<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition period from ________ to ________
Commission File Number: 0-25674
SMARTFORCE PUBLIC LIMITED COMPANY
(Exact name of registrant as specified in its charter)
Republic of Ireland Not Applicable
------------------------------ ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
900 Chesapeake Drive
Redwood City, California 94063
(Address of principal executive offices, including zip code)
(650) 817-5900
(Registrant's telephone number, including area code)
Indicate by check mark whether 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 12 months (or for such shorter period that 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 [_]
The number of American Depositary Shares ("ADSs") (issued or issuable in
exchange for Registrant's outstanding Ordinary Shares) outstanding as of March
31, 2000 was 50,568,165.
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
Table of Contents
<TABLE>
<CAPTION>
Page
Number
------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of December 31, 1999 and as 2
of March 31, 2000
Condensed Consolidated Statements of Operations for the three months 3
ended March 31, 1999 and 2000
Condensed Consolidated Statements of Cash Flows for the three months 4
ended March 31, 1999 and 2000
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and 8
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities 24
Item 4. Submission of Matters to a vote of the Security Holder 25
Item 6. Exhibits and Reports on Form 8-K 26
Signature 27
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
SMARTFORCE PUBLIC LIMITED COMPANY
Condensed Consolidated Balance Sheets
(dollars in thousands)
December 31, March 31,
1999 2000
-------- --------
Assets
<S> <C> <C>
Current Assets
Cash $ 69,260 $ 65,470
Short-term investments 38,913 40,558
Accounts receivable, net 62,035 46,395
Inventories 188 427
Deferred tax assets 192 1,177
Prepaid expenses 9,935 13,129
-------- --------
Total current assets 180,523 167,156
Intangible assets 59,155 64,480
Property and equipment, net 26,111 27,178
Investment 850 900
Deferred tax assets -- 119
Other assets 23,078 25,365
-------- --------
Total assets $289,717 $285,198
======== ========
Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable 5,368 6,170
Accrued payroll and related expenses 6,680 6,134
Other accrued liabilities 28,213 21,824
Deferred revenues 6,141 9,090
------ ------
Total current liabilities 46,402 43,218
Non-Current Liabilities
Minority equity interest 383 383
Other liabilities 209 1,715
--- -----
Total non-current liabilities 592 2,098
Shareholders' Equity
Ordinary Shares, IR9.375p par value: 120,000,000 shares authorized at 7,432 8,089
December 31, 1999 and March 31, 2000; issued and outstanding: 50,035,087
and 50,009,318 shares at December 31, 1999 and 50,593,934 and 50,568,165
at March 31, 2000,respectively
Additional paid-in capital 200,547 208,789
Accumulated profit 34,919 23,180
Capital redemption reserve 231 231
Other comprehensive income (404) (405)
Treasury stock (2) (2)
-------- --------
Total shareholders' equity 242,723 239,882
-------- --------
Total liabilities and shareholders' equity $289,717 $285,198
======== ========
</TABLE>
See notes to condensed consolidated financial statements
Note: The balance sheet does not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
2
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
Condensed Consolidated Statements of Operations
(dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months
ended March 31,
1999 2000
------- --------
<S> <C> <C>
Revenues $40,197 $ 28,534
Cost of revenues 6,330 4,667
------- --------
Gross profit 33,867 23,867
Operating expenses:
Research and development 7,387 8,500
Sales and marketing 20,973 23,193
General and administrative 4,478 4,464
Amortization of acquired intangibles - 1,717
------- --------
Total operating expenses 32,838 37,874
------- --------
Income/(loss) from operations 1,029 (14,007)
Other income, net 533 1,154
------- --------
Income/(loss) before provision for income taxes 1,562 (12,853)
Provision for income taxes (234) 1,114
------- --------
Net income/(loss) $ 1,328 $(11,739)
======= ========
Net income/(loss) per share - Basic $0.03 $(0.23)
======= ========
Shares used in computing net income/(loss) per share - 44,476 50,353
Basic ======= ========
Net income/(loss) per share - Diluted $0.03 $(0.23)
======= ========
Shares used in computing net income/(loss) per share - 47,484 50,353
Diluted ======= ========
</TABLE>
See notes to condensed consolidated financial statements
Note: The statement of operations does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
3
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
Condensed Consolidated Statements of Cash Flows
(dollars in thousands)
<TABLE>
<CAPTION>
Three months ended
March 31,
1999 2000
-------- --------
<S> <C> <C>
Decrease in Cash and Cash Equivalents
Cash Flows from Operating Activities
Net income/(loss) $ 1,328 $(11,739)
Adjustments to reconcile net income to net cash used
by operating activities:
Depreciation and amortization 1,909 4,681
Accrued interest on short-term investments 201 (575)
Changes in operating assets and liabilities:
Accounts receivable 1,655 15,251
Inventories 71 (249)
Deferred tax assets 113 (1,101)
Prepaid expenses and other assets (4,667) (5,595)
Accounts payable (580) 846
Accrued payroll and related expenses and other accrued liabilities (4,472) (7,145)
Deferred revenues (394) 2,941
-------- --------
Net cash used by operating activities (4,836) (2,685)
-------- --------
Cash Flows from Investing Activities
Purchases of property and equipment (1,466) (3,828)
Payment to acquire assets of Advanced Education Systems - (271)
Proceeds from sale of short-term investments 29,084 43,000
Payment to acquire investments - (50)
Payments to acquire short-term investments (31,449) (44,071)
-------- --------
Net cash used in investing activities (3,831) (5,220)
-------- --------
Cash Flows from Financing Activities
Proceeds from issuance of ordinary shares, net 825 3,748
-------- --------
Net cash provided by financing activities 825 3,748
-------- --------
Effect of exchange rate changes on cash and cash equivalents (203) 367
-------- --------
Net decrease in cash and cash equivalents (8,045) (3,790)
Cash and cash equivalents at beginning of period 65,648 69,260
-------- --------
Cash and cash equivalents at end of period $ 57,603 $ 65,470
======== ========
</TABLE>
See notes to condensed consolidated financial statements
Note: The statements of cash flow does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
4
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS
These interim unaudited condensed and consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all the information and footnotes required by
generally accepted accounting principles for complete financial statements.
However, we believe that the disclosures are adequate to ensure that the
information presented is not misleading. The accompanying interim financial
statements should be read in conjunction with the financial statements and
related notes included in our Annual Report to Shareholders as amended on Form
10-K/A for the year ended December 31, 1999. In the opinion of management, all
adjustments (consisting of normal recurring accruals), considered necessary for
a fair presentation of financial position, results of operations and cash flows
at the dates and for the periods presented have been included. The results of
operations for the periods presented are not necessarily indicative of the
results expected for the full financial year or for any future period.
NOTE 2. COMPUTATION OF NET INCOME PER SHARE
Basic net income per share is calculated using the weighted average number of
our ordinary shares outstanding during the period including the issuance of
ordinary shares as a result of pooling of interests, at the beginning of the
earliest period presented or subsequent date of incorporation of the pooled
entity as applicable. Diluted net income per share is similarly calculated using
the combined weighted average number of ordinary and dilutive potential ordinary
shares, (as determined using the treasury stock method), such as shares issuable
pursuant to the exercise of options outstanding including the issuance of
ordinary and dilutive potential ordinary shares as a result of pooling of
interests.
The following table sets forth the computation of basic and diluted net
income/(loss) per share:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 2000
- --------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
<S> <C> <C>
Numerator:
Numerator for basic and diluted
net income/(loss) per share - income/(loss)
available to common shareholders $ 1,328 $(11,739)
======= ========
Denominator:
Denominator for basic net income/(loss)
per share - weighted average shares 44,476 50,353
Effect of dilutive securities:
Employee stock options 3,008 -
------- --------
Denominator for diluted net income
per share - adjusted weighted average
shares and assumed conversion 47,484 50,353
======= ========
Basic net income/(loss) per share $ 0.03 $ (0.23)
======= ========
Diluted net income/(loss) per share $ 0.03 $ (0.23)
======= ========
</TABLE>
5
<PAGE>
NOTE 3. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," establishes rules for the reporting and display of comprehensive income
and its components. SFAS 130 requires foreign currency translation adjustments,
which prior to adoption were reported separately in stockholders' equity, to be
included in other comprehensive income.
