UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal quarter ended April 30, 2005

Commission File Number 000-21535

Prosoft Learning Corporation

(Exact name of Registrant as specified in its charter)

NEVADA

87-0448639

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification No.)

410 N. 44^th Street, Suite 600

Phoenix, Arizona 85008

(Address of Principal Executive Offices)

Registrant’s telephone number, including area code: (602) 794-4199

Indicate by check mark whether the 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 twelve (12) months (or such shorter period that the 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 ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

The number of shares of the registrants’ common stock, $.001 par value, outstanding as of June 10, 2005 was 4,635,481 shares.

PROSOFT LEARNING CORPORATION

TABLE OF CONTENTS


		Page
	PART I

Item 1.	Financial Statements
	Consolidated Statements of Operations (Unaudited) for the Three Months Ended April 30, 2005 and 2004 and for the Nine Months Ended April 30, 2005 and 2004	3
	Consolidated Balance Sheets at April 30, 2005 (Unaudited) and July 31, 2004	4
	Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended April 30, 2005 and 2004	5
	Notes to Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16
Item 4.	Controls and Procedures	16

	PART II

Item 6.	Exhibits	17
	Signatures	18

PART I

Item 1. Financial Statements

PROSOFT LEARNING CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share data)

(Unaudited)


	Three Months Ended April 30,						Nine Months Ended April 30,
	2005			2004			2005			2004
Revenues:
Content	$	1,320		$	1,552		$	4,226		$	4,929
Certification		334			416			1,040			1,366

Total revenues		1,654			1,968			5,266			6,295

Costs and expenses:
Costs of revenues		549			662			1,490			2,093
Content development		174			147			542			443
Sales and marketing		526			704			1,604			2,009
General and administrative		631			792			2,130			2,078
Depreciation and amortization		108			121			321			375

Total costs and expenses		1,988			2,426			6,087			6,998

Loss from operations		(334	)		(458	)		(821	)		(703	)

Gain on the settlement of liability		—			—			95			—
Interest income		1			—			3			—
Interest expense		(270	)		(76	)		(1,395	)		(227	)

Net loss	$	(603	)	$	(534	)	$	(2,118	)	$	(930	)

Net loss per share: basic and diluted	$	(0.13	)	$	(0.13	)	$	(0.49	)	$	(0.23	)

Weighted average shares outstanding: basic and diluted		4,565,710			4,038,236			4,294,507			4,035,997

The accompanying notes are an integral part of these consolidated statements.

PROSOFT LEARNING CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)


	April 30, 2005			July 31, 2004
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	903		$	502
Accounts receivable, less allowances of $104 and $148		475			644
Prepaid expenses and other current assets		247			132

Total current assets		1,625			1,278

Property and equipment, net of accumulated depreciation of $3,398 and $3,252		165			283
Goodwill, net of accumulated amortization of $5,506		6,745			6,745
Licenses, net of accumulated amortization of $2,948 and $2,756		37			229
Other, net		104			87

Total assets	$	8,676		$	8,622

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable, trade	$	489		$	591
Accrued expenses		486			768
Current portion of capital lease obligations		—			98
Other		52			64

Total current liabilities		1,027			1,521

Long-term debt		3,612			3,264

Total liabilities		4,639			4,785

Stockholders’ equity:
Common shares, par value $.001 per share; authorized shares: 12,500,000; issued: 4,635,481 and 4,053,554 shares		5			4
Additional paid-in capital		106,738			104,456
Accumulated deficit		(102,845	)		(100,727	)
Accumulated other comprehensive income		214			179
Less common stock in treasury, at cost: 1,985 shares		(75	)		(75	)

Total stockholders’ equity		4,037			3,837

Total liabilities and stockholders’ equity	$	8,676		$	8,622

The accompanying notes are an integral part of these consolidated statements.

