<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20548
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 September 30, 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
incorporation or organization) Identification No.)
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
October 31, 2000 was 51,626,245.
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
Table of Contents
<TABLE>
<CAPTION>
<S> <C>
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of December 31, 1999 3
and as of September 30, 2000
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 1999 and 2000 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 2000 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition 9
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
Signature 25
</TABLE>
2
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
SMARTFORCE PUBLIC LIMITED COMPANY
Condensed Consolidated Balance Sheets
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
Assets ---- ----
Current Assets
<S> <C> <C>
Cash $ 69,260 $ 59,532
Short term investments 38,913 41,903
Accounts receivable, net 62,035 64,280
Inventories 188 388
Deferred tax assets, net 192 2,395
Prepaid expenses 9,935 12,432
-------- --------
Total current assets 180,523 180,930
Intangible assets 59,155 75,800
Property and equipment, net 26,111 26,382
Investments 850 3,716
Deferred tax assets, net -- 119
Other assets 23,078 27,224
-------- --------
Total assets $289,717 $314,171
======== ========
Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable $ 5,368 $ 4,593
Accrued payroll and related expenses 6,680 6,932
Other accrued liabilities 28,213 22,115
Deferred revenues 6,141 37,787
------- -------
Total current liabilities 46,402 71,427
Non-Current Liabilities
Minority equity interest 383 383
Other liabilities 209 1,439
--- -----
Total non current liabilities 592 1,822
Shareholders' Equity
Ordinary Shares, IR9.375p par value: 120,000,000 shares authorized at 7,432 8,586
December 31, 1999 and September 30, 2000; issued and outstanding:
50,035,087 and 50,009,318 shares at December 31, 1999 and 51,538,051 and
51,512,282 at September 30, 2000,respectively
Additional paid-in capital 200,547 225,835
Accumulated profit 34,919 7,931
Capital redemption reserve 231 231
Other comprehensive loss (404) (1,659)
Treasury stock, 25,769 at cost (2) (2)
-------- --------
Total shareholders' equity 242,723 240,922
-------- --------
Total liabilities and shareholders' equity $289,717 $314,171
======== ========
</TABLE>
See notes to condensed consolidated financial statements
3
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
Condensed Consolidated Statements of Operations
(dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Nine Months
------------------------------- ---------------------------------
Ended September 30, Ended September 30,
------------------------------- ---------------------------------
1999 2000 1999 2000
------- ------- -------- --------
<S> <C> <C> <C> <C>
Revenues $50,188 $45,572 $137,632 $110,498
Cost of revenues 7,436 7,456 21,294 18,043
------- ------- -------- --------
Gross profit 42,752 38,116 116,338 92,455
Operating expenses:
Research and development 8,915 11,189 23,856 30,036
Sales and marketing 22,246 26,423 64,861 74,429
General and administrative 4,033 4,954 12,972 14,259
Amortization of acquired intangibles 1,567 2,323 1,724 6,280
Acquired research and development -- -- 5,900 --
------- ------- -------- --------
Total operating expenses 36,761 44,889 109,313 125,004
------- ------- -------- --------
Income (loss) from operations 5,991 (6,773) 7,025 (32,549)
Other income, net 1,216 1,069 2,382 3,260
------- ------- -------- --------
Income (loss) before provision for income 7,207 (5,704) 9,407 (29,289)
taxes
Provision (benefit) for income taxes 1,081 (338) 2,319 (2,301)
------- ------- -------- --------
Net income (loss) $ 6,126 $(5,366) $ 7,088 $(26,988)
======= ======= ======== ========
Net income (loss) per share - Basic $ 0.13 $ (0.10) $ 0.15 $ (0.53)
======= ======= ======== ========
Shares used in computing net income (loss) 48,988 51,324 46,242 50,888
per share - Basic ======= ======= ======== ========
Net income (loss) per share - Diluted $ 0.11 $ (0.10) $ 0.14 $ (0.53)
======= ======= ======== ========
Shares used in computing net income (loss) 55,109 51,324 50,263 50,888
per share - Diluted ======= ======= ======== ========
</TABLE>
See notes to condensed consolidated financial statements
4
<PAGE>
SMARTFORCE PUBLIC LIMITED COMPANY
Condensed Consolidated Statements of Cash Flows
(dollars in thousands)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1999 2000
-------- ---------
<S> <C> <C>
Cash Flows from Operating Activities
Net income (loss) $ 7,088 $ (26,988)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization 7,893 14,995
Accrued interest on short term investments 199 19
Non cash acquired R&D expense 5,900 --
Changes in operating assets and liabilities:
Accounts receivable (6,820) (3,686)
Inventories 65 (200)
Deferred tax assets 97 (2,310)
Prepaid expenses and other assets (13,312) (6,933)
Accounts payable 61 (628)
Accrued payroll, related expenses and other accrued liabilities 2,891 (4,766)
Deferred revenues (153) 31,739
-------- ---------
Net cash provided by operating activities 3,909 1,242
-------- ---------
Cash Flows from Investing Activities
Purchases of property and equipment (7,961) (8,385)
Payments to acquire Knowledge Well, Learning Productions and net assets
of Advanced Education Systems, net of cash acquired 768 (6,893)
Payments to acquire short term investments (77,695) (111,592)
Proceeds from sale of short term investments 75,297 108,583
Payments to acquire investments (300) (2,866)
-------- ---------
Net cash used in investing activities (9,891) (21,153)
-------- ---------
Cash Flows from Financing Activities
Proceeds under bank overdraft facility 89 --
Proceeds from issuance of ordinary shares, net 10,161 10,171
-------- ---------
Net cash provided by financing activities 10,250 10,171
-------- ---------
Effect of exchange rate changes on cash and cash equivalents (378) 12
-------- ---------
Net increase (decrease) in cash and cash equivalents 3,890 (9,728)
Cash and cash equivalents at beginning of period 65,648 69,260
-------- ---------
Cash and cash equivalents at end of period $ 69,538 $ 59,532
======== =========
</TABLE>
See notes to condensed consolidated financial statements
5
<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, the Company believes 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 the Company's 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
per share:
<TABLE>
<CAPTION>
(dollars in thousands, except per share amounts)
Three Months Nine Months
------------------------------ -------------------------------
Ended September 30, Ended September 30,
------------------------------ -------------------------------
1999 2000 1999 2000
------- ------- ------- -------
<S> <C> <C> <C> <C>
Numerator:
Numerator for basic and diluted net income $ 6,126 $(5,366) $ 7,088 $(26,988)
(loss) per share - net income (loss) available ======= ======= ======= ========
to common shareholders
Denominator:
Denominator for basic net income (loss) per 48,988 51,324 46,242 50,888
share - weighted average shares
Effect of dilutive securities:
Employee stock options 6,121 -- 4,021 --
------- ------- ------- --------
Denominator for diluted net income (loss) per 55,109 51,324 50,263 50,888
share - adjusted weighted average shares and ======= ======= ======= ========
assumed conversion
Basic net income (loss) per share $ 0.13 $ (0.10) $ 0.15 $ (0.53)
======= ======= ======= ========
Diluted net income (loss) per share $ 0.11 $ (0.10) $ 0.14 $ (0.53)
======= ======= ======= ========
</TABLE>
6
<PAGE>
NOTE 3. COMPREHENSIVE INCOME
The components of comprehensive income (loss), net of tax, for the nine months
ended September 30, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
(dollars in thousands) 1999 2000
------ --------
<S> <C> <C>
Net Income (loss) $7,088 $(26,988)
Other comprehensive income (loss) (640) (1,255)
------ --------
Total Comprehensive Income (loss) $6,448 $(28,243)
====== ========
</TABLE>
NOTE 4. SEGMENT GEOGRAPHIC AND CUSTOMER INFORMATION
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 locations. The 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 in the financial statements and related notes included in
the Company's Annual Report to the shareholders, as amended on Form 10-K/A, for
the year ended December 31, 1999. The Company's CODM does not view segment
results below operating profit (loss), therefore, net interest income, other
income and the provision (benefit) 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.
The Company presents financial information for its three reportable
operating segments: Americas, Europe Middle East Africa ("EMEA") and Ireland.
The Americas and EMEA segments are sales operations and Ireland is the Company's
research and development operation.
A summary of the segment financial information reported to the CODM is as
follows:
<TABLE>
<CAPTION>
Nine Months Ended September 30, 2000
-----------------------------------------------------------------------------
Consolidated
--------------
Americas EMEA Ireland All Other Total
--------------- --------------- ------------ ------------- --------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Revenues--External.................... $ 88,389 $15,123 $ 1,665 $ 5,321 $110,498
Inter segment Revenues................ -- -- 52,219 -- 52,219
Depreciation and Amortization......... 5,177 258 2,960 6,600 14,995
Segment Operating Loss................ (14,262) (3,445) (6,254) (8,588) (32,549)
Nine Months Ended September 30, 1999
---------------------------------------------------------------------------
Consolidated
-------------
Americas EMEA Ireland All Other Total
-------------- -------------- ------------ ------------ -------------
(dollars in thousands)
Revenues--External.................... $113,340 $17,201 $ 1,574 $ 5,517 $137,632
Inter segment Revenues................ -- -- 67,344 -- 67,344
Depreciation and Amortization......... 3,345 204 2,301 2,043 7,893
Segment Operating Income (Loss)....... (11,442) (3,022) 31,587 (10,098) 7,025
</TABLE>
7
<PAGE>
Revenues from external customers, based on the location of the customer,
are categorized by geographical areas as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
1999 2000 1999 2000
------- ------- -------- --------
<S> <C> <C> <C> <C>
Revenues
Ireland........................ $ 1,013 $ 633 $ 2,111 $ 2,269
United States.................. 35,139 30,703 97,933 72,570
United Kingdom................. 7,327 6,381 18,923 16,749
Other countries................ 6,709 7,855 18,665 18,910
------- ------- -------- --------
Total.......................... $50,188 $45,572 $137,632 $110,498
======= ======= ======== ========
</TABLE>
The Company regards its e-Learning solutions as homogenous products and
services.
NOTE 5. ACQUISITIONS
On March 2, 2000, the Company acquired the net assets of Advanced Educational
Systems ("AES"), providers of secure e-Testing solutions and services to
organizations to support their internal certification and compliance procedures.
The consideration for AES in respect of the assets of AES comprises of 103,128
ADSs and $1.6 million in cash. The transaction was accounted for under the
purchase method of accounting in accordance with generally accepted accounting
principles. Goodwill of approximately $7.3 million was recorded as a result of
the acquisition of AES. Goodwill in respect of AES is being amortized on a
straight line basis over 10 years.
On April 10, 2000, the Company acquired Learning Productions LLC, a developer of
advanced, web-based role play business simulations. The consideration for the
outstanding securities of Learning Productions consists of 224,916 ADSs and $4.8
million in cash. The Company has accounted for the acquisition of Learning
Productions under the purchase method of accounting in accordance with generally
accepted accounting principles. Goodwill of approximately $16.4 million was
recorded as a result of the acquisition of Learning Productions. Goodwill in
respect of Learning Productions is being amortized on a straight line basis over
10 years.
Proforma Accounts
The following unaudited pro forma information combines the consolidated results
of operations of the Company with those of Learning Productions as if the
acquisition had occurred at the beginning of each period presented. These pro
forma results do not include the effect of non-recurring purchase accounting
adjustments. The pro forma results give effect to certain purchase accounting
adjustments, including additional amortization expense from goodwill, related
income tax effects and the issuance of additional shares in connection with the
acquisitions of Learning Productions and the net assets of AES.
Pro Forma Results of Operations
(unaudited, in thousands except per share amounts)
<TABLE>
<CAPTION>
Nine Months
Ended September 30
---------------------------------
1999 2000
-------- --------
<S> <C> <C>
Revenues $138,170 $111,383
Net loss $ 5,240 $(28,044)
Net loss per share $ 0.10 $ (0.55)
</TABLE>
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 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.
8
<PAGE>
PART I. FINANCIAL INFORMATION
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 1,400 SmartCourses, online SmartSeminars, 24x7
SmartMentoring, e-Simulations, e-Testing solutions and services, 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
have been 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.
We launched our e-Learning platform in the fourth quarter of 1999. With the
introduction of our e-Learning solutions, our business model is evolving 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.
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.
9
<PAGE>
The migration of new and existing customers to our e-Learning solutions has
resulted in the nine months ended September 30, 2000 and will continue to result
for the remainder of 2000 in the deferral of a significant portion of our
revenues from 2000 into 2001, and, accordingly, a decrease in reported revenues
in 2000 compared to 1999 as well as a decrease in reported revenues for each
quarter during 2000 as compared to that which would be expected under the
software license model. 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 revenue and operating expenses as a percentage of
revenues, will not necessarily be meaningful measures of our financial
performance during 2000. /1/
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 have significantly increased and anticipate that we
will continue to significantly increase (i) our research and development
expenses and capital expenditures to build out our e-Learning infrastructure and
(ii) our sales and marketing expenses to build the SmartForce brand and market
presence. As a result of the deferral of revenue under e-Learning agreements and
these incremental expenses, we have recorded a net loss in the nine months ended
September 30, 2000 and expect to record a net loss for quarter four of 2000.
These losses could continue beyond 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 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. Our actual future performance may differ materially from 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>
Recent Developments
Acquisitions
On March 2, 2000, we acquired the net 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. The consideration for AES comprises of 103,128 ADSs and
$1.6 million in cash. The transaction has been 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. The consideration for
the outstanding securities of Learning Productions consists of 224,916 ADSs and
$4.8 million in cash. We accounted 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 and from us. 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
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. Our actual future performance may differ materially from 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.
11
<PAGE>
Results of Operations
The following table sets forth certain consolidated statements of operations
data as a percentage of revenues:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------ ------------------
1999 2000 1999 2000
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues 100% 100% 100% 100%
Cost of revenues 14.8 16.4 15.5 16.3
---- ------ ---- ------
Gross Profit 85.2 83.6 84.5 83.7
Operating expenses:
Research and development 17.8 24.5 17.3 27.2
Sales and marketing 44.3 58.0 47.2 67.4
General and administrative 8.0 10.9 9.4 12.9
Amortization of acquired intangibles 3.1 5.1 1.2 5.7
Acquired research and development -- -- 4.3 --
---- ------ ---- ------
Total operating expenses 73.2 98.5 79.4 113.2
---- ------ ---- ------
Income (loss) from operations 12.0 (14.9) 5.1 (29.5)
Other income, net 2.4 2.4 1.7 3.0
---- ------ ---- ------
Income (loss) before provision for income 14.4 (12.5) 6.8 (26.5)
taxes
Provision (benefit) for income taxes 2.2 (0.7) 1.7 (2.1)
---- ------ ---- ------
Net income (loss) 12.2% (11.8)% 5.1% (24.4)%
==== ====== ===== ======
</TABLE>
Revenues and Backlog
Revenues decreased to $45.6 million in the three months ended September 30,
2000 from $50.2 million in the three months ended September 30, 1999, and
decreased to $110.5 million in the nine months ended September 30, 2000 from
$137.6 million in the nine months ended September 30, 1999.
The decrease in revenues was attributable to the rapid customer adoption in
the nine months ended September 30, 2000 of our e-Learning solutions, for which
revenue is generally recognized ratably over the term of the customer agreement
and deferred into future periods. Revenues for the nine months ended September
30, 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, we do not believe that the year over year
revenue comparison between the 1999 and 2000 periods is indicative of the growth
of our business during the nine months ended September 30, 2000.
Our backlog increased to $290 million at September 30, 2000 from $256
million at June 30, 2000, $222 million at March 31, 2000 and $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 primarily attributable to the rapid customer adoption of
SmartForce e-Learning.
Revenues in the United States for the three months and nine months ended
September 30, 2000 were $30.7 million (or 67% of revenues) and $72.6 million (or
66% of revenues), respectively, compared to $35.1 million (or 70% of revenues)
and $97.9 million (or 71% of revenues) for the three and nine month periods
ended September 30, 1999, respectively.
Revenues in the United Kingdom for the three months and nine months ended
September 30, 2000 were $6.4 million (or 14% of revenues) and $16.7 million (or
15% of revenues), respectively, compared to $7.4 million (or 15% of revenues)
and $19.0 million (or 14% of revenues) for the three and nine month periods
ended September 30, 1999, respectively. Revenues in Ireland for the three and
nine months ended September 30, 2000 were $0.6 million (or 2% of revenues) and
$2.2 million (or 2% of revenues) compared to $1.0 million (or 2% of revenues)
and $2.1 million (or 1% of revenues) for the nine months ended September 30,
1999.
In addition, revenues from outside the United States, United Kingdom and
Ireland (principally from Asia Pacific, Europe (other than the United Kingdom
and Ireland), Latin America, Canada, South Africa and the Middle East)
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in the three and nine months ended September 30, 2000 were $7.9 million (or 17%
of revenues) and $19.0 million (or 17% of revenues), compared to $6.7 million
(or 13% of revenues) and $18.6 million (or 14% of revenues) for the three and
nine months ended September 30, 1999.
The increase in international percentage revenue was due primarily to the
rapid adoption of e-Learning in the United States corporate market, resulting in
the deferral of a greater proportion of the United States revenue compared to
international revenue.
Cost of Revenues
Cost of revenues includes the cost of materials (such as 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% and 83.7%, respectively, in the three and
nine months ended September 30, 2000, from 85.2% and 84.5% in the three and nine
months ended September 30, 1999. The reductions in gross margins were primarily
due to the decrease in revenue in the three and nine months ended September 30,
2000 due to ratable revenue recognition of SmartForce e-Learning as a certain
portion of our cost of revenues are fixed, this reduces gross margins slightly.
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 revenue mix (between content, e-Learning
platform, services and partner's products) and the timing of expenses associated
with development and marketing alliances.
Operating Expenses
Our operating expenses increased in the three and nine months ended
September 30, 2000 as compared to the three and nine months ended September 30,
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 nine months ended September
30, 2000, resulted in the deferral of revenues into future periods and,
consequently a significant increase in operating expenses as a percentage of
revenues. Operating expenses for the three and nine months ended September 30,
2000 include amortization of intangibles acquired following the acquisition of
Knowledge Well in June 1999, AES in March 2000 and Learning Productions in April
2000. Operating expenses in the three and nine months ended September 30, 1999
included acquired research and development of $5.9 million. Accordingly, year
over year comparisons of operating expenses between the 1999 and the 2000
periods are not necessarily meaningful measures of our financial performance
during the three and nine months ended September 30, 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 and nine months
ended September 30, 2000 to $11.2 million and $30.0 million, respectively, from
$8.9 million and $23.9 million in the three and nine months ended September 30,
1999. The increase in research and development is primarily the result of
hiring additional research and development personnel, the expansion of our
Dublin development center and the continued investment in our e-Learning
solutions, all of which were required to develop our e-Learning offerings and to
develop the e-Learning infrastructure.
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/
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.
/3/ This paragraph consists of forward-looking statements reflecting our current
expectations. Our actual future performance may differ materially from 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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Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries and commissions,
advertising and promotional expenses and related overhead costs.
Sales and marketing expenses increased in the three and nine months ended
September 30, 2000 to $26.4 million and $74.4 million, respectively, from $22.2
million and $64.9 million for the three and nine months ended September 30,
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. We expect to continue to increase
sales and marketing expenses in the future to build the SmartForce brand, to
support an increase in our sales force and the 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 increased in the three and nine months
ended September 30, 2000 to $5.0 million and $14.3 million, respectively,
compared to $4.0 million and $13.0 million for the three and nine months ended
September 30, 1999. We anticipate 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 and nine months ended
September 30, 2000 was $2.3 million and $6.3 million, respectively, compared to
$1.6 million and $1.7 million for the three and nine months ended September 30,
1999. Acquired intangibles being amortized include identifiable intangible
assets of $35.5 million and goodwill of $47.6 million, which were recorded on
the acquisitions of Knowledge Well in June 1999, Dunloe in July 1999, AES in
March 2000 and Learning Productions in April 2000.
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 and $3.3 million in the
three and nine months ended September 30, 2000, respectively, as compared to
other income, net, of $1.2 million and $2.4 million in the three and nine months
ended September 30, 1999. Other income for both periods was primarily interest
on short term investments. Included in other income, net, was net exchange
losses of $0.5 million and $1.0 million for the three and nine months ended
September 30, 2000, compared to a net exchange gain of $0.2 million for the
three months ended September 30, 1999 and a net exchange loss of $0.5 million
for the nine months ended September 30, 1999. The net exchange losses incurred
were primarily attributable to the weakening of the Euro and pound Sterling
against the U.S. Dollar. The increase in other income for the three and nine
months ended September 30, 2000, as compared to the three and nine months ended
September 30, 1999 is primarily attributable to greater interest income from
higher average cash and short term investment balances as well as higher
interest rates.
/4/ This paragraph consists of forward-looking statements reflecting our current
expectations. Our actual future performance may differ materially from 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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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 and nine months ended September 30, 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
September 30, 2000 of $10.5 million, $7.2 million, $5.1 million and $4.5
million, respectively.
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, asset and investment disposals and write downs.
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.
We recorded a tax benefit, at an effective tax rate of 10%, before
amortization of acquired intangibles, in the three and nine months ended
September 30, 2000, 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 September 30, 2000 were $101.4 million
compared to $108.2 million at December 31, 1999. Working capital was $109.5
million as of September 30, 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 net cash used in investing activities.
Cash flows from operating activities. Net cash provided by operating activities
was $1.2 million for the nine months ended September 30, 2000 compared to net
cash provided by operating activities of $3.9 million for the nine months ended
September 30, 1999. During the three months ended September 30, 2000, we
generated $3.2 million from operating activities.
Despite a net loss of $27.0 million for the nine months ended September 30,
2000, as compared to a net income of $7.1 million for the nine months ended
September 30, 1999, cash flows provided by operations for the nine months ended
September 30, 2000 decreased by $2.7 million from cash flows provided by
operations for the nine months ended September 30, 1999. This resulted
primarily from an increase in depreciation and amortization, an increase in
deferred
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revenues and a decrease in accrued payroll, related expenses and other accrued
liabilities from December 31, 1999 to September 30, 2000.
Cash flows from investing activities. Net cash used by investing activities was
$21.2 million in the nine months ended September 30, 2000 compared to net cash
used by investing activities of $9.9 million for the nine months ended September
30, 1999. The increase in cash outflow from investing was primarily due to
payments, net of cash acquired, on the acquisition of Learning Productions and
AES, a minority equity investment in Capella Education and Docent, and increased
capital expenditure required to continue to build our e-Learning infrastructure
and to support our expanding operations. We expect to make significant
investments in 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
was $10.2 million for the nine months ended September 30, 2000 and 1999. Cash
provided by financing activities arose from the exercise of employee stock
options.
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
twelve months. /5/ 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 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.
/5/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.
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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 revenue mix between content, e-Learning platform, services and
partner's products
. 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 Web site,
to host, operate and manage our 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 2001, 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 and market presence. 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 sales and marketing expenses
significantly to build the SmartForce brand and market presence. As a result of
the deferral of revenue under e-Learning agreements and these incremental
expenses, we expect to record a net loss for quarter four of the year 2000.
