SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE - --- ACT OF 1934 FOR THE FISCAL YEAR ENDED OCTOBER 31, 1997 or ___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ COMMISSION FILE NUMBER 0-20842 ------- TRO LEARNING, INC. ------------------ (Exact name of Registrant as specified in its charter) Delaware 36-3660532 - -------- ---------- (State or other jurisdiction of incorporation or organization) (IRS Employer Identification Number) 1721 Moon Lake Blvd., Suite 555 Hoffman Estates, IL 60194 - ---------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (847) 781-7800 -------------- 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 $.01 Per Share --------------------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ The number of shares of the Registrant's common stock, par value $.01 per share, outstanding as of December 10, 1997 was: 6,405,346 shares. The aggregate market value of common stock (based on the closing price on December 10, 1997) held by non-affiliates of the Registrant was approximately $28,948,000. Index for exhibits is located on page 55. This document contains 59 pages. 1 DOCUMENTS INCORPORATED BY REFERENCE Certain information in the Proxy Statement for the Company's Annual Meeting of Stockholders to be held on April 16, 1998 (the "1998 Proxy Statement") is incorporated herein by reference in Part III of this Form 10-K. Pursuant to Regulation 14A under the Securities Exchange Act of 1934, the 1998 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year. NOTE REGARDING FORWARD LOOKING INFORMATION This Form 10-K contains forward looking statements identified by the use of "believes", "expects", "anticipates", and similar expressions. Such statements are subject to risk and uncertainties that could cause actual results to differ from those contemplated by the forward looking statement. Such risks and uncertainties include any change in the market acceptance of the Company's products and services, the risk of failure of the Company's technology to remain at market standards, the risk of the Company being able to finance its business operations, and other similar business and market risks. Readers are cautioned not to place undue reliance on such forward looking statements. 2 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 TABLE OF CONTENTS ----------------- Page ---- PART I Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 Item 2. Facilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . 24 Item 4. Submission of Matters to Vote of Security Holders . . . . . . . . . 24 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Item 6. Selected Consolidated Financial Data. . . . . . . . . . . . . . . . 29 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . . . . . . . . . . . 30 Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . 37 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. . . . . . . . . . . . . . . 54 PART III Item 10. Directors and Executive Officers of the Registrant. . . . . . . . . 54 Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . 54 Item 12. Security Ownership of Certain Beneficial Owners and Management. . . 54 Item 13. Certain Relationships and Related Transactions. . . . . . . . . . . 54 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. . 55 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 3 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS GENERAL: TRO Learning, Inc. (the Company) is a leading developer and marketer of microcomputer-based, interactive, self-paced instructional systems used in a wide variety of adult settings. Offering comprehensive educational courseware specifically designed for young adult and adult learners, the Company's PLATO-Registered Trademark- Learning Systems are marketed to middle schools and high schools, community colleges, job training programs, correctional institutions, government-funded programs, the military, and corporations. The Company's TRO Aviation Training Systems are marketed to airlines worldwide for use by commercial airline pilots, maintenance crews, and cabin personnel. COMPANY HISTORY: The Company was incorporated in July 1989 as Edu Corp., and in October 1992 it changed its name to TRO Learning, Inc. The Company's wholly-owned operating subsidiary is The Roach Organization, Inc. (TRO). TRO has two wholly-owned subsidiaries, one in Canada, TRO Learning (Canada), Inc., and one in the United Kingdom, TRO Learning (U.K.) Ltd. In September 1989, the Company acquired most of the assets of Control Data Corporation's (Control Data) computer-based education, training and testing business. Under the Company's senior management team, the marketing focus of the business was redirected from sales of hardware and data processing services to the delivery of solution-oriented courseware and training services to education providers in a wide variety of settings. In addition, the Company initiated a new business strategy of developing a library of courseware to market to commercial airlines. The Company made significant additional investments in organizational infrastructure and personnel for sales and marketing. At the same time, the Company reduced general and administrative expenses through implementation of cost controls and streamlined operations. The Company also made substantial investments in the development and introduction of new products and services, as well as the enhancement of its existing courseware for education and training applications. During fiscal 1992, the Company discontinued two businesses, the NASD testing center business and the end user computer training distribution business. In addition, in September 1993, the Company entered into a Certification and Testing Services Agreement with Sylvan Learning Systems (SLS), whereby SLS agreed to assume and perform the Company's rights and obligations under its Certification and Testing Services contracts. 4 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED COMPANY STRATEGY: The Company's strategy is to address the needs of adult and young adult learners by providing a broad range of interactive, multimedia, self-paced educational and training courseware delivered on personal computers. The critical elements of the Company's business strategy are as follows: TARGET ADULT AND YOUNG ADULT MARKET OPPORTUNITIES. The Company targets growing market niches that serve adult and young adult learners rather than pre-school and elementary school-aged children. These market niches, including the corporate workplace environment, have specific educational and training requirements that can be addressed by the Company's computer-based products and services. The Company's courseware incorporates themes, graphics and media appropriate to adult and young adult learners. PROVIDE COMPREHENSIVE, SOLUTION-ORIENTED COURSEWARE AND SERVICES. Drawing upon its extensive library of computer-based courseware, the Company's education and training specialists work closely with clients to design a program of instruction which meets their specific educational and training needs. The Company offers its products in modular form and flexible formats that can be tailored to a wide variety of applications. EMPHASIZE SALES OF HIGH MARGIN COURSEWARE. Since the acquisition from Control Data in 1989, the Company has redirected the marketing focus of the business from hardware and data processing services, which have generally experienced declining profit margins, to solution-oriented education and training courseware and services which generate higher profit margins and greater opportunities for growth. COMMITMENT TO ON-GOING COURSEWARE DEVELOPMENT AND SUPPORT. Since the acquisition, the Company has made substantial investments in developing and enhancing courseware for education and training applications and is committed to maintaining a diverse and comprehensive curriculum. The Company uses the design and structural advantages inherent in its proprietary software development systems to design and produce new courseware and services to meet the changing needs of its clients and prospects. INTERNET/INTRANET DELIVERY: The Company is focused on developing the broadest delivery system for its instructional management system and courseware library. The rapid acceptance and worldwide accessibility of the Internet, as well as the increased acceptance of a technology-based distance learning model, offers the potential of just-in-time learning and expanded access to PLATO education and training products. Internet delivery is also very supportive of the sales and marketing focus on organizations 5 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED INTERNET/INTRANET DELIVERY, CONTINUED providing a wide range of education and training services throughout the community, allowing for new distribution channels to complement the direct sales model. Corporations and many of the larger school districts and training organizations have developed intranets to share information and communication. The expanding availability of intranets offers a platform for the delivery and distribution of education and training across the organization to any location. With the availability of high-speed telecommunications links between facilities, intranets are a powerful delivery system for PLATO education and training. MARKET OVERVIEW: Many competitive, social, and political trends over the past few years have led to significant demand for technology-based education and training: - Identification by numerous government and private studies that basic skills and training deficiencies are a major threat to American industry's ability to achieve its goals and compete internationally. This trend has been accompanied by increased governmental and private-sector spending on basic skills and job skills training. - In industry, pressure to improve cost-efficiency and access to training and education has led to a willingness to adopt non-traditional training methods. - The acceleration of technological changes requires ongoing workforce retraining and skills enhancement. - Widely reported declines in standardized test scores and an increased demand by states and school districts for measurable results of such programs have increased concern over training and educational program effectiveness. - Legislative initiatives and governmental mandates (such as welfare, prison reform, and regulatory requirements in the aviation industry) have increased the demand for education and training outside traditional educational settings. - Dramatic improvements in the price and performance of hardware have made it feasible for more institutions to purchase microcomputers of adequate power to deliver effective educational and training courseware products. 6 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED MARKET OVERVIEW, CONTINUED - Advances in instructional design, programming, and presentation technologies have made it possible to develop courseware and software cost-effectively. - The development of multimedia software has heightened the interest in education and training, both for business and education as well as for the consumer market. A prominent example of these trends is the PLATO Learning System, which combines extensive courseware and curriculum management software with networked hardware and system management software. The Company believes sales will grow at a faster rate in the adult and young adult markets than in the traditional primary school markets. The adult and young adult segments of the education markets are receiving increased levels of funding as schools, government, and private sector programs seek to reduce school drop-out rates and to provide basic skills and education. Further, private sector employers continue to provide their employees with remedial and basic literacy skills training as well as specific job-related training. The demand for pilot and other airline personnel training is driven by several factors, including new aircraft acquisition, retrofitting existing equipment, and cross-training on various types of equipment. The Federal Aviation Administration (FAA) and foreign government regulators, as well as competitive factors, require commercial pilots and other flight personnel to be certified on new and upgraded equipment. Technological advances in aircraft, new aircraft acquisitions, and personnel promotions create an ongoing demand for high quality, standardized, flexible, and cost-effective training. Retrofitting existing aircraft to update equipment and to meet new regulatory requirements creates further industry need for training pilots, maintenance and in-flight personnel. The Company uses microcomputer-based educational technology to address these trends. This technology offers a number of advantages in both traditional and non-traditional educational settings, including self-pacing, interactive instruction, standardized curricula, individual tailoring of programs, remote service delivery, scheduling flexibility, and ready measurement of performance providing instantaneous student feedback. In addition, educational technology enables instructors to manage curricula and provide individualized tutoring rather than provide the same instruction for all students. 7 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES: The Company develops and markets microcomputer-based, interactive, self-paced instructional systems. The Company also delivers its PLATO Education courseware products to customers over the Internet or intranets. Although the design and specific features of a system depend upon the particular needs of each client, a learning system typically includes a library of educational courseware, instructional management software, a delivery system, and consulting services. The Company provides educational courseware and services to middle and high schools, community colleges, job training programs, correctional institutions, government-funded training programs, the military and private industry. It also provides courseware for the aviation industry, developed by the Company in partnership with aircraft operators. The suite of courseware currently available encompasses the majority of modern aircraft types manufactured by Boeing, Airbus, Fokker, Saab, Bombadier, ATR, British Aerospace and McDonnell-Douglas. Solutions are offered for all aspects of an airline's training requirements for flight crews (pilot and cabin staff) and ground personnel (aircraft maintenance and support services). In general, the PLATO Learning System offers educators an effective supplement or alternative to traditional, instructor-led education. A typical learning system installation consists of 10 to 30 workstations, educational courseware, instructional management software, and hardware and typically sells for $50,000 to $200,000. PLATO Learning Systems are currently installed at over 3,000 sites with an aggregate of approximately 52,000 workstations. The Company's PLATO clients include New York City Board of Education, State of Tennessee Board of Regents, California Department of Corrections, Montana Department of Corrections, AT&T, Abbott Laboratories, Honeywell, Georgia Pacific, Kimberly-Clark, Printpack, Saturn, USAA, Siemens, Bethlehem Steel, Houston Community College, Victoria Independent School District, Garland Independent School District, Dayton Public Schools, Polk County Schools, Glendale Union High School District, Weber County Schools, New Hampshire Technical College System, Florida Correctional Educational School Authority, and Open Learning Agency (Canada). The Company's Aviation Training Systems address the training needs of the aviation industry through the analysis, design and development of courseware specific to a particular training requirement; and through the resale of its library of courseware titles. In fiscal 1997, the average Aviation Training System sale was in excess of $300,000. Over the past seven years, the Company has sold to more than 90 of the world's major airlines and key companies within the aviation industry and its courseware can be found on over 1,400 workstations. The Company's Aviation Training clients include United Airlines, American Airlines, Lufthansa, SAS, Singapore Airlines, Flight Safety International, Crossair, Kuwait Airways, Malaysia Airlines, Gulf Air, Cathay Pacific Airways, Braathens SAFE, CST Berlin, Czeskolovenske Aerolinie, Hughes Flight Training, Icare and SAAB Aircraft. In fiscal 1997, the Company derived approximately 88% of its 8 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED Aviation Training revenues from sales to non U.S.