FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
For the Transition Period from ________ to ________
Commission File #0-11078
THE AMERICAN EDUCATION CORPORATION
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(Exact name of small business issuer as specified in its charter)
Nevada 73-1621446
- ------------------------------- ----------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
7506 North Broadway Extension, Suite 505, Oklahoma City, OK 73116
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(Address of principal executive offices)
(405) 840-6031
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(Issuer's telephone number)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.025 per share
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports,
and (2) has been subject to such filing requirements for the past 90 days.
YES X NO__
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). YES__ NO X
Number of shares of the issuer's common stock outstanding as of May 12,
2006: 14,133,461
Transitional Small Business Disclosure Format YES NO X
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THE AMERICAN EDUCATION CORPORATION
INDEX
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Page No.
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PART I - FINANCIAL INFORMATION
Item 1 Balance Sheets
March 31, 2006 and December 31, 2005 3
Statements of Operations
For the Three Months Ended March 31, 2006
and for the Three Months Ended March 31, 2005 4
Statements of Cash Flows
For the Three Months Ended March 31, 2006
and for the Three Months Ended March 31, 2005 5
Notes to Interim Financial Statements 6
Item 2 Management's Discussion and Analysis
or Plan of Operation 10
Item 3 Controls and Procedures 14
PART II - OTHER INFORMATION 15
SIGNATURE PAGES 18
<Page> 2
PART I - FINANCIAL INFORMATION
ITEM 1 - BALANCE SHEETS
THE AMERICAN EDUCATION CORPORATION
BALANCE SHEETS
March 31 December 31
2006 2005
----------- -----------
(unaudited) (audited)
ASSETS
Current assets:
Cash and cash equivalents $ 733,592 $ 977,040
Accounts receivable, net of allowance
for returns and uncollectible accounts
of $300,000 and $300,000 2,201,752 2,314,586
Inventory 17,376 21,368
Prepaid expenses and deposits 250,183 306,001
Deferred tax asset 125,388 125,388
----------- -----------
Total current assets 3,328,291 3,744,383
Property and equipment, at cost 1,339,644 1,295,781
Less accumulated depreciation and
amortization (1,151,177) (1,134,226)
----------- -----------
Net property and equipment 188,467 161,555
Other assets:
Capitalized software costs, net of
accumulated amortization of $8,582,952
and $8,197,969 3,924,077 3,896,582
Deferred tax asset 119,604 31,857
----------- -----------
Total other assets 4,043,681 3,928,439
----------- -----------
Total assets $ 7,560,439 $ 7,834,377
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable trade $ 246,251 $ 288,881
Accrued liabilities 779,299 758,124
Deferred revenue 594,867 786,230
Notes payable and current portion of
long-term debt 705,880 305,880
----------- -----------
Total current liabilities 2,326,297 2,139,115
Other long-term accrued liabilities 822,975 752,475
Long-term debt - 400,000
----------- -----------
Total liabilities 3,149,272 3,291,590
----------- -----------
Commitments and contingencies - -
Stockholders' Equity:
Preferred Stock, $.001 par value;
Authorized - 50,000,000 shares-issued
and outstanding-none - -
Common Stock, $.025 par value
Authorized 30,000,000 shares
Issued and outstanding - 14,133,461
shares 359,186 359,186
Additional paid in capital 6,698,817 6,698,817
Treasury stock, at cost, 234,000 shares (319,125) (319,125)
Retained deficit (2,196,091) (2,196,091)
Year-to-date earnings (131,620) -
----------- -----------
Total stockholders' equity 4,411,167 4,542,787
----------- -----------
Total liabilities and stockholders' equity $ 7,560,439 $ 7,834,377
=========== ===========
The accompanying notes are an integral part of the financial statements.
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THE AMERICAN EDUCATION CORPORATION
STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(unaudited)
2006 2005
----------- -----------
Sales $ 1,858,200 $ 2,339,607
Cost of goods sold 95,100 341,849
----------- -----------
Gross profit 1,763,100 1,997,758
Operating expenses:
Selling and marketing 739,337 733,520
Operations 220,323 158,471
General and administrative 628,820 525,481
Amortization of capitalized software costs 384,983 372,708
----------- -----------
Total operating expenses 1,973,463 1,790,180
----------- -----------
Operating income (loss) from continuing
operations (210,363) 207,578
Other income (expense):
Interest expense (9,004) (10,530)
----------- -----------
Income (loss) from continuing operations
before income taxes (219,367) 197,048
Deferred income tax expense (benefit) (87,747) 78,819
----------- -----------
Income (loss) from continuing operations (131,620) 118,229
Loss from discontinued operations (net of tax
benefits of $35,162 in 2005) (Note 13) -- (52,743)
----------- -----------
Net Income (loss) $ (131,620) $ 65,486
=========== ===========
Earnings per share:
Basic:
Continuing operations $ (.009) $ .008
Discontinued operations $ -- $ (.004)
Net income (loss) $ (.009) $ .004
Diluted:
Continuing operations $ (.008) $ .007
Discontinued operations $ -- $ (.003)
Net income (loss) $ (.008) $ .004
Weighted average common shares outstanding:
Basic 14,133,461 14,133,461
Diluted 17,138,395 16,665,726
The accompanying notes are an integral part of the financial statements.