These losses could continue beyond that time.
Our operating results are subject to seasonal fluctuations which may adversely
impact our business.
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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 events 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 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
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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 March 2000 we acquired the net assets of AES, providers of e-Testing
solutions and services, and in April 2000 we acquired Learning Productions, a
developer of web-based role play business simulations. 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.
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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 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 primarily 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 e-Learning 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 recognition, 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.
Our business is subject to currency fluctuations that can adversely affect our
operating results.
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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 other
currencies relative to the U.S. dollar 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.
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
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<PAGE>
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.
The market price of our 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,
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.
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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
September 30, 2000.
Table of Investment Securities:
<TABLE>
<CAPTION>
Average
Principal Interest
Amount Rate
September 30, 2000 -------------- -------------
(Dollars in thousands)
<S> <C> <C>
Cash and cash equivalents........................................ $ 59,532 6.1%
Short term investments........................................... 41,903 6.5%
--------
Total cash and investment securities............................. $101,435
========
</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 nine months ended September 30, 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
our results of operations cannot be accurately predicted.
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Our outstanding foreign currency forward exchange contracts at September
30, 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 $ 9,500,000 December 31, 2000 1.1692
Irish pounds $ 8,000,000 March 31, 2001 1.1334
Irish pounds $ 7,000,000 June 30, 2001 1.1695
Irish pounds $ 7,000,000 September 30, 2001 1.2112
Irish pounds $ 8,000,000 December 31, 2001 1.1707
Irish pounds $10,000,000 March 31, 2002 1.0722
Irish pounds $ 5,000,000 June 30, 2002 1.0757
</TABLE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Since the end of the third quarter of 1998, purported class action lawsuits were
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 the
Company, CBT USA and certain of the Company's former and current officers and
directors alleging violation of the federal securities laws. The complaints
allege that the defendants misrepresented and/or omitted to state material facts
regarding the Company's business and financial condition and prospects during
the class periods in order to artificially inflate and maintain the price of the
Company's ADSs, and misrepresented and/or omitted to state material facts in the
registration statement and prospectus issued in connection with the merger with
ForeFront, artificially inflating the price of the Company's ADSs.
The Company believes that these actions are without merit and intends to
vigorously defend itself against these claims. Although the outcome of these
actions cannot presently be determined, an adverse resolution of these matters
could have a material adverse effect on the Company's 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 present and former
officers and directors of the Company alleging that these persons violated
various duties to the Company. The derivative complaint also names the Company
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 the Company's Board of Directors or shareholders
concerning the allegations of the derivative complaint. The parties reached a
settlement of the derivative litigation, involving the implementation of certain
policies and procedures by the company and the payment of attorneys' fees to
plaintiff's counsel. The settlement did not have a material adverse effect on
the Company's financial position or on its financial results of operations. On
July 31, 2000, the San Mateo County Superior Court dismissed the derivative
action with prejudice.
On June 17, 1999, Datatask Pty, Ltd ("Datatask") and Interskill Services, Inc.
("Interskill") filed a complaint against the Company in the Superior Court of
the State of Delaware. Datatask and Interskill alleged breach of contract and
breach of implied covenant of good faith and fair dealing by the Company under
the terms of a distribution agreement. Datatask and Interskill alleged that they
suffered financial harm of approximately $5 million as a result of such
purported breach. In October 2000, the parties reached a settlement. This
settlement did not have a material adverse effect on the Company's financial
position or on its financial results of operations.
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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 a report on Form 8-K during the three months ended
September 30, 2000.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SmartForce PLC
Date: November 14, 2000 By: /s/ Gregory M. Priest
---------------------
Gregory M. Priest
President and Chief Executive Officer
Date: November 14, 2000 By: /s/ David C. Drummond
---------------------
David C. Drummond
Executive Vice President of Finance and
Chief Financial Officer
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