PROSOFT LEARNING CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Nine Months Ended April 30,
	2005			2004
Operating activities:
Net loss	$	(2,118	)	$	(930	)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization		321			372
Gain on settlement of liability		(95	)
Non-cash interest expense		1,395			221
Changes in operating assets and liabilities:
Accounts receivable, net		169			325
Prepaid expenses and other current assets		(42	)		43
Accounts payable		(101	)		(451	)
Accrued expenses		(265	)		(212	)
Other		(12	)		(244	)

Net cash used in operating activities		(748	)		(876	)

Investing activities:
Purchase of property and equipment		(8	)		(18	)

Net cash used in investing activities		(8	)		(18	)

Financing activities:
Issuance of common stock					14
Issuance of long term debt		1,350
Long-term debt issuance costs		(199	)
Principal payments on capital leases		(3	)		(25	)

Net cash provided by (used in) financing activities		1,148			(11	)

Effects of exchange rate changes on cash		9			18

Net increase (decrease) in cash and cash equivalents		401			(887	)
Cash and cash equivalents at the beginning of period		502			1,567

Cash and cash equivalents at the end of period	$	903		$	680

Supplementary disclosure of cash paid during the period for:
Interest	$	—		$	5

Non-cash investing and financing activity:
Conversion of debt and interest into common stock	$	831		$	—

The accompanying notes are an integral part of these consolidated statements.

PROSOFT LEARNING CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share data)

(unaudited)

1. General

These interim consolidated financial statements do not include certain footnotes and financial information normally presented annually under accounting principles generally accepted in the United States of America and, therefore, should be read in conjunction with the Consolidated Financial Statements and the Notes thereto contained in the Company’s 2004 Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC. The results of operations for the interim period ended April 30, 2005, are not necessarily indicative of results that can be expected for the fiscal year ending July 31, 2005. The interim consolidated financial statements are unaudited but contain all adjustments, consisting of normal recurring adjustments management considers necessary to present fairly its consolidated financial position, results of operations, and cash flows as of and for the interim periods. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

The report on the Company’s consolidated financial statements as of and for the year ended July 31, 2004, issued by the Company’s independent registered public accounting firm and dated September 24, 2004, contained a qualification regarding matters related to the substantial doubt about the Company’s ability to continue as a going concern. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements for the year ended July 31, 2004, the Company is party to certain note agreements that provide creditors with the ability to demand accelerated repayment of amounts owed to those creditors if the Company is unable to comply with the terms of those note agreements. Should the Company fail to comply with the terms of those agreements the creditors could demand accelerated repayment of the amounts owed. The Company’s ability to comply with the terms of the agreements is uncertain and raises substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Certain reclassifications have been made in the prior-period consolidated financial statements to conform with the current-period presentation. All share and per share data have been restated to reflect the one-for-six stock consolidation as approved by the shareholders and the Board of Directors and effected on January 20, 2005.

2. Comprehensive Income

The components of comprehensive income for the three and nine months ended April 30, 2005 and 2004 are as follows:


	Three Months ended April 30,						Nine Months ended April 30,
	2005			2004			2005			2004
Net loss	$	(603	)	$	(534	)	$	(2,118	)	$	(930	)
Other comprehensive income (loss):
Foreign currency translation adjustments		(16	)		(29	)		35			28

Comprehensive loss	$	(619	)	$	(563	)	$	(2,083	)	$	(902	)

3. Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151, Inventory Costs, an amendment of APB No. 43, Chapter 4. The purpose of this statement is to clarify the accounting of abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) be recognized as current-period charges and by requiring the allocation of fixed production overhead to inventory based on the normal capacity of production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 24, 2004. The Company is evaluating SFAS No. 151, and does not believe it will have a material impact on our financial position or results of operations.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, with earlier application permitted. The Company is evaluating SFAS No. 153, and does not believe it will have a material impact on our consolidated financial statements.

In December 2004, FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and superseded Accounting Principal Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees. Generally, SFAS No. 123R requires that all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. Under SFAS No. 123R, we must determine the appropriate fair value method to be used at the date of adoption.

In April 2005, the SEC amended Rule 401(a) of Regulation S-X to delay the effective date for compliance with SFAS No. 123R. Based on the amended rule, the Company is required to adopt SFAS No. 123R effective the beginning of its fiscal year 2006. The Company is evaluating the requirements of SFAS No. 123R and expects the adoption of SFAS No. 123R will have a material effect on its results of operations and earnings per share. The Company has not yet determined its method of adoption of SFAS No. 123R. See Note 7 of the Notes to the Consolidated Financial Statements for the proforma impact of stock-based compensation on the three and nine-month periods ended April 30, 2005 and April 30, 2004, respectively.

