FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
For the Transition Period from ________ to ________
Commission File #0-11078
THE AMERICAN EDUCATION CORPORATION
(Exact name of small business issuer as specified in its charter)
Nevada 73-1621446
------ ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
7506 North Broadway Extension, Suite 505, Oklahoma City, OK 73116
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(Address of principal executive offices)
(405) 840-6031
--------------
(Issuer's telephone number)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.025 per share
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports,
and (2) has been subject to such filing requirements for the past 90 days.
YES X NO__
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). YES__ NO X
Number of shares of the issuer's common stock outstanding as of August 10,
2006: 14,133,461
Transitional Small Business Disclosure Format YES NO X
<Page>
THE AMERICAN EDUCATION CORPORATION
INDEX
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Page No.
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PART I - FINANCIAL INFORMATION
Item 1 Balance Sheets
June 30, 2006 and December 31, 2005 3
Statements of Income
For the Three Months Ended June 30, 2006
and for the Three Months Ended June 30, 2005 4
For the Six Months Ended June 30, 2006
and for the Six Months Ended June 30, 2005 5
Statements of Cash Flows
For the Six Months Ended June 30, 2006
and for the Six Months Ended June 30, 2005 6
Notes to Interim Financial
Statements 7
Item 2 Management's Discussion and Analysis
Of Financial Condition and Results of
Operations 10
Item 3 Controls and Procedures 13
PART II - OTHER INFORMATION 14
SIGNATURE PAGES 16
<Page> 2
PART I - FINANCIAL INFORMATION
ITEM 1 - BALANCE SHEETS
THE AMERICAN EDUCATION CORPORATION
BALANCE SHEETS
June 30 December 31
2006 2005
------------ -----------
(unaudited) (audited)
ASSETS
Current assets:
Cash and cash equivalents $ 793,503 $ 977,040
Accounts receivable, net of allowance
for returns and uncollectible accounts
of $300,000 and $300,000 3,370,129 2,314,586
Inventory 18,808 21,368
Prepaid expenses and deposits 199,605 306,001
Deferred tax asset 125,388 125,388
----------- -----------
Total current assets 4,507,433 3,744,383
Property and equipment, at cost 1,362,157 1,295,781
Less accumulated depreciation and
amortization (1,167,667) (1,134,226)
----------- -----------
Net property and equipment 194,490 161,555
Other assets:
Capitalized software costs, net of
accumulated amortization of
$8,986,171 and $8,197,969 4,020,105 3,896,582
Deferred tax asset -- 31,857
----------- -----------
Total other assets 4,020,105 3,928,439
----------- -----------
Total assets $ 8,722,028 $ 7,834,377
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable trade $ 159,107 $ 288,881
Accrued liabilities 1,184,504 758,124
Deferred revenue 593,525 786,230
Notes payable and current portion of
long-term debt 851,657 305,880
----------- -----------
Total current liabilities 2,788,793 2,139,115
Other long-term accrued liabilities 888,975 752,475
Deferred income Tax 181,475 -
Long-term debt - 400,000
----------- -----------
Total liabilities 3,859,243 3,291,590
----------- -----------
Commitments and contingencies - -
Stockholders' Equity:
Preferred Stock, $.001 par value;
Authorized - 50,000,000 shares-issued
and outstanding-none - -
Common Stock, $.025 par value
Authorized 30,000,000 shares
Issued and outstanding -
14,133,461 shares 359,186 359,186
Additional paid in capital 6,698,817 6,698,817
Treasury stock, at cost, 234,000 shares (319,125) (319,125)
Retained deficit (2,196,091) (2,196,091)
Year-to-date earnings 319,998 -
----------- -----------
Total stockholders' equity 4,862,785 4,542,787
----------- -----------
Total liabilities and
stockholders' equity $ 8,722,028 $ 7,834,377
=========== ===========
The accompanying notes are an integral part of the financial statements.
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THE AMERICAN EDUCATION CORPORATION
STATEMENTS OF INCOME
THREE MONTHS ENDED JUNE 30, 2006 AND 2005
(unaudited)
2006 2005
----------- -----------
Sales $ 3,186,623 $ 3,158,524
Cost of goods sold 119,988 285,719
----------- -----------
Gross profit 3,066,635 2,872,805
Operating expenses:
Selling and marketing 1,143,965 1,039,485
Operations 188,347 126,987
General and administrative 639,482 705,652
Impairment of goodwill (Note 15) -- 1,215,015
Amortization of capitalized software costs 403,219 390,592
----------- -----------
Total operating expenses 2,375,013 3,477,731
----------- -----------
Operating income (loss) from continuing
operations 691,622 (604,926)
Other income (expense):
Interest income (expense), net (Note 16) 61,074 (18,039)
----------- -----------
Income (loss) from continuing operations
before income taxes 752,696 (622,965)
Deferred income tax expense (benefit) 301,079 (204,925)
----------- -----------
Income (loss) from continuing operations 451,617 (418,040)
Loss from discontinued operations (net of tax
benefits of $27,245 in 2005 ) (Note 14) -- (68,401)
----------- -----------
Net Income (loss) $ 451,617 $ (486,441)
=========== ===========
Earnings per share:
Basic:
Continuing operations $ .032 $ (.030)
Discontinued operations $ -- $ (.004)
Net income (loss) $ .032 $ (.034)
Diluted:
Continuing operations $ .026 $ (.025)
Discontinued operations $ -- $ (.004)
Net income (loss) $ .026 $ (.029)
Weighted average common shares outstanding:
Basic 14,133,461 14,133,461
Diluted 17,138,395 16,596,726
The accompanying notes are an integral part of the financial statements.
