jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the world, including, but not limited to, such major jurisdictions as Canada, the United Kingdom and the United States. With few exceptions, the Company is no longer subject to U.S. and international income tax examinations for years before 2002.2003.
12. COMMITMENTS AND CONTINGENCIES
In January 2007, the Boston District Office of the SEC informed the Company that it was the subject of an informal investigation concerning option granting practices at SmartForce for the period beginning April 12, 1996 through July 12, 2002 (the Option Granting Investigation). These grants were made prior to the September 6, 2002 merger with SmartForce PLC. The Company has produced documents in response to requests from the SEC. The SEC staff has informed the Company that the staff has not determined whether to close the Option Granting Investigation.
The Company believes that it accounted for SmartForce stock option grants appropriately in the merger. When SkillSoft Corporation and SmartForce merged on September 6, 2002, SkillSoft Corporation was for accounting purposes deemed to have acquired SmartForce. Accordingly, the pre-merger financial statements of SmartForce are not included in the historical financial statements of the Company, and the Company’s financial statements include the results of SmartForce only from the date of the merger. Under applicable accounting rules, the Company valued all of the outstanding SmartForce stock options assumed in the merger at fair value upon consummation of the merger. Accordingly, the Company believes that its accounting for SmartForce stock options will not be affected by any error that SmartForce may have made in its own accounting for stock option grants and that that the Option Granting Investigation should not require any change in the Company’s financial statements.
The Company has cooperated with the SEC in the Option Granting Investigation. At the present time, the Company is unable to predict the outcome of the Option Granting Investigation or its potential impact on its operating results or financial position.
From time to time, the Company is a party to or may be threatened with other litigation in the ordinary course of its business. The Company regularly analyzes current information, including, as applicable, the Company’s defenses and insurance coverage and, as necessary, provides accruals for probable and estimable liabilities for the eventual disposition of these matters. The Company is not a party to any other material legal proceedings.
13. GEOGRAPHICAL DISTRIBUTION OF REVENUESREVENUE
The Company attributes revenue to different geographical areas on the basis of the location of the customer. Revenues by geographical area for the three and sixnine month periods ended JulyOctober 31, 2008 and 2007 were as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| | | THREE MONTHS ENDED | | | SIX MONTHS ENDED | |
| | | JULY 31, | | | JULY 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Revenues: | | | | | | | | | | | | | | | | |
| United States | | $ | 60,756 | | | $ | 57,261 | | | $ | 119,809 | | | $ | 101,080 | |
| United Kingdom (UK) | | | 11,790 | | | | 7,319 | | | | 23,622 | | | | 14,259 | |
| Canada | | | 3,292 | | | | 2,575 | | | | 6,784 | | | | 5,129 | |
| Europe, excluding UK | | | 1,842 | | | | 626 | | | | 3,680 | | | | 1,024 | |
| Australia/New Zealand | | | 4,080 | | | | 3,077 | | | | 7,963 | | | | 5,838 | |
| Other | | | 1,572 | | | | 611 | | | | 3,117 | | | | 1,279 | |
| | | | | | | | | | | | | |
| Total revenues | | $ | 83,332 | | | $ | 71,469 | | | $ | 164,975 | | | $ | 128,609 | |
| | | | | | | | | | | | | |
Long-lived tangible assets at international locations are not significant.| | | THREE MONTHS ENDED | | | NINE MONTHS ENDED | |
| | | OCTOBER 31, | | | OCTOBER 31, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Revenue: | | | | | | | | | | | | |
| United States | | $ | 61,998 | | | $ | 59,076 | | | $ | 181,807 | | | $ | 160,161 | |
| United Kingdom (UK) | | | 11,358 | | | | 8,234 | | | | 34,980 | | | | 22,493 | |
| Canada | | | 3,047 | | | | 2,726 | | | | 9,831 | | | | 7,855 | |
| Europe, excluding UK | | | 1,758 | | | | 1,036 | | | | 5,438 | | | | 2,055 | |
| Australia/New Zealand | | | 3,343 | | | | 3,290 | | | | 11,306 | | | | 9,128 | |
| Other | | | 1,560 | | | | 762 | | | | 4,677 | | | | 2,041 | |
| Total revenue | | $ | 83,064 | | | $ | 75,124 | | | $ | 248,039 | | | $ | 203,733 | |
14. ACCRUED EXPENSES
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Accrued expenses in the accompanying condensed combined balance sheets consistedconsist of the following (in thousands):
| | | | | | | | | |
| | | JULY 31, 2008 | | | JANUARY 31, 2008 | |
| Professional fees | | | 3,879 | | | | 5,308 | |
| Sales tax payable/VAT payable | | | 1,539 | | | | 4,366 | |
| Accrued royalties | | | 1,992 | | | | 6,892 | |
| Other accrued liabilities | | | 9,980 | | | | 12,941 | |
| | | | | | | |
| Total accrued expenses | | $ | 17,390 | | | $ | 29,507 | |
| | | | | | | |
| | | OCTOBER 31, 2008 | | | JANUARY 31, 2008 | |
| Professional fees | | | 3,555 | | | | 5,308 | |
| Sales tax payable/VAT payable | | | 1,324 | | | | 4,366 | |
| Accrued royalties | | | 2,246 | | | | 6,892 | |
| Other accrued liabilities | | | 12,403 | | | | 12,941 | |
| Total accrued expenses | | $ | 19,528 | | | $ | 29,507 | |
15. OTHER ASSETS
Other assets in the accompanying condensed consolidated balance sheets consist of the following (in thousands):
| | | OCTOBER 31, 2008 | | | JANUARY 31, 2008 | |
| Note receivable – long term | | | - | | | | 3,507 | |
| Debt financing cost – long term (See Note 18) | | | 3,498 | | | | 4,126 | |
| Other | | | 204 | | | | 97 | |
| Total other assets | | $ | 3,702 | | | $ | 7,730 | |
16. OTHER LONG TERM LIABILITIES
Other long term liabilities in the accompanying condensed consolidated balance sheets consist of the following (in thousands):
| | | | | | | | | |
| | | JULY 31, 2008 | | | JANUARY 31, 2008 | |
| Note receivable – long term | | | — | | | | 3,507 | |
| Debt financing cost – long term (See Note 18) | | | 3,718 | | | | 4,126 | |
| Other | | | 81 | | | | 97 | |
| | | | | | | |
| Total other assets | | $ | 3,799 | | | $ | 7,730 | |
| | | | | | | |
16. OTHER LONG TERM LIABILITIESOther long term liabilities in the accompanying consolidated balance sheets consist of the following (in thousands):| | | OCTOBER 31, 2008 | | | JANUARY 31, 2008 | |
| Merger accrual – long term | | | 1,597 | | | | 2,914 | |
| Interest rate swap liability (See Note 19) | | | 1,542 | | | | 3,467 | |
| Other | | | 2,793 | | | | 2,828 | |
| Total other long-term liabilities | | $ | 5,932 | | | $ | 9,209 | |
| | | | | | | | | |
| | | JULY 31, 2008 | | | JANUARY 31, 2008 | |
| Merger accrual – long term | | | 2,923 | | | | 2,914 | |
| Interest rate swap liability (See Note 19) | | | 1,984 | | | | 3,467 | |
| Other | | | 2,916 | | | | 2,828 | |
| | | | | | | |
| Total other long-term liabilities | | $ | 7,823 | | | $ | 9,209 | |
| | | | | | | |
In Note 17 of “Notes to Consolidated Financial Statements” presented in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2008, the Company had unintentionally included approximately $2.5 million in “Merger accrual – long term” instead of “Other”. Such amount has been reclassified above forto reflect the correct presentation.
17. FAIR VALUE OF FINANCIAL INSTRUMENTS
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. As defined in SFAS No. 157, fair value is the amount that would be received if an asset was sold or a liability transferred in an orderly transaction between market participants at the measurement date.
Effective February 1, 2008, the Company adopted the provision of SFAS No. 157 with respect to its financial assets and liabilities that are measured at fair value within the condensed consolidated financial statements. The adoption of SFAS No. 157 did not have a material impact on the Company’s financial position, results of operations or cash flows.
In February 2008, the FASB issued FASB Staff Position (FSP) SFAS No. 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Its Related Interpretive Accounting Pronouncements That Address Leasing Transactions,” (FSP SFAS No. 157-1), and FSP SFAS No. 157-2, “Effective Date of FASB Statement No. 157” (FSP SFAS No. 157-2). FSP SFAS No. 157-1 removes leasing from the scope of SFAS No. 157, “Fair Value Measurements.” FSP SFAS No. 157-2 delays the effective date of SFAS No. 157 from 2008 to 2009 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of FSP SFAS No. 157-1, effective February 1, 2008, did not impact the Company’s financial position, results of operations or cash flows. The Company has deferred the application of the provisions of this statement to its non-financial assets and liabilities in
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accordance with FSP SFAS No. 157-2. The Company does not expect that its adoption of the provisions of FSP SFAS 157-2 will have a material impact on its financial position, results of operations or cash flows.
SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are inputs that reflect the assumptions that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
The three levels of the fair value hierarchy established by SFAS No. 157 in order of priority are as follows:
| • | · | Level 1: Quoted prices in active markets for identical assets as of the reporting date. |
|
| • | · | Level 2: Pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. |
|
| • | · | Level 3: Unobservable inputs that reflect the Company’s assumptions about the assumptions that market participants would use in pricing the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available. |
The Company’s commercial paper, corporate debt securities, certificates of deposit, and federal agency notes and treasury bills are classified as cash equivalents or available for sale securities based on the original maturity period and carried at fair value. These assets, except for federal agency notes and treasury bills, are generally classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. The Company classifies federal agency notes and treasury bills within Level 2 of the fair value hierarchy because they are valued using pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date.
The Company recognizes all derivative financial instruments in its consolidated financial statements at fair value in accordance with FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.”The Company determines the fair value of these instruments using the framework prescribed by SFAS No. 157 by considering the estimated amount the Company would receive to terminate these agreements at the reporting date and by taking into account current interest rates and the creditworthiness of the counterparty. In certain instances, the Company may utilize financial models to measure fair value. Generally, the Company uses inputs that include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, other observable inputs for the asset or liability and inputs derived principally from, or corroborated by, observable market data by correlation or other means. The Company has classified its derivative liability within Level 2 of the fair value hierarchy because these observable inputs are available for substantially the full term of the derivative instrument.
The following table summarizes the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of JulyOctober 31, 2008 (in thousands):
| | | | | | | | | | | | | | | | | |
| | | | | | | Quoted Prices in | | Significant | | |
| | | | | | | Active Markets | | Other | | Significant |
| | | | | | | for Identical | | Observable | | Unobservable |
| | | July 31, 2008 | | Assets Level 1 | | Inputs Level 2 | | Inputs Level 3 |
| Financial Assets: | | | | | | | | | | | | | | | | |
| Cash equivalents (1) | | $ | 33,413 | | | $ | 7,487 | | | $ | 25,926 | | | $ | — | |
| Available for sale securities (2) | | $ | 8,100 | | | $ | 8,100 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | |
| Interest rate swap agreement (Note 19) | | $ | 1,984 | | | $ | — | | | $ | 1,984 | | | $ | — | |
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| | |
(1) | | Consists of high-grade commercial paper and federal agency notes with original and remaining maturities of less than 90 days. |
|
(2) | | Consists of high-grade commercial paper, corporate debt securities and certificates of deposit with original maturities of 90 days or more and remaining maturities of less than 365 days. |
| | | October 31, 2008 | | | Quoted Prices in Active Markets for Identical Assets Level 1 | | | Significant Other Observable Inputs Level 2 | | | Significant Unobservable Inputs Level 3 | |
| Financial Assets: | | | | | | | | | | | | |
| Cash equivalents (1) | | | 30,821 | | | $ | 15,625 | | | $ | 15,196 | | | $ | - | |
| Available for sale securities (2) | | | 8,804 | | | $ | 6,505 | | | $ | 2,299 | | | $ | - | |
| | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | |
| Interest rate swap agreement (Note 19) | | | 1,542 | | | $ | - | | | $ | 1,542 | | | $ | - | |
(1) Consists of high-grade commercial paper and federal agency notes with original and remaining maturities of less than 90 days.
(2) Consists of high-grade commercial paper, corporate debt securities and certificates of deposit with original maturities of 90 days or more and remaining maturities of less than 365 days.
18. LINE OF CREDIT
The Company has an agreement (the Credit Agreement) with certain lenders (the Lenders) providing for a $225 million senior secured credit facility comprised of a $200 million term loan facility and a $25 million revolving credit facility. The term loan was used to finance the NETg acquisition and the revolving credit facility may be used for general corporate purposes.
On July 7, 2008, the Company entered into an amendment (Amendment No. 1) to the Credit Agreement, and the related Guarantee and Collateral Agreement, dated May 14, 2007. Pursuant to the Credit Agreement, the Company and any subsidiary of the Company have a limited ability to repurchase shares in the Company. The primary purpose of Amendment No. 1 was to expand the ability of the Company and its subsidiaries to be able to make additional repurchases of the Company’s Ordinary Shares. The Company’s expanded repurchase ability under Amendment No. 1 is conditioned on the absence of an event of default and a requirement that (i) the leverage ratio shall be no greater than 2.75:1.0 as of the most recently completed fiscal quarter ending prior to the date of such repurchase and (ii) that the Company make a prepayment of the term loan under the Credit Agreement in an amount equal to the dollar amount of any such repurchase. Such term loan prepayments will not, however, be required in connection with the first $24.0 million of repurchases made from and after July 7, 2008.
Amendment No. 1 also provides for an increase in the interest rate on the term loan outstanding under the Credit Agreement and the payment of additional fees to the Lenders upon execution of Amendment No. 1. Pursuant to Amendment No. 1, the term loan will bear interest at a rate per annum equal to, at the Company’s election, (i) a base rate plus a margin of 2.50% (increased from 1.75%) or (ii) adjusted LIBOR plus a margin of 3.50% (increased from 2.75%).
In connection with the Credit Agreement and Amendment No. 1, the Company incurred debt financing costs of $5.9 million and $0.3 million, respectively, which were capitalized and are being amortized as additional interest expense over the term of the loans using the effective-interest method. During the three and sixnine months ended JulyOctober 31, 2008, the Company paid approximately $2.5$2.3 million and $6.3$8.6 million, respectively, in interest. The Company recorded $0.4$0.3 million and $0.6$0.9 million of amortized interest expense related to the capitalized debt financing costs for the three and sixnine months ended JulyOctober 31, 2008, respectively. As of JulyOctober 31, 2008, total unamortized debt financing costs of $1.1$1.0 million and $3.7$3.5 million are recorded within prepaid expenses and other current assets and non-current other assets, respectively, based on scheduled future amortization.
During the three and sixnine months ended July,October 31, 2008, the Company paid $30.4$0.4 million and $54.9$55.3 million, respectively, against the term loan amount. As a result, the balance outstanding under the term loan was $144.1$143.7 million at JulyOctober 31, 2008, with a weighted average interest rate for the three month period ended JulyOctober 31, 2008 of 7.49%8.21%.
Future scheduled minimum payments under this credit facility are as follows (in thousands):
| | | | | |
| Fiscal 2009 (remaining 6 months) | | $ | 728 | |
| Fiscal 2010 | | | 1,455 | |
| Fiscal 2011 | | | 1,455 | |
| Fiscal 2012 | | | 1,455 | |
| Fiscal 2013 | | | 1,455 | |
| Thereafter | | | 137,512 | |
| | | | |
| Total | | $ | 144,060 | |
| | | | |
| Fiscal 2009 (remaining 3 months) | | $ | 364 | |
| Fiscal 2010 | | | 1,455 | |
| Fiscal 2011 | | | 1,455 | |
| Fiscal 2012 | | | 1,455 | |
| Fiscal 2013 | | | 1,455 | |
| Thereafter | | | 137,513 | |
| Total | | $ | 143,697 | |
19. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
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The Company has an interest rate swap to hedge the variable cash flows associated with existing variable-rate debt. As of JulyOctober 31, 2008 and 2007, the notional amount on the interest rate swap was $120.0$100.4 million and $160.0$159.6 million, respectively.
At JulyOctober 31, 2008 and 2007, the interest rate swap had a fair value of $(2.0)$(1.5) million and ($0.2)$(1.1) million, respectively, which was included in other long-term liabilities. No hedge ineffectiveness was recognized during the sixnine months ended JulyOctober 31, 2008 and 2007. For the three months ended JulyOctober 31, 2008 and 2007, the change in net unrealized gains (losses) on the interest rate swap designated as a cash flow hedge and reported as a component of comprehensive income was a $0.5$0.3 million net gain and $0.2a $0.8 million net loss, respectively. For the sixnine months ended JulyOctober 31, 2008 and 2007, the change in net unrealized gains (losses) on the interest rate swap designated as a cash flow hedge and reported as a component of comprehensive income was a $0.9$1.2 million net gain and a $0.2$1.1 million net loss, net of tax, respectively.
Amounts reported in accumulated other comprehensive income related to derivatives will be incurred as interest expense as payments are made on the Company’s variable-rate debt. The change in net unrealized gaingains (losses) on cash flow hedges reflects a reclassification of $0.8$0.6 million of net unrealized losses and $0.1 million of net unrealized gains from accumulated other comprehensive income to interest expense for the three months ended JulyOctober 31, 2008 and 2007, respectively. The change in net unrealized gaingains (losses) on cash flow hedges reflects a reclassification of $1.2$1.8 million of net unrealized losses and $0.1$0.2 million of net unrealized gains from accumulated other comprehensive income to interest expense for the sixnine months ended JulyOctober 31, 2008 and 2007, respectively. During the twelve month period ending JulyOctober 31, 2009, the Company estimates that it will incur an additional $1.8$1.5 million of interest expense relating to the interest rate swap.