-based air carriers. See Note 7 of Notes to Consolidated Financial Statements for geographic area information. COURSEWARE: The PLATO Learning System courseware library has over 5,000 hours of on-line instruction, including in excess of 3,300 lessons and 8,500 objectives. PLATO offers a comprehensive curriculum developed specifically for adult and young adult learners. The Company's Aviation courseware library consists of over 2,000 hours of on-line, highly-interactive instruction and simulation of aviation-related topics. This library is being increased by over 250 hours of new courseware each year developed by the in-house development team. The library covers a range of topics for pilot transition and recurrent training, in-flight cabin services (including safety and survival courses), maintenance and air traffic control. The following tables set forth the current PLATO and Aviation courseware. 9 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED COURSEWARE, Continued PLATO LEARNING SYSTEM COURSEWARE AND SOFTWARE OFFERINGS PLATO COURSEWARE: THIRD PARTY COURSEWARE: - ---------------- ---------------------- COMMUNICATION Reading Horizons Reading 1 and 2 Mindplay Writing Series Writing Series English Discoveries (ESL) Communication Projects for the Real World Reading for Information Job Skills for the Real World Writing in the Workplace Basic Skills for the Real World Advanced Reading Strategies Rediscover Science 6-9 and 9-12 Towards Algebra MATHEMATICS Business Software Training Series Math Fundamentals Substances Abuse Series Math Fundamentals (Spanish Edition) Blueprint Reading Applied Math Mastering Geometric Dimensioning and Data Skills Tolerancing Pre-Algebra Technical Skills Series Beginning, Intermediate and Advanced Health, Safety and Environmental Series Algebra Ultrakey Keyboarding Beginning and Intermediate Algebra (Spanish Edition) PLATO SOFTWARE PRODUCTS Geometry and Measurement 1 and 2 PLATO Curriculum Manager Trigonometry PLATO Pathways Instructional Management Calculus 1 and 2 System for Windows PLATO Remote Administration SCIENCE PLATO Records Transfer and Consolidation Science Fundamentals Utility Chemistry 1 and 2 PCD3 Authoring System Physics 1 and 2 PLATO S.T.A.R. SOCIAL STUDIES Social Studies TECHNOLOGY Quality Fundamentals LIFE SKILLS Life and Job Skills Parenting Skills 10 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED COURSEWARE, Continued TRO AVIATION COURSEWARE FLIGHT IN-FLIGHT SERVICES Airbus: A300-600 B747-700 and B757 Transition Training A310 Basic Service A320 Key Position A321 Recurrent Emergency Training A320 FMGS LOFT Trainer Cocktail Services A330 Preflight/Inflight/Postflight Responsibilities A340 New Tech Cart Boeing: B737-200 to B737-300 Differences Single Aisle Cabin and Galley Systems B737-300/400/500 Cabin and Galley Systems: B767 and DC-10 B737-300 FMGS LOFT Trainer B747 Equipment and Systems B747-400 Purser Control Center (PCC) B747-400 Systems Simulations Cabin Intercom Data Systems (CIDS) B747-400 Freighter Difference B757 SYSTEMS AND OPERATIONS B757/767 FMGS LOFT Trainer Traffic Collision and Avoidance (TCAS) Systems B767 Category (CAT) II and III Operations Canadair: Regional Jet North Atlantic Navigation Fokker: F50 South Atlantic Navigation F100 KNS 660 Area Navigation Saab 2000 International Flight Operations 2000 FMGS LOFT Trainer Head Up Guidance System (HUGS)* ACARS MAINTENANCE TRAINING ETOPS* McDonnell-Douglas MD-80 Aircraft Performance Jet Aircraft Maintenance Fundamentals* Collins 4200 and 6000* FMS Trainer Ramp Services Navigation Trainer* A340 CMCS Simulation B747-400 CMS Simulation SAFETY AND SURVIVAL First Aid GENERAL AVIATION General Safety and Emergency Beech Baron Safety and Emergency: A320/330/340 Beech Bonanza F33 and A36 Safety and Emergency: B737/747/767/777 Piper Arrow Dangerous Goods Piper Cheyenne IIIA Airline Security Eagle (PPL) Basic Cabin Crew Courses AIR TRAFFIC CONTROL CAA NERC System Central Flow Management _____________________________________________ * in development 11 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED PLATO COURSEWARE AND SOFTWARE: Each PLATO course teaches a set of skills which has been defined in terms of measurable performance. The course teaches the skill through a progression of tutorials and practice lessons with diagnostic feedback. New courseware developed has added an instructional model focused on problem-solving. Learners have access to assessments which target instruction. After each sequence of tutorial and practice, a test follows which verifies the learner's achievement. The PLATO Curriculum Manager (described below) can identify the specific skills each individual learner needs to master, and prescribe instruction the student needs. Teachers can adapt PLATO courseware to their own lesson plans because of its modular design. While PLATO can be used effectively with minimal teacher support, the Company believes that the greatest learning gains are achieved when teachers use PLATO to transform their role in the classroom from mere information presenter to that of tutor, manager, and counselor. PLATO courseware is correlated to many national standardized tests. Increasingly, educators are being judged according to their students' progress as measured by a number of these tests. Product correlation, therefore, has become an important factor in how educators evaluate the usefulness and effectiveness of an integrated learning system and its courseware. Some of the major standardized tests to which PLATO courseware is closely aligned are: Adult Basic Literacy Exam (ABLE) Comprehensive Adult Student American College Test (ACT) Assessment System (CASAS) California Achievement Test (CAT) General Education Development Exam California Basic Education Skills Test (GED) (CBEST) Scholastic Aptitude Test (SAT) Canadian Adult Achievement Test (CAAT) Test of Achievement and Proficiency (TAP) Test of Adult Basic Education (TABE) An independent evaluation conducted comparing PLATO computer-based education with traditional classroom instruction showed that PLATO computer-based education resulted in 10% greater learning gains with approximately half the instruction time. In addition, surveys and third party evaluations have shown that learners prefer PLATO over conventional classroom instruction because it is success-oriented, places the learner in control, does not waste time, sustains interest, supports learning on demand, and is private. 12 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED PLATO COURSEWARE AND SOFTWARE, Continued In late 1992, the Company undertook major upgrades and enhancements to its products. The new PLATO products represent a significant redesign of the Company's core PLATO curricula. Completed in 1995, the new PLATO products have four major elements: INSTRUCTIONAL IMPROVEMENTS. Hundreds of instructional improvements have been incorporated throughout the lessons based on learner and client feedback and subject-matter expert input. The new PLATO courseware is fully compatible with the existing PLATO curriculum structure so that learners encounter a smooth transition from old to new. A NEW USER INTERFACE. Streamlined screens and graphically-based function buttons that can be activated by either the keyboard or mouse improve learner interaction and control and give PLATO courseware a new look and feel. A NEW GRAPHIC LOOK. New graphics are instructionally integrated and visually appealing to our target audience of young adult and adult learners. The graphics were carefully designed and created to contribute to the instructional objectives and to enhance the learning experience. Animation and color combine to make the new PLATO products what the Company believes to be the premier computer-based instructional system on the market today. NEW INSTRUCTOR OPTIONS. New features have been added that allow instructors to easily preview and review all aspects of each lesson, including a review of all questions. This "page down" mode will be extremely helpful in facilitating instructor familiarization with PLATO lessons. Building on an excellent foundation, these new features significantly enhance and further improve the effectiveness and acceptance of PLATO. In 1995 and 1996, the Company completed the development of a major new program designed to enhance the foundation skills of workers in support of the high performance workplace required by business and industry to be competitive in today's global economy. PLATO-Registered Trademark- WorkSkills focuses on developing the reading, math, writing, and communication skills necessary for worker success, using a series of skill-building lessons structured in skill levels to accommodate the different competencies necessary to perform specific job functions. The PLATO WorkSkills curricula have broad applicability in the school and job training markets as well, fully complementing the core PLATO courseware library. The development of PLATO WorkSkills was the result of extensive consultation with a wide range of large and small companies representing many business sectors, as well as with state and local 13 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED PLATO COURSEWARE AND SOFTWARE, Continued secondary and adult educators, both individually and through an advisory group process. The new curricula will further enhance the Company's leadership position in the education and training market. In the past year, the first Windows-based curriculum, Advanced Reading Strategies, was released. It builds on the PLATO instructional model and adds extensive problem-based activities to enhance and extend learning, consistent with new trends in education and training. New courseware under development builds on this instructional architecture, adding extensive media, including animation, audio and video, and extending the problem-based applications. TRO AVIATION COURSEWARE: Substantially all of the Aviation Training courseware library has been developed over the last seven years. This courseware offers high-quality, cost-effective methods of meeting the training requirements imposed, in particular, by regulatory authorities. The demands placed on the aviation industry by these authorities make the use of computer-based training an efficient and cost-effective way of covering these training requirements. Courseware can be customized to accommodate different equipment configurations and individual airline operating policies. The Aviation Training group follows industry standard training analysis techniques and has received ISO 9001 certification for quality procedures. Courseware development begins with an initial analysis of the customer's training requirement, including the overall job and skills required, the relevant regulations, the target student population and a financial analysis of the costs of various training approaches (including the cost of not training). Following initial analysis, the design phase begins, during which time the details required in the courseware modules are gradually developed. At all times, the customer's training authority describes, checks and approves the technical content before it becomes finalized on screen, or supported with audio material. The development team includes specialists in video, computer audio, graphics and animation. Many of the courseware packages can be presented in different languages. 