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THE AMERICAN EDUCATION CORPORATION
STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(unaudited)
2006 2005
----------- -----------
Cash flows from operating activities:
Net income (loss) $ (131,620) $ 65,486
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization 401,934 394,344
Deferred compensation 70,500 70,500
Changes in assets and liabilities:
Accounts receivable 112,834 (319,637)
Inventories 3,992 (2,339)
Prepaid expenses and other 55,818 (42,461)
Accounts payable and accrued liabilities (21,455) (2,885)
Deferred revenue (191,363) (48,542)
Deferred income taxes (87,747) 43,658
----------- -----------
Net cash provided by operating activities 212,893 158,124
----------- -----------
Cash flow from investing activities:
Software development costs capitalized (412,478) (348,942)
Purchase of property and equipment (43,863) (5,494)
----------- -----------
Net cash used in investing activities (456,341) (354,436)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of debt -- 400,000
Principal payments on notes payable -- (88,101)
----------- -----------
Net cash provided by financing activities -- 311,899
----------- -----------
Net increase (decrease) in cash (243,448) 115,587
Cash at beginning of the period 977,040 549,343
----------- -----------
Cash at end of the period $ 733,592 $ 664,930
=========== ===========
The accompanying notes are an integral part of the financial statements.
<Page> 5
THE AMERICAN EDUCATION CORPORATION
Part I
NOTES TO INTERIM FINANCIAL STATEMENTS
FOR THE PERIODS ENDED MARCH 31, 2006 AND 2005
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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1. Description of Business:
-----------------------
The American Education Corporation's ("the Company") business is the
development and marketing of educational software to elementary, middle and
secondary schools, adult literacy centers and vocational, junior and
community colleges.
2. Basis of Presentation:
---------------------
The summary of significant accounting policies of the Company is presented
to assist in understanding the Company's financial statements. These
accounting policies conform to generally accepted accounting principles and
have been consistently applied in the preparation of the financial
statements.
In November and December 2005, all of the Company's subsidiaries were either
sold or merged into the Company. Therefore, for 2006 the financial
statements include only The American Education Corporation. For 2005, the
Company's financial statements include the Company and its wholly owned
subsidiaries, Dolphin, Inc. and Learning Pathways, Ltd. All material
inter-company transactions were eliminated.
The interim financial statements at March 31, 2006, and for the three-month
periods ended March 31, 2006 and 2005 are unaudited, but include all
adjustments that the Company considers necessary for a fair presentation.
The December 31, 2005 balance sheet was derived from the Company's audited
financial statements.
The accompanying unaudited financial statements are for the interim periods
and do not include all disclosures normally provided in annual financial
statements. They should be read in conjunction with the Company's audited
financial statements included in the Company's Form 10-KSB for the year
ended December 31, 2005. The accompanying unaudited interim financial
statements for the three-month period ending March 31, 2006 are not
necessarily indicative of the results that can be expected for the entire
year.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported revenues and expenses during the reporting
period. Actual results could differ from those estimates.
3. Revenue Recognition:
-------------------
The Company recognizes revenue in accordance with the American Institute of
Certified Public Accountant's Statement of Position 97-2, 98-9 and
modifications thereto on software revenue recognition. The Company has also
adopted revenue recognition policies regarding sales with multiple
deliverables, which comply with Emerging Issues Task Force Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables" that became effective
July 1, 2003.
<Page> 6
4. Capitalized Software Costs:
--------------------------
Capitalized software costs consist of licenses for the rights to produce and
market computer software, salaries and other direct costs incurred in the
production of computer software. Costs incurred in conjunction with product
development are charged to research and development expense until
technological feasibility is established. Thereafter, all software
development costs are capitalized and amortized on a straight-line basis
over the product's estimated economic life of between three and five years.
5. Inventories:
-----------
Inventories are stated at the lower of cost (first-in, first-out), or
market, and consist of packaging and educational software materials.
6. Property and Equipment:
----------------------
Property and equipment is stated at cost. Depreciation is provided on the
straight-line basis over the estimated useful life of the assets, usually
three to five years.
