Item 7. |
Management’s Discussion And Analysis Of Financial Condition And Results Of
Operations
The following discussion analyzes the changes in the Company’s
results of operations during the three years in the period ended December 31, 2003
and comments on the Company’s financial position as of December 31, 2003.
CRITICAL
ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America. As such, some accounting
policies have a significant impact on the amounts reported in these financial statements.
The preparation of our financial statements requires us to make estimates and assumptions
that affect the reported amount of assets and liabilities, the level of contingent assets
and liabilities disclosed at the date of our financial statements, and the reported
amounts of revenue and expenses during the reporting period. There can be no assurance
that actual results will not differ from those estimates. We believe our most critical
accounting policies include software revenue recognition, stock-based compensation,
capitalization and amortization of software development costs, and goodwill and other
intangible assets as explained below.
SOFTWARE
REVENUE RECOGNITION
Substantially
all of the Company’s software sales are made under contracts that call for only the
delivery of software with no significant additional obligations. Revenue is recognized at
the time of delivery, provided that there is a signed purchase order, delivery of the
product has taken place, the fee is fixed by the contract and collection is considered
probable.
STOCK-BASED
COMPENSATION
We account for our employee stock-based compensation plans in accordance with APB Opinion No.
25 (APB No. 25), Accounting for Stock Issued to Employees, and Financial Accounting
Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving
Stock Compensation — an Interpretation of APB Opinion No. 25, and the disclosure
provisions of SFAS No. 148, Accounting for Stock-Based Compensation – Transition
and Disclosure.
Accordingly,
no compensation cost is recognized for our stock options granted to employees when the
exercise price of the option equals or exceeds the fair value of the underlying common
stock as of the grant date for the stock option.
Page 11
PROPRIETARY
SOFTWARE IN DEVELOPMENT
In accordance with Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, we have
capitalized certain computer software development costs upon the establishment of
technological feasibility. Technological feasibility is considered to have occurred upon
completion of a detailed program design that has been confirmed by documenting and tracing
the detailed program design to product specifications and has been reviewed for high-risk
development issues, or to the extent a detailed program design is not pursued, upon
completion of a working model that has been confirmed by testing to be consistent with the
product design. Amortization is provided based on the greater of the ratio that current
gross revenue for a product for the period involved bears to the total of current and
anticipated future gross revenues for the product or the straight-line method over an
estimated four-year useful life of the product. Future events such as market conditions,
customer demand, or technological obsolescence could cause us to conclude that the
carrying value of the software at a given point in time is impaired, and the amount of the
impairment so determined would be required to be written off against the carrying value of
the asset and charged as an expense against operations at the time such determination is
made.
GOODWILL
AND OTHER INTANGIBLE ASSETS
On
January 1, 2002 we adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Intangible Assets (SFAS 142). SFAS 142 eliminates the
amortization of goodwill and instead requires that goodwill be tested for impairment at
least annually. Intangible assets deemed to have indefinite life under SFAS 142, such as
goodwill, are no longer amortized, but instead reviewed at least annually for impairment.
Prior to the adoption of SFAS 142, goodwill amortization amounted to $209,612 in 2001.
Intangible assets with finite lives are amortized over their useful lives. As part of the
implementation of SFAS 142, we were required to complete a transitional impairment test of
goodwill and other intangible assets. The fair value of the Company’s only operating
business unit was estimated by obtaining an independent business valuation. There was no
impairment of goodwill upon the adoption of SFAS 142. Prospectively, we will test our
goodwill and intangible assets for impairment not less frequently than as a part of our
annual business planning cycle during the fourth quarter of each year. Future events such
as market conditions or operational performance could cause us to conclude that impairment
exists. Any resulting impairment loss would be written off against the carrying value of
the asset and charged as an expense against operations at the time such determination is
made and could have a material adverse impact on our financial condition and results of
operations.
Page 12
IMPACT
OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities (FIN 46R), which addresses how a
business enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and accordingly should consolidate the
entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, which was issued in January 2003. The Company will be required to apply FIN
46R to variable interests in VIEs created after December 31, 2003. For variable interests
in VIEs created before January 1, 2004, the Interpretation will be applied beginning on
January 1, 2005. For any VIEs that must be consolidated under FIN 46R and that were
created before January 1, 2004, the assets, liabilities and noncontrolling interests of
the VIE initially would be measured at their carrying amounts with any difference between
the net amount added to the balance sheet and any previously recognized interest being
recognized as the cumulative effect of an accounting change. If determining the carrying
amounts is not practicable, fair value at the date FIN 46R first applies may be used to
measure the assets, liabilities and noncontrolling interest of the VIE. The Company does
not have any variable interest entities, and therefore expects no impact of the adoption
of FIN 46R.
In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities (SFAS 149), which amends and clarifies
accounting for derivative instruments, including certain derivative instruments embedded
in other contracts, and for hedging activities under SFAS 133. The Statement is effective
(with certain exceptions) for contracts entered into or modified after June 30, 2003. The
Company does not own any derivative instruments or participate in any hedging activities,
and therefore experienced no impact of the adoption of SFAS 149.
FASB
Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity (FAS 150), was issued in May 2003. This Statement
establishes standards for the classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. The Statement also
includes required disclosures for financial instruments within its scope. For the Company,
the Statement was effective for instruments entered into or modified after May 31, 2003
and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable
financial instruments. For certain mandatorily redeemable financial instruments, the
Statement will be effective for the Company on January 1, 2005. The effective date has
been deferred indefinitely for certain other types of mandatorily redeemable financial
instruments. The Company currently does not have any financial instruments that are within
the scope of this Statement, and therefore experienced no impact of the adoption of SFAS
150.
Page 13
Results
of Operations
2003
In Comparison With 2002
For
the year ended December 31, 2003 the Company’s consolidated revenues decreased 1.7%
to $8.8 million from $8.9 million recorded in 2002. This decrease was the result of the
third consecutive year of difficult funding for K-12 schools, due primarily to cutbacks in
states’ budgets.
Sales
of the Company’s single title products, GAMCO and Teacher Support Software, continued
to decline in 2003, reflecting an industry-wide trend toward more comprehensive solutions
that began in 2000. In addition, the Company experienced lower sales to families through a
distributor specializing in direct home sales.
Sales
of the Company’s flagship Orchard product to schools increased 9% in 2003 compared to
2002, primarily as a result of an increase in sales generated by the Company’s direct
sales force in territories not covered by the Company’s network of resellers.
Additionally, Educational Activities Software, acquired in January 2001, generated an
increase in sales of 7% compared to 2002.
The
Company did not receive any revenue from the Company’s coal properties in 2003
compared with revenues of $30,000 in 2002. During 2003, the Company, by mutual agreement
with the lessee of the properties who mined the coal, terminated the lease.
The
cost of products sold increased $68,314 to $2.0 million in 2003. This increase reflected
higher amortization of development expenses and higher royalty advances totaling $223,264.
These increases were partially offset by lower material costs of $154,950.
Selling,
general and administrative expenses increased to $6.0 million in 2003, or 5%, from $5.7
million in 2002, due primarily to increased expenses for salaries, professional fees and
general marketing expenses.
As a result of the above factors, income from operations declined 42% to $699,509 in 2003
from $1,204,015 in 2002.
Net interest expense decreased 58% to $19,432 in 2003 from $46,706 in 2002, as the Company
continued to pay down acquisition-related debt.
Income
tax expense decreased to $234,075 in 2003, a reduction of $219,325 from $453,400 in 2002
primarily as a result of the decrease in pretax income.
As
a result of the above factors, the net income for the year ended December 31, 2003 was
$451,035 compared to net income for 2002 of $706,081, representing a decrease of 36%.
Earnings per share decreased to $0.03 per share from $0.04 per share.
2002
In Comparison With 2001
For
the year ended December 31, 2002 the Company’s consolidated revenues increased 8% to
$8.9 million from $8.2 million recorded in 2001. This increase was accomplished in another
difficult funding year for K-12 schools. |