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SPRO > SEC Filings for SPRO > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for SMARTPROS LTD.


7-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report. Some of the statements in this discussion and elsewhere in this report constitute forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934. See "Forward-Looking Statements" following the Table of Contents of this report. Because this discussion involves risk and uncertainties, our actual results may differ materially from those anticipated in these forward-looking statements.
The terms "we," "our," "us," or any derivative thereof, as used in this report refer to SmartPros Ltd., a Delaware corporation, its subsidiaries and its predecessors.

Overview
We provide learning solutions for accounting/finance, legal, insurance, securities and engineering professionals - five large vertical markets with mandatory continuing education requirements - as well as for tax compliance, banking and information technology professionals. We provide corporate governance, ethics and compliance training for the general corporate market. We also have content consisting of web-based training in the human resources and health and safety areas. We offer off-the-shelf courses and custom-designed programs with delivery methods suited to the specific needs of our clients. Through Loscalzo Associates Ltd. ("Loscalzo"), one of our wholly-owned subsidiaries, and our Executive Enterprise Institute ("EEI") product line within our Accounting division, we are a leading provider of live training to accountants, tax and financial professionals. These courses are delivered through various state CPA societies, accounting firms, corporations or through seminars, Webinars and conferences that they conduct. Our customers include professional firms of all sizes, and a large number of businesses.
We measure our operations using both financial and other metrics. The financial metrics include revenues, gross margins, operating expenses and income from continuing operations. Other key metrics include (i) revenues by sales source,
(ii) online sales, (iii) cash flows and (iv) EBITDA. Some of the most significant issues affecting our business are the following:
the increasing recognition by professionals and their employers of the importance of continuing professional education in order to maintain their licenses, remain current on new developments and best practices, develop and improve their skills and to generally remain competitive;

          continuing professional education requirements by governing bodies,
           including states and professional associations;


          the issuance of new laws, case law and regulations affecting the
           conduct of business and the relationship between employers and their
           employees;


          the lack of the issuance of new financial accounting standards and the
           continued delay in the United States to converge with International
           Financial Reporting Standards;


          the increased competition in today's economy for skilled employees and
           the recognition that effective training can be used to recruit, train
           and redeploy employees; and


          the development and acceptance of the Internet as a delivery channel
           for the types of products and services we offer.

Over the last five years, our annual net revenues have ranged from $15.9 million to $18.3 million. We experienced an overall decline in revenues from 2009 through 2012. We attribute this decline to a number of factors, but primarily due to general economic conditions as well as the relative absence of changes in laws, regulations and accounting standards. Many companies have looked at their budgets, reduced their headcounts and considered other factors in evaluating their expenditures for continuing education for their employees. Although, we have made acquisitions of companies, assets and product lines that have enhanced our overall content and product offerings, the staggering effects of the economy have resulted in lowered attendance at our live seminars, pricing pressure on our subscription-based products and reduced interest in custom work. We have countered these pressures by introducing new products, re-mixing our product offerings and changing our selling


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strategies. We continue to believe that our growth will be through acquisitions, the development of new products and cross selling our existing libraries to the various markets we serve.
While our subscription-based revenue in general has not fluctuated much from quarter to quarter or year to year, we have experienced a decline in revenue from live training programs and from custom-designed projects, which has adversely impacted our operating results. We believe that this trend is primarily due to current economic conditions, competition, consolidations in various industries and the relative absence of new accounting standards, laws and regulations. However, we believe that our subscription based products provide a cost-effective means for many companies to provide continuing education for their employees. We are constantly seeking both new markets and new ways to market our products. As we expand our product offerings and the content of our various libraries, we are able to offer more products to the same customer through cross-selling. We also recognize that we will most likely need to invest more money in our sales infrastructure and outbound marketing budgets to drive net revenue.
Business acquisitions or strategic asset purchases are our preferred strategy to increase the breadth and depth of our current product offerings. Unless there are other compelling reasons, we will only consider acquisitions that we believe will be accretive within the first year of ownership. Ultimately, however, our goal is to maximize shareholder value rather than short-term profits. The size of the acquisitions will be determined, in part, by the amount of capital available to us and the liquidity and price of our stock. We may use debt to enhance or augment our ability to consummate larger transactions. We cannot assure that we will be able to identify appropriate acquisition opportunities or negotiate reasonable terms or that any acquired business or assets will deliver the shareholder value that we anticipated at the outset.
With the launch of our SmartPros eCampus (eCampus) Learning Management System (LMS), a robust platform and toolset for managing and deploying corporate training and accredited continuing education programs in multiple formats, we anticipate that this product will help drive opportunities with both existing and new clients. It can also be licensed as a stand-alone-offering to companies of all sizes who are looking for a cost-effective cloud based LMS. In addition, we are developing technology so that our content may be used on iPads, tablets and other similar devices.
There are many risks involved with acquisitions, some of which are discussed in Item 1 of Part 1 under the caption "Certain Risk Factors That May Affect Our Growth and Profitability" of our annual report on Form 10-K for the fiscal year ended December 31, 2012. These risks include seasonality of revenues, integrating the acquired business into our existing operations and corporate structure, retaining key employees and minimizing disruptions to our existing business.
Our common stock ("Common Stock") trades on the NASDAQ Capital Market under the symbol "SPRO."

Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements that have been prepared according to accounting principles generally accepted in the United States. In preparing these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We evaluate these estimates on an ongoing basis. We base these estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We consider the following accounting policies to be the most important to the portrayal of our financial condition. Revenue recognition
A large portion of our revenue is in the form of subscription fees for our monthly accounting update programs or access to our library of accounting, financial services training and legal courses. Other sources of revenue include direct sales of programs or courses on a non-subscription basis or from various forms of live training, fees for Web site design, software development, video production, course design and development and ongoing maintenance fees from our client's use of eCampus or our Smartpros' Professional Education Center ("PEC"), our proprietary learning management systems. Subscriptions are billed on an annual basis, payable in advance and deferred at the time of billing. Sales made over the Internet are by credit card only. Renewals are usually sent out 60 days before the subscription period ends. Larger transactions are usually dealt with by contract, the financial terms of which depend on the services being provided. Contracts for development and production services typically provide for a significant upfront payment and a series of payments based on deliverables specifically identified in the contract.
Revenue from subscription services are recognized as earned, deferred at the time of billing or payment and amortized into revenue on a monthly basis over the term of the subscription. Engineering products are non-subscription based and revenue is recognized upon shipment of the product or, in the case of online sales, payment. Revenue from non-subscription services provided to customers, such as Web site design, video production, consulting services and custom projects is generally


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recognized on a proportional performance basis where sufficient information relating to project status and other supporting documentation is available. The contracts may have different billing arrangements resulting in either unbilled or deferred revenue. We obtain either a signed agreement or purchase order from our non-subscription customers outlining the terms and conditions of the sale or service to be provided. Otherwise, these services are recognized as revenue after completion and delivery to the customer. Revenue from the sale of other products and services are generally recognized upon shipment or, if later, when our obligations are complete and realization of receivable amounts is assured. Revenue from live training is recognized when the seminar or conference is completed. These are usually one to three day events. Impairment of long-lived assets
We review long-lived assets and certain intangible assets at least annually or when events or circumstances indicate that the carrying amounts may not be recovered. We recognize that the economy has not yet fully recovered and has impacted the operations of certain divisions of our company. Therefore, we are continuously reviewing certain intangible assets related to prior acquisitions. In 2012, we recognized an impairment to assets acquired from an acquisition and management continues to monitor the situation as it relates to our overall operations.
Stock-based compensation
Compensation costs are recognized in the financial statements for stock options or grants awarded to employees and directors. Options and warrants granted to non-employees recorded as an expense at the date of grant based on the then estimated fair value of the stock-based instrument granted. Options and grants awarded to employees or directors are expensed over their prespective vesting periods.
Segment accounting
All of our operations constitute a single segment, that of educational services. Revenues from non-educational services, such as video production are not a material part of our operating income.
Income taxes
We account for deferred tax assets available principally from the temporary differences related to our fixed and intangible assets and our net operating loss carryforwards in accordance with the Accounting Standards Codification. We make significant estimates and assumptions in calculating our current period income tax liability and deferred tax assets. The most significant of these are estimates regarding future period earnings. Our net deferred tax asset is estimated by management using a three-year taxable income projection. In the event that our projections change due to economic uncertainties, we may adjust the realizable amount of our deferred tax asset. Management continues to monitor these projections and assumptions on an ongoing basis.

Results of Operations
Our operating results for the first quarter are affected by the seasonality of some of our products, primarily live training, resulting in substantial losses. The first quarter of 2013 as compared to the first quarter of 2012, reflected a 7% increase in net revenues with an accompanying increase in cost of revenues. This resulted in a higher gross profit and a decreased operating loss of $79,000 or 12%. Our net loss for the three-month period ended March 31, 2013, as compared to the 2012 period reflected a decrease of approximately $67,000 or 16%. The operating and net losses for the current quarter are the lowest they have been in the past four years. Our net revenues for the period increased approximately $211,000 from the 2012 period. Our core businesses have remained fairly stable, and we experienced an increase in net revenues from custom work during the quarter. We continue to seek to acquire either content in new or complimentary market; make our sales force more effective and reduce expenses where appropriate. As previously mentioned, in 2012, we acquired content in the human resources and health and safety areas, markets that we previously did not serve. We also entered into an agreement in 2012, with Villanova University to market and distribute their Online Professional Engineering Review Course, "Power for Electrical Engineers", with over 100 hours of online content. In addition, several of our divisions have signed agreements for work that have either been delayed or extended at the request of the client. Comparison of three months ended March 31, 2013 and 2012 We recorded a $211,000, or 7% increase in net revenues in the 2013 period compared to the 2012 period. Although we made significant cuts in direct expenses, our product mix resulted in our gross profit margin remaining relatively constant at 55.7% in the 2013 period as compared to 55.4% in the 2012 period. A substantial portion of the increase in gross revenues came from our Skye Multimedia Ltd. ("Skye") division. Skye's custom work has a lower gross profit than subscription based revenue. Operating results for the 2013 period were impacted by overall increases in net revenues from many of our divisions,


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as we continue to seek ways to work in a still sluggish economy. General and administrative expenses were approximately $50,000 higher in the 2013 period as compared to the 2012 period. We continue to believe that these fluctuations in net revenues from period to period are not necessarily indicative of any long-term expectations from all of our divisions. Although, we experienced an increase in net revenues from custom work in this quarter, we cannot be certain that it is indicative of future results. We do see growth potential in our content-based businesses in the various verticals that we service and in technology that we have designed for the financial services industry. Custom work is non-repetitive and subject to market conditions and can vary from quarter to quarter. Our live training divisions revenues were flat as most accounting professionals do not take continuing education in the first quarter of the year. The live training business primarily recognizes its revenues in the second through fourth quarters of the year.
Online revenues, which previously were primarily derived from the sales of accounting/finance products, continue to be an important factor to our net revenues. Many of our other products, including our Cognistar Legal library, our Financial Campus courses, our technology training products and our human resources and health and safety, are also delivered online and are also significant generators of net revenues. Approximately 48% of our current period net revenues were derived from online products.
The following table compares our statement of operations data for the three-months ended March 31, 2013 and 2012. The trends suggested by this table may not be indicative of future operating results, which will depend on various factors including the relative mix of products sold (accounting/finance, law, engineering, financial services, sales training - product, technology or compliance and ethics) and the method of sale (video or online) as well as the timing of custom project work, which can vary from quarter to quarter. In addition, our operating results in future periods may also be affected by acquisitions.

                                                  Three months ended March 31,
                                        2013                          2012
                                Amount       Percentage       Amount       Percentage      Change
Net revenues                 $ 3,218,667        100.0  %   $ 3,008,195        100.0  %        7.0  %
Cost of revenues               1,427,454         44.3  %     1,342,097         44.6  %        6.4  %
Gross profit                   1,791,213         55.7  %     1,666,098         55.4  %        7.5  %
Selling, general and
administrative                 2,101,027        (65.3 )%     2,051,056        (68.2 )%        2.4  %
Depreciation and
amortization                     268,513          8.3  %       272,219          9.0  %       (1.4 )%
Total operating expenses       2,369,540         73.6  %     2,323,275         77.2  %        2.0  %
Operating loss                  (578,327 )      (18.0 )%      (657,177 )      (21.8 )%      (12.0 )%
Other income, net                  3,248          0.1  %         5,585          0.1  %      (41.8 )%
Net loss before income tax      (575,079 )      (17.9 )%      (651,592 )      (21.7 )%      (11.7 )%
Benefit from income taxes        218,597          6.8  %       228,353          7.6  %       (4.3 )%
Net loss                     $  (356,482 )      (11.1 )%   $  (423,239 )      (14.1 )%      (15.8 )%

Net revenues
The increase in net revenues reflected above was due to: (i) a $219,000 increase in net revenues from our Skye subsidiary; (ii) a $71,000 increase in net revenues from our Accounting/Finance division; (iii) an increase of $10,000 from our Engineering division; (iv) a $19,000 increase in net revenues from our SmartPros Legal and Ethics, Ltd. ("SLE") subsidiary and (v) a $5,000 increase from other divisions. These increases were offset by a $113,000 decrease in net revenues from our Financial Services division. Under our long-standing policy, revenue is credited to the originating department regardless of the type of service that is performed. For example, our Skye subsidiary may provide a custom e-learning solution for a client of our SLE subsidiary. However, SLE is credited with the entire amount of the sale.
In the first quarter of 2013, net revenues from the Accounting/Finance division were approximately $2.2 million, or 69% of net revenues, compared to $2.1 million, or 71% of net revenues, in the comparable 2012 period. Net revenues from subscription-based products and direct sales of course material on a non-subscription basis were $1.95 million and $1.9 million in the 2013 and 2012 periods, respectively. Net revenues from other projects in our Accounting/Finance division that are not subscription based and live-training were relatively constant from 2012 to 2013, as we generally do not generate revenues from live training until the second quarter. Non-subscription-based revenues fluctuate from period to period and are not indicative of any trends. In the 2013 period, net revenues from online sales of accounting products increased by approximately $103,000 as compared to the 2012 period, primarily as a result of increased usage. Net revenues from our Loscalzo live training subsidiary increased $3,000 in the 2013 period compared to the 2012. Our EEI live training division's revenues were $2,000 in the 2013


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period as compared to $15,000 in 2012 period. This revenue is earned from CPE administration and not live training. EEI's live training business is seasonal and its revenues are primarily earned in the second and fourth calendar quarters. EEI has introduced new products and services to its clients such as Continuing Professional Education (CPE) administration.
For the three-months ended March 31, 2013, Skye generated net revenues of $359,000 compared to $140,000 in the first quarter of 2012. Skye's income is derived primarily from designing custom training projects and, as such, varies from quarter to quarter. Therefore, we believe the increase in Skye's net revenue is not indicative of any long-term trends. Skye continues to see competitive pressure from both domestic and foreign sources, especially in pricing, Businesses are continuing to evaluate these types of services and products and their cost effectiveness. We are seeing more requests for proposals and often contracts are signed but the work does not begin for a period of time thereafter. Skye continues to market its iReflect product developed in a joint venture.
Our Financial Services division generated $324,000 of net revenues in the quarter ended March 31, 2013. For the quarter ended March 31, 2012, this division generated $437,000 of net revenues. The decrease is due primarily to reduced subscription-based revenues. We recently released our Audit Management System which we believe will have a positive effect on this division's future revenues.
For the quarter ended March 31, 2013, SLE had net revenues of $128,000 compared to net revenues of $109,000 for the comparable 2012 quarter. For the 2013 period, $37,000 of SLE's net revenues was generated by the Working Values Ethics and Compliance division, and $91,000 was generated by the Cognistar Legal division, as compared to $72,000 and $37,000, respectively, in the 2012 period. Net revenues generated by the Working Values Ethics and Compliance division are derived primarily from custom consulting work and can fluctuate from period to period based on a number of factors. The Cognistar Legal division derives its revenue primarily from prepaid usage and direct sales of its courses. Our Engineering division generated $154,000 of net revenues in the first quarter of 2013 compared to $144,000 in the first quarter of 2012. The increase is primarily related to the inclusion of our health and safety library of courses that was acquired in June 2012. Sales of our engineering products are not subscription based. We now include our information technology product, Watch-IT's revenues in the Engineering division.
Net revenues generated by our other divisions, which consist of video production and duplication and consulting in the first quarter of 2013 were $37,000. In comparison, these divisions recorded $32,000 of net revenue for the first quarter of 2012.
Cost of revenues
Cost of revenues includes: (i) production costs - i.e., the salaries, benefits and other costs related to personnel, whether our employees or independent contractors, who are used directly in production, including producing our educational programs and/or upgrading our technology; (ii) royalties paid to third parties; (iii) the cost of materials, such as DVD's and packaging supplies; (iv) costs related to live training; and (v) shipping and other costs. There are many different types of expenses that are characterized as production costs and many of them vary from period to period depending on many factors. Generally, subscription based products have higher profit margins than non-subscription based products and online sales have higher profit margins than sales involving physically delivery of materiel.
Our gross profit margins for the three-months ended March 31, 2013 increased slightly from 55.4% in the 2012 period to 55.7% in the 2013 period, primarily due to the increase in revenues. Although, we have made meaningful reductions in both personnel and outsourced labor, our expenses increased from $1.34 million in 2012 to $1.43 million in the 2013 period. Most of this increase is directly related to the increase in revenues from our Skye subsidiary, as their custom work requires a significant amount of out-sourced services. We also devote a significant amount of internal and external resources to develop new products and to re-tool existing products and technology. These costs are charged to expense as they are incurred.
Outside labor and direct production costs. Outside labor includes the cost of hiring actors and production personnel such as directors, producers and cameramen and the outsourcing of non-video technology. The cost of such outside labor, which is primarily video production and technology personnel, increased $116,000. This increase is primarily related to increased net revenue from custom work. Direct production costs, which are costs related to producing videos, courses, custom projects or live instruction and includes such costs as renting equipment and locations and the use of live instructors for either teaching or developing the courses, decreased $17,000. We also continue to expend significant sums updating and introducing new courses in our live training programs. The variation in direct production costs are related to the type of production and other projects and do not reflect any trends in our business. As our business grows we may be required to hire additional production personnel, increasing our cost of revenues. Our course libraries require regular updating.

Royalties. Royalty expense increased by $6,000 in the three-months ended March 31, 2013, compared to the corresponding period in 2012. Royalty expense varies from period to period based on sales and usage of our various


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products. Royalty expense is primarily driven by our accounting course catalog and our engineering product sales. Generally, royalties are paid twice per year and are calculated based on a number of factors, not all of which are available to us on a monthly, or even a quarterly basis. Accordingly, a substantial portion of our royalty expense for the quarter is estimated.
Salaries. Overall, payroll and related costs attributable to production personnel increased by only $2,000.

Other production related costs. These are other costs directly related to the production of our products or the costs related to live training such as purchases of materials, cost of venues, travel, shipping, and other. These costs increased $19,000 in the 2013 period from the 2012 period, and is primarily related to travel and other costs from our live training business.

Selling, general and administrative expenses Selling, general and administrative expenses include corporate overhead, such as compensation and benefits for administrative, sales and marketing and finance personnel, rent, insurance, professional fees, travel and entertainment and . . .

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