FORM 10-KSB
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the Transition Period from ________ to ________
Commission File #0-11078
THE AMERICAN EDUCATION CORPORATION
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(Name of Small Business issuer in its charter)
Nevada 73-1621446
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7506 N. Broadway Extension, Suite 505, Oklahoma City, OK 73116
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(Address of principal executive offices ) (Zip Code)
(405) 840-6031
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(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange 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 Act during the past 12 months (or for
such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the
past 90 days.
YES X NO____
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure
will be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III
of this Form 10-KSB or any amendment to this Form 10-KSB. [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act) YES____ NO X
Revenues for the year ended December 31, 2005: $9,819,396
The aggregate market value of the issuer's voting and non-voting common
equity held by non-affiliates of the issuer as of March 24, 2005 was
$4,707,125 based on 7,471,627 shares at $.63 per share, the closing
sale price of the issuer's common stock on March 24, 2006. (For
purposes of calculating this amount only, all the directors and
executive officers of the issuer have been treated as affiliates.)
Number of shares of the issuer's common stock outstanding as of March
24, 2006: 14,133,461
Transitional Small Business Disclosure Format YES____ NO X
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TABLE OF CONTENTS TO FORM 10-KSB
PART I
Page Number
Item 1 Description of Business 3
Item 2 Description of Property 11
Item 3 Legal Proceedings 11
Item 4 Submission of Matters to a Vote of Security
Holders 11
PART II
Item 5 Market for Common Stock, Related Stockholder
Matters and Small Business Issuer Repurchases
of Equity Securities 12
Item 6 Management's Discussion and Analysis or Plan
of Operation 13
Item 7 Financial Statements 19
Item 8 Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure 19
Item 8A Controls and Procedures 20
Item 8B Other Information 20
PART III
Item 9 Directors, Executive Officers, Promoters and
Control Persons; Compliance with Section 16(a)
of the Exchange Act 21
Item 10 Executive Compensation 23
Item 11 Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 25
Item 12 Certain Relationships and Related Transactions 26
Item 13 Exhibits 26
Item 14 Principal Accountant Fees and Services 28
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
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. These
forward-looking statements are subject to numerous risks and
uncertainties, including, but not limited to, the risks and
uncertainties described under the heading "Risk Factors and
Uncertainties" in the "Management's Discussion and Analysis or Plan of
Operation" section of this annual report. 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 its forward-looking
statements to reflect the impact of events or circumstances that arise
after the date the forward-looking statements were made.
<Page>
THE AMERICAN EDUCATION CORPORATION
FORM 10-KSB
PART I
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Item 1. Description of Business.
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The Company's Business
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The Company's primary business is the development and marketing of
educational software to elementary, middle and secondary schools, adult
literacy centers and vocational, junior and community colleges. The
Company develops software for Windows, registered, Macintosh,
registered, Unix, registered, and Linux, registered, operating systems.
From 1995 to 2001, the Company's revenues were primarily derived from
the sale of its product family, the A+dvanced Learning System, registered,
Version 2.15, a comprehensive courseware offering developed by the Company.
In early 2001, the Company released the A+nyWhere Learning System,
registered, V 3.0 ("A+LS", registered), a Java, trademark, based program
that is now the Company's principal delivery platform for its extensive
grade level 1-12 educational content and assessment tools. The A+nyWhere
Learning System, registered, V 3.0, and the browser-based version,
A+nyWhere Learning System, registered, V 4.0, accounted for over ninety
percent of the Company's total revenues at the close of fiscal 2005, while
the A+dvanced Learning System Version 2.15 accounted for less than ten
percent of the Company's total revenues. The educational effectiveness
of the Company's products and their instructional design are substantiated
through a significant body of historically generated data. In accordance
with the No Child Left Behind Act of 2001, which requires schools to use
educational products whose effectiveness has been demonstrated through
scientifically based research studies, the Company has conducted a series
of formal effectiveness studies to better inform its school customers of
the potential performance of the Company's products. These studies, which
have been independently reviewed, have established that the Company's
instructional design is effective in a range of instructional settings
and grade levels. The Company is currently engaged in additional
scientifically-based research studies to continue to compile data regarding
the effectiveness of the Company's products as its product offerings are
upgraded and expanded.
In 1998, the Company acquired Projected Learning Programs, Inc.
("PLP"), a company that engaged in catalogue marketing of both the
Company's products and distribution of other publishers' software. In
2001, management elected to wind down and ultimately discontinue the
PLP catalog selling operations as a result of the reduction in
catalogue sales due to the increasing use of the Internet to purchase
products offered by PLP, as well as the significant cash required to
operate a catalogue sales business.
The Company also acquired Learning Pathways, Limited ("LPL"), a United
Kingdom educational software provider, in 1998. From 2002 through the
year ended December 31, 2004, the marketplace in the UK became more
competitive and funding declined for the technology and products
produced by LPL. As a result, LPL suffered a series of sustained
annual losses. Through this period, the Company downsized its
operations in an effort to counter this trend. Management elected to
write off the remaining goodwill and the Company's investment in this
subsidiary in fiscal 2004. Subsequently, the Company sold LPL in
November 2005. The Company expects to save approximately $350,000 in
2006 as a result of no longer having to fund the operations of LPL.
The Company also expects that it will receive long-term royalties under
a distribution agreement with LPL; however, management believes that
these royalties will not have a material impact on the future financial
performance of the Company.
The Company purchased Dolphin, Inc., ("Dolphin") in December 1999.
Dolphin was an established, fourteen year-old developer of educational
software for many of the world's leading textbook and electronic
publishers. The Company purchased Dolphin to provide additional depth
to the Company's development activities and, through its ongoing
industry contacts, to assist the Company in initiating partnering
opportunities in the areas of content development, marketing and
business development with major textbook and assessment testing
publishers. Changes in the development practices of major textbook
publishers, as well as their increasing use of offshore developers,
began to impact the size of contracts that Dolphin was able to secure
in 2003 and the subsidiary's operations were downsized in 2004 and
2005. Management elected to cease Dolphin's development for outside
companies in 2005 when it became apparent that the fundamentals of the
subsidiary's business had changed. All customer contract
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fulfillment obligations have been met and Dolphin was merged into the
Company in December 2005. The Company expects to save approximately $400,000
as a result of the restructuring of the Dolphin operations.
The Company internally develops software and content and licenses, to a
limited extent, software or content from third parties for inclusion in
its products for the school market. The Company utilizes an in-house
programming staff and limited, external contract services to develop
its software technology. The Company is the primary developer of its
curriculum content and employs full-time educational professionals to
assist in this electronic publishing effort. The Company also makes
extensive use of contract services to secure the specialized educator
skills that are necessary to publish the wide range of subject matter
and grade level content required by the Company's comprehensive product
offering, and to ensure their correlation to state and other
educational standards.
The use of computers, software and the Internet as educational,
instructional and assessment aids in the nation's schools is the major
focus of the Company's marketing strategy. The Company's marketing
plan calls for separate promotional efforts to be directed toward the
various segments of the school market and channels of distribution that
provide specialized market access. Currently, the Company utilizes an
in-house employee sales force and a network of independent school
dealers to market its products to schools. Each independent school
dealer generally covers a geographically limited territory such as a
single state. Other marketing efforts are executed through business
partners as well as direct mail to the school and library markets.
The Company is a technology-based business and is actively engaged in
developing new software applications to facilitate the delivery of its
assessment testing and instructional content in a networked
environment, which includes the Internet. A significant percentage of
the Company's current revenues are derived from product sales to
schools that deliver curriculum content on a local area network ("LAN")
within a single school site. The rapid adoption of wide-area networks
("WAN"), and increased Internet usage, or online delivery of the
Company's products, are growing as a percentage of the Company's
revenues. In late 2000, the Company began the testing and delivery of
its content online. As a result of the availability of the browser-
based version, A+nyWhere Learning System V4.0, the Company, at December
31, 2005, had 393 schools in 37 states using online curriculum content.
These users are supported by company-maintained Tier 1 data facilities
in Oklahoma City at the Perimeter Technology Center, Inc., and at the
Vericenter, Inc. facility in Dallas, TX. Management believes that it
has in place the development of technology and programs to allow it to
capitalize on the forecasted, rapid changes in the structure of the
marketplace for the delivery of electronic-based instruction that will
be required by school districts in future years.
Principal Products
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The Company engages in extensive efforts to develop new programming
technology as well as new instructional content and academic skills
assessment tools. As a result of this effort, the Company now supports
all contemporary Macintosh, Windows, Novell, UNIX and Linux operating
systems with one of the largest curriculum offerings in the core
subject areas for grade levels 1-12. At December 31, 2005 the Company
now publishes under its various A+, registered, brands 148 separate
software titles and has another 14 titles in revision or development
for release in 2006. All of the Company's currently released products
carry 2001 or later copyrights reflecting the Company's commitment not
only to development of content but also keeping its products up to date.
There is a growing use of LAN, WAN and Internet technologies in schools
and school districts to provide both assessment and educational content
to students. The Company provides these schools with software designed
to perform in these network environments. The Company's educational
software for the elementary, middle and high school markets is designed
for use in classroom instruction and assessment and provides the
educator with tools and the reporting resources to assist schools in
meeting and documenting their average yearly performance (AYP)
improvement objectives. The Company's products for schools are
designed for the professional educator and feature a management
function, which records assessment and student activity data for both
individual student, class and school performance measurement. This
management function also provides for a wide range of performance
reports, lesson materials, tests and assignments that are required to
meet the No Child Left Behind Act of 2001 initiative of the Federal
Government. A hallmark feature of the Company's products is a unique
authoring tool, which allows the educator to add, modify and expand the
graphics, text and incorporate the use of the Internet content to the
curriculum coursework provided by the Company. The Company's software
is correlated to over 120 major national and state standards so that
educators can develop specific lesson plans to assist students with a
course of study that is directly related to specific state or national
learning objectives, or to correct individual student skill
deficiencies.
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The Company's computer software products are carefully
designed to be utilized by both educators and students without
extensive computer training.
In an industry where there are in excess of 300 educational software
publishers, the Company has developed a distinctive niche in the form
of its content, delivery, instructional design and assessment tools.
This approach features high educational value and extensive content
that is highly correlated to the leading states' desired learning
outcomes, national educational objectives and major, adopted textbook
series. The Company has concentrated on a design of its products that
offers educational content substance that is highly specific to grade
and age level. These are delivered to the student by a Learning
Management System ("LMS") that allows full educator control of the
content delivery rather than an approach controlled by the software.
Various software tools, such as the Company's products for assessment
and instruction, allow the use of the Internet as a source of content
at the school's or individual teacher's option. It also provides
educators with the means to effectively utilize the Company's products
as a comprehensive supplemental instructional solution designed to
address individual student skill deficiencies that may be identified by
the Company's assessment tools. In addition, the Company's product
design is modular so that each title sold by the Company has an
integral LMS function. This management function is shared so that new
software titles purchased by a customer utilize preexisting A+LS class
and student records that have been previously established. This
feature allows schools to add additional content and titles or updated
versions simply and easily.
The No Child Left Behind Act of 2001 initiative places significant
emphasis on spending federal funds on software programs that have been
demonstrated to improve student academic performance using
"scientifically-based" research. The Company's A+ brands in various
versions are supported by a body of research that validates the
Company's instructional design. In 2003, the Company amplified its
ongoing efforts to establish programs to document through rigorous,
systematic and objective procedures the educational effectiveness of
its products. The Company has published various white papers and
formal studies to document completed studies of product performance in
schools. The Company has engaged Edvantia, Inc. (formerly The
Institute for the Advancement of Research in Education at Appalachian
Educational Laboratory) in Charleston, WV, to assist the Company in
continuing to refine its design for future scientifically-based
research and to provide an independent review of the completed studies
and the publication of the results of these efforts. A total of
fifteen studies have been undertaken and at the end of fiscal 2005.
Seven of the studies have been published and submitted to various
industry publications or are directly printed or electronically
distributed by the Company. The remaining eight studies are scheduled
for publication in 2006 and 2007.