20. SHARE REPURCHASE PROGRAM
On April 8, 2008, the Company’s shareholders approved a program for the repurchase by the Company of up to an aggregate of 10,000,000 ADSs. On September 24, 2008, the Company’s shareholders approved an increase in the number of shares that may be repurchased under the program to 25,000,000 and an extension of the repurchase program until March 23, 2010. During the three and sixnine months ended JulyOctober 31, 2008, the Company repurchased a total of 1,511,8192,985,680 and 2,723,7195,709,399 shares, respectively, for a total purchase price, including commissions, of $15.0$29.3 million and $27.2$56.5 million, respectively. The Company retired 11,586,183 shares during the three months ended October 31, 2008, including 6,533,884 shares repurchased in prior fiscal years. As of October 31, 2008, 657,100 of the repurchased shares werehave not been retired or canceled but ratherand are held as treasury stock at cost; however, the Company does intendintends to retire these shares in the near future. As of JulyOctober 31, 2008, 7,276,281 remained19,290,601 shares remain available for repurchase, subject to certain limitations, under the shareholder approved repurchase program which expires on October 7, 2009. The Company has submitted a proposal to its shareholders to increase the number of shares that may be repurchased under the repurchase program from 10,000,000 to 25,000,000 and to extend the duration of the repurchase program until March 23, 2010. The proposal will be voted on by the Company’s shareholders at the Company’s annual general meeting to be held on September 24, 2008. As discussed in Note 18, the Company has amended provisions of its Credit Agreement to expand the ability of the Company and its subsidiaries to repurchase shares.program.
21. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB, issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (SFAS No. 159), which permits entities to choose to measure many financial instruments and certain other items at fair value and is effective for fiscal years beginning after November 15, 2007, or February 1, 2008 for SkillSoft. The Company adopted SFAS No. 159 on February 1, 2008 and elected not to measure any additional financial instruments or other items at fair value. Adoption of SFAS No. 159 did not have a material impact on the Company’s financial position or results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised), “Business Combinations”(SFAS (SFAS No. 141(R)). SFAS No. 141(R) changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141(R) is effective for the Company for any business combinations for which the acquisition date is on or after February 1, 2009, with early adoption prohibited.
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In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”(SFAS No. 160). SFAS No. 160 changes the accounting for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. Additionally, SFAS No. 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. SFAS No. 160 is effective for the Company in fiscal 2009, with early adoption prohibited. Currently, the Company does not anticipate thatAdoption of SFAS No. 160 willdid not have a material impact on the Company’s financial statements.position or results of operations.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”(SFAS No. 161). SFAS No. 161 applies to all derivative instruments and nonderivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 37 and 42 of Statement 133 and related hedged items accounted for under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS(SFAS No. 133). SFAS No. 161 requires entities to provide greater transparency through additional disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. SFAS No. 161 is effective for the Company on February 1, 2009. The Company is currently analyzing the effect, SFAS No. 161 will have on its disclosures related to the Company’s interest rate swap agreement.
Any statement in this Quarterly Report on Form 10-Q about our future expectations, plans and prospects, including statements containing the words “believes,” “anticipates,” “plans,” “expects,” “will” and similar expressions, constitute forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those set forth under Part II, Item 1A, “Risk Factors.”
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q.
OVERVIEW
We are a leading Software as a Service (SaaS) provider of on-demand e-learning and performance support solutions for global enterprises, government, education and small to medium-sized businesses. We enable business organizations to maximize business performance through a combination of comprehensive e-learning content, online information resources, flexible learning technologies and support services. Our multi-modal learning solutions support and enhance the speed and effectiveness of both formal and informal learning processes and integrate our in-depth content resources, learning management system, virtual classroom technology and support services.
We generate revenue primarily from the license of our products, the provision of professional services as well as from the provision of hosting and application services. The pricing for our courses varies based upon the content offering selected by a customer, the number of users within the customer’s organization and the length of the license agreement (generally one, two or three years). Our agreements permit customers to exchange course titles, generally on the contract anniversary date. Hosting services are separately licensed for an additional fee.
Cost of revenues includes the cost of materials (such as storage media), packaging, shipping and handling, CD duplication, custom content development and hosting services, royalties and certain infrastructure and occupancy expenses and share-based compensation. We generally recognize these costs as incurred. Also included in cost of revenues is amortization expense related to capitalized software development costs and intangible assets related to developed software and courseware acquired in business combinations.
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We account for software development costs in accordance with Statement of Financial Accounting Standards (SFAS) No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” (SFAS No. 86), which requires the capitalization of certain computer software development costs incurred after technological feasibility is established. No software development costs incurred during the three and sixnine months of fiscal 2009ended October 31, 2008 met the requirements for capitalization in accordance with SFAS No. 86.
Research and development expenses consist primarily of salaries and benefits, share-based compensation, certain infrastructure and occupancy expenses, fees to consultants and course content development fees. Selling and marketing expenses consist primarily of salaries and benefits, share-based compensation, commissions, advertising and promotion expenses, travel expenses and certain infrastructure and occupancy expenses. General and administrative expenses consist primarily of salaries and benefits, share-based compensation, consulting and service expenses, legal expenses, audit and tax preparation costs, regulatory compliance costs and certain infrastructure and occupancy expenses.
Amortization of intangible assets represents the amortization of customer value, non-compete agreements, trademarks and tradenames from our acquisitions of NETg, Targeted Learning Corporation (TLC), Books24x7 and GoTrain Corp. and our merger with SkillSoft Corporation (the SmartForce Merger).
Merger and integration related expenses primarily consist of salaries paid to NETg employees for transitional work assignments, facilities, systems and process integration activities.
SEC investigation expenses primarily consist of legal and consulting fees incurred related to the SEC’s review of SmartForce’s option granting practices prior to the SmartForce Merger, and historically, the SEC investigation relating to the restatement of SmartForce’s financial statements for 1999, 2000, 2001 and the first two quarters of 2002.
BUSINESS OUTLOOK
In the three and sixnine months ended JulyOctober 31, 2008, we generated revenues of $83.3$83.1 million and $165.0$248.0 million, respectively, as compared to $71.5$75.1 million and $128.6$203.7 million in the three and sixnine months ended JulyOctober 31, 2007, respectively. We reported net income in the three and sixnine months ended JulyOctober 31, 2008 of $12.9$12.0 million and $20.0$32.0 million, respectively, as compared to $12.4$5.8 million and $19.9$25.7 million in the three and sixnine months ended JulyOctober 31, 2007, respectively.
While we have achieved increased revenues and profitability from last fiscal year’s comparable periods, and remain profitable,we have experienced a more cautious customer environment due to the current challenging global economic climate. In addition, we continue to find ourselves in a challenging business environment due to (i) the relatively slow overall market adoption rate for e-learning solutions, (ii) budgetary constraints on information technology (IT) spending by our current and potential customers, and (iii)(ii) price competition and value basedvalue-based competitive offerings from a broad array of competitors in the learning market. Despite these challenges,market and (iii) the relatively slow overall market adoption rate for e-learning solutions. In recent months the challenging U.S. and global economic environment has put additional pressure on potential budgetary constraints on IT and spending by our current and potential customers. While we have seen some stability incustomers put spending on hold, we have seen others increase spending and utilize e-learning as a cost effective alternative to traditional learning. Despite the marketplace andchallenges, our core business has performed predominately in accordance with our expectations. Our recent revenue growth, as compared to last fiscal year, was primarily derived fromthe result of the realization of additional revenue resulting from anthe increased customer base associated with the NETg acquisition, as well as from third party resellers of our product and international sales. Our growth prospects are strongest in developing our expanded core business, which leverages our various product lines in a strategy of bundled product offerings, as well as continued distribution partnerships with third party resellers and international distribution growth. As a result, we have increased our sales and marketing investment related to these areas to help capitalize on the recent growth and potential continued growth. We have also invested aggressively in research and development in those areas to accelerate the time by which our planned new products will be available to our customers. In order to pursue the small and mediummedium-sized business markets, we continue to invest in our telesales unit, butbusiness unit; however, we have not seen results in line with our expectations and as a result we have made and will needcontinue to see renewal rates consistent with those ofmake organizational changes as needed to achieve our direct sales business to determine its growth potential.expected growth. We plan to continue to invest in our new business direct field sales team and lead generator organization.organizations.
On May 14, 2007, we acquired NETg for approximately $254.7 million, after giving effect to certain customary post-closing adjustments. NETg was a global enterprise-learning company delivering integrated learning solutions for businesses, professional associations and government agencies that include instructional content, multiple delivery options, enabling technologies, and a range~ 20 ~
licensing model for access to its learning resources library, a direct sales force distribution system complemented by resellers and telesales support, and a Global 2000 client base offering visibility through multi-year contracts and renewal rates. The acquisition added to our existing offerings through the addition of complementary NETg offerings such as live virtual instructor-led training, blended learning, learning content and custom development services among others. The acquisition supports our overall strategy to continually increase the quality, breadth and flexibility of the learning solutions we can make available to our corporate, government, education and small-to-medium size business customers and we anticipate the integrated assets and services will result in an increase in value to our customers. Also, the addition of NETg’s capabilities strengthens our ability to compete for a greater share of the $13.2 billion corporate training market that includes many larger players with more comprehensive product offerings and broader distribution.