7. Debt:
----
The Company had the following indebtedness under notes and loan agreements:
Current Long-term Total
--------- --------- --------
Line of credit with bank, matures
October 30, 2006; maximum line -
$550,000, interest at the bank's
prime rate plus 1% (8.75% at
March 31, 2006) $ -- $ -- $ --
Subordinated debt due to unrelated
individual, originated March 30, 2005,
matures March 30, 2007; interest at 8%
payable at maturity; convertible into
the Company's common stock at $.463 per
share 400,000 -- 400,000
Subordinated debt due to shareholder
affiliates, originated April 1, 2003,
matures September 30, 2006; interest
at 8% payable quarterly, principal due
at maturity, convertible into the
Company's common stock at $.40 per share 305,880 -- 305,880
--------- --------- --------
$705,880 $ -- $705,880
========= ========= ========
8. Stock Options:
-------------
The shareholders approved an Incentive Stock Option Plan for employees
during 1998 and approved amendments to the plan in 1999, 2000 and 2001 to
increase the number of shares available. The total shares issuable under
this plan are 2,650,000. The Committee of this Plan determines the
employees who will receive options to purchase common shares and the number
granted. Option prices will be the fair market value at date of grant.
Options are exercisable as deemed by the Committee and terminate within
ninety days of employment termination, or as designated by the Committee.
In no event shall an option be exercisable more than ten years from the date
it is granted. No options may be issued under this Plan after March 31,
2008.
The shareholders also approved a Director's Stock Option Plan during 1998
and approved an amendment to the Plan in 2001 to increase the number of
shares available. The total shares issuable under this Plan are 200,000.
Each outside director initially elected or appointed shall be granted an
option to purchase 5,000 shares of common stock at the fair market value at
the date of
<Page> 7
the grant. Additionally, each outside director shall automatically be
granted an option to purchase 3,000 shares of common stock as of January 1
of each succeeding calendar year, if options are available, through
termination of the Plan on March 31, 2008. Options granted are exercisable
immediately and for a period of three years after the date of the grant or,
if earlier, ninety days after the date when the participant ceases to be a
director of the Company. Additionally, the Company has a non-qualified
stock option plan that originated in 1996.
The Company has historically measured compensation from issuing employee
stock options under the accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees" which is an intrinsic value
method. Through December 31, 2005 the compensation cost for stock options
has been measured as the excess, if any, of the quoted market price of
Company stock at the date of the grant over the amount the employee must pay
to acquire the stock. No compensation has been incurred unless the market
value was greater than the option exercise price.
Effective January 1, 2006 the Company adopted accounting pronouncement
FAS 123 (R) Share Based Payments, which establishes standards for the
accounting for transactions in which an entity exchanges its equity
instruments for goods or services. FAS 123 (R) also addresses transactions
in which an entity incurs liabilities in exchange for goods or services that
are based on the fair value of the entity's equity instruments or that may
be settled by the issuance of those equity instruments. This Statement
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions.
There were no options granted or exercised during the three months ended
March 31, 2006. All existing options were fully vested as of the beginning
of the period. Therefore, there is no compensation expense recognized during
the period. Additionally, there was no share-based compensation expense
related to employee stock options recognized during the three months ended
March 31, 2005. Prior to January 1, 2006, the Company accounted for its
share-based compensation under the recognition and measurement principles of
APB 25 and related interpretations and the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation." In accordance with
APB 25, no share-based compensation cost was reflected in the Company's net
income for grants of stock options to employees because the Company granted
stock options with an exercise price equal to the market value of the stock
on the date of grant. Had the Company used the fair value based accounting
method for share-based compensation expense prescribed by SFAS No. 123 for
the period ended March 31, 2005, the Company's consolidated net income and
net income per share would have been decreased to the pro-forma amounts
illustrated as follows:
2005
--------
Net income - as reported $65,486
Stock - based employee compensation expense -
pro forma 11,825
--------
Net income - pro forma 53,661
Basic earnings per common share - as reported $.01
Diluted earnings per common share - as reported .01
Basic earnings per common share - pro forma $.01
Diluted earnings per common share - pro forma .01
<Page> 8
A summary of the activity under the Company's stock options plans for the
three-month period ended March 31, 2006 is presented below:
Weighted
Average
Weighted Remaining
Average Contractual Approximate
Exercise Term Intrinsic
Shares Price (Years) Value
---------- -------- ----------- -----------
Options outstanding
at December 31,
2005 4,255,544 $ 0.38
Granted - -
Exercised -
Expired (13,500) $ 0.33
---------
Options outstanding
at March 31, 2006 4,242,044 $ 0.38 1.59 $715,677
=========
Options exercisable
at March 31, 2006 4,242,044 $ 0.38 1.59 $715,677
---------
9. Statements of Cash Flows:
------------------------
In the Statements of Cash Flows, cash and cash equivalents may include
currency on hand, demand deposits with banks or other financial
institutions, treasury bills, commercial paper, mutual funds or other
investments with original maturities of three months or less. The
carrying values of the Company's assets and liabilities approximate fair
value due to their short-term nature.