4. Earnings (Loss) Per Share of Common Stock

Basic earnings (loss) per share, or basic EPS, of common stock was calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during each period. Dilutive earnings (loss) per share, or diluted EPS, is computed by dividing net income (loss) after adjustments for the effect of our convertible notes (if dilutive), by the weighted average number of common shares and potentially dilutive shares outstanding (if dilutive) during each period. Potentially dilutive shares include stock options, warrants and assumed conversion of the convertible notes. The number of potentially dilutive shares outstanding relating to stock options is computed using the treasury stock method and the potentially dilutive shares outstanding relating to warrants and convertible notes is computed using the if-converted method. Since the Company recorded losses for the three-month periods and nine-month periods ended April 30, 2005 and 2004, the diluted EPS of common stock is the same as the basic EPS, as any potentially dilutive securities would be anti-dilutive.

The reconciliation of the amounts used to calculate the basic EPS and diluted EPS is as follows:


	Three Months Ended April 30,						Nine Months Ended April 30,
	2005			2004			2005			2004
Weighted average shares outstanding - basic		4,565,710			4,038,236			4,294,507			4,035,997
Dilutive effect of stock option grants		—			—			—			—
Dilutive effect of warrants		—			—			—			—
Dilutive effect of convertible notes		—			—			—			—

Weighted average shares outstanding - diluted		4,565,710			4,038,236			4,294,507			4,035,997

Net loss	$	(603	)	$	(534	)	$	(2,118	)	$	(930	)

Net loss per share – basic	$	(0.13	)	$	(0.13	)	$	(0.49	)	$	(0.23	)

Net loss per share - diluted	$	(0.13	)	$	(0.13	)	$	(0.49	)	$	(0.23	)

Stock options to acquire 577,083 shares for the three months and nine-months ended April 30, 2005 and 440,817 shares for the three months and nine-months ended April 30, 2004 were not included in potentially dilutive shares because the effect of including these stock options would have been anti-dilutive. Warrants to acquire 1,093,722 shares for the three months and nine-months ended April 30, 2005 and 247,960 shares for the three months and nine-months ended April 30, 2004 were not included in potentially dilutive shares because the effect of including these warrants would have been anti-dilutive. Shares that would be issued upon conversion of convertible notes totaled 1,070,321 shares for the three months and nine-months ended April 30, 2005 and 668,523 shares for the three months and nine-months ended April 30, 2004, were not included in the computations of diluted EPS because the effect of including them would have been anti-dilutive. These options, warrants and the convertible notes may become dilutive in the future.

5. Goodwill and License Agreements

License agreements are those rights acquired from others through business combinations to produce and distribute courseware and other publications. License agreements are amortized on a straight-line basis over a period of seven years, subject to impairment based on the carrying value exceeding fair value. Goodwill is not amortized, but tested for impairment at least annually in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The Company adopted SFAS No. 142 on August 1, 2002 and identified one reporting unit and discontinued goodwill amortization at that time.

Intangible assets consist of the following:


	April 30, 2005				July 31, 2004
	Gross Carrying Value		Accumulated Amortization		Gross Carrying Value		Accumulated Amortization
Amortized intangible assets:
Licenses	$	2,985	$	2,948	$	2,985	$	2,756
Intangible assets not subject to amortization:
Goodwill		12,251		5,506		12,251		5,506

Total intangibles	$	15,236	$	8,454	$	15,236	$	8,262

Amortization expense related to intangible assets totaled $64 and $192 during the three and nine months ended April 30, 2005 and $63 and $192 during the three and nine months ended April 30, 2004. The aggregate estimated amortization expense for intangible assets remaining as of April 30, 2005 is $37. License agreements will become fully amortized during the remainder of fiscal year 2005.

On May 6, 2005, the Company 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 was provided a grace period through November 2, 2005, to regain compliance with the requirement. If the Company does not cure its minimum bid price deficiency, and if Nasdaq delists the Company’s common stock, the Company will be in default on the listing requirement covenant in the Secured Convertible Note and the 8% Convertible Notes. Such a default provides the holders of the notes with the ability to require immediate repayment of the principal and interest then owned under the notes. The Company believes the May 6, 2005 Nasdaq notice combined with the recent decline in the Company’s common stock price are events which will require it to reassess goodwill for any impairment in the quarter ended July 31, 2005.