In the sixnine months ended JulyOctober 31, 2008 and for the remainder of fiscal 2009, we have and will continue to focus on revenue and earnings growth, excluding normal and anticipated acquisition and integration related expenses, primarily by:
• | | cross selling and up selling; |
|
• | | looking at new markets, which may include expanding or investing internationally; |
|
• | | acquiring new customers; |
|
• | | continuing to execute on our new product and telesales distribution initiatives; and |
|
• | | continuing to evaluate merger and acquisition and possible partnership opportunities that could contribute to our long-term objectives. |
evaluating our current operating cost structure to determine where we can realize cost efficiencies;
cross selling and up selling;
looking at new markets, which may include expanding or investing internationally;
acquiring new customers through our core sales team as well as through the recently formed New Business Field Sales team;
continuing to execute on our new product and telesales distribution initiatives; and
continuing to evaluate merger and acquisition and possible partnership opportunities that could contribute to our long-term objectives.
CRITICAL ACCOUNTING POLICIES
We believe that our critical accounting policies are those related to revenue recognition, amortization of intangible assets and impairment of goodwill, share-based compensation, deferral of commissions, restructuring charges, legal contingencies, income taxes and valuation of business combinations. We believe these accounting policies are particularly important to the portrayal and understanding of our financial position and results of operations and require application of significant judgment by our management. In applying these policies, management uses its judgment in making certain assumptions and estimates. Our critical accounting policies are more fully described under the heading “Critical Accounting Policies” in Note 2 of the Notes to the Consolidated Financial Statements and under “Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Critical Accounting Policies” in our Annual Report on Form 10-K as filed with the SEC on March 31, 2008. The policies set forth in our Form 10-K have not changed.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JULYOCTOBER 31, 2008 VERSUS THREE MONTHS ENDED JULYOCTOBER 31, 2007
| | | | | | | | | | | | | | | | | |
| | | Three Months Ended July 31, | |
| | | Dollar | | | Percent Change | | | | |
| | | Increase (Decrease) | | | Increase (Decrease) | | | Percentage of Revenue | |
| | | 2007/2008 | | | 2007/2008 | | | 2008† | | | 2007† | |
| | | (In thousands) | |
| Revenue | | $ | 11,863 | | | | 17 | % | | | 100 | % | | | 100 | % |
| Cost of revenue | | | 1,112 | | | | 13 | % | | | 12 | % | | | 12 | % |
| Cost of revenue — amortization of intangible assets | | | (4 | ) | | | — | | | | 2 | % | | | 2 | % |
| | | | | | | | | | | | | | |
| Gross profit | | | 10,755 | | | | 18 | % | | | 86 | % | | | 85 | % |
| | | | | | | | | | | | | | |
| Research and development | | | 1,155 | | | | 10 | % | | | 15 | % | | | 16 | % |
| Selling and marketing | | | 2,385 | | | | 10 | % | | | 31 | % | | | 33 | % |
| General and administrative | | | 435 | | | | 5 | % | | | 11 | % | | | 13 | % |
| Amortization of intangible assets | | | (1,000 | ) | | | (27 | )% | | | 3 | % | | | 5 | % |
| Merger related integration expenses | | | (8,253 | ) | | | (97 | )% | | | — | | | | 12 | % |
| SEC investigation | | | (364 | ) | | | * | | | | — | | | | — | |
| | | | | | | | | | | | | | |
| Total operating expenses | | | (5,642 | ) | | | (10 | )% | | | 61 | % | | | 79 | % |
| | | | | | | | | | | | | | |
| Operating income | | | 16,397 | | | | 377 | % | | | 25 | % | | | 6 | % |
| | | | | | | | | | | | | | |
| Other income expense, net | | | (96 | ) | | | 38 | % | | | — | | | | — | |
| Interest income | | | (153 | ) | | | (21 | )% | | | 1 | % | | | 1 | % |
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Revenue
| | | | | | | | | | | | | | | | | |
| | | Three Months Ended July 31, | |
| | | Dollar | | | Percent Change | | | | |
| | | Increase (Decrease) | | | Increase (Decrease) | | | Percentage of Revenue | |
| | | 2007/2008 | | | 2007/2008 | | | 2008† | | | 2007† | |
| | | (In thousands) | |
| Interest expense | | | 451 | | | | (12 | )% | | | (4 | )% | | | (5 | )% |
| | | | | | | | | | | | | | |
| Income before income taxes | | | 16,599 | | | | 1,564 | % | | | 21 | % | | | 1 | % |
| Provision for income taxes | | | 17,648 | | | | * | | | | 8 | % | | | (15 | )% |
| | | | | | | | | | | | | | |
| Income from continuing operations | | | (1,049 | ) | | | (9 | )% | | | 13 | % | | | 17 | % |
| Income from discontinued operations, net of income tax | | | 1,543 | | | | * | | | | 2 | % | | | 1 | % |
| | | | | | | | | | | | | | |
| Net income | | $ | 494 | | | | 4 | % | | | 15 | % | | | 17 | % |
| | | | | | | | | | | | | | |
| | |
* | | Not meaningful |
|
† | | Does not add due to rounding. |
Revenue| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | 2007 | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | |
| Revenues | $ | 83,064 | | $ | 75,124 | | | $ | 7,940 | | | | 11 | % |
| Operating income | | 21,607 | | | 10,361 | | | | 11,246 | | | | 109 | % |
Revenue increased primarily due to the realization of additional revenue resulting from an increased customer base associated with the NETg acquisition in May 2007 as well as from continued additional revenue earned under agreements with third party resellers of our products. We expect revenue growth to continue through the fourth quarter of fiscal 2009.2009 compared to the fourth quarter of fiscal 2008.
| | | | | | | | | | | | | |
| | | THREE MONTHS ENDED JULY 31, | |
| (IN THOUSANDS) | | 2008 | | | 2007 | | | CHANGE | |
| Revenue: | | | | | | | | | | | | |
| United States | | $ | 60,756 | | | $ | 57,261 | | | $ | 3,495 | |
| International | | | 22,576 | | | | 14,208 | | | | 8,368 | |
| | | | | | | | | | |
| Total | | $ | 83,332 | | | $ | 71,469 | | | $ | 11,863 | |
| | | | | | | | | | |
| | | THREE MONTHS ENDED OCTOBER 31, | | | | |
| (In thousands) | | 2008 | | | 2007 | | | CHANGE | |
| Revenue: | | | | | | | | | |
| United States | | $ | 61,998 | | | $ | 59,076 | | | $ | 2,922 | |
| International | | | 21,066 | | | | 16,048 | | | | 5,018 | |
| Total | | $ | 83,064 | | | $ | 75,124 | | | $ | 7,940 | |
Revenue increased by 6%5% and 59%31% in the United States and internationally, respectively, in the three months ended JulyOctober 31, 2008 as compared to the three months ended JulyOctober 31, 2007 as a result of increased revenue generated from the NETg acquisition and from existing customers and new business.
We exited the fiscal year ended January 31, 2008 with non-cancelable backlog of approximately $255 million compared to $181 million at January 31, 2007. This amount is calculated by combining the amount of deferred revenue at each fiscal year end with the amounts to be added to deferred revenue throughout the next twelve months from billings under committed customer contracts and determining how much of these amounts are scheduled to amortize into revenue during the upcoming fiscal year. The amount scheduled to amortize into revenue during fiscal 2009 is disclosed as “backlog” as of January 31, 2008. Amounts to be added to deferred revenue during fiscal 2009 include subsequent installment billings for ongoing contract periods as well as billings for committed contract renewals. We have included this non-GAAP disclosure as it is directly related to our subscription based revenue recognition policy. This is a key business metric, which factors into our forecasting and planning activities and provides visibility into fiscal 2009 revenue.
Costs and Expenses
| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE | |
| | 2008 | | | 2007 | | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Cost of revenues | $ | 9,374 | | | $ | 8,282 | | | $ | 1,092 | | | | 13 | % |
| As a percentage of revenue | | 11 | % | | | 11 | % | | | | | | | | |
| Cost of revenues - amortization of intangible assets | | 1,690 | | | | 1,740 | | | | (50 | ) | | | (3 | )% |
| As a percentage of revenue | | 2 | % | | | 2 | % | | | | | | | | |
The increase in cost of revenue in the three months ended JulyOctober 31, 2008 versus the three months ended JulyOctober 31, 2007 was primarily due to increased revenues. Gross margin increased less than 1% during these periods.
| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Research and development | $ | 12,138 | | | $ | 13,710 | | | $ | (1,572 | ) | | | (11 | )% |
| As a percentage of revenue | | 15 | % | | | 18 | % | | | | | | | | |
The increasedecrease in research and development expense in the three months ended JulyOctober 31, 2008 versus the three months ended July 31, 2007 was primarily due to an increase in compensation and benefits of $1.0 million associated with additional headcount and an increase in outsource partner costs of $0.2 million to support expanded product and software development initiatives resulting from our larger customer base. A portion of these incremental costs are attributable to NETg integration initiatives, which include maintaining multiple platforms, fulfilling obligations of acquired customer contracts and product commitments assumed in the acquisition of NETg.
The increase in selling and marketing expense in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to an increase in compensation and benefits of $3.0 million as a result of an increase in sales and marketing headcount, which includes additional direct sales, telesales and field support personnel required to service our increased customer base as a result of the NETg acquisition, as well as incremental commissions resulting from increased order intake and billings from our larger base business and from the acquired
21
NETg customer base. This was partially offset by a reduction in costs related to sales meetings and marketing events of $0.5 million.