10. Income Taxes:
------------
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial
statements or tax returns, determined by using the enacted tax rates in
effect for the year in which the differences are expected to reverse.
11. Computation of Earnings Per Share:
---------------------------------
The Company has adopted Statement of Financial Accounting Standards No. 128
"Earnings Per Share" (SFAS 128). SFAS 128 requires presentation of basic
and diluted earnings per share. Basic earnings per share are calculated
based only upon the weighted average number of common shares outstanding
during the period. Diluted earnings per share are calculated based
upon the weighted average number of common and, where dilutive, potential
common shares outstanding during the period, utilizing the treasury stock
method. Potential common shares include conversions of convertible debt and
options to purchase common stock.
The weighted average number of basic and diluted common shares outstanding
is as follows:
2006 2005
---------- ----------
Basic 14,133,461 14,133,461
Diluted 17,138,395 16,665,726
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12. Commitments and Contingencies:
-----------------------------
The Company amortizes capitalized software costs over the product's
estimated useful life. Due to inherent technological changes in the
software development industry, the period over which such capitalized
software cost is being amortized may have to be accelerated.
13. Discontinued Operations:
-----------------------
Effective December 31, 2004 Learning Pathways, Ltd. was deemed to be an
asset held for sale and was subsequently sold in November 2005. Therefore,
its results in 2005 are presented as discontinued operations.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- ------------------------------------------------------------------
Overview
- --------
The American Education Corporation is a developer of instructional content,
computer adaptive assessment testing software, and software management
technology specifically designed to manage the delivery of and record the
results of student progress in schools and other institutions. Java-based
technology, the A+nyWhere Learning System, registered, ("A+LS") Versions 3.0
and 4.0 of educational software products, provides a research-based,
integrated curriculum offering of software for grade levels 1-12 for
Reading, Mathematics, Language Arts, Science, Writing, History, Government,
Economics and Geography. In addition, the Company provides formative
assessment testing and formative instructional content for various segments
of the primary, secondary and post secondary educational markets. All
company products are designed to provide for LAN, WAN and Internet delivery
options. The Company has developed computer adaptive, formative assessment
testing tools to provide educators with the resources to more effectively
use the Company's curriculum content, which is aligned to important state
and national academic standards. Spanish-language versions are available
for Mathematics and Language Arts for grade levels 1-8.
The A+LS comprehensive family of educational software is now in use in over
12,100 schools, centers of adult literacy, colleges and universities, and
correctional institutions in the U.S., UK and other international locations.
A+dvancer, trademark, Online, the Company's postsecondary offering,
identifies basic skill deficiencies and provides remedial coursework helping
students to attain college entry-level academic skills in Mathematics,
Elementary Algebra, Reading Comprehension, and Sentence Skills. A+dvancer
reduces demand on institutional admissions and developmental departments,
while providing students with both improved skills assessment and the
alignment to developmental and remedial coursework in an online, self-paced
learning environment.
The Company is a technology-based publishing enterprise. To remain
competitive it must constantly invest in the development of programming
technology to keep its product offering up-to-date and ensure that its
products maintain compatibility with constantly changing and revised
database and operating system platforms sold to schools by other developers.
Additionally, the Company must also update its content and underwrite
content revisions to realign its content with new, or updated state and
national educational standards to remain competitive. During the quarter
ended March 31, 2006 the Company spent approximately $412,000 in both of
these efforts, an increase of 18% over the first quarter of 2005. The
Company expects this rate of increase over the prior year will approximate
15% for the full year. To accomplish this essential, ongoing corporate
function requires retention and recruitment of a highly skilled professional
workforce. These investments are essential, recurring costs of doing
business that impact the Company's operating cost and margin structures.
The Company's business is subject to risks or uncertainties. Among these
uncertainties are a dependency on funding for school technology purchases,
lengthy sales cycles, seasonal demand cycles and a
<Page> 10
dependency on retention of key personnel. Certain matters discussed herein
(including the documents incorporated herein by reference) may contain
forward-looking statements intended to qualify for the safe harbors from
liabilities established by the Private Securities Litigation Reform Act of
1995. These forward-looking statements can generally be identified as such
because the context of the statement will include words such as the Company
"believes," "plans," "intends," "anticipates," "expects," or words of
similar import. Similarly, statements that describe the Company's future
plans, objectives, estimates, or goals are also forward-looking statements.