6. Valuation of Long-Lived Assets

The Company evaluates the carrying value of other long-lived assets whenever events or changes in circumstances indicate the carrying amount may not be fully recoverable. If the total expected future undiscounted cash flow is less than the carrying value of the assets, a loss is recognized based on the amount by which the carrying value exceeds the asset’s fair value.

7. Stock-Based Compensation

The Company has adopted only the disclosure provisions of FASB No. 123 for employee stock options and continues to apply Accounting Principles Board, or APB, Opinion No. 25 for recording stock options issued to its employees and directors. Pro forma information regarding net loss and net loss per share is required by FASB No. 123 as if the Company had accounted for its stock-based awards to employees under the fair value method. The fair value of the Company’s stock-based awards to employees was estimated using the Black-Scholes multiple option model.

The fair value of the Company’s stock-based awards to employees was estimated assuming no expected dividends and the following assumptions:


	Three Months Ended April 30,				Nine months Ended April 30,
	2005		2004		2005		2004
Weighted average expected life	4 years		4 years		4 years		4 years
Expected stock price volatility	74	%	96	%	74	%	96	%
Risk-free interest rate	3.8	%	3.4	%	3.8	%	3.4	%

FASB Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123, amends the disclosure requirement of FASB Statement No 123. The following table illustrates the effect on net loss if the fair-value-based method had been applied to our stock-based employee compensation plans in each period.


	Three Months Ended April 30,						Nine months Ended April 30,
	2005			2004			2005			2004
Net loss as reported	$	(603	)	$	(534	)	$	(2,118	)	$	(930	)
Deduct: Total stock-based employee compensation under fair-value based method		(117	)		(254	)		(346	)		(746	)

Pro forma net loss	$	(720	)	$	(788	)	$	(2,464	)	$	(1,676	)

Net loss per share – basic and diluted:
As reported	$	(0.13	)	$	(0.13	)	$	(0.49	)	$	(0.23	)

Pro forma	$	(0.16	)	$	(0.10	)	$	(0.57	)	$	(0.42	)

8. Debt

On August 30, 2004, the Company issued $1.35 million of Secured 8% Convertible Notes due August 30, 2006, to institutional investors. 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, 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 $1.68 per share. In connection with this financing, the Company also issued to the investors (i) warrants to purchase up to 200,893 shares of the Company’s Common Stock, exercisable at $2.28 per share and expiring in March 2010, and (ii) warrants to purchase up to 642,858 shares, exercisable at $2.10 per share and generally expiring in February 2006.

The intrinsic value of the beneficial conversion feature of the note was $0.79 million and the portion of the proceeds allocated to the warrants issued in connection with the debt totaled $0.56 million. Thus, $1.35 million was recognized as a reduction of the convertible debt and an addition to paid-in capital.

The Company engaged a registered broker-dealer to assist in the sale of the Notes and Warrants. The broker-dealer received a placement fee of $0.10 million and a warrant to purchase 60,268 shares at $2.28 per share. The issuance of the warrants to the broker-dealer was valued at $0.10 million.

On May 6, 2005, the Company 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 November 2, 2005, to regain compliance with the requirement. If the Company does not cure its minimum bid price deficiency, and if Nasdaq delists the Company’s common stock, the Company will be in default on the listing requirement covenant in the Secured Convertible Note and the 8% Convertible Notes. Such a default provides the holders of the notes with the ability to require immediate repayment of the principal and interest then owned under the notes.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 13.

Overview

Prosoft Learning 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

Prosoft Learning 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.

Results of Operations

Revenues

Total revenues were $1.65 million in the three months ended April 30, 2005, compared with $1.97 million in the three months ended April 30, 2004, a decrease of $0.32 million. Total revenues decreased to $5.27 million in the nine months ended April 30, 2005 from $6.30 million in the nine months ended April 30, 2004, a decrease of $1.03 million. The decline in total revenues was driven by continued weakness in corporate training budgets and reduced purchases of our courseware products and certifications by our learning center customers. In addition, academic customer purchases continue to be limited by budget constraints, though academic adoption for our programs continues to progress.