The following table sets forth the calculation of comprehensive income on an
interim basis:
<TABLE>
<CAPTION>
Three months ended
March 31,
1999 2000
------ --------
<S> <C> <C>
(dollars in thousands)
Net Income/(loss) $1,328 $(11,739)
Foreign Currency Translation gain /(loss) (513) (1)
------ --------
Total Comprehensive Income/(loss) $ 815 $(11,740)
====== ========
</TABLE>
NOTE 4. SEGMENT GEOGRAPHIC AND CUSTOMER INFORMATION
The Company presents financial information for its three reportable operating
segments: Americas, Europe Middle East Asia ("EMEA") and Ireland. The Americas
and EMEA segments are sales operations and Ireland is the Company's Research and
Development operation.
The Company and its subsidiaries operate in one industry segment, the
development and marketing of e-learning solutions. Operations outside of Ireland
consist principally of sales and marketing.
The Company's products are developed in Ireland and sold to the Company's
distribution subsidiaries in other geographic segments. These inter segment
revenues are determined on arms length bases pursuant to which a fair profit is
earned by the Irish development subsidiary and which is designed to comply with
the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrators. All such inter segment revenues and costs of revenues are
eliminated on consolidation.
The Company's Chief Operating Decision Maker ("CODM"), the Company's President
and CEO allocates resources and evaluates performance based on a measure of
segment profit or loss from operations. The accounting policies of the
reportable segments are the same as described in the summary of significant
accounting policies. The Company's CODM does not view segment results below
operating profit (loss), therefore, net interest income, other income and the
provision for income taxes are not broken out by segment below. The Company does
not account for nor report to the CODM its assets or capital expenditures by
segment, thus asset information is not provided on a segment basis.
6
<PAGE>
A summary of the segment financial information reported to the CODM is as
follows:
<TABLE>
<CAPTION>
Quarter Ended March 31, 2000
-----------------------------------------------------------------------------
Consolidated
Americas EMEA Ireland All Other Total
--------------- ---------------- ------------ ------------- -------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Revenues--External $ 22,764 $ 4,399 $ 82 $ 1,289 $ 28,534
Inter segment Revenues -- -- 13,624 -- 13,624
Depreciation and Amortization 2,011 108 829 1,733 4,681
Segment Operating Income/(Loss) (12,305) (1,690) 2,849 (2,861) (14,007)
Quarter Ended March 31, 1999
-----------------------------------------------------------------------------
Consolidated
Americas EMEA Ireland All Other Total
-------------- --------------- ------------ ------------ ------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Revenues--External $ 32,077 $ 5,809 $ 526 $ 1,785 $ 40,197
Inter segment Revenues -- -- 19,730 -- 19,730
Depreciation and Amortization 1,064 48 757 40 1,909
Segment Operating Income/(Loss) (7,634) (418) 9,812 (731) 1,029
</TABLE>
Revenues from external customers, based on the location of the customer, are
categorized by geographical areas as follows:
<TABLE>
<CAPTION>
Quarter Ended March 31,
------------------------
1999 2000
---------- ----------
(dollars in thousands)
<S> <C> <C>
Revenues
Ireland $ 600 $ 1,061
United States 28,566 18,285
United Kingdom 4,689 4,909
Other countries 6,342 4,279
------- -------
Total $40,197 $28,534
======= =======
</TABLE>
Long-Lived assets are those assets that can be directly associated with a
particular geographic area. These assets are categorized by geographical areas
as follows:
<TABLE>
<CAPTION>
March 31,
---------------------
1999 2000
--------- ----------
(dollars in thousands)
<S> <C> <C>
Long-Lived Assets
Ireland $ 7,505 $ 13,743
United States 28,526 38,661
Other countries 3612 65,519
------- --------
Total $39,643 $117,923
======= ========
</TABLE>
The Company regards its e-learning solutions, as homogenous products and
services.
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement No. 133, "Accounting for Derivative Instruments and Hedging Activity"
("SFAS 133") which is required to be adopted in years beginning after June 15,
2000. SFAS 133 established accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. SFAS 133 requires all companies to
recognize derivatives as either assets or liabilities in the balance sheet and
measure those instruments at fair value. Derivatives that are not hedges of
underlying transactions must be adjusted to fair value through income. If
7
<PAGE>
the derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives will either be offset against the change in fair value
of the hedged assets, liabilities or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. Management has not yet determined what the
effect of SFAS 133 will be on the Company's consolidated financial position,
results of operations or cash flows.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
We provide comprehensive, integrated e-Learning solutions that help businesses
deploy knowledge across their extended enterprise of employees, customers,
suppliers, distributors and other business partners. Our hosted e-Learning
platform provides access to a comprehensive offering of learning events and
resources comprising over 1,300 SmartCourses, online SmartSeminars, 24x7
SmartMentoring, articles, peer-to-peer collaboration, customer-created content
and other e-Learning services. Our platform allows organizations to customize
their e-Learning environment to meet their corporate objectives and to train
their employees and business partners quickly, efficiently and effectively. Our
e-Learning solutions also provide individuals access to dynamic, continuously-
updated learning events so they can personalize their e-Learning environment to
meet their specific educational and career objectives. In addition, we provide
tracking, assessment and feedback tools which help users better understand their
educational progress and managers track and assess the effectiveness of their
training initiatives.
We have historically derived our revenues primarily under a software license
model pursuant to license agreements under which customers license usage of
delivered software products for a period of one, two or three years. On each
anniversary date during the term of multi-year license agreements, customers are
generally allowed to exchange any or all of the licensed products for an
equivalent number of alternative products within our library. The first year
license fee has historically been generally recognized as revenue at the time of
delivery of all products, provided our fees are fixed or determinable and
collections of accounts receivable are probable. Subsequent annual license fees
under the software license model are recognized on each anniversary date,
provided our fees are fixed or determinable and collections of accounts
receivable are probable. The cost of satisfying any post contract support, or
PCS, is accrued at the time revenue is recognized, as PCS fees are included in
the annual license fee, the estimated cost of providing PCS during the
agreements is insignificant and unspecified upgrades or enhancements offered
have been and are expected to be minimal and infrequent. For multi-element
agreements where vendor specific objective evidence exists to allocate the total
fee among the various elements of the agreement each element is recognized as
appropriate. Where no such vendor specific objective evidence exists revenue is
recognized ratably over the life of the agreement. In addition, we derive
revenues from sales of our products, which is recognized upon shipment, net of
allowances for estimated future returns and for excess quantities in
distribution channels, provided our fees are fixed or determinable and
collections of accounts receivable are probable.
We launched our e-Learning platform in the fourth quarter of 1999. With the
introduction of our e-Learning solutions, our business model has evolved from a
software license model, under which we historically sold annual licenses to our
customers to use certain of our products, to an Internet rental model, under
which we rent to our customers access to our Internet learning environment for a
certain period of time. Under the Internet rental model, revenue derived from e-
Learning rental agreements is generally deferred and recognized ratably over the
term of the relevant agreement rather than annually in advance as was the case
under the historical software license model.
8
<PAGE>
The migration of new and existing customers to our e-Learning solutions has
resulted in the three months ended March 31, 2000 and will continue to result in
the deferral of a significant portion of our revenues from year 2000 into future
periods, and, accordingly, a decrease in reported revenues in year 2000 compared
to year 1999 as well as a decrease in reported revenues for each quarter during
year 2000 as compared to that which would be expected under the software license
model./1/ As a result, year over year comparisons between our operating results
for each reporting period in 2000 and each reporting period in 1999, including
comparisons of revenues and operating expenses as a percentage of revenues, will
not necessarily be meaningful measures of our financial performance during 2000.
In addition, we have made and intend to continue to make significant
investments in our e-Learning infrastructure and in building the SmartForce
brand. In particular, we anticipate that we will significantly increase our
research and development expenses and capital expenditures to build out our e-
Learning infrastructure and expect to increase marketing expenses significantly
to build the SmartForce brand. As a result of the deferral of revenue under e-
Learning agreements and these incremental expenses, we have recorded a net loss
for the three months ended March 31, 2000 and expect to record a net loss for
each remaining quarter during the year 2000. These losses could continue beyond
year 2000. /1/
Our e-Learning agreements may have other accounting and operating model
consequences that are materially different from our software licensing
structure. For example, in the second quarter of 1999, we entered into an
agreement with a major customer to provide an outsourced virtual university for
technical education. Under the contract, the customer has licensed educational
software from us, and has also contracted for professional services, management
fees, on-line mentoring services and certain other items. In addition, the
agreement provides for the reselling by us of third parties' instructor-led
training to the customer. Revenues from the non-software licenses component of
this agreement, which represent a substantial majority of the firmly contracted
amount with the customer and all of the potential incremental revenues over the
firmly contracted amount, will generally be recognized ratably as services are
performed, which will have the effect of deferring revenue.
Moreover, the gross margins associated with the non-software license
components (and in particular the resale of third-party instructor-led training)
are expected to be substantially lower than the gross margins typically
associated with our software license agreements./1/
We may not be successful in our efforts to migrate our customers to our e-
Learning solutions and the economic terms of any arrangements that might be
expected may not be as favorable as the traditional licensing agreements. We
believe that a lack of success in this regard could have a material negative
effect on us.
In recent years, we have entered into several development and marketing
alliances with key vendors of technology software under which we develop titles
for training on specific products. Under certain of our development and
marketing alliances, our partners have agreed to fund certain product
development costs. We recognize such funding as revenues on a percentage of
completion, basis, and the costs associated with such revenues are reflected as
cost of revenues. These agreements have the effect of shifting expenses
associated with developing certain new products from research and development to
cost of revenues. We expect that cost of revenues may fluctuate from period to
period in the future, based upon many factors. We do not expect funding from
development partners to contribute significantly to revenues in future years.
- ------------
/1/ This paragraph consists of forward-looking statements reflecting our
current expectations. In addition, our actual future performance may not meet
our current expectations. You are strongly encouraged to review the section
entitled "Additional Risk Factors That Could Affect Operating Results"
commencing on page 16 and discussions elsewhere in this Quarterly Report on Form
10-Q of the factors that could affect future performance.
9
<PAGE>
Recent Developments
Acquisitions
In March 2000, we acquired the assets of Advanced Educational Systems ("AES"),
providers of secure e-Testing solutions and services to organizations to support
their internal certification and compliance initiatives. E-Testing solutions can
also be used to support certification of customers, vendors, resellers and other
business partners. The suite of Web-based testing products we acquired from AES
allows organizations to create and publish customized tests covering mission-
critical business knowledge to administer these tests over the internet, to
track and process test results, and to generate management reports. These
testing solutions help organizations maximize their investments in workforce
training and knowledge deployment across the extended enterprise. We have issued
103,129 ADSs to AES as consideration for those assets. The transaction will be
accounted for under the purchase method of accounting in accordance with
generally accepted accounting principles.
In April 2000, we acquired Learning Productions LLC, a developer of advanced,
web-based role play business simulations. Learning Productions simulations put
the learner in the midst of "virtual" sales calls, business meetings, and
customer service scenarios as they unfold, helping users gain experience in a
variety of complex business world situations. Learning Productions is developing
a series of standardized role play simulations covering sales, customer service
and customer support topics, which can be configured to meet customers specific
business situations. We issued 224,916 ADSs , and paid $4.8 million in cash, as
consideration for the acquisition of the outstanding securities of Learning
Productions. We intend to account for the acquisition of Learning Productions
under the purchase method of accounting in accordance with generally accepted
accounting principles.
The successful integration of AES and Learning Productions will require
substantial effort from each company. The diversion of the attention of
management and any difficulties encountered in the transition process could have
an adverse impact on our ability to realize the full benefits of the
acquisitions. The successful combination of the companies will also require
coordination of their research and development and sales and marketing efforts.
In addition, the process of combining the organizations could cause the
interruption of, or loss of momentum in, AES's and Learning Productions'
activities. We may not be able to retain AES's or Learning Productions'
technical, sales and marketing personnel or realize any of the anticipated
benefits of the acquisitions.
The combination of the operations of AES and Learning Productions with our
operations will result in an increase in our research and development, general
and administrative and other expenses. In addition, the amortization of goodwill
and any intangible assets acquired as part of AES and Learning Productions, will
negatively impact the results of operations in future periods. Unanticipated
contingencies that would substantially increase the costs of combining the
operations of AES and Learning Productions with us may occur. /2/
- ------------
/2/ This paragraph consists of forward-looking statements reflecting our
current expectations. In addition, our actual future performance may not meet
our current expectations. You are strongly encouraged to review the section
entitled "Additional Risk Factors That Could Affect Operating Results"
commencing on page 16 and discussions elsewhere in this Quarterly Report on Form
10-Q of the factors that could affect future performance.
10
<PAGE>
Results of Operations
The following table sets forth certain consolidated statements of operations
data as a percentage of revenues:
<TABLE>
<CAPTION>
Three months
ended March 31,
1999 2000
---- ------
<S> <C> <C>
Revenues 100% 100%
Cost of revenues 15.7 16.4
---- ------
Gross Profit 84.3 83.6
Operating expenses:
Research and development 18.4 29.8
Sales and marketing 52.2 81.3
General and administrative 11.1 15.6
Amortization of acquired intangibles - 6.0
---- ------
Total operating expenses 81.7 132.7
---- ------
Income/(loss) from operations 2.6 (49.1)
Other income, net 1.3 4.1
---- ------
Income/(loss) before provision for income 3.9 (45.0)
taxes
Provision for income taxes (0.6) 3.90
---- ------
Net income/(loss) 3.3% (41.1)%
==== ======
</TABLE>
Revenues and Backlog
Revenues decreased to $28.5 million in the three months ended March 31,
2000 from $40.2 million in the three months ended March 31, 1999. The decrease
in revenues was attributable to the rapid customer adoption in the first quarter
of 2000 of our e-Learning solutions, for which revenue is recognized ratably
over the term of the customer agreement and deferred into future periods.
Revenues for the first quarter of 1999 were generated from licenses of software
under our historical model, under which revenue is generally recognized annually
in advance. Because of our introduction of SmartForce e-Learning, the year over
year revenue comparison between the 1999 and 2000 periods is not indicative of
the growth of our business during the first quarter of 2000.
Our backlog increased to $222 million at March 31, 2000 from $190 million
at December 31, 1999. Backlog represents the total amount of fully committed
contract value that has not been recognized as revenue. The sequential increase
in backlog was attributable to the rapid customer adoption of SmartForce e-
Learning.
Revenues in the United States for the three months ended March 31, 2000
were $18.3 million (or 64% of revenues) compared to $28.6 million (or 71% of
revenues) for the three months ended March 31, 1999.
Revenues in the United Kingdom for the three months ended March 31, 2000
were $4.9 million (or 17% of revenues), compared to $4.7 million (or 12% of
revenues) for the three months ended March 31, 1999. Revenues in Ireland for
the three months ended March 31, 2000 were $1 million (or 4% of revenues)
compared to $0.6 million (or 1% of revenues) for the three months ended March
31, 1999.
11
<PAGE>
In addition, revenues from outside the United States, United Kingdom and
Ireland (principally from Australia, Europe (other than the United Kingdom and
Ireland), Canada, South Africa and the Middle East) for the three months ended
March 31, 2000 were $4.3 million (or 15% of revenues), compared to $6.3
million (or 16% of revenues) for the three months ended March 31, 1999.
Because a significant portion of our business is conducted outside the United
States, we are subject to a number of risks associated with doing business in
other countries, including risks related to currency fluctuations.
Cost of Revenues
Cost of revenues includes the cost of materials (such as compact discs,
packaging and documentation), royalties to third parties, the portion of
development costs associated with funded development projects and fulfillment
costs.
Gross margins decreased to 83.6% in the three months ended March 31, 2000
from 84.3% in the three months ended March 31, 1999. Gross margins were
negatively impacted by the decrease in revenue in the three months ended March
31, 2000 as a certain portion of our cost of revenues are fixed. We expect that
cost of revenues may fluctuate from period to period in the future based upon
many factors, including the rate of migration of our customers to our e-Learning
solutions, the mix of titles licensed (between titles developed exclusively by
us and royalty-bearing titles developed pursuant to development and marketing
alliances) and the timing of expenses associated with development and marketing
alliances.
Operating Expenses
Our operating expenses increased in the three months ended March 31, 2000
as compared to the three months ended March 31, 1999, primarily as a result of
the growth in our business and our ongoing investments in our e-learning
solutions. In addition, as discussed above, the rapid adoption of our e-learning
solutions in the first quarter of 2000 resulted in the deferral of revenues into
future periods and, consequently, a significant increase in operating expenses
as a percentage of revenues. Accordingly, year over year comparisons of
operating expenses between the 1999 and 2000 periods are not necessarily
meaningful measures of our financial performance during the first quarter of
2000.
Research and Development Expenses
Research and development expenses consist primarily of salaries and
benefits, related overhead costs, travel expenses and fees paid to outside
consultants.
Research and development expenses increased in the three months ended March
31, 2000 to $8.5 million from $7.4 million in the three months ended March 31,
1999. The increase in research and development is primarily the result of hiring
additional research and development personnel, and the expansion of our Dublin
development center, both of which were required to expand and enhance our
library of SmartCourses, to develop our e-Learning offerings and to develop the
e-Learning infrastructure. We delivered 80 new IT titles during the three months
ended March 31, 2000, which brought our library of IT titles to 1,221.
We believe that significant investment in research and development is
required to build-out our e-Learning infrastructure and to remain competitive in
the information technology and business skills education and training market. We
therefore expect research and development expenses to increase in future
periods. /3/
- ------------
/3/ This paragraph consists of forward-looking statements reflecting our
current expectations. In addition, our actual future performance may not meet
our current expectations. You are strongly encouraged to review the section
entitled "Additional Risk Factors That Could Affect Operating Results"
commencing on page 16 and discussions elsewhere in this Quarterly Report on Form
10-Q of the factors that could affect future performance.
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Software development costs are accounted for in accordance with Statement
of Financial Accounting Standards No. 86, under which we are required to
capitalize software development costs after technological feasibility has been
established. To date, development costs after establishment of technological
feasibility have been immaterial, and all software development costs have been
expensed as incurred.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries and commissions,
advertising and promotional expenses and related overhead costs.
These expenses increased in the three months ended March 31, 2000 to $23.2
million from $21.0 million for the three months ended March 31, 1999. The
increase was primarily attributable to increased marketing expenses associated
with our e-learning solutions, as well as costs associated with an increase in
the number of sales personnel in the United States and, to a lesser extent,
outside the United States. We expect to continue to increase sales and marketing
expenses in the future to build the SmartForce brand and to support an increase
in our sales force and expansion of our marketing efforts. /4/
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and
benefits, travel expenses, legal, accounting and consulting fees and related
overhead costs for administrative officers and support personnel.
General and administrative expenses remained constant at $4.5 million
percentage of revenues for the three months ended March 31, 2000 compared to
$4.5 million for the three months ended March 31, 1999. We anticipate that
general and administrative expenses will increase in absolute dollars in future
periods due to increases in staffing and infrastructure to support our e-
Learning infrastructure and acquisitions. /4/
Amortization of acquired intangibles
Amortization of acquired intangibles for the three months ended March 31,
2000, was $1.7 million as compared to $nil for the three months ended March 31,
1999. The acquired intangibles, being amortized in the three months ended March
31, 2000, are identifiable intangible assets of $35.5 million and goodwill of
$23.7 million, which were recorded on the acquisition of Knowledge Well in June
1999. We expect that the amortization of acquired intangibles will increase in
future periods as a result of the acquisitions of AES and Learning Productions.
- ----------
/4/ This paragraph consists of forward-looking statements reflecting our current
expectations. In addition, our actual future performance may not meet our
current expectations. You are strongly encouraged to review the section entitled
"Additional Risk Factors That Could Affect Operating Results" commencing on page
16 and discussions elsewhere in this Quarterly Report on Form 10-Q of the
factors that could affect future performance.
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Other Income, Net
Other income, net, comprises interest income, interest expense and foreign
currency exchange gains and losses.
We recognized other income, net, of $1.1 million for the three months ended
March 31, 2000, as compared to other income, net, of $0.5 million for the three
months ended March 31, 1999. Other income for both periods was primarily
interest on short-term investments. Included in other income, net, was net
exchange losses of $0.2 million for the three months ended March 31, 2000,
compared to net exchange losses of $0.5 million for the three months ended March
31, 1999. The net exchange losses incurred were primarily attributable to the
weakening of the Euro and related currencies, in particular the Irish pound,
against the U.S. Dollar. The increase in other income for the three months ended
March 31, 2000 as compared to the three months ended March 31, 1999 is primarily
attributable to greater interest income from higher cash and short term
investment balances as well as higher interest rates and reduced foreign
exchange losses.
Our consolidated financial statements are prepared in dollars,
although several of our subsidiaries have functional currencies other than the
dollar, and a significant portion of our revenues, costs and assets and those of
our subsidiaries are denominated in currencies other than their respective
functional currencies. We have significant subsidiaries in the United Kingdom,
Australia, the Netherlands and Canada whose functional currencies are their
local currencies and the majority of whose sales and operating expenses other
than cost of goods sold are denominated in their respective local currencies. In
addition, our Irish subsidiaries, whose functional currency is the U.S. dollar,
incur substantial operating expenses denominated in Irish pounds. Fluctuations
in exchange rates may have a material adverse effect on our results of
operations, particularly our operating margins, and could result in exchange
losses, as it has done in the three months ended March 31, 2000. The impact of
future exchange rate fluctuations on our results of operations cannot be
accurately predicted.
Our subsidiaries in the United Kingdom, Canada, the Netherlands, and
Australia, whose functional currencies are their local currencies, had unhedged
liabilities denominated in U.S. dollars payable to SmartForce Ireland at March
31, 2000 of $9.3 million, $6.2 million, $5.5 million and $3.5 million,
respectively.
During the three months ended March 31, 2000 we entered into forward
currency exchange contracts to hedge identified expenses denominated in Irish
pounds. We have not sought to hedge the risks associated with fluctuations in
the exchange rates of other currencies against the U.S Dollar, but may undertake
such transactions in the future. Any hedging techniques implemented by us may
not be successful in eliminating or reducing the effects of currency
fluctuations. Fluctuations in exchange rates may have a material adverse effect
on our results of operations, particularly our operating margins, and could
result in exchange losses. The impact of future exchange rate fluctuations on
the results of operations cannot be accurately predicted./5/
Other income, net may fluctuate in future periods as a result of movements
in cash, cash equivalents and short-term investment balances, interest rates,
foreign currency exchange rates and asset disposals.
- -------------
/5/ This paragraph consists of forward-looking statements reflecting our
current expectations. In addition, our actual future performance may not meet
our current expectations. You are strongly encouraged to review the section
entitled "Additional Risk Factors That Could Affect Operating Results"
commencing on page 16 and discussions elsewhere in this Quarterly Report on
Form 10-Q of the factors that could affect future performance.
14
<PAGE>
Provision for Income Taxes
We operate as a holding company with operating subsidiaries in several
countries, and each subsidiary is taxed based on the laws of the jurisdiction in
which it operates. Because taxes are incurred at the subsidiary level, and one
subsidiary's tax losses cannot be used to offset the taxable income of
subsidiaries in other tax jurisdictions, our consolidated effective tax rate may
increase to the extent that we report tax losses in some subsidiaries and
taxable income in others.
We have significant operations and generate a majority of our taxable income
in the Republic of Ireland, and certain of our Irish operating subsidiaries are
taxed at rates substantially lower than tax rates in effect in the United States
and other countries in which we have operations. Two Irish subsidiaries
currently qualify for a 10% tax rate and another Irish subsidiary is income tax
exempt. If such subsidiaries were no longer to qualify for such tax rates or if
the tax laws were rescinded or changed, our operating results could be
materially adversely affected. Moreover, because we incur income tax in several
countries, an increase in our profitability in one or more of these countries
could result in a higher overall tax rate. In addition, if tax authorities were
to challenge successfully the manner in which profits are recognized among our
subsidiaries, our taxes could increase and our cash flow and net income could be
materially adversely affected.
Our effective tax rate, before amortization of acquired intangibles, was
15.0%, and 10.0% for the three months ended March 31, 1999 and March 31, 2000,
respectively. The tax benefit of 10%, before amortization of acquired
intangibles, which we recorded in the three months ended March 31, 2000, is as a
result of the anticipated loss for 2000, which will be recognized for tax
purposes by one of our Irish subsidiaries. This Irish subsidiary is taxed at
10%.
Liquidity and Capital Resources
Cash and short-term investments at March 31, 2000 were $106 million
compared to $108 million at December 31, 1999. Working capital was $123.9
million as of March 31, 2000 compared to $134.1 million as of December 31, 1999.
The decrease in cash, short term investments and working capital is due
principally to operating cash outflows and investments in property and equipment
to support the building of our e-Learning infrastructure and expanded
operations.
Cash flows from operating activities. Net cash used by operating activities was
$2.7 million for the three months ended March 31, 2000 compared to net cash used
by operating activities of $4.8 million for the three months ended March 31,
1999. During the three months ended March 31, 2000, cash outflows from
operations decreased from that for the three months ended March 31, 1999,
despite a net loss for the period of $11.7 million, primarily as a result of the
reduction in accounts receivable from December 31, 1999 to March 31, 2000. The
reduction in the accounts receivable balance is a function of the revenue for
the preceding quarter and the timing of payments in respect of receivables.
Cash flows from investing activities. Net cash used by investing activities was
$5.2 million in the three months ended March 31, 2000 compared to net cash used
by investing activities of $3.8 million for the three months ended March 31,
1999. The increase in cash outflow from investing was primarily due to
increased capital expenditure required to continue to build our e-Learning
infrastructure and to support our expanding operations. We expect to make
significant investments to our information systems and other capital
expenditures projects over the next two years primarily as a result of building
the infrastructure for our e-Learning solutions.
Cash flows from financing activities. Net cash provided by financing activities
increased to $3.7 million for the three months ended March 31, 2000 from $0.8
million for the three months ended March 31, 1999. The increase is attributable
to increased employee stock option exercises during the three months ended March
31, 2000 as compared with the three months ended March 31, 1999.
We believe our existing cash, cash equivalents and short-term investments
and cash to be generated from operations will be sufficient to meet our expected
working capital and capital expenditure requirements for at least the next
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<PAGE>
twelve months. /6/ We may from time to time consider the acquisition of
complementary businesses, products or technologies, which may require additional
financing or pursue other strategic capital raising.
Additional Risk Factors that Could Affect Operating Results
Important Note About Forward Looking Statements
In addition to historical statements, this Quarterly Report on Form 10-Q
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. Words such as "anticipates", "expects", "intends",
"plans", "believes", "seeks", "estimates" and similar expressions identify such
forward looking statements. These forward looking statements are not guarantees
of future performance and are subject to certain risks and uncertainties that
could cause actual results to differ materially from those expressed or
forecasted. Actual results may vary because of factors such as product ship
schedules, life cycles, terms and conditions, product mix, competitive products
and pricing, customer demand, technological shifts, litigation and other issues
discussed elsewhere in this Quarterly Report and in our most recent annual
report, as amended on Form 10-K/A, for the fiscal year ended December 31, 1999.
These forward-looking statements reflect management's opinions only as of the
date hereof, and we assume no obligation unless required by law to revise or
publicly release the results of any revision to these forward-looking
statements. Risks and uncertainties include, but are not limited to, those
discussed in the section entitled "Additional Risk Factors That Could Affect
Operating Results." Other risks and uncertainties are disclosed in the our SEC
filings, including our Annual Report, as amended on Form 10-K/A, for the year
ended December 31, 1999. Historical results are not necessarily indicative of
trends in operating results for any future period.
In addition to the other factors identified in this Quarterly Report on Form
10-Q, the following risk factors could materially and adversely affect our
future operating results, and could cause actual events to differ materially
from those predicted in our forward looking statements relating to our business.
Our quarterly operating results are difficult to predict because they can
fluctuate significantly. This limits your ability to evaluate our historical
financial results and increases the likelihood that our results will fall below
market analysts' expectations, which could cause the price of our ADSs to drop
rapidly and severely.
We have in the past experienced fluctuations in our quarterly operating
results and anticipate that these fluctuations will continue and could intensify
in the future. As a result, we believe that our quarterly revenue, expenses and
operating results are likely to vary significantly in the future. Thus, it is
likely that in some future quarters our results of operations will be below the
expectations of public market analysts and investors, which could have a severe
adverse effect on the price of our ADSs. For example, our revenue for the
quarter ended September 30, 1998 did not increase at a rate comparable to prior
quarters. As a direct result, the trading price of our ADSs decreased rapidly
and significantly, having an extreme adverse effect on the value of an
investment in our securities.
- -------------
/6/ This statement is a forward-looking statement and actual results may differ
materially depending on a variety of factors, including variable operating
results or presently unexpected uses of cash such as mergers and acquisitions.
16
<PAGE>
Our operating results have historically fluctuated, and may in the future
continue to fluctuate, as a result of factors which include:
* the size and timing of new and renewal agreements
* the rate at which we migrate our customers to our e-Learning solutions
* the number and size of outsourced virtual university agreements or other
agreements providing for professional services or the resale of instructor-
led training
* the mix of sales between courseware we develop and courseware developed
through development and marketing alliances
* royalty rates
* the announcement, introduction and acceptance of new products, product
enhancements and technologies by us and our competitors
* the mix of sales between our field sales force, our other direct sales
channels and our telesales sales channels
* competitive conditions in the industry
* the loss of significant customers
* delays in availability of existing or new products
* the spending patterns of our customers
* litigation costs and expenses
* currency fluctuations
* the length of sales cycles
We have recently introduced fully integrated, Internet-based learning solutions,
an area in which we have limited experience.
We recently introduced SmartForce e-Learning, a hosted Internet-based learning
solution. As a result, we have a very limited experience with these solutions,
which makes our historical results of limited value in predicting the potential
success of this initiative. The success of this initiative will depend on our
ability to build-out and maintain our e-Learning infrastructure, to market and
sell the new e-Learning solutions to existing and prospective customers, to
create a significant subscriber base for our e-Learning destination Web site, to
host, operate and manage our destination site, and to attract and retain key
management and technical personnel.
We may not be successful in our efforts to migrate our customers to our e-
Learning solutions and the economic terms of any arrangements that might be
expected may not be as favorable as the traditional licensing agreements. We
believe that a lack of success in this regard could have a material negative
effect on us. Moreover, to the extent that we are successful in our efforts to
enter into e-Learning agreements with our customers, those arrangements are
expected to have accounting and operating model consequences that would also be
materially different from the consequences of our traditional software licensing
model.
Our introduction of e-Learning solutions will have a significant impact on our
operating model.
In connection with our SmartForce e-Learning initiative, we are moving from a
software license model, where we sell a license to a specified list of software
titles, to an Internet rental model where we provide our customers with access
to a constantly evolving Internet environment. As a consequence, revenue under
e-Learning rental agreements will generally be deferred and recognized ratably
over the term of the agreement rather than annually in advance under the
historical licensing structure. The migration of new and existing customers to
our e-Learning solutions will result in the deferral of a significant portion of
revenues from year 2000 into future periods, and, accordingly, a decrease in
reported revenues in year 2000 compared to year 1999 as well as a decrease in
reported revenues for each quarter during year 2000 as compared to that which
would be expected under the software license model.
Additionally, we intend to make significant investments in our e-Learning
infrastructure and in building the SmartForce brand. In particular, we
anticipate that we will significantly increase our research and development
expenses and capital expenditures to build out our e-Learning infrastructure,
and expect to increase marketing expenses significantly to build the SmartForce
brand. As a result of the deferral of revenue under e-Learning agreements and
17
<PAGE>
these incremental expenses, we expect to record a net loss for each quarter
during the year 2000. These losses could continue beyond that time.
Our operating results are subject to seasonal fluctuations which may adversely
impact our business.
Our operating results are subject to seasonal fluctuations, based in part on
customers' annual budgetary cycles and in part on the annual nature of sales
quotas. These seasonal trends have in the past caused revenues in the first
quarter of a year to be less, perhaps substantially so, than revenues for the
immediately preceding fourth quarter. We expect that these seasonal trends will
continue to adversely affect our revenues. In addition, we have in past years
added significant headcount in the sales and marketing and research and
development functions in the first quarter, and to a lesser extent, the second
quarter. Because these headcount additions do not immediately contribute
significant revenues, our operating margins in the earlier part of the year tend
to be significantly lower than in the later parts of the year. In addition, many
technology companies also experience a seasonal downturn in demand during the
summer months. These seasonal trends may have a material adverse effect on our
results of operations.
We rely on strategic alliances that may not continue in the future.
We have developed strategic alliances to develop and market many of our
products, and we believe that an increasing proportion of our future revenues
may be attributable to products developed and marketed through these and other
future alliances. However, these relationships are not exclusive and we may be
unable to continue to develop future products through these alliances in a
timely fashion or may be unable to negotiate additional alliances in the future
on acceptable terms or at all.
The marketing efforts of our partners may also disrupt our direct sales
efforts. Our development and marketing partners could pursue their existing or
alternative training programs in preference to and in competition with those
being developed by us. In the event that we are unable to maintain or expand our
current development and marketing alliances or enter into new development and
marketing alliances, our operating results and financial condition could be
materially adversely affected. Furthermore, we are required to pay royalties to
our development and marketing partners on products developed with them, which
reduces our gross margins. We expect that cost of revenues may fluctuate from
period to period in the future based upon many factors, including the mix of e-
Learning events licensed (between e-Learning events developed exclusively by us,
and royalty-bearing courseware developed pursuant to development and marketing
alliances) and the timing of expenses associated with development and marketing
alliances. In addition, the collaborative nature of the development process
under these alliances may result in longer development times and less control
over the timing of product introductions than for e-Learning offerings developed
solely by us.
Our success depends on our ability to meet the needs of the rapidly changing
market.
The market for interactive education and training is influenced by rapidly
changing technology, evolving industry standards, changes in customer needs and
frequent introductions of new products by software vendors. New methods of
providing interactive education in a technology-based format are being developed
and offered in the marketplace, including intranet and Internet offerings. Many
of these new offerings involve new and different business models and contracting
mechanisms. In addition, multimedia and other product functionality features are
being added to the educational software. Accordingly, our future success will
depend upon the extent to which we are able to develop and implement products
which address these emerging market requirements on a timely basis. If we are
unsuccessful in addressing the changing needs of the marketplace due to
resource, technological or other constraints, to anticipate and respond
adequately to changes in customers' software technology and preferences, our
business and results of operations would be materially adversely affected.
If we are unable to build the SmartForce brand, we may be unable to grow our
business.
We believe that establishing and maintaining the SmartForce brand will be
critical to the success of our e-Learning strategy and that the importance of
brand recognition will increase due to the growing number of education-oriented
Internet sites. Successful promotion and marketing of the SmartForce brand will
depend on providing compelling educational content, community and commerce, and
we intend to significantly increase our marketing and branding
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<PAGE>
expenditures in our effort to increase our brand awareness. If our brand
building strategy is unsuccessful, these expenses may never be recovered, and
our business could be materially harmed.
The success of our e-Learning strategy depends on the reliability and consistent
performance of our information systems and Internet infrastructure.
The success of our e-Learning strategy is highly dependent on the consistent
performance of our information systems and Internet infrastructure. If our Web
site fails for any reason or if we exercise any unscheduled down times, even for
only a short period of time, our business and reputation would be materially
harmed. We rely on third parties for proper functioning of our computer
infrastructure, delivery of our e-Learning application and the performance of
our destination site. Our systems and operations could be damaged or interrupted
by fire, flood, power loss, telecommunications failure, break-ins, earthquake
and similar events. Any system failures could adversely affect customer usage of
our solutions and user traffic results in any future quarters, which could
adversely affect our revenues and operating results and harm our reputation with
corporate customers, subscribers and commerce partners. A key element of our
strategy is to generate a high volume of traffic to the Web site and create a
significant subscriber base. Accordingly, the satisfactory performance,
reliability and availability of our Web site and computer infrastructure is
critical to our reputation and ability to attract and retain corporate
customers, subscribers and commerce partners. We cannot accurately project the
rate or timing of any increases in traffic to our Web site and, therefore, the
integration and timing of any upgrades or enhancements required to facilitate
any significant traffic increase to the Web site are uncertain. The failure to
expand and upgrade the Web site or any system error, failure or extended down
time could materially harm our business, reputation, financial condition or
results of operations.
We may fail to integrate adequately acquired products, technologies and
businesses.
As a result of the consummation of a number of acquisitions our operating
expenses have increased. The integration of these businesses may not be
successfully completed in a timely fashion, or at all. Further, the revenues
from the acquired businesses may not be sufficient to support the costs
associated with those businesses, without adversely affecting our operating
margins. Any failure to successfully complete the integration in a timely
fashion or to generate sufficient revenues from the acquired businesses could
have a material adverse effect on our business and results of operations.
In addition in June 1999, we acquired Knowledge Well. Knowledge Well provides
interactive software that delivers business, management and professional
education skills and/or courses. Although, the software delivery systems are
similar, we and Knowledge Well developed distinct architectures for our
respective products. Successful integration of these architectures will require
substantial effort. Difficulties in combining the companies, products and
technologies could have an adverse impact on our ability to fully benefit from
its existing and future investment in this business and on the future prospects
for the business, management and professional education software products.
We regularly evaluate acquisition opportunities and are likely to make
acquisitions in the future. Future acquisitions could result in potentially
dilutive issuances of equity securities, the incurrence of debt and contingent
liabilities and amortization expenses related to goodwill and other intangible
assets, which could materially adversely affect our results of operations.
Product and technology acquisitions entail numerous risks, including
difficulties in the assimilation of acquired operations, technologies and
products, diversion of management's attention to other business concerns, risks
of entering markets in which we have no or limited prior experience and the
potential loss of key employees of acquired companies. Our management has had
limited experience in assimilating acquired organizations and products into our
operations. We may be unable to integrate successfully any operations, personnel
or products that have been acquired or that might be acquired in the future, and
our failure to do so could have a material adverse effect on our results of
operations.
Rapid expansion of our operations could strain our personnel and systems.
We have recently experienced rapid expansion of our operations, which has
placed, and is expected to continue to place, significant demands on our
executive, administrative, operational and financial personnel and systems. Our
future operating results will substantially depend on the ability of our
officers and key employees to manage changing
19
<PAGE>
business conditions and to implement and improve our operational, financial
control and reporting systems. In particular, we require significant improvement
in our order entry and fulfillment and management information systems in order
to support our expanded operations. If we are unable to respond to and manage
changing business conditions, our business and results of operations could be
materially adversely affected.
Our expense levels are fixed in the short term and we may be unable to adjust
spending to compensate for unexpected revenue shortfalls.
Our expense levels are based in significant part on our expectations regarding
future revenues and are fixed to a large extent in the short term. Accordingly,
we may be unable to adjust spending in a timely manner to compensate for any
unexpected revenue shortfall. Any significant revenue shortfall would therefore
have a material adverse effect on our results of operations. This risk
materialized in the third quarter of 1998, where profit was dramatically
negatively affected by a shortfall in revenues as against management's
expectations.
We depend on a few key personnel to manage and operate us.
Our success is largely dependent on the personal efforts and abilities of our
senior management. Failure to retain these executives, or the loss of certain
additional senior management personnel or other key employees, could have a
material adverse effect on our business and future prospects.
We are also dependent on the continued service of our key sales, product
development and additional operational personnel and on our ability to attract,
motivate and retain highly qualified employees. In addition, we depend on
writers, programmers and graphic artists. We expect to continue to hire
additional product development, sales and marketing, information systems and
accounting staff. However, we may be unsuccessful in attracting, retaining or
motivating key personnel. The inability to hire and retain qualified personnel
or the loss of the services of key personnel could have a material adverse
effect upon our current business, new product development efforts and future
business prospects.
Increased competition may result in decreased demand for our products and
services, which may result in reduced revenues and gross margins and loss of
market share.
The market for business education training solutions is highly fragmented and
competitive, and we expect this competition to increase. We expect that because
of the lack of significant barriers to entry into this market, new competitors
may enter the market in the future. In addition to increased competition from
new companies entering into the market, established companies are entering into
the market through acquisitions of smaller companies which directly compete with
us, and we expect this trend to continue. We expect the market to become
increasingly competitive due to the lack of significant barriers to entry. We
may also face competition from publishing companies and vendors of application
software, including those vendors with whom we have formed development and
marketing alliances
Our primary source of direct competition comes from third-party suppliers of
instructor-led information technology, business, management and professional
skills education and training as well as suppliers of computer-based training
and e-Learning solutions. We also face indirect competition from internal
training departments of our potential customers. We also compete to a lesser
extent with consultants, value-added resellers and network integrators. Certain
of these value-added resellers also market products competitive with ours. We
expect that as organizations increase their dependence on outside suppliers of
training, we will face increasing competition from these other suppliers as
education and training managers more frequently compare training products
provided by outside suppliers.
Growing competition may result in reduced revenue and gross margins and loss
of market share, any one of which have a material adverse effect on our
business. Many of our current and potential competitors have substantially
greater financial, technical, sales, marketing and other resources, as well as
greater name price competition, and we expect that we will face increasing price
pressures from competitors as managers demand more value for their training
budgets. Accordingly, we may be unable to provide products that compare
favorably with new instructor-led techniques or other interactive training
software or competitive pressures may require us to reduce our prices
significantly.
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Our business is subject to currency fluctuations that can adversely affect our
operating results.
Due to our multinational operations, our business is subject to fluctuations
based upon changes in the exchange rates between the currencies in which we
collect revenues or pay expenses. In particular, the value of the U.S. dollar
against the Euro and related currencies impacts our operating results. Our
expenses are not necessarily incurred in the currency in which revenue is
generated, and, as a result, we are required from time to time to convert
currencies to meet our obligations. These currency conversions are subject to
exchange rate fluctuations, and changes to the value of the Euro and related
currencies relative to other currencies could adversely affect our business and
results of operations.
Our corporate tax rate may increase, which could adversely impact our cash flow,
financial condition and results of operations.
We have significant operations and generate a majority of our taxable income
in the Republic of Ireland, and some of our Irish operating subsidiaries are
taxed at rates substantially lower than tax rates in effect in the United States
and other countries in which we have operations. If our Irish subsidiaries were
no longer to qualify for these lower tax rates or if the applicable tax laws
were rescinded or changed, our operating results could be materially adversely
affected. Moreover, because we incur income tax in several countries, an
increase in our profitability in one or more of these countries could result in
a higher overall tax rate. In addition, if U.S. or other foreign tax authorities
were to change applicable tax laws or successfully challenge the manner in which
our subsidiaries' profits are currently recognized, our taxes could increase,
and our business, cash flow, financial condition and results of operations could
be materially adversely affected.
We may be unable to protect our proprietary rights. Unauthorized use of our
technology may result in development of products or services which compete with
ours.
Our success depends on our ability to protect our rights in our intellectual
property and trade secrets. We rely upon a combination of copyright, trademark
and trade secret laws and customer license agreements, and other methods to
protect our proprietary rights. We also enter into confidentiality agreements
with our employees, consultants and third parties to seek to limit and protect
the distribution of our proprietary information regarding this technology.
However, we have not signed protective agreements in every case. Unauthorized
parties may copy aspects of our products and services and obtain and use
information that we regard as proprietary. Other parties may breach
confidentiality agreements and other protective contracts we have executed. We
may not become aware of, or have adequate remedies in the event of, a breach.
Litigation may be necessary in the future to enforce our intellectual property
rights, to protect trade secrets or to determine the validity and scope of the
proprietary rights of others. This litigation could result in substantial costs
and diversion of management and technical resources.
Some may claim that we infringe their intellectual property rights, which could
result in costly litigation or require us to reengineer or cease sales of our
products or services.
Third parties could in the future claim that our current or future products
infringe their intellectual property rights. Any claim, with or without merit,
could result in costly litigation or require us to reengineer or cease sales of
our products or services, any of which could have a material adverse effect on
our business. Infringement claims could also result in an injunction in the use
of our products or require us to enter into royalty or licensing agreements.
Licensing agreements, if required, may not be available on terms acceptable to
us or at all.
We are subject to a pending legal proceeding and may become subject to
additional proceedings, and adverse determinations in these proceedings could
harm our business.
We may be from time to time involved in various lawsuits and legal proceedings
which arise in the ordinary course of business. An adverse resolution of these
matters could significantly negatively impact our financial position and results
of operations.
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<PAGE>
Our non-U.S. operations are subject to risks which could negatively impact our
future operating results.
We expect that international operations will continue to account for a
significant portion of our revenues, and intend to continue to expand our
operations outside of the United States. Operations outside of the United States
are subject to inherent risks, including difficulties or delays in developing
and supporting non-English language versions of our products and services,
political and economic conditions in various jurisdictions, in staffing and
managing foreign subsidiary operations, longer accounts receivable payment
cycles and potential adverse tax consequences. Any of these factors could have a
material adverse effect on our future operations outside of the United States,
which could negatively impact our future operating results.
The Internet-based learning market is a developing market, and our business will
suffer if e-Learning is not widely accepted.
The market for Internet-based enterprise learning is a new and emerging
market. Corporate training and education has historically been conducted
primarily through classroom instruction and has traditionally been performed by
a company's internal personnel. Many companies have invested heavily in their
current training solutions. Although technology-based training applications have
been available for several years, they currently account for only a small
portion of the overall training market.
Accordingly, our future success will depend upon the extent to which companies
adopt technology based solutions and use the Internet in connection with their
training activities, and the extent to which companies utilize the services or
purchase products of third-party providers. Many companies that have already
invested substantial resources in traditional methods of corporate training may
be reluctant to adopt a new strategy that may implement or compete with their
existing investments. Even if companies implement technology-based training or
Internet learning solutions, they may still choose to design, develop, deliver
or manage all or part of their education and training internally. If technology
based learning and the use of the Internet for learning does not become
widespread, or if companies do not use the products and services of third
parties to develop, deliver or manage their training needs, then our products
and services, may not achieve commercial success.
Because many users of our e-Learning solutions access them over the Internet,
factors adversely affecting the use of the Internet could harm our business
Many of our users access our e-Learning solutions over the Internet. Any
factors that adversely affect Internet usage could disrupt the ability of those
users to access our e-Learning solutions, which would adversely effect customer
satisfaction and therefore our business. Factors which could disrupt Internet
usage include slow access to download times, security concerns, network problems
or service disruptions that prevent users from accessing an Internet server and
delays in, or disputes concerning, the development of industry wide Internet
standards and protocols.
Demand for our products and services may be especially susceptible to adverse
economic conditions.
Our business and financial performance may be damaged by adverse financial
conditions affecting our target customers or by a general weakening of the
economy. Some companies may not view training products and services as critical
to the success of their businesses. If these companies experience disappointing
operating results, whether as a result of adverse economic conditions,
competitive issues or other factors, they may decrease or forego education and
training expenditures before limiting their other expenditures.
The market price for our ADSs may fluctuate and may not be sustainable.
Our initial public offering of the ADSs was completed in April 1995, and there
can be no assurance that a viable public market for the ADSs will be sustained.
The market price of the ADSs has fluctuated significantly since our initial
public offering. We believe that factors such as announcements of developments
related to ourselves or our competitors' business, announcements of new products
or enhancements by ourselves or our competitors, sales of the ADSs into the
public market, developments in our relationships with our customers, partners
and distributors, shortfalls or changes in revenues, gross margins, earnings or
losses or other financial results from public market expectations,
22
<PAGE>
regulatory developments, fluctuations in results of operations and general
conditions in our market or the markets served by our customers or the economy
could cause the price of the ADSs to fluctuate, perhaps substantially.
In addition, in recent years the stock market in general, and the market for
shares of technology stocks in particular, has experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
affected companies. The market price of the ADSs may continue to experience
significant fluctuations in the future, including fluctuations that are
unrelated to our performance.
Year 2000 Readiness
The Year 2000 issue existed because many computer systems and applications use
two-digit rather than four-digit date fields to designate a year. As of May 10,
2000 we have not experienced any year 2000 issues with our products or services,
or the internal network and supporting infrastructure of our manufacturers,
suppliers or strategic partners. We plan to continue to monitor our computer
systems and products throughout the year to assess whether any problems develop.
If we become aware of year 2000 issues in the future, we may incur costs to
resolve them which could adversely affect our business and results of
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to market risk for changes in interest rates relate primarily to
our investment portfolio. We do not use any derivative financial instruments in
our investment portfolio. The primary objective of our investment activities is
to preserve capital while maximizing yields without significantly increasing
risk. We achieve this by investing our excess cash in deposits with major banks
and in U.S. Treasury and U.S. agency obligations and in debt securities of
corporations with strong credit ratings. Due to the nature of our investments,
we believe that there is no material risk exposure. All investments are carried
at market value, which approximates cost.
The table below presents the principal amount and related weighed average
interest rates for our investment portfolio. Our short term investments are all
in fixed rate instruments. The principal amounts approximate fair value at March
31, 2000.
Table of Investment Securities:
<TABLE>
<CAPTION>
Average
Principal Interest
Amount Rate
March 31, 2000 -------------- -------------
(Dollars in thousands)
<S> <C> <C>
Cash and cash equivalents $ 65,470 5.5%
Short term investments 40,558 5.7%
--------
Total cash and investment securities $106,028
========
</TABLE>
Foreign Currency Risk
Due to our multinational operations, our business is subject to
fluctuations based upon changes in the exchange rates between the currencies in
which we collect revenues or pay expenses and the U.S. dollar. In particular,
the value of the Euro and related currencies to the U.S. dollar impacts our
operating results. Our expenses are not necessarily incurred in the currency in
which revenue is generated, and, as a result, we are required from time to time
to convert currencies to meet our obligations. These currency conversions are
subject to exchange rate fluctuations, and changes to the value of the Euro and
related currencies relative to the U.S. dollar could adversely affect our
business and the results of operations.
During the three months ended March 31, 2000 we entered into forward
currency exchange contracts to hedge identified expenses denominated in Irish
pounds. We have not sought to hedge the risks associated with fluctuations in
23
<PAGE>
the exchange rates of other currencies against the U.S Dollar, but may undertake
such transactions in the future. Any hedging techniques implemented by us may
not be successful in eliminating or reducing the effects of currency
fluctuations. Fluctuations in exchange rates may have a material adverse effect
on our results of operations, particularly our operating margins, and could
result in exchange losses. The impact of future exchange rate fluctuations on
our results of operations cannot be accurately predicted.
Our outstanding foreign currency forward exchange contracts at March 31,
2000, are presented in the table below. The weighted average exchange rate
quoted represents the functional currency to the U.S. dollar.
<TABLE>
<CAPTION>
Functional Expected Maturity Weighted Average
Currency Amount Quarter Ended Exchange Rate
- ---------- ------ -------------------- ------------------------
<S> <C> <C> <C>
Irish pounds $4,000,000 June 30, 2000 1.2321
Irish pounds $6,000,000 September 30, 2000 1.2395
Irish pounds $6,000,000 December 31, 2000 1.2150
</TABLE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Since the end of the third quarter of 1998, several purported class action
lawsuits have been filed in United States District Court for the Northern
District of California and the Superior Court of California for the County of
San Mateo against us, one of our subsidiaries, SmartForce USA and certain of our
former and current officers and directors alleging violation of the federal
securities laws. It has been alleged in these lawsuits that we misrepresented or
omitted to state material facts regarding our business and financial condition
and prospects in order to artificially inflate and maintain the price of our
ADSs, and misrepresented or omitted to state material facts in our registration
statement and prospectus issued in connection with our merger with ForeFront,
which also is alleged to have artificially inflated the price of our ADSs.
We believe that these actions are without merit and intend to vigorously
defend ourselves against them. Although we cannot presently determine the
outcome of these actions, an adverse resolution of these matters could
significantly negatively impact our financial position and results of
operations.
On October 29, 1998, a derivative complaint was filed in the Superior Court of
California for the County of San Mateo against several of our present and former
officers and directors alleging that these persons violated various duties they
owed in their official capacities to us. The derivative complaint also names us
as a nominal defendant. The derivative complaint is predicated on the factual
allegations contained in the class action complaints discussed above. No demand
was previously made to our board of directors or shareholders concerning the
allegations of the derivative complaint, which seeks an unspecified amount of
damages.
ITEM 2. CHANGES IN SECURITIES
On March 2, 2000 we issued an aggregate of 103,129 ADSs to AES as partial
consideration for our acquisition of certain assets of AES. The ADSs were
issued at a deemed issue price of $ 49.9375 per ADS. The issuance of the ADSs
was, exempt from the registration requirements of the Securities Act of 1933,
pursuant to Section 4.2 there of as the transaction did not involve a public
offering.
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<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
Extraordinary General Meeting
- -----------------------------
We held an extraordinary general meeting of shareholders on January 26,
2000 (the "EGM"). Under the terms of the deposit agreement, Bank of New York is
entitled to vote on behalf of the ADS holders. Three individual shareholders and
a representative of Bank of New York were present for the vote. Voting was
conducted by a show of hands in accordance with Irish law. There were no
abstentions, broker non-votes or votes withheld with respect to any matter
submitted to a vote of the security holders at the EGM.
The following is a brief description of each matter submitted to a vote of the
security holders (Ordinary Shareholders and the representative of the ADS
holders) and a summary of the votes tabulated with respect to each such matter
at the EGM, as well as a summary of the votes cast by the Bank of New York based
on the American Depositary Receipts ("ADR") facility:
(1) The shareholders approved the changing of our name to SmartForce Public
Limited Company, and the amendment to paragraph 1 of our memorandum of
Association to give effect to same.
Votes "FOR" Votes "AGAINST" Votes "ABSTAIN"
----------- --------------- ---------------
Ordinary Shareholders 3 0 0
ADS holders 49,793,582 43,857 14,218
(2) The shareholders approved the granting of the unconditional authority to
the directors to exercise all of the powers of the Company to allot
relevant securities (within the meaning of Section 20 of the Companies
(Amendment) Act, 1983(the "1983 Act")) up to an amount equal to but not
exceeding our authorized but unissued share capital as at the date of
passing of the resolution provided that such authority shall expire at the
close of business January 25, 2005, unless previously renewed, varied or
revoked in general meeting, except that we may before such expiry make an
offer or agreement which would or might require relevant securities
pursuant to any such offer or agreement as if the authority conferred had
not expired.
Votes "FOR" Votes "AGAINST" Votes "ABSTAIN"
----------- --------------- ---------------
Ordinary Shareholders 3 0 0
ADS holders 49,102,949 64,550 684,158
(3) The shareholders approved a resolution empowering our directors pursuant to
Section 24 of the 1983 Act to allot equity securities (within the meaning
of Section 23 of the 1983 Act) for cash pursuant to the authority conferred
on our directors by the item (2) above as if subsections (1) of the said
section 23 did not apply to any such allotment, provided that such power
shall expire at the close of business on January 25, 2005 unless such power
shall be renewed in accordance with and subject to the provision of Section
24 of the 1983 act, except that we may before such expiry make an offer or
agreement which would or might require equity securities to be allotted
after such expiry and our directors may allot equity securities pursuant to
any such offer or agreement as if the power conferred by the resolution had
not expired. Section 23 of the 1983 Act provides that in general, a
Company may not allot any shares (or a right to subscribe for or to convert
any securities into shares in a company) for cash unless it has first
offered those shares ,on a pro rata basis, to the existing shareholders of
the company.
Votes "FOR" Votes "AGAINST" Votes "ABSTAIN"
----------- --------------- ---------------
Ordinary Shareholders 3 0 0
ADS holders 49,066,984 68,570 716,103
25
<PAGE>
(4) The shareholders approved, conditional on the passing of items (2) and (3)
above, the proposal to delete Article 8(a) from the Articles of Association
of the Company and to renumber the current Article 8(b) as Article 8 and to
delete the words "Notwithstanding the provisions of Article 8(a) above" at
the beginning of that Article.
Votes "FOR" Votes "AGAINST" Votes "ABSTAIN"
----------- --------------- ---------------
Ordinary Shareholders 3 0 0
ADS holders 49,076,480 43,748 731,429
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
We did not file any report on Form 8-K with the Securities and Exchange
Commission in the three months ended March 31, 2000.
26
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SmartForce PLC
Date: May 15, 2000 By: /s/ Gregory M. Priest
----------------------------
Gregory M. Priest
President and Chief Executive Officer
Date: May 15, 2000 By: /s/ David C. Drummond
---------------------
David C. Drummond
Executive Vice President of Finance and
Chief Financial Officer
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 65,470
<SECURITIES> 40,558
<RECEIVABLES> 48,995
<ALLOWANCES> 2,600
<INVENTORY> 427
<CURRENT-ASSETS> 167,156
<PP&E> 48,914
<DEPRECIATION> 21,736
<TOTAL-ASSETS> 285,198
<CURRENT-LIABILITIES> 43,218
<BONDS> 0
0
0
<COMMON> 216,878
<OTHER-SE> 23,004
<TOTAL-LIABILITY-AND-EQUITY> 285,198
<SALES> 28,534
<TOTAL-REVENUES> 28,534
<CGS> 4,667
<TOTAL-COSTS> 37,874
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,154)
<INCOME-PRETAX> (12,853)
<INCOME-TAX> (1,114)
<INCOME-CONTINUING> (11,739)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,739)
<EPS-BASIC> (0.23)
<EPS-DILUTED> (0.23)
</TABLE>