Such statements address future events and conditions concerning capital
expenditures, earnings, litigation, liquidity, capital resources and
accounting matters. Actual results in each case could differ materially from
those currently anticipated in such statements as a result of factors such
as future economic conditions, changes in customer demands, future
legislative, regulatory and competitive developments in markets in which the
Company operates and other circumstances affecting anticipated revenues and
costs. Accordingly, investors should be alert to the possibility that
factors beyond the control of management may have impact on the short or
long-term operations of the business. The Company undertakes no duty to
update forward-looking statements to reflect the impact of events or
circumstances that arise after the date the forward-looking statement was
made.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2006
AS COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2005
- ---------------------------------------------------------
The Company sold its UK subsidiary, Learning Pathways, in November 2005 and,
therefore, its operations are shown as discontinued. As a result, the
comparisons discussed here are only for the Company and its Dolphin, Inc.
subsidiary, which was merged into the Company on December 31, 2005. Net
sales for the three months ended March 31, 2006 totaled $1,858,200 compared
to $2,339,607 for the same period in 2005. This represents a decrease of
21% over the comparable 2005 quarter and is attributable to two primary
factors. The first factor was that in 2005 the Company announced that its
Dolphin subsidiary would be integrated into the Company's development effort
and would no longer participate in the contract software development
business. Accordingly, in 2006 there was no revenue from this subsidiary as
compared to approximately $180,000 in 2005. Secondly, revenues in the
Company's core business decreased by approximately $300,000 or 14% compared
to the first quarter of 2005. This decrease is attributable to continued
negative impacts of last year's hurricanes in the Southern Gulf region,
which includes several of the Company's highest revenue producing states as
well as slow approval of orders anticipated to close during the quarter.
Cost of goods sold decreased 72% from $341,849 in 2005 to $95,100 for the
three months ending March 31, 2006 because of the elimination of contract
development sales and the related cost of sales at Dolphin. The Company's
principal product family, A+nyWhere Learning System, registered, provided
gross profit margins of 95% in the first quarter of 2006, consistent with
prior quarters. The Company expects that its gross profit margins for its
principle product families should remain at this level for the remainder of
2006. Cost of goods sold represents the actual cost to produce the software
products and includes certain allocated overhead costs.
Total operating expenses recorded for the three months ended March 31, 2006
were $1,973,463 or 106% of sales, compared to $1,790,180 or 77% of sales,
for the first quarter of 2005. The increase in total operating expenses is
comprised of slight increases in marketing and selling expenditures, an
increase in operations expenses, an increase in general and administrative
expenses and an increase in amortization of product development charges for
the period. Selling and marketing expenses increased by less than 1% from
$733,520 in 2005 to $739,337 for 2006. There are several offsetting changes
within this expense category. Sales commissions increased by approximately
$45,000 and is primarily the result of changes in sales mix, as the Company
billed a higher percentage of orders directly to school customers. The
Company recognizes sales revenue based upon the type of customer. If the
sale is made to a distributor who in turn resells a product to the end user,
the amount of the sale is recorded, no commission is due the distributor
and the transaction is recorded as a net sale. If the sale is billed direct
to the school or other end user, a commission is paid to the distributor or
a sales representative, which increases the amount of the sale, but a
transaction of this nature would directly increase marketing expense as a
result of an obligation to pay a commission. Commission percentages vary
depending up the type of sale and the status of the individual or
organization making the sale. The decision to sell and to bill direct to
the customer and pay a subsequent commission can result from a number of
factors, including credit policy issues with individual distributors as a
result of payment history or limitations on authorized limits. Additionally,
method of
<Page> 11
delivery of the product may necessitate direct billing to the customer and
the subsequent payment of a commission. An example would be an online
product sale that requires delivery from company servers and related record
keeping on licensed number of users accessing the product online as well as
the number of units delivered. This level of record keeping requires
company monitoring and billing directly to the customer. These factors
create a change in sales mix affecting the amount of commission paid and the
manner in which revenues may be recorded by the Company. Accordingly, these
factors, and the source and nature of recorded revenue, can impact period
revenue recognition and related costs of securing revenue may vary from
period to period. The increase in sales commissions was offset by a $55,000
decrease in the cost of free titles given away as sales promotions during
the period. Operations expense increased by 39% from $158,471 to $220,323 as
a result of increased compensation and benefits due to additional technical
support staff hired compared to the same period last year. The Company
expects operations costs to increase approximately 10% over the full year in
2006. General and administrative expenses increased by 20% from $525,481 to
$628,820 for several different reasons. Audit and legal fees increased
approximately $44,000 as a result of required additional legal costs
experienced during the first quarter of 2006. These costs are associated
primarily with the legal costs of the Company's proposed privatization
transaction and other legal fees associated with the pursuit of several
trademark infringement actions initiated by the Company. Management
believes that these costs will decline in 2006 after the Company completes
its "going private" transaction and deregisters its securities with the SEC.
