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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: July 31, 1997
[ ] 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 000-21535
PROSOFT I-NET SOLUTIONS, INC.
(Exact name of Registrant as specified in its charter)
NEVADA 87-0448639
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2333 N. Broadway, Santa Ana, California 92706
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including
area code: (714) 953-1200
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 $.001 Per Share
(Title of class)
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 (12) months (or such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety (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 Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K [X].
The aggregate market value of the Registrant's common stock held by non-
affiliates of the Registrant as of October 15, 1997 was $84,814,010 based on
the number of shares outstanding on such date and the last sale price for the
common stock on such date of $16.50 per share as reported on the NASDAQ -
SmallCap market.
Part III is incorporated by reference from the Registrant's definitive proxy
statement for its 1997 Annual Meeting of Stockholders to be filed with the
Commission within 120 days of July 31, 1997.
The number of shares of Common Stock issued and outstanding as of October 15,
1997: 10,375,184.
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PROSOFT I-NET SOLUTIONS, INC.
Index to Annual Report
on Form 10K
PART I
Page No.
Item 1. Business
Overview 3
Market Background 5
Prosoft's Market Positioning 6
The Prosoft Strategy 6
Strategies Alliances 7
Courseware, Computer Based Training and Distance Learning 8
Marketing 9
Market Potential 9
Competition 10
Seasonality 10
Proprietary Rights 11
Government Regulation 11
Employees 12
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to Vote of Security Holders 14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 15
Item 6. Selected Financial Data 16
Item 7. Management's Discussion & Analysis of
Financial Condition & Results of Operations 16
Item 8. Financial Statements and Supplementary Data 22
Item 9. Changes in and Disagreements with Accountants on
Accounting & Financial Disclosure 37
PART III
Item 10. Directors and Executive Officers of the Registrant 38
Item 11. Executive Compensation 38
Item 12. Security Ownership of Certain Beneficial
Owners and Management 38
Item 13. Certain Relationships and Related Transactions 38
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 39
Signatures 40
Exhibit Index 41
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PART I
Item 1. Business
Overview
Prosoft I-Net Solutions, Inc. ("Prosoft" or the "Company") is incorporated
under the laws of the State of Nevada. From its incorporation in May 1985 until
March 1996, the Company had no significant operations. The business of the
Company was initially operated as a sole proprietorship (the "Proprietorship")
beginning in February 1995. In December 1995, Pro-Soft Development Corp., a
California corporation ("Old ProSoft"), was incorporated and acquired the
business from the Proprietorship effective January 1, 1996. In March 1996, the
Company entered into an Agreement and Plan of Reorganization (the
"Reorganization Agreement") with Old ProSoft and the Old ProSoft shareholders.
Under the terms of the Reorganization Agreement, Old ProSoft shareholders
received one share of Common Stock of the Company in exchange for each of their
shares of Old ProSoft, and Old ProSoft became a wholly owned subsidiary of the
Company (the "Reorganization"). As part of the Reorganization, all of the
executive officers and directors of the Company resigned and the executive
officers and directors of Old ProSoft became the executive officers and
directors of the Company and the Company changed its name from Tel-Fed, Inc. to
ProSoft Development, Inc. The Company changed its name to Prosoft I-Net
Solutions, Inc. in October 1996.
Under applicable accounting rules, for financial statement purposes, the
Reorganization is required to be accounted for as an acquisition of the Company
by Old ProSoft, with the additional shares held by the Company's prior
shareholders reflected as a recapitalization of Old ProSoft. As a result, the
consolidated financial statements included in this annual report for the Company
reflect, for the period prior to the Reorganization, the operations of Old
ProSoft. Financial statements of the Proprietorship are also included herein.
Prosoft is engaged in the business of training individuals in small, medium
and large organizations in Internet and Intranet technologies, with a current
emphasis on Netscape, Sun-Microsystems, and Microsoft-based Internet/Intranet
products and solutions. Prosoft is a certified Microsoft Authorized Technical
Education Center ("ATEC"), which is a certification from Microsoft Corporation
("Microsoft") allowing the Company to teach courses using certified Microsoft
courseware. In order to become a Microsoft ATEC, the Company first had to be
designated by Microsoft as a Microsoft Solution Provider (which was received
after the Company demonstrated to Microsoft that it trains others to use
Microsoft products), then had to submit an ATEC application and comprehensive
business plan to Microsoft for approval, which approval was received in November
1995. In October 1997, Prosoft was chosen by Netscape Communications Corp.
("Netscape") to be a Netscape Education Partner ("NEP") for selected locations.
This authorization will allow Prosoft to conduct training on Netscape products,
as well as receive the benefits of training references and leads provided
directly through Netscape. The Company is also a certified Private Post
Secondary Institution in the State of California, and an approved recipient of
Job Training Partnership Act (the "JTPA") funding, the last of which enables the
Company to recruit, train and hire its own advanced technology instructor staff.
In addition, Prosoft develops proprietary Internet/Intranet courseware and
offers more than 40 customized hands-on and instructor-led Internet/Intranet-
related courses for end-users, system engineers and developers.
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Internet/Intranet instruction is made available through Company-operated
Internet/Intranet Training Resource Centers ("Training Centers") offering
commercial Internet/Intranet training to the employees of organizations ranging
from Fortune 1000 corporations to small entrepreneurial enterprises throughout
the United States. The Company also offers tailored training on-site at the
customer's facility, usually for larger organizations with a significant number
of trainees. On-site training facilities are set up by the customer, at its
expense, in substantially the same configuration as a Training Center classroom.
Each Prosoft student who takes an Internet or Intranet class is taught using a
personal computer that is connected to the Internet. As of September 30, 1997,
the Company had opened 35 Training Centers in 22 states. In addition, the
Company expects to continue offering tailored on-site training, usually for
larger organizations with a significant number of trainees.
A typical Training Center ranges in size from 600 to 5,000 square feet and
is comprised of from one to four classrooms that can accommodate approximately
12 to 16 students per classroom. The Company has either leased commercial space
for the Training Centers or has entered into marketing affiliations with
existing computer training, consulting, distribution and reseller companies.
Under such marketing affiliations, the affiliate typically makes classroom space
available to Prosoft in exchange for a royalty payment based upon the training
revenue collected by Prosoft. Whether Prosoft leases commercial space or enters
into a marketing affiliation, the Company is responsible for building the
infrastructure of the Training Center to its specifications. The Training
Centers are connected directly to the Internet by means of a high speed T-1 line
that guarantees a connection of 1.544 MBps and insures that the students'
computers have the high speed bandwidth required to complete the complex, hands-
on exercises efficiently, especially those exercises that are focused on the
graphics-intensive World Wide Web. The Company's commercial Internet/Intranet
training courses range in length from one to five days at a cost of between $295
to $795 per day per student.
A common barrier to entry in the advanced technical education business is
developing and maintaining a staff of qualified, motivated instructors. In
addition to hiring experienced commercial instructors, Prosoft has developed a
strategy to internally develop staff members to support a national network of
Internet/Intranet training centers. Prosoft is an authorized recipient of JTPA
funding and uses these funds to recruit displaced defense, airline and aerospace
workers, provide them with instruction in advanced Microsoft and
Internet/Intranet technologies, and then hire them as Microsoft Certified
Professionals, Internet/Intranet Training Professionals or both. The JTPA-
funded programs pay Prosoft approximately $10,000 for each displaced worker that
receives advanced Microsoft technology training, which vocational training runs
eight hours a day, five days a week and spans six to nine months. The Company
has been successful at attracting and retraining displaced employees to become
Microsoft Certified and qualified to teach the Company's Internet/Intranet
curriculum. Each of the Company's vocational students graduates as a Microsoft
Certified System Engineer, a Microsoft Certified Solution Developer, a Microsoft
Certified Trainer (all three of these certifications fall under a designation
known as a Microsoft Certified Professional or "MCP") or an Internet/Intranet
Professional ("IIP").
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Once a student completes vocational training, he or she is either placed
into the job market through Prosoft's placement efforts or, if the student meets
Prosoft's training standards, is generally offered the opportunity to teach in
one of the Company's Training Centers. In addition, some students have been
recruited directly by employers on the Company's property. Through September 30,
1997, 159 vocational training students had graduated from the Company's Training
Centers and the Company had retained 24 graduates as instructors.
In June 1996, Prosoft created a division to develop and publish Internet,
Intranet and distant learning courseware and curriculum, which Prosoft uses in
its Internet/Intranet classes. The Company has several proprietary courseware
projects under development that support Microsoft, Netscape and Sun Microsystems
Internet/Intranet technologies.
Market Background
Internet and Intranet information technology is transforming the way people
live and work. Companies are migrating to Internet and Intranet technologies in
order to improve customer service, achieve productivity gains, access voluminous
databases around the world, and create a competitive advantage. International
Data Corp. and Forrester Research, Inc. estimate that the number of Internet
users doubles every nine months and that there will be more than 200 million
users by the year 2000. Forrester estimates that less than 10% of the
population is currently connected to the Internet, with no estimate of how many
of those connected actually know how to access the full potential of the medium.
Companies are also beginning to develop private internal networking systems
called Intranets, which use the infrastructure, standards and many of the
technologies of the Internet and the World Wide Web, but are cordoned off and
protected from the public through software programs known as "fire walls."
Companies are developing Intranets in order to improve internal communications,
facilitate employee training and motivation, and to reduce the need for paper-
based materials such as operational and procedural manuals, internal phone
books, requisition forms, and other items that must be updated frequently.
Intranets can integrate all of the computers within an organization, including
software and databases, into a unified system that allows employees to quickly
access and utilize information. The percentage of large and mid-size companies
employing some sort of Intranet system increased to 55% in 1996 from just 11% in
1995, according to Business Research Group of Newton, Massachusetts. Zona
Research in Redwood City, California estimates that investment in Intranets
could rise from approximately $2.7 billion in 1996 to more than $13 billion in
1999.
The Company believes that the market for Internet and Intranet training is
substantial. The Internet is the world's largest network of computer networks,
and one which grows everyday. Originally conceived and implemented by the U.S.
Department of Defense and later taken over by the National Science Foundation,
the Internet was developed for scientists and those in academia. It was not
developed nor intended for the average American or as a corporate information
tool, and as a result, it is neither intuitive nor user friendly. In the eyes
of many executives in corporate America, understanding how to efficiently move
through this "maze" and identify and manage its power is critical if the
Internet is to achieve its full promise as a productivity tool and not become
merely a distraction in the workplace.
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Prosoft's Market Positioning
Prosoft has and will continue to develop courseware, provide training and
deliver technical support relating to the Internet and Intranets as a
competitive business tool.
