**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM10-K**

 
| **(Mark One)**                                                                                                                        |
|---------------------------------------------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                            | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                  |   |   |
| **For the fiscal year ended December 31, 2005**                                                                                  |
| ** **                                                                                                                            |
| **OR**                                                                                                                                |
|                                                                                                                                  |
| **o**                                                                                                                                 | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                  |   |   |
| **For the transition period  from                to** |
| ** **                                                                                                                            |
| **Commission file number 000-28393**                                                                                                  |

 

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**eCollege.com**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                       | ** ** | **84-1351729**                       |
|--------------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)     |       | (I.R.S. Employer Identification No.) |
| ** **                                                         | ** ** | ** **                           |
| **One N. LaSalle ****Street, Suite 1800,  Chicago, Illinois** | ** ** | **60602**                            |
| (Address of principal executive offices)                           |       | (Zip Code)                           |

 

Registrant’stelephone number, including area code **(312) 706-1710**

 

Securitiesregistered pursuant to Section 12(b) of the Act: **None.**

 

Securitiesregistered pursuant to Section 12(g) of the Act:**Common Stock**(Title ofClass)

 

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Indicate by check mark if the registrant is a well-knownseasoned issuer, as defined in Rule 405 of the Securities Act. o Yes    ý No

 

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes    ý No

 

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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. ý Yes    o No

 

Indicated by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, andwill not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

 
| Large  Accelerated Filer  o |   | Accelerated  Filer ý |   | Non-Accelerated  Filer o |
|----------------------------------|--------|---------------------------|--------|--------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act. oYes  ý No

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the registrant as of June30, 2005, the last business day of the registrant’s most recently completedsecond fiscal quarter, was approximately $207,270,916, based on the closingprice of the common stock as reported on the Nasdaq National Market.

 

As of March 13, 2006, 22,054,627 shares of ourcommon stock were outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**[None]

 

 

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**eCollege.com**

**FORM 10-K**

 

**For theYear Ended December 31, 2005**

 

**TABLE OFCONTENTS**

 
| **PART I**   |
|--------------|
|         |   |   |
| ITEM 1:      | Business |   |
| ITEM 1A:     | Risk Factors |   |
| ITEM 1B:     | Unresolved Staff Comments |   |
| ITEM 2:      | Properties |   |
| ITEM 3:      | Legal Proceedings |   |
| ITEM 4:      | Submission of Matters to a  Vote of Security Holders |   |
| ** **   | ** ** | ** ** |
| **PART II**  |
| ** **   | ** ** | ** ** |
| ITEM 5:      | Market For Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities |   |
| ITEM 6:      | Selected Financial Data |   |
| ITEM 7:      | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   |
| ITEM 7A:     | Quantitative  and Qualitative Disclosures About Market Risk |   |
| ITEM 8:      | Financial  Statements and Supplementary Data |   |
| ITEM 9:      | Changes In  and Disagreements With Accountants on Accounting and Financial Disclosures |   |
| ITEM 9A:     | Controls and  Procedures |   |
| ITEM 9B:     | Other Information |   |
| ** **   | ** ** | ** ** |
| **PART III** |
| ** **   | ** ** | ** ** |
| ITEM 10:     | Directors  and Executive Officers of the Company |   |
| ITEM 11:     | Executive  Compensation |   |
| ITEM 12:     | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |   |
| ITEM 13:     | Certain  Relationships and Related Transactions |   |
| ITEM 14:     | Principal  Accountant Fees and Services |   |
| ** **   | ** ** | ** ** |
| **PART IV**  |
| ** **   | ** ** | ** ** |
| ITEM 15:     | Exhibits and  Financial Statement Schedules |   |
| Signatures   |   |   |

 

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**PART I**

 

References in this AnnualReport on Form 10-K to “eCollege,” the “Company,” “we,” “us” or “our” refer to eCollege.comand its subsidiaries unless the context otherwise requires.

 

**Information Concerning Forward-Looking Statements.**  This Annual Report onForm 10-K contains “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995 which reflect our currentexpectations and beliefs regarding the Company’s future results of operationsand performance and other future developments. You can identify theseforward-looking statements when you see us using words such as “expect,” “anticipate,”“estimate,” “plan,” “believe” and other similar expressions, and suchstatements include, but are not limited to, statements concerning the Company’splans to offer additional products or services, the timing of any suchofferings and the expected benefits to customers of any such offerings;expected technology developments; the Company’s growth strategy; futurefinancial and operating results; future enrollment levels; future levels ofcapital expenditures; expected seasonality; and any other statements that arenot based on historical facts.

 

We caution our readers that these forward-lookingstatements involve risks and uncertainties. Our actual results could differmaterially from those anticipated in these forward-looking statements as aresult of, among other things, the factors described in  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations, Risk Factors and elsewhere inthis report, and in the Company’s filings with the Securities and Exchange Commission(the “SEC”). We advise readers not to place undue reliance on theforward-looking statements contained in this report, which reflect our beliefsand expectations only as of the date of this report. We undertake no obligationto update or revise these forward-looking statements to reflect new events orcircumstances or any changes in our beliefs or expectations, other than asrequired by law.

 

**ITEM1:    BUSINESS**

 

**General**

 

eCollege is an outsource provider of valueadded information services to the post-secondary education industry. We wereorganized as a Delaware corporation in 1999 and operate through two divisions,our eLearning division and our Enrollment division, Datamark, Inc. (the terms “Datamark”and “Enrollment division” are used interchangeably throughout this report todescribe the latter division).

 

 OureLearning division provides on-demand outsourced technology, products andservices that enable colleges, universities and high schools (“K-12 schools”)to offer online distance and hybrid educational programs as well as on-campuscourses. Datamark provides integrated enrollment marketing services,primarily to the proprietary post-secondary school industry.

 

Our growth strategies are aimed at providingvalue-added information services along the student life cycle to our targetmarket, which consists of for-profit and growth oriented not-for-profitpost-secondary schools, colleges, universities and K-12 schools in the UnitedStates and Canada.  The student life cycle is the chain of activities andinteractions a student goes through, from the beginning of the decision to goto school (or go back to school), throughout the completion of courses, tograduation and career placement and progression.  Our goal is to provideour customer institutions with value-added solutions along this chain, therebyhelping to ensure the efficient and effective growth of their educationalprograms. After careful analysis, we recently decided to invest in theinternational expansion of our eLearning business, initially by supportingUnited States clients who are expanding internationally and then by moving intoselected international markets over the next several years.

 

Theprincipal components of the Company’s growth strategy include:

 

***Continue fueling the profitable growth ofour current customers through existing services and in so doing drive our ownrevenue growth:*****As oursolutions in both the eLearning division and the Enrollment divisionsuccessfully help our clients attract, retain and educate a growing pool ofstudents, our revenue increases.  In the eLearning division, our pricestructure is tied directly to the number of course enrollments on ourplatform.  In the Enrollment division, as our products and services helpdrive customers’ enrollments and corresponding revenues, there is anopportunity for our revenues to grow along with our customers’ increasingmarketing expenditures.

 

***Add new products and services along thestudent life cycle that leverage both divisions in bringing additional value toour  target market*****:** This growth strategy involves gainingmarket acceptance of recent and planned product introductions within divisions,planning the development and integration of new product opportunities acrossthe divisions, and analyzing other solution providers in the industry forpotential acquisitions to provide additional products and services that arecomplementary to our core businesses. As part of our commitment to operationalexcellence in our new products, we recently

 

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expanded the role of theProduct Engineering & Technology organization, originally part of oureLearning business, to also support product innovation in the Enrollmentbusiness. We have also created a cross-divisional product committee, led bysenior executives, to align development resources with a unified productvision.

 

***Up-sell and cross-sell additional servicesto current customers*****:** Up-selling involves selling additional products and services to currentcustomers within the eLearning and Enrollment divisions. Cross-selling focuseson selling products of one operating division to appropriate customers of theother division.  Our past cross-selling experience has focused on thebiggest revenue opportunities and customers most resembling the institutionscurrently served by each division.  We intend to expand our cross-sellinginitiatives to package Enrollment solutions appropriately across varioussegments of customers within eLearning to help those clients achieve their growthtargets. In addition, we plan to market eLearning solutions as a core growthengine for appropriate Enrollment division clients.

 

***Add additional customers***:  We expect to continue to increase ourcustomer base by targeting sales efforts at entrepreneurially-mindedinstitutions that are committed to achieving enrollment growth in both onlineand on-campus programs.  Additionally, we will explore strategicrelationships where appropriate to drive sales of our products andservices.  For example, we recently entered into an agreement with acourse evaluation vendor that combines the vendor’s course evaluations with ouronline survey technology and infrastructure. Under the agreement, both ourclients and the vendor’s clients can purchase access to quality assessmentinstruments delivered through our platform. The agreement provides us with anadditional channel to facilitate sales of our online survey applications.

 

***Expand the eLearning business to selected international markets:***Webelieve that certain countries present significant opportunities for onlineeducation as they move towards knowledge-based economies. We intend to beginour international expansion in 2006 by internationalizing the eLearningplatform and supporting clients who wish to begin operating with us in selectinternational markets in the latter half of the year. We will also exploreother business opportunities and distribution channels in internationalmarkets. We do not expect our international expansion to generate significantrevenue in 2006.

 

**Segment Information**

 

eCollegehas two business segments, eLearning and Enrollment. A summary of our netrevenue, income from operations, and assets for each of our business segmentsmay be found in Items 7 and 8 of this Annual Report on Form 10-K.

 

**Our Solution**

 

**eLearning**

 

OureLearning technology, products and services are designed to be comprehensive,powerful and flexible to drive the success and growth of the online educationalprograms of our target market. As an on-demand software vendor, we provide ourcustomers access to our software products, consisting of online campuses,courses, reporting, content management and program administration solutions,through hosting services in our reliable data centers. We also provide servicescomplementing our software, including design, development and management ofonline campuses and courses, as well as ongoing administration, faculty andstudent support. Our suite of products and services provides customers with theflexibility to either outsource the development of their online campus andcourses or to select individual products and services to meet their uniqueneeds.

 

*The eCollege System*SM.    The eCollege System consists of proprietary,web-based  software and services thatfacilitate the creation of online programs by our customers and support theiroperational and academic needs. The eCollege System includes eCollege TeachingSolutionsSM, eCollege Program Administration SolutionsSMand our technology infrastructure.

 

*eCollege Teaching Solutions.*    eCollege TeachingSolutions support the development, delivery and efficient management of qualityonline courses and the training of online instructors. The eCollege AU+SMCourse Management System is our teaching and learning system for online coursedelivery. The eCollege Teaching Solutions include the following:

 

**eCourseSM and eCompanionSM.**    eCourse, ourfully-online course designed for distance learning and hybrid learning (whichencompasses both online and face-to-face class sessions), includes applicationsnecessary for managing courses, outlining assignments, facilitating classdiscussions, conducting lectures, testing, grading and interacting with andamong students. The majority of our eLearning revenue is derived from studenttechnology service fees charged for enrollments in eCourses. eCompanion, ourlower-priced online supplement to a face-to-face or on-campus course, offerscustomers some of the functions of eCourse and provides instructors with thetools necessary to create an interactive online component to supplementtraditional on-campus courses.

 

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**Content Manager.**The eCollege Content Manager helps our customers centrally manage,standardize and reuse content across multiple programs, courses, sections andother applications. Content Manager is tightly integrated into eCollege’scourse management system so users do not have to go outside of a course tocreate, edit, search for or add content to a course or course section.

 

*eCollege Program Administration Solutions.*    The eCollege ProgramAdministration Solutions include products and services that provide assistanceand tools to our customers’ administrators to assist them in enhancing overallprogram quality and efficient administration. These products and servicesinclude:

 

**Gateway CampusSM and CampusPortalSM.**    Gateway Campus andCampusPortal are online portal products that offer community, academic andadministrative functions similar to those found on a physical college campus.The Gateway Campus provides access to online campus services, courses andcourse supplements, and includes faculty and administrative services. Ourcustomers can choose to add premium features, such as interactive coursecatalogs, online admissions forms and online registration, to their GatewayCampus. CampusPortal is our most comprehensive portal product and includes allof the functionality of the Gateway Campus and the premium features.

 

**Program Management and Reporting.**    We assign everycustomer a client services consultant and a back-up team to provide assistancewith term and course administration and user management, and to ensure that thecustomer’s communications and reporting needs are met. We also offer customersa wide range of standard reports, including activity usage and enrollmentreports that analyze student data to help customers manage their onlineprograms. In addition, we are able to create custom reports that respond to ourcustomers’ unique needs.

 

**Evaluation Solutions.**    Evaluation Solutionsare comprehensive Internet-based products that automate the entire course andinstructor evaluation process. These products allow our customers to gatherdata from students and faculty online, and then aggregate the data into reportsto help monitor course and program quality and instructor effectiveness.

 

**Program Intelligence Manager.**ProgramIntelligence Manager is an interactive analysis toolset that enables customersto identify and act on key drivers affecting student satisfaction, course andprogram quality and course completion and student retention rates. Thefunctionality allows customers to analyze user activity and trends acrossmultiple courses, programs and schools.

 

*eCollege Services.*eCollege offers asuite of professional services that complement its Teaching and ProgramAdministration Solutions. These offerings include:

 

**Help Desk.**    As part of our core offering, we provideassistance to students, faculty and administrators 24 hours a day,365 days a year, to ensure that technical questions related to theeCollege System are resolved quickly and effectively.

 

**Course Development and Support, Instructional DesignConsulting and Training, and Content Solutions.**    We offer coursedevelopment services to help customers reduce the time it takes to develop newcourse offerings, create enhancements to existing courses with new learningobjects or multi-media, and convert existing course content from othercompanies’ course management systems. Our instructional designers leverage ourproduct and service offerings to help customers deliver quality online courses,instruction and programs.

 

**Technical Consulting.**    Our softwaredevelopment team offers custom technical consulting to meet a customer’s uniqueneeds, whether it be for a special eLearning-related application, a customizedbrochure website, or for integrating the customer’s online programs with itsstudent information systems and other enterprise-wide applications through ouropen platform initiative.

 

*Technology Infrastructure.*    eCollege’s technologyinfrastructure provides our customers with a turnkey online program solutionand offers reliability, scalability, accessibility, security and performancedesigned to provide program stability and growth. The reliability of aninstitution’s online learning environment and support services can affect itsfaculty and student satisfaction, and thus its student completion, retentionand graduation rates. Our technology infrastructure consists of:

 

**Hosting.**    As an on-demand provider, we host our softwarefor our customers in a highly reliable and scalable hosting environment,allowing customers to provide their online programs through a standard Webbrowser. We have two commercial data centers and have built redundancy intoevery critical area of the eCollege System, including security, switches,communication servers, network management, Web servers, application servers,database servers and data storage. This redundancy enabled us to achieve99.999% internal system availability to our customers during the 2003-2004  academic year, 99.978% availability duringthe 2004-2005 academic year and 99.989% availability thus far in the 2005-2006academic year.

 

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**Internet Connectivity.**    To ensure maximumup-time for our customers, we provide full OC-3 and Gigabit Ethernetconnections balanced over three Tier I Internet providers: multiple Internetproviders to insure instant data rerouting if one of the connections shouldever fail;  .Alt Access—a completely separate alternate network path to acustomer’s website; and world-wide network and application performancemonitoring.

 

**Product Advancement.**    Our development andquality assurance teams focus not only on features and functionality, but alsoon the usability and scalability of our products. All new product developmentinitiatives go through a rigorous definition, development and quality assuranceprocess. Furthermore, because of our on-demand model, whenever we release anupgrade or enhancement to our Teaching Solutions or Program AdministrationSolutions, all of our customers have immediate access to the benefits of thenew product offering.

 

**Enrollment**

 

The products and services offered by Datamark arefocused on three stages of the student life cycle: recruiting (leadgeneration), enrollment (lead conversion), and student retention. Our leadgeneration products primarily consist of direct mail, media placement andinteractive marketing solutions that are designed to attract the interest ofthe most likely candidates for enrollment at our customers’ institutions. Weprovide sophisticated lead response tracking and utilize that tracking tooptimize the media mix for customers on a continual basis.

 

With respect to enrollment products and services, weprovide lead conversion systems and training to enhance the performance of ourcustomers’ admissions employees, as well as post-lead communication campaignsto increase the number of leads that actually convert into enrollments. OurLeadBoost service is a customized lead contact strategy that uses a tailoredmix of mail, interactive and telephonic media to keep interested prospectsengaged.

 

Our retention marketing products and servicesinclude a suite of tools for identifying “at risk” students, communicationplans to help those students stay in school and monitoring and response plansto keep track of students as they progress through the program.

 

The following is adescription of Datamark’s key product and service offerings:

 

**DirectMail***.*    Weaccess comprehensive lists of potential students from several leading studentmarketing groups. These lists include information about high school students aswell as non-traditional learning prospects. We also have direct online access,through national list compilers, to lists that target young adults, careerchangers and individuals seeking continuing education. By targeting selectedgroups,  we help to ensure that mailingsare received by qualified sales leads and enable our customers to reachpotential students at lower costs. Datamark also provides customized responsemodeling and list development. Our custom software and database systems enableus to streamline the direct mail production process and provide efficientturnaround times for direct mailings.

 

**InteractiveMarketing.**    Weoffer interactive services based on managing and buying internet media mixesfor lead generation on behalf of our customers. Our eMaxSM servicecreates customer leads through Web marketing, using techniques   such as online advertising and media placements,search management and email communications. We also offer  research and competitive analysis, searchengine optimization and web site design and related services. Our eOptSMsolution allows us to group smaller schools together and purchase media for thegroup as a whole to obtain more efficient rates. Our database driven leadmanagement system provides a complete lead verification process that minimizesthe number of invalid leads sent to our customers, as well as  real-time reporting  on key aspects of our customers’ media buys. Werecently introduced an interactive product model under which the customerprocures the lead and we provide lead “scrubbing,” media management, analyticand other services.

 

**MediaPlacement.**    Weprovide comprehensive media buying for both broadcast and print advertisingmedia. Through our MediamaxSM lead tracking technology, ourcustomers can obtain real-time information on media-generated leads and measurethe effectiveness of various advertisements.

 

**StudentRetention.**    OurPath FinderTM solution is a custom-designed retention solution that records and mines data comprisedof student success guides, course evaluation surveys, student satisfactionsurveys, faculty and staff surveys and exit surveys. While the program isdesigned to help all students succeed, it is particularly effective atidentifying students most susceptible to attrition and utilizes specializedtools and technologies to motivate  themto stay in in school. This enhanced monitoring allows our customers toproactively address student issues and increase retention rates. OurStartBoostTM solution is a custom-designed solution that identifies thoseenrolled students who are at risk for not starting their courses or programsand provides specialized email, mail and telephone communications designed tomotivate them to start.

 

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**Other Products***.* Other Datamark products include customresearch, admissions training and admissions shopper services. Our custom researchincludes focus groups, surveys and studies of curriculum mix, school site locations and other factors that affect enrollment and retention. We also offertraining to our customers’ admissions staffs to improve their conversion rateof leads into enrollments. Our admissions shopper services allow customers toview the admissions process through the eyes of a prospect. These services aresupported by specialized database technology and research and optimizationmethods.

 

**Customers**

 

We define customers based on their common ownership.Even though certain school groups do not centralize budgetary or purchasingdecisions, a goup of customers under common control or otherwise affiliatedwith each other is regarded as a single customer.. Online distance educationpurchasing decisions are generally made at the consolidated school group level,while enrollment marketing budgetary and purchasing decisions are more oftenmade at the individual school or campus level.

 

As of December 31, 2005, our eLearning divisionhad more than 280 customers located primarily in the United States and Canada.Our eLearning customers include some of the fastest growing and largestprograms for online degrees, certification and professional development. TheeLearning division serves for-profit education companies and post-secondaryschools, public and private universities, community colleges, career commutercolleges, state departments of education and K-12 school districts. Inaddition, we have contracts with several providers of continuing education andcorporate training. For the year ended December 31, 2005, our 30 largesteLearning customers accounted for approximately 70% of our eLearning revenue.

 

OurEnrollment division operates in three key customer sectors within the post-secondarymarket: proprietary; continuing education; and community colleges, with themajority of customers coming from the proprietary sector. As of December 31,2005, the Enrollment division had more than 150 customers. These customers arelocated throughout the United States and Canada. For the year ended December31, 2005, our 30 largest Enrollment customers accounted for approximately 92%of our Enrollment division revenue.

 

For the year ended December 31, 2005,Corinthian Colleges, a customer of both the eLearning and Enrollment divisions,accounted for approximately 22% of our consolidated revenue.

 

**Sales and Marketing**

 

**eLearning**

 

Wetarget prospective customers in the United States and Canada. We have adedicated eLearning sales force who are responsible for new businessdevelopment and whom we compensate with a combination of base salary,revenue-based commissions and bonuses for sales and specified sales activities,including activities relating to cross-sales of Datamark services. Most membersof the sales force have a background in education and/or technology. We divideour sales force into two groups: post-secondary education and K-12, eachmanaged by a vice president responsible for regional directors located withinthe geographic territories they serve. Our regional directors focus on sellingto institutions with large distance programs or the potential for largedistance programs within a clearly defined target account list for eachgeographic region.

 

Oncea customer contracts with us, the account is assigned to our Account Managementdepartment, which is responsible for partnering with our customers to build newonline programs for new schools or departments within customers’ institutions.The Account Management department also promotes and sells additional productsand service offerings to our customers for their existing programs and providesassistance to program administrators to ensure that customers’ communicationsand reporting needs are met. We compensate our Account Managers with a combinationof salary, revenue-based commissions and bonuses for contract renewals,up-sales and cross-sales.

 

To further penetrate the distance education market,we offer our on-campus product and service offerings at significantly reducedprices for customers that demonstrate a commitment to building or maintaining alarge distance education program as an overall enterprise solution. Thispricing strategy is designed to encourage further familiarity with our TeachingSolutions software for students who have never taken online distance courses aswell as on-campus faculty who may also wish to teach online in a distanceeducation program. We also plan to continue to expand our product offerings, byboth offering new products and by increasing the flexibility with whichexisting products may be deployed.

 

Wemarket our eLearning technology and services through trade shows,eCollege-sponsored symposiums, speaking engagements and direct marketing. OureCollege.com website includes a demonstration of the eCollege System andprovides information on industry news, trends and important events in onlinelearning. We use press releases and communications to the news and trade mediato promote online learning and our customers’ programs in order to increaseonline student enrollments. We are continuing to strengthen our brand identityby participating in trade shows, conferences and executive speakingengagements.

 

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**Enrollment**

 

Our Enrollment divisionemploys an experienced sales force which is comprised of a new businessdevelopment team and an account management team. Incentive compensation plansfor our new business sales executives include a base salary plus commission ongross sales of direct mail, interactive, research, training and retentionservices and on net sales of media placement for the first 12 months of newbusiness revenue. New business account executives are also responsible for andcompensated for cross-divisional sales.

 

Incentive compensation plansfor our account management sales executives include a base salary pluscommission on gross sales of direct mail, interactive, research, training andretention services and on net sales of media placement. This team isresponsible for overseeing the projects of our existing client base to ensurequality service and for growing business from existing clients by sellingadditional products and solutions. Datamark rewards up-selling activities bypaying accelerated commissions on non-core products and services.

 

TheEnrollment division is pursuing several growth initiatives to leverage its corecompetencies, business model and customer base. The division’s near-term growthareas include further penetrating its core market and broadening its servicesofferings. We are actively working with our customers to integrate additionalservice offerings to support enrollment and retention objectives. WhileDatamark’s customers continue to purchase marketing services primarily to driveon-campus enrollments, demand for Datamark’s marketing solutions for onlineprograms is growing quickly.

 

Weprimarily market our Enrollment division solutions through the sales efforts ofour account executives. We also participate in industry trade shows,sponsorships, e-mail campaigns, and newsletters. In addition, we rely on ourDatamark website and place advertisements in major trade magazines.

 

**Competition**

 

**eLearning**

 

Theonline learning market has evolved quickly over the past ten years and issubject to technological change.   Some colleges and universitiesconstruct online learning systems utilizing in-house personnel and create theirown software or purchase software components from a vendor. Therefore, we facesignificant competition from a variety of entities including software companieswith specific products for the college and university market, some of whichprovide hosting services, as well as service companies that specialize inconsulting, system integration, and support in the online learning industry. Inaddition, we have recently seen a number of open source solutions enter themarket. Other competitors in this market include a wide range of education andtraining providers using video, mail correspondence, CD-ROM, and live onlinetraining. We believe that the market has begun to consolidate, as evidenced bythe recent merger of Blackboard, Inc. and WebCT, Inc. Our principal competitorsinclude Blackboard, Inc., Desire2Learn Inc. and ANGEL Learning, Inc.

 

Webelieve that the principal competitive factors in our market include:

 

•                         The ability to provide high quality onlinelearning, meeting the needs of colleges, universities, K-12 schools and theirstudents;

 

•                         A proven approach and process to ensure thesuccessful growth of online educational programs;

 

•                         Reliable technology,  with up-time and degradation free usage beingthe significant measures;

 

•                         Scalable technology and support services thatensure continued security and system performance as customers grow;

 

•                         Flexibility and the ability to integrateother technology-based products;

 

•                         The ability to offer a full complement ofproducts, services, and hosting capabilities as a single-source provider;

 

•                         Single source accountability for customersupport and satisfaction;

 

•                         Financial viability and company reputation;

 

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•                         Competitive pricing; and

 

•                         The quality of implementation and ongoingsupport teams.

 

Webelieve that we compare favorably to our competitors on the basis of thesefactors.

 

**Enrollment**

 

Theprimary source of competition for our Enrollment division comes from largeeducational institutions that perform a significant portion of their marketingfunction in-house and from local advertising agencies, media companies andprinting services companies who compete for our accounts. There are a fewoutsourced marketing service providers that we believe are our primarycompetitors, but we believe that few, if any, of these companies offer ascomprehensive a selection of integrated marketing solutions as we offer. Webelieve that the principal competitive factors in our market include:

 

•                         The ability to deliver an industry-specificsolution;

 

•                         The ability to provide a comprehensivesolution for student enrollment and retention;

 

•                         Knowledge of the education industry,including an understanding of the drivers of success;

 

•                         The ability to provide high quality marketingproducts and customer service; and

 

•                         Delivering to customers a superior return ontheir marketing investments.

 

Webelieve that we compare favorably to our competitors on the basis of thesefactors.

 

**Technology**

 

In late 2004, we consolidated the technologyorganizations for eLearning and Enrollment under the management of our ProductEngineering and Technology division. This division is also responsible fordevelopment and maintenance of the MIS applicatons that support our business.Following is a discussion of the technology we employ in each of our operatingdivisions:

 

**eLearning**

 

Ourtechnology strategy for the eLearning division is to employ the best availablesoftware on stable and scalable platforms. All of our solutions contain ourproprietary software and include access to certain widely-available softwareproducts we license from third parties. To create the custom components of oursoftware, we employ Microsoft’s most current and commonly used Internetprogramming technologies, allowing applications to communicate and share dataover the Internet.

 

Because our current business depends on our ability to host Web-basedsoftware applications for our customers, one of our primary technical goals isto provide a highly reliable, fault tolerant system. To do so, we have madesubstantial investments in systems monitoring, fault handling, technologyredundancy and other system up-time enhancements. For example, we continuouslymonitor our customers’ online campuses and our own core systems foravailability. All of our primary servers contain fault-tolerant disk storagetechnology, backup network cards and power supplies, which reduce thepossibility of a single point of failure in our servers and reduce downtime.Our database servers contain the latest clustering technology, which uses acombination of scalable hardware and Microsoft software technologies. Wemaintain sophisticated “firewall” technology to prevent access by unauthorized usersand to minimize known vulnerabilities to system security. We also haveIntrusion Detection Systems and offer SSL (Secure Socket Layer) encryption forsensitive data, and VPN (Virtual Private Network) access to safely transferdata.

 

Ourproducts are delivered to our customers from a network of centralized Webservers. Our Web servers are located in two data centers, commonly known as Web“server farms,” which provide us with scalable, high bandwidth Internetconnections. Our primary facility is co-located at ViaWest InternetServices, Inc. (“ViaWest”) in Denver, Colorado, and our back-up facilitiesare located at our eLearning division headquarters in Denver. Having multipledata centers provides us with the capability to provide backup in the case offailure of a data center, thereby mitigating or eliminating customer downtime.We have begun a two-year build-out of an additional data center at a ViaWestfacility outside of Denver which we plan to use as a disaster recovery facilitylater in 2006 and as a second production facility beginning in 2007.

 

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**Enrollment**

 

Ourtechnology strategy for the Enrollment division is to employ the best availablesoftware and systems to provide our customers with an integrated enrollmentmarketing and retention solution. This strategy is supported by the following:

 

•                       We have direct online access to targetednational lists of potential students;

 

•                       We employ sophisticated lead responsetracking systems to optimize the media mix for customers;

 

•                       Our Path Finder solution helps record andmine data; and

 

•                       We offer other value-added services such asInternet search engine optimization and web site review, consultation, design,and development.

 

Weemploy Microsoft’s most current and commonly used programming technologies, aswell as open source software such as Linux, PHP and MySQL, in the developmentand support of our technology solutions.

 

TheEnrollment division uses state-of-the-art equipment in its direct mailproduction facility. Using high volume laser printers and direct-to-platetechnology, which reduces turnaround times and increases quality, ourproduction facility is easily scalable and is designed specifically forshort-run, highly personalized direct mail campaigns. The facility has severalprinting presses, folding machines, inserting machines and sorting machines. Weare  investing in additional equipment inthe first half of 2006 to increase the level of automation and optimizescheduling in our production facility

 

**Research and Development**

 

The Company’s product development activities aremanaged from Denver, Colorado, with development teams in both operatingdivisions. Most of our development activities take place in Denver and SaltLake City. In January 2004 we decided, based on timing and costconsiderations, to supplement our development efforts by committing resourcesto offshore development in Sri Lanka. eCollege entered into an agreement with athird party vendor to provide supplemental software development for ourdevelopment projects. In April 2007, we will have the option of hiring thethird party’s staff and establishing our own facility in Sri Lanka. Our minimumfuture commitments under this agreement totaled $2.4 million at December 31, 2005.If we elect to terminate the agreement before April 2007, we will have to pay atermination penalty equal to six months’ expense at the then current minimumstaffing level. Our integrated technology operations and software developmentin Denver, Salt Lake City and Sri Lanka ensure common architectural standardsand processes throughout the Company. Both onshore and offshore resourcessupport research and development for the eLearning and Enrollment divisions aswell as our MIS activities.

 

eCollege’s total expenditures for research anddevelopment were $7.2 million in 2005 (of which $1.4 million related todevelopment in Sri Lanka),  $6.6 millionin 2004 (of which $0.9 million related to development in Sri Lanka) and$5.7 million in 2003 (all in the United States). In 2005, 2004 and 2003,we capitalized $1.4 million,  $1.8million and $304,000, respectively, in costs for internally developed software,which reduced research and development expense by corresponding amounts. Weanticipate that we will continue to have significant research and developmentexpenditures in the future as we continue to develop and provide innovative,high-quality products and services to maintain and enhance our competitiveposition.

 

**Seasonality**

 

Becausethe majority of our eLearning revenue is derived from the number of studentsour customers have enrolled in online courses delivered on our CourseManagement System, our results of operations are impacted by the seasonalityinherent in the traditional academic calendar. However, in 2005, we continuedto see our customers offer more non-traditional course terms (i.e. quarterly,monthly and bi-monthly), which has somewhat mitigated the seasonality of ourresults. We expect this trend to continue in the future. We also experience someseasonality in our Enrollment division. This seasonality is primarily driven byour customers’ direct mail campaigns, which tend to be weighted toward thesecond half of the calendar year.

 

As a result of the seasonality in our businesses,sequential quarter-to-quarter financial results are not directly comparable.

 

**Intellectual Property and Proprietary Rights**

 

The Company relies upon federal statutory and commonlaw copyright, trademark and servicemark law, patent law, trade secretprotection and confidentiality and/or license agreements with its employees,customers, partners, and others to protect its proprietary

 

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rights.As of December 31, 2005, the Company has six patents registered with the UnitedStates Patent and Trademark Office (“USPTO”) covering certain features of theeCollege System, with expiration dates between 2012 and 2015. eCollege hasadditional patent applications filed with the USPTO covering other features ofthe software included in the eCollege System.

 

We have certain registered servicemarks andtrademarks including eCollege.com®, eCollege® and Datamark®. We willcontinue to evaluate the registration of additional servicemarks asappropriate.

 

**Employees**

 

Asof December 31, 2005 we employed 519 people. None of our employees aresubject to collective bargaining agreements, and we consider our relations withour employees to be good.

 

**Available Information**

 

We make available free ofcharge on our website at www.eCollege.com our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K and amendments tothose reports filed or furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), as soon asreasonably practicable after we electronically file or furnish such material tothe SEC. You can  access such filingsfrom the Investor Relations section of our website via a hyperlink to athird-party SEC Filings website. The information found on our website is notpart of this or any other report we file or furnish to the SEC.

 

**ITEM 1A. RISKFACTORS**

 

**Risk Factors**

 

This section identifies certain risks anduncertainties that we face. If we are unable to appropriately address these andother circumstances that could have a negative effect on our business, ourbusiness may suffer. Negative events may decrease our revenues, increase ourcosts, negatively affect our financial results and decrease our financialstrength, thereby causing our stock price to decline. The risks anduncertainties described below are not the only ones we face. Additional risksnot presently known to us or other factors not perceived by us to presentsignificant risks to our business at this time also may have a negative impacton our business.

 

*A Significant Portion of OurRevenue Is Generated From a Relatively Small Number of Customers.*

 

Revenue from a small number of customers hascomprised a substantial portion of the historical revenue of eLearning andDatamark and is expected to represent a substantial portion of divisionalrevenue for the foreseeable future. For the year ended December 31, 2005, our30 largest eLearning customers accounted for approximately 70% of eLearningdivision revenue and the 30 largest customers of the Enrollment divisionaccounted for approximately 92% of Enrollment division revenue. One institution(Corinthian Colleges) that is a customer of both the eLearning and Enrollmentdivisions accounted for approximately 22% of consolidated revenue in the yearended December 31, 2005. Any cancellation, deferral, or significant reductionin work performed for these principal customers, or failure to collect accountsreceivable from these principal customers, could have a material adverse effecton our business, financial condition, and results of operations.

 

*Our Stock Price Is Likely to beVolatile.*

 

The market price of our common stock has been and islikely to continue to be volatile and could be subject to significantfluctuations in response to factors such as the following, some of which arebeyond our control:

 

•                 Quarterly variations in our operatingresults;

 

•                 Operating results that vary from theexpectations of securities analysts and investors;

 

•                 Changes in expectations as to our futurefinancial performance;

 

•                 Announcements of technological innovations ornew products by us or our competitors;

 

•                 Changes in market valuations of other onlineservice companies or our customers;

 

•                 Future issuances of our common stock;

 

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•                 Stock market price and volume fluctuations;

 

•                 General political and economic conditions,such as a recession, further military action or additional terrorist attacks,or interest rate or currency rate fluctuations; and

 

•                 Other risk factors discussed in this report.

 

These factors may adversely affect the market priceof our common stock. In addition, the market prices for stocks of manyinternet-related and technology companies have historically experienced extremeprice fluctuations that appeared to bear no relationship to the operatingperformance of these companies. In the event our stock price fellsignificantly, investors might sue the Company, causing increased litigationexpenses and, possibly, the payment of large damages or settlement fees.

 

*We Depend On Our Customers andThird Parties to Market Student Enrollments for Online Courses.*

 

A substantial portion of our eLearning divisionrevenue is derived from fees for each enrollment in an online course that wehost for our customers. Generally, we do not market directly to students togenerate enrollments in our customers’ courses and therefore have littleinfluence on the number of students that enroll. We are therefore dependent onthe institutions and organizations that purchase our products and services tomarket to individual students. The failure of these third parties toeffectively attract, maintain, and increase student enrollments could affectour revenue growth and have a material adverse effect on our business andfinancial results. Although Datamark provides enrollment marketing services toits customers, the majority of Datamark’s customers are not customers of oureLearning division, and there can be no assurance that they will becomecustomers of our eLearning division.

 

*Our Operating Results MayFluctuate Significantly and May Be Below the Expectations of Analysts andInvestors.*

 

The sales cycle for our products and services varywidely and can be very lengthy, particularly for the eLearning division. Becauseof the variability and length of the sales cycle, it may be difficult for us topredict the timing of particular sales, the rate at which online campuses,courses, and/or course supplements will be implemented, the number of studentswho will enroll in the online courses, or the rate of which new or futurecustomers will utilize our enrollment marketing services. Because a significantportion of our eLearning division’s costs are fixed and are based onanticipated revenue levels, small variations in the timing of revenue recognitioncould cause significant variations in operating results fromquarter-to-quarter. Since we may be unable to adjust spending in a timelymanner to compensate for any unexpected revenue shortfall, any significantdecrease in revenue would likely have an immediate material adverse effect onour business and financial results.Further, any such variations could cause ouroperating results to fall below the expectations of securities analysts andinvestors. In such an event, the trading price of our stock would likely falland investors might sue the Company, causing increased litigation expenses and,possibly, the payment of large damages or settlement fees.

 

*We Depend on Our Key Personnel.*

 

Our success depends on the performance of our keymanagement, technical, sales and other critical personnel and on our ability tocontinue to attract, motivate and retain management and highly qualified keypersonnel. Failure to do so could disrupt our operations, adversely affect ourcustomer relationships and impair our ability to successfully implement andcomplete Company initiatives. We are facing increased labor costs, particularlywith respect to technical personnel; if this trend continues, we may berequired to pay higher compensation to attract qualified personnel and ourresults of operations may be adversely affected.

 

Our future success and our ability to pursue ourgrowth strategy will depend to a significant extent on the continued service ofour senior management personnel. Executives have left the Company over theyears, and there may be additional departures from time to time. Although wehave employment agreements with our executive officers, these agreements do notobligate them to remain employed by us. The loss of services of any seniormanagement personnel could make it more difficult for us to successfully pursueour business goals.

 

*We Face Significant Competitionin our Markets***.**

 

The online learning market has evolved quickly overthe past ten years and is subject to technological change. Some colleges anduniversities construct online learning systems using in-house personnel andcreate their own software or purchase software components from a vendor. Thereforewe face significant competition from a variety of entities including softwarecompanies with specific products for the college and university market andservice companies that specialize in consulting, system integration and supportin the eLearning industry. We have recently seen a number of open sourcesolutions enter the market. Other competitors in this market include a widerange of education and training providers using video, mail correspondence,CD-ROM, and live online training. We also face significant competition in themarket for enrollment marketing services to the post-secondary educationindustry. Competition is most intense from colleges and universities thatperform their own enrollment marketing services in-house. Datamark also facescompetition from other enrollment marketing companies, direct marketingcompanies, media placement agencies and online marketing companies.

 

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Some of our current and potential competitors havelonger operating histories, larger customer bases, greater brand recognitionand significantly greater financial, marketing and other resources than we do.Certain competitors may be able to secure alliances with customers andaffiliates on more favorable terms, devote greater resources to marketing andpromotional campaigns and devote substantially more resources to systemsdevelopment than we can. In addition, it is possible that certain competitors,or potential competitors, could reduce their pricing to levels that would makeit difficult for us to compete. Increased competition may result in reducedoperating margins, as well as loss of market share and brand recognition.

 

In addition, in order to compete effectively in ourmarkets, we may need to change our business in significant ways. For example,we may change our pricing, product, or service offerings, make key decisionsabout technology directions or marketing strategies, or acquire additionalbusinesses or technologies. Any of these actions could hurt our business,results of operations, and financial condition.

 

*Recent Rapid Growth in OurMarkets May Not Continue and our Ability to Grow May be Adversely Affected.*

 

The online learning marketand the for-profit post-secondary education market have grown rapidly in recentyears, and there can be no assurance that such growth levels will continue. Ourability to execute our growth strategy will depend in part on continued growthin these markets. With respect to the online learning market, our success willdepend in part on the continued adoption by our customers and potentialcustomers of online education initiatives. Online education is a relatively newdevelopment, and some academics and educators are opposed to it in principle.It is possible that their opposition could reduce the demand for our productsand services or result in increased costs or burdens for customers andpotential customers offering online education. With respect to our enrollmentmarketing services, the marketing strategies and budgets of our current andprospective customers are subject to frequent change.

 

*Our Network Infrastructure andComputer Systems May Fail.*

 

The continuing and uninterrupted performance of ournetwork infrastructure and computer systems is critical to our success. Anysystem failure that causes interruptions in our ability to provide servicescould reduce customer satisfaction and, if sustained or repeated, would reducethe attractiveness of our technology and services to our customers and theirstudents and to prospective customers and could require us to issue credits orpay penalties under our contracts with certain customers. In addition, a systemfailure could expose us to significant remediation expense and could divertmanagement’s attention and other company resources.

 

Because our services involve the storage andtransmission of proprietary and confidential customer and student information,our success depends on our ability to provide superior network securityprotection and maintain the confidence of our customers in that ability.Unauthorized disclosure of such information could subject us to liability andhave a negative impact on our reputation. Our system is designed to preventunauthorized access from the internet and, to date, our operations have notbeen affected by security breaks; nevertheless, in the future we may not beable to prevent unauthorized disruptions of our network operations, whethercaused unintentionally or by computer “hackers” or by the failure of ourinternet service providers to provide us with adequate bandwidth and service.Despite precautions we have taken, unanticipated problems affecting our systemshave from time to time in the past caused, and in the future could cause,interruptions or delays in the delivery of our products and services. Anydamage or failure that interrupts or delays our operations could have a materialadverse effect on our business and financial results.

 

We are almost exclusively dependent on Microsoft forour underlying software technology platform. We are therefore potentiallyvulnerable to business or operational disruption caused by changes in the Microsoftplatform, security flaws in Microsoft software, and/or potential priceincreases or licensing changes by Microsoft.

 

*We Have Incurred Debt, WhichCould Adversely Affect Our Financial Health and Our Ability to Obtain Financingin the Future and React to Changes in Our Business.*

 

As of December 31, 2005, the Company’s principaldebt obligations totaled approximately $20.0 million ($22.0 million face value).Of this amount, $17.9 million ($20.0 million face value) is secured by all ofour assets. Our debt could have important consequences to our stockholders.Because of our substantial debt:

 

•                  Our ability to obtain additional financingfor working capital, capital expenditures, acquisitions, general corporatepurposes, or other purposes may be impaired in the future;

 

•                  A substantial portion of our cash flow fromoperations may be dedicated to the payment of principal and interest on ourindebtedness, thereby reducing the funds available to us for other purposes;

 

•                  We may be exposed to increased interest ratesbecause certain of our borrowings are at variable rates of interest; and

 

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•                  Our flexibility to adjust to changing marketconditions and ability to withstand competitive pressures could be limited, andwe may be more vulnerable to a downturn in general economic conditions or ourbusiness or be unable to carry out capital spending that is necessary orimportant to our growth strategy and productivity improvement programs.

 

The breach of any of the covenants or restrictionscontained in our Senior Subordinated Notes, Seller Notes or New Revolver couldresult in a cross default under the applicable agreements which would permitthe applicable lenders to declare all amounts then outstanding to be due andpayable, together with accrued and unpaid interest, and, in the case of theSenior Subordinated Notes and New Revolver, to foreclose on our assets. In anysuch case, we may be unable to make any borrowings under our New Revolver andmay not be able to repay the amounts due under our Senior Subordinated Notes orSeller Notes. This could have serious consequences to our financial conditionand results of operations and could cause us to become bankrupt or insolvent.

 

*We May Desire or Need to Raise Additional Capital In The Future And ItMay Not Be Available On Acceptable Terms.*

 

Wemay desire or need to raise additional capital through public or privatefinancing, strategic relationships, or other arrangements in the future. In theevent that we desire or need to raise additional capital, we cannot assure thatadditional funds will be available or that funds will be available on termsfavorable to us. Furthermore, we may have to sell stock at prices lower thanthose paid by existing stockholders, which would result in dilution to thosestockholders, or we may have to sell stock or bonds with rights superior torights of holders of common stock. Any debt financing might involve restrictivecovenants that could limit our operating flexibility. If adequate funds are notavailable on acceptable terms, we may be unable to develop or enhance ourservices and products, take advantage of future opportunities, or respond tocompetitive pressures, which could have an adverse effect on our business andour financial position. Any future need to raise additional funds could alsodirectly and adversely affect our stockholders’ investment in our common stock.

 

*We May be Unable to SustainProfitability.*

 

Although we have reported net income for each fiscalquarter beginning with the period ended March 31, 2003, and Datamark, under itsprevious owners and structure, had realized net income for each reportingperiod since 2001, there can be no guarantee that we will be able to sustainprofitability. We believe that our success depends, among other things, on ourability to increase our revenue by further developing existing customerrelationships and developing new relationships with colleges, universities, andother potential customers without increasing our expenses at the same rate. Ifwe are unable to continue to increase our revenue, our business and financialresults will be materially and adversely affected.

 

*Our Internal Control overFinancial Reporting Is Not Effective, which Could Result in Possible RegulatorySanctions and a Decline in our Stock Price.*

 

Section 404 of theSarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) requires us to furnish annually areport on our internal control over financial reporting. The internal controlreport must contain an assessment by our management of the effectiveness of ourinternal control over financial reporting (including disclosure of any materialweakness) and a statement that our independent auditors have attested to andreported on management’s evaluation of such internal control.****As disclosed in Item 9A of this Annual Report on Form 10-K, we haveidentified a material weakness in our internal control over financial reportingthat existed as of December 31, 2005. As a result, neither management nor ourindependent auditors were able to conclude that our internal control overfinancial reporting was effective within the meaning of Section 404 ofSarbanes-Oxley as of such date. As a result, we could be subject to regulatorysanctions or lose investor confidence in the accuracy and completeness of ourfinancial reports, either of which could have an adverse effect on the marketprice for our securities.

 

*We May Not be Able to Protect OurIntellectual Property and Proprietary Rights and We May be Subject to Claims ofInfringement by Third Parties.*

 

Our success depends, in part, on our ability toprotect our proprietary rights and technology, such as our trade and productnames, and the proprietary software included in our products. We rely on acombination of copyrights, trademarks, servicemarks, patents, trade secretlaws, and employee and third-party nondisclosure agreements to protect ourproprietary rights. Despite our efforts to protect these rights, unauthorizedparties may attempt to duplicate or copy aspects of our services or software orto obtain and use information that we regard as proprietary. If others infringeor misappropriate our copyrights, servicemarks or other proprietary rights, ourbusiness could be hurt. In addition, the laws of many countries do not protectour proprietary rights to as great an extent as do the laws of the UnitedStates. Our failure to meaningfully protect our intellectual property couldhave a material adverse effect on our business and financial results.

 

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In addition, although we do not believe that we areinfringing the intellectual property rights of others, other parties mightassert infringement claims against us. We may encounter disputes over rightsand obligations concerning intellectual property. These disputes, even ifwithout merit, could lead to litigation, which may be time-consuming and costly(even if we are successful), may require us to redesign our products orservices, may require us to enter into royalty or licensing agreements (whichmay not be available on acceptable terms or at all), and could be a distractionto management, any of which could have a material adverse effect on ourbusiness. In addition, our agreements with our customers require us toindemnify our customers in the event they are sued by a third party claimingthat our products and services infringe a third party’s intellectual propertyrights. In the event of such a lawsuit against our customers, our performanceof these indemnification obligations could have a material adverse effect onour business, financial condition and results of operations.

 

*Government Regulation MayAdversely Affect Our Future Operating Results.*

 

The federal government, through the Higher EducationAct and other legislation, may consider changes in the laws that affectdistance education in higher education. Legislation could be adopted that wouldhave a material adverse effect on our business. In addition, it is possiblethat laws and regulations may be adopted with respect to the internet, relatingto user privacy, content, taxation, intellectual property ownership andinfringement, distribution, and characteristics and quality of products andservices. The adoption of any additional laws or regulations may decrease thepopularity or expansion of online education, and may cause us to incurunanticipated compliance costs. The adoption of federal or state laws orregulations concerning privacy of personal information could impair Datamark’sability to purchase lists of prospective students from third party vendors orincrease the costs of obtaining such lists. Our increasing presence in manystates across the country may subject us to additional tax laws and governmentregulations, which may adversely affect our future operating results. Our violationof any state statutes, laws or other regulations could have a material adverseeffect on our business and financial results. We cannot predict the impact, ifany, that future regulation or regulatory changes may have on our business.

 

*Datamark Does Not Have Long-TermAgreements With Its Customers and May Be Unable to Retain Customers, AttractNew Customers or Replace Departing Customers With Customers that Can ProvideComparable Revenues.*

 

Most of Datamark’s contracts with its customers areshort-term. Datamark’s current customers may not continue to use its productsand services, Datamark may not be able to replace in a timely or effectivemanner departing customers with new customers that generate comparablerevenues, and Datamark may not continue to increase its customer base. Further,there can be no assurance that Datamark’s customers will continue to generateconsistent amounts of revenues over time. Datamark’s failure to develop andsustain long-term relationships with its customers could materially andadversely affect the results of operations of Datamark and eCollege as a whole.

 

*If We are Unable to Continue toReceive our Current Level of Access to and Costs for Mailing Lists, OurCompetitive Advantage Could Be Materially Affected.*

 

Our Enrollment division obtains mailing lists fromthird party vendors. Because of our unique relationships with some of our keyvendors, we are able to purchase these lists in high volumes under favorablepricing and in formats compatible with our systems. If we were unable tocontinue to obtain these mailing lists at our current pricing levels and in theformats in which we historically have received these lists, it could reduce ourcompetitive advantage and have a material adverse effect on our business.

 

*Increases in Costs of RevenueCould Harm Datamark’s Business.*

 

The direct marketing activities of Datamark may beadversely affected by increases in certain costs. Datamark’s direct mailactivities may be adversely affected by postal rate increases, especially increasesthat are imposed without sufficient advance notice to allow adjustments to bemade to marketing budgets. With regards to Datamark’s interactive marketingservices, rising demand for online advertising has in the past and may in thefuture cause Internet media prices to increase. Because Datamark is generallyobligated under its contracts to deliver a specified number of leads at aspecified price, Datamark may be unable to adjust its pricing to reflectincreased Internet lead costs until contracts expire and are renegotiated. Anyof these occurrences could materially and adversely affect the business,financial condition and results of operations of Datamark and eCollege as awhole.

 

*Our Business and Future OperatingResults Are Subject to a Broad Range of Uncertainties Arising Out of TerroristAttacks on the United States of America.*

 

Our business and operating results are subject touncertainties arising out of terrorist attacks on the United States of America.These uncertainties include a potential global economic slowdown and theeconomic consequences of further military action or additional terroristactivities. While terrorist attacks have not had a material impact on ourfinancial position or results of operations to date, any future attacks orevents arising as a result of the attacks, such as interruptions to theinternational telecommunications network or the internet, could have a materialimpact on our business.

 

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**ITEM 1B. UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM2.    PROPERTIES**

 

In2004, the Company relocated its principal executive office to Chicago,Illinois. The Chicago office houses our Chief Executive Officer, ChiefFinancial Officer and General Counsel as well as certain accounting, financeand administrative employees. The office comprises approximately 6,178 squarefeet and is held under a lease that expires in January 2010, with an option toextend for one additional five year period.

 

Ourother corporate executives and our eLearning division continue to be located inDenver, Colorado. The Denver facility encompasses approximately 47,600 squarefeet and is held under a lease that expires on September 30, 2007. We havethe option to extend this lease for two additional periods of three years each.

 

OurEnrollment division is located in Salt Lake City, Utah in leased office spacethat is attached to its production facility. The production facility isapproximately 22,000 square feet and the office space is approximately 28,000square feet. The Enrollment division also has a media placement center inSpokane, Washington which was expanded in 2005 and currently consists ofapproximately 7,200 square feet. The lease on our Salt Lake City facilitiesexpires in June 2012 and the lease on our Spokane facility expires in May2010.

 

Webelieve that our current facilities are adequate for our current needs and thatsuitable additional or alternative space will be available in the future oncommercially reasonable terms as needed.

 

**ITEM 3.    LEGAL PROCEEDINGS**

 

In July 2005, the Companyreceived a letter from counsel to Arthur Benjamin, who resigned as Datamark’schief executive officer in April 2005. The letter alleged unspecified breachesby eCollege and/or Datamark of Mr. Benjamin’s employment agreement and relatedagreements, including without limitation Mr. Benjamin’s stock appreciationrights agreement, and demanded that the Company submit such disputes to bindingarbitration as required by the employment agreement. The Company agreed toarbitrate the dispute. On December 12, 2005, Mr. Benjamin filed a lawsuitcaptioned *Arthur Benjamin vs.**Datamark,Inc. and eCollege.com* in theUnited States District Court, District of Utah. The suit alleges, among otherthings, that eCollege and Datamark breached Mr. Benjamin’s  employment and stock appreciation rightsagreements by forcing Mr. Benjamin to resign for “good reason”  and subsequently failing to pay him severanceand accelerate the vesting of his stock appreciation rights and restrictedstock. Using an assumed common stock price of up to $150 per share,  Mr.Benjamin seeks compensatory damages of up to $38 million and punitive damagesof up to $380 million.

 

From a proceduralstandpoint, the Company believes that all disputes between the Company and Mr.Benjamin must be resolved in arbitration in accordance with the terms of theemployment agreement and has filed a motion to dismiss the federal lawsuit. Ahearing on the motion is scheduled for March 16, 2006. With regard to thesubstance of Mr. Benjamin’s complaint, the Company  believes that his allegations are withoutmerit and that his calculations of alleged damages are in error. The Companyintends to vigorously defend against these allegations. However, due to theuncertainty inherent in litigation, we are unable to predict the outcome ofthis dispute. An outcome unfavorable to the Company could have a materialadverse effect on our business, results of operations and financial condition.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

There were no matters submitted to a vote ofsecurity holders during the fourth quarter of 2005.

 

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**PART II**

 

**ITEM 5.    MARKET FOR REGISTRANT’S COMMONEQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

eCollege’scommon stock has been traded on the NASDAQ National Market System (“Nasdaq NMS”)under the symbol “ECLG” since December 15, 1999. The following table setsforth the high and low sales prices of the Company’s common stock for theperiods indicated as reported on the Nasdaq NMS.

 
| ** **                        | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------|------------|----------|------------|---------|------------|
| **Year  ended December 31, 2004** |       |     |       |    |       |
| 1st Quarter                       |       | $        | 23.85      |    | $          | 16.84 |   |
| 2nd Quarter                       |       | $        | 23.00      |    | $          | 14.44 |   |
| 3rd Quarter                       |       | $        | 16.08      |    | $          | 6.04 |   |
| 4th Quarter                       |       | $        | 12.25      |    | $          | 8.36 |   |
|                              |       |     |       |    |       |
| **Year  ended December 31, 2005** |       |     |       |    |       |
| 1st Quarter                       |       | $        | 13.26      |    | $          | 9.58 |   |
| 2nd Quarter                       |       | $        | 13.75      |    | $          | 9.01 |   |
| 3rd Quarter                       |       | $        | 15.24      |    | $          | 11.61 |   |
| 4th Quarter                       |       | $        | 19.95      |    | $          | 13.35 |   |

 

Theclosing price for our common stock on March 13, 2006 was $18.62 per share.

 

Asof March 13, 2006 there were approximately 91 holders of record of our commonstock.

 

TheCompany has never paid cash dividends on its stock, and is currently precludedfrom doing so under its borrowing agreements.

 

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**ITEM 6.    SELECTED FINANCIAL DATA**

 

Thefollowing table sets forth our summary consolidated financial data for each ofthe past five years. Data for 2005, 2004 and 2003 include Datamark’s results ofoperations from October 31, 2003, the acquisition date. You should readthis information together with the Consolidated Financial Statements and theNotes to those statements included in Item 8 of this Annual Report onForm 10-K and the information set forth under the caption “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inItem 7 of this Annual Report on Form 10-K.

 

**Statement of Operations Data:**

 
| ** **                                                                       | ** ** | **Years Ended December 31,**              | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                       | ** ** | **2005(1)**                               | ** ** | **2004 (1)** | ** ** | **2003(1)(2)** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| Revenue:                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Student fees                                                                     |       | $                                         | 36,818     |   | $ | 31,154 |   | $ | 24,971 |   | $ | 18,058 |   | $ | 13,054 |   |
| Direct mail enrollment marketing                                                 |       | 37,619                                    |       | 38,347 |   | 6,277 |   | — |   | — |   |
| Interactive enrollment marketing                                                 |       | 16,939                                    |       | 11,079 |   | 790 |   | — |   | — |   |
| Other                                                                            |       | 11,492                                    |       | 8,687 |   | 4,822 |   | 5,634 |   | 6,793 |   |
| Total revenue                                                                    |       | 102,868                                   |       | 89,267 |   | 36,860 |   | 23,692 |   | 19,847 |   |
| Cost of revenue                                                                  |       | 53,976                                    |       | 46,780 |   | 16,183 |   | 11,663 |   | 13,840 |   |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Gross profit                                                                     |       | 48,892                                    |       | 42,487 |   | 20,677 |   | 12,029 |   | 6,007 |   |
| Operating expenses:                                                              |       |                                      |       |   |   |   |   |   |   |   |   |
| Product development                                                              |       | 7,249                                     |       | 6,635 |   | 5,723 |   | 5,658 |   | 4,810 |   |
| Selling and marketing                                                            |       | 10,178                                    |       | 9,878 |   | 5,843 |   | 5,613 |   | 7,147 |   |
| General and administrative                                                       |       | 16,317                                    |       | 16,213 |   | 7,140 |   | 5,621 |   | 6,718 |   |
| Other general and administrative expense  (3)                                    |       | 1,613                                     |       | 1,492 |   | 249 |   | — |   | — |   |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Total operating expenses                                                         |       | 35,357                                    |       | 34,218 |   | 18,955 |   | 16,892 |   | 18,675 |   |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations                                                    |       | 13,535                                    |       | 8,269 |   | 1,722 |   | (4,863 | ) | (12,668 | ) |
| Interest income (expense), loss from early  repayment of debt and other, net (4) |       | (3,515                                    | )          | (7,406 | ) | (1,154 | ) | (58 | ) | 331 |   |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes                                                |       | 10,020                                    |       | 863 |   | 568 |   | (4,921 | ) | (12,337 | ) |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Income tax (expense) benefit (5)                                                 |       | (4,092                                    | )          | 18,497 |   | — |   | — |   | — |   |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                |       | $                                         | 5,928      |   | $ | 19,360 |   | $ | 568 |   | $ | (4,921 | ) | $ | (12,337 | ) |
|                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Basic net income (loss) per share                                                |       | $                                         | 0.27       |   | $ | 0.95 |   | $ | 0.03 |   | $ | (0.30 | ) | $ | (0.76 | ) |
| Diluted net income (loss) per share                                              |       | $                                         | 0.26       |   | $ | 0.88 |   | $ | 0.03 |   | $ | (0.30 | ) | $ | (0.76 | ) |
| Weighted average shares outstanding – basic                                 |       | 21,729                                    |       | 20,358 |   | 17,758 |   | 16,329 |   | 16,219 |   |
| Weighted average shares outstanding –  diluted                              |       | 22,405                                    |       | 21,996 |   | 19,578 |   | 16,329 |   | 16,219 |   |

 

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(1)   Note on adoption of Statement of Financial AccountingStandards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation”: TheCompany adopted SFAS No. 123 effective January 1, 2003 for itsfinancial statements, using the prospective method as described in SFASNo. 148 “Accounting for Stock-Based Compensation-Transition andDisclosure, an amendment of SFAS 123.” The Company’s use of theprospective method of adoption means that the fair value for stock-basedcompensation required by SFAS No. 123 was applied only to stock-basedcompensation awards granted, modified, or settled subsequent to January 1,2003. Accordingly, the results for 2005, 2004 and 2003 are not directlycomparable to results of prior years in this regard. The Company recorded $2.8million, $3.8 million and $1.0 million of total stock-based compensationexpense in 2005, 2004 and 2003, respectively.

 

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(2)   The Company acquired  Datamark on October 31, 2003. Results ofoperations for the year ended December 31, 2003 include two months of Datamarkactivity.

 

(3)   Other General and Administrative Expense: In2005 and 2004 other general and administrative expense consisted ofamortization of intangible assets acquired in the Datamark acquisition of $1.6million and $1.5 million, respectively. In 2003 other general andadministrative expense consists of two months of amortization expense for ourintangible assets acquired in the Datamark acquisition.

 

(4)   Interest Income (expense), loss from earlyrepayment of debt and other, net: In 2005, 2004 and 2003, other expenseconsists primarily of interest expense associated with our various debtobligations, net of interest income. In 2004 other expense also includes a lossfrom early repayment of debt in the amount of $2.5 million. Other income in 2002and 2001is primarily interest income on our invested cash and cash equivalents,net of interest expense on debt and capital leases.

 

(5)   We recorded an income tax benefit for theyear ended December 31, 2004 from the reversal of the valuation allowance wehad previously recorded against our deferred tax asset as well as from therecognition of changes in other temporary differences.

 

**Balance Sheet Data:**

 
| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                            | ** ** | **(In thousands)**    | ** ** |
| Cash and cash equivalents investments |       | $                     | 23,037     |   | $ | 8,223 |   | $ | 15,974 |   | $ | 13,633 |   | $ | 16,626 |   |
| Working capital                       |       | 22,695                |       | 4,495 |   | 4,437 |   | 6,624 |   | 8,677 |   |
| Total assets                          |       | 134,074               |       | 117,815 |   | 102,023 |   | 22,567 |   | 27,240 |   |
| Line of credit                        |       | —                |       | — |   | 9,365 |   | 2,938 |   | 2,500 |   |
| Current portion of long-term debt     |       | —                |       | 1,000 |   | 1,000 |   | — |   | — |   |
| Long-term portion of debt             |       | 20,023                |       | 20,023 |   | 27,785 |   | 706 |   | 946 |   |
| Total liabilities                     |       | 39,630                |       | 39,899 |   | 51,590 |   | 12,163 |   | 12,242 |   |
| Total stockholders’ equity       |       | 94,444                |       | 77,916 |   | 50,433 |   | 10,404 |   | 14,998 |   |
|                                       |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 7.    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS**

 

The following discussion and analysis should be readin conjunction with the “Selected Financial Data” set forth in Item 6 of thisAnnual Report on Form 10-K and the Consolidated Financial Statements and Notesthereto included in Item 8 of this Annual Report on Form 10-K.

 

**Critical Accounting Policies**

 

Revenue recognition, accounting for stock-basedcompensation, accounting for the issuance of debt obligations, valuation ofgoodwill and identifiable intangible assets, amortization of intangible assets,software development costs and income taxes are all critical accountingpolicies for the Company. The policies in effect in 2005 have been discussedwith, and evaluated by, our Audit Committee and are substantially consistentwith the policies in effect during 2004 and 2003. Each of these policies isdiscussed in detail below, as well as in the Notes to Consolidated FinancialStatements included in Item 8 of this Annual Report on Form 10-K.

 

**Revenue Recognition**

 

Revenue recognition is a critical accounting policyfor our Company, as it affects the timing of when we recognize the fees wecharge our customers for our services. We recognize revenue in accordance withStaff Accounting Bulletin (“SAB”) 101, “Revenue Recognition in FinancialStatements,” as modified by SAB 104, which provides guidance on revenuerecognition for public companies. Revenue is recognized when all of thefollowing criteria are met: (1) persuasive evidence of an arrangementexists; (2) delivery has occurred or services have been rendered;(3) the seller’s price to the buyer is fixed or determinable; and(4) collectibility is reasonably assured. We follow Emerging Issues TaskForce (“EITF”) 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables,” to identify units of accounting in revenue arrangements withmultiple deliverables. We follow EITF 99-19, “Reporting Revenue Gross as aPrincipal vs. Net as an Agent,” for media services where the Company is not atrisk with vendors for services and the Company receives a commission for suchservices.

 

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For both divisions, the Company enters intoagreements that may contain multiple elements. For multiple-elementarrangements, the Company recognizes revenue for delivered elements only whenthe delivered item provides stand-alone value to the customer, fair values ofundelivered elements are known, customer acceptance has occurred and there areonly customary refund or return rights related to the delivered elements.

 

Recognized revenue is reflected as accrued revenuereceivable on the consolidated balance sheets to the extent that the customerhas not yet been billed for such services. The Company records deferred revenuefor amounts received from or billed to customers in excess of revenue that hasbeen earned. The Company also records a liability for customer deposits paid inadvance of Datamark’s services.

 

*eLearning*

 

Weenter into contracts with our customers to provide our online learning productsand services. Our contracts typically have initial terms of one to three years.Each contract specifies the type and price of the online campus purchased andthe number and price of online courses purchased, as well as the fees forstudent enrollments and any other products or services purchased. Since ourcustomer contracts are generally applicable campus-wide, colleges anduniversities can add new online programs and schools without the need tonegotiate new contract terms.

 

The majority of our eLearning division revenue isearned by charging a per-enrollment student technology service fee to ourcustomers for access to their eCourses and our help desk. A smaller percentageof revenue is generated by our eCompanion product for which we typically chargean annual license fee for up to a predetermined number of users with therevenue being is recognized on a straight line basis over the contract year.For our Program Administration Solutions, we generally charge a one timeset-up and design fee to implement an online campus, and an annual license,hosting and maintenance fee for access to our software. We sell ourprofessional services on a fixed-fee contract basis as well as standard hourlyrates.

 

Student fees are recognized on a per enrollment basisover each course’s specific academic term or over the length of the student feelicense purchased by the customer, depending upon contract terms. An enrollmentis generally defined as one user in one course for one academic term. Nobilling occurs, and no revenue is recognized, for cancelled classes and studentwithdrawals or drops that occur before the agreed-upon enrollment census date.Campus license, hosting, and maintenance fees, including the design and developmentof a customer’s campus, are recognized on a straight-line basis from the campuslaunch date through the end of the relevant contract period or the expectedlife of the customer relationship, whichever is greater. The averagerecognition period for these campus fees is approximately three years.

 

Professional services revenue is derived from eitherfixed fee or time and materials consulting contracts and recognized as servicesare performed. We also offer customers the option to purchase blocks of coursedevelopment service hours, based on our standard hourly rates. Revenue fromthese services is also recognized as the services are performed.

 

*Enrollment*

 

OurEnrollment division revenues are primarily generated from the sale of directmail, interactive marketing and media placement services. We derive otherrevenue from research services, admissions training, admissions shopper andretention services.

 

Itis our practice to execute contracts or work orders for direct mail advertisingcampaigns, typically for up to three months in duration. In most cases,individual direct mail projects take 10 to 18 business days to complete withpayments due two days before marketing materials are mailed. Fees aredetermined based on the number of pieces mailed and the associated revenue isrecognized when the marketing materials are mailed. Our pricing and revenue fordirect mailings include all applicable postage costs.

 

Interactivemedia arrangements usually range from three months to one year in duration. Ourpricing is typically based on a fee-per-lead generated model, with an up frontpayment or deposit due at the time the customer’s agreement is signed andmonthly invoices thereafter based on the number of leads generated. Paymentsreceived are recorded as customer advances (a liability) until the leads aregenerated, at which point the revenue is recognized.

 

In2005, our Enrollment division introduced a new, service fee-based interactiveproduct model under which the customer procures the lead and we provide lead “scrubbing,”media management, analytic and other services. Under these contracts, whichtypically have a duration of one year, Datamark receives monthly fixedmanagement fees, with opportunities for performance-based bonuses. Fixed feesfrom these arrangements are recognized as revenue when services are provided,and incentive revenue is recognized as the incentives are earned.

 

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Wegenerally enter into master services agreements with larger clients for whom weprovide media buying services. We charge customers for the cost of theadvertisement placed with the third-party media supplier (e.g. newspaper,television, radio station, etc.) as well as a commission for work performed.Revenue is recognized when the media advertisements are run by the third-partymedia supplier. Revenue is recorded on a net basis, meaning that we include inour consolidated revenue only the commission portion of the amount we charge,not the gross amount of fees charged to, and collected from, our customers.Accordingly, we exclude the direct cost of the advertisement charged by themedia supplier from our cost of revenues in our consolidated statements ofoperations.

 

Otherenrollment marketing revenue sources include retention services, admissionstraining, admissions shopper, research services and bundled lead generation andadmissions services. Student retention services agreements have terms of notless than six months and typically are for a period of one year. We chargea fee based on the number of students actively enrolled in a particular month,as well as  a one-time productimplementation fee that is recognized as revenue over the contract period.Contracts for admissions training, admissions shopper and research services arenegotiated based on scope of work. These services are provided on an hourly orper project rate and revenues are recognized at the time of performance of theservice or over the length of the service period. Datamark receives apercentage of tuition revenue per enrollment for its bundled lead generationand admissions services solution. Such revenues are recognized at the timeleads are provided.

 

**Stock-Based Compensation**

 

Stock-basedcompensation is a critical accounting policy for the Company, due primarily tothe significant judgment required when estimating the fair value of thestock-based compensation awards, including the selection of a valuation method(e.g. Black-Scholes) and the underlying assumptions within such valuation (e.g.estimated lives outstanding and volatility).

 

Duringthe fourth quarter of 2003, we adopted Statement of Financial AccountingStandard (“SFAS”) No. 123 effective January 1, 2003 for our employeestock options and other employee stock-based compensation arrangements usingthe prospective method under SFAS No. 148. This method applies theprovisions of SFAS No. 123 to all employee stock awards granted, modifiedor settled after January 1, 2003, and accordingly, we have recognizedcompensation expense for such awards. The fair values of restricted sharerights are determined using the closing price of our common stock on the dateof grant, while the fair values of stock options and stock purchase awards areestimated at the date of grant using the Black-Scholes option-pricing model.The fair values of stock appreciation rights are estimated at the date of grantusing a Monte Carlo simulation for an Asian type award. The estimated fairvalues of awards are being amortized over the vesting period of the applicableaward, generally three to five years.

 

TheCompany recorded $2.8 million of stock-based compensation expense in 2005, $3.8million of stock-based compensation expense in 2004 and $1.0 million ofstock-based compensation expense in 2003.

 

OnSeptember 13, 2004, the Company granted stock appreciation rights with respectto 1.1 million shares of common stock to executives and certain other keyemployees. The rights were granted under the terms and conditions of theCompany’s 1999 Stock Incentive Plan, as amended and approved by stockholders.The rights will be settled in common stock. Each grant is separated into fivedifferent levels of base prices to reflect minimum required levels ofstockholder return over a five-year performance period. The base price for thefirst level is 10% higher than the grant date stock price, and the base pricefor each successive level is 10% higher than the previous level. Except in thecase of a change in control of the Company, as described below, a participantwill receive a distribution with respect to the shares of common stock in eachgrant level only if the average closing price of our common stock for the lastquarter in the five year term exceeds the base price for such shares. Eachparticipant may elect to receive a distribution with respect to 10% of therights he or she was granted after the third anniversary of the grant and withrespect to an additional 10% after the fourth anniversary of the grant. In theevent of a change in control, participants will be entitled to receive a distributionwith respect to a specified percentage of the shares granted (50% if the changein control occurs on September 13, 2004, increasing by 1/36 each month to 100%on September 13, 2007), and will forfeit the right to receive a distributionwith respect to the unvested portion of the shares. The number of shares ofcommon stock issued following a change in control will be based on thedifference between the base prices and the share price as of the date thechange in control occurs. The fair value of each stock appreciation right wasestimated on the date of grant using a Monte Carlo simulation for an Asian typeaward. On March 23, 2005, the Company granted substantially the same recipientsadditional stock appreciation rights with respect to 1.1 million shares ofcommon stock. On May 2, 2005, the Company granted additional stock appreciationrights to an executive in connection with a promotion. Such grants have thesame terms as the 2004 grants, including without limitation the same change incontrol vesting schedules,  except thatthey have different base prices and  newfive-year performance periods beginning on the grant dates. In addition, theCompany may grant stock appreciation rights to new hires and in connection withpromotions and other special circumstances. Compensation expense for each grantis recognized ratably over the five year performance period.

 

EffectiveNovember 1, 2004, the Company amended its 1999 Employee Stock Purchase Plan torevise certain features. Effective with the purchase interval that began onNovember 1, 2004, the ability of plan participants to increase contributionsduring an offering

 

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period was eliminated as was a reset feature thatestablished a new offering period if the fair market value of the Company’scommon stock on any purchase date within an offering period was less than thefair market value at the beginning of such offering period. Effective May 1,2005, the length of an offering period was reduced from two years to one yearand the length of each purchase interval was increased from six months to oneyear. The Employee Stock Purchase Plan has been and continues to be accountedfor under the fair value method in accordance with SFAS No. 123, whichrequires that compensation expense be recognized for the fair value of awards.

 

**Debt Obligations**

 

In October 2003, the Company financed a portionof the purchase of Datamark with $20.0 million (face value) seniorsubordinated secured notes (“Senior Subordinated Notes”) issued to a lender and$12.0 million (face value) subordinated seller notes (“Seller Notes”)issued to the selling stockholders. The Senior Subordinated Notes require principalpayments due in $5.0 million quarterly increments beginning on December 31,2007, with interest payments due quarterly beginning on December 31, 2003,at a rate of 12.5% per annum. The Seller Notes, with interest and principal duein 2008, initially consisted of a series of notes aggregating $7.0 million(face value), with a stated interest rate of 10.0% per annum, simple interest,and another series of notes aggregating $5.0 million (face value), with aninterest rate of 10.0%, interest compounded annually.

 

In accordance with generallyaccepted accounting principles, the Company estimated the fair value of theSenior Subordinated Notes and the Seller Notes. The initial fair value of theSenior Subordinated Notes reflected a fair value adjustment to the notes forthe estimated fair value of the warrants issued in connection with this debt.The estimated fair value of the warrants at the date of issuance, using theBlack-Scholes valuation method, was $3.3 million, and was recorded as adebt discount against the face value of the $20.0 million SeniorSubordinated Notes. This discount is being amortized as interest expense overthe five-year term of the Senior Subordinated Notes using the interest method.The effective interest rate on this debt is 19.7%. The carrying value of theSenior Subordinated Notes was $17.9 million at December 31, 2005, whichincludes amortization of warrant costs.

 

The initial fair value ofthe Seller Notes was determined by a third party who considered, among otherfactors, the effective interest rate of our Senior Subordinated Notes and othercomparable debt securities. The effective interest rate on this debt is 14.9%.In December 2004 the Company repaid all of the $7.0 million (face value)of simple interest notes and $3.0 million (face value) of the annuallycompounding notes. The carrying value of the repaid Notes was $7.5 million andthe repayment resulted in a $2.5 million charge for the write-off of theunamortized discount on these notes. The carrying value of the remaining SellerNotes was $2.1 million at December 31, 2005, which includesamortization of the original discount recorded and accrued interest payable.Interest will accrue on the remaining notes until they are paid.

 

Due to the discountsrecorded when the Senior Subordinated Notes and Seller Notes were issued, anyfurther pre-payments of these debt obligations would again result in asignificant amount of interest expense, since cash paid would exceed thediscounted carrying amount. The Senior Subordinated Notes also contain aprovision that provides for the acceleration of all interest payments duethrough October 31, 2006 upon payment of the debt prior to maturity.

 

**Goodwill and Other IntangibleAssets**

 

With the acquisition of Datamark in October 2003,we recorded $68.0 million of the approximate $70.3 million purchase price asgoodwill and other intangible assets. Significant judgment is required inestablishing the fair value, determining appropriate amortization periods andassessing such intangibles for impairment. In the future, we may determine thatthe carrying value of these intangibles exceeds their value, in which case wewould be required to record an impairment charge which could  be material.

 

Goodwill represents the excess of the acquisitioncosts over the net of the fair value of the identifiable tangible andintangible assets acquired and the fair value of liabilities assumed in theacquisition. We account for goodwill and other intangible assets under  SFAS No. 142 “Goodwill and OtherIntangible Assets,” whereby goodwill and intangible assets deemed to haveindefinite lives are not amortized but are tested for impairment annually.

 

The fair values of the intangible assets wererecorded based upon valuations determined by a third party using the income andcost methods at the date of the acquisition. The income method determines avalue based upon estimated future cash flows and the cost method determinesvalue based on what it would cost to replace the asset less depreciation andfunctional obsolescence.

 

Based upon the nature of Datamark’s assets, theincome approach was utilized to value the customer relationship intangibleasset. In performing the allocation, the assets were analyzed within thecontext of the Datamark business enterprise. The Company

 

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consideredthis context to be representative of assumptions marketplace participants woulduse in analyzing the assets acquired. In establishing the amortization periodfor the customer relationship intangible asset, the Company considered therelative weighting of customer revenues and customer lives and determined thatwhile certain customer relationships are expected to span as long as 16 years,the economic benefit attributable to these customers generally declines in thefinal eight years as compared to the first eight years of the relationship.Therefore, the Company used an eight year period (weighted average) fordetermining amortization. During the life of a customer relationship, a customer’srevenue streams can increase (and decrease), creating a pattern of economicbenefit that is not reliably determinable. Therefore, the Company hasdetermined that a straight-line amortization method over eight years isappropriate and representative of the economic benefits of the intangibleasset.

 

In determining the value of the Datamark trade name,the Company utilized the relief-from-royalty method – using a royalty rateapplied to projected Datamark sales streams. In determining that the trade nameintangible asset had an indefinite life, the Company considered the followingfactors: the ongoing active useful life of the trade name; the lack of anylegal, regulatory, or contractual provisions that may limit the useful life ofthe trade name; the lack of any substantial costs to maintain the asset; thepositive impact on the trade name generated by Datamark’s other ongoingbusiness activities; and Datamark’s commitment to products being branded withits trade name over its corporate history. The Datamark trade name hassignificant market recognition and the Company expects to derive benefits fromthe use of this asset beyond the foreseeable future. However, should theCompany discontinue use of or otherwise determine that the value of the trade nameis diminished, the Company may be required to record an impairment charge withrespect to all or a significant portion of this asset.

 

Pursuant to the Datamark transaction, eight Datamarkemployees signed agreements that legally restrict them from competing witheCollege during their respective employment periods and for two yearstherafter; provided that the total restricted period may not exceed five years.In determining the value of the non-compete agreements, the Company estimatedthe incremental sales associated with having the non-compete agreements inplace versus not having them in place. The Company is amortizing the fair valueof the non-compete agreements over the maximum five year period. Certainfactors that could affect the useful life of this asset include the terminationof one or more of these employees, which could accelerate amortization if itwould cause their non-compete agreements to have lives of less than five years.In April 2005,  a Datamark executiveresigned from the Company, resulting in the acceleration of the amortization ofthe fair value of his non-compete agreement to correspond with the resultingdecrease in the term of his agreement.

 

**Goodwilland Identified Intangible Assets with Indefinite Lives**

 

Goodwill andpurchased intangible assets with indefinite useful lives are notamortized.  The Company reviews goodwilland identified intangible assets with indefinite lives for impairment in thefourth quarter of each year and whenever events or changes in circumstancesindicate the carrying value of an asset may not be recoverable.  The goodwill impairment review is performedusing a two-step impairment test.  Thefirst phase screens for impairment; while the second phase (if necessary),measures the impairment.  For purposes ofthis test we have identified two reporting units, which are the same as ourreportable segments (see Note 10).  Inthe first step of the goodwill analysis, the Company compares the fair value ofa reporting unit to its carrying value. If the carrying value exceeds the fair value, the second step must becompleted to determine the amount impaired. In the second step, the Company compares the carrying value to theimplied fair value of the goodwill under a theoretical purchase allocationscenario.

 

The impairmentreview of the identified intangible assets with indefinite lives consists of acomparison of the fair value of an intangible asset with its carryingamount.  If the carrying amount of anintangible asset exceeds its fair value, an impairment loss is recognized in anamount equal to such excess.  After animpairment loss is recognized, the adjusted carrying amount of the intangibleasset is its new accounting basis.  Impairmenttests completed in the years ended December 31, 2005 and 2004 indicated noimpairment of either goodwill or intangible assets with indefinite lives.

 

**Software Development Costs**

 

The Company’s activities include ongoing developmentof internal-use software used in connection with delivery of services via ourproprietary software platform and network. Pursuant to the provisions of theAmerican Institute of Certified Public Accountants’ (“AICPA’s”)  Statement of Position 98-1, “Accounting forthe Costs of Computer Software Developed or Obtained for Internal Use,” costsincurred during the application development stage are capitalized and costsincurred during the preliminary project and post-implementation stages areexpensed as incurred. Capitalized software development costs are amortizedusing the straight-line method over their estimated useful lives, generallythree years. Capitalized software development costs for the years ended December 31,2005, 2004 and 2003 were $1.3 million, $1.8 million and $304,000,respectively.  Amortization begins whenthe products are ready for their intended use.  Amortization expense forthe years ended December 31, 2005, 2004 and 2003 was $583,000, $325,000and $1.3 million, respectively. If the internal-use software developed isdetermined to have a reduced life or is otherwise abandoned or impaired,amortization could be accelerated or a write-off of the asset could result.

 

**Income Taxes**

 

Income taxes consist of federal, state and localtaxes. Accounting for income taxes and any related valuation allowance requiresthe application of significant judgment and estimates. We incurred significanttax losses from our inception through December 31, 2003 resulting inapproximately $66 million of net operating loss carryforwards which expirein varying amounts beginning in 2012. The Company was profitable in the yearsended December 31, 2004 and 2005 and has used net operating losscarryforwards to reduce income taxes payable during such periods. As of December 31,2005, net operating loss carryforwards of $58 million remained.  However, utilization of such net operatingloss carryforwards may be subject to certain limitations, such as limitationsresulting from significant changes in ownership. In addition, income taxes maybe payable during this time, due to operating income in certain taxjurisdictions which cannot be offset by operating loss carryforwards. If wehave taxable income and the net operating loss carryforwards are not available,because they have been limited by tax law, have been exhausted or have expired,we may be liable for significant taxes payable.

 

In assessing the realizability of deferred taxassets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The realizationof deferred tax assets is dependent upon the generation of future taxableincome during the periods in which temporary differences, as determinedpursuant to SFAS No. 109, “Accounting for Income

 

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Taxes,”become deductible. Management considers the reversal of deferred taxliabilities, projected future taxable income, and tax planning strategies inmaking this assessment. Management’s evaluation of the realizability ofdeferred tax assets must consider both positive and negative evidence.The weightgiven to the potential effects of positive and negative evidence is based onthe extent to which it can be objectively verified. Prior to the fourth quarterof 2004, we had provided a full valuation allowance for the potential benefitsof the aforementioned net operating loss carryforwards as we believed it wasmore likely than not that the benefits would not be realized. During the fourthquarter of 2004, we reversed $21.3 million of the valuation allowance relatedto the net operating loss carryforwards and other temporary items as wedetermined it was now more likely than not that we would be able to use theassets to reduce future tax liabilities. Approximately $591,000 in valuationreserves associated with state net operating loss carryforwards were notreversed in the fourth quarter of 2004 as we determined that  it was more likely than not that the benefitsof such carryforwards would not be realized. The reversal resulted inrecognition of an income tax benefit of $18.5 million in 2004 and an increasein the deferred tax asset on the consolidated balance sheet. The 2004 reversalalso resulted in an increase of $1.9 million to additional paid in capitalassociated with tax benefits from stock-based compensation and an increase of$900,000 to goodwill associated with certain tax benefits related to theDatamark acquisition.  We recorded incometax expense of $4.1 million for the year ended December 31, 2005.  In 2005, the Company recorded a $3.1 millionincrease to additional paid in capital related to tax benefits associated withstock based compensation, including $2.7 million related to the exercise of972,335 options held by Blumenstein/Thorne Information Partners I, L.P., aninvestment fund affiliated with the Company’s Chief Executive Officer.  The Company recorded a $353,000 reduction togoodwill during 2005 associated with tax benefits related to the Datamarkacquisition.

 

**Description of SignificantComponents of our Consolidated Statement of Operations**

 

**Revenue**

 

Our revenue in 2005 primarily consisted of eLearningstudent technology fees for students enrolled in online courses and onlinecourse supplements and revenues generated by direct mail and interactivemarketing products and services provided by our Enrollment division. We alsorecognized a smaller portion of revenue from eLearning online campus and coursedesign and development services (including licensing and hosting services feesfor online campuses), and other eLearning professional services as well asEnrollment division media placement, custom research, admissions training,  student retention and bundled lead generationand admissions services.

 

**Cost of Revenue**

 

Cost of revenue for our eLearning division consistsprimarily of employee compensation and benefits for our account management,online campus development, course design, technical personnel, and help deskdepartments as well as sales commissions. Our cost of revenue also includessoftware, hardware, and other direct costs associated with maintaining our datacenter operations and our network infrastructure. Amortization of capitalizedsoftware development costs is also included in cost of revenue.

 

Cost of revenue for our Enrollment division includespostage costs, raw material costs and costs for interactive marketing leads, aswell as all costs associated with the purchase/license of mailing lists. Costof revenue also includes direct labor costs, allocable indirect labor andoverhead, sales tax and contract production costs.

 

**Product Development**

 

Product development includes costs of maintaining,developing, creating and improving our online solutions and software products.These costs consist primarily of employee compensation and benefits, consultingfees, occupancy costs, and depreciation expenses. Product development costs inthe future may be reduced by any software development costs that arecapitalized in accordance with relevant accounting standards.

 

**Selling and Marketing**

 

The principal components of our selling andmarketing expenses in both divisions are employee compensation and benefits,advertising, industry conferences, and travel. Other significant componentsinclude marketing collaterals and direct mailings, consulting fees, occupancycosts, and depreciation expenses.

 

**General and Administrative**

 

Weinclude costs from both divisions as well as unallocated corporate expenses ingeneral and administrative expense. These costs include executives, humanresources, corporate facilities, corporate and divisional accounting andfinance, legal, internal

 

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technicalnetwork administration and support and management information systems. Employeecompensation and benefits, including stock-based compensation, represents themost significant component of general and administrative expense. Othercomponents include rent, depreciation, communications, insurance andprofessional and consulting fees, including fees relating to the audit of ourfinancial statements and our compliance with Sarbanes-Oxley.

 

**Amortization of Intangible Assets**

 

Our amortization of intangible assets consistsentirely of the amortization of identified intangible assets that we recordedin connection with the Datamark acquisition. Specifically, customerrelationships are amortized over their estimated useful lives of eight yearsand non-compete agreements are being amortized over their estimated usefullives of five years. In April 2005, a Datamark executive resigned from theCompany, resulting in the acceleration of the amortization of the fair value ofhis non-compete agreement to correspond with the decrease in the term of hisnon-compete. The Datamark trade name has been deemed to have an indefinite lifeand is not subject to amortization expense.

 

**Other Income (Expense), net**

 

Other Income (Expense), net consists primarily ofinterest expense associated with our various debt obligations, as well asinterest income from invested cash and cash equivalents.

 

**Results of Operations**

 

The following discussion compares the historicalresults of operations for the years ended December 31, 2005, 2004, and2003. The results for 2003 include the Enrollment division’s results ofoperations from October 31, 2003, the date on which we acquired all of theoutstanding stock of Datamark, Inc. The inclusion of the Enrollment division’sresults for 2005, 2004 and the two months ended December 31, 2003 causedsignificant fluctuations in the operating results of eCollege for the yearsshown.  In addition, operating resultsfor the Enrollment division may vary significantly from quarter to quarterbased upon various factors that include the timing of start dates for customers’courses and programs and their associated enrollment marketing expenditures.

 

**Years Ended December 31,2005 and 2004**

 

*Revenue.*  Revenue increased $13.6 million,or 15%, to $102.9 million for the year ended December 31, 2005 from$89.3 million for the year ended December 31, 2004. The Enrollmentdivision was responsible for $6.9 million of this increase, primarily due to a$5.9 million increase in revenue from bundled lead generation and admissionsservices, offset in part by a $728,300 decrease in revenue from direct mailmarketing services. The eLearning division contributed $6.7 million of theincrease, primarily due to a $5.7 million increase in student fees from onlinecourses.

 

At the eLearning division, student feesrepresented $36.8 million and $31.2 million of total revenue for the yearsended December 31, 2005 and 2004, respectively, an increase of $5.6million, or 18%. Our eLearning customers benefit from volume discounts on theirstudent technology fees based on the success of their distance programs. Inaddition, they often guarantee a minimum amount of student technology fees foreach year they are under contract with us, for which they receive furtherdiscounts on our services. Therefore, the 18% increase in our student feerevenue was not directly proportional to the increase in our customers’ onlinestudent enrollments. Studentenrollments in eCourses increased 55% to 773,424 in 2005 from 499,489 in theprior year, while the corresponding revenue earned from eCourse enrollmentsincreased 23% to $35.7 million in 2005 from $29.0 million in 2004. The2005 and 2004 enrollment numbers are not directly comparable because 2004includes approximately 20,000 enrollments in short-term faculty trainingcourses that generated significantly less revenue per enrollment than othereCourses.  We expect the trend ofdistance enrollment growth outpacing associated revenue growth to continue in2006.

 

Campus and course development fees represented $1.1million and $1.8 million of total revenue for the years ended December 31,2005 and 2004, respectively, a decrease of $630,000, or 36%. The decrease isprimarily the result of a decline in course development and course maintenancerevenue attributable to an increasing number of customers taking advantage ofour products and tools to design and develop their own courses.

 

Other eLearning revenue increased by $1.6 million,or 84%, to $3.5 million for the year ended December 31, 2005 from $1.9million for the year ended December 31, 2004. The increase is primarilyattributable to a greater demand for our technical and academic consultingservices during 2005 as compared to 2004, especially by new customers adoptingeLearning’s technology platform.

 

With respect to our Enrollment division, revenuefrom direct mail marketing activities was $37.6 million and $38.3 million,respectively, for the years ended December 31, 2005 and 2004, a decreaseof $728,000, or 2%.  The decrease resultedprimarily from a shift by several existing customers from direct mail marketingto interactive lead generation, offset in part by increased sales of directmarketing

 

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servicesto other existing customers as well as new customers.  Direct mail accounted for 61% of Enrollmentdivision revenue for the year ended December 31, 2005 compared to 70% ofEnrollment division revenue for the year ended December 31, 2004.

 

Revenue from interactive marketing servicesincreased by $5.9 million, or 53%, to $16.9 million for the year ended December 31,2005 from $11.1 million for the year ended December 31, 2004, dueprimarily to increased acceptance of the internet as a vehicle for leadgeneration.  This increase in interactivemarketing revenue was a reason for the decrease in direct mail revenue as apercentage of Enrollment division total revenue, as interactive marketingrevenue growth exceeded direct mail revenue growth.  Interactive growth for the year ended December 31,2005 was also impacted by the introduction in 2005 of a managed servicespricing structure.  As compared to thetraditional cost-per-lead model, the managed services model generates lessrevenue because inventory costs of interactive leads are not passed through tocustomers.  Managed services pricingaccounted for 18% of interactive revenues for the year ended December 31,2005.  Interactive marketing in totalaccounted for 28% of total Enrollment division revenue for the year ended December 31,2005 as compared to 20% for the prior year period.

 

Media placement revenue remained relatively flat at$3.2 million for the year ended December 31, 2005 as compared to $3.1million for the year ended December 31, 2004.

 

Other enrollment marketing revenue increased by $1.7million, or 89%, to $3.6 million for the year ended December 31, 2005 from$1.9 million for the year ended December 31, 2004. The increase consistedprimarily of revenue from a bundled lead generation/admissions solutionprovided by Datamark to a customer beginning in the fourth quarter of2004.  Under this relationship, revenuesare recognized upon the delivery of leads following enrollment marketingprograms and additional enrollment services specific to the customer’s degreeprograms. Datamark receives a share of program tuition for each enrollment.

 

*Cost of Revenue.*  Cost of revenue for the yearended December 31, 2005 increased by $7.2 million, or 15%, to $54.0million from $46.8 million for the year ended December 31, 2004.  The Enrollment division’s cost of revenue was$41.5 million for the year ended December 31, 2005, an increase of $5.1million, or 14%, from $36.4 million for the year ended December 31, 2004.The Enrollment division’s cost of revenue as a percentage of revenue remainedrelatively flat at 68% in 2005 as compared to 67% in 2004. The cost of revenueas a percentage of revenue is affected by reduced margins in direct mail,shifts in product mix from direct mail to interactive marketing, improvedmargins for our interactive business due to automation and the introduction ofa new managed services pricing model, as well as the timing of revenues relatedto bundled lead generation and admissions services.  The eLearning division’s cost of revenueincreased by $2.1 million, or 20%, to $12.4 million for the year ended December 31,2005 from $10.3 million for the year ended December 31, 2004. As apercentage of revenue, eLearning cost of revenue increased from 27% for the2004 period to 28% for the 2005 period. The increase as a percentage of revenueis attributable to a $2.0 million increase in salaries for informationtechnology, professional services, and client services employees; softwarelicensing costs; and the write-off of third party software no longer in use.Corporate cost of revenue remained relatively flat at $878,300 for the yearended December 31, 2005, compared to $882,100 for the year ended December 31,2004.

 

*Gross Profit.*  We realized gross profit of $48.9million and $42.5 million for the years ended December 31, 2005 and 2004,respectively, resulting in a 15% or $6.4 million increase.  The Enrollment division contributed $19.9million to our gross profit for the year ended December 31, 2005, up from$18.1 million for the year ended December 31, 2004.  The increase of $1.8 million  primarily related to the increase ininteractive revenue somewhat offset by a decrease in direct mail revenue.  The eLearning division contributed $29.9million to our gross profit for the year ended December 31, 2005, up from$25.2 million for the year ended December 31, 2004. The increase of 19%resulted from the increase in our higher margin student fee revenue.

 

*Product Development.*  Including the impact ofcapitalized software development costs, product development expenses increased$600,000, or 9%, to $7.2 million for the year ended December 31, 2005 from$6.6 million for the year ended December 31, 2004.  The increase results primarily from areduction in the amount of capitalized software development, an increase in ouroffshore development efforts in Sri Lanka and an increase in personnelcosts.  For the years ended December 31, 2005 and 2004, capitalizedsoftware development costs were $1.4 and $1.8 million, respectively, a decreaseof $400,000 or 22%. The decrease results primarily from the completion andrelease into production of development projects in process during the prioryear.  We continue to focus our efforts on increasing the functionality ofall products and the development of new product lines that enhance our currentofferings.

 

*Selling and Marketing.*  Selling and marketing expensesincreased by $300,000 to $10.2 million for the year ended December 31,2005, up from $9.9 million for the year ended December 31, 2004. TheEnrollment division incurred $5.2 million of selling and marketing expenses forthe year ended December 31, 2005 compared to $5.1 million for the yearended December 31, 2004, and the eLearning division’s selling andmarketing expenses decreased by $117,000, or 3% , to $4.3 million for the yearended December 31, 2005 from $4.4 million for the year ended December 31,2004.  The modest decrease resulted fromreductions in new business development expenses and general marketing expenses.Corporate selling and marketing expenses were $653,000 and $324,000 for theyears ended December 31, 2005 and 2004, respectively, an increase of$329,000 or 102%, due primarily to payroll-related charges.

 

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*General and Administrative.*  General and administrative expensesincreased by $100,000, to $16.3 million for the year ended December 31,2005 from $16.2 million for the year ended December 31, 2004. A $200,000decrease in corporate general and administrative expenses was offset byincreased payroll expense associated with increased staffing at both theeLearning and Datamark divisions. The decrease in corporate expenses resultedfrom a $900,000 decrease in bonuses paid under the eCollege Bonus Plan, a $1.2million decrease in stock-based compensation related to our Employee StockPurchase Plan (“ESPP”) and a $446,000 decrease in consulting costs associatedwith Sarbanes-Oxley compliance. These decreases were offset by a $1.1 millionincrease in stock-based compensation associated with stock appreciation rights,a $811,000 increase in external audit fees and increased tax consulting andlegal fees. Corporate payroll expenses increased by $400,000 due to staffing ofthe Chicago office.

 

We record non-cash stock-based compensation expensein connection with the grant of stock options, stock awards under our ESPP,stock appreciation rights and restricted share rights to employees, officers,and directors in accordance with SFAS 123, which we adopted January 1,2003. The deferred charges are amortized over the relevant vesting periods ofsuch awards, which range from one to five years. We recorded $2.8 millionof stock-based compensation in the year ended December 31, 2005, adecrease of $1 million from the $3.8 million recorded in the year ended December 31,2004. The decrease results from a  $1.1million reduction in stock based compensation expense following theterminations of employment of three Datamark management employees and theforfeiture of their unvested equity compensation. Such reduction includes$668,000 from the reversal of previously recognized stock-based compensationexpense and $438,000 resulting from the elimination of expense for the periodsfollowing the terminations.  Expensesassociated with stock appreciation rights increased by $1.3 million and expensesassociated with the ESPP decreased by $1.2 million. A portion of the Company’snon-cash stock-based compensation expense was allocated to cost of revenue,selling and marketing expense and product development expense, as appropriate,based on the recipients of the awards; however, the majority of the stock-basedcompensation expense relates to our executive team and was therefore includedin general and administrative expense.

 

*Amortization of Intangible Assets.*  Amortization of intangible assetswas $1.6 million and $1.5 million for the years ended December 31, 2005and 2004, respectively. Amortization of intangible assets consists entirely ofthe amortization of identified intangible assets which we recorded inconnection with the Datamark acquisition. Specifically, customer relationshipswith an estimated value of $8.1 million are being amortized over theirestimated useful lives of eight years, and non-compete agreements valuedat $2.4 million are being amortized over their estimated useful lives offive years. In April 2005, a Datamark executive resigned from theCompany, resulting in the acceleration of the amortization of the fair value ofhis non-compete agreement to correspond with the decrease in the term of theagreement. Beginning in the second quarter of 2005, such amortization increasedby approximately $40,000 per quarter.

 

*Other Income (Expense).*  Interest expense decreased by$3.9 million, or 53%, to $3.5 million for the year ended December 31, 2005from $7.4 million for the year ended December 31, 2004.  Included in interest expense for the yearended December 31, 2004 was $2.5 million in expense associated with theprepayment of $10.0 million (face amount) of the Seller Notes.  The remaining $1.4 million decrease isprimarily attributable to lower interest expense on the remaining Seller Notesas well as the prepayment in March 2005 of the $1.7 million remainingbalance on the Term Loan.

 

*Income taxes.*  Income tax expense increased by$22.6 million, to $4.1 million for the year ended December 31, 2005 from atax benefit of  $18.5 million for theyear ended December 31, 2004.  Theincrease is due to our increasing profitability and our conclusion that it ismore likely than not that the Company will realize the tax benefitsassociated with deferred tax assets created by net operating losscarryforwards.  Prior to this conclusion,and the resulting recognition of deferred tax assets relating to net operatingloss carryforwards, income tax expense was offset by equivalent reductions inthe valuation reserve against the deferred tax asset.  Wehad $120,000 of cash expenditures for income taxes for the year ended December 31,2005 and $115,000 for the year ended December 31, 2004.   The effective tax rate for  2005 was 40.8%, which reflects the statutorycorporate tax rate as well as the impact of certain non-deductible stock-basedcompensation and other expenses.

 

*Net income.*  Our net income decreased by $13.4million, or 69 %, to $5.9 million or $0.27 per basic share and $0.26 perdiluted share for the year ended December 31, 2005, from net income of$19.4 million or $0.95 per basic share and $0.88 per diluted share for the yearended December 31, 2004.

 

**Years Ended December 31, 2004and 2003**

 

*Revenue.*    Revenue increased$52.4 million, or 142% to $89.3 million for the year ended December 31,2004 from $36.9 million for the year ended December 31, 2003. TheEnrollment division was responsible for $46.8 million of this increase,primarily from inclusion of a full year’s operating results, as compared to twomonths in 2003. The remaining $5.6 million of the revenue increase is primarilydue to a $6.2 million increase in student fees from online coursespartially offset by a $600,000 decrease in other eLearning revenue.

 

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Student fees represented$31.2 million and $25.0 million of total revenue for the years ended December 31,2004 and 2003, respectively, an increase of 25%. Our eLearning customersbenefit from volume discounts on their student technology fees based on thesuccess of their distance programs. In addition, they often guarantee a minimumamount of student technology fees for each year they are under contract withus, for which they receive further discounts on our services. Therefore, the 25%increase in our student fee revenue was not directly proportional to theincrease in our customers’ online student enrollments in 2004. Studentenrollments in eCourses increased 53% to 499,489 in 2004 from 327,308 in theprior year, while the corresponding revenue earned from eCourse enrollmentsincreased 25% to $29.0 million in 2004 from $23.2 million in 2003.The 2004 and 2003 enrollment numbers are not directly comparable because 2004includes approximately 20,000 enrollments in short-term faculty trainingcourses that generated significantly less revenue per enrollment than othereCourses offered.

 

Revenue from direct mailmarketing activities at our Enrollment division was $38.3 million for the yearended December 31, 2004, an increase of $32.1 million from the two monthsof Enrollment division operations included in 2003. Direct mail accounted for70% of total Enrollment division revenue we recognized in 2004 compared to 81%of Enrollment division revenue in the two months included in operations in 2003.

 

Revenue from interactivemarketing services increased to $11.1 million in 2004 from $790,000 in the twomonths of operations included in the year ended December 31, 2003. Thisincrease in interactive marketing revenue was the primary reason for the decreasein direct mail revenue as a percentage of Enrollment division total revenue, asinteractive marketing revenue growth exceeded direct mail revenue growth in2004.

 

Campus and coursedevelopment fees represented $1.8 million and $2.6 million of total revenuefor the years ended December 31, 2004 and 2003, respectively, a decreaseof $800,000, or 31%. We recognized revenue from developing, licensing, andhosting online campuses for 152 customers during 2004, down from the 198customers that had online campuses in 2003. The decrease results from anincreasing number of customers taking advantage of our tools by self-designingand developing their own courses.

 

Other revenue includedeLearning technical and instructional design consulting revenue of $1.9 millionand $986,000 for the years ended December 31, 2004 and 2003, respectively.It also included $3.1 million from media placement activities from ourEnrollment division in the year ended December 31, 2004 compared to$448,000 for the two months ended December 31, 2003.

 

*Cost of Revenue.*    Cost of revenue forthe year ended December 31, 2004 increased by $30.6 million, or 189%, to$46.8 million from $16.2 million for the year ended December 31,2003. The Enrollment division’s direct mail and other cost of revenue was$36.4 million in 2004, an increase of $31.4 million from $5.0 million forthe two months of operations included in 2003. eLearning division cost ofrevenue decreased by $1.0 million, or 8%, to $10.3 million for the yearended December 31, 2004 from $11.3 million in 2003. This decrease isattributable to a $1.0 million decrease in amortization expense related to ourcapitalized software costs.

 

*GrossProfit.*    Werealized gross profit of $42.5 million for the year ended December 31,2004, resulting in a 105%, or $21.8 million, increase compared to the$20.7 million we realized for the year ended December 31, 2003. TheEnrollment division contributed $18.1 million to our gross profit for2004, up from $2.7 million for the two months of operations included in 2003,while the eLearning division contributed $24.4 million for 2004, up from$18.0 million in 2003. The increase of $15.4 million related to the EnrollmentDivision was primarily due to the inclusion of a full year of operations in 2004as compared to two months in 2003, while the $6.4 million increase relatedto the eLearning division was primarily due to the increase in higher marginstudent fee revenue.

 

*ProductDevelopment.*    Productdevelopment expenses increased to $6.6 million for the year ended December 31,2004 from $5.7 million for the year ended December 31, 2003, anincrease of $900,000 or 16%. The increase was primarily attributable toincreased staffing (including offshore developers) and travel expenses relatedto our Sri Lanka development facility. We capitalized $1.8 million in costs forinternally developed software in 2004, which reduced research and developmentexpense by a corresponding amount. In 2003, we capitalized $304,000 in costsfor internally developed software.

 

*Sellingand Marketing.*    Sellingand marketing expenses increased by $4.1 million, or 71%, to $9.9 millionfor the year ended December 31, 2004 from $5.8 million for 2003. TheEnrollment division recorded $5.1 million of selling and marketing expenses during2004, an increase of $4.5 million from 2003, reflecting a full year of expensein 2004 as compared to two months in 2003. The eLearning division had $4.8million of selling and marketing expenses in 2004, a decrease of $400,000 from2003, primarily due to a decrease in the number of sales and marketingpersonnel in 2004 and the expiration of a prepaid marketing contract.

 

*Generaland Administrative.*    Generaland administrative expenses increased by $9.1 million, or 127%, to$16.2 million for the year ended December 31, 2004 from$7.1 million for the year ended December 31, 2003. Of this increase,$5.0 million related to a full year of operations for the Enrollment divisionin 2004 ($5.6 million), as compared to two months in 2003 ($644,000). Otherfactors contributing to the increase in 2004 from 2003 included increases ingeneral corporate expenses such as bonuses ($1.4 million),

 

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Sarbanes-Oxley compliance ($1.3 million), audit feesand higher stock-based compensation. These increased costs were offset somewhatby a decrease in information systems costs.

 

We record non-cash stock-based compensation inconnection with the grant of stock options, stock awards under our ESPP, stockappreciation rights and restricted share rights to employees, officers, anddirectors in accordance with SFAS 123, which we adopted using the prospectivemethod, effective January 1, 2003. The deferred charges are beingamortized over the relevant vesting periods of such options or restricted sharerights, which range from one to five years. We recorded $3.8 millionof stock-based compensation in the year ended December 31, 2004 and $1.0million in the year ended December 31, 2003. A portion of suchcompensation expense was allocated to cost of revenue, selling and marketingexpense, and product development expense, as appropriate, based on therecipients of the awards; however, the majority of the stock-based compensationexpense relates to our executive team and was therefore included in general andadministrative expense.

 

*Amortizationof Intangible Assets.*    Amortizationof intangible assets for the year ended December 31, 2004 was $1.5 millioncompared to $300,000 for the year ended December 31, 2003. The increasewas due to twelve months of amortization in 2004 compared to two months in2003. Amortization of intangible assets consists entirely of the amortizationof identified intangible assets which we recorded in connection with theDatamark acquisition. Specifically, customer relationships with an estimatedvalue of $8.1 million are being amortized over their estimated usefullives of eight years, and non-compete agreements valued at$2.4 million are being amortized over their estimated useful lives of five years.

 

*Other Income(Expense).*    Interestexpense increased by $6.1 million, or 483%, to $7.4 million for the yearended December 31, 2004 from $1.3 million for the year ended December 31,2003. The majority of the increase is related to a full year of interestexpense on the debt obligations incurred to fund the acquisition of Datamark inOctober 2003. Included in interest expense for the year ended December 31,2004 was $2.5 million in expense from prepayment of $7.5 million ($10.0 millionface value) in Seller Notes issued as a part of the Datamark acquisition.Included in interest expense for the year ended December 31, 2003 wasapproximately $353,000 of foregone debt issuance costs incurred in September,2003 to obtain a financing commitment to fund the Datamark acquisition; wesubsequently obtained more favorable terms from different lenders and thecommitment was never funded.

 

*Incometaxes.*    Werecorded an income tax benefit of $18.5 million for the year ended December 31,2004 due to the reversal of the valuation allowance we had previously recordedagainst our deferred tax asset as well as from the recognition of changes inother temporary differences. We had $115,000 in cash expenditures for incometaxes in 2004. We determined in 2004 that it is more likely than not that wewill be able to realize the tax benefits of our approximately $66 million innet operating losses as a carryforward against future taxable income. We had noincome tax expense or benefit in 2003.

 

*Netincome.*    Ournet income increased to $19.4 million or $0.95 per basic and $0.88 per dilutedshare for the year ended December 31, 2004, from a net income of $568,000or $0.03 per basic and diluted share in 2003.

 

**Segment Information**

 

The two reportable segments disclosed in thisdocument are based on our management organizational structure as of December 31,2005. A detailed description of the products and services, as well as financialdata, for each segment can be found in Note 10 to the ConsolidatedFinancial Statements included in Item 8 of this Annual Report on Form 10-K.Please note that based on the way in which our management team reviews andevaluates segment performance, the segment operating results shown below for2005, 2004 and 2003 do not include certain operating expenses which areseparately managed at the corporate level and not allocated to segments. Thesecosts include executive management salaries and benefits, stock-basedcompensation, bonuses paid under the eCollege bonus plan, certain corporatefinance and legal salaries and benefits, audit, consulting and legal costsincurred at the corporate level, rent and occupancy costs for the Chicagooffice, amortization of intangible assets, interest income, interest expense and other income/(expense). Such items are only considered whenevaluating the results of the consolidated company. Future changes to thisorganizational structure may result in changes to the reportable segmentsdisclosed.

 

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**Historical Results**

 

The historical results and discussions below includethe historical results of each of eCollege’s segments in fiscal 2005, 2004, and2003, including Datamark’s results of operations from October 31, 2003(the acquisition date).

 

***eLearningDivision*******

 
| ** **                                             | ** ** | **Year Ended December 31,**        | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                             | ** ** | **(in thousands, except  percentages)** | ** ** |
| ** **                                             | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                            |       | $                                       | 41,457     |   | $ | 34,781 |   | $ | 29,135 |   |
| Income from  operations                                |       | $                                       | 15,847     |   | $ | 11,683 |   | $ | 1,392 |   |
| Income from  operations as a percentage of net revenue |       | 38                                      | %          | 34 | % | 5 | % |

 

eLearning revenue grew 19% in 2005 and 19% in 2004from the prior year. The increase in revenue for both years is primarily due toan increase in the number of student enrollments in online courses.  Our customers offer traditional, as well asquarterly, bi-monthly and monthly course terms to their students and wetypically host more courses during the spring academic term than in the summeror fall terms. As a result, consecutive academic term enrollment results arenot directly comparable. The following table presents the number of studentenrollments our customers had start in distance courses during the 2005, 2004,and 2003 spring, summer and fall academic terms.

 
| ** **                                    | ** ** | **Distance Course Enrollments** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **2005**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| ACADEMIC TERM:                                |       |                            |       |   |   |   |   |
| Spring (January 1 - May 15)    |       | 287,412                         |       | 220,126 |   | 138,630 |   |
| Summer (May 16 - August 15)    |       | 180,505                         |       | 105,072 |   | 70,129 |   |
| Fall (August 16 - December 31) |       | 305,507                         |       | 174,291 |   | 118,549 |   |
| Total student enrollments                     |       | 773,424                         |       | 499,489 |   | 327,308 |   |

 

For a more detailed explanation of revenuecomponents and the growth trends of the eLearning division revenue, please seethe information under the caption “Results of Operations” earlier in this Item7.

 

The eLearning division’s income from operationsincreased by $10.3 million between 2003 and 2004 and by $1.6 million between2004 and 2005.  The increase wasprimarily due to increased student fees, which have a relatively highercontribution margin than most of our other revenue sources. In addition,  non-allocable corporate general andadministrative expenses were excluded from eLearning’s segment results in 2004and 2005. In 2003, eLearning results included these corporate expenses, as theEnrollment division had only two months of operations in 2003.

 

***EnrollmentDivision***

 
| ** **                                                    | ** ** | **Year Ended December 31,**        | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except  percentages)** | ** ** |
| Net revenue                                                   |       | $                                       | 61,411     |   | $ | 54,486 |   | $ | 7,725 |   |
| Income  (loss) from operations                                |       | $                                       | 10,276     |   | $ | 8,690 |   | $ | 1,592 |   |
| Income  (loss) from operations as a percentage of net revenue |       | 17                                      | %          | 16 | % | 21 | % |

 

As Datamark was acquired on October 31, 2003,the preceding results only show activity for the the years ended December 31,2005 and 2004 and the last two months of 2003. During the ten months ended October 31,2003 (prior to our acquisition of Datamark), Datamark’s revenue was$35.6 million and its income from operations was $3.8 million.Therefore, on a pro forma basis for the year ended December 31, 2003,Datamark’s revenue was $43.3 million and its income from operations was$5.4 million (12% of net revenue).

 

For a more detailed explanation of revenuecomponents and operating results of the Enrollment division, please see theinformation under the caption “Results of Operations” earlier in this Item 7.

 

30

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**Liquidity and Capital Resources**

 

The Company’s cash and cash equivalentsincreased by $14.8 million from $8.2 million at December 31, 2004 to $23.0million at December 31, 2005. The increase from December 31, 2004 wasprimarily due to cash provided by operating activities of $16.2 million andcash provided by financing activities of $2.8 million, offset by cash used ininvesting activities of $4.4 million. Included in cash provided by financingactivities for the year ended December 31, 2005 was $4.9 million receivedfrom issuing additional common stock upon the exercise of stock options and inconnection with purchases under the employee stock purchase plan. On February 1,2005, 955,760 of the 1.0 million options held by BTIP were exercised at a priceof $3.875 per share.  An additional 16,575 options were exercised on March 23,2005 at the same exercise price.  Majorcash uses for financing activities for the year ended December 31, 2005included the prepayment of the $1.9 million balance of our Term Loan. Includedin cash used in investing activities for the year ended December 31, 2005were $3.6 million of property and equipment purchases and $1.4 million ofcapitalized software development costs.

 

Under the terms of the stockpurchase agreement for the Datamark acquisition, the purchase price was to beadjusted based upon Datamark’s working capital at the date of completion of thetransaction. eCollege and the former Datamark stockholders agreed that$1.0 million of the cash consideration paid by eCollege would be put intoa working capital escrow until the final purchase price was determined. As aresult, at December 31, 2003, the Company recorded $1.2 million asdue from former Datamark stockholders on the consolidated balance sheet ofwhich $1.0 million of cash was in escrow and $208,000 was owed by theformer Datamark stockholders. During the fourth quarter of 2004, the Companyand the former Datamark stockholders reached agreement concerning the purchaseprice. Under the terms of the agreement, the Company was entitled to receivethe $1 million in escrow as well as $157,000 of the $208,000 owed by the formerDatamark stockholders. The remaining $51,000 was recorded during 2004 as anincrease to goodwill. Under the terms of the agreement, the Company agreed topay the former Datamark stockholders $959,000 in federal and state tax refundsassociated with returns filed subsequent to the acquisition. Following an auditby the Internal Revenue Service of Datamark’s federal tax return for the periodended October 31, 2003 (the date of the acquisition), the amount of thefederal tax refund relating to the pre-closing period and the Company’sliability to the selling stockholders were reduced by approximately  $114,000. As of December 31, 2005,approximately $331,000 of this liability remained outstanding as the federaltax refund had not yet been received.

 

Pursuant to the stockpurchase agreement, Datamark’s former stockholders were required to indemnifyeCollege for certain liabilities. As security for the indemnificationobligations, $5.0 million of the cash paid in the acquisition was placed inescrow. In 2004 and 2005, the escrow paid out a total of $575,932 insatisfaction of various claims. In December 2005, the escrow wasterminated with earnings divided between eCollege and the selling stockholdersand the remaining balance returned to the selling stockholders.

 

eCollege continues to havethe right to offset the remaining balance owed under the Seller Notes forindemnified claims.

 

***Issuance of equitysecurities***

 

We have financed the majority of our operationsthrough the issuance of equity securities. We used the net proceeds from equityfinancings for the following purposes: funding capital expenditures, supportingsales, marketing and product development activities; expanding our datacenters; enhancing financial information systems; and funding other expensesassociated with our growth, including partial funding of the Datamarkacquisition in 2003.

 

***Borrowings***

 

The Company obtained a $3.0 million term loan (“TermLoan”) with a bank in October 2003 and repaid the Term Loan in full in March 2005.The Term Loan, which bore interest at 7% per annum, refinanced a previous termloan and the outstanding debt on an equipment financing facility.  The Company incurred approximately $56,000 indebt issuance costs in connection with obtaining this loan, which costs wereamortized as interest expense over the loan’s term.

 

As a part ofthe master debt agreement with the bank that provided the Term Loan, the Companyalso obtained a $10.0 million revolving line of credit, (the “PriorRevolver”) which matured on October 31, 2005. The Prior Revolver replaceda previous revolving line of credit. The interest rate on the Prior Revolverwas equal to the bank’s prime rate plus 1.25% but not less than 5.25%.

 

In October 2005,the Company restructured its bank credit facility and obtained a $15.0 millionrevolving line of credit (the “New Revolver”) that matures on October 31,2007. The interest rate on the New Revolver is equal to the bank’s prime rate(7.25% at December 31, 2005). The New Revolver is secured by all of theCompany’s assets and contains certain financial covenants, includingrequirements that the Company maintain a specified minimum ratio of quickassets to current liabilities and a specified minimum level of EBITDA. TheCompany was in compliance with all financial covenants of the New Revolver at December 31,2005.

 

31

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The Company drew$9.4 million from the Prior Revolver in December 2003 and$9.7 million in each of March, June and September 2004. Eachdraw was repaid in the month following the draw. No amounts were drawn underthe Prior Revolver or the  New Revolverduring the year ended December 31, 2005.

 

In October 2003, inconnection with its acquisition of Datamark, the Company issued$20.0 million in Senior Subordinated Notes to a lender. The SeniorSubordinated Notes have principal payments due in $5.0 million quarterlyincrements beginning December 31, 2007, with interest payments duequarterly beginning December 31, 2003, at a rate of 12.5% per annum. TheSenior Subordinated Notes have certain financial covenants, including minimumratio of quick assets to current liabilities, minimum tangible net worth,minimum debt service coverage, and minimum EBITDA, and are secured by all theCompany’s assets. The Senior Subordinated Notes also contain a cross defaultprovision with the Company’s bank debt. We were in compliance with allfinancial covenants of the Senior Subordinated Notes as of December 31,2005.

 

In connection with theissuance of the Senior Subordinated Notes, the Company issued warrants to thelender to purchase 200,000 shares of common stock at a price of $13.00 pershare. However, if at the time of exercise of all or any portion of thewarrants, the trading price of the Company’s common stock is less than $13.00per share for the thirty trading days immediately preceding the date of suchexercise, then the exercise price shall be automatically adjusted such that theexercise price will be equal to $10.00 per share with respect to suchexercise.  The warrants expire on October 31,2008.

 

The net proceeds received in connection with theissuance of the Senior Subordinated Notes totaled $20.0 million, which wasallocated to the Senior Subordinated Notes and the warrants. The Companyallocated $3.3 million to the warrants based upon the fair value of thewarrants, which was estimated using the Black-Scholes option pricing model, arisk free interest rate of 3.0%, volatility of 85%, 0% dividend yield, and anexpected life of five years (the contractual life of the warrants). Theremaining $16.7 million was allocated to the Senior Subordinated Notes.The debt discount attributable to the value of the warrants is being amortizedas interest expense over the five-year term of the Senior Subordinated Notesusing the interest method. The Company also incurred approximately$1.0 million in debt issuance costs in connection with the SeniorSubordinated Notes. The debt issuance costs were deferred and are beingamortized as interest expense over the five-year term of the SeniorSubordinated Notes. The effective interest rate on the Senior SubordinatedNotes, including the amortization of the warrant and debt issuance costs, is19.7%. The Senior Subordinated Notes also contain a provision that provides forthe acceleration of all interest payments due through October 31, 2006upon early extinguishment of the debt prior to October 31, 2006.

 

Also in connection with the acquisition of Datamarkin October 2003, the Company issued Seller Notes totaling$12.0 million (face amount) to the selling stockholders. The Seller Notes,with interest and principal due in 2008, were comprised of a series of notesissued to the selling stockholders, aggregating to $7.0 million (faceamount), which bear simple interest at a rate of 10.0% per annum and anotherseries of notes, aggregating to $5.0 million (face amount), which bearinterest at a rate of 10.0%, compounded annually. All of the simple interestnotes, as well as $3.0 million (face amount) of the annually compounding notes,were repaid in 2004. The Company recorded $8.9 million for the SellerNotes at the time of their issuance based upon their estimated fair value, resultingin a discount in the original amount of $3.1 million, which is beingamortized over the term of the debt using the interest method. The effectiveinterest rate on these notes, including the amortization of the recordeddiscount, is 14.9%. The fair value of the Seller Notes was determined by athird party who considered, among other factors, the effective interest rate ofthe Senior Subordinated Notes and other comparable debt securities. Due to thediscounts on the Senior Subordinated Notes and Seller Notes, any payment ofthese debt obligations prior to their maturity results in additional interestexpense due to the realization of the unamortized portions of the costs anddiscounts recorded. The early repayment of $7.5 million carrying value ($10.0million face value) of Seller Notes during the fourth quarter of 2004 resultedin an additional $2.5 million interest charge. The remaining balance of theSeller Notes was $2.1 million at December 31, 2005, with an unamortizeddiscount of $343,000 and accrued interest payable of $460,000.

 

We expect our current cash, cash equivalents, andshort-term investments, together with cash generated from operations, to meetour working capital and capital expenditure requirements for at least the nexttwelve months.  The Company expects itscapital expenditures in 2006 to increase by approximately $2.0 million ascompared to 2005 due to planned investments that include internationalizing theeLearning platform, building a second data center and upgrading the direct mailproduction facility at Datamark.

 

32

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**Contractual Obligations,Commitments and Off-Balance Sheet Arrangements**

 

The following table summarizes, as of December 31,2005, our obligations to make future payments under current contracts (inthousands):

 
| ** **                                    | ** ** | **Total** | ** ** | **Less than 1 Year** | ** ** | **1 - 3 Years** | ** ** | **4 - 5 Years** | ** ** | **More than 5 Years** | ** ** |
|-----------------------------------------------|------------|-----------|------------|---------------------------|------------|-----------------|------------|-----------------|------------|----------------------------|------------|
| Long term  debt including current portion (1) |       | $         | 23,221     |                      | $          | —          |       | $               | 23,221     |                       | $          | — |   | $ | — |   |
| Capital  lease obligations                    |       | 569       |       | 320                       |       | 250             |       | —          |       |                       |       |
| Operating  lease obligations (2)              |       | 7,549     |       | 2,195                     |       | 3,830           |       | 1,524           |       | —                     |       |
| Purchase  commitments (3)                     |       | 2,080     |       | 1,501                     |       | 579             |       | —          |       | —                     |       |
| Consulting  agreement (4)                     |       | 600       |       | 200                       |       | 400             |       | —          |       | —                     |       |
| Total                                         |       | $         | 34,019     |                      | $          | 4,216           |       | $               | 28,280     |                       | $          | 1,524 |   | $ | — |   |

 

----

(1)          Amountsrepresent the expected cash payments of the stated face value of principal onour debt as well as interest payments.

 

(2)          TheCompany leases office space and equipment under various non-cancelableoperating leases.

 

(3)          eCollegeentered into an agreement with a third party vendor in January 2004 toprovide supplemental software development for our development projects. Minimumfuture commitments under this contract aggregated $2.4 million at December 31,2005. If eCollege terminates the agreement prior to April 2007, it will berequired to pay a termination penalty equal to six months expense at thethen-current minimum staffing level.

 

(4)          Inconjunction with the Datamark acquisition, on October 31, 2003, we enteredinto a five year consulting agreement with Leeds Equity Advisors Inc., ofwhich Jonathan Newcomb, a former director, was a principal. Payments under thisagreement aggregate $200,000 per year, plus expenses, if any.

 

Rent expense for the years ended December 31,2005, 2004 and 2003 was $1.5 million, $1.9 million and  $1.1 million, respectively.

 

The Company maintains twoletters of credit with the bank in the amounts of $250,000 and $62,000 underwhich the vendor of the Company’s back-up computer systems and the landlord forthe Company’s Denver facility are the respective beneficiaries.  The letters of credit effectively reduce theborrowing ability under the New Revolver by $312,000.

 

**Recent Accounting Pronouncements**

 

On December 16, 2004,the FASB issued FASB Statement No. 123 (revised 2004) *“Share-BasedPayment”*(“SFAS 123(R)”), which is a revision of SFAS 123.SFAS 123(R) supersedes APB No. 25, and amends FASB Statement No. 95,*“Statement of Cash Flows*.” Generally theapproach in SFAS 123(R) is similar to the approach described inSFAS 123. However, SFAS 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based on their fair values. Pro forma disclosure is nolonger an alternative following the adoption of SFAS 123(R). The Companyis in the process of evaluating the impact of SFAS 123(R) on its consolidatedfinancial statements. The Company does not expect that the adoption of SFAS123(R) will have a material impact on its financial statements. SFAS 123(R)must be adopted no later than the beginning of the first fiscal year following June 15,2005, therefore we are required to adopt SFAS 123(R) for the year beginning January 1,2006. We intend to use the modified prospective method.

 

In June 2005,the FASB issued SFAS No. 154 “Accounting Changes and Error Corrections”  (“SFAS No. 154”), which will requireentities that voluntarily make a change in an accounting principle to applythat change retrospectively to prior periods’ financial statements, unless suchretrospective application would be impracticable. SFAS No. 154 supersedesAccounting Principles Board Opinion No. 20, Accounting Changes (“APB No. 20”),which previously required that most voluntary changes in accounting principlebe recognized by including in the current period’s net income the cumulativeeffect of changing to the new accounting principle. SFAS No. 154 alsomakes a distinction between “retrospective application” of an accountingprinciple and the “restatement” of financial statements to reflect thecorrection of an error. Another significant change in practice under SFAS No. 154will be the requirement that if an entity changes its method of depreciation,amortization, or depletion for long-lived, non-financial assets, the changemust be accounted for as a change in accounting estimate. Under APB No. 20,such a change would have been reported as a change in accounting principle.SFAS No. 154 applies to accounting changes and error corrections that aremade in fiscal years beginning after December 15, 2005 and will have aneffect on the Company to the extent the Company makes an accounting change orcorrects an error.

 

33

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**ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Market risk represents the risk of loss that mayimpact our financial position, operating results or cash flows due to adversechanges in financial market prices and rates. The Company is, or may become,exposed to market risk in the areas of changes in United States interest ratesand changes in foreign currency exchange rates as measured against the UnitedStates dollar. These exposures are directly related to our normal operating andfunding activities. Historically, and as of December 31, 2005, we have notused derivative instruments or engaged in hedging activities.

 

The Company does not have significant exposure tochanging interest rates that would impact its cash balance which was$23.0 million at December 31, 2005. Our short-term investmentportfolio is managed in accordance with our investment policy, which allows usto invest in investment securities of less than one year in maturity includingmoney market accounts, certificates of deposit, investment grade commercialpaper, United States government debt obligations and other securitiesguaranteed by or carrying the implied guarantee of the United Statesgovernment. Since October 2001, substantially all of our available cashhas been invested in money market accounts. As a result, the interest rate market risk implicit in these investmentsat December 31, 2005, is low. However, factors influencing the financialcondition of security issuers may impact their ability to meet their financialobligations and could impact the realizability of our security portfolio.

 

A hypothetical ten percent change in market interestrates over the next year would not have a material effect on the fair value ofthe Company’s debt instruments or our cash equivalent,  nor would it materially impact the earningsor cash flow associated with our cash investments. See Note 2 to theConsolidated Financial Statements included in Item 8 of this Annual Report on Form 10-Kfor further information on the fair value of the Company’s financialinstruments. Although our revolving line of credit bears interest at anadjustable rate equal to the prime rate, a hypothetical ten percent change inthe market rates as of December 31, 2005 would not have a material effecton our earnings and cash flows in 2006, because we expect drawings on our line ofcredit during 2006, if any, to be for short-term working capital needs.

 

34

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**ITEM8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**ECOLLEGE.COMAND SUBSIDIARIES**

 

**INDEX TOFINANCIAL STATEMENTS**

 

**Financial Statements**

 
|   | Report of Independent Registered Public Accounting Firm                                                                           |   |
|--------|-----------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                              |   |
|   | Report of Independent Registered Public Accounting Firm                                                                           |   |
|   |                                                                                                                              |   |
|   | Consolidated Balance Sheets as of December 31,  2005 and 2004                                                                |   |
|   |                                                                                                                              |   |
|   | Consolidated Statements of Operations and  Comprehensive Income (Loss) for the years ended December 31, 2005, 2004  and 2003 |   |
|   |                                                                                                                              |   |
|   | Consolidated Statements of Stockholders’ Equity for the years ended December 31,  2005, 2004 and 2003                   |   |
|   |                                                                                                                              |   |
|   | Consolidated Statements of Cash Flows for  the years ended December 31, 2005, 2004 and 2003                                  |   |
|   |                                                                                                                              |   |
|   | Notes to Consolidated Financial Statements                                                                                        |   |

 

35

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**Reportof Independent Registered Public Accounting Firm**

** **

The Board of Directors and Stockholders’

eCollege.com:

 

We have audited the accompanying consolidatedbalance sheet of eCollege.com and subsidiaries as of December 31, 2005,and the related consolidated statements of operations, stockholders’ equity andcash flows for the year then ended. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of eCollege.com as of December 31, 2005 and the resultsof their operations and cash flows for the year ended December 31, 2005,in conformity with accounting principles generally accepted in the UnitedStates of America.

 

We also have audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theeffectiveness of eCollege.com’s internal control over financialreporting as of December 31, 2005, based on the criteria established inInternal Control – Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) and our report dated March 16,2006 expressed an unqualified opinion on management’s assessment and an adverseopinion on the effectiveness of eCollege.com’s internal control over financialreporting.

 
|                | /s/ GRANT THORNTON LLP |   |
|---------------------|------------------------|--------|
|                |                   |
| Chicago, Illinois   |                   |
| March 16, 2006 |                   |

 

36

 

**Report of Independent Registered PublicAccounting Firm**

 

The Board of Directors and Stockholders

eCollege.com:

 

We have audited the accompanying consolidatedbalance sheet of eCollege.com and subsidiaries as of December 31, 2004,and the related consolidated statements of operations, stockholders’ equity andcash flows for the years ended December 31, 2004 and 2003. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of eCollege.com and subsidiaries as of December 31,2004, and the results of their operations and their cash flows for the yearsended December 31, 2004 and 2003, in conformity with U.S. generallyaccepted accounting principles.

 
|                | /s/ KPMG LLP |   |
|---------------------|--------------|--------|
|                |         |
| Denver, Colorado    |         |
| March 31, 2005 |         |

 

37

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**eCollege.com**

 

**CONSOLIDATED BALANCE SHEETS (in thousands except per share data)**

 
| ** **                                                                                                                                                       | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                       |       |                  |       |   |   |
| CURRENT  ASSETS:                                                                                                                                                 |       |                  |       |   |   |
| Cash and  cash equivalents                                                                                                                                       |       | $                     | 23,037     |   | $ | 8,223 |   |
| Accounts  receivable, net of allowances of $272 and $155, respectively                                                                                           |       | 13,911                |       | 12,166 |   |
| Accrued  revenue receivable                                                                                                                                      |       | 1,191                 |       | 250 |   |
| Deferred  income taxes                                                                                                                                           |       | 2,146                 |       | 1,927 |   |
| Other  current assets                                                                                                                                            |       | 1,419                 |       | 1,195 |   |
| Total  current assets                                                                                                                                            |       | 41,704                |       | 23,761 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| Property and  equipment, net                                                                                                                                     |       | 6,101                 |       | 5,265 |   |
| Software  development costs, net                                                                                                                                 |       | 2,859                 |       | 2,103 |   |
| Other assets                                                                                                                                                     |       | 1,114                 |       | 1,384 |   |
| Deferred  income taxes                                                                                                                                           |       | 18,806                |       | 19,846 |   |
| Intangible  assets, net                                                                                                                                          |       | 8,745                 |       | 10,359 |   |
| Goodwill                                                                                                                                                         |       | 54,745                |       | 55,097 |   |
| TOTAL ASSETS                                                                                                                                                     |       | $                     | 134,074    |   | $ | 117,815 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                   |       |                  |       |   |   |
| CURRENT  LIABILITIES:                                                                                                                                            |       |                  |       |   |   |
| Accounts  payable                                                                                                                                                |       | $                     | 8,157      |   | $ | 8,215 |   |
| Other  accrued liabilities                                                                                                                                       |       | 6,733                 |       | 5,820 |   |
| Customer  advances                                                                                                                                               |       | 1,273                 |       | 1,493 |   |
| Deferred  revenue, current portion                                                                                                                               |       | 2,493                 |       | 2,297 |   |
| Current  income taxes                                                                                                                                            |       | 33                    |       | 305 |   |
| Current  portion of long-term debt                                                                                                                               |       | —                |       | 1,000 |   |
| Current  portion of capital lease obligations                                                                                                                    |       | 320                   |       | 136 |   |
| Total  current liabilities                                                                                                                                       |       | 19,009                |       | 19,266 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| LONG-TERM  LIABILITIES:                                                                                                                                          |       |                  |       |   |   |
| Deferred  revenue, net of current portion                                                                                                                        |       | 26                    |       | 67 |   |
| Other  liabilities                                                                                                                                               |       | 322                   |       | 395 |   |
| Long-term  debt, net of current portion                                                                                                                          |       | 20,023                |       | 20,023 |   |
| Capital  lease obligations, net of current portion                                                                                                               |       | 250                   |       | 148 |   |
| Total  long-term liabilities                                                                                                                                     |       | 20,621                |       | 20,633 |   |
| Total  liabilities                                                                                                                                               |       | 39,630                |       | 39,899 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| COMMITMENTS  AND CONTINGENCIES                                                                                                                                   |       | —                |       | — |   |
|                                                                                                                                                             |       |                  |       |   |   |
| STOCKHOLDERS’  EQUITY:                                                                                                                                      |       |                  |       |   |   |
| Preferred  stock, no par value; 5,000 shares authorized; none issued or outstanding                                                                              |       | —                |       | — |   |
| Common  stock, $0.01 par value, 50,000 shares authorized, 22,002 and 20,719 shares  issued, respectively, and 21,987 and 20,704 shares outstanding, respectively |       | 220                   |       | 207 |   |
| Additional  paid-in capital                                                                                                                                      |       | 139,943               |       | 127,739 |   |
| Treasury  stock at cost, 15 shares                                                                                                                               |       | (148                  | )          | (148 | ) |
| Warrants,  restricted stock rights, and options for common stock                                                                                                 |       | 6,982                 |       | 8,601 |   |
| Deferred  compensation                                                                                                                                           |       | (2                    | )          | (4 | ) |
| Accumulated  deficit                                                                                                                                             |       | (52,551               | )          | (58,479 | ) |
|                                                                                                                                                             |       |                  |       |   |   |
| Total  stockholders’ equity                                                                                                                                 |       | 94,444                |       | 77,916 |   |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                             |       | $                     | 134,074    |   | $ | 117,815 |   |

 

The accompanying notes toconsolidated financial statements are an integral part of theseconsolidated balance sheets.

 

38

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**eCollege.com**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(in thousands, except per share data)**

 
| ** **                                                       | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                       | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| REVENUE:                                                         |       |                              |       |   |   |   |   |
| Student fees                                                     |       | $                                 | 36,818     |   | $ | 31,154 |   | $ | 24,971 |   |
| Direct mail  enrollment marketing                                |       | 37,619                            |       | 38,347 |   | 6,277 |   |
| Interactive  enrollment marketing                                |       | 16,939                            |       | 11,079 |   | 790 |   |
| Campus and  course fees                                          |       | 1,131                             |       | 1,761 |   | 2,593 |   |
| Other                                                            |       | 10,361                            |       | 6,926 |   | 2,229 |   |
| Total  revenue                                                   |       | 102,868                           |       | 89,267 |   | 36,860 |   |
|                                                             |       |                              |       |   |   |   |   |
| COST OF  REVENUE:                                                |       |                              |       |   |   |   |   |
| Student  fees, campus and course fees, and other cost of revenue |       | 12,433                            |       | 10,345 |   | 11,207 |   |
| Direct mail,  Interactive and other cost of revenue              |       | 41,543                            |       | 36,435 |   | 4,976 |   |
| Total cost  of revenue                                           |       | 53,976                            |       | 46,780 |   | 16,183 |   |
|                                                             |       |                              |       |   |   |   |   |
| Gross profit                                                     |       | 48,892                            |       | 42,487 |   | 20,677 |   |
|                                                             |       |                              |       |   |   |   |   |
| OPERATING  EXPENSES:                                             |       |                              |       |   |   |   |   |
| Product  development                                             |       | 7,249                             |       | 6,635 |   | 5,723 |   |
| Selling and  marketing                                           |       | 10,178                            |       | 9,878 |   | 5,843 |   |
| General and  administrative                                      |       | 16,317                            |       | 16,213 |   | 7,140 |   |
| Amortization  of intangible assets                               |       | 1,613                             |       | 1,492 |   | 249 |   |
| Total  operating expenses                                        |       | 35,357                            |       | 34,218 |   | 18,955 |   |
| INCOME FROM  OPERATIONS                                          |       | 13,535                            |       | 8,269 |   | 1,722 |   |
|                                                             |       |                              |       |   |   |   |   |
| OTHER INCOME  (EXPENSE):                                         |       |                              |       |   |   |   |   |
| Interest  income and other income (expense)                      |       | 312                               |       | (35 | ) | 111 |   |
| Interest  expense                                                |       | (3,827                            | )          | (4,892 | ) | (1,265 | ) |
| Loss on  early repayment of debt                                 |       | —                            |       | (2,479 | ) | — |   |
| Income  before income taxes                                      |       | 10,020                            |       | 863 |   | 568 |   |
| Income tax  (expense) benefit                                    |       | (4,092                            | )          | 18,497 |   | — |   |
| NET INCOME                                                       |       | 5,928                             |       | 19,360 |   | 568 |   |
|                                                             |       |                              |       |   |   |   |   |
| BASIC NET  INCOME PER SHARE                                      |       | $                                 | 0.27       |   | $ | 0.95 |   | $ | 0.03 |   |
| DILUTED NET  INCOME PER SHARE                                    |       | $                                 | 0.26       |   | $ | 0.88 |   | $ | 0.03 |   |
| WEIGHTED  AVERAGE SHARES OUTSTANDING—BASIC                  |       | 21,729                            |       | 20,358 |   | 17,758 |   |
| WEIGHTED  AVERAGE SHARES OUTSTANDING—DILUTED                |       | 22,405                            |       | 21,996 |   | 19,578 |   |

 

The accompanying notes toconsolidated financial statements are an integral part of these statements.

 

39

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**eCollege.com**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(in thousands)**

 
| ** **                                                                         | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Treasury Stock** | ** ** | **Warrants,  Restricted** | ** ** | **Deferred** | ** ** | **Accumulated**              | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------|------------|------------------|------------|-------------------------|------------|--------------------|------------|---------------------------|------------|--------------|------------|------------------------------|------------|------------------|------------|
| ** **                                                                         | ** ** | **Shares**       | ** ** | **Par Value**           | ** ** | **Capital**        | ** ** | **Shares**                | ** ** | **Amount**   | ** ** | **Stock Rights And Options** | ** ** | **Compensation** | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| ** **                                                                         | ** ** | ** **       | ** ** | ** **              | ** ** | ** **         | ** ** | ** **                | ** ** | ** **   | ** ** | ** **                   | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| BALANCES, January 1, 2003                                                     |       | 16,432           |       | 164                     |       | 85,434             |       | (6                        | )          | (22          | )          | 3,313                        |       | (78              | )          | (78,407 | ) | 10,404 |   |
| Sale of common stock issued in private placement, net  of issuance costs of $1,750 |       | 2,900            |       | 29                      |       | 28,671             |       | —                    |       | —       |       | —                       |       | —           |       | — |   | 28,700 |   |
| Sale of common stock issued in connection with  acquisition of Datamark            |       | 75               |       | 1                       |       | 1,251              |       | —                    |       | —       |       | —                       |       | —           |       | — |   | 1,252 |   |
| Issuance of common stock in connection with  acquisition of Datamark               |       | 150              |       | 1                       |       | 2,501              |       | —                    |       | —       |       | —                       |       | —           |       | — |   | 2,502 |   |
| Stock-based compensation, awards to employees                                      |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | 980                          |       | —           |       | — |   | 980 |   |
| Estimated fair value of warrants for common stock  issued in connection with debt  |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | 3,304                        |       | —           |       | — |   | 3,304 |   |
| Forfeited options                                                                  |       | —           |       | —                  |       | 312                |       | —                    |       | —       |       | (312                         | )          | —           |       | — |   | — |   |
| Issuance of common stock upon exercise of options and  warrants                    |       | 480              |       | 5                       |       | 2,770              |       | —                    |       | —       |       | (324                         | )          | —           |       | — |   | 2,451 |   |
| Issuance of common stock in connection with employee  stock purchase plan          |       | 82               |       | 1                       |       | 362                |       | —                    |       | —       |       | (81                          | )          | —           |       | — |   | 282 |   |
| Amortization of deferred compensation                                              |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | —                       |       | 49               |       | — |   | 49 |   |
| Acquisition of treasury stock at cost                                              |       | —           |       | —                  |       | —             |       | (5                        | )          | (59          | )          | —                       |       | —           |       | — |   | (59 | ) |
| Net income                                                                         |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | —                       |       | —           |       | 568 |   | 568 |   |
|                                                                               |       |             |       |                    |       |               |       |                      |       |         |       |                         |       |             |       |   |   |   |   |
| BALANCES, DECEMBER 31, 2003                                                   |       | 20,119           |       | 201                     |       | 121,301            |       | (11                       | )          | (81          | )          | 6,880                        |       | (29              | )          | (77,839 | ) | 50,433 |   |
| Stock issuance costs                                                               |       | —           |       | —                  |       | (10                | )          | —                    |       | —       |       | —                       |       | —           |       | — |   | (10 | ) |
| Stock-based compensation awards to employees                                       |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | 3,794                        |       | —           |       | — |   | 3,794 |   |
| Forfeited options                                                                  |       | —           |       | —                  |       | 24                 |       | —                    |       | —       |       | (24                          | )          | —           |       | — |   | — |   |
| Issuance of common stock upon exercise of options and  warrants                    |       | 413              |       | 4                       |       | 1,659              |       | —                    |       | —       |       | (15                          | )          | —           |       | — |   | 1,648 |   |
|                                                                               |       |             |       |                    |       |               |       |                      |       |         |       |                         |       |             |       |   |   |   |   |
| Issuance of common stock in connection with employee  stock purchase plan          |       | 163              |       | 2                       |       | 2,475              |       | —                    |       | —       |       | (1,541                       | )          | —           |       | — |   | 936 |   |
| Issuance of common stock for restricted share awards                               |       | 24               |       | —                  |       | 393                |       | —                    |       | —       |       | (493                         | )          | —           |       | — |   | (100 | ) |
| Amortization of deferred compensation                                              |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | —                       |       | 25               |       | — |   | 25 |   |
| Acquisition of treasury stock at cost                                              |       | —           |       | —                  |       | —             |       | (4                        | )          | (67          | )          | —                       |       | —           |       | — |   | (67 | ) |
| Deferred income taxes                                                              |       | —           |       | —                  |       | 1,897              |       | —                    |       | —       |       | —                       |       | —           |       | — |   | 1,897 |   |
| Net income                                                                         |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | —                       |       | —           |       | 19,360 |   | 19,360 |   |
|                                                                               |       |             |       |                    |       |               |       |                      |       |         |       |                         |       |             |       |   |   |   |   |
| BALANCES, DECEMBER 31, 2004                                                   |       | 20,719           |       | $                       | 207        |               | $          | 127,739                   |       | (15          | )          | $                            | (148       | )                | $          | 8,601 |   | $ | (4 | ) | $ | (58,479 | ) | $ | 77,916 |   |
| Stock-based compensation awards to employees                                       |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | 3,680                        |       | —           |       | — |   | 3,680 |   |
| Forfeited awards                                                                   |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | (802                         | )          | —           |       | — |   | (802 | ) |
| Issuance of common stock upon exercise of options and  warrants                    |       | 1,149            |       | 11                      |       | 6,995              |       | —                    |       | —       |       | (2,580                       | )          | —           |       | — |   | 4,426 |   |
| Issuance of common stock in connection with employee  stock purchase plan          |       | 78               |       | 1                       |       | 1,386              |       | —                    |       | —       |       | (886                         | )          | —           |       | — |   | 501 |   |
| Issuance of common stock for restricted share awards                               |       | 56               |       | 1                       |       | 747                |       | —                    |       | —       |       | (1,031                       | )          | —           |       | — |   | (283 | ) |
| Amortization of deferred compensation                                              |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | —                       |       | 2                |       | — |   | 2 |   |
| Deferred income taxes                                                              |       | —           |       | —                  |       | 3,076              |       | —                    |       | —       |       | —                       |       | —           |       | — |   | 3,076 |   |
| Net income                                                                         |       | —           |       | —                  |       | —             |       | —                    |       | —       |       | —                       |       | —           |       | 5,928 |   | 5,928 |   |
|                                                                               |       |             |       |                    |       |               |       |                      |       |         |       |                         |       |             |       |   |   |   |   |
| BALANCES, DECEMBER 31, 2005                                                   |       | 22,002           |       | $                       | 220        |               | $          | 139,943                   |       | (15          | )          | $                            | (148       | )                | $          | 6,982 |   | $ | (2 | ) | $ | (52,551 | ) | $ | 94,444 |   |

 

The accompanying notes toconsolidated financial statements are an integral part of these statements.

 

40

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**eCollege.com**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                      |       |                                      |       |   |   |   |   |
|                                                                                        |       |                                      |       |   |   |   |   |
| Net income                                                                                  |       | $                                         | 5,928      |   | $ | 19, 360 |   | $ | 568 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities—     |       |                                      |       |   |   |   |   |
| Depreciation                                                                                |       | 2,702                                     |       | 2,438 |   | 1,996 |   |
| Loss on  dispositions of assets                                                             |       | 69                                        |       | 73 |   | 17 |   |
| Accrued  interest                                                                           |       | —                                    |       | 37 |   | — |   |
| Provision  for doubtful accounts                                                            |       | 117                                       |       | 60 |   | — |   |
| Amortization  of capitalized internal-use software development costs                        |       | 583                                       |       | 325 |   | 1,255 |   |
| Amortization  of intangible assets                                                          |       | 1,614                                     |       | 1,492 |   | 249 |   |
| Amortization  of debt issuance costs and discounts on debt                                  |       | 887                                       |       | 890 |   | 505 |   |
| Loss on  early repayment of debt                                                            |       | —                                    |       | 2,479 |   | — |   |
| Stock-based  compensation                                                                   |       | 2,840                                     |       | 3,820 |   | 1,029 |   |
| Deferred  income taxes                                                                      |       | 3,529                                     |       | (18,716 | ) | — |   |
| Changes in—                                                                            |       |                                      |       |   |   |   |   |
| Accounts  receivable and accrued revenue receivables                                        |       | (2,805                                    | )          | (3,613 | ) | (208 | ) |
| Other  current assets                                                                       |       | (223                                      | )          | 1,584 |   | (102 | ) |
| Other assets                                                                                |       | 77                                        |       | 88 |   | 164 |   |
| Accounts  payable and accrued liabilities                                                   |       | 854                                       |       | 3,668 |   | (1,125 | ) |
| Deferred  revenue and customer advances                                                     |       | (64                                       | )          | 1,261 |   | (1,335 | ) |
| Grant  liabilities                                                                          |       | —                                    |       | — |   | (354 | ) |
| Other  liabilities                                                                          |       | 2                                         |       | (82 | ) | 157 |   |
| Net cash  provided by operating activities                                                  |       | 16,110                                    |       | 15,164 |   | 2,816 |   |
|                                                                                        |       |                                      |       |   |   |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                      |       |                                      |       |   |   |   |   |
| Purchases of  property and equipment                                                        |       | (3,077                                    | )          | (2,848 | ) | (930 | ) |
| Proceeds  from disposition of property and equipment                                        |       | —                                    |       | 6 |   | 7 |   |
| Capitalized  internal-use software development costs                                        |       | (1,339                                    | )          | (1,809 | ) | (304 | ) |
| Net cash  paid for business acquisition, net of cash acquired, including acquisition  costs |       | 353                                       |       | (208 | ) | (57,552 | ) |
| Restricted  cash to investments                                                             |       | —                                    |       | (516 | ) | — |   |
| Net cash  used in investing activities                                                      |       | (4,063                                    | )          | (5,375 | ) | (58,779 | ) |
|                                                                                        |       |                                      |       |   |   |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                      |       |                                      |       |   |   |   |   |
| Proceeds  from issuance of common stock                                                     |       | 4,927                                     |       | 2,551 |   | 33,962 |   |
| Payment of  stock issuance costs                                                            |       | —                                    |       | (10 | ) | (1,750 | ) |
| Proceeds  from sale-leaseback arrangements                                                  |       | —                                    |       | 409 |   | 649 |   |
| Payments on  sale-leaseback arrangements                                                    |       | —                                    |       | (125 | ) | (525 | ) |
| Payments on  line of credit, net                                                            |       | —                                    |       | (9,365 | ) | 6,427 |   |
| Payments on  capital lease                                                                  |       | (243                                      | )          | — |   | — |   |
| Proceeds  from term loan                                                                    |       | —                                    |       | — |   | 1,207 |   |
| Payments on  term loan                                                                      |       | (1,917                                    | )          | (1,000 | ) | (257 | ) |
| Payment on  Seller Notes                                                                    |       | —                                    |       | (10,000 | ) | — |   |
| Proceeds from  senior subordinated notes                                                    |       | —                                    |       | — |   | 20,000 |   |
| Debt  issuance costs                                                                        |       | —                                    |       | — |   | (1,409 | ) |
| Net cash  provided by (used in) financing activities                                        |       | 2,767                                     |       | (17,540 | ) | 58,304 |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                       |       | 14,814                                    |       | (7,751 | ) | 2,341 |   |
| CASH AND  CASH EQUIVALENTS, beginning of year                                               |       | 8,223                                     |       | 15,974 |   | 13,633 |   |
| CASH AND  CASH EQUIVALENTS, end of year                                                     |       | $                                         | 23,037     |   | $ | 8,223 |   | $ | 15,974 |   |
|                                                                                        |       |                                      |       |   |   |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                          |       |                                      |       |   |   |   |   |
| Cash paid  for interest                                                                     |       | $                                         | 2,681      |   | $ | 4,146 |   | $ | 243 |   |
| Cash paid  for income taxes                                                                 |       | 120                                       |       | 115 |   | — |   |
|                                                                                        |       |                                      |       |   |   |   |   |
| SCHEDULE OF  NON-CASH INVESTING AND FINANCING ACTIVITIES: ensure all proper categories |       |                                      |       |   |   |   |   |
| Discount on  shares issued in conjunction with business acquisition                         |       | $                                         | —     |   | $ | — |   | $ | 464 |   |
| Estimated  fair value of warrants issued in conjunction with senior subordinated notes      |       | $                                         | —     |   | $ | — |   | $ | 3,304 |   |
| Shares  issued in conjunction with business acquisition                                     |       | $                                         | —     |   | $ | — |   | $ | 2,502 |   |
| Estimated  fair value of notes payable issued in connection with business acquisition       |       | $                                         | —     |   | $ | — |   | $ | 8,850 |   |
| Financed  software purchases                                                                |       | $                                         | 529        |   | $ | — |   | $ | 19 |   |
| Acquisition  of treasury stock included in accrued liabilities                              |       | $                                         | —     |   | $ | 67 |   | $ | 59 |   |

 

The accompanying notes toconsolidated financial statements are an integral part of these statements.

 

41

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**eCollege.com**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**(1)    Organization and Nature ofBusiness**

 

**Company History**

 

eCollege.com is a Delaware corporation.  eCollege International, Inc. is a whollyowned subsidiary of eCollege and was incorporated in the state of Colorado onJanuary 9, 2002. On October 31, 2003, eCollege.com acquired all ofthe capital stock of Datamark, Inc., a Delaware corporation (“Datamark”)at which time Datamark became a wholly owned subsidiary of eCollege.com.

 

**Business Activity**

 

eCollege is an outsource provider of value-addedinformation services to the post-secondary education industry. eCollege’seLearning division is an outsource provider of on-demand technology, productsand services that enable colleges, universities, and K-12 schools to offeronline, distance and hybrid educational programs as well as on-campus courses.Datamark, the Company’s Enrollment division, is an outsource provider ofintegrated enrollment marketing services to the proprietary post-secondaryeducation industry.

 

**(2)    Summary of SignificantAccounting Policies**

 

**Consolidation and Operating Segments**

 

The accompanying consolidated financial statementshave been prepared by the Company in accordance with accounting principlesgenerally accepted in the United States of America. The Company has eliminatedintercompany transactions and balances in consolidation. The Company hasdetermined that it has two reportable operating segments.  Substantially all of the Company’s operatingresults and identifiable assets are in the United States of America.

 

**Use of Estimates in the Preparation of FinancialStatements**

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions. These estimates andassumptions may affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period. Actual results could differ from those estimates. Some of themost significant areas for which management uses significant estimates andassumptions are the valuation of goodwill and identified intangible assets,establishing reserves for uncollectible accounts receivable, establishingestimated useful lives for long-lived assets, revenue recognition, accountingfor the issuance of debt obligations, establishing the valuation reserve fordeferred tax assets, and estimating the fair value of stock options, stockappreciation rights and warrants.

 

**Cash and Cash Equivalents**

 

The Company considers investments in highly liquidinstruments purchased with an original maturity of 90 days or less to becash equivalents. Such investments are held in money market accounts,certificates of deposit, or available-for-sale securities.

 

**Accounts Receivable**

 

The terms of our accounts receivable arepredominantly net 30 for the eLearning division and net 15 for the Enrollmentdivision. The Company maintains an allowance for doubtful accounts based upon Management’sestimate of the expected collection of accounts receivable. AtDecember 31, 2005 and 2004, the allowance for doubtful accounts was$272,000 and $155,000, respectively. Two customers accounted for 11% and 10%,respectively, of the consolidated gross accounts receivable balance atDecember 31, 2005.  One customeraccounted for 15% of the consolidated gross accounts receivable balance atDecember 31, 2004.  Sales to onecustomer represented 22% of the Company’s total revenue in 2005.  Sales to two customers represented 16% and14%, respectively, of the Company’s total revenue in 2004 and one customerrepresented 11% of the Company’s total revenue for 2003.

 

***Fair Value of FinancialInstruments***

 

The carrying amounts reported in the balance sheets for cash and cashequivalents, accounts receivable, accrued revenue receivable, accounts payable,and accrued liabilities approximate their fair values due to the short-termnature of these financial instruments.

 

**Concentration of Credit Risk**

 

Financial instruments that potentially subject theCompany to significant concentrations of credit risk consist primarily of cashand cash equivalents, and accounts receivable. The Company has no off-balancesheet concentrations of credit risk, such as foreign

 

42

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exchangecontracts, option contracts or other foreign currency hedging arrangements. TheCompany maintains its cash balances in the form of bank demand deposits andmoney market accounts with financial institutions that management believes arecredit worthy. Accounts receivable are typically unsecured and are derived fromtransactions with and from educational institutions primarily located in theUnited States. Accordingly, the Company may be exposed to credit risk generallyassociated with educational institutions. The Company performs ongoing creditevaluations of its customers and maintains reserves for estimated creditlosses. The Company historically has not had significant write-offs of accountsreceivable.

 

**Property and Equipment**

 

Property and equipment are stated at historical costor at estimated fair value upon acquisition. Depreciation is provided using thestraight-line method, generally over estimated useful lives of two to sevenyears. Maintenance and repairs are expensed as incurred and major additions,replacements, and improvements are capitalized. Leasehold improvements aredepreciated using the straight-line method over the shorter of the useful livesor the life of the related lease. The components of property and equipment areas follows (in thousands):

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Computer equipment (3 - 5 years)              |       | $                     | 8,133      |   | $ | 10,903 |   |
| Purchased software (3 - 5 years)              |       | 4,296                 |       | 3,663 |   |
| Office furniture and equipment (3 -  7 years) |       | 2,230                 |       | 2,094 |   |
| Machinery and production equipment  (7 years) |       | 1,140                 |       | 781 |   |
| Construction in progress                           |       | 52                    |       | — |   |
| Leasehold improvements (2 - 7 years)               |       | 1,350                 |       | 1,093 |   |
|                                               |       | 17,201                |       | 18,534 |   |
| Less: accumulated depreciation and  amortization   |       | (11,100               | )          | (13,269 | ) |
|                                               |       | $                     | 6,101      |   | $ | 5,265 |   |

 

Depreciation expense for the years endedDecember 31, 2005, 2004 and 2003 was $2.7 million, $2.4 million and,$2.0 million, respectively.

 

Property and equipment at December 31, 2005 and 2004includes assets under two capital leases with original cost of $890,000 and$442,000. The combined accumulated depreciation for such leases totaled$394,000 and $147,000, respectively, at December 31, 2005 and 2004.

 

**Goodwill and Identified Intangible Assets withIndefinite Lives**

 

Goodwill and purchased intangible assets withindefinite useful lives are not amortized. The Company reviews goodwill and identified intangible assets withindefinite lives for impairment in the fourth quarter of each year and wheneverevents or changes in circumstances indicate the carrying value of an asset maynot be recoverable. The goodwill impairment review is performed using atwo-step impairment test. The first phase screens for impairment; while thesecond phase (if necessary), measures the impairment. For purposes of this testwe have identified two reporting units, which are the same as our reportablesegments (see Note 10). In the first step of the goodwill analysis, theCompany compares the fair value of a reporting unit to its carrying value. Ifthe carrying value exceeds the fair value, the second step must be completed todetermine the amount impaired. In the second step, the Company compares thecarrying value to the implied fair value of the goodwill under a theoreticalpurchase allocation scenario.

 

The impairment review of the identified intangibleassets with indefinite lives consists of a comparison of the fair value of anintangible asset with its carrying amount. If the carrying amount of anintangible asset exceeds its fair value, an impairment loss is recognized in anamount equal to such excess. After an impairment loss is recognized, theadjusted carrying amount of the intangible asset is its new accounting basis.Impairment tests completed in the years ended December 31, 2005 and 2004indicated no impairment of either goodwill or intangible assets with indefinitelives.

 

**Long-Lived Assets—Including Identified IntangibleAssets with Finite Lives**

 

Intangible assets with finite lives are amortizedusing the straight-line method over the estimated economic lives of the assets,ranging from five to eight years. The Company reviews long-lived assets tobe held and used for impairment whenever there is an indication that thecarrying amount may not be recoverable from future estimated cash flows. InApril 2005, a Datamark executive Officer resigned from the Company.   Accordingly, in the second quarter of 2005,the amortization of the fair value of the related non-compete agreement wasaccelerated to correspond with the resulting decrease in the term of thenon-compete.  As of December 31,2005 and December 31, 2004, management believes that there were no indicationsof impairment of the Company’s long-lived assets.

 

**Software Development Costs**

 

The Company’s activities include ongoing developmentof internal-use software used in connection with delivery of services via itsproprietary software platform and network. Pursuant to the provisions of theAICPA’s Statement of Position 98-1, “Accounting for

 

43

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theCosts of Computer Software Developed or Obtained for Internal Use,” costsincurred during the application development stage are capitalized and costsincurred during the preliminary project and the post-implementation stages areexpensed as incurred. Capitalized software development costs are amortizedusing the straight-line method over their estimated useful lives, generallythree years.  Capitalized softwaredevelopment costs for the years ended December 31, 2005, 2004 and 2003 were$1.3 million, $1.8 million and $304,000, respectively.  Amortization begins when the products areready for their intended use.  The Company recorded $0.6 million,$0.3 million and $1.3 million of amortization expense for the yearsended December 31, 2005, 2004 and 2003, respectively.

 

**Other Accrued Liabilities**

 

Other accrued liabilities are comprised primarily ofaccrued compensation expense and the related taxes, as well as other accruedexpense items as of each reporting date as shown below (in thousands):

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Accrued compensation and related taxes |       | $                     | 3,401      |   | $ | 3,617 |   |
| Other accruals                         |       | 3,332                 |       | 2,203 |   |
| Total other accrued liabilities        |       | $                     | 6,733      |   | $ | 5,820 |   |

 

**Stock-Based Compensation**

 

Through December 31, 2005, generally acceptedaccounting principles provided two methods for accounting for employee stockoption plans and other employee stock-based compensation arrangements.Companies may recognize stock-based compensation expense under the intrinsicvalue-based method prescribed by APB Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations or under a fair value-basedmethod prescribed by SFAS No. 123, “Accounting for Stock-BasedCompensation” and related interpretations.

 

During the fourth quarter of 2003, the Companyadopted SFAS No. 123 effective January 1, 2003 for the Company’semployee stock-based compensation arrangements using the prospective methodunder SFAS No. 148. This method applies the provisions of SFAS No. 123to all employee stock awards granted, modified, or settled afterJanuary 1, 2003 and accordingly, eCollege recognized compensation expensefor such awards made under its stock-based employee compensation plans. Thefair values of restricted share rights were determined using the closing priceof the Company’s common stock on the date of grant, while the fair values ofstock options were estimated at the date of grant using the Black-Scholesoption-pricing model. The fair values of stock appreciation rights areestimated on the date of grant using a Monte Carlo simulation for an Asian typeaward.  The estimated fair values ofawards are being amortized over the vesting period of the applicable award,generally three to five years.

 

As required by SFAS No. 123, the Companypresents pro forma disclosures of its net income using the fair value-basedaccounting model for awards granted prior to January 1, 2003, as shownbelow (in thousands, except per share data). Cumulative compensation cost recognized in actual and pro forma netincome or loss with respect to options that are forfeited prior to vesting isadjusted as a reduction of pro forma compensation expense in the period offorfeiture:

 
| ** **                                                 | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income:                                                |       |                                       |       |   |   |   |   |
| As reported                                                |       | $                                          | 5,928      |   | $ | 19,360 |   | $ | 568 |   |
| Stock-based compensation expense, as  reported, net of tax |       | 1,706                                      |       | 2,349 |   | 1,029 |   |
| Stock-based compensation expense, pro  forma, net of tax   |       | (1,754                                     | )          | (2,486 | ) | (1,720 | ) |
| Pro forma income (loss)                                    |       | $                                          | 5,880      |   | $ | 19,223 |   | $ | (123 | ) |
|                                                       |       |                                       |       |   |   |   |   |
| Basic net income (loss) per share:                         |       |                                       |       |   |   |   |   |
| As reported                                                |       | $                                          | 0.27       |   | $ | 0.95 |   | $ | 0.03 |   |
| Pro forma                                                  |       | $                                          | 0.27       |   | $ | 0.94 |   | $ | (0.01 | ) |
|                                                       |       |                                       |       |   |   |   |   |
| Diluted net income (loss) per share:                       |       |                                       |       |   |   |   |   |
| As reported                                                |       | $                                          | 0.26       |   | $ | 0.88 |   | $ | 0.03 |   |
| Pro forma                                                  |       | $                                          | 0.26       |   | $ | 0.87 |   | $ | (0.01 | ) |

 

44

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**Income Taxes**

 

The current provision for income taxes representsactual or estimated amounts payable on tax return filings each year. Deferredtax assets and liabilities are recorded for the estimated future tax effects oftemporary differences between the tax bases of assets and liabilities andamounts reported in the accompanying balance sheets, and for operating loss andtax credit carryforwards. The change in deferred tax assets and liabilities forthe period measures the deferred tax provision or benefit for the period.Effects of changes in enacted tax laws on deferred tax assets and liabilitiesare reflected as adjustments to the tax provision or benefit in the period ofenactment. The Company’s deferred tax assets have been reduced by a valuationallowance to the extent that management has concluded that realization of theassets is not more likely than not at each balance sheet date (seeNote 9).

 

**Advertising Costs**

 

Advertising costs are expensed as incurred and areincluded in sales and marketing expense in the accompanying statements ofoperations. Advertising expense for each of the periods presented in theaccompanying statements of operations, was $162,000, $315,000 and $293,000 forthe years ended December 31, 2005, 2004 and 2003, respectively.

 

**Net Income Per Share**

 

Basic net income per share is computed by dividingnet income for the period by the weighted average number of common sharesoutstanding for the period. Diluted net income per share is computed by(i) adjusting net income for the effects, if any, of assuming theconversion of certain convertible securities, and (ii) adjusting theweighted average number of shares outstanding for the effects, if any, ofcommon shares issuable upon the conversion or exercise of certain securitiessuch as warrants and options for common stock outstanding during the period, ifthe effect of such adjustments is dilutive. Certain options, warrants and othercommon stock equivalents were dilutive as of December 31, 2005, 2004 and2003 and, using the treasury stock method, resulted in an additional 0.7million,1.6 million and 1.8 million weighted-average common shares outstandingfor the computation of diluted net income per share for the years endedDecember 31, 2005  2004 and 2003,respectively.

 

The following table provides a reconciliation of the denominators usedin computing basic and diluted net income per common share.  There were no adjustments to the numerator.

 
| ** **                                             | ** ** | **Year Ended December 31,**                        | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                             | ** ** | **(In thousands,  except per share amounts)** | ** ** |
|                                                   |       |                                                              |       |   |   |   |   |
| Net income                                             |       | $                                                                 | 5,928      |   | $ | 19,360 |   | $ | 568 |   |
|                                                   |       |                                                              |       |   |   |   |   |
| Weighted average shares outstanding - basic            |       | 21,729                                                            |       | 20,358 |   | 17,758 |   |
|                                                   |       |                                                              |       |   |   |   |   |
| Basic net income per share                             |       | $                                                                 | 0.27       |   | $ | 0.95 |   | $ | 0.03 |   |
|                                                   |       |                                                              |       |   |   |   |   |
| Diluted net income per share:                          |       |                                                              |       |   |   |   |   |
| Net income                                             |       | $                                                                 | 5,928      |   | $ | 19,360 |   | $ | 568 |   |
|                                                   |       |                                                              |       |   |   |   |   |
| Weighted average number of basic shares  outstanding   |       | 21,729                                                            |       | 20,358 |   | 17,758 |   |
| Dilutive effect of:                                    |       |                                                              |       |   |   |   |   |
| Stock options related to the purchase of  common stock |       | 602                                                               |       | 1,546 |   | 1,801 |   |
| Restricted stock units                                 |       | 63                                                                |       | 15 |   | 19 |   |
| Stock appreciation rights                              |       | 3                                                                 |       | — |   | — |   |
| Employee stock purchase plan                           |       | 8                                                                 |       | 15 |   | — |   |
| Warrants related to the purchase of common  stock      |       | —                                                            |       | 62 |   | — |   |
|                                                   |       |                                                              |       |   |   |   |   |
| Diluted shares outstanding                             |       | 22,405                                                            |       | 21,996 |   | 19,578 |   |
|                                                   |       |                                                              |       |   |   |   |   |
| Diluted net income per share                           |       | $                                                                 | 0.26       |   | $ | 0.88 |   | $ | 0.03 |   |

 

45

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The table below summarizes common stock equivalentsfor 2005, 2004 and 2003 which would have been included except for theiranti-dilutive effect (in thousands):

 
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Stock options                            |       | 1                     |       | 2 |   | 5 |   |
| Employee stock purchase plan             |       | 10                    |       | 10 |   | 197 |   |
| Warrants                                 |       | —                |       | — |   | 200 |   |
| Stock appreciation rights                |       | 448                   |       | 224 |   | — |   |
| Restricted share rights and common stock |       | 87                    |       | 52 |   | 198 |   |
| Total                                    |       | 546                   |       | 288 |   | 600 |   |

 

**Comprehensive Income**

 

Comprehensive income includes all changes instockholders’ equity from non-owner sources. Comprehensive income was the sameas net income for the years ended December 31, 2005, 2004 and 2003.

 

**Treasury Stock**

 

The Company accounts for treasury stock purchases atcost. In 2005 and 2004, the Company withheld 0 and 4,000 shares of common stockwith a cost of $0 and $67,000, respectively, in satisfaction of statutory taxwithholding requirements upon the vesting of restricted share rights held by anofficer of the Company (See Note 8). These shares are presented astreasury stock in the consolidated balance sheet.

 

**Recent Accounting Pronouncements**

 

On December 16, 2004, the FASB issued FASBStatement No. 123 (revised 2004) *“Share-Based Payment”*(“SFAS 123(R)”),which is a revision of SFAS 123. SFAS 123(R) supersedes APBNo. 25, and amends FASB Statement No. 95, *“Statementof Cash Flows*.” Generally the approach in SFAS 123(R) issimilar to the approach described in SFAS 123. However, SFAS 123(R)requires all share-based payments to employees, including grants of employeestock options, to be recognized in the statement of operations based on theirfair values. Pro forma disclosure is no longer an alternative following theadoption of SFAS 123(R). The Company is in the process of evaluating theimpact of SFAS 123(R) on its consolidated financial statements. The Company doesnot expect that the adoption of SFAS 123(R) will have a material impact on itsfinancial statements. SFAS 123(R) must be adopted no later than the beginningof the first fiscal year following June 15, 2005, therefore we are required toadopt SFAS 123(R) for the year beginning January 1, 2006. We intend to use themodified prospective method.

 

In June 2005, the FASB issued SFAS No. 154 “AccountingChanges and Error Corrections”  (“SFASNo. 154”), which will require entities that voluntarily make a change in anaccounting principle to apply that change retrospectively to prior periods’financial statements, unless such retrospective application would beimpracticable. SFAS No. 154 supersedes Accounting Principles Board Opinion No.20, Accounting Changes (“APB No. 20”), which previously required that mostvoluntary changes in accounting principle be recognized by including in thecurrent period’s net income the cumulative effect of changing to the newaccounting principle. SFAS No. 154 also makes a distinction between “retrospectiveapplication” of an accounting principle and the “restatement” of financialstatements to reflect the correction of an error. Another significant change inpractice under SFAS No. 154 will be the requirement that if an entity changesits method of depreciation, amortization, or depletion for long-lived,non-financial assets, the change must be accounted for as a change inaccounting estimate. Under APB No. 20, such a change would have been reportedas a change in accounting principle. SFAS No. 154 applies to accounting changesand error corrections that are made in fiscal years beginning after December15, 2005 and will have an effect on the Company to the extent the Company makesan accounting change or corrects an error.

 

**(3)    Acquisitionof Datamark**

 

On October 31, 2003, the Company, pursuant to adefinitive purchase agreement dated September 15, 2003, acquired all ofthe capital stock of Datamark. The Company’s consolidated financial statementsinclude Datamark’s results of operations from October 31, 2003.

 

The Company paid total consideration ofapproximately $69.8 million, consisting of $58.0 million in cash,$8.9 million subordinated notes payable to the sellers (principal of$12.0 million), $464,000 related to the discount on 75,000 shares of theCompany’s common stock sold to Datamark’s management, and 150,000 shares ofeCollege common stock (valued at $2.5 million based on the average closingprice per share of eCollege’s common stock for the two days prior to and twodays after the signing of the definitive purchase agreement onSeptember 15, 2003). The $58.0 million in cash consideration wasfunded by cash on hand, proceeds from a $3.0 million term loan, andproceeds from $20.0 million in senior subordinated notes. The totalpurchase price allocated to the acquired assets and assumed liabilitiesincluded $1.7 million in capitalized acquisition costs. Acquisition costs 

 

46

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primarilyconsisted of investment banking fees, professional fees, and consulting fees.

 

Under the terms of the stock purchase agreement forthe Datamark acquisition, the purchase price was to be adjusted based uponDatamark’s working capital at the date of completion of the transaction.eCollege and the former Datamark stockholders agreed that $1.0 million ofthe cash consideration paid by eCollege would be put into a working capitalescrow until the final purchase price was determined. As a result, at December31, 2003, the Company recorded $1.2 million as due from former Datamarkstockholders on the consolidated balance sheet, of which $1.0 million ofcash was in escrow and $208,000 was owed by the former Datamark stockholders.During the fourth quarter of 2004, the Company reached a final settlementagreement regarding the purchase price with the former Datamarkstockholders.  The agreement providedthat the Company would receive the $1 million in escrow as well as $157,000 ofthe $208,000 owed by the former Datamark stockholders.  The Company agreed to pay the former Datamarkstockholders $51,000 of the $208,000 owed by them to the Company at December31, 2003.  The $51,000 was recordedduring 2004 as an increase to goodwill. The Company also agreed to pay the former Datamark shareholders $959,000in federal and state tax refunds associated with returns filed subsequent tothe acquisition of Datamark. As a result of an audit by the Internal RevenueService of the Datamark tax return filed for the period ended October 31, 2003,the expected refund for such period was reduced by approximately $114,000.  Pursuant to the terms of the settlementagreement, the Company has reduced its payable to the selling stockholdersaccordingly. As of December 31, 2005, after taking the reduction into account,approximately $331,000 remained to be paid to the selling stockholders as thefederal tax refund had not yet been received.

 

The stock purchase agreement provides for certainindemnification of eCollege by the selling stockholders, severally and notjointly. To satisfy, in part, these indemnification obligations,$5.0 million of the purchase price was placed in escrow.  Prior to being terminated, the escrow paidout a total of $575,932 in satisfaction of various claims. In December 2005,the escrow was terminated, with earnings divided between eCollege and theselling stockholders and the remaining balance distributed to the sellingstockholders.

 

47

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eCollegeretains the right to offset up to the balance owed under the Seller Notes forindemnified claims. However, the former stockholders of Datamark are liable toeCollege for indemnification only to the extent that the aggregateindemnifiable damages incurred by eCollege exceed the sum of $500,000. Thislimitation on indemnification does not apply to claims involving certaindisputes known at the time of the acquisition or to certain breaches of therepresentations of the selling stockholders under the stock purchase agreement,including indemnification for damages incurred by eCollege associated with anyunpaid or unrecorded liabilities for taxes related to periods prior toOctober 31, 2003.

 

Thefollowing is a reconciliation of the adjusted purchase price (in thousands):

 
| Cash                                                                                                        |   | $      | 58,000 |   |
|-------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Estimated fair value of subordinated notes  payable                                                         |   | 8,850  |   |
| 150,000 shares of eCollege common stock                                                                     |   | 2,502  |   |
| Discount on 75,000 shares of eCollege  common stock sold to Datamark’s management for $10.50 per share |   | 464    |   |
| Total consideration paid                                                                                    |   | 69,816 |   |
| Capitalized acquisition costs                                                                               |   | 1,714  |   |
| Total purchase price                                                                                        |   | 71,530 |   |
| Less: working capital adjustment at  purchase date                                                          |   | (1,208 | )      |
| Adjusted Purchase Price                                                                                     |   | $      | 70,322 |   |

 

The total adjusted purchase price of approximately$70.3 million was allocated as follows (in thousands):

 
| Cash and cash equivalents                               |   | $      | 2,154  |   |
|---------------------------------------------------------|--------|--------|--------|--------|
| Accounts receivable                                     |   | 5,211  |   |
| Prepaid expenses and other current assets               |   | 1,043  |   |
| Accounts payable                                        |   | (4,500 | )      |
| Accrued bonus payable and payroll                       |   | (2,653 | )      |
| Customer advances                                       |   | (1,255 | )      |
| Other accrued expenses                                  |   | (408   | )      |
| Net deferred tax liability                              |   | (4,771 | )      |
| Fixed assets                                            |   | 2,833  |   |
| Customer relationships                                  |   | 8,100  |   |
| Non-compete agreements                                  |   | 2,400  |   |
| Trademark/trade name                                    |   | 1,600  |   |
| Reduction of eCollege deferred tax  valuation allowance |   | 4,771  |   |
| Goodwill                                                |   | 55,797 |   |
| Total purchase price                                    |   | $      | 70,322 |   |

 

The Company recorded deferred tax assets of $497,000and deferred tax liabilities of $5.3 million upon the acquisition ofDatamark during the year ended December 31, 2003. The deferred tax assetswere primarily due to customer advances. The deferred tax liabilities wereprimarily related to future amortization or impairment of purchased intangibleassets that will not be deductible for tax purposes. However, the Company mayutilize the historical eCollege net operating loss carryforwards to offset thefuture taxable income resulting from these net deferred tax liabilities. As aresult, the Company reduced the valuation allowance on its net deferred taxassets by approximately $4.8 million. As the change in the valuationallowance was attributable directly to the acquisition, the Company recordedthe change as a reduction of goodwill, offsetting the impact on goodwill fromthe recording of the net deferred tax liabilities. Accordingly, there was nonet impact on goodwill from deferred taxes resulting from the acquisition.

 

During the year ended December 31, 2004, the totalpurchase price allocated to the acquired assets and assumed liabilitiesdecreased by $0.7 million due to reversal of the valuation reserve againstdeferred tax assets associated with certain tax benefits related to theDatamark acquisition, offset by additional capitalized acquisition costs forlegal and other expenses.

 

During the year ended December 31, 2005, the totalpurchase price allocated to the acquired assets and assumed liabilitiesdecreased by $0.4 million due to adjustment of the deferred tax assetassociated with certain benefits related to the Datamark acquisition.

 

*Intangible assets subject to amortization*

 

Ofthe total purchase price, $10.5 million was allocated to amortizableintangible assets, including customer relationships and non-compete agreements,based on a third party valuation prepared using estimates and assumptionsprovided by management.

 

48

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Basedupon the nature of Datamark’s assets, the income approach was utilized to valuethe customer relationship intangible asset. In performing the allocation, the assets were analyzed within thecontext of the Datamark business enterprise. The Company considered this context to be representative of assumptionsmarketplace participants would use in analyzing the assets acquired.  In establishing the amortization period forthe customer relationship intangible asset, the Company considered the relativeweighting of customer revenues and customer lives and determined that whilecertain customer relationships are expected to span as long as sixteen years,the economic benefit attributable to these customers generally declines in thefinal eight years and compared to the first 8 years.  Therefore, the Company used an eight yearperiod (weighted average) for determining amortization.  During the life of a customer relationship, acustomer’s revenue streams can increase (and decrease); creating a pattern ofeconomic benefit that is not reliably determinable.  Therefore, the Company has determined that astraight-line amortization method over eight years is appropriate andrepresentative of the economic benefits of the intangible asset.

 

Pursuant to the Datamark transaction, eight Datamarkemployees signed agreements that legally restrict them from competing witheCollege for two years after the last date of employment, but not to exceedfive years.  In determining the value ofthe non-compete agreements, the Company estimated the incremental salesassociated with having the non-compete agreements in place versus without thenon-compete agreements.  The Company isamortizing the fair value of the non-compete agreements over five years.  Certain factors that could affect the usefullife include the termination of one or more of these employees, which couldaccelerate amortization.  In April, 2005,a Datamark executive resigned from the Company, resulting in the accelerationof the amortization of his non-compete agreement to correspond with thedecrease in the term of the agreement.

 

*Goodwill and intangible assets with an indefinitelife*

 

The Company initially recorded $55.8 million ofgoodwill as a result of the Datamark acquisition. The Company paid a premiumfor Datamark because eCollege believes that the acquisition will enableeCollege to strengthen its position in the for-profit-post-secondary educationindustry and increase its service offerings along the student life cycle.Operationally, the Company believes the acquisition is valuable in that itoffers the potential to cross-sell to each company’s customer base and theability to offer new integrated products and services.  All of the goodwill has been allocated to theEnrollment division as of December 31, 2005. Goodwill is not deductible for tax purposes.

 

The Company allocated $1.6 million to theDatamark trade name.  In determining thevalue of the Datamark trade name, the Company utilized the relief-from-royaltymethod – using a royalty rate applied to projected Datamark sales streams.  In determining that the trade name intangibleasset had an indefinite life, the Company considered the following factors: theongoing active useful life of the trade name; the lack of any legal, regulatory,or contractual provisions that may limit the useful life of the trade name; thelack of any substantial costs to maintain the asset, the positive impact on itstrade name generated by its other ongoing business activities; and the Company’scommitment to products being branded with its trade name over its corporatehistory.  The acquired trade name hassignificant market recognition and the Company expects to derive benefits fromthe use of this asset beyond the foreseeable future.  However, should the Company discontinue useof or otherwise determine that its value is diminished, the Company may berequired to write off all or a significant portion of this asset.

 

eCollege’s purchased intangible assets associatedwith the completed acquisition at December 31, 2005, are as follows (inthousands):

 
| ** **                                     | ** ** | **Gross** | ** ** | **December 31, 2005  Accumulated  Amortization** | ** ** | **Net** | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------------------------------------------------|------------|---------|------------|
| Customer Relationships (8 years)          |       | $         | 8,100      |                                                       | $          | 2,194   |       | $ | 5,906 |   |
| Non-compete agreements (5 years)          |       | 2,400     |       | 1,161                                                      |       | 1,239   |       |
| Total amortizable purchased intangible  assets |       | 10,500    |       | 3,355                                                      |       | 7,145   |       |
| Datamark trade name                            |       | 1,600     |       | —                                                     |       | 1,600   |       |
| Total purchased intangible assets              |       | $         | 12,100     |                                                       | $          | 3,355   |       | $ | 8,745 |   |

 

Amortization expense related to purchased intangibleassets was $1.6 million in 2005, $1.5 million in 2004 and $249,000 in 2003.

 

49

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Estimated future amortization expense related topurchased intangible assets by year at December 31, 2005 is as follows (inthousands):

 
| **Year  ending December 31,** | ** ** | **Amortization** | ** ** |
|---------------------------------------------------|------------|------------------|------------|
|                                              |       |             |       |
| 2006                                              |       | $                | 1,654      |   |
| 2007                                              |       | 1,388            |       |
| 2008                                              |       | 1,234            |       |
| 2009                                              |       | 1,013            |       |
| 2010                                              |       | 1,013            |       |
| Thereafter                                        |       | 843              |       |
| Total                                             |       | 7,145            |       |
|                                                   |            |                  |            |  |

 

*Pro forma results*

 

The following unaudited pro forma financialinformation presents the combined results of operations of eCollege andDatamark as if the acquisition had occurred as of January 1, 2003.  An adjustment of $5.4 million was madeto the combined results of operations, reflecting amortization of purchasedintangible assets, stock compensation expense, interest expense, and relatedfinancing costs, net of tax, that would have been recorded if the acquisitionhad occurred at the beginning of 2003. The unaudited pro forma financialinformation is not intended to represent or be indicative of the consolidatedresults of operations of eCollege that would have been reported had theacquisition been completed as of the beginning of the periods presented, andshould not be taken as representative of the future consolidated results oroperations of financial condition of eCollege. Pro forma results were asfollows for the year ended December 31, 2003 (in thousands, except pershare amounts):

 
| ** **                           | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------|------------|
| Revenue                              |       | $        | 72,446     |   |
| Cost of revenue                      |       | 38,408   |       |
| Gross profit                         |       | 34,038   |       |
| Operating expenses:                  |       |     |       |
| Product development                  |       | 5,723    |       |
| Selling and marketing                |       | 11,034   |       |
| General and administrative           |       | 11,013   |       |
| Amortization of intangible assets    |       | 1,493    |       |
| Total operating expenses             |       | 29,263   |       |
| Income (loss) from operations        |       | 4,775    |       |
| Other income (expense), net          |       | (4,855   | )          |
| Net loss                             |       | $        | (80        | ) |
| Basic and diluted net loss per share |       | $        | (0.00      | ) |

 

**(4)    Revenue Recognition**

 

The majority of the Company’s revenue prior toOctober 31, 2003 was generated from enrollment fees for students enrolled inonline courses. The Company also generated modest amounts of revenue fromenrollment fees for students enrolled in online supplements for on-campuscourses; services fees for the design, development, licensing and hosting ofonline digital campuses; and services fees for the design and development ofonline courses. With the acquisition of Datamark on October 31, 2003, theCompany began to generate revenue from a variety of other products and servicesincluding direct mail, media placement, interactive marketing, custom research,admissions training, and student retention services. Other revenue is primarilyfrom professional consulting and other training services.

 

The Company recognizes revenue in accordance withSAB 101, “Revenue Recognition in Financial Statements,” as modified by SAB 104,which provides guidance on revenue recognition for public companies. Revenue isrecognized when all of the following criteria are met: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or serviceshave been rendered; (3) the seller’s price to the buyer is fixed ordeterminable; and, (4) collectibility is reasonably assured.  We follow EITF 00-21, “Accounting for RevenueArrangements with Multiple Deliverables,” to identify units of accounting inrevenue arrangements with multiple deliverables.  We follow EITF 99-19, “Reporting RevenueGross as a Principal vs. Net as an Agent,” for media services where the Companyis not at risk with vendors for services and the Company receives a commissionfor such services.

 

50

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*eLearning Division*

 

The Company enters into contracts with customers toprovide online learning products and services. The contracts typically have initial terms of one to three years. Eachcontract specifies the type and price of the online campus purchased and thenumber and price of online courses purchased, as well as the fees for studentenrollments and any other products or services purchased. Since customercontracts are generally applicable campus-wide, colleges and universities canadd new online programs and schools without the need to negotiate new contractterms.

 

The majority of eLearning division revenue is earnedby charging a per-enrollment student technology service fee to our customersfor access to their eCourses and our help desk. A smaller percentage of revenueis generated by our eCompanion product for which we typically charge an annuallicense fee for up to a predetermined number of users with revenue being recognizedon a straight line basis over the contract year. For our Program AdministrationSolutions, we generally charge a one time set-up and design fee to implement anonline campus, and an annual license, hosting and maintenance fee for access tosoftware. We sell our professional services on a fixed-fee contract basis aswell as a standard hourly rate basis.

 

Student fees are recognized on a per enrollmentbasis over each course’s specific academic term or over the length of thestudent fee license purchased by the customer, depending upon contract terms.An enrollment is generally defined as one user in one course for one academicterm.  No billing occurs, and no revenueis recognized, for cancelled classes and student withdrawals or drops thatoccur before the agreed-upon enrollment census date. Campus license, hosting,and maintenance fees, including the design and development of a customer’scampus, are recognized on a straight-line basis from the campus launch datethrough the end of the relevant contract period or the expected life of thecustomer relationship, whichever is greater. The average recognition period forthese campus fees is approximately three years.

 

Professional services revenue is derived from eitherfixed fee or time and materials consulting contracts and recognized as servicesare performed. The Company also offers customers the option of purchasing blocksof course development service hours, based on our standard hourly rates.  These revenues are also recognized asservices are performed.

 

*Enrollment Division*

 

Enrollment division revenues are primarily generatedfrom the sale of direct mail, interactive marketing, and media placement. TheCompany also derives other revenue from research services, admissions training,admissions shopper and retention services.

 

It is the Company’s practice to execute contracts orwork orders of various lengths for direct mail advertising campaigns, whichtypically have durations of up to three months. In most cases, individualdirect mail projects take ten to eighteen business days to complete withpayments due two days before marketing materials are mailed. Fees are determinedbased on the number of pieces mailed and the associated revenue is recognizedwhen the marketing materials are mailed. The pricing includes all applicablepostage costs.

 

Interactive media arrangements usually range fromthree months to one year in length. Pricing is typically based on afee-per-lead-generated model, with an initial up front payment due at the timethe customer’s agreement is signed. The customer is invoiced monthly thereafterbased on the number of leads generated. Payments received are recorded ascustomer advances (liability) until the leads are generated, at which point therevenue is recognized.

 

Datamark recently introduced a new, servicefee-based interactive product model under which the customer procures the leadand Datamark provides lead “scrubbing,” media management, analytic and otherservices. Under these contracts, which typically have a duration of one year,Datamark receives monthly fixed management fees, with opportunities forperformance-based bonuses. Fixed fees from these arrangements are recognized asrevenue when services are provided, and incentive revenue is recognized as theincentives are earned.

 

Datamark generally executes written master servicesagreements with larger customers for which we provide media placement services.Datamark charges customers for the cost of the advertisement placed with thethird-party media supplier (i.e. newspaper, television, radio station, etc.),as well as a commission for work performed. Revenue is recognized when themedia advertisements are run by the third-party media supplier. Revenue isrecorded on a net basis, meaning that the Company only includes the commissionportion of the amount it charges in consolidated revenue, not the gross amountof fees charged to, and collected from, customers. Accordingly, the Companyexcludes the direct cost of the advertisement charged by the media supplierfrom cost of revenue in the consolidated statements of operations.

 

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Other enrollment marketing revenue sources include retention services,admissions training, admissions shopper, research services and bundled leadgeneration and admissions services. Student retention services agreements haveterms of not less than six months and typically are for a period of one year.Datamark charges a fee based on the number of students actively enrolled in aparticular month, as well as a one-time implementation fee that is recognizedas revenue over the contract period. Contracts for admissions training,admissions shopper and research services are negotiated based on scope of work.These services are provided on an hourly or per project rate and are recognizedat the time of performance of the service or over the length of the serviceperiod. Datamark receives a share of tuition revenue per enrollment for itsbundled lead generation and admissions services solution.

 

For both divisions, the Company enters intoagreements that may contain multiple-elements. For multiple-elementarrangements, the Company recognizes revenue for delivered elements when thedelivered item has stand-alone value to the customer, fair values ofundelivered elements are known, customer acceptance has occurred, and there areonly customary refund or return rights related to the delivered elements.

 

Revenue that is recognized is reflected as accruedrevenue receivable on the consolidated balance sheets to the extent that thecustomer has not yet been billed for such services. The Company recordsdeferred revenue for amounts received from or billed to customers in excess ofthe revenue that has been earned. The Company also records a liability forcustomer advances (deposits) that it requires customers to pay for interactivemedia services.

 

**(5)    Debt**

 

**Revolving Line of Credit**

 

In October 2005, the Company restructured its bankcredit facility and obtained a $15.0 million line of credit (the “New Revolver”)that matures on October 31, 2007. The New Revolver replaced a $10.0 millionrevolving line of credit which was obtained in October 2003 (the “PriorRevolver”).  The interest rate on the NewRevolver is equal to the bank’s prime rate, which was 7.25% atDecember 31, 2005. The New Revolver contains certain financial covenants,including requirements that the Company maintain a specified minimum ratio ofquick assets to current liabilities and a specified minimum level of EarningsBefore Interest, Taxes, Depreciation and Amortization (“EBITDA”). The Revolveris secured by all of the Company’s assets. The Company was in compliance with all financial covenants as ofDecember 31, 2005 and 2004.

 

The Company maintains two letters of credit with thebank in the amounts of $250,000 and $62,000 under which the vendor of theCompany’s back-up computer systems and the landlord for the Company’s Denverfacility are the respective beneficiaries. The letters of credit effectively reduce the borrowing ability under theNew Revolver by $312,000.  At December31, 2004, the Company maintained same two letters of credit in the amounts of$250,000 and $62,000 which effectively reduced the borrowing ability under theRevolver by $312,000.

 

**Long-Term Debt**

 

*Term Loan*

 

The Company obtained a $3.0 million term loan (“TermLoan”) with a bank in October 2003 and repaid the Term Loan in full inMarch 2005. The Term Loan, which bore interest at the rate of 7% per annum,refinanced a previous term loan and the outstanding debt on the equipment leasefacility described below. The Company incurred approximately $56,000 in debtissuance costs in connection with the Term Loan. These debt issuance costs weredeferred and amortized as interest expense over the three-year term of theloan.

 

The previous term loan was obtained in May 2003in order to refinance two sale-leaseback arrangements, and had a 36 monthterm and an adjustable interest rate of prime plus 2.75% (not less than 7.00%or more than 9.00%). The previous equipment lease facility was obtained inMay 2003, provided up to $1.0 million in equipment financing, and hadan adjustable rate of prime plus 2.75% (not less than 7.00% or more than9.25%).

 

*Letter of Credit*

 

The Company maintains a letter of credit in theamount of $250,000 with Colorado Business Bank under which Silicon Valley Bankis the beneficiary.  The letter of creditis secured by a certificate of deposit in the amount of $252,577 at ColoradoBusiness Bank.   The letter of creditwill automatically renew for one year on May 5, 2006 and on each May 5thereafter until 2025 unless the Company provides notice of its desire not torenew.

 

At December 31, 2004, the Company maintainedsame letter of credit. The amount of this letter of credit was $472,949 atDecember 31, 2004 and was secured by a certificate of deposit in the amount of$516,000 at Colorado Business Bank. During 2005, the Company reduced thisletter of credit to be in the amount of $250,000 which is now secured by acertificate of deposit in the amount of $252,577 at Colorado Business Bank.

 

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*Capital Lease*

 

The Company entered into a capital lease agreementto acquire computer hardware and software in January 2004.  The lease carries an imputed interest rate of8.4% and is payable in 36 monthly installments. At December 31, 2005, $148,000was outstanding on this lease. In April 2005, the Company entered into anothercapital lease agreement to acquire computer hardware and software.

 

Thelease caries an imputed interest rate of 7.5% and is payable in 36 monthlyinstallments. At December 31, 2005, $421,000 was outstanding on this lease.

 

*Subordinated Notes*

 

In October 2003, the Company issued$20.0 million in Senior Subordinated Notes. The Senior Subordinated Noteshave principal payments due in $5.0 million quarterly increments beginningon December 31, 2007, with interest payments due quarterly beginning onDecember 31, 2003, at a rate of 12.5% per annum. The Senior SubordinatedNotes are secured by all of the Company’s assets. In connection with theissuance of the Senior Subordinated Notes, the Company issued warrants to thelender to purchase 200,000 shares of common stock at a price of $13.00 pershare. However, if at the time of exercise of all or any portion of thewarrants, the trading price of the Company’s common stock is less than $13.00per share for the 30 trading days immediately preceding the date of suchexercise, then the exercise price shall be automatically adjusted such that theexercise price will be equal to $10.00 per share with respect to such exercise.The warrants expire on October 31, 2008. The net proceeds received in connectionwith the issuance of the Senior Subordinated Notes totaled $20.0 million,which were allocated to the Senior Subordinated Notes and the warrants. TheCompany allocated $3.3 million of the net proceeds to the warrants basedupon the fair value of the warrants, which was estimated using theBlack-Scholes option pricing model, a risk free interest rate of 3.0%,volatility of 85%, 0% dividend yield, and an expected life of 5 years (thecontractual life). The remaining $16.7 million of the net proceeds wasallocated to the Senior Subordinated Notes. The discount attributable to thevalue of the warrants is being amortized as interest expense over the five-yearterm of the Senior Subordinated Notes using the interest method. The Companyalso incurred approximately $1.0 million in debt issuance costs inconnection with the Senior Subordinated Notes. The debt issuance costs weredeferred and are being amortized as interest expense over the five-year term ofthe Senior Subordinated Notes. The Senior Subordinated Notes contain certainfinancial covenants, including minimum quick ratio, minimum tangible net worth,minimum debt service coverage, and minimum EBITDA, and are secured by all theCompany’s assets.  The SeniorSubordinated Notes have a cross default provision with the Company’s other bankdebt. The Company was in compliance with all financial covenants as ofDecember 31, 2005 and December 31, 2004.

 

The Senior Subordinated Notes also contain aprovision that provides for the acceleration of all interest payments duethrough October 31, 2006 upon payment of the debt prior toOctober 31, 2006.

 

Also in connection with the acquisition of Datamarkin October 2003, the Company issued Seller Notes totaling$12.0 million.  The Seller Notes,with interest and principal due in 2008, were comprised of a series of notesissued to the selling stockholders, aggregating to $7.0 million (faceamount) and bearing simple interest at a rate of 10.0% per annum and anotherseries of notes, aggregating to $5.0 million (face amount) and bearinginterest at a rate of 10.0%, compounded annually. All of the simple interestnotes, as well as $3.0 million (face amount) of the annually compounding notes,were repaid in 2004.  The Company recorded$8.9 million for the Seller Notes at the time of their issuance based upontheir estimated fair value, resulting in a discount in the original amount of$3.1 million, which is being amortized over the term of the debt using theinterest method.  The effective interestrate on these notes, including the amortization of the recorded discount, is14.9%.  The fair value of the SellerNotes was determined by an independent third party who considered, among otherfactors, the effective interest rate of the Senior Subordinated Notes, andother comparable debt securities. Due to the discounts on the SeniorSubordinated Notes and Seller Notes, any payment of these debt obligationsprior to their maturity results in additional interest expense due to therealization of the unamortized portions of the costs and discounts recorded.The early repayment of $7.5 million carrying value ($10.0 million face value)of Seller Notes during the fourth quarter of 2004 resulted in an additional$2.5 million interest charge.

 

The carrying value of the Seller Notes was $2.1million at December 31, 2005, with an unamortized discount of $343,000 andaccrued interest payable of $460,000, and $1.8 million at December 31, 2004,with an unamortized discount of $411,000 and accrued interest payable of$238,000.

 

The Company is currently precluded by its borrowingagreements from paying dividends on its stock.

 

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The following is a summary of the Company’slong-term debt and capital lease obligations as of December 31, 2005 and2004, respectively (in thousands):

 
| ** **                                                                                                                                                                                                | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan, 7% interest rate, due through  November 2006                                                                                                                                                   |       | $                           | —     |                        | $          | 1,917 |   |
| Seller note, 10% face interest rate, 14.9%  effective interest rate, interest and principal due October 31, 2008, face  amount of $2.0 million                                                            |       | 2,118                       |       | 1,827                       |       |
| Senior subordinated notes, 12.5% face  interest rate, 19.7% effective interest rate, $5.0 million quarterly  payments starting December 2007, due October 31, 2008, principal of  $20.0 million |       | 17,906                      |       | 17,279                      |       |
| Capital lease obligation, 8.4% and 7.5%,  respectively, imputed interest rate, 36 monthly payments beginning January  2004 and April 2005, respectively                                                   |       | 569                         |       | 284                         |       |
| Total                                                                                                                                                                                                     |       | 20,593                      |       | 21,307                      |       |
| Less current portion                                                                                                                                                                                      |       | (320                        | )          | (1,136                      | )          |
| Long-term portion                                                                                                                                                                                         |       | $                           | 20,273     |                        | $          | 20,171 |   |

 

The following is a schedule by year of futureprincipal debt payments, as of December 31, 2005. Amounts represent thecontractual cash payments of our debt and exclude the debt discounts discussedabove (in thousands):

 
| **Year  ending December 31,** | ** ** | **Term Loan** | ** ** | **Senior  Subordinated  Notes** | ** ** | **Seller Notes** | ** ** | **Capital  Lease** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|---------------------------------|------------|-----------------------|------------|--------------------|------------|-----------|------------|
| 2006                                              |       | $                  | —     |                            | $          | —                |       | $                  | —     |      | $          | 320 |   | $ | 320 |   |
| 2007                                              |       | —             |       | 5,000                           |       | —                |       | 185                |       | 5,185     |       |
| 2008                                              |       | —             |       | 15,000                          |       | 2,000                 |       | 65                 |       | 17,065    |       |
| 2009                                              |       | —             |       | —                          |       | —                |       | —             |       | —    |       |
| 2010                                              |       | —             |       | —                          |       | —                |       | —             |       | —    |       |
|                                              |       |               |       |                            |       |                  |       |               |       |      |       |
| Total principal                                   |       | $                  | 0          |                            | $          | 20,000                |       | $                  | 2,000      |      | $          | 570 |   | $ | 22,570 |   |

 

Capital lease obligationsat December 31, 2005 and2004 included assets with original cost of $890,000 and $442,000. The combinedaccumulated depreciation for such leases totaled $394,000 and $147,000,respectively, at December 31, 2005 and 2004.

 

**(6)    Commitments andContingencies**

 

**Operating Lease Obligations**

 

The Company leases office space and equipment undervarious non-cancelable operating leases. At December 31, 2005 theaggregate future minimum lease commitments were as follows (in thousands):

 
| **Year  ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|------------|------------|
| 2006                                              | ** ** | **$**      | 2,195      | ** ** |
| 2007                                              |       | 1,971      |       |
| 2008                                              |       | 1,011      |       |
| 2009                                              |       | 848        |       |
| 2010                                              |       | 667        |       |
| Thereafter                                        |       | 857        |       |
|                                              |       | $          | 7,549      |   |

 

Rent expense for the years ended December 31,2005, 2004 and 2003 was $1.5 million, $1.9 million and $1.1 million,respectively.  In connection with thelease on the corporate headquarters building, the Company has recognized$316,000 in deferred rent liability as of December 31, 2005, as the amountof the monthly cash rental payments increases over the lease term.

 

**Offshore Development Commitment**

 

InJanuary 2004, the Company entered into a contract with a third party toestablish an offshore development facility in Sri Lanka.  Minimum future commitments under thiscontract were $2.4 million at December 31, 2005.  If the Company terminates the

 

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agreementprior to April, 2007, it will be required to pay a termination penalty equal tosix months expense at the then current minimum staffing level.

 

**Employee Benefit Plan**

 

The Company has a defined contribution plan underSection 401(k) of the Internal Revenue Code. Eligible employees arepermitted to contribute a percentage of their annual compensation up to themaximum allowed by IRS regulations. In addition, the Company may makediscretionary and/or matching contributions on behalf of participatingemployees. No such contributions were made under this plan in 2005, 2004, or2003. With the acquisition of Datamark, the Company continued to use Datamark’s401(k) plan for the Enrollment division through 2005. Datamark’s 401(k)featured a discretionary matching provision in which the Board determinedmatching levels yearly.  During 2005 and2004, the Company made discretionary matching contributions to the Datamarkplan of $27,875 and $37,954. The Company made no such contributions in 2003.

 

Effective January 1, 2006, the Datamark plan wasmerged into the Company plan with the Company plan surviving. The Companyintends to make matching contributions to the plan in 2006 in an amount equalto ten percent of participant contributions up to a maximum six percent ofsalary.

 

**Legal Matters**

 

In July 2005, the Companyreceived a letter from counsel to Arthur Benjamin, who was Datamark’s chiefexecutive officer until April 2005. The letter alleged unspecified breaches byeCollege and/or Datamark of Mr. Benjamin’s employment agreement and relatedagreements, including without limitation Mr. Benjamin’s stock appreciationrights agreement, and demanded that the Company submit such disputes to bindingarbitration as required by the employment agreement. The Company agreed toarbitrate the dispute. In December 2005, Mr. Benjamin filed suit againsteCollege and Datamark in the United States District Court, District of Utah,alleging, among other things, that eCollege and Datamark breached Mr. Benjamin’semployment and stock appreciation rights agreements by forcing Mr. Benjamin toresign for “good reason” and subsequently failing to pay him severance andaccelerate the vesting of stock appreciation rights and restricted stock. Usingan assumed common stock price of up to $150 per share, Mr. Benjamin seekscompensatory damages of up to $38 million and punitive damages of up to $380million.

 

From a proceduralstandpoint, the Company believes that all disputes between the Company and Mr.Benjamin must be resolved in arbitration in accordance with the terms of theemployment agreement and has filed a motion to dismiss the federal lawsuit. Ahearing on the motion is scheduled for March 16, 2005.  With regard to the substance of Mr. Benjamin’scomplaint, the Company believes that his allegations are without merit and thathis calculations of alleged damages are in error. The Company intends tovigorously defend against these allegations. However, due to the uncertaintyinherent in litigation, we are unable to predict the outcome of this dispute.An outcome unfavorable to the Company could have a material adverse effect onour business, results of operations and financial condition.

 

**Sales and Use Tax**

 

In the second quarter of2005, as part of the Company’s effort to remediate identified materialweaknesses in internal controls, the Company conducted a preliminary study ofsales and use tax obligations for the eLearning and Enrollment divisions. Thatstudy revealed that the Enrollment division could have liability foruncollected sales and use tax in various states. Accordingly, the Companyretained outside advisors to conduct a more detailed analysis of the issue byexamining, on a state-by-state basis for 2001 through 2005, whether theEnrollment’s division’s activities in the state were sufficient to create asales and use tax collection obligation and, if so, whether some or all of theservices provided by the Enrollment division in the state were subject totaxation. As a result of the detailed analysis, the Company determined thatDatamark may have been obligated to collect sales/use taxes in certainjurisdictions and thus faces potential liability. Datamark believes that someof its clients may have paid sales tax on Datamark’s services directly, whichwould relieve Datamark of its collection obligation. Datamark is surveying itsclients to see if they have done so. In addition, to the extent that theliability relates to periods that preceded the date of the Datamarkacquisition, the Company believes that the former Datamark stockholders arerequired to indemnify the Company for such liability.

 

 To date, no jurisdiction has audited orindicated any intention of auditing Datamark’s sales and use tax compliance.However, in an effort to mitigate its potential liability, the Company intendsto approach certain states (in which Datamark faces the most significant riskof liability) pursuant to voluntary disclosure arrangements. Such arrangementspermit taxpayers, in many situations, to resolve outstanding tax obligationsfor less than the full amount of the potential exposure, and at a minimumenable taxpayers to avoid penalties. In addition, Datamark will likely registerwith the Streamlined Sales Tax Project, which provides amnesty for past taxobligations in member states in exchange for the registrant’s agreement tocollect and remit taxes for three years going forward.

 

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While the Company cannotpredict with certainty either Datamark’s potential exposure for prior taxperiods or the outcome of the actions it has undertaken in mitigation of thepotential liability as described in the preceding paragraph, it has estimatedits exposure to sales and use tax liability and related interest and penalties,if any, in all states at issue to be within a range of $355,000 to $959,000 andhas established a reserve of $485,000 in the fourth quarter of 2005. Suchreserve is net of the exposure related to periods that preceded the Datamarkacquisition, for which the Company has established a receivable of $197,000from the selling stockholders. The Company believes that the reserve and thereceivable are reasonable; however, we will evaluate Datamark’s sales and usetax liability on a periodic basis and may adjust our reserve and receivableestimates in future periods based on the outcome of our mitigation efforts.

 

**Datamark AcquisitionIndemnification**

 

The Datamark stock purchase agreement provides forcertain indemnification of eCollege by the selling stockholders, severally andnot jointly. eCollege has the right to offset up to the $2.0 million balanceowed under the Seller Notes for indemnified claims. However, the formerstockholders of Datamark are liable to eCollege for indemnification if and onlyto the extent that the aggregate indemnifiable damages incurred by eCollegeexceed the sum of $500,000. This limitation on indemnification does not applyto claims involving certain disputes known at the time of the acquisition or tocertain breaches of the representations of the selling stockholders under thestock purchase agreement, including indemnification for damages incurred byeCollege associated with any unpaid or unrecorded liabilities for taxes relatedto periods prior to October 31, 2003.

 

**Product Indemnifications**

 

The Company’s eLearning contracts generally includea product indemnification provision pursuant to which the Company is requiredto indemnify and defend a client in actions brought against the client basedupon claims by a third party that the Company’s products or services infringeupon the intellectual property rights of the third party. Historically, theCompany has not incurred any significant costs related to productindemnification claims, and as a result, does not maintain a reserve for suchexposure.

 

**(7)    Other Related PartyTransactions**

 

During the year ended December 31, 2003, theCompany made payments totaling $30,000 to a vendor for online coursedevelopment services. The Company’s then-Chief Technology Officer was a boardmember of, and held a minority ownership interest in the vendor.

 

During the years ended December 31, 2005 and2004, Datamark received payments of $1,344,516 and $454,823, respectively, forservices provided to a customer for whom the then-Chief Executive Officer ofthe Enrollment Division served on the Board of Directors.

 

In conjunction with the Datamark acquisition, theCompany entered into a five year consulting agreement beginning January 1, 2004with Leeds Equity Advisors Inc., of which Jonathan Newcomb, a formerdirector, was a principal. Under the terms of the consulting agreement, in 2005and 2004 the Company paid Leeds Equity Advisors, Inc. the sum of $200,000plus expenses. The agreement continues for three additional years at $200,000per year plus expenses, if any.

 

On February 1, 2005, 955,760 of 1.0 million optionsheld by Blumenstein Thorne Information Partners I, L.P. (“BTIP”), an investmentfund affiliated with the Company’s Chief Executive Officer, were exercised at aprice of $3.875 per share. An additional 16,575 options were exercised on March23, 2005 at the same price per share.

 

As of December 31, 2005 and 2004, approximately $76,000and $473,000, respectively, of the outstanding principal amount of the SellerNotes was held by executive officers of the Company.

 

**(8)    Stockholders’ Equity**

 

**Private Placement**

 

In August 2003, the Company completed a privateplacement of 2.9 million shares of common stock with a group ofinstitutional investors for an aggregate purchase price of $30.5 million.The Company incurred $1.7 million for stock issuance costs related to thisprivate placement.

 

**1999 Employee Stock Purchase Plan**

 

The Company’s 1999 Employee Stock Purchase Plan (the“Purchase Plan”) is designed to allow the Company’s eligible employees topurchase shares of common stock, at specified intervals, with their accumulatedpayroll deductions. As of December 31, 2005, the Company had reserved 1,166,667shares of common stock for issuance under the Purchase Plan, of which 481,157shares

 

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remainedavailable for purchase.  Eligibleemployees are individuals scheduled to work more than 20 hours per weekfor more than five calendar months per year. Under the Purchase Plan,eligible employees may contribute up to 15% of their cash earnings throughpayroll deductions, and the accumulated deductions will be applied to thepurchase of shares on each purchase date. The purchase price per share will beequal to 85% of the fair value per share of the Company’s common stock on theparticipant’s entry date into the offering period or, if lower, 85% of the fairvalue per share on the purchase date. In no event, however, may any participantpurchase more than 2,000 shares on any purchase date, and not more than 333,334shares may be purchased in total by all participants on any purchase date.

 

From its inception through April 2005, the PurchasePlan had a series of successive offering periods, each with a maximum durationof 24 months and each comprised of successive six-month purchaseintervals.  Effective November 1, 2004,the Company amended the Purchase Plan to revise certain features.  Effective with the purchase interval thatbegan on November 1, 2004, the ability of plan participants to increasecontributions during an offering period was eliminated as was a reset featurethat established a new offering period if the fair value of the Company’s commonstock on any purchase date within an offering period was less than the fairvalue at the beginning of such period. Effective May 1, 2005, the length of an offering period was reduced fromtwo years to one year and the length of each purchase interval was increasedfrom six months to one year.

 

During 2005, 2004 and 2003, the Company recognized$0.5 million, $1.7 million and $0.6 million, respectively, of compensationexpense for employee stock purchases under the Purchase Plan.  In 2005, the Company issued 78,000 shares ofcommon stock at an average per share price of $6.43. In 2004, the Companyissued 163,000 shares of common stock at an average per share price of $5.75.The Company issued 81,896 shares of common stock in 2003 at an average per shareprice of $3.45 per share.

 

**Employee Stock Option Grants**

 

The Company’s 1999 Stock Incentive Plan (the “1999 Plan”)is the successor equity incentive program to the Company’s 1997 Stock OptionPlan (the “1997 Plan”).  The 1999 Planprovides for equity grants to employees and directors of the Company in theform of options, restricted stock units, stock appreciation rights and otherequity instruments.  All outstandingoptions under the 1997 Plan were incorporated into the 1999 Plan, and nofurther option grants will be made under the 1997 Plan. All informationdisclosed below for the period from January 1, 2003 throughDecember 31, 2005 includes options issued under the 1999 Plan and the 1997Plan (collectively, the “Plans”). Options granted may be incentive ornon-qualified options.  Options vest overvarious terms, with a maximum vesting period of five years, and expire after amaximum of ten years. At December 31, 2005, 6.8 million shares hadbeen authorized for issuance under the Plans, of which 1.7 million sharesremained available for grant.

 

The following table summarizes the employee stockoption activity during the years ended December 31, 2005, 2004 and 2003,respectively (in thousands, expect per share data).

 
| ** **                     | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------------------|------------|------------|------------|----------------------------------------|------------|
| Outstanding, January 1, 2003   |       | 2,106      |       | $                                      | 4.85       |   |
| Granted                        |       | 72         |       | 4.75                                   |       |
| Forfeited or canceled          |       | (73        | )          | 3.83                                   |       |
| Exercised                      |       | (476       | )          | 5.15                                   |       |
| Outstanding, December 31, 2003 |       | 1,629      |       | 4.80                                   |       |
| Granted                        |       | 3          |       | 18.38                                  |       |
| Forfeited or canceled          |       | (33        | )          | 4.45                                   |       |
| Exercised                      |       | (413       | )          | 3.99                                   |       |
| Outstanding, December 31, 2004 |       | 1,186      |       | 4.58                                   |       |
| Granted                        |       | —     |       | —                                 |       |
| Forfeited or canceled          |       | (3         | )          | 6.18                                   |       |
| Exercised                      |       | (176       | )          | 3.75                                   |       |
| Outstanding, December 31, 2005 |       | 1,007      |       | 5.40                                   |       |
|                                |            |            |            |                                        |            |  |

 

As of December 31, 2005, 2004 and 2003, 0.9million, 1.0 million and 1.2 million of the above options wereexercisable, respectively, with weighted average exercise prices of $5.47 ,$5.35 and $5.19, respectively.

 

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The following table summarizes the weighted averageexercise prices of options granted during the years ended December 31,2005, 2004 and 2003. The table includes options for common stock for which theexercise price was less than the fair value of the underlying common stock atthe date of grant and options for which the exercise price was equal to orgreater than the fair value at the date of grant (in thousands, except pershare data):

 
| ** **                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Exercise price-less than fair value:   |       |                                        |       |   |   |   |   |
| Number of options                      |       | —                                      |       | — |   | — |   |
| Weighted average exercise price        |       | $                                           | —     |   | $ | — |   | $ | — |   |
| Weighted average fair value of options |       | $                                           | —     |   | $ | — |   | $ | — |   |
|                                   |       |                                        |       |   |   |   |   |
| Equal to fair value:                   |       |                                        |       |   |   |   |   |
| Number of options                      |       | —                                      |       | 3 |   | 72 |   |
| Weighted average exercise price        |       | $                                           | —     |   | $ | 18.38 |   | $ | 4.75 |   |
| Weighted average fair value of options |       | $                                           | —     |   | $ | 12.61 |   | $ | 2.46 |   |
|                                   |       |                                        |       |   |   |   |   |
| Greater than fair value:               |       |                                        |       |   |   |   |   |
| Number of options                      |       | —                                      |       | — |   | — |   |
| Weighted average exercise price        |       | $                                           | —     |   | $ | — |   | $ | — |   |
| Weighted average fair value of options |       | $                                           | —     |   | $ | — |   | $ | — |   |

 

The status of stock options outstanding andexercisable under the Plans as of December 31, 2005 is as follows (inthousands except per share data):

 
| ** **                                  | ** ** | **Stock Options Outstanding** | ** ** | **Stock Options Exercisable**             | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number Of  Shares**              | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $1.29 - $2.95                               |       | 213                                     |       | 4.4                                                 |       | $ | 2.78 |   | 202 |   | $ | 2.77 |   |
| $3.08 - $3.75                               |       | 183                                     |       | 6.0                                                 |       | $ | 3.50 |   | 183 |   | $ | 3.50 |   |
| $3.85 - $4.44                          |       | 213                                     |       | 3.6                                                 |       | $ | 3.99 |   | 180 |   | $ | 3.99 |   |
| $5.38 - $8.21                          |       | 101                                     |       | 4.6                                                 |       | $ | 6.19 |   | 101 |   | $ | 6.18 |   |
| $9.00 - $18.38                         |       | 297                                     |       | 3.9                                                 |       | $ | 9.15 |   | 297 |   | $ | 9.14 |   |
|                                        |       | 1,007                                   |       | 4.4                                                 |       | $ | 5.40 |   | 963 |   | $ | 5.47 |   |

 

**Option and Restricted Stock Grants to Officers**

 

On June 21, 2001, the Company’s Board ofDirectors’ Compensation Committee awarded Douglas Kelsall, then Executive VicePresident and Chief Financial Officer, 50,000 shares of the Company’s commonstock under the 1999  Plan, asconsideration for Mr. Kelsall’s services to the Company and his consent toterminate a previous option grant issued in 1999. One third of the sharesvested on June 21, 2002, the one year anniversary of the award, and thebalance vested in 24 successive equal monthly installments beginning inJuly 2002 and ending in June 2004. The Company recorded stock-baseddeferred compensation cost of $143,000 in connection with this grant, whichamount equaled the fair value of the restricted common stock on June 21,2001. The deferred compensation cost was amortized on a straight-line basisthrough July 2, 2004. During the years ended December 31,  2004 and 2003, the Company recorded $24,000and $47,000 of compensation expense, respectively, in connection with thisgrant. The Company withheld 4,000 and 5,000 shares of stock during 2004 and2003, respectively, from Mr. Kelsall’s vested shares to cover minimum taxwithholding requirements. These shares are included in treasury shares on theaccompanying consolidated balance sheets as of December 31, 2005 and 2004.

 

**Restricted Share Rights**

 

In the third quarter of 2003, the Company began togrant employees restricted share rights instead of stock options. Therestricted share rights offer employees the opportunity to earn shares of theCompany’s common stock over time, as compared to options, which give employeesthe right to purchase stock at a set price. In 2005, 2004 and 2003,respectively, the Company awarded 38,528, 116,236 and 55,487 restrictedshare rights to employees. These rights vest over three to four years. Thevalue of these restricted share rights

 

58

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awards was $0.5 million in 2005, $1.7 million in 2004 and $0.7 millionin 2003 based on the closing prices of the common stock on the dates of thegrants. On October 31, 2003, the Company awarded 195,000 restricted sharerights, vesting over four years, to certain Datamark employees. The value ofthese restricted share rights was $4.2 million based on the closing priceof the common stock on October 31, 2003. The Company recognizes theissuance of the shares related to these stock-based compensation awards and therelated compensation expense on a straight-line basis over the vesting period.The Company recorded $0.8 million, $1.7 million and $0.3 million of stock-basedcompensation expense related to the restricted share rights awarded for theyears ended December 31, 2005, 2004 and 2003, respectively. The remaining$2.0  million will be recognized over theremaining vesting periods.

 

**Stock Appreciation Rights**

 

On September 13, 2004, the Company granted stockappreciation rights with respect to 1.1 million shares of common stock toexecutives and selected other key employees. The rights had a weighted average grant date fair value of $3.95. Therights were granted under the Company’s 1999 Stock Incentive Plan.  The rights will be settled in commonstock.  Each grant is separated into fivedifferent levels of base prices to reflect minimum required levels ofstockholder return over a five-year performance period.  The base price for the first level is 10%higher than the grant date stock price, and the base price for each successivelevel is 10% higher than the previous level. Except in the case of a change incontrol of the Company, as described below, a participant will receive a distributionwith respect to the shares of common stock in each grant level only if theaverage closing price of our common stock for the last quarter in the five yearterm exceeds the base price for such shares. Each participant may elect to receive a distribution with respect to 10%of the rights he or she was granted after the third anniversary of the grantand with respect to an additional 10% after the fourth anniversary of the grantdate. In the event of a change in control, participants will be entitled toreceive a distribution with respect to a specified percentage of the sharesgranted (50% if the change in control occurs on September 13, 2004, increasingby 1/36 each month to 100% on September 13, 2007), and will forfeit the rightto receive a distribution with respect to the unvested portion of the shares.The number of shares of common stock issued following a change in control willbe based on the difference between the base prices and the share price as ofthe date the change in control occurs.  The fair value of each stock appreciationright was estimated on the date of grant using a Monte Carlo simulation for anAsian type award.

 

On March 23, 2005, the Company granted substantiallythe same recipients additional stock appreciation rights with respect to 1.1million shares of common stock.   On May2, 2005, the Company granted additional stock appreciation rights with respectto 30,000 shares of common stock to an executive in connection with apromotion. Such grants have the same terms as the 2004 grants, includingwithout limitation the same change in control vesting schedule, except thatthey have different base prices and new five-year performance periods beginningon the grant dates.  In addition, the Companymay grant stock appreciation rights to new hires and in connection withpromotions and other special circumstances. Compensation expense for each grant is recognized ratably over theapplicable five year performance period.

 

**Warrants**

 

In connection with the Senior Subordinated Notes issuedin 2003, the Company issued warrants to the lender to purchase 200,000 sharesof common stock at a price of $13.00 per share. However, if at the time of exercise of all or any portion of thewarrants, the trading price of the Company’s common stock is less than $13.00per share for the thirty trading days immediately preceding the date of suchexercise, then the exercise price shall be automatically adjusted such that theexercise price will be equal to $10.00 per share with respect to such exercise.  The warrants were immediately exercisable atthe grant date and expire October 31, 2008 (See Note 5). The value ofthe warrants at the date of issuance was $3.3 million, which resulted in adiscount on the Senior Subordinated Notes that is being amortized as interestexpense over the five-year term of the Senior Subordinated Notes.

 

**Valuation Assumptions**

 

The Company estimated the fair value of stockoptions, restricted stock awards, and employee stock purchase plan awards usingthe Black-Scholes option pricing model. The fair value of stock appreciation rights was estimated using a MonteCarlo simulation for an Asian type award. The following weighted average assumptions were used for the fair valuecalculations:

 

59

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| ** **                                                          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                |       |                                       |       |   |   |   |   |
| Stock options granted to employees and  non-employee board members: |       |                                       |       |   |   |   |   |
| Expected lives outstanding                                          |       | —                                     |       | 5 years |   | 3 years |   |
| Expected volatility                                                 |       | —                                     |       | 85 | % | 85 | % |
| Risk-free interest rates                                            |       | —                                     |       | 3.4 | % | 3.0 | % |
| Expected dividend yield                                             |       | —                                     |       | 0 | % | 0 | % |
|                                                                |       |                                       |       |   |   |   |   |
| Employee stock purchase plan:                                       |       |                                       |       |   |   |   |   |
| Expected lives outstanding                                          |       | 1 year                                     |       | 9 months |   | 1 year |   |
| Expected volatility                                                 |       | 66                                         | %          | 68 | % | 70 | % |
| Risk-free interest rates                                            |       | 3.3                                        | %          | 1.6 | % | 1.3 | % |
| Expected dividend yield                                             |       | 0                                          | %          | 0 | % | 0 | % |
|                                                                |       |                                       |       |   |   |   |   |
| Stock Appreciation Rights granted to  employees:                    |       |                                       |       |   |   |   |   |
| Expected lives outstanding                                          |       | 4.7 years                                  |       | 4.7 years |   | — |   |
| Expected volatility                                                 |       | 77                                         | %          | 77 | % | — |   |
| Risk-free interest rates                                            |       | 4.3                                        | %          | 3.2 | % | — |   |
| Expected dividend yield                                             |       | 0                                          | %          | 0 | % | — |   |

 

The total stock-based compensation recorded was $2.8million, $3.8 million and $1.0 million, respectively, for the years endedDecember 31, 2005, 2004 and 2003. Stock-based compensation recorded in 2005 included $15,000 for options,$0.5 million for grants under the Purchase Plan, $0.8 million for restrictedshare rights, and $1.5 million for stock appreciation rights.

 

**(9)    Income Taxes**

 

Componentsof the income tax provision applicable to federal and state income taxes are asfollows (in thousands):

 
| ** **                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current (benefit) expense:       |       |                                       |       |   |   |   |   |
| Federal                          |       | $                                          | 2,691      |   | $ | 110 |   | $ | — |   |
| State                            |       | 580                                        |       | 53 |   | — |   |
| Total                            |       | 3,271                                      |       | 163 |   | — |   |
| Deferred expense (benefit):      |       |                                       |       |   |   |   |   |
| Federal                          |       | 340                                        |       | 2,418 |   | 339 |   |
| State                            |       | 476                                        |       | 269 |   | 62 |   |
| Total                            |       | 816                                        |       | 2,687 |   | 401 |   |
| Total gross tax expense          |       | 4,087                                      |       | 2,850 |   | 401 |   |
| Valuation allowance              |       | 5                                          |       | (21,347 | ) | (401 | ) |
| Net income tax expense (benefit) |       | $                                          | 4,092      |   | $ | (18,497 | ) | $ | — |   |

 

The difference between the statutory federal incometax rate and the Company’s effective income tax rate is summarized as follows(in thousands):

 
| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Federal income tax rate                   |       | 35.0                                       | %          | 35.0 | % | 35.0 | % |
| Increase (decrease) as a result of—  |       |                                       |       |   |   |   |   |
| State income taxes net of federal benefit |       | 6.8                                        | %          | 4.0 | % | 3.9 | % |
| Stock based compensation                  |       | 1.2                                        | %          | 82.5 | % | 28.8 | % |
| Other                                     |       | (2.2                                       | )%         | 8.2 | % | 2.9 | % |
| Change in valuation allowance             |       | 0.0                                        | %          | (2,271.6 | )% | (70.6 | )% |
| Effective income tax rate                 |       | 40.8                                       | %          | (2,141.9 | )% | — | % |

 

60

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Deferredtax assets and liabilities result from the following (in thousands):

 
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred tax assets—                        |       |                  |       |   |   |
| Current:                                         |       |                  |       |   |   |
| Accrued liabilities and other                    |       | $                     | 971        |   | $ | 701 |   |
| Deferred revenue                                 |       | 1,479                 |       | 1,462 |   |
| Non-current:                                     |       |                  |       |   |   |
| Depreciation on property and equipment           |       | (424                  | )          | 320 |   |
| Stock-based compensation                         |       | 1,249                 |       | 780 |   |
| Intangibles                                      |       | 1,165                 |       | 1,891 |   |
| Net operating loss carryforward                  |       | 22,322                |       | 21,606 |   |
| Other                                            |       | (359                  | )          | 525 |   |
| Total deferred tax assets                        |       | 26,403                |       | 27,285 |   |
| Valuation allowance                              |       | (596                  | )          | (591 | ) |
| Deferred tax assets, net of valuation  allowance |       | 25,807                |       | 26,694 |   |
| Deferred tax liabilities—                   |       |                  |       |   |   |
| Acquired intangible assets                       |       | (3,402                | )          | (4,271 | ) |
| Capitalized software costs                       |       | (1,079                | )          | (467 | ) |
| Other                                            |       | (374                  | )          | (183 | ) |
| Total deferred tax liabilities                   |       | (4,855                | )          | (4,921 | ) |
| Net deferred tax assets and liabilities          |       | $                     | 20,952     |   | $ | 21,773 |   |

 

Through 2002, the Company generated losses for both financial reportingand tax purposes. As a result, for income tax reporting purposes, the Companymay utilize approximately $58 million of net operating loss carryforwards,which begin to expire in 2019 and are available as late as 2023. The Tax ReformAct of 1986 contains provisions which may limit the net operating losscarryforwards available to be used in any given year if certain events occur,including significant changes in ownership interests.  Of the $58 million in available netoperating loss carryforwards, approximately $19 million will be availableto offset taxable income in 2006 due to an estimated Section 382 annuallimitation resulting from an ownership change in 1999. Barring any change inownership or tax laws, the net operating loss carryforward will be limited toapproximately $24 million in 2007 and $28 million in 2008.  Any net operating loss carryforwards that arelimited due to the Section 382 limit can be carried forward.

 

The following table detailsthe timing of the expiration of net operating loss carryforwards:

 
| **Year of expiration** | ** ** | **Net  operating loss  carryforwards** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|
| Prior to 2019                    |       | $                                           | —     |   |
| 2019                             |       | 18,114                                      |       |
| 2020                             |       | 25,612                                      |       |
| 2021                             |       | 12,266                                      |       |
| 2022                             |       | 1,536                                       |       |
| 2023                             |       | 482                                         |       |
|                             |       |                                        |       |
|                             |       | $                                           | 58,010     |   |

 

Prior to the fourth quarter of 2004, the Company hadfully provided a valuation allowance for the potential benefits of theaforementioned net operating loss carryforwards in excess of deferred taxliabilities as management believed it was more likely than not that thebenefits would not be realized. During the fourth quarter of 2004, the Companyreversed $21.3 million of the valuation allowance related to the net operatingloss carryforwards and other temporary items as management believes it is nowmore likely than not that the Company will be able to use the benefit to reducefuture tax liabilities. This conclusion was based on the Company’s demonstratedprofitability in 2003 and 2004 and expected future profitability. Approximately$591,000 in valuation reserves associated with state net operating losscarryforwards were not reversed as it is more likely than not that the benefitswill not be realized.  This conclusion isprimarily based on the shorter expiration period of these net operating losses.The reversal resulted in recognition of an income tax benefit of $18.5 million in 2004 and an increase inthe deferred tax asset on the consolidated balance sheet.  The reversal also resulted in an increase of$1.9 million to additional paid in capital associated with tax benefits fromstock-based compensation, and a decrease of $900,000 to goodwill associatedwith certain tax benefits related to the Datamark acquisition.  In 2005, the Company recorded $4.1million ofincome tax expense, and we expect to

 

61

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continueto record income tax expense related to our pretax income in future years.  In 2005, the Company recorded a $3.1 millionincrease to additional paid in capital related to tax benefits associated withstock based compensation, including $2.7 million related to the exercise of972,335 options held by Blumenstein/Thorne Information Partners I, L.P., aninvestment fund affiliated with the Company’s Chief Executive Officer.  The Company recorded a $353,000 reduction togoodwill during 2005 assoicated with tax benefits related to the Datamarkacquisition.

 

**(10)    SegmentInformation**

 

**Description of Segments**

 

Beginning October 31, 2003, as a result of theacquisition of Datamark, eCollege organized its operations into two businesssegments: eLearning and Enrollment. eCollege’s organizational structure isbased on factors that management uses to evaluate, view and run its businessoperations which include, but are not limited to, customer base, homogeneity ofproducts, technology and delivery channels. The business segments are based onthis organizational structure and information reviewed by eCollege’s managementto evaluate the associated business group results. A description of the types of products and services provided by eachreportable segment follows:

 

•                  eLearning provides software products,consisting of online campuses, courses, reporting, content management andadministration solutions, through hosting services in the Company’s reliabledata centers. The eLearning division also provides services complementing thesoftware products, including design, development and management of onlinecampuses and courses, as well as ongoing administration, faculty and studentsupport. eLearning’s suite of products and services provides customers with theflexibility to either outsource the development of their online campus andcourses, or to select individual products and services to meet their uniqueneeds.

 

•                  Enrollment provides lead generation,enrollment and student retention marketing services primarily to proprietarypost-secondary education institutions. Enrollment’s solutions include directmail, media placement and interactive marketing solutions, as well as customresearch, admissions shopper and admissions training. These solutions are usedby higher education institutions to increase student enrollment leads, conversionrates and retention rates.

 

**Segment Data**

 

The results of the reportable segments are deriveddirectly from eCollege’s internal management reporting system. The accountingpolicies used to derive reportable segment results are substantially the same as those used by the consolidatedCompany. Management measures the performance of each segment based on severalmetrics, including income (loss) from operations. These results are used, inpart, to evaluate the performance of, and to assign resources to, each of thesegments. A significant portion of total consolidated expenditures are directlyattributable to the two business segments. However, certain operating expenses,which are separately managed at the corporate level, are not allocated tosegments. These unallocated costs include executive management salaries andbenefits; stock-based compensation; bonuses paid under the eCollege bonus plan;certain corporate finance and legal salaries and benefits; audit, consulting,and legal costs incurred at the corporate level; rent and occupancy costs forthe Company’s Chicago office; amortization of intangibles; income taxes;interest expense; interest income; and other income/(expense). There was nointersegment revenue for the years ending December 31, 2005, 2004 and2003.

 

Selected financial information for each reportable segment was as follows for the years endedDecember 31, 2005, 2004 and 2003 (in thousands):

 
| ** **             | ** ** | **eLearning** | ** ** | **Enrollment(1)** | ** ** | **Total** | ** ** |
|------------------------|------------|---------------|------------|-------------------|------------|-----------|------------|
| **2005:**              |       |          |       |              |       |      |       |
| Total net revenue      |       | 41,457        |       | 61,411            |       | 102,868   |       |
| Income from operations |       | 15,847        |       | 10,276            |       | 26,123    |       |
|                   |       |          |       |              |       |      |       |
| **2004:**              |       |          |       |              |       |      |       |
| Total net revenue      |       | $             | 34,781     |              | $          | 54,486    |       | $ | 89,267 |   |
| Income from operations |       | 11,683        |       | 8,690             |       | 20,373    |       |
|                   |       |          |       |              |       |      |       |
| **2003:**              |       |          |       |              |       |      |       |
| Total net revenue      |       | $             | 29,135     |              | 7,725      |      | $          | 36,860 |   |
| Income from operations |       | 1,392         |       | 1,592             |       | 2,984     |       |
|                        |            |               |            |                   |            |           |            |  |  |  |

 

----

(1)               The Enrollment division was acquiredOctober 31, 2003.

 

62

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The reconciliation of segment information toeCollege’s consolidated total was as follows for the years ended (inthousands):

 
| ** **                                  | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net segment revenue                         |       | $                                 | 102,868    |   | $ | 89,267 |   | $ | 36,860 |   |
| Income (loss) from operations:              |       |                              |       |   |   |   |   |
| Total segment earnings from operations      |       | 26,123                            |       | 20,373 |   | 2,984 |   |
| Unallocated corporate costs                 |       | (10,975                           | )          | (10,612 | ) | (1,013 | ) |
| Amortization of purchased intangible assets |       | (1,613                            | )          | (1,492 | ) | (249 | ) |
| Total consolidated income from operations   |       | $                                 | 13,535     |   | $ | 8,269 |   | $ | 1,722 |   |

 

Assets are allocated to the individual segmentsbased on the primary segment benefiting from the assets. Corporate assets arecomposed primarily of cash and cash equivalents, amounts due from formerDatamark shareholders, goodwill, and purchased intangible assets. Total assetsby segment and the reconciliation of segment assets to eCollege consolidatedtotal assets as of December 31, 2005 and 2004 (in thousands) is asfollows:

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| eLearning                       |       | $                     | 20,155     |   | $ | 11,139 |   |
| Enrollment                      |       | 27,196                |       | 17,166 |   |
| Goodwill and  intangible assets |       | 63,490                |       | 65,455 |   |
| Corporate                       |       | 23,233                |       | 24,055 |   |
|                            |       | $                     | 134,074    |   | $ | 117,815 |   |

 

No customer represented 10% or more of eLearningrevenue and two customers represented 33% and 14%, respectively, of Enrollmentdivision revenue for the year ended December 31, 2005. One customer accountedfor 25% of eLearning division accounts receivable and two customers eachaccounted for 16% of Enrollment division accounts receivable as of December 31,2005 .One customer represented 12% of eLearning revenue and three customersrepresented 23%, 21% and 11%, respectively, of Enrollment revenue for the yearending December 31, 2004. Two customers accounted for 14% and 12%,respectively, of eLearning division accounts receivable and two customersaccounted for 23% and 11%, respectively, of Enrollment division accountsreceivable as of December 31, 2004. One customer represented 11% ofeLearning revenue and two customers each accounted for 27% of Enrollmentdivision revenue for the year ending December 31, 2003. One customeraccounted for 25% of eLearning division accounts receivable as ofDecember 31, 2003 and one customer accounted for 13% of Enrollmentdivision accounts receivable balance as of December 31, 2003.

 

*Geographic Information*

 

Substantially all of the Company’s assets arelocated in and substantially all of the Company’s operating results are derivedfrom operations in the United States.

 

**(11)    Valuationand Qualifying Accounts**

 
| ** **                          | ** ** | **Balance at  beginning  of period** | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **Balance  at end of  period** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|---------------|------------|----------------|------------|--------------------------------|------------|
| Year ended December 31, 2005        |       |                                 |       |          |       |           |       |                           |       |
| Allowance for doubtful accounts     |       | $                                    | 155        |          | $          | 568            |       | $                              | (451       | ) | $ | 272 |   |
| Allowance for deferred income taxes |       | 591                                  |       | 5             |       | —         |       | 596                            |       |
|                                |       |                                 |       |          |       |           |       |                           |       |
| Year ended December 31, 2004   |       |                                 |       |          |       |           |       |                           |       |
| Allowance for doubtful accounts     |       | $                                    | 188        |          | $          | 60             |       | $                              | (93        | ) | $ | 155 |   |
| Allowance for deferred income taxes |       | 21,922                               |       | —        |       | (21,331        | )          | 591                            |       |
|                                |       |                                 |       |          |       |           |       |                           |       |
| Year ended December 31, 2003   |       |                                 |       |          |       |           |       |                           |       |
| Allowance for doubtful accounts     |       | 166                                  |       | 23            |       | (1             | )          | 188                            |       |
| Allowance for deferred income taxes |       | 27,096                               |       | —        |       | (5,174         | )          | 21,922                         |       |

 

63

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**(12) Selected Quarterly Information(Unaudited)**

 

The following summarizes selected quarterly informationwith respect to the Company’s operations for the last eight fiscal quarters:

 
| ** **                   | ** ** | **2005 Quarter Ended (unaudited)** | ** ** | **2004 Quarter Ended (unaudited)** | ** ** |
|------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **                   | ** ** | **Dec. 31**                   | ** ** | **Sept. 30**                  | ** ** | **June 30** | ** ** | **Mar. 31** | ** ** | **Dec. 31** | ** ** | **Sept. 30** | ** ** | **June 30** | ** ** | **Mar. 31** | ** ** |
| Total revenue                |       | $                                  | 29,563     |                               | $          | 26,419 |   | $ | 23,087 |   | $ | 23,799 |   | $ | 24,429 |   | 24,291 |   | 20,940 |   | 19,606 |   |
|                         |       |                               |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                 |       | 12,763                             |       | 12,898                             |       | 11,288 |   | 11,943 |   | 11,355 |   | 11,404 |   | 10,140 |   | 9,587 |   |
| Net income (1)               |       | 2,003                              |       | 1,766                              |       | 1,559 |   | 600 |   | 17,534 |   | 1,108 |   | 654 |   | 64 |   |
| Basic net income per share   |       | 0.09                               |       | 0.08                               |       | 0.07 |   | 0.03 |   | 0.85 |   | 0.05 |   | 0.03 |   | 0.00 |   |
| Diluted net income per share |       | 0.09                               |       | 0.08                               |       | 0.07 |   | 0.03 |   | 0.80 |   | 0.05 |   | 0.03 |   | 0.00 |   |
|                              |            |                                    |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  The Company recorded an income tax benefit inthe fourth quarter of 2004 from the reversal of the valuation allowancepreviously recorded against deferred tax assets as well as from the recognitionof changes in other temporary differences.

 

**ITEM 9.    CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES**

 

None.

 

**ITEM 9A.CONTROLS AND PROCEDURES**

 

**(a) Evaluation of Disclosure Controls and Procedures**

 

TheCompany maintains a Disclosure Committee comprised of the Chief ExecutiveOfficer, President and Chief Operating Officer, Chief Financial Officer,General Counsel, Chief Executive Officer of Datamark, Chief Operating Officerof Datamark, President of the eLearning division, Chief Technology Officer andDirector of Corporate Accounting. The Company is required to maintaindisclosure controls and procedures (as such is defined in Rules 13a-15(e) or15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)), that are designed to ensure that information required to be disclosedby the Company in the reports it files or submits under the Exchange Act isrecorded, processed, summarized and reported on a timely basis and that suchinformation is accumulated and communicated to the Company’s management,including the Chief Executive Officer and Chief Financial Officer, as appropriate,to allow timely decisions regarding required disclosure. Based on thatevaluation, and because of the material weakness discussed below, the ChiefExecutive Officer and Chief Financial Officer concluded that as of December 31,2005, the Company’s disclosure controls and procedures were not effective toensure that information required to be disclosed by us in the reports we fileor submit under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the SEC’s rules and forms.

 

**(b) Management’s Report on Internal Control over FinancialReporting**

 

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act. Internal control over financial reporting is a process designedto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies and procedures may deteriorate.

 

Amaterial weakness is a significant deficiency (within the meaning of the PublicCompany Accounting Oversight Board’s (PCAOB) Auditing Standard No. 2), orcombination of significant deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected.

 

64

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Managementperformed an assessment of the effectiveness of the Company’s internal controlover financial reporting as of December 31, 2005, using the criteria set forthin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). Management’s assessmentidentified the following material weakness as of December 31, 2005:

 

The Company does not have adequate proceduresrelated to properly determining sales and use tax liabilities in certain taxingjurisdictions. This deficiency was first identified as a material weakness inmanagement’s assessment as of December 31, 2004 and was not remediated byDecember 31, 2005. This deficiency resulted in understatements of sales and usetax liabilities in the Company’s financial statements for 2004 and for thequarters ended March 31, 2005, June 30, 2005 and September 30, 2005. Therelated errors were identified and corrected prior to the issuance of theconsolidated financial statements as of December 31, 2005. This deficiencyresults in more than a remote likelihood that a material misstatement of theannual or interim consolidated financial statements would not be prevented ordetected on a timely basis by employees in the normal course of performingtheir assigned functions.

 

 Becauseof the aforementioned material weakness, management has concluded that, as ofDecember 31, 2005, the Company’s internal control over financial reporting wasnot effective based on the COSO criteria.

 

**(c) Remediation Efforts**

 

Sincethis deficiency was first identified in late 2004, the Company has taken anumber of actions to remediate it:

 

•                  The Company has increased the scope andfrequency of its contacts with outside advisors, such as tax consultants andtax counsel. This process began in the third quarter of 2004 and continues asof the date of this filing.

 

•                  The Company initiated a study of sales anduse tax for both operating divisions which was completed by management duringthe third quarter of 2005 and reviewed by an outside advisor during the fourthquarter of 2005. That study revealedthat the Enrollment division could have liability for uncollected sales and usetax in various states. Accordingly, in January 2006, the Company retainedoutside tax counsel to conduct a more detailed analysis of the issue. Thedetailed analysis is expected to be completed in the first quarter of 2006.

 

•                  The Company isevaluating its internal procedures for determining sales and use tax liability andrelated controls and will modify them as required to ensure that accountingstaff are familiar with the requirements for this area and that the Company’ssales and use tax liability is accurately assessed and reflected in the Company’sfinancial statements on a timely basis. This process began in the secondquarter of 2005 and continues as of the date of this filing.

 

•                  The Company is evaluating the costs andbenefits of adding a full time tax position to the Company’s accountingorganization. This process began during the second quarter of 2005 andcontinues as of the date of this filing.

 

Whileremediation efforts are underway, the aforementioned material weakness will notbe considered remediated until analyses are completed and new processes arefully implemented, operate for a period of time and are tested and the Companyconcludes that they are operating effectively.

 

Asa result of its assessment, management determined that with the exception ofthe aforementioned material weakness, the material weaknesses identified inmanagement’s assessment as of December 31, 2004 had been remediated as ofDecember 31, 2005.

 

TheCompany will continue to be vigilant in reviewing and identifying areas ofimprovement in its internal controls over financial reporting and creating andimplementing new policies and procedures as deemed appropriate. To facilitatethis process, the Company has created an internal audit function and iscurrently working to establish the appropriate scope and staffing of suchfunction. The Company anticipates that the internal audit function will beoperational beginning in the first quarter of 2006.

 

GrantThornton LLP, the independent registered public accounting firm that alsoaudited the Company’s consolidated financial statements, has issued an auditreport on management’s assessment of the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2005, which isfiled herewith.

 

** (d) Changes in Internal Control over FinancialReporting**

 

Asdetailed above under the caption “Remediation Efforts,” the Company was engagedin certain remediation efforts during the fourth quarter of 2005. Except forsuch remediation efforts noted above, there were no other changes in theCompany’s internal control over financial reporting during the fourth quarterof 2005 which have materially affected, or are reasonably likely to materiallyaffect, such internal control over financial reporting.

 

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**(e) Report of Independent Registered Public Accounting Firm**

 

TheBoard of Directors and Stockholders’

eCollege.com:

 

Wehave audited management’s assessment, included in the accompanying Management’sReport on Internal Control over Financial Reporting, that eCollege.com (theCompany) did not maintain effective internal control over financial reportingas of December 31, 2005, because of the effect of the material weaknessidentified in management’s assessment, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1)pertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

 

Amaterial weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. The following material weakness has been identified andincluded in management’s assessment:

 

TheCompany does not have adequate procedures related to properly determining salesand use tax liabilities in certain taxing jurisdictions. This deficiency wasfirst identified as a material weakness in management’s assessment as ofDecember 31, 2004 and was not remediated by December 31, 2005. This deficiencyresulted in understatements of sales and use tax liabilities in the Company’sfinancial statements for 2004 and for the quarters ended March 31, 2005,June 30, 2005 and September 30, 2005. The related errors were identifiedand corrected prior to the issuance of the consolidated financial statements asof December 31, 2005. This deficiency results in more than a remote likelihoodthat a material misstatement of the annual or interim consolidated financialstatements would not be prevented or detected on a timely basis by employees inthe normal course of performing their assigned functions.

 

Thematerial weakness was considered in determining the nature, timing and extentof the audit tests applied in our audit of 2005 consolidated financialstatements, and this report does not affect our report dated March 16,2006 on those financial statements.

 

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Inour opinion, management’s assessment that the Company did not maintaineffective internal control over financial reporting as of December 31, 2005, isfairly stated, in all material respects, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Also, in our opinion, becauseof the effect of the material weakness described above on the achievement ofthe objectives of the control criteria, the Company has not maintainedeffective internal control over financial reporting as of December 31, 2005,based on criteria established in Internal Control—Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofthe Company as of December 31, 2005, and the related consolidatedstatements of operations and comprehensive income (loss), stockholders’ equityand cash flows for the year ended December 31, 2005. The material weaknessdescribed above was considered in determining the nature, timing, and extent ofaudit tests applied in our audit of the 2005 consolidated financial statements,and this report does not affect our report dated March 16, 2006, whichexpressed an unqualified opinion on those consolidated financial statements.

 
| /s/  Grant Thornton, LLP |   |
|--------------------------|--------|
|                     |
|                     |
| Chicago,  Illinois       |
| March  16, 2006          |

 

**ITEM 9B. OTHER INFORMATION**

 

None.

 

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**PART III.**

 

**ITEM 10.    DIRECTORS AND EXECUTIVEOFFICERS OF THE COMPANY**

 

The directors and executive officers of eCollege asof March 13, 2006 are as follows:

 
| **Name**                         | ** ** | **Age**    | ** ** | **Position**                                                          |
|----------------------------------|------------|------------|------------|-----------------------------------------------------------------------|
| ** **                       | ** ** | ** ** | ** ** | ** **                                                            |
| Directors and Executive Officers |       |       |       |                                                                  |
| Oakleigh Thorne                  |       | 48         |       | Chief Executive Officer and Chairman of the Board                     |
| Douglas H. Kelsall               |       | 52         |       | President, Chief Operating Officer and Director                       |
| Reid E. Simpson                  |       | 49         |       | Chief Financial Officer                                               |
| Marguerite M. Elias              |       | 51         |       | Senior Vice President, General Counsel and Secretary                  |
| Robert S. Haimes                 |       | 44         |       | Senior Vice President; Chief Operating Officer of Enrollment Division |
| Thomas L. Dearden                |       | 49         |       | Chief Executive Officer of Enrollment Division                        |
| Matthew T. Schnittman            |       | 34         |       | President of eLearning Division                                       |
| Jack W. Blumenstein(3)           |       | 62         |       | Director                                                              |
| Christopher E. Girgenti(1)(2)    |       | 42         |       | Director                                                              |
| Jeri L. Korshak(1)(2)            |       | 51         |       | Director                                                              |
| Robert H. Mundheim(1)(2)(3)      |       | 73         |       | Director                                                              |

 

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(1)  Memberof the Compensation Committee.

(2)  Memberof the Audit Committee.

(3)  Member of the Nominating Committee.

 

*Oakleigh Thorne* has served as our Chief Executive Officersince May 30, 2000 and as a member of our Board of Directors since February 1998.Mr. Thorne has been the co-President of Blumenstein/Thorne InformationPartners, L.L.C. since October 1996, and is a co-founder of this privateequity investment firm. From September 1986 to August 1996,Mr. Thorne served in various management positions, including most recentlyas President and Chief Executive Officer, of CCH Incorporated, a leadingprovider of tax and business law information, software, and services.Mr. Thorne holds a Bachelor of Science degree in Journalism from BostonUniversity and a Master of Business Administration degree from ColumbiaUniversity. Mr. Thorne serves on the boards of directors ofShopperTrak, Inc. and AirCell, Inc. Mr. Thorne is also a member ofvarious charitable boards, including the Art Institute of Chicago and the LakeForest Open Lands Association.

 

*Douglas H. Kelsall* has served as the Company’s President andChief Operating Officer since November 2003 and as a member of the Boardof Directors since August 2002. Mr. Kelsall served as our Executive VicePresident from November 2000 to November 2003, as Chief Financial Officer andTreasurer from September 1999 to May 2004 and as Secretary from November 2000to July 2004. From July 1997 to August 1999, Mr. Kelsall servedas Chief Financial Officer of TAVA Technologies, Inc.; fromDecember 1995 to June 1997, he served as Chief Financial Officer ofEvolving Systems, Inc.; and from June 1993 to December 1995, heserved as President of Caribou Capital Corporation. Prior to that time,Mr. Kelsall served in various management and vice president positions atColorado National Bank. Mr. Kelsall holds a Bachelor of Arts degree fromthe University of Colorado and a Master of Business Administration degree fromthe University of Denver. Mr. Kelsall presently serves on the boards ofdirectors of Caribou Capital Corporation, the Colorado Institute of Technologyand Smart Move LLC.

 

*Reid E. Simpson* was named Chief FinancialOfficer in May 2004. FromSeptember 1999 to April 2004, Mr. Simpson served as executive vice presidentand CFO of CCC Information Services (CCC), a publicly held company providingsoftware and services to the automobile claims industry. Prior to CCC,Mr. Simpson held CFO positions at The Signature Group and DelphiInformation Systems. Additionally, Mr. Simpson spent 16 years with the Dun& Bradstreet Corporation where he held a number of senior financepositions, including CFO for three of the corporation’s businesses: Dun &Bradstreet Plan Services, Nielsen Marketing Research and DonTech. Mr. Simpsonholds a Bachelor of Science in Accounting degree from Michigan StateUniversity.

 

*Marguerite M. Elias* joined the Company in July 2004 as Senior Vice President, GeneralCounsel and Secretary. From January 2004 until joining eCollege, Ms. Eliaswas a partner in the law firm of Hogan Marren, Ltd. From April 2001 to December2003, Ms. Elias served as senior vice president and general counsel ofCenterprise Advisors, Inc., a national professional services firm. Prior tothat time, Ms. Elias was in private practice focusing on securities andcorporate law. She was a partner in Katten Muchin Zavis Rosenman from August1995 to April 2001 and an associate at Skadden Arps Slate Meagher and Flom fromSeptember 1986 to July 1995. Ms. Elias received a Bachelor of Arts degreein Economics from Northwestern University and a Juris Doctor degree from LoyolaUniversity of Chicago School of Law.

 

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*Robert S. Haimes* was named Chief Operating Officer of theEnrollment Division in March 2005 and continues to serve as a Senior VicePresident of eCollege, a position he has held since 2001. Mr. Haimes served asour Senior Vice President of Strategy from January 2004 to March 2005, as ourSenior Vice President of Strategy and Market Communication fromJanuary 2003 to January 2004, as our Senior Vice President of Market andProduct Management from August 2001to January 2003 and as our VicePresident of Marketing from November 1999 through August 2001. From1996 to 1999, he served as the Brand Marketing Director and the Director ofMarket Development for Coors Brewing Company. In 1995 and 1996, Mr. Haimeswas Director of New Products and New Business Development at BostonChicken, Inc. Prior to September of 1995, Mr. Haimes held positionsin brand management, new business development and operations management atProcter and Gamble. Mr. Haimes holds a Bachelor of Science degree inMechanical Engineering from the University of Cincinnati and a Master ofBusiness Administration degree from Xavier University.

 

*Thomas L. Dearden* was named Chief Executive Officer of theEnrollment Division in March 2005. He previously served as the President andChief Operating Officer of the Enrollment Division from October 31, 2003 untilMarch 2005, as Executive Vice President and Chief Operating Officer of Datamarkfrom June 2000 to October 2003 and as Vice President of Operations for theDatamark division of Focus Direct, Inc. from 1998 to June 2000. Mr. Deardenjoined Datamark in 1989 as the original member of its creative staff. Beforejoining Datamark, Mr. Dearden was a founder of and senior partner inBennett/Allen Associates, a Salt Lake City based advertising agency.Mr. Dearden serves as the Industry Co-Chair of the Utah Postal CustomerCouncil. Mr. Dearden holds a Bachelor of Fine Arts degree from theUniversity of Utah.

 

*Matthew T. Schnittman* has served as President of the eLearningDivision since April  2005. He previously served as Executive VicePresident/General Manager of the eLearning Division from November 2003 to April2005, as Senior Vice President of Account Management from January 2003 toNovember 2003 and as Vice President of Professional Services fromJuly 2001 to January 2003. Mr. Schnittman served as our Directorof Strategic Planning and Analysis from July 1999 to June 2001. Beforejoining eCollege, Mr. Schnittman worked at PricewaterhouseCoopers fromJune 1998 to June 1999 in the Management Consulting Strategy group,where he provided strategic consulting services to Fortune 1000 companies. FromJanuary 1995 to June 1997, Mr. Schnittman was with CCD, LLP, aconsulting boutique focused on consumer product strategy. Mr. Schnittmanholds a Bachelor of Science degree in Business and Public Administration inMarketing from the University of Arizona, and a Master of BusinessAdministration degree in Management and Strategy, Finance and Marketing from JLKellogg Graduate School of Management.

 

*Jack W. Blumenstein* has served as a member of our Board ofDirectors since January 1998 and currently serves as chair of ourNominating Committee. Mr. Blumenstein has been the co-President ofBlumenstein/Thorne Information Partners, L.L.C. since October 1996, and isa co-founder of this private equity investment firm. From October 1992 toSeptember 1996, Mr. Blumenstein held various positions with TheChicago Corporation (now ABN AMRO, Inc.), serving most recently asExecutive Vice President, Debt Capital Markets Group and a member of the boardof directors. Mr. Blumenstein was President and CEO of Ardis, a joint ventureof Motorola and IBM, and held various senior management positions in productdevelopment and sales and marketing for Rolm Corporation and IBM.Mr. Blumenstein also presently is chairman and CEO of AirCell, Inc.,and serves on the board of directors of ShopperTrak, Inc. and ConsolidatedCommunications, Inc.

 

*Christopher E. Girgenti* has served as a member of our Board ofDirectors since June 1997 and currently serves as chairman of our AuditCommittee and as a member of our Compensation Committee. Mr. Girgenti hasbeen Senior Managing Director of New World Equities, Inc. sinceNovember 1996 and Managing Director of New World Venture Advisors, LLCsince January 1998. From April 1994 through October 1996,Mr. Girgenti served as Vice President and was co-head of the technologyinvestment banking group of The Chicago Corporation (now ABN AMRO, Inc.).He held various corporate finance positions with Kemper Securities, Inc.and KPMG Peat Marwick (now KPMG LLP) . Mr. Girgenti is a Chartered FinancialAnalyst. Mr. Girgenti presently serves on the advisory board of IllinoisTechnology Enterprise Corporation—Evanston and also serves on the boards ofdirectors of Tavve Software Company, Sportvision, Inc. and UnivaCorporation.

 

*Jeri L. Korshak*has served as a member of our Board of Directors since February 1999, andis currently a member of our Audit  andCompensation Committees. Ms. Korshak has over twenty years of experiencein marketing and business development. Since 2001, Ms. Korshak has been anindependent consultant. Prior to that time, Ms. Korshak served as SeniorVice President of Marketing and Business Development for AuraServCommunications from June 2000 to March 2001 and Vice President ofStrategy for MediaOne Group from June 1998 to June 2000.Ms. Korshak was Vice President and General Manager of US WEST Dex— Mountain Region from September 1995 toMay 1998, and Vice President and General Manager of Interactive Televisionof US WEST Multimedia from November 1994 to September 1995. In theseand other positions, Ms. Korshak has been involved in developing andintroducing interactive services.

 

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*Robert H. Mundheim* has served as a member of our Board ofDirectors since January 2001, and currently serves as chairman of ourCompensation Committee and as a member of our Audit and Nominating Committees.Mr. Mundheim has been Of Counsel to Shearman & Sterling sinceMarch 1999. Mr. Mundheim formerly held the position of SeniorExecutive Vice President and General Counsel of Salomon Smith BarneyHoldings Inc. Before that he was Executive Vice President and GeneralCounsel of Salomon Inc., a firm which he joined in September 1992.Prior to joining Salomon Inc., Mr. Mundheim was co-Chairman of theNew York law firm of Fried, Frank, Harris, Shriver & Jacobson. Until1992, Mr. Mundheim was the University Professor of Law and Finance at theUniversity of Pennsylvania Law School, where he had taught since 1965. Heserved as Dean of that institution from 1982 through 1989. Among his otherprofessional activities, Mr. Mundheim has been General Counsel to the U.S.Treasury Department (1977-1980); Special Counsel to the Securities and ExchangeCommission (1962-1963); and Vice Chairman, Governor-at-Large and a member ofthe Executive Committee of the National Association of Securities Dealers(1988-1991). He is a trustee of the American Academy in Berlin, a trustee ofthe New School University, a member of the Council of the American LawInstitute, and a director of the Appleseed Foundation. Mr. Mundheim also serveson the supervisory board of Hypo Real Estate Holding AG and the board ofdirectors of Arnhold & S. Bleichroeder, Inc.

 

**Directors’ and Executive Officers’ Terms**

 

All directors hold office until the next annualmeeting of stockholders or until their successors have been duly elected andqualified. All executive officers are elected by the Board of Directors toserve in their respective capacities until their successors are elected andqualified or until their earlier resignation or removal.

 

**Audit Committee**

 

The members of the Company’s Audit Committee of theBoard of Directors are Mr.  Girgenti (chairman), Mr. Mundheim andMs. Korshak, all of whom are independent under the Nasdaq rules. The Boardhas determined that Mr. Girgenti is an “audit committee financial expert”within the meaning of SEC regulations and is “independent” as that term is usedin Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act .

 

**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Section 16(a) of the Exchange Act requires thatthe Company’s officers and directors, and persons who own more than ten percentof a registered class of the Company’s equity securities,  file with the SEC and the Nasdaq NationalMarket reports of ownership of Company securities and changes in reportedownership. Officers, directors and greater than ten percent shareholders arerequired by SEC rules to furnish the Company with copies of allSection 16(a) reports they file.

 

Based solely on a review of the reports furnished tothe Company, or written representations from reporting persons that allreportable transactions were reported, the Company believes that during thefiscal year ended December 31, 2005, the Company’s officers, directors andgreater than ten percent owners timely filed all reports they were required tofile under Section 16(a); except for the two reports that wereinadvertently filed late as described below. A Form 4 for Jack W. Blumenstein,a director, was filed on May 31, 2005 for a purchase of shares that occurred onMay 24, 2005. A Form 4 for Mr. Blumenstein was filed on November 28, 2005 for asale of shares that occurred on November 22, 2005.

 

**Code of Ethics**

 

We have adopted a Code of Ethics which is applicableto all of our employees and directors. We have posted the Code of Ethics, whichis titled “Code of Business Conduct and Ethics” on our website at *www.ecollege.com* and any waivers of, oramendments to, the Code of Ethics will be approved by the Board of Directorsand disclosed on our website. The Company encourages all employees anddirectors to properly report any violation of the Code of Ethics to theappropriate persons identified in the Code of Ethics.

 

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**ITEM 11.    EXECUTIVE COMPENSATION**

 

The following table setsforth information with respect to compensation earned by the Company’s ChiefExecutive Officer and the next four most highly compensated executive officerswho were serving as executive officers at the end of 2005 (collectively, the “NamedExecutive Officers”).

 

**SummaryCompensation Table**

 
| ** **                             | ** ** | **Annual  Compensation** | ** ** | ** ** | **Long  Term  Compensation Awards** | ** ** |
|----------------------------------------|------------|--------------------------|------------|------------|-------------------------------------|------------|
| **Name and Principal Position(s)**     | ** ** | **Year**                 | ** ** | **Salary** | ** **                          | **Bonus**  | ** ** | **Other  Annual  Compensation)** | ** ** | **Restricted  Stock  Award(s)** | ** ** | **Securities  Underlying  Options/SARs  (#)** | ** ** | **All  Other  Compensation  ($)** | ** ** |
| Oakleigh Thorne                        |       | 2005                     |       | $          | 374,880                             |       | $ | 127,420 |   | $ |   | — |   | 210,000 | (3) | — |   |
| Chief Executive  Officer               |       | 2004                     |       | $          | 373,958                             |       | — |   | $ | 25,417 | (2) | — |   | 210,000 | (3) | — |   |
|                                   |       | 2003                     |       | $          | 350,000                             |       | $ | 295,560 | (1) | $ | 28,924 | (2) | $ | 402,289 | (1) | — |   | — |   |
|                                   |       |                     |       |       |                                |       |   |   |   |   |   |   |   |   |   |
| Douglas H.  Kelsall                    |       | 2005                     |       | $          | 310,265                             |       | $ | 89,194 |   | — |   | $ | — |   | 150,000 | (3) |   |   |
| President and  Chief Operating Officer |       | 2004                     |       | $          | 285,416                             |       | $ | — |   | — |   | $ | — |   | 150,000 | (3) | — |   |
|                                   |       | 2003                     |       | $          | 250,000                             |       | $ | 174,671 | (4) |   |   | $ | 232,389 | (4) | — |   | — |   |
|                                   |       |                     |       |       |                                |       |   |   |   |   |   |   |   |   |   |
| Reid E. Simpson                        |       | 2005                     |       | $          | 260,000                             |       | $ | 57,024 |   | — |   | $ | — |   | 90,000 | (3) |   |   |
| Chief Financial  Officer               |       | 2004                     |       | $          | 162,000                             | (5)        | $ | 15,600 |   | — |   | $ | 186,100 | (5) | 90,000 | (3) | — |   |
|                                   |       | 2003                     |       | $          | —                              |       | $ | — |   | — |   | $ | — |   | — |   | — |   |
|                                   |       |                     |       |       |                                |       |   |   |   |   |   |   |   |   |   |
| Thomas L. Dearden                      |       | 2005                     |       | $          | 206,255                             |       | $ | 104,623 |   | — |   | $ | — |   | 75,000 | (7) | — |   |
| Chief Executive  Officer,              |       | 2004                     |       | $          | 178.980                             |       | $ | 73,158 |   | — |   | $ | — |   | 45,000 | (3) | — |   |
| Enrollment Division                    |       | 2003                     |       | $          | 27,500                              | (6)        | $ | 32,972 | (6) | — |   | $ | 1,084,500 | (6) | — |   | — |   |
|                                   |       |                     |       |       |                                |       |   |   |   |   |   |   |   |   |   |
| Robert S. Haimes                       |       | 2005                     |       | $          | 213,542                             |       | $ | 60,005 |   | — |   | — |   | 60,000 | (3) | — |   |
| Senior Vice  President, eCollege       |       | 2004                     |       | $          | 203,350                             |       | $ | 42,050 |   | — |   | — |   | 60,000 | (3) | — |   |
| and Chief Operating  Officer,          |       | 2003                     |       | $          | 187,200                             |       | $ | 82,219 | (8) | — |   | $ | 71,855 | (8) | — |   | — |   |
| Enrollment  Division                   |       |                     |       |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |

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(1)          OnAugust 13, 2003, Mr. Thorne was granted a Share Rights Award of24,129 shares of the Company’s common stock under the 1999 Plan inconsideration for his services to the Company. One third of the shares vested onJuly 1, 2004 and the balance will vest in eight successive equal quarterlyinstallments beginning October 2004, provided Mr. Thorne continues inemployment with the Company. The value of the Share Right Award as ofDecember 31, 2005 was $435,045. Mr. Thorne received an additionalbonus of $225,000, one half of which was paid in cash and the remaining halfwas paid in the form of 5,594 share rights, the value of which was $100,860 asof December 31, 2005. These share rights vested 100% on January 27,2006.

 

(2)          In2004, the Company paid $13,403 of Mr. Thorne’s personal travel expensespursuant to his employment agreement. In addition, prior to 2005 the Companypaid certain living expenses for Mr. Thorne, which totaled $12,014 in 2004and $14,040 in 2003.

 

(3)          Stockappreciation rights were granted to the Named Executive Officers on September13, 2004 and March 23, 2005 and are exercisable on September 13, 2009 and  March 23, 2010, respectively. At the exercisedate, if the average fair market value per share of common stock (the “PerformancePrice”) for the three month period preceding the exercise date (the “PerformancePeriod”) exceeds the base price for a stock appreciation right, then therecipient will be entitled to receive a distribution of shares of common stockwith a value calculated by dividing the excess of the Performance Price overthe base price per stock appreciation right by the Performance Price. Therecipient may elect to receive 10% of his distribution on each of the third andfourth anniversaries of the grant date. Subject to vesting provisions, thedistributions will accelerate upon the occurrence of a change in control.

 

(4)          OnAugust 13, 2003 Mr. Kelsall was granted a Share Rights Award of12,064 shares of the Company’s common stock under the 1999 Plan inconsideration for his services to the Company. One third of the shares vestedon July 1, 2004 and the balance will vest in eight successive equalquarterly installments beginning October 2004, provided Mr. Kelsallcontinues in employment with the Company. The value of the Share Right Award asof December 31, 2005 was $217,514. Mr. Kelsall received an additionalbonus of $175,000, one half of which was paid in cash and the remaining halfwas paid in the form of 4,351 share rights, the value of which was $78,449 asof December 31, 2005. These share rights vested 100% on January 27,2006.

 

(5)          Mr.Simpson joined the Company on May 3, 2004, and the salary and bonus shown for2004 represent partial year compensation. On May 3, 2004 Mr. Simpson wasgranted a Share Rights Award of 10,000 shares of the Company’s common stockunder the 1999 Plan in consideration for his services to the Company. One thirdof the shares vested May 3, 2005 and the balance will vest in eight successiveequal quarterly installments beginning August 2005, provided Mr. Simpsoncontinues in employment with the Company. The value of the Share Rights Awardas of December 31, 2005 was $180,300.

 

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(6)          Mr.Dearden joined the Company on October 31, 2003, the date on which the Companyacquired Datamark, Inc., and the salary and bonus shown for 2003 represent theportion of his 2003 compensation earned after such date. Pursuant to hisemployment agreement with the Company, on October 31, 2003 Mr. Dearden wasgranted a Share Rights Award of 50,000 shares of the Company’s common stockunder the 1999 Plan. The shares vest in 24 successive equal monthlyinstallments beginning October 31, 2005, provided Mr. Dearden continues inemployment with the Company. The value of the Share Right Award as of December31, 2005 was $901,500.

 

(7)          Inaddition to receiving Stock Appreciation Right Awards on September 13, 2004 andMarch 23, 2005 as described in footnote (3), on May 2, 2005 Mr. Dearden was grantedan additional award of 30,000 stock appreciation rights which are exercisableMay 2, 2010. At such time, if the average fair market value per share of commonstock (the “Performance Price”) for the three month period preceding theexercise date (the “Performance Period”) exceeds the base price for a stockappreciation right, then the recipient will be entitled to receive adistribution of shares of common stock with a value calculated by dividing theexcess of the Performance Price over the base price per stock appreciationright by the Performance Price. The recipient may elect to receive 10% of hisor her distribution on each of the third and fourth anniversaries of the grantdate. Subject to vesting provisions, the distributions will accelerate upon theoccurrence of a change in control.

 

(8)          OnAugust 13, 2003 Mr. Haimes was granted a Share Rights Award of 3,485shares of the Company’s common stock under the 1999 Plan in consideration forhis services to the Company. One third of the shares vest on July 1, 2004and the balance will vest in 8 successive equal quarterly installmentsbeginning October 2004, provided Mr. Haimes continues in employmentwith the Company. The value of the Share Right Award as of December 31,2005 was $62,835. Mr. Haimes received an additional bonus of $60,000, onehalf of which was paid in cash and the remaining half was paid in the form of1,491 share rights, the value of which was $26,883 as of December 31,2005. These share rights vested 100% on January 27, 2006.

 

**Stock Appreciation Right Grants in Last Fiscal Year**

 

Thefollowing table provides information on the stock appreciation rights grantedto the Named Executive Officers during the fiscal year ended December 31, 2005.All rights were granted under the Company’s 1999 Stock Incentive Plan. Absentpromotions or other special circumstances, the Company does not intend to grantadditional equity to these individuals for the next four years. No optiongrants were made to the Named Executive Officers during the 2005 fiscal year.

 
| ** **         | ** ** | **Individual Grants**                      | ** ** | ** **                                     | ** ** | **Potential Realizable Value** | ** ** |
|--------------------|------------|--------------------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|
| ** **         | ** ** | **Number of  Securities  Underlying  SAR** | ** ** | **% of Total  SARs  Granted to  Employees in** | ** ** | **Exercise or  Base Price**    | ** ** | **Expiration** | ** ** | **at Assumed Annual Rates  of Stock Price  Appreciation for  SAR Term(3)** | ** ** |
| **Name**           | ** ** | **Granted($)**                             | ** ** | **Fiscal Year**                                | ** ** | **($/Sh)**                     | ** ** | **Date** | ** ** | **5% ($)** | ** ** | **10% ($)** | ** ** |
| Oakleigh Thorne    |       | 210,000                                    |       | 18.0                                           |       |                           | (1)        | 3/23/2010 |   | 376,159 |   | 1,233,908 |   |
| Douglas H. Kelsall |       | 150,000                                    |       | 12.8                                           |       |                           | (1)        | 3/23/2010 |   | 268,685 |   | 881,363 |   |
| Reid E. Simpson    |       | 90,000                                     |       | 7.7                                            |       |                           | (1)        | 3/23/2010 |   | 161,211 |   | 528,818 |   |
| Thomas L. Dearden  |       | 45,000                                     |       | 3.9                                            |       |                           | (1)        | 3/23/2010 |   | 80,606 |   | 264,409 |   |
|               |       | 30,000                                     |       | 2.6                                            |       |                           | (2)        | 5/2/2010 |   | 51,583 |   | 169,226 |   |
| Robert S. Haimes   |       | 60,000                                     |       | 5.1                                            |       |                           | (1)        | 3/23/2010 |   | 107,474 |   | 352,545 |   |

 

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(1)          Thesestock appreciation rights were granted on March 23, 2005 and are exercisable onMarch 23, 2010. At such time, the recipient will be entitled to receive adistribution of shares of common stock with a value calculated by dividing (x)the excess of (A) the Performance Price over (B) the base price per stockappreciation right by (y) the Performance Price. Each stock appreciation rightis divided into five (5) equal levels with an assigned base price to each levelas follows:  Level 1 - $12.672, Level 2 -$13.939, Level 3 - $15.333, Level 4 - $16.866 and Level 5 - $18.553. Therecipient may elect to receive 10% of his or her distribution on each of March23, 2008 and March 23, 2009. Subject to vesting provisions, the distributionwill accelerate upon the occurrence of a change in control.

 

(2)          Thisstock appreciation right was granted on May 2, 2005 and is exercisable on May2, 2010. At such time, the recipient will be entitled to receive a distributionof shares of common stock with a value calculated by dividing (x) the excess of(A) the Performance Price over (B) the base price per stock appreciation rightby (y) the Performance Price. Each stock appreciation right is divided intofive (5) equal levels with an assigned base price to each level asfollows:  Level 1 - $12.166, Level 2 -$13.383, Level 3 - $14.721, Level 4 - $16.193 and Level 5 - $17.812. Therecipient may elect to receive 10% of his or her distribution on each of May 2,2008 and May 2, 2009. Subject to vesting provisions, the distribution willaccelerate upon the occurrence of a change in control.

 

(3)          Therecan be no assurance provided to any executive officer or other holder of theCompany’s securities that the actual stock price appreciation over the stockappreciation rights term will be at the 5% and 10% levels or at any other level.Unless the market price of the Company’s common stock appreciates so that thePerformance Price is higher than the base price, no value will be realized fromthese grants.

 

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**Aggregated Year-End Option and SAR Exercises and Values**

 

Thefollowing table provides information as to options and stock appreciationrights exercised and the value of outstanding options and stock appreciationrights held by the Named Executive Officers at December 31, 2005.

 

**Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-EndOption/SAR Values**

 
| ** **         | ** ** | **Shares  Acquired** | ** ** | **Value**    | ** ** | **Number of Securities  Underlying Unexercised  Options/SARs at  December 31, 2005** | ** ** | **Value of Unexercised In-the-  Money Options/SARs at  December 31, 2005(1)** | ** ** |
|--------------------|------------|----------------------|------------|--------------|------------|-------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| **Name**           | ** ** | **on Exercise**      | ** ** | **Realized** | ** ** | **Exercisable**                                                                           | ** ** | **Unexercisable**                                                                  | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Oakleigh Thorne    |       | 972,335              |       | $            | 6,921,866  |                                                                                      | 27,665/0   | (2)                                                                                | 0          |   | $ | 391,598 |   | $ | 0 |   |
|               |       | —               |       | —       |       | 10,695/0                                                                                  |       | 0/420,000                                                                          |       | $ | 151,655, |   | $ | 1,851,780 |   |
| Douglas H. Kelsall |       | —               |       | —       |       | 286,944/0                                                                                 |       | 0/300,000                                                                          |       | $ | 3,096,258 |   | $ | 1,322,700 |   |
| Reid E. Simpson    |       | —               |       | —       |       | 0                                                                                         |       | 0/180,000                                                                          |       | $ | 0 |   | $ | 793,620 |   |
| Thomas L. Dearden  |       | —               |       | —       |       | 0                                                                                         |       | 0/120,000                                                                          |       | $ | 0 |   | $ | 492,060 |   |
| Robert S. Haimes   |       | —               |       | —       |       | 128,500/0                                                                                 |       | 0/120,000                                                                          |       | $ | 1,390,005 |   | $ | 529,080 |   |
|                    |            |                      |            |              |            |                                                                                           |            |                                                                                    |            |  |  |  |  |  |  |  |

 

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(1)                                  Whether an option or SAR is “in-the-money” isdetermined by subtracting the exercise price of the option (or base price ofthe SAR) from the closing price for the common stock as reported by the Nasdaqon December 31, 2005 ($18.03). If the amount is greater than zero, theoption or SAR is “in-the-money.”

(2)                                  Represents fully vested options granted toBlumenstein/Thorne Information Partners I, L.P. (“BTIP”), an investment fundaffiliated with Mr. Thorne, in lieu of salary, benefits and other compensationto Mr. Thorne in 2000 and 2001. The Compensation Committee awarded this stockoption grant to BTIP to provide the limited partners of BTIP with a significantequity incentive to contribute Mr. Thorne’s services to the financial successof the Company and to align his interests with those of the Company’sstockholders. Of these options for 1,000,000 shares, options for 200,000 shareshave an exercise price of $3.875, the fair market value of the Company’s commonstock on date of grant; options for the remaining 800,000 shares have anexercise price of $3.875 based on the Company having met certain stock priceperformance criteria. Options for 955,760 of such shares were exercised onFebruary 1, 2005 and options for 16,575 of such shares were exercised on March23, 2005.

 

**Director Compensation**

 

All non-employee directors are reimbursed for theirreasonable travel expenses incurred in connection with attending the Company’smeetings.

 

On February 15, 2005 the Board ofDirectors approved the eCollege.com 2005 Outside Directors Compensation Plan(the “Directors Compensation Plan”), which provides for the payment, beginningin 2005, of a $15,000 annual cash retainer to each non-employee director forservices performed as a member of the Board of Directors. The DirectorsCompensation Plan also provides for the payment, beginning in 2005, of anannual cash retainer to each non-employee director for each committee of theBoard of Directors on which he or she serves, as follows:

 
| ** **                  | ** ** | **Committee Member** | ** ** | **Committee Chair** | ** ** |
|-----------------------------|------------|----------------------|------------|---------------------|------------|
| **Audit  Committee**        |       | $                    | 7,500      |                | $          | 15,000 |   |
| **Compensation  Committee** |       | $                    | 5,000      |                | $          | 10,000 |   |
| **Nominating  Committee**   |       | $                    | 5,000      |                | $          | 7,500 |   |

 

Each non-employee director may elect to defer all or a portion of theannual cash retainers payable to him or her in a particular year and in suchcase the director will receive a grant of deferred stock units that are issuedpursuant to the Stock Issuance Program established under the 1999 StockIncentive Plan. The number of deferred stock units credited to a non-employeedirector’s stock account will equal the amount of compensation he or she hasdeferred divided by the fair market value of a share of common stock on the daythe compensation would otherwise have been paid to the non-employee director.

 

Inaddition to the cash retainers, the Directors Compensation Plan provides thateach individual who becomes a non-employee director on or after January 1, 2005will receive a grant of 4,000 deferred stock units (an “Initial Grant”) on thefirst business day coinciding with or immediately following the date his or herservice on the Board of Directors commences. The Company’s current non-employeedirectors will not receive such grants. The Directors Compensation Plan alsoprovides that on the first business day in January of each year, eachnon-employee director will receive a grant (an “Annual Grant”) of 2,000deferred stock units. With respect to the Company’s current non-employeedirectors, Mr. Mundheim received his first Annual Grant in January 2006 andMessrs. Blumenstein and Girgenti and Ms. Korshak will begin to receive AnnualGrants in 2007. Individuals who become outside directors

afterJanuary 1, 2005 will receive Annual Grants beginning in the year after the yearin which service as a member of the Board of

 

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Directorscommenced. Initial Grants vest in monthly increments over a three-year period,subject to acceleration upon a change in control of the Company, and AnnualGrants vest immediately upon grant.

 

**Employment Agreements**

 

TheCompany has entered into employment agreements with the Named ExecutiveOfficers. On August 10, 2004, the Company entered into agreements with Messrs.Thorne, Kelsall and Simpson. Mr. Thorne’s agreement provides for an annualsalary (currently $375,000) and bonus potential of 90% of base salary, or$337,500. Mr. Kelsall’s agreement provides for an annual salary (currently  $315,000) and bonus potential of 75% of base salary, or $236,250. Mr. Simpson’sagreement provides for an annual salary (currently $260,000) and bonuspotential of 60% of base salary, or $156,000. Each agreement also provides thatthe employee is entitled to receive a specified percentage of the equity poolestablished under a new long-term equity plan as approved by the CompensationCommittee. The Compensation Committee subsequently approved a long-term stockincentive plan pursuant to which each of the Named Executive Officers receivedstock appreciation rights as described in footnote (3) to the SummaryCompensation Table shown above. The agreements also provide that futurelong-term equity compensation will be determined by the Compensation Committee.In the event of termination by the Company without cause or by Messrs. Thorne,Kelsall or Simpson for good reason, the employee  will receive severance payments equal to oneyear’s salary, plus pro rata target bonus through the date of termination(assuming satisfaction of pro-rated performance objectives), plus one year’starget bonus. In addition to severance, the employee will vest immediately inany equity incentives outstanding on the contract date that would otherwisevest within one year of the termination date. In the event of a terminationwithout cause or for good reason within two years following a change in control,Messrs. Thorne and Kelsall will receive the severance described above plus anadditional year of salary and Mr. Simpson will receive the severance describedabove plus an additional six months of salary . The agreements provide thatupon a change in control, all equity incentives held by Messrs. Thorne, Kelsalland Simpson (other than stock appreciation rights) will vest, and allrestrictions on their stock will lapse.

 

Uponthe closing of the Datamark acquisition, the Company entered into an employmentagreement with Mr. Dearden dated September 15, 2003. The agreement provides foran annual base salary (currently $215,000) and a target bonus of 80% of basesalary, or $172,000. The agreement also provides that Mr. Dearden will receive50,000 share rights, which were issued to him on October 31, 2003. Upontermination without cause or for good reason, Mr. Dearden will receiveseverance equal to six months’ salary plus his pro rata bonus through thetermination date and vesting of his share rights (but not his stockappreciation rights) will accelerate.

 

OnSeptember 6, 2002, the Company entered into an employment agreement with Mr.Haimes. The agreement provides for an annual salary (currently $215,000) andbonus potential of 60% of base salary, or $129,000. The agreement also providesthat Mr. Haimes may receive equity compensation from time to time as determinedby the Compensation Committee or the Chief Executive Officer. In the event of atermination without cause, Mr. Haimes will receive six months’ salary asseverance.

 

Eachof the contracts between the Company and its Named Executive Officers includesthe following terms:

 

•                  Standard benefits including vacation days,participation in a flexible reimbursement plan and medical/dental insurance;

 

•                  Employment may be terminated by eCollege oremployee at any time and for any reason;

 

•                  Non-competition and non-solicitationprovisions ranging from six months to two years from the date of separation;

 

•                  Confidentiality provisions;

 

•                  Assignment of ideas and inventions; and

 

•                  Nondisparagement provisions.

 

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**ITEM 12.    SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The following table setsforth certain information known to the Company with respect to the beneficialownership of its common stock as of March 13, 2006 (unless otherwise stated inthe footnotes) by (i) each of the Named Executive Officers, (ii) eachdirector, (iii) each stockholder that the Company knows is the beneficialowner of more than 5% of the common stock, and (iv) all executive officersand directors as a group. Unless otherwise indicated, each of the securityholders has sole voting and investment power with respect to the shares beneficiallyowned, subject to community property laws, where applicable. We received theinformation with respect to beneficial ownership from the respectivestockholders and from reports filed with the SEC by certain stockholders.

 
| **Name of Beneficial Owner**                                  | ** ** | **Amount and Nature of  Beneficial  Ownership** | ** ** | **Percentage  of Common  Stock** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------|------------|
| Oakleigh  Thorne                                              |       | 3,937,484                                       | (1)        | 17.8                             | %          |
| Douglas H.  Kelsall                                           |       | 385,104                                         | (2)        | 1.7                              | %          |
| Reid E.  Simpson                                              |       | 10,898                                          | (3)        |                             | *          |
| Thomas L.  Dearden                                            |       | 40,638                                          | (4)        |                             | *          |
| Robert S.  Haimes                                             |       | 130,893                                         | (5)        |                             | *          |
| Jack W.  Blumenstein                                          |       | 2,657,043                                       | (6)        | 12.0                             | %          |
| Christopher  E. Girgenti                                      |       | 39,406                                          | (7)        |                             | *          |
| Jeri L.  Korshak                                              |       | 62,389                                          | (8)        |                             | *          |
| Robert H.  Mundheim                                           |       | 96,838                                          | (9)        |                             | *          |
| Blumenstein/Thorne  Information Partners I, L.P.              |       | 2,622,975                                       | (10)       | 11.9                             | %          |
| Tiger  Technology Management LLC                              |       | 2,025,000                                       | (11)       | 9.2                              | %          |
| Federated  Investors, Inc.                                    |       | 1,863,115                                       | (12)       | 8.5                              | %          |
| William  Blair Capital Management LLC                         |       | 1,500,945                                       | (13)       | 6.8                              | %          |
| Gilder,  Gagnon, Howe & Co.                               |       | 1,423,355                                       | (14)       | 6.5                              | %          |
| Oakleigh B.  Thorne                                           |       | 722,222                                         | (15)       | 3.3                              | %          |
| All  executive officers and directors as a group (11 persons) |       | 4,816,832                                       | (16)       | 21.2                             | %          |

 

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*              Lessthan one percent.

(1)           Includesoptions to purchase 10,695 shares of the Company’s common stock, 2,011 sharesof the Company’s common stock issuable pursuant to a Share Rights Award, and anoption grant to BTIP to purchase up to 27,665 shares of the Company’s commonstock at an exercise price of $3.875 per share, all of which are exercisable orissuable within 60 days of March 13, 2006. Also includes 2,595,310 sharesbeneficially owned by BTIP, 75,955 shares owned by the Oakleigh ThorneIrrevocable GST Trust, 247,100 shares owned by the Oakleigh L. Thorne Trust U/Adated December 15, 1976, and 68,500 shares owned by the Oakleigh Thorne GSTTrust III. Mr. Thorne is a co-President of Blumenstein/Thorne InformationPartners L.L.C, the general partner of BTIP. Mr. Thorne disclaimsbeneficial ownership of the shares owned by BTIP, except to the extent of hispecuniary interest, if any. The address for Mr. Thorne is One N. LaSalleStreet, Suite 1800, Chicago, IL 60602.

(2)           Includesoptions to purchase 286,944 shares of the Company’s common stock and 1,006shares of the Company’s common stock issuable pursuant to a Share Rights Award,all of which are exercisable or issuable within 60 days of March 13,2006  . Also includes 4,500 shares heldby Mr. Kelsall’s spouse and 1,500 shares held by Mr. Kelsall’schildren. The address for Mr. Kelsall is 4900 South Monaco Street, Denver,Colorado 80237.

(3)           Includes833 shares of the Company’s common stock issuable pursuant to a Share RightsAward within 60 days of March 13, 2006. The address for Mr. Simpson is OneNorth LaSalle Street, Suite 1800, Chicago, Illinois 60602.

(4)           Includes 4,167 shares of the Company’s commonstock issuable pursuant to a Share Rights Award within 60 days of March 13, 2006. The address for Mr. Dearden is 2305Presidents Drive, Salt Lake City, Utah 84120.

(5)           Includesoptions to purchase 128,500 shares of the Company’s common stock and 291 sharesof the Company’s common stock issuable pursuant to a Share Rights Award, all ofwhich are exercisable or issuable within 60 days of March 13, 2006. The addressfor Mr. Haimes is 4900 South Monaco Street, Denver, Colorado 80237.

(6)           Consistsof options to purchase 30,568 shares of the Company’s common stock and a fullyvested option granted to BTIP to purchase up to 27,665 shares of the Company’scommon stock at an exercise price of $3.875 per share, all of which areexercisable or issuable within 60 days of March 13, 2006. Also consists of2,595,310 shares beneficially owned by BTIP and 3,500 shares owned by the JackWray Blumenstein Contributory IRA. Mr. Blumenstein is a co-President ofBlumenstein/Thorne Information Partners L.L.C., the general partner of BTIP.Mr. Blumenstein disclaims beneficial ownership of the shares owned byBTIP, except to the extent of his pecuniary interest, if any. The address forMr. Blumenstein is P.O. Box 871, Lake Forest, Illinois 60045.

(7)           Consistsof options to purchase 39,406 shares of the Company’s common stock exercisablewithin 60 days of March 13, 2006. The address for Mr. Girgenti is1603 Orrington Avenue, Suite 1600, Evanston, Illinois 60201.

 

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(8)           Includesoptions to purchase 61,389 shares of the Company’s common stock exercisable within60 days of March 13, 2006. The address for Ms. Korshak is c/oeCollege, 4900 South Monaco Street, Denver, Colorado 80237.

(9)           Includesoptions to purchase 43,838 shares of the Company’s common stock exercisablewithin 60 days of March 13, 2006. The address for Mr. Mundheim is 599Lexington Avenue, Room 1640, New York, New York 10022.

(10)         Includesa fully vested option to purchase up to 27,665 shares of the Company’s commonstock at an exercise price of $3.875 per share. The address for Blumenstein/ThorneInformation Partners I, L.P. is P.O. Box 871, Lake Forest, Illinois 60045.

(11)         Theaddress for Tiger Technology Management LLC is 101 Park Avenue, 48th floor, NewYork, New York 10178-4700.

(12)         Theaddress for Federated Investors, Inc. is 1001 Liberty Avenue, Pittsburgh,Pennsylvania 15222.

(13)         Theaddress for William Blair Capital Management LLC is 222 West Adams Street, 13thfloor, Chicago, Illinois, 60606.

(14)         Theaddress for Gilder, Gagnon, Howe & Company is 1775 Broadway, 26th floor,New York, New York 10019.

(15)         Excludesshares beneficially owned by BTIP. Mr. Oakleigh B. Thorne is thebeneficiary of a trust that is a limited partner in BTIP. Mr. Oakleigh B.Thorne is the father of Oakleigh Thorne, the Company’s Chief Executive Officer.

(16)         Includes694,005 shares issuable upon the exercise of options and 8,980 shares of theCompany’s common stock issuable pursuant to Share Rights Awards, all of whichare exercisable or issuable within 60 days of March 13, 2006.

 

**Equity Compensation Plans**

 

The following table summarizes the status of theCompany’s equity compensation plans as of December 31, 2005:

 
| **Plan Category**                                            | ** ** | **Number of Securities  to be  Issued upon Exercise  of  Outstanding Options,  Warrants, and Rights** | ** ** | **Weighted Average  Exercise Price of  Outstanding Options,  Warrants and Rights** | ** ** | **Number of Securities  Remaining Available  for  Future Issuance under  Equity Compensation  Plans (excluding  securities  reflected in column  (a))** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **(a)**                                                                                               | ** ** | **(b)**                                                                            | ** ** | **(c)**                                                                                                                                                 | ** ** |
| Equity Compensation Plans approved by  security holders:     |       | 3,178,317                                                                                             |       | $                                                                                  | 10.22,     |                                                                                                                                                    | 2,211,975  |   |
|                                                         |       |                                                                                                  |       |                                                                               |       |                                                                                                                                                    |       |
| Equity Compensation Plans not approved by  security holders: |       | 33,471                                                                                                | (1)        | $                                                                                  | 3.41       |                                                                                                                                                    | —     |   |
|                                                         |       |                                                                                                  |       |                                                                               |       |                                                                                                                                                    |       |
| **Total**                                                    |       | 3,211,788                                                                                             |       |                                                                               |       | 2,211,975                                                                                                                                               |       |

 

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(1)  Includes:  (i)  options to purchase 27,665 shares of the Company’s commonstock at an exercise price of $3.875 per share granted to BTIP  (see footnote 2) under the heading “Aggregated Option/SAR Exercises in LastFiscal Year and Fiscal Year-End Option/SAR Values” in Item 11 of this AnnualReport on Form 10-K); and(ii) options to purchase up to 5,806 shares of the Company’s common stockgranted to Jeri L. Korshak, for services rendered as a director of theCompany from January 1, 2000 through December 31, 2000.

 

**ITEM 13.    CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

 We have entered into indemnificationagreements with our non-employee directors, Messrs. Blumenstein, Girgentiand Mundheim and Ms. Korshak.

 

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.**ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES**

 

In June 2005, KPMG LLP (“KPMG”)informed the Company that KPMG declined to stand for re-election as the Company’sindependent registered public accounting firm, effective upon the filing by theCompany of its Quarterly Report on Form 10-Q for the quarter ended June 30,2005. In August 2005, the Audit Committee of the Company’s Board of Directorsappointed Grant Thornton LLP (“Grant Thornton”) as the Company’s independentregistered public accounting firm

 

The following table shows the fees billed for 2005and 2004 for audit and other services provided to the Company by KPMG (inthousands) 

 
| ** **          | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
| Audit Fees          |       | $        | 999        |     | $          | 530 |   |
| Audit-Related  Fees |       | $        |       | $        | —     |   |
| Tax Fees            |       | $        |       | $        | —     |   |
| All Other  Fees     |       | $        |       | $        | —     |   |
| Total               |       | $        | 999        |     | $          | 530 |   |

 

 

The following table shows the fees billed for 2005 for audit and otherservices provided to the Company by Grant Thornton (in thousands):    

 
| ** **          | ** ** | **2005** | ** ** |
|---------------------|------------|----------|------------|
| Audit Fees          |       | $        | 275        |   |
| Audit-Related  Fees |       | $        |       |
| Tax Fees            |       | $        |       |
| All Other  Fees     |       | $        |       |
| Total               |       | $        | 275        |   |

 

*Audit Fees.*    This category includesthe audit of the Company’s annual financial statements, review of financialstatements included in the Company’s Form 10-Q Quarterly Reports, audit ofcontrols over financial reporting and services that are normally provided bythe independent auditors in connection with statutory and regulatory filings orengagements for those fiscal years. This category also includes advice on auditand accounting matters that arose during, or as a result of, the audit or thereview of interim financial statements, and the preparation of an annual “managementletter” on internal control matters.

 

*Audit Related-Fees.*    This categoryconsists of assurance and related services by the Company’s auditors that arereasonably related to the performance of the audit or review of the Company’sfinancial statements and are not reported above under “Audit Fees.” Theservices for the fees disclosed under this category include benefit planaudits, consultation on other accounting matters not reported in the “AuditFees” category, due diligence pertaining to potential business combinations,and evaluating the effect of various accounting issues and changes inprofessional standards.

 

*Tax Fees.*    This categoryconsists of professional services rendered by the Company’s auditors for taxcompliance and tax advice. The services for the fees disclosed under thiscategory include tax return preparation and technical tax advice.

 

*All Other Fees.*    This categoryconsists of fees for translation services, subscriptions, net operating loss study,and other miscellaneous items.

 

*Pre-Approval of Audit andPermitted Non-Audit Services.*    The Audit Committee charter requires theCompany to have the Audit Committee pre-approve all audit and permittednon-audit services from the independent accountants, provided, however, thatneither the Committee nor the Company may engage the Company’s independentaccountants for the following services:

 

•                  Bookkeeping or other services related to theaccounting records or financial statements of the Company;

 

•                  Financial information systems design andimplementation;

 

•                  Appraisal or valuation services, fairnessopinions or contribution-in-kind reports;

 

•                  Actuarial services;

 

•                  Internal audit outsourcing services;

 

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•                  Management or human resources functions;

 

•                  Broker or dealer, investment adviser orinvestment banking services; or

 

•                  Legal services and expert services unrelatedto the audit.

 

The Company’s management submits requests to theAudit Committee for pre-approval of any such allowable services by the Company’sindependent accountants. The Committee may delegate to the CommitteeChairperson the authority to preapprove, on behalf of the Committee, theprovision of permitted non-audit services, up to $2,500 per engagement, fromthe independent accountants as are permitted under the applicable rules andregulations; provided, however, that a report of all non-audit servicespre-approved pursuant to this paragraph shall be presented to the Committee atits next scheduled meeting. In 2005, all of the audit and permitted non-auditservices rendered by the Company’s independent accountants were approved by theAudit Committee.

 

78

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**PART IV.**

 

**ITEM 15.    EXHIBITS AND FINANCIALSTATEMENT SCHEDULES**

 
| (a)    |                                                                                                                                                                                         | The  following documents are filed as part of this report:                                                                                                                                     |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                         |                                                                                                                                                                                           |
|   | 1)                                                                                                                                                                                           | Financial  Statements. (See Item 8 of this Annual Report on Form 10-K.)                                                                                                                        |
|   |                                                                                                                                                                                         |                                                                                                                                                                                           |
|   | 2)                                                                                                                                                                                           | Financial  Statement Schedules.                                                                                                                                                                |
|   |                                                                                                                                                                                         | None                                                                                                                                                                                           |
|   |                                                                                                                                                                                         |                                                                                                                                                                                           |
|   | 3)                                                                                                                                                                                           | Exhibits  required by Securities and Exchange Commission Regulation S-K, Item 601.                                                                                                             |
|   |                                                                                                                                                                                         |                                                                                                                                                                                           |
|   |                                                                                                                                                                                         | The  Exhibits filed as part of this Annual Report on Form 10-K are listed on the  Exhibit Index immediately preceding such Exhibits, which Exhibit Index is  incorporated herein by reference. |
|   |                                                                                                                                                                                         |                                                                                                                                                                                           |
| (b)    | Exhibits  – see Item 15(a)(3) above. The following exhibits are filed herewith or are  incorporated by reference to exhibits previously filed with the Securities  Exchange Commission. |

 

79

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

**eCollege.com**

 

 
| By:    | /s/  OAKLEIGH THORNE                         |   |
|--------|----------------------------------------------|--------|
|   | Name:  Oakleigh Thorne                       |
|   | Title:  Chief Executive Officer and Chairman |
|   | Date:  March 16, 2006                        |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 

 
| By:    | /s/  OAKLEIGH THORNE           |                                  |
|--------|--------------------------------|---------------------------------------|
|   | Name:  Oakleigh Thorne         |
|   | Title:                         | Chief  Executive Officer and Chairman |
|   |                           | (principal  exceutive officer)        |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  REID SIMPSON              |                                  |
|   | Name:  Reid Simpson            |
|   | Title:                         | Chief  Financial Officer              |
|   |                           | (principal  financial officer)        |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  DAVID REIS                |                                  |
|   | David  Reis                    |
|   | Title:                         | Director  of Corporate Accounting     |
|   |                           | (principal  accounting officer)       |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  JACK W. BLUMENSTEIN       |                                  |
|   | Name:  Jack W. Blumenstein     |
|   | Title:                         | Director                              |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  CHRISTOPHER E. GIRGENTI   |                                  |
|   | Name:  Christopher E. Girgenti |
|   | Title:  Director               |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  DOUGLAS H. KELSALL        |                                  |
|   | Name:  Douglas H. Kelsall      |
|   | Title:                         | Director                              |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  JERI L. KORSHAK           |                                  |
|   | Name:  Jeri L. Korshak         |
|   | Title:                         | Director                              |
|   | Date:  March 16, 2006          |
|   |                           |
| By:    | /s/  ROBERT H. MUNDHEIM        |                                  |
|   | Name:  Robert H. Mundheim      |
|   | Title:  Director               |
|   | Date:  March 16, 2006          |
|        |                                |                                       |  |

 

80

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**EXHIBITINDEX**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                    |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1(9)             |       | Stock  Purchase Agreement dated as of September 15, 2003, among Leeds Equity  Partners III, I.P., Other Selling Parties Party Thereto,  Datamark Inc. and the Registrant                                                                                                       |
| 3.1(1)             |       | Second  Amended and Restated Certificate of Incorporation.                                                                                                                                                                                                                                         |
| 3.2(1)             |       | Amended  and Restated Bylaws.                                                                                                                                                                                                                                                                      |
| 4.1(1)             |       | Specimen  Common Stock Certificate.                                                                                                                                                                                                                                                                |
| 4.2(1)             |       | Amended  and Restated Registration Agreement made as of December 21, 1998 by and  among the Registrant, each of the Series A Investors, each of the  Series B Investors and each of the Series C Purchasers                                                                    |
| 4.3(2)             |       | Registration  Agreement between Company and Blumenstein/Thorne Information Partners I,  L.P.*                                                                                                                                                                                                 |
| 4.4(2)             |       | Stock  Option Agreement between Company and Blumenstein/Thorne Information  Partners I, L.P.*                                                                                                                                                                                                 |
| 4.5(8)             |       | Form  of Stock Purchase Agreement dated as of August 13, 2003, among  eCollege.com and the purchasers identified on the Schedule of Purchasers on  Schedule A thereto.                                                                                                                   |
| 4.6(10)            |       | Stock  Purchase Agreement dated as of October 31, 2003, among the Company and  the Investors listed on Schedule I attached thereto.                                                                                                                                                      |
| 4.7(10)            |       | Registration  Rights Agreement dated as of October 31, 2003, among the Company and the  stockholders listed on Exhibit A thereto.                                                                                                                                                        |
| 4.8(10)            |       | Registration  Rights Agreement dated as of October 31, 2003, between the Company and  Capital Resource Partners IV, L.P.                                                                                                                                                                 |
| 4.9(10)            |       | Form  of Promissory Note dated October 31, 2003 issued by the Company to the  parties identified on Schedule A thereto in the aggregate principle  amount of $7,000,000.                                                                                                                 |
| 4.10(10)           |       | Form  of Promissory Note dated October 31, 2003 issued by the Company to the  parties identified on Schedule A thereto in the aggregate principle  amount of $5,000,000.                                                                                                                 |
| 4.11(10)           |       | Common  Stock Purchase Warrant of the Company dated October 31, 2003 issued to  Capital Resource Partners IV, L.P.                                                                                                                                                                       |
| 4.12(10)           |       | Senior  Subordinated Note dated October 31, 2003 issued by the Company to  Capital Resource Partners IV, L.P.                                                                                                                                                                            |
| 4.13(11)           |       | Waiver  of Registration Rights under Registration Agreement between Company and  Blumenstein/Thorne Information Partners I. L.P. dated August 15,  2003                                                                                                                                  |
| 4.14(11)           |       | Waiver  of Registration Rights under Amended and Restated Registration Agreement made  as of December 21, 1998 by and among the Registrant, each of the  Series A Investors, each of the Series B Investors and each of the  Series C Purchasers dated September 2, 2003. |
| 4.15(11)           |       | Waiver  of Registration Rights under Registration Agreement between Company and  Blumenstein/Thorne Information Partners I. L.P. dated October 28,  2003                                                                                                                                 |
| 4.16(11)           |       | Waiver  of Registration Rights under Amended and Restated Registration Agreement made  as of December 21, 1998 by and among the Registrant, each of the A  Investors, each of the Series B Investors and each of the Series C  Purchasers dated October 28, 2003.              |
| 10.1(1)            |       | Form  of Indemnification Agreement by and between the Company and its outside  directors.                                                                                                                                                                                                          |
| 10.2(1)            |       | 1999  Employee Stock Purchase Plan.*                                                                                                                                                                                                                                                               |
| 10.3(1)            |       | 1999  Stock Incentive Plan.*                                                                                                                                                                                                                                                                       |
| 10.4(4)            |       | Lease  Agreement dated March 29, 2002 between Bedford Property Investors, Inc.  and the Company.                                                                                                                                                                                         |
| 10.6(5)            |       | Employment  Agreement dated as of September 5, 2002 between Robert S. Haimes  and the Company.*                                                                                                                                                                                          |
| 10.7(5)            |       | Employment  Agreement dated as of July 31, 2002 between Matthew Schnittman and the  Company.*                                                                                                                                                                                                 |
| 10.8(5)            |       | First  Amendment to Lease Agreement dated September 30, 2002 between Bedford  Property Investors, Inc. and the Company.                                                                                                                                                                  |
| 10.9(10)           |       | Senior  Subordinated Secured Note and Warrant Purchase Agreement dated as of  October 31, 2003 among the Registrant, eCollege International, Inc.  and Capital Resource Partners IV, L.P.                                                                                           |
| 10.10(10)          |       | Loan  and Security Agreement dated as of October 30, 2003 among Silicon Valley  Bank, the Company and Datamark Inc.                                                                                                                                                                      |
| 10.12(10)          |       | Employment  Agreement dated as of September 15, 2003 between Datamark Inc. and  Thomas Dearden.*                                                                                                                                                                                         |
| 10.13(11)          |       | Lease  Agreement dated April 9, 1998 between Boyd Enterprises Utah, LLC and  Datamark Systems.                                                                                                                                                                                                |
| 10.14(11)          |       | First  Amendment to Lease Agreement dated as of April 12, 2001 between Boyd  Enterprises Utah, LLC and Datamark Systems, Inc.                                                                                                                                                            |
| 10.15(11)          |       | Second  Amendment to Lease Agreement dated as of January 15, 2004 between Boyd  Enterprises Utah, LLC and Datamark, Inc.                                                                                                                                                                 |

 

81

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| 10.16(12) |   | Employment Agreement dated August 9, 2004 between  Oakleigh Thorne and the Company.*                                                                                                                                                                                                                            |
|-----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17(12) |   | Employment Agreement dated August 9, 2004 between  Douglas H. Kelsall and the Company.*                                                                                                                                                                                                                         |
| 10.18(12) |   | Employment Agreement dated August 9, 2004 between  Reid E. Simpson and the Company.*                                                                                                                                                                                                                            |
| 10.19(12) |   | Employment Agreement dated August 9, 2004 between  Marguerite M. Elias and the Company.*                                                                                                                                                                                                                        |
| 10.20(13) |   | Lease Agreement dated December 14, 2004 between  One North LaSalle Properties LLC and eCollege.com.                                                                                                                                                                                                             |
| 10.21(13) |   | Amendment No. 1 to Senior Subordinated Secured  Note and Warrant Purchase Agreement dated May 30, 2004 among the Registrant,  eCollege International, Inc. and Capital Resource Partners IV, LP.                                                                                                                |
| 10.22(13) |   | Amendment No. 2 to Senior Subordinated Secured  Note and Warrant Purchase Agreement dated December 28, 2004 among the Registrant,  eCollege International, Inc. and Capital Resource Partners IV, LP.                                                                                                           |
| 10.23(13) |   | Loan Modification Agreement dated April 1, 2004  between Silicon Valley Bank, eCollege.com and Datamark, Inc.                                                                                                                                                                                                   |
| 10.24(13) |   | Loan Modification Agreement dated December 28, 2004  between Silicon Valley Bank, eCollege.com and Datamark, Inc.                                                                                                                                                                                               |
| 10.25(13) |   | First Amendment to the Employee Stock Purchase  Plan dated October 15, 2004.*                                                                                                                                                                                                                                   |
| 10.27(14) |   | Third Amendment to the Lease Agreement dated  January 27, 2005 between Boyd Enterprises Utah, LLC and Datamark, Inc.                                                                                                                                                                                            |
| 10.28(14) |   | First Amendment to the 1999 Stock Incentive Plan  dated March 22, 2005.*                                                                                                                                                                                                                                        |
| 10.29     |   | Lease Modification Agreement dated February 26,  2005 between Peyton Building LLC and Datamark, Inc.                                                                                                                                                                                                            |
| 10.30     |   | Second Amendment to the 1999 Employee Stock  Purchase Plan dated March 22, 2005.                                                                                                                                                                                                                                |
| 10.31     |   | Fourth Amendment to the Loan and Security  Agreement dated October 30, 2005 between Silicon Valley Bank, eCollege.com  and Datamark, Inc.                                                                                                                                                                       |
| 21.1      |   | Subsidiaries of Registrant.                                                                                                                                                                                                                                                                                     |
| 23.1      |   | Consent of Grant Thornton LLP                                                                                                                                                                                                                                                                                   |
| 23.2      |   | Consent of KPMG LLP.                                                                                                                                                                                                                                                                                            |
| 31.1      |   | Certification of Chief Executive Officer pursuant  to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                                                                                                |
| 31.2      |   | Certification of Chief Financial Officer pursuant  to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                                                                                                |
| 32.1      |   | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                 |
| 99.1(10)  |   | Audited financial statements for Datamark as of  June 30, 2003 and December 31, 2002, 2001, and 2000, and for the  six months ended June 30, 2003, the years ended December 31, 2002,  and 2001, and for the period June 21, 1000 (date of inception) through  December 31, 2000. |
| 99.2(10)  |   | Unaudited pro forma combined financial information  for the year ended December 31, 2002, for the nine months ended  September 30, 2003 and as of September 30, 2003.                                                                                                                            |
| 99.3(10)  |   | Unaudited pro forma combined reconciliations of  adjusted earnings before interest, taxes, depreciation and amortization  (EBITDA) to net income (loss) for the year ended December 31, 2002 and  for the nine months ended September 30, 2003.                                                       |

 

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*              Indicates management contract or compensatoryplan or arrangement.

 

(1)           Incorporated by reference from the Company’sRegistration Statement on Form S-1 (File No. 333-78365).

 

(2)           Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q filed withthe Securities and Exchange Commission on November 14, 2000.

 

(3)           Incorporatedby reference from the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission on April 2, 2001.

 

(4)           Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q filed withthe Securities and Exchange Commission on May 15, 2002.

 

(5)           Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q filed withthe Securities and Exchange Commission on November 13, 2002.

 

(6)           Filedas part of Current Report on 8-K filed with the Securities and Exchange Commissionon July 1, 2002.

 

(7)           Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q filed withthe Securities and Exchange Commission on August 12, 2003.

 

(8)           Incorporatedby reference from the Company’s 8-K filed with the Securities and ExchangeCommission on August 21, 2003.

 

82

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(9)           Incorporatedby reference from the Company’s 8-K filed with the Securities and ExchangeCommission on November 3, 2003.

 

(10)         Incorporatedby reference from the Company’s 8-K/A filed with the Securities and ExchangeCommission on December 2, 2003.

 

(11)         Incorporatedby reference from the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission on March 15, 2004.

 

(12)         Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on August 16, 2004.

 

(13)         Incorporatedby reference from the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission on March 31, 2005.

 

(14)         Incorporatedby reference from the Company’s Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on May 10, 2005.

 

83

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