Equipment rental increased by approximately $12,000 resulting from an
increase in lease expense for equipment to support the Company's online
delivery capabilities and royalty expense increased $34,000 over the prior
year as a result of the purchase of additional licenses to support our SQL
format.
Costs incurred in conjunction with product development are charged to
research and development expense until technological feasibility is
established. During the first quarter of 2006, the Company capitalized
$412,478 of product development costs, and net of accumulated amortization,
had capitalized software costs of $3,924,077 at March 31, 2006. Amortization
of product development costs was $384,983 for the three months ended March
31, 2006, a 3% increase over the $372,708 amortized in the first quarter of
2005. It is anticipated that these costs will increase by approximately 10%
over the full year. Over the past year, the Company made substantial
progress in development efforts on revised, updated and expanded curriculum
offerings and improvements to its software technology. The increase in
amortization expense is a result of greater capitalized development costs
associated with these essential investments in the Company's future and
competitive position.
Interest expense, net of interest income, was $9,004 for the three months
ended March 31, 2006 compared to $10,530 for the same 2005 quarter
reflecting the reduction in average daily bank debt levels in 2006 compared
to the prior year offset by higher interest rates. The Company had a net
loss of $(131,620) for the three months ended March 31, 2006 compared to net
income of $65,486 for the same period in 2005.
Liquidity and Capital Resources
- -------------------------------
The Company has invested significantly in the development of new products
and the acquisition and licensing of new products to improve the ability of
the organization and its published products to meet the needs of the
marketplace. These changes were required to update, expand and keep current
the Company's extensive curriculum product offerings and to position the
Company for long-term growth. To finance the business, management has
utilized secured bank revolving credit lines, bank financed equipment loans,
lease financing sources and convertible debt from private individuals.
As of March 31, 2006 the Company's principal sources of liquidity included
cash and cash equivalents of $733,592, net accounts receivable of $2,201,752
and inventory of $17,376. The Company's net cash provided by operating
activities during the three months ended March 31, 2006 was $212,893
compared to $158,124 for the same period in 2005. Net cash used in investing
activities for the three months ended March 31 increased by 29% from
$354,436 in 2005 to $456,341 in 2006, and was comprised primarily of
investment in capitalized software development costs. At March 31, 2006, the
Company had working capital of $1,001,994 compared to $1,605,268 at December
31, 2005. The decrease in working capital was primarily due to the change of
$400,000 in subordinated debt from a long-term to a current liability during
the quarter. The Company has a $550,000 revolving line of credit that bears
interest at a rate of
<Page> 12
1.00% over the prime rate (8.75% as of March 31, 2006) and matures on
October 30, 2006. At March 31, 2006, there were no borrowings under this
line of credit.
In April 2003, the Company borrowed $305,880 from major shareholder
affiliates, which is subordinated to the debt owed to the Company's senior
lender. This debt matures in September of 2006 and is convertible into the
Company's common stock at $.40 per share. On March 30, 2005, the Company
entered into a Convertible Note Purchase Agreement with an unaffiliated
individual. Pursuant to the terms of the Convertible Note Purchase
Agreement, the Company issued the note purchaser an unsecured 8%
Subordinated Convertible Note in the original aggregate principal amount of
$400,000 (the "Note"). All principal and interest on the Note is due and
payable on March 30, 2007. The Note is convertible at any time at the note
purchaser's option into shares of the Company's common stock at the initial
conversion price of $0.463 per share, subject to certain anti-dilution
adjustments. Any shares of common stock issued upon conversion of the Note
will have "piggy-back" registration rights. The proceeds from the
subordinated convertible debt were used to reduce accounts payable, bank
debt and to support the normal operations of the business.
There are no material operating covenants in either of the subordinated debt
agreements nor in the bank loan agreements. The Company does not believe
that there are any covenants that affect the way the business is operated or
that would require material financial obligations.
With the continued expansion of the Company's product lines, the cost of the
addition of new products and markets and the increase in marketing that the
Company expects to incur in 2006, along with the cash requirement to fund
the stock repurchase that will lead to privatization of the Company, there
will be continuing cash needs for the business. Management believes that it
can undertake these projects with most, if not all, of the Company's working
capital requirements secured from its operating cash flows. If successful,
the Company should be able to enhance the liquidity of the business and the
overall strength of the Company's balance sheet and financial position.
Additional working capital beyond that available within the Company has been
and may be required to expand operations. Management has and will consider
options available in providing such funding, including debt and equity
financing.
Off-Balance Sheet Arrangements
- ------------------------------
The Company does not have any off-balance sheet arrangements.
Critical Accounting Policies
- ----------------------------
Management is responsible for the integrity of the financial information
presented herein. The Company's financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States of America. Where necessary, they reflect estimates based on
management's judgment. Significant accounting policies that are important
to the portrayal of the Company's financial condition and results, which in
some cases require management's judgment, are summarized in the Notes to
Interim Financial Statements, which are included herein.
ITEM 3 - CONTROLS AND PROCEDURES
- --------------------------------
It is the responsibility of the Chief Executive Officer and the Chief
Financial Officer to ensure that the Company maintains disclosure controls
and procedures designed to be disclosed by the Company in its reports that
it files or submits under the Securities Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported within the time periods
sspecified in the Securities and Exchange Commission's rules and forms.
These disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is accumulated and communicated
to the Company's management, including its principal executive and principal
financial officers, or persons performing similar functions, as appropriate,
to allow timely decisions regarding required disclosure.
<Page> 13
As of March 31, 2006, management, including the Chief Executive Officer and
Chief Financial Officer, conducted an evaluation of disclosure controls and
procedures pursuant to Exchange Act Rules 13a-14 and 13a-15 as of the end of
the period covered by this report. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that such
disclosure controls and procedures are effective. During the three months
ended March 31, 2006, there have been no changes in internal controls, or
in factors that have materially affected, or are reasonably likely to
materially affect, the Company's internal controls over financial reporting.
<Page> 14
THE AMERICAN EDUCATION CORPORATION
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
Management knows of no pending or threatened litigation involving the
Company that is considered material to the on-going operations and viability
of the Company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
None.
Item 3. Default Upon Senior Securities
------------------------------
Omitted from this report as inapplicable.
Item 4. Submission of Matters to a Vote of Securities Holders
-----------------------------------------------------
None.
Item 5. Other Information
-----------------
Omitted from this report as inapplicable.
Item 6. Exhibits
--------
The following exhibits have been filed as a part of this report:
Exhibit
No. Description of Exhibits
- ------- ---------------------------------------------------------------
3.1 Articles of Incorporation of The American Education Corporation
(incorporated by reference Annex B to the Definitive Proxy
Statement filed with the Securities and Exchange Commission on
October 12, 2001)
3.2 Bylaws of The American Education Corporation (incorporated by
reference to Annex C to the Definitive Proxy Statement filed
with the Securities and Exchange Commission on October 12, 2001)
4.1 Form of Stock Certificate (incorporated by reference to Form
8-A12G/A filed with the Securities and Exchange Commission on
January 20, 2004)
4.2 Directors' Stock Option Plan (incorporated by reference to
Exhibit B to the Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 24, 1998)
4.3 First Amendment to the Directors' Stock Option Plan
(incorporated by reference to the Company's registration
statement on Form S-8 filed with the Securities and
Exchange Commission on October 22, 1999)
4.4 Stock Option Plan for Employees (incorporated by reference to
Exhibit C to the Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 24, 1998)
<Page> 15
4.5 First Amendment to the Stock Option Plan for Employees
(incorporated by reference to the Company's registration
statement on Form S-8 filed with the Securities and Exchange
Commission on October 22, 1999)
4.6 Second Amendment to the Stock Option Plan for Employees
(incorporated by reference to Exhibit 4.7 to the Company's
registration statement on Form S-8 filed with the Securities and
Exchange Commission on September 29, 2000)
10.1 Convertible Note Purchase Agreement dated March 30, 2005 by and
between The American Education Corporation and David J. Smith
(incorporated by reference to the exhibit in the Current Report
on Form 8-K filed with the Securities and Exchange Commission on
April 11, 2005)
10.2 The American Education Corporation 8% Subordinated Convertible
Promissory Note dated March 30, 2005 in favor of David J. Smith
(incorporated by reference to the exhibit in the Current Report
on Form 8-K filed with the Securities and Exchange Commission on
April 11, 2005)
10.3 Promissory Note dated March 31, 2004 from The American Education
Corporation in favor of UMB Bank, N.A. (incorporated by
reference to the exhibit in the quarterly report 10-Q filed with
the Securities and Exchange Commission on August 15, 2005)
10.4 Promissory Note dated March 31, 2004 from The American Education
Corporation in favor of UMB Bank, N.A. (incorporated by
reference to the exhibit in the quarterly report 10-Q filed with
the Securities and Exchange Commission on August 15, 2005)
10.5 Promissory Note dated April 30, 2006 from The American Education
Corporation in favor of UMB Bank, N.A. (incorporated by
reference to the exhibit in the Current Report on Form 8-K filed
with the Securities and Exchange Commission on April 28, 2006)
10.6 Business Loan Agreement (Asset Based) dated April 30, 2006 from
The American Education Corporation in favor of UMB Bank, N.A.