The increase in general and administrative expense in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to an increase of $0.5 million of professional fees primarily related to an on-going feasibility analysis related to our business realignment strategy.
The decrease in amortization of intangible assets in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to certain assets becoming fully amortized.
The decrease in merger and integration related expenses in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to the significant charges in last year’s second quarter, when the NETg acquisition was consummated, and the near completion of efforts undertaken to integrate NETg’s operations into ours. We do not expect to incur additional material merger-related expenses related to the NETg acquisition after the third quarter of fiscal 2009.
SEC investigation expenses decreased in the three months ended July 31, 2008 versus the three months ended July 31, 2007 due to a decrease in legal activities related to the SEC’s informal inquiry into the pre-merger option granting practices at SmartForce.
Other Expense, Net
The change in other income expense, net, in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to foreign currency fluctuations. Due to our multi-national operations, our business is subject to fluctuations based upon changes in the exchange rates between the currencies used in our business.
Interest Income
The reduction of interest income in the three months ended July 31, 2008 versus the three months ended July 31, 2007 was primarily due to lower interest rates and a reduction in our short-term investments.
Interest Expense
The decrease in interest expense in the three months ended July 31, 2008 versus the three months ended JulyOctober 31, 2007 was primarily due to a reduction in professional fees of our debt$0.8 million as a result of prepayments made in the first half oflast year’s third fiscal 2009.
Provision for Income Taxes
For the three months ended July 31, 2008, we had a tax provision of $6.8 million versus a tax benefit of $10.8 million for the three months ended July 31, 2007. For the three months ended July 31, 2008, the effective tax rate is higher than the Irish statutory rate of 12.5% primarily duequarter incurring costs attributable to earnings realized in higher tax jurisdictions outside of Ireland. The tax benefit for the three months ended July 31, 2007 was influenced significantly by certain purchase accounting tax adjustments as a result of the NETg acquisition and the release of approximately $49.1 million of our valuation allowance primarily related to U.S. net operating loss (NOL) carryforwards. Approximately $25 million of this valuation allowance was recorded through reductions to tax expense and $24.1 million was recorded through adjustments to goodwill.
Discontinued Operations
During the three months ended July 31, 2008, the acquirer of our former NETg Press business prepaid the remaining portion of the purchase price for the NETg Press business resulting in a gain from the disposal of $2.0 million, net of income tax.
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SIX MONTHS ENDED JULY 31, 2008 VERSUS SIX MONTHS ENDED JULY 31, 2007
| | | | | | | | | | | | | | | | | |
| | | Six Months Ended July 31, | |
| | | Dollar | | | Percent Change | | | | |
| | | Increase (Decrease) | | | Increase (Decrease) | | | Percentage of Revenue | |
| | | 2007/2008 | | | 2007/2008 | | | 2008† | | | 2007† | |
| | | (In thousands) | |
| Revenue | | $ | 36,366 | | | | 28 | % | | | 100 | % | | | 100 | % |
| Cost of revenue | | | 3,093 | | | | 20 | % | | | 11 | % | | | 12 | % |
| Cost of revenue — amortization of intangible assets | | | 1,538 | | | | 79 | % | | | 2 | % | | | 2 | % |
| | | | | | | | | | | | | | |
| Gross profit | | | 31,735 | | | | 29 | % | | | 87 | % | | | 86 | % |
| | | | | | | | | | | | | | |
| Research and development | | | 4,393 | | | | 20 | % | | | 16 | % | | | 17 | % |
| Selling and marketing | | | 9,536 | | | | 21 | % | | | 34 | % | | | 36 | % |
| General and administrative | | | 2,198 | | | | 14 | % | | | 11 | % | | | 13 | % |
| Amortization of intangible assets | | | 1,417 | | | | 33 | % | | | 3 | % | | | 3 | % |
| Merger related integration expenses | | | (7,767 | ) | | | (91 | )% | | | — | | | | 7 | % |
| SEC investigation | | | (1,174 | ) | | | (96 | )% | | | — | | | | (1 | )% |
| | | | | | | | | | | | | | |
| Total operating expenses | | | 8,603 | | | | 9 | % | | | 65 | % | | | 76 | % |
| | | | | | | | | | | | | | |
| Operating income | | | 23,132 | | | | 177 | % | | | 22 | % | | | 10 | % |
| | | | | | | | | | | | | | |
| Other income expense, net | | | (651 | ) | | | 170 | % | | | (1 | )% | | | — | |
| Interest income | | | (1,144 | ) | | | (49 | )% | | | 1 | % | | | 2 | % |
| Interest expense | | | (3,199 | ) | | | 84 | % | | | (4 | )% | | | (3 | )% |
| | | | | | | | | | | | | | |
| Income before income taxes | | | 18,138 | | | | 162 | % | | | 18 | % | | | 9 | % |
| Provision for income taxes | | | 19,509 | | | | * | | | | 7 | % | | | (6 | )% |
| | | | | | | | | | | | | | |
| Income from continuing operations | | | (1,371 | ) | | | (7 | )% | | | 11 | % | | | 15 | % |
| Income from discontinued operations, net of income tax | | | 1,450 | | | | * | | | | 1 | % | | | — | |
| | | | | | | | | | | | | | |
| Net income | | $ | 79 | | | | — | | | | 12 | % | | | 15 | % |
| | | | | | | | | | | | | | |
| | |
* | | Not meaningful. |
|
† | | Does not add due to rounding. |
Revenue
Revenue increased primarily due to the realization of additional revenue resulting from an increased customer base associated with the acquisition of NETg in May 2007 as well as from continued additional revenue earned under agreements with third party resellers of our products. We expect revenue growth to continue through fiscal 2009.
| | | | | | | | | | | | | |
| | | SIX MONTHS ENDED JULY 31, | |
| (IN THOUSANDS) | | 2008 | | | 2007 | | | CHANGE | |
| Revenue: | | | | | | | | | | | | |
| United States | | $ | 119,809 | | | $ | 101,080 | | | $ | 18,729 | |
| International | | | 45,166 | | | | 27,529 | | | | 17,637 | |
| | | | | | | | | | |
| Total | | $ | 164,975 | | | $ | 128,609 | | | $ | 36,366 | |
| | | | | | | | | | |
Revenue increased by 19% and 64% in the United States and internationally, respectively, in the six months ended July 31, 2008 as compared to the six months ended July 31, 2007 as a result of increased revenue generated from the NETg acquisition and from existing customers and new business.
Costs and Expenses
The increase in cost of revenue — amortization of intangible assets in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to the amortization of the intangible assets acquired in the acquisition of NETg, which was partially offset by certain intangible assets becoming fully amortized since July 31, 2007.
The increase in cost of revenue in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to increased revenue. Gross margin increased less than 1% during these periods.
The increase in research and development expense in the six months ended July 31, 2008 versus the six months ended July 31, 2007 was primarily due to additional contractor and outsource partner costs of $2.2 million to support expanded product and software development initiatives resulting from our larger customer base. A portion of these
23
incremental costs are attributable to NETgsubsequent integration initiatives, which includewere materially completed by July 31, 2008. This included maintaining multiple platforms and fulfilling obligations of acquired customer contracts and product commitments assumed in the acquisition of NETg. In addition, we incurred an increasethere was a decrease in compensation and benefits expense of $2.0$0.2 million as a result of an increaseprimarily due to performance bonuses being paid in the researchthird quarter of last fiscal year which were related to the acquisition of NETg and development headcount.the integration efforts of our employees. There was also a decrease in facility charges of $0.4 million for the three months ended October 31, 2008 due to a reduction in redundant leased space assumed in the acquisition of NETg.
| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE | |
| | 2008 | | | 2007 | | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Selling and marketing | $ | 26,387 | | | $ | 25,227 | | | $ | 1,160 | | | | 5 | % |
| As a percentage of revenue | | 32 | % | | | 34 | % | | | | | | | | |
The increase in selling and marketing expense in the sixthree months ended JulyOctober 31, 2008 versus the sixthree months ended JulyOctober 31, 2007 was primarily due to an increase in compensation and benefits of $7.5$1.1 million as a result of an increase in sales and marketing headcount, which includes additional direct sales, telesales and field support personnel required to service our increased customer base as a result of the NETg acquisition, as well as incremental commissions resulting from increased order intake and billings from our larger base business and from the acquired NETg customer base. The decrease in selling and marketing expense as a percentage of revenue in the three months ended October 31, 2008 versus the three months ended October 31, 2007 reflects the growth of revenue partially offset by the aforementioned factors.
| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| General and administrative | $ | 9,130 | | | $ | 9,449 | | | $ | (319 | ) | | | (3 | )% |
| As a percentage of revenue | | 11 | % | | | 13 | % | | | | | | | | |
The decrease in general and administrative expense in the three months ended October 31, 2008 versus the three months ended October 31, 2007 was primarily due to a reduction in bad debt expense of $0.5 million resulting from an improvement in collection efforts on accounts receivable as compared to the third quarter of fiscal 2008, as well as a reduction in depreciation of fixed assets of $0.3 million and lower facility charges of $0.2 million. This was partially offset by an increase of $0.6 million in professional fees, primarily related to an on-going feasibility analysis related to our business realignment strategy.