Because the Company's Internet/Intranet training relates primarily to the
software products developed by two of the major Internet software companies,
Microsoft and Netscape, the business strategies of these companies are highly
relevant to Prosoft. Microsoft and Netscape have given away "browser" software
(software that provides a user-friendly interface to the Internet) while selling
the more expensive "server" software. In addition, Microsoft is bundling both
browser and server software (Internet Information Server) with its Window NT
operating system. Dozens of major computer companies plan to ship their
machines with this software. Windows NT has become a leading network operating
system for the kind of small-scale servers used on local area networks and now
those machines are positioned to become Intranet servers. Microsoft's Internet
Information Server includes security features and has the ability to connect to
corporate databases.
Based on Microsoft's aggressive strategy and historical dominance of the
software market, Prosoft's management believes that Microsoft is well positioned
to be a leader in the Internet/Intranet technology market and has strategically
incorporated Microsoft's vision and approach. Currently, most training courses
offered by Prosoft revolve around Microsoft's Internet/Intranet tools and
platforms, ranging from advanced courses for system engineers and solution
developers to courses for end-users and self-paced, self-help instruction. A
central part of the Company's strategy will be to proactively assist Microsoft
in building marketshare for Microsoft's Internet/Intranet products and
technologies by providing a nationwide network of Training Centers that offer
courses in all of the major Microsoft Internet and Intranet technologies.
Notwithstanding the number of Prosoft courses that relate to Microsoft
products, the Company realizes that not every corporation and end-user will
ultimately embrace Microsoft's technologies, and that other Internet companies,
such as Netscape, will continue to maintain a large presence in this arena.
Accordingly, the Company intends to maintain its training curriculum which
covers Internet and Intranet tools and products offered by companies other than
Microsoft, including those offered by Netscape and Sun MicroSystems.
The Prosoft Strategy
Prosoft believes that it should have an advantage over the majority of
other computer and advanced technology training companies by virtue of its
national presence and its specific emphasis and expertise in Internet/Intranet
technologies. While other training institutions may offer a limited number of
Internet/Intranet courses, this type of training is Prosoft's primary area of
emphasis. As a result, the Company believes that it has developed a broad range
of experience with respect to classroom infrastructure, curriculum, courseware
and instructor development, mastery of subject matter, breadth and depth of
course offerings, and the ability to quickly develop and offer new
Internet/Intranet technology training as market demands shift.
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The Company's strategy is to continue to expand the number of Training
Centers across the country as market demand dictates, with the goal of creating
a nationwide network of Training Centers that will make Prosoft a primary choice
for Fortune 1000 corporations and other smaller firms that require unified,
quality Internet and Intranet training. As of September 30, 1997, the Company
had opened 35 Training Centers located in 22 states and had 4 additional
Training Centers under development. Prosoft believes that the development of a
nationwide network of Prosoft Training Centers is essential to the delivery of
quality Internet/Intranet instruction. By the very nature of Internet/Intranet
technology, the delivery of uniform, consistent training is mandatory in order
for companies with multiple geographic locations to efficiently learn and use
the technology. In addition, Prosoft believes that because the Internet/Intranet
demands that an entire organization be properly trained in order for the
technology to be effective, training should be delivered locally, but with
identical curriculum and content in every region of the country.
Internet/Intranet training is not effective if varying curriculum is dispensed
to one office or group of employees at a time. All members of an organization
must simultaneously learn the proper skills necessary to realize the full
capabilities of the Internet/Intranet.
The Company also believes there is excellent potential for future growth in
on-site training. The Company anticipates its on-site customers will be larger
organizations with a significant number of trainees, including both corporate
and government entities. As the trend of outsourcing Internet/Intranet
technology training continues, the Company believes that the largest and fastest
growing customer base within this market are those larger organizations that
require sophisticated technology training.
Strategic Alliances
Prosoft will continue to develop strategic relationships with Internet and
Intranet software developers, computer distributors (otherwise known as value-
added-resellers or "VARs"), telecommunications companies, local training
affiliates under the Affiliate Program (described below), and future Internet
technology developers to attract and deliver training opportunities.
In December 1996, the Company entered into an alliance with Gartner Group
Learning ("GGL"), a developer and distributor of technology-based training, for
the development of proprietary technology-based Internet/Intranet training
courses to be sold exclusively by Gartner Group Learning. The training courses
will be developed for local area networks (LANs), CBT, and Internet/Intranet
delivery, and will offer the marketplace stand alone, technology-based
courseware supported by Prosoft's classroom curricula. This courseware will
also provide students with the prerequisite knowledge to undertake other Prosoft
instructor-led training courses and provides a reference tool upon completion.
Prosoft and GGL extended this relationship in June 1997 by entering into a
Distribution Agreement pursuant to which GGL will resell Prosoft's instructor-
led training courses to GGL's corporate clients.
In January 1997, the Company entered into an alliance with Netscape to
collaborate in using Netscape's server products and technical personnel to
design Internet/Intranet applications for Prosoft and to enhance Prosoft's
Netscape Internet/Intranet training course offerings to their customers. Under
this arrangement, Prosoft will use Netscape products and work with Netscape's
consulting organization, Worldwide Professional Services, to build 2-3 Netscape-
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based Internet/Intranet applications based on Netscape software for use in
Prosoft's course curriculum. This will enable Prosoft to quickly acclimate to
current and future Netscape server products and to be able to develop content
more rapidly than if it relied on more traditional methods. In June 1997,
Prosoft and Netscape entered into a Development and Distribution Agreement for
the creation by Prosoft of courseware relating to the Netscape Communicator
software product and the distribution of such courseware by Prosoft and
Netscape.
In March 1997, the Company entered into an agreement with AT&T pursuant to
which Prosoft offers businesses regularly scheduled courses on the
implementation and use of AT&T Website Services, at Prosoft's Training Centers
at discounted rates.
In August 1997, the Company entered into a strategic alliance with GTE that
allows GTE to resell all Prosoft courses. After having completed training for a
group of GTE salespeople, which included 300 people in thirteen cities
nationwide, GTE chose Prosoft as a preferred provider of Internet/Intranet
training for their employees and affiliates worldwide.
Prosoft will continue to work with the DOL through "subrecipients"
(administrators of JTPA funds on the local level) to access JTPA retraining
funds as a steady source of revenue and to develop its advanced technology
instructors. With respect to the Company's hiring programs, Prosoft is able to
administer its own intake and eligibility criteria under authority granted by
the City of Los Angeles. This is significant because Prosoft can execute its
own intake and eligibility of displaced workers living in the City of Los
Angeles to determine if they qualify for a JTPA grant. In addition, the Company
can complete the intake and eligibility process significantly quicker than the
normal government processing. This processing speed has enabled the Company to
attract and process large pools of qualified displaced workers from which to
select its instructor trainees.
The Company's success will depend in large part on the success of its
strategic alliances and the Company's ability to establish successful strategic
relationships with other entities.
Courseware, Computer Based Training and Distance Learning
The Company intends to continue to develop cutting edge courseware for all
new Microsoft and Netscape Internet/Intranet product releases as well as other
popular and emerging Internet/Intranet technologies. Once Prosoft has designed
the books and materials that will constitute the courseware for a given class,
it is able to internally produce such courseware on demand.
Prosoft is also building the staff and technological resources necessary to
offer what the Company calls "Learning on Demand" ("LOD") or instructor
facilitated distance learning. The Company is developing proprietary
Internet/Intranet technologies that will allow the Company or its customers to
create instructor facilitated distance courses. To reach this goal, the Company
is developing strategic alliances and plans to invest in the infrastructure and
development of LOD technologies.
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Marketing
Prosoft will market Internet and Intranet training through its own internal
sales and marketing organization with additional distribution key strategic
alliances. As of September 30, 1997, the Company's sales and marketing
organization consisted of 36 employees. Prosoft is currently creating and
producing marketing material designed to help position Prosoft as the premier
Internet/Intranet training and resource company.
Prosoft, as part of its strategy to open additional Training Centers,
established what is called the Affiliate Training Program (the "Affiliate
Program"). Under the terms of the Affiliate Program, an existing computer
training, consulting, distribution and/or reseller company, such as a
ComputerLand franchisee, provides the physical space within its premises for the
completion and operation of one or more Prosoft training rooms in a particular
market. In exchange for this rent-free classroom space, the affiliate is
entitled to 5% of all revenue generated from the Internet and Intranet training
that occurs at that location. In addition, if the affiliate's sales staff,
either acting alone or in concert with Prosoft's sales force, sells the training
course, the affiliate is entitled to purchase the training course at a wholesale
price. In the past, the price at which an affiliate could purchase a training
course ranged from 4% to 25% (and in one instance 40%) less than the Company's
retail list price depending, among other things, on the affiliate's level of
participation in the sales effort and the volume of delivered sales. Beginning
in August 1996, all new affiliates purchase training courses at a wholesale
price which is 20% less than the Company's retail list price if they participate
in the sales effort, regardless of the level of their participation. By forming
various affiliations in this fashion, the Company has dramatically reduced its
fixed operating expense by replacing fixed rent or lease payments with a small
variable expense tied to sales revenue. In addition, the Affiliate Program
permits the Company to take advantage of the affiliate's local sales force in
each market, which understands and has personal relationships with the local
customer base.
In addition to the local affiliate's marketing and sales efforts, the
Company has a national inbound/outbound telemarketing organization located in
Jacksonville, Florida. The Company's telemarketing sales group markets the
Company's Internet and Intranet training to computer resellers and end-users and
supports the efforts of the direct sales force.
Prosoft has also entered into agreements with various software training and
consulting companies to permit such companies to sell Prosoft training seats in
their regularly published catalogues and marketing materials. As part of this
program, these companies, including end-user application training firms,
software companies and VARs, may publish Prosoft training schedules in their
course catalogs and other marketing materials and will be paid a percentage of
the training revenue generated by such means. In this way, potential
competitors that offer a wide range of unrelated training courses can add
Internet offerings to their catalog without having to develop the curriculum or
instructors, install T-1 lines, or compete with Prosoft.
Market Potential
Because Prosoft has offered and will continue to offer a significant number
of courses and has broad categorical expertise in Internet and Intranet training
ranging from the most advanced system engineering to end-user training, Prosoft
believes that it is well positioned to sell its training to small, medium and
large organizations. As a result of the Company's approach to
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Internet/Intranet training, which features highly-trained instructors, course
materials designed by the Company's internal courseware department, high speed
lines connected to the Internet, individual computers for each student, and
numerous pre- and post-testing of students, the Company believes it can offer
the highest quality, consistent Internet curriculum in the industry. In
addition, because of the short curriculum development cycle that the Company
maintains, it can quickly create new course offerings to support new and
emerging technologies. Internet/Intranet software offerings and technology will
continue to evolve and training related to such software and technology will
need to keep pace. Technology trends indicate that end-user interfaces are and
will become more intuitive and user-friendly while system engineering and
solution development required to support these simple interfaces will become
increasingly complex. Because Prosoft addresses a broad range of Internet and
Intranet technology training, the Company believes it is well positioned to
pursue and deliver on the expanding advanced Internet technology training
opportunities.