14 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED TRO AVIATION COURSEWARE, Continued Courseware developed includes tutorials and competency-based drill and practice procedure simulations, providing students with a realistic, highly-interactive, criterion-referenced training environment. Development tools, including many of the new Windows-based packages, enable courseware to be produced efficiently and to facilitate customization and maintenance. The Company is constantly reviewing new development tools and its development specialists are active in networking within the market place to ensure that only the most up-to-date, efficient and cost-effective tools are utilized. The Company also monitors some of the most advanced computer techniques, such as virtual reality. If these technologies become viable training tools, the Company is positioned to take full advantage of them. New regulations are continuously forcing aircraft operators into new training activities. One such area covers the training and licensing of aircraft maintenance staff. In response to this requirement, TRO partnered with Lufthansa to analyze, design and produce the Jet Aircraft Maintenance Fundamentals (JAMF) courseware package of some 130 hours. These regulations will eventually be adopted worldwide and TRO will initially be the only company to offer a fully comprehensive course covering the majority of topics demanded by the regulators. Additionally, there are a number of PLATO courses that have been identified to support some of the basic educational requirements of the new regulations. Another new area for Aviation Training is the introduction of Ab Initio courseware for new pilot students. An exclusive marketing contract has been signed to market this courseware worldwide. Topics ranging from Theory of Flight Meteorology and Power Plant to Navigation Principles are covered in this 150-hour package, which is delivered on CD-ROM and uses all relevant multi-media training techniques. The courseware addresses the topics required for basic pilot licenses from most of the regulatory authorities throughout the world. INSTRUCTION MANAGEMENT SOFTWARE: Both the Company's PLATO and Aviation courseware are managed by sophisticated computer-based software called the Curriculum Manager. It provides an effective means of monitoring learner progress and recording and reporting performance data. The Curriculum Manager provides access to courseware as well as administrative control of the integrated learning system, and gives instructors the flexibility to design customized learning paths to meet individual learner needs, program objectives and/or alignments. Through the Curriculum Manager, courseware can be 15 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED INSTRUCTION MANAGEMENT SOFTWARE, Continued presented as published or restructured to correspond to specific program requirements or teaching strategies. Instructors also have the flexibility to customize the criteria for learner access and mastery of courses. The Curriculum Manager also allows learners to work on their individual lesson plans while other learners are working independently on the system. Learners are not required to be assigned a specific workstation on the network since the system identifies them from their sign-on and password. The Company has just completed the development of a new, state-of-the-art, highly sophisticated Windows-based instructional management system, PLATO-Registered Trademark- Pathways, that will replace the current DOS-based Curriculum Manager for systems that support the Windows operating environment. PLATO Pathways incorporates a new, easy to use graphical user interface allowing administrators and instructors to create customized learning paths and monitor student progress. A new suite of reports, including graphical and comparative reports, has been designed into the new system. PLATO Pathways includes step-by-step help sequences to guide administrators and instructors to perform specific functions easily. Because PLATO Pathways is Windows-based, third-party programs compatible with MS DOS-TM-, MS Windows 3.x-TM-, or Windows-TM- 95 can be integrated easily into lesson plans to enhance the learning process. DELIVERY SYSTEMS: The PLATO delivery system is configured to use personal computers (PC's) running MS-DOS-TM- or MS-Windows/DOS-TM-. While the PLATO system can run on a stand-alone PC with a CD-ROM drive, the vast majority of installations use a local area network (LAN) with a file server computer and 10 to 30 workstation PC's. The PLATO system may be physically housed in a single room or laboratory setting or dispersed among several rooms within a building or buildings in a campus setting. Additionally, PLATO LAN-based systems may be configured with remote administration software enabling any number of distant learning locations and workstations to be connected to a central site via telecommunications software and hardware. Courseware is stored on the file server on a high speed hard disk or, for single PC's and CD-ROM server networks, on a CD-ROM. Students access the file server through the LAN and the network software accesses the courseware as needed. Instructors can monitor the system and the students via any workstation, or using a dedicated administrator's workstation, printing test results or other data on a network printer. A typical Aviation Training System is configured to run on 486 and Pentium-TM- multimedia PC's. Aviation Training courseware can run on stand-alone or networked systems ranging from a few 16 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED DELIVERY SYSTEMS, Continued workstations to a company-wide intranet with full administrative and student monitoring capabilities. Since many airlines have large information technology departments, the Company is becoming less involved in the supply and installation of hardware, but still retains a worldwide customer consultation and support capability when clients require it. There are also a growing number of airlines reviewing the benefits of using laptop computers with courseware to enable training at any time. PLATO ON THE INTERNET/INTRANET: During 1996, the Company initiated a project to develop the capability to deliver the PLATO courseware library over the Internet. The initial implementation of the system was piloted in Tennessee in partnership with Tennessee Tomorrow, Inc., a public private partnership involved with economic development. The test included delivery to medium and large businesses and community training organizations in the state. In addition to delivery via the Internet, the Company has successfully piloted this system on several client Intranets. Based on the positive results of the Tennessee pilot, the Company has introduced the production version of PLATO courseware on the Internet. The new platform includes a Windows-based learning folder that allows seamless access to both local computer and World Wide Web-based learning resources. The product includes delivery of the PLATO library over the Internet using the new PLATO Pathways instructional management system, access to Web links and off line resources, and discussion groups. Program coordinators, who manage learner activity, have special access to new Web-based tools for creating and managing learner activity, managing discussion groups and generating administrative reports on learner usage and progress. In addition, provisions have been made for adding third-party Web and non-Web based products to enhance the breadth and scope of the learning experience. Currently, TRO is delivering PLATO courseware on the Internet via a network of PLATO Education Partners (described below), a regional telephone company (BC-TEL), as well as several charter schools. In addition, the Company expects to deliver PLATO courseware on the Internet via another regional telephone company (Bell South) in 1998. The Company is currently adding new features such as the ACT WorkKeys locator tests, a new Windows-based assessment system, problem-based Web activities, and the Company's new Windows-based courseware products. 17 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCTS AND SERVICES, CONTINUED CONSULTING SERVICES: Pre-sale and post-sale support services provided by the Company's education consultants assist in the successful implementation of the Company's programs. Education consultants help clients prepare the site for installation of computer hardware and software, monitor the actual installation process, and provide on-site consultation and training for lab managers, instructors and administrators in the use and integration of courseware within their programs. The Company's education consultants maintain ongoing contact with each client, providing consultative and support services to ensure the success of their programs. SALES AND MARKETING: The Company's strategy is to use its own sales force in North America and the U.K. In Aviation Training, the Company utilizes agents in many foreign countries to supplement its marketing service and support activities. The Company has established exclusive distribution agreements with distributors experienced in education product distribution in the following countries: Singapore, Malaysia, Korea, Taiwan, United Arab Emirates, Brunei, Panama, Costa Rica and South Africa. The Company targets potentially large and high growth market niches to which the Company's existing and future products can be effectively sold. The Company's marketing and sales efforts are designed to increase market penetration and reinforce the Company's reputation for product quality, customer satisfaction, and service. As of October 31, 1997, sixty-nine account managers are responsible for sales of PLATO Learning Systems and for maintaining an active relationship with both current and potential clients. Sixty-one education consultants are responsible for training clients and implementing PLATO Learning Systems. In addition, as a strategy to extend PLATO Education's sales and marketing reach to businesses and other constituencies served by community colleges, the Company enters into contracts with PLATO Education Partners (PEP's). Under these arrangements, the PEP's, principally community colleges, market PLATO courseware and consulting services to small and medium sized businesses within the local community to meet the education and training needs of their employees. Within this strategy, the Company has also identified other organizations as Internet Marketing Partners to specifically market licenses for delivery of PLATO over the Internet. When the PEP commits to a minimum level of purchases of PLATO licenses or usage over a period of time, the Company expects generally to recognize revenue ratably over the contract term. 18 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED SALES AND MARKETING, CONTINUED The Company is also pursuing marketing relationships with Internet providers to make available the PLATO courseware library to consumers and businesses. The Company expects to recognize revenue from such sales principally as usage occurs. The Company reaches potential clients and reinforces its market image by attending and making presentations at national, regional and state conventions and conferences, sponsoring instructional and teaching seminars, and publicity in trade journals. It conducts extensive direct mail and telemarketing campaigns to targeted prospects within each market segment to secure leads and promote increased awareness of the Company and the PLATO courseware. In addition, the Company has developed and maintains a comprehensive web site on the Internet's World Wide Web, which allows for the dissemination of news and information about the Company's products, services, and clients. The Company has relationships with many industry associations, such as the American Association of Community and Junior Colleges, the National Alliance of Business, and the Corrections Education Association. Additional marketing activities to promote the effectiveness of PLATO products to potential clients include the publication of formal evaluation data, program and application reports, and the distribution of press/news releases to appropriate sources. The Company's Aviation Training products and services are marketed directly to airlines and training centers around the world through account managers based in Minneapolis and in London. Sales regions for the consolidated U.S. and U.K. operations include North America, South America, Asia/Pacific, Europe, Africa, and the Middle East. The Company participates in the major international air shows. In addition to direct sales activities, the Company markets to its prospective aviation clients by direct mail, including publication and distribution of its AVIATION NEWSLETTER and AVIATION PRODUCT UPDATE. Major trade publications also include articles about the Company's Aviation Training products and services. These publications are effective in reinforcing the Company's position as one of the leaders in aviation training. COMPETITION: In all of its markets, the Company competes primarily against more traditional methods of education and training, principally live classroom instruction. The Company has seen increased acceptance of multimedia-based, computer-aided methods of training and education due to, among other reasons, their flexibility, cost-efficiency, and demonstrated effectiveness. 19 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED COMPETITION, CONTINUED Within the education and training services market, the Company competes primarily on the basis of the depth and recognized quality of its courseware and its ability to deliver a flexible, cost-effective, and customized solution to a client's education and training needs on a timely basis. Based on recent competitive situations in which it has participated, the Company believes that product depth, quality, and effectiveness are more important competitive factors than price. Within the academic computer-based education market, the Company competes most directly with other learning system providers, including Viacom and Jostens Learning. While these companies are focused primarily on the elementary school market, they compete to some degree with the Company in the adult and young adult market. Although Viacom is significantly larger than the Company, PLATO courseware offers a comprehensive curriculum developed specifically for adult and young adult learners. In the post-secondary and training markets there are many regional and specialized competitors. The Company's competition in computer-based aviation training comes from three distinct sources: airframe manufacturers, airlines' internal training departments, and other computer-based training companies. Major airframe manufacturers such as Airbus, Boeing, and McDonnell-Douglas occasionally provide their own training programs with the purchase of the aircraft. Often, airlines accept these courses because they are included in the purchase price of the aircraft. Internal training departments of airlines also compete with the Company. The Company believes that airlines have developed their own training programs because the quality of training provided by airframe manufacturers has been inconsistent. Large airlines, for example, American Airlines and Delta Airlines, have significant internal resources to develop courseware. Internally developed programs include stand-up instruction, audio and video tape, and computer-aided training programs. The Company's major external competitor is Attachematc Corporation. The majority of this competitor's courseware, which is principally owned by third parties and marketed by Attachematc, uses older technology and was developed in a lower resolution than the Company's courseware. PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT: The technological aspects of product development, maintenance, and client support are in many ways similar for all of the Company's products. The Company's product development and systems development group develops, enhances, and maintains the courseware, curriculum management software, and delivery system platforms employing a rigorous multi-phased product development methodology and process management system. While based on both classical instructional design concepts and models, as well as 20 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT, CONTINUED traditional systems development management techniques, the product development methodology has been constructed to specifically address the creation of individualized, learner-controlled, interactive instruction using the full multimedia capabilities of today's personal computing and other related technologies. The integral quality control and assurance mechanisms and procedures of the development methodology enhance the instructional effectiveness and content integrity of the resulting product. They also help to ensure that the most appropriate and highest quality production values are achieved in the development of all software graphics, audio, video, and text. Central to the courseware development process are three proprietary software tools: the PLATO instructional management system, PLATO PATHWAYS - designed for system control, the tracking and reporting of student performance and administration; MICRO PLATO AUTHORING SYSTEM (MPAS) - software used in the enhancement and maintenance of existing PLATO courseware; and PLATO CURRICULUM DESIGN, DEVELOPMENT AND DELIVERY (PCD3) SYSTEM - a proprietary yet flexible MS-DOS-TM- based development tool. The Company recently released its first major new PLATO Education product specifically developed for Windows. The Advanced Reading Strategies (ARS) course has been developed with the Company's new WinPLATO architecture using the Asymetrix ToolBook Author system. Seven new Windows courses for the education and workplace environments are currently in development and will be released in phases during 1998. The Company's technical support group provides a full range of support services in an effort to ensure a client's satisfaction with the quality and effectiveness of its products and services. In addition, staff engineers continuously evaluate and recommend new technology that not only improves system performance and capability, but also reduces cost. Before release, each individual product undergoes a series of separate tests before it is approved and made available for client use. The Company does not develop any operating system software, as distinct from its courseware products, nor does it manufacture any hardware components. The Company assembles ("integrates") standard hardware components and off-the-shelf software products into an appropriately configured platform for the Company's proprietary courseware and management system which is then integrated and fully tested for 24 to 48 hours under normal operating conditions. Full-time professionals, with general technical expertise and extensive operational knowledge of the Company's products, provide pre-sales technical consultation and support to the Company's field sales organization and are responsible for the final technical review and approval of all proposed delivery platforms and installation configurations. These professionals also consult and 21 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT, CONTINUED coordinate with the client, account manager, and installation team regarding site preparation, schedule system installation and confirm full acceptance. They also monitor client satisfaction, maintenance, and other support requirements. All manufacturers' warranties are passed through to the Company's clients. After the warranty periods are over, the Company offers maintenance contracts through third-party service organizations. The Company contracts with outside vendors, primarily BancTec Services Corp., for hardware installation and maintenance services for its client sites. In addition, the Company distributes a limited amount of third-party courseware and also purchases various off-the-shelf software and hardware products from Novell, Microsoft, and other vendors. The Company provides its clients with a 24-hour, toll-free, problem resolution and support "hotline" service. Through the use of a remote diagnostics tool and on-line access to the Company's "Client Profile" database, full-time client support specialists can address client issues and successfully resolve most problems during the initial call. Depending on the nature of the problem, the hotline staff may dispatch a service engineer to the client site, document the problem and refer it to the appropriate specialist for resolution, or call for immediate on-line support from more senior technical personnel. The Company has supplier relationships with several hardware and software vendors. Although these relationships are important to the Company, management believes that, in the event that such products or services were to cease to be available, alternative sources could be found on terms acceptable to the Company. PROPRIETARY RIGHTS: The Company regards its courseware and software as proprietary and relies primarily on a combination of statutory and common law copyright, trademark, trade secret laws, license and distribution agreements, employee and third-party non-disclosure agreements, and other methods to protect its proprietary rights. The Company owns the federal registration of the PLATO trade-mark. In addition, in 1989 Control Data assigned to the Company federally-registered copyrights in the PLATO courseware. The Company has not recorded the assignment of these copyrights because it believes the additional statutory rights resulting from recordation are not necessary for the protection of the Company's rights therein. The Company has federal copyrights in all PLATO and Aviation courseware produced since 1989. The Company has not applied for trademark registration at the state level, but has instead relied on its federal registrations and state common law rights to protect its proprietary information. The Company has registered trademarks in the United States and overseas for PLATO. The Company regards these registrations as material to its 22 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 1. BUSINESS, CONTINUED PROPRIETARY RIGHTS, CONTINUED business. The Company licenses some courseware and software from third-party developers and incorporates them into the Company's courseware offerings and integrated learning systems. Pursuant to a settlement agreement entered into in October 1992, the Company has granted certain limited courseware and software licenses to Drake and Control Data Systems, Inc. (CDSI). The licenses will permit Drake and CDSI to market certain earlier versions of portions of the PLATO courseware in certain specified situations. The Company believes that the limited licenses granted to Drake and CDSI will have no material adverse impact on its future business. BACKLOG: The Company's backlog consists of orders for the delivery of goods and services in future periods. The total Company backlog was approximately $11.7 million at October 31, 1997 and $17.5 million at October 31, 1996. The backlog for PLATO Education and Aviation Training was $8.5 million and $3.2 million, respectively, at October 31, 1997. From time to time, the Company may have longer-term contracts in its backlog for the delivery of Aviation Training and PLATO Learning Systems. At October 31, 1997, approximately $1.6 million of such orders (included in the foregoing backlog figure) are expected to be delivered subsequent to fiscal 1998. CYCLICALITY: The Company's quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions by the Company, product shipments, client funding issues, marketing expenditures, product development expenditures, and promotional programs. In addition, certain of the Company's PLATO Education and Aviation Training clients experience cyclical variations in funding which can impact the Company's revenue patterns. The Company's quarterly revenues can also fluctuate based upon spending patterns, budget cycles, and the fiscal year ends of these clients. The Company historically has experienced higher levels of revenues in its fourth fiscal quarter. EMPLOYEES: As of October 31, 1997, the Company employed 358 people on a full-time basis, including 73 in product development and operations, 209 in sales and marketing, 47 in technical support, and 29 in finance and administration. 23 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 2. FACILITIES The Company leases approximately 50,000 square feet of office and warehouse space in Edina and Bloomington, Minnesota for its corporate headquarters and 5,400 square feet of office space for its executive offices in Hoffman Estates, Illinois. The Company's Canadian subsidiary leases 2,700 square feet for its principal offices in Toronto, and the United Kingdom subsidiary occupies 8,000 square feet in Berkshire, England. The Company also maintains sales offices in Dallas, Houston, San Antonio and Texarkana, Texas; Skippack, Pennsylvania; Alexandria, Virginia; Huntington Beach, California; Ft. Lauderdale, Florida; Westport, Connecticut; Lenexa, Kansas; Chicago, Illinois; Nashville, Tennessee; and Charlotte, North Carolina. In Canada, the Company maintains sales offices in Vancouver, British Columbia; Bedford, Nova Scotia; Winnipeg, Manitoba; and Moncton, New Brunswick. The leases for the Company's offices in Edina and Bloomington, Minnesota expire March 31, 1999 and March 31, 2001, respectively and the lease for the executive offices in Hoffman Estates, Illinois expires August 31, 2000. See Note 6 of Notes to Consolidated Financial Statements. The Company's leased facilities are adequate to meet its business requirements. ITEM 3. LEGAL PROCEEDINGS On December 15, 1997, a securities fraud class action was filed in the United States District Court for the Northern District of Illinois against the Company and two of its current and former executive officers. The purported class action was filed on behalf of all persons who purchased common stock of the Company during the period December 7, 1995 through June 10, 1997, seeking damages for alleged violations of the federal securities laws. The complaint in the purported class action alleges that throughout this time period, defendants knowingly participated in a course of conduct involving misrepresentation and concealment of adverse material information about the business and finances of the Company. The complaint alleges that the course of action followed by the defendants caused the plaintiff and other members of the purported class to purchase the Company's securities at artificially inflated prices. The complaint seeks damages suffered as a result of the actions of the defendants, including costs, expenses and fees incurred in the litigation. The Company cannot predict the outcome of this litigation but believes it has meritorious defenses to these allegations and intends to defend itself vigorously. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter ended October 31, 1997. 24 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The Executive Officers of the Company are as follows: William R. Roach Chairman of the Board, President and Chief Executive Officer G. Thomas Ahern Senior Vice President, PLATO Education Sales and Marketing Wellesley R. Foshay Vice President, Instructional Design and Cognitive Learning David H. LePage Vice President, Systems Development, Client Support and Operations Mary Jo Murphy Vice President, Corporate Controller and Chief Accounting Officer John Murray Senior Vice President, Operations Andrew N. Peterson Senior Vice President, Chief Financial Officer, Secretary and Treasurer Steven R. Schuster Vice President and Assistant Treasurer John C. Super Vice President, Marketing Carl Thompson Vice President, Aviation Sales and Operations Executive officers are appointed by, and serve at the discretion of, the Board of Directors. William R. Roach, age 57, has been Chairman of the Board of Directors, President and Chief Executive Officer of the Company since its founding in 1989. Prior to founding the Company, from 1987 to 1988, Mr. Roach was President and Chief Executive Officer of Applied Learning International, Inc. (ALI), a training and education company and successor to Advanced Systems, Inc. (ASI), and a Director and Senior Vice President of ALI's parent, National Education Corporation (NEC). From 1981 to 1987, Mr. Roach was the Chief Executive Officer of ASI, a New York Stock Exchange listed training and education company which was acquired by NEC in 1987. After leaving ALI in 1988, Mr. Roach led a group of investors in pursuing an acquisition in the field of training and education. 25 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT, CONTINUED G. Thomas Ahern, age 39, was promoted to Senior Vice President, PLATO Education Sales and Marketing in October 1997. From January to October 1997, he was Vice President, PLATO Education Sales, North America, and from December 1992 to October 1997 he served as Vice President, U.S. Sales, PLATO Education. Previously, he was Regional Vice President, Sales for the Company since its founding in 1989. From January 1989 to September 1989, Mr. Ahern was National Sales Manager for the training and education group of Control Data Corporation, a computer hardware, software and data services company. Wellesley R. Foshay, Ph.D., age 50, has served as Vice President, Instructional Design and Cognitive Learning since the Company's founding in 1989. From 1987 to 1989, Dr. Foshay was Senior Director, Quality Assurance, Standards and Training for ALI. David H. LePage, age 51, has served in his present capacity, Vice President, Systems Develop-ment, Client Support and Operations, since the Company's founding in 1989. From 1972 to 1989, Mr. LePage was General Manager, Systems Development and Technical Support for the training and education group of Control Data Corporation. Mary Jo Murphy, age 41, joined the Company in August 1993 as Vice President, Corporate Controller and Chief Accounting Officer. From 1986 to 1992, she was Corporate Controller for Krelitz Industries, Inc., a drug distribution company. Ms. Murphy, a Certified Public Accountant, was formerly an Audit Supervisor for Coopers & Lybrand. John Murray, age 42, joined the Company in 1989 as Managing Director of the United Kingdom subsidiary. He has served in his present capacity, Senior Vice President, Operations since October 1997. From April 1996 to October 1997 he held the position of Vice President, Product Development. From November 1994 to March 1996, Mr. Murray was Vice President, Aviation Sales and Operations. He served as Vice President, Eastern Aviation Sales and Operations, from 1991 to 1994. From 1986 to 1989, Mr. Murray was Manager of Training Systems Group for Control Data Limited. Andrew N. Peterson, age 45, joined the Company in April 1997 as Senior Vice President, Chief Financial Officer, Corporate Secretary and Treasurer. From 1995 to 1996 Mr. Peterson was Chief Financial Officer of TSR, Inc., a publishing company. From 1986-1994 Mr. Peterson held the position of Chief Financial Officer of Duplex Products, Inc., a business forms manufacturer. Mr. Peterson is a Certified Public Accountant and holds an MBA from Northern Illinois University. Steven R. Schuster, age 37, joined the Company in December 1996 as Vice President and Assistant Treasurer. From 1993 to 1996, he was Vice President for Norwest Bank, a financial services company. Mr. Schuster was formerly the Assistant Treasurer of St. Jude Medical, Inc. 26 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART I ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT, CONTINUED John C. Super, age 50, joined the Company in 1990 as a Workplace Account Manager. He has served in his present capacity as Vice President, Corporate Marketing, since February 1997. From 1992 through 1996 he served as Vice President, Strategic Sales and during 1991 as Vice President Sales, Eastern Region. Prior to joining TRO, Mr. Super served in sales and management capacities with Wicat Systems and Computer Curriculum Corporation. Carl E. Thompson, age 35, has served in his present capacity as Vice President, Aviation Sales and Operations and Managing Director of the United Kingdom Aviation Training subsidiary since April 1996. From November 1994 to March 1996 has was General Manager of the U.K. subsidiary. From May 1993 to October 1994 he was Manager - Customer Support, of Aviation Training. Prior to joining TRO, Mr. Thompson was Business Manager for CSS Limited, a computer services company. 27 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION: The Company's common stock is publicly traded on the NASDAQ National Market System under the symbol, TUTR. The following table presents the high and low closing prices for the Company's common stock as reported by NASDAQ for each quarter during the years ended October 31, 1997 and 1996: FISCAL 1997 ---------------------------------------- FIRST SECOND THIRD FOURTH --------- -------- ------- ---------- High $ 21.88 $ 11.50 $ 12.13 $ 11.00 Low 10.00 7.06 7.00 7.25 FISCAL 1996 ---------------------------------------- FIRST SECOND THIRD FOURTH --------- -------- ------- ---------- High $ 16.75 $ 17.00 $ 19.75 $ 19.50 Low 5.94 10.00 12.38 14.25 HOLDERS: There were approximately 4,100 stockholders of record as of December 10, 1997 (includes individual participants in security position listings). DIVIDENDS: The Company has not declared or paid dividends on its common stock. The Company's ability to pay dividends is restricted by its revolving loan agreement (see Note 3 of Notes to Consolidated Financial Statements). While future dividend payments are at the discretion of the Board of Directors, the Company is growth-oriented and there is no present intention to pay a cash dividend on its common stock. 28 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (In thousands, except per share data) YEAR ENDED OCTOBER 31, ---------------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ------------ ------------ ------------ ----------- INCOME STATEMENT DATA: Revenues by product line: PLATO Education. . . . . . . . . . . . $ 33,265 $ 36,980 $ 30,613 $ 22,591 $ 17,333 Aviation Training. . . . . . . . . . . 3,694 4,425 6,724 5,774 9,200 ----------- ------------ ------------ ------------ ----------- Total revenues . . . . . . . . . . . . 36,959 41,405 37,337 28,365 26,533 Gross profit . . . . . . . . . . . . . 30,484 35,192 29,669 22,587 21,419 Selling, general and administrative expense. . . . . . . . . . . . . . 36,988 27,537 19,027 15,494 11,144 Product development and customer support. . . . . . . . . . . . . . 8,036 5,307 4,487 7,515 4,671 Operating income (loss). . . . . . . . (14,540) 2,348 6,155 (1,222) 5,604 Interest expense . . . . . . . . . . . (1,317) (723) (300) (344) (102) Provision (credit) for income taxes. . 4,061 564 2,157 (533) 1,950 Income (loss) from continuing operations . . . . . . . . . . . . (20,217) 982 3,752 (889) 3,785 Income (loss) from discontinued operations . . . . . . . . . . . . --- --- --- (1,250) (738) PER SHARE OF COMMON STOCK (Pro forma basis for 1993): Income (loss) from continuing operations . . . . . . . . . . . . (3.24) 0.15 0.60 (0.14) 0.63 Loss from discontinued operations . . . . . . . . . . . . -- --- --- (0.20) (0.12) Net income (loss). . . . . . . . . . . (3.24) 0.15 0.60 0.53 0.76 BALANCE SHEET DATA: Total assets . . . . . . . . . . . . . 29,088 42,327 33,660 26,931 21,312 Total liabilities. . . . . . . . . . . 28,341 21,515 14,158 10,990 8,973 Stockholders' equity . . . . . . . . . 747 20,812 19,502 15,941 12,339 29 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW: The Company is a leading developer and marketer of microcomputer-based, interactive, self-paced instructional systems used in a wide variety of adult settings. Offering comprehensive educational courseware specifically designed for young adult and adult learners, the Company's PLATO-Registered Trademark- Learning Systems are marketed to middle schools and high schools, community colleges, job training programs, correctional institutions, government-funded programs, the military and corporations. The Company's TRO Aviation Training Systems are marketed to airlines worldwide for use by commercial airline pilots, maintenance crews, and cabin personnel. In November 1997, the Company announced that it had retained BancAmerica ROBERTSON STEPHENS to advise it regarding strategic alternatives to enhance shareholder value. FISCAL 1997 COMPARED TO FISCAL 1996: REVENUES: Total revenues of $36,959,000 for 1997 decreased by $4,446,000 or 11% as compared to $41,405,000 for 1996. The following table highlights revenues by product line (in 000's): PLATO Education AVIATION TRAINING TOTAL -------------------- ------- ------- ----------------------- 1997 1996 1997 1996 1997 1996 -------- -------- ------- ------- -------- -------- Courseware license and support . . . . . . . . $27,830 $31,252 $3,390 $4,183 $31,220 $35,435 Hardware, third party courseware and other . . 5,435 5,728 304 242 5,739 5,970 -------- -------- ------- ------- -------- -------- Total revenues. . . . . . . . . . . . . . $33,265 $36,980 $3,694 $4,425 $36,959 $41,405 -------- -------- ------- ------- -------- -------- -------- -------- ------- ------- -------- -------- As summarized in the above table, PLATO Education courseware license and support revenues of $27,830,000 for 1997 decreased by $3,422,000 or 11% as compared to 1996. The majority of this decrease occurred in the fourth quarter of 1997 as compared to 1996. The Company does not anticipate that this is a long term trend. Aviation Training revenues of $3,694,000 decreased by $731,000 or 17% from the prior year, reflecting a general weakness in the aviation industry. The Company's quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions by the Company, product shipments, client funding issues, marketing expenditures, product development expenditures and promotional programs. The Company historically has experienced higher levels of revenues in its fourth fiscal quarter. 30 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED FISCAL 1997 COMPARED TO FISCAL 1996, CONTINUED GROSS PROFIT: Gross profit for 1997 decreased by $4,708,000 or 13% to $30,484,000 as compared to $35,192,000 for 1996. This decrease was due principally to the decline in PLATO Education courseware revenues. The Company's gross margin was 82% for 1997 as compared to 85% for 1996, reflecting the decline in courseware revenues. PLATO Education gross margin for 1997 was 83% compared to 86% for 1996. Aviation Training gross margin was 81% for 1997 compared to 76% for 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE: Selling, general, and administrative expense for 1997 increased by $9,451,000 or 34% to $36,988,000 as compared to $27,537,000 for 1996. This increase was principally due to the additional provision for doubtful accounts of approximately $5,132,000 recorded in 1997, when it was determined that payment for numerous sales contracts would not be received. The majority of these sales were to customers which are dependent upon various government funding sources, and therefore subject to standard non-appropriation of funds. This one time adjustment is not expected to recur in future years. In addition, PLATO Education selling expense increased by approximately $2,736,000, primarily for salaries, fringe benefits and travel due to the expansion of the sales and service organization. In late fiscal 1997, the Company initiated plans to restructure its operations to achieve significant cost reductions and improve operating efficiencies. PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT: Product development and customer support expense for 1997 increased by $2,729,000 or 51% to $8,036,000 as compared to $5,307,000 for 1996. While PLATO Education product development spending was comparable for 1997 as compared to 1996, product development expense increased principally as a result of decreased capitalization and the increased effect of amortization of previously capitalized costs. 31 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED FISCAL 1997 COMPARED TO FISCAL 1996, CONTINUED OPERATING INCOME (LOSS): Operating loss for 1997 was $(14,540,000) as compared to operating income of $2,348,000 for 1996. This decline was due primarily to the decrease in PLATO Education revenues and gross profit, and the increase in PLATO Education selling, bad debt and product development expenses. INTEREST EXPENSE: Interest expense was $1,317,000 for 1997 as compared to $723,000 for 1996. Interest expense increased due to the Company's long term debt incurred during 1997. PROVISION FOR INCOME TAXES: The Company took a non-cash tax charge of $4,061,000 in 1997 to record a valuation allowance against the deferred tax asset. Such valuation allowance has been provided based on the inherent uncertainty of predicting the sufficiency of the future taxable income necessary to realize the benefit of the net deferred tax asset in light of the Company's recent loss history and the competitive nature of the industry in which the Company operates. FISCAL 1996 COMPARED TO FISCAL 1995: REVENUES: Total revenues of $41,405,000 for 1996 increased by $4,068,000 or 11% as compared to $37,337,000 in 1995. The following table highlights revenues by product line (in 000's): PLATO Education AVIATION TRAINING TOTAL --------------------------------------------------------------------------- 1996 1995 1996 1995 1996 1995 --------- --------- --------- -------- --------- ------- Courseware license and support . . . . . . . . $31,252 $ 25,612 $ 4,183 $ 4,599 $ 35,435 $30,211 Hardware, third party courseware and other . . 5,728 5,001 242 2,125 5,970 7,126 --------- --------- --------- -------- --------- ------- Total revenues. . . . . . . . . . . . . . $36,980 $ 30,613 $ 4,425 $ 6,724 $ 41,405 $37,337 --------- --------- --------- -------- --------- ------- --------- --------- --------- -------- --------- ------- As summarized in the above table, PLATO Education revenues of $36,980,000 for 1996 increased by $6,367,000 or 21% as compared to 1995. This increase can be attributed to increased market penetration resulting from the expansion of the PLATO Education sales force and new products. 32 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED FISCAL 1996 COMPARED TO FISCAL 1995, CONTINUED REVENUES, CONTINUED: Aviation Training revenues of $4,425,000 decreased by $2,299,000 or 34% from the prior year, due principally to a decline in low margin hardware sales, reflecting the Company's focus on the sale of high margin courseware products. The decline in Aviation Training courseware revenues reflects a general weakness in the aviation industry. The Company's quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions by the Company, product shipments, client funding issues, marketing expenditures, product development expenditures and promotional programs. The Company historically has experienced higher levels of revenues in its fourth fiscal quarter. GROSS PROFIT: Gross profit for 1996 increased by $5,523,000 or 19% to $35,192,000 as compared to $29,669,000 for 1995. This increase was due principally to PLATO Education revenue growth and a favorable mix of courseware revenue. The Company's gross margin was 85% for 1996 as compared to 79% for 1995. Increased courseware revenues and a decline in hardware revenues resulted in a significantly improved gross margin for 1996. PLATO Education gross margin for 1996 was 86% compared to 84% for 1995. Aviation Training gross margin was 76% for 1996 compared to 57% for 1995. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE: Selling, general, and administrative expense for 1996 increased by $8,510,000 or 45% to $27,537,000 as compared to $19,027,000 for 1995. PLATO Education sales and marketing expenses, including commissions, increased $6,264,000, principally as a result of the growth in sales volume and the planned expansion of the sales and service organization. In addition, in the fourth quarter of 1996, the Company recorded a provision for doubtful accounts of approximately $1,700,000. 33 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED FISCAL 1996 COMPARED TO FISCAL 1995, CONTINUED PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT: Product development and customer support expense for 1996 increased by $820,000 or 18% to $5,307,000 as compared to $4,487,000 for 1995. Product development expense of $2,947,000 increased by $366,000, or 14%, as a result of increased Aviation Training product development spending as well as a slight increase in PLATO Education spending. During fiscal 1996, the Company developed a new, state-of-the-art, Windows-based instructional management system that will replace the current DOS-based curriculum manager for systems that support the Windows operating system. These costs were offset by a decrease in spending due to the completion of the PLATO WorkSkills curricula. Customer support expense for PLATO Education of $2,097,000 increased by $438,000, or 26%, as a result of increased revenue levels and the broadening customer base. OPERATING INCOME: Operating income for 1996 was $2,348,000 as compared to $6,155,000 for 1995. This decline was due primarily to PLATO Education increased revenues and gross profit being more than offset by increased sales and marketing and customer support expenses. INTEREST EXPENSE: Interest expense was $723,000 for 1996 as compared to $300,000 for 1995. Interest expense increased due to a higher level of borrowings under the Company's revolving loan agreement during 1996. In addition, the sale of certain installment receivables at a discount resulted in the recognition of interest expense in the second quarter of fiscal 1996 (see Note 2 of Notes to Consolidated Financial Statements). LIQUIDITY AND CAPITAL RESOURCES: As of October 31, 1997, the Company's principal sources of liquidity included cash and cash equivalents of $537,000, net accounts receivable of $18,305,000 and its line of credit. The Company has total installment receivables of $6,829,000 at October 31, 1997, of which $6,264,000 are due within one year and are included in net accounts receivable. Net cash used in the Company's operating activities was $5,677,000 in 1997, $4,223,000 in 1996, and $4,782,000 in 1995. Cash flows from operations were used principally to fund the Company's working capital requirements. In addition to cash flows from operations, the Company has 34 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED LIQUIDITY AND CAPITAL RESOURCES, CONTINUED resources available under its revolving loan agreement to provide borrowings up to a maximum of $18,000,000 (see Note 3 of Notes to Consolidated Financial Statements). At October 31, 1997, borrowings of $8,908,000 were outstanding at an interest rate of 10%. The agreement provides for financial covenants which require a minimum level of operating profit and a minimum liabilities to equity ratio. The Company did not comply with the financial covenants for the year ended October 31, 1997. On December 8, 1997 the loan agreement was amended to waive compliance with certain covenants for the period ended October 31, 1997, to reset such covenants, to provide additional borrowings up to a maximum of $3,500,000 from time to time during certain periods of the term of the loan agreement and to extend the commitment through August 31, 1998. Additionally, the amendment terminated the Company's option to incur LIBOR-based interest loans and the option to automatically extend the commitment for an additional two years. The Company's net cash flow used in investing activities was $762,000 in 1997 and $1,020,000 in 1996 principally for capital expenditures. The Company's net cash flow provided by investing activities was $1,557,000 in 1995, principally from the sale of marketable securities to fund working capital needs. The Company's capital expenditures totaled $762,000, $1,033,000, and $668,000 in 1997, 1996 and 1995, respectively. At October 31, 1997, the Company had no material commitments for capital expenditures. The Company's net cash flow provided by financing activities was $6,527,000 in 1997, principally from long term debt issued, and $5,429,000 in 1996 and $3,319,000 in 1995, principally from borrowings under the line of credit. The Company took a non-cash tax charge of $4,061,000 in 1997 to record a valuation allowance against the deferred tax asset. Such valuation allowance has been provided based on the inherent uncertainty of predicting the sufficiency of the future taxable income necessary to realize the benefit of the net deferred tax asset in light of the Company's recent loss history and the competitive nature of the industry in which the Company operates. In prior years the primary differences between pretax earnings for financial reporting purposes and taxable income for income tax purposes included revenue recognition, the capitalization of product development costs and various reserves. The Company has net operating loss carryforwards of approximately $27.5 million which do not start expiring until 2004. 35 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED LIQUIDITY AND CAPITAL RESOURCES, CONTINUED From time to time, the Company evaluates making acquisitions of products or businesses that complement the Company's core business. The Company has no present understandings, commitments, or agreements with respect to any material acquisitions of other businesses, products, or technologies. However, the Company may consider and acquire other complementary businesses, products, or technologies in the future. The Company is currently reviewing financing alternatives to meet its short and long-term working capital, capital expenditure, and business investment requirements. 36 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page (a) (1) Consolidated Financial Statements: Report of Independent Accountants. . . . . . . . . . . . . . . 38 Consolidated Balance Sheets as of October 31, 1997 and 1996. . 39 Consolidated Statements of Income for the years ended October 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . 40 Consolidated Statements of Stockholders' Equity for the years ended October 31, 1997, 1996 and 1995. . . . . . . . . . . . . 41 Consolidated Statements of Cash Flows for the years ended October 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . 42 Notes to Consolidated Financial Statements . . . . . . . . . . 43-53 (2) Consolidated Financial Statement Schedule for the years ended October 31, 1997, 1996 and 1995: Report of Independent Accountants on Consolidated Financial Statement Schedule . . . . . . . . . . . . . . . . . . . . . . 57 Schedule II. Valuation and Qualifying Accounts and Reserves. . 58 All other schedules called for under Regulation S-X are not submitted because they are not applicable, or because the required information is not material or is included in the consolidated financial statements or notes thereto. 37 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of TRO Learning, Inc. We have audited the accompanying consolidated balance sheets of TRO Learning, Inc. and Subsidiaries as of October 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 31, 1997. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of TRO Learning, Inc. and Subsidiaries as of October 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1997 in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Chicago, Illinois January 12, 1998 38 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) OCTOBER 31, ----------------------- 1997 1996 ---------- -------- ASSETS Current assets: Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 537 $ 475 Accounts receivable, less allowances of $7,020 and $510, respectively . . . . . . . . . . . . 18,305 24,163 Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 1,097 Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . 688 1,051 -------- -------- Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,520 26,786 Equipment and leasehold improvements, less accumulated depreciation of $4,092 and $3,250, respectively. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,271 1,368 Product development costs, less accumulated amortization of $2,562 and $680, respectively . . . 5,989 5,528 Deferred tax asset. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . --- 5,906 Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,308 2,739 -------- -------- $29,088 $42,327 -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,472 $ 2,588 Accrued employee salaries and benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,199 3,079 Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,072 3,705 Revolving loan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,908 8,612 Deferred tax liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . --- 1,845 Deferred revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,949 1,137 -------- -------- Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,600 20,966 Long term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,050 --- Deferred revenue, less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 519 296 Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 253 Stockholders' equity: Common stock, $.01 par value, 25,000 shares authorized; 6,450 shares issued and 6,405 shares outstanding in 1997; 6,190 shares issued and 6,167 shares outstanding in 1996 . . . . . . . . . . . . . . . . . 64 62 Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,074 21,634 Treasury stock at cost, 45 and 23 shares, respectively. . . . . . . . . . . . . . . . . . . . (469) (208) Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (20,660) (443) Foreign currency translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . (262) (233) -------- -------- Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 20,812 -------- -------- $29,088 $42,327 -------- -------- -------- -------- See Notes to Consolidated Financial Statements 39 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED OCTOBER 31, -------------------------------------- 1997 1996 1995 ---------- --------- --------- Revenues by product line: PLATO Education.............................................. $33,265 $36,980 $30,613 Aviation Training............................................ 3,694 4,425 6,724 ---------- --------- --------- Total revenues............................................. 36,959 41,405 37,337 Cost of revenues............................................... 6,475 6,213 7,668 ---------- --------- --------- Gross profit............................................... 30,484 35,192 29,669 ---------- --------- --------- Operating expenses: Selling, general and administrative expense.................. 36,988 27,537 19,027 Product development and customer support..................... 8,036 5,307 4,487 ---------- --------- --------- Total operating expenses................................... 45,024 32,844 23,514 ---------- --------- --------- Operating income (loss).................................. (14,540) 2,348 6,155 Interest expense............................................... (1,317) (723) (300) Interest income and other expense, net......................... (299) (79) 54 ---------- --------- --------- Income (loss) before income taxes........................ (16,156) 1,546 5,909 Provision for income taxes..................................... 4,061 564 2,157 ---------- --------- --------- Net income (loss)........................................ $(20,217) $ 982 $3,752 ---------- --------- --------- ---------- --------- --------- Income (loss) per common and common equivalent share: Net income (loss)........................................ $ (3.24) $ 0.15 $ 0.60 ---------- --------- --------- ---------- --------- --------- Weighted average common and common equivalent shares outstanding.............................................. 6,233 6,643 6,280 ---------- --------- --------- ---------- --------- --------- See Notes to Consolidated Financial Statements 40 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS) COMMON STOCK ---------------------------------------------- FOREIGN CURRENCY TOTAL TREASURY ACCUMULATED TRANSLATION STOCKHOLDERS' SHARES AMOUNT PAID IN CAPITAL STOCK DEFICIT ADJUSTMENT EQUITY ------- ------- --------------- -------- ----------- ------------ ------------ Balances, November 1, 1994. . . . . . . . 6,073 $ 61 $ 21,291 --- $ (5,177) $(234) $15,941 Net income. . . . . . . . . . . . . . . --- --- --- --- 3,752 --- 3,752 Exercise of stock options and shares issued under employee stock purchase plan. . . . . . . . . . . . 27 --- 54 --- --- --- 54 Repurchase of shares. . . . . . . . . . (28) --- --- (183) --- --- (183) Changes in exchange rates . . . . . . . --- --- --- --- --- (62) (62) ------- ------- --------------- -------- ----------- ------------ ------------ Balances, October 31, 1995. . . . . . . . 6,072 61 21,345 (183) (1,425) (296) 19,502 Net income. . . . . . . . . . . . . . . --- --- --- --- 982 --- 982 Exercise of stock options and shares issued under employee stock purchase plan. . . . . . . . . . . . 99 1 289 50 --- --- 340 Repurchase of shares. . . . . . . . . . (4) --- --- (75) --- --- (75) Changes in exchange rates . . . . . . . --- --- --- --- --- 63 63 ------- ------- --------------- -------- ----------- ------------ ------------ Balances, October 31, 1996. . . . . . . . 6,167 62 21,634 (208) (443) (233) 20,812 Net loss. . . . . . . . . . . . . . . . --- --- --- --- (20,217) --- (20,217) Exercise of options, stock grants and shares issued under employee stock purchase plan . . . . . . . . . . . . 260 2 440 --- --- --- 442 Repurchase of shares. . . . . . . . . . (22) --- --- (261) --- --- (261) Changes in exchange rates . . . . . . . --- --- --- --- --- (29) (29) ------- ------- --------------- -------- ----------- ------------ ------------ Balances, October 31, 1997. . . . . . . . 6,405 $ 64 $ 22,074 $(469) $(20,660) $(262) $ 747 ------- ------- --------------- -------- ----------- ------------ ------------ ------- ------- --------------- -------- ----------- ------------ ------------ See Notes to Consolidated Financial Statements 41 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) YEAR ENDED OCTOBER 31, ---------------------------------------- 1997 1996 1995 ---------- --------- --------- Cash flows from operating activities: Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . $(20,217) $ 982 $3,752 ---------- --------- --------- Adjustments to reconcile net income (loss) to net cash used in operating activities: Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . 4,061 564 2,157 Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . 2,644 1,466 807 Provision for doubtful accounts. . . . . . . . . . . . . . . . . . . . 7,252 2,120 300 Disposal of fixed assets . . . . . . . . . . . . . . . . . . . . . . . 2 180 41 Amortization of deferred revenue . . . . . . . . . . . . . . . . . . . --- --- (251) Changes in assets and liabilities: Increase in accounts receivable. . . . . . . . . . . . . . . . . . . (1,394) (8,680) (6,153) (Increase) decrease in inventories . . . . . . . . . . . . . . . . . 107 (52) 141 (Increase) decrease in prepaid expenses and other current and noncurrent assets. . . . . . . . . . . . . . . . . . . . . . . 1,794 1,255 (1,746) Increase in product development costs. . . . . . . . . . . . . . . . (2,251) (3,356) (2,851) Increase in accounts payable. . . . . . . . . . . . . . . . . . . . 884 341 144 Increase (decrease) in accrued liabilities, accrued employee salaries and benefits and other liabilities. . . . . . . . . . . . 406 742 (522) Increase (decrease) in deferred revenue. . . . . . . . . . . . . . . 1,035 215 (601) ---------- --------- --------- Total adjustments. . . . . . . . . . . . . . . . . . . . . . . . . 14,540 (5,205) (8,534) ---------- --------- --------- Net cash used in operating activities. . . . . . . . . . . . . . . (5,677) (4,223) (4,782) ---------- --------- --------- Cash flows from investing activities: Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . (762) (1,033) (668) Proceeds from disposal of fixed assets . . . . . . . . . . . . . . . . --- 13 --- Decrease in marketable securities. . . . . . . . . . . . . . . . . . . --- --- 2,225 ---------- --------- --------- Net cash provided by (used in) investing activities . . . . . . . . (762) (1,020) 1,557 ---------- --------- --------- Cash flows from financing activities: Proceeds from issuance of long-term debt . . . . . . . . . . . . . . . 6,050 --- --- Net proceeds from short term borrowings. . . . . . . . . . . . . . . . 296 5,164 3,448 Net proceeds from the issuance of common stock . . . . . . . . . . . . 442 290 54 Purchase of treasury stock . . . . . . . . . . . . . . . . . . . . . . (261) (25) (183) ---------- --------- --------- Net cash provided by financing activities. . . . . . . . . . . . . . 6,527 5,429 3,319 ---------- --------- --------- Effect of foreign currency on cash . . . . . . . . . . . . . . . . . . . (26) 58 (63) ---------- --------- --------- Net increase in cash and cash equivalents. . . . . . . . . . . . . . . . 62 244 31 Cash and cash equivalents at beginning of period . . . . . . . . . . . . 475 231 200 ---------- --------- --------- Cash and cash equivalents at end of period . . . . . . . . . . . . . . . $537 $475 $231 ---------- --------- --------- ---------- --------- --------- Cash paid for interest expense . . . . . . . . . . . . . . . . . . . . . $1,234 $829 $293 ---------- --------- --------- ---------- --------- --------- See Notes to Consolidated Financial Statements 42 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS: TRO Learning, Inc. and its subsidiaries (the Company) develop and market microcomputer-based, interactive, self-paced instructional systems. The Company markets such systems primarily to educational institutions and private industry. The Company's fiscal year is from November 1 to October 31. Unless otherwise stated, references to the years 1997, 1996 and 1995 relate to the fiscal years ended October 31, 1997, 1996 and 1995, respectively. PRINCIPLE OF CONSOLIDATION: The accompanying consolidated financial statements include the accounts of TRO Learning, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CONCENTRATION OF CREDIT RISK: Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable. Credit risk is minimized as a result of the large number of the Company's customers. The Company performs evaluations of its customers' credit worthiness and generally requires no collateral from its customers. Although many of the Company's educational customers are dependent upon various government funding sources, and are subject to non-appropriation of funds, the Company does not believe there is a significant concentration of risk associated with any specific governmental program or funding source. Reserves have been established for numerous sales contracts for which payments were not received in 1997 due to non-appropriation of funds. As of October 31, 1997, the Company had no significant concentrations of credit risk. 43 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED CASH EQUIVALENTS: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Such investments are carried at cost, which approximates fair value. INVENTORIES: Inventories, which consist principally of goods purchased for resale, are stated at the lower of cost (first in, first out) or market. EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Equipment and leasehold improvements are stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Upon retirement or disposition, cost and related accumulated depreciation are removed from the accounts, and any gain or loss is included in the results of operations. Maintenance and repairs are expensed as incurred. OTHER ASSETS: Other assets include principally intangible assets and installment receivables with terms greater than one year. FAIR VALUE OF FINANCIAL INSTRUMENTS: The fair value of the Company's debt is estimated to approximate the carrying value of these liabilities based upon borrowing rates currently available to the Company for borrowings with similar terms. REVENUE RECOGNITION: Revenue from the sale of education and training courseware licenses, computer hardware and related support services, principally maintenance, is recognized when the courseware, hardware, and related services are delivered. Upon delivery, future service costs, if any, are accrued. Future service costs represent the Company's problem resolution and support "hotline" service for a one year period. Deferred revenue represents the portion of billings made or payments received in advance of services being performed or products being delivered. 44 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED PRODUCT DEVELOPMENT, ENHANCEMENT, AND MAINTENANCE COSTS: The Company develops education and training products, referred to hereafter as courseware products. Costs incurred in the development of the Company's current generation courseware products and related enhancements and routine maintenance thereof are expensed as incurred. All costs incurred by the Company in establishing the technical feasibility of new courseware products to be sold, leased, or otherwise marketed are expensed as incurred. Once technical feasibility has been established, costs incurred in the development of new generation courseware products are capitalized. Amortization is provided over the estimated useful life of the new courseware products, generally three years, using the straight-line method. Amortization begins when the product is available for general release to customers. Unamortized capitalized costs determined to be in excess of the net realizable value of the product are expensed at the date of such determination. INCOME TAXES: The Company accounts for income taxes as required under the provisions of Statement of Financial Accounting Standards 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. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. In addition, the amount of any future tax benefits are reduced by a valuation allowance to the extent such benefits are not expected to be realized. COMPUTATION OF INCOME (LOSS) PER SHARE: Income (loss) per share is based upon the weighted average number of shares of common stock outstanding and, where dilutive, common equivalent shares from stock options and warrants (using the treasury stock method) and other potentially dilutive securities. Fully diluted income (loss) per share is not presented since the results are equivalent to primary income (loss) per share. FOREIGN CURRENCY TRANSLATION: Results of operations for foreign entities are translated using the average exchange rates during the period. Assets and liabilities are translated using the exchange rate in effect at the balance sheet date. Resulting translation adjustments are recorded as a separate component of stockholders' equity. 45 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED NEW ACCOUNTING STANDARDS: In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards 128, "Earnings Per Share" (SFAS 128), which requires the dual presentation of basic and diluted earnings per share. Under SFAS 128, the dilutive effect of stock options is excluded for calculating basic earnings per share. The Company will be required to adopt SFAS 128 beginning in the interim period ending January 31, 1998, and all prior periods are required to be restated. There will be no impact on reported earnings per share for 1997 because the Company incurred a loss for the period. The impact is expected to result in an increase to reported earnings per share of $0.01 for 1996. In June 1997, the FASB issued Statement of Financial Accounting Standards 130, "Reporting Comprehensive Income" (SFAS 130). Under SFAS 130, companies are required to report comprehensive income as a measure of overall performance. Comprehensive income includes all changes in equity during a reporting period, except those resulting from investments by owners and distributions to owners. The Company will adopt SFAS 130 for the fiscal year ending October 31, 1999. In June 1997, the FASB issued Statement of Financial Accounting Standards 131, "Disclosure About Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 redefines how operating segments are determined and requires expanded quantitative and qualitative disclosures relating to an entity's operating segments. The Company will adopt SFAS 131 for the fiscal year ending October 31, 1999. The American Institute of Certified Public Accountants has issued Statement of Position 97-2 "Software Revenue Recognition". SOP 97-2 is effective for transactions entered into in fiscal years beginning after December 15, 1997 and provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The Company does not expect the application of the SOP to have a material impact on the Company's financial condition or results of operations. 2. ACCOUNTS RECEIVABLE: Accounts receivable include net installment receivables of $6,264,000 and $13,023,000 at October 31, 1997 and 1996, respectively. Installment receivables with terms greater than one year were $565,000 and $1,909,000 at October 31, 1997 and 1996, respectively, and are included in other assets on the consolidated balance sheets. The provision for doubtful accounts, included in selling, general and administrative expenses on the consolidated statements of income, was $7,252,000, $2,120,000 and $300,000 for 1997, 1996 and 1995, respectively. During 1996 and 1995, the Company sold certain installment receivables, on a non-recourse basis, to financial institutions. Approximately $735,000 and $1,081,000 of receivables were sold at their discounted present value of approximately $599,000 and $981,000 in 1996 and 1995, respectively, at an effective rate of 8.6% and 9.3%, respectively. The difference between the gross receivable amount and the proceeds has been recorded as interest expense in the consolidated statements of income. 46 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 3. DEBT: The components of debt at October 31 are as follows (in thousands): 1997 1996 ------ ------ Current: Revolving loan........................... $ 8,908 $8,612 15% term loan............................ 3,000 --- ------- ------ Total current debt..................... $11,908 $8,612 ------- ------ ------- ------ Long term: 10% subordinated convertible debentures.. $ 3,050 $ --- ------- ------ ------- ------ The weighted average interest rate of borrowings outstanding under the revolving loan was 10% and 8.9% at October 31,1997 and 1996, respectively. In March 1997, the Company expanded its revolving loan agreement to provide for a maximum $18 million line of credit. The agreement has a commitment through August 2, 1998 with an option to extend for an additional two years. Substantially all of the Company's assets are pledged as collateral under the agreement. Borrowings are limited by the available borrowing base, as defined, consisting primarily of certain accounts receivable and inventory, and bear interest at the prime rate plus 1.5% or the LIBOR rate plus 3.25%, as determined by the Company. A commitment fee is payable based on the unused portion of the line of credit. The agreement provides for restrictions on dividends, investments, additional indebtedness, and the sale of assets, as defined, and for financial covenants requiring a minimum level of operating profit and a minimum liabilities to equity ratio. The Company did not comply with the financial covenants for the period ended October 31, 1997. On December 8, 1997, the loan agreement was amended to waive compliance with certain covenants for the period ended October 31, 1997, to reset such covenants, to provide additional borrowings up to a maximum of $3,500,000 from time to time during certain periods of the term of the loan agreement and to extend the commitment through August 31, 1998. Additionally, the amendment terminated the Company's option to incur LIBOR-based interest loans and the option to automatically extend the commitment for an additional two years. In addition, the expanded revolving loan agreement makes available a $3 million term loan, at an annual interest rate of 15%, during the remaining term of the agreement. The funds were borrowed in May 1997 and used to reduce the balance of the outstanding revolving loan. Also, in March 1997, the Company issued $3,050,000 of 10% subordinated convertible debentures with interest payable semiannually. At the option of the holder, the debentures are convertible into the Company's common stock at $9.60 per share. The Company may redeem the debentures at 101% of principal, plus interest, subject to certain terms and conditions. The debentures have a scheduled maturity in 2004 and are subject to mandatory redemption at 25% of principal annually beginning in 2001. 47 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 3. DEBT, CONTINUED Scheduled maturities of long term debt are as follows (in thousands): 2001....................... $ 763 2002....................... 763 Thereafter................. 1,524 -------- $ 3,050 -------- -------- 4. INCOME TAXES: The components of income (loss) before provision for income taxes are as follows (in thousands): 1997 1996 1995 --------- ------- ------- United States . . . . . . . . . $(13,432) $2,066 $6,646 Foreign . . . . . . . . . . . . (2,724) (520) (737) --------- ------- ------- $(16,156) $1,546 $5,909 --------- ------- ------- --------- ------- ------- The components of the provision for income taxes are as follows (in thousands): 1997 1996 1995 --------- ------- ------- Federal . . . . . . . . . . . . $ 3,397 $ 703 $ 2,260 Foreign . . . . . . . . . . . . 408 (178) (269) State and local . . . . . . . . 256 39 166 --------- ------- ------- $ 4,061 $ 564 $ 2,157 --------- ------- ------- --------- ------- ------- The provision for income taxes differs from the amount computed by applying the U.S. federal statutory income tax rate to income (loss) before income taxes. The principal reasons for the differences are as follows (in thousands): 1997 1996 1995 --------- ------- ------- U.S. federal statutory rate at 34% $ (5,493) $ 525 $ 2,009 State taxes, net of U.S. federal income tax . . . . . . . . . (565) 52 166 Other . . . . . . . . . . . . . 10,119 (13) (18) --------- ------- ------- $ 4,061 $ 564 $ 2,157 --------- ------- ------- --------- ------- ------- 48 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 4. INCOME TAXES, CONTINUED The components of the deferred tax asset at October 31, are as follows (in thousands): 1997 1996 -------------------------- -------------------------- TEMPORARY TEMPORARY DIFFERENCE TAX EFFECTED DIFFERENCE TAX EFFECTED ---------- ------------ ----------- ------------- Current: Revenue recognition . . . . . . . . . . . . . . $ (3,793) $ (1,385) $(8,285) $ (3,065) Accrued liabilities and reserves. . . . . . . . 7,701 2,811 3,297 1,220 ---------- ------------ ----------- ------------- Total current deferred tax asset (liability). . . . . . . . . . . . . . . . . 3,908 1,426 (4,988) (1,845) ---------- ------------ ----------- ------------- Long-term: Net operating loss carryforwards. . . . . . . . 26,498 9,673 18,516 6,851 Product development expense recognition. . . . . . . . . . . . . . . . . (3,133) (1,144) (2,668) (987) Discontinued operations reserve . . . . . . . . 500 183 1,000 370 Equipment basis difference. . . . . . . . . . . 812 296 646 239 Revenue recognition . . . . . . . . . . . . . . (517) (189) (1,024) (379) Other . . . . . . . . . . . . . . . . . . . . . (345) (126) (356) (188) ---------- ------------ ----------- ------------- Total long-term deferred tax asset . . . . . 23,815 8,693 16,114 5,906 ---------- ------------ ----------- ------------- $ 27,723 $ 10,119 $11,126 $ 4,061 ---------- ----------- ---------- ----------- Less valuation allowance (10,119) --- ------------ ------------- $ --- $ 4,061 ------------ ------------- ------------ ------------- The Company took a non-cash charge of $4,061,000 in 1997 to record a valuation allowance against the deferred tax asset. Such valuation allowance has been provided based on the inherent uncertainty of predicting the sufficiency of the future taxable income necessary to realize the benefit of the net deferred tax asset in light of the Company's recent loss history and the competitive nature of the industry in which the Company operates. At October 31, 1997, the Company had a federal net operating loss carryforward of $21,639,000 and a foreign net operating loss carryforward of $5,854,000. These net operating loss carryforwards begin to expire in 2004. 49 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 5. STOCKHOLDERS' EQUITY: STOCK INCENTIVE AND STOCK OPTION PLANS: The Company has adopted various stock incentive and stock option plans that authorize the granting of stock options, stock appreciation rights, and stock awards to directors, officers and key employees, subject to certain conditions, including continued employment. Under these plans, 1,953,540 shares are reserved for granting. In September 1997, stock awards totaling 101,000 shares of the Company's common stock were granted to certain key employees for the purchase price of $1.00 per share. These shares vest over a five-year period and they may not be sold or transferred. Stock options are granted with an exercise price equal to the fair market value of the Company's common stock on the date of grant. All options become exercisable ratably over three years and expire ten years from the grant date. Effective for 1997, the Company has adopted the disclosure only provisions of SFAS 123, "Accounting for Stock-Based Compensation". All stock options are granted at an exercise price equal to the fair market value on the grant date and, accordingly, no compensation expense has been recognized in the accompanying consolidated financial statements. Had compensation expense been recognized based on the fair value of options granted, consistent with the provisions of SFAS 123, the Company's net income (loss) and net income (loss) per share would have been changed to the pro forma amounts as follows (in thousands, except per share amounts): AS REPORTED PRO FORMA ------------- ------------- Net income (loss): 1997 $ (20,217) $ (20,816) 1996 982 (40) Net income (loss) per share: 1997 $ (3.24) $ (3.34) 1996 0.15 (0.01) The fair value of these options was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: Expected life: 5 years Interest rate: 5.5 to 6.7% Volatility: 70% to 73% Dividend yield: None 50 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 5. STOCKHOLDERS' EQUITY, CONTINUED STOCK INCENTIVE AND STOCK OPTION PLANS, Continued Information regarding stock option plans is as follows (in thousands): 1997 1996 1995 ------ ------ ------ Options at beginning of year 1,016 937 713 Options granted 151 196 259 Options exercised (148) (96) (19) Options forfeited (67) (21) (16) ------ ------ ------ Options outstanding at end of year 952 1,016 937 ------ ------ ------ ------ ------ ------ Options exercisable at end of year 646 623 562 ------ ------ ------ ------ ------ ------ Weighted average option prices: Outstanding at beginning of year $ 7.77 $6.12 $5.70 Granted 9.85 13.19 6.79 Exercised 2.68 2.89 0.77 Forfeited 12.88 6.81 4.92 Outstanding at end of year 8.53 7.77 6.12 Exercisable at end of year 7.76 6.25 5.34 STOCK WARRANTS AND CONVERTIBLE SECURITIES: In March 1997, the Company issued subordinated debentures which are convertible into shares of common stock at $9.60 per share (see Note 3). Concurrent with this issuance, the Company issued approximately 51,000 warrants to purchase common stock at $9.60 per share. The warrants expire from 2002 to 2007. 6. COMMITMENTS: The Company leases its warehouse, sales and administration facilities. Certain of these leases contain renewal options, escalation clauses and requirements that the Company pay taxes, insurance and maintenance costs. Commitments for future minimum rental payments under noncancelable leases for the next five years ending October 31, are as follows (in thousands): 1998......................$1,339 1999.........................792 2000.........................244 2001..........................19 2002...........................5 Rent expense was $1,616,000, $1,413,000 and $1,251,000 for 1997, 1996 and 1995, respectively. 51 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 6. COMMITMENTS, CONTINUED In December 1996, the Company extended an agreement for rights to distribute certain products. In consideration for this license, the Company agreed to pay royalties through April 1999. For each of the two years ended April 30, 1998 and 1999, the guaranteed minimum royalty is $625,000. Revenue from the sale of these products is recognized when the products are delivered to the customer, at which time costs are accrued for the earned royalty. 7. INDUSTRY SEGMENT AND GEOGRAPHIC AREA INFORMATION: The Company operates in one industry segment, namely education and training. Information about the Company's operations in different geographic areas is as follows (in thousands): YEAR ENDED OCTOBER 31 --------------------------------- 1997 1996 1995 -------- -------- -------- Revenues from unaffiliated customers: United States. . . . . . . . . . . . . $ 30,779 $33,217 $27,471 Canada . . . . . . . . . . . . . . . . 1,644 2,955 2,871 United Kingdom . . . . . . . . . . . . 4,536 5,233 6,995 -------- -------- -------- $ 36,959 $41,405 $37,337 -------- -------- -------- -------- -------- -------- Operating income (loss): United States. . . . . . . . . . . . . $(11,856) $3,006 $6,546 Canada . . . . . . . . . . . . . . . . (1,444) (528) (364) United Kingdom . . . . . . . . . . . . (1,240) (130) (27) -------- -------- -------- $(14,540) $2,348 $ 6,155 -------- -------- -------- -------- -------- -------- Total assets: United States. . . . . . . . . . . . $ 23,398 $35,497 $27,392 Canada . . . . . . . . . . . . . . . 1,026 2,322 2,052 United Kingdom . . . . . . . . . . . 4,664 4,508 4,216 -------- -------- -------- $ 29,088 $42,327 $33,660 -------- -------- -------- -------- -------- -------- Revenues from affiliates, while not significant, are recorded at established intercompany selling prices which are based upon cost plus mark-up. 52 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED - -------------------------------------------------------------------------------- 8. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED): (In thousands, except per share data) JAN 31 APR 30 JUL 31 OCT 31 TOTAL ------- ------- ------- ------- ------- 1997: - ---- Revenues by product line: PLATO Education. . . . . . . $4,265 $6,224 $10,674 $12,102 $33,265 Aviation Training. . . . . . 822 1,376 669 827 3,694 ------ ------ ------- ------- ------- Total revenues . . . . . . . 5,087 7,600 11,343 12,929 36,959 Gross profit . . . . . . . . . 4,307 6,249 9,582 10,346 30,484 Net loss . . . . . . . . . . . (2,315) (2,281) (1,080) (14,541) (20,217) Net loss per common and common equivalent share. (0.37) (0.37) (0.17) (2.31) (3.24) 1996: - ---- Revenues by product line: PLATO Education. . . . . . . $4,545 $6,021 $10,917 $15,497 $36,980 Aviation Training. . . . . . 1,864 720 484 1,357 4,425 ------ ------ ------- ------- ------- Total revenues . . . . . . . 6,409 6,741 11,401 16,854 41,405 Gross profit . . . . . . . . . 5,195 6,109 9,422 14,466 35,192 Net income (loss). . . . . . . (1,049) (988) 725 2,294 982 Net income (loss) per common and common equivalent share . . . . . . (0.17) (0.16) 0.11 0.34 0.15 9. SUBSEQUENT EVENTS: In November 1997, the Company announced that it had retained BancAmerica ROBERTSON STEPHENS to advise it regarding strategic alternatives to enhance shareholder value. On December 15, 1997, a securities fraud class action was filed in the United States District Court for the Northern District of Illinois against the Company and two of its current and former executive officers. The purported class action was filed on behalf of all persons who purchased common stock of the Company during the period December 7, 1995 through June 10, 1997, seeking damages for alleged violations of the federal securities laws. The complaint in the purported class action alleges that throughout this time period, defendants knowingly participated in a course of conduct involving misrepresentation and concealment of adverse material information about the business and finances of the Company. The complaint alleges that the course of action followed by the defendants caused the plaintiff and other members of the purported class to purchase the Company's securities at artificially inflated prices. The complaint seeks damages suffered as a result of the actions of the defendants, including costs, expenses and fees incurred in the litigation. The Company cannot predict the outcome of this litigation but believes it has meritorious defenses to these allegations and intends to defend itself vigorously. 53 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART II - -------------------------------------------------------------------------------- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III - -------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See the information with respect to the Directors of the Registrant which is set forth in the section entitled "Election of Directors" of the Company's 1998 Proxy Statement, which is incorporated herein by reference. See the information set forth in the section entitled "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the 1998 Proxy Statement, which is incorporated herein by reference. The 1998 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year. For information regarding Executive Officers of the Registrant, see Item 4A of this Report, which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION See the information set forth in the sections entitled "Director Compensation", "Executive Compensation", and "Compensation Committee Interlocks and Insider Participation" in the 1998 Proxy Statement, which is incorporated herein by reference. Such incorporation by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Regulation S-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT See the information set forth in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the 1998 Proxy Statement, which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS See the information set forth in the section entitled "Certain Relationships and Transactions" in the 1998 Proxy Statement, which is incorporated herein by reference. 54 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART IV - -------------------------------------------------------------------------------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as a part of this report: 1. Financial Statements - see index on page 37. 2. Financial Statement Schedules - see index on page 37. (b) Reports on Form 8-K: None (c) Exhibits: The following documents are filed herewith or incorporated herein by reference and made a part of this Form 10-K. EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - -------------- ----------------------- 3.01 Certificate of Incorporation of the Company (1) 3.02 Bylaws of the Company (1) 4.01 Form of stock certificate of the Company (1) 10.01 Amended and Restated Revolving Loan and Security Agreement between Sanwa Business Credit Corporation and The Roach Organization, Inc. and TRO Learning (Canada), Inc. dated March 5, 1997 10.02 Registration Agreement (1) 10.03 Exchange Agreement (1) 10.04 1993 Outside Director Stock Option Plan+ (4) 10.05 Warrants of the Registrant (1) 10.06 Series B Preferred Stock Purchase Agreement, as amended, and agreements relating thereto (1) 10.08 Lease for Edina, Minnesota office (5) 10.10 Settlement Agreement with Control Data (1) 10.11 Form of Indemnification Agreement (1) 10.12 Stock Purchase Warrant of TRO (1) 10.13 Certification and Testing Services Agreement between the Company and Sylvan Learning Systems, Inc. dated August 31, 1993 (2) 10.14 1993 Stock Option Plan + (3) 10.15 Severance and Non Competition Agreement with William R. Roach + (4) 10.16 Severance and Non Competition Agreement with Andrew N. Peterson+ 10.17 First Amendment to Amended and Restated Revolving Loan and Security Agreement between Sanwa Business Credit Corporation and The Roach Organization, Inc. and TRO Learning (Canada), Inc. dated March 18, 1997 10.18 Form of Series 1997 10% Subordinated Convertible Debentures due March 27, 2004 10.19 Form of Common Stock Warrants dated March 27, 1997 55 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1997 PART IV - -------------------------------------------------------------------------------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K, CONTINUED 10.20 Second Amendment to Amended and Restated Revolving Loan and Security Agreement between Sanwa Business Credit Corporation and The Roach Organization, Inc. and TRO Learning (Canada), Inc. dated December 8, 1997 11.01 Statement re: computation of per share earnings 21.01 Subsidiaries of the Registrant (1) 23.01 Consent of Coopers & Lybrand L.L.P. with respect to Registration Statements on Form S-8 24.01 Powers of Attorney 27.00 Financial Data Schedule (1) Incorporated by reference to the corresponding exhibit to the Company's Registration Statement on Form S-1 (File No. 33-54296). (2) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1993 (File Number 0-20842). (3) Incorporated by reference to Exhibit A to the Company's 1994 Proxy Statement (File Number 0-20842). (4) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1994 (File Number 0-20842). (5) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1995 (File Number 0-20842). (6) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1996 (File Number 0-20842). + Management contract or compensatory plan, contract or arrangement. 56 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of TRO Learning, Inc. Our report on the consolidated financial statements of TRO Learning, Inc. and Subsidiaries is included on page 38 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 37 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. Chicago, Illinois January 12, 1998 57 TRO LEARNING, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED OCTOBER 31, 1995, 1996 AND 1997 (IN THOUSANDS) - -------------------------------------------------------------------------------- ADDITIONS ---------------------- CHARGED TO BALANCE AT CHARGED TO OTHER BEGINNING COSTS AND ACCOUNTS DEDUCTIONS BALANCE AT DESCRIPTION OF PERIOD EXPENSES (DESCRIBE) (DESCRIBE) END OF PERIOD - ---------------------------- ---------- ---------- ---------- ---------- ------------- Deducted in the balance sheets from the assets to which they apply: Allowance for doubtful accounts: For the year ended October 31, 1995 $ 363 $ 300 --- $ (79) (a) $ 584 For the year ended October 31, 1996 584 2,120 264 (b) (2,458) (a) 510 For the year ended October 31, 1997 510 7,252 --- (742) (a) 7,020 Allowance for inventory obsolescence: For the year ended October 31, 1995 388 125 --- (22) (a) 491 For the year ended October 31, 1996 491 150 --- (185) (a) 456 For the year ended October 31, 1997 456 --- --- (140) (a) 316 (a) Amounts written off, net of recoveries. (b) Amounts reclassified. 58 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 on January 12, 1998. TRO LEARNING, INC. By /s/William R. Roach ------------------------ William R. Roach Chairman of the Board, President and Chief Executive Officer 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 indicated on January 12, 1998. Signature: Title: /s/ William R. Roach Chairman of the Board, President and Chief - ------------------------- Executive Officer (principal executive officer) William R. Roach /s/ Andrew N. Peterson Senior Vice President, Chief Financial Officer, - ------------------------- Treasurer and Secretary Andrew N. Peterson (principal financial officer) /s/ Mary Jo Murphy Vice President, Corporate Controller and Chief - ------------------------- Accounting Officer Mary Jo Murphy (principal accounting officer) * - ------------------------- Jack R. Borsting Director * - ------------------------- Tony J. Christianson Director * - ------------------------- John L. Krakauer Director * - ------------------------- Vernon B. Lewis Director * - ------------------------- John Patience Director * By /s/ Mary Jo Murphy --------------------- Mary Jo Murphy Attorney-in Fact 59