<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
Quarterly Report Under Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
Commission File Number 0-13741
ITC LEARNING CORPORATION
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(Exact name of small business issuer as specified in its charter)
<TABLE>
<CAPTION>
Maryland 52-1078263
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<S> <C>
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
</TABLE>
13515 Dulles Technology Drive, Herndon, Virginia 20171
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(Address of principal executive offices)
(703) 713-3335
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Issuer's telephone number
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X; No
- -
As of September 30, 1998, 3,958,245 shares of Common Stock were outstanding.
Transitional Small Business Disclosure Format: Yes ; No X
- -
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TABLE OF CONTENTS
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<TABLE>
<CAPTION>
PART I PAGE
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<S> <C> <C>
Item 1 Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations for the
Three Months and Nine Months Ended September 30, 1998 and 1997 1
Condensed Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 2
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 1998 and 1997 4
Notes to Condensed Consolidated Financial Statements 5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II
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Item 1 Legal Proceedings 16
Item 2 Changes in Securities 16
Item 3 Defaults Upon Senior Securities 16
Item 4 Submission of Matters to a Vote of Security Holders 16
Item 5 Other Information 16
Item 6 Exhibits and Reports on Form 8-K 16
</TABLE>
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
ITC LEARNING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months, For the Nine Months
Ended September 30, Ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $ 4,053,955 $ 7,088,571 $ 10,928,910 $ 16,298,834
Cost of sales 2,837,768 4,930,351 6,566,057 9,211,907
------------ ------------ ------------ ------------
Gross margin 1,216,187 2,158,220 4,362,853 7,086,927
Selling, general, and
administrative expense 3,153,362 2,663,521 8,848,343 9,586,995
Equity in earnings of affiliates (19,949) (159,389) (176,902) (198,503)
Interest income, net (21,201) (55,140) (171,836) (138,473)
------------ ------------ ------------ ------------
3,112,212 2,448,992 8,499,605 9,250,019
------------ ------------ ------------ ------------
Loss before income taxes (1,896,025) (290,772) (4,136,752) (2,163,092)
Income tax benefit -- (48,000) (222,516) (716,000)
------------ ------------ ------------ ------------
Net loss $ (1,896,025) $ (242,772) $ (3,914,236) $ (1,447,092)
============ ============ ============ ============
Net loss per common
share, basic and diluted
(note 2) $ (0.48) $ (0.06) $ (1.00) $ (0.37)
============ ============ ============ ============
Weighted average number
of shares outstanding 3,991,629 3,897,034 3,909,630 3,897,027
============ ============ ============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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ITC LEARNING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
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(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,047,758 $ 4,885,672
Accounts receivable, net (note 3) 3,940,584 6,167,592
Due from affiliates 114,847 33,092
Inventories 239,256 357,374
Prepaid expenses 202,744 123,042
Income taxes receivable 153,714 175,206
Other current assets -- 11,912
------------ ------------
Total current assets 5,698,903 11,753,890
Long-term receivable (note 4) -- 836,882
Note receivable (note 5) 791,297 922,940
Property and equipment:
Video and computer equipment 2,039,276 1,336,735
Furniture and fixtures 206,313 125,259
Leasehold improvements 35,093 21,313
------------ ------------
2,280,682 1,483,307
Less accumulated depreciation and amortization (1,181,116) (802,989)
------------ ------------
Net property and equipment 1,099,566 680,318
Capitalized program development costs, net 4,066,721 3,947,086
Intangible assets (note 6) 5,391,696 1,631,299
Other 12,688 12,340
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Total assets $ 17,060,871 $ 19,784,755
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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ITC LEARNING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
(Unaudited)
<S> <C> <C>
Current liabilities:
Line of credit (note 7) $ -- $ --
Current installments of long-term debt (note 8) 300,000 100,000
Accounts payable 1,902,192 740,353
Due to affiliates 173,173 293,561
Accrued compensation and benefits 777,435 1,281,691
Deferred revenues 290,523 422,787
Other accrued expenses 745,103 1,236,012
Income taxes payable 104,097 335,102
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Total current liabilities 4,292,523 4,409,506
Deferred lease obligations 45,563 60,296
Long-term debt (note 8) 1,470,497 400,000
------------ ------------
Total liabilities 5,808,583 4,869,802
Stockholders' equity:
Common Stock, $0.10 par value, 12,000,000 shares
authorized; 3,958,245 and 3,897,074 shares
issued and outstanding in 1998 and
1997, respectively 395,826 389,708
Additional paid-in capital 16,290,877 16,090,816
Note receivable from ESOP (465,177) (541,677)
Retained earnings (deficit) (4,970,819) (1,056,583)
Accumulated other comprehensive income (note 9) 1,581 32,689
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Total stockholders' equity 11,252,288 14,914,953
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Total liabilities and stockholders' equity $ 17,060,871 $ 19,784,755
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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ITC LEARNING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For Nine Months Ended September 30,
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net loss $ (3,914,236) $ (1,447,092)
Reconciling items:
Deferred tax benefit -- (716,000)
Depreciation and amortization 1,774,230 2,642,781
Provision for doubtful accounts 127,500 106,515
Salespeople awards of common shares 4,119 938
Foreign currency translation adjustment (31,108) (45,044)
Changes in operating assets and liabilities:
Decrease in accounts receivable 2,962,891 2,208,512
Decrease (increase) in inventories 118,118 (3,105,466)
Increase in prepaid expenses (79,702) (174,100)
Decrease in other assets -- 17,910
Decrease in income taxes receivable 21,492 253,976
Decrease in long term receivable 143,207 573,938
Increase (decrease) in accounts payable 1,118,775 (206,835)
Decrease in due to affiliates, net (202,143) (77,643)
Decrease in accrued compensation and benefits (522,953) (81,495)