Amortization of intangible assets decreased $0.9 million, or 25%, to $2.7 million in the three months ended October 31, 2008 from $3.6 million in the three months ended October 31, 2007. This decrease was primarily due to certain assets becoming fully amortized during fiscal 2009.
In the three months ended October 31, 2008, we did not incur material merger and integration related expenses as compared to the $2.6 million in the three months ended October 31, 2007. The significant charges in last year’s third quarter were primarily due to the NETg acquisition. We do not expect to incur any significant additional merger-related expenses related to the NETg acquisition in future periods.
| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE | |
| | 2008 | | | 2007 | | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Other income (expense), net | $ | 752 | | | $ | (642 | ) | | $ | 1,394 | | | | * | |
| As a percentage of revenue | | 1 | % | | | (1 | )% | | | | | | | | |
| Interest income | | 248 | | | | 654 | | | | (406 | ) | | | (62 | )% |
| As a percentage of revenue | | 0 | % | | | 1 | % | | | | | | | | |
| Interest expense | | (3,103 | ) | | | (3,927 | ) | | | (824 | ) | | | (21 | )% |
| As a percentage of revenue | | (4 | )% | | | (5 | )% | | | | | | | | |
____________
* Not meaningful
Other Income (Expense), Net
The increase in other income (expense), net in the three months ended October 31, 2008 versus the three months ended October 31, 2007 was primarily due to foreign currency fluctuations. Due to our multi-national operations, our business is subject to fluctuations based upon changes in the exchange rates between the currencies used in our business. During the three months ended October 31, 2008 the strengthening of the U.S. dollar in relation to certain other foreign currencies resulted in significant gains, whereas in the same period of the prior year, the U.S. dollar declined in relation to foreign currencies.
Interest Income
The reduction in interest income in the three months ended October 31, 2008 versus the three months ended October 31, 2007 was primarily due to a reduction in our short-term investments and lower interest rates.
Interest Expense
The decrease in interest expense in the three months ended October 31, 2008 versus the three months ended October 31, 2007 was primarily due to a reduction of our debt as a result of $55.3 million in principal debt repayments made in the first half of fiscal 2009.
Provision for Income Taxes
| | THREE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
Provision (benefit) for income taxes | $ | 7,438 | | | $ | 270 | | | $ | 7,168 | | | | 2,655 | % |
| As a percentage of revenue | | 9 | % | | | 0 | % | | | | | | | | |
For the three months ended October 31, 2008, the effective tax rate of 38.5% was higher than the Irish statutory rate of 12.5% primarily due to earnings realized in higher tax jurisdictions outside of Ireland. The tax benefit for the three months ended October 31, 2007 was influenced significantly by certain purchase accounting tax adjustments as a result of the NETg acquisition and the release of $49.1 million of our valuation allowance primarily related to U.S. net operating loss (NOL) carryforwards. Approximately $25 million of this valuation allowance was recorded through reductions to tax expense and $24.1 million was recorded through adjustments to goodwill.
Discontinued Operations
In connection with the NETg acquisition, we decided to discontinue four product lines that were acquired from NETg because we believed these product offerings did not represent businesses that could grow or produce operating results consistent with our profit model. The product lines that have been identified as discontinued operations are Wave, NETg Press, Interact Now and Financial Campus. We recorded a loss from discontinued operations, net of tax, of $37 thousand in the three months ended October 31, 2008 versus a loss, net of tax, of $0.4 million in the three months ended October 31, 2007. This was primarily due to NETg Press and Financial Campus being sold in the three months ended October 31, 2007. In addition, we exited the Wave business in the three months ended October 31, 2007. We do not anticipate operations from discontinued operation to materially affect our liquidity, financial condition or results of operations going forward.
NINE MONTHS ENDED OCTOBER 31, 2008 VERSUS NINE MONTHS ENDED OCTOBER 31, 2007
Revenue
| | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Revenues | $ | 248,039 | | | $ | 203,733 | | | $ | 44,306 | | | | 22 | % |
| Operating income | | 57,796 | | | | 23,420 | | | | 34,376 | | | | 147 | % |
Revenue increased primarily due to the realization of additional revenue resulting from an increased customer base associated with the acquisition of NETg in May 2007 as well as from continued additional revenue earned under agreements with third party resellers of our products.
| | | NINE MONTHS ENDED OCTOBER 31, | | | | |
| (In thousands) | | 2008 | | | 2007 | | | CHANGE | |
| Revenue: | | | | | | | | | |
| United States | | $ | 181,807 | | | $ | 160,161 | | | $ | 21,646 | |
| International | | | 66,232 | | | | 43,572 | | | | 22,660 | |
| Total | | $ | 248,039 | | | $ | 203,733 | | | $ | 44,306 | |
Revenue increased by 14% and 52% in the United States and internationally, respectively, in the nine months ended October 31, 2008 as compared to the nine months ended October 31, 2007 as a result of increased revenue generated from the NETg acquisition and from existing customers and new business as well as from continued additional revenue earned under agreements with third party resellers of our products.
Costs and Expenses
| | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE | |
| | 2008 | | | 2007 | | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Cost of revenues | $ | 28,013 | | | $ | 23,827 | | | $ | 4,186 | | | | 18 | % |
| As a percentage of revenue | | 11 | % | | | 12 | % | | | | | | | | |
| Cost of revenues - amortization of intangible assets | | 5,170 | | | | 3,683 | | | | 1,487 | | | | 40 | % |
| As a percentage of revenue | | 2 | % | | | 2 | % | | | | | | | | |
The increase in cost of revenue in the nine months ended October 31, 2008 versus the nine months ended October 31, 2007 was primarily due to increased revenue. Gross margin remained consistent during these periods.
The increase in cost of revenue — amortization of intangible assets in the nine months ended October 31, 2008 versus the nine months ended October 31, 2007 was primarily due to the amortization of the intangible assets acquired in the acquisition of NETg being included for the entire nine month period of fiscal 2009 versus less than six months in fiscal 2008, partially offset by certain intangible assets becoming fully amortized since October 31, 2007.
| | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Research and development | $ | 38,136 | | | $ | 35,315 | | | $ | 2,821 | | | | 8 | % |
| As a percentage of revenue | | 15 | % | | | 17 | % | | | | | | | | |
The increase in research and development expense in the nine months ended October 31, 2008 versus the nine months ended October 31, 2007 was primarily due to additional contractor and outsource partner costs of $1.4 million to support expanded product and software development initiatives resulting from our larger customer base. A portion of these incremental costs are attributable to NETg integration initiatives, which include maintaining multiple platforms, fulfilling obligations of acquired customer contracts and product commitments assumed in the acquisition of NETg. In addition, we incurred an increase in compensation and benefits expense of $1.8 million as a result of an increase in our research and development headcount. The decrease in research and development expense as a percentage of revenue in the nine months ended October 31, 2008 versus the nine months ended October 31, 2007 reflects the growth of revenue partially offset by the aforementioned factors.
| | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Selling and marketing | $ | 82,185 | | | $ | 71,489 | | | $ | 10,696 | | | | 15 | % |
| As a percentage of revenue | | 33 | % | | | 35 | % | | | | | | | | |
The increase in selling and marketing expense in the nine months ended October 31, 2008 versus the nine months ended October 31, 2007 was primarily due to an increase in compensation and benefits of $8.6 million as a result of an increase in our sales and marketing headcount, which includes additional direct sales, telesales and field support personnel required to service our increased customer base as a result of the NETg acquisition, as well as incremental commissions resulting from increased order intake and billings from our larger base business and from the acquired NETg customer base. In addition, we incurred incremental marketing costs of $0.9$1.2 million to support our larger customer base.base, which includes the expense associated with our efforts to retain customers acquired in the NETg acquisition. The decrease in selling and marketing expense as a percentage of revenue in the nine months ended October 31, 2008 versus the nine months ended October 31, 2007 reflects the growth of revenue partially offset by the aforementioned factors.
| | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| General and administrative | $ | 27,454 | | | $ | 25,572 | | | $ | 1,882 | | | | 7 | % |
| As a percentage of revenue | | 11 | % | | | 13 | % | | | | | | | | |
The increase in general and administrative expense in the sixnine months ended JulyOctober 31, 2008 versus the sixnine months ended JulyOctober 31, 2007 was primarily due to an increase of $2.7$3.4 million of professional fees primarily related to our share capital reduction initiative aimed at increasing distributable profits in our Irish parent entity as well as a feasibility analysis related to our business realignment strategy.
This was partially offset by a reduction in bad debt expense of $0.5 million resulting from improved collection efforts on accounts receivable balances compared to the fiscal 2008 third quarter, as well as a reduction in depreciation of fixed assets of $0.7 million, which was due primarily to certain fixed assets related to the NETg acquisition becoming fully depreciated by the end of fiscal 2008 and lower facility charges of $0.3 million. The increasedecrease in amortizationgeneral and administrative expense as a percentage of intangible assetsrevenue in the sixnine months ended JulyOctober 31, 2008 versus the sixnine months ended JulyOctober 31, 2007 reflects the growth of revenue partially offset by the aforementioned factors.