Costs of Revenues

Costs of revenues decreased $0.11 million, or 17 percent, compared with the year-ago quarter, and decreased $0.60 million, or 29 percent, compared with the year-ago nine-month period. This decrease is related to the decrease in revenues and a reduction in costs of revenues related to a credit in the current nine-month period for over-billings by our major content supplier. As a percentage of revenue, gross profit, defined as total revenues less costs of revenues, increased to 67 percent from 66 percent in the year-ago quarter and to 72 percent from 67 percent in the year-ago nine-month period.

Content Development

Content development expenses increased $0.03 million, or 18 percent, compared with the year-ago quarter and increased $0.10 million, or 23 percent, compared with the year-ago nine-month period. The increase in content development expenses was attributable to the development of new products including the introductions of major revisions to our CIW product lines.

Sales and Marketing

Sales and marketing expenses decreased $0.18 million, or 25 percent, compared with the year-ago quarter, and decreased $0.41 million, or 20 percent, compared with the year-ago nine-month period. The decrease was attributable to lower revenues and associated sales commissions.

General and Administrative

General and administrative expenses were $0.63 million for the current quarter compared with $0.79 million for the year-ago quarter, a decrease of $0.16 million, or 20 percent. General and administrative expenses increased $0.05 million, or 3 percent, for the nine months ended April 30, 2005, compared with the year-ago nine-month period. The decrease for the current quarter was primarily attributable to a reduction of bad debt expenses and non-recurring legal fees and professional services expenses related to the abandoned merger with Trinity Learning Corporation in July 2004. The increase for the nine months ended April 30, 2005 was primarily 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 11 percent compared with the year-ago quarter and 14 percent compared with the year-ago nine-month period. The decrease is due primarily to the closing of the Santa Ana, California and Eden Prairie, Minnesota offices in the year-ago periods.

Gain on the Settlement of Liability

The Company settled a liability of $0.18 million for $0.08 million and recognized a gain of $0.10 million in the first quarter of fiscal year 2005.

Interest Income and Interest Expense

Interest expense was $0.27 million for the three months ended April 30, 2005, compared with $0.08 for the three months ended April 30, 2004, an increase of $0.19 million. Interest expense was $1.40 million for the nine months ended April 30, 2005, compared with $0.23 for the nine months ended April 30, 2004, an increase of $1.17 million. The increase is attributable to the issuance on August 30, 2004 of $1.35 million in Secured 8% Convertible Notes and the subsequent conversion of 58 percent of the debt into the Company’s common stock by the Investors. The conversion of the debt accelerated the amortization of deferred debt issuance expenses and debt discount.

The components of interest expense are reflected in the following table:


	Three Months Ended April 30,				Nine months Ended April 30,
	2005		2004		2005		2004
Interest expense	$	95	$	72	$	293	$	215
Amortization of debt issuance expenses		35		4		210		12
Amortization of debt discount		140		—		892		—

	$	270	$	76	$	1,395	$	227

Liquidity and Capital Resources

The Company’s primary need for liquidity relates to funding its operations and financing its working capital needs. At April 30, 2005, the Company had $0.90 million of cash.

Net cash used in operating activities was $0.75 million in the nine months ended April 30, 2005, compared with $0.88 million for the nine months ended April 30, 2004, a decrease of $0.13 million. Cash used in operating activities for the nine months ended April 30, 2005 was the result of our net loss of $2.12 million, adjusted for non-cash items of $1.62 million and an increase in collections of outstanding trade accounts receivable offset by payments made on accounts payable and accrued expenses.

Cash used in investing activities was minimal for the nine months ended April 30, 2005 and 2004 and was related primarily to the purchase of computer equipment.

Cash provided by (used in) financing activities was $1.15 million and $(0.11) million in the nine months ended April 30, 2005 and 2004, 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 $1.15 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 $1.68 per share. In connection with this financing, the Company also issued to the investors (i) warrants to purchase up to 200,893 shares of the Company’s Common Stock, exercisable at $2.28 per share and expiring in March 2010, and (ii) warrants to purchase up to 642,858 shares, exercisable at $2.10 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 and the intrinsic value of the beneficial conversion feature of the notes was $0.79 million. Thus, $1.35 million was recognized as a reduction of the convertible debt and an addition to paid-in capital.