As corporations move to develop and expand internal Intranet systems,
Prosoft believes it will be positioned to deliver a wide range of Intranet
training classes, ranging from Internet Information Servers to Web Page
development and maintenance, as well as a host of other courses necessary for an
organization to maximize the utility of Intranet systems. Prosoft believes that
company-developed Intranets will become indispensable tools in the workplace and
intends to position itself to take advantage of this growing market.
Competition
Historically, few computer-training companies offered the breadth and depth
of Internet and Intranet courses that Prosoft offered, or taught such courses in
centers located across the country. However, as the Internet and company-
developed Intranets have continued to grow in popularity and become mandatory
productivity tools in the workplace, several existing training companies have
increased their focus on Internet/Intranet training. In addition, other large
computer software and reseller companies with even greater financial resources
have and may continue to enter the market and begin providing Internet training.
Although studies by the American Society for Training and Development and
the International Technology Training Association consistently demonstrate that
hands-on, instructor led training is the most effective manner in which to learn
and master technology-oriented subject matter, most Internet users in the U.S.
have not had access to this type of training. Historically, most Internet
instruction was delivered seminar-style in hotel auditoriums or similar venues
using passive training techniques such as slides, multimedia presentations or
perhaps an overhead of an instructor's computer in action. There are now several
national and regionally based Internet/Intranet training companies that have
direct, high speed access to the Internet and offer hands-on, instructor-led
training. These include Learning Tree, New Horizons, Productivity Point,
Executrain, Global Knowledge Network and Wave Technologies.
Seasonality
The Company's revenues and income are expected to vary significantly from
quarter to quarter due to seasonal and other factors. The Company expects
greater revenue in the second half of its fiscal year (February through July)
than in the first half of its fiscal year (August through January). This
seasonality is due in part to seasonal spending patterns of the Company's
customers, and in part to quarterly anticipated differences in the frequency and
size of the
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Company's marketing campaigns, as well as weather, holiday and vacation
patterns.
Proprietary Rights
Most of Prosoft's Internet courseware is protected by copyright laws. The
Company has also filed for trademark registration for certain of its products,
tags lines and feature names. The Company will continue to seek copyright
registration on certain newly developed courseware products and on operating
software products that relate to the delivery of Internet and Intranet training.
Government Regulation
The Company is subject to extensive state and federal regulations with
respect to its vocational training. As a vocational, non-degree-granting school,
the Company is governed by the State of California Council for Private
Postsecondary and Vocational Education. In addition to commercial business, the
Company also actively seeks vocational retraining funding as a vendor under the
JTPA.
Federal job re-training programs under the JTPA pay Prosoft, on average, a
grant of approximately $10,000 for each qualifying student for 22 to 37 weeks of
intensive advanced Microsoft-based Internet technology training. If a student
leaves a JTPA program before the completion of the course, Prosoft is paid a pro
rata portion of the grant. The Company has been successful in attracting and
re-training displaced defense and aerospace workers to become Microsoft
Certified Professionals. As discussed above, those MCPs who Prosoft deems to
meet the Company's high standards are then offered positions as instructors to
deliver Internet and Intranet training in Prosoft Training Centers.
Because the JTPA imposes new regulations annually and because the DOL has
not fully developed administrative interpretations of such new regulations,
there exists some uncertainty concerning the application of the evolving rules.
New or revised interpretations of such requirements could have a material
adverse effect on the Company's vocational training business. In addition,
changes in and new interpretations of the applicable laws, rules or regulations
could have a material adverse effect on Prosoft's accreditation, authorization
to operate, permissible activities and cost of doing business in various states.
The failure to maintain or renew any required approval, accreditation or state
authorization by Prosoft could have a material adverse effect on the Company's
vocational training business.
During fiscal 1997, the vocational training business accounted for
approximately 21% of the Company's total revenues. The majority of this revenue
was from three Southern California governmental agencies. Each of these
agencies provided JTPA vocational training funds for students in the Company's
Training Centers. Although a portion of the Company's revenues to
date have been generated from JTPA vocational training and these three agencies,
the Company expects an increasing amount of its revenues in the future will come
from Internet/Intranet training, and its dependence on these agencies and its
exposure to state and federal regulations referred to above will continue to
diminish.
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Employees
As of September 30, 1997, Prosoft had 198 full-time employees. The current
employees have considerable experience in all areas of vocational and commercial
advanced technology school management, education and training.
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Item 2. Properties
As of September 30, 1997, the Company had entered into leases for
commercial space in the following locations:
<TABLE>
<CAPTION>
Location Square Footage Monthly Lease Rent Expiration
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Carson, CA* 6,893 $ 8,616 December 1999
North Hollywood, CA* 3,000 $ 3,000 April 1999
Santa Ana, CA* 22,813 $23,953 September 1999
Jacksonville, FL* 6,191 $ 6,325 January 2000
Atlanta, GA* 3,127 $ 3,648 December 2001
New York, NY* 5,558 $ 7,410 August 1999
Austin, TX 2,746 $ 4,342 April 1998
Dallas, TX* 5,022 $ 8,082 January 2002
Salt Lake City, UT 8,443 $ 9,322 March 2000
Vienna, VA* 3,497 $ 5,732 November 2001
Bellevue, WA* 3,550 $ 5,547 November 2001
- --------------------
* Open Training Center
</TABLE>
In addition, Prosoft has entered into the Affiliate Program with several
independent training, consulting, distribution and/or reseller companies under
which the affiliates provide space to Prosoft for its Training Centers.
Prosoft's use of such affiliates' space is not subject to a lease or sublease
arrangement, but rather is set forth in an agreement under which Prosoft is
given use of such affiliates' facilities at certain times for the providing of
Internet/Intranet training in exchange for the payment of commissions or
royalties to such affiliates. The lease or rental agreements reside with the
affiliate and Prosoft has no fixed obligation or liability for this rent.
Prosoft is obligated to pay such affiliates a royalty of 5% that is directly
tied to the training revenues generated at such affiliates' sites. In addition,
the Company is responsible for all necessary tenant improvements relating to the
Training Centers made at the affiliates' locations, which can range anywhere
from $5,000 to $50,000 per site. As of September 30, 1997, the Company operated
26 Training Centers under this type of arrangement in the following locations:
<TABLE>
<S> <C> <C>
Bloomington, MN Indianapolis, IN San Diego, CA
Boston, MA Irving, TX San Jose, CA
Brentwood, TN Largo, FL South Plainfield, NJ
Charlotte, NC Miami, FL Springfield, IL
Chicago, IL Overland Park, KS Springfield, PA
Deerfield Beach, FL Owings Mills, MD St. Louis, MO
Denver, CO Philadelphia, PA Tulsa, OK
Greenville, SC Richardson, TX Waltham, MA
Houston, TX Salt Lake City, UT
</TABLE>
Item 3. Legal Proceedings
On January 22, 1997, PAL Employer Services ("PAL") filed a complaint against the
Company in the Superior Court of the State of California, County of Orange. The
complaint is based upon allegations that the Company breached a contract, which
supposedly entitled PAL to convert a promissory note into 50,000 shares of the
Company's common stock. PAL has also alleged that the Company improperly
terminated a separate contract with PAL, thereby
13
<PAGE>
entitling PAL to a termination penalty of $30,000. Discovery is ongoing and
trial is presently set to commence on January 26, 1998. Among other things, the
Company believes that no binding and enforceable contract on the terms alleged
by PAL exists between the parties.
Although there can be no assurances as to the ultimate outcome of this matter,
based upon currently available information, including the deposition testimony
taken thus far, the Company does not presently anticipate that the resolution of
this action will have a material adverse effect on the Company's business,
financial condition, results of operations or cash flows.
Item 4. Submission of Matters to Vote of Security Holders
None.
14
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The Company's Common Stock currently trades on the NASDAQ SmallCap Market,
under the trading symbol of "POSO." Prior to December 6, 1996, the Company's
Common Stock traded on the National Association of Security Dealers Over-the-
Counter (OTC) Market Bulletin Board. For the period prior to December 6, 1996,
the following table sets forth the high and low bid quotation for the Common
Stock as reported by various Bulletin Board market makers. For the period on or
after December 6, 1996, the following table sets forth the price range of high
and low last sales price per share for the Common Stock as reported by NASDAQ.
There were no trades of the Company's Common Stock between August 1, 1995 and
April 1, 1996, therefore the following table does not reflect the bid price per
share during the quarters ending prior to April 1, 1996.
<TABLE>
<CAPTION>
Quarter Low High
------- --- ----
<S> <C> <C>
May 1, 1997--July 31, 1997 $6.25 $10.75
February 1, 1997--April 30, 1997 $11.00 $18.00
November 1, 1996--January 31, 1997 $16.38 $20.00
August 1, 1996--October 31, 1996 $18.00 $20.00
May 1, 1996--July 31, 1996 $15.00 $19.00
February 1, 1996--April 30, 1996 $6.00 $15.00
</TABLE>
On October 15, 1997, the Company had approximately 350 stockholders of record.
To date, no dividends have been declared or paid on any capital stock of
the Company, and the Company does not anticipate paying any dividends in the
foreseeable future.
15
<PAGE>
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
Company Company Proprietorship
------- ------- --------------
Fiscal Year December 8, 1995 February 1, 1995
Ended to (date of inception) to
July 31, 1997 July 31, 1996 December 31, 1995
---------------- ------------------ -------------------
<S> <C> <C> <C>
Consolidated Statement of Operations
Data:
Revenue.................................... $ 3,483,140 $ 907,772 $ 77,477
Cost of services........................... 10,197,373 698,725 60,526
------------ ----------- ---------
Gross profit (loss)........................ (6,714,233) 209,047 16,951
Operating expenses:
Sales and marketing....................... 4,918,942 426,221 44,769
General and administrative................ 9,215,521 2,788,188 556,382
------------ ----------- ---------
Loss from operations....................... (20,848,696) (3,005,362) (584,200)
Interest income (expense).................. 201,423 (67,961) (20,126)
------------ ----------- ---------
Loss before provision for taxes............ (20,647,273) (3,073,323) (604,326)
Provision for state franchise tax.......... 4,000 800 --
------------ ----------- ---------
Net loss................................... $(20,651,273) $(3,074,123) $(604,326)
============ =========== =========
Net loss per share......................... $(2.48) $(0.61)
============ ===========
Shares used in computing net loss
per share................................. 8,312,911 5,011,781
============ ===========
</TABLE>
<TABLE>
<CAPTION>
At At At
July 31, July 31, December 31,
1997 1996 1995
---------------- ------------------ -------------------
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Working capital (deficiency)....................... $9,520,217 $6,764,828 $(561,885)
Total assets....................................... 20,784,177 8,997,490 765,990
Capital lease obligations, net of current portion.. 1,519,965 437,532 308,671
Stockholders' equity (owner's deficit)............. 13,039,562 7,694,729 (194,473)
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto found elsewhere herein. It
includes certain forward-looking statements. Actual results could differ
materially from those reflected by the forward-looking statements and a number
of factors may affect future results, liquidity and capital resources. These
factors include softness in the general economic environment, the Company's
extremely limited operating history and expectation of continuing significant
losses, uncertainty of rapidly evolving market, future capital requirements and
uncertainty of future funding, the need to respond to rapid technological change
and a highly competitive market. Although the Company believes it has the
business strategy and resources needed for improved operations, future revenue
and margin trends cannot be reliably predicted and may cause the Company to
adjust its business strategy during the 1998 fiscal year.