Amortization of intangible assets increased $0.5 million, or 7%, to $8.5 million in the nine months ended October 31, 2008 from $8.0 million in the nine months ended October 31, 2007. This was primarily due to the amortization of the intangible assets acquired in the acquisition of NETg which wasbeing included for the entire nine month period of fiscal 2009 versus less than six months in fiscal 2008, partially offset by certain intangible assets becoming fully amortized since JulyOctober 31, 2007.
The decrease in merger
Merger and integration related expenses decreased $10.3 million, or 93%, to $0.8 million in the sixnine months ended JulyOctober 31, 2008 versusfrom $11.1 in the sixnine months ended JulyOctober 31, 20072007. This was primarily due to the significant charges in last year’s second and third quarter when the NETg acquisition was consummated, and the near completion of efforts undertaken to integrate NETg’s operations into ours.ours during fiscal 2009.
In the nine months ended October 31, 2008, we did not incur material SEC investigation expenses decreasedas compared to the $1.3 million in the sixnine months ended JulyOctober 31, 2008 versus the six months ended July 31, 20072007. This is due to a decrease in legal activities related to the SEC’s informal inquiry into the pre-merger option granting practices at SmartForce.
| | | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE | |
| | | 2008 | | | 2007 | | | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | | |
| Other expense, net | | $ | (282 | ) | | $ | (1,026 | ) | | $ | (744 | ) | | | (73 | )% |
| As a percentage of revenue | | | (0 | )% | | | (1 | )% | | | | | | | | |
| Interest income | | | 1,440 | | | | 2,990 | | | | (1,550 | ) | | | (52 | )% |
| As a percentage of revenue | | | 1 | % | | | 1 | % | | | | | | | | |
| Interest expense | | | (10,116 | ) | | | (7,741 | ) | | | 2,375 | | | | 31 | % |
| As a percentage of revenue | | | (4 | )% | | | (4 | )% | | | | | | | | |
Other Expense, Net
The change in other income expense, net in the sixnine months ended JulyOctober 31, 2008 versus the sixnine months ended JulyOctober 31, 2007 was primarily due to foreign currency fluctuations. Due to our multi-national operations, our business is subject to fluctuations based upon changes in the exchange rates between the currencies used in our business.
Interest Income
The reduction of interest income in the sixnine months ended JulyOctober 31, 2008 versus the sixnine months ended JulyOctober 31, 2007 was primarily due to lower interest rates and a reduction in our short-term investments.investments and lower interest rates.
Interest Expense
The increase in interest expense in the sixnine months ended JulyOctober 31, 2008 versus the sixnine months ended JulyOctober 31, 2007 was primarily due to the interest expense on the debt incurred for the acquisition of NETg being incurred for the full sixnine months through JulyOctober 31, 2008 versus only threesix months through JulyOctober 31, 2007. This was partially offset by a reduction of the debt as a result of$55.3 million in prepayments made during fiscal 2009.2009 to reduce debt.
Provision for Income Taxes
| | NINE MONTHS ENDED OCTOBER 31, 2008 | | | DOLLAR INCREASE/(DECREASE) | | | PERCENT CHANGE |
| | 2008 | | | 2007 | | | | | |
| (In thousands, except percentages) | | | | | | | | | | | |
| Provision (benefit) for income taxes | $ | 18,790 | | | $ | (7,886 | ) | | $ | 26,676 | | | | (338 | )% |
| As a percentage of revenue | | 8 | % | | | (4 | )% | | | | | | | | |
For the sixnine months ended July 31, 2008, we had a tax provision of $11.4 million versus a tax benefit of $8.2 million for the six months ended July 31, 2007. For the six months ended JulyOctober 31, 2008, the effective tax rate isof 38.5% was higher than the Irish statutory rate of 12.5% primarily due to earnings realized in higher tax jurisdictions outside of Ireland. For the sixnine month period ended JulyOctober 31, 2007, the $8.2 million tax benefit was comprised of a $25 million deferred tax
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benefit related to the reduction in our deferred tax asset valuation allowance, which was partially offset by the effects of certain purchase accounting tax adjustments related to the NETg acquisition.
Discontinued Operations
During
Income from discontinued operations was $1.9 million in the sixnine months ended JulyOctober 31, 2008 versus $0.2 million during the nine months ended October 31, 2007. This increase was primarily due to the acquirer of our former NETg Press business prepaidprepaying the remaining portion of the purchase price for the NETg Press business resultingduring the nine months ended October 31, 2008, which resulted in a gain from the disposal of $2.0 million, net of income tax.
LIQUIDITY AND CAPITAL RESOURCES
As of JulyOctober 31, 2008, our principal source of liquidity was our cash and cash equivalents and short-term investments, which totaled $82.0$73.6 million. This compares to $89.6 million at January 31, 2008.
Net cash provided by operating activities of $59.7$75.4 million for the sixnine months ended JulyOctober 31, 2008 was primarily due to a decrease in accounts receivable of $88.8$92.8 million. Net cash provided by operating activities was also a result of net income from continuing operations of $18.0$30.0 million, which included the impact of non-cash expenses for depreciation and amortization and amortization of intangible assets of $12.1$17.6 million, non-cash provision for income taxes of $9.4$15.7 million and share-based compensation expense of $3.1$4.5 million. These amounts were partially offset by a decrease in accrued expenses of $19.8$23.4 million as well as a decrease in deferred revenue of $53.0$68.6 million. These decreases in accounts receivable, accrued expenses and deferred revenue are primarily a result of the seasonality of our operations, with the fourth quarter of our fiscal year historically generating the most activity, including order intake and billing.
Net cash provided by investing activities was $2.6$0.7 million for the sixnine months ended JulyOctober 31, 2008, which includes the maturities of investments, net of purchases, generating a cash inflow of approximately $5.5$4.8 million. This was partially offset by the purchases of capital assets of approximately $2.7$4.1 million.
Net cash used in financing activities was $71.7$91.1 million for the sixnine months ended JulyOctober 31, 2008. During this period, we made a principal paymentpayments on our long-term debt of $54.9$55.3 million and purchased shares having a value of $27.2$56.5 million under our shareholder-approved share repurchase program. These uses of cash were partially offset by proceeds of $9.8$19.5 million received from the exercise of share options under our various share option programs and share purchases made under our 2004 Employee Share Purchase Plan.
Cash provided from discontinued operations for the sixnine months ended July 31,2008October 31, 2008 included the gross proceeds of $6.9 million from the sale of NETg Press.
We had working capital of approximately $1.7$6.0 million as of JulyOctober 31, 2008 and approximately $30.4 million as of January 31, 2008. The decrease in working capital was primarily due to a principal payment on debt payments of $54.9$55.3 million and the purchase of treasury shares having a value of $27.2$56.5 million under our shareholder-approved share repurchase program. This was partially offset by net income from continuedcontinuing operations of $18.0$30.0 million, which includes non-cash charges for depreciation and amortization of $12.1$17.6 million, share-based compensation expense of $3.1$4.5 million and a non-cash tax charge of $9.4$15.7 million. Additionally, we received proceeds of $9.8$19.5 million from the exercise of share options under our various share option programs and from share purchases made under our 2004 Employee Share Purchase Plan.
As of January 31, 2008, we had U.S. NOL carryforwards of approximately $258.3 million. These NOLs represent the gross carrying value of operating loss carryforwards. TheseThe NOL carryforwards, which are subject to potential limitations based upon change in control provisions of Section 382 of the Internal Revenue Code, are available to reduce future taxable income, if any, through 2025. Included in the $258.3 million of U.S. NOL carryforwards is approximately $121.3 million of U.S. NOL carryforwards that were acquired in the SmartForce Merger and the purchase of Book 24x7. Also included in the $258.3 million at January 31, 2008 is approximately $36.3 million of NOL carryforwards in the United States resulting from disqualifying dispositions. We will realize the benefit of these losses through increases to shareholder’s equity in the periods in which the losses are utilized to reduce tax payments. Additionally, we had approximately $193.0 million of NOL carryforwards in jurisdictions outside of the U.S. Included in the $193.0 million is approximately $142.2 million of NOL carryforwards in jurisdictions outside the U.S., which were acquired in the SmartForce Merger, the purchase of Books24x7 and the purchase of NETg foreign entities. We will realize the benefits of these acquired NOL
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carryforwards through reductions to goodwill and non-goodwill intangible assets during the period that the losses are utilized. We also had U.S. federal tax credit carryforwards of approximately $2.5 million at January 31, 2008.
