The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this document. Results for interim periods are not necessarily indicative of results for the full year. Statements in this report that relate to future results and events are based on our current expectations. Actual results in future periods may differ materially from those currently expected or desired because of a number of risks and uncertainties, including those discussed under "Additional Factors That May Affect Results of Operations and Market Price of Stock" on Page 12.

Overview

ProsoftTraining is a leading provider of information and communications technology ("ICT") curriculum and certifications, which helps individuals develop, upgrade and validate critical ICT skills. We sell and license our content and certifications to academic institutions, commercial training centers, internal corporate training departments and individuals around the world.

Development of Business

ProsoftTraining was founded in 1995 as a proprietorship that delivered training in vocational and advanced technical subjects. After completing a private placement of stock in March 1997, the Company embarked on a strategy to build a nationwide network of learning centers to teach technical skills for the emerging Internet market. Fixed costs associated with the "bricks-and-mortar" network significantly outpaced revenues. In fiscal year 1999, the Company closed the learning center network and focused exclusively on selling its content and educational services to the technology training industry and building its propriety certification programs. The demand for instruction services declined sharply from fiscal year 2000 to fiscal year 2002. At the end of fiscal year 2002, the Company reduced its full-time instructor base to zero and effectively exited the services business. The Company has refocused its business on offering job-role certifications and proprietary content solutions to academic institutions and adult education providers.

The discussion below represents our historical results only.

Results of Operations

Revenues

Total revenues were $1.86 million in the three months ended October 31, 2004, compared with $2.33 million in the three months ended October 31, 2003, a decrease of 20 percent. Content revenues decreased by $0.25 million, or 14 percent, to $1.48 million for the three months ended October 31, 2004, compared with $1.73 million for the three months ended October 31, 2003. Certification revenues decreased by $0.23 million, or 37 percent, to $0.38 million for the three months ended October 31, 2004, compared with $0.60 million for the three months ended October 31, 2003. The decline in content revenues for the current quarter was driven by continued weakness in corporate training budgets and the subsequent reduced purchases of our courseware products by our learning center customers. Certification revenues consist of CIW, CTP and CCNT certification exam fees and annual fees received from CIW and CTP Authorized Training Providers ("ATP"). The certification revenue decline for the current quarter was related to the continued weakness in the Internet skills training sector, resulting in lower demand for our CIW products.

Costs of Revenues

Costs of revenues decreased by $0.25 million, or 31 percent, in the three months ended October 31, 2003, as compared with the year-ago quarter. This decrease in costs of revenues was primarily the result of lower revenues. Gross profit as a percentage of revenue increased to 71 percent in the three months ended October 31, 2004, up from 66 percent for the three months ended October 31, 2003. The increase in gross profit as a percentage of revenue was primarily due to operating cost reductions and efficiency gains.

Content Development

Content development expenses increased by $0.03 million, or 18 percent, in the three months ended October 31, 2004, as compared with the year-ago quarter. The increase in content development expenses was attributable to the development of new products including the introduction of a major revision to our CIW product line.

Sales and Marketing

Sales and marketing expenses decreased by $0.07 million, or 11 percent, to $0.55 million for the three months ended October 31, 2004, compared with $0.62 million for the three months ended October 31, 2003. The decrease was attributable to lower sales commissions and personnel. As a percentage of revenue, sales and marketing expenses increased by three percentage points in the three months ended October 31, 2004, as compared with the three months ended October 31, 2003.

General and Administrative

General and administrative expenses increased by $0.07 million for the three months ended October 31, 2004, as compared with the year-ago quarter. The increase in general and administrative expenses was attributable to non-recurring legal fees and professional services expenses related to the abandoned merger with Trinity Learning Corporation in July 2004.

Depreciation and Amortization

Depreciation and amortization expenses decreased by $0.02 million, or 17 percent, in the three months ended October 31, 2004, as compared with the year-ago quarter. The decrease was primarily attributable to the closing of the Santa Ana, California and Eden Prairie, Minnesota offices.

Gain on the Settlement of Liability

The gain on the settlement of liability for $0.10 million resulted from the settlement of a liability of $0.18 million for $0.08 million.

Interest Income and Interest Expense

Interest expense was $0.17 million for the three months ended October 31, 2004, compared with $0.08 for the three months ended October 31, 2003, an increase of $0.09 million. The increase in interest expense during the three months ended October 31, 2004 is attributable to the issuance on August 30, 2004 of $1.35 million in Secured 8% Convertible Notes. Interest expense recorded in the three months ended October 31, 2004 in connection with this note totaled $0.09, and included the contractual interest component as well as the amortization of deferred financing costs and debt discount.

Liquidity and Capital Resources

The Company's primary need for liquidity relates to funding its operations and financing its working capital needs. At October 31, 2004, the Company had $1.28 million of cash.

Cash used in operating activities was $0.41 million in the three months ended October 31, 2004, compared with $0.05 million for the three months ended October 31, 2003, an increase of $0.36 million. The increase in cash used in operating activities was the result of an increased net loss adjusted for non-cash items of $0.25 million, and by a $0.11 net increase in changes in operating assets and liabilities.

There was no cash used in investing activities for the three months ended October 31, 2004, compared with $0.02 million in the same year-ago period. Cash used in investing activities for the three months ended October 31, 2003 was related to the purchase of property and equipment.

Cash provided by (used in) financing activities was $1.17 million and $(0.02) million in the three months ended October 31, 2004 and 2003, respectively. The change in cash provided by financing activities was due to the issuance on August 30, 2004 of $1.35 million of Secured 8% Convertible Notes, due August 30, 2006, to institutional investors. We received net proceeds of $1.18 million. The Notes are secured by all of the assets of the Company, subject to an intercreditor agreement with the Company's existing secured creditor, and require interest payments semi-annually on February 28 and August 30, in cash or, at the Company option, in shares of its Common Stock or in the form of additional one-year notes accruing interest at the rate of 10% per annum. The Notes are convertible into common stock of the Company at $0.28 per share. In connection with this financing, the Company also issued to the investors (i) warrants to purchase up to 1,205,358 shares of the Company's Common Stock, exercisable at $0.38 per share and expiring in March 2010, and (ii) warrants to purchase up to 3,857,143 shares, exercisable at $0.35 per share and generally expiring in February 2006. The portion of the proceeds allocated to the warrants issued in connection with the debt totaled $0.56 million.

The following summarizes our contractual cash obligations as of October 31, 2004, (in millions):

                                               Payments Due for the Twelve Month
                                                   Periods Ending October 31,
                                          --------------------------------------------
                                            2005         2006         2007      Total
                                          ---------    ---------    ---------   ------
     Long term debt                       $      -     $    5.38    $      -    $ 5.38
     Operating leases                          0.33         0.18         0.08     0.59
                                          -- ------    -- ------    -- ------   - ----
     Total contractual cash obligations   $    0.33    $    5.56    $    0.08   $ 5.97
                                          -- ------    -- ------    -- ------   - ----

The long-term debt identified as due in year 2006 in the preceding table represents principal and capitalized interest to date on the Subordinated Secured Convertible Note of $4.03 million and principal on the Secured 8% Convertible Notes of $1.35 million. Accordingly, given the potentially significant cash requirements to meet this debt repayment schedule during the first fiscal quarter of our fiscal year 2007, the Company may need to seek additional capital to refinance these note issues in fiscal 2007 if they have not been converted into common stock prior to that time.

A term of the Subordinated Secured Convertible Note and the Secured 8% Convertible Notes requires that the Company maintain the listing and trading of its common stock on either the Nasdaq National Market or the Nasdaq SmallCap Market. If the Company is unable to maintain its listing on Nasdaq, the Company will be in default on the listing requirement covenant in the note agreements. Such a default provides the holders of the notes with the ability to require immediate repayment of the principal and interest then owed under the notes.

The Company's stock has remained listed on the Nasdaq SmallCap Market subject to a grace period granted by Nasdaq through December 20, 2004, as a result of the Company's failure to meet the $1.00 minimum bid price listing maintenance requirement of the exchange. To remain listed past that date, the bid price of the Company's stock must be at least $1.00 for 10 consecutive trading days prior to that date. At its next annual meeting of stockholders to be held on January 7, 2005, the Company will seek stockholder approval of a share consolidation in an attempt to meet the Nasdaq minimum bid price requirement, if necessary. If the Company's stock is delisted from Nasdaq, if the notes have not been converted to common stock, and if as a result of a delisting the lenders should choose to accelerate the repayment of their notes, the Company may be unable to repay the principal and interest owed.

We believe, based on current activity and expectations, including maintaining our listing on Nasdaq, that cash on hand will be sufficient to meet our cash requirements for at least the next twelve months. If future financing is required, we will seek to arrange a financing to meet our requirements with the timing, amount and form of issue depending on the prevailing market and general economic conditions.

Critical Accounting Policies

Our critical accounting policies are as follows:

Revenue recognition

The Company derives revenue from two primary sources: content and certification.

Content revenue includes fees received from the sale of course materials such as books, CD-ROM's, Web-based course books, assessment products and content licenses. We recognize content revenue from the sale of course books and other products when they are shipped. Content licenses are either purchased on a fee-per-use basis or for a one-time fee. Revenue is recognized over the period in which we have a commitment for continuing involvement or obligation to provide services to the customer. In most cases no such commitment exists, and revenue is recognized when content is shipped.

Certification revenue includes fees paid by certification candidates to take our certification tests and annual fees received from our education partners, including CIW ATP's. We recognize certification revenue when certification tests are administered, and partner fees over the period during which we have a commitment for continuing involvement or obligation to provide services to the partner.

Valuation of intangible and long-lived assets

We assess the impairment of identifiable intangibles, long-lived assets and related goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review include the following:

• Significant underperformance relative to expected historical or projected future operating results;

• Significant changes in the manner of our use of the acquired assets or strategy for our overall business;

• Significant negative industry or economic trends; and

• Our market capitalization and other market value indicators relative to net book value.

When it is determined that the carrying value of intangibles and long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, the measurement of any impairment is determined and the carrying value is reduced as appropriate. Goodwill is tested for impairment at least annually in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets.

Additional Factors that May Affect Results of Operations and Market Price of Stock

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve a number of risks and uncertainties. Without limiting the foregoing, the words "believes", "anticipates", "plans", "expects" and similar expressions are intended to identify forward-looking statements. In addition, forward-looking statements include, but are not limited to, statements regarding future financing needs, changes in business strategy, competitive advantage, market growth, future profitability, and factors affecting liquidity. Although we believe that these statements are reasonable in view of the facts available to us, no assurance can be given that all of these statements will prove to be accurate. Numerous factors could have a material effect upon whether these projections could be realized or whether these trends will continue. Among these factors are those set forth in the following section, as well as those discussed elsewhere in this Form 10-Q and those discussed in our Annual Report on Form 10-K for the year ended July 31, 2004 on file with the SEC and subsequent reports on Forms 10-Q and 8-K. We undertake no obligation to update this forward-looking information.

We have limited cash resources and may need to raise additional funds.

We are operating with limited cash resources. Based on our current activity and expectations, including maintaining our listing on Nasdaq, we believe we have sufficient cash resources for at least the next twelve months of operations. However, a moderate change to our revenue-generating capability or expense structure could result in increased operating losses. Increased operating losses would erode our liquidity by further reducing cash resources and could result in the need to raise additional funds.

In the first quarter of fiscal year 2007 both the Subordinated Secured Convertible Note and the Secured 8% Convertible Notes will mature and all outstanding principal and capitalized interest thereupon will become due and payable. Although these securities are convertible into common stock by their holders prior to their maturity dates, the Company may need to seek capital to refinance these debt instruments.

Given our relatively small size and historical operating results, our access to capital is limited. Should we need to raise additional funds, it cannot be certain that we will be able to obtain them on terms satisfactory to us. If we could not raise additional funds on terms satisfactory to us, we would be forced to raise funds on terms that we would not otherwise accept, seek funds through other means such as a sale of some or all of our assets or operations, or otherwise significantly alter our operating plan, any of which could have a material adverse effect on our business, financial condition, and results of operations.

Our common stock could be delisted from the Nasdaq Stock Market.

On June 23, 2004, we received notice from Nasdaq that for 30 consecutive business days our common stock had closed below the minimum $1.00 per share requirement for continued listing on the Nasdaq SmallCap Market, and were provided a grace period through December 20, 2004, to regain compliance with the requirement. In order to remain on the Nasdaq SmallCap Market, we will need to satisfy the $1.00 bid price requirement by having a closing bid price of our common stock of at least $1.00 for a minimum of ten consecutive business days. If we do not comply by December 20, 2004, Nasdaq has indicated it will provide written notification that we did not regain compliance. According to Nasdaq rules, the Company would then be afforded an opportunity to request a hearing at which it could present a plan of compliance. At its next annual meeting of stockholders, to be held on January 7, 2005, the Company will seek stockholder approval of a share consolidation in an attempt to meet the Nasdaq minimum bid price requirement, if necessary.

If we do not cure our minimum bid price deficiency, and if Nasdaq delists our common stock, then the common stock may be traded on the OTC Bulletin Board or the "pink sheets". Many institutional and other investors refuse to invest in stocks that are traded at levels below the Nasdaq Markets, which could reduce the trading liquidity in our common stock or make our effort to raise capital more difficult. OTC Bulletin Board and "pink sheets" stocks are often lightly traded or not traded at all on any given day. Any reduction in trading liquidity or active interest on the part of our investors could have adverse consequences on our stockholders, either because of reduced market prices or lack of a regular, active trading market for our common stock.

If our common stock is delisted from the Nasdaq Stock Market, payment of our secured debt could be accelerated.

A term of the Secured Convertible Note and the Secured 8% Convertible Notes requires that the Company maintain the listing and trading of its common stock on the Nasdaq SmallCap Market. If we do not cure our minimum bid price deficiency, and if Nasdaq delists our common stock, we will be in default on the listing requirement covenant in the note agreements. Such a default provides the holders of the notes with the ability to require immediate repayment of the principal and interest then owed under the notes. If the Company's stock is delisted, and if as a result of that delisting the lenders should choose to accelerate the repayment of their notes, the Company may be unable to repay the principal and interest owed and would be forced to seek alternative financing at that time. Although the Company intends to cure its minimum price deficiency by effecting a share consolidation which must be approved by its stockholders, and has proposed a share consolidation to its stockholders, no assurances can be given that it will be successful in that regard. As a result, the Company's audited financial statements for the year ended July 31, 2004 contain a going concern qualification from the Company's auditors.

We have incurred significant losses to date and may continue to incur losses in the future.

We have incurred losses of approximately $101 million from our inception in 1995 through October 31, 2004. Our ability to generate revenue growth in the future is subject to uncertainty. There can be no assurance that we will be able to increase revenues, manage expenses or maintain profitability. Should revenue decrease in the future, we may not be able to stem losses thereafter through expense reductions, given the magnitude of the reductions already implemented.

Our industry is intensely competitive and we may lose market share to companies developing similar services and products and to larger competitors with greater resources.

We face substantial competition in the education and training market. Competition in the ICT training market is intense and is affected by the rapidly evolving nature of the information technology industry. A number of other companies offer products and services similar to ours, and additional new competitors may emerge in the future. Many of our existing competitors have substantially greater capital resources, technical expertise, marketing experience, research and development status, established customers and facilities than do we. As a result, there is a risk that we will not be able to successfully compete with existing and future competitors, which would adversely affect our financial performance.

In our industry, technology advances rapidly and industry standards change frequently. To remain competitive and improve profitability, we must continually enhance our existing products and promptly introduce new products, services, and technologies to meet the changing demands of our customers. Our failure to respond to technological changes quickly would adversely affect our financial performance.

Demand for our products is susceptible to adverse economic conditions and educational funding constraints.

Our business and financial performance is influenced by adverse financial conditions affecting our target customers and by general weakness in the economy. In the short run, many corporations may not view ICT skills training as critical to the success of their businesses. When these companies experience poor operating results, whether as a result of adverse economic conditions, competitive issues or other factors, they may decrease or delay spending on training and education. In addition, most of our academic customers are reliant on the availability of funding to pursue their existing educational programs and new initiatives. If educational funding is limited, whether as a result of overall economic conditions, budgetary constraints, the political environment or other factors, these institutions may delay or forego spending for our content and certification products.

Shares that may be sold could result in a market overhang that depresses our stock price.

The potential for future sales of our common stock could depress the market price of our common stock. In addition, the perception that such sales will occur could also adversely affect the price. As long as certain registration statements that have been filed with the SEC remain effective, the selling stockholders under those registration statements may sell approximately 19.9 million shares, or approximately 46% of the shares of common stock outstanding (assuming the issuance of all shares covered by those registration statements). These shares were privately issued and many shares are otherwise subject to restrictions on resale under securities laws. Any such sales, or even the market perception that such sales could be made, may depress the price of the common stock.

Our common stock may experience extreme price and volume fluctuations.

Our common stock has experienced substantial price and volume volatility, which may continue in the future. Additionally, the stock market from time to time experiences significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These broad market fluctuations may also adversely affect the market price of our common stock. In addition to such broad market fluctuations, factors such as, but not limited to, the following may have a significant effect on the market price of our common stock:

• The delisting of our common stock from the Nasdaq SmallCap Market;

• Fluctuations in our operating results, including those caused by our lengthy sales cycle and seasonal effects on our business;

• The perception by others of our ability to obtain any necessary new financing;

• A limited trading market for our common stock; and

• Public announcements concerning our competitors, our industry or us.