The following summarizes our contractual cash obligations as of April 30, 2005(in millions):


	Payments Due for the Twelve Months Ended April 30,
	2006		2007		Total
Long term debt	$	—	$	4.07	$	4.07
Operating leases		0.34		—		0.34

Total contractual cash obligations	$	0.34	$	4.07	$	4.41

The long-term debt identified as due in year 2007 in the preceding table represents principal and accrued interest to date on a Subordinated Secured Convertible Note of $3.51 million and principal remaining on the Secured 8% Convertible Notes of $0.56 million. In the three months ended April 30, 2005, investors converted $0.06 million of the Secured 8% Convertible Notes into the Company’s common stock. In the nine months ended April 30, 2005, investors converted a total of $0.79 million of the Secured 8% Convertible Notes into the Company’s common stock. Given the potentially significant cash requirements to meet this debt repayment schedule during the first fiscal quarter of our fiscal year 2007, the Company will 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 for any reason, 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 common stock is currently listed on the Nasdaq SmallCap Market. However, the Company’s stock remains listed on Nasdaq subject to a grace period granted by Nasdaq through November 2, 2005, as a result of the Company’s failure to meet the 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. If the Company is unable to meet this requirement, Nasdaq will determine whether the Company meets The Nasdaq SmallCap initial listing criteria as set forth in Marketplace Rule 4310(c), except for the bid price requirement. If the Company meets the initial listing criteria, Nasdaq will notify the Company that it has been granted an additional 180 calendar day compliance period. If the Company is not eligible for an additional compliance period, Nasdaq will provide written notification that the Company’s securities will be delisted. At that time, the Company may appeal Nasdaq’s determination to delist its securities to a Listing Qualifications Panel. If the Company’s stock is delisted from Nasdaq, 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.

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. In addition, if we are unable to maintain our listing on Nasdaq, the holders of these securities could choose to accelerate the repayment of these notes, and the Company would be forced to seek alternative financing at that time.

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 May 6, 2005, 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 November 2, 2005, 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, which we have not done to date. If we do not comply by November 2, 2005, Nasdaq will determine whether the Company meets The Nasdaq SmallCap initial listing criteria as set forth in Marketplace Rule 4310(c), except for the bid price requirement. If the Company meets the initial listing criteria, Nasdaq will notify the Company that it has been granted an additional 180 calendar day compliance period. If the Company is not eligible for an additional compliance period, Nasdaq will provide written notification that the Company’s securities will be delisted. At that time, the Company may appeal Nasdaq’s determination to delist its securities to a Listing Qualifications Panel.

If we do not cure our minimum bid price deficiency by November 2, 2005, 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.

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

We have incurred losses of approximately $103 million from our inception in 1995 through April 30, 2005. 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 3.2 million shares, or approximately 41% 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:

•

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.

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including Section 404 of the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq SmallCap Market rules, may lead to an increase in our costs of compliance. A failure to comply with these new laws and regulations may impact market perception of our financial condition and could materially harm our business.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk relating to our operations results primarily from changes in foreign currency exchange rates. A portion of our cash flow is expected to be received in non-U.S. currencies. In addition, a portion of our assets is held in foreign subsidiaries. Accordingly, we are exposed to foreign currency fluctuations against the U.S. dollar. Such exposure is not significant relative to our overall operations and we believe that the risk associated with our exposure will not have a material adverse impact on our consolidated results of operations.

Item 4. Controls and Procedures

Based on evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) our Chief (principal) Executive Officer and Vice President Finance (principal financial officer) have concluded that such controls and procedures were effective as of the period covered by this report. In connection with such evaluation, no changes in our internal control over financial reporting was identified that occurred during the period covered by this report and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 6. Exhibits

a) Exhibits


3.1		Restated Articles of Incorporation of the Company, as amended.

31.1		Rule 13a-14(a)/15d-14(a) Certification – Principal Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification – Principal Financial Officer

32.1		Section 1350 Certification - Principal Executive Officer

32.2		Section 1350 Certification - Principal Financial Officer

SIGNATURES

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.


		Prosoft Learning Corporation
Dated: June 14, 2005
		/s/ WILLIAM J. WERONICK
		William J. Weronick
		Vice President Finance
		(Principal Financial and Accounting Officer)

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Prosoft Learning CORP 10-Q