(incorporated by reference to the exhibit in the Current Report
on Form 8-K filed with the Securities and Exchange Commission on
April 28, 2006)
10.7 Employment Agreement with Jeffrey E. Butler dated December 5,
1998 (incorporated by reference to the exhibit in the quarterly
report 10-Q filed with the Securities and Exchange Commission on
August 15, 2005)
10.8 Employment Agreement with Thomas A. Shively dated December 5,
1998 (incorporated by reference to the exhibit in the quarterly
report 10-Q filed with the Securities and Exchange Commission on
August 15, 2005)
10.9 Employment Agreement with Neil R. Johnson dated December 5, 1998
(incorporated by reference to the exhibit in the quarterly
report 10-Q filed with the Securities and Exchange Commission on
August 15, 2005)
10.10 Promissory Note dated October 16, 2000 from Jeffrey E. Butler in
favor of the Company (incorporated by reference to the exhibit
in the annual report 10-KSB/A filed with the Securities and
Exchange Commission on September 9, 2005)
10.11 Promissory Note dated September 30, 2004 from the Company in
favor of John Garber (incorporated by reference to the exhibit
in the annual report 10-KSB/A filed with the Securities and
Exchange Commission on September 9, 2005)
<Page> 16
10.12 Promissory Note dated September 30, 2004 from the Company in
favor of Janis L. Butler (incorporated by reference to the
exhibit in the annual report 10-KSB/A filed with the Securities
and Exchange Commission on September 9, 2005)
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
<Page> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
The American Education Corporation
/s/ Jeffrey E. Butler
-----------------------
Jeffrey E. Butler,
Chief Executive Officer
Chairman of the Board
Treasurer
/s/ Neil R. Johnson
-----------------------
Chief Financial Officer
Chief Accounting Officer
Date: May 15, 2006
<Page> 18
Index to Exhibits
Exhibit
No. Description of Exhibits Method of Filing
- ------- ------------------------------- --------------------------------
3.1 Articles of Incorporation Incorporated herein by reference
3.2 Bylaws Incorporated herein by reference
4.1 Form of Stock Certificate Incorporated herein by reference
4.2 Director's Stock Option Plan Incorporated herein by reference
4.3 First Amendment to Director's
Stock Option Plan Incorporated herein by reference
4.4 Stock Option Plan for Employees Incorporated herein by reference
4.5 First Amendment to Stock
Option Plan for Employees Incorporated herein by reference
4.6 Second Amendment to Stock
Option Plan for Employees Incorporated herein by reference
10.1 Smith Convertible Note Purchase
Agreement Incorporated herein by reference
10.2 Smith Subordinated Convertible
Promissory Note Incorporated herein by reference
10.3 Promissory Note dated 03/31/04
in favor of UMB Bank, N.A. Incorporated herein by reference
10.4 Promissory Note dated 03/31/04
in favor of UMB Bank, N.A. Incorporated herein by reference
10.5 Promissory Note dated 04/30/06
in favor of UMB Bank, N.A. Incorporated herein by reference
10.6 Business Loan Agreement Incorporated herein by reference
10.7 Butler Employment Agreement Incorporated herein by reference
10.8 Shively Employment Agreement Incorporated herein by reference
10.9 Johnson Employment Agreement Incorporated herein by reference
10.10 Promissory Note dated 10/16/2000
in favor of the Company Incorporated herein by reference
10.11 Promissory Note dated 09/30/04
in favor of John Garber Incorporated herein by reference
10.12 Promissory Note dated 09/30/04
in favor of Janis L. Butler Incorporated herein by reference
31.1 CEO Certification pursuant to
Section 302 Filed Herewith Electronically
31.2 CFO Certification pursuant to
Section 302 Filed Herewith Electronically
32.1 CEO Certification pursuant to
18 U.S.C. Section 1350, as
adopted pursuant to Section 906 Filed Herewith Electronically
32.2 CFO Certification pursuant to
18 U.S.C. Section 1350, as
adopted pursuant to Section 906 Filed Herewith Electronically