The majority of the Company's installed software base is deployed in a
LAN environment as an LMS. The LMS allows teachers and school
administrators to monitor and analyze student performance, which is
increasingly important in the wake of the No Child Left Behind Act of
2001 initiative which emphasizes school accountability. This approach
provides complete district, school and educator control of class and
student lesson assignments, an individualized path of study, skills
assessment, authoring, testing, reporting and the integration of third-
party and Internet-based content. The A+LS product family's
capabilities and its range of reporting, and documentation of
individual student performance and progress assist the educator in
directing the use, and understanding the effectiveness, of instruction,
while improving the efficiency of the learning process. Management
believes that fewer than six companies in the educational software
industry provide a comprehensive, fully-managed instructional LMS
software solution that is comparable to the products provided by the
Company.
A+nyWhere Learning System, registered, Versions 3.0 and 4.0
The A+nyWhere Learning System makes use of standardized Structured
Query Language ("SQL") and Open Database Connectivity ("ODBC")
technology to ensure transferability of student data between the system
and the existing customer databases. The powerful class and student
management features of this product provide the means to link and
transfer student data to most school and district central records.
These features also include the ability to dynamically assess student
capabilities against specific individual state standards, and to
prescribe individualized instructional plans based on such assessments.
The system can be an important element in providing the data needed to
measure Adequate Yearly Progress (AYP) as required by the No Child Left
Behind Act of 2001.
From an educational content perspective, A+LS, Version 3.0 and Version
4.0 has been designed as a comprehensive grade level 1-12 core
curriculum solution. It is a product family currently comprised of 148
subject titles that provide for an interactive multimedia instructional
environment with extensive sound and graphics. Major subject
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areas covered are: reading, writing, mathematics, science, history,
geography and language arts. Each ascending grade level subject title of
the Company's content presents increasingly more complex concepts that
provide overlapping subject matter reinforcement by grade level. As a
body of published work, it is one of the most extensive in the industry
for the elementary, middle and secondary grade levels. A+LS's content
is divided into subject titles, each containing a number of lessons.
Each lesson contains a number of activities such as study, practice
exercises, tests and essay.
These instructional activities are further supported by computer
adaptive skill assessment tests for all subject areas and lesson-
related activities. This design facilitates the use of the advanced
A+LS class and student management system to pretest, posttest, record
academic gains, maintain academic performance data and to report on
individual student and class activities. This capability is required
by schools to simplify and assist in the management and reporting of
student academic performance data to comply with certain aspects of the
No Child Left Behind Act of 2001. Using tools embedded in the
Company's software, educators may select a series of specific lessons
across all subject areas to create a curriculum plan for a specific
time period, while specifying independent mastery levels for each
lesson for a class, group or an individual student. They may also
integrate third-party publishers' materials into a specified course of
study for enrichment or remediation activities. The product design
also permits the development of individualized courses of study as a
result of diagnostic testing and prescriptive capabilities designed
into A+LS for the at-risk or special education student, which might
require specific emphasis to correct skill deficiencies. Approximately
12,100 public and private schools, centers of adult literacy and
correctional institutions have purchased the Company's products since
the introduction of the Company's new A+dvanced Learning System,
Version 2.0.
During 2005 the Company continued to receive excellent marketplace
acceptance of A+nyWhere Learning System Version 4.0, the browser-based
version of Version 3.0. This version has most of the features of
Version 3.0, but is designed to be delivered in standard Internet
browsers. Importantly, Version 4.0 utilizes all of the assessment
testing resources of Version 3.0. Version 4.0's browser-based delivery
can be used as an independent, stand alone solution as well as in
combination with a Version 3.0 installation. This design approach is a
major selling feature because it allows schools to deploy a common
instructional resource and performance-tracking technology from a
single vendor throughout a community or campus; which simplifies the
use, training and data collection processes. In addition, the ability
to deploy in LAN, WAN and Internet configurations provides the school
with a long-term solution to effectively utilize computer and bandwidth
resources as these are upgraded over time.
Throughout 2005, the Company has maintained active development efforts
in updating and expanding both its technology and curriculum offerings
for the A+LS product family. During the year, the Company released
nine new subject titles, including a new K-2 emergent reading series.
The Company also began development of new subject title additions for
high school electives. The Company expects to release nine new titles
in 2006. In addition, during fiscal 2005 significant portions of the
Company's current assessments and standards database were expanded,
updated and realigned to meet new or revised state and national
academic standards; in total, approximately 30 state standard sets were
revised or added to keep pace with changes made by individual states
and their departments of education.
These ongoing investments in new technology provide the Company with
the means to deliver its products in the highly connected, future
marketplace. This capability should increase and enhance the Company's
competitive ability to expand its delivery alternatives to customers
and to secure new marketing and strategic business relationships.
A+ University, trademark
A+ University, trademark, is a product training and staff development
product line, which is designed to instruct school administrators,
curriculum specialists and teachers in the use of the Company's various
products. Initial release of this new product family occurred in the
second quarter of 2002 and revisions and updates have been made in
subsequent fiscal years including 2005 to maintain this product
family's currency and relevancy to the Company's evolving product
structure. It is believed that this product family should become an
important source of incremental revenue from existing and new customers
in future years.
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A+dvancer Learning System, trademark
In mid-2003, the Company completed the development of A+dvancer
Learning System, an online assessment and course of remedial study,
which is aligned to the College Board's ACCUPLACER, registered,
postsecondary test. In 2005, the Company secured orders from
approximately forty-five postsecondary institutions and now has
approximately seventy-five institutions utilizing this product in their
admissions process. ACCUPLACER is utilized by two and four-year
institutions to screen incoming, first-year students and their
capabilities to be successful in college-level studies. ACCUPLACER
tests are widely used by the nation's postsecondary institutions for
admissions screening and is thought to be the market leading admissions
test in mathematics, reading, writing, language comprehension and
algebra. ACCUPLACER is designed to render a single score and provides
the admissions department with little additional information should the
student fail to achieve college's minimum ACCUPLACER score.
A+dvancer's assessment test identifies for admissions personnel the
specific undeveloped skills that caused the student to fail the
ACCUPLACER test, while providing diagnostic guidance and a prescriptive
recommendation for a course of study to build college-level skills. In
addition to the diagnostic/prescriptive test element, A+dvancer
provides for comprehensive online coursework to assist the student in a
highly focused course of study to develop or refresh the skills
necessary to retake the ACCUPLACER test. Controlled pilot studies on
the effectiveness of A+dvancer indicates that it provides both the
postsecondary admissions department and students seeking entry to these
institutions an important new online resource to simply and effectively
deal with the needs of developmental testing and instruction. A
significant percentage of graduating high school seniors seeking
admission, or individuals in the work force who are returning to
postsecondary institutions require remedial education programs to
secure entry into postsecondary institutions.
Third Party Publishing, Marketing Affiliations and Partnerships
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The Company is actively pursuing and is being pursued by third-party
publishing and marketing companies, which have curriculum content that
is complementary to the publications of the Company or have access to
specialized segments of the market. Many of these companies do not
have the software management technology or distribution resources of
the Company. These relationships are generally sought by the Company
to supplement and complement the content of existing and planned A+LS
subject matter or to enter new markets. Management also believes
continued expansion of these types of relationships enhances the value
of the Company's products to educators and strengthens the business
relationships with its distributors and other business partners.
The Market For Educational Software Products
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The Company addresses four major market segments for its products; the
K-12 school, adult literacy, corrections and postsecondary markets.
The K-12 School Market
In 2005 the K-12 U.S. school market for educational software showed
indications of recovery and that the market segment for the Company's
products evidenced a return to growth. The Company purchases reports
and market research services from industry-recognized organizations
such as Simba, Quality Education Data, Educational Turnkey Systems,
Heller Associates and EduVentures on a periodic or subscription basis.
These organizations are forecasting continued growth of the educational
technology market segment through 2006 despite some reductions that
have been made and are currently under consideration by the federal
government in its funding of various programs. This continued growth
is expected to be driven principally by (i) the increased recovery or
adjustment by individual states to their budget difficulties and, (ii)
a growing priority of the individual states to provide schools with the
necessary means to purchase software with the assessment data
management capabilities similar to those offered by the Company to
permit them to deal with reporting and school accountability
requirements of the No Child Left Behind Act of 2001 initiative. In the
United States, future market growth is also expected to be driven by
record student enrollments in primary through secondary schools
projected through the year 2008. The U.S. market is currently
comprised of approximately 15,000 school districts that control 111,000
schools. Many states in the South and Southwest with high population
growth projections are expected to have expansion of student
populations exceeding 20% during the next several years.
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This market is well documented by the industry sources, referred to
above, to be moving to wider use of technology, access to the Internet
and the increasing use of online services. At December 31, 2005,almost
100% of the schools in the U.S. are connected to the Internet. Use of
the Internet is expected to increase in schools as improved bandwidth
access is installed throughout the nation's school buildings.
Importantly, it is believed that increased home access to the Internet
will open up the potential for distributed learning and "e-learning"
with the local school functioning as the hub of a community-wide
network to access educational resources.
Market growth is also expected to effect significant changes in the use
and increased adoption of technology to cope with teacher and physical
facility shortages in an attempt to gain increasing efficiency and to
secure more accountability for academic performance at the individual
school and district level. To meet the future challenges, schools are
expected to embrace the increased use of a range of technologies
including the areas of database management, e-learning through the
Internet and its capabilities.
The Adult Literacy/Lifelong Learning/Corrections Market
The Company believes it has designed its curriculum content delivery so
that it is both appealing and engaging to children and not offensive to
adult learners. As a result, in 2005 the Company continued to have
success in this segment of the market. The Company has installed its
software in state and municipal centers of literacy and the juvenile
and adult corrections market segments, including a state wide
deployment of content in Kansas, Utah and Oklahoma in both the prison
system and a number of regional adult literacy centers. Preliminary
information from these installations is that the Company's products are
highly effective in preparing adults for high school equivalency tests
and other recognized measurements of literacy. The adult literacy and
certain related work and college preparedness market segments are
believed to be growing at an annual rate of approximately 20% per annum
according to research sources. In some cases, these market segments
are served by specialized distributors and the Company is seeking to
secure additional distribution resources to support its expansion
efforts in this area.
The Postsecondary Market
This market segment includes both two and four year institutions, both
public and private, as well as the for-profit segment operated by
educational services companies. The Company is focused on the first
time freshman student population with under-performing college level
placement efforts, which is comprised of both traditional students,
those moving directly from high school to college and non-traditional
students, those returning for postsecondary education following other
life-changing events; such as the termination of military service, or
those seeking additional skills to improve employment opportunities.
National statistics from The American Association of Community Colleges
indicate that approximately forty percent of all graduating students
are not prepared to be successful in the postsecondary environment.
Current U.S. Department of Education studies indicate approximately
2.7 million students were eligible for graduation from high school in
its recent publications with statistics for the 2002-2003 school year.
The non-traditional student component of this market is estimated by
the Company to represent approximately 500,000 students in the current
school year. The combination of the graduating high school students
and the population of the non-traditional students returning to secure
additional postsecondary education skills requiring refresher and
development of college entry level skills is believed to represent a
large target market for the Company's product offerings designed
specifically to support the assessment and online instruction needs of
this market segment.
Trade Names, Service Marks and Logo Types
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The Company's service mark for the A+ products was registered with the
United States Patent and Trademark Office on the Principal Register,
registration number 1,345,712, on July 2, 1985. On April 18, 1989, the
A+ trademark, for use with educational software, was registered with
the United States Patent and Trademark Office. The Company was
notified that, as of May 12, 1997, the use of the A+ symbol is deemed
incontestable for use on educational software. Other various
trademarks and logos associated with the Company's software products
have also been registered.
On June 16, 1995, the Company filed for the separate and expanded use
of its A+ registered mark as A+dvanced Learning System with its A+ logo
design to describe and identify this extensive family of educational
software products released in the latter part of fiscal 1995. This
mark was registered with the United States Patent and
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Trademark Office
on Principal Register, registration number 2,038,215, on February 18,
1997. On December 29, 1999, the Company filed for the trademark
A+Datalink which has been approved for registration by the United
States Patent and Trademark Office.
The Company filed for additional separate and expanded use of its A+
registered mark for use as A+nyWhere Learning System and Adult Learning
System in the second quarter of 1999 and continued registration efforts
on these marks during 2000. In 2001, the Company was notified of the
registration of the A+nyWhere trademark. In addition, the Company
continued actions to file necessary documents in the United Kingdom to
ensure protection and preservation of its A+ brand in that country.
The A+LS mark was registered with the United Kingdom's Trade Marks
Office, registration number 2,194,275, on April 12, 1999. The A+
design and A+dvanced Learning System has been approved for registration
in the United Kingdom.
In 2003 the Company filed for additional separate and expanded use of
its A+ registered mark as A+dvancer Learning System to describe this
new product family of educational software products for the
postsecondary marketplace.
The use of the Company's distinctive A+ logo is viewed as an integral,
distinctive brand element to the Company's product families and is
important to corporate recognition.
Production and Manufacturing
- ----------------------------
The Company purchases CD-ROM blanks from various sources. The Company
owns commercial quality, high-speed software duplication equipment and
duplicates its software both internally and externally. The Company
develops, with outside packaging developers, materials and packaging
concepts, and internally authors necessary product instructional
manuals. The Company maintains duplication equipment that is suitable
for production of catalogs and manuals. The Company secures product
packaging from external sources and performs quality control, final
assembly, inventory and distribution on most orders received. Large
production runs of catalogs and sales literature are contracted to
outside printers. The Company has no dependence on any individual
supplier.
The Company, with its release to schools of the A+nyWhere Learning
System, Version 3.0 in 2001 and version 4.0 in 2002 has the capability
to electronically deliver and install its products at customer
locations. This capability should serve to further reduce the
Company's cost of publication of its products as it reduces the need to
produce its products and their extensive documentation on CD-ROM discs.
Research and Development
- ------------------------
At December 31, 2005, the Company employed twelve (12) full-time
development and support personnel in its product development efforts.
These individuals are responsible for the development of new versions
of the Company's software technology and the support and refinement of
current versions of its software offerings.
The Company employs a staff of professional educators who are
responsible for the development and support of its curriculum content.
The Company also utilizes part-time educational consultants in the
design of its curriculum-based product offering. These individuals
provide the curriculum design support on the development and
enhancement of Company products. These consultants allow the Company
to effectively and efficiently address the specialized grade level and
diverse content needs of its A+LS product family. Management believes
that it will continue to rely upon external sources for a portion of
its new product content. However, the growing sophistication and
complexity of the interactive design of company products will require
continued expansion of in-house curriculum and graphics development
personnel resources.
At December 31, 2005, the Company employed ten (10) full-time education
professionals in support of this effort. These individuals plan,
manage and coordinate the efforts of up to twenty independent
educational consultants and graphic designers.
<Page 9>
Research and Development Costs
- ------------------------------
Costs incurred with product development are charged to research and
development expense until technological feasibility of a product is
established. Thereafter, all software development costs are
capitalized and amortized on a straight-line basis over the product's
estimated economic life. The Company capitalized $1,692,811 in
software research and development costs in 2005 and $1,372,955 in 2004.
Amortization of product development costs for the year ended December
31, 2005, was $1,611,909 as compared to $1,572,654 (including $158,765
in discontinued operations) for the year ended December 31, 2004.
Distribution and Sales Programs
- -------------------------------
In marketing its products, the Company utilizes approximately 40
independent school dealers to reach its school-based customers. During
2005, the Company hired and employed both field and in-house sales
forces to provide support to its dealers and to improve its access to
school customers in rural areas not easily reached by its dealers.
This sales team was comprised of three individuals at December 31,
2005.
Internet Marketing and e-commerce
- ---------------------------------
The Company views the Internet as a channel for future sales growth and
means to develop new customer service and support programs. In
addition, the Internet has become a valuable tool for improved customer
service and support on product use and technical matters. During 2005,
the Company invested substantial resources in improving and expanding
its Internet presence and e-commerce capabilities for all business
units. The Company employs full time personnel to update, functionally
and graphically, its www.amered.com, www.aplusuniversity.com, and
www.advancerlearning.com URL's. At the end of 2005, the Company has
three active Internet site facilities.
Backlog
- -------
The Company's software products are normally shipped within five days
of receipt of the order. The Company believes that a level of backlog
at any particular date may not be a meaningful indicator of future
performance, unless technical difficulties delay the fulfillment of
orders related to the release of new products. The backlog at
December 31, 2005 was not material.
Seasonality
- -----------
Decisions by schools and individual consumers to purchase educational
software have most frequently been made at the beginning or near the
end of school periods. The months of January and December generally
represent the lowest new order booking months for the Company and the
school market industry segment. This seasonal cycle can directly
affect the Company's total revenues and earnings levels in both the
first and fourth quarterly reporting periods.
Significant Customers
- ---------------------
The Company sells its A+LS product family almost exclusively to schools
through various school dealers of educational materials. No individual
customer accounted for more than 10% of the Company's total revenues in
2004 or 2005.
Competition
- -----------
The educational software industry is highly competitive and subject to
rapid change. An increasing number of new publicly financed and
privately funded organizations have been identified that are
potentially competitive to the Company's current business and future
plans for electronically delivered content. Many of these companies
are better known and have substantially greater financial, marketing
and technical resources than the Company. Such participants are
textbook publishing companies and their software divisions and other
larger independent educational software and content developers, which
may compete directly with the Company.
<Page 10>
The primary competitive factors applicable to the educational software
industry are produuct features (such as subject areas, graphics and
color), price, ease of use, suitability of the product offering for
Internet delivery, educational content, product reliability, sales
support and customer service. Management believes through constant
analysis of its competitors and ongoing surveys that it sponsors at the
customer level that the Company is currently competitive and enjoys a
reputation as a quality organization and publisher of educational
material.
The Internet and the delivery of curriculum by electronic means may
have the capacity to alter the competitive environment and the current
means to content access for both the school and home customer. The
Company, in the judgment of management, has the necessary programs
underway or in development to remain competitive in the future
marketplace environment. Business development programs to identify
future partners and the means to exploit the Company's investment in
both technology and content are an ongoing process with a number of
companies that have a focus on the Internet, the education marketplace
and are seeking content partners.
Employees
- ---------
As of December 31, 2005, the Company had 57 full-time employees. The
Company believes that its relationship with employees is satisfactory.
Item 2. Description of Property.
- ------ ------------------------
The Company leases approximately 17,600 sq. ft. of contiguous office
and light warehouse space in Oklahoma City, Oklahoma, under an
agreement that expires December 31, 2008. The monthly rent under this
lease is $13,109.
The Company leases 3,750 sq. ft. of office space in Voorhees, New
Jersey, under a lease agreement expiring May 31, 2009. Monthly lease
expense is $5,000.
Prior to the sale of LPL in November, 2005, the Company leased
approximately 3,500 sq. ft. of office space in Derby, United Kingdom.
The monthly lease expense approximated $1,580. The purchaser of LPL
assumed this lease in connection with the purchase.
Total corporate cost of leased facilities was $221,530 for 2005 for the
Company's Oklahoma, New Jersey and Derby, UK facilities. Cost of
leased facilities for 2004 was $263,691. Because the Company is no
longer responsible for the lease expenses of the Derby, UK facility, it
expects that its total corporate cost of leased facilities will be
approximately $220,000 in 2006.
Item 3. Legal Proceedings.
- ------ ------------------
In late 2005 and early 2006, the Company filed complaints in the United
States District Court for the Western District of Oklahoma against
two educational technology organizations that are believed to have
inappropriately utilized its registered trademark, "A+." As a result
of the circumstances of these infringements, the historical use and
defense of its trademarks, the Company believes that it should be
successful in these matters. With respect to materiality, it is too
early in discussion with the representatives of these organizations to
determine what, if any, settlement may be reached or its timing and
financial impact on the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------ ----------------------------------------------------
There were no matters submitted for a vote of the security holders
during the last quarter of 2005.
<Page 11>
PART II
- -------
Item 5. Market for Common Equity, Related Stockholder Matters and
Small Business Issuer Repurchases of Equity Securities.
- ------ ---------------------------------------------------------
As of December 31, 2005, there were approximately 2,300 record holders
of the Company's common stock. The Company's common stock trades on
the OTC Bulletin Board under the ticker symbol AEDU. The following is
a summary of the high and low sales prices for each quarter of 2005 and
2004.
2005 2004
HIGH LOW HIGH LOW
-------------- --------------
Quarter Ending March 31 $0.75 $0.35 $0.52 $0.35
Quarter Ending June 30 $0.62 $0.30 $0.57 $0.36
Quarter Ending September 30 $0.63 $0.47 $0.55 $0.28
Quarter Ending December 31 $0.70 $0.55 $0.51 $0.26
The above information was obtained from the Yahoofinance.com website.
Dividends
- ---------
The Company has never declared a cash dividend on the Common Stock and
does not anticipate declaring any dividends on the Common Stock in the
foreseeable future. The Company intends, at this point, to retain any
future earnings to support the Company's growth. Any payment of cash
dividends in the future will be dependent upon the amount of funds
legally available and is contingent upon the Company's earnings,
financial condition, capital requirements, and other factors which the
Board of Directors deem relevant.
Securities Authorized for Issuance Under Equity Compensation Plans
- ------------------------------------------------------------------
(a) (b) (c)
Number of
securities
remaining
Number of Weighted- available for
securities to average future issuance
be issued upon exercise under equity
exercise of price of compensation
outstanding outstanding plans (excluding
options, options, securities
warrants warrants reflected in
Plan Category and rights and rights column (a))
- ------------------------- --------------- --------------- ---------------
Equity compensation plans
approved by security
holders (1) 2,649,998 $ .37 0
Equity compensation plans
not approved by security
holders (2) 1,605,546 $ .39 0
--------- ------- -------
Total 4,255,544 $ .38 0
========= ======= =======
(1) Consists of the 1998 Employee Stock Option and the Director Stock
Option Plan.
(2) Consists of the 1996 Non-Qualified Stock Option Plan.
<Page 12>
Item 6. 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 postsecondary 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 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. The Company must also update its content and underwrite
content revisions to realign its content with new, or updated state and
national educational standards and to develop additional educational
content offerings to remain competitive. In 2005, the Company incurred
costs of approximately $840,000 for these updates and new content-based
products and expects this amount to increase by approximately five
percent in 2006. During 2005, the Company spent approximately $853,000
in modifying its software technology to improve delivery of its content
online and to develop additional reporting and data management features
to assist its customers in meeting school accountability requirements.
The Company expects to increase this amount in 2006 by approximately
twenty percent. These investments are an essential, recurring cost of
doing business and impact the Company's operating cost and margin
structures.
Market research from several market research services available to the
Company, noted on page 7, under section: The Market For Educational
Software Products, The K-12 School Market, estimates the segment for all
K-12 courseware, adult literacy and postsecondary remedial software
approximates $1.7 billion dollars in annual expenditures. These
expenditures are separate from the major expenditures in school
infrastructure for the Internet, hardware connectivity and communications.
The LMS segment in which the Company competes is estimated at between $500
aand $600million dollars for K-12, adult literacy and may be experiencing
overall growth of approximately 5-7 percent per annum. The research
indicates that certain segments of this market, such as the secondary
and postsecondary remedial markets, may be experiencing growth rates
that are somewhat higher than the elementary or middle school markets.
This growth is driven by a change in funding emphasis by the federal
government as well as the recognition by the individual states of
performance of high schools, persistently high drop-out statistics and
the lack of preparedness of the nation's high school population to
qualify for post-secondary studies or employment. The National
Association of Community Colleges continues to report in 2005 that
approximately 42 percent of first-time freshman applying for entry
require remediation in one or more core skill areas of mathematics,
reading or writing. The Company has and will continue to invest in new
content, technology and product offerings to meet what are believed to
be opportunities in these higher growth secondary and post-secondary
market segments.
Certain K-12 geographical markets addressed by the Company are growing
at different rates as a result of population growth-related school
system expansion in the Southeast, South, Southwest and Western states
as a result of national
<Page 13>
population shifts that are documented from a number of government and
media sources. The Company has quality, effective representation in many
of these higher growth markets, and is working to secure broader market
coverage in open areas.
In the last five years the Company has experienced rates of growth of
its core AEC business that the Company believes have approximated the
growth of the overall marketplace for portions of a given fiscal year.
Over this same time period unexpected events as well as a national
recession have interrupted the Company's performance and have prevented
a full fiscal-year of growth in excess of market expansion rates. For
example, in the first half of fiscal year 2005, growth of five percent
was reported for the core business for this six-month period. This growth
was interrupted in the quarter ended September 30, 2005 as a result of
extensive hurricane activity, which caused the cancellation or deferment
of orders in the Gulf States' region ranging from Florida to South Texas.
These interruptions are at least, in part, a cause for the core business'
overall rate of growth to fall approximately one-half percent for the full
year. Additional detail on this interruption is discussed under the Risk
Factors, Unanticipated Events section contained in this report. These
interruptions also impact overall financial performance with respect to
profitability, cash flow and earnings. The Company is in a competitive
business that requires constant investment in content and technology, which
requires experienced and talented employees resulting in a high fixed cost
structure. The Company has difficulty forecasting its revenues because
(i) its products have a lengthy sales cycle, and (ii) schools typically order
the Company's products at the end of each quarter. These business
characteristics represent quarterly and annual financial control challenges
to the Company's management in the essential effort to direct the growth of
its business and its earnings while maintaining employment levels and
essential organizational and business development programs.
The Company has what it believes to be an excellent record of product
performance and a reputation as an established publisher of
supplemental materials in schools and districts that are its
established customers. It continues to receive reorders, version-to-
version upgrades and expansion of its content position with newly
revised or expanded grade-level offerings. The Company's records
indicate a total of 618 new school customers purchased its products for
the first time in 2005. The following table indicates the Company's
total installed base of 12,100 schools by percentage of type of
purchasing institution at December 31, 2005 for all versions released
over the past twelve years.
2005 Installed Base - All Institutions
--------------------------------------
K-12 Schools 17%
Elementary Schools 24%
Middle Schools 18%
High Schools 26%
Alternative Education 5%
Post-Secondary & Adult 10%
Total 100%
--------------------------------------
The Company's management believes that its products and technology are
competitive and that the business is positioned for future growth in
certain segments of the educational market. As indicated in the above
table, the Company's products are accepted by all of the major grade-
level segments that comprise the total educational market.
The Company has divested or closed non-performing subsidiaries to
concentrate on the development and expansion of its core business. The
current focus of the Company's staff and available financial resources
is on the
<Page 14>
opportunities in its key market and geographical segments. A
parallel effort to expand its sales and distribution capabilities in
an effort to increase its revenue at, or exceeding the rate of overall
market growth is a priority in 2006 and future years.
On June 21, 2005, the Company filed its initial Schedule 13e-3 with the
Securities and Exchange Commission (the "SEC") with respect to its
planned reverse split of its stock, which would reduce the number of
its shareholders to less than 300, thereby allowing the Company to
deregister its securities with the SEC. This would result in the
Company no longer being a public company. This action was taken by the
Board of Directors in large part to contain growing regulatory, legal
and accounting costs associated with the Company's business and
redirect these meaningful resources into the business. The Company is
in contact with the SEC and continues to file amendments to this
initial filing in response to SEC comments but is uncertain as to the
effective date of this filing.
Risk Factors and Uncertainties
The Company's business is subject to a number risks or uncertainties
with respect to its future growth and profitability. Management
believes that the Company is positioned for future growth and
profitability as a result of its continued investment in content and
technology. The ability to achieve growth of revenues and earnings
consistent with or exceeding the overall growth of its market is
dependent on the successful execution of company programs to expand its
market coverage. The potential for success is tempered by the
Company's exposure to a number of business risk factors and
uncertainties presented below.
Funding Sources: A dependency on federal funding for school technology
purchases may limit the availability of resources to the marketplace.
Federal programs, such as Title I grants and Enhancing Education
Through Technology (EETT) grants, have been cut in scope approximately
ten and twenty-nine percent, respectively in the 2005-2006 school year
and further potential reductions are being reviewed for the 2006-2007
school year. In addition, a recent report from Educational Turnkey
Systems indicates that across approximately eighteen categories of
federal grants made to schools to purchase technology-based products
that there is a trend of a decline in funding in the 2005-2006 school
year. Although it is too early to predict the outcome for the 2006-
2007 school year, the important EETT program may have major reductions
ranging up to forty-five percent. In addition, other programs and
sources of funding from the federal government to the nation's schools
are often cumbersome and unpredictable as to their timing and release
of funds and may impact the business cycle traditionally experienced by
the Company.
State and local governments are the primary source of funding for most
schools to be able to purchase the Company's products and technology,
which are often viewed as a long-term investment as a result of their
cost. The sources of these local government's funds are highly
dependent on the condition of both national and local economies to
provide funding for the purchase of the Company's products. Entering
calendar year 2006, the state and local government funding environment
for education is thought to be positive. However, inflationary trends
for other essential expenditures, such as energy costs, may be
disruptive or delay new investment in school technologies as schools
seek to manage fixed budgets and unanticipated costs.
Unanticipated Events: The education market segments to which the
Company markets its products are vulnerable to unanticipated events
such as extreme weather conditions that result in large, regional
disruptions. Recent hurricane patterns affecting the Gulf Coast
states, an important area of market strength for the Company, provide
an example of such a disruption of current business. The extent and
severity of weather events in 2005 not only impacted the immediately
affected geographical areas, but disrupted adjoining metropolitan areas
and states as other school districts sought to provide facilities and
assistance to temporarily or permanently displaced families. Experts
are forecasting continued possible severe weather events for the next
several years in these key market areas, adding a potential element of
uncertainty to management's ability to forecast, plan and manage the
business.
Limited Market Coverage: The Company is dependent upon a limited
number of states for its current revenue levels, as a result of the
selective coverage provided by its distribution network. Future company
success in these states is dependent on the retention of key marketing
personnel and distributor organizations in these geographic locations.
This limited national presence in key markets is of concern to the
Company. To counter this business risk, the Company has invested in
substantial, marketing programs beginning in the latter part of 2004
and continuing throughout fiscal 2005. The Company expects to increase
expenditures for the marketing and sales
<Page 15>
departments in 2006, by approximately twenty percent from the expenditures
made for the these departments in 2005 to attempt to secure broader
geographic sales coverage.
Competition: The Company competes with substantially larger
organizations with greater resources than those available to the
Company. Organizations such as Plato Learning, Compass Learning,
Pearson and Riverdeep are able to field full-time, directly employed
sales personnel to better cover certain markets and customers. They
can also invest greater resources in the development of technology,
content and research which may allow them to react to market changes
faster, putting the Company at a possible competitive disadvantage.
Competition in the market may also prevent the increase in price of
products that may be necessary to offset rising costs of doing business
and the continued development of the organization and its products
could be delayed or deferred.
Exposure to Potential Litigation and Increased Legal Expense: The
Company has potential exposure from its various shareholder interests
as a result of its current public company status and the efforts to
privatize the business. A range of other exposures may exist as
schools increase their reliance on the Company's products, including:
the Company's ability to deliver its products in accordance with the
terms of its various license agreements, the possible loss of student
and school data or insufficient security to protect such information
and preserve privacy of school-age children. Online access through
various company-operated web sites is a growing component of the
Company's business and requires the careful consideration of the future
legal and regulatory environment. This would indicate greater access
to legal services that may become an increased cost component when
considering the development of new products and technologies.
Access to Capital: The Company may require additional capital to
sustain the growth of the business. Depending upon operating results
and profitability, the cost of such capital in terms of dilution in
current ownership or interest costs could impact future company per
share earnings. The ability of the Company to raise additional capital
is dependent upon the quality of its financial performance. Failure to
secure additional access to debt or equity could impair the
competitiveness of the business and its ability to grow at the same
rate as its industry segment.
Loss of Key Employees: The Company is highly dependent upon its
professional and technical staff. The loss of key individuals, at the
Company's current size and stage of development, and combined with the
possible inability to recruit experienced replacements in a timely
manner could impair the Company's future performance.
Results of Operations
- ---------------------
Fiscal Year Ended December 31, 2005 Compared to Fiscal Year Ended
December 31, 2004
- -----------------------------------------------------------------
Effective December 31, 2004, the Company's UK subsidiary, LPL, was
deemed to be an asset held for sale and its value was written down to
zero as an impairment loss. It was subsequently sold on November 7,
2005 and, therefore, its operations are shown as discontinued. The
2004 amounts have been restated to reclassify the results of LPL as
discontinued. Therefore, the comparisons discussed here are only for
the continuing operations of the Company and its Dolphin, Inc. subsidiary.
Net consolidated revenues for the twelve months ended December 31, 2005
totaled $9,819,396 compared to net revenues of $10,186,517 for the year
ended 2004. This represents a decrease of 4% in net consolidated
revenues over the prior fiscal year, attributable to a modest decrease
in revenues in the Company's core business and a larger decrease at
Dolphin as a result of the planned integration of this subsidiary unit
into the Company's product development effort. The Company's revenues
of its core business decreased slightly, by approximately $55,000, or
less than 1% over the prior year, despite the negative impacts hurricanes
in the Southern Gulf states had on results during the second half of the
year. The areas affected by these hurricanes include several of the Company's
largest revenue producing states. The Company believes the ability to maintain
stable revenue despite these events is a result of increased state and
federal government education funding and higher educational spending
outside of the hurricane affected states in 2005. The sales decrease of
approximately $312,000 at Dolphin is a result of the previously announced
exit from the contract software development business. Dolphin employees
began to provide additional development resources for the Company during the
third quarter of 2005 and, as of year-end are spending full-time on the
Company's product development. On December 31, 2005 Dolphin, Inc. was merged
into the Company.
<Page 16>
Cost of goods sold as a percentage of sales revenue for the year ended
December 31, 2005 decreased to 12% from 14% of net revenues for the
same period in 2004. This improvement is primarily due to the smaller
contribution of Dolphin-related revenues to consolidated corporate net
revenues. The Company's principal product families, A+nyWhere Learning
System, registered, and A+dvanced Learning System, registered,
("A+LS"), provided gross profit margins of 97% in both 2005 and 2004.
The Company expects that its gross profit margins for its principal
product families should remain at this level in 2006. Cost of goods
sold represents the actual cost to produce the software products and
includes certain allocated overhead costs.
As noted above, during 2005 the Company decided to exit the contract
software development business at its Dolphin subsidiary. As a result,
the Company determined the goodwill recorded on the balance sheet
arising from the acquisition of Dolphin was impaired and wrote off the
entire amount of $1,215,015 as an operating expense. Total operating
expenses recorded for the year ended December 31, 2005 (excluding the
goodwill write-down) were $8,077,440 or 82% of sales, compared to
$7,522,597 or 74% of sales, for the previous fiscal year. The increase
in total operating expenses is comprised of a decrease 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 year. Selling and marketing
expenses decreased by 7% from $3,628,550 in 2004 to $3,391,767 for
2005 and is primarily the result of changes in sales mix, which caused
decreased sales commissions of approximately $230,000 as the Company
billed a lower 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 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.
Operations expense increased by 16% from $501,401 to $580,375 as a
result of increased compensation and benefits due to additional technical
support staff hired during the year. The Company expects operations costs
to increase approximately 10% in 2006. General and administrative
expenses increased by 26% from $1,978,757 to $2,493,389 for several
different reasons. General and administrative salaries and benefits
increased approximately $137,000 at AEC due to the addition of personnel
in accounting and other departments, but was offset by decreases of
approximately $90,000 at Dolphin resulting from the reduction in staff and
other ancillary costs as part of their planned downsizing. Deferred
compensation payable upon executive officers' and directors' retirement
for the period increased $48,000 as a result of additional employees who
were eligible for this program, compared to the prior year. Audit and
legal fees increased approximately $138,000 as a result of required
additional legal costs experienced during 2005 primarily from the legal
costs of the privatization transaction and the sale of LPL. Management
believes that these costs will decline in 2006 after the Company completes
its "going private" transaction and deregisters its securities with the
SEC. Outside services increased approximately $85,000 due to consulting
fees paid to integrate the Learning Letter Sounds product line content
into the Company's product line and advice regarding the future of
Dolphin. Bad debt expense increased $232,000 over the prior year as a
result of an increase in the allowance for uncollectible accounts based
upon higher accounts receivable balances compared to the prior year and
the write-off of several specific accounts. The Company expects its bad
debt expense to decrease in 2006, because the Company had to write off
several specific accounts in 2005 and believes the allowance for doubtful
accounts is adequate to cover any potential write-offs.
Costs incurred in conjunction with product development are charged to
research and development expense until technological feasibility is
established. During fiscal 2005, the Company capitalized $1,692,811 of
product development costs, and net of accumulated amortization had
capitalized software costs of $3,896,582 at December
<Page 17>
31, 2005. Amortization of product development costs was $1,611,909 for
2005, a 14% increase over the $1,413,889 amortized in 2004. During 2005,
the Company made substantial progress in development efforts on revised,
updated and expanded curriculum offerings. 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. It is believed amortization costs will increase in 2006, by a
similar amount to the 2005 increase.
Interest expense, net of interest income, was $49,933 in 2005 compared
to $61,058 in 2004 reflecting the reduction in average daily bank debt
levels in 2005 compared to the prior year offset by higher interest
rates and higher interest due to the increase in convertible debt
issued by the Company in 2005. The income tax benefit at 17% of the
pretax loss differs from the statutory amount of approximately 40%
primarily because management determined that the tax benefit of the
state tax loss carry forward for Dolphin would never be utilized and
greater non-deductible expenses incurred in 2005. The Company had a
net loss of $(849,927) in 2005 compared to a net loss of $(343,260) in
2004 primarily as a result of the impairment of goodwill at Dolphin noted
above. There was a loss $(.05) per share in 2005 compared to a loss of
$(.02) in 2004.
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 December 31, 2005 the Company's principal sources of liquidity
included cash and cash equivalents of $977,040, net accounts receivable
of $2,314,586 and inventory of $21,368. The Company's net cash provided
by operating activities during the year ended December 31, 2005 was
$2,176,830 compared to $2,137,957 for the same period in 2004. Net cash
used in investing activities for the year ended December 31 increased
by 25% from $1,426,219 in 2004 to $1,777,271 in 2005, and was comprised
primarily of investment in capitalized software development costs.
During the year ended December 31, 2005, debt due to financial
institutions was reduced by $371,862 or 100%, reflecting no bank
indebtedness at December 31, 2005. At December 31, 2005, the Company
had working capital of $1,605,268 compared to $1,097,949 at December
31, 2004. The Company's term loan with its bank was fully paid in
November and the Company and its lender are in discussions to extend
the maturity of its revolving line of credit past the current March 31,
2006 expiration date. Management believes this will be accomplished
in early April 2006.
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.
The Company has a $450,000 revolving line of credit with a bank that
bears interest at a rate of 2.50% over the prime rate (9.25% as of
December 31, 2005) and matures on March 31, 2006. The bank is currently
in discussions with the Company on an extension of that facility, which
the Company believes will be accomplished in early April, 2006. At
December 31, 2005, the Company had no borrowings under this line of credit.
The Company is continuing to discuss future borrowing arrangements with
its current lender and several bank financing sources.
<Page 18>
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.
Contractual Cash Obligations
- ----------------------------
The following is a summary of the Company's significant contractual
cash obligations for the periods indicated that existed as of December
31, 2005 and is more fully disclosed in Notes 4 and 5 of the Notes to
Consolidated Financial Statements.
Year ended December 31
2006 2007 2008 2009 2010
-------- -------- -------- -------- --------
Long and short term debt $305,880 $ 400,000 $ -- $ -- $ --
Operating leases 334,958 287,151 248,374 32,157 857
-------- -------- -------- -------- --------
Total contractual
Obligations $640,838 $687,151 $248,374 $ 32,157 $ 857
======== ======== ======== ======== ========
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 Financial
Statements which are included herein in Item 7.
Item 7. Financial Statements.
- ------ ---------------------
Financial Statements and Financial Statement Schedules - See Index to
Consolidated Financial Statements and Schedules immediately following
the signature page of this report.
Item 8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure.
- ------ -----------------------------------------------------------
Steakley & Gilbert, P.C. has audited the Company's financial statements
for the years ending December 31, 1994 through 2005. There are no
disputes with the independent accountants regarding matters of
accounting or reporting.
<Page 19>
Item 8A. 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 provide reasonable assurance that
material information, both financial and non-financial, and other
information required under the securities laws to be disclosed is
identified and communicated to senior management on a timely basis.
The Company's disclosure controls and procedures include controls and
other procedures of the Company that are designed to ensure that
information required to be disclosed by the Company in its reports that
it submits under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
As of December 31, 2005, management, including the Chief Executive
Officer and Chief Financial Officer, conducted an evaluation of
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14
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 the disclosure controls and procedures currently in
place are effective. During the three months ended December 31, 2005,
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.
Item 8B. Other Information
- ------- -----------------
None.
<Page 20>
PART III
- --------
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16 (a) of the Exchange Act.
- ------ -------------------------------------------------------------
The directors and executive officers of the Company are set forth
below. All directors hold office until the next annual meeting of
stockholders, or until their death, resignation, retirement, removal,
disqualification, and until their successors have been elected and
qualified. Vacancies in the existing board are filled by a majority
vote of the remaining directors.
Name Age Position Director Since
- -----------------------------------------------------------------
Jeffrey E. Butler 64 President, Director, 1989
Chief Executive Officer
Thomas A. Shively 52 Executive Vice President and
Chief Operating Officer
Neil R. Johnson 55 Vice President and
Chief Financial Officer
Monty C. McCurry 60 Director 1989
Newton W. Fink 69 Director 1991
Stephen E. Prust 61 Director 1992
Business Experience
- -------------------
JEFFREY E. BUTLER became a director of the Company in August 1989 and
was elected Chief Executive Officer and President in March, 1990. From
1985 to 1990, Mr. Butler was a management consultant to businesses in
the biotechnology, computer science, software, educational and
entertainment video industries. Mr. Butler served as a director of
Video Professor Industries, Inc., a publicly held corporation, from
February 1, 1989 to October 31, 1990. Prior to establishing his
management consulting business, Mr. Butler was the Chief Executive
Officer and President of Infomed Corporation, which provided computer
diagnostic equipment and management services to hospitals, corporations
and physicians. Prior to 1985, Mr. Butler was employed by Sandoz,
Ltd., Corning, Inc. and Becton Dickinson Corporation in middle and
senior management positions.
THOMAS A. SHIVELY joined the Company as Executive Vice President in
September 1991. From 1990 to 1991, Mr. Shively was Vice President and
General Manager of AVID Home Entertainment, a division of LIVE Inc.,
with headquarters in Denver, Colorado. From 1989 to 1990, he was Vice
President and General Manager of the Richie Resource Group with
headquarters in Minneapolis, Minnesota. From 1978 to 1988, he was
employed by Gelco Corporation, Minneapolis, Minnesota, a $2 billion
NYSE firm that was purchased by General Electric Corporation in 1988.
During the first five years of his career with Gelco, he was Director
of Corporate Planning and from 1983, he served as a staff Vice
President and as a Vice President of various Gelco operating divisions.
Upon graduation from the Wharton School of Finance and Commerce in
1976, Mr. Shively began his business career with the 3M Corporation,
Minneapolis, Minnesota.
NEIL R. JOHNSON has been employed by the Company since August 1998.
Immediately prior to being employed by the Company, Mr. Johnson was an
independent business consultant. From 1994 to 1997, Mr. Johnson was
Chief Financial Officer and Treasurer for Unit Parts, Inc., an Oklahoma
City-based remanufacturer of automotive parts. From 1985 to 1994, Mr.
Johnson was Vice President of Corporate Finance and Treasurer of
Doskocil Companies, Inc., a diversified food products manufacturer.
Prior to those positions, Mr. Johnson spent twelve years with the
public accounting firm of Coopers & Lybrand. Mr. Johnson graduated from
Valparaiso University in 1972 with a BS in Business Administration.
MONTY C. McCURRY was elected to the Board of Directors in April 1989.
Since 1985, Mr. McCurry has been the President of Executive Resource
Management, an executive search firm headquartered in Aurora, Colorado.
From 1969 to 1985, Mr. McCurry was employed by Paul M. Riggins and
Associates, an executive search firm where he was associate general
manager.
NEWTON W. FINK, Ed.D. was elected to the Board of Directors in January
1991. Dr. Fink is currently an Adjunct Professor of Educational
Leadership at National Louis University, Tampa, Florida. From 1998 to
2003, Dr. Fink
<Page 21>
was the Superintendent of Schools in Manteno, IL. From 1994 to 1998 he
was Superintendent of the VIT Schools in Table Grove, IL. Prior to 1994,
Dr. Fink was the President of Computer Instructional Services, Inc., a
privately held corporation providing computer educational services to
individuals, schools, corporations and institutions. Additionally, he has
been employed as a teacher and an elementary/middle school principal earlier
in his career. Dr. Fink has also published and lectured extensively on the
use of computers in education.
STEPHEN E. PRUST was elected to the Board of Directors in April 1992.
Since 1992, Mr. Prust has provided business consulting services,
including advice on equity and debt transactions, mergers and
acquisitions, to a variety of companies, ranging from entertainment
concerns, Internet start-ups and industry consolidators. From 1990 to
1992, Mr. Prust was the President of AVID Home Entertainment, a
division of LIVE Entertainment, Inc. From 1981 to 1990, Mr. Prust was
a consultant to companies in the entertainment industry. In 1975, Mr.
Prust founded Dominion Music, Inc., a joint venture with K-Tel Records,
Inc. He served as President of Dominion Music until 1981.
Compliance with Section 16(a) of the Exchange Act
- -------------------------------------------------
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's directors, executive officers and holders of
more than 10% of the Common Stock to file with the Securities and
Exchange Commission initial reports of ownership and reports of changes
in ownership of the Common Stock. Based solely upon a review of Forms
3, 4 and 5 furnished to the Company with respect to the year ended
December 31, 2005, the Company has determined that all reports were
filed timely.
Audit Committee Financial Expert
- --------------------------------
The entire Board of Directors serves as the Audit Committee of the
Company. The Board of Directors does not have a financial expert
serving as a member of the Board. The Company does not have a
financial expert serving on its Board due to the Company's size,
financial condition for the past several years and its inability to
offer sufficient incentives and D&O insurance to attract a financial
expert to serve on the Board.
Code of Ethics
- --------------
The Company has adopted a written Code of Ethics that applies to the
Company's principal executive officer, principal financial officer,
principal accounting officer or controller and any persons performing
similar functions. The Company will provide a copy of its Code of
Ethics to any person without charge upon written request addressed
to The American Education Corporation, 7506 N. Broadway Ext. Suite 505,
Oklahoma City, Oklahoma 73116, Attention: Shareholder Relations.
<Page 22>
Item 10. Executive Compensation.
- ------- -----------------------
Compensation
- ------------
The following table shows the compensation of the Company's executive
officers.
Summary Compensation Table
Long-Term
Annual Compensation Compensation
------------------------------ -------------------
Securities
Other Restricted Underlying
Name and Principal Annual Stock Options/
Position Year Salary Bonus Compensation(1) Awards SARS(#)
- ------------------------------------------------------------------------------
Jeffrey E. Butler, 2005 $170,722 $12,900 $ -- -- 215,470
President and Chief 2004 150,167 2,060 -- -- 356,800
Executive Officer 2003 132,000 2,060 -- -- 360,000
Thomas A. Shively, 2005 $161,608 $ -- $ -- -- 121,000
Executive Vice 2004 144,399 26,384 -- -- 273,276
President 2003 126,500 -- -- -- 260,000
Neil R. Johnson, 2005 $138,431 $ 4,060 $ -- -- 121,000
Vice President and 2004 122,609 -- -- -- 25,000
Chief Financial 2003 108,350 -- -- -- 125,000
Officer
(1) The executive officers did not receive any perquisites or other
benefits, the aggregate amount of which exceeded the lesser of $50,000
or 10% of their compensation.
Employment Agreements
- ---------------------
In December, 1998, the Company entered into an employment agreement
with Jeffrey E. Butler providing for a base salary and benefits as
determined by the Board of Directors, including incentive bonuses based
on profitability, that are provided to all employees of the Company. If
Mr. Butler is terminated without cause, his compensation will continue
for one year. In the event of a change in control, Mr. Butler may
require the Company to purchase up to 50% of his beneficial stock
ownership. In addition, Mr. Butler has a deferred retirement benefit
as disclosed in Note 10 of the Notes to Consolidated Financial
Statements.
Messrs. Thomas A. Shively, and Neil R. Johnson also have employment
agreements with the Company. These agreements also provide for
severance payments and repurchase of a portion of their beneficial
stock ownership in the event of a change in control. They also have a
deferred retirement benefit as disclosed in Note 10 of the Notes to
Consolidated Financial Statements.
Stock Incentive Plans
- ---------------------
The shareholders approved an Incentive Stock Option Plan for employees,
including officers, during 1998, and approved amendments to the plan in
1999, 2000 and 2001 to increase the number of shares available. The
total common shares issuable under this plan are 2,650,000 shares. The
Board of Directors acts as the Compensation Committee ("Committee").
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.
Since its inception, options to purchase 4,648,000 shares have been
granted, 1,997,030 options have expired, and 200,970 options have been
exercised. At December 31, 2005, there were options to purchase
2,450,000 shares outstanding under this Plan.
<Page 23>
In March 1996, a Non-Qualified Stock Option Plan was approved by the
Board of Directors. Since its inception non-qualified stock options to
purchase a total of 3,250,241 shares of restricted common stock have
been issued, 1,448,995 have expired and 195,700 have been exercised. At
December 31, 2005, there were options to purchase 1,605,546 shares
outstanding.
Stock Option Grants In 2005
- ---------------------------
Options Percentage of Total Exercise
Granted Options Granted to Price Expiration
Name (Shares) Employees in 2005(Per share) Date
- -----------------------------------------------------------------------------
Jeffrey E. Butler 215,470 29.0% $.63 December 29, 2008
Thomas A. Shively 121,000 16.3% $.63 December 29, 2008
Neil R. Johnson 121,000 16.3% $.63 December 29, 2008
Option Exercises and Fiscal Year-End Values
- -------------------------------------------
No executive officer exercised options during 2005. The following table
sets forth, for the executive officers named in the Summary
Compensation Table above, the year-end value of unexercised stock
options:
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options at Year-End Options at Year-End
Name Exercisable/Unexercisable Exercisable/Unexercisable
- ----------------------------------------------------------------------------
Jeffrey E. Butler 1,032,270/0 $256,704/$0
Thomas A. Shively 714,276/0 $185,117/$0
Neil R. Johnson 331,000/0 $71,050/$0
Directors' Compensation
- -----------------------
In 2005 the Company's non-employee directors each were granted 52,500
non-qualified options to purchase the Company's common stock at $.63
per share. The directors received no compensation, other than stock
options, for services in their capacity as directors. In 2005, two
directors received cash compensation for services rendered outside of
the scope of normal directors duties. Monty McCurry received $27,500
for assisting the Company in recruiting key personnel required for the
Company's expansion and growth. Stephen Prust received $15,000 for
assistance to management in the review of operations of the Company's
subsidiaries whose operations were causing substantial losses for the
Company and the development of strategic alternatives to manage the
losses being generated by these subsidiaries, including the potential
sale of the subsidiaries. Both of the extra assignments were related
to the specific skills and experience of each director.
The shareholders 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 common shares issuable under this Plan are
200,000 shares. Each outside director initially elected or appointed
after March 27, 1998, shall be granted options to purchase 5,000 shares
of common stock at the fair market value at the date of the grant.
Additionally, each outside director shall automatically be granted an
option to purchase 3,000 shares of common stock, if available, in each
succeeding calendar year 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. Since its inception options to purchase a total of 292,998
shares of restricted common stock have been issued and 93,000 have
expired. At December 31, 2005, there were 199,998 options outstanding.
<Page 24>
Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.
- ------- ---------------------------------------------------
The following table sets forth ownership of the common stock of each
director and officer, all officers and directors as a group, and each
person known or believed by the Company to have beneficially owned five
percent or more of the Company's outstanding common stock as of March
24, 2006. Unless otherwise indicated, the beneficial owner has sole
voting and investment power over the common stock listed below:
Shares Beneficially
Owned
--------------------
Name/Address of Beneficial Owner Number Percent
- ---------------------------------- ----------------------
Jeffrey E. Butler (1) 1,813,845 12.0%
7506 N. Broadway Ext.,
Oklahoma City, OK 73116
Thomas A. Shively (2) 950,664 6.4%
7506 N. Broadway Ext.,
Oklahoma City, OK 73116
Neil R. Johnson (3) 343,500 2.4%
7506 N. Broadway Ext.,
Oklahoma City, OK 73116
Monty C. McCurry (4) 306,066 2.1%
2134 S. Eagle Ct.,
Aurora, CO 80014
Newton W. Fink (5) 270,566 1.9%
1143 Corinth Greene Dr.,
Sun City Center, FL 33573
Stephen E. Prust (6) 608,434 4.2%
9025 East Kenyon Avenue,
Denver, CO 80237
John D. Garber (7) 3,936,986 27.3%
7323 Linden Terrace,
Carlsbad, CA 92009
Robert Schoolfield (8) 1,536,517 10.9%
5 Pleasant Cove,
Austin, TX 78746
David J. Smith (9) 863,930 5.8%
10 South Close, Workingham
Berks, United Kingdom
The Pennsylvania State 750,000 5.3%
University (10)
University Park, PA 16802
Officers and Directors 4,293,075 25.3%
as a Group (6 persons)
(1) (2) (3) (4) (5) (6)
(1) The amount and percentage figures include the possible exercise of
356,800 common stock options with an exercise price of $.35 per share,
100,000 common stock options at $.25 per share, 360,000 common stock
options at $.30 per share and 215,470 common stock options at $.63 per
share exercisable within 60 days.
(2) The amount and percentage figures include the possible exercise of
273,276 common stock options with an exercise price of $.35 per share,
60,000 common stock options at $.25 per share, 260,000 common stock
options at $.30 per share and 121,000 common stock options at $.63 per
share exercisable within 60 days.
(3) The amount and percentage figures include the possible exercise of
25,000 common stock options with an exercise price of $.35 per share,
60,000 common stock options at $.25 per share, 125,000 common stock
options at $.30 per share and 121,000 common stock options at $.63 per
share exercisable within 60 days.
<Page 25>
(4) The amount and percentage figures include the possible exercise of
84,000 common stock options with an exercise price of $.35 per share,
60,000 common stock options at $.13 per share, 42,666 common stock
options at $.30 per share and 52,500 common stock options at $.63 per
share exercisable within 60 days.
(5) The amount and percentage figures include the possible exercise of
84,000 common stock options with an exercise price of $.35 per share,
60,000 common stock options at $.13 per share, 42,666 common stock
options at $.30 per share and 52,500 common stock options at $.63 per
share exercisable within 60 days.
(6) The amount and percentage figures include the possible exercise of
129,000 common stock options with an exercise price of $.35 per share,
60,000 common stock options at $.13 per share, 42,666 common stock
options at $.30 per share and 52,500 common stock options at $.63 per
share exercisable within 60 days.
(7) The amount and percentage figures include 3,192,286 shares of
common stock held by John D. Garber and Clare C. Garber as trustees of
the John D. Garber and Clare C. Garber Trust for which Mr. Garber is
the beneficiary; 440,000 shares of common stock held by John D. Garber
and Clare C. Garber, as trustees of the John D. Garber and Clare C.
Garber defined benefit plan, 40,000 owned personally by Mr. Garber and
264,700 shares of common stock which would be issued to Mr. Garber if
he elects to convert his $105,880 8% Subordinated Convertible Note
dated April 1, 2003 to common stock.
(8) The amount and percentage figures include 737,528 shares of common
stock owned by the Schoolfield 1994 Charitable Unitrust for which Mr.
Schoolfield is the trustee; 614,607 shares of common stock owned by Mr.
Schoolfield individually; and 184,382 shares of common stock owned by
the Schoolfield Grandchildren's Trust for which Mr. Schoolfield is the
trustee.
(9) The amount and percentage figures include 863,930 shares of common
stock which would be issued to Mr. Smith if he elects to convert his
$400,000 8% Subordinated Convertible Note dated March 30, 2005 to
common stock.
(10) In 1999, the John D. Garber and Clare C. Garber Trust donated
750,000 shares of the Company's common stock to The Pennsylvania State
University.
Item 12. Certain Relationships and Related Transactions.
- ------- -----------------------------------------------
The Company is indebted to two major shareholder affiliates, John D.
Garber and Janis L. Butler, for convertible subordinated debt in the
amount of $305,880, which was advanced in April, 2003. The debt bears
interest at 8% and the interest is payable quarterly. Principal is due
in one payment on September 30, 2006. The debt is subordinated to the
debt owed the Company's senior lender and is convertible into the
Company's common stock at $.40 per share.
Item 13. Exhibits.
- ------- ---------
The following documents have been filed as a part of this annual
report:
Exhibit
No. Description of Exhibits
- ----------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of The
American Education Corporation (incorporated by reference to
the exhibit in the Current Report on Form 8-K filed with the
Securities and Exchange Commission on June 25, 1998)
3.2 Bylaws of The American Education Corporation (incorporated
by reference to the Company's registration statement on Form
S-8 filed with the Securities and Exchange Commission on
October 22, 1999)
4.1 Form of Stock Certificate (incorporated by reference to the
Company's registration statement on Form S-8 filed with the
Securities and Exchange Commission on October 22, 1999)
4.2 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)
<Page 26>
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)
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 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)
10.6 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)
10.7 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)
10.8 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)
10.9 Memorandum of Action of the Board of Directors dated January
30, 2004 correcting the Promissory Note dated October 16,
2000 from Jeffrey E. Butler in favor of the Company (filed
herewith)
<Page 27>
10.10 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)
10.11 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)
11 Statement re: computation of per share earnings (filed
herewith)
23.1 Consent of Steakley & Gilbert, P.C. (filed herewith)
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. (filed herewith)
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. (filed herewith)
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. (filed herewith)
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. (filed herewith)
Item 14. Principal Accountant Fees and Services
- ------- --------------------------------------
Audit Fees. The aggregate fees of Steakley & Gilbert, P.C. for
professional services rendered for the audit of the Company's annual
financial statements for the years ended December 31, 2005 and 2004,
and the review of the financial statements included in the Company's
Forms 10-QSB totaled $31,450 and $28,225, respectively.
Audit-Related Fees. The aggregate fees billed by Steakley & Gilbert,
P.C. for audit related services for the years ended December 31, 2005
and 2004, and are not disclosed in "Audit Fees" above, were $9,400 and
$6,300, respectively.
Tax Fees. The aggregate fees billed by Steakley & Gilbert, P.C. for tax
compliance for the years ended December 31, 2005 and 2004 were $6,800
and $8,325, respectively.
All Other Fees. The aggregate fees billed by Steakley & Gilbert, P.C.
for services, other than those described above, for the years ended
December 31, 2005 and 2004 were $-0- and $-0-, respectively.
<Page 28>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
The American Education Corporation
March 31, 2006 By:/s/Jeffrey E. Butler
------------------------
Jeffrey E. Butler,
Chief Executive Officer
Chairman of the Board
Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Name Title Date
- ----------------- ------------------------- --------------
Jeffrey E. Butler /s/Jeffrey E. Butler March 31, 2006
Chief Executive Officer
Chairman of the Board
Treasurer
Neil R. Johnson /s/Neil R. Johnson March 31, 2006
Chief Financial Officer
Chief Accounting Officer
Monty C. McCurry /s/Monty C. McCurry March 31, 2006
Director
Newton W. Fink /s/Newton W. Fink March 31, 2006
Director
Stephen E. Prust /s/Stephen E. Prust March 31, 2006
Director
<Page 29>
The American Education Corporation
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Item Page No.
- ----------------------------------------------- --------
Independent Auditors' Report F-1
Financial Statements:
Consolidated Balance Sheet, December 31, 2005 F-2
Consolidated Statements of Income for the years
ended December 31, 2005 and 2004 F-3
Consolidated Statements of Changes In Stockholders'
Equity for the years ended December 31, 2005 and 2004 F-4
Consolidated Statements of Cash Flows for the years
ended December 31, 2005 and 2004 F-5
Notes to Consolidated Financial Statements F-6
All schedules are omitted as the required information is included in
the financial statements or notes thereto or is not present in
sufficient amounts.
-----------------------------
<Page 29>
INDEPENDENT AUDITORS' REPORT
To Board of Directors and Stockholders
The American Education Corporation
Oklahoma City, Oklahoma
We have audited the consolidated balance sheet of The American
Education Corporation as of December 31, 2005 and the related
consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the two years in the period ended
December 31, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free
of material misstatement. We were not engaged to perform an audit
of the Company's internal control over financial reporting. Our
audits included consideration of internal control over financial
reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal
control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial
position of The American Education Corporation as of December 31,
2005 and the consolidated results of its operations and cash flows
for each of the two years in the period ended December 31, 2005, in
conformity with U.S. generally accepted accounting principles.
STEAKLEY & GILBERT, P.C.
Oklahoma City, Oklahoma
March 24, 2006
<Page F-1>
THE AMERICAN EDUCATION CORPORATION
CONSOLIDATED BALANCE SHEET
December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents $ 977,040
Accounts receivable, net of allowance for
returns and uncollectible accounts of $300,000 (Note 1) 2,314,586
Inventory (Note 1) 21,368
Prepaid expenses and deposits 306,001
Deferred tax asset (Note 6) 125,388
-----------
Total current assets 3,744,383
Property and equipment, at cost (Note 1) 1,295,781
Less accumulated depreciation and amortization (1,134,226)
-----------
Net property and equipment 161,555
Other assets:
Capitalized software costs, net of accumulated
amortization of $8,197,969 (Note 1) 3,896,582
Deferred tax asset (Note 6) 31,857
-----------
Total other assets 3,928,439
-----------
Total assets $ 7,834,377
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable trade $ 288,881
Accrued liabilities (Note 11) 758,124
Deferred revenue 786,230
Notes payable and current portion of
long-term debt (Note 4) 305,880
-----------
Total current liabilities 2,139,115
Other long-term accrued liabilities (Note 10) 752,475
Long term debt (Note 4) 400,000
Deferred income tax liability - Long-term (Note 6) --
-----------
Total liabilities 3,291,590
-----------
Commitments and contingencies (Notes 5, 7, 10 and 12) --
Stockholders' Equity (Note 3)
Preferred Stock $.001 par value;
Authorized-50,000,000 shares, issued and
outstanding-none; liquidation preference-$.02 per share --
Common Stock, $.025 par value;
Authorized 30,000,000 shares; issued and outstanding-
14,133,461 shares 359,186
Additional paid in capital 6,698,817
Treasury stock, at cost, 234,000 shares (319,125)
Retained deficit (2,196,091)
-----------
Total stockholders' equity 4,542,787
-----------
Total liabilities and stockholders' equity $ 7,834,377
===========
See accompanying notes and accountants' report.
<Page F-2>
THE AMERICAN EDUCATION CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2005 and 2004
2005 2004
------------ --------------
Sales $ 9,819,396 $10,186,517
Cost of goods sold 1,137,528 1,398,246
----------- -----------
Gross Profit 8,681,868 8,788,271
----------- -----------
Operating expenses:
Selling and marketing 3,391,767 3,628,550
Operations 580,375 501,401
General and administrative 2,493,389 1,978,757
Impairment of goodwill (Note 1) 1,215,015 --
Amortization of capitalized
software costs 1,611,909 1,413,889
----------- -----------
Total operating expenses 9,292,455 7,522,597
----------- -----------
Operating income (loss) from
continuing operations (610,587) 1,265,674
Other income (expense):
Interest expense (49,933) (61,058)
----------- -----------
Income (loss) from continuing
operations before income taxes (660,520) 1,204,616
Deferred income tax expense
(benefit) (40,024) 493,673
----------- -----------
Income (loss) from continuing
operations (620,496) 710,943
Loss from discontinued operations
(net of tax benefits 2005 -
$134,599; 2004 - $1,016,897)
(Note 15) (229,431) (1,054,203)
----------- -----------
Net loss $ (849,927) $ (343,260)
=========== ===========
Earnings per share: (Note 13)
Basic:
Continuing operations $ (.04) $ .05
Discontinued operations $ (.02) $ (.07)
Net loss $ (.06) $ (.02)
Diluted:
Continuing operations $ (.04) $ .05
Discontinued operations $ (.01) $ (.07)
Net loss $ (.05) $ (.02)
See accompanying notes and accountants' report.
<Page F-3>
THE AMERICAN EDUCATION CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 2005 and 2004
Additional Retained
Common Stock paid in Treasury Earnings
Shares Amount Capital Stock (Deficit)
-------------------- ---------- ---------- ------------
Balance at
December 31, 2003 14,133,461 $359,186 $6,674,130 $(319,125) $(1,002,904)
Net loss (343,260)
Comprehensive Income
adjustment:
Foreign currency
Translation 24,687
---------- -------- ---------- ---------- -----------
Balance at
December 31, 2004 14,133,461 359,186 6,698,817 ( 319,125) (1,346,164)
Net loss (849,927)
---------- -------- ---------- ---------- -----------
Balance at
December 31, 2005 14,133,461 $359,186 $6,698,817 $( 319,125) $(2,196,091)
========== ======== ========== ========== ===========
See accompanying notes and accountants' report.
<Page F-4>
THE AMERICAN EDUCATION CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2005 and 2004
2005 2004
----------- -----------
Cash flows from operating activities:
Net income (loss) $ (849,927) $ (343,260)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization 2,894,175 2,768,465
Increase in reserve for bad debts 50,000 25,000
Deferred compensation 282,000 234,000
Foreign currency translation -- 24,687
Changes in assets and liabilities:
Accounts receivable (218,322) 619,063
Inventories (6,883) 1,966
Prepaid expenses and deposits (104) (131,415)
Accounts payable and accrued liabilities 68,622 (604,125)
Deferred revenue 131,893 44,637
Deferred income taxes (174,624) (501,061)
---------- ----------
Net cash provided by operating
activities 2,176,830 2,137,957
---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (84,460) (53,264)
Software development costs capitalized (1,692,811) (1,372,955)
---------- ----------
Net cash used in investing activities (1,777,271) (1,426,219)
---------- ----------
Cash flows from financing activities:
Proceeds received from issuance of debt 400,000 --
Principal payments on notes payable (371,862) (379,071)
---------- ----------
Net cash used in financing activities 28,138 (379,071)
---------- ----------
Net increase in cash 427,697 332,667
Cash at beginning of year 549,343 216,676
---------- ----------
Cash at end of year $ 977,040 $ 549,343
========== ==========
Interest paid in cash $ 27,716 $ 62,263
========== ==========
Income taxes paid $ -- $ 14,766
========== ==========
See accompanying notes and accountants' report.
<Page F-5>
THE AMERICAN EDUCATION CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
1. Summary of significant accounting policies
------------------------------------------
The summary of significant accounting policies of The American
Education Corporation ("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.
Principles of consolidation
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All material intercompany
accounts and transactions have been eliminated.
History and business activity
The American Education Corporation (formerly Plasmedics, Inc.) was
incorporated under the laws of the State of Colorado on February 23,
1981. Through 1986, the Company's principal purpose was to manufacture
and market medical devices and medical technology. The Company's
activities from inception through 1984 were directed toward raising
equity capital, acquisition of license and patent rights and research
and development. From 1986 through 1990, the Company was essentially
inactive and seeking acquisition or merger candidates.
On January 8, 1991, the Company purchased substantially all of the
assets of American Educational Computer, Inc., and assumed specific
trade accounts payable and other accrued liabilities related to that
business.
On August 15, 1991, Plasmedics, Inc., changed its name to The American
Education Corporation ("AEC"). AEC's principal business is the
development of educational computer software and its distribution to
retail outlets and school districts nationally.
Effective October 1, 1998, the Company purchased the business of
Learning Pathways, Limited, ("LPL"), an entity organized under the laws
of the United Kingdom, pursuant to an Agreement between the Company and
the stockholders of LPL. The transaction was accounted for using
purchase method accounting. The business of LPL principally has been to
distribute the Anywhere Learning System in the United Kingdom.
Effective December 31, 2004 Learning Pathways, Ltd. was deemed to be an
asset held for sale and an impairment loss of $1,150,000 was
recognized. On November 7, 2005 LPL was subsequently sold and therefore
in 2005 the results of operations for this business unit are presented
as discontinued operations. The income statement for the prior year has
been restated to reflect the results as if LPL had been discontinued as
of the beginning of 2004.
During 1999, the Company acquired 100% of the capital stock of Dolphin,
Inc., ("Dolphin") a New Jersey corporation. The acquisition was
accounted for using purchase method accounting. Results of Dolphin's
operations are included in the consolidated income statements for the
two years ended December 31, 2005. Since the acquisition, Dolphin has
provided software design services for unaffiliated customers. Effective
June 30, 2005 the Company determined that the goodwill recorded on the
balance sheet that resulted from the acquisition of Dolphin was
impaired and wrote off the entire amount of $1,215,015. The Company has
ceased Dolphin's software development business for outside customers
and has transferred all remaining Dolphin employees to the Company's
payroll to expand the internal software development staff. On December
31, 2005 Dolphin was merged into the Company and is no longer a
separate corporate entity.
Revenue recognition
The Company recognizes revenue in accordance with the American
Institute of Certified Public Accountant's Statement of Position 97-2
and 98-9 on software revenue recognition. The Company has
<Page F-6>
recognized revenue and a like amount of expense on products traded for
advertising and promotional services. Sales revenue and selling and
marketing expense include approximately $154,875 and $259,145 of such
non-monetary transactions for the years ended December 31, 2005 and
2004, respectively. Revenue for software design services for outside
customers at Dolphin has been recognized on the percentage-of-
completion method.
The Company has 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,"
which became effective July 1, 2003. Revenues from technical service
contracts are deferred and amortized ratably over the period of the
service contract.
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 and costs to defend the
Company's trademark. The Company accounts for software capitalization
under the guidelines of FASB 86. 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. Software development costs of $1,692,811 were
capitalized during 2005. Amortization expense totaled $1,611,909 in
2005 and $1,572,654 in 2004. Capitalized software costs are reviewed
for potential impairment whenever events or circumstances indicate that
carrying amounts may not be recoverable.
Goodwill
Goodwill represents the excess of the cost of purchased companies over
the fair value of their net assets at dates of acquisition. Goodwill
is reviewed for possible impairment at least annually or more
frequently upon the occurrence of an event or when circumstances
indicate that the carrying amount is greater than its fair value.
During 2005, the Company determined that the carrying amount of
Dolphin's goodwill exceeded its fair value, accordingly, a goodwill
impairment loss of $1,215,015 was recognized, reducing goodwill to
zero.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market and consist of packaging and educational software materials.
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,
which is five years. Depreciation expense totaled $67,251 and $131,616
for 2005 and 2004, respectively. The components of property and
equipment at December 31, 2005, are as follows:
Furniture, fixtures and office equipment $ 601,908
Computers and software 651,618
Leasehold improvements 42,255
----------
1,295,781
Less: accumulated depreciation (1,134,226)
----------
Net property and equipment $ 161,555
==========
<Page F-7>
Stock Options
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 will adopt 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.
Pro forma information regarding net income (loss) and earnings (loss)
per share has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma income and earnings/(loss) per share are as follows
for the year ended:
2005 2004
---------- ----------
Net loss - as reported $(849,927) $(343,260)
Stock -based employee compensation
expense - pro forma 75,500 35,467
--------- ---------
Net loss - pro forma $(925,427) $(378,727)
========= =========
Basic earnings/(loss) per common
share-as reported $ (.06) $ (.02)
Diluted earnings/(loss) per common
share as reported (.05) (.02)
Basic earnings/(loss) per common
share - pro forma $ (.07) $ (.02)
Diluted earnings/(loss) per common
share-pro forma (.05) (.02)
Statements of cash flows
In the consolidated 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.
Use of estimates
The preparation of the financial statements in conformity with U.S.
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
2. Options to purchase common stock
--------------------------------
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
<Page F-8>
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 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.