Increase (decrease) in deferred revenues (132,264) 3,252,428
Decrease in other accrued expenses (490,909) (460,127)
Decrease in income taxes payable (233,005) --
Decrease in deferred lease obligation (14,733) (10,191)
Net effect of acquired operating assets and liabilities (206,533) --
------------ ------------
Net cash provided by operating activities 442,746 2,733,005
Cash flows from investing activities:
Deferred program development costs (280,026) (2,075,540)
Capital expenditures (528,581) (413,731)
Acquisitions, net of cash acquired and notes payable (3,148,471) --
------------ ------------
Net cash used for investing activities (3,957,078) (2,489,271)
Cash flows from financing activities:
Repayments under line of credit (3,834,935) (515,000)
Borrowings under line of credit 3,809,935 --
Principal payments of long-term debt (62,837) (96,230)
Issuance of common stock 223,603 --
Repurchase of common stock (535,848) --
Employee stock ownership plan note collections 76,500 76,500
------------ ------------
Net cash used for financing activities (323,582) (534,730)
------------ ------------
Net decrease in cash (3,837,914) (290,996)
Cash and cash equivalents at beginning of period 4,885,672 2,697,566
------------ ------------
Cash and cash equivalents at end of period $ 1,047,758 $ 2,406,570
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 7
ITC LEARNING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
1) SIGNIFICANT ACCOUNTING POLICIES
a) Basis of Presentation
The condensed consolidated financial statements of ITC Learning Corporation
("ITC" or the "Company") include the accounts of its wholly owned subsidiaries
Activ Training, Ltd ("Activ"), ITC Australasia Pty. Ltd. ("ITCA"), Turn-Key
Training Technologies, Inc. ("Turn-Key"), ITC Canada Limited, and ComSkill
Learning Centers, Inc. ("ComSkill"). Significant intercompany accounts and
transactions have been eliminated in consolidation. In the opinion of the
Company's management, the interim condensed consolidated financial statements
include all adjustments, consisting of only normal recurring adjustments,
necessary for a fair presentation of the results for the interim periods.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Certain prior year amounts have been
reclassified to improve comparability to current year presentations. The interim
condensed consolidated financial statements should be read in conjunction with
the Company's December 31, 1997 and 1996 audited financial statements included
with the Company's filing on Form 10-KSB. The interim operating results are not
necessarily indicative of the operating results for the full fiscal year.
b) Revenues and Cost
In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue
Recognition, which supercedes SOP 91-1. The provisions of SOP 97-2 took effect
in fiscal years beginning after December 15, 1997 and clarify rules of revenue
recognition related to customer acceptance, product upgrades and post-contract
customer support. In March 1998, the AICPA issued SOP 98-4, which defers for one
year the implementation of certain provisions of SOP 97-2. The Company
implemented SOP 97-2 as amended by SOP 98-4 for transactions entered into
beginning January 1, 1998, and has determined that there has been no material
impact on revenue recognized in the first nine months of 1998 under these
provisions. In October 1998, the AICPA voted to amend certain provisions of SOP
97-2 subject to final clearance by the Financial Accounting Standards Boards.
The Company is currently analyzing the provisions of the proposed SOP; however,
it doesn't expect the impact to be material.
Revenues include both off-the-shelf and custom courseware sales, courseware
licenses, consulting service revenues and hardware revenues. The Company
recognizes revenues from off-the-shelf product and hardware sales as units are
shipped. The Company permits the customer the right to return the courseware
within 30 days of purchase. In the event that sales returns are material, the
Company adjusts revenue accordingly. Revenues from sales of custom training
programs that are developed and produced under specific contracts with
customers, including contracts with affiliated joint ventures and limited
partnerships, are recognized on the percentage of completion basis as related
costs are incurred during the production period. Gross revenues from sales of
affiliated joint venture and limited partnership copyrighted courseware are
included in the Company's financial statements, as are related production,
selling and distribution costs. Amounts due to co-owners of the affiliated
venture/partnerships related to such courseware sales are reflected as royalties
and included in cost of sales in the financial statements. Revenues from
courseware licenses are recognized upon the delivery of the initial copy of each
product licensed, and related duplication costs are accrued based on estimates.
Revenues from consulting services are recognized as services are performed.
5
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2) NET LOSS PER COMMON SHARE
In 1997, the Financial Accounting Standards Board issued SFAS No. 128, Earnings
Per Share ("Statement 128"). Statement 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the requirements of
Statement 128.
3) ACCOUNTS RECEIVABLE
Accounts receivable include the following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
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<S> <C> <C>
Trade accounts receivable $ 3,361,684 $ 5,412,822
Current portion of long-term receivable (note 4) 864,881 909,575
Unbilled contract receivables 80,399 98,162
Less allowance for doubtful accounts (366,524) (254,728)
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Trade accounts receivable, net 3,940,440 6,165,831
Other receivables 144 1,761
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$ 3,940,584 $ 6,167,592
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</TABLE>
4) LONG-TERM RECEIVABLE
During the second quarter of 1996, the Company entered into a contract with the
DeKalb County (GA) Board of Education ("DeKalb") for the sale of a district-wide
multicopy courseware license, hardware and certain future services. The total
contract amount of $5,060,000 is payable in four installments, $1,535,000 upon
contract execution, and the remaining $3,525,000 in three equal annual
installments beginning in June 1997. The 1997 and 1998 installments were
received in accordance with the provisions of the contract and the effect of the
payment is reflected in the financial statements. The long-term portion of the
net receivable has been discounted assuming a 6% interest rate. As the final
payment is scheduled to be received in June 1999, the resulting balance has been
classified as current.