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THE AMERICAN EDUCATION CORPORATION
STATEMENTS OF INCOME
SIX MONTHS ENDED June 30, 2006 AND 2005
(unaudited)
2006 2005
----------- -----------
Sales $ 5,044,823 $ 5,498,131
Cost of goods sold 215,088 627,568
----------- -----------
Gross profit 4,829,735 4,870,563
Operating expenses:
Selling and marketing 1,883,302 1,773,005
Operations 408,670 285,458
General and administrative 1,268,302 1,231,133
Impairment of goodwill (Note15) -- 1,215,015
Amortization of capitalized software costs 788,202 763,300
----------- -----------
Total operating expenses 4,348,476 5,267,911
----------- -----------
Operating income (loss) from continuing
operations 481,259 (397,348)
Other income (expense):
Interest income (expense), net (Note 16) 52,072 (28,569)
----------- -----------
Income (loss) from continuing operations
before income taxes 533,331 (425,917)
Deferred income tax expense (benefit) 213,333 (126,106)
----------- -----------
Income (loss) from continuing operations 319,998 (299,811)
Loss from discontinued operations (net of tax
benefits of $62,407 in 2005) (Note 14) -- (121,143)
----------- -----------
Net Income (loss) $ 319,998 $ (420,954)
=========== ===========
Earnings per share:
Basic:
Continuing operations $ .023 $ (.022)
Discontinued operations $ -- $ (.008)
Net income (loss) $ .023 $ (.030)
Diluted:
Continuing operations $ .019 $ (.018)
Discontinued operations $ -- $ (.007)
Net income (loss) $ .019 $ (.025)
Weighted average common shares outstanding:
Basic 14,133,461 14,133,461
Diluted 17,138,395 16,596,726
The accompanying notes are an integral part of the financial statements.
<Page> 5
THE AMERICAN EDUCATION CORPORATION
STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(unaudited)
2006 2005
----------- -----------
Cash flows from operating activities:
Net income (loss) $ 319,998 $ (420,954)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization 821,643 2,015,771
Reserve for bad debts -- 50,000
Deferred compensation 136,500 141,000
Changes in assets and liabilities:
Accounts receivable (1,055,543) (1,079,396)
Inventories 2,560 (6,269)
Prepaid expenses and other 106,396 (35,079)
Accounts payable and accrued liabilities 296,606 50,978
Deferred revenue (192,705) (7,486)
Deferred income taxes 213,332 (188,513)
----------- -----------
Net cash provided by operating activities 648,787 520,052
----------- -----------
Cash flow from investing activities:
Software development costs capitalized (911,725) (733,884)
Purchase of property and equipment (66,376) (36,284)
----------- -----------
Net cash used in investing activities (978,101) (770,168)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of debt 145,777 400,000
Principal payments on notes payable -- (165,188)
----------- -----------
Net cash provided by financing activities 145,777 234,812
----------- -----------
Net increase (decrease) in cash (183,537) (15,304)
Cash at beginning of the period 977,040 549,343
----------- -----------
Cash at end of the period $ 793,503 $ 534,039
=========== ===========
The accompanying notes are an integral part of the financial statements.
<Page> 6
THE AMERICAN EDUCATION CORPORATION
Part I
NOTES TO INTERIM FINANCIAL STATEMENTS
FOR THE PERIODS ENDED JUNE 30, 2006 AND 2005
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- -----------------------------------------------------------------
1. Description of Business:
-----------------------
The American Education Corporation's ("the Company") business is the
development and marketing of educational software to elementary, middle and
secondary schools, adult literacy centers and vocational, junior and
community colleges.
2. Basis of Presentation:
---------------------
The summary of significant accounting policies of the Company is presented to
assist in understanding the Company's financial statements. These accounting
policies conform to generally accepted accounting principles and have been
consistently applied in the preparation of the financial statements.
In November and December 2005, all of the Company's subsidiaries were either
sold or merged into the Company. Therefore, for 2006 the financial statements
include only The American Education Corporation. For 2005 the Company's
financial statements include the Company and its wholly owned subsidiaries,
Dolphin, Inc. and Learning Pathways, Ltd. All material intercompany
transactions were eliminated.
The interim financial statements at June 30, 2006, and for the three and six-
month periods ended June 30, 2006 and 2005 are unaudited, but include all
adjustments that the Company considers necessary for a fair presentation.
The December 31, 2005 balance sheet was derived from the Company's audited
financial statements.