The Company's non-qualified stock option plan originated in 1996. The
following table summarizes stock option plan activity:
(In Shares)
--------------------------
1998 1998
1996 Plan Directors Plan Employee Plan Total
--------- -------------- ------------- ---------
Number of shares under
options outstanding as of:
December 31, 2004 1,362,576 199,998 2,020,001 3,582,575
Shares granted 259,970 -- 641,000 900,970
Shares exercised -- -- -- --
Shares expired (17,000) -- (211,001) ( 228,001)
--------- ------- --------- ---------
December 31, 2005 1,605,546 199,998 2,450,000 4,255,544
========= ======= ========= =========
Option price
range per share $.13 - $.63 $.13 - $.35 $.25 - $.63
In November 2004, the Company extended the expiration date of 595,000
stock options, originally granted in 2002 with an expiration in
February 2005, to December 31, 2008. The original exercise price was
$.25 per share, the market value at date of grant. The exercise price
of the options remains the same, however, since the market value of the
Company's common stock was $.27 per share at the date the modification
of terms was made, the Company has recorded compensation expense of
$11,900.
3. Common and preferred stock
--------------------------
There were no common stock transactions during 2005.
4. Notes Payable and Long-term debt
--------------------------------
The Company had the following indebtedness under notes and loan
agreements:
Current Long-term Total
------- --------- ----------
Lines of credit with bank,
originated April 30,
1999, to December 23,1999,
matures March 31, 2006;
maximum line - $450,000,
interest at the bank's
prime rate plus 2.5%
(9.25% at December 31, 2005),
payable monthly, principal
due at maturity, secured
by accounts receivable and
inventory $ -- $ -- $ --
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
-------- -------- --------
$305,880 $400,000 $705,880
======== ======== ========
Aggregate maturities of notes payable are as follows:
2006 $ 305,880
2007 400,000
---------
$ 705,880
=========
5. Operating leases
----------------
The Company leases office space in Oklahoma City, Oklahoma, under an
agreement renewed December 31, 2005 at $13,109 a month. The agreement
expires December 31, 2008. The Company also leases office space in
Voorhees, New Jersey, for $5,000 a month under a lease agreement
expiring May 31, 2009.
The Company leases automobiles and certain office equipment with lease
payments totaling $11,294 per month. The agreements expire between
June 2006 and May 2009.
Total lease expense was $344,286 for 2005 and $369,238 for 2004.
Future rental commitments under lease agreements are as follows:
2006 $ 334,958
2007 287,151
2008 248,374
2009 32,157
2010 857
<Page F-10>
6. Income taxes
------------
Deferred tax liabilities and assets are recognized 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.
The following is a reconciliation of the statutory federal income tax
rate to the Company's effective income tax rate:
2005 2004
------- -------
Statutory federal income tax rate (34.0%) (34.0%)
State income taxes (6.0%) (6.0%)
Nondeductible expenses 3.7% 1.1%
Write-off of subsidiary stock 4.1% --
Unutilized State NOL carryforward due
to merger 16.9% --
Foreign loss taxed at different rate -- (21.5%)
Other (1.7%) --
------- -------
Effective income tax rate (17.0%) (60.4%)
======= =======
Deferred tax liabilities and assets at December 31, 2005 are comprised
of the following:
Deferred tax liabilities:
Capitalized software $1,558,633
----------
Total deferred tax liabilities 1,558,633
Deferred tax assets:
Receivables allowance 120,000
Net operating loss carryforward 1,279,979
Deferred compensation 306,379
Plant and equipment and related depreciation 9,520
----------
Total deferred tax assets 1,715,878
----------
Net asset $ 157,245
==========
Net deferred tax asset $ 157,245
Net deferred tax liability --
----------
Net asset $ 157,245
==========
A deferred tax asset has been recorded for the tax benefit of the net
operating loss carryforward. No valuation allowance has been recorded
against the deferred tax asset.
The Company has available U.S. net regular tax and alternative minimum
tax operating loss carryforwards of approximately $3,633,420 and
$3,809,829 respectively, expiring between the years 2021 and 2025.
7. Royalty agreements
------------------
Several of the Company's software titles are authored by independent
consultants for which royalty agreements exist. These agreements call
for quarterly payments based upon a percentage of the net sales of
the particular titles. These agreements expire in the years 2006 to
2010. Royalty expense totaled $64,209 and $62,640 in 2005 and 2004,
respectively.
<Page F-11>
8. Related party transactions
--------------------------
The Company is indebted to two major shareholder affiliates for
convertible subordinated debt in the amount of $305,880, which was
advanced in April 2003 with an original maturity of April 2005. The
debt bears interest at 8% and the interest is payable quarterly. In
September 2004, the maturity date of the debt was extended to September
2006. The debt is subordinated to the debt owed the Company's senior
lender and is convertible at any time before maturity into the
Company's common stock at $.40 per share.
9. Significant customers and concentration of credit risk
------------------------------------------------------
Accounts Receivable
- -------------------
The Company sells its products almost exclusively to schools through
various distributors of educational materials.
No individual customer accounted for more than 10% of sales in 2005 or
2004.
The Company reserves for returns and bad debts in the normal course of
its operations. Management believes the allowance is sufficient to
cover any losses from uncollectible trade receivables.
Cash
- ----
The Company maintains its bank accounts with three financial
institutions, Cash deposits in excess of FDIC limits were
approximately $873,000 at December 31, 2005.
10. Commitments and contingencies
-----------------------------
The Company amortizes capitalized software costs over the products
estimated useful life. Due to inherent technological changes in the
software development industry, the period over which such capitalized
software costs are being amortized may have to be accelerated. Software
costs are carried in the accompanying balance sheet net of
amortization.
The Company has employment agreements with its officers which include
salary terms and severance benefits. The agreement also provides that
in the event of a change in control, the officer can require the
Company to purchase up to 50% of the shares of the Company's common
stock owned by the officer. The Company has a deferred retirement
benefit agreement with its executive officers and has accrued $752,475
as of December 31, 2005. Deferred benefit expense was $282,000 in 2005
and $234,000 in 2004, respectively.
11. Accrued liabilities
-------------------
Accrued liabilities are comprised of the following at December 31,
2005:
Accrued interest $ 34,120
Accrued payroll, taxes and benefits 122,572
Accrued commissions and royalties 520,345
Accrued professional fees 31,206
Accrued - other 49,881
--------
$758,124
========
12. Litigation
----------
The Company may be the subject of various legal proceedings that could
arise during the normal course of business. However, 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.
<Page F-12>
13. Earnings per share
------------------
Basic earnings per share are computed by dividing earnings available to
common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflect per
share amounts that would have resulted if dilutive potential common
stock had been converted to common stock.
The weighted average number of basic and diluted common shares
outstanding is as follows:
2005 2004
---------- ----------
Basic 14,133,461 14,133,461
Diluted 17,143,279 15,801,795
Employee stock options are included in the number of diluted common
shares using the treasury stock method.
14. Employee benefit plans
----------------------
The Company adopted a 401(k) Plan effective January 1, 1999. The Plan
allows eligible employees to defer part of their income on a tax-
favored basis into the Plan. The Plan is subject to the provisions of
the Employee Retirement Income Security Act of 1974 (ERISA). The
Company may make contributions to the Plan as a matching percentage or
as a lump sum amount determined annually. There were no matching
contributions in 2005 and 2004.
15. Discontinued operations
-----------------------
Effective December 31, 2004 Learning Pathways, Ltd. was deemed to be an
asset held for sale and an impairment loss of $1,150,000 was
recognized. On November 7, 2005 LPL was subsequently sold and therefore
in 2005 the results of operations for this business unit are presented
as discontinued operations. The income statement for the prior year has
been restated to reflect the results as if LPL had been discontinued as
of the beginning of 2004.
<Page F-13>
Exhibit 10.9
The American Education Corporation
Memorandum of Action by The Board of Directors
January 30, 2004
The undersigned, all being duly elected directors of The American
Education Corporation, do hereby authorize the payment from Jeffrey E.
Butler, Chief Executive Officer of the Corporation 200,000 shares of
common stock as payment, in full, for $300,000 in funds loaned to Mr.
Butler in October 2000. This loan arrangement was discussed and agreed
to in December 1999 and consummated in October of 2000 with repayment
to be made in October 2003. This loan retirement approach with Mr.
Butler repaying the loan from his common stock holdings in the
Corporation was reviewed with the key, control shareholder who concurs
with the Board's action in this matter.
In accordance with the prior understanding reached with the Board in
December 1999, Mr. Butler was to be permitted to repay the loan in
either stock or cash, at his election. If Mr. Butler elected to use
stock as the medium of repayment, its value was to set at the higher of
market at the time of the initial loan commitment, or that of a
subsequent, independent valuation of the worth of the business based on
industry comparable valuations. Berkery Noyes and Company conducted
such an independent study in early 2003 as part of a process of helping
the Board to understand the value of the business, vis-a-vis current
public market valuations afforded to the Company.
In making this decision, the Board, since October of 2003, has studied
this matter and reviewed several alternatives for Mr. Butler to effect
repayment. In this deliberation, the Board took into the consideration
of the interests of the Corporation and those of Mr. Butler. This
study process included complex taxation issues, the Corporation's
ability currently to provide for bonus compensation to offset the loan
amount and the impact of potentially significant bonus payment on
earnings performance of the Corporation and its financial position as
well as the Corporation's valuation. Further, the consent of the major
control shareholder was secured in the final disposition of this
matter.
Approved this 30th day of January 2004.
Abstain
- -------------------------------------
Jeffrey E. Butler
Director and Chief Executive Officer
/s/ Newton Fink
- -------------------------------------
Newton Fink
Director
/s/ Monty McCurry
- -------------------------------------
Monty McCurry
Director
/s/ Steve Prust
- -------------------------------------
Steve Prust
Director
Exhibit 11
Statement re: computation of per share earnings
Basic earnings per share are computed by dividing earnings available to
common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflect per
share amounts that would have resulted if dilutive potential common
stock had been converted to common stock.
The weighted average number of basic and diluted common shares
outstanding is as follows:
2005 2004
---------- ----------
Basic 14,133,461 14,133,461
Diluted 17,143,279 15,801,795
Employee stock options are included in the number of diluted common
shares using the treasury stock method.
<Page F-14>
Exhibit 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration
Statement (Form S-8) filed October 22, 1999, pertaining to The American
Education Corporation Stock Option Plan for Employees and The American
Education Corporation Directors' Stock Option Plans of our report dated
March 24, 2006, with respect to the consolidated financial statement of
The American Education Corporation included in its Annual Report (Form
10-KSB) for the year ended December 31, 2005, filed with the Securities
and Exchange Commission.
Steakley & Gilbert, P.C.
March 31, 2006
Oklahoma City, Oklahoma
<Page F-15>
Exhibit 31.1
CERTIFICATIONS
- --------------
I, Jeffrey E. Butler, certify that:
1. I have reviewed this annual report on Form 10-KSB of The American
Education Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based upon such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls over financial reporting.
Date: March 31, 2006
/s/ Jeffrey E. Butler
- ----------------------
Signature
Title: Chief Executive Officer
<Page F-16>
Exhibit 31.2
CERTIFICATIONS
- --------------
I, Neil R. Johnson, certify that:
1. I have reviewed this annual report on Form 10-KSB of The American
Education Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based upon such
evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls over financial reporting.
Date: March 31, 2006
/s/ Neil R. Johnson
- --------------------
Signature
Title: Chief Financial Officer
<Page F-17)
Exhibit 32.1
THE AMERICAN EDUCATION CORPORATION
CERTIFICATION BY CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-KSB of The American
Education Corporation (the "Company") for the year ended December 31, 2005
as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), I, Jeffrey E. Butler, Chief Executive Officer of the
Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my
knowledge:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of the operations
of the Company.
By: /s/ Jeffrey E. Butler
---------------------
Jeffrey E. Butler
Chief Executive Officer
<Page F-18>
Exhibit 32.2
THE AMERICAN EDUCATION CORPORATION
CERTIFICATION BY CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-KSB of The American
Education Corporation (the "Company") for the year ended December 31, 2005
as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), I, Neil R. Johnson, Chief Financial Officer of the Company,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my
knowledge:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of the operations
of the Company.
By: /s/ Neil R. Johnson
-------------------
Neil R. Johnson
Chief Financial Officer
<Page F-19>