We lease certain of our facilities and certain equipment and furniture under operating lease agreements that expire at various dates through 2023. In addition, we have a term loan which will be paid out over the next 5 years. Future minimum lease payments, net of estimated sub-rentals, under these agreements and the debt repayments schedule are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| | | Payments Due by Period | |
| | | | | | | Less Than | | | 1-3 | | | 3-5 | | | More Than | |
| Contractual Obligations | | Total | | | 1 Year | | | Years | | | Years | | | 5 Years | |
| Operating Lease Obligations | | $ | 18,481 | | | $ | 4,568 | | | $ | 4,790 | | | $ | 2,741 | | | $ | 6,382 | |
| Debt Obligations | | | 144,060 | | | | 1,455 | | | | 2,910 | | | | 139,695 | | | | — | |
| | | | | | | | | | | | | | | | |
| Total Obligations | | $ | 162,541 | | | $ | 6,023 | | | $ | 7,700 | | | $ | 142,436 | | | $ | 6,382 | |
| | | Payments Due By Period | |
| | | | | | Less Than | | | 1 - 3 | | | 3 - 5 | | | More Than |
| Contractual Obligations | | Total | | | 1 Year | | | Years | | | Years | | | 5 Years | |
| Operating Lease Obligations | | $ | 13,185 | | | $ | 4,442 | | | $ | 5,504 | | | $ | 3,239 | | | $ | - | |
| Debt Obligations | | | 143,697 | | | | 1,455 | | | | 2,910 | | | | 139,332 | | | | - | |
| Total Obligations | | $ | 156,882 | | | $ | 5,897 | | | $ | 8,414 | | | $ | 142,571 | | | $ | - | |
We do not have any off-balance sheet arrangements, as defined under SEC rules, such as relationships with unconsolidated entities or financial partnerships, which are often referred to as structured finance or special purpose entities, established for the purpose of facilitating transactions that are not required to be reflected on our balance sheet.
In May 2007, we entered into a credit agreement with certain lenders providing for a $225$225.0 million senior credit facility comprised of a $200 million term loan facility and a $25$25.0 million revolving credit facility. On July 7, 2008, we entered into an amendment to the credit agreement dated May 14, 2007.agreement. The primary purpose of the amendment was to expand theour ability to make additional repurchases of shares. The expanded repurchase ability under the amendment is conditioned on the absence of an event of default and a requirement that (i) the leverage ratio shall be no greater than 2.75:1.0 as of the most recently completed fiscal quarter ending prior to the date of such repurchase and (ii) that we make a prepayment of the term loan under the Credit Agreementcredit agreement in an amount equal to the dollar amount of any such repurchase. Such term loan prepayments will not, however, be required in connection with the first $24,000,000$24.0 million of repurchases made from and after July 7, 2008.
Please see Note 10 of The Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K as filed with the SEC on March 31, 2008 and our 8-K filed July 11, 2008, for a detailed description of the credit agreement, as amended.
We will continue to invest in research and development and sales and marketing in order to execute our business plan and achieve expected revenue growth. To the extent that our execution of the business plan results in increased sales, we expect to experience corresponding increases in deferred revenue, cash flow and prepaid expenses. Capital expenditures for the fiscal year ended January 31, 2009 are expected to be approximately $6.0$5.0 million to $8.0$7.0 million.
We expect that the principal sources of funding for our operating expenses, capital expenditures, debt payment obligations and other liquidity needs will be a combination of our available cash and cash equivalents and short-term investments, and funds generated from future cash flows from operating activities. We believe our current funds and expected cash flows from operating activities will be sufficient to fund our operations, including our debt repayment obligations, for at least the next 12 months. However, there are several items that may negatively impact our available sources of funds. In addition, our cash needs may increase due to factors such as unanticipated developments in our business or the marketplace for our products in general or significant acquisitions (in addition to and including NETg). The amount of cash generated from operations will be dependent upon the successful execution of our business plan. Although we do not foresee the need to raise additional capital, any unanticipated economic or business events could require us to raise additional capital to support our operations.
EXPLANATION OF USE OF NON-GAAP FINANCIAL RESULTS
In addition to our audited and unaudited financial results in accordance with United States generally accepted accounting principles (GAAP), to assist investors we may on occasion provide certain non-GAAP financial results as an alternative means to explain our periodic results. The non-GAAP financial results typically exclude non-cash or one-time charges or benefits.
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Our management uses the non-GAAP financial results internally as an alternative means for assessing our results of operations. By excluding non-cash charges such as share-based compensation, amortization of purchased intangible assets, impairment of goodwill and purchased intangible assets, management can evaluate our operations excluding these non-cash charges and can compare its results on a more consistent basis to the results of other companies in our industry. By excluding charges such as restructuring charges (benefits) and merger and integration related expenses, our management can compare our ongoing operations to prior quarters where such items may be materially different and to ongoing operations of other companies in our industry who may have materially different unusual charges. Our management recognizes that non-GAAP financial results are not a substitute for GAAP results, but believes that non-GAAP measures are helpful in assisting them in understanding and managing our business.
Our management believes that the non-GAAP financial results may also provide useful information to investors. Non-GAAP results may also allow investors and analysts to more readily compare our operations to prior financial results and to the financial results of other companies in the industry who similarly provide non-GAAP results to investors and analysts. Investors may seek to evaluate our business performance and the performance of our competitors as they relate to cash. Excluding one-time and non-cash charges may assist investors in this evaluation and comparisons.
In addition, certain covenants in our Credit Agreementcredit agreement are based on non-GAAP financial measures, such as adjusted EBITDA, and evaluating and presenting these measures allows us and our investors to assess our compliance with the covenants in our Credit Agreementcredit agreement and thus our liquidity situation.
We intend to continue to assess the potential value of reporting non-GAAP results consistent with applicable rules and regulations.
As of JulyOctober 31, 2008, we did not use derivative financial instruments for speculative or trading purposes.
INTEREST RATE RISK
Our general investing policy is to limit the risk of principal loss and to ensure the safety of invested funds by limiting market and credit risk. We currently use a registered investment manager to place our investments in highly liquid money market accounts and government-backed securities. All highly liquid investments with original maturities of three months or less are considered to be cash equivalents. Interest income is sensitive to changes in the general level of U.S. interest rates. Based on the short-term nature of our investments, we have concluded that there is no significant market risk exposure.
In order to limit our exposure to interest rate changes associated with our term loan, we entered into an interest rate swap agreement with an initial notional amount of $160 million which amortizes over a period consistent with our anticipated payment schedule. This strategy uses an interest rate swap to effectively convert $160 million in variable rate borrowings into fixed rate liabilities at a 5.1015% effective interest rate. The interest rate swap is considered to be a hedge against changes in the amount of future cash flows associated with interest payments on a variable rate loan.
FOREIGN CURRENCY RISK
Due to our multi-national operations, our business is subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues or pay expenses and the U.S. dollar. Our expenses are not necessarily incurred in the currency in which revenue is generated, and, as a result, we are required from time to time to convert currencies to meet our obligations. These currency conversions are subject to exchange rate fluctuations, in particular with respect to changes in the value of the Euro, Canadian dollar, Australian dollar, New Zealand dollar, Singapore dollar, and pound sterling relative to the U.S. dollar, which could adversely affect our business and our results of operations. During the sixnine months ended JulyOctober 31, 2008 and 2007, we incurred a foreign currency exchange lossesgain of $677,000$0.3 million and $407,000,a foreign currency exchange loss of $0.5 million, respectively.
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Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of JulyOctober 31, 2008. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of JulyOctober 31, 2008, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended JulyOctober 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. — LEGAL PROCEEDINGS
SEC Investigations
See Part I Item 3 of our Annual Report on Form 10-K for the fiscal year ended January 31, 2008 for a discussion of legal proceedings. There were no material developments in these proceedings during the quarter ended JulyOctober 31, 2008.
Investors should carefully consider the risks described below before making an investment decision with respect to our shares. While the following risk factors have been updated to reflect developments subsequent to the filing of our Annual Report on Form 10-K for the fiscal year ended January 31, 2008, there have been no material changes to the risk factors included in that report.
RISKS RELATED TO THE OPERATION OF OUR BUSINESS
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, LIMITING YOUR ABILITY TO EVALUATE HISTORICAL FINANCIAL RESULTS AND INCREASING THE LIKELIHOOD THAT OUR RESULTS WILL FALL BELOW MARKET ANALYSTS’ EXPECTATIONS, WHICH COULD CAUSE THE PRICE OF OUR ADSs TO DROP RAPIDLY AND SEVERELY.
We have in the past experienced fluctuations in our quarterly operating results, and we anticipate that these fluctuations will continue. As a result, we believe that our quarterly revenue, expenses and operating results are likely to vary significantly in the future. If in some future quarters our results of operations are below the expectations of public market analysts and investors, this could have a severe adverse effect on the market price of our ADSs.
Our operating results have historically fluctuated, and our operating results may in the future continue to fluctuate, as a result of factors, which include, without limitation:
| • | | the size and timing of new/renewal agreements and upgrades; |
|
| • | | royalty rates; |
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Most of our expenses, such as rent and most employee compensation, do not vary directly with revenue and are difficult to adjust in the short-term. As a result, if revenue for a particular quarter is below our expectations, we could not proportionately reduce operating expenses for that quarter. Any such revenue shortfall would, therefore, have a disproportionate effect on our expected operating results for that quarter.
PAST AND FUTURE ACQUISITIONS, INCLUDING OUR ACQUISITION OF NETG, MAY NOT PRODUCE THE BENEFITS WE ANTICIPATE AND COULD HARM OUR CURRENT OPERATIONS.
One aspect of our business strategy is to pursue acquisitions of businesses or technologies that will contribute to our future growth. On May 14, 2007, we acquired NETg from The Thomson Corporation. However, we may not be successful in identifying or consummating future attractive acquisition opportunities. Moreover, any acquisitions we do consummate, may not produce benefits commensurate with the purchase price we pay or our expectations for the acquisition. In addition, acquisitions involve numerous risks, including:
