10-Q 1 b44199sce10vq.txt SKILLSOFT CORPORATION UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO _____________ COMMISSION FILE 000-28823 SKILLSOFT CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 02-0496115 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 20 INDUSTRIAL PARK DRIVE 03062 NASHUA, NEW HAMPSHIRE (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (603) 324-3000 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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] On September 4, 2002, the registrant had outstanding 17,668,018 shares of common stock, $.001 par value per share. SKILLSOFT CORPORATION FORM 10-Q FOR THE QUARTER ENDED JULY 31, 2002 INDEX

2 PART I ITEM 1. - FINANCIAL STATEMENTS SKILLSOFT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)

The accompanying notes are an integral part of these condensed consolidated financial statements. 3 SKILLSOFT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED, IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

The accompanying notes are an integral part of these condensed consolidated financial statements. 4 SKILLSOFT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED, IN THOUSANDS)

The accompanying notes are an integral part of these condensed consolidated financial statements. 5 SKILLSOFT CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. OPERATIONS SkillSoft Corporation (the "Company" or "SkillSoft") was incorporated in Delaware on October 15, 1997. The Company commenced operations on January 8, 1998 in conjunction with its initial round of financing. The Company is a provider of web-based training resources that cover a variety of professional effectiveness and business topics. 2. BASIS OF PRESENTATION The accompanying, unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States, have been condensed or omitted pursuant to such SEC rules and regulations. Nevertheless, the management of the Company believes that the disclosures herein are adequate to make the information presented not misleading. In the opinion of management, the condensed consolidated financial statements reflect all material adjustments (consisting only of those of a normal and recurring nature) which are necessary to present fairly the consolidated financial position of the Company as of July 31, 2002, the results of its operations for the three and six months ended July 31, 2002 and 2001 and its cash flows for the six months ended July 31, 2002 and 2001. These condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2002. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. 3. CASH, CASH EQUIVALENTS AND INVESTMENTS The Company considers all highly liquid investments with original maturities of 90 days or less at the time of purchase to be cash equivalents. At July 31, 2002 and January 31, 2002, cash equivalents consisted mainly of commercial paper, short term notes and money market funds. The Company accounts for its investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, securities that the Company has the positive intent and ability to hold to maturity are reported at amortized cost, which approximates market value, and are classified as held-to-maturity. At July 31, 2002, the Company's investments consisted of held-to-maturity securities that are investments in short-term notes which had an average maturity of 201 days. The investments in short-term notes are classified as current assets in the accompanying consolidated balance sheets as they mature within one year. 4. REVENUE RECOGNITION The Company follows the provisions of the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9. The Company derives revenue primarily pursuant to license agreements under which customers license usage of delivered products for a period of one, two or three years. On each anniversary date during the term of multi-year license agreements, customers are generally allowed to exchange any or all of the licensed products for an equivalent number of alternative products within the Company's course library. The annual license fee for the first year is generally billed in advance. Revenue is recognized either at the time of delivery of products or over the term of the contract, depending on specific contract terms. In the event that the customer initially specifies the entire set of licensed courses to be delivered and those courses are available and delivered, the license revenue for the first year of the contract is recognized upon execution of the contract and delivery of the courses. License fees for subsequent years of multiyear license agreements are billed generally on the anniversary date of the agreement and recognized in the manner described above or, if the customer exchanges courses at the renewal date, upon delivery of the exchanged courses. Revenue is recognized ratably over the license period if the number of courses that a customer has access to is not clearly defined and / or is not yet available or selected at the inception of the contract. This occurs if the customer: does not initially specify the entire set of licensed courses, is given exchange privileges that are exercisable other than on the contract anniversaries, or licenses all courses currently available and to be developed during a particular term. In some circumstances, the Company offers payment terms of up to six months from the initial shipment date 6 or anniversary date for multi-year agreements to its customers. To the extent that a customer is given extended payment terms, revenue is recognized as cash becomes due, assuming all of the other elements of revenue recognition have been satisfied. The Company also derives revenue from extranet hosting/application service provider (ASP) services and online mentoring services. Revenue related to extranet hosting/ASP services and online mentoring services is recognized on a straight line basis over the period in which the services are provided. For the three and six months ended July 31, 2002 and the three and six months ended July 31, 2001, the Company recognized approximately $1,055,000, $1,995,000, $429,000 and $769,000 of service revenue, respectively. For multi-element agreements where the Company provides these services, vendor specific objective evidence exists to allocate the total fee to the elements of the agreement. The cost of satisfying any Post Contract Support (PCS), which essentially represents a warranty obligation, is accrued at the time license revenue is recognized, as PCS fees are included in the annual license fee. The accrued PCS costs are included in deferred revenue in the accompanying consolidated balance sheets. The estimated cost of providing PCS during the agreements is insignificant and the Company does not offer it separately. Deferred revenue includes the unrecognized portion of revenue associated with license fees for which the Company has received payment. In addition, deferred revenue includes amounts which have been billed and not collected for which revenue is being recognized ratably over the license period, which totaled approximately $11,467,000 and $12,232,000 at July 31, 2002 and January 31, 2002, respectively. 5. GOODWILL AND INTANGIBLE ASSETS On February 1, 2002, the Company adopted Statement of Financial Accounting Standard No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which requires companies to discontinue amortizing goodwill and certain intangible assets with indefinite useful lives and requires an annual review for impairment. The non-amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. The Company's goodwill and intangible assets relate solely to its acquisition of Books24x7.com on December 28, 2001, which was accounted for in accordance with the non-amortization provisions of SFAS 142. Therefore, there is no impact on the comparability of the accompanying condensed consolidated statements of operations as a result of discontinuing the amortization of goodwill. Goodwill and intangible assets are as follows:

A reconciliation of the net carrying amount of intangible assets as of January 31, 2002 and July 31, 2002 is as follows: Net Carrying Amount (in thousands) Balance at January 31, 2002 $48,701 Adjustment to goodwill 142 Amortization expense (163) ------- Balance at July 31, 2002 $48,680 ======= Amortization expense for the six months ended July 31, 2002 and the fiscal year ended January 31, 2002 is as follows: 7 Six Months Ended Fiscal Year Ended July 31, 2002 January 31, 2002 (Dollars in thousands) Internally developed software $100 $17 Customer contracts 63 10 ---- --- $163 $27 ==== === Amortization expense for the next five fiscal years is expected to be as follows: (in thousands): Fiscal Year Amortization Expense 2003 $325 2004 325 2005 308 2006 115 2007 -- 6. COMPREHENSIVE INCOME (LOSS) SFAS No. 130, Reporting Comprehensive Income, requires disclosure of all components of comprehensive income (loss) on an annual and interim basis. Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions, other events and circumstances from non-owner sources. The translation adjustment is the only element of comprehensive income (loss) incurred by the Company other than net income (loss). The components of comprehensive income (loss) for the three and six months ended July 31, 2002 and 2001 are as follows:

7. NET INCOME (LOSS) PER SHARE Basic net income (loss) per common share was determined by dividing net income (loss) by the weighted average common shares outstanding during the period. Diluted net income (loss) per common share was computed by giving effect to all dilutive potential common shares outstanding. Basic and diluted net loss per share for the three and six months ended July 31, 2001 are the same, as outstanding common stock options and unvested restricted stock are antidilutive because the Company has recorded a net loss for the period. The calculation of basic net income (loss) per share and diluted net income (loss) per share is as follows:

8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 2002, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 146, "Accounting for Costs Associated With Exit or Disposal Activities". SFAS 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Therefore, SFAS 146 eliminates the definition and requirements for recognition of exit costs in EITF 94-3. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial statements. 9. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, in the fiscal year ended January 31, 1999. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions how to allocate resources and assess performance. The Company's chief operating decision-makers, as defined under SFAS No. 131, are the Chief Executive Officer and the Chief Financial Officer. To date, the Company has viewed its operations and manages its business as principally one operating segment. As a result, the financial information disclosed herein represents all of the material financial information related to the Company's principal operating segment. 10. COMMITMENTS AND CONTINGENCIES There have been no significant changes in the status of the outstanding litigation as reported in SkillSoft's Annual Report on Form 10-K for the year ended January 31, 2002. The Company considered the disclosure requirements of FR-60 regarding critical accounting policies and FR-61 regarding liquidity and capital resources, certain trade activities and related/certain other disclosures, and concluded that nothing materially changed during the quarter that would warrant further disclosure under these releases. 11. MERGER On June 10, 2002, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") among the Company, SmartForce Public Limited Company, a public limited liability company organized under the laws of the Republic of Ireland ("SmartForce"), and Slate Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of SmartForce (the "Merger Sub"). Pursuant to the Merger Agreement, the Merger Sub will be merged with and into the Company with the Company continuing as the surviving corporation and a wholly-owned subsidiary of SmartForce (the "Merger"). As a result of the Merger, each issued and outstanding share of Common Stock, par value $0.001 per share, of the Company (the "Company Common Stock") will be automatically converted into the right to receive 2.3674 (the "Exchange Ratio") validly issued, fully paid and nonassessable American Depository Shares of SmartForce ("SmartForce ADSs"). In addition, SmartForce will assume all options to purchase shares of the Company Common Stock outstanding as of the effective time of the Merger under the Company's existing stock option plans, excluding the Company's employee stock purchase plans, and each such option to purchase shares of the Company Common Stock will be or will later become exercisable for SmartForce ADSs rather than shares of the Company Common Stock, in a number adjusted to reflect the Exchange Ratio, and at an exercise price adjusted to reflect the Exchange Ratio. The Merger is intended to be a tax-free reorganization under Section 368(a) of the Internal Revenue Code of 1986, as amended. The consummation of the Merger is subject 9 to the approval of the stockholders of the Company and SmartForce and other customary closing conditions. The Company currently anticipates that the Merger will close in September 2002. ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Any statement in this Quarterly Report on Form 10-Q about future expectations, plans and prospects for SkillSoft, including statements containing the words "believes," "anticipates," "plans," "expects," "will" and similar expressions, constitute forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those set forth in this Item 2 under the heading "Future Operating Results". You should also refer to the "Risk Factors" section of our Joint Proxy Statement/Prospectus dated August 5, 2002 for a description of the risks associated with our pending merger with SmartForce. The following discussion and analysis of the financial condition and results of operations of SkillSoft should be read in conjunction with SkillSoft's financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q. OVERVIEW We commenced operations in January 1998, and until March 1999, devoted substantially all of our efforts to product development, establishing a course content developer and supplier base, and building a direct sales and support organization in the United States and a business application and network infrastructure to support future growth. Since March 1999, we have devoted substantial resources to sales and marketing activities as well as to continued product development. We incurred losses in every fiscal quarter from our inception through the fiscal quarter ended October 31, 2001. We have recorded net income in each subsequent fiscal quarter through the fiscal quarter ended July 31, 2002. We derive revenue primarily from license agreements under which customers license our products for periods of one, two or three years. The pricing for our courseware licenses varies based upon the number of course titles licensed by a customer, the number of users within the customer's organization and the length of the license agreement. For example, a customer would generally pay us approximately $122,000 per year for a three-year license for 25 courses for 5,000 users. Our license agreements typically permit customers to exchange courses, generally on the contract anniversary date. A referenceware license gives users access to the full library within one or more collections (ITPro, BusinessPro and OfficeEssentials) from our Books24x7.com Group. The pricing for our referenceware licenses varies based on the collections specified by the customer, the number of users within the customer's organization and the length of the license agreement. For example, a customer who purchases the ITPro collection for 100 users for 3 years would pay $177 per user. Customers may amend the license agreements, for an additional fee, to gain access to additional courses and/or to increase the size of the user base. We also derive revenue from hosting fees for clients that use our solutions on an Application Service Provider (ASP) basis. In selected circumstances, we derive revenue on a pay-for-use basis under which some customers are charged based on the number of courses accessed by users. Revenue derived from pay-for-use contracts has been minimal to date. The annual license fee for the first year is generally billed in advance. Revenue is recognized either at the time of delivery of products or over the term of the contract, depending on specific contract terms. In the event that the customer initially specifies the entire set of licensed courses to be delivered and those courses are available and delivered, the license revenue for the first year of the contract is recognized upon execution of the contract and delivery of the courses. License fees for subsequent years of multi-year license agreements are generally billed on the anniversary date of the agreement and recognized in the manner described above, or if the customer exchanges courses at the renewal date, upon delivery of the exchanged courses. Revenue is recognized ratably over the license period if the number of courses that a customer has access to is not clearly defined and/or is not yet available or selected at the inception of the contract. This occurs if the customer: does not initially specify the entire set of licensed courses, is given exchange privileges that are exercisable other than on the contract anniversaries, or licenses all courses currently available and to be developed during a particular term. This license approach results in the building of backlog of future revenue streams. To the extent that a customer is given extended payment terms, revenue is recognized as cash becomes due, assuming all of the other elements of revenue recognition have been satisfied. We also derive revenue from extranet hosting/ASP services and online mentoring services. Revenue related to extranet hosting/ASP services and online mentoring services is recognized on a straight-line basis over the period in which the services are provided. 10 Our backlog at any given time represents the amount of license fees which are due to us within the following 12 months under existing license agreements but which have not yet been recognized as revenue. This amount is comprised of license fees attributable to (1) licensed courses/referenceware that have not been selected by and delivered to the customer, (2) special terms, including exchange privileges and extended payment terms, as part of the non-cancelable license agreement, and (3) revenue to be recognized for non-cancelable license agreements that are renewing during the twelve-months ending July 31, 2003. Our backlog can vary based upon a number of factors, including the timing of the execution of new license agreements, the timing of product deliveries and the length of our license agreements. Cost of revenue includes the cost of materials (such as storage media), packaging, duplication, custom library CD production, internet hosting services, the cost of online mentoring services, royalties and certain infrastructure and occupancy expenses. These costs of revenue are generally recognized as incurred. Research and development expenses consist primarily of salaries and benefits, certain infrastructure and occupancy expenses, fees to consultants and course content development fees. Software development costs are accounted for in accordance with SFAS No. 86, which requires the capitalization of certain computer software development costs incurred after technological feasibility is established. To date, development costs after establishment of technological feasibility have been immaterial, and all software development costs have been expensed as incurred. Selling and marketing expenses consist primarily of salaries, commissions and benefits, advertising and promotion, travel and certain infrastructure and occupancy expenses. General and administrative expenses consist primarily of salaries and benefits, consulting and service expenses, legal expenses and certain infrastructure and occupancy expenses. Please see the "Critical Accounting Policies" section under Item 7 of our Annual Report of Form 10-K for the fiscal year ended January 31, 2002 for a discussion of our accounting policies that involve the most significant judgments and estimates by management. RESULTS OF OPERATIONS THREE MONTHS ENDED JULY 31, 2002 VERSUS THREE MONTHS ENDED JULY 31, 2001 Revenue increased $6.0 million, or 64%, to $15.4 million in the three months ended July 31, 2002 from $9.4 million in the three months ended July 31, 2001. This increase was due primarily to new customers and to a lesser extent, to increased revenue from existing customers. Our standard pricing matrix increased 15% on May 1, 2001. This increase had a nominal effect on revenue in the three months ended July 31, 2002 when compared to the impact of new customers. Cost of revenue increased $447,000, or 83%, to $984,000 in the three months ended July 31, 2002 from $537,000 in the three months ended July 31, 2001 due to our increased revenue, increased costs of supporting our hosting business and royalty fees associated with our Referenceware product line. Cost of revenue as a percentage of total revenue remained at 6% in both the three months ended July 31, 2002 and the three months ended July 31, 2001. Research and development expenses did not increase materially in the three months ended July 31, 2002 from $3.7 million in the three months ended July 31, 2001. Research and development expenses as a percentage of total revenue decreased to 24% in the three months ended July 31, 2002 from 40% in the three months ended July 31, 2001. We expect research and development expenses to continue to increase in absolute dollars and potentially as a percentage of revenue, although we believe our outsourcing strategy provides us significant flexibility to control these expenditures. Selling and marketing expenses increased $1.2 million, or 19%, to $7.8 million in the three months ended July 31, 2002 from $6.6 million in the three months ended July 31, 2001. Selling and marketing expenses as a percentage of total revenue decreased to 51% in the three months ended July 31, 2002 from 70% in the three months ended July 31, 2001. Selling and marketing expenses increased due to increased personnel and commission costs. We believe that a significant investment in selling and marketing to expand our distribution channels worldwide is required to remain competitive, and we therefore expect selling and marketing expenses in absolute dollars to continue to increase. General and administrative expenses increased approximately $99,000, or 6%, to $1.8 million in the three months ended July 31, 2002 from $1.7 million in the three months ended July 31, 2001. General and administrative expenses as a percentage of total revenue decreased to 12% in the three months ended July 31, 2002 from 18% in the three months ended July 31, 2001. General and administrative expenses increased primarily due to increased personnel expenses and litigation. We anticipate that general and 11 administrative expenses will continue to increase in absolute dollars due to increases in litigation, public company costs and additional personnel. Amortization of intangible assets was approximately $81,000 for the three months ended July 31, 2002. Intangible assets being amortized are internally developed software and customer contracts of an acquired company. Stock-based compensation expense increased $165,000 or 90%, to $349,000 in the three months ended July 31, 2002 from $184,000 in the three months ended July 31, 2001. The increase reflects additional deferred compensation expense as a result of the Books 24x7.com, Inc. acquisition in December 2001. The expense was primarily the result of amortization of deferred compensation resulting from granting of stock options to employees at exercise prices below the fair market value of the stock and the sale of restricted common stock with sales prices below the fair market value of the stock. The stock options granted at exercise prices below fair market value of the stock were granted by SkillSoft prior to our initial public offering and for Books24x7.com, prior to our acquisition in December 2001. Interest income increased $182,000 to $417,000 in the three months ended July 31, 2002 from $235,000 in the three months ended July 31, 2001. This increase was primarily due to higher cash and investment balances. SIX MONTHS ENDED JULY 31, 2002 VERSUS SIX MONTHS ENDED JULY 31, 2001 Revenue increased $11.3 million, or 63%, to $29.2 million in the six months ended July 31, 2002 from $17.9 million in the six months ended July 31, 2001. This increase was due primarily to new customers and to a lesser extent, to increased revenue from existing customers. Our standard pricing matrix increased 15% on May 1, 2001. This increase had a nominal effect on revenue in the six months ended July 31, 2002 when compared to the impact of new customers. Cost of revenue increased $755,000, or 71%, to $1.8 million in the six months ended July 31, 2002 from $1.1 million in the six months ended July 31, 2001 due to our increased revenue, increased costs of supporting our hosting business and royalty fees associated with our Referenceware product line. Cost of revenue as a percentage of total revenue remained at 6% in both the six months ended July 31, 2002 and the six months ended July 31, 2001. Research and development expenses decreased $175,000, or 2%, to $7.2 million in the six months ended July 31, 2002 from $7.4 million in the six months ended July 31, 2001. Research and development expenses as a percentage of total revenue decreased to 25% in the six months ended July 31, 2002 from 41% in the six months ended July 31, 2001. Research and development expenses were lower in the April 30, 2002 quarter than in the corresponding quarter of the prior year, but were higher in the July 31, 2002 quarter than the prior year quarter. We do not anticipate any future decreases. Selling and marketing expenses increased $2.1 million, or 16%, to $15.2 million in the six months ended July 31, 2002 from $13.1 million in the six months ended July 31, 2001. Selling and marketing expenses as a percentage of total revenue decreased to 52% in the six months ended July 31, 2002 from 73% in the six months ended July 31, 2001. Selling and marketing expenses increased due to increased personnel and commission costs. General and administrative expenses increased approximately $311,000, or 9%, to $3.6 million in the six months ended July 31, 2002 from $3.3 million in the six months ended July 31, 2001. General and administrative expenses as a percentage of total revenue decreased to 12% in the six months ended July 31, 2002 from 18% in the six months ended July 31, 2001. General and administrative expenses increased primarily due to increased personnel expenses and litigation. Amortization of intangible assets was approximately $163,000 for the six months ended July 31, 2002. Intangible assets being amortized are internally developed software and customer contracts of an acquired company. Stock-based compensation expense increased $332,000 or 90%, to $700,000 in the six months ended July 31, 2002 from $368,000 in the six months ended July 31, 2001. The increase reflects additional deferred compensation expense as a result of the Books 24x7.com, Inc. acquisition in December 2001. The expense was primarily the result of amortization of deferred compensation resulting from granting of stock options to employees at exercise prices below the fair market value of the stock and the sale of restricted common stock with sales prices below the fair market value of the stock . The stock options granted at exercise prices below fair market value of the stock were granted by SkillSoft prior to our initial public offering and for Books24x7.com, prior to our acquisition in December 2001. 12 Interest income increased $226,000 to $830,000 in the six months ended July 31, 2002 from $604,000 in the six months ended July 31, 2001. This increase was primarily due to higher cash and investment balances. LIQUIDITY AND CAPITAL RESOURCES From inception through January 31, 2000, we were funded primarily through preferred stock financings with Warburg Pincus and other minority investors. The net proceeds from these financings through January 31, 2000 were approximately $20.7 million. In February 2000, we received net proceeds totaling $45.1 million from the sale of 3,565,000 shares of common stock in our initial public offering. On July 30, 2001, we received net proceeds totaling $72.0 million from the sale of 2,796,250 shares of common stock in a public offering. As of July 31, 2002, our principal source of liquidity was our cash and cash equivalents and short-term investments, which totaled $75.4 million. Net cash used in operating activities was $4.6 million for the six months ended July 31, 2002, which resulted primarily from an increase in prepaid expenses of $1.7 million, a decrease in accrued expenses of $5.8 million and a decrease in deferred revenue of $2.2 million. These charges were partially offset by a decrease in accounts receivable of $1.1 million, amortizations of approximately $1.6 million, an increase in accounts payable of $1.1 million and net income of $1.3 million. Our primary investing activities during the six months ended July 31, 2002 were purchases of property and equipment and maturation and purchases of investments. Property and equipment purchases for the six months ended July 31, 2002 and 2001 were approximately $3.1 million and $1.0 million, respectively. Maturation of investments, net of purchases, generated a net cash inflow of approximately $4.7 million in the six months ended July 31, 2002 compared to a net cash inflow of approximately $2.6 million in the six months ended July 31, 2001. Cash provided by financing activities was approximately $1.0 million and $72.8 million for the six months ended July 31, 2002 and 2001, respectively. For the six months ended July 31, 2002, this consisted of $0.8 million from the exercise of stock options and purchases under our employee stock purchase plan and $0.2 million from the repayment of notes receivable from stockholders. For the six months ended July 31, 2001, this consisted of the net proceeds from the sale of common stock in the secondary offering of approximately $72.0 million and $0.8 million from the exercise of stock options. Working capital was approximately $62.5 million and $48.7 million as of July 31, 2002 and January 31, 2002, respectively. Total assets were approximately $149.9 million and $153.4 million as of July 31, 2002 and January 31, 2002, respectively. The increase in working capital was predominantly the result of a reclassification of long term investments to short term investments. We expect to continue to experience significant growth in capital expenditures and operating expenses, particularly sales and marketing and product development expenses, for the foreseeable future in order to execute our business plan. To the extent that our execution of the business plan results in increased sales, we expect to experience corresponding increases in deferred revenue and prepaid expenses. We expect that the principal sources of funding for our operating expenses, capital expenditures and other liquidity needs will be a combination of our available cash equivalents and marketable securities (which totaled $75.4 million as of July 31, 2002) and funds generated from operations. We believe that our current funds will be sufficient to fund our operations for at least the next 12 months. However, there are a number of factors that may negatively impact our available sources of funds. The amount of cash generated from operations will be dependent upon the successful execution of our business plan and worldwide economic conditions. In addition, our cash needs may increase due to factors such as unanticipated developments in our business or significant acquisitions. RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 146, "Accounting for Costs Associated With Exit or Disposal Activities". SFAS 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Therefore, SFAS 146 eliminates the definition and requirements for recognition of exit costs in EITF 94-3. The 13 provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial statements. FUTURE OPERATING RESULTS WE HAVE ONLY RECENTLY ACHIEVED PROFITABILITY, AND WE MAY NOT BE ABLE TO SUSTAIN THIS IN THE FUTURE, WHICH MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK We have incurred losses in every fiscal quarter from our inception in January 1998 through the fiscal quarter ended October 31, 2001. We have recorded net income in each subsequent fiscal quarter thereafter, through the fiscal quarter ended July 31, 2002. We expect to continue to incur significant expenses, particularly in sales and marketing, in an effort to develop our business. As a result, we will need to generate significant revenue to maintain profitability. Moreover, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. WE AND SEVERAL OF OUR EXECUTIVES, THREE OF OUR KEY EMPLOYEES AND OUR LARGEST INVESTOR ARE DEFENDANTS IN LITIGATION WITH NETG WHICH ALLEGES, AMONG OTHER THINGS, MISAPPROPRIATION OF TRADE SECRETS; THIS LITIGATION WILL CONTINUE TO BE COSTLY AND MAY DIVERT THE EFFORTS OF OUR MANAGEMENT AND MAY ULTIMATELY RESTRICT OUR ABILITY TO DO BUSINESS We, several of our executives, three of our key employees and our largest investor are defendants in a lawsuit brought by National Education Training Group, Inc. (NETg), the former employer of these individuals. NETg alleges in substance that the defendants breached their fiduciary and contractual obligations to NETg in connection with the organization and operation of SkillSoft, misappropriated trade secrets from NETg, tortiously interfered with NETg's business and employees and breached provisions of a license agreement with NETg relating to the use of its software. NETg maintains that the trade secrets allegedly misappropriated by SkillSoft and the other defendants include, among other things: - various aspects of the design and functionality of its education and training software and products; - customer lists and information; - relationships with service providers; and - NETg's soft skills product line business plan. The claims seek injunctive relief against the defendants demanding the return, and no future use by these defendants, of the alleged trade secrets. The claims also seek compensatory damages of $400 million and exemplary damages in the additional amount of $400 million, compensatory, incidental and consequential damages in an unspecified amount and punitive damages totaling $50 million or such other amount as the court deems just or appropriate. Named as defendants in the lawsuit, in addition to SkillSoft, are Charles E. Moran, Jerald A. Nine, Jr., Mark A. Townsend, Lee A. Ritze, Dennis E. Brown, Sally H. Hovis, Warburg, Pincus Ventures, L.P., our largest investor, and each partner of Warburg Pincus. In addition, NETg also filed suit against SkillSoft in July 2000 alleging that our educational and training software products infringe a patent allegedly owned by NETg. The complaint seeks both monetary damages and injunctive relief. We have filed an answer and a counterclaim for a declaration of invalidity of the NETg patent. The lawsuit has been stayed pending resolution of our efforts to have the U.S. Patent and Trademark Office declare the patent invalid. These lawsuits are still in discovery, and we cannot yet assess the potential liability of SkillSoft or the other defendants. Our failure to prevail in these cases could have any or all of the following significant adverse effects on our business and financial performance: - injunctive relief against SkillSoft and our officers and employees, which could significantly restrict our ability to conduct our business; 14 - an adverse judgment against us for monetary damages; - a settlement on unfavorable terms; - obligations we have to indemnify our employees for liabilities and expenses they incur in connection with the lawsuits; - obligations to customers for breach of our warranty of noninfringement; or - a requirement to reengineer our products to avoid patent infringement, which would likely result in additional expense and delay. In addition, these cases, regardless of their outcome, will continue to result in significant expenses in defending the lawsuits. Our legal expenses related to the defense of these lawsuits totaled approximately $1.9 million in the fiscal year ended January 31, 2000, $1.4 million in the fiscal year ended January 31, 2001 and $1.7 million in the fiscal year ended January 31, 2002. Moreover, these lawsuits may divert the efforts and attention of our management team from normal business operations. OUR OPERATING RESULTS MAY FLUCTUATE FROM QUARTER TO QUARTER DUE TO THE NATURE OF OUR BUSINESS, AND A REVENUE OR EARNINGS SHORTFALL IN A PARTICULAR QUARTER WOULD HAVE A NEGATIVE IMPACT ON THE PRICE OF OUR COMMON STOCK If our quarterly revenue or operating results falls below the expectations of investors or securities analysts, the price of our common stock could fall substantially. Our quarterly operating results may fluctuate as a result of a variety of factors, including: - seasonality -- due to the budget and purchasing cycles of our customers, we expect our revenue and operating results will generally be strongest in the fourth quarter of our fiscal year and weakest in the first quarter; and - non-recurring charges related to acquisitions, - the expenses we incur to support the anticipated growth of our business. Most of our expenses, such as rent and most employee compensation, do not vary directly with revenue and are difficult to adjust in the short term. As a result, if revenue for a particular quarter is below our expectations, we could not proportionately reduce operating expenses for that quarter. Any such revenue shortfall would, therefore, have a disproportionate effect on our expected operating results for that quarter. In addition, we expect that a disproportionate amount of our revenue each quarter will be recognized in the final weeks of that quarter. As a result, any delays in receiving orders or signing contracts may defer the associated revenue to the following quarter, which would adversely affect our operating results for the preceding quarter. OUR BUSINESS WILL SUFFER IF E-LEARNING PRODUCTS ARE NOT WIDELY ADOPTED Our e-Learning solutions represent a new and emerging approach for the corporate education and training market. Our success depends substantially upon the widespread adoption of e-Learning products for education and training. The early stage of development of this market makes it difficult for us to predict customer demand accurately. The failure of this market to develop, or a delay in the development of this market -- whether due to technological, competitive or other reasons -- would severely limit the growth of our business and adversely affect our financial performance. INTENSE COMPETITION FROM OTHER EDUCATION AND TRAINING COMPANIES COULD IMPAIR OUR ABILITY TO GROW AND TO ACHIEVE PROFITABILITY The market for corporate education and training products is fragmented and highly competitive. Increased competition may result in lost sales and may force us to lower prices. We expect that competition in this market will increase substantially in the future. One source of competition for our products is the internal educational and technological personnel of potential customers. If an organization decides to use external providers to supply some or all of its training, our principal sources of competition are: 15 - Providers of traditional classroom instruction. Many of the companies, colleges and universities in this category are attempting to adapt their courses to e-Learning formats suitable for deployment over the internet and corporate intranets. - Providers of CD-ROM training courses. - Suppliers of corporate education and training products. We may be unable to maintain or improve our competitive position. Many of our current and potential competitors have longer operating histories, greater name recognition and greater financial, technical, sales, marketing, support and other resources than we do. This may place us at a disadvantage in responding to competitors' pricing strategies, marketing campaigns, and technological advances, alliances and other initiatives. WE RELY ON A LIMITED NUMBER OF THIRD PARTIES TO PROVIDE US WITH EDUCATIONAL CONTENT FOR OUR COURSES, AND THEY MAY NOT BE ABLE TO DEVELOP NEW COURSES OR ENHANCE EXISTING COURSES ON A TIMELY BASIS, AND WE RELY ON A LIMITED NUMBER OF PUBLISHERS TO PROVIDE US WITH CONTENT FOR OUR REFERENCEWARE To be competitive, we must develop and introduce on a timely basis new course offerings which meet the needs of companies seeking to use our education and training products. In addition, some of our courses may need to be updated due to changes in educational doctrines or the evolving requirements of educational institutions and certification organizations. We rely on independent third parties to provide us with the educational content for our courses based on learning objectives and specific instructional design templates that we provide to them. We do not have exclusive arrangements or long-term contracts with any of these content providers. If one or more of our third party content providers were to stop working with us, we would have to rely on other parties to develop our course content. In addition, these providers may fail to develop new courses or enhance existing courses on a timely basis. We cannot predict whether new content or enhancements would be available from reliable alternative sources on reasonable terms. In addition, our Books24x7.com Group relies exclusively on content from third party publishers for it referenceware products. If one or more of these publishers were to terminate their license with us, we may not be able to find substitute publishers for such content. In addition, we may be forced to pay increased royalties to these publishers to continue our licenses with them. OUR COURSE CONTENT PROVIDERS SUPPLY US WITH THE EDUCATIONAL CONTENT OF OUR COURSES AND ARE GENERALLY NOT RESTRICTED FROM DEVELOPING SIMILAR CONTENT FOR OUR COMPETITORS, WHICH COULD MAKE IT EASIER FOR OUR COMPETITORS TO COMPETE WITH US We rely on independent third parties to provide us with the educational content for our courses based on learning objectives and specific instructional design templates that we provide to them. Our agreements with these content providers do not restrict them from developing courses on similar topics for our competitors or from competing directly with us, so long as they do not use our toolkit or templates. As a result, our competitors may be able to duplicate some of our course content and may, therefore, find it easier to enter the market for corporate education and training. OUR SUCCESS DEPENDS ON THE SERVICES OF CHARLES E. MORAN AND OUR OTHER EXECUTIVE OFFICERS AND KEY EMPLOYEES Our future success depends to a significant degree on the skills and efforts of Charles E. Moran, our founder, Chairman of the Board, President and Chief Executive Officer. The loss of the services of Mr. Moran could have a material adverse effect on our business and financial performance. We also depend on the ability of our other executive officers and members of senior management to work effectively as a team. The loss of one or more of our executive officers or senior management members could result in less effective development of our products and management of our business, which could have a material adverse effect on our business and financial performance. OUR FUTURE GROWTH DEPENDS ON SUCCESSFUL HIRING AND RETENTION, PARTICULARLY WITH RESPECT TO SALES, MARKETING AND DEVELOPMENT PERSONNEL, AND WE MAY BE UNABLE TO HIRE AND RETAIN THE SKILLED PERSONNEL WE NEED TO SUCCEED 16 Our failure to attract and retain sufficient skilled personnel, particularly sales and marketing personnel, may limit the rate at which we can grow, may adversely affect the quality or availability of our products and may result in less effective management of our business, any of which may harm our business and financial performance. Qualified personnel are in great demand throughout the software industry. Moreover, newly hired employees generally take several months to attain full productivity, and not all new hires satisfy our performance expectations. THE VARIABILITY AND LENGTH OF THE SALES CYCLE FOR OUR PRODUCTS MAY MAKE OUR OPERATING RESULTS UNPREDICTABLE AND VOLATILE The period between our initial contact with a potential customer and the purchase of our products by that customer typically ranges from three to 12 months. Factors that contribute to our long sales cycle, include: - our need to educate potential customers about the benefits of our products; - competitive evaluations by customers; - the customers' internal budgeting and approval processes; - the fact that some customers view training products as discretionary spending, rather than purchases essential to their business; and - the fact that we target large companies, which often take longer to make purchasing decisions due to the size and complexity of the enterprise. Our long sales cycle makes it difficult for us to predict if and when a potential sale will actually occur. In addition, if a sale is delayed from the quarter in which we expect it to occur, our operating results for that quarter would be adversely affected. OUR FAILURE TO PROPERLY MANAGE OUR RECENT AND ANTICIPATED GROWTH COULD HAVE A MATERIAL ADVERSE EFFECT ON THE QUALITY OF OUR PRODUCTS, OUR ABILITY TO RETAIN KEY PERSONNEL AND THE EFFICIENCY OF OUR OPERATIONS Our failure to properly manage our recent and anticipated growth could have a material adverse effect on the quality of our products, our ability to retain key personnel and the efficiency of our operations, any of which could have a material adverse effect on our business and financial performance. From February 1, 2001 to January 31, 2002, the number of our employees increased from 234 to 314, including 58 employees added as a result of our December 2001 acquisition of Books24x7.com. In addition, as a result of the Books24x7.com acquisition, we now operate out of two distinct locations - the SkillSoft organization is located in Nashua, New Hampshire and the Books24x7.com Group operates out of a facility in Norwood, Massachusetts - which may make it more difficult to integrate and manage the Books24x7.com Group. This growth has strained, and our future growth may continue to strain, our management, operational systems and other resources. To manage our growth effectively, we must be able to maintain and enhance our financial and accounting systems and controls, integrate new personnel and manage expanded operations. We may be unable to do so. BECAUSE MANY OF OUR COURSES AND TECHNOLOGIES ARE STILL UNDER DEVELOPMENT AND WE EXPECT TO CONTINUE TO DEVELOP NEW COURSES AND ENHANCE OUR TECHNOLOGIES, OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO INTRODUCE THESE NEW COURSES AND TECHNOLOGIES ON A TIMELY BASIS OR IF NEW COURSES ARE UNSUCCESSFUL Our future success will depend significantly on whether we are able to introduce new courses and enhance our Web-based technologies on a timely basis. While we have new courses and technology features scheduled for commercial launch, we may not be successful in releasing them as scheduled, and they may not meet with market acceptance. We may not have sufficient resources to develop the new courses and technology enhancements necessary to maintain or improve our competitive position. BECAUSE OUR PRODUCTS AND SERVICES MAY NOT BE VIEWED BY OUR CUSTOMERS AS ESSENTIAL TO THEIR BUSINESS, DEMAND FOR OUR PRODUCTS MAY BE ESPECIALLY SUSCEPTIBLE TO ADVERSE ECONOMIC CONDITIONS 17 Our business and financial performance may be damaged, more so than most companies, by adverse financial conditions affecting our target customers or by a general weakening of the economy. Some companies may not view training products as critical to the success of their business. If these companies experience disappointing operating results, whether as a result of adverse economic conditions, competitive issues or other factors, they may decrease or forego education and training expenditures before limiting their other expenditures. WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS, AND OUR PRODUCTS MUST ADAPT TO FREQUENT CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS, AND WE MAY HAVE DIFFICULTY INTRODUCING NEW PRODUCTS OR KEEPING UP WITH THESE CHANGES The market for education and training products is characterized by rapidly changing technologies, frequent new product and service introductions and evolving industry standards. The growth in the use of the Web and intense competition in our industry exacerbate these market characteristics. If we fail to adapt to rapidly changing technologies and customer demands by continually improving the features and performance of our products on a timely basis, we may lose existing customers or fail to gain new customers. In addition, we could incur substantial costs to modify our services or infrastructure to adapt to rapid technological change. THE NATURE OF OUR PRODUCTS MAKES THEM PARTICULARLY VULNERABLE TO UNDETECTED ERRORS, OR BUGS, WHICH COULD REDUCE OUR REVENUE, MARKET SHARE OR THE DEMAND FOR OUR PRODUCTS Product performance problems could result in lost or delayed revenue, loss of market share, failure to achieve market acceptance, diversion of development resources or injury to our reputation, any of which could have a material adverse effect on our business and financial performance. Software products such as ours may contain undetected errors, or bugs, that result in product failures or poor product performance. Our products may be particularly susceptible to bugs or performance degradation because of the emerging nature of Web-based technologies and the stress that may be placed on our products by the full deployment of our products to thousands of users. WE MAY BE UNABLE TO GENERATE ENOUGH REVENUE FROM OUR INTERNATIONAL EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND MAINTAINING FOREIGN OPERATIONS A key component of our growth strategy is to expand our presence in foreign markets. It will be costly to establish international operations, market our products internationally and support and manage geographically dispersed operations. Revenue from international operations is unlikely to offset the expense of establishing and maintaining these foreign operations in the foreseeable future. OUR INTERNATIONAL BUSINESS WILL EXPOSE US TO RISKS WE HAVE NOT HAD TO FACE IN OUR U.S. OPERATIONS As we grow our international operations, we will have to increasingly confront and manage a number of risks that we have not had to address in our U.S. operations. We may not be successful in managing these risks. These risks include: - expenses associated with customizing products for foreign countries; - challenges and costs inherent in managing geographically dispersed operations; - protectionist laws and business practices that favor local competitors; - economic or political instability in some international markets; - difficulties in finding and managing local resellers; - longer sales and payment cycles; - multiple, conflicting and changing governmental laws and regulations; and 18 - foreign currency exchange rate fluctuations. BECAUSE MANY USERS OF OUR COURSES ACCESS THEM OVER THE INTERNET, FACTORS ADVERSELY AFFECTING THE USE OF THE INTERNET COULD HARM OUR BUSINESS Some users access our courses over the public internet. Examples include users who access courses from their employer's intranet via remote access and employees of companies that utilize our hosting services and who therefore access courses from SkillSoft-managed servers via the internet. Any factors that adversely affect internet usage could disrupt the ability of those users to access our courses, which would adversely affect customer satisfaction and therefore our business. Among the factors that could disrupt internet usage is: - slow access and download times; - security concerns; - network problems or service disruptions that prevent users from accessing an internet server; and - delays in, or disputes concerning, the development and adoption of industry-wide internet standards and protocols. WE COULD BE SUBJECTED TO LEGAL ACTIONS BASED UPON THE CONTENT WE OBTAIN FROM THIRD PARTIES OVER WHOM WE EXERT LIMITED CONTROL It is possible that we could become subject to legal actions based upon claims that our course content infringes the rights of others or is erroneous. Any such claims, with or without merit, could subject us to costly litigation and the diversion of our financial resources and management personnel. The risk of such claims is exacerbated by the fact that our course content is provided by third parties over whom we exert limited control. Further, if those claims are successful, we may be required to alter the content, pay financial damages or obtain content from others. OUR PRODUCTS MAY BE SUSCEPTIBLE TO CLAIMS BY OTHER COMPANIES THAT OUR PRODUCTS INFRINGE UPON THEIR INTELLECTUAL PROPERTY, WHICH COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION If any of our products violate the proprietary rights of third parties, we may be required to reengineer our products or to obtain licenses to continue offering our products without substantial reengineering. Any efforts to reengineer our products or obtain licenses from third parties may not be successful and, in any case, could have a material adverse effect on our business and financial performance by substantially increasing our costs. We do not conduct comprehensive patent searches to determine whether the technologies used in our products infringe upon patents held by others. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. THE PRICE OF OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE PAST AND MAY CONTINUE TO DO SO Our common stock price has fluctuated significantly since our initial public offering on February 1, 2000. While much of the fluctuation in our common stock price may be due to our business and financial performance, we believe that these fluctuations are also due in large part to fluctuations in the stock market in general based on factors not directly related to our performance, such as general economic conditions or prevailing interest rates. As a result of these fluctuations in the price of our common stock, it is difficult to predict what the price of our common stock will be at any point in the future, and you may not be able to sell your common stock at or above the price that you paid for it. WARBURG, PINCUS VENTURES, L.P. AND OUR EXECUTIVE OFFICERS AND DIRECTORS AND THEIR AFFILIATES BENEFICIALLY OWN A SIGNIFICANT PORTION OF OUR OUTSTANDING COMMON STOCK WHICH WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE ACTIONS 19 The concentration of ownership of our common stock may have the effect of delaying, preventing or deterring a change in control of SkillSoft, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of SkillSoft and might affect the market price of our common stock. Warburg, Pincus Ventures, L.P. owns approximately 32% of our outstanding common stock and, together with our executive officers and directors and their affiliates, beneficially owns approximately 44% of our outstanding common stock. As a result, those stockholders, if they act together, are able to substantially influence or control all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions and amendments to our certificate of incorporation. These stockholders may use their ownership position to approve or take actions that are adverse to your interests. SOME PROVISIONS OF OUR CHARTER AND BY-LAWS MAY DELAY OR PREVENT TRANSACTIONS THAT MANY STOCKHOLDERS MAY FAVOR The following provisions of our certificate of incorporation and by-laws may discourage, delay or prevent a merger or acquisition that our stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares.: - the ability of our board of directors to issue preferred stock, and determine its terms, without a stockholder vote; - our classified board of directors, which effectively prevents stockholders from electing a majority of the directors at any one annual meeting of stockholders; - the prohibition against stockholder actions by written consent; and - the inability of stockholders to call a special meeting of stockholders. In addition, some provisions of Delaware law, particularly the "business combinations" statute in Section 203 of the Delaware General Corporation Law, may also discourage, delay or prevent someone from acquiring us or merging with us. ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of July 31, 2002, SkillSoft does not use derivative financial instruments. Interest Rate Risk SkillSoft's general investing policy is to limit the risk of principal loss and to ensure the safety of invested funds by limiting market and credit risk. SkillSoft currently uses a registered investment manager to place its investments in highly liquid money market accounts and government-backed securities. All highly liquid investments with original maturities of three months or less are considered to be cash equivalents. Interest income is sensitive to changes in the general level of U.S. interest rates. Based on the short-term nature of our investments, SkillSoft has concluded that there is no material market risk exposure. Foreign Currency Exchange Risk SkillSoft develops products in the United States and sells them worldwide. As a result, its financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since its sales are currently priced in U.S. dollars and translated to local currency amounts, a strengthening of the dollar could make its products less competitive in foreign markets. ITEM 4. - CONTROLS AND PROCEDURES Not applicable. PART II ITEM 1. - LEGAL PROCEEDINGS 20 On May 31, 2002, IP Learn, LLC ("IP Learn") served SkillSoft with a complaint alleging that SkillSoft is infringing several of IP Learn's United States patents. The complaint seeks both monetary damages and injunctive relief. The complaint has been filed with the United States District Court for the Northern District of California. SkillSoft is not yet able to assess the merits of this lawsuit. However, based upon information currently available, management does not anticipate this suit will have a material impact on SkillSoft's business or operating results. Please refer to our Annual Report on Form 10-K for a description of litigation pending against us. ITEM 2. - CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. - DEFAULTS UPON SENIOR SECURITIES. Not applicable. ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Our Annual Meeting of Stockholders was held on June 13, 2002. The following proposals were adopted by the vote specified below:

ITEM 5. - OTHER INFORMATION. Not applicable. ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K. (A) Exhibits Not applicable. (B) Reports on Form 8-K The Company filed a Current Report on Form 8-K dated June 10, 2002 that reported under Item 5 the Company's execution of an Agreement and Plan of Merger with SmartForce Public Limited and Slate Acquisition Corp., a wholly-owned subsidiary of SmartForce. 21 The Company filed a Current Report on Form 8-K dated June 25, 2002 that reported under Item 4 the Company's dismissal of Arthur Andersen LLP as the Company's independent accountants and engagement of Ernst & Young LLP as the Company's independent accountants. 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SKILLSOFT CORPORATION (Registrant) By: /s/ Thomas J. Mcdonald --------------------------------- Thomas J. McDonald, Chief Financial Officer Date: September 5, 2002 CERTIFICATIONS I, CHARLES E. MORAN, CERTIFY THAT: 1. I have reviewed this quarterly report on Form 10-Q of SkillSoft Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. Date: September 5, 2002 /s/ Charles E. Moran -------------------------------------- Charles E. Moran President and Chief Executive Officer (principal executive officer) I, THOMAS J. MCDONALD, CERTIFY THAT: 1. I have reviewed this quarterly report on Form 10-Q of SkillSoft Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. Date: September 5, 2002 /s/ Thomas J. McDonald ------------------------------------- Thomas J. McDonald Chief Financial Officer (principal financial officer) 23

SKILLSOFT CORP 10-Q