The accompanying unaudited financial statements are for the interim periods
and do not include all disclosures normally provided in annual financial
statements. They should be read in conjunction with the Company's audited
financial statements included in the Company's Form 10-KSB for the year ended
December 31, 2005. The accompanying unaudited interim financial statements
for the three and six-month periods ending June 30, 2006 are not necessarily
indicative of the results that can be expected for the entire year.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported revenues and expenses during the reporting
period. Actual results could differ from those estimates.
3. Revenue Recognition:
-------------------
The Company recognizes revenue in accordance with the American Institute of
Certified Public Accountant's Statement of Position 97-2, 98-9 and
modifications thereto on software revenue recognition. The Company has also
adopted revenue recognition policies regarding sales with multiple
deliverables, which comply with Emerging Issues Task Force Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables" that became effective
July 1, 2003.
<Page> 7
4. Capitalized Software Costs:
--------------------------
Capitalized software costs consist of licenses for the rights to produce and
market computer software, salaries and other direct costs incurred in the
production of computer software. Costs incurred in conjunction with product
development are charged to research and development expense until
technological feasibility is established. Thereafter, all software
development costs are capitalized and amortized on a straight-line basis over
the product's estimated economic life of between three and five years.
5. Inventories:
-----------
Inventories are stated at the lower of cost (first-in, first-out), or market,
and consist of packaging and educational software materials.
6. Property and Equipment:
----------------------
Property and equipment is stated at cost. Depreciation is provided on the
straight-line basis over the estimated useful life of the assets, usually
three to five years.
8. Debt:
----
The Company had the following indebtedness under notes and loan agreements:
Current Long-term Total
--------- --------- --------
Line of credit with bank, matures
October 30, 2006; maximum line -
$550,000, interest at the bank's prime
rate plus 1% (9.25% at June 30, 2006) $ 120,000 -- $120,000
Equipment line of credit with bank;
maximum line - $50,000, interest at the
bank's prime rate plus 1.5% payable
monthly (9.75% at June 30, 2006) until
February 21, 2007 at which time the
outstanding balance will become a three
year term loan with principal and
interest payable monthly 25,777 25,777
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
--------- --------- --------
$ 851,657 $ -- $851,657
========= ========= ========
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9. Stock Options:
-------------
The shareholders approved an Incentive Stock Option Plan for employees during
1998 and approved amendments to the plan in 1999, 2000 and 2001 to increase
the number of shares available. The total shares issuable under this plan
are 2,650,000. The Committee of this Plan determines the employees who will
receive options to purchase common shares and the number granted. Option
prices will be the fair market value at date of grant. Options are
exercisable as deemed by the Committee and terminate within ninety days of
employment termination, or as designated by the Committee. In no event shall
an option be exercisable more than ten years from the date it is granted.
No options may be issued under this Plan after March 31, 2008.
The shareholders also approved a Director's Stock Option Plan during 1998 and
approved an amendment to the Plan in 2001 to increase the number of shares
available. The total shares issuable under this Plan are 200,000. Each
outside director initially elected or appointed is 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 will automatically be granted
an option to purchase 3,000 shares of common stock as of January 1 of each
succeeding calendar year, if options are available, through termination of
the Plan on March 31, 2008. Options granted are exercisable immediately and
for a period of three years after the date of the grant or, if earlier,
ninety days after the date when the participant ceases to be a director of
the Company. Additionally, the Company has a non-qualified stock option plan
that originated in 1996.
The Company has historically measured compensation from issuing employee
stock options under the accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees" which is an intrinsic value
method. Through December 31, 2005 the compensation cost for stock options
has been measured as the excess, if any, of the quoted market price of
Company stock at the date of the grant over the amount the employee must pay
to acquire the stock. No compensation has been incurred unless the market
value was greater than the option exercise price.
Effective January 1, 2006 the Company adopted accounting pronouncement FAS
123 (R) Share Based Payments, which establishes standards for the accounting
for transactions in which an entity exchanges its equity instruments for
goods or services. FAS 123 (R) also addresses transactions in which an
entity incurs liabilities in exchange for goods or services that are based on
the fair value of the entity's equity instruments or that may be settled by
the issuance of those equity instruments. This Statement focuses primarily
on accounting for transactions in which an entity obtains employee services
in share-based payment transactions.
There were no options granted or exercised during the three months or six
months ended June 30, 2006. All existing options were fully vested as of the
beginning of the period. Therefore, there is no compensation expense
recognized during the period. Additionally, there was no share-based
compensation expense related to employee stock options recognized during the
three and six months ended June 30, 2005. Prior to January 1, 2006, the
Company accounted for its share-based compensation under the recognition and
measurement principles of APB 25 and related interpretations and the
disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." In accordance with APB 25, no share-based compensation cost
was reflected in the Company's net income for grants of stock options to
employees because the Company granted stock options with an exercise price
equal to the market value of the stock on the date of grant. Had the Company
used the fair value based accounting method for share-based compensation
expense prescribed by SFAS No. 123 for the three and six month periods ended
June 30, 2005, the Company's consolidated net income and net income per share
would have been decreased to the pro-forma amounts illustrated as follows:
<Page> 9
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
------------- -------------
Net income - as reported ($486,441) ($420,954)
Stock - based employee compensation
expense - pro forma 11,825 23,650
--------- ---------
Net income - pro forma (498,266) (444,604)
Basic earnings per common share -
as reported ($.03) ($.03)
Diluted earnings per common share -
as reported (.03) (.02)
Basic earnings per common share -
pro forma ($.04) ($.03)
Diluted earnings per common share -
pro forma (.03) (.03)
A summary of the activity under the Company's stock option plans for the six
month period ended June 30, 2006 is presented below:
Weighted
Average
Weighted Remaining
Average Contractual Aggregate
Exercise Term Intrinsic
Shares Price (Years) Value
--------- -------- ----------- ---------
Options outstanding
at December 31, 2005 4,255,544
$0.38
Granted -
Exercised -
Expired (13,500) 0.33
---------
Options outstanding at
June 30, 2006 4,242,044 $0.38 1.35 $715,677
=========
Options exercisable at
June 30, 2006 4,242,044 $0.38 1.35 $715,677
=========
10. 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. The carrying
values of the Company's assets and liabilities approximate fair value due to
their short-term nature.
11. Income Taxes:
------------
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial
statements or tax returns, determined by using the enacted tax rates in
effect for the year in which the differences are expected to reverse.
<Page> 10
12. Computation of Earnings Per Share:
---------------------------------
The Company has adopted Statement of Financial Accounting Standards No. 128
"Earnings Per Share" (SFAS 128). SFAS 128 requires presentation of basic and
diluted earnings per share. Basic earnings per share are calculated based
only upon the weighted average number of common shares outstanding during the
period. Diluted earnings per share are calculated based upon the weighted
average number of common and, where dilutive, potential common shares
outstanding during the period, utilizing the treasury stock method.
Potential common shares include conversions of convertible debt and options
to purchase common stock.
The weighted average number of basic and diluted common shares outstanding is
as follows:
2006 2005
---------- ----------
Basic 14,133,461 14,133,461
Diluted 17,138,395 16,596,726
13. Commitments and Contingencies:
-----------------------------
The Company amortizes capitalized software costs over the product's estimated
useful life. Due to inherent technological changes in the software
development industry, the period over which such capitalized software cost is
being amortized may have to be accelerated.
14. Discontinued Operations:
-----------------------
Effective December 31, 2004 Learning Pathways, Ltd. was deemed to be an asset
held for sale and was subsequently sold in November 2005. Therefore its
results in 2005 are presented as discontinued operations.
15. Impairment of Goodwill:
----------------------
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.
16. Related Party Transaction:
-------------------------
During the three months ended June 30, 2006 the Company recorded as
compensation expense and interest income the interest due on a note from the
Company's Chief Executive Officer, Jeffrey E. Butler in the amount of
$72,000, representing interest on a $300,000 loan that he repaid in 2003. The
amount, approved by the Company's board of directors, was treated as a bonus
granted for the successful completion of the elimination of the Company's
subsidiaries and their related cost to the Company.
<Page> 11
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------
Overview
- --------
The American Education Corporation is a developer of instructional content,
computer adaptive assessment testing software, and software management
technology specifically designed to manage the delivery of and record the
results of student progress in schools and other institutions. Java-based
technology, the A+nyWhere Learning System, registered, ("A+LS") Versions 3.0
and 4.0 of educational software products, provides a research-based,
integrated curriculum offering of software for grade levels 1-12 for Reading,
Mathematics, Language Arts, Science, Writing, History, Government, Economics
and Geography. In addition, the Company provides formative assessment
testing and formative instructional content for various segments of the
primary, secondary and post secondary educational markets. All company
products are designed to provide for LAN, WAN and Internet delivery options.
The Company has developed computer adaptive, formative assessment testing
tools to provide educators with the resources to more effectively use the
Company's curriculum content, which is aligned to important state and
national academic standards. Spanish-language versions are available for
Mathematics and Language Arts for grade levels 1-8.
The A+LS comprehensive family of educational software is now in use in over
12,100 schools, centers of adult literacy, colleges and universities, and
correctional institutions in the U.S., UK and other international locations.
A+dvancer, trademark, Online, the Company's postsecondary offering,
identifies basic skill deficiencies and provides remedial coursework helping
students to attain college entry-level academic skills in Mathematics,
Elementary Algebra, Reading Comprehension, and Sentence Skills. A+dvancer
reduces demand on institutional admissions and developmental departments,
while providing students with both improved skills assessment and the
alignment to developmental and remedial coursework in an online, self-paced
learning environment.
The Company is a technology-based publishing enterprise. To remain
competitive it must constantly invest in the development of programming
technology to keep its product offering up-to-date and ensure that its
products maintain compatibility with constantly changing and revised database
and operating system platforms sold to schools by other developers. The
Company must also update its content and underwrite content revisions to
realign its content with new, or updated state and national educational
standards to remain competitive. During the six months ended June 30, 2006
the Company spent approximately $912,000 in these efforts, an increase of 24%
over the first six months of 2005. The Company expects this rate of increase
over the prior year will approximate 20% for the full year. To accomplish
this essential, ongoing corporate function requires retention and recruitment
of a highly skilled professional workforce. These investments are essential,
recurring costs of doing business that impact the Company's operating cost
and margin structures.
The Company's business is subject to risks or uncertainties. Among these
uncertainties are a dependency on funding for school technology purchases,
lengthy sales cycles, seasonal demand cycles and a dependency on retention of
key personnel. Certain matters discussed herein (including the documents
incorporated herein by reference) may contain forward-looking statements
intended to qualify for the safe harbors from liabilities established by the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements can generally be identified as such because the context of the
statement will include words such as the Company "believes," "plans,"
"intends," "anticipates," "expects," or words of similar import. Similarly,
statements that describe the Company's future plans, objectives, estimates,
or goals are also forward-looking statements. Such statements address future
events and conditions concerning capital expenditures, earnings, litigation,
liquidity, capital resources and accounting matters. Actual results in each
case could differ materially from those currently anticipated in such
statements as a result of factors such as future economic conditions, changes
in customer demands, future legislative, regulatory and competitive
developments in markets in which the Company operates and other circumstances
affecting anticipated revenues and costs. Accordingly, investors should be
alert to the possibility that factors beyond the control of management may
have impact on the short or long-term operations of the business. The
<Page> 12
Company undertakes no duty to update forward-looking statements to reflect
the impact of events or circumstances that arise after the date the forward-
looking statement was made.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2006
AS COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2005
- --------------------------------------------------------
The Company's UK subsidiary, Learning Pathways, was sold in November 2005 and
therefore its operations are shown as discontinued. As a result, the
comparisons discussed here and for the six months ended June 30, 2006 below
are only for the Company and its Dolphin, Inc. subsidiary, which was merged
into the Company on December 31, 2005. Net sales for the three months ended
June 30, 2006 totaled $3,186,623 compared to $3,158,524 for the same period
in 2005. This represents an increase of 1% over the comparable 2005 quarter
and is attributable to two primary factors. Revenues in the Company's core
business increased by approximately $254,000 or 9% compared to the second
quarter of 2005. This result is primarily attributable to increased spending
in the Southern Gulf region which dropped precipitously after the hurricanes
devastated the area in 2005. Offsetting this increase, in 2005 the Company
announced that its Dolphin subsidiary would be integrated into the Company's
development effort and would no longer participate in the contract software
development business. Therefore, in 2006 there was no revenue from this
source compared to approximately $226,000 in 2005. Orders in the second
quarter were bolstered by approximately $193,000 in sales that we previously
noted were delayed from the first quarter.
Cost of goods sold decreased 58% from $285,719 in 2005 to $119,988 for the
three months ending June 30, 2006 because of the elimination of contract
development sales and the related cost of sales at Dolphin. The Company's
principal product family, A+nyWhere Learning System(r), provided gross profit
margins of 96% in the second quarter of 2006, consistent with prior quarters.
The Company expects that its gross profit margins for its principle product
families should remain at this level for the remainder of 2006. Cost of goods
sold represents the actual cost to produce the software products and includes
certain allocated overhead costs.
Total operating expenses recorded for the three months ended June 30, 2006
were $2,375,013 or 75% of sales, compared to $2,262,716 (excluding the
impairment of goodwill write-down) or 72% of sales, for the same 2005
quarter. The increase in total operating expenses is comprised of an
increase in marketing and selling expenditures, an increase in operations
expenses, a decrease in general and administrative expenses and an increase
in amortization of product development charges for the period. Selling and
marketing expenses increased by 10% from $1,039,485 in 2005 to $1,143,965 for
2006. There are several reasons for this increase. Sales commissions
increased by approximately $18,000 and is primarily the result of changes in
sales mix, as the Company billed a higher percentage of orders directly to
school customers. The Company recognizes sales revenue based upon the type of
customer. If the sale is made to a distributor who in turn resells a product
to the end user, the amount of the sale is recorded, no commission is due the
distributor and the transaction is recorded as a net sale. If the sale is
billed direct to the school or other end user, a commission is paid to the
distributor or a sales representative, which increases the amount of the
sale, but a transaction of this nature would directly increase marketing
expense as a result of an obligation to pay a commission. Commission
percentages vary depending up the type of sale and the status of the
individual or organization making the sale. The decision to sell and to bill
direct to the customer and pay a subsequent commission can result from a
number of factors, including credit policy issues with individual
distributors as a result of payment history or limitations on authorized
limits. Additionally, method of 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. Additionally, there was
approximately a $53,000 increase in the cost of free titles given away as
sales promotions during the period and an increase in services of
approximately $33,000 resulting from the addition of several sales
consultants to increase coverage of our distribution in various parts of the
country. The Company expects selling and marketing expenses to increase by
approximately 10% over the full year.
<Page> 13
Operations expense increased by 48% from $126,987 to $188,347 primarily as a
result of increased compensation and benefits due to additional technical
support staff hired compared to the same period last year. The Company
expects its operations costs to increase approximately 20% over the full year
in 2006. General and administrative expenses decreased by 9% from $705,652 to
$639,482 from a range of cost elements which, on a cumulative basis
contributed to lower total expense. Compensation expense increased by
$72,000 as a result of interest owed on a note from the Company's Chief
Executive Officer that was repaid in 2003. This amount, approved by the board
of directors, was treated as a bonus granted for the successful completion of
the elimination of the Company's subsidiaries and their related costs and
impact on the business. Other material elements were: 1.) Royalty expense
decreased $36,000 over the prior year as a result of the termination of one
of the Company's royalty agreements; 2.) Bad debt expense decreased by
$50,000 because of an absence of specific write-offs that were not necessary
in 2006 as compared to fiscal 2005; 3.) Consulting services were approximately
$24,000 lower in 2006 resulting from the completion of payment of consulting
fees necessary to integrate Learning Letter Sounds, an emergent reading
product line acquired in late 2005. The remainder of the decrease resulted
from the cumulative effect of lower expense levels in a number of general and
administrative cost areas.
Costs incurred in conjunction with product development are charged to
research and development expense until technological feasibility is
established. During the second quarter of 2006, the Company capitalized
$499,247 of product development costs, and net of accumulated amortization
had capitalized software costs of $4,020,105 at June 30, 2006. Amortization
of product development costs was $403,219 for the three months ended June 30,
2006, a 3% increase over the $390,592 amortized in the second quarter of
2005. It is anticipated that these costs will increase by 5% over the full
year. Over the past year, 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.
There was net interest income of $61,074 for the three months ended June 30,
2006 compared to net interest expense of $18,039 for the same 2005 quarter
reflecting the reduction in average daily bank debt levels in 2006 compared
to the prior year offset by higher interest rates and the recognition of
interest income from the Company's Chief Executive Officer discussed above.
The Company had net income of $451,617 for the three months ended June 30,
2006 compared to a net loss of $(486,441) for the same period in 2005, which
was largely a result of the $1,215,015 impairment write-off last year of the
Dolphin subsidiary goodwill.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2006
AS COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2005
- ------------------------------------------------------
Net sales for the six months ended June 30, 2006, totaled $5,044,823 compared
to $5,498,131 for the same period in 2005. This represents a decrease of 8%
over the comparable 2005 period. This decrease is attributable to a decrease
of 1% in sales in the Company's core business resulting from a slow first
quarter still suffering from the effects of last years hurricanes in the
Southern Gulf region and a decrease in sales due to the cessation of outside
programming services and integration of Dolphin into the Company's
development effort that resulted in no Dolphin sales in 2006 compared to
$406,128 in 2005. This decrease was partially offset by improved results in
the second quarter as the Company began to see a return to educational
spending in that region.
Cost of goods sold decreased 66% from $627,568 in 2005 to $215,088 for the
six months ending June 30, 2006 because of the elimination of contract
development sales and the related cost of sales at Dolphin. The Company's
principal product family, A+nyWhere Learning System(r), provided gross profit
margins of 96% for the first six months of 2006.
Total operating expenses for the six months ended June 30, 2006 increased to
$4,348,476 compared to $4,052,896 for the same 2005 period (excluding the
impairment of goodwill write-down), an increase of 7%. As a percentage of
sales revenue, operating expenses increased from 74% in 2005 to 86% in 2006.
The increase in total operating expenses is primarily comprised of planned
increases in marketing and
<Page> 14
selling expenditures, operations expenses, general and administrative
expenses and amortization of product development charges for the period.
Selling and marketing expenses increased by 6% from $1,773,005 in 2005 to
$1,883,302 for 2006. There are several offsetting changes within this expense
category. Sales commissions increased by approximately $61,000 and is
primarily the result of changes in sales mix, as the Company billed a higher
percentage of orders directly to school customers. See the discussion of the
Company's three-month results above, for a discussion of the Company's sales
revenue recognition practices. There was also an increase in services of
approximately $45,000 resulting from the addition of several sales
consultants to increase coverage of our distribution in various parts of the
country. Operations expense increased by 43% from $285,458 to $408,670 as a
result of increased compensation and benefits due to additional technical
support staff hired compared to the same period last year. General and
administrative expenses increased by 3% from $1,231,133 to $1,268,302 for
several different reasons. Salaries and wages costs increased as a result of
higher employment and compensation costs noted in the three-month discussion
above. Additionally, audit and legal fees increased approximately $40,000 as
a result of required additional legal costs experienced during 2006 primarily
from the legal costs of the Company's proposed privatization transaction and
the legal fees associated with the pursuit of several trademark infringement
actions initiated by the Company. Management believes that these costs will
decline in the last two quarters of 2006 after the Company completes its
"going private" transaction and deregisters its securities with the SEC. The
Company has received clearance from the SEC for its disclosure document that
will be sent to the Company's shareholders in connection with the Company's
"going private" transaction. The Company anticipates that it will complete
the "going private" transaction in the third quarter of 2006. Consulting
services decreased by approximately $21,000 resulting from the end of the
consulting payments made to integrate Learning Letter Sounds product line
into the Company's software delivery and management engines. Bad debt expense
decreased by $50,000 as a result of imposition of new credit policies
designed to control this exposure. During the six months ended June 30,
2006, the Company capitalized $911,725 of product development costs, while
the amortization of product development costs was $788,202 for the same
period, a 3% increase over the $763,300 amortized in the first six months of
2005.
There was net interest income of $52,072 for the six months ended June 30,
2006 compared to net interest expense of $28,569 for the same 2005 quarter
reflecting the reduction in average daily bank debt levels in 2006 compared
to the prior year offset by higher interest rates and the recognition of
interest income from the Company's Chief Executive Officer discussed above.
The Company had net income of $319,998 for the six months ended June 30, 2006
compared to a net loss of $(420,954) for the same period in 2005, resulting
primarily from the impairment write-off last year of the Dolphin subsidiary
goodwill.
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 June 30, 2006 the Company's principal sources of liquidity included
cash and cash equivalents of $793,503, net accounts receivable of $3,370,129
and inventory of $18,808. The Company's net cash provided by operating
activities during the six months ended June 30, 2006 was $648,787 compared to
$520,052 for the same period in 2005. Net cash used in investing activities
for the six months ended June 30 increased by 27% from $770,168 in 2005 to
$978,101 in 2006, and was comprised primarily of investment in capitalized
software development costs. At June 30, 2006, the Company had working capital
of $1,718,640 compared to $1,605,268 at December 31, 2005. The increase in
working capital was primarily due to an increase in accounts receivable of
approximately $1,056,000 offset by the change of $400,000 in subordinated
debt from a long-term to a current liability during the six month period and
an increase of approximately $426,000 in accrued liabilities resulting from
an increase in accrued commissions.. The Company has a $550,000 revolving
line of credit that bears interest at a rate of 1.00% over the prime rate
(9.25% as of June 30, 2006) and matures on October 30, 2006. At June 30,
2006,
<Page> 15
there were borrowings totaling $120,000 under this line of credit.
Additionally, the Company has a $50,000 equipment credit line that bears
interest at 1.5% over the prime rate (9.75% as of June 30, 2006) that will
be converted into a three-year term loan on February 21, 2007. As of June 30,
2006, $25,777 was borrowed under the equipment line of credit.
In April 2003, the Company borrowed $305,880 from major shareholder
affiliates, which is subordinated to the debt owed to the Company's senior
lender. This debt matures in September of 2006 and is convertible into the
Company's common stock at $.40 per share. On March 30, 2005, the Company
entered into a Convertible Note Purchase Agreement with an unaffiliated
individual. Pursuant to the terms of the Convertible Note Purchase
Agreement, the Company issued the note purchaser an unsecured 8%
Subordinated Convertible Note in the original aggregate principal amount of
$400,000 (the "Note"). All principal and interest on the Note is due and
payable on March 30, 2007. The Note is convertible at any time at the note
purchaser's option into shares of the Company's common stock at the initial
conversion price of $0.463 per share, subject to certain anti-dilution
adjustments. Any shares of common stock issued upon conversion of the Note
will have "piggy-back" registration rights. The proceeds from the
subordinated convertible debt were used to reduce accounts payable, bank debt
and to support the normal operations of the business.
There are no material operating covenants in either of the subordinated debt
agreements nor in the bank loan agreements. The Company does not believe
that there are any covenants that affect the way the business is operated or
that would require material financial obligations.
With the continued expansion of the Company's product lines, the cost of the
addition of new products and markets and the increase in marketing that the
Company expects to incur in 2006, along with the cash requirement to fund the
stock repurchase that will lead to privatization of the Company, there will
be continuing cash needs for the business. Management believes that it can
undertake these projects with most, if not all, of the Company's working
capital requirements secured from its operating cash flows. If successful,
the Company should be able to enhance the liquidity of the business and the
overall strength of the Company's balance sheet and financial position.
Additional working capital beyond that available within the Company has been
and may be required to expand operations. Management has and will consider
options available in providing such funding, including debt and equity
financing.
Off-Balance Sheet Arrangements
- ------------------------------
The Company does not have any off-balance sheet arrangements.
Critical Accounting Policies
- ----------------------------
Management is responsible for the integrity of the financial information
presented herein. The Company's financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
of America. Where necessary, they reflect estimates based on management's
judgment. Significant accounting policies that are important to the
portrayal of the Company's financial condition and results, which in some
cases require management's judgment, are summarized in the Notes to Interim
Consolidated Financial Statements, which are included herein.
ITEM 3 - CONTROLS AND PROCEDURES
- --------------------------------
As of June 30, 2006, management, including the Chief Executive Officer and
Chief Financial Officer, conducted an evaluation of disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15 (e)) pursuant to Exchange
Act Rules 13a-14 and 13a-15 as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that such disclosure controls and procedures
are effective. During the three months ended June 30, 2006, there have been
no changes in internal controls, or in factors that have materially affected,
or are reasonably likely to materially affect, the Company's internal
controls over financial reporting.
<Page> 16
THE AMERICAN EDUCATION CORPORATION
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
Management knows of no pending or threatened litigation involving the Company
that is considered material to the on-going operations and viability of the
Company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
None.
Item 3. Default Upon Senior Securities
------------------------------
Omitted from this report as inapplicable.
Item 4. Submission of Matters to a Vote of Securities Holders
-----------------------------------------------------
None.
Item 5. Other Information
-----------------
Omitted from this report as inapplicable.
Item 6. Exhibits
--------
The following exhibits have been filed as a part of this report:
Exhibit
No. Description of Exhibits
- ------- ---------------------------------------------------------------
3.1 Articles of Incorporation of The American Education Corporation
(incorporated by reference Annex B to the Definitive Proxy
Statement filed with the Securities and Exchange Commission on
October 12, 2001)
3.2 Bylaws of The American Education Corporation (incorporated by
reference to Annex C to the Definitive Proxy Statement filed with
the Securities and Exchange Commission on October 12, 2001)
4.1 Form of Stock Certificate (incorporated by reference to Form 8-
A12G/A filed with the Securities and Exchange Commission on
January 20, 2004)
4.2 Directors' Stock Option Plan (incorporated by reference to
Exhibit B to the Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 24, 1998)
4.3 First Amendment to the Directors' Stock Option Plan (incorporated
by reference to the Company's registration statement on Form S-8
filed with the Securities and Exchange Commission on October 22,
1999)
4.4 Stock Option Plan for Employees (incorporated by reference to
Exhibit C to the Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 24, 1998)
<Page> 17
4.5 First Amendment to the Stock Option Plan for Employees
(incorporated by reference to the Company's registration
statement on Form S-8 filed with the Securities and
Exchange Commission on October 22, 1999)
4.6 Second Amendment to the Stock Option Plan for Employees
(incorporated by reference to Exhibit 4.7 to the Company's
registration statement on Form S-8 filed with the Securities and
Exchange Commission on September 29, 2000)
10.1 Convertible Note Purchase Agreement dated March 30, 2005 by and
between The American Education Corporation and David J. Smith
(incorporated by reference to the exhibit in the Current Report
on Form 8-K filed with the Securities and Exchange Commission on
April 11, 2005)
10.2 The American Education Corporation 8% Subordinated Convertible
Promissory Note dated March 30, 2005 in favor of David J. Smith
(incorporated by reference to the exhibit in the Current Report
on Form 8-K filed with the Securities and Exchange Commission on
April 11, 2005)
10.3 Promissory Note dated March 31, 2004 from The American Education
Corporation in favor of UMB Bank, N.A. (incorporated by reference
to the exhibit in the quarterly report 10-Q filed with the
Securities and Exchange Commission on August 15, 2005)
10.4 Promissory Note dated March 31, 2004 from The American Education
Corporation in favor of UMB Bank, N.A. (incorporated by reference
to the exhibit in the quarterly report 10-Q filed with the
Securities and Exchange Commission on August 15, 2005)
10.5 Promissory Note dated April 30, 2006 from The American Education
Corporation in favor of UMB Bank, N.A. (incorporated by reference
to the exhibit in the Current Report on Form 8-K filed with the
Securities and Exchange Commission on April 28, 2006)
10.6 Business Loan Agreement (Asset Based) dated April 30, 2006 from
The American Education Corporation in favor of UMB Bank, N.A.
(incorporated by reference to the exhibit in the Current Report
on Form 8-K filed with the Securities and Exchange Commission on
April 28, 2006)
10.7 Employment Agreement with Jeffrey E. Butler dated December 5,
1998 (incorporated by reference to the exhibit in the quarterly
report 10-Q filed with the Securities and Exchange Commission on
August 15, 2005)
10.8 Employment Agreement with Thomas A. Shively dated December 5,
1998 (incorporated by reference to the exhibit in the quarterly
report 10-Q filed with the Securities and Exchange Commission on
August 15, 2005)
10.9 Employment Agreement with Neil R. Johnson dated December 5, 1998
(incorporated by reference to the exhibit in the quarterly report
10-Q filed with the Securities and Exchange Commission on August
15, 2005)
10.10 Promissory Note dated October 16, 2000 from Jeffrey E. Butler in
favor of the Company (incorporated by reference to the exhibit in
the annual report 10-KSB/A filed with the Securities and Exchange
Commission on September 9, 2005)
10.11 Promissory Note dated September 30, 2004 from the Company in
favor of John Garber (incorporated by reference to the exhibit in
the annual report 10-KSB/A filed with the Securities and Exchange
Commission on September 9, 2005)
<Page> 18
10.12 Promissory Note dated September 30, 2004 from the Company in
favor of Janis L. Butler (incorporated by reference to the
exhibit in the annual report 10-KSB/A filed with the Securities
and Exchange Commission on September 9, 2005)
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
<Page> 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
The American Education Corporation
/s/ Jeffrey E. Butler
----------------------------------
Jeffrey E. Butler,
Chief Executive Officer
Chairman of the Board
Treasurer
/s/ Neil R. Johnson
----------------------------------
Chief Financial Officer
Chief Accounting Officer
Date: August 14, 2006
<Page> 20