In March 1996, the Company and Old ProSoft completed a reorganization pursuant
to an Agreement and Plan of Reorganization whereby Old ProSoft became a wholly
owned subsidiary of the Company. Although the Company survived as the parent of
Old ProSoft, the transaction was accounted for such that the financial
statements for the Company following the transaction are the financial
statements of Old ProSoft, with the additional shares held by the Company's
prior shareholders reflected as a recapitalization of Old ProSoft. The assets
and operating results of the Company separate from Old ProSoft are not material
and separate financial statements of the Company prior to the transaction are
not presented herein. The financial statements of the Proprietorship, which
operated the business from its inception in February 1995 until it was acquired
by Old ProSoft January 1, 1996, are included herein.
Development of Business
Prosoft, and prior to that, the Proprietorship, has delivered training in
the vocational and advanced technical education business since February 1995.
Initially, a majority of time and resources were spent in the development of
government funded, JTPA vocational business and qualifying as a recipient of
JTPA funds. Resources were also spent training and developing the initial staff
of Microsoft Certified Engineers, Developers and Trainers and in securing and
maintaining its status as a Microsoft ATEC. Vocational training sales commenced
on a limited basis at the end of 1995.
16
<PAGE>
Upon completion of a private placement of stock in February 1996, the
Company had the resources to expand its vocational training capacity in March
through May of 1996. As the Company began to graduate MCSEs, MCSDs and MCPs, it
was able to retain several of these graduates as instructors to accommodate the
expanding vocational business.
Concurrent with the expansion of the government-funded vocational business,
the Company embarked on a strategy to build a nationwide network of Training
Centers. As of September 30, 1997, the Company had opened 35 Training Centers
located in 22 states. The Company is also in preliminary negotiations for
approximately four additional sites around the country. To support this
expansion strategy, the Company significantly increased its accounting,
operational, administrative, marketing, sales, courseware development,
instructor development, instructor, information systems and technology staffing.
Results of Operations
Twelve Months Ended July 31, 1997 Compared to Eight Months Ended
July 31, 1996
Revenues. Revenues for the twelve-month period ended July 31, 1997 were
$3,483,140, compared with $907,772 for the eight-month period ended July 31,
1996. The increase in revenues is attributable to the increase in the number of
students taking classes from the Company. This is a direct result of the
expansion of the Company from six locations on July 31, 1996 to 34 locations on
July 31, 1997.
Cost of Services. The Company's cost of services includes the costs
associated with course instructors, content developers, course materials and
equipment and classroom facilities. Cost of services for the twelve-month
period ended July 31, 1997 were $10,197,373 compared with $698,725 for the
eight-month period ended July 31, 1996. This increase is primarily the result
of an increased number of course events, a larger course library, and an
increase in the number of and training of instructors and content developers in
the twelve-month period ended July 31, 1997 compared to the corresponding period
of the prior year.
Sales and Marketing. Sales and marketing expense consists of salaries,
commissions and travel-related costs of sales and marketing personnel, the costs
of designing, producing and distributing direct mail marketing and media
advertisements, and the costs of the information systems to support these
activities. Sales and marketing expense for the twelve-month period ended July
31, 1997 were $4,918,942, compared with $426,221 for the eight-month period
ended July 31, 1996. The increase in sales and marketing expense is due to an
increase in marketing intended to reach a broader range of potential customers,
to expand the Company's presence in certain U.S. cities and to communicate the
availability of new course titles.
17
<PAGE>
General and Administrative. General and administrative expenses for the
twelve-month period ended July 31, 1997 were $9,215,521, compared to $2,788,188
for the eight-month period ended July 31, 1996. This increase is primarily due
to the continued buildup of the administrative staffing needed to support the
expansion of sites and the growth in sales.
Interest. Net interest income for the twelve-month period ended July 31,
1997 was $201,423, compared to net interest expense of $67,961 for the eight-
month period ended July 31, 1996. Interest expense, which consists principally
of interest paid on capital leases, increased for the twelve-month period ended
July 31, 1997 due to an increase in the amount of equipment financed under
capital leases. However, this increase was more than offset by interest earned
from higher cash balances generated by the proceeds from private placements
completed in late 1996 and early 1997.
Net Loss. Net loss for the twelve-month period ended July 31, 1997 was
$20,651,273, compared to $3,074,123 for the eight-month period ended July 31,
1996. The increase in net loss resulted from (i) increased staffing, (ii) the
opening of new Training Centers without a corresponding increase in revenues,
(iii) the development of new courseware, and (iv) an increase in the Company's
sales and marketing efforts.
December 8, 1995 to July 31, 1996 Compared to February 1, 1995 (date of
inception) to December 31, 1995
Revenues. Revenues for the period from December 8, 1995 to July 31, 1996
were $907,772, compared to $77,477 for the period from February 1, 1995 to
December 31, 1995. The increase was principally attributable to an increase in
the number of students enrolled in the Company's JTPA vocational training
programs. In January 1995, the number of students enrolled was 16 with monthly
training revenue of $34,000. By July 1996, student enrollment was up to 102 and
monthly training revenue was $213,000.
Cost of Services. Cost of services for the period ended July 31, 1996 was
$698,725, compared to $60,526 for the period ended December 31, 1995. For the
period ended July 31, 1996, cost of services primarily consisted of courseware
($244,000), instructor salaries ($177,000) and overhead salaries ($161,000). The
increase was principally attributable to an increase in the number of classes
being conducted, and the related increase in the number of students attending
those classes. The gross margin for the period ended July 31, 1996 was 23%,
compared to a gross margin of 22% for the period ended December 31, 1995.
Sales and Marketing. Sales and marketing expenses for the period ended
July 31, 1996 were $426,221, compared to $44,769 for the period ended December
31, 1995. For the period ended July 31, 1996, sales and marketing expenses
primarily consisted of promotions ($200,000), advertising ($90,000) and travel
($75,000). The increase in sales and marketing expenses was based on the
following: (i) new positioning of the Company in the commercial market of
Internet and Intranet training, (ii) establishing a national presence and image,
(iii) opening of a national sales office in Jacksonville Florida, (iv) hiring
four regional sales managers, and (v) participating in the Microsoft World Wide
Live promotion.
General and Administrative. General and administrative expenses for the
period ended July 31, 1996 were $2,788,188, compared to $556,382 for the period
ended December 31, 1995.
18
<PAGE>
For the period ended July 31, 1996, general and administrative expenses
primarily consisted of payroll ($1,510,000), depreciation ($257,000) and rent
($206,000). Other than $381,000 of compensation related to stock issued to the
founders, these costs are substantially fixed costs. The increase in general and
administrative expenses related primarily to expenses incurred in hiring and
staffing of additional personnel to support the business expansion.
Interest Expense. Interest expense for the period ended July 31, 1996 was
$67,961, compared to $20,126 for the period ended December 31, 1995. For the
period ended July 31, 1996, interest expense consisted solely of interest paid
on capital equipment leases. The increase in interest expense was related to
the increase in the amount of equipment financed under capital leases.
Net Loss. Net loss increased for the period ended July 31, 1996 to
$3,074,123, compared to $604,326 for the period ended December 31, 1995. The
increase in net loss resulted from (i) increased staffing, (ii) the opening of
new Training Centers without a corresponding increase in revenues, (iii) the
development of new courseware, and (iv) an increase in the Company's sales and
marketing efforts.
Liquidity and Capital Resources
From inception, the Company has financed its operations and met a portion
of its capital expenditure requirements primarily through net proceeds from
private sales of equity securities. Cash and cash equivalents increased from
$6,466,460 at July 31, 1996 to $12,911,684 at July 31, 1997. For the twelve
months ending July 31, 1997, operating activities used cash of $17,050,419,
primarily due to a net operating loss of $20,848,696.
From February through April 1997, the Company received gross proceeds of
approximately $22 million in a private placement through the sale of 2,081,758
shares of common stock. Net proceeds from that offering, after payment of
commissions and finders' fees, was $20,811,332. Additionally, in April 1997, the
Company sold 408,164 shares of its common stock to an institutional investor for
$5 million. The net proceeds from this offering were $4,700,008.
During the twelve months ended July 31, 1997, the Company invested
$1,214,914 in equipment and leasehold improvements. The Company currently
estimates that the cost to open a Training Center is approximately $100,000.
The Company anticipates that its existing resources will be sufficient to
meet its needs for working capital expenditures through at least fiscal 1998,
and management believes that other sources of financing are also available,
including funding commitments obtained from certain significant shareholders.
The Company's long-term capital requirements will depend on numerous factors,
including the rate at which new Training Centers are opened, the profitability
of existing Training Centers and the acquisition and/or development of
additional training tools.
The Company has incurred losses aggregating approximately $24 million since
inception, primarily due to the start-up nature of its business. The Company has
used these funds to implement its strategy of becoming one of the leading
national Training Companies focused on the Internet/Intranet. This strategy
consisted of opening 29 additional state-of-the-art training centers across the
country, preparing and executing a national image defining marketing campaign in
numerous national publications, recruiting one of the nation's largest high-end
group of Internet/Intranet instructors strategically located across the nation,
recruiting top management and sales professionals, and developing one of the
largest libraries of Internet/Intranet courses available anywhere. Having
substantially completed these tasks, the Company is beginning to realize
increasing revenue.
If revenue continues to grow as demonstrated in the fourth quarter of
fiscal 1997, the Company expects to reach quarterly profitability in fiscal year
1998, based on existing resources. However, no assurances can be given that the
Company will be successful in realizing these goals. If the Company is unable to
increase revenue as anticipated, management will implement a plan to
substantially reduce the size of the Company's operations. Such a reduction in
operations may reduce the Company's ability to meet expected market demand. The
Company's ability to continue as a going concern is dependent upon its ability
to obtain necessary financing, grow revenue, attain operational efficiencies
and, ultimately, sustain a profitable level of operations.
The above discussion concerning future financing needs, business expansion
and factors affecting liquidity are forward-looking statements. Although
management believes that these statements are reasonable in view of the facts
available to it, there can be no assurance that all of these statements will
prove to be accurate.
19
<PAGE>
There are numerous factors, which could have a material impact upon whether
these projections could be realized or whether these trends will continue.
Among these factors are those set forth in the following section, as well as
those discussed elsewhere herein.
Additional Factors That May Affect Results of Operations
Extremely Limited Operating History and Expectation of Continuing Significant
Losses
The Company has an extremely limited operating history, which makes it
difficult to predict future operating results. Although the Company was formed
in 1985, from its incorporation until its acquisition of Old ProSoft in March
1996, it had no significant operations. The business of the Company was only
begun in February 1995 where it was run as the Proprietorship until its
acquisition by Old ProSoft in January 1996. The first Training Center was not
opened until late 1995. As a result, there is little financial information
concerning the business of the Company of the type commonly used by investors to
evaluate a potential investment. In addition, certain aspects of the Company's
business are relatively new and have not yet been fully tested in the
marketplace. The Company incurred a net loss of $3,074,123 from December 8, 1995
through July 31, 1996. For the twelve months ended July 31, 1997, the Company
incurred a net loss of $20,651,273 and expects to continue to incur losses on a
quarterly basis through at least the second quarter of fiscal 1998. The
Company's ability to generate significant revenues in the future is subject to
uncertainty, particularly with respect to the Internet/Intranet training on
which it focuses. There can be no assurances that the Company will be able to
address any of those challenges, that its activities will be successful or that
projected earnings will result from these activities.
Uncertainty of Rapidly Evolving Market
The market for Internet/Intranet products and services has only recently
begun to develop and is rapidly evolving. The Company and its prospects must be
considered in light of the risks, costs and difficulties frequently encountered
by companies in their early stage of development, particularly companies in the
new and rapidly evolving Internet market. In order to be successful, the Company
must, among other things, continue to attract, retain and motivate qualified
training personnel, successfully implement its Internet/Intranet training
programs, open new Training Centers as the market demands, respond to
competitive developments and successfully develop its internal infrastructure,
particularly sales, marketing and administrative personnel and its accounting
system. Moreover, due to the intense competition in the emerging markets
addressed by the Company, the Company must seek to grow its business rapidly,
which increases the challenges facing the Company, making it more difficult for
the Company to recover from business errors.
20
<PAGE>
Future Capital Requirements and Uncertainty of Future Funding
Since inception, the Company has been dependent on outside financing to
fund its growth. The Company raised approximately $35 million from the private
placement of Common Stock since inception. The Company anticipates that the
proceeds from these offerings and cash flows from operations will be sufficient
to meet its needs for working capital expenditures through at least fiscal 1998.
However, the Company's long-term capital requirements will be dependent on
numerous factors, including the rate at which new Training Centers are opened,
the profitability of existing Training Centers and the acquisition and/or
development of additional training tools. See "Liquidity and Capital Resources."
Need to Respond to Rapid Technological Change
The market for the Company's products and services is characterized by rapid
technological change; changing customer needs, frequent new product
introductions and evolving industry standards. These market characteristics are
exacerbated by the emerging nature of the Internet market and the fact that many
companies are expected to introduce new Internet products and services in the
near future. The Company's future success will depend in significant part on
its ability to continually and on a timely basis introduce new products,
services and technologies and to continue to improve the Company's products and
services in response to both evolving demands of the marketplace and competitive
product offerings.
Highly Competitive Market
The higher education market is highly competitive. The Company is subject
to intense competition from a large number of public and private companies
providing training, many of which are older, larger and have greater financial
and personnel resources than the Company. In addition, the market for Internet
products and services has only recently begun to develop, is rapidly evolving
and is characterized by an increasing number of market entrants with competing
products and services. There can be no assurance that the Company will be able
to compete successfully against its current or future competitors or that
competition will not have a material adverse effect on the Company's business,
operating results and financial condition.
21
<PAGE>
Item 8. Financial Statements and Supplementary Data
Prosoft I-Net Solutions, Inc. and Predecessor
Index to Consolidated Financial Statements and Schedules
<TABLE>
<CAPTION>
Contents
<S> <C>
Reports of Independent Auditors
Ernst & Young LLP........................................................................ 23
Kelly & Company.......................................................................... 24
Financial Statements of Prosoft I-Net Solutions, Inc. and Predecessor
Consolidated Balance Sheets at July 31, 1997 and 1996.................................... 25
Consolidated Statements of Operations for the year ended July 31, 1997
and for the periods ended July 31, 1996 and December 31, 1995........................... 26
Consolidated Statements of Stockholders' Equity for the year ended July 31, 1997
and for the periods ended July 31, 1996 and December 31, 1995........................... 27
Consolidated Statements of Cash Flows for the year ended July 31, 1997
and for the periods ended July 31, 1996 and December 31, 1995........................... 28
Notes to Consolidated Financial Statements............................................... 29
</TABLE>
Schedules
The schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
22
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders
Prosoft I-Net Solutions, Inc.
We have audited the accompanying consolidated balance sheets of Prosoft I-Net
Solutions, Inc. (formerly known as ProSoft Development, Inc.) as of July 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for the year ended July 31, 1997 and the
period from December 8, 1995 (date of incorporation) to July 31, 1996. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Prosoft I-Net
Solutions, Inc. at July 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for the year ended July 31 1997 and the period
from December 8, 1995 (date of incorporation) to July 31, 1996, in conformity
with generally accepted accounting principles.
ERNST & YOUNG LLP
Orange County, California
October 24, 1997
23
<PAGE>
Report of Independent Auditors
To the Owner
Professional Development Institute (a Sole Proprietorship)
We have audited the accompanying balance sheet of Professional Development
Institute (a Sole Proprietorship) as of December 31, 1995, and the related
statements of operations, Owner's deficit and cash flows for the period February
1, 1995 (date of inception) to December 31, 1995. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Professional Development
Institute (a Sole Proprietorship) as of December 31, 1995, and the results of
its operations and its cash flows for the period February 1, 1995 (date of
inception) to December 31, 1995, in conformity with generally accepted
accounting principles.
KELLY & COMPANY
Newport Beach, California
March 8, 1996
24
<PAGE>
Prosoft I-Net Solutions, Inc. and Subsidiary
Consolidated Balance Sheets
<TABLE>
<CAPTION>
July 31,
---------------------------
1997 1996
------------ -----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 12,911,684 $ 6,466,460
Tuition and accounts receivable, less allowances
of $506,182 at July 31, 1997 1,646,765 766,405
Notes receivable from officers/shareholders 308,370 85,600
Prepaid expenses and other current assets 878,048 311,592
------------ -----------
Total current assets 15,744,867 7,630,057
Property and equipment:
Computer equipment and software 5,489,035 1,494,677
Office equipment, furniture and fixtures 1,030,460 118,211
------------ -----------
6,519,495 1,612,888
Less accumulated depreciation 1,480,185 245,455
------------ -----------
5,039,310 1,367,433
------------ -----------
Total assets $ 20,784,177 $ 8,997,490
============ ===========
Liabilities and stockholders' equity
Current liabilities:
Notes payable $ -- $ 61,832
Accounts payable 1,817,314 25,164
Accrued payroll and related expenses 924,781 88,474
Payable to underwriters 1,454,375 338,250
Deferred revenue 67,959 --
Current portion of capital lease obligations 1,960,221 351,509
------------ -----------
Total current liabilities 6,224,650 865,229
Obligations under capital leases, net of current portion 1,519,965 437,532
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value:
Authorized shares -- 50,000,000
Issued and outstanding shares -- 10,119,651 and
7,336,404 shares at July 31, 1997 and 1996,
respectively 10,120 7,336
Additional capital 36,764,338 10,771,016
Note receivable from stockholder (9,500) (9,500)
Deficit (23,725,396) (3,074,123)
------------ -----------
Total stockholders' equity 13,039,562 7,694,729
------------ -----------
Total liabilities and stockholders' equity $ 20,784,177 $ 8,997,490
============ ===========
</TABLE>
See accompanying notes.
25
<PAGE>
Prosoft I-Net Solutions, Inc. and Predecessor
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Company Predecessor Entity
----------------------------------------------- ------------------
<S> <C> <C>
Period from Period from
December 8, 1995 February 1, 1995
(date of (date of inception)
Year ended July 31, Incorporation) to to December 31,
1997 July 31, 1996 1995
------------------- ----------------- -------------------
Revenue $ 3,483,140 $ 907,772 $ 77,477
Costs and expenses:
Cost of services 10,197,373 698,725 60,526
Sales and marketing 4,918,942 426,221 44,769
General and administrative 9,215,521 2,788,188 556,382
------------------- ----------------- -------------------
Total costs and expenses 24,331,836 3,913,134 661,677
------------------- ----------------- -------------------
Loss from operations (20,848,696) (3,005,362) (584,200)
Interest income (expense) 201,423 (67,961) (20,126)
------------------- ----------------- -------------------
Loss before provision for income taxes (20,647,273) $(3,073,323) $(604,326)
Provision for state franchise tax 4,000 800 _
------------------- ----------------- -------------------
Net loss $ (20,651,273) $(3,074,123) $(604,326)
=================== ================= ==================
Net loss per share $ (2.48) $ (.61)
=================== =================
Shares used in computing net loss per share 8,312,911 5,011,781
=================== =================
</TABLE>
See accompanying notes.
26
<PAGE>
Prosoft I-Net Solutions, Inc. and Predecessor
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Prosoft I-Net
Solutions, Inc.
Predecessor Pro-Soft Development Corp. ----------------------
entity Common Stock Common Stock
----------- ---------------------------- ----------------------
Owner's
deficit Shares Amount Shares Amount
----------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Capital contributions to sole
proprietorship $ 409,853 -- $ -- -- $ --
Net loss (604,326) -- -- -- --
----------- ---------- --------- ---------- ---------
Balance at December 31, 1995 (194,473) -- -- -- --
Contribution of net assets of
Predecessor to Pro-Soft Development Corp. in
exchange for common stock 194,473 1,000,000 1,000 -- --
Issuance of common stock for
cash, note and services -- 3,576,250 3,576 -- --
Conversion of accounts payable to
common stock -- 150,000 150 -- --
Shares outstanding prior to
reorganization -- -- -- 480,060 480
Acquisition of Pro-Soft
Development Corp. by the Company -- (4,726,250) (4,726) 4,726,250 4,726
Issuance of common stock for
cash, net of issuance costs of
$338,000 -- -- -- 1,169,462 1,169
Exercise of warrants -- -- -- 960,632 961
Net loss -- -- -- -- --
----------- ---------- --------- ---------- ---------
Balance at July 31, 1996 -- -- -- 7,336,404 7,336
----------- ---------- --------- ---------- ---------
Issuance of common stock for
cash, net of issuance costs of
$1,628,375 -- -- -- 2,502,922 2,503
Exercise of warrants -- -- -- 111,807 112
Exercise of stock options -- -- -- 168,518 169
Net loss -- -- -- -- --
----------- ---------- --------- ---------- ---------
Balance at July 31, 1997 $ -- -- $ -- 10,119,651 $10,120
=========== ========== ========= ========== =========
<CAPTION>
Prosoft I-Net Solutions, Inc.
------------------------------------------------------------------------------
Note
Receivable
Additional from
capital stockholder Deficit Total
------------ ------------- ------------ -----------
<S> <C> <C> <C> <C>
Capital contributions to sole
proprietorship $ -- $ -- $ -- $ --
Net loss -- -- -- --
------------ ------------- ------------ -----------
Balance at December 31, 1995 -- -- -- --
Contribution of net assets of
Predecessor to Pro-Soft Development Corp. in
exchange for common stock (195,473) -- -- (195,473)
Issuance of common stock for
cash, note and services 1,380,174 (9,500) -- 1,374,250
Conversion of accounts payable to
common stock 37,350 -- -- 37,500
Shares outstanding prior to
reorganization (455) -- -- 25
Acquisition of Pro-Soft
Development Corp. by the Company -- -- -- --
Issuance of common stock for
cash, net of issuance costs of
$338,000 8,307,221 -- -- 8,308,390
Exercise of warrants 1,242,199 -- -- 1,243,760
Net loss -- -- (3,074,123) (3,074,123)
------------ ------------- ------------ -----------
Balance at July 31, 1996 10,771,016 (9,500) (3,074,123) 7,694,729
------------ ------------- ------------ -----------
Issuance of common stock for
cash, net of issuance costs of
$1,628,375 25,669,052 -- -- 25,671,555
Exercise of warrants 140,325 -- -- 140,437
Exercise of stock options 183,945 -- -- 184,114
Net loss -- -- (20,651,273) (20,651,273)
------------ ------------- ------------ -----------
Balance at July 31, 1997 $36,764,338 $(9,500) $(23,725,396) $13,039,562
============ ============= ============ ===========
</TABLE>
See accompanying notes.
27
<PAGE>
Prosoft I-Net Solutions, Inc. and Predecessor
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Company Predecessor entity
------------------------------------------ ----------------------
Period from
December 8,
1995 Period from
(date of February 1, 1995
Year ended incorporation) (date of inception) to
July 31, 1997 to July 31, 1996 December 31, 1995
------------------ -------------------- ----------------------
<S> <C> <C> <C>
Operating activities
Net loss $(20,651,273) $(3,074,123) $(604,326)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 1,235,129 257,454 40,441
Compensation and operating expenses paid in
common stock -- 397,250 --
Change in operating assets and liabilities:
Tuition and accounts receivable (880,360) (766,405) (89,487)
Prepaid expenses and other current assets (566,456) (311,592) (28,200)
Accounts payable and payable to underwriter 2,908,275 363,414 293,305
Accrued liabilities 836,307 88,474 16,811
Deferred revenue 67,959 -- 38,744
Other -- 2,200 --
------------------ -------------------- ----------------------
Net cash used in operating activities (17,050,419) (3,043,328) (332,712)
Investing activities
Acquisition of Predecessor, net of cash acquired -- (194,893) --
Acquisition of Tel-Fed, Inc., net of cash acquired -- (560) --
Purchases of property and equipment (1,214,914) (570,838) --
Purchases of licenses -- -- (52,450)
Notes receivable from officers/shareholders (222,770) (85,600) --
------------------ -------------------- ----------------------
Net cash used in investing activities (1,437,684) (851,891) (52,450)
Financing activities
Capital contributions -- -- 409,853
Issuances of common stock 25,996,106 10,528,575 --
Principal payments on debt and capital leases (1,062,779) (228,728) (24,271)
Proceeds from notes payable -- 61,832 --
------------------ -------------------- ----------------------
Net cash provided by financing activities 24,933,327 10,361,679 385,582
------------------ -------------------- ----------------------
Increase in cash and cash equivalents 6,445,224 6,466,460 420
Cash and cash equivalents at beginning of period 6,466,460 -- --
------------------ -------------------- ----------------------
Cash and cash equivalents at end of period $12,911,684 $6,466,460 $ 420
================== ==================== ======================
Supplementary disclosure of cash paid during the
period for:
Interest $ 171,349 $ 84,772 $ 3,315
================== ==================== ======================
Income taxes $ 4,000 $ -- $ --
================== ==================== ======================
Supplementary disclosure of non-cash financing
activities:
Accounts payable converted to common stock $ -- $ 37,500 $ --
================== ==================== ======================
Equipment acquired under capital leases $ 3,691,693 $ 393,460 $ 635,874
================== ==================== ======================
</TABLE>
28
<PAGE>
Prosoft I-Net Solutions, Inc. and Predecessor
Notes to Consolidated Financial Statements
July 31, 1997
1. Significant Accounting Policies
Company Background
Prosoft I-Net Solutions, Inc. (Prosoft or the Company) is a Nevada
corporation (previously named Tel-Fed, Inc. and ProSoft Development, Inc.) that
is engaged in the business of training individuals in small, medium and large
organizations in Internet and Intranet technologies, with a current emphasis on
Microsoft and Netscape Internet/Intranet products and solutions. Such training
is accomplished at Company classrooms with Company instructors, at client sites
with Company instructors and through the sale and licensing of the Company's
courseware.
Professional Development Institute, the predecessor entity, (a sole
proprietorship formed on February 1, 1995), acquired and developed training
curricula and commenced a marketing program for a private vocational training
institution. Its first students were enrolled in September 1995. On December
8, 1995, Pro-Soft Development Corp. was formed as a California corporation, and
effective January 1, 1996, the assets and liabilities of the Professional
Development Institute, (Predecessor) were contributed to Pro-Soft Development
Corp. in exchange for 1,000,000 shares of common stock.
In March 1996, Pro-Soft Development Corp. entered into an Agreement and
Plan of Reorganization whereby Pro-Soft Development Corp.'s shareholders
received one share of common stock of the Company in exchange for each of the
4,726,250 outstanding shares and Pro-Soft Development Corp. became a wholly
owned subsidiary of the Company. For accounting purposes, Pro-Soft Development
Corp. is deemed to be the acquiring corporation and, therefore, the transaction
is being accounted for as a reverse acquisition of the Company by Pro-Soft
Development Corp. Prior to March 31, 1996, the Company did not have operations
and at March 31, 1996, only immaterial liabilities existed. Accordingly, the
financial statements present the historical financial position and results of
operations of Pro-Soft Development Corp. and its predecessor entity,
Professional Development Institute.
The Company anticipates that its existing resources will be sufficient to
meet its needs for working capital expenditures through at least fiscal 1998,
and management believes that other sources of financing are also available,
including funding commitments obtained from certain significant shareholders.
The Company's long-term capital requirements will depend on numerous factors,
including the rate at which new Training Centers are opened, the profitability
of existing Training Centers and the acquisition and/or development of
additional training tools.
The Company has incurred losses aggregating approximately $24 million since
inception, primarily due to the start-up nature of its business. The Company has
used these funds to implement its strategy of becoming one of the leading
national Training Companies focused on the Internet/Intranet. This strategy
consisted of opening 29 additional state-of-the-art training centers across the
country, preparing and executing a national image defining marketing campaign in
numerous national publications, recruiting one of the nation's largest high-end
group of Internet/Intranet instructors strategically located across the nation,
recruiting top management and sales professionals, and developing one of the
largest libraries of Internet/Intranet courses available anywhere. Having
substantially completed these tasks, the Company is beginning to realize
increasing revenue.
If revenue continues to grow as demonstrated in the fourth quarter of
fiscal 1997, the Company expects to reach quarterly profitability in fiscal year
1998, based on existing resources. However, no assurances can be given that the
Company will be successful in realizing these goals. If the Company is unable to
increase revenue as anticipated, management will implement a plan to
substantially reduce the size of the Company's operations. Such a reduction in
operations may reduce the Company's ability to meet expected market demand. The
Company's ability to continue as a going concern is dependent upon its ability
to obtain necessary financing, grow revenue, attain operational efficiencies
and, ultimately, sustain a profitable level of operations.
29
<PAGE>
Basis of Consolidation
The financial statements include the accounts of the Company and its
wholly owned subsidiary. All significant inter-company transactions and
balances have been eliminated in consolidation. Certain prior year amounts have
been reclassified to conform to current year presentation.
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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
Concentration of Business and Credit Risk
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash and cash equivalents
and accounts receivable. The Company places its cash and cash equivalents with
high credit quality financial institutions. At times, such investments may be
uninsured or in excess of the FDIC insurance limit. Concentrations of credit
risk with respect to account receivable are limited due the number of customers
comprising the Company's customer base, and their dispersion across many
different industries and geographic regions. Generally, the Company does not
require collateral or other security to support customer receivables. The
Company routinely assesses the financial strength of its customers and, as a
consequence, believes that its accounts receivable credit risk exposure is
limited.
Revenue from three southern California governmental agencies aggregated 8%,
4%, and 3% of revenue, respectively, in 1997; 34%, 27% and 21% of revenue,
respectively, in 1996, and revenue from two southern California governmental
agencies in 1995 aggregated 57% and 39% of revenue, respectively.
Advertising Costs
The Company expenses the costs of advertising as incurred. Advertising
expenses aggregated $805,301 in 1997, $90,000 in 1996, and were not significant
in 1995.
Taxes Based on Income
Deferred taxes are provided for items recognized in different periods for
financial and tax reporting purposes in accordance with Financial Accounting
Standards Board Statement No. 109, Accounting for Income Taxes.
Net Loss Per Share
Net loss per share is computed using the weighted average number of common
shares outstanding during the period presented.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per
Share. The statement simplifies the standards for computing earnings per share
("EPS"), and requires the presentation of both basic and diluted EPS on the face
of the statement of earnings with supplementary disclosures. SFAS 128 will be
effective for financial statements issued for periods ending after December 15,
1997, including interim periods. The Company will adopt SFAS 128 in the second
quarter of fiscal 1998 and does not expect the impact on the calculation of
primary earnings (loss) per share and fully diluted earnings (loss) per share to
be material.
30
<PAGE>
Long-Lived Assets
In 1996, the Company adopted SFAS 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, which requires
impairment losses to be recorded on long-lived assets used in operations or are
expected to be disposed of, when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying value of the assets. There were no impairment losses recorded in
fiscal 1997 or 1996 as the result of adopting SFAS 121.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization
are computed on a straight-line basis over the lesser of the estimated useful
lives of the related assets or the lease term. The estimated useful lives range
from two to seven years. Depreciation expense includes amortization of assets
recorded under capital leases.
Stock Options
In October 1995, the FASB issued SFAS 123, Accounting for Stock-Based
Compensation. As permitted by SFAS 123, the Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", and related Interpretations ("APB 25"), in accounting for stock-
based awards to employees, and has made pro forma disclosures required by SFAS
123. Under APB 25, the Company has generally recognized no compensation
expense with respect to such awards.
Recognition of Revenue and Costs
Tuition revenue is recognized ratably as earned over course term. Amounts
charged customers are deferred until earned. Vocational training courses
generally range from 20 to 37 weeks while Internet training courses range from
one to five days. Costs of providing services to students are charged to
expense as incurred. Cost of developing courses is expensed as incurred.
Revenues from the sale of courseware are recognized when courseware is shipped
to customers.
The Company provides an estimated allowance for doubtful accounts and for
estimated returns of courseware materials. The allowance for estimated returns
of courseware materials is established at the time of sale and is based on
management's estimates. The allowances for doubtful accounts and for returns are
shown as a reduction of receivables in the accompanying consolidated balance
sheet and amounted to $131,182 and $375,000, respectively, at July 31, 1997.
Tuition Receivable
At various times, the Company will have unbilled receivables for tuition
earned prior to, or in excess of, billings under the terms of various contracts
with paying agencies. Tuition receivable, which is included in Tuition and
accounts receivable, consists of the following:
31
<PAGE>
<TABLE>
<CAPTION>
July 31, 1997 July 31, 1996
<S> <C> <C>
Billed tuition $1,218,787 $542,054
Unbilled tuition 104,110 224,351
---------- --------
$1,322,897 $766,405
========== ========
</TABLE>
Recently Issued Pronouncements
In June 1997, the FASB issued SFAS 130, Reporting Comprehensive
Income. The Statement establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS 130 will be effective for fiscal years
beginning after December 15, 1997. The Company will adopt SFAS 130 during the
first quarter of fiscal year 1999, and does not expect the impact to be
material.
In June 1997, the FASB issued SFAS 131, Disclosures about Segments of an
Enterprise and Related Information. The Statement requires public business
enterprises to report certain information about operating segments in complete
sets of financial statements of the enterprise and in condensed financial
statements of interim periods issued to shareholders. It also requires that
public business enterprises report certain information about their products and
services, the geographic areas in which they operate, and their major customers.
SFAS 131 will be effective for fiscal years beginning after December 15, 1997.
The Company will adopt SFAS 131 in its fiscal year 1999.
2. Stockholders' Equity
Formation of Pro-Soft Development Corp.
Upon the formation of Pro-Soft Development Corp. two of the founders
acquired an aggregate of 2,000,000 shares of common stock in exchange for
$19,000. For financial statement purposes, these shares were valued at $.20 per
share and compensation expense of $381,000 was recorded to reflect the
difference between the amount paid and the deemed fair market value of the
shares issued.
Stock Options
The Company's stock option plan provides for the granting of options to
purchase shares of the Company's common stock, to employees, officers,
consultants, and directors. The plan includes nonstatutory options and incentive
stock options. Options generally vest over three to four years and expire no
later than ten years after the date of grant.
The plan, as amended by the Company's Board of Directors, allows for the
issuance of up to 2,250,000 shares of common stock. At July 31, 1997, options to
purchase 1,360,919 shares of common stock at exercise prices ranging from $3.50
to $20 per share were outstanding. At July 31, 1997, 687,386 of the options
issued under the plan were exercisable. Options may be granted subject to
approval by the Company's Board of Directors and Shareholders.
As a result of the reorganization, nonstatutory stock options to purchase
1,042,500 shares of common stock of Pro-Soft Development Corp. were converted
into options to purchase 1,042,500 shares of the Company's common stock at an
exercise price of $1.00 per share. At July 31, 1997, 799,900 of these options
remained outstanding and are exercisable.
32
<PAGE>
Information relating to the outstanding stock options is as follows:
<TABLE>
<CAPTION>
Shares Price
------ -----
<S> <C> <C>
Outstanding at December 8, 1995, (Incorporation)
Options granted 697,500 $3.50-$20.00
Conversion of Pro-Soft Development Corp.
options 1,042,500 $1.00
Options exercised --
Options cancelled (46,250) $1.00
---------
Outstanding at July 31, 1996 1,693,750 $1.00-$20.00
Options granted 752,500 $6.75-$18.00
Options exercised (168,518) $1.00-$5.00
Options cancelled (116,913) $1.00-$18.00
---------
Outstanding at July 31, 1997 2,160,819 $1.00-$20.00
=========
</TABLE>
The following table summarizes information concerning options outstanding
and exercisable as of July 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------- ----------------------------
Weighted Average Weighted Weighted
Range of Exercise Remaining Average Average
Prices Number Contractual Life Exercise Price Number Exercise Price
- ----------------- --------- ---------------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
$1.00-$3.50 832,400 1.10 $1.10 817,400 $1.05
$5.00-$7.12 763,601 3.42 5.51 473,277 5.03
$9.5-$11.00 534,818 4.28 9.71 189,109 9.76
$15.00-$20.00 30,000 3.66 19.33 7,500 19.33
--------- ---------
2,160,819 1,487,286
========= =========
</TABLE>
Pro forma information regarding net loss and net loss per share is required
by SFAS 123 for awards granted after January 31, 1995 as if the Company had
accounted for its stock-based awards to employees under the fair value method of
SFAS 123. The fair value of the Company's stock-based awards to employees was
estimated using the Black-Scholes multiple option pricing model. The Black-
Scholes option valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions are fully
transferable. In addition, the Black-Scholes model requires the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock-based awards to employees have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock based awards to employees.
33
<PAGE>
The fair value of the Company's stock-based awards to employees was
estimated assuming no expected dividends and the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Expected life (years) 1.00 1.00
Expected stock price volatility 0.75 0.75
Risk-free interest rate (percent) 4.85 4.85
</TABLE>
For purpose of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information for the year ended July 31, 1997 and the period ended July
31, 1996 follows:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Net loss - actual $(20,651,273) $(3,074,123)
Net loss - pro forma (22,453,127) (3,944,187)
Net loss per share - actual $ (2.48) $ (.61)
Net loss per share - pro forma (2.70) (.79)
</TABLE>
Because SFAS 123 is applicable only to options granted subsequent to
December 8, 1995, its pro forma effect will not be fully reflected until fiscal
2000. The weighted average fair value of options granted during the year ended
July 31, 1997 and the period ended July 31, 1996 was $3.89 and $0.98,
respectively.
Warrants
During 1996, the Company issued warrants to purchase 1,556,461 shares of
common stock to purchasers of its common stock and other parties at prices
ranging from $1.00 to $11.00 per share. During 1996, warrants for 960,632
shares of common stock were exercised at prices ranging from $1.00 to $5.00, and
warrants for 49,882 were redeemed for a nominal amount. During 1997, warrants
for 111,807 were exercised at prices ranging from $1.00 to $5.00, and warrants
for 2,476 shares expired. At July 31, 1997, warrants for 371,664 shares of
common stock, exercisable at $1 to $11 per share and expiring through 2003,
remained outstanding.
Common Stock Reserved
At July 31, 1997, a total of approximately 3,500,000 shares of the
Company's common stock were reserved for future exercise of stock options and
warrants.
3. Commitments and Contingencies
Commitments
The Company leases certain facilities as well computers and production
equipment under noncancelable lease agreements. The Company's future minimum
lease payments under such agreements are as follows:
34
<PAGE>
<TABLE>
<CAPTION>
Capital Operating
leases leases
---------- ----------
<S> <C> <C>
1998 $1,960,221 $1,035,390
1999 1,520,800 1,110,861
2000 316,677 625,546
2001 134,074 390,669
2002 79,746 174,445
---------- ----------
4,011,518 $3,336,911
==========
Less amounts representing interest 531,332
----------
Present value of minimum lease payments 3,480,186
Less current portion 1,960,221
----------
Obligations under capital lease, net of current portion $1,519,965
==========
</TABLE>
Assets held under capital leases are included in property and equipment and
had a total value of $4,934,474 and $1,242,781, respectively, and a net book
value of $3,804,667 and $1,043,822, at July 31, 1997 and 1996, respectively.
Rent expense for the periods ended July 31, 1997 and 1996 and December 31,
1995 totaled $930,675, $166,763, and $20,516, respectively.
Contingencies
The Company is involved, from time to time, in legal proceedings arising
from the ordinary course of its business. In the opinion of management, none of
these matters, based on factors currently known to management, is expected to
have a material adverse effect on consolidated financial position, results of
operations or cash flows of the Company.
4. Employee Benefit Plan
The Company has adopted a defined contribution plan for the benefit of its
employees who have met certain eligibility requirements. The Prosoft 401(k) Plan
(the "401(k) Plan") is a profit-sharing plan qualifying under Section 401(k) of
the Internal Revenue Code, and provides employees with tax deferred salary
deductions and alternative investment options. Employees may contribute up to
25% of their salary, subject to certain limitations. The Company, at the
discretion of the Company's Board of Directors, may make contributions to the
401(k) Plan. The Company has not contributed to the 401(k) Plan.
5. Income Taxes
The Predecessor's financial statements include no provision for income
taxes because, as a proprietorship, the results of operations were reported on
the individual income tax return of the owner.
There was no significant provision for federal or state income taxes for
any period as the Company has incurred operating losses and there can be no
assurance that the Company will realize the benefit of the resulting net
operating loss carryforwards.
Deferred income taxes reflect the tax consequences on future years of
differences between the tax bases of assets and liabilities and their bases for
financial reporting purposes. Temporary differences which give rise to deferred
tax assets are as follows:
35
<PAGE>
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Net operating loss carryforwards $ 8,585,000 $ 995,000
Accrued expenses 185,000
Allowance for returns and for
doubtful accounts 217,000
Other 23,000
----------- ---------
Total deferred tax assets 9,010,000 995,000
Valuation allowance (9,010,000) (995,000)
----------- ---------
Net deferred tax assets $ -- $ --
=========== ==========
</TABLE>
Due to the uncertainties surrounding the timing of realizing the benefits
of its favorable tax attributes in future tax returns, the Company has placed a
valuation allowance against its otherwise recognizable deferred tax assets. The
valuation allowance increased by approximately $8,000,000 during the year ended
July 31, 1997 and by approximately $1,000,000 during the period ended July 31,
1996. The increase in the valuation allowance is due to the increase in the net
operating loss carry forward.
At July 31, 1997, the Company has net operating loss carryforwards
available to offset future federal and state taxable income of approximately
$23,500,000 and $10,900,000, respectively. Such carryforwards expire principally
in 2012 and 2002, respectively. Because of the equity transactions completed by
the Company in 1996, utilization of certain net operating loss carryforwards for
federal income tax reporting purposes created prior to those transactions will
be subject to annual limitations under the change in ownership provisions of the
Tax Reform Act of 1986.
6. Notes Payable
At July 31, 1996, notes payable consisted of a $61,832 demand note payable
to a shareholder bearing interest at 8%. This note was repaid prior to July 31,
1997.
7. Related Party Transactions
During 1996 and 1997, the Company made short-term loans and advances to
certain officers and shareholders generally bearing interest at 10%. Such
advances are generally repayable on demand.
8. Valuation and qualifying accounts
The following table summarizes changes in valuation accounts all of which
have been deducted from Tuition and accounts receivable in the Company's
consolidated balance sheet.
<TABLE>
<CAPTION>
Allowance for Allowance for
Doubtful Accounts Returns
----------------- -------------
<S> <C> <C>
Balance, July 31, 1996 $ -- $ --
Additions charged to expense 150,000 --
Additions charged against revenues -- 375,000
Deductions - charge offs (18,818) --
-------- --------
Balance, July 31, 1997 $131,182 $375,000
======== ========
</TABLE>
There was no activity in these accounts prior to July 31, 1996.
36
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
37
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item will be included in the Company's
Proxy Statement with respect to its 1997 Annual Meeting of Stockholders to be
filed with the Commission within 120 days of July 31,1997 and is incorporated
herein by this reference.
Item 11. Executive Compensation
The information required by this item will be included in the Company's
Proxy Statement with respect to its 1997 Annual Meeting of Stockholders to be
filed with the Commission within 120 days of July 31,1997 and is incorporated
herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item will be included in the Company's
Proxy Statement with respect to its 1997 Annual Meeting of Stockholders to be
filed with the Commission within 120 days of July 31,1997 and is incorporated
herein by this reference
Item 13. Certain Relationships and Related Transactions
The information required by this item will be included in the Company's
Proxy Statement with respect to its 1997 Annual Meeting of Stockholders to be
filed with the Commission within 120 days of July 31,1997 and is incorporated
herein by this reference.
38
<PAGE>
PART IV
Item 14. Exhibits and Financial Statement Schedules and Reports on Form 8-K.
a. The following documents are filed as part of this report.
1. Consolidated Financial Statements
See "Index to Consolidated Financial Statements"- Item 8.
2. Exhibits
See "Exhibit Index."
b. Reports on Form 8-K. No reports on Form 8-K were filed during the
last quarter of the fiscal year ended July 31, 1997.
39
<PAGE>
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.
PROSOFT I-NET SOLUTIONS, INC.
/s/ BROOKS A. CORBIN
--------------------------------------
Brooks A. Corbin
Chief Financial Officer
(Principal Financial Officer
and Duly Authorized Officer)
Dated: 11-5-97
------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
--------- -------- ----
<S> <C> <C>
/s/ KEITH D. FREADHOFF
- ------------------------- Chief Executive Officer and 11-5-97
Keith D. Freadhoff Chairman of the Board (Principal -------------------------
Executive Officer)
/s/ DONALD L. DANKS
- ------------------------- 11-5-97
Donald L. Danks Vice Chairman and Director -------------------------
/s/ JERRELL M. BAIRD
- ------------------------- 11-5-97
Jerrell M. Baird President & Chief Operating Officer -------------------------
/s/ JOHN R. LINDSEY
- ------------------------- 11-5-97
John R. Lindsey Controller (Principal Accounting -------------------------
Officer)
/s/ ANDREW STALLMAN
- ------------------------- 11-5-97
Andrew Stallman Director -------------------------
/s/ JEFFREY G. KORN
- ------------------------- 11-5-97
Jeffrey G. Korn Director -------------------------
</TABLE>
40
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit
No. Description of Exhibits
- --------------------------------------------------------------------------------
<S> <C>
2 Agreement and Plan of Reorganization dated March 26, 1996 between the
Company, Pro-Soft Development Corp. and the shareholders of Pro-Soft
Development Corp. Filed as Exhibit 2 to the Company's Registration
Statement on Form S-1 (No. 333-11247) ("Registration Statement No.
333-11247") and incorporated herein by reference.
3.1 Restated Articles of Incorporation of the Company, as amended. Filed
as Exhibit 3.1 to Registration Statement No. 333-11247 and incorporated
herein by reference.
3.2 Amended and Restated Bylaws of the Company. Filed as Exhibit 3.2 to
Registration Statement No. 333-11247 and incorporated herein by
reference.
10.1 Pro-Soft Development Corp. 1996 Stock Option Plan. Filed as Exhibit
10.1 to Registration Statement No. 333-11247 and incorporated herein by
reference.
10.2 ProSoft I-Net Solutions, Inc. Amended 1996 Stock Option Plan. Filed as
Exhibit 10.2 to Registration Statement No. 333-11247 and incorporated
herein by reference.
10.3 Stock and Warrant Purchase Agreement dated April 15, 1996 by and among
the Company, Donald L. Danks, Keith D. Freadhoff, Douglas Hartman and
various investors. Filed as Exhibit 10.3 to Registration Statement
No. 333-11247 and incorporated herein by reference.
10.4 Form of Subscription Agreement, entered into in July and August 1996,
between the Company and various investors. Filed as Exhibit 10.4 to
Registration Statement No. 333-11247 and incorporated herein by
reference.
10.5 Form of Registration and Lock-Up Agreement dated September __, 1996
between the Company and certain of the Selling Stockholders. Filed as
Exhibit 10.5 to Registration Statement No. 333-11247 and incorporated
herein by reference.
10.6 Microsoft/Internet Contract Teaching Agreement dated as of April 29,
1996 by and between the Company and Merisel, Inc. Filed as Exhibit
10.6 to Registration Statement No. 333-11247 and incorporated herein
by reference.
10.7 AT&T Professional Consultant Agreement dated March 28, 1997 by and
between the Company and AT&T Corp.
10.8 Xerox Order Agreement dated September 26, 1995 between Professional
Development Institute and Xerox Corporation. Filed as Exhibit 10.9
to Registration Statement No. 333-11247 and incorporated herein by
reference.
10.9 Term Lease Master Agreement dated as of April 19, 1996 between Pro-Soft
Development Corp. and IBM Credit Corporation. Filed as Exhibit 10.10
to Registration Statement No. 333-11247 and incorporated herein by
reference.
10.10 Lease Agreement dated as of June 21, 1996 between Pro-Soft Development
Corp. and Sanwa Leasing Corporation. Filed as Exhibit 10.11 to
Registration Statement No. 333-11247 and incorporated herein by
reference.
10.11 Promissory Notes dated July 3, 1996 and July 31, 1996 made by Keith
Freadhoff in favor of the Company. Filed as Exhibit 10.12 to
Registration Statement No. 333-11247 and incorporated herein by
reference.
10.12 Form of Indemnification Agreement between the Company and its
Directors and Officers. Filed as Exhibit 10.13 to Registration
Statement No. 333-11247 and incorporated herein by reference.
10.13 Licensing Agreement dated August 6, 1996 between Street Technologies,
Inc. and the Company. Filed as Exhibit 10.14 to Registration Statement
No. 333-11247 and incorporated herein by reference.
10.14 Office Building Lease dated as of December 16, 1996 between COSCAN
California Limited Partnership and the Company. Filed as Exhibit 10
to the Company's Report on Form 10-Q for the
</TABLE>
41
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit
No. Description of Exhibits
- --------------------------------------------------------------------------------
<S> <C>
quarter ended January 31, 1997 and incorporated herein by reference.
10.15 Form of Subscription Agreement, entered into in February through April
1997, between the Company and various investors. Filed as Exhibit
10.16 to Registration Statement No. 333-11247 and incorporated herein
by reference.
10.16 Registration Rights Agreement dated as of March 13, 1997 among the
Company and various investors. Filed as Exhibit 10.17 to Registration
Statement No. 333-11247 and incorporated herein by reference.
10.17 Subscription Agreement between the Company and General Electric Pension
Trust dated April 4, 1997. Filed as Exhibit 10.18 to Registration
Statement No. 333-11247 and incorporated herein by reference.
10.18 Escrow Agreement among the Company, General Electric Pension Trust and
State Street Bank and Trust dated April 4, 1997. Filed as Exhibit
10.19 to Registration Statement No. 333-11247 and incorporated herein
by reference.
10.19 Secured Promissory Note dated April 9, 1997 in favor of the Company.
Filed as Exhibit 10.20 to Registration Statement No. 333-11247 and
incorporated herein by reference.
21 Subsidiaries of the Company. Filed as Exhibit 21 to Registration
Statement No. 333-11247 and incorporated herein by reference.
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Kelly & Co.
27 Financial Data Schedule.
</TABLE>
42
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-19477) pertaining to the 1996 Stock Option Plan of Prosoft I-Net
Solutions, Inc. (formerly known as Prosoft Development, Inc.) of our report
dated October 24, 1997, with respect to the consolidated financial statements of
Prosoft I-Net Solutions, Inc. included in the Annual Report (Form 10-K) for the
year ended July 31, 1997.
Orange County, California ERNST & YOUNG LLP
November 6, 1997
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-19477) pertaining to the 1996 Stock Option Plan of Prosoft I-Net
Solutions, Inc. (formerly known as Prosoft Development, Inc.) of our report
dated March 8, 1996 with respect to the consolidated financial statements and
schedules of Prosoft I-Net Solutions, Inc. included in the Annual Report (Form
10-K) for the year ended July 31, 1997.
/s/ KELLY & COMPANY
- -------------------
Newport Beach, California
October 27, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1997
<PERIOD-START> AUG-01-1996
<PERIOD-END> JUL-31-1997
<CASH> 12,911,684
<SECURITIES> 0
<RECEIVABLES> 2,461,317
<ALLOWANCES> 506,182
<INVENTORY> 0
<CURRENT-ASSETS> 15,744,867
<PP&E> 6,519,495
<DEPRECIATION> 1,480,185
<TOTAL-ASSETS> 20,784,177
<CURRENT-LIABILITIES> 6,970,835
<BONDS> 0
0
0
<COMMON> 10,120
<OTHER-SE> 13,029,442
<TOTAL-LIABILITY-AND-EQUITY> 20,784,177
<SALES> 3,483,140
<TOTAL-REVENUES> 3,483,140
<CGS> 10,197,373
<TOTAL-COSTS> 24,331,836
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<LOSS-PROVISION> 20,647,273
<INTEREST-EXPENSE> (201,423)
<INCOME-PRETAX> (20,647,273)
<INCOME-TAX> 4,000
<INCOME-CONTINUING> (20,651,273)
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<EPS-PRIMARY> (2.48)
<EPS-DILUTED> (2.48)
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