5) NOTE RECEIVABLE
On November 20, 1997, the Company entered into a stock purchase agreement with
Anderson Holdings, Inc., an investor group headed by a former employee of the
Company, to sell all of the Company's stock in Anderson Soft-Teach in exchange
for $4,000,000 cash, a promissory note in the amount of $950,000, and
forgiveness of AST's outstanding intercompany obligations to ITC. Under the
terms of the stock purchase agreement, ITC and AST entered into a reciprocal
agreement to sell each other's products over the remainder of 1997 and all of
1998. Royalties earned by AST for sales of their products under this agreement
are applied to the principal value of the note. As of September 30, 1998, the
note's principal had been reduced by $158,703 for such royalties. Under the
terms of the note, AST makes quarterly interest payments to ITC at an interest
rate of 8% and will pay the remaining principal balance at the end of four
years.
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6) ACQUISITIONS
On January 30, 1998, the Company invested US$1,000,000 in the stock of Mentor
Networks Inc. ("Mentor"). For its investment, ITC acquired 8% of the outstanding
stock of Mentor with an option to acquire an additional 12%. The Company had
previously acquired the rights to distribute Mentor's products exclusively in
the United States.
During the second quarter of 1998, ITC restructured the terms of its
distribution agreement with Mentor. Certain terms of the agreement were revised,
including the revenue sharing arrangement and extension of the agreement through
June of 2001. In consideration, ITC issued Mentor a prepaid order totaling
US$300,000 for product relating to pending third quarter 1998 sales which was
subsequently written off in connection with Mentor being placed into
Receivership. Additionally, the Company elected to forego its option to acquire
the previously mentioned 12% ownership position.
On July 20, 1998, the Company was notified by Mentor that its secured lender,
the Nova Scotia Business Development Corporation ("NSBDC") had placed Mentor
into Receivership. ITC issued a Tender Offer for the assets of Mentor on August
19, 1998. The acquisition was consummated on September 25, 1998. ITC, through
its wholly-owned subsidiary, ITC Canada Limited, acquired all of the assets of
Mentor and its wholly-owned subsidiary, High Performance Group (Canada) Inc.
("HPG"). The assets included furniture, fixtures and computer equipment,
software products developed or owned by Mentor and HPG, assignment of the leased
premises in Halifax, Nova Scotia, the assignment of certain contractual
commitments, and the assignment of all trade names, copyrights, patents and
other intellectual property of both Mentor and HPG. The purchase price totaled
CDN$3,000,000 (approximately US$1,981,000) and consisted of a cash payment
CDN$1,000,000 (approximately US$661,000) and a five year promissory note bearing
8% interest payable to the NSBDC in the amount of CDN$2,000,000 (approximately
US$1,320,000). Additionally, the Company agreed to pay the NSBDC up to
CDN$1,600,000 (approximately US$1,058,000) in certain future royalty payments
based on the ongoing performance of the Mentor assets. (The U.S. equivalent for
all amounts shown are at then-current exchange rates.) ITC's Toronto-based sales
and marketing office was combined with ITC Canada Limited. As a result of
the acquisition, the Company recorded approximately US$2,827,000 of intangible
assets primarily consisting of workforce investment, leasehold premises,
customer base, contractual commitments, intellectual property rights and other
intangible assets, including capitalized program development costs reclassified
from ITC's original investment in Mentor of US$1,000,000. The intangible assets
will be amortized over a period of three years.
On March 25, 1998, the Company acquired Turn-Key Training Technologies, Inc.
("Turn-Key"), a developer and distributor of performance-based administrative
software. Pursuant to the acquisition agreement, ITC purchased all of the
outstanding stock of Turn-Key for $700,000 in cash. Additionally, ITC paid
$600,000 and issued 100,000 shares of its common stock to Philip L. Camillo,
Turn-Key's founder and president, in connection with a long-term non-competition
agreement. As a result of the acquisition, the Company recorded intangible
assets of approximately $1,795,000, consisting of the non-competition agreement
and goodwill. These assets will be amortized over periods of seven years and ten
years, respectively.
On June 18, 1998, the Company acquired certain assets of iNEX Corporation
("iNEX") for cash and stock valued at $466,000. In exchange for its investment,
ITC acquired iNEX's technology-based delivery platforms, intellectual property
rights, content, certain other assets and ten employees. As a result of the
acquisition, the Company recorded intangible assets of $374,000. These assets
will be amortized over a period of ten years.
The following table sets forth proforma unaudited results of operations of the
Company for the nine months ended September 30, 1998 and 1997, as if Mentor had
been acquired January 1, 1997.
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<TABLE>
<CAPTION>
Nine Months Ending Nine Months Ending
September 30, September 30,
1998 1997
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<S> <C> <C>
Net revenues $ 11,696,700 $ 16,663,445
============ ============
Net loss $ (6,477,264) $ (4,487,081)
============ ============
Net loss per common share $ (1.66) $ (1.15)
============ ============
</TABLE>
7) LINE OF CREDIT
At September 30, 1998, the Company had no balance outstanding relating to its
$3,000,000 and $250,000 revolving bank lines of credit, each of which bear
interest at the bank's prime lending rate. Borrowings under the lines are
collateralized by the Company's accounts receivable and inventory.
8) LONG-TERM DEBT
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<CAPTION>
Long-term debt consists of the following: September 30, December 31,
1998 1997
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<S> <C> <C>
8.5% note payable to financial institution due in $ 437,163 $ 500,000
monthly principal and interest installments of
$10,258 through December 2002, collateralized by
the assignment of interest in the shares of the
Company's common stock held by the ESOP,
accounts receivable, inventory and property and
equipment
8.0% note payable to Nova Scotia Business 1,333,334 --
Development Corporation due in monthly interest
installments (beginning October 31, 1998)
and quarterly principal installments (beginning
March 31, 1999), maturing in December 2003,
collateralized by the assignment of interest in
the working capital, fixed assets and intellectual
property of ITC Canada Limited.
Less amount classified as current (300,000) (100,000)
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$1,470,497 $ 400,000
========== ==========
</TABLE>
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9) COMPREHENSIVE INCOME (LOSS)
As of January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive
Income ("Statement 130"). Statement 130 establishes new rules for the reporting
and display of comprehensive income and its components. Statement 130 requires
that foreign currency translation adjustments, which prior to adoption were
reported separately as a component of stockholders' equity, be included in other
comprehensive income. Prior year financial statements have been restated to
conform with the requirements of Statement 130.
The components of comprehensive income, net of related tax, for the nine-month
periods ending September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
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<S> <C> <C>
Net loss $ (3,914,236) $ (1,447,092)
Foreign currency translation adjustment (31,108) (45,044)
------------ ------------
Comprehensive net loss $ (3,945,344) $ (1,492,136)
============ ============
</TABLE>
The components of accumulated other comprehensive income, net of related tax, at
September 30, 1998 and December 31, 1997 are as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Cumulative foreign currency translation adjustment $ 1,581 $ 32,689
============ ============
</TABLE>
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
Certain statements made by the Company's management may be considered to be
"forward-looking statements" within the meaning of the Private Securities
Litigation Act of 1995. Forward-looking statements are based on various factors
and assumptions that include known and unknown risks and uncertainties. Actual
results could differ materially from those described in the forward-looking
statements as a result of the risks set forth in the following discussion among
others. These risks and uncertainties include, but are not limited to, the
Company's ability to continue to expand its sales and marketing organization,
the Company's ability to identify and acquire additional training courseware to
add to its product portfolio and to negotiate favorable distribution agreements
for these products, the Company's ability to successfully deploy its courseware
over the Internet and corporate intranets, the Company's ability to control
costs in relation to future revenues, obtain desired financial results in the
near future, and the Company's ability to capitalize on market opportunities.
A number of factors could also contribute to significant fluctuations in
operating results, which may result in volatility in the price of the Company's
common stock. These include the size and timing of orders and shipments, the mix
of ITC-developed products and third party products, the mix of sales from the
Company's direct and indirect distribution channels, the introduction and
acceptance of new products, and the degree to which the market understands and
accepts the Company's role as a provider of training solutions.
In addition, the Company faces certain general business risks which could
materially and adversely impact future operating results. These include, but are
not limited to, changes in economic conditions, the cost of labor and raw
materials, changes in technology and general competitive factors.
OVERVIEW
ITC Learning Corporation ("ITC" or the "Company") is a provider of self-directed
multimedia learning solutions that improve employee skills in business,
education and government. The Company's products, which include the largest
library of interactive CD-ROM programs available today, have improved
productivity in major corporations, government agencies and school systems
across the United States. These products also enable local communities to open
learning opportunities to the general public through the use of multimedia
learning centers. The Company has a worldwide customer base of approximately
5,000 organizations.
During 1997, the Company embarked on a new strategy intended to position itself
as a broad-based education and training integrator of an expanded line of
multimedia training products. In addition to broadening its own courseware
library, ITC began to seek strategic alliances with publishers of training
software in the areas of customer service, leadership, financial skills and
other "soft skills" training topics. International Data Corporation's August
1997 industry report estimates the training market at $60 billion.
During the first nine months of 1998, the Company continued to concentrate its
efforts on product development and increasing its distribution capabilities. The
Company completed development of its "Using the Internet" courseware product and
began work on its web-enabled versions of Microsoft(R) Office suite of PC skills
and Regulatory Compliance courseware library.
In an effort to increase its distribution capabilities, the Company made, and
will continue to make, significant investments in its Business Alliance Partner
("BAP") program which is intended to increase both market coverage and bring
additional industry knowledgeable resources to drive sales. The Company also
invested in expanding its direct sales force and intends to triple its number of
sales representatives
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and to continue the expansion of the BAP program in 1998. The Company currently
has over 60 BAP's selling and distributing its portfolio of products.
In January 1998, the Company invested $1 million in the stock of Mentor Networks
Inc. ("Mentor"). For its investment, ITC acquired 8% of the outstanding stock of
Mentor with an option to acquire an additional 12%. The Company had previously
acquired the rights to distribute Mentor's products exclusively in the United
States. Mentor, based in Nova Scotia, specialized in the development and
distribution of interactive multimedia courseware. Mentor's product offerings
include the Microsoft Office(R) suite of PC Skills training products and
Professional Skills training products in the areas of customer service,
telesales, collections, leadership training and human resources.
On July 20, 1998, the Company was notified by Mentor that its secured lender,
the Nova Scotia Business Development Corporation ("NSBDC") had placed Mentor
into Receivership. ITC issued a Tender Offer for the assets of Mentor on August
19, 1998. The acquisition was consummated on September 25, 1998. ITC, through
its wholly-owned subsidiary, ITC Canada Limited, acquired all of the assets of
Mentor and its wholly-owned subsidiary, High Performance Group (Canada) Inc.
("HPG"). The assets included furniture, fixtures and computer equipment,
software products developed or owned by Mentor and HPG, assignment of the leased
premises in Halifax, Nova Scotia, the assignment of certain contractual
commitments, and the assignment of all trade names, copyrights, patents and
other intellectual property of both Mentor and HPG. The purchase price totaled
CDN$3,000,000 (approximately US$1,981,000) and consisted of a cash payment
CDN$1,000,000 (approximately US$661,000) and a five year promissory note bearing
8% interest payable to the NSBDC in the amount of CDN$2,000,000 (approximately
US$1,320,000). Additionally, the Company agreed to pay the NSBDC up to
CDN$1,600,000 (approximately US$1,058,000) in certain future royalty payments
based on the ongoing performance of the Mentor assets. (The U.S. equivalent for
all amounts shown are at then-current exchange rates.) ITC's Toronto-based sales
and marketing office was combined with ITC Canada Limited. As a result of the
acquisition, the Company recorded approximately US$2,827,000 of intangible
assets primarily consisting of workforce investment, leasehold premises,
customer base, contractual commitments, intellectual property rights and other
intangible assets, including capitalized program development costs reclassified
from ITC's original investment in Mentor of US$1,000,000. The intangible assets
will be amortized over a period of three years.
In March 1998, the Company acquired Turn-Key Training Technologies, Inc.
("Turn-Key"), a developer and distributor of performance-based training
administration software. The purchase price for all of the outstanding common
stock of Turn-Key was $700,000 in cash. ITC also agreed to employ the founder
and president of Turn-Key, and paid him $600,000 cash and issued 100,000 shares
of ITC common stock in consideration of his employment and certain extended
non-competitive covenants. Turn-Key is located in Saugatuck, Michigan and
operates as a wholly-owned subsidiary of ITC. Turn-Key's proprietary
administration software, AdminSTAR(TM), provides customers with the capability
for personal skills assessment, creation of individual development plans,
management of the training process for corporate training departments, and a
broad array of reporting capabilities. Turn-Key's customers included the Coca
Cola Corporation, NASA, Shaw Industries, the U.S. Department of Defense (the
Pentagon) and others. As a result of the acquisition, the Company recorded
$1,795,000 of intangible assets consisting of goodwill and the non-competition
agreement.
In June 1998, the Company completed the acquisition of iNEX Corporation's
("iNEX") on-line training business for cash and stock totaling approximately
$466,000. For its investment, the Company acquired certain assets of iNEX
including computer hardware and software, intellectual property rights,
courseware content, certain other assets and ten employees, consisting of
management, technical and development personnel. The acquisition of these assets
is expected to enable the Company to deliver its courseware libraries via the
Internet and corporate intranet platforms. As a result of the acquisition, the
Company recorded $374,000 of intangible assets.
11
<PAGE> 14
In July 1998, the Company established a partnership with NIIT (USA) Inc.
("NIIT") for distribution rights to a comprehensive library of over 250
Information Technology ("IT") courseware products. These IT product offerings
provide ITC with an extensive high-quality curriculum for high-tech computer
professionals in such topics as Microsoft Certified Software Engineer (MCSE),
Oracle, Client/Server Computing, Java, Unix, C, C++, Windows NT, and many
others. NIIT's products are currently available in a CD-ROM format and are
expected to be web-enabled within the next six to nine months.
RESULTS OF OPERATIONS
Revenues
Revenues for the three months ended September 30, 1998 totaled $4,054,000, as
compared to $7,089,000 for the same period in 1997, representing a decrease of
$3,035,000 or 43%. The decrease in revenues was primarily attributable to the
inclusion of $1,282,000 of revenues generated by Anderson Soft-Teach ("AST")
during the third quarter of 1997 and lower third quarter 1998 hardware revenues
as compared to the same period in 1997. During the third quarter of 1998, ITC
recorded $1,373,000 in hardware sales as compared to $2,552,000 recorded during
1997. The remaining decrease in revenues is due to lower multimedia courseware
sales from the Company's principal markets. ITC sold AST during the fourth
quarter of 1997.
Revenues for the nine months ending September 30, 1998 totaled $10,929,000 as
compared to $16,299,000 for the same period in 1997, representing a decrease of
$5,370,000 or 33%. The decrease in revenues is primarily attributable to the
inclusion of $3,850,000 of revenues generated by AST during the first nine
months of 1997 and lower 1998 hardware revenues as compared to 1997. Year to
date hardware revenues have totaled $1,754,000 as compared to $3,176,000
recorded during the first nine months of 1997.
Cost of Sales and Gross Margin
Cost of sales includes the cost of materials (CD-ROMs and related packaging and
documentation), hardware costs, royalties for the sale of third party products,
sales commissions, dealer fees, and the amortization of capitalized product
development costs. Total cost of sales for the third quarter of 1998 was
$2,838,000, resulting in a gross margin of $1,216,000 or 30% of total revenues.
This compares to cost of sales of $4,930,000 and gross margin of $2,158,000 or
30% of total revenues in the third quarter of 1997. The lower overall gross
margin is largely the result of lower courseware sales for the third quarter of
1998 as compared to 1997.
For the first nine months of 1998, cost of sales totaled $6,566,000 resulting in
a gross margin of $4,363,000 or 40% of total revenues. This compares to cost of
sales of $9,212,000 and gross margin of $7,087,000 or 43% of sales for the first
nine months of 1997. The decline in gross margin of $2,724,000 and the decline
in gross margin percentage is primarily attributable to the courseware revenue
shortfall but also reflects a change in the channel mix from direct sales to
Business Alliance Partner (BAP) sales which carry a higher commission or dealer
fee and increased sales of third party products which result in royalties
ranging from 25% to 50% of courseware sales. The impact of the change in channel
mix is expected to continue as the Company expands its BAP program and derives a
greater portion of its revenue from dealer sales. While elements of ITC's
product and channel mix will result in a lower gross margin return on sales, the
Company believes they are critical to leveraging the Company's sales and
marketing investment to achieve significant revenue growth.
Sales & Marketing, and General & Administrative Expense
Sales and marketing expense consists primarily of salaries of sales personnel
and related overhead costs such as facilities, travel, advertising, marketing
and promotional expenses. Sales and marketing expenses for the quarter ending
September 30, 1998 totaled $1,644,000, as compared to $1,388,000 for
12
<PAGE> 15
the third quarter of 1997. The increase in selling related expenses of $256,000
or 18% reflects the increased investment in the Company's direct sales force,
the cost of expanding the Company's BAP channels, and a focused investment in
developing new marketing programs for the Company during the third quarter.
Additionally, during the third quarter of 1998, the Company instituted a phase
of cost reductions including the elimination of certain sales management
positions. ITC expects to benefit from these cost reductions during the fourth
quarter of 1998 and beyond.
For the first nine months of 1998, selling and marketing expenses totaled
$4,369,000, as compared to $3,934,000 for the same period in 1997, representing
an increase of $435,000, or 11%. The increase is primarily due to the Company's
effort to expand its sales and marketing organization during 1998.
General and administrative expenses consist of the costs of researching new
technologies and developing new products and the costs of the Company's
executive management and support functions such as customer assurance, product
fulfillment, human resources, and finance and administration. General and
administrative expenses for the three months ending September 30, 1998 totaled
$1,509,000, as compared to $1,276,000 incurred during the third quarter of 1997,
representing an increase of $233,000 or 18%. The increase in overhead expenses
is primarily the result of costs associated with the Company's acquisitions
during 1998 and the addition of their respective overheads.
For the first nine months of 1998, general and administrative expenses totaled
$4,479,000, as compared to $5,653,000 for the same period in 1997. The decrease
of $1,174,000 or 21% is primarily due to tighter control of discretionary costs
in response to the revenue shortfall and the overall shift from investment in
infrastructure to sales and marketing.
Loss before income taxes and net loss
Operations for the third quarter of 1998 resulted in a pre-tax loss of
$1,896,000, as compared to a pre-tax loss of $291,000 for the same period in
1997. The resulting net loss of $1,896,000 or $0.48 per share compares with a
net loss of $243,000 or $0.06 per share in the third quarter of 1997. The higher
pre-tax loss for the third quarter of 1998 is primarily due to the lower
courseware sales as compared to the same period in 1997.
For the nine months ending September 30, 1998, the Company experienced a loss
before taxes of $4,137,000 and a net loss of $3,914,000 or $1.00 per share. This
compares with a pre-tax loss of $2,163,000 and net loss of $1,447,000 or $0.37
per share for the first nine months of 1997. The higher net loss for 1998 is the
result of a pre-tax loss which was higher than last year by $1,974,000 and a
reduced net income tax benefit of $493,000 relative to last year. The higher
pre-tax loss is the result of the gross margin shortfall of $2,724,000,
partially offset by lower and more focused levels of selling, general and
administrative expense.
Cash Flow, Liquidity and Capital Resources
Working capital as of September 30, 1998 was $1,406,000, as compared to
$7,344,000 at December 31, 1997. The decrease of $5,938,000 or 81% is
principally due to investments of cash made to acquire Turn-Key Training
Technologies, Inc. ("Turn-Key"), the assets of iNEX Corporation ("iNEX"), the
assets of Mentor Networks Inc. ("Mentor"), and cash used to repurchase the
Company's common stock. The total cash outlay for these transactions was
$3,684,000. The remaining reduction in working capital is the result of the
higher year-to-date operating loss and normal changes in working capital
accounts.
Net cash provided by operations was $443,000 for the first nine months of 1998,
as compared to $2,733,000 generated for the same period in 1997. The difference
of $2,290,000 is primarily attributable to the increased net loss experienced in
1998, as compared to 1997. The net inflow of cash from operations is primarily
due to non-cash changes totaling $1,875,000, a decrease in accounts receivable
of $2,963,000 and an increase in accounts payable of $1,119,000. These are
partially offset by the effect of decreases in other current liabilities
totaling $1,600,000.
13
<PAGE> 16
The increased level of accounts payable is primarily due to costs associated
with the Company's September 1998 hardware sales.
Net cash used in investing activities for the first nine months of 1998 totaled
$3,957,000, as compared to $2,489,000 for the same period in 1997. Principal
investing activities for the first nine months of 1998 were the acquisitions of
Turn-Key, iNEX, and Mentor. Amounts capitalized for the development of new
courseware programs were $280,000 for the first nine months of 1998, as compared
to $2,076,000 in 1997, reflecting the Company's shift in strategy from solely
publishing courseware to marketing third party courseware products in addition
to the Company's own products. Capital expenditures, principally the purchase of
computer equipment and software for new sales personnel and investments in
product development equipment and software, were $529,000 in 1998 as compared
with $414,000 in 1997.
Net cash used in financing activities was $324,000 for the nine months ending
September 30, 1998, as compared to $535,000 in 1997. The major outflow of cash
associated with financing activities was the repurchase of approximately 130,000
shares of the Company's common stock to fund the Company's Employee Stock
Ownership Plan ("ESOP"). Approximately 17,000 of these shares were repurchased
on the open market and the remainder through a private transaction. The stock
repurchase transactions used approximately $536,000 in cash.
Management believes that the cash generated from operations combined with the
Company's existing resources and available lines of credit are adequate to meet
ITC's working capital needs and other financing requirements for the remainder
of 1998. Management is currently evaluating and pursuing various options to
strengthen the Company's capital resources through a combination of profitable
operations, strategic partnerships and capital infusion for 1999.
SOFTWARE REVENUE RECOGNITION
In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue
Recognition, which supercedes SOP 91-1. The provisions of SOP 97-2 took effect
in fiscal years beginning after December 15, 1997 and clarify rules of revenue
recognition related to customer acceptance, product upgrades and post-contract
customer support. In March 1998, the AICPA issued SOP 98-4, which defers for one
year the implementation of certain provisions of SOP 97-2. The Company
implemented SOP 97-2 as amended by SOP 98-4 for transactions entered into
beginning January 1, 1998 and has determined that there is no material impact on
revenue recognized in the first nine months of 1998 under these provisions. In
October 1998, the AICPA voted to amend certain provisions of SOP97-2 subject to
final clearance by the Financial Accounting Standards Boards. The Company is
currently analyzing the provisions of the proposed SOP; however, it doesn't
expect the impact to be material.
IMPLICATIONS OF THE YEAR 2000
The year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
courseware products, hardware, or software packages that have time-sensitive
programs may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities. Similar failures in the Company's courseware could result in an
impairment of revenue recognition due to significant future obligations,
impairment of future sales of the Company's products, or potential product
liability. In addition, disruptions in the economy generally resulting from
Year 2000 issues could have a material adverse affect on the Company.
The Company began an assessment of the implications of the Year 2000 Issue
during late 1997. Based on the assessment, the Company presently believes that
with modification or replacement of existing software and certain hardware, the
Year 2000 Issue can be mitigated. However, if such modifications and
replacements are not made, or are not completed timely, the Year 2000 Issue
could have a material impact on the operations of the Company.
14
<PAGE> 17
The Company's plan to resolve the Year 2000 issue involves the following four
phases: assessment, remediation, testing, and implementation. To date, the
Company has substantially completed its assessment of all software and hardware
systems that could be significantly affected by the Year 2000. Based on these
assessments, current versions of the Company's administrative courseware
products and the majority of the Company's operational software applications
have been determined to be Year 2000 compliant, and require no remediation.
Versions of the Company's legacy products, primarily analog-laserdisc delivered
products, are not Year 2000 compliant. This is primarily due to the authoring
language that the products were developed in as well as the operating systems
and computer equipment that delivered the laserdisc training programs. The
Company does not plan to modify the analog-laserdisc product to become Year
2000 compliant. Any impact of Year 2000 compliance associated with laserdisc
products is not expected to be material. Courseware and operating applications
that were found to be non-compliant are currently being reprogrammed or
replaced. While initial assessments of Year 2000 implications are substantially
complete, the Company plans to continually re-assess each of its courseware
products and its operational software applications to insure compliance with
the Year 2000 Issue. In addition, the Company has gathered information about
the Year 2000 compliance status of its significant suppliers, vendors, and
subcontractors and continues to monitor their compliance.
The Company has and will continue to utilize both internal and external
resources during the testing and implementation phases of its Year 2000 plan.
The testing and implementation phases of the Company's Year 2000 plan are
currently focused on courseware products and operational software applications
that have been determined to be Year 2000 compliant.
The Company has contingency plans for certain critical applications and is
working on such plans for others. These contingency plans involve, among other
actions, manual workarounds, increasing inventories, and adjusting staffing
strategies.
15
<PAGE> 18
PART II
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See attached Exhibit Index.
(b) Reports on Form 8-K
On September 29, 1998, the Company filed a report on Form 8-K relating to
the acquisition of the assets of Mentor Networks Inc.
16
<PAGE> 19
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ITC LEARNING CORPORATION
(Registrant)
BY /s/Carl D. Stevens DATE 11/12/98
--------------------------------------------- ---------------
Carl D. Stevens
President and Chief Executive Officer
BY /s/Christopher E. Mack DATE 11/12/98
--------------------------------------------- ---------------
Christopher E. Mack
Vice President, Treasurer, and Chief Financial Officer
17
<PAGE> 20
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------------------------
<S> <C>
2.1 Assignment of Rights Under Offer from ITC Learning Corporation to ITC
Canada Limited dated September 1, 1998, incorporated by reference to the
Company's Form 8-K filed September 29, 1998 with the Securities and
Exchange Commission ("SEC") (Commission File No. 0-13741).
2.2 Receiver's Bill of Sale from Grant Thornton Limited to ITC Canada Limited
dated September 16, 1998, incorporated by reference to the Company's Form
8-K filed September 29, 1998 with the SEC (Commission File No. 0-13741).
2.3 Assignment of Lease from Grant Thornton Limited to ITC Canada Limited dated
September 16, 1998, incorporated by reference to the Company's Form 8-K
filed September 29, 1998 with the SEC (Commission File No. 0-13741).
2.4 Assignments of Courseware from Grant Thornton Limited to ITC Canada Limited
dated September 16, 1998, incorporated by reference to the Company's Form
8-K filed September 29, 1998 with the SEC (Commission File No. 0-13741).
2.5 Assignments of Intellectual Property Rights from Grant Thornton Limited to
ITC Canada Limited dated September 16, 1998, incorporated by reference to
the Company's Form 8-K filed September 29, 1998 with the SEC (Commission
File No. 0-13741).
2.6 Assignment of Trademarks from Grant Thornton Limited to ITC Canada Limited
dated September 23, 1998, incorporated by reference to the Company's Form
8-K filed September 29, 1998 with the SEC (Commission File No. 0-13741).
2.7 Principal Agreement between ITC Canada Limited and Nova Scotia Business
Development Corporation dated September 16, 1998, incorporated by reference
to the Company's Form 8-K filed September 29, 1998 with the SEC (Commission
File No. 0-13741).
2.8 Promissory Note in the Amount of Cdn. $2,000,000 Executed by ITC Canada
Limited dated September 16, 1998, incorporated by reference to the Company's
Form 8-K filed September 29, 1998 with the SEC (Commission File No. 0-13741).
2.9 Demand Debenture between ITC Canada Limited and Nova Scotia Business
Development Corporation dated September 18, 1998, incorporated by reference
to the Company's Form 8-K filed September 29, 1998 with the SEC (Commission
File No. 0-13741).
2.10 Debenture Pledge Agreement in the Amount of Cdn. $3,600,000 between ITC
Canada Limited and Nova Scotia Business Development Corporation dated
September 18, 1998, incorporated by reference to the Company's Form 8-K filed
September 29, 1998 with the SEC (Commission File No. 0-13741).
</TABLE>
<PAGE> 21
<TABLE>
<S> <C>
2.11 General Security Agreement between ITC Canada Limited and Nova Scotia
Business Development Corporation dated September 18, 1998, incorporated by
reference to the Company's Form 8-K filed September 29, 1998 with the SEC
(Commission File No. 0-13741).
2.12 Guarantee of Obligation by ITC Learning Corporation dated September 22, 1998,
incorporated by reference to the Company's Form 8-K filed September 29, 1998
with the SEC (Commission File No. 0-13741).
2.13 Agreement between ITC Learning Corporation and Nova Scotia Business
Development Corporation dated September 22, 1998, incorporated by reference
to the Company's Form 8-K filed September 29, 1998 with the SEC (Commission
File No. 0-13741).
2.14 Royalty Agreement among ITC Canada Limited, ITC Learning Corporation and
Grant Thornton Limited dated September 18, 1998, incorporated by reference
to the Company's Form 8-K filed September 29, 1998 with the SEC (Commission
File No. 0-13741).
2.15 Inter-Lender Agreement among ITC Canada Limited, Nova Scotia Business
Development Corporation and Wachovia Bank, N.A. dated September 23, 1998,
incorporated by reference to the Company's Form 8-K filed September 29, 1998
with the SEC (Commission File No. 0-13741).
3.1 Amended Articles of Incorporation of the Company, incorporated by reference
to the Company's Form 10-QSB for the quarter ended June 30, 1996 and Exhibit
3.3 to the Company's 10-QSB for the quarter ended June 30, 1997, filed with
the SEC (Commission File No. 0-13741).
3.2 Amended By-Laws of the Company, incorporated by reference to the Company's
Form 10-KSB for the fiscal year ended December 31, 1997, filed March 13, 1998
with the SEC (Commission File No. 0-13741).
4.1 Specimen Certificate for ITC Common Stock incorporated by reference to the
Company's 10-QSB for the quarter ended March 31, 1998 filed May 1, 1998 with
the SEC (Commission File No. 0-13741).
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S 10-QSB FOR THE QUARTER ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,047,758
<SECURITIES> 0
<RECEIVABLES> 3,574,000
<ALLOWANCES> (366,584)
<INVENTORY> 239,256
<CURRENT-ASSETS> 5,698,903
<PP&E> 2,280,682
<DEPRECIATION> (1,181,116)
<TOTAL-ASSETS> 17,060,871
<CURRENT-LIABILITIES> 4,292,523
<BONDS> 0
0
0
<COMMON> 395,826
<OTHER-SE> 10,856,462
<TOTAL-LIABILITY-AND-EQUITY> 17,060,871
<SALES> 4,053,955
<TOTAL-REVENUES> 4,053,955
<CGS> 2,837,768
<TOTAL-COSTS> 3,112,212
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 45,000
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,896,025)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,896,025)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,896,025)
<EPS-PRIMARY> (0.48)
<EPS-DILUTED> (0.